Tilly's Earnings 2021-01-30
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM | ||
(Mark One)
| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |||||
For the fiscal year ended January 30, 2021
OR
| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |||||
Commission File Number: 001-35535
(Exact name of registrant as specified in its charter) | ||
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |||||||
| (Address of principal executive offices) | (Zip Code) | |||||||
( | ||
(Registrant’s telephone number, including area code) | ||
Securities registered pursuant to Section 12(b) of the Act: | ||
| Title of Each Class | Trading Symbol | Name of Each Exchange on Which Registered | ||||||
| Securities registered pursuant to Section 12(g) of the Act: None | ||
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “small reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act:
| Large accelerated filer: | ¨ | x | |||||||||||||||
| Nonaccelerated filer: | ¨ | Smaller reporting company: | |||||||||||||||
| Emerging growth company: | |||||||||||||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant has filed a report on and attestation to its management's assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No x
As of July 31, 2020, the last business day of the registrant's most recently completed second quarter, the aggregate market value of voting stock held by non-affiliates of the registrant was $132,012,919 based on the closing price of the registrant's common stock of $6.01 per share at July 31, 2020.
As of March 31, 2021, the registrant had 22,773,496 shares of Class A common stock, par value $0.001 per share, outstanding, and 7,306,108 shares of Class B common stock, par value $0.001 per share, outstanding.
| DOCUMENTS INCORPORATED BY REFERENCE | ||
Portions of the Proxy Statement for the registrant’s Annual Meeting of Stockholders to be held June 9, 2021 are incorporated by reference into Part III of this Annual Report on Form 10-K.
TABLE OF CONTENTS
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EXPLANATORY NOTE
As of the date of filing of this Annual Report on Form 10-K (this “Report”), there remain many uncertainties regarding the ongoing COVID-19 pandemic (the "pandemic"), including the anticipated duration and severity of the pandemic, particularly in light of ongoing vaccination efforts and emerging variant strains of the virus. To date, the pandemic has had far-reaching impacts on many aspects of the operations of Tilly’s, Inc. (the “Company, “we,” “our” or “us”), directly and indirectly, including on consumer behavior, store traffic, operational capabilities and our operations generally, timing of deliveries, demands on our information technology and e-commerce capabilities, inventory and expense management, managing our workforce, our storefront configurations and operations upon reopening, and our people, which have materially disrupted our business and the market generally. The scope and nature of these impacts continue to evolve. The pandemic has resulted in, and may continue to result in, regional quarantines, labor stoppages and shortages, changes in consumer purchasing patterns, mandatory or elective shut-downs of retail locations, disruptions to supply chains, including the inability of our suppliers and service providers to deliver materials and services on a timely basis, or at all, severe market volatility, liquidity disruptions, and overall economic instability, which, in many cases, have had, and we expect will continue to have, material adverse impacts on our business, financial condition and results of operations. This situation is continually evolving, and additional impacts may arise that we are not aware of currently, or current impacts may become magnified.
In light of these uncertainties, for purposes of this Report, except where otherwise indicated, the descriptions of our business, our strategies, our risk factors, and any other forward-looking statements, including regarding us, our business and the market generally, do not reflect the potential impact of the pandemic or our responses thereto. In addition, the disclosures contained in this Report are made only as of the date hereof, and we undertake no obligation to publicly update or revise any forward-looking statement as a result of new information, future events or otherwise, except as otherwise required by law. For further information, please see “Risk Factors” and “Forward-Looking Statements.”
Forward-Looking Statements
This Report contains forward-looking statements that are subject to risks and uncertainties. All statements other than statements of historical or current fact included in this Report are forward-looking statements. Forward-looking statements refer to our current expectations and projections relating to our financial condition, results of operations, plans, objectives, strategies, future performance and business. You can identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. These statements may include words such as “anticipate”, “estimate”, “expect”, “project”, “plan”, “intend”, “believe”, “may”, “might”, “will”, “should”, “can have”, “likely” and other words and terms of similar meaning in connection with any discussion of the timing or nature of future operating or financial performance or other events. For example, all statements we make relating to our estimated and projected earnings, revenues, comparable store sales, operating income, earnings per share, costs, expenditures, cash flows, growth rates and financial results, our plans and objectives for future operations, growth or initiatives, strategies or the expected outcome or impact of pending or threatened litigation are forward-looking statements. All forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those that we expected, including:
•the impacts of the pandemic generally, and on our operations, future financial or operational results, including with respect to our ability to keep stores open and e-commerce operational, cash and liquidity, payroll and inventory management, and our ability to realize cost savings and manage expected capital expenditures;
•our ability to adapt to downward trends in traffic for our stores and changes in our customers' purchasing patterns;
•our ability to successfully open new stores and profitably operate our existing stores;
•our ability to attract customers to our e-commerce website;
•our ability to efficiently utilize our e-commerce fulfillment center;
•effectively adapting to new challenges associated with our expansion into new geographic markets;
•our ability to establish, maintain and enhance a strong brand image;
•generating adequate cash from our existing stores to support our growth;
•identifying and responding to new and changing customer fashion preferences and fashion-related trends;
•competing effectively in an environment of intense competition both in stores and online;
•adjusting to increasing costs of mailing catalogs, paper and printing;
•the success of the malls, power centers, neighborhood and lifestyle centers, outlet centers and street-front locations in which our stores are located;
•our ability to attract customers in the various retail venues and geographies in which our stores are located;
•adapting to declines in consumer confidence and decreases in consumer spending;
•our ability to adapt to significant changes in sales due to the seasonality of our business;
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•our ability to compete in social media marketing platforms;
•price reductions or inventory shortages resulting from failure to purchase the appropriate amount of inventory in advance of the season in which it will be sold;
•natural disasters, unusually adverse weather conditions, port delays, boycotts, epidemics, pandemics, acts of war, terrorism, civil unrest, and other unanticipated events;
•our dependence on third-party vendors to provide us with sufficient quantities of merchandise at acceptable prices;
•increases in costs of energy, transportation or utility costs and in the costs of labor and employment;
•our ability to balance proprietary branded merchandise with the third-party branded merchandise we sell;
•most of our merchandise is made in foreign countries, making price and availability of our merchandise susceptible to international trade conditions;
•failure of our vendors and their manufacturing sources to use acceptable labor or other practices;
•our dependence upon key executive management or our inability to hire or retain the talent required for our business;
•our ability to effectively adapt to our planned expansion;
•failure of our information technology systems to support our current and growing business, before and after our planned upgrades;
•disruptions in our supply chain and distribution center;
•our indebtedness and lease obligations, including restrictions on our operations contained therein;
•our reliance upon independent third-party transportation providers for certain of our product shipments;
•our ability to increase comparable store sales or sales per square foot, which may cause our operations and stock price to be volatile;
•disruptions to our information systems in the ordinary course of business or as a result of systems upgrades;
•our inability to protect our trademarks or other intellectual property rights;
•the impact of governmental laws and regulations and the outcomes of legal proceedings;
•our ability to secure our data and comply with the security standards for the credit card industry;
•our failure to maintain adequate internal controls over our financial and management systems; and
•continuing costs incurred as a result of being a public company.
We derive many of our forward-looking statements from our operating budgets and forecasts, which are based upon detailed assumptions. While we believe that our assumptions are reasonable, we caution that it is very difficult to predict the impact of known factors, and it is impossible for us to anticipate all factors that could affect our actual results.
See “Risk Factors” for a more complete discussion of the risks and uncertainties mentioned above and for discussion of other risks and uncertainties. All forward-looking statements attributable to us are expressly qualified in their entirety by these cautionary statements as well as others made in this Report and hereafter in our other SEC filings and public communications. You should evaluate all forward-looking statements made by us in the context of these risks and uncertainties.
We caution you that the risks and uncertainties identified by us may not be all of the factors that are important to you. Furthermore, the forward-looking statements included in this Report are made only as of the date hereof. We undertake no obligation to publicly update or revise any forward-looking statement as a result of new information, future events or otherwise, except as otherwise required by law.
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PART I
Item 1. Business
Tillys is a leading destination specialty retailer of casual apparel, footwear, accessories, and hardgoods 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. Tillys is headquartered in Irvine, California and operated 238 stores in 33 states as of January 30, 2021. Our stores are located in a variety of retail centers, including malls, lifestyle centers, "power" centers, community centers, outlet centers, and street-front locations. Customers may also shop online, where we feature substantially the same assortment of products as is 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.
The Tillys concept began in 1982 when our co-founders, Hezy Shaked and Tilly Levine, opened their first store in Orange County, California. Since 1984, the business has been conducted through World of Jeans & Tops, a California corporation, or "WOJT", which operates under the name "Tillys". In May 2011, Tilly's, Inc., a Delaware corporation, was formed solely for the purpose of reorganizing the corporate structure of WOJT in preparation for an initial public offering. As part of the initial public offering in May 2012, WOJT became a wholly owned subsidiary of Tilly's, Inc.
As used in this Report, except where the context otherwise requires or where otherwise indicated, the terms "the Company", "World of Jeans and Tops", "WOJT", "we", "our", "us", and "Tillys" refer to World of Jeans & Tops before our initial public offering, and to Tilly's, Inc. and its subsidiary after our initial public offering.
Our fiscal year ends on the Saturday closest to January 31. For example, "fiscal 2020" refers to the fiscal year ended January 30, 2021; "fiscal 2019" refers to the fiscal year ended February 1, 2020; and "fiscal 2018" refers to the fiscal year ended February 2, 2019.
Our Strengths
We believe that the following strengths contribute to our success and distinguish us from our competitors:
•Destination retailer with a broad and differentiated assortment. We believe the combined depth and breadth of apparel, footwear and accessories offered at our stores exceeds the selection offered at many other specialty retailers. We offer an extensive selection of lifestyle and emerging third-party brands, as well as proprietary brands. Our merchandise includes a wide assortment of relevant brands, styles, colors, sizes, and price points to ensure our customers have a variety of choices every time they visit our stores. We offer a balanced mix of merchandise across the apparel, footwear and accessories categories serving young men, young women, boys, and girls. We believe that by combining proven and emerging fashion trends and core style products with a vibrant blend of carefully selected music and visuals, we provide an in-store experience that is authentic, fun, and engaging for our core customers. We believe that our differentiated in-store environment, evolving selection of relevant brands, and broader and deeper assortment positions us as a retail destination that appeals to a larger demographic than many other specialty retailers.
•Dynamic merchandise model. We believe our extensive selection of third-party and proprietary merchandise allows us to identify and offer several trends simultaneously, offer a greater range of price points, and manage our inventories more dynamically. By closely monitoring trends and shipping product to our stores multiple times per week, we are able to adjust our merchandise mix based on store size and location. We also keep our merchandise mix relevant by introducing emerging brands and new merchandise from established brands not available at many other retailers. Our merchandising capabilities enable us to adjust our merchandise mix with a frequency that promotes a current look to our stores and website.
•Flexible real estate strategy across real estate venues and geographies. Our stores have proven to be successful in a variety of retail centers and geographies. We operate stores in malls, lifestyle centers, power centers, community centers, outlet centers, and street-front locations across 82 markets in 33 states. We believe our success operating in these different retail venues and geographies demonstrates the portability of the Tillys brand.
•Multi-pronged marketing approach. We utilize a multi-pronged marketing strategy to connect with our customers and drive traffic to our stores and online platforms. We offer an integrated digital platform for our customers to shop how and when they like, and to drive further connection with them. We partner and collaborate with our vendors on exclusive, compelling in-store events, digital new customer acquisition, and contests to build credibility with our target customers, actively involve them in our brands, and enhance the connection between Tillys and our customers' active lifestyle. We have a growing customer loyalty program, “Tilly’s Rewards”, to further engage with our customers, reward our most loyal customers, provide loyalty only events, and gain valuable customer insights. From time to time, we distribute catalogs and postcards to potential and existing customers to familiarize them with the Tillys brand, our products, and to drive traffic to
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our stores and website. We use social media to communicate directly with our customers while also encouraging customers to interact with one another and provide feedback on our events and products. We also look to partner with social media stars and influencers to drive brand awareness. All of these programs are complemented by digital and email marketing, as well as print advertising, to build customer awareness and loyalty, highlight key merchandise offerings, drive traffic to our stores and online platforms, and promote the Tillys brand. We also seek to maintain a connection with our local communities through our various community outreach initiatives.
•Systems and distribution/fulfillment infrastructure to support growth. We have previously made investments in distribution, fulfillment and allocation infrastructure that we believe are adequate to support continued growth for a number of years. Our distribution center allows us to quickly sort and process merchandise and deliver it to our stores in a floor-ready format for immediate display. We also have a dedicated e-commerce fulfillment center to support our online growth potential. Our systems enable us to respond to changing fashion trends, manage inventory in real time, and provide a customized selection of merchandise at each location. We believe our distribution and fulfillment infrastructure can support significant growth in our stores and e-commerce platform with minimal incremental capital investment.
•Experienced management team. Our senior management team, led by Hezy Shaked and Edmond Thomas, has extensive experience across a wide range of disciplines in the specialty retail and direct-to-consumer industries, including store operations, merchandising, distribution, real estate, and finance. Mr. Shaked, our Co-Founder, Executive Chairman of the Board of Directors, and Chief Strategy Officer, plays an important role in developing our long-term growth initiatives and cultivating our unique culture. Mr. Thomas, our President and Chief Executive Officer, has over 30 years of retail industry experience.
Growth Strategy
Subject to our ongoing evaluation of the COVID-19 pandemic and its impacts on our business (as further described elsewhere in this Report), we are pursuing several strategies to drive long-term sales and profitability, including:
•Drive Comparable Store Sales Growth. We seek to maximize our comparable store sales by consistently offering new, on-trend and relevant merchandise, including exclusive and proprietary branded merchandise, across a broad assortment of categories, increasing our brand awareness through our multi-pronged marketing approach, providing an authentic in-store and online experience for our core customers, and maintaining a high level of customer service. We continue to enhance our existing loyalty program to further reward our most loyal customers. We believe the combination of these factors, together with the operating strategies described below, will improve our comparable store sales results over time.
•Increase Our Operating Margins. We believe we have the opportunity to drive operating margin expansion through scale efficiencies and continued process improvements. We believe comparable store sales increases will permit us to generate more favorable buying costs from larger volume purchases, and better leverage largely fixed occupancy costs, labor costs for store management and corporate overhead, as well as the fixed portion of shipping and handling costs over higher sales volumes. In addition, we expect to improve operating margins and support growth by leveraging previous investments in infrastructure, including our dedicated fulfillment center for e-commerce, upgraded e-commerce platform, and in-store point-of-sale system. We also will continue to use established business processes to identify and execute initiatives focused on lowering our unit costs and improving operational efficiency throughout our organization.
•Continue Growing E-Commerce. Our e-commerce net sales represented approximately 33% of our total net sales for fiscal 2020 and 16% of our total net sales for fiscal 2019. We believe that a significant portion of this increase was driven by changing consumer behaviors associated with the pandemic, including as a result of the temporary shutdown of all of our stores beginning in mid-March 2020 in response thereto and the staggered reopening of those stores with government-mandated restrictions on customer traffic and reduced operating hours throughout the remainder of the fiscal year. Notwithstanding these impacts of the pandemic, we believe that significant growth opportunities continue to exist for our e-commerce business. We believe our e-commerce platform is an extension of our brand and retail stores, and we seek to maintain an extensive selection of our newest and best merchandise assortments online, providing our customers with a seamless shopping experience. Our e-commerce platform allows us to reach new customers, and build our brand in markets where we currently do not have stores. For example, we generate e-commerce sales in all 50 states and the District of Columbia although we have physical stores in only 33 states. Our target customer regularly shops online and via mobile devices in addition to visiting stores, giving us a continued opportunity to grow our e-commerce platform over time. In recent years, we have invested in a new point-of-sale system in stores, an upgraded e-commerce website platform, and a new order management system that is integrated with our stores and website to allow for certain omni-channel capabilities, including fulfilling e-commerce orders from stores when items are out of stock in our e-commerce distribution center, allowing customers to place orders online for in-store or curbside pickup, or to have items shipped to them from our stores. We have also partnered with Afterpay and Postmates to offer our customers greater flexibility in payment options and delivery convenience. We plan to continue to invest in additional customer-facing technologies to improve customer convenience and engagement over time. Key factors we expect to drive growth may include continuing our catalog, online
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and mobile application marketing efforts, enhancing the efficiency and responsiveness of our digital capabilities, and supplementing the assortment available in our brick-and-mortar stores with additional online-only styles. We also expect to continue to expand digital marketing efforts, customer loyalty, and build brand awareness in the communities surrounding our existing stores to drive growth in both brick-and-mortar and e-commerce sales.
•Improve Inventory Management. We continue to improve our operating results through more refined micro-merchandising tactics based on specific store and online characteristics. We regularly update individual store profiles for every store to highlight the differences in brand performance, gender penetrations, and customer interests that exist within our fleet of stores. We also monitor sell-through rates online versus stores to identify opportunities for inventory efficiencies. By adapting allocation strategies to capitalize on these individual store and online differences, we believe we can continue to improve our net sales results.
•Develop Omni-Channel Capabilities. We have a direct-to-consumer program that allows online orders to be fulfilled and shipped directly to our customers from our brick-and-mortar stores when inventory is otherwise unavailable in our e-commerce fulfillment center. In addition, our omni-channel capabilities allow customer online orders to be picked up in our stores at our customers' discretion, allowing us to satisfy an order from existing inventories within our stores as well as shipping product from our e-commerce fulfillment center to our stores. We also offer same-day delivery and curbside pickup options from a large majority of our stores. We continue to further enhance our omni-channel capabilities by seeking to offer a ship-to-store ordering option for our e-commerce customers. We believe these omni-channel capabilities will drive additional traffic to our stores and increase sales opportunities with customers who come to the store to pick up their online orders.
•Reinvest in Existing Stores. We believe that re-investing in our existing stores is strategically important to enhance customer loyalty, elevate the customer experience and, in turn, drive additional comparable store sales. We have remodeled or refreshed approximately 90% of our stores in recent years, and intend to continue to do so in the future to keep the shopping experience associated with the Tillys brand updated and compelling for our customers.
•Real Estate Opportunities. With 238 total stores at the end of fiscal 2020, we believe there are numerous attractive opportunities for Tillys to continue to open new stores in the future. We currently expect to open seven new stores during fiscal 2021 which had been originally signed and planned for opening during fiscal 2020. We intend to continue to maintain a disciplined approach to store growth in the future by targeting existing markets with room for growth and new markets with high population density, and clustering stores within key markets to build brand awareness. With regard to existing stores, we have approximately 34 lease decisions to make during fiscal 2021, covering a range of stores in a variety of markets. These lease decisions include lease extension options, lease kick-out options, and lease expirations that require negotiated renewals. In each case, our real estate decisions will be driven by the overarching goal of improving our profitability. As a result, we may close a limited number of stores from time to time if acceptable levels of profitability cannot be obtained through occupancy negotiations with landlords, particularly in light of the ongoing COVID-19 pandemic.
Merchandising, Purchasing, and Planning and Allocation
Merchandising
We seek to be viewed by our customers as the destination for the apparel, footwear and accessories that best represent their active, outdoor and social lifestyle. We believe we offer an unparalleled selection of relevant brands, styles, colors, sizes and price points to ensure our customers have a variety of choices 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 mix of merchandise for young men, young women, boys and girls across the apparel, footwear and accessories categories. We believe this category mix contributes to our broad demographic appeal. Our apparel merchandise includes branded, fashion, and core styles for tops, outerwear, bottoms, and dresses. Accessories merchandise includes backpacks, hydration bottles, hats, sunglasses, small electronics and accessories, handbags, watches, jewelry, and more. We focus on our merchandise presentation and vary the visual displays in our stores and windows throughout the month, presenting new looks and fashion combinations to our customers.
Our ability to maintain an image consistent with our customers' lifestyles is important to our branded vendors and provides us better access to a wide assortment of products and styles. Our third-party and proprietary branded merchandise includes a broad selection of lifestyle and emerging brands. We strive to keep our merchandise mix current by continuously introducing emerging brands and styles not available at many other specialty retailers in order to identify and respond to the evolving desires of our customers. Our third-party brands represented approximately 74%, 75% and 75% of our total net sales in fiscal 2020, 2019 and 2018, respectively. In fiscal 2020, our proprietary RSQ brand was our top selling brand overall and accounted for approximately 11% of our total net sales, while Vans (a third-party brand) and our proprietary Full Tilt brand accounted for 8% and 6% of our total net sales, respectively. No other brand, whether third-party or proprietary, exceeded 5% of our total net sales during fiscal 2020.
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Selected third-party brands (in alphabetical order) include:
Adidas BDG Billabong Birkenstock
Brixton Champion Converse Diamond Supply
Brixton Champion Converse Diamond Supply
Dickies Dr. Martens Ethika Free People
G-Shock Herschel Supply Co. HUF Hurley
Hydro Flask Jansport Levi's Neff
Nike SB O'Neill Obey Primitive
RayBan Riot Society Rip Curl Roxy
RVCA Salty Crew Santa Cruz Spy
Stance The North Face Vans Volcom
We supplement our third-party merchandise assortment with our own proprietary brands across many of our product categories. We utilize our own proprietary, branded merchandise to expand our price point range, identify and respond to changing fashion trends quickly, fill merchandise gaps and provide a deeper selection of styles and colors for proven fashion items. Our proprietary brands represented approximately 26%, 25% and 25% of our total net sales in fiscal 2020, 2019 and 2018, respectively.
Examples of our proprietary brands include:
| Brand | Category | ||||
 | Denim, apparel and fragrance brand for young men, young women and kids | ||||
 | Apparel and accessories brand for young women and girls | ||||
 | Apparel and accessories brand for young men and boys | ||||
 | Apparel, beauty and fragrance brand for young women | ||||
 | Apparel for girls | ||||
 | Apparel for young women | ||||
 | Fragrance brand for young men | ||||
 | Apparel and accessories for young women | ||||
We believe that our extensive selection of merchandise, from established and emerging third-party brands as well as our proprietary brands, caters to a wide demographic of core customers and enhances our image as a destination for the most sought-after apparel, footwear and accessories.
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Merchandise Purchasing
Our merchandising team is organized by category and product type under our Senior Vice President, General Merchandising Manager and includes divisional merchandise managers, a technical design and fashion trend team, buyers, associate buyers and assistant buyers. We believe a key element of our success is our team’s ability to identify and source the proven and emerging fashion trends and core styles that are most relevant to our customers.
Our purchasing approach focuses on product relevance, quality, fit, availability, cost and speed of production in order to provide timely frequent delivery of merchandise to our stores. Our purchasing group and planning and allocation team are highly coordinated and maintain a disciplined buying strategy.
To ensure a relevant assortment, our teams:
•perform comprehensive analysis of sales trends for both stores and e-commerce;
•constantly seek out new emerging brands, while maintaining close partnerships with existing brands;
•utilize trend and color forecasting services;
•attend trade shows and youth culture events;
•conduct store visits to gather feedback from our customers and staff; and
•maintain market and consumer insight through shopping trends of leading retailers, direct competitors and relevant social media influencers.
We have developed and maintain strong and, in many cases, long-standing relationships with our third-party vendors and we have a history of identifying and growing with emerging brands. We believe the Tillys brand, shopping experience and core customer lifestyle is highly consistent with the image and philosophy of our key vendors. This, in addition to our customer connectivity, facilitates a partnership culture with our key vendors and provides us access to an extensive variety of products and styles, as well as certain merchandise that is exclusive to our stores and website. Our merchandise purchasing group also works closely with independent third parties who design and procure merchandise for our proprietary brands. Our proprietary brand capabilities enhance our ability to rapidly identify and respond to trends and consistently offer proven fashion items that provide a broader demographic appeal. We work with numerous vendors based in the United States to supply us with our proprietary branded product. These vendors source from both domestic and international markets and either have their own factories or contract with owners of factories to source finished product. By sourcing merchandise for our proprietary brands both domestically and internationally, we have the flexibility to benefit from shorter lead times associated with domestic manufacturing and lower costs associated with international manufacturing.
Planning and Allocation
We have developed inventory planning and allocation processes to support our merchandising strategies. Working closely with our merchandise purchasing team, the planning and allocation team utilizes a disciplined approach to buying, forecasting, inventory control and allocation. Our planning and allocation team continually analyzes inventory levels and sell-through data to regularly adjust the assortment at each store and the inventory levels for our company as a whole. Our broad third-party vendor base allows us to shift merchandise purchases to react quickly to changing consumer preferences and market conditions. Furthermore, the vendor base for our proprietary products provides us flexibility to develop our own branded products to quickly address emerging fashion trends and provide a deeper selection of styles, colors, and price points for proven fashion items. We modify our merchandising mix based upon store size, the season, and consumer preferences in different parts of the country. We are also able to react quickly to changing customer needs because we ship merchandise to our stores multiple times per week. Finally, we coordinate closely with our visual merchandise managers and marketing group in order to manage inventory levels in connection with our promotions and seasonality.
Stores
As of January 30, 2021, we operated 238 stores in 33 states averaging approximately 7,400 square feet per store. Our stores are located in regional mall, off-mall and outlet locations. Our stores generated average net sales of $1.5 million per store, or $202 per square foot, in fiscal 2020.
The table below shows our number of stores by type of retail center as of the end of each of the last three fiscal years:
| 2020 | 2019 | 2018 | |||||||||||||||
| Regional Mall | 136 | 139 | 131 | ||||||||||||||
Off-Mall (1) | 87 | 86 | 83 | ||||||||||||||
| Outlet | 15 | 15 | 15 | ||||||||||||||
| 238 | 240 | 229 | |||||||||||||||
(1)Includes lifestyle centers, "power" centers, community centers, and street-front locations.
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The table below shows the total number of stores by state as of January 30, 2021:
| State | Number of Stores | State | Number of Stores | |||||||||||||||||
| Arizona | 19 | New Jersey | 7 | |||||||||||||||||
| California | 98 | New Mexico | 1 | |||||||||||||||||
| Colorado | 5 | New York | 4 | |||||||||||||||||
| Delaware | 1 | North Carolina | 2 | |||||||||||||||||
| Florida | 19 | Ohio | 3 | |||||||||||||||||
| Georgia | 2 | Oklahoma | 2 | |||||||||||||||||
| Illinois | 7 | Oregon | 2 | |||||||||||||||||
| Indiana | 5 | Pennsylvania | 4 | |||||||||||||||||
| Kansas | 1 | Rhode Island | 1 | |||||||||||||||||
| Maryland | 1 | South Dakota | 1 | |||||||||||||||||
| Massachusetts | 4 | Tennessee | 3 | |||||||||||||||||
| Michigan | 3 | Texas | 16 | |||||||||||||||||
| Minnesota | 2 | Utah | 4 | |||||||||||||||||
| Missouri | 2 | Virginia | 3 | |||||||||||||||||
| Nebraska | 1 | Washington | 4 | |||||||||||||||||
| New Hampshire | 2 | Wisconsin | 3 | |||||||||||||||||
| Nevada | 6 | |||||||||||||||||||
Distinctive Store Experience
Tillys is a customer-driven lifestyle brand. We are energized and inspired by our customers’ individuality and passion for an active, outdoor and social lifestyle. Our stores bring these interests together in a vibrant, stimulating and authentic environment that is an extension of our customers’ multitasking lifestyles. We do this by blending the most relevant brands and styles with music videos, product-related visuals, and a dedicated team of store associates. Our associates share the same passion as our customers for action sports, music, art and fashion, enabling them to easily engage with our customers and make shopping at Tillys a fun, social experience. Outside of our stores, we connect with our consumers using the same authentic approach, including social media, community outreach and sponsorship of contests, demos, and other events. We believe the Tillys experience drives customer awareness, loyalty and repeat visits while generating excitement for our brand.
Store Expansion Opportunities and Site Selection
The following table shows the number of stores opened and closed in each of our last five fiscal years:
| Fiscal Year | Stores Opened | Stores Closed | Total Number of Stores at End of Period | ||||||||||||||
| 2016 | 3 | 4 | 223 | ||||||||||||||
| 2017 | 2 | 6 | 219 | ||||||||||||||
| 2018 | 16 | 6 | 229 | ||||||||||||||
| 2019 | 14 | 3 | 240 | ||||||||||||||
| 2020 | 2 | 4 | 238 | ||||||||||||||
| 37 | 23 | ||||||||||||||||
We currently expect to open seven new stores during fiscal 2021 which had been originally signed and planned for opening during fiscal 2020. We intend to continue to maintain a disciplined approach to store growth in the future by targeting existing markets with room for growth and new markets with high population density, clustering to build brand awareness. We focus on opening new stores in locations that have above-average incomes and an ability to draw from a sufficient population. We may also close a limited number of stores in any given year based on market conditions, under-performance, or lease negotiations with landlords.
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Store Management, Culture and Training
We believe that a key to our success is our ability to attract, train, retain and motivate qualified employees at all levels of our organization. Each of our stores typically operates with a three to five member store management team. In addition, each store typically has 10 or more full time equivalent store associates who reflect our customers' lifestyles and promote the Tillys brand not only inside the store, but also in their schools and communities. The number of store associates we employ generally increases during peak selling seasons, particularly the back-to-school and the winter holiday seasons, and will increase to the extent that we open new stores.
We have developed a corporate culture that we believe empowers the individual store managers to make store-level business decisions and we reward them when they exceed sales targets. We are committed to improving the skills and careers of our workforce and providing advancement opportunities for employees. We evaluate our store associates weekly on measures such as sales per hour, units per transaction and dollars per transaction to ensure productivity, to recognize top performers and to identify potential training opportunities. We endeavor to design incentive programs for store associates that promote a competitive, yet fun, culture that is consistent with our image.
We provide our managers with the knowledge and tools to succeed through comprehensive training programs, focusing on both operational expertise and supervisory skills. Our training programs and workshops are offered at the store, district and regional levels, allowing managers from multiple locations to interact with each other and exchange ideas to better operate stores. Store associates receive training from their managers to improve their product expertise and selling skills.
We believe Tillys is a place where people have a voice, will be heard, and have bias-free opportunities. Accordingly, our work place is built upon the foundation of equity and inclusion where its people are diverse in their backgrounds, communities, and points of view, yet all share the same core cultural values of working hard, giving back, and empowering others. In this regard, the Company aims to be an inclusive reflection of its customers, employees, and business partners. Pay equity, without regard for race or gender, is a base line component of this focus on equity and inclusion.
As a result of the pandemic, we have health and safety measures in place and implemented new operating standards and procedures in order to keep employees and customers at all levels of Tillys as safe as possible. For example, we have established safety protocols, limitations on non-essential business travel, and daily health and safety screenings that include temperature checks and health screening questions for every employee upon entry into any of our stores, distribution centers or corporate offices. All employees are provided with personal protective equipment according to their tasks and hygiene conditions. Employees that are not needed on-site, including certain corporate employees, are encouraged to work remotely with additional technical support and resources provided as needed.
E-Commerce
Our e-commerce platform generated total net sales of $173 million during fiscal 2020, or 32.6% of our total net sales. We believe our digital platform is an extension of our brand and retail stores and we seek to maintain an extensive selection of our newest and best merchandise assortments online at any point in time, providing our customers a seamless shopping experience. We believe that our target customer regularly shops online through various digital channels and mobile applications in addition to visiting stores. Our website serves both as a sales channel and a marketing tool to our extended customer base, including those customers in markets where we do not currently have stores. For example, we sell merchandise to customers in all 50 states and the District of Columbia even though we have brick-and-mortar stores in only 33 states. We also believe our fully-integrated digital platform reinforces the Tillys brand image and serves as an effective advertising vehicle for our retail stores. Our digital platform provides substantially the same assortment available in our brick-and-mortar stores, supplemented by additional online-only styles. Similar to the merchandising approach in our stores, we frequently change the look of our website to highlight new brands and products. We utilize multiple tools to drive traffic online, including our catalog, postcards, marketing materials in our retail stores, search engine marketing, online ad placement, shopping site partnerships, third-party affiliations, email marketing, digital marketing and direct mail. In addition, we utilize the website to offer current information on our upcoming events, promotions and store locations.
Marketing and Advertising
Our marketing approach is designed to create an authentic connection with our customers by consistently generating excitement for our brand and the active, outdoor and social lifestyle we represent. We utilize a multi-pronged marketing strategy to connect with our customers and drive traffic to our stores and online platform, comprised of the following:
•Loyalty Program. We have a customer loyalty program wherein customers accumulate points based on purchase activity. Once a loyalty member achieves a certain point level, the member earns awards that may be used towards purchase of merchandise. Once an award is earned, our loyalty program allows customers to redeem their award instantly towards the purchase of merchandise or to continue to build up to additional awards over time. We currently expire unredeemed awards and accumulated partial points 365 days after the last purchase activity. This program is designed to interact with our customers in a more direct and targeted manner, and to provide more insight into their shopping behaviors and
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preferences. We are actively engaging with customers through Tilly's Rewards and offering loyalty members-only events and offerings. We are also using the data and information provided by loyalty members to personalize the experience to the user and improve the communication and offering. We plan to continue to further enhance this program during fiscal 2021.
•Email Marketing. We utilize email marketing to build awareness, drive traffic to our stores and online platform and to promote local in-store promotions and events. We periodically send emails to the customers in our proprietary database to introduce new brands and products, offer promotions on select merchandise, highlight key events and announce new store openings. We personalize emails and communications to customers and audiences.
•Digital Marketing. We use digital marketing to drive new customers to Tillys.com and the Tillys stores. We use multiple forms of digital advertising, including Pay Per Click, Display, Retargeting, Social and Affiliate Marketing. We continue to invest in digital marketing to grow our digital business. We are also partnering with brands in co-op marketing to grow awareness and increase brand sales.
•Social Media. Our customers rely heavily on the opinions of their peers, often expressed through social media. We engage on a variety of social medial platforms to communicate directly with our customers, while allowing customers to interact with one another, and provide feedback on the products they care about and our company. Our influencer strategy, in support of driving brand awareness and growth, is designed to connect customers to key categories, trends, and activities in an authentic way.
•Brand Partnerships. We partner and collaborate with our vendors for exclusive events such as autograph signings, in-store performances, contests, demos, online marketing, giveaways, shopping sprees and VIP trips. We organize a variety of events, many involving musicians, celebrities and athletes in the entertainment, music and action sports industries. Through brand partnerships such as these, we are able to connect with and engage our customers in an exciting, authentic way.
•Catalog and Postcards. We view our print-format catalog and postcards and our digital-format catalog primarily as sales and marketing tools to drive online and store traffic from both existing and new customers. We also believe our marketing materials reinforce the Tillys brand and showcase our comprehensive selection of products in settings designed to reflect our brand’s lifestyle image. We send these marketing materials, which include coupons that can be redeemed at stores or online, to the customers in our database several times a year, primarily around key shopping periods such as spring break, back-to-school, and the winter holidays.
•Community Outreach. Through our “We Care Program” and in partnership with our vendors, we support and participate in various academic, art, and athletic programs at local schools and other organizations in communities surrounding our stores. We also support Tilly’s Life Center ("TLC"), a non-profit foundation started by our co-founder, Tilly Levine, which provides underprivileged youth a healthy and caring environment to help create a well-defined sense of self, cultivate community mindedness, and release negative emotional stress. We have given our customers the opportunity to support TLC with point-of-sale donations by allowing them to elect to "round up" their purchases to the nearest dollar and donate the rounded up portion to TLC.
Distribution
We distribute all of our store merchandise through a 126,000 square foot distribution facility co-located with our headquarters in Irvine, California. Our lease expires in December 2027. Extensive investments have been made to the distribution-center infrastructure, focused around systems automation, material-handling equipment, radio frequency technologies, and automated sorters in order to enhance our processing speed and long term scalability in support of our planned growth.
We also operate a dedicated e-commerce fulfillment center in Irvine, California to handle all e-commerce orders in a highly automated environment that leverages material handling equipment, automated systems and other technologies consistent with our current distribution facility. This infrastructure supports our e-commerce growth initiatives.
We ship merchandise to our stores multiple times per week, providing them with a steady flow of both new and replenishment products. Merchandise is shipped in a floor-ready format (carrying price tickets, sensor tags and with hangers where appropriate) which allows store employees to spend less time processing the merchandise and more time with our customers. We use our own fleet of trucks to transport merchandise to our Southern California stores and third-party distributors to transport merchandise to stores outside of our local area.
We believe our distribution and fulfillment infrastructure can support future growth of our e-commerce platform and additional stores with minimal incremental capital investment.
Information Technology
Our information technology systems provide a full range of business process support and information to our store, merchandising, financial, real estate and other business teams. We selected, customized and integrated our information systems to enable and support our dynamic merchandise model. We believe our systems provide us with improved operational
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efficiencies, scalability, management control and timely reporting that allow us to identify and quickly respond to changes in our business. We believe that our information systems are scalable, flexible and have the capacity to accommodate our current growth plans.
We have recently implemented new point-of-sale, order management, and customer relationship management systems through an end-to-end, cloud-based suite of technology additions, which included a re-platforming of our e-commerce website to a cloud-based, more cost-effective solution. We believe that these enhancements have improved customer engagement, increased sales opportunities, enhanced our real-time inventory visibility and order management, facilitated seamless omni-channel execution integrated across mobile devices and stores, and allowed for effective customer relations management capabilities. We plan to further upgrade our e-commerce platform and mobile application during fiscal 2021.
Competition
The teenage and young adult retail apparel, accessories and footwear industry is highly competitive. We compete with various publicly-traded and privately-held teen-oriented apparel retailers for customers, store locations, store associates and management personnel, including but not limited to Abercrombie & Fitch, Aeropostale, American Eagle Outfitters, The Buckle, Forever 21, Hot Topic, Pacific Sunwear, Urban Outfitters, and Zumiez. In addition, we compete with independent specialty shops, department stores, off-price retailers, online marketplaces such as Amazon, stores and websites operated by our third-party brands and direct marketers that sell similar lines of merchandise and that target customers through catalogs and e-commerce. Further, we may face new competitors and increased competition from existing competitors as we expand into new markets and increase our presence in existing markets. Given the extensive number and types of retailers with which Tillys competes for customers, we believe that our target market is highly fragmented and we do not believe we have a significant share of this market.
Competition in our sector is based, among other things, upon merchandise offerings, store location, price and the ability to identify with the customer. We believe that we compete favorably with many of our competitors based on our differentiated merchandising strategy, store environment, flexible real estate strategy and company culture. However, many of our competitors are larger, have significantly more stores, and have substantially greater financial, marketing and other resources than we do. Moreover, we recognize that we do not possess exclusive rights to many of the elements that comprise our in-store experience and product offerings. Our competitors can emulate facets of our business strategy and in-store experience, which could result in a reduction of any competitive advantage or special appeal that we might possess. For more details, see Item 1A. “Risk Factors—Risks Related to Our Business. We face intense competition in our industry and we may not be able to compete effectively.”
Trademarks
“Ambitious”, “Blue Crown”, "Destined", “Division 7”, “Eldon”, “Full Tilt”, “Full Tilt Sport”, ”Full Tilt Swim”, “Girl in Motion”, “If it’s not here...it’s not happening”, “Infamous”, “Ivy + Main”, “RSQ”, "RSQ by Tillys", “#RSQME”, “Sky and Sparrow”, “Tilly's”, “Tilly’s Clothing & Shoes”, "Tilly's Clothing Shoes Accessories, “Vindicated”, “West of Melrose”, “White Fawn”, and "2/Second Saturdays" and logos related to some of these names, are among our trademarks registered with the United States Patent and Trademark Office. We regard our trademarks as valuable and intend to maintain such marks and any related registrations. We are not aware of any claims of infringement or other challenges to our right to use our marks in the United States. We vigorously protect our trademarks.
Employees
As of January 30, 2021, we employed approximately 1,400 full-time and approximately 3,700 part-time employees, of which approximately 450 were employed at our corporate office and distribution facilities and approximately 4,650 were employed at our store locations. However, the number of total employees, especially part-time employees, fluctuates depending upon our seasonal needs and, in fiscal 2020, varied between approximately 3,600 and 6,700 employees. None of our employees are represented by a labor union and we consider our relationship with our employees to be good.
Government Regulation
We are subject to labor and employment laws, laws governing advertising and promotions, privacy laws, safety regulations, consumer protection regulations, intellectual property laws, and other laws that regulate retailers and govern the promotion and sale of merchandise and the operation of stores and warehouse facilities, as well as laws governing public companies. We monitor changes in these laws and believe that we are in material compliance with applicable laws.
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Insurance
We use insurance to address or reduce our exposure to actual or potential enterprise risks, including but not limited to workers’ compensation claims, property damage or loss, directors' and officers' liability, cyber/data security risks, fiduciary liability, general liability claims, automobile liability, employment practices liability, and employee-related health care, a portion of which is paid by the employees. We evaluate our insurance requirements on an ongoing basis to maintain what we believe to be adequate levels of coverage for these risks.
Seasonality
Due to the seasonal nature of the retail industry, we have historically experienced and expect to continue to experience fluctuations in our revenues and net income. Net revenues are typically smallest in the first quarter and largest during the fourth quarter of a given fiscal year. Our net sales fluctuate significantly in relation to various holidays and other peak shopping periods, including but not limited to the Thanksgiving and year-end holiday season, the back-to-school season, spring break periods, and other holidays. If, for any reason, our revenues were below seasonal norms or expectations during these quarters, particularly during peak selling periods, our annual results of operations could be adversely affected. The level of our working capital reflects the seasonality of our business. We expect inventory levels, along with an increase in accounts payable and accrued expenses, generally to reach their highest levels in anticipation of the increased revenues during these periods.
Additional Information
We make available free of charge on our internet website, www.tillys.com, copies of our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, or the Exchange Act, as soon as reasonably practicable after filing such material electronically with, or otherwise furnishing it to, the Securities and Exchange Commission, or the SEC. In addition, these materials may be obtained at the web site maintained by the SEC at www.sec.gov. The reference to our website address does not constitute incorporation by reference of the information contained on the website, and the information contained on the website is not part of this document.
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Item 1A. Risk Factors
Our business faces significant risks and uncertainties. Certain important factors may have a material adverse effect on our business, prospects, financial condition and results of operations, any of which could subsequently have an adverse effect on the trading price of our Class A common stock, and you should carefully consider them. Accordingly, in evaluating our business, we encourage you to consider the following discussion of risk factors in its entirety, in addition to other information contained in or incorporated by reference into this Annual Report on Form 10-K and our other public filings with the SEC. Additional risks not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and results of operations in future periods.
Risks Related to our Business
The COVID-19 pandemic materially disrupted our operations during fiscal 2020 and may possibly continue to have an adverse effect on our business.
Beginning in March 2020, we took several precautionary actions in response to the COVID-19 pandemic to protect our longer-term business prospects and help minimize risk to our Company, employees, customers, and the communities in which we operate. Those actions included the temporary closure of all 239 of our stores across the United States and our store distribution center, establishing remote work capabilities for all corporate employees, drawing down 100% of our available borrowings under our prior credit facility, furloughing 91% of our entire employee population, implementing significant temporary corporate management pay cuts, temporarily withholding store lease payments, significantly reducing future inventory commitments, and eliminating or reducing a variety of expenses. As stores reopened later in 2020, furloughed employees were brought back to work, management pay cuts were reversed, and amounts borrowed under our prior credit facility were repaid. We ended fiscal 2020 with all 238 of our stores in operation, but with reduced operating hours and significant restrictions on customer traffic that remain in place as of the date of this filing. There remain many uncertainties regarding the anticipated duration and severity of the current COVID-19 pandemic, particularly in light of ongoing vaccination efforts and emerging variant strains of the virus. To date, the COVID-19 pandemic has had far-reaching impacts on many aspects of our operations, directly and indirectly, including on consumer behavior, store traffic, operational capabilities and our operations generally, timing of deliveries, demands on our information technology and e-commerce capabilities, inventory and expense management, managing our workforce, our store configurations and operations upon reopening, and our people, which have materially disrupted our business and the market generally. The scope and nature of these impacts continue to evolve. The COVID-19 pandemic has resulted in, and may continue to result in, regional quarantines, labor stoppages and shortages, changes in consumer purchasing patterns, mandatory or elective shut-downs of retail locations, disruptions to supply chains, including the inability of our suppliers and service providers to deliver materials and services on a timely basis, or at all, severe market volatility, liquidity disruptions and overall economic instability, which, in many cases, have had, and we expect will continue to have, material adverse impacts on our business, financial condition and results of operations. We cannot predict the specific extent to which the COVID-19 pandemic may impact our business, financial condition and results of operations (including our near-term and long-term revenues, earnings, liquidity and cash flows), as such impacts will depend on how the COVID-19 pandemic and its impacts continue to develop, which are highly uncertain and cannot be predicted at this time. This situation is changing rapidly, and additional impacts may arise that we are not aware of currently, or current impacts may become magnified. Any future actions we take in response to the COVID-19 pandemic could further negatively impact our business, financial condition and results of operations.
Our sales could be severely impacted by decreases in consumer spending.
We depend upon consumers feeling confident to spend discretionary income on our product offerings to drive our sales. Consumer spending may be adversely impacted by economic conditions such as consumer confidence in future economic conditions, interest and tax rates, employment levels, salary and wage levels, general business conditions, the availability of consumer credit and the level of housing, energy and food costs. In addition, consumer spending can be impacted by non-economic factors, including geopolitical issues, trade restrictions, unseasonable weather, pandemics/epidemics, including the current COVID-19 pandemic, and other factors that are outside of our control. These risks may be exacerbated for retailers like us who focus on specialty apparel, footwear and accessories. Our financial performance is particularly susceptible to economic and other conditions in regions or states where we have a significant number of stores, such as the southwestern and northeastern United States and Florida. We experienced significant decreases in consumer spending during certain periods of fiscal 2020 as a result of COVID-19, and similar impacts may occur in the future, both as a result of the pandemic or in connection with other events. If periods of decreased consumer spending persist, our sales could decrease, and our financial condition and results of operations could be adversely affected.
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We are required to make significant lease payments for our store leases, corporate offices, and distribution centers, which may strain our cash flow. In addition, in light of the COVID-19 pandemic, we may need to take certain actions with respect to some or all of our existing leases to preserve our cash position during periods wherein stores are unable to operate, which may create legal and financial risk for us.
We lease all of our retail store locations as well as our corporate headquarters, warehouses, distribution and e-commerce fulfillment centers. We do not own any real estate. Leases for our stores are typically for terms of ten years and many can be extended in five-year increments. Many of our leases have early cancellation clauses which permit us to terminate the lease if certain sales thresholds are not met in certain periods of time. Our costs under these leases are a significant amount of our expenses and are growing rapidly as we expand the number of locations and existing locations experience expense increases. We are required to pay additional rent under many of our lease agreements based upon achieving certain sales plateaus for each store location. In addition, we must make significant payments for common area maintenance and real estate taxes. Many of our lease agreements also contain provisions which increase the rent payments on a set time schedule, causing the cash rent paid for a location to escalate over the term of the lease. In addition, rent costs could escalate when multi-year leases are renewed at the expiration of their lease term. These costs are significant, recurring and increasing, which places a consistent strain on our cash flows.
We depend on cash flows from operations to pay our lease expenses and to fulfill our other cash needs. If our business does not generate sufficient cash flows from operating activities, and sufficient funds are not otherwise available to us from borrowings under our available revolving credit facility or from other sources, we may not be able to service our operating lease expenses, grow our business, respond to competitive challenges or to fund our other liquidity and capital needs, which would harm our business. The COVID-19 pandemic had a material, negative impact on our cash flows from operations during periods of 2020 in which stores were temporarily shut down, which placed further pressure on our ability to service our operating lease expenses, and such adverse impacts could potentially happen again in fiscal 2021 if vaccination and other mitigation efforts are not successful in containing the pandemic. As a result of these pressures, we withheld nearly all store lease payments during the periods in which our stores were shut down. While we have generally negotiated with our landlords to share the impact of those withheld payments, we still have an aggregate of $1.4 million in withheld store lease payments for which we have not negotiated a settlement with the landlords as of the date of this filing. These withheld payments may result in additional costs or liability to the Company in the future. In addition, any future store closures arising from federal, state and local instructions resulting from the COVID-19 pandemic may again require us to take certain actions with respect to some or all of our existing leases, including negotiating with landlords for rent abatement, terminating certain leases, or discontinuing payment, which may subject us to legal, reputational and financial risks. We can provide no assurances that any forbearance of our lease obligations will be provided to us in the future.
Additional sites that we lease are likely to be subject to similar long-term leases. If an existing or future store is not profitable, and we decide to close it, we may nonetheless be committed to perform our obligations under the applicable lease including, among other things, paying the base rent for the balance of the lease term. In addition, as our leases expire, we may fail to negotiate renewals, either on commercially acceptable terms or at all, which could cause us to close stores in desirable locations. If we are unable to enter into new leases or renew existing leases on terms acceptable to us or be released from our obligations under leases for stores that we close, our business, profitability and results of operations may be harmed.
Actual borrowing capacity under our $65 million asset-backed credit facility is subject to monthly fluctuations as a function of the amount of inventory and receivables we carry, which could result in limitations on our ability to access sufficient levels of additional liquidity in the event of new pandemic-related or other store shutdown periods.
We maintain an asset-backed credit facility with Wells Fargo Bank, National Association, pursuant to the New Credit Agreement (as defined herein) which provides for up to $65 million in borrowing capacity subject to the amount and aging of the inventory and receivables we carry. Actual borrowing capacity fluctuates on a monthly basis as a function of our qualifying inventories and receivables and subject to certain reserve calculations. The credit facility also contains customary affirmative and negative covenants, including limitations on share repurchases, cash dividends, and indebtedness; limitations on consolidations, mergers and sales of assets; and limitations on transactions with affiliates. These limitations may restrict our ability to obtain sufficient levels of additional liquidity when needed, particularly in response to the ongoing COVID-19 pandemic, and may therefore have a material adverse effect on our business in the event we require such liquidity in the future, including in response to any future pandemic-related or other store closure events.
In addition, the interest rates and commitment fees payable by us under the credit facility are variable, including as a result of fluctuations in LIBOR and our available borrowing capacity, and any adverse variations in those rates in the future may adversely impact our ability to service those interest payments. Also, if we are unable to comply with the covenants under the credit facility, including as a result of the COVID-19 pandemic, we may be in default under the credit facility, which could accelerate the payment of any amounts then outstanding, limit our ability to incur future borrowings under the credit facility, or impair our ability to find additional or alternative financing, any of which could have a material adverse effect on our business.
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We face intense competition in our industry and we may not be able to compete effectively.
The retail industry is highly competitive. We currently compete with a variety of publicly-traded and privately-held specialty apparel retail chains such as, but not limited to, Abercrombie & Fitch, Aeropostale, American Eagle Outfitters, The Buckle, Forever 21, Hot Topic, Pacific Sunwear, Urban Outfitters, and Zumiez. In addition, we compete with independent specialty shops, department stores, off-price retailers, online marketplaces such as Amazon, stores and websites operated by our third-party brands, and direct marketers that sell similar lines of merchandise and target customers through catalogs and e-commerce. Moreover, the internet and other new technologies facilitate competitive entry and comparison shopping in our retail market. While we offer a multichannel shopping experience and use social media as a way to interact with our customers and enhance their shopping experiences, multichannel retailing is rapidly evolving, and we must keep pace with changing customer expectations and new developments by our competitors. Competition with some or all of these retailers noted above could require us to lower our prices or risk losing customers. In addition, significant or unusual promotional activities by our competitors may cause us to respond in-kind and adversely impact our operating cash flow. Because of these factors, current and future competition could have a material adverse effect on our financial condition and results of operations.
Furthermore, many of our competitors have greater financial, marketing and other resources than we currently do, and therefore may be able to devote greater resources to the marketing and sale of their products, generate national brand recognition or adopt more aggressive pricing policies than we can, which would put us at a competitive disadvantage. Moreover, we do not possess exclusive rights to many of the elements that comprise our in-store experience and product offerings. Our competitors may seek to emulate facets of our business strategy and in-store experience, which could result in a reduction of any competitive advantage or special appeal that we might possess. In addition, most of the third-party branded products we sell are sold to us on a non-exclusive basis. As a result, our current and future competitors may be able to duplicate or improve on some or all of our in-store experience or product offerings that we believe are important in differentiating our stores and our customers’ shopping experience. If our competitors were to duplicate or improve on some or all of our in-store experience or product offerings, our competitive position and our business could suffer.
We may experience comparable store sales or sales per square foot declines, which may cause our results of operations to decline.
The investing public may use comparable store sales or net store sales per square foot projections or results, over a certain period of time, such as on a quarterly or yearly basis, as an indicator of our profitability growth. Our comparable store sales can vary significantly from period to period for a variety of reasons, such as the age of stores, changing economic factors, unseasonable weather, continued declines in mall and retail foot traffic, changing fashion trends, pricing, the timing of the release of new merchandise and promotional events and increased competition. These factors could cause comparable store sales or net store sales per square foot to decline or fail to grow at expected rates, which could adversely affect our results of operations and stock price during such periods.
Our business depends upon identifying and responding to changing customer fashion preferences and fashion-related trends. If we cannot identify trends in advance or we select the wrong fashion trends, our sales could be adversely affected.
Fashion trends in the apparel, footwear and accessories market can change rapidly. We need to anticipate, identify and respond quickly to changing trends and consumer demands in order to provide the merchandise our customers seek and maintain our brand image. If we cannot identify changing trends in advance, fail to react to changing trends or misjudge the market for a trend, our sales could be adversely affected, and we may be faced with a substantial amount of unsold inventory or missed opportunities. As a result, we may be forced to mark down our merchandise in order to dispose of slow moving inventory, which may result in lower profit margins, negatively impacting our financial condition and results of operations.
Our continued growth depends upon our ability to successfully open profitable new stores and improve the performance of our existing stores, which is subject to a variety of risks and uncertainties.
We have grown our store count and improved the profitability of our existing stores in recent years. However, there can be no assurance that we will continue to be able to open new stores that are profitable or to continue to improve the performance of our existing stores sufficiently to continue to improve our profitability.
Our ability to successfully open and operate new stores is subject to a variety of risks and uncertainties, such as:
•identifying suitable store locations, the availability of which is beyond our control;
•obtaining acceptable lease terms;
•sourcing sufficient levels of inventory;
•selecting the appropriate merchandise that appeals to our customers;
•hiring and retaining store employees;
•assimilating new store employees into our corporate culture;
•effectively marketing new store locations;
•avoiding construction delays and cost overruns in connection with the build-out of new stores;
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•managing and expanding our infrastructure to accommodate growth;
•integrating the new stores with our existing buying, distribution and other support operations; and
•pandemics or other outbreaks of illness, disease or virus (such as COVID-19) that affect countries or regions in which our stores are located.
Additionally, some of our new stores may open in locations close enough to our existing stores that a segment of customers will stop shopping at our existing locations and prefer to shop at the new locations, and therefore sales and profitability at those existing stores may decline. Any failure to continue to open profitable new stores or improve the performance of existing stores could have a material adverse effect on our financial condition, results of operations, and stock price.
Our continued growth depends upon our ability to continue to grow our e-commerce business and improve its profitability, which is subject to a variety of risks and uncertainties.
We sell merchandise over the internet through our e-commerce website, www.tillys.com. In fiscal 2019, e-commerce generated nearly $98 million in total net sales, or approximately 15.9% of our total net sales for the year. In fiscal 2020, e-commerce generated $173 million in total net sales, or approximately 32.6% of our total net sales for the year, aided by the pandemic's impact on store operations during fiscal 2020. The e-commerce retail market continues to rapidly evolve, creating new competition and increasing cost pressures from shipping charges and online marketing costs. As a result, there can be no guarantee that we will be able to continue to grow our e-commerce net sales or to improve the profitability of our e-commerce operations. Our e-commerce platform and its continued growth subjects us to certain risks that could have an adverse effect on our results of operations, including:
•diversion of traffic from our stores;
•liability for online content;
•government regulation impacting the Internet; and
•risks related to the computer systems that operate our website and related support systems, including computer viruses, electronic break-ins, system errors or failures, or similar disruptions.
Our failure to address and respond to these risks successfully could reduce e-commerce net sales, increase costs and damage the reputation of our brand. Any failure to continue to grow e-commerce net sales or improve the profitability of e-commerce operations could have a material adverse impact on our financial condition, results of operations, and stock price.
We may not be able to implement our business strategies on the timelines we anticipate, in a cost-effective manner, or at all.
At any point in time, we are in the process of implementing new merchandising strategies, customer-facing technology enhancements, new systems or upgrades to existing systems, and cost reduction or containment plans. The implementation of these strategies or plans may not be completed or achieve the anticipated results within the expected timeframe, which may result in declines in net sales or unanticipated cost increases. Even if implemented, we cannot assure that our strategies or plans will be successful to meet our current and future business needs or that they will operate as designed. If the implementation of our business strategies and plans are not executed efficiently and effectively, our business, financial condition, and our operating results could be adversely affected.
Our ability to attract customers to our stores depends significantly on the success of the retail centers where our stores are located.
We have historically depended on the location of our stores to generate a large amount of traffic for our stores. We try to select well-known and popular malls, power centers, neighborhood and lifestyle centers, outlet centers and street-front locations, usually near prominent retailers, to generate traffic to our stores. Traffic at these retail centers, and consequently our stores, could be adversely affected by economic downturns nationally or regionally, competition from Internet retailers, changes in consumer demographics, the closing or decrease in popularity of other retailers in the retail centers in which our stores are located, our inability to obtain or maintain prominent store locations within retail centers or the selection by prominent retailers and businesses of other locations. Over the last few years, the retail industry has experienced continued declines in consumer traffic to retail centers as consumer purchasing behaviors have shifted toward online purchases and this trend may continue in the future. Additionally, in response to the COVID-19 pandemic, we have experienced mandatory and elective temporary closures of certain retail centers in which our stores are located (in addition to our own election to temporarily close all of our stores, as further described elsewhere in this Report). In addition, prior to such closures, we experienced significant declines in traffic to our stores as consumer purchasing behaviors shifted toward online purchases, and we may experience similar further declines in the future when our stores reopen. A continuing reduction in traffic to retail centers may likely lead to a decrease in our net sales and results of operations, which could have a material adverse effect on our financial condition, results of operations and stock price.
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We buy and stock merchandise based upon seasonal weather patterns and therefore unseasonable weather could negatively impact our sales.
We buy select merchandise for sale based upon expected weather patterns during the seasons of winter, spring, summer and fall. If we encounter untimely aberrations in weather conditions, such as warmer winters or cooler summers than would be considered typical, these weather variations could cause some of our merchandise to be inconsistent with what consumers wish to purchase, causing our sales to decline. Furthermore, extended unseasonable weather conditions in regions such as in the southwestern United States, particularly in California, Arizona, Nevada, Florida and the northeastern United States will likely have a greater impact on our sales because of our store concentration in those regions.
Our sales can significantly fluctuate based upon shopping seasons, which may cause our operating results to fluctuate disproportionately on a quarterly basis.
Because of a traditionally higher level of sales during the back-to-school and winter holiday shopping seasons, our sales are typically higher in the third and fourth fiscal quarters than they are in the first and second fiscal quarters. Accordingly, the results of a single fiscal quarter, particularly the third and fourth fiscal quarters, should not be relied on as an indication of our annual results or future performance. In addition, any factors that harm our third and fourth fiscal quarter operating results could have a disproportionate effect on our results of operations for the entire fiscal year.
We purchase merchandise in advance of the season in which it will be sold and if we purchase too much inventory we may need to reduce prices in order to sell it, which may adversely affect our overall profitability.
We must actively manage our purchase of inventory. Generally, we order merchandise months in advance of it being received and offered for sale. If there is a significant decrease in demand for our products or if we fail to accurately predict fashion trends or consumer demands, or unseasonable weather impacts the anticipated demand for certain product categories, we may be forced to rely on markdowns or promotional sales to dispose of excess inventory. In addition, seasonal fluctuations also affect our inventory levels, as we usually order and carry a significant amount of inventory before the back-to-school and winter holiday shopping seasons. If we are not successful in selling our inventory during these periods, we may be forced to rely on markdowns or promotional sales to dispose of the inventory, or we may not be able to sell the inventory at all, which could have an adverse effect on our margins and operating income.
If we fail to maintain good relationships with our suppliers or if our suppliers are unable or unwilling to provide us with sufficient quantities of merchandise at acceptable prices, our business and operations may be adversely affected.
Our business is largely dependent on continued good relations with our suppliers, including vendors for our third-party branded products and manufacturers for our proprietary branded products. We operate on a purchase order basis for our proprietary branded and third-party branded merchandise and do not have long-term contractual relationships with our suppliers. Accordingly, our suppliers can refuse to sell us merchandise, limit the type or quantity of merchandise they sell us or raise prices at any time, which can have an adverse impact on our business. Deterioration in our relationships with our suppliers or increased demand for their products could have a material adverse impact on our business, and there can be no assurance that we will be able to acquire desired merchandise in sufficient quantities on terms acceptable to us in the future. Also, some of our vendors are vertically integrated, selling products directly from their own retail stores, and therefore are in direct competition with us. These vendors may decide at some point in the future to reduce or discontinue supplying their merchandise to us, supply us less desirable merchandise or raise prices on the products they do sell us. Additionally, in connection with the COVID-19 pandemic, we have been notified of delays in certain new product receipts in the March through June period, and may receive similar notices in the future if the COVID-19 pandemic continues. Further, if we lose key vendors or are unable to find alternative vendors to supply us with substitute merchandise for lost products, our business may be adversely affected.
If we cannot retain or find qualified employees to meet our staffing needs in our stores, our distribution and e-commerce fulfillment centers, or our corporate offices, our business could be adversely affected.
Our success depends upon the quality of the employees we hire. We seek employees who are motivated, represent our corporate culture and brand image and, for many positions, have knowledge of our merchandise and the skill necessary to excel in a customer service environment. The turnover rate in the retail industry is high and finding qualified candidates to fill positions may be difficult. If we cannot attract and retain corporate employees, district managers, store managers and store associates with the qualifications we deem necessary at requisite cost, our ability to effectively operate and expand may be adversely affected. In addition, we rely on temporary personnel to staff our distribution and fulfillment centers, as well as seasonal part-time employees to provide incremental staffing to our stores in busy selling seasons such as the back-to-school and winter holiday seasons. In addition, as described elsewhere in this Report, we have furloughed certain of our employees in response to the store closures due to the COVID-19 pandemic, which may create additional challenges in attracting and retaining quality employees in the future. We cannot guarantee that we will be able to find adequate temporary or seasonal personnel to staff our operations when needed, particularly during the COVID-19 pandemic, which may strain our existing personnel or increase costs, and negatively impact our operations.
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Our business largely depends on a strong brand image, and if we are not able to maintain and enhance our brand, particularly in new markets where we have limited brand recognition, we may be unable to increase or maintain our level of sales.
We believe that our brand image and brand awareness has contributed significantly to the success of our business. We also believe that maintaining and enhancing our brand image, particularly in new markets where we have limited brand recognition, is important to maintaining and expanding our customer base. As we execute our growth strategy, our ability to successfully integrate new stores into their surrounding communities, to expand into new markets or to maintain the strength and distinctiveness of our brand image in our existing markets will be adversely impacted if we fail to connect with our target customer. Maintaining and enhancing our brand image may require us to make substantial investments in areas such as merchandising, marketing, store operations, e-commerce, social-media, community relations, store graphics, catalog distribution and employee training, which could adversely affect our cash flow and which may not ultimately be successful. Failure to successfully market our brand in new and existing markets could harm our business, results of operations and financial condition.
A rise in the cost of raw materials, labor and transportation could increase our cost of sales and cause our results of operations and margins to decline.
Fluctuations in the price, availability and quality of fabrics or other raw materials used to manufacture our products, as well as the price for transportation and labor, including the impact of federal or state minimum wage rate increases, could have adverse impacts on our cost of sales and our ability to meet our customers’ demands. In particular, because a key component of our clothing is cotton, increases in the cost of cotton may significantly affect the cost of our products and could have an adverse impact on our cost of sales. We may not be able to pass all or a portion of these higher costs on to our customers, which could have a material adverse effect on our profitability.
Any inability to balance merchandise bearing our proprietary brands with the third-party branded merchandise we sell may have an adverse effect on our sales and gross margin.
Our proprietary branded merchandise represents a significant portion of our net sales. Our proprietary branded merchandise generally has a higher gross margin than the third-party branded merchandise we offer. As a result, we may determine that it is best for us to continue to hold or increase the penetration of our proprietary brands in the future. However, carrying our proprietary brands limits the amount of third-party branded merchandise we can carry and, therefore, there is a risk that the customers’ perception that we offer many major brands will decline. By maintaining or increasing the amount of our proprietary branded merchandise, we are also exposed to greater fashion risk, as we may fail to anticipate fashion trends correctly. These risks, if they occur, could have a material adverse effect on sales and profitability.
Most of our merchandise is produced in foreign countries, making the price and availability of our merchandise susceptible to international trade and other international conditions.
Although we purchase our merchandise from domestic suppliers, these suppliers have a majority of their merchandise made in foreign countries. Some foreign countries can be, and have been, affected by political and economic instability and natural disasters, negatively impacting trade, including as a result of the COVID-19 pandemic which we have been informed has already had a material adverse impact on the operations of our suppliers and the manufacturers with whom they work, and has resulted in material delays in the delivery of certain merchandise to us from foreign manufacturers. The countries in which our merchandise currently is manufactured or may be manufactured in the future could become subject to new trade restrictions imposed by the United States or other foreign governments. Trade restrictions, including increased tariffs or quotas, embargoes and customs restrictions, against apparel items, as well as United States or foreign labor strikes, work stoppages or boycotts (including as a result of the COVID-19 pandemic) could increase the cost or reduce the supply of apparel available to us and have a material adverse effect on our business, financial condition and results of operations. In addition, our merchandise supply could be impacted if our suppliers’ imports become subject to existing or future duties and quotas, or if our suppliers face increased competition from other companies for production facilities, import quota capacity and shipping capacity. Any increase in the cost of our merchandise or limitation on the amount of merchandise we are able to purchase could have a material adverse effect on our financial condition and results of operations.
Our corporate headquarters, distribution and e-commerce fulfillment centers and information technology systems are in Irvine, California, and if their operations are disrupted, we may not be able to operate our store support functions, ship merchandise to our stores, or fulfill e-commerce orders, which would adversely affect our business.
Our corporate headquarters, distribution center and information technology systems are in two locations in Irvine, California. If we encounter any disruptions to our operations within these buildings or if they were to shut down for any reason, including by fire or other natural disaster, or as a result of the COVID-19 pandemic, then we may be prevented from effectively operating our stores, shipping and processing our merchandise and operating our e-commerce platform. As discussed previously in this Report, we have already discontinued the operations of the distribution center for our stores, and have implemented other precautions in light of the COVID-19 pandemic that have materially disrupted our operations in Irvine, California, and
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elsewhere. Furthermore, the risk of disruption or shut down at these buildings is greater than it might be if they were located in another region, as southern California is prone to natural disasters such as earthquakes and wildfires. Any disruption or shut down at these locations could significantly impact our operations and have a material adverse effect on our financial condition and results of operations.
Our stores are mostly located in the southwestern and northeastern United States and in Florida, with a significant number of stores located in California, putting us at risk to region-specific disruptions.
The majority of our stores are located in California, Arizona, Nevada, Florida and the northeastern United States. Sales in these states could be more susceptible to disruptions than other parts of the country, such as from economic and weather conditions, demographic and population changes and changes in fashion tastes, and consequently, we may be more susceptible to these factors than more geographically diversified competitors. For example, because of the negative economic impact caused by the downturn in the housing market that occurred several years ago, sales in these states have slowed more than sales in other regions. Compared to the country as a whole, stores in California are exposed to a relatively high risk of damage from a major earthquake or wildfires, while stores in Florida are exposed to a relatively high risk from hurricane damage. Any negative impact upon or disruption to the operations of stores in these states could have a material adverse effect on our financial condition and results of operations.
Litigation costs and the outcome of litigation could have a material adverse effect on our business.
From time to time we may be subject to litigation claims through the ordinary course of our business operations regarding, but not limited to, employment matters, compliance with the Americans with Disabilities Act of 1990, apparel, footwear and accessory safety standards, security of customer and employee personal information, contractual relations with vendors, marketing and infringement of trademarks and other intellectual property rights. For example, we are currently engaged in several legal proceedings as it relates to California's wage and hour laws. In addition, as described elsewhere in this Report, the COVID-19 pandemic, and our responses thereto, may subject us to further litigation, including with respect to employment matters, contract disputes, and other matters. Litigation to defend ourselves against claims by third parties, or to enforce any rights that we may have against third parties, may continue to be necessary, which could result in substantial costs and diversion of our resources, causing a material adverse effect on our business, financial condition, results of operations or cash flows.
If our vendors and manufacturing sources fail to use acceptable labor or other practices our reputation may be harmed, which could negatively impact our business.
We purchase merchandise from independent third-party vendors and manufacturers. If any of these suppliers have practices that are not legal or accepted in the United States, consumers may develop a negative view of us, our brand image could be damaged, and we could become the subject of boycotts by our customers and/or interest groups. Further, if the suppliers violate labor or other laws of their own country, these violations could cause disruptions or delays in their shipments of merchandise. For example, much of our merchandise is manufactured in China and Mexico, which have different labor practices than the United States. We do not independently investigate whether our suppliers are operating in compliance with all applicable laws and therefore we rely upon the suppliers’ representations set forth in our purchase orders and vendor agreements concerning the suppliers’ compliance with such laws. If our goods are manufactured using illegal or unacceptable labor practices in these countries, or other countries from which our suppliers source the product we purchase, our ability to supply merchandise for our stores without interruption, our brand image and, consequently, our sales may be adversely affected.
If we lose key management personnel our operations could be negatively impacted.
Our business and growth depends upon the leadership and experience of our key executive management team, including our co-founder, Hezy Shaked, who currently serves as our Chief Strategy Officer and Executive Chairman of our Board of Directors, and Edmond Thomas, our President and Chief Executive Officer, and we may be unable to retain their services. We also may be unable to retain other existing management personnel that are critical to our success, which could result in harm to our vendor and employee relationships, loss of key information, expertise or know-how and unanticipated recruitment and training costs. The loss of services of any of our key personnel could have a material adverse effect on our business and prospects, and could be viewed in a negative light by investors and analysts, which could cause our Class A common stock price to decline. Except for Mr. Thomas, none of our employees has an employment agreement and we do not intend to purchase key person life insurance covering any employee. If we lose the services of any of our key personnel or we are not able to attract additional qualified personnel, we may not be able to successfully manage our business.
We rely on third parties to deliver merchandise to our stores located outside of southern California and therefore our business could be negatively impacted by disruptions in the operations of these third-party providers.
We rely on third parties to ship our merchandise from our distribution center in Irvine, California to our stores located across the United States, as well as to ship e-commerce sales packages directly to our customers. Relying on these third-party delivery services puts us at risk from disruptions in their operations, such as employee strikes, inclement weather and their ability to meet our shipping demands (including as a result of the COVID-19 pandemic which we have been informed has already
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disrupted the operations of many of our third-party service providers). If we are forced to use other delivery services, our costs could increase, and we may not be able to meet shipment deadlines. Moreover, we may not be able to obtain delivery terms as favorable as those received from the transportation providers we currently use, which would further increase our costs. These circumstances may negatively impact our financial condition and results of operations.
We rely on print and online marketing services.
We use the U.S. Postal Service to mail printed marketing materials several times each year to inform our customers about our products, acquire new customers, drive customers into our stores, and promote our website and stores. As a result, postal rates and paper and printing costs affect the cost of our mailings. We also use third-party online services to market our website and stores and to distribute promotions to attract new customers and encourage existing customers to purchase from us. Any significant or unanticipated increase in postage, reduction in postal service, or slow-down in postal delivery, increases in paper and printing costs, increases in the cost of our online marketing services or any service interruption or failure on the part of such service providers could impair our ability to deliver printed marketing materials or our online marketing in a timely or economically efficient manner. This could also adversely impact our sales and earnings if we are unable to pass such increases on to our customers or are unable to implement more efficient printing, mailing, delivery and order fulfillment systems or, in the case of our online marketing, to find alternative providers in a timely manner and on terms that are not significantly more costly to us.
We may incur substantial expenses related to our issuance of share-based compensation, which may have a negative impact on our operating results for future periods.
We follow the provisions of Financial Accounting Standards Board ("FASB") Accounting Standards Codification, or ASC, 718, Compensation-Stock Compensation, for share-based compensation. Our share-based compensation expenses may be significant in future periods, which could have an adverse impact on our operating and net income. FASB ASC 718 requires the use of subjective assumptions, including the options’ expected lives and the price volatility of our Class A common stock. Changes in the subjective input assumptions can materially affect the amount of our share-based compensation expense. In addition, an increase in the competitiveness of the market for qualified employees could result in an increased use of share-based compensation awards, which in turn would result in increased share-based compensation expense in future periods.
Risks Related to Information Technology, Data Privacy and Intellectual Property
If our information technology fails to operate or are unable to support our growth, our operations could be disrupted.
We rely upon our management information systems in almost every aspect of our daily business operations. For example, our management information systems serve an integral part in enabling us to order merchandise, process merchandise at our distribution center and retail stores, perform and track sales transactions, manage personnel, pay vendors and employees, operate our e-commerce platform and report financial and accounting information to management. In addition, we rely on our management information systems to enable us to leverage our costs as we grow. If our management information systems fail to operate (including as a result of the COVID-19 pandemic) or are unable to support our growth, our store operations and e-commerce platform could be severely disrupted, and we could be required to make significant additional expenditures to remediate any such failure.
Our business is subject to a variety of laws, rules, and other obligations regarding data protection, which could result in additional compliance costs, subject us to enforcement actions, or cause us to change our platform or business practices.
We are subject to a complex array of federal, state, and international laws relating to the collection, use, retention, disclosure, security, and transfer of personal data. Many jurisdictions have passed laws in this area, and other jurisdictions are considering imposing additional restrictions, including regulating the level of notice and consent required to collect and process end-user data. The data protection landscape is rapidly evolving, and implementation standards and enforcement practices are likely to remain uncertain for the foreseeable future. Complying with emerging and changing laws and requirements may cause us to incur substantial costs or require us to change our business practices.
For example, in June 2018, California passed the California Consumer Privacy Act of 2018 (“CCPA”), which grants California residents certain rights with respect to their personal information. Under the CCPA, businesses are required to grant expansive access, deletion and portability rights to consumers in the United States. The law may also impose burdensome retention and compliance obligations on publishers and advertising technology companies. The CCPA also provides for civil penalties for violations, as well as a private right of action for data breaches that is expected to increase data breach litigation. Interpretation of the requirements remains unclear due to the recent passage of the regulation. The law took effect on January 1, 2020.
The cost of compliance with these laws, regulations, policies, legal obligations and industry standards is high and is likely to increase in the future. If our privacy or data security measures fail or are perceived to fail to comply with current or future laws, regulations, policies, legal obligations or industry standards, or any changed interpretations of the foregoing, we may be subject to litigation, regulatory investigations, enforcement actions, inquiries, prosecutions, fines or other liabilities, as well as negative publicity and a potential loss of business. Moreover, if future laws, regulations, industry standards, or other legal obligations, or
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any changed interpretations of the foregoing, limit the ability of our customers, partners or service providers to use and share personally identifiable information or other data or our ability to store, process and share personally identifiable information or other data, our costs could increase and our business, financial condition and operating results could be harmed. Even the perception of privacy or data protection concerns, whether or not valid, may inhibit market adoption, effectiveness or use of our technology services that rely on consumer data. Any failure or perceived failure by us to comply with federal, state, or foreign laws or self-regulatory standards could result in negative publicity, significant fines and expenses for remediation, diversion of management time and effort and proceedings against us by governmental entities, individuals or others.
Our internal operations, management information systems and databases containing the personal information of our employees and customers could be disrupted by system security or operational failures or breached by intentional attacks. These disruptions or attacks could negatively impact our sales, increase our expenses, and harm our reputation.
Database privacy, network security and identity theft are matters of growing public concern. Hackers, computer programmers and internal users may be able to penetrate our network security and create system disruptions, cause shutdowns and misappropriate our confidential information or that of third parties, including our employees and customers. We may incur significant costs related to prevention of breaches of our cyber-security and to comply with laws regarding the unauthorized disclosure of confidential information, including customer payment information, and we could incur significant expenses addressing problems created by security breaches to our network. This risk is heightened because we collect and store customer information for marketing purposes, and use credit card information to process transactions. We must, and do, take precautions to secure customer information and prevent unauthorized access to our database of confidential information. However, if unauthorized parties, including external hackers or computer programmers, gain access to our database, they may be able to steal this confidential information. Our failure to secure this information could result in costly litigation, adverse publicity or regulatory action that could have a material adverse effect on our financial condition and results of operations. In addition, sophisticated hardware and operating system software and applications that we procure from third parties may contain defects in design or manufacture that could unexpectedly interfere with our operations, including potentially unintentionally sharing personal information retained by us. The cost to alleviate security risks, defects in software and hardware and address any problems that occur could negatively impact our sales, distribution and other critical functions, as well as our financial results.
If we are unable to protect our intellectual property rights, our financial results may be negatively impacted.
Our success depends in large part on our brand image. Our company’s name, logo, domain name and our proprietary brands and our registered and unregistered trademarks and copyrights are valuable assets that serve to differentiate us from our competitors. We currently rely on a combination of copyright, trademark, trade dress and unfair competition laws to establish and protect our intellectual property rights. We cannot assure you that the steps taken by us to protect our proprietary rights will be adequate to prevent infringement of our trademarks and proprietary rights by others, including imitation and misappropriation of our brand. We cannot assure you that obstacles will not arise as we expand our product lines and geographic scope. The unauthorized use or misappropriation of our intellectual property could damage our brand identity and the goodwill we created for our company, which could cause our sales to decline. Moreover, litigation may be necessary to protect or enforce these intellectual property rights, which could result in substantial costs and diversion of our resources, causing a material adverse effect on our business, financial condition, results of operations or cash flows. If we cannot protect our intellectual property rights, our brand identity and the goodwill we created for our company may diminish, causing our sales to decline.
Most of our intellectual property has not been registered outside of the United States and we cannot prohibit other companies from using our unregistered trademarks in foreign countries. Use of our trademarks in foreign countries could negatively impact our identity in the United States and cause our sales to decline.
We may be subject to liability if we, or our vendors, infringe upon the intellectual property rights of third parties.
We may be subject to liability if we infringe upon the intellectual property rights of third parties. If we were to be found liable for any such infringement, we could be required to pay substantial damages and could be subject to injunctions preventing further infringement. Such infringement claims could harm our brand image. In addition, any payments we are required to make and any injunction with which we are required to comply as a result of such infringement actions could adversely affect our financial results.
We purchase merchandise from vendors that may utilize design copyrights, or design patents, or that may otherwise incorporate protected intellectual property. We are not involved in the manufacture of any of the merchandise we purchase from our vendors for sale to our customers, and we do not independently investigate whether these vendors legally hold intellectual property rights to merchandise that they are manufacturing or distributing. As a result, we rely upon vendors’ representations set forth in our purchase orders and vendor agreements concerning their right to sell us the products that we purchase from them. If a third-party claims to have licensing rights with respect to merchandise we purchased from a vendor, or we acquire unlicensed merchandise, we could be obligated to remove such merchandise from our stores, incur costs associated with destruction of such merchandise if the distributor or vendor is unwilling or unable to reimburse us and be subject to liability
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under various civil and criminal causes of action, including actions to recover unpaid royalties and other damages and injunctions. Although our purchase orders and vendor agreement with each vendor require the vendor to indemnify us against such claims, a vendor may not have the financial resources to defend itself or us against such claims, in which case we may have to pay the costs and expenses associated with defending such claim. Any of these results could harm our brand image and have a material adverse effect on our business and growth.
Risks Related to Our Ownership Structure and Ownership of Our Common Stock
Our founders control a majority of the voting power of our common stock, which may prevent other stockholders from influencing corporate decisions and may result in conflicts of interest.
Our common stock consists of two classes: Class A and Class B. Holders of Class A common stock are entitled to one vote per share, and holders of Class B common stock are entitled to 10 votes per share, on all matters to be voted on by our common stockholders. All of the shares of Class B common stock are beneficially owned by Hezy Shaked and Tilly Levine. As a result, Mr. Shaked and Ms. Levine own a significant economic interest in the company and substantial majority of the total voting power of our outstanding common stock. In addition, Mr. Shaked serves as Executive Chairman of the Board of Directors, and is the voting trustee, pursuant to a voting trust agreement, covering the shares owned by Ms. Levine. As a result, Mr. Shaked may dictate the outcome of most 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. Mr. Shaked may also have interests that differ from yours and may vote in a way with which you disagree and which may be adverse to your interests. This ownership concentration may adversely impact the trading of our Class A common stock because of a perceived conflict of interest that may exist, thereby depressing the value of our Class A common stock.
We are a controlled company within the meaning of the NYSE rules, and, as a result, we may rely on exemptions from certain corporate governance requirements that provide protection to stockholders of other companies.
Mr. Shaked controls more than 50% of the total voting power of our common stock and we are considered a controlled company under the NYSE corporate governance listing standards. As a controlled company, certain exemptions under the NYSE listing standards will exempt us from the obligation to comply with certain NYSE corporate governance requirements, including the requirements:
•that a majority of our Board of Directors consist of independent directors, as defined under the rules of the NYSE;
•that we have a corporate governance and nominating committee that is composed entirely of independent directors with a written charter addressing the committee’s purpose and responsibilities; and
•that we have a compensation committee that is composed entirely of independent directors with a written charter addressing the committee’s purpose and responsibilities.
Although we intend to continue to comply with these listing requirements even though we are a controlled company, there is no guarantee that we will not take advantage of these exemptions in the future. Accordingly, so long as we are a controlled company, holders of our Class A common stock may not have the same protections afforded to stockholders of companies that are subject to all of the NYSE corporate governance requirements.
If securities or industry analysts publish inaccurate or unfavorable research about our business, the price and trading volume of our Class A common stock could decline.
The trading market for our Class A common stock depends in part on the research and reports that securities or industry analysts publish about us or our business. If one or more of the analysts who covers us downgrades our Class A common stock or publishes inaccurate or unfavorable research about our business, the price of our Class A common stock would likely decline. If one or more of these analysts ceases coverage of us or fails to publish reports on us regularly, demand for our Class A common stock could decrease, which could cause the price of our Class A common stock and trading volume to decline.
Financial forecasting by us and financial analysts who may publish estimates of our performance may differ materially from actual results.
Given the dynamic nature of our business, the current uncertain economic climate and the inherent limitations in predicting the future, forecasts of our revenues, comparable sales, margins, net income and other financial and operating forecasts may differ materially from actual results. Such discrepancies could cause a decline in the trading price of our Class A common stock.
We have a small public float compared to other larger publicly-traded companies, which may result in price swings in our Class A common stock or make it difficult to acquire or dispose of our Class A common stock.
This small public float can result in large swings in our stock price with relatively low trading volume. In addition, a purchaser that seeks to acquire a significant number of shares may be unable to do so without increasing our common stock price, and conversely, a seller that seeks to dispose of a significant number of shares may experience a decreasing stock price.
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The price of our Class A common stock has been, and may continue to be, volatile and may decline in value.
The market for retail apparel stocks can be highly volatile. As a result, the market price of our Class A common stock is likely to be volatile and investors may experience a decrease in the value of the Class A common stock, unrelated to our operations. The price of our Class A common stock has, and could in the future, fluctuate significantly in response to a number of factors, as discussed in this “Risk Factors” section. Further, securities class action litigation has often been initiated against companies following periods of volatility in their stock price. This type of litigation could result in substantial costs and divert our management’s attention and resources, and could also require us to make substantial payments to satisfy judgments or to settle litigation. The threat or filing of class action litigation lawsuits could cause the price of our Class A common stock to decline.
Future sales of our common stock by us or by existing stockholders could cause the price of our Class A common stock to decline.
Any sales of a substantial number of shares of our common stock in the public market, or the perception that such sales might occur, may cause the market price for our Class A common stock to decline. Most of these are freely tradable without restriction under the Securities Act of 1933, as amended, or Securities Act. The shares of Class A common stock and Class B common stock held by Mr. Shaked and Ms. Levine, and the shares of Class A common stock held by our directors, officers and other affiliates, are restricted securities under the Securities Act, and may not be sold in the public market unless the sale is registered under the Securities Act or an exemption from registration is available.
While we have paid special cash dividends in the past, there can be no assurance that we will pay dividends in the future, which may make our Class A common stock less desirable to investors and decrease its value.
We paid special cash dividends of $1.00 per share in February of each of 2020, 2019 and 2018, and $0.70 per share in February 2017 to all holders of record of issued and outstanding shares of our common stock. However, we did not pay any cash dividend to our stockholders in February of 2021, and there can be no assurance that we will pay additional cash dividends on our common stock in the future. In addition, our credit facility restricts the payment of cash dividends until November 2021. We currently intend to retain all of our earnings to finance our operations and growth until the current pandemic environment is more stable. We do not currently have any formal plans for paying any additional cash dividends on our common stock at this time. Therefore, capital appreciation, if any, of our Class A common stock could be the sole source of gain for our Class A common stockholders for the foreseeable future.
Our corporate organizational documents and Delaware law have anti-takeover provisions that may inhibit or prohibit a takeover of us and the replacement or removal of our management.
In addition to the concentration of ownership and voting power held by Mr. Shaked and Ms. Levine, the anti-takeover provisions under Delaware law, as well as the provisions contained in our corporate organizational documents, may make an acquisition of us more difficult. For example:
•our certificate of incorporation includes a provision authorizing our Board of Directors to issue blank check preferred stock without stockholder approval, which, if issued, would increase the number of outstanding shares of our capital stock and could make it more difficult for a stockholder to acquire us;
•our certificate of incorporation provides that if all shares of our Class B common stock are converted into Class A common stock or otherwise cease to be outstanding, our Board of Directors will be divided into three classes in the manner provided by our certificate of incorporation. After the directors in each class serve for the initial terms provided in our certificate of incorporation, each class will serve for a staggered three-year term;
•our certificate of incorporation permits removal of a director only for cause by the affirmative vote of the holders of a majority of the voting power of the company once the Board of Directors is divided into three classes and provides that director vacancies can only be filled by an affirmative vote of a majority of directors then in office;
•our amended and restated bylaws require advance notice of stockholder proposals and director nominations; and
•Section 203 of the Delaware General Corporation Law may prevent large stockholders from completing a merger or acquisition of us.
These provisions may prevent a merger or acquisition of us which could limit the price investors would pay for our common stock in the future.
Our amended and restated bylaws designate the Court of Chancery of the State of Delaware as the sole and exclusive forum for certain types of actions and proceedings that may be initiated by our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers or other employees.
Our amended and restated bylaws provide that, unless we consent in writing to an alternative forum, the Court of Chancery of the State of Delaware will be the sole and exclusive forum for (i) any derivative action or proceeding brought on our behalf, (ii) any action asserting a claim of breach of a fiduciary duty owed by any director, officer or other employee to us or our stockholders, (iii) any action asserting a claim arising pursuant to any provision of the Delaware General Corporation Law, or (iv) any action asserting a claim that is governed by the internal affairs doctrine. Any person purchasing or otherwise acquiring
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any interest in any shares of our capital stock shall be deemed to have notice of and to have consented to this provision of our amended and restated bylaws. This choice-of-forum provision may limit our stockholders’ ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers or other employees, which may discourage such lawsuits. Alternatively, if a court were to find this provision of our amended and restated bylaws inapplicable or unenforceable with respect to one or more of the specified types of actions or proceedings, we may incur additional costs associated with resolving such matters in other jurisdictions, which could adversely affect our business and financial condition.
General Risks
Epidemics, pandemics, war, terrorism, civil unrest or other public disruptions could negatively affect our business.
All of our stores are located in public areas where large numbers of people typically gather. Epidemics or pandemics, including COVID-19, terrorist attacks or threats thereof, civil unrest, and/or acts or threats of violence involving public areas could cause people not to visit areas where our stores are located, including with respect to the current mandatory and elective closures as a result of the COVID-19 pandemic. These and other potential impacts of pandemics or other outbreaks of an illness, disease or virus could therefore adversely affect our results of operations and financial condition. Further, armed conflicts or acts of war throughout the world may create uncertainty, causing consumers to spend less on discretionary purchases, including on apparel and accessories, and disrupting our ability to obtain merchandise for our stores. Such decreases in consumer spending or disruptions in our ability to obtain merchandise would likely decrease our sales and materially adversely affect our financial condition and results of operations. Other types of violence, such as shootings in malls or in public areas, could lead to lower traffic in shopping malls or centers in which we operate stores. In addition, local authorities or management from the mall or shopping center could close the mall or shopping center in response to security concerns. Such closures, as well as lower traffic due to security concerns, could result in decreased sales.
We may be subject to unionization, work stoppages, slowdowns or increased labor costs.
Currently, none of our employees are represented by a union. However, our employees have the right under the National Labor Relations Act to form or affiliate with a union. If some or all of our workforce were to become unionized and the terms of the collective bargaining agreement were significantly different from our current compensation arrangements, it could increase our costs and adversely impact our profitability. Moreover, participation in labor unions could put us at increased risk of labor strikes and disruption of our operations.
Violations of and/or changes in laws, including employment laws and laws related to our merchandise, could make conducting our business more expensive or change the way we do business.
We are subject to numerous regulations, including labor and employment, customs, truth-in-advertising, consumer protection, health and safety, and zoning and occupancy laws and ordinances that regulate retailers generally and/or govern the importation, promotion and sale of merchandise and the operation of stores and warehouse facilities. If these regulations were violated by our management, employees or vendors, the costs of certain goods could increase, or we could experience delays in shipments of our goods, be subject to fines or penalties or suffer reputational harm, which could reduce demand for our merchandise and hurt our business and results of operations. Similarly, changes in laws could make operating our business more expensive or require us to change the way we do business. For example, changes in laws related to employee health care, hours, wages, job classification and benefits could significantly increase operating costs and adversely impact our results of operations. In addition, in response to the COVID-19 pandemic, many state and local governments have enacted, and continue to enact, ordinances and laws temporarily limiting the operations of certain businesses, including with respect to aspects of our business and those of our vendors. Furthermore, changes in product safety or other consumer protection laws could lead to increased costs for certain merchandise, or additional labor costs associated with readying merchandise for sale. It may be difficult for us to foresee regulatory changes impacting our business and our actions needed to respond to changes in the law could be costly and may negatively impact our operations.
As a result of being a publicly traded company, our management is required to devote substantial time to complying with public company regulations.
As a result of being a publicly traded company, we are obligated to file periodic reports with the SEC under the Exchange Act. We are also subject to other reporting and corporate governance requirements, including certain requirements of the New York Stock Exchange, or NYSE, Financial Industry Regulatory Authority, or FINRA, and certain provisions of the Sarbanes-Oxley Act of 2002, or SOX, and the regulations promulgated thereunder, which impose significant compliance obligations on us. SOX, as well as rules subsequently implemented by the SEC, NYSE and FINRA, have imposed increased regulation and disclosure and have required enhanced corporate governance practices of public companies. Our efforts to comply with evolving laws, regulations and standards result in increased administrative expenses and a diversion of management’s time and attention from revenue-generating activities. In addition, if we fail to implement or maintain the requirements with respect to our internal accounting and audit functions, our ability to continue to report our operating results on a timely and accurate basis could be impaired and we could be subject to sanctions or investigation by regulatory authorities, such as the SEC, NYSE or
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FINRA. Any such action could harm our reputation and the confidence of investors and customers in our company and could materially adversely affect our business.
Our failure to maintain adequate internal controls over our financial and management systems may cause errors in our financial reporting, which could in turn cause a loss of investor confidence.
Our public company reporting obligations and our anticipated growth will likely strain our financial and management systems, internal controls and our employees. In addition, pursuant to Section 404 of SOX, we are required to provide annually an assessment of the effectiveness of our internal controls over financial reporting and our independent registered public accounting firm will be required to provide an attestation on our assessment of our internal controls over financial reporting. The process required to comply with Section 404 of SOX is time consuming and costly. If during this process we identify one or more material weaknesses in our internal controls, it is possible that our management may not be able to certify that our internal controls are effective by the certification deadline. Moreover, if we identify any material weaknesses or significant deficiencies in our internal controls we will have to implement appropriate changes to these controls, which may require specific compliance training for our directors, officers and employees, require the hiring of additional finance, accounting, legal and other personnel, entail substantial costs to modify our existing accounting systems and take a significant period of time to complete. Such changes may not, however, be effective in maintaining the adequacy of our internal controls, and any failure to maintain that adequacy, or consequent inability to produce accurate financial statements on a timely basis, could increase our operating costs and could materially impair our ability to operate our business. Effective internal controls are necessary for us to produce reliable financial reports and are important to prevent fraud. As a result, our failure to satisfy the requirements of Section 404 on a timely basis could result in us being subject to regulatory action and a loss of investor confidence in the reliability of our financial statements, both of which in turn could cause the market value of our Class A common stock to decline.
We depend on cash generated from our operations to support our growth, which could strain our cash flow.
We primarily rely on cash flows generated from existing stores to fund our current operations and our growth plans. An increase in our net cash outflow for new stores or remodels of existing stores could adversely affect our operations by reducing the amount of cash available to address other aspects of our business. In addition, as we expand our business, we will need significant amounts of cash from operations to pay our existing and future lease obligations, build out new store space, remodel existing stores, purchase inventory, create new marketing and advertising initiatives, fund the expansion of our e-commerce business, pay personnel, pay for the increased costs associated with operating as a public company, and, if necessary, further invest in our infrastructure and facilities. If our business does not generate sufficient cash flows from operations to fund these activities and sufficient funds are not otherwise available from our existing revolving credit facility or future credit facilities, we may need additional equity or debt financing. If such financing is not available to us on satisfactory terms, our ability to operate and expand our business or to respond to competitive pressures would be limited and we could be required to delay, curtail or eliminate planned store openings or investment in existing stores. Moreover, if we raise additional capital by issuing equity securities or securities convertible into equity securities, your ownership may be diluted. Any debt financing we may incur may impose covenants on us that restrict our operations or require interest payments that would create additional cash demands and financial risk for us.
We may engage in strategic transactions that could negatively impact our liquidity, increase our expenses and present significant distractions to our management.
We may consider strategic transactions and business arrangements, including, but not limited to, acquisitions, asset purchases, partnerships, joint ventures, restructurings, divestitures and investments. Any such transaction may require us to incur non-recurring or other charges, may increase our near and long-term expenditures and may pose significant integration challenges or disrupt our management or business, which could harm our operations and financial results.
Changes to accounting rules or regulations could significantly affect our financial results.
Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America, or GAAP. New accounting rules or regulations and changes to existing accounting rules or regulations have occurred and may occur in the future. Future changes to accounting rules or regulations, such as changes as a requirement to convert to international financial reporting standards, could negatively affect our results of operations and financial condition through increased cost of compliance.
We may experience fluctuations in our tax obligations and effective tax rate.
We are subject to income taxes in federal and applicable state and local tax jurisdictions in the U.S. We record tax expense based on our estimates of current and future payments based on the income tax laws currently in effect. At any time, many tax years are subject to audit by various taxing jurisdictions. The results of these audits and negotiations with taxing authorities may impact the ultimate settlement of these tax positions. As a result, there could be ongoing variability in our tax rates as taxable
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events occur and exposures are re-evaluated. Further, our effective tax rate in any financial statement period may be materially affected by changes in the mix and level of earnings, or changes in tax laws in any relevant jurisdiction.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
We lease approximately 172,000 square feet for our corporate headquarters and retail support and distribution center located at 10 Whatney and 12 Whatney, Irvine, California. Our lease began on January 1, 2003 and terminates on December 31, 2027.
We lease approximately 26,000 square feet of office and warehouse space located at 11 Whatney, Irvine, California. The lease began on June 29, 2012 and terminates on June 30, 2022.
We lease approximately 81,000 square feet for our e-commerce fulfillment center located at 17 Pasteur, Irvine, California. The lease began on November 1, 2011 and terminates on October 31, 2021.
All of our 238 stores, encompassing a total of approximately 1.8 million total square feet as of January 30, 2021, are occupied under operating leases. The store leases generally have a base lease term of 10 years and many have renewal option periods, and we are generally responsible for payment of property taxes and utilities, common area maintenance and mall marketing fees.
We consider all of our properties adequate for our present and anticipated future needs.
Item 3. Legal Proceedings
The information under the subheading "Legal Proceedings" contained in "Note 10: Commitments and Contingencies" to our consolidated financial statements included in this Report is incorporated by reference into this Item.
Item 4. Mine Safety Disclosures
Not applicable.
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PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our Class A common stock is traded on the NYSE under the symbol “TLYS”. There is no established trading market for our Class B common stock. As of March 31, 2021, we had approximately seven stockholders of record, five of whom were holders of our Class A common stock and two of whom were holders of our Class B common stock. The number of stockholders of record is based upon the actual number of stockholders registered at such date and does not include holders of shares in “street names” or persons, partnerships, associates, corporations or other entities identified in security position listings maintained by depositories.
Dividends on Common Stock
We paid special cash dividends of $1.00 per share in February of each of 2020, 2019 and 2018, and $0.70 per share in February 2017 to all holders of record of issued and outstanding shares of our common stock. Under the terms of our new asset-backed credit facility, we are temporarily restricted from paying any cash dividends until the one-year anniversary of the credit facility on November 9, 2021. There can be no assurance that we will pay additional cash dividends on our common stock in the future, and we do not currently have any formal plans to issue dividends in the future at this time.
Securities Authorized for Issuance under Equity Compensation Plans
The information required by this Item is incorporated herein by reference to our Proxy Statement for the 2021 Annual Meeting of Stockholders, which will be filed with the SEC no later than 120 days after the end of the fiscal year ended January 30, 2021 (the "2021 Proxy Statement").
Stock Performance Graph
The following graph compares the cumulative stockholder return on our Class A common stock for the five years ended January 30, 2021 to the cumulative return of (i) the S&P Midcap 400 Index and (ii) the S&P 400 Apparel Retail Index over the same period. This graph assumes an initial investment of $100 on January 30, 2016 in our Class A common stock, the S&P Midcap 400 Index and the S&P 400 Apparel Retail Index and assumes the reinvestment of dividends, if any.
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Comparison of 5-Year Cumulative Total Return as of January 30, 2021
Among Tilly's, Inc., the S&P Midcap 400 Index and the S&P 400 Apparel Retail Index
Recent Sales of Unregistered Securities
We did not sell any unregistered equity securities or purchase any of our securities during the fiscal year ended January 30, 2021.
Item 6. Selected Financial Data
The following tables present selected consolidated financial and other data as of and for the periods indicated.
The selected consolidated statement of operations data for the fiscal year ended January 30, 2021, February 1, 2020 and February 2, 2019 and selected balance sheet data as of January 30, 2021 and February 1, 2020 are derived from our audited consolidated financial statements included in Part II, Item 8, "Financial Statements and Supplementary Data" of this Annual Report on Form 10-K. The selected consolidated statement of operations data for the fiscal years ended February 3, 2018 and February 28, 2017 and the selected consolidated balance sheet data as of February 2, 2019, February 3, 2018 and February 3, 2017 are derived from our audited consolidated financial statements that have not been included elsewhere in this report. The historical results presented below are not necessarily indicative of the results to be expected for any future period. You should read this selected consolidated financial data in conjunction with the consolidated financial statements and accompanying notes and the information under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere in this report.
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| Fiscal Year Ended (1) | |||||||||||||||||||||||||||||
| January 30, 2021 | February 1, 2020 | February 2, 2019 | February 3, 2018 | January 28, 2017 | |||||||||||||||||||||||||
| (in thousands, except per share data) | |||||||||||||||||||||||||||||
| Consolidated Statements of Operations Data: | |||||||||||||||||||||||||||||
| Net sales (2) | $ | 531,329 | $ | 619,300 | $ | 598,478 | $ | 576,899 | $ | 568,952 | |||||||||||||||||||
Cost of goods sold (3) | 389,139 | 432,592 | 417,582 | 401,529 | 400,493 | ||||||||||||||||||||||||
| Gross profit | 142,190 | 186,708 | 180,896 | 175,370 | 168,459 | ||||||||||||||||||||||||
| Selling, general and administrative expenses | 145,230 | 158,253 | 149,416 | 151,384 | 149,129 | ||||||||||||||||||||||||
| Operating (loss) income | (3,040) | 28,455 | 31,480 | 23,986 | 19,330 | ||||||||||||||||||||||||
| Other income, net | 581 | 2,901 | 2,313 | 1,223 | 418 | ||||||||||||||||||||||||
| (Loss) Income before income taxes | (2,459) | 31,356 | 33,793 | 25,209 | 19,748 | ||||||||||||||||||||||||
| Income tax (benefit) expense | (1,314) | 8,734 | 8,850 | 10,509 | 8,338 | ||||||||||||||||||||||||
| Net (loss) income | $ | (1,145) | $ | 22,622 | $ | 24,943 | $ | 14,700 | $ | 11,410 | |||||||||||||||||||
| Basic (loss) earnings per share of Class A and Class B common stock | $ | (0.04) | $ | 0.77 | $ | 0.85 | $ | 0.51 | $ | 0.40 | |||||||||||||||||||
| Diluted (loss) earnings per share of Class A and Class B common stock | $ | (0.04) | $ | 0.76 | $ | 0.84 | $ | 0.51 | $ | 0.40 | |||||||||||||||||||
| Cash dividends declared per share | $ | — | $ | 1.00 | $ | 1.00 | $ | 1.00 | $ | 0.70 | |||||||||||||||||||
| Weighted average basic shares outstanding | 29,697 | 29,533 | 29,278 | 28,804 | 28,496 | ||||||||||||||||||||||||
| Weighted average diluted shares outstanding | 29,697 | 29,788 | 29,768 | 29,074 | 28,529 | ||||||||||||||||||||||||
| Fiscal Year Ended | |||||||||||||||||||||||||||||
| January 30, 2021 | February 1, 2020 | February 2, 2019 | February 3, 2018 | January 28, 2017 | |||||||||||||||||||||||||
| Operating Data (unaudited): | |||||||||||||||||||||||||||||
| Stores operating at beginning of period | 240 | 229 | 219 | 223 | 224 | ||||||||||||||||||||||||
| Stores opened during the period | 2 | 14 | 16 | 2 | 3 | ||||||||||||||||||||||||
| Stores closed during the period | 4 | 3 | 6 | 6 | 4 | ||||||||||||||||||||||||
| Stores operating at end of period | 238 | 240 | 229 | 219 | 223 | ||||||||||||||||||||||||
| Comparable store sales change (4) | 3.7 | % | 0.8 | % | 4.0 | % | 1.0 | % | 0.5 | % | |||||||||||||||||||
| Total square feet at end of period (in thousands) | 1,751 | 1,776 | 1,703 | 1,668 | 1,703 | ||||||||||||||||||||||||
| Average square footage per store at end of period | 7,358 | 7,399 | 7,437 | 7,616 | 7,637 | ||||||||||||||||||||||||
| Average net sales per brick-and-mortar store (in thousands) (5) | $ | 1,494 | $ | 2,240 | $ | 2,263 | $ | 2,258 | $ | 2,188 | |||||||||||||||||||
| Average net store sales per square foot (5) | $ | 202 | $ | 301 | $ | 301 | $ | 296 | $ | 287 | |||||||||||||||||||
| Capital expenditures (in thousands) | $ | 8,471 | $ | 14,299 | $ | 14,923 | $ | 13,753 | $ | 17,047 | |||||||||||||||||||
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| As of | |||||||||||||||||||||||||||||
| January 30, 2021 | February 1, 2020 | February 2, 2019 | February 3, 2018 | January 28, 2017 | |||||||||||||||||||||||||
| (in thousands) | |||||||||||||||||||||||||||||
| Consolidated Balance Sheet Data: | |||||||||||||||||||||||||||||
| Cash, cash equivalents and marketable securities | $ | 141,139 | $ | 139,917 | $ | 144,079 | $ | 135,952 | $ | 133,917 | |||||||||||||||||||
| Working capital (6) | 78,597 | 63,598 | 119,882 | 107,423 | 129,819 | ||||||||||||||||||||||||
| Total assets (6) | 505,473 | 546,640 | 293,168 | 290,111 | 290,506 | ||||||||||||||||||||||||
| Total capital lease obligation (7) | — | — | — | — | 835 | ||||||||||||||||||||||||
| Stockholders’ equity | $ | 160,622 | $ | 159,901 | $ | 163,327 | $ | 160,425 | $ | 189,220 | |||||||||||||||||||
(1)The fiscal years ended January 30, 2021, February 1, 2020, February 2, 2019, and January 28, 2017 each included 52 weeks. The fiscal year ended February 3, 2018, included 53 weeks.
(2)Net sales for fiscal years 2020, 2019 and 2018 reflect the adoption of the new revenue recognition standard. Net sales for prior fiscal years have not been restated and reflect the revenue recognition standard in effect for those periods.
(3)Includes buying, distribution and occupancy costs. Fiscal 2020 and 2019 occupancy costs reflect our adoption of Accounting Standards Update ("ASU") 2016-02, Leases, using the additional modified retrospective transition method. By electing this additional transition method, we were not required to recast our comparative financial statements by the new standard for fiscal 2018 and prior years.
(4)Comparable store sales are sales from our e-commerce platform and stores open at least 12 full fiscal months as of the end of the current reporting period. However, as a result of the COVID-19 pandemic, our comparable store sales for fiscal 2020 are defined as sales from our e-commerce platform and stores open on a daily basis compared to the same respective fiscal dates last year. A remodeled, relocated or refreshed store is included in comparable store sales, both during and after construction, if the square footage of the store used to sell merchandise was not changed by more than 20% and the store was not closed for more than five days in any fiscal month. We include sales from our e-commerce platform as part of comparable store sales as we manage and analyze our business on a single omni-channel and have substantially integrated our investments and operations for our stores and e-commerce platform to give our customers seamless access and increased ease of shopping. Comparable store sales exclude gift card breakage income and e-commerce shipping and handling fee revenue. The comparable store sales change for the period ended February 3, 2018 includes the 53rd week in fiscal 2017.
(5)The number of stores and the amount of square footage reflect the number of days during the period that new stores were open. E-commerce sales, e-commerce shipping revenue, and gift card breakage income are excluded from our sales in deriving net sales per store.
(6)Working capital and total assets for fiscal year 2020 and 2019 reflect the adoption of the new lease accounting standard. Working capital and total assets for prior fiscal years have not been restated and reflect the lease accounting standard in effect for those periods.
(7)Comprised solely of a capital lease for our corporate headquarters and distribution center.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion in conjunction with the consolidated financial statements and the accompanying notes and the information contained in other sections of this report, particularly under the headings “Risk Factors”, “Selected Consolidated Financial Data” and “Business”. This discussion and analysis is based on the beliefs of our management, as well as assumptions made by, and information currently available to, our management. The statements in this discussion and analysis concerning expectations regarding our future performance, liquidity and capital resources, as well as other non-historical statements in this discussion and analysis, are forward-looking statements. See “Forward-Looking Statements”. These forward-looking statements are subject to numerous risks and uncertainties, including those described under “Risk Factors”. Our actual results could differ materially from those suggested or implied by any forward-looking statements.
We operate on a fiscal calendar widely used by the retail industry that results in a given fiscal year consisting of a 52- or 53-week period ending on the Saturday closest to January 31 of the following year. References to "fiscal year 2020" or "fiscal 2020" refer to the fiscal year ended January 30, 2021, references to "fiscal year 2019" or "fiscal 2019" refer to the fiscal year ended February 1, 2020 and references to "fiscal year 2018” or "fiscal 2018” refer to the fiscal year ended February 2, 2019. Fiscal years 2020, 2019, and 2018 each consisted of a 52-week period.
The discussion and analysis of our financial condition and results of operations for fiscal 2020 compared to fiscal 2019 appears below. As permitted by SEC rules, we have omitted the discussion and analysis of our financial condition, cash flows and results of operations for fiscal 2019 compared to fiscal 2018. See Item 7,“Management’s Discussions and Analysis of Financial Condition and Results of Operations”, in our Annual Report on Form 10-K for the year ended February 1, 2020, for this discussion.
Overview
Tillys is a leading destination specialty retailer of casual apparel, footwear, accessories and hardgoods for young men, young women, boys and girls. We believe we bring together an unparalleled selection of iconic global, emerging and proprietary brands rooted in an active and outdoor lifestyle. The Tillys concept began in 1982 when our co-founders, Hezy Shaked and Tilly Levine, opened our first store in Orange County, California. As of January 30, 2021, we operated 238 stores in 33 states, averaging approximately 7,400 square feet. We also sell our products through our e-commerce website, www.tillys.com.
Known or Anticipated Trends
As described elsewhere in this Report, the COVID-19 pandemic had far-reaching adverse impacts on many aspects of our business during fiscal 2020, both directly and indirectly, including on consumer behavior, store traffic, operational capabilities and our operations generally, timing of deliveries, demands on our information technology and e-commerce capabilities, inventory and expense management, managing our workforce, our store configurations and operations upon reopening, and our people, which have materially disrupted our business and the market generally. The scope and nature of these impacts continue to evolve.
As previously disclosed, all of our stores were abruptly closed on March 18, 2020, as a precautionary action in response to the COVID-19 pandemic and remained closed pursuant to government mandate for the remainder of the first quarter and into the second quarter of fiscal 2020. As a result, if our stores and e-commerce can remain in operation throughout the first and second quarters of fiscal 2021, we would expect our total net sales and earnings per share to be significantly improved compared to the first and second quarters of fiscal 2020. However, specifics are impossible to predict with any certainty, particularly with regard to how our operations may be impacted by the pandemic in the future as the situation continues to evolve, and how close store performance will be in relation to fiscal 2019 pre-pandemic levels, as well as how e-commerce will perform as it begins to anniversary last year's significant net sales increases during the store shutdown period noted above. While all of our stores are open as of the date of this filing, roll-outs of the COVID-19 vaccines have begun, and rates of COVID-19 cases in the United States appear to be declining, we believe our operations continue to be adversely impacted by the COVID-19 pandemic, including as a result of reduced hours of store operation, restrictions on in-store customer traffic, and shipping delays from foreign sources, among other factors. We cannot predict whether or to what degree those impacts may continue. In addition, we may experience additional or further impacts from the COVID-19 pandemic, and/or elect or need to take additional measures as the information available to us continues to develop, including with respect to our employees, inventory receipts, store leases, and relationships with our third-party vendors. We will continue to assess the evolving impact of the COVID-19 pandemic on our consumers, employees, supply chain, and operations, and intend to adjust our responses accordingly. The extent to which the COVID-19 pandemic and our response thereto may impact our business, financial condition, and results of operations will depend on future developments, which are highly uncertain and cannot be predicted at this time. For more details, see Item 1A. “Risk Factors - Risks Related to Our Business”.
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How We Assess the Performance of Our Business
In assessing the performance of our business, we consider a variety of performance and financial measures. The key indicators of the financial condition and operating performance of our business are net sales, comparable store sales, gross profit, selling, general and administrative expenses and operating income.
Net Sales
Net sales reflect revenue from the sale of our merchandise at store locations and through e-commerce, net of sales taxes. Store sales are reflected in sales when the merchandise is received by the customer. For e-commerce sales, we recognize revenue, and the related cost of goods sold at the time the merchandise is shipped to the customer. Net sales also include shipping and handling fees for e-commerce shipments that have been shipped to the customer. Net sales are net of returns on sales during the period as well as an estimate of returns expected in the future stemming from current period sales. We recognize revenue from gift cards as they are redeemed for merchandise. Prior to redemption, we maintain a current liability for unredeemed gift card balances. Our gift cards do not have expiration dates and in most cases there is no legal obligation to remit unredeemed gift cards to relevant jurisdictions. Based on actual historical redemption patterns, we determined that a small percentage of gift cards are unlikely to be redeemed (which we refer to as gift card “breakage”). Based on our historical gift card breakage rate, we recognize breakage revenue over the redemption period in proportion to actual gift card redemptions.
Our business is seasonal and as a result our revenues fluctuate from quarter to quarter. In addition, our revenues in any given quarter can be affected by a number of factors including the timing of holidays and weather patterns. The third and fourth quarters of the fiscal year, which include the back-to-school and holiday sales seasons, have historically produced stronger sales and disproportionately stronger operating results than have the first two quarters of the fiscal year.
Comparable Store Sales
Comparable store sales is a measure that indicates the change in year-over-year comparable store sales, which allows us to evaluate how our store base is performing. Numerous factors affect our comparable store sales, including:
•overall economic trends;
•our ability to attract traffic to our stores and online platform;
•our ability to identify and respond effectively to consumer preferences and fashion trends;
•competition;
•the timing of our releases of new and seasonal styles;
•changes in our product mix;
•pricing;
•the level of customer service that we provide in stores;
•our ability to source and distribute products efficiently;
•calendar shifts of holiday or seasonal periods;
•the number and timing of store openings and the relative proportion of new stores to mature stores; and
•the timing and success of promotional and advertising efforts.
Historically, our comparable store sales are sales from our e-commerce platform and stores open at least 12 full fiscal months as of the end of the current reporting period. However, as a result of the COVID-19 pandemic, our comparable store sales for fiscal 2020 are defined as sales from our e-commerce platform and stores open on a daily basis compared to the same respective fiscal dates of last year in light of the varying periods of pandemic-related store closures that took place during fiscal 2020. A remodeled, relocated or refreshed store is included in comparable store sales, both during and after construction, if the square footage of the store used to sell merchandise was not changed by more than 20% and the store was not closed for remodel for more than five days in any fiscal month. We include sales from our e-commerce platform as part of comparable store sales as we manage and analyze our business on a single omni-channel basis and have substantially integrated our investments and operations for our stores and e-commerce platform to give our customers seamless access and increased ease of shopping. Comparable store sales exclude gift card breakage income and e-commerce shipping and handling fee revenue. Some of our competitors and other retailers may calculate comparable or “same store” sales differently than we do. As a result, data in this report regarding our comparable store sales may not be comparable to similar data made available by other retailers.
Gross Profit
Gross profit is equal to our net sales less our cost of goods sold. Cost of goods sold reflects the direct cost of purchased merchandise as well as buying, distribution and occupancy costs. Buying costs include compensation and benefit expense for our internal buying organization. Distribution costs include costs for receiving, processing and warehousing our store merchandise, and shipping of merchandise to or from our distribution and e-commerce fulfillment centers and to our e-commerce customers and between store locations. Occupancy costs include the rent, common area maintenance, utilities, property taxes, security and depreciation costs of all store locations. These costs are significant and can be expected to continue
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to increase as our company grows. The components of our reported cost of goods sold may not be comparable to those of other retail companies.
We regularly analyze the components of gross profit as well as gross profit as a percentage of net sales. Specifically we look at the initial markup on purchases, markdowns and reserves, shrinkage, buying costs, distribution costs and occupancy costs. Any inability to obtain acceptable levels of initial markups, a significant increase in our use of markdowns or a significant increase in inventory shrinkage or inability to generate sufficient sales leverage on the buying, distribution and occupancy components of cost of goods sold could have an adverse impact on our gross profit and results of operations.
Gross profit is also impacted by shifts in the proportion of sales of proprietary branded products compared to third-party branded products, as well as by sales mix shifts within and between brands and between major product departments such as young men's and women's apparel, footwear or accessories. A substantial shift in the mix of products could have a material impact on our results of operations. In addition, gross profit and gross profit as a percent of sales have historically been higher in the third and fourth quarters of the fiscal year, as these periods include the back-to-school and winter holiday selling seasons. This reflects that various costs, including occupancy costs, generally do not increase in proportion to the seasonal sales increase.
Selling, General and Administrative Expenses
Our selling, general and administrative, or SG&A, expenses are comprised of store selling expenses and corporate-level general and administrative expenses. Store selling expenses include store and regional support costs, including personnel, advertising and debit and credit card processing costs, e-commerce receiving and processing costs and store supplies costs. General and administrative expenses include the payroll and support costs of corporate functions such as executive management, legal, accounting, information systems, human resources, impairment charges and other centralized services. Store selling expenses generally vary proportionately with net sales and store growth. In contrast, general and administrative expenses are generally not directly proportional to net sales and store growth, but will be expected to increase over time to support the needs of our growing company. SG&A expenses as a percentage of net sales are usually higher in lower volume periods and lower in higher volume periods.
Operating (Loss) Income
Operating (loss) income equals gross profit less SG&A expenses. Operating (loss) income excludes interest income, interest expense and income taxes. Operating (loss) income percentage measures operating income as a percentage of our net sales.
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Results of Operations
The following tables summarize key components of our results of operations for the periods indicated, both in dollars and as a percentage of our net sales:
| Fiscal Year Ended | |||||||||||||||||
| January 30, 2021 | February 1, 2020 | February 2, 2019 | |||||||||||||||
| (in thousands) | |||||||||||||||||
| Statements of Operations Data: | |||||||||||||||||
| Net sales | $ | 531,329 | $ | 619,300 | $ | 598,478 | |||||||||||
| Cost of goods sold | 389,139 | 432,592 | 417,582 | ||||||||||||||
| Gross profit | 142,190 | 186,708 | 180,896 | ||||||||||||||
| Selling, general and administrative expenses | 145,230 | 158,253 | 149,416 | ||||||||||||||
| Operating (loss) income | (3,040) | 28,455 | 31,480 | ||||||||||||||
| Other income, net | 581 | 2,901 | 2,313 | ||||||||||||||
| (Loss) Income before income taxes | (2,459) | 31,356 | 33,793 | ||||||||||||||
| Income tax (benefit) expense | (1,314) | 8,734 | 8,850 | ||||||||||||||
| Net (loss) income | $ | (1,145) | $ | 22,622 | $ | 24,943 | |||||||||||
| Percentage of Net Sales: | |||||||||||||||||
| Net sales | 100.0 | % | 100.0 | % | 100.0 | % | |||||||||||
| Cost of goods sold | 73.2 | % | 69.9 | % | 69.8 | % | |||||||||||
| Gross profit | 26.8 | % | 30.1 | % | 30.2 | % | |||||||||||
| Selling, general and administrative expenses | 27.3 | % | 25.6 | % | 25.0 | % | |||||||||||
| Operating (loss) income | (0.6) | % | 4.6 | % | 5.3 | % | |||||||||||
| Other income, net | 0.1 | % | 0.5 | % | 0.4 | % | |||||||||||
| (Loss) Income before income taxes | (0.5) | % | 5.1 | % | 5.6 | % | |||||||||||
| Income tax (benefit) expense | (0.3) | % | 1.4 | % | 1.5 | % | |||||||||||
| Net (loss) income | (0.2) | % | 3.7 | % | 4.2 | % | |||||||||||
The following table presents store operating data for the periods indicated:
| Fiscal Year Ended | |||||||||||||||||
| January 30, 2021 | February 1, 2020 | February 2, 2019 | |||||||||||||||
| Store Operating Data: | |||||||||||||||||
| Stores operating at end of period | 238 | 240 | 229 | ||||||||||||||
Comparable store sales change (1) | 3.7% | 0.8% | 4.0% | ||||||||||||||
| Total square feet at end of period (in thousands) | 1,751 | 1,776 | 1,703 | ||||||||||||||
Average net sales per brick-and-mortar store (in thousands) (2) | $1,494 | $2,240 | $2,263 | ||||||||||||||
Average net sales per square foot (2) | $202 | $301 | $301 | ||||||||||||||
E-commerce revenues (in thousands) (3) | $173,433 | $98,457 | $89,625 | ||||||||||||||
| E-commerce revenues as a percentage of net sales | 32.6% | 15.9% | 15.0% | ||||||||||||||
(1)During fiscal 2019 and 2018, our comparable store sales were sales from our e-commerce platform and stores open at least 12 full fiscal months as of the end of the current period. However, as a result of the COVID-19 pandemic, our comparable store sales for fiscal 2020 are defined as sales from our e-commerce and stores open on a daily basis compared to the same respective fiscal dates last year. A remodeled or relocated store is included in comparable store sales, both during and after construction, if the square footage of the store used to sell merchandise was not change by more than 20% and the store was not closed for remodel for more than five days in any fiscal month. Comparable store sales include sales through our e-commerce platform but exclude gift card breakage income, deferred revenue from the loyalty program and e-commerce shipping and handling fee revenue.
(2)E-commerce sales, e-commerce shipping and handling fee revenue and gift card breakage income are excluded from net sales in deriving average net sales per brick-and-mortar store.
(3)E-commerce revenues include e-commerce sales and e-commerce shipping fee revenue.
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Fiscal Year 2020 Compared to Fiscal Year 2019
Net Sales
Net sales were $531.3 million in fiscal 2020 compared to $619.3 million in fiscal 2019, a decrease of $88.0 million, or 14.2% from last year, primarily as a result of the various periods of store closures resulting from the COVID-19 pandemic. The components of our net sales decrease were as follows:
| $ millions | Attributable to | |||||||
| $18.5 | Increase in comparable net sales of 3.7%, including e-commerce and periods of actual store operation in physical stores (i.e., for stores, excluding periods of pandemic-related closures in 2020) | |||||||
| (106.5) | Decrease in non-comparable store net sales, including decreases from physical stores during periods of pandemic-related store closures | |||||||
| $(88.0) | Total | |||||||
Our comparable net sales, including e-commerce net sales and excluding stores for periods of pandemic-related closures, increased 3.7% during fiscal 2020 compared to an increase of 0.8% during fiscal 2019. E-commerce net sales increased 76.2% and represented approximately 32.6% of total net sales during fiscal 2020 compared to an increase of 9.7% and a 15.9% share of total net sales during fiscal 2019. Comparable net sales in physical stores, excluding periods of pandemic-related closures, decreased 13.5%. Total net sales from physical stores represented approximately 67.4% of total net sales during fiscal 2020. This compares to a comparable decrease of 0.7% and a 84.1% share of total net sales during fiscal 2019. All stores were closed in mid-March 2020 as a result of the impacts of the COVID-19 pandemic and remained closed for two months or more on a case by case basis. Upon reopening, physical stores operated with significant government-mandated restrictions on customer traffic and reduced operating hours for the remainder of fiscal 2020.
Gross Profit
Gross profit was $142.2 million in fiscal 2020 compared to $186.7 million in fiscal 2019, a decrease of $44.5 million, or 23.8%. These results were negatively influenced by the restrictions on store customer traffic and operating hours and the government imposed impacts due to COVID-19. Gross margin, or gross profit as a percentage of net sales, decreased to 26.8% in fiscal 2020 from 30.1% in fiscal 2019. Product margins improved 60 basis points as a percentage of net sales, primarily due to reduced total markdowns overall compared to last year. Buying, distribution, and occupancy costs deleveraged 400 basis points, collectively. Distribution costs deleveraged 190 basis points as a percentage of net sales primarily due to an increase in e-commerce shipping costs of $8.5 million resulting from a greater volume of e-commerce orders. Occupancy costs deleveraged 200 basis points as a percentage of net sales despite being reduced by $4.1 million and having two fewer stores compared to last year, against lower total net sales. Buying costs deleveraged 10 basis points as a percentage of net sales
Selling, General and Administrative Expenses ("SG&A")
SG&A was $145.2 million in fiscal 2020 compared to $158.3 million in fiscal 2019. As a percentage of net sales, SG&A was 27.3% for fiscal 2020 and 25.6% for fiscal 2019. The components of the changes in SG&A, both in terms of percentage of net sales and total dollars, were as follows:
| % | $ millions | Attributable to | ||||||||||||
| (1.5)% | (18.9) | Decrease in store payroll and benefits primarily due to temporary store closures related to COVID-19 and reduced staffing levels upon reopening of stores | ||||||||||||
| (0.5)% | (2.3) | Decrease in print advertising costs | ||||||||||||
| 2.6% | $11.5 | Increase in marketing and fulfillment costs associated with e-commerce net sales growth | ||||||||||||
| 1.1% | (3.3) | Net change in all other SG&A expenses | ||||||||||||
| 1.7% | $(13.0) | Total | ||||||||||||
Operating (Loss) Income
Operating loss was $(3.0) million in fiscal 2020 compared to operating income of $28.5 million for fiscal 2019, a decrease of $31.5 million, or 110.7%. As a percentage of net sales, operating loss was (0.6)% for fiscal 2020 compared to operating income of 4.6% for fiscal 2019. The $31.5 million decrease in operating income was primarily due to the significant COVID-19 pandemic impacts on our business as noted above.
Income Tax (Benefit) Expense
Income tax benefit was $(1.3) million for fiscal 2020 compared to income tax expense of $8.7 million for fiscal 2019. Our effective tax rates were 53.4% for fiscal 2020 and 27.9% for fiscal 2019.
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Net (Loss) Income and (Loss) Earnings Per Share
Net loss was $(1.1) million for fiscal 2020 compared to net income of $22.6 million for fiscal 2019, a decrease of $23.8 million, or 105.1%. Loss per basic share was $(0.04) for fiscal 2020 compared to diluted earnings per share of $0.76 for fiscal 2019. The decrease was primarily due to the significant COVID-19 pandemic impacts on our business noted above.
Liquidity and Capital Resources
Our business relies on cash flows from operating activities as well as cash on hand as our primary sources of liquidity. We currently expect to finance company operations, store growth and remodels with existing cash on hand, marketable securities and cash flows from operations.
In addition to cash and cash equivalents and marketable securities, the most significant components of our working capital are merchandise inventories, accounts payable and accrued expenses. Subject to certain assumptions regarding the duration and severity of the COVID-19 pandemic, and our responses thereto (including such actions we have taken or may take in the future as disclosed elsewhere in this Report), we believe that cash flows from operating activities, our cash and marketable securities on hand, and credit facility availability will be sufficient to cover our working capital requirements and anticipated capital expenditures for the next 12 months from the issuance of this Report. If cash flows from operations are not sufficient or available to meet our capital requirements, then we will be required to obtain additional equity or debt financing in the future. There can be no assurance that equity or debt financing will be available to us when we need it or, if available, that the terms will be satisfactory to us and not dilutive to our stockholders.
Impact of CARES Act on Company Liquidity
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act, or the CARES Act, was signed into law. The CARES Act includes tax provisions applicable to businesses, such as net operating losses, enhanced interest deductibility, optional deferral of deposits of payroll taxes, a refundable employee retention payroll tax credit, and changes to the depreciation rules for qualified improvement property. As of January 30, 2021, pursuant to the CARES Act, we have deferred the deposit of certain payroll taxes, applied for certain tax credits, and accelerated depreciation on qualified improvement property.
Working Capital
Working capital at January 30, 2021, was $78.6 million compared to $63.6 million at February 1, 2020, an increase of $15.0 million. The changes in our working capital during fiscal 2020 were as follows:
| $ millions | Description | |||||||
| $63.6 | Working capital at February 1, 2020 | |||||||
| 29.7 | Increase in working capital primarily due to no cash dividend accrual at the end of fiscal 2020 | |||||||
| (9.9) | Decrease in working capital primarily due to timing of accrued expenses | |||||||
| (4.8) | Net changes in all other assets and liabilities | |||||||
| $78.6 | Working capital at January 30, 2021 | |||||||
Cash Flow Analysis
A summary of operating, investing and financing activities is shown in the following table:
| Fiscal Year Ended | |||||||||||||||||
| January 30, 2021 | February 1, 2020 | February 2, 2019 | |||||||||||||||
| (in thousands) | |||||||||||||||||
| Net cash provided by operating activities | $ | 38,897 | $ | 36,434 | $ | 46,743 | |||||||||||
| Net cash used in investing activities | (3,197) | (6,509) | (6,259) | ||||||||||||||
| Net cash used in financing activities | (29,653) | (27,948) | (25,526) | ||||||||||||||
Net Cash Provided by Operating Activities
Operating activities consist primarily of net income adjusted for non-cash items that include depreciation, asset impairment write-downs, deferred income taxes and share-based compensation expense, plus the effect on cash of changes during the year in our assets and liabilities.
Net cash provided by operating activities increased in fiscal 2020 as compared to fiscal 2019 primarily due to the timing of payments to vendors, an increase in accrued expenses and an increase in accrued compensation and benefits, offset by a decrease in prepaid expenses and other assets and a decrease in net income.
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Net Cash Used in Investing Activities
Investing activities consist of capital expenditures for growth related to new store openings as well as for remodels and changes in fixtures and equipment at existing stores, investments in information technology, distribution center enhancements, assets at our corporate headquarters and the addition or replacement of company vehicles. Investing activities also consist of the purchase and sale of marketable securities.
Net cash used in investing activities was $3.2 million in fiscal 2020. Capital expenditures totaled $8.5 million, primarily related to new and remodeled stores and other improvements in our existing stores and information technology systems. We purchased $80.9 million of marketable securities and received proceeds of $86.2 million from marketable securities during fiscal 2020.
Net cash used in investing activities was $6.5 million in fiscal 2019. Capital expenditures totaled $14.3 million, primarily related to new and remodeled stores and other improvements in our existing stores and information technology systems. We purchased $126.5 million of marketable securities and received proceeds of $134.3 million from marketable securities during fiscal 2019.
Net Cash Used in Financing Activities
Financing activities consist of proceeds from the exercise of stock options, cash dividends paid, borrowings and repayments of our line of credit, and employee taxes paid in result of the net settlement of issued restricted stock.
Net cash used in financing activities was $29.7 million in fiscal 2020. This included $29.7 million of cash dividends paid and $23.7 million in both borrowings and repayments under our line of credit.
Net cash used in financing activities was $27.9 million in fiscal 2019. This included $29.5 million of cash dividends paid, partially offset by $1.6 million of proceeds from the exercise of stock options.
Asset-Backed Credit Facility
On November 9, 2020, we entered into a credit agreement (the "New Credit Agreement") with Wells Fargo Bank, N.A. ("Bank"), which replaced our previous amended and restated credit agreement (as amended, the "Prior Credit Agreement") with the Bank, which was terminated concurrently therewith. No borrowings were outstanding under the Prior Credit Agreement as of the closing date.
The New Credit Agreement provides for an asset-based, senior secured revolving credit facility of up to $65.0 million consisting of revolving loans, letters of credit and swing line loans provided by lenders, with a sub limit on credit outstanding at any time of $10.0 million and a sub limit for swing line loans of $7.5 million. The New Credit Agreement also includes an uncommitted accordion feature whereby we may increase the revolving commitment by an aggregate amount not to exceed $12.5 million, subject to certain conditions. The revolving facility matures on November 9, 2023. The payment and performance in full of the secured obligations under the revolving facility are secured by a lien on and security interest in all of the assets of our company.
The maximum borrowings permitted under the revolving facility is equal to the lesser of (x) the revolving commitment and (y) the borrowing base. The borrowing base is equal to (a) 90% of the borrowers’ eligible credit card receivables, plus (b) 90% of the cost of the borrowers’ eligible inventory, less inventory reserves established by the agent, and adjusted by the appraised value of such eligible inventory, plus (c) 90% of the cost of the borrowers’ eligible in-transit inventory, less inventory reserves established by the agent, and adjusted by the appraised value of such eligible in-transit inventory (not to exceed 10% of the total amount of all eligible inventory included in the borrowing base) less (d) reserves established by the agent. As of the closing date, we were eligible to borrow up to a total of $40.1 million under the revolving facility. As of the closing date, we had no outstanding borrowings under the New Credit Agreement and the only utilization of the letters of credit sub limit under the New Credit Agreement was a $2.025 million irrevocable standby letter of credit, which was previously issued under the Prior Credit Agreement and was transferred on the closing date to the New Credit Agreement.
The unused portion of the revolving commitment accrues a commitment fee, which ranges from 0.375% to 0.50% per annum, based on the average daily borrowing capacity under the revolving facility over the applicable fiscal quarter. Borrowings under the revolving facility bear interest at a rate per annum that ranges from the LIBOR rate plus 2.0% to the LIBOR rate plus 2.25%, or the base rate plus 1.0% to the base rate plus 1.25%, based on the average daily borrowing capacity under the revolving facility over the applicable fiscal quarter. We may elect to apply either the LIBOR rate or base rate interest to borrowings at our discretion, other than in the case of swing line loans, to which the base rate shall apply.
Under the New Credit Agreement, we are subject to a variety of affirmative and negative covenants of types customary in an asset-based lending facility, including a financial covenant relating to availability, and customary events of default. Prior to the first anniversary of the closing date, we are prohibited from declaring or paying any cash dividends to our respective stockholders or repurchasing of our own common stock. After the first anniversary of the closing date, we are allowed to declare and pay cash dividends to our respective stockholders and repurchase our own common stock, provided, among other
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things, no default or event of default exists as of the date of any such payment and after giving effect thereto and certain minimum availability and minimum projected availability tests are satisfied.
In connection with the entry into the New Credit Agreement, on November 9, 2020, we entered into certain ancillary agreements, including (i) a security agreement in favor of the agent, and (ii) a guaranty by us in favor of the agent. The security agreement and the guaranty replaced (i) the general pledge agreement, dated as of May 3, 2012, by us in favor of the bank, (ii) the continuing guaranty by us in favor of the agent, dated May 3, 2012, and (iii) the amended and restated security agreement with respect to equipment and the amended and restated security agreement with respect to rights to payment and inventory, in each case, dated as of May 3.
As of January 30, 2021, we were in compliance with all of our covenants, eligible to borrow up to a total of $35.4 million, and had no outstanding borrowings under the New Credit Agreement.
Contractual Obligations
We enter into long-term contractual obligations and commitments in the normal course of business, primarily non-cancellable operating leases.
We lease approximately 172,000 square feet for our corporate headquarters and distribution center from a company that is owned by the co-founders of Tillys. These buildings are located at 10 and 12 Whatney, Irvine, California. The lease is accounted for as an operating lease and expires on December 31, 2027.
We lease approximately 26,000 square feet of office and warehouse space with a company that is owned by one of the co-founders of Tillys. This building is located at 11 Whatney, Irvine, California. The lease is accounted for as an operating lease and expires on June 30, 2022.
We lease approximately 81,000 square feet for our e-commerce distribution center from a company that is owned by one of the co-founders of Tillys. This building is located at 17 Pasteur, Irvine, California. The lease is accounted for as an operating lease and expires on October 31, 2021.
Our leases are generally non-cancellable operating leases expiring at various dates through fiscal year 2031. Certain leases provide for additional rent based on a percentage of sales and annual rent increases based upon the Consumer Price Index. In addition, many of our store leases contain certain co-tenancy provisions that permit us to pay rent based on a pre-determined percentage of sales when the occupancy of the retail center falls below minimums established in such lease.
Off-Balance Sheet Arrangements
We are not a party to any off-balance sheet arrangements, except with respect to certain purchase obligations primarily for software maintenance services and the letter of credit outstanding under our New Credit Agreement as discussed above.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires the appropriate application of accounting policies, some of which require us to make estimates and assumptions about future events and their impact on amounts reported in our consolidated financial statements. Since future events and their impact cannot be determined with absolute certainty, the actual results will inevitably differ from our estimates.
We believe the application of our accounting policies, and the estimates inherently required therein, are reasonable. Our accounting policies and estimates are reevaluated on an ongoing basis and adjustments are made when facts and circumstances dictate a change.
The policies and estimates discussed below involve the selection or application of alternative accounting policies that are material to our consolidated financial statements. With respect to critical accounting policies, even a relatively minor variance between actual and expected experience can potentially have a materially favorable or unfavorable impact on subsequent results of operations. However, our historical results for the periods presented in the consolidated financial statements have not been materially impacted by such variances. Our accounting policies are more fully described in "Note 2: Summary of Significant Accounting Policies” in the notes to our consolidated financial statements. Management has discussed the development and selection of these critical accounting policies and estimates with our Board of Directors.
We have certain accounting policies that require more significant management judgment and estimates than others. These include our accounting policies with respect to revenue recognition, loyalty program, merchandise inventories, long-lived assets, operating leases, share-based compensation and accounting for income taxes, which are more fully described below.
Revenue Recognition
Revenue is recognized for store sales when the customer receives and pays for the merchandise at the register, net of estimated returns. Taxes collected from our customers are recorded on a net basis. For e-commerce sales, we recognize revenue, net of
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sales taxes and estimated sales returns, and the related cost of goods sold at the time the merchandise is shipped to the customer. Amounts related to shipping and handling that are billed to customers are reflected in net sales, and the related costs are reflected in cost of goods sold in the Consolidated Statements Operations.
Our business is seasonal and as a result our revenues fluctuate from quarter to quarter. In addition, our revenues in any given quarter can be affected by a number of factors including the timing of holidays and weather patterns. The third and fourth quarters of the fiscal year, which include the back-to-school and holiday sales seasons, have historically produced stronger sales and disproportionately stronger operating results than have the first two quarters of the fiscal year.
Gift Cards
We recognize revenue from gift cards as they are redeemed for merchandise. Prior to redemption, we maintain a current liability for unredeemed gift card balances. Our gift cards do not have expiration dates and in most cases there is no legal obligation to remit unredeemed gift cards to relevant jurisdictions. Based on actual historical redemption patterns, we determined that a small percentage of gift cards are unlikely to be redeemed (which we refer to as gift card "breakage"). Based on our historical gift card breakage rate, we recognize breakage revenue over the redemption period in proportion to actual gift card redemptions.
Loyalty Program
We have a customer loyalty program wherein customers accumulate points based on purchase activity. Once a loyalty member achieves a certain point level, the member earns an award that may be used towards the purchase of merchandise. Unredeemed awards and accumulated partial points are accrued as deferred revenue and awards redeemed by the member for merchandise are recorded as an increase to net sales. Our loyalty program allows customers to redeem their awards instantly or build up to additional awards over time. We currently expire unredeemed awards and accumulated partial points 365 days after the last purchase activity. A liability is estimated based on the standalone selling price of awards and partial points earned and estimated redemptions.
Merchandise Inventories
Merchandise inventories are stated at the lower of cost or net realizable value, which generally is the merchandise selling price. Cost is calculated using the retail inventory method. Under the retail inventory method, inventory is stated at its current retail selling value and then is converted to a cost basis by applying a cost-to-retail ratio based on beginning inventory and the fiscal year purchase activity. The retail inventory method inherently requires management judgments and estimates, such as the amount and timing of markdowns needed in order to sell through slow-moving inventories.
Markdowns are recorded when the sales value of the inventory has diminished. Factors considered in the determination of markdowns include current and anticipated demand, customer preferences, age of the merchandise and fashion trends. When a decision is made to mark down merchandise, the resulting gross margin reduction is recognized in the period in which the markdown is recorded. During each accounting period we record adjustments to our inventories, which are reflected in cost of goods sold, if the cost of specific inventory items on hand exceeds the amount we expect to realize from the ultimate sale or disposal of the inventory. This adjustment calculation requires us to make assumptions and estimates, which are based on factors such as merchandise seasonality, historical trends and inventory levels, including estimated sell-through rates of remaining units.
To the extent that management’s estimates differ from actual results, additional markdowns may be required that could reduce our gross margin, operating income and the carrying value of inventories. Our success is largely dependent upon our ability to anticipate the changing fashion tastes of our customers and to respond to those changing tastes in a timely manner. If we fail to anticipate, identify or react appropriately to changing styles, trends or brand preferences of our customers, we may experience lower sales, excessive inventories and more frequent and extensive markdowns, which would adversely affect our operating results.
We also record an inventory shrinkage reserve calculated as a percentage of net sales for estimated merchandise losses for the period between the last physical inventory count and the balance sheet date. These estimates are based on historical percentages and can be affected by changes in merchandise mix and changes in shrinkage trends. We perform physical inventory counts at least once per year for the entire chain of stores and our distribution center and adjust the inventory shrinkage reserve accordingly. If actual physical inventory losses differ significantly from the estimate, our results of operations could be adversely impacted. The inventory shrinkage reserve reduces the value of total inventory and is a component of inventories on the Consolidated Balance Sheets. The inventory shrinkage reserve at January 30, 2021 and February 1, 2020 was not material.
Long-Lived Assets
We evaluate the carrying value of our long-lived assets, consisting largely of leasehold improvements, furniture and fixtures and equipment at store, distribution center and corporate office locations, for impairment whenever events or changes in
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circumstances indicate that the carrying value of such assets may not be recoverable. Factors that are considered important that could result in the necessity to perform an impairment review include a current-period operating or cash flow loss combined with a history of operating or cash flow losses and a forecast that indicates continuing losses or insufficient income associated with the realization of a long-lived asset or asset group. Other factors include a significant change in the manner of the use of the asset or a significant negative industry or economic trend. This evaluation is performed based on estimated undiscounted future cash flows from operating activities compared with the carrying value of the related assets. If the undiscounted future cash flows are less than the carrying value, an impairment loss is recognized, measured by the difference between the carrying value and the estimated fair value of the assets, based on discounted cash flows using our weighted-average cost of capital, with such estimated fair values determined using the best information available. Quarterly, we assess whether events or changes in circumstances have occurred that potentially indicate the carrying value of long-lived assets may not be recoverable.
The estimation of future cash flows from operating activities requires significant estimates of factors that include future sales and gross margin performance. Factors used in the valuation of long-lived assets with finite lives include, but are not limited to, discount rates, management’s plans for future operations, recent operating results and projected future cash flows. If our net sales or gross profit performance or other estimated operating results are not achieved at or above our forecasted level, or inflation exceeds our forecast and we are unable to recover such costs through price increases, the carrying value of certain of our retail stores may prove to be unrecoverable and we may incur additional impairment charges in the future.
Operating Leases
During the first quarter of 2019, we adopted ASC 842, Leases (the "Lease Standard"), using the transition method provided in ASU 2018-11 (refer to "Note 2: Summary of Significant Accounting Policies" in Item 8). As a result, reporting periods beginning in the first quarter of 2019 are presented under the Lease Standard while prior period amounts are not adjusted and continue to be reported in accordance with our historic accounting under ASC 840 - Leases.
Upon adoption of the Lease Standard, we recorded our operating leases on the consolidated balance sheet as operating lease assets, current portion of operating lease liabilities and non-current operating lease liabilities. Operating lease liabilities are initially recognized based on the net present value of the fixed portion of our lease components through the lease term. To calculate the net present value, we apply an incremental borrowing rate ("IBR"). The incremental borrowing rate is determined using a portfolio approach based on the rate of interest we would pay to borrow an amount equal to the lease payments on a collateralized basis over a similar term. From our adoption of ASC 842 during Q1 FY2019 through Q2 FY2020, the IBR used was obtained from our financial institution. Beginning Q3 FY2020, the IBR used was obtained from an independent third-party valuation firm. We recognize operating lease assets based on lease liabilities and initial direct costs, less any tenant allowance incentives. We test operating lease assets for impairment in the same manner as long-lived assets, and include the related operating lease liability and operating lease payments in our analysis.
Share-based Compensation
We account for share-based compensation in accordance with the provisions of ASC Topic 718, Compensation-Stock Compensation, or ASC 718, which establishes accounting for equity instruments exchanged for employee services. Under the provisions of this standard, share-based compensation expense is measured at the grant date, based on the calculated fair value of the award, and is recognized as an expense on a straight-line basis over the employee’s requisite service period (generally the vesting period of the equity grant). Changes in these inputs and assumptions can materially affect the measurement of the estimated fair value of the award and related share-based compensation expense.
Determining the fair value of share-based awards at the grant date requires judgment. We use the Black-Scholes option-pricing model to determine the fair value of stock options. The determination of the grant date fair value of options using an option-pricing model is affected by a number of assumptions, such as the fair value of the common stock, our expected stock price volatility over the expected term of the options, stock option exercise and cancellation behaviors, risk-free interest rates, and expected dividends, which we estimate as follows:
•Fair Value of Our Common Stock. We use the closing price of our Class A common stock on the date of grant.
•Expected Term. We have limited historical information regarding expected option term. Accordingly, we determined the expected stock option term of the awards using the latest historical data available from comparable public companies and our expectation of exercise behavior.
•Volatility. Our stock volatility for each grant is measured using the weighted average of historical daily price changes of our common stock over the most recent period equal to the expected option term of the awards.
•Risk-Free Rate. The risk-free interest rate is based on the yields of United States Treasury securities with maturities similar to the expected term of the stock options for each stock option group.
•Dividend Yield. We do not currently have any policy with respect to recurring dividends in place. However, we have declared and paid special cash dividends in each of the prior four years, including $0.70 per share in early 2017 and
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$1.00 per share in each of early 2018, 2019 and 2020 to all holders of record of issued and outstanding shares of Class A common stock and Class B common stock. Under our New Credit Agreement, we are prohibited from declaring or paying any cash dividend to our respective stockholders through the first anniversary of the closing date. There can be no guarantee that we will continue to pay special cash dividends in the future. Consequently, we used an expected dividend yield of zero in the valuation of our share-based compensation.
If any of the assumptions used in the Black-Scholes model change significantly, share-based compensation expense for future awards may differ materially compared with the expense for awards granted previously.
Accounting for Income Taxes
We account for income taxes and the related accounts using the asset and liability method in accordance with FASB ASC Topic 740, Income Taxes, or ASC 740. Under this method, we accrue income taxes payable or refundable and recognize deferred tax assets and liabilities based on differences between GAAP and tax bases of assets and liabilities. We measure deferred tax assets and liabilities using enacted tax rates in effect for the years in which the differences are expected to reverse, and recognize the effect of a change in enacted rates in the period of enactment.
We record net deferred tax assets to the extent we believe these assets will more likely than not be realized. In making such determination, we consider all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies and recent financial operations.
We establish assets and liabilities for uncertain positions taken or expected to be taken in income tax returns, using a more-likely-than-not recognition threshold. We include in income tax expense any interest and penalties related to uncertain tax positions.
Item 7A. Quantitative and Qualitative Disclosures About Market Risks
Interest Rate Risk
We are subject to interest rate risk in connection with borrowings, if any, under our credit facility, which bears interest at variable rates. As of January 30, 2021 and February 1, 2020, we had no outstanding borrowings under our credit facility.
Impact of Inflation
Our results of operations and financial condition are presented based on historical cost. While it is difficult to accurately measure the impact of inflation due to the imprecise nature of the estimates required, we believe the effects of inflation, if any, on our results of operations and financial condition have been immaterial.
Foreign Exchange Rate Risk
We currently source all merchandise through domestic vendors. We source certain fixtures and materials from various suppliers in other countries. All purchases are denominated in U.S. dollars, and therefore we do not hedge using any derivative instruments. Historically, we have not been impacted by changes in exchange rates.
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Item 8. Financial Statements and Supplementary Data
Tilly’s, Inc.
Index to Consolidated Financial Statements
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Report of Independent Registered Public Accounting Firm
Shareholders and Board of Directors
Tilly’s, Inc.
Irvine, California
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Tilly’s, Inc. (the “Company”) as of January 30, 2021 and February 1, 2020, the related consolidated statements of operations, comprehensive (loss) income, stockholders’ equity, and cash flows for each of the three years in the period ended January 30, 2021, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at January 30, 2021 and February 1, 2020, and the results of its operations and its cash flows for each of the three years in the period ended January 30, 2021, in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company's internal control over financial reporting as of January 30, 2021, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) and our report dated March 31, 2021 expressed an unqualified opinion thereon.
Change in Accounting Method Related to Leases
As discussed in Notes 2 and 9 to the consolidated financial statements, the Company has changed its method of accounting for leases during the year ended February 1, 2020 due to the adoption of the Accounting Standards Codification (“ASC”) 842, Leases.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or were required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements; and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
Cash Flow Projections Used In Impairment of Long-Lived Assets
As described in Notes 6 and 9 to the consolidated financial statements, the Company’s consolidated balance of net property and equipment was $52.6 million and consolidated operating lease right-of-use assets balance was $227.9 million as of January 30, 2021, respectively. As described in Notes 2, 6 and 11, the Company recognized store asset impairment charges of $1.0 million during the fiscal year ended January 30, 2021. On at least a quarterly basis, management assesses whether events or changes in circumstances have occurred that potentially indicate the carrying value of long-lived assets may not be recoverable. For stores with impairment indicators, the Company determines whether projected undiscounted future cash flows from operations are sufficient to recover their carrying value. Impairment may result when the carrying value of the store assets exceeds the estimated undiscounted
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future cash flows over the remaining useful life. The Company’s impairment analysis consists of (1) identifying stores with indicators of impairment; (2) testing the identified store assets for recoverability; and (3) measuring the impairment loss.
We identified cash flow projections used in impairment of long-lived assets as a critical audit matter. The determination of the estimated growth rates used to project future sales and gross margin at individual stores requires significant management judgment. Changes in these estimates could have a significant impact on whether long-lived store assets should be further evaluated for impairment and could have a significant impact on any resulting impairment charge. Auditing these elements was especially challenging and subjective due to the effort required to perform audit procedures to evaluate the Company’s judgments used in these estimates.
The primary procedures we performed to address this critical audit matter included:
•Testing the design and operating effectiveness of certain controls over the Company's long-lived asset impairment review process. These procedures included testing controls over management’s review of the data used in its cash flow projections and models, as well as the review of significant assumptions including estimates of future sales and gross margin of individual stores.
•Testing the reasonableness of management’s assumptions about future sales and gross margin for the relevant retail stores by comparing the forecasts to:
▪Historical sales and gross margin;
▪Recent trends by store considering the uncertainties related to the COVID-19 pandemic; and
▪Available industry and economic trends, to determine if contradictory evidence existed.
Determination of Incremental Borrowing Rates for Leases
As described in Notes 2 and 9 to the consolidated financial statements, the Company renegotiated a significant number of lease contracts during the year ended January 30, 2021. The Company establishes an operating lease right-of-use asset and operating lease liability for leases. The measurement of the operating lease right-of-use asset and operating lease liability requires the determination of an incremental borrowing rate, which involves complex judgment by management.
We identified the determination of the incremental borrowing rates for new and renegotiated lease contracts as a critical audit matter. Significant judgment is required by management to develop inputs and assumptions used to determine the incremental borrowing rate for lease contracts. Auditing the reasonableness of these inputs and assumptions involved especially challenging auditor judgment due to the nature and extent of audit effort required to address these matters including the extent of specialized skill or knowledge needed.
The primary procedures we performed to address this critical audit matter included:
•Testing the design and operating effectiveness of certain controls over the Company’s accounting for leases. These procedures included testing controls over management’s review of the incremental borrowing rate.
•Developing independent estimates of fully collateralized incremental borrowing rates for newly executed and amended lease contracts, by utilizing personnel with specialized knowledge and skill in valuation to assist in (i) developing synthetic credit ratings for the Company; and (ii) identifying market interest rates based on the determined rating and applicable lease terms.
/s/ BDO USA, LLP
We have served as the Company's auditor since 2015.
Costa Mesa, California
March 31, 2021
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Tilly’s, Inc.
Consolidated Balance Sheets
(In thousands, except per share data)
| January 30, 2021 | February 1, 2020 | ||||||||||
| ASSETS | |||||||||||
| Current assets: | |||||||||||
| Cash and cash equivalents | $ | $ | |||||||||
| Marketable securities | |||||||||||
| Receivables | |||||||||||
| Merchandise inventories | |||||||||||
| Prepaid expenses and other current assets | |||||||||||
| Total current assets | |||||||||||
| Operating lease assets | |||||||||||
| Property and equipment, net | |||||||||||
| Other assets | |||||||||||
| Total assets | $ | $ | |||||||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | |||||||||||
| Current liabilities: | |||||||||||
| Accounts payable | $ | $ | |||||||||
| Accrued expenses | |||||||||||
| Deferred revenue | |||||||||||
| Accrued compensation and benefits | |||||||||||
| Dividends payable | |||||||||||
| Current portion of operating lease liabilities | |||||||||||
| Total current liabilities | |||||||||||
| Noncurrent portion of operating lease liabilities | |||||||||||
| Other | |||||||||||
| Total long-term liabilities | |||||||||||
| Total liabilities | |||||||||||
| Commitments and contingencies (Note 10) | |||||||||||
| Stockholders’ equity: | |||||||||||
Common stock (Class A), $ | |||||||||||
Common stock (Class B), $ | |||||||||||
Preferred stock, $ | |||||||||||
| Additional paid-in capital | |||||||||||
| Retained earnings | |||||||||||
| Accumulated other comprehensive income | |||||||||||
| Total stockholders’ equity | |||||||||||
| Total liabilities and stockholders’ equity | $ | $ | |||||||||
The accompanying notes are an integral part of these consolidated financial statements.
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Tilly’s, Inc.
Consolidated Statements of Operations
(In thousands, except per share data)
| Fiscal Year Ended | |||||||||||||||||
| January 30, 2021 | February 1, 2020 | February 2, 2019 | |||||||||||||||
| Net sales | $ | $ | $ | ||||||||||||||
| Cost of goods sold (includes buying, distribution, and occupancy costs) | |||||||||||||||||
| Gross profit | |||||||||||||||||
| Selling, general and administrative expenses | |||||||||||||||||
| Operating (loss) income | ( | ||||||||||||||||
| Other income, net | |||||||||||||||||
| (Loss) Income before income taxes | ( | ||||||||||||||||
| Income tax (benefit) expense | ( | ||||||||||||||||
| Net (loss) income | $ | ( | $ | $ | |||||||||||||
| Basic (loss) earnings per share of Class A and Class B common stock | $ | ( | $ | $ | |||||||||||||
| Diluted (loss) earnings per share of Class A and Class B common stock | $ | ( | $ | $ | |||||||||||||
| Weighted average basic shares outstanding | |||||||||||||||||