Tilly’s(TLYS) - 2019 Q4 - Annual Report

Forward-Looking Statements This section outlines various risks and uncertainties that could cause Tillys' actual results to differ materially from expectations, encompassing operational, market, financial, and external factors, serving as a cautionary statement for investors regarding future performance - Operational risks include the ability to successfully open new stores, attract e-commerce customers, efficiently utilize fulfillment centers, adapt to new geographic markets, maintain a strong brand image, generate adequate cash, identify and respond to fashion trends, compete effectively, manage inventory, adapt to declining store traffic, and manage rapid expansion[13] - External risks include natural disasters, adverse weather conditions, changes in the competitive environment, dependence on third-party vendors, increases in costs (energy, transportation, labor), international trade conditions, vendor labor practices, disruptions in the supply chain and distribution center, information system failures, acts of war/terrorism/civil unrest, governmental laws and regulations, and the inability to protect intellectual property rights[13][17] - Financial risks include indebtedness and lease obligations, the ability to increase comparable store sales or sales per square foot, and continuing costs incurred as a public company[13][17] PART I Item 1. Business Tillys is a leading specialty retailer of casual apparel, footwear, and accessories for young men, women, boys, and girls, operating 229 stores in 33 states and an e-commerce platform with a dynamic merchandise model and flexible real estate strategy 1.1 Company Overview - Tillys is a leading destination specialty retailer of casual apparel, footwear, and accessories for young men, young women, boys, and girls[19] - As of February 2, 2019, Tillys operated 229 stores, including four RSQ-branded pop-up stores, in 33 states, complemented by an e-commerce website[19] 1.2 Strengths - Tillys offers a broad and differentiated assortment of over 200 brands, including lifestyle, emerging third-party, and proprietary brands, appealing to a wide demographic[23] - The company employs a dynamic merchandise model, closely monitoring trends and shipping products multiple times per week to adjust the mix based on store size and location[23] - Tillys utilizes a flexible real estate strategy, successfully operating stores in various venues (malls, power centers, lifestyle centers, outlet centers, street-front) across 85 markets in 33 states[23] - A multi-pronged marketing approach connects with customers through catalogs, digital platforms, vendor collaborations, social media, and a customer loyalty program[23][24] 1.3 Growth Strategy - Tillys leverages existing distribution, fulfillment, and allocation infrastructure to support continued growth with minimal incremental capital investment[25] - Strategies include driving comparable store sales through new merchandise, exclusive brands, multi-pronged marketing, and enhanced customer experience[25] - The company aims to increase operating margins through scale efficiencies, favorable buying costs, and leveraging fixed occupancy and corporate overhead[25] - E-commerce growth is pursued by enhancing mobile applications, launching same-day delivery and ship-from-store options, and expanding online-only styles[25] - Real estate opportunities include opening 10 to 15 new full-size stores in fiscal 2019, evaluating RSQ-branded pop-up stores, and making approximately 140 lease decisions over fiscal 2019-2021 to improve profitability[28] 1.4 Merchandising, Purchasing, and Planning and Allocation This section details Tillys' approach to merchandise selection, procurement, and inventory management, emphasizing a broad assortment of brands, dynamic trend identification, and efficient allocation strategies 1.4.1 Merchandising - Tillys offers an extensive selection of over 200 third-party and proprietary brands across apparel, footwear, and accessories, catering to an active, connected lifestyle[27][29] - Third-party brands constituted approximately 75% of total net sales in fiscal 2018, with proprietary brands making up the remaining 25%[29][30] Percent of Net Sales by Department (Fiscal Year Ended February 2, 2019) | Department | Percent of Net Sales | | :--------- | :------------------- | | Mens | 35% | | Womens | 25% | | Accessories| 18% | | Footwear | 12% | | Boys | 6% | | Girls | 4% | | Total | 100% | 1.4.2 Merchandise Purchasing - The merchandising team focuses on product relevance, quality, fit, availability, cost, and speed of production to ensure timely delivery of merchandise[35] - Strong relationships with over 100 domestic third-party vendors provide access to a wide variety of products and exclusive merchandise[36] - Proprietary brands are sourced both domestically and internationally, offering flexibility in lead times and costs to quickly respond to fashion trends[36] 1.4.3 Planning and Allocation - The planning and allocation team continuously analyzes inventory levels and sell-through data to adjust merchandise assortment and inventory levels across stores[37] - Merchandise mix is modified based on store size, season, and regional consumer preferences, with frequent shipments to stores enabling quick reactions to changing needs[37] 1.5 Stores Tillys operated 229 stores across 33 states as of February 2, 2019, with an average of 7,500 square feet per full-size store, planning 10-15 new full-size stores in fiscal 2019 and strategic lease decisions 1.5.1 Store Locations and Types - As of February 2, 2019, Tillys operated 229 stores (225 full-size, 4 RSQ-branded pop-up) in 33 states[38] - In fiscal 2018, stores generated average net sales of $2.3 million per store, or $301 per square foot[38] Number of Stores by Type of Retail Center | Type of Retail Center | 2018 | 2017 | 2016 | | :-------------------- | :--- | :--- | :--- | | Regional Mall | 131 | 119 | 114 | | Off-Mall | 83 | 85 | 90 | | Outlet | 15 | 15 | 19 | | Total | 229| 219| 223| 1.5.2 Store Expansion Opportunities and Site Selection - Tillys plans to open 10 to 15 new full-size stores in fiscal 2019, focusing on clustering in promising markets to enhance brand awareness[44] - The company will make approximately 140 lease decisions (extensions, kick-outs, renewals) over fiscal 2019, 2020, and 2021, with profitability as the overarching goal, potentially leading to store closures[28][44] Store Openings and Closures (Last Five Fiscal Years) | Fiscal Year | Stores Opened | Stores Closed | Total Number of Stores at End of Period | | :---------- | :------------ | :------------ | :-------------------------------------- | | 2014 | 19 | 2 | 212 | | 2015 | 15 | 3 | 224 | | 2016 | 3 | 4 | 223 | | 2017 | 2 | 6 | 219 | | 2018 | 16 | 6 | 229 | 1.5.3 Store Management, Culture and Training - Tillys focuses on attracting, training, retaining, and motivating qualified employees, with each store typically having a three to five-member management team and 10+ full-time equivalent associates[45] - The corporate culture empowers store managers to make business decisions and rewards them for exceeding sales targets, fostering a competitive yet fun environment[46] - Comprehensive training programs are provided at store, district, and regional levels to improve operational expertise and selling skills[47] 1.6 E-Commerce - Tillys' e-commerce platform generated $90 million in sales during fiscal 2018, representing 15% of total net sales, and serves customers in all 50 states[48] - Recent technology investments include a new point-of-sale system, an upgraded e-commerce website platform, and a new order management system to enable omni-channel capabilities like fulfilling online orders from stores and in-store pickup[48] - In fiscal 2019, plans include upgrading the mobile application and launching same-day delivery from select stores and a ship-from-store ordering option[48] 1.7 Marketing and Advertising - Tillys employs a multi-pronged marketing strategy, including an enhanced customer loyalty program, email marketing, catalogs, and postcards to drive traffic and build brand awareness[49] - The company actively uses social media (Facebook, Instagram, Twitter, Snapchat) and partners with social media stars and influencers to communicate with customers and drive brand awareness[56] - Brand partnerships with vendors facilitate exclusive in-store events, contests, and appearances by musicians, celebrities, and athletes to engage customers[56] - Through its 'We Care Program' and Tilly's Life Center, the company supports academic, art, and athletic programs in local communities[56] 1.8 Distribution - Tillys operates a 126,000 square foot distribution facility and a dedicated e-commerce fulfillment center, both co-located with its headquarters in Irvine, California[50][51] - Extensive investments in automation, material-handling equipment, and radio frequency technologies enhance processing speed and long-term scalability[50] - Merchandise is shipped to stores multiple times per week in a floor-ready format, minimizing in-store processing time[52] 1.9 Information Technology - Tillys' information technology systems provide comprehensive business process support, enabling a dynamic merchandise model, operational efficiencies, and scalability[54] - Recent upgrades include new cloud-based point-of-sale, order management, and customer relationship management systems, along with an e-commerce website re-platforming[55] - These improvements aim to enhance customer engagement, increase sales opportunities, improve real-time inventory visibility, and facilitate seamless omni-channel execution[55] 1.10 Competition - The teenage and young adult retail apparel, accessories, and footwear industry is highly competitive, with Tillys competing against specialty retailers, department stores, online marketplaces (e.g., Amazon), and direct marketers[56] - Competition is based on merchandise offerings, store location, price, and the ability to identify with the customer[58] - Many competitors are larger and possess substantially greater financial, marketing, and other resources, and can emulate Tillys' business strategy and in-store experience[58] 1.11 Trademarks - Tillys protects its valuable trademarks, including 'Tilly's', 'RSQ', 'Full Tilt', and other proprietary brand names, through registration with the United States Patent and Trademark Office[59] - The company vigorously protects its trademarks to maintain brand identity and prevent infringement[59] 1.12 Employees - As of February 2, 2019, Tillys employed approximately 1,400 full-time and 4,200 part-time employees, with numbers fluctuating seasonally[60] - None of the employees are represented by a labor union, and the company considers its relationship with employees to be good[60] 1.13 Government Regulation - Tillys is subject to various labor and employment laws, advertising and promotions laws, privacy laws, safety regulations, and consumer protection regulations[61] - The company monitors changes in these laws and believes it is in material compliance with applicable regulations[61] 1.14 Insurance - Tillys uses insurance to address or reduce exposure to enterprise risks, including workers' compensation, property damage, directors' and officers' liability, cyber/data security, and general liability[62] - Insurance requirements are evaluated on an ongoing basis to maintain adequate levels of coverage for identified risks[62] 1.15 Seasonality - Tillys' business is seasonal, with revenues and net income typically smallest in the first fiscal quarter and increasing sequentially, peaking during back-to-school and winter holiday seasons[63] - Performance during peak selling periods significantly impacts annual results, and working capital levels reflect this seasonality, with inventory reaching highest levels in anticipation of increased revenues[63] 1.16 Additional Information - Tillys makes its Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, and Current Reports on Form 8-K available free of charge on its investor relations website (www.tillys.com) and the SEC's website (www.sec.gov)[65](index=65&type=chunk) Item 1A. Risk Factors This section details significant risks and uncertainties that could materially adversely affect Tillys' business, financial condition, results of operations, and stock price, categorized by business-specific and stock ownership risks 1A.1 Risks Related to Our Business - Inability to identify and respond quickly to changing fashion preferences and trends can adversely affect sales and profit margins due to unsold inventory[68] - Tillys faces intense competition from larger retailers and online marketplaces, which may lead to price reductions and negatively impact operating cash flow[69][70] - Sales are highly susceptible to declines in consumer confidence and spending, influenced by economic conditions and non-economic factors, particularly in regions with high store concentration[71][93] - Risks associated with store expansion include identifying suitable locations, obtaining acceptable lease terms, sourcing inventory, hiring staff, and managing infrastructure, while e-commerce growth faces risks like diversion of store traffic and system failures[81][82] - Dependence on third-party suppliers for merchandise, potential increases in raw material, labor, and transportation costs, and susceptibility to international trade conditions due to foreign production can adversely affect business and operations[84][85][87] - The company is subject to data protection laws (e.g., CCPA) and risks of system security failures or breaches, which could result in compliance costs, litigation, fines, and reputational harm[101][102][103][104] 1A.2 Risks Related to Ownership of Our Class A Common Stock - Tillys is a 'controlled company' under NYSE rules, with co-founders controlling a majority of voting power, potentially allowing reliance on exemptions from certain corporate governance requirements[110][126] - The price of Class A common stock may be volatile due to analyst research, a small public float, and general market conditions, potentially leading to price swings or difficulty in trading significant shares[127][129][130] - Anti-takeover provisions in corporate documents and Delaware law may inhibit or prohibit a takeover, potentially limiting the price investors would pay for common stock[134] - There is no assurance of future dividend payments, as the company currently intends to retain all earnings to finance operations and growth[137] Item 1B. Unresolved Staff Comments Tillys reports no unresolved staff comments from the Securities and Exchange Commission - There are no unresolved staff comments[138] Item 2. Properties Tillys leases all its facilities, including corporate headquarters, distribution, and 229 retail stores totaling 1.7 million square feet, generally with 10-year terms and renewal options - Tillys leases approximately 172,000 square feet for its corporate headquarters and retail support/distribution center in Irvine, California, with a lease expiring in December 2027[139] - An additional 26,000 square feet of office and warehouse space is leased in Irvine, California, with a lease expiring in June 2022[139] - The e-commerce fulfillment center, approximately 81,000 square feet, is also leased in Irvine, California, with a lease expiring in October 2021[140] - All 229 stores, totaling approximately 1.7 million square feet, are occupied under operating leases, typically with 10-year base terms and renewal options[141] Item 3. Legal Proceedings Tillys is involved in various lawsuits, including wage and hour class actions and a TCPA settlement for $1.5 million cash and discount coupons, which the company vigorously defends - A putative class action, Juan Carlos Gonzales v. Tilly's Inc. et al, alleging California wage and hour law violations, was dismissed in June 2018[143] - The Lauren Minniti v. Tilly's, Inc. class action, alleging TCPA violations, was settled for an estimated $6.2 million (subsequently reduced to $1.5 million cash payment) and the issuance of approximately 612,000 non-transferable discount coupons[144][326][327] - The Skylar Ward v. Tilly's, Inc. class action, also alleging California wage and hour law violations, saw a trial court dismissal overturned on appeal in February 2019, with Tillys filing a petition for review with the California Supreme Court[145][146][328] - A copyright infringement lawsuit involving a vendor was concluded with a final settlement payment in June 2018, which was not materially different from the amount previously accrued[147][329] Item 4. Mine Safety Disclosures This item is not applicable to Tillys, as the company is not involved in mining operations - This item is not applicable[148] PART II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Tillys' Class A common stock trades on the NYSE under 'TLYS', with approximately seven stockholders of record as of March 26, 2019, and no unregistered securities sold or purchased by the issuer during the fiscal year - Tillys' Class A common stock is traded on the New York Stock Exchange (NYSE) under the symbol 'TLYS'[150] - As of March 26, 2019, there were approximately seven stockholders of record, including five holders of Class A common stock and two holders of Class B common stock[150] - No unregistered equity securities were sold, and no securities were purchased by the issuer during the fiscal year ended February 2, 2019[155] Item 6. Selected Financial Data This section provides a five-year summary of selected consolidated financial and operating data, including statements of income, balance sheet data, and key operating metrics, offering a historical perspective on performance Consolidated Statements of Income Data (in thousands, except per share data) | Metric | FY 2018 (Feb 2, 2019) | FY 2017 (Feb 3, 2018) | FY 2016 (Jan 28, 2017) | FY 2015 (Jan 30, 2016) | FY 2014 (Jan 31, 2015) | | :-------------------------------- | :-------------------- | :-------------------- | :-------------------- | :-------------------- | :-------------------- | | Net sales | $598,478 | $576,899 | $568,952 | $550,991 | $518,294 | | Gross profit | $180,896 | $175,370 | $168,459 | $167,246 | $155,532 | | Operating income | $31,480 | $23,986 | $19,330 | $18,096 | $23,189 | | Net income | $24,943 | $14,700 | $11,410 | $7,541 | $14,075 | | Basic EPS | $0.85 | $0.51 | $0.40 | $0.27 | $0.50 | | Diluted EPS | $0.84 | $0.51 | $0.40 | $0.27 | $0.50 | | Cash dividends declared per share | $1.00 | $1.00 | $0.70 | $— | $— | Operating Data (unaudited) | Metric | FY 2018 (Feb 2, 2019) | FY 2017 (Feb 3, 2018) | FY 2016 (Jan 28, 2017) | FY 2015 (Jan 30, 2016) | FY 2014 (Jan 31, 2015) | | :-------------------------------- | :-------------------- | :-------------------- | :-------------------- | :-------------------- | :-------------------- | | Stores operating at end of period | 229 | 219 | 223 | 224 | 212 | | Comparable store sales change | 4.0% | 1.0% | 0.5% | 1.2% | (2.8)% | | Total square feet at end of period| 1,703,187 | 1,668,008 | 1,703,144 | 1,704,031 | 1,622,156 | | Average net sales per brick-and-mortar store (in thousands) | $2,263 | $2,258 | $2,188 | $2,219 | $2,250 | | Average net store sales per square foot | $301 | $296 | $287 | $290 | $292 | | Capital expenditures (in thousands) | $14,923 | $13,753 | $17,047 | $23,100 | $23,636 | Consolidated Balance Sheet Data (in thousands) | Metric | As of Feb 2, 2019 | As of Feb 3, 2018 | As of Jan 28, 2017 | As of Jan 30, 2016 | As of Jan 31, 2015 | | :-------------------------------- | :---------------- | :---------------- | :---------------- | :---------------- | :---------------- | | Cash, cash equivalents and marketable securities | $144,079 | $135,952 | $133,917 | $100,952 | $84,746 | | Working capital | $119,882 | $107,423 | $129,819 | $110,965 | $94,394 | | Total assets | $293,168 | $290,111 | $290,506 | $270,751 | $257,551 | | Stockholders' equity | $163,327 | $160,425 | $189,220 | $173,213 | $158,686 | Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations This section provides management's perspective on Tillys' financial condition and results of operations for fiscal years 2018-2016, discussing key performance indicators, trends, strategies, liquidity, capital resources, and critical accounting policies 7.1 Overview - Tillys is a leading destination specialty retailer of casual apparel, footwear, and accessories for young men, young women, boys, and girls, operating 229 stores in 33 states and an e-commerce website[163] - Fiscal years 2018 and 2016 consisted of 52 weeks, while fiscal year 2017 included a 53-week period[162] 7.2 Known or Anticipated Trends - The retail industry continues to experience a downward trend in physical store traffic, offset by increased online shopping, leading Tillys to focus on improving existing stores and expanding omni-channel capabilities[164] - In fiscal 2019, Tillys expects to open 10 to 15 new full-size stores and potentially additional RSQ-branded pop-up stores, with total capital expenditures not exceeding $25 million[165] - Anticipated operating cost increases of approximately $6 million in fiscal 2019 are due to minimum wage increases, merit increases, new systems costs, and the adoption of the new lease accounting standard[166] - Discount coupons issued as part of a legal settlement had no material impact on fiscal 2018 comparable store net sales or operating results, but their potential impact through September 4, 2019, could be material[167][168] 7.3 How We Assess the Performance of Our Business Tillys evaluates business performance using key indicators like net sales, comparable store sales, gross profit, SG&A expenses, and operating income, analyzed considering seasonality, market trends, and operational efficiencies 7.3.1 Net Sales - Net sales include revenue from store and e-commerce merchandise, net of sales taxes and estimated returns; e-commerce sales revenue is recognized at the time merchandise is shipped[170] - Revenue from gift cards is recognized as they are redeemed, with breakage revenue recognized over the redemption period in proportion to actual redemptions[170] - The business is seasonal, with the third and fourth fiscal quarters historically producing stronger sales and operating results due to back-to-school and holiday sales seasons[171] 7.3.2 Comparable Store Sales - Comparable store sales measure year-over-year changes in net sales from stores open at least 12 full fiscal months, including e-commerce platform sales[172] - This metric excludes gift card breakage income, deferred revenue from the loyalty program, and e-commerce shipping and handling fee revenue[160][172] - Numerous factors affect comparable store sales, including economic trends, customer traffic, fashion trends, competition, timing of new merchandise, product mix, pricing, customer service, and promotional efforts[172] 7.3.3 Gross Profit - Gross profit equals net sales less cost of goods sold, which includes direct merchandise costs, buying, distribution, and occupancy costs[173] - Gross profit is impacted by initial markups, markdowns, shrinkage, and shifts in the sales mix between proprietary and third-party branded products[175][176] - Gross profit and gross profit as a percentage of net sales are historically higher in the third and fourth fiscal quarters due to seasonal sales increases leveraging fixed costs[176] 7.3.4 Selling, General and Administrative Expenses ("SG&A") - SG&A expenses comprise store selling expenses (personnel, advertising, card processing) and corporate-level general and administrative expenses (executive, legal, accounting, IT, HR, impairment charges)[177] - Store selling expenses generally vary proportionately with net sales and store growth, while general and administrative expenses are less directly proportional but increase to support company growth[177] 7.3.5 Operating Income - Operating income is calculated as gross profit less selling, general and administrative expenses, excluding interest income, interest expense, and income taxes[178] 7.4 Results of Operations This section presents a detailed analysis of Tillys' financial performance for fiscal years 2018-2016, highlighting changes in net sales, gross profit, SG&A expenses, operating income, income tax expense, and net income 7.4.1 Fiscal Year 2018 Compared to Fiscal Year 2017 - Net sales increased by $21.6 million, or 3.7%, to $598.5 million in fiscal 2018, despite fiscal 2017 containing an extra week[181] - Comparable store net sales increased 4.0%, driven by a 1.4% increase in physical stores and a 21.7% increase in e-commerce[181] - Gross profit increased by $5.5 million, or 3.2%, to $180.9 million, but gross margin decreased by 20 basis points to 30.2% due to higher distribution costs and lower product margins[182] - SG&A expenses decreased by $2.0 million to $149.4 million, representing 25.0% of net sales (down from 26.2%), primarily due to a $7.6 million reduction in legal matter impacts[183] - Operating income increased by $7.5 million, or 31.2%, to $31.5 million, with operating income as a percentage of net sales improving by 110 basis points to 5.3%[184] - Net income increased by $10.2 million, or 69.7%, to $24.9 million, and diluted earnings per share rose to $0.84 from $0.51, largely due to reduced legal provisions and the Tax Act's lower corporate tax rates[185][186] 7.4.2 Fiscal Year 2017 Compared to Fiscal Year 2016 - Net sales increased by $7.9 million, or 1.4%, to $576.9 million in fiscal 2017[187] - Comparable store net sales increased 1.0%, driven by a 1.6% increase in store sales, partially offset by a 2.5% decrease in e-commerce sales due to transitional issues with a new order management system[187] - Gross profit increased by $6.9 million, or 4.1%, to $175.4 million, with gross margin improving by 0.8% to 30.4% primarily due to a decline in buying, distribution, and occupancy costs[188] - SG&A expenses were $151.4 million, remaining flat at 26.2% of net sales, despite increases in legal provisions and IT system implementation expenses, offset by decreases in marketing spend[189] - Operating income increased by $4.7 million, or 24.1%, to $24.0 million, with operating income as a percentage of net sales improving to 4.2%[190] - Net income increased by $3.3 million, or 28.8%, to $14.7 million, and diluted earnings per share rose to $0.51 from $0.40[192] 7.5 Liquidity and Capital Resources Tillys relies on operating cash flows and cash on hand to fund operations and growth, with working capital at $119.9 million in fiscal 2018, a $25.0 million revolving line of credit, and $25 million in planned fiscal 2019 capital expenditures 7.5.1 Cash Flow Analysis Summary of Cash Flows (in thousands) | Activity | FY 2018 (Feb 2, 2019) | FY 2017 (Feb 3, 2018) | FY 2016 (Jan 28, 2017) | | :-------------------------------- | :-------------------- | :-------------------- | :-------------------- | | Net cash provided by operating activities | $46,743 | $32,708 | $48,509 | | Net cash used in investing activities | $(6,259) | $(40,878) | $(21,658) | | Net cash (used in) provided by financing activities | $(25,526) | $(17,622) | $1,123 | - Net cash provided by operating activities increased in fiscal 2018 primarily due to higher net income, an increase in accrued compensation and benefits, and a decrease in deferred rent[197] - Net cash used in investing activities was $6.3 million in fiscal 2018, primarily for $14.9 million in capital expenditures and net purchases of marketable securities[200] - Net cash used in financing activities was $25.5 million in fiscal 2018, driven by $29.1 million in cash dividends paid, partially offset by $3.7 million from stock option exercises[204] 7.5.2 Line of Credit - Tillys maintains a $25.0 million revolving line of credit with Wells Fargo Bank, N.A., maturing on January 26, 2020, secured by substantially all company assets[207] - The credit facility includes financial covenants requiring minimum income before taxes, a maximum Funded Debt to EBITDAR ratio, minimum eligible inventory, and maximum fixed asset investment[208][313] - As of February 2, 2019, Tillys had no outstanding borrowings under the credit facility and was in compliance with all covenants[210][315] 7.5.3 Contractual Obligations Contractual Cash Obligations as of February 2, 2019 (in thousands) | | Total | Less Than 1 Year | 1-3 Years | 3-5 Years | More Than 5 Years | | :-------------------------- | :---- | :--------------- | :-------- | :-------- | :---------------- | | Operating Lease Obligations | $324,067 | $63,893 | $113,947 | $79,282 | $66,945 | | Purchase Obligations | $6,130 | $2,603 | $3,119 | $408 | $— | | Total | $330,197| $66,496 | $117,066| $79,690 | $66,945 | - Operating leases include minimum lease commitments for stores, corporate headquarters, and distribution centers, with certain leases being related-party transactions[211][215] - Purchase obligations primarily consist of software maintenance commitments[216] 7.5.4 Off-Balance Sheet Arrangements - Tillys is not a party to any off-balance sheet arrangements, except for the operating leases, purchase obligations, and revolving credit facility discussed elsewhere in the report[217] 7.6 Critical Accounting Policies and Estimates This section outlines Tillys' critical accounting policies and estimates requiring significant management judgment, including revenue recognition, loyalty program, inventories, long-lived assets, share-based compensation, and income taxes, with potential material impact from estimate variances 7.6.1 Revenue Recognition - Revenue from store sales is recognized when the customer receives and pays for merchandise; e-commerce sales revenue is recognized at the time merchandise is shipped to the customer[223] - Revenue from gift cards is recognized upon redemption, with breakage revenue recognized over the redemption period in proportion to actual redemptions[285] - The business is seasonal, with revenues fluctuating quarterly and typically stronger in the third and fourth fiscal quarters[224] 7.6.2 Loyalty Program - Customers accumulate points based on purchase activity, earning awards redeemable for merchandise[225] - Unredeemed awards and accumulated partial points are accrued as deferred revenue, and revenue is recognized when awards are redeemed[225] - Revenue recognized from the loyalty program was $1.7 million in fiscal 2018, $1.3 million in fiscal 2017, and $0.6 million in fiscal 2016[287] 7.6.3 Merchandise Inventories - Merchandise inventories are stated at the lower of cost or net realizable value, calculated using the retail inventory method[226] - Markdowns are recorded when the sales value of inventory diminishes, based on factors like demand, customer preferences, and age of merchandise[227] - An inventory shrinkage reserve is recorded as a percentage of net sales for estimated merchandise losses between physical counts[229] 7.6.4 Long-Lived Assets - The carrying value of long-lived assets (leasehold improvements, furniture, fixtures, equipment) is evaluated for impairment when events or changes indicate non-recoverability[230] - Impairment losses are recognized if estimated undiscounted future cash flows are less than the carrying value, measured by the difference between carrying value and estimated fair value based on discounted cash flows[230] - Non-cash impairment charges of $0.8 million, $0.8 million, and $2.4 million were recorded in fiscal years 2018, 2017, and 2016, respectively[309] 7.6.5 Share-based Compensation - Share-based compensation expense is measured at the grant date fair value and recognized on a straight-line basis over the employee's requisite service period[232] - The Black-Scholes option-pricing model is used to determine the fair value of stock options, requiring assumptions for expected term, volatility, risk-free interest rates, and expected dividends (zero for Tillys)[233][234] - Total share-based compensation expense was $2.2 million in fiscal 2018, $2.4 million in fiscal 2017, and $2.6 million in fiscal 2016[349] 7.6.6 Accounting for Income Taxes - Tillys accounts for income taxes using the asset and liability method, recognizing deferred tax assets and liabilities based on differences between GAAP and tax bases[235] - Net deferred tax assets are recorded to the extent they are believed to be more likely than not realized, considering future taxable income and tax planning strategies[236] - The impact of the Tax Cuts and Jobs Act, which reduced the U.S. federal tax rate from 35% to 21%, has been included in financial results for fiscal 2018 and 2017[238] 7.6.7 New Accounting Standards Not Yet Adopted and Accounting Standard Adopted in 2018 - Tillys adopted FASB ASU No. 2014-09, Revenue from Contracts with Customers (ASC 606), on February 4, 2018, resulting in a $1.4 million increase to opening retained earnings and changes in gift card breakage and e-commerce revenue recognition[301][302] - The company expects to adopt ASU No. 2016-02, Leases (ASC 842), on February 3, 2019 (fiscal 2020), which will materially impact the balance sheet by recognizing approximately $324 million in right-of-use assets and lease liabilities for operating leases[298][299] - ASU No. 2016-13, Measurement of Credit Losses on Financial Instruments, will become effective in the first quarter of fiscal 2020, requiring estimation of expected losses over the life of financial assets[300] Item 7A. Quantitative and Qualitative Disclosures About Market Risk Tillys is exposed to interest rate risk from variable-rate borrowings, with no outstanding amounts as of February 2, 2019, and considers inflation immaterial with no foreign exchange rate risk - Tillys is subject to interest rate risk in connection with borrowings under its line of credit, which bears variable interest rates; however, there were no outstanding borrowings as of February 2, 2019[240] - The effects of inflation on Tillys' results of operations and financial condition are believed to be immaterial[241] - Tillys does not have foreign exchange rate risk as all merchandise and fixture purchases are denominated in U.S. dollars[242] Item 8. Financial Statements and Supplementary Data This section presents Tillys' audited consolidated financial statements, including balance sheets, income, comprehensive income, stockholders' equity, and cash flows for fiscal years ended February 2, 2019, February 3, 2018, and January 28, 2017, with accompanying notes 8.1 Report of Independent Registered Public Accounting Firm - BDO USA, LLP, the independent registered public accounting firm, expressed an unqualified opinion on Tillys' consolidated financial statements as of February 2, 2019, and February 3, 2018, and for the three years ended February 2, 2019[248] - The firm also issued an unqualified opinion on the effectiveness of the company's internal control over financial reporting as of February 2, 2019[249] 8.2 Consolidated Balance Sheets Consolidated Balance Sheets (in thousands) | ASSETS | February 2, 2019 | February 3, 2018 | | :-------------------------------- | :--------------- | :--------------- | | Cash and cash equivalents | $68,160 | $53,202 | | Marketable securities | $75,919 | $82,750 | | Merchandise inventories | $55,809 | $53,216 | | Total current assets | $217,141 | $203,054 | | Property and equipment, net | $73,842 | $83,321 | | Total assets | $293,168 | $290,111 | | LIABILITIES AND STOCKHOLDERS' EQUITY | | | | Accounts payable | $24,207 | $21,615 | | Accrued expenses | $18,756 | $22,731 | | Deferred revenue | $10,373 | $10,879 | | Dividends payable | $29,453 | $29,067 | | Total current liabilities | $97,259 | $95,631 | | Total liabilities | $129,841 | $129,686 | | Total stockholders' equity | $163,327 | $160,425 | 8.3 Consolidated Statements of Income Consolidated Statements of Income (in thousands, except per share data) | Metric | Fiscal Year Ended Feb 2, 2019 | Fiscal Year Ended Feb 3, 2018 | Fiscal Year Ended Jan 28, 2017 | | :-------------------------------- | :---------------------------- | :---------------------------- | :----------------------------- | | Net sales | $598,478 | $576,899 | $568,952 | | Cost of goods sold | $417,582 | $401,529 | $400,493 | | Gross profit | $180,896 | $175,370 | $168,459 | | Selling, general and administrative expenses | $149,416 | $151,384 | $149,129 | | Operating income | $31,480 | $23,986 | $19,330 | | Income before income taxes | $33,793 | $25,209 | $19,748 | | Income tax expense | $8,850 | $10,509 | $8,338 | | Net income | $24,943 | $14,700 | $11,410 | | Basic earnings per share | $0.85 | $0.51 | $0.40 | | Diluted earnings per share | $0.84 | $0.51 | $0.40 | 8.4 Consolidated Statements of Comprehensive Income Consolidated Statements of Comprehensive Income (in thousands) | Metric | Fiscal Year Ended Feb 2, 2019 | Fiscal Year Ended Feb 3, 2018 | Fiscal Year Ended Jan 28, 2017 | | :-------------------------------- | :---------------------------- | :---------------------------- | :----------------------------- | | Net income | $24,943 | $14,700 | $11,410 | | Net change in unrealized gains on available-for-sale securities | $212 | $(52) | $44 | | Comprehensive income | $25,155 | $14,648 | $11,454 | 8.5 Consolidated Statements of Stockholders' Equity - Total stockholders' equity increased from $160.4 million at February 3, 2018, to $163.3 million at February 2, 2019[264] - Key changes in stockholders' equity during fiscal 2018 included net income of $24.9 million, dividends declared of $(29.5) million, and share-based compensation expense of $2.2 million[264] - The cumulative-effect adjustment from the adoption of ASC 606 increased retained earnings by $1.4 million in fiscal 2018[264] 8.6 Consolidated Statements of Cash Flows Consolidated Statements of Cash Flows (in thousands) | Activity | Fiscal Year Ended Feb 2, 2019 | Fiscal Year Ended Feb 3, 2018 | Fiscal Year Ended Jan 28, 2017 | | :-------------------------------- | :---------------------------- | :---------------------------- | :----------------------------- | | Net cash provided by operating activities | $46,743 | $32,708 | $48,509 | | Net cash used in investing activities | $(6,259) | $(40,878) | $(21,658) | | Net cash (used in) provided by financing activities | $(25,526) | $(17,622) | $1,123 | | Change in cash and cash equivalents | $14,958 | $(25,792) | $27,974 | | Cash and cash equivalents, end of period | $68,160 | $53,202 | $78,994 | 8.7 Notes to Consolidated Financial Statements These notes provide detailed information supporting the consolidated financial statements, covering company description, significant accounting policies, financial statement line items, commitments, contingencies, and other disclosures 8.7.1 Note 1: Description of the Company and Basis of Presentation - Tillys is a leading destination specialty retailer of casual apparel, footwear, and accessories, operating 229 stores in 33 states and an e-commerce platform[268] - The company's fiscal year ends on the Saturday closest to January 31; fiscal years 2018 and 2016 were 52 weeks, and fiscal year 2017 was 53 weeks[271] - Tillys identifies its operating segments based on how the business is managed and evaluated, aggregating them into one reportable segment[272] 8.7.2 Note 2: Summary of Significant Accounting Policies - Merchandise inventories are stated at the lower of cost or net realizable value using the retail inventory method, including markdowns and shrinkage reserves[275][276][277] - Revenue recognition for e-commerce sales changed with the adoption of ASC 606 in fiscal 2018, now recognized at the shipping point rather than upon customer receipt[283][301] - Gift card breakage revenue is now recognized over time in proportion to actual customer redemptions, a change from previous recognition after two full fiscal years[285][301] - The adoption of ASC 606 resulted in a net cumulative effect adjustment that increased the opening balance of retained earnings by $1.4 million in fiscal 2018[302] - Tillys expects the adoption of ASC 842 (Leases) in fiscal 2020 to have a material effect on financial statements, including the recognition of approximately $324 million in right-of-use assets and lease liabilities[298][299] 8.7.3 Note 3: Marketable Securities - Marketable securities consist of commercial paper (available-for-sale) and fixed income securities (held-to-maturity), all with maturities less than one year[303] Marketable Securities at February 2, 2019 (in thousands) | | Cost or Amortized Cost | Gross Unrealized Gains | Estimated Fair Value | | :-------------------- | :--------------------- | :--------------------- | :------------------- | | Commercial paper | $49,402 | $302 | $49,704 | | Fixed income securities | $26,215 | $— | $26,215 | | Total | $75,617 | $302 | $75,919 | - Gains on investments for commercial paper were $1.0 million in fiscal 2018, $0.8 million in fiscal 2017, and $0.3 million in fiscal 2016[304] 8.7.4 Note 4: Receivables Receivables at February 2, 2019 (in thousands) | Type | Amount | | :--- | :----- | | Credit and debit card receivables | $2,679 | | Tenant allowances due from landlords | $2,729 | | Vendor receivables | $467 | | Other | $210 | | Less: Allowance for doubtful accounts | $(3) | | Total receivables | $6,082 | 8.7.5 Note 5: Prepaid Expenses and Other Current Assets Prepaid Expenses and Other Current Assets at February 2, 2019 (in thousands) | Type | Amount | | :--- | :----- | | Prepaid rent | $7,680 | | Prepaid maintenance | $1,759 | | Prepaid insurance | $816 | | Other | $916 | | Total prepaid expenses and other current assets | $11,171 | 8.7.6 Note 6: Property and Equipment Property and Equipment, Net (in thousands) | Category | February 2, 2019 | February 3, 2018 | | :-------------------------- | :--------------- | :--------------- | | Leasehold improvements | $138,996 | $132,428 | | Furniture and fixtures | $45,061 | $43,983 | | Computer hardware and software | $39,110 | $37,722 | | Machinery and equipment | $32,377 | $31,509 | | Vehicles | $2,080 | $1,891 | | Construction in progress | $2,469 | $1,854 | | Property and equipment, gross | $260,093 | $249,387 | | Accumulated depreciation | $(186,251) | $(166,066) | | Property and equipment, net | $73,842 | $83,321 | - Depreciation expense related to property and equipment was $22.5 million in fiscal 2018, $23.4 million in fiscal 2017, and $23.3 million in fiscal 2016[307] - Non-cash impairment charges of $0.8 million, $0.8 million, and $2.4 million were recorded in fiscal years 2018, 2017, and 2016, respectively, to write down long-lived assets to their estimated fair values[309] 8.7.7 Note 7: Accrued Expenses Accrued Expenses at February 2, 2019 (in thousands) | Type | Amount | | :--- | :----- | | Accrued construction | $2,539 | | Accrued freight | $2,703 | | Sales and use taxes payable | $1,702 | | Income taxes payable | $1,679 | | Merchandise returns | $1,399 | | Computer services | $868 | | Loss contingencies | $42 | | Other | $7,824 | | Total accrued expenses | $18,756 | - Accrued loss contingencies significantly decreased from $6.466 million at February 3, 2018, to $42 thousand at February 2, 2019[311] 8.7.8 Note 8: Line of Credit - Tillys has a $25.0 million revolving line of credit with Wells Fargo Bank, N.A., maturing on January 26, 2020, secured by substantially all company assets[312] - Financial covenants include maintaining income before income taxes of at least $1 million, a maximum Funded Debt to EBITDAR ratio of 4.00 to 1.00, minimum eligible inventory/cash/marketable securities of $50 million, and maximum fixed asset investment of $50 million annually[313] - As of February 2, 2019, Tillys was in compliance with all covenants and had no outstanding borrowings under the revolving credit facility[315] 8.7.9 Note 9: Leases - Tillys leases all its retail stores and corporate operations facilities, with lease terms generally up to ten years, including related-party leases for its headquarters and distribution centers[316][317][318][319] Future Minimum Rental Commitments as of February 2, 2019 (in thousands) | Fiscal Year | Related Party | Other | Total | | :---------- | :------------ | :---- | :---- | | 2019 | $3,351 | $60,542 | $63,893 | | 2020 | $3,451 | $56,681 | $60,132 | | 2021 | $3,274 | $50,541 | $53,815 | | 2022 | $2,278 | $41,893 | $44,171 | | 2023 | $2,163 | $32,948 | $35,111 | | Thereafter | $9,112 | $57,833 | $66,945 | | Total | $23,629 | $300,438| $324,067| - Total rent expense was $44.1 million in fiscal 2018, $37.1 million in fiscal 2017, and $44.2 million in fiscal 2016[321] 8.7.10 Note 10: Commitments and Contingencies - Tillys has future minimum payments under purchase obligations, primarily for software maintenance, aggregating to $6.1 million as of February 2, 2019[323] - The company is involved in several legal proceedings, including class actions related to California wage and hour laws (Juan Carlos Gonzales, Skylar Ward) and the Telephone Consumer Protection Act (Lauren Minniti)[325][326][328] - The Lauren Minniti TCPA class action was settled for a reduced cash payment of $1.5 million and the issuance of discount coupons, with the potential for material impact through September 2019[326][327] 8.7.11 Note 11: Fair Value Measurements - Tillys measures financial assets at fair value using a three-level hierarchy: Level 1 (quoted prices in active markets), Level 2 (observable inputs), and Level 3 (unobservable inputs)[330][331] - Marketable securities and cash equivalents are primarily classified as Level 1 or Level 2, while long-lived assets are evaluated for impairment on a non-recurring basis using Level 3 inputs (discounted cash flows)[332][333][336][337] - Non-cash impairment charges of $0.8 million, $0.8 million, and $2.4 million were recorded in fiscal years 2018, 2017, and 2016, respectively, affecting 2, 4, and 9 stores[337][338] 8.7.12 Note 12: Share-Based Compensation - Tillys grants stock options and restricted stock awards under the 2012 Amended and Restated Equity and Incentive Award Plan, with 1,530,115 shares available for future issuance as of February 2, 2019[339] - Stock options vest 25% annually over four years and are valued using the Black-Scholes option valuation model, with key assumptions including expected term, volatility, risk-free interest rates, and expected dividends (zero for Tillys)[340][344] - Restricted stock awards for Board members vest 50% over two years, and for employees 25% over four years, valued at the Class A common stock's closing price on the grant date[347] - Total share-based compensation expense was $2.2 million in fiscal 2018, $2.4 million in fiscal 2017, and $2.6 million in fiscal 2016[349] 8.7.13 Note 13: Retirement Savings Plan - Tillys offers a 401(k) Plan covering eligible employees (age 21+ with 3+ months of employment), with matching contributions made at the discretion of the Board of Directors[350] - Total employer contributions to the 401(k) Plan were $0.6 million in fiscal 2018 and 2017, and $0.8 million in fiscal 2016[350] 8.7.14 Note 14: Income Taxes - Tillys accounts for income taxes using the asset and liability method, recognizing deferred tax assets and liabilities based on temporary differences between GAAP and tax bases[235][355] - The effective tax rate was 26.2% in fiscal 2018, significantly lower than 41.7% in fiscal 2017, primarily due to the reduction in the U.S. federal tax rate from 35% to 21% by the Tax Cuts and Jobs Act[185][353] - Net deferred tax assets were $1.3 million at February 2, 2019, down from $2.8 million at February 3, 2018[355] - There were no material unrecognized tax benefits as of February 2, 2019, and no interest or penalties related to uncertain tax positions were recognized in fiscal years 2018, 2017, or 2016[357] 8.7.15 Note 15: Earnings Per Share Basic and Diluted Earnings Per Share (in thousands, except per share amounts) | Metric | Fiscal Year Ended Feb 2, 2019 | Fiscal Year Ended Feb 3, 2018 | Fiscal Year Ended Jan 28, 2017 | | :-------------------------------- | :---------------------------- | :---------------------------- | :----------------------------- | | Net income | $24,943 | $14,700 | $11,410 | | Weighted average basic shares outstanding | 29,278