Tilly’s Has a Great Quarter, But I’m Not Sure They Completely Know Why

You can’t fault the numbers.  Sales grew 7.4% for the quarter ended October 29^th compared to the same quarter last year.  That got them to $152.1 million in revenue for the quarter.  Comparable store sales rose 4.4%, accounting for $6 million of the revenue increase.  “Store comps were up low-single digits and e-commerce continued to grow at a double-digit rate.”  The rest of the increase ($4.4 million) came from five stores opened since the end of last year’s quarter.

Their gross profit margin, at 31.5%, didn’t change.  A 1.1% decline in product gross margin due to higher markdowns was offset by a reduction in expenses.

This is a good time to remind you how retailers calculate cost of goods sold to arrive at their gross profit margin.  Here’s how Tilly’s does it.

“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 ecommerce customers and between store locations. Occupancy costs include the rent, common area maintenance, utilities, property taxes, security and depreciation costs of all store locations.”

As they note, not all retailers include the same costs, so keep that in mind as you compare.

Tilly’s ended the quarter with 225 stores in 32 states.  They expect to end their year with 223 stores.

SG & A expenses were down 5% and as a percentage of revenue fell from 27.7% to 24.5%.    They doubled operating income to $10.7 million and net income more than doubled, rising from $2.81 to $6.42 million.

The balance sheet improved with cash and investments rising from $76 to $105 million. Inventory fell $5 million to $65 million even with rising sales.  The current ratio stayed about the same, there’s no long-term debt, and equity rose from $170 to $180 million.

Okay, how did they do this?  First, directly from the 10-Q, here’s how they describe themselves.

“Tilly’s is a leading destination specialty retailer of West Coast inspired casual apparel, footwear and accessories for young men, young women, boys and girls…Our stores are located in malls, lifestyle centers, ‘power’ centers, community centers, outlet centers and street-front locations. Customers may also shop online, where we feature a substantially similar assortment of products as carried in our brick-and-mortar stores… Our goal is to serve as a destination for the latest, most relevant merchandise and brands important to our customers.”

Two things to notice.  First, no large, public retailer is only an action sports retailer any longer.  There’s not adequate growth potential.  Second, look where their stores are located.  As I’ve said before, my sense is that they are focused on managing their occupancy costs, and they weight that heavily.  If they are in fact a destination retailer, why not?

Consistent with this, they note in the conference call they have 60 stores where the opportunity will exist to negotiate with the landlord next year.  “While we will remain,” says CEO Ed Thomas, “optimistic about new stores where we believe the location and economics are appropriate, our primary focus will be on improving the productivity of our existing fleet in order to drive increased profitability for our company overall.”

I don’t think I’d enjoy negotiating with these guys.  More importantly, note how they are deemphasizing new store openings.  Most larger, multi store retailers are doing that.  Go back to the first paragraph and remind yourself where most of the 4.4% comparable store increase came from.

Here are some more things CEO Thomas says about what they are doing.

“…we’re trying to get better at adjusting to some climatic differences…”  I’ve seen climate mentioned in risk factors before, but this is the first mention of inventory adjustments due to climate I’ve seen in a conference call.

“What we try to do is again our stores as you know carry a lot more brands than what our perceived direct competition is. And we’re not just about action sports. So, it gives us a lot of flexibility in terms of what we can do in merchandise mix and so on and so forth and the biggest thing we are trying to do is shorten the life-cycle of a time – the time it takes, the lead times it takes to get some of our merchandise in that will give us more flexibility for adjusting to any potential trend that we missed or anything like that.”

Tilly’s is hardly unique in this approach right now.  They emphasize managing inventories and taking markdowns more quickly to stay fresh.

Mr. Thomas also points to some “assortment adjustment initiatives launched last year,” and “our repurposed more localized marketing efforts” he believes responsible for some improvement in traffic.  They are being rolled out into more stores.

CFO Mike Henry discusses the traffic increase as well.  Leave it to the finance guy to rain on people’s parade.

“…when you look back at Q3, how we ended up doing so much better than our guidance was the fact that our store traffic suddenly turned positive. We haven’t had positive traffic in a long time and as that began to happen, we’re looking at each other and saying well how long is this going to last. And as soon as we flip the calendar to November, we saw store traffic drop for the next three weeks. And then even during Black Friday weekend, we had a great Thursday, Friday, but then Saturday fell off. Than Sunday bounced back the other way and early this week it’s fallen off again. So, it’s going back and forth as we said in our commentary, we’re seeing some erratic behavior from traffic and we think that’s going to continue, so we’re taking a cautious outlook on what the fourth quarter might bring.”

In the 10-Q, they call the September and October improvements in store traffic, “unexpected.”

You can see where I got the second half of the article title.  Like most retailers, Tilly’s hopes that all the good things they are doing are what caused the improvement in store traffic.  But they aren’t sure or confident it will continue.  Meanwhile, I’m wondering if some of the traffic improvement isn’t the result of all the inventory from the various retail bankruptcies earlier in the year working its way through the system.

Let’s just hope that the retailers left standing enjoy a strong holiday shopping season.