The following discussion and analysis of the financial condition and results of our operations should be read together with the financial statements and related notes ofTilly's, Inc. included in Part I Item 1 of this Quarterly Report on Form 10-Q and with our audited consolidated financial statements and the related notes included in our Annual Report on Form 10-K for the fiscal year endedFebruary 1, 2020 . As used in this Quarterly Report on Form 10-Q, except where the context otherwise requires or where otherwise indicated, the terms "the Company", "World of Jeans & Tops", "we", "our", "us", "Tillys" and "Tilly's" refer toTilly's, Inc. and its subsidiary. Overview Tillys is a destination specialty retailer of casual apparel, footwear and accessories for young men, young women, boys and girls. We offer an extensive assortment of iconic global, emerging, and proprietary brands rooted in an active and social lifestyle. Tillys started operations in 1982, whenHezy Shaked andTilly Levine opened our first store inOrange County, California . As ofAugust 1, 2020 , we operated 238 stores, including one RSQ-branded pop-up store in 33 states, averaging approximately 7,400 square feet per store, of which 33California stores were temporarily closed as a result of government response to the COVID-19 pandemic, compared to 229 total stores, including three RSQ-branded pop-up stores, last year at this time, all of which were open to the public without restrictions on operating hours and customer traffic. 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 has had far-reaching adverse impacts on many aspects of our business, both directly and indirectly, including on our operations generally, consumer behavior, store traffic, demands on our information technology and e-commerce capabilities, inventory and expense management, production capabilities, timing of deliveries, managing our workforce, our store configurations and operations upon reopening, and the market generally. The scope and nature of these impacts continue to evolve each day. The following is a summary of additional updates regarding our business subsequent to the end of the second quarter of fiscal 2020 endedAugust 1, 2020 : • Net Sales Results for Fiscal August EndedAugust 29, 2020 : Our total net sales for fiscal August, which began onAugust 2, 2020 , and ended onAugust 29, 2020 , were$50.2 million , a decrease of$27.7 million or 35.6%, compared to$77.9 million for fiscal August last year. Net sales from physical stores, including all periods of store closures and net sales from new stores not yet open a full year, were$36.6 million , a decrease of$31.6 million or 46.3%, compared to$68.3 million for the comparable period last year. Net sales from e-commerce were$13.6 million , an increase of$4.0 million or 40.6%, compared to$9.6 million for the comparable period last year. Cumulative comparable store net sales in reopened stores have decreased 23.0% collectively since their respective reopening dates throughout the period fromMay 15, 2020 , throughSeptember 7, 2020 , compared to the respective comparable fiscal dates of last year. • Important Factors to Consider When Assessing Comparisons of Fiscal August
Results:
•Net sales during the fiscal month of August have represented approximately 50% of our third quarter net sales for each of the past four fiscal years. •In fiscal 2020, many school districts across the country have delayed back-to-school dates and adjusted some or all of their curriculum to an online or remote format, including in many of the markets in which our physical stores are located. This has resulted in a highly negative start to the third quarter of fiscal 2020 with respect to our comparable net sales. In fiscal 2019, the first two weeks of fiscal August were the two highest net sales volume weeks of the third quarter. During those two weeks last year, we generated net sales of$49.1 million compared to just$27.0 million during the first two weeks of August this year. •Although comparable net sales remained highly negative for the rest of August compared to last year, results improved trend-wise from week to week as the month progressed. •As ofAugust 29, 2020 , only 205 of our total 238 stores were open to the public due to the continued closure of 33 of ourCalifornia -based stores as a result of government response to the COVID-19 pandemic. These closed stores represent 14% of our total store count, and accounted for approximately$22 million , or 14%, of our total net sales during the third quarter of fiscal 2019. OnAugust 28, 2020 , theState of California issued new guidelines regarding the reopening of businesses in light of the ongoing pandemic, including significant restrictions on customer occupancy. In accordance with these new guidelines, the Company reopened 15 of these stores onAugust 31, 2020 , six additional stores onSeptember 1, 2020 , one additional store onSeptember 2, 2020 , and two additional stores onSeptember 4, 2020 . The Company continues to monitor the latest guidelines from local, state and federal governments and health organizations to determine when the remaining 9 of these stores may be able to reopen, but cannot predict with any certainty at this time when that may be. 8 of the 9 remaining closed stores are located inLos Angeles County . 24
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•In light of continuing uncertainties surrounding the COVID-19 pandemic, including but not limited to its impacts on consumer behavior, our ability to continue to operate some or all of our stores or our e-commerce business at any point in time, and the adverse impacts on the back-to-school season so far this year, we are unable to reliably predict our future sales or earnings at this time. • Cash/Liquidity: As ofSeptember 8, 2020 , cash on hand, cash equivalents, and marketable securities totaled approximately$165.1 million , which includes$23.7 million borrowed under our credit facility and$13.2 million in aggregate withheld contractual store lease payments for stores closed to the public as a result of government response to the COVID-19 pandemic. Excluding borrowed cash and withheld store lease payments, our remaining cash on hand, cash equivalents, and marketable securities would have totaled approximately$128.2 million as ofSeptember 8, 2020 , compared to approximately$162.5 million with no borrowings under our credit facility and no withheld lease payments as ofSeptember 10, 2019 , the comparable fiscal date last year. Based on all currently available information, the Company believes that the combination of its cash, marketable securities, and credit facility availability will be more than sufficient to support its operations for at least the next twelve months. • Inventory Management: We ended the second quarter of fiscal 2020 with merchandise inventories 8.9% below last year on a per square foot basis compared to the end of the second quarter of fiscal 2019. In anticipation of a much more unpredictable and challenging back-to-school and holiday season this year, we have reduced our future inventory commitments for physical stores significantly for the remainder of fiscal 2020. As a result, we currently expect our future inventories per square foot to remain below prior year levels for the remainder of fiscal 2020. However, there can be no guarantee that our inventory management efforts will be sufficient to keep our inventory levels consistent with the level of net sales declines in the future. • Capital Expenditures: We currently expect to open two new stores during fiscal 2020, one in each of October and November. We currently anticipate total capital expenditures for fiscal 2020 for new stores and continuing customer-facing and other information technology enhancements to be in the range of approximately$8 million to$10 million . The COVID-19 pandemic, and certain of the measures taken by us in response to it, have had, and we expect will continue to have, material adverse impacts on our current business, financial condition and results of operations, and may create additional risks for us. While we anticipate that the foregoing impacts are temporary, we cannot predict the specific duration for which we may be impacted, and 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 expect to 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. See also "Risk Factors" within our most recently filed Annual Report on Form 10-K. 25
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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 "breakage"). Based on our historical gift card breakage rate, we recognize breakage revenue over the redemption period in proportion to actual gift card redemptions. Net sales are also adjusted for the unredeemed awards and accumulated partial points on our customer loyalty program. 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 e-commerce 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 and through our
e-commerce platform;
• our ability to source and distribute products efficiently;
• calendar shifts of holiday or seasonal periods;
• the number and timing of new 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 this fiscal year 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. 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. 26
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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 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 mens apparel, womens 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 percentage of net 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. In those periods, various costs, such as 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 composed 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 Income (Loss) Operating income (loss) equals gross profit less SG&A expenses. Operating income (loss) excludes interest income, interest expense and income taxes. Operating income (loss) percentage measures operating income (loss) as a percentage of our net sales. 27
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Results of Operations The following tables summarize key components of our unaudited results of operations for the periods indicated, both in dollars (in thousands) and as a percentage of our net sales. Thirteen Weeks Ended Twenty-Six Weeks Ended August 1, August 3, August 1, August 3, 2020 2019 2020 2019 Statements of Operations Data: Net sales$ 135,845 $ 161,738 $ 213,134 $ 292,041 Cost of goods sold 94,171 110,019 169,866 204,638 Gross profit 41,674 51,719 43,268 87,403 Selling, general and administrative expenses 33,965 39,609 63,960 75,147 Operating income (loss) 7,709 12,110 (20,692 ) 12,256 Other income, net 311 572 720 1,401 Income (loss) before income taxes 8,020 12,682 (19,972 ) 13,657 Income tax expense (benefit) 2,754 3,398 (7,843 ) 3,696 Net income (loss)$ 5,266 $ 9,284 $ (12,129 ) $ 9,961 Percentage ofNet Sales : Net sales 100.0 % 100.0 % 100.0 % 100.0 % Cost of goods sold 69.3 % 68.0 % 79.7 % 70.1 % Gross profit 30.7 % 32.0 % 20.3 % 29.9 % Selling, general and administrative expenses 25.0 % 24.5 % 30.0 % 25.7 % Operating income (loss) 5.7 % 7.5 % (9.7 )% 4.2 % Other income, net 0.2 % 0.4 % 0.3 % 0.5 % Income (loss) before income taxes 5.9 % 7.8 % (9.4 )% 4.7 % Income tax expense (benefit) 2.0 % 2.1 % (3.7 )% 1.3 % Net income (loss) 3.9 % 5.7 % (5.7 )% 3.4 % The following table presents store operating data for the periods indicated: Thirteen Weeks Ended Twenty-Six Weeks Ended August 1, August 3, August 1, August 3, 2020 2019 2020 2019 Operating Data: Stores operating at end of period 238 229 238 229 Comparable store sales change (1) 8.3 % 0.6 % 8.6 % 1.4 % Total square feet at end of period (in thousands) 1,760 1,710 1,760 1,710 Average net sales per retail store (in thousands) (2)$ 352 $ 606 $ 550 $ 1,102 Average net sales per square foot (2)$ 48 $ 81 $ 74 $ 147 E-commerce revenues (in thousands) (3)$ 51,987 $ 22,820 $ 82,323 $ 42,487 E-commerce revenues as a percentage of net sales 38.3 % 14.1 % 38.6 % 14.5 %
(1) During fiscal 2019, 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 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 changed 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 on 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 are excluded from net sales in deriving average net sales per retail
store.
(3) E-commerce revenues include e-commerce sales and e-commerce shipping fee
revenue. 28
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Second Quarter (13 Weeks) EndedAugust 1, 2020 Compared to Second Quarter (13 Weeks) EndedAugust 3, 2019 Net Sales Net sales were$135.8 million , a decrease of$25.9 million , or 16.0%, compared to$161.7 million last year. We began the second quarter with all 239 of our stores closed to the public as a result of the impacts of the COVID-19 pandemic. Beginning onMay 15, 2020 , we began reopening our stores in a phased approach. We reopened 144 of our stores during the second half of May, 88 more stores throughout the month of June, and 3 additional stores in early July to reach 235, or 98%, of total stores re-opened. FollowingCalifornia state order onJuly 13 regarding indoor malls, we had 33 of ourCalifornia stores closed to the public for the remainder of the quarter. Net sales from physical stores for the second quarter of fiscal 2020 were$83.9 million , a decrease of$55.1 million or 39.6%, compared to$138.9 million for the second quarter of fiscal 2019. Net sales from stores represented 61.7% of total net sales for the quarter compared to 85.9% of total net sales last year. Net sales from e-commerce for the second quarter of fiscal 2020 were$52.0 million , an increase of$29.2 million or 127.8%, compared to$22.8 million for the second quarter of fiscal 2019. E-commerce net sales represented 38.3% of total net sales for the quarter compared to 14.1% last year. Gross Profit Gross profit was$41.7 million , a decrease of$10.0 million or 19.4%, compared to$51.7 million last year. Gross margin, or gross profit as a percentage of net sales, was 30.7% compared to 32.0% last year. Product margins improved 360 basis points as a percentage of net sales primarily due to significantly better regular priced selling upon the reopening of stores. Buying, distribution and occupancy costs deleveraged by 490 basis points collectively against lower total sales. Occupancy costs deleveraged 270 basis points as a percentage of net sales, despite being$0.4 million lower than last year, against lower total net sales. Distribution costs deleveraged 200 basis points as a percentage of net sales primarily due to an increase in e-commerce shipping charges of$3.0 million resulting from a greater volume of e-commerce orders. Buying costs deleveraged 20 basis points as a percentage of net sales. Selling, General and Administrative Expenses SG&A expenses were$34.0 million , or 25.0% of net sales, compared to$39.6 million , or 24.5% of net sales, last year. The components of the SG&A variances, both in terms of percentage of net sales and total dollars, were as follows: % $ millions Primarily Attributable to Decrease in store payroll and benefits primarily due to (3.2)%$(7.5) temporary store closures related to COVID-19 and reduced staffing levels upon reopening of stores. 3.3% 3.9 Increase in marketing and fulfillment costs associated with e-commerce net sales growth. 0.4% (2.0) Net change in all other SG&A expenses. 0.5%$(5.6) Total Operating Income Operating income was$7.7 million , or 5.7% of net sales, compared to operating income of$12.1 million , or 7.5% of net sales, last year. The decrease in operating income was primarily due to the impact of the COVID-19 pandemic and the other changes noted above. Income Tax Expense Income tax expense was$2.8 million , or 34.3% of income before taxes, compared to$3.4 million , or 26.8% of income before taxes, last year. Income tax expense for both periods includes certain discrete items associated with stock-based award activity. The increase in the effective income tax rate for fiscal 2020 is primarily due to the anticipated benefit from the Coronavirus Aid, Relief, and Economic Security Act enacted onMarch 27, 2020 (the "CARES Act"), which provides for net operating losses in fiscal 2020 to be carried back to earlier tax years with higher tax rates than the current year. Net Income and Income Per Diluted Share Net income was$5.3 million , or$0.18 per diluted share, compared to net income of$9.3 million , or$0.31 per diluted share, last year as result of the factors noted above. First Half (26 Weeks) EndedAugust 1, 2020 Compared to First Half (26 Weeks) EndedAugust 3, 2019 Net Sales Net sales were$213.1 million , a decrease of$(78.9) million , or (27.0)%, compared to$292.0 million last year. All 239 of our stores were closed to the public effectiveMarch 18, 2020 , in response to the COVID-19 pandemic and remained closed to the public until reopened as noted above. Net sales from physical stores were$130.8 million , a decrease of$118.7 million or 29
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47.6%, compared to$249.6 million last year. Net sales from stores represented 61.4% of total net sales compared to 85.5% of total net sales last year. Net sales from e-commerce were$82.3 million , an increase of$39.8 million or 93.8% compared to approximately$42.5 million last year. E-commerce net sales represented 38.6% of total net sales compared to 14.5% last year. Gross Profit Gross profit was$43.3 million , a decrease of$44.1 million , or 50.5%, compared to$87.4 million last year. Gross margin, or gross profit as a percentage of net sales, was 20.3% compared to 29.9% last year. Product margins decreased 50 basis points as a percentage of net sales primarily due to increased markdowns. Occupancy costs deleveraged 600 basis points as a percentage of net sales, despite being$0.8 million lower than last year, against lower total net sales. Distribution costs deleveraged 280 basis points as a percentage of net sales primarily due to an increase in e-commerce shipping charges of$3.9 million resulting from a greater volume of e-commerce orders. Buying costs deleveraged 40 basis points as a percentage of net sales despite being flat in dollars compared to last year. Selling, General and Administrative Expenses SG&A expenses were$64.0 million , a decrease of$11.2 million , or 14.9%, compared to$75.1 million last year. As a percentage of net sales, SG&A expenses were 30.0% compared to 25.7% last year. The components of the SG&A variances, both in terms of percentage of net sales and total dollars, were as follows: % $ millions Primarily Attributable to Decrease in store payroll and benefits primarily due to (1.1)%$(12.4) temporary store closures related to COVID-19 and reduced staffing levels upon reopening of stores. 3.4% 5.2 Increase in marketing and fulfillment costs associated with e-commerce net sales growth. 2.0% (4.0) Net change in all other SG&A expenses. 4.3%$(11.2) Total Operating (Loss) Income Operating loss was$(20.7) million , or (9.7)% of net sales, compared to operating income of$12.3 million , or 4.2% of net sales, last year. The decrease in operating results was primarily attributable to the significant COVID-19 pandemic impacts on our business as noted above. Income Tax (Benefit) Expense Income tax benefit was$(7.8) million , or 39.3% of loss before taxes, compared to income tax expense of$3.7 million , or 27.1% of income before taxes, last year. Income tax (benefit) expense for both periods includes certain discrete items associated with employee stock-based award activity. The increase in the effective income tax rate for fiscal 2020 is primarily due to the anticipated benefit from the CARES Act, which provides for net operating losses in fiscal 2020 to be carried back to earlier tax years with higher tax rates than the current year. Net (Loss) Income and (Loss) Income Per Share Net loss was$(12.1) million , or$(0.41) per share, compared to net income of$10.0 million , or$0.33 per diluted share, last year, 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. 30
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Working Capital Working capital atAugust 1, 2020 , was$61.6 million compared to$63.6 million atFebruary 1, 2020 , a decrease of$2.0 million . The changes in our working capital during the first half of fiscal 2020 were as follows: $ millions Description$63.6 Working capital atFebruary 1, 2020 Decrease in working capital due to lower cash and marketable (2.0) securities, excluding$23.7 million in cash borrowed under the credit facility, as a result of lower net sales resulting from the impacts of the COVID-19 pandemic on our business.$61.6 Working capital atAugust 1, 2020 Line of Credit Our amended and restated credit agreement withWells Fargo Bank, N.A . (the "Bank") provides for a$25.0 million revolving line of credit with a maturity date ofJanuary 31, 2023 . The interest rate charged on borrowings is selected at our discretion at the time of draw between the London Interbank Offered Rate ("LIBOR"), plus 0.75%, or at the Bank's prime rate. The agreement allows for the declaration and payment of dividends or distributions to stockholders, subject to certain limitations. OnFebruary 12, 2020 andFebruary 27, 2019 , we paid a special cash dividend of$1.00 per share to all holders of record of issued and outstanding shares of both our Class A and Class B common stock. The line of credit is secured by substantially all of our assets. As a sub-feature under the credit agreement, the Bank may also issue stand-by and/or commercial letters of credit up to$15.0 million . InMarch 2020 , we borrowed$23.7 million under our revolving credit facility, which represented the maximum borrowings permitted thereunder. AtAugust 1, 2020 , the variable interest rate on these borrowings was based on LIBOR plus 75 basis points, or 0.9% per annum. OnAugust 27, 2020 , the interest rate remained at 0.9% per annum based on our choice of available LIBOR rates at that time. The line of credit is recorded as a current liability. We are required to maintain certain financial and non-financial covenants in accordance with the line of credit. The financial covenants require certain levels of profitability, leverage and assets, such as: (i) income before income taxes not less than$1.0 million , calculated at the end of each fiscal quarter on a trailing 12-month basis; (ii) a maximum "Funded Debt to EBITDAR" ratio of 4.00 to 1.0, calculated at the end of each fiscal quarter on a trailing 12-month basis, defined as the sum of total debt, capital leases and annual rent expense multiplied by six divided by the sum of net income, interest expense, taxes, depreciation, amortization and annual rent expense; (iii) a minimum "Fixed Charge Coverage Ratio" not less than 1.25 to 1.0, calculated at the end of each fiscal quarter on a trailing 12-month basis, with the ratio defined as (a) EBITDAR minus cash taxes, dividends, distributions, redemptions and repurchases of equity interest, divided by (b) the aggregate of the current maturity of long-term debt, capitalized lease payments, interest expense and rent expense; (iv) minimum eligible inventory, cash, cash equivalents and marketable securities totaling$50.0 million as of the end of each quarter; and (v) not more than$50.0 million in allowable investments in fixed assets in any fiscal year. In addition, pursuant to the terms of our revolving credit facility, we are required to pay any and all indebtedness, obligations, assessments and taxes when due, subject to certain limitations. As ofAugust 1, 2020 , we were not in compliance with all of our covenants under our credit agreement, with respect to (i) the financial covenants related to our Fixed Coverage Ratio, Funded Debt to EBITDAR Ratio and minimum profitability, and (ii) the covenant that we pay any and all contractual store lease obligations when due on the basis of our non-payment of certain of our contractual rental obligations pursuant to our store leases during the COVID-19 pandemic, including for those stores closed to the public during June andJuly 2020 . As ofAugust 1, 2020 , our Fixed Coverage Ratio was 0.8 to 1.0, our Funded Debt to EBITDAR Ratio was 4.9 and income before income taxes on a trailing 12-month basis was$(2.3) million . We are currently in discussions with the Bank to amend the credit agreement to obtain covenant relief with respect to these covenants. InAugust 2019 , we increased the standby letter of credit from$1.1 million to$1.3 million . The standby letter of credit was established for security against insurance claims, as required by our workers' compensation insurance policy. There has been no activity or borrowings under this letter of credit since its inception. 31
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Impact of CARES Act on Company Liquidity OnMarch 27, 2020 ,President Trump signed into law the CARES Act which, among other things, includes provisions relating to refundable payroll tax credits, deferment of employer side social security payments, net operating loss carryback periods, alternative minimum tax credit refunds, modifications to the net interest deduction limitations and technical corrections to tax depreciation methods for qualified improvement property. We continue to examine the impacts the CARES Act may have on our business. We anticipate that we may benefit from the net operating loss carryback provision, which may enable us to recover certain income taxes paid during prior tax years, and certain payroll tax deferrals. Due to the uncertainty surrounding the COVID-19 pandemic and its impacts on our business, we cannot estimate any specific tax benefits from the CARES Act at this time beyond the income tax benefit for the second quarter of fiscal 2020 disclosed above within "Income Tax (Benefit)/Expense". Cash Flow Analysis A summary of operating, investing and financing activities for the first half of fiscal 2020 compared to the first half of fiscal 2019 is shown in the following table (in thousands): Twenty-Six Weeks Ended August 1, August 3, 2020 2019 Net cash provided by operating activities$ 18,843 $
14,085
Net cash provided by investing activities 49,977
9,530
Net cash used in financing activities (6,002 )
(29,387 )
Net increase (decrease) in cash and cash equivalents
Net Cash Provided by Operating Activities Operating activities consist primarily of net (loss) income adjusted for non-cash items, plus the effect on cash of changes during the period in our assets and liabilities. Net cash flows used in operating activities were$18.8 million this year compared to$14.1 million last year. The$4.8 million increase in cash provided by operating activities was primarily due to the timing of accounts payable payments, partially offset by lower net sales associated with the temporary closure of some or all of our stores in response to the COVID-19 pandemic throughout the quarter and reduced net sales from reopened stores compared to last year as a result of significant declines in customer traffic. Net Cash Provided By Investing Activities Cash flows from investing activities consist primarily of capital expenditures and maturities and purchases of marketable securities. Net cash provided by investing activities was$50.0 million this year compared to$9.5 million last year. Net cash provided by investing activities in the first half of fiscal 2020 consisted of proceeds from the maturities of marketable securities of$70.2 million , partially offset by purchases of marketable securities of$16.0 million and capital expenditures totaling$4.3 million . Net cash provided by investing activities during the first half of fiscal 2019 consisted of proceeds from the maturities of marketable securities of$76.5 million , partially offset by purchases of marketable securities of$62.1 million and capital expenditures totaling$4.8 million .Net Cash Used in Financing Activities Financing activities primarily consist of cash dividend payments, borrowings under our line of credit, taxes paid in lieu of shares issued for share based compensation and proceeds from employee exercises of stock options. Net cash used in financing activities was$6.0 million this year compared to$29.4 million last year. Financing activities in the first half of fiscal 2020 consisted of dividends paid of$29.7 million , partially offset by$23.7 million in borrowings under our line of credit, which was the maximum amount available thereunder. Financing activities in the first half of fiscal 2019 consisted of dividends paid of$29.5 million and taxes paid in lieu of shares issued for share-based compensation of$0.1 million , partially offset by$0.2 million in proceeds from stock option exercises. Contractual Obligations As ofAugust 1, 2020 , there were no material changes to our contractual obligations as described in the "Management's Discussion and Analysis of Financial Condition and Results of Operations" section of our Annual Report on Form 10-K for the fiscal year endedFebruary 1, 2020 . 32
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Off-Balance Sheet Arrangements We are not a party to any off-balance sheet arrangements, except for purchase obligations and our revolving credit facility. Critical Accounting Policies and Estimates The preparation of financial statements in accordance with accounting principles generally accepted inthe United States requires the appropriate application of certain 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. As noted elsewhere in this Report, the COVID-19 pandemic has had significant, adverse impacts on our business and the economy generally, making estimates and assumptions about future events far more difficult, if not impossible. A summary of our significant accounting policies is included in Note 2 to the consolidated financial statements in our Annual Report on Form 10-K for the fiscal year endedFebruary 1, 2020 . Item 3. Quantitative and Qualitative Disclosures About Market Risk As ofAugust 1, 2020 , there were no material changes in the market risks described in the "Quantitative and Qualitative Disclosure of Market Risks" section of our Annual Report on Form 10-K for the fiscal year endedFebruary 1, 2020 . Item 4. Controls and Procedures Evaluation of Disclosure Controls and Procedures Our management, with the participation of our Disclosure Committee, including our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as ofAugust 1, 2020 . The term "disclosure controls and procedures," as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in theSEC's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Based on the evaluation of our disclosure controls and procedures as ofAugust 1, 2020 , our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level. Changes in Internal Control Over Financial Reporting There was no change in our internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(d) and 15d-15(d) of the Exchange Act that occurred during the period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. Inherent Limitations on Effectiveness of Controls Our management, including our Chief Executive Officer and Chief Financial Officer, believes that our disclosure controls and procedures and internal control over financial reporting are designed to provide reasonable assurance of achieving their objectives and are effective at the reasonable assurance level. However, our management does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of the controls. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. 33
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