TILLY'S, INC.

TLYS
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TILLY : S, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations (form 10-Q)

09/08/2020 | 05:10pm


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 of Tilly'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 ended
February 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 to Tilly'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, when Hezy Shaked
and Tilly Levine opened our first store in Orange County, California. As of
August 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 33
California 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 ended August
1, 2020
:
• Net Sales Results for Fiscal August Ended August 29, 2020:


Our total net sales for fiscal August, which began on August 2, 2020, and ended
on August 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 from May 15, 2020,
through September 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 of August 29, 2020, only 205 of our total 238 stores were open to the public
due to the continued closure of 33 of our California-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. On August 28,
2020
, the State 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 on August 31, 2020, six additional stores on
September 1, 2020, one additional store on September 2, 2020, and two additional
stores on September 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 in Los Angeles County.


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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 of September 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 of
September 8, 2020, compared to approximately $162.5 million with no borrowings
under our credit facility and no withheld lease payments as of September 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.


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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.


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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.


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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 of Net 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.




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Second Quarter (13 Weeks) Ended August 1, 2020 Compared to Second Quarter (13
Weeks) Ended August 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 on May 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. Following California state order on July
13
regarding indoor malls, we had 33 of our California 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 on March 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) Ended August 1, 2020 Compared to First Half (26 Weeks)
Ended August 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 effective March 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


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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.


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Working Capital
Working capital at August 1, 2020, was $61.6 million compared to $63.6 million
at February 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 at February 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 at August 1, 2020


Line of Credit
Our amended and restated credit agreement with Wells Fargo Bank, N.A. (the
"Bank") provides for a $25.0 million revolving line of credit with a maturity
date of January 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. On February 12, 2020 and February 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.
In March 2020, we borrowed $23.7 million under our revolving credit facility,
which represented the maximum borrowings permitted thereunder. At August 1,
2020
, the variable interest rate on these borrowings was based on LIBOR plus 75
basis points, or 0.9% per annum. On August 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 of August 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 and July
2020
. As of August 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.
In August 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.



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Impact of CARES Act on Company Liquidity
On March 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 $ 62,818 $ (5,772 )





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 of August 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 ended February 1, 2020.


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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 in the 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 ended February 1, 2020.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
As of August 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 ended February 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 of August 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 the SEC'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 of August 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.


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