TILLY'S, INC. 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 ofOctober 31, 2020 , we operated 238 stores, including one RSQ-branded pop-up store and one RSQ Skate store in 33 states, averaging approximately 7,400 square feet per store, compared to 232 total stores, including one RSQ-branded pop-up store, 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 fiscal quarter endedOctober 31, 2020 (unless otherwise stated, the information provided is throughDecember 1, 2020 ): •Quarter-to-Date Comparable Net Sales Results throughDecember 1, 2020 : Our quarter-to-date comparable net sales for the fourth quarter of fiscal 2020 throughDecember 1, 2020 , were$56.0 million , a slight decrease of$0.3 million or 0.6%, compared to$56.3 million throughDecember 3, 2019 , which is the comparable fiscal date last year. •Comparable net sales from physical stores, including all periods of store closures, were$36.7 million , a decrease of$6.1 million or 14.2%, compared to$42.8 million for the comparable period last year. Store traffic decreased by 29% compared to the corresponding period of last year, partially offset by a high single-digit percentage increase in conversion rate and a low double-digit percentage increase in average transaction value. •Net sales from e-commerce were$19.3 million , an increase of$5.7 million or 42.4%, compared to$13.5 million for the comparable period last year. •The results of operations noted above thus far in the fourth quarter of fiscal 2020 are not necessarily indicative of results to be expected for the fourth quarter as a whole, especially in light of the uncertainties surrounding the impacts of the COVID-19 pandemic, including but not limited to our ability to continue operating some or all of our stores or e-commerce, significant restrictions on store customer traffic and operating hours, anticipated reductions in consumer spending, and higher unemployment compared to last year's fourth quarter. •Cash/Liquidity: As ofDecember 2, 2020 , cash on hand, cash equivalents, and marketable securities totaled$138.6 million , including an aggregate of$4.4 million of withheld store lease payments and no debt outstanding, compared to$143.7 million and no withheld store lease payments or debt outstanding as ofDecember 4, 2019 , which is the comparable fiscal date last year. Based on all available current information, we believe the combination of our cash, marketable securities, and credit facility availability will be sufficient to support our operations for at least the next twelve months. •Inventory Management: Merchandise inventories as of the end of the third quarter of fiscal 2020 were 7.4% below comparable inventory levels as of the end of the third quarter of fiscal 2019 on a per square foot basis. In anticipation of a much more unpredictable and challenging 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 at or 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 any net sales declines in the future. 25 -------------------------------------------------------------------------------- Table of Contents •Capital Expenditures: We opened 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 approximately$8 million . We currently expect to open 7 new stores during fiscal 2021 which were originally signed and planned for opening during fiscal 2020, but were deferred upon agreement with the respective landlords. We currently expect total capital expenditures for fiscal 2021 not to exceed$20 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, particularly in light of the recent significant increases in the number of COVID-19 cases acrossthe United States , and corresponding actions that have been taken or that may be taken in response thereto. 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. 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. 26 -------------------------------------------------------------------------------- Table of Contents 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. 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. 27 -------------------------------------------------------------------------------- Table of Contents 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. 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 Thirty-Nine Weeks Ended October 31, November 2, October 31, November 2, 2020 2019 2020 2019 Statements of Operations Data: Net sales$ 140,275 $ 154,780 $ 353,409 $ 446,821 Cost of goods sold 99,615 107,609 269,481 312,247 Gross profit 40,660 47,171 83,928 134,574 Selling, general and administrative expenses 37,122 39,467 101,082 114,614 Operating income (loss) 3,538 7,704 (17,154) 19,960 Other income, net (28) 911 692 2,312 Income (loss) before income taxes 3,510 8,615 (16,462) 22,272 Income tax expense (benefit) 1,397 2,227 (6,446) 5,923 Net income (loss)$ 2,113 $
6,388
Percentage ofNet Sales : Net sales 100.0 % 100.0 % 100.0 % 100.0 % Cost of goods sold 71.0 % 69.5 % 76.3 % 69.9 % Gross profit 29.0 % 30.5 % 23.7 % 30.1 % Selling, general and administrative expenses 26.5 % 25.5 % 28.6 % 25.7 % Operating income (loss) 2.5 % 5.0 % (4.9) % 4.5 % Other income, net 0.0 % 0.6 % 0.2 % 0.5 % Income (loss) before income taxes 2.5 % 5.6 % (4.7) % 5.0 % Income tax expense (benefit) 1.0 % 1.4 % (1.8) % 1.3 % Net income (loss) 1.5 % 4.1 % (2.8) % 3.7 % The following table presents store operating data for the periods indicated: Thirteen Weeks Ended Thirty-Nine Weeks Ended October 31, November 2, October 31, November 2, 2020 2019 2020 2019 Operating Data: Stores operating at end of period 238 232 238 232 Comparable store sales change (1) (1.4) % 3.1 % 4.3 % 2.0 % Total square feet at end of period (in thousands) 1,753 1,732 1,753 1,732 Average net sales per retail store (in thousands) (2)$ 439 $ 571 $ 987 $ 1,661
Average net sales per square foot (2)
$ 223
E-commerce revenues (in thousands) (3)
$ 65,200 E-commerce revenues as a percentage of net sales 25.5 % 14.7 % 33.4 % 14.6 % (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. 28 -------------------------------------------------------------------------------- Table of Contents (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. Third Quarter (13 Weeks) EndedOctober 31, 2020 Compared to Third Quarter (13 Weeks) EndedNovember 2, 2019 Net Sales Net sales were$140.3 million , a decrease of$14.5 million , or 9.4%, compared to$154.8 million for the corresponding period last year. These results were negatively influenced by the delayed back-to-school dates this year, restrictions on store customer traffic and operating hours, and the government-mandated closure of 33 California stores for a portion of the third quarter. Compared to the respective fiscal months of last year, August net sales decreased by 35%, followed by a 22% increase in September net sales and a 10% increase in October net sales. •Net sales from physical stores were$104.6 million , a decrease of$27.5 million or 20.8%, compared to$132.1 million for the corresponding period last year. Store traffic decreased by 34% compared to last year's third quarter, partially offset by a low double-digit percentage increase in conversion rate and a high single-digit percentage increase in average transaction value. Net sales from stores represented 74.5% of total net sales compared to 85.3% of total net sales for the corresponding period last year. The Company ended the third quarter of fiscal 2020 with 238 total stores, including one RSQ-branded pop-up store and one RSQ Skate store, all of which were open to the public with restrictions on operating hours and customer traffic in light of the ongoing pandemic. This compares to 232 total stores, including one RSQ-branded pop-up store, all of which were open without restrictions, for the corresponding period last year. •Net sales from e-commerce were$35.7 million , an increase of$13.0 million or 57.3% compared to approximately$22.7 million for the corresponding period last year. E-commerce net sales represented 25.5% of total net sales compared to 14.7% for the corresponding period last year. Gross Profit Gross profit was$40.7 million , a decrease of$6.5 million or 13.8%, compared to$47.2 million for the corresponding period last year. Gross margin, or gross profit as a percentage of net sales, was 29.0% compared to 30.5% for the corresponding period last year. Product margins improved 70 basis points as a percentage of net sales primarily due to improved full-price selling on e-commerce and reduced markdowns overall compared to last year. Buying, distribution and occupancy costs deleveraged by 220 basis points collectively against lower total sales. Distribution costs deleveraged 120 basis points as a percentage of net sales primarily due to an increase in e-commerce shipping costs of$1.5 million resulting from a greater volume of e-commerce orders. Occupancy costs deleveraged 110 basis points as a percentage of net sales despite being reduced by$1.0 million . Buying costs leveraged 10 basis points as a percentage of net sales Selling, General and Administrative Expenses SG&A expenses were$37.1 million , or 26.5% of net sales, compared to$39.5 million , or 25.5% of net sales, for the corresponding period 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 temporary
(0.7)% $(2.7) store closures related to COVID-19 and reduced staffing levels upon
reopening of stores.
1.9% 2.3 Increase in marketing and fulfillment costs associated with
e-commerce net sales growth.
Sales tax assessment received from
the
1.2% 1.7 quarter end, relating to the 2015-2017 period (currently disputed by
the Company)
(0.9)% (1.2) Payroll tax credit from the Coronavirus Aid, Relief, and Economic
Stimulus Act (the "CARES Act")
(0.5)% (2.4) Net change in all other SG&A expenses.
1.0% $(2.3) Total
Operating Income
Operating income was $3.5 million , or 2.5% of net sales, compared to operating
income of $7.7 million , or 5.0% of net sales, for the corresponding period last
year. The decrease in operating income was primarily due to the impact of the
COVID-19 pandemic noted above.
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Income Tax Expense
Income tax expense was $1.4 million , or 39.8% of income before taxes, compared
to $2.2 million , or 25.9% of income before taxes, for the corresponding period
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
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 $2.1 million , or $0.07 per diluted share, compared to net income
of $6.4 million , or $0.21 per diluted share, for the corresponding period last
year as result of the factors noted above.
Thirty-Nine Weeks Ended October 31, 2020 Compared to Thirty-Nine Weeks Ended
November 2, 2019
Net Sales
Net sales were $353.4 million , a decrease of $93.4 million , or 20.9%, compared
to $446.8 million for the corresponding period last year primarily as a result
of the various periods of store closures resulting from the impact of the
COVID-19 pandemic.
•Net sales from physical stores were $235.3 million , a decrease of $146.3
million or 38.3%, compared to $381.6 million for the corresponding period last
year. In terms of total available store operating days in fiscal 2020, physical
stores were open for 50% of the first quarter, 65% of the second quarter, and
94% of the third quarter. Net sales from stores represented 66.6% of total net
sales compared to 85.4% of total net sales for the corresponding period last
year.
•Net sales from e-commerce were $118.1 million , an increase of $52.9 million or
81.1% compared to approximately $65.2 million for the corresponding period last
year. E-commerce net sales represented 33.4% of total net sales compared to
14.6% for the corresponding period last year.
Gross Profit
Gross profit was $83.9 million , a decrease of $50.6 million , or 37.6%, compared
to $134.6 million for the corresponding period last year. Gross margin, or gross
profit as a percentage of net sales, was 23.7% compared to 30.1% for the
corresponding period last year. Product margins were flat compared to the
corresponding period last year. Occupancy costs deleveraged 400 basis points as
a percentage of net sales, despite being reduced by $1.8 million compared to and
having six additional stores compared to the corresponding period last year.
Distribution costs deleveraged 220 basis points as a percentage of net sales
primarily due to an increase in e-commerce shipping charges of $5.4 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 $101.1 million , a decrease of $13.5 million , or 11.8%,
compared to $114.6 million for the corresponding period last year. As a
percentage of net sales, SG&A expenses were 28.6% compared to 25.7% for the
corresponding period last year. The components of the SG&A variances, both in
terms of percentage of net sales and total dollars, were as follows:
% $ millions PrimarilyAttributable to
Decrease in store payroll and benefits primarily due to temporary
(1.3)% $(16.3) store closures related to COVID-19 and reduced staffing levels upon
reopening of stores.
2.8% 7.4 Increase in marketing and fulfillment costs associated with
e-commerce net sales growth.
1.4% (4.6) Net change in all other SG&A expenses.
2.9% $(13.5) Total
Operating (Loss) Income
Operating loss was $(17.2) million , or (4.9)% of net sales, compared to
operating income of $20.0 million , or 4.5% of net sales, for the corresponding
period 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 $(6.4) million , or 39.2% of loss before taxes, compared
to income tax expense of $5.9 million , or 26.6% of income before taxes, for the
corresponding period 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, as noted above.
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Net (Loss) Income and (Loss) Income Per Share
Net loss was $(10.0) million , or $(0.34) per diluted share, compared to net
income of $16.3 million , or $0.55 per diluted share, for the corresponding
period 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 filing 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.
Working Capital
Working capital at October 31, 2020 , was $66.1 million compared to $63.6 million
at February 1, 2020 , a decrease of $2.5 million . The changes in our working
capital during the first three quarters of fiscal 2020 were as follows:
$ millions Description
2.5 Increase in working capital due to timing of accounts payable payments.
Line of Credit As ofOctober 31, 2020 , our previous amended and restated credit agreement ( as amended, the "Prior Credit Agreement") withWells Fargo Bank, N.A. (the "Bank") provided for a$25.0 million revolving line of credit with a maturity date ofJanuary 31, 2023 . The interest rate charged on borrowings was 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 allowed 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 was secured by substantially all of our assets. As a sub-feature under the Prior Credit Agreement, the Bank could 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. InSeptember 2020 , we repaid all of the borrowings under the revolving credit facility, and as a result, we had no debt outstanding under the revolving credit facility as ofOctober 31, 2020 . We were required to maintain certain financial and non-financial covenants in accordance with the line of credit. The financial covenants required 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$50.0 million in allowable investments in fixed assets in any fiscal year. In addition, pursuant to the terms of our revolving credit facility, we are required to pay any and all indebtedness, obligations, assessments and taxes when due, subject to certain limitations. 31 -------------------------------------------------------------------------------- Table of Contents As ofOctober 31, 2020 , we were not in compliance with our covenants under the Prior Credit Agreement, with respect to (i) the financial covenants related to our Fixed Coverage Ratio, Funded Debt to EBITDAR Ratio and minimum profitability, and (ii) the covenant that we pay any and all contractual store lease obligations when due on the basis of our non-payment of certain of our contractual rental obligations pursuant to our store leases during the COVID-19 pandemic, including for those stores closed to the public during June andJuly 2020 . As ofOctober 31, 2020 , our Fixed Coverage Ratio was 0.7 to 1.0, our Funded Debt to EBITDAR Ratio was 5.2 and income before income taxes on a trailing 12-month basis was$(7.4) million . The Bank provided a limited waiver with respect to all of the violations noted above. InSeptember 2020 , we increased the standby letter of credit from$1.3 million to$2.0 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. OnNovember 9, 2020 , we entered into a credit agreement (the "New Credit Agreement") with the Bank, which replaced the Prior Credit Agreement which was terminated concurrently therewith. No borrowings were outstanding under the Prior Credit Agreement as of the closing date or as ofDecember 1, 2020 . The New Credit Agreement provides for an asset-based, senior secured revolving credit facility of up to$65.0 million consisting of revolving loans, letters of credit and swing line loans provided by lenders, with a sub limit on letters of credit outstanding at any time of$10.0 million and a sub limit for swing line loans of$7.5 million . The credit agreement also includes an uncommitted accordion feature whereby we may increase the revolving commitment by an aggregate amount not to exceed$12.5 million , subject to certain conditions. The revolving facility matures onNovember 9, 2023 . The payment and performance in full of the secured obligations under the revolving facility are secured by a lien on and security interest in all of the assets of our company. The maximum borrowings permitted under the revolving facility is equal to the lesser of (x) the revolving commitment and (y) the borrowing base. The borrowing base is equal to (a) 90% of the borrowers' eligible credit card receivables, plus (b) 90% of the cost of the borrowers' eligible inventory, less inventory reserves established by the agent, and adjusted by the appraised value of such eligible inventory, plus (c) 90% of the cost of the borrowers' eligible in-transit inventory, less inventory reserves established by the agent, and adjusted by the appraised value of such eligible in-transit inventory (not to exceed 10% of the total amount of all eligible inventory included in the borrowing base) less (d) reserves established by the agent. As of the closing date, we were eligible to borrow up to a total of$40.1 million under the revolving facility. As of the closing date, we had no outstanding borrowings under the New Credit Agreement and the only utilization of the letters of credit sub limit under the New Credit Agreement was a$2.025 million irrevocable standby letter of credit, which was previously issued under the Prior Credit Agreement and was transferred on the closing date to the New Credit Agreement. The unused portion of the revolving commitment accrues a commitment fee, which ranges from 0.375% to 0.50% per annum, based on the average daily borrowing capacity under the revolving facility over the applicable fiscal quarter. Borrowings under the revolving facility bear interest at a rate per annum that ranges from the LIBOR rate plus 2.0% to the LIBOR rate plus 2.25%, or the base rate plus 1.0% to the base rate plus 1.25%, based on the average daily borrowing capacity under the revolving facility over the applicable fiscal quarter. We may elect to apply either the LIBOR rate or base rate interest to borrowings at our discretion, other than in the case of swing line loans, to which the base rate shall apply. Under the New Credit Agreement, we are subject to a variety of affirmative and negative covenants of types customary in an asset-based lending facility, including a financial covenant relating to availability, and customary events of default. Prior to the first anniversary of the closing date, we are prohibited from declaring or paying any cash dividends to our respective stockholders or repurchasing of our own common stock. After the first anniversary of the closing date, we are allowed to declare and pay cash dividends to our respective stockholders and repurchase our own common stock, provided, among other things, no default or event of default exists as of the date of any such payment and after giving effect thereto and certain minimum availability and minimum projected availability tests are satisfied. In connection with the entry into the New Credit Agreement, onNovember 9, 2020 , we entered into certain ancillary agreements, including (i) a security agreement in favor of the agent, and (ii) a guaranty by us in favor of the agent. The security agreement and the guaranty replaced (i) the general pledge agreement, dated as ofMay 3, 2012 , by us in favor of the bank, (ii) the continuing guaranty by us in favor of the agent, datedMay 3, 2012 , and (iii) the amended and restated security agreement with respect to equipment and the amended and restated security agreement with respect to rights to payment and inventory, in each case, dated as ofMay 3, 2012 , by us in favor of the bank, which were all terminated concurrently with the termination of the Prior Credit Agreement. In addition, onNovember 8, 2020 , we and the agent entered into a limited waiver letter, pursuant to which the agent waived compliance with certain covenants under the Prior Credit Agreement for the fiscal quarter endingOctober 31, 2020 . 32 -------------------------------------------------------------------------------- Table of Contents Impact of CARES Act on Company Liquidity The CARES Act, which was signed into law onMarch 27, 2020 , includes, among other things, 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 third quarter of fiscal 2020 disclosed above within "Income Tax (Benefit)/Expense". Cash Flow Analysis A summary of operating, investing and financing activities for the thirty-nine weeks of fiscal 2020 compared to the thirty-nine weeks of fiscal 2019 is shown in the following table (in thousands):
Thirty-Nine Weeks Ended
October 31, November 2,
2020 2019
Net cash provided by operating activities $ 21,033 $ 24,504
Net cash provided by investing activities 37,816 4,058
Net cash used in financing activities (29,677) (29,126)
Net increase (decrease) in cash and cash equivalents $
29,172
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 provided by operating activities were$21.0 million this year compared to$24.5 million last year. The$3.5 million decrease in cash provided by operating activities was primarily due to 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, partially offset by the timing of accounts payable payments and payments associated with accrued expenses and operating lease liabilities. 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$37.8 million this year compared to$4.1 million last year. Net cash provided by investing activities in the first three quarters of fiscal 2020 consisted of proceeds from the maturities of marketable securities of$75.2 million , partially offset by purchases of marketable securities of$30.9 million and capital expenditures totaling$6.4 million . Net cash provided by investing activities during the first three quarters of fiscal 2019 consisted of proceeds from the maturities of marketable securities of$111.5 million , partially offset by purchases of marketable securities of$96.8 million and capital expenditures totaling$10.6 million .Net Cash Used in Financing Activities Financing activities primarily consist of cash dividend payments, borrowings and repayments of 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$29.7 million this year compared to$29.1 million last year. Financing activities in the first three quarters of fiscal 2020 consisted of dividends paid of$29.7 million and$23.7 million in both borrowings and repayments under our line of credit. Financing activities in the first three quarters 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$0.4 million in proceeds from stock option exercises. Contractual Obligations As ofOctober 31, 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 . 33 -------------------------------------------------------------------------------- Table of Contents 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 ofOctober 31, 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 ofOctober 31, 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 ofOctober 31, 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. 34
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