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TILLY'S, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations
[September 09, 2014]

TILLY'S, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations


(Edgar Glimpses Via Acquire Media NewsEdge) 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 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, 2014. As used in this Quarterly Report on Form 10-Q, except where the context otherwise requires or where otherwise indicated, the terms "company", "World of Jeans & Tops", "we", "our", "us" and "Tilly's" refer to Tilly's, Inc. and its subsidiary.



Cautionary Statement Regarding Forward-Looking Statements This Quarterly Report on Form 10-Q contains forward-looking statements that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. The statements contained in this Quarterly Report on Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. Forward-looking statements are often identified by the use of words such as, but not limited to, "anticipate", "believe", "can", "continue", "could", "estimate", "expect", "intend", "may", "plan", "project", "seek", "should", "target", "will", "would" and similar expressions or variations intended to identify forward-looking statements. These statements are based on the beliefs and assumptions of our management based on information currently available to management. These forward-looking statements are subject to numerous risks and uncertainties, including the risks and uncertainties described under the section titled "Risk Factors" in our Annual Report on Form 10-K for the fiscal year ended February 1, 2014, those identified in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in this Quarterly Report on Form 10-Q, and in other filings we may make with the Securities and Exchange Commission from time to time. Moreover, we operate in an evolving environment. New risk factors and uncertainties emerge from time to time and it is not possible for our management to predict all risk factors and uncertainties, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors may cause actual results to differ materially from those contained in any forward-looking statement. We qualify all of our forward-looking statements by these cautionary statements.

Overview Tilly's is a fast-growing destination specialty retailer of West Coast inspired apparel, footwear and accessories. We believe we bring together an unparalleled selection of the most sought-after brands rooted in action sports, music, art and fashion. Our West Coast heritage dates back to 1982 when Hezy Shaked and Tilly Levine opened our first store in Orange County, California. As of August 2, 2014, we operated 203 stores, averaging 7,700 square feet, in 33 states. We also sell our products through our e-commerce website, www.tillys.com (the information available at our website is not incorporated by reference into this report).


Net sales increased slightly compared to last year to $123.1 million for the thirteen weeks ended August 2, 2014 from $123.0 million for the thirteen weeks ended August 3, 2013. Operating income decreased 68%, to $2.3 million for the thirteen weeks ended August 2, 2014 from $7.2 million for the thirteen weeks ended August 3, 2013, primarily due to a decline in our comparable store sales and increased occupancy and payroll costs related to store growth. Our comparable store sales decreased 7.1% for the thirteen weeks ended August 2, 2014, which followed a 1.9% decrease for the full fiscal year 2013 and compares to a 0.5% decrease in the second quarter of fiscal year 2013.

Since the beginning of fiscal 2009, we have more than doubled our store count from 99 stores to 203 stores as of August 2, 2014. As of August 2, 2014, we have added eight net new stores in fiscal year 2014 and plan to add at least ten additional net stores by the end of the fiscal year. We expect to fund this store expansion through our cash on hand and cash flows from operations.

We believe our business strategy will continue to offer significant opportunity, but it also presents risks and challenges. These risks and challenges include, but are not limited to, that we may not be able to effectively identify and respond to changing fashion trends and customer preferences, that we may not be able to find desirable locations 15-------------------------------------------------------------------------------- Table of Contents for new stores and that we may not be able to effectively manage our future growth. In addition, our financial results can be expected to be directly impacted by trends in the general economy. A decline in consumer spending or a substantial increase in product costs due to commodity cost increases or general inflation could lead to a reduction in our sales as well as greater margin pressure as costs may not be able to be passed on to consumers and the competitive environment could become more highly promotional. See "Risk Factors" in our Annual Report on Form 10-K for the fiscal year ended February 1, 2014 for other important factors that could adversely impact us and our results of operations.

How We Assess the Performance of Our BusinessIn 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 as well as sales of merchandise through our e-commerce store, which is reflected in sales when the merchandise is received by the customer. Net sales also include shipping and handling fees for e-commerce shipments that have been delivered 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. Revenue from the sale of gift cards is deferred and not included in net sales until the gift cards are used to purchase merchandise. However, over time, the redemption of some gift cards becomes remote (referred to as gift card breakage). Revenue from estimated gift card breakage is also included in net sales.

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 A store is included in comparable store sales when it has been open at least 12 full fiscal months as of the end of the current reporting period. A remodeled or relocated store is included in comparable store sales, both during and after construction, if the square footage of the store was not changed by more than 20% and the store was not closed for more than five days in any fiscal month.

Comparable store sales include sales through our e-commerce store, but 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.

Measuring the change in year-over-year comparable store sales allows us to evaluate how our store base is performing. Numerous factors affect our comparable store sales, including: • overall economic trends; • 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; • our ability to source and distribute products efficiently; • calendar shifts of holiday or seasonal periods; • the number and timing of store openings and the relative proportion of new stores to mature stores; and • the timing and success of promotional and advertising efforts.

16 -------------------------------------------------------------------------------- Table of Contents Opening new stores is an important part of our growth strategy and we expect a significant percentage of our net sales during this growth period to come from non-comparable store sales. Accordingly, comparable store sales are only one element we use to assess the success of our business.

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 expense for our internal buying organization. Distribution costs include costs for receiving, processing, warehousing and shipping of merchandise to or from our distribution center, 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 categories such as guys' and juniors' 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 percent of 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. This reflects that various costs, including 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 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 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.

The components of our SG&A expenses may not be comparable to those of other retailers. We expect that our SG&A expenses will increase in future periods due to our continuing store growth and in part due to additional legal, accounting, insurance and other expenses we incur as a result of being a public company.

Among other things, we expect that ongoing compliance with the Sarbanes-Oxley Act of 2002 and related rules and regulations could result in significant incremental legal, accounting and other overhead costs.

17-------------------------------------------------------------------------------- Table of Contents Operating Income Operating income equals gross profit less SG&A expenses. Operating income excludes interest income, interest expense and income taxes. Operating income percentage measures operating income 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 and as a percentage of our net sales.

Thirteen Weeks Ended Twenty-Six Weeks Ended August 2, August 3, August 2, August 3, 2014 2013 (1) 2014 2013 (1) (in thousands) (in thousands) Statements of Income Data: Net sales $ 123,060 $ 123,043 $ 234,194 $ 232,161 Cost of goods sold 88,405 85,155 168,212 162,467 Gross profit 34,655 37,888 65,982 69,694 Selling, general and administrative expenses 32,326 30,689 62,576 58,578 Operating income 2,329 7,199 3,406 11,116 Other income (expense), net 4 (47 ) 3 (96 ) Income before income taxes 2,333 7,152 3,409 11,020 Income tax expense 1,067 2,885 1,552 4,445 Net income $ 1,266 $ 4,267 $ 1,857 $ 6,575 Percentage of Net Sales: Net sales 100.0 % 100.0 % 100.0 % 100.0 % Cost of goods sold 71.8 % 69.2 % 71.8 % 70.0 % Gross profit 28.2 % 30.8 % 28.2 % 30.0 % Selling, general and administrative expenses 26.3 % 24.9 % 26.7 % 25.2 % Operating income 1.9 % 5.8 % 1.5 % 4.8 % Other income (expense), net 0.0 % 0.0 % 0.0 % -0.1 % Income before income taxes 1.9 % 5.8 % 1.5 % 4.7 % Income tax expense 0.9 % 2.3 % 0.7 % 1.9 % Net income 1.0 % 3.5 % 0.8 % 2.8 % The following table presents store operating data for the periods indicated: Thirteen Weeks Ended Twenty-Six Weeks Ended August 2, August 3, August 2, August 3, 2014 2013 2014 2013 Store Operating Data: Stores operating at end of period 203 182 203 182 Comparable store sales change (2) -7.1 % -0.5 % -6.9 % 0.2 % Total square feet at end of period 1,563,409 1,423,413 1,563,409 1,423,413 Average net sales per store (in thousands) (3) $ 552 $ 618 $ 1,051 $ 1,184 Average net sales per square foot (3) $ 71 $ 79 $ 136 $ 151 (1) Gross profit in the thirteen and twenty-six weeks ended August 3, 2013 includes a $0.3 and $0.7 million reclassification respectively, of stock-based compensation expense from selling, general and administrative expenses to cost of goods sold to correct for an immaterial prior period error.

(2) Comparable store sales include sales through our e-commerce store, but exclude gift card breakage income and e-commerce shipping and handling fee revenue.

(3) E-commerce sales, e-commerce shipping fee revenue and gift card breakage are excluded from net sales in deriving average net sales per store and average net sales per square foot.

18 -------------------------------------------------------------------------------- Table of Contents Thirteen Weeks Ended August 2, 2014 Compared to Thirteen Weeks Ended August 3, 2013 Net Sales Net sales increased slightly to $123.1 million for the thirteen weeks ended August 2, 2014 from $123.0 million for the thirteen weeks ended August 3, 2013.

A portion of this increase was due to net sales of $8.8 million from stores open in the second quarter of fiscal 2014 that were not open during the same period last year. This was offset by a comparable store net sales decrease of 7.1%, or $8.6 million, in the thirteen weeks ended August 2, 2014 compared to the thirteen weeks ended August 3, 2013. Net sales decreases in men's and accessories were higher than the total company trend, while declines in junior's, kid's and footwear were below the trend. There were 177 comparable brick-and-mortar stores and 26 non-comparable brick-and-mortar stores open as of August 2, 2014.

Gross Profit Gross profit decreased $3.2 million, or 9%, to $34.7 million for the thirteen weeks ended August 2, 2014 from $37.9 million for the thirteen weeks ended August 3, 2013. As a percentage of net sales, gross profit was 28.2% and 30.8% for the thirteen weeks ended August 2, 2014 and August 3, 2013, respectively.

The decrease in gross profit margin was primarily due to occupancy costs increasing at a higher rate than net sales and a 40 basis point decrease in product margins.

Selling, General and Administrative Expenses SG&A expenses increased $1.6 million, or 5%, to $32.3 million for the thirteen weeks ended August 2, 2014 from $30.7 million for the thirteen weeks ended August 3, 2013. As a percentage of net sales, SG&A expenses were 26.3% and 24.9% for the thirteen weeks ended August 2, 2014 and August 3, 2013, respectively.

Selling expenses increased $2.0 million, or 9%, to $23.2 million for the thirteen weeks ended August 2, 2014 from $21.2 million for the thirteen weeks ended August 3, 2013. As a percentage of net sales, selling expenses were 18.8% and 17.2% for the thirteen weeks ended August 2, 2014 and August 3, 2013, respectively.

The following contributed to the increase in selling expenses as a percentage of net sales: • store, regional and e-commerce fulfillment payroll, payroll benefits and related personnel costs increased $2.6 million, or 2.1% as a percentage of net sales, as these costs increased at a higher rate than net sales primarily due to the addition of new stores and a relatively small increase in net sales and e-commerce fulfillment labor costs being reclassified into selling expenses from general and administrative expenses; partially offset by • marketing costs, supplies and other store support costs decreased $0.6 million, or 0.5% as a percentage of net sales, primarily due to lower catalog and promotional spend compared to last year.

General and administrative expenses decreased $0.4 million, or 4%, to $9.1 million for the thirteen weeks ended August 2, 2014 from $9.5 million for the thirteen weeks ended August 3, 2013. As a percentage of net sales, general and administrative expenses were 7.5% and 7.7% for the thirteen weeks ended August 2, 2014 and August 3, 2013, respectively.

The following contributed to the decrease in general and administrative expenses as a percentage of net sales: • payroll, payroll benefits and related costs for corporate office personnel decreased $1.1 million, which represents a decrease of 0.9% as a percentage of net sales, primarily due to e-commerce fulfillment labor costs being reclassified to selling expenses, partially offset by • ongoing stock-based compensation increased $0.3 million, or 0.2%, as a percentage of net sales; and • depreciation, consulting and other office expenses increased $0.4 million, or 0.3% as a percentage of net sales, due to the growth of the company.

19 -------------------------------------------------------------------------------- Table of Contents Operating Income Operating income decreased $4.9 million, or 68%, to $2.3 million for the thirteen weeks ended August 2, 2014 from $7.2 million for the thirteen weeks ended August 3, 2013. As a percentage of net sales, operating income was 1.9% and 5.8% for the thirteen weeks ended August 2, 2014 and August 3, 2013, respectively. The decrease in operating income as a percentage of net sales was primarily due to occupancy and store payroll costs increasing at a higher rate than net sales, as discussed above.

Other Income / Expense, Net Net other income was four thousand compared to expense of $47 thousand for the thirteen weeks ended August 2, 2014 and August 3, 2013, respectively. Net other income reflects interest income earned on cash balances and on tenant construction allowances due from landlords, partially offset by interest expense paid on the capitalized lease of our corporate office and distribution center.

Provision for Income Tax Expense Income taxes were $1.1 million and $2.9 million for the thirteen weeks ended August 2, 2014 and August 3, 2013, respectively. This reflects effective tax rates of 45.7% and 40.3% for the thirteen weeks ended August 2, 2014 and August 3, 2013, respectively. The higher effective tax rate for the thirteen week period ended August 2, 2014 over the prior period reflects the write-off of deferred tax assets related to the forfeiture of certain vested stock options in the second quarter of fiscal 2014.

Net Income Net income decreased $3.0 million, or 70%, to $1.3 million for the thirteen weeks ended August 2, 2014 from $4.3 million for the thirteen weeks ended August 3, 2013, due to the factors discussed above.

Basic and diluted earnings per share of Class A and Class B common stock decreased 67% to $0.05 for the thirteen weeks ended August 2, 2014 from $0.15 for the thirteen weeks ended August 3, 2013.

Twenty-Six Weeks Ended August 2, 2014 Compared to Twenty-Six Weeks Ended August 3, 2013 Net Sales Net sales increased $2.0 million, or 0.9%, to $234.2 million for the twenty-six weeks ended August 2, 2014 from $232.2 million for the twenty-six weeks ended August 3, 2013. A portion of this increase was due to net sales of $18.5 million from stores open in the first half of fiscal 2014 that were not open during the same period last year. This was partially offset by a comparable store net sales decrease of 6.9%, or $15.8 million, in the twenty-six weeks ended August 2, 2014 compared to the twenty-six weeks ended August 3, 2013. Net sales decreases in men's, accessories and footwear were higher than the total company trend, while declines in junior's and kid's were lower than the company trend. There were 177 comparable brick-and-mortar stores and 26 non-comparable brick-and-mortar stores open as of August 2, 2014.

Gross Profit Gross profit decreased $3.7 million, or 5%, to $66.0 million for the twenty-six weeks ended August 2, 2014 from $69.7 million for the twenty-six weeks ended August 3, 2013. As a percentage of net sales, gross profit was 28.2% and 30.0% for the twenty-six weeks ended August 2, 2014 and August 3, 2013, respectively.

The decrease in gross profit margin was primarily due to occupancy costs increasing at a higher rate than net sales, partially offset by approximately 10 basis points of product margin improvement.

20-------------------------------------------------------------------------------- Table of Contents Selling, General and Administrative Expenses SG&A expenses increased $4.0 million, or 7%, to $62.6 million for the twenty-six weeks ended August 2, 2014 from $58.6 million for the twenty-six weeks ended August 3, 2013. As a percentage of net sales, SG&A expenses were 26.7% and 25.2% for the twenty-six weeks ended August 2, 2014 and August 3, 2013, respectively.

Selling expenses increased $4.4 million, or 11%, to $44.4 million for the twenty-six weeks ended August 2, 2014 from $40.0 million for the twenty-six weeks ended August 3, 2013. As a percentage of net sales, selling expenses were 18.9% and 17.2% for the twenty-six weeks ended August 2, 2014 and August 3, 2013, respectively.

The following contributed to the increase in selling expenses as a percentage of net sales: • store, regional and e-commerce fulfillment payroll, payroll benefits and related personnel costs increased $4.7 million, or 1.9% as a percentage of net sales, as these costs increased at a higher rate than net sales primarily due to the addition of new stores and a relatively small increase in net sales and e-commerce fulfillment labor costs being reclassified into selling expenses from general and administrative expenses; partially offset by • marketing costs, supplies and other store support costs decreased $0.3 million, which represents a decrease of 0.2% as a percentage of net sales, primarily due to lower net catalog and promotional spend compared to last year.

General and administrative expenses decreased $0.4 million to $18.2 million for the twenty-six weeks ended August 2, 2014 from $18.6 million for the twenty-six weeks ended August 3, 2013. As a percentage of net sales, general and administrative expenses were 7.8% and 8.0% for the twenty-six weeks ended August 2, 2014 and August 3, 2013, respectively.

The following contributed to the decrease in general and administrative expenses as a percentage of net sales: • payroll, payroll benefits and related costs for corporate office personnel decreased $1.8 million, which represents a decrease of 0.8% as a percentage of net sales, mostly due to e-commerce fulfillment labor costs being reclassified to selling expenses; partially offset by • ongoing stock-based compensation increased $0.5 million, or 0.2%, as a percentage of net sales; and • depreciation, consulting and other office expenses increased $0.9 million, or 0.4% as a percentage of net sales, due to the growth of the company.

Operating Income Operating income decreased $7.7 million, or 69%, to $3.4 million for the twenty-six weeks ended August 2, 2014 from $11.1 million for the twenty-six weeks ended August 3, 2013. As a percentage of net sales, operating income was 1.5% and 4.8% for the twenty-six weeks ended August 2, 2014 and August 3, 2013, respectively. The decrease in operating income as a percentage of net sales was primarily due to occupancy and store payroll costs increasing at a higher rate than net sales, as discussed above.

Other Income / Expense, Net Net other income was three thousand compared to expense of $96 thousand for the twenty-six weeks ended August 2, 2014 and August 3, 2013, respectively. Net other income reflects interest income earned on cash balances and on tenant construction allowances due from landlords, partially offset by interest expense paid on a capitalized lease of our corporate office and distribution center.

21 -------------------------------------------------------------------------------- Table of Contents Provision for Income Tax Expense Income taxes were $1.6 million and $4.4 million for the twenty-six weeks ended August 2, 2014 and August 3, 2013, respectively. This reflects effective tax rates of 45.5% and 40.3% for the twenty-six weeks ended August 2, 2014 and August 3, 2013, respectively. The higher effective tax rate for the twenty-six week period ended August 2, 2014 over the prior period reflects the write-off of deferred tax assets related to the forfeiture of certain vested stock options in both the first and second quarters of fiscal 2014.

Net Income Net income decreased $4.7 million, or 71%, to $1.9 million for the twenty-six weeks ended August 2, 2014 from $6.6 million for the twenty-six weeks ended August 3, 2013, due to the factors discussed above.

Basic earnings per share of Class A and Class B common stock decreased 71%, to $0.07 for the twenty-six weeks ended August 2, 2014 from $0.24 for the twenty-six weeks ended August 3, 2013. Diluted earnings per share of Class A and Class B common stock decreased 70%, to $0.07 for the twenty-six weeks ended August 2, 2014 from $0.23 for the twenty-six weeks ended August 3, 2013.

22-------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources General Our business relies on cash flows from operating activities as well as cash on hand as our primary sources of liquidity. In addition, we have access to additional liquidity through a $25.0 million revolving credit facility with Wells Fargo Bank, N.A. We have never drawn funds from or issued letters of credit financing from the revolving credit facility and do not expect to draw from the revolving credit facility over the next 12 months. We expect to finance company operations and store growth with existing cash on hand, marketable securities and cash flows from operations.

Historically our primary cash needs have been for merchandise inventories, payroll, store rent, capital expenditures associated with opening new stores, improvements to our distribution facilities, marketing and information technology expenditures. In addition to cash and cash equivalents, the most significant components of our working capital are merchandise inventories, accounts payable and other current liabilities. We believe that cash flows from operating activities, the availability of cash under our revolving credit facility, if necessary, and our cash and marketable securities on hand will be sufficient to cover working capital requirements and anticipated capital expenditures for the next 12 months. If cash flows from operations and borrowings under our revolving credit facility are not sufficient 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 then-current stockholders.

Cash Flow Analysis A summary of operating, investing and financing activities is shown in the following table: Twenty-Six Weeks Ended August 2, August 3, 2014 2013 (in thousands) Net cash provided by operating activities $ 11,743 $ 17,158 Net cash used in investing activities (4,539 ) (13,730 ) Net cash (used in) provided by financing activities (208 ) 141 Net Cash Provided by Operating Activities Operating activities consist primarily of net income adjusted for non-cash items that include depreciation, stock-based compensation expense, deferred income taxes and gains or losses on disposals of assets, plus the effect on changes during the period in our assets and liabilities.

We generated $11.7 million of net cash from operating activities for the twenty-six weeks ended August 2, 2014. The significant components of cash flows from operating activities were net income of $1.9 million and the add-back of non-cash depreciation and amortization expense of $10.2 million, non-cash stock-based compensation expense of $1.9 million and the change in deferred income taxes of $0.3 million. In addition, accounts payable and accrued expenses increased by $25.3 million, and accrued compensation and benefits increased $0.8 million due to the timing of payments. The above was offset by an increase in merchandise inventories of $24.1 million due to inventory purchases in anticipation of the upcoming back-to-school season and the opening of new stores, an increase in receivables of $1.8 million, a decrease in deferred revenue of $1.4 million due to the redemption of gift cards throughout the period and an increase in prepaid expenses and other assets of $1.3 million.

We generated $17.2 million of net cash from operating activities for the twenty-six weeks ended August 3, 2013. The significant components of cash flows from operating activities were net income of $6.6 million, the add-back of non-cash depreciation and amortization expense of $9.4 million, non-cash stock-based compensation expense recognized during the period of $1.7 million and the change in deferred income taxes of $0.6 million. In addition, accounts payable and accrued expenses increased by $20.9 million due to the timing of payments, and 23 -------------------------------------------------------------------------------- Table of Contents deferred rent increased by $3.8 million due to the opening of new stores. The above was offset by a decrease in accrued compensation and benefits of $0.8 million due to reduced bonus accruals, an increase in merchandise inventories of $16.8 million due to inventory purchases in anticipation of the upcoming back-to-school season and the opening of new stores, an increase in receivables of $5.0 million due to the timing of payments received from credit card companies and landlord construction allowances, an increase in prepaid expenses and other assets of $1.8 million mainly due to increases in prepaid rent resulting from the opening of new stores and a decrease in deferred revenue of $1.3 million due to the redemption of gift cards throughout the period.

Net Cash Used in Investing Activities Investing activities consist primarily of capital expenditures for growth related to new store openings as well as for remodels and changes in fixtures and equipment at existing stores, investments in information technology, distribution center enhancements, investments in assets at our corporate headquarters and the addition or replacement of company vehicles, net of proceeds from sales and maturities of marketable securities.

Net cash used in investing activities was $4.5 million for the twenty-six weeks ended August 2, 2014, compared to net cash used of $13.7 million for the twenty-six weeks ended August 3, 2013. We received proceeds of $35.0 million from the maturities of marketable securities and purchased $25.0 million of marketable securities during the period. Capital expenditures for the twenty-six weeks ended August 2, 2014 totaled $14.6 million, the majority of which related to stores and our new e-commerce fulfillment center. Spending on new stores and the remodeling or other improvements of existing stores were $8.9 million and $14.1 million for the twenty-six weeks ended August 2, 2014 and August 3, 2013, respectively.

Net Cash (Used in) Provided by Financing Activities Financing activities consist of payments on our capital lease obligation, proceeds from the exercise of stock options and excess tax benefits from stock-based compensation.

Net cash used in financing activities was $0.2 for the twenty-six weeks ended August 2, 2014, consisting of payments on our capital lease obligation totaling $0.4 million partially offset by $0.2 million of proceeds from the exercise of stock options. Net cash provided by financing activities was $0.1 million for the twenty-six weeks ended August 3, 2013, consisting of $0.5 million of proceeds from the exercise of stock options, partially offset by payments on our capital lease obligation totaling $0.4 million during the period.

Line of Credit On May 3, 2012, the Company entered into an amended and restated credit agreement with Wells Fargo Bank, N.A., which the Company amended on March 17, 2014 to extend the maturity date, reduce the borrowing rate, eliminate a fee of 0.10% on the average daily unused amount on the line of credit, eliminate certain financial covenants related to current liabilities, funded debt and net profits, and add certain new covenants relating to total net losses and maximum balance sheet leverage. The amended credit facility, which was effective as of February 3, 2014, continues to provide for a $25.0 million revolving line of credit with a maturity date of May 31, 2017. The interest charged on borrowings is either at LIBOR plus 1.00%, or at the bank's prime rate. The Company has the ability to select between the prime rate or LIBOR-based rate at the time of a cash advance. The revolving credit facility is secured by substantially all of the Company's assets. As a sub-feature under the revolving credit facility the bank may issue stand-by and commercial letters of credit up to $15.0 million.

The Company is required to maintain certain financial and nonfinancial covenants in accordance with the revolving credit facility. The financial covenants require certain levels of leverage and profitability, such as (i) an aggregate maximum net loss after taxes not to exceed $5 million (measured at the end of each fiscal quarter), with no more than one annual net loss after taxes for any fiscal year (in either case, excluding all charges for impairment of goodwill, other intangibles and store assets impairment on the balance sheet of WOJT, in an aggregate amount of up to $2.0 million for the relevant period), and (ii) a maximum ratio of 2.00 to 1.00 for "balance sheet leverage", defined as total liabilities divided by total tangible net worth.

24-------------------------------------------------------------------------------- Table of Contents As of August 2, 2014, the Company was in compliance with all of its covenants and had no outstanding borrowings under the revolving credit facility.

Contractual Obligations As of August 2, 2014, there were no material changes to our contractual obligations 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, 2014.

Off-Balance Sheet ArrangementsWe are not a party to any off-balance sheet arrangements, except for operating leases, purchase obligations and our revolving credit facility.

25-------------------------------------------------------------------------------- Table of Contents Critical Accounting Policies and Estimates The preparation of financial statements in accordance with accounting principles generally accepted in the U.S. 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. A summary of the Company's significant accounting policies is included in Note 2 to the consolidated financial statements of Tilly's, Inc. in the Company's Annual Report on Form 10-K for the fiscal year ended February 1, 2014.

Certain of the Company's accounting policies and estimates are considered critical, as these policies and estimates are the most important to the depiction of the Company's consolidated financial statements and require significant, difficult or complex judgments, often about the effect of matters that are inherently uncertain. Such policies are summarized 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, 2014.

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