Executive Summary / Key Takeaways

• Tillys (NYSE: TLYS) is demonstrating early signs of stabilization following a challenging period, with comparable net sales trends showing sequential improvement since Q4 2024, culminating in a modest 2.2% decrease in fiscal May 2025.
• Strategic initiatives focused on merchandising adjustments, rigorous cost control (including store closures and payroll management), and enhanced marketing efforts are central to the company's turnaround plan.
• Despite ongoing macroeconomic pressures impacting consumer spending and increased labor costs, Tillys maintains a debt-free balance sheet and strong liquidity, providing financial flexibility.
• Technological investments in e-commerce platforms, app functionality, and price optimization are aimed at driving efficiency and customer engagement, though the core competitive moat remains tied to brand mix and youth culture positioning.
• Management's Q2 2025 guidance anticipates comparable net sales ranging from a 5% decrease to flat, signaling cautious optimism for continued improvement, while profitability remains challenged in the near term due to deleveraging fixed costs against lower sales volumes.

Setting the Scene: A Specialty Retailer's Journey Through Shifting Tides

Tillys, Inc. traces its roots back to 1982 in Orange County, California, establishing itself as a destination specialty retailer for young men, young women, boys, and girls. The company built its identity around an extensive assortment of iconic global, emerging, and proprietary brands catering to an active, outdoor, and social lifestyle. Operating through a dual channel model encompassing physical stores across 33 states and an e-commerce platform, Tillys positioned itself as a curator of relevant fashion and lifestyle products within the youth culture segment.

However, like many retailers, Tillys has faced significant headwinds in recent years. Following a period of strong performance, the company has experienced declining sales trends since fiscal 2019. This downturn has been attributed to a confluence of factors, including a challenging macroeconomic environment marked by persistent inflation and recession concerns impacting consumer spending, particularly within their core demographic. Structural issues, such as a notable drop in sales per square foot in stores compared to pre-pandemic levels and substantially increased labor costs (with average hourly store payroll rates estimated to be 35% higher in fiscal 2025 than in fiscal 2019), have further pressured profitability. Past operational and merchandising decisions are also acknowledged to have contributed to the challenges.

In response, Tillys has embarked on a strategic turnaround effort under the leadership of co-founder Hezy Shaked, who assumed the permanent CEO role. The central narrative for Tillys today is one of stabilization and strategic adaptation, aiming to regain sales momentum and improve profitability in a demanding retail landscape.

Strategic Pillars and Operational Focus

Tillys' strategy to navigate the current environment is multifaceted, focusing on key areas designed to address recent performance shortfalls and capitalize on potential opportunities.

A primary focus has been on merchandising. Recognizing that past assortments missed the mark, particularly in late fiscal 2024, the company made organizational changes within the merchandising team. The goal is to realign the brand and product mix to better resonate with current consumer preferences, with management expressing belief that the spring 2025 assortment is on trend and that the full impact of the merchandising team's efforts should be visible around July 2025. The company balances its offering between third-party brands (63% of Q1 2025 sales) and proprietary brands (37%), a mix that impacts gross margins.

Cost control and operational efficiency are also critical. Tillys is undertaking a rigorous review of its store portfolio, aiming to close underperforming locations. The company ended Q1 2025 with 238 stores, down from 246 a year prior, and expects further closures, potentially up to 15 additional stores by the end of fiscal 2025 depending on lease negotiations. Beyond occupancy costs, strict management of payroll (store, distribution, and corporate) and renegotiating contractual commitments across departments are targeted for significant expense reductions in fiscal 2025.

Marketing and brand building are being leveraged to drive customer engagement and traffic. Recent initiatives include launching a TikTok shop, which has quickly grown to outperform Amazon (AMZN) in daily order volume, and hosting in-person events with influencers and celebrities to solidify its connection with youth culture. The "Discover Your Style" brand campaign, launched in late fiscal 2024, aims to build deeper customer affinity by emphasizing values like confidence and self-expression, tying into the company's long-standing support for teen mental health through the Tilly's Life Center Foundation.

Technology and Operational Enhancements

While Tillys is not a technology company in the traditional sense, strategic investments in its digital infrastructure and operational technology are crucial components of its strategy to enhance efficiency and improve the customer experience. The company operates a hybrid fulfillment model, shipping from both its e-commerce distribution center and directly from stores, aiming to optimize inventory utilization and delivery speed.

Recent technological initiatives mentioned include:

• Website Search Engine Upgrade: Intended to improve the online shopping experience by making it easier for customers to find desired products.
• Mobile App Re-launch: Focused on significantly improving speed and functionality to enhance the mobile shopping experience.
• Price Optimization Tool: Expected to launch in early 2025, this tool is intended to help drive improved pricing decisions and merchandise management efficiency.
• TikTok Shop: A direct engagement and sales channel on a platform popular with the target demographic, demonstrating early success by exceeding Amazon daily order volume.

These investments, while not representing a unique, proprietary technology moat in the way a manufacturing process might, are vital for a modern retailer. They aim to improve operational efficiency (e.g., through price optimization and potentially faster fulfillment), enhance the customer journey across channels, and expand reach within key digital spaces like social media. The success of the TikTok shop highlights the potential for digital channels to contribute meaningfully to sales and customer acquisition, complementing the physical store footprint.

Competitive Landscape and Positioning

Tillys operates in a highly competitive retail environment, facing pressure from a diverse set of players across physical stores, e-commerce, and social media marketing platforms. Key publicly traded competitors targeting similar demographics include Urban Outfitters (URBN), American Eagle Outfitters (AEO), Five Below (FIVE), and Foot Locker (FL).

Comparing TLYS to these peers reveals distinct positioning and financial performance differences:

• Scale and Reach: TLYS's footprint of 238 stores is significantly smaller than that of AEO (over 1,000 stores), URBN (over 600 stores across brands), or FIVE (over 1,400 stores). This smaller scale can impact operating costs per unit and negotiating leverage with suppliers and landlords.
• Financial Performance: Based on recent TTM data, TLYS's financial metrics lag behind many peers. Its Gross Profit Margin (26.29% TTM) is lower than URBN (35%), AEO (39%), and FIVE (35%), though comparable to FL (29%). More significantly, TLYS is currently operating at a loss (Operating Margin -8.44% TTM, Net Margin -8.12% TTM), while URBN, AEO, and FIVE are profitable (URBN Net Margin 7%, AEO Net Margin 6%, FIVE Net Margin 7%). FL also shows a very low Net Margin (0.15%). This highlights TLYS's current challenges in driving sufficient sales volume and managing its cost structure relative to its revenue base.

• Efficiency: Metrics like Inventory Turnover (6.07 TTM for TLYS vs. URBN 5.83, AEO 5.09, FIVE 3.83, FL 3.72) show TLYS is turning inventory at a rate comparable to or slightly better than some peers, reflecting efforts in inventory management. However, overall capital efficiency, as suggested by profitability metrics, is currently weaker.

• Differentiation: Tillys' core differentiation lies in its curated mix of third-party and proprietary brands, particularly its strength in action sports and youth culture hardgoods (skateboards, surf gear). This niche focus provides a unique value proposition compared to the broader lifestyle focus of URBN or AEO, the value focus of FIVE, or the athletic focus of FL. Management believes this positioning, combined with experiential retail elements and community engagement, can build customer affinity.
• Challenges: TLYS faces intense competition for consumer attention and spending. While its niche is a strength, it also means competing with specialists within each product category (e.g., skate shops, surf shops, athletic retailers). The company's reliance on third-party brands also means its assortment is influenced by the health and strategies of its brand partners, some of whom have faced their own challenges.

The competitive landscape analysis underscores the urgency of Tillys' turnaround efforts. To improve financial performance and regain market share, Tillys must effectively leverage its brand positioning, optimize its operational efficiency (including through technology), and execute its merchandising strategy to drive sales growth that can outpace its largely fixed cost base.

Financial Performance and Liquidity

Tillys' recent financial performance reflects the challenges discussed, but also hints at potential stabilization.

In the first quarter of fiscal 2025 (ended May 3, 2025), total net sales were $107.6 million, a decrease of 7.1% compared to $115.9 million in Q1 2024. Comparable net sales, encompassing both physical stores and e-commerce, decreased by 7.0%. This marked a sequential improvement from the 11.2% comparable net sales decrease experienced in Q4 2024. The trend continued into fiscal May 2025, with comparable net sales decreasing by a more modest 2.2%.

Profitability remains under pressure. Gross profit in Q1 2025 was $21.3 million, or 19.8% of net sales, down from $24.3 million, or 21.0% of net sales, in Q1 2024. While product margins saw a slight improvement of 40 basis points due to better initial markups, this was more than offset by deleveraging in buying, distribution, and occupancy costs (160 basis points) due to the lower sales base.

Selling, general, and administrative (SGA) expenses totaled $44.0 million, or 40.9% of net sales, compared to $45.1 million, or 38.9% of net sales, last year. Despite a $1.1 million decrease in total SGA dollars (driven by lower store payroll and asset write-offs, partially offset by increased marketing), SGA deleveraged significantly as a percentage of lower net sales (190 basis points).

The combination of lower gross profit and deleveraged SGA resulted in an operating loss of $22.7 million in Q1 2025, wider than the $20.8 million operating loss in Q1 2024. Net loss for the quarter was $22.2 million, or $0.74 per share, compared to a net loss of $19.6 million, or $0.65 per share, in the prior year. The effective income tax rate remains near zero due to a full valuation allowance on deferred tax assets, a situation expected to persist until consistent operating profits are generated.

Despite operating losses, Tillys maintains a solid liquidity position. As of May 3, 2025, total liquidity stood at $92.6 million, comprising $37.2 million in cash and marketable securities and $55.4 million in available borrowing capacity under its asset-backed credit facility. This facility was recently extended through June 2027, providing financial runway. The company ended Q1 2025 with no outstanding borrowings and was in compliance with all covenants. Management projects remaining debt-free throughout fiscal 2025, estimating that a consistent comparable net sales decrease of 10% or more would be required to necessitate borrowing.

Working capital decreased in Q1 2025, primarily influenced by changes in accounts payable and cash/investments. Net cash used in operating activities improved significantly, totaling $8.1 million in Q1 2025 compared to $25.7 million in Q1 2024. This improvement was largely driven by more efficient inventory management and the timing of accounts payable. Net cash provided by investing activities was positive ($14.3 million) due to maturities of marketable securities outpacing capital expenditures ($1.5 million). Inventory management remains a focus, with total balance sheet inventory down 3.8% and unit inventories down 10.9% year-over-year at the end of Q1 2025.

Outlook and Forward-Looking Commentary

Tillys' outlook for the second quarter of fiscal 2025 reflects cautious optimism based on the recent sequential improvement in sales trends, particularly the performance in fiscal May.

For the second quarter of fiscal 2025, management provides the following guidance:

• Net Sales: Approximately $150 million to $158 million.
• Comparable Net Sales: Decrease of 5% to flat.
• SG&A Expenses: Approximately $48 million to $49 million (excluding potential non-cash asset impairment charges).
• Effective Income Tax Rate: Near zero (due to valuation allowance).
• Net Loss/Income: Approximately $2.7 million net loss to $2 million net income.
• Earnings Per Share: Net loss of $0.09 to net income of $0.07.

This guidance implies a significant improvement in comparable sales performance compared to recent quarters, potentially reaching flat sales growth at the high end of the range. Management's assumptions include the expectation that the positive momentum seen in May will continue, particularly as the quarter includes the crucial back-to-school selling season in late July, which historically represents the largest sales weeks of the quarter and has been a stronger period for the company even during recent downturns.

The guidance also factors in continued efforts to manage expenses, although SG&A dollars are expected to be higher than Q1 due to seasonality. Profitability remains uncertain, with the guidance range spanning from a modest loss to a modest profit, highlighting the sensitivity of results to sales performance against a relatively fixed cost base.

Regarding the store footprint, Tillys expects to end Q2 2025 with 232 stores (after 7 closures and 1 opening in the quarter) and anticipates closing at least two more in Q3. The potential for up to 15 additional closures by the end of fiscal 2025 underscores the ongoing portfolio optimization aimed at improving overall profitability.

Management expects to operate with lower unit inventories throughout fiscal 2025 compared to last year, a key component of their strategy to improve inventory turns and product margins. The strong liquidity position is anticipated to allow the company to remain debt-free through the fiscal year, providing a buffer against potential sales volatility.

Risks and Challenges

Despite the signs of stabilization and strategic efforts, Tillys faces significant risks and challenges that could impact its ability to execute its turnaround and return to consistent profitability.

• Macroeconomic Headwinds: Persistent inflation and concerns about a potential recession continue to weigh on consumer spending, particularly impacting the discretionary purchases of apparel and accessories that form the core of Tillys' business. The target demographic may be particularly sensitive to economic pressures.
• Intense Competition: The retail apparel market is highly fragmented and intensely competitive. Tillys competes not only with direct peers like Urban Outfitters, American Eagle Outfitters, Five Below, and Foot Locker but also with department stores, mass merchants, off-price retailers, and a vast array of online-only players, including fast-fashion giants. This competition puts pressure on pricing, margins, and the ability to attract and retain customers.
• Fashion and Trend Risk: Success in the youth apparel market is heavily dependent on the ability to identify and respond quickly to rapidly changing fashion preferences and trends. Missteps in merchandising, as acknowledged in past quarters, can lead to excess inventory, increased markdowns, and reduced profitability.
• Labor Costs: Significant increases in minimum wages, particularly in key states like California where a large portion of Tillys' stores are located, represent a structural increase in operating costs that is difficult to offset without commensurate sales growth or significant productivity improvements.
• Supply Chain and Tariffs: While current tariff impacts are noted as minor, the volatile global trade environment and potential disruptions to the supply chain could impact the cost and availability of merchandise, much of which is sourced internationally.
• Seasonality: The business is highly seasonal, with a significant portion of sales and profitability concentrated in the back-to-school and holiday seasons (Q3 and Q4). Weak performance during these critical periods can have a disproportionately negative impact on full-year results.
• Execution Risk: The success of the turnaround strategy hinges on the effective execution of merchandising changes, cost control initiatives, marketing programs, and store portfolio adjustments. Failure to deliver on these fronts could prolong operating losses and further erode financial health.

Conclusion

Tillys is currently a company in transition, working to reverse a trend of declining sales and operating losses that have persisted since fiscal 2019. The first quarter of fiscal 2025 and the start of Q2 have shown encouraging signs of sequential improvement in comparable net sales trends, suggesting that recent strategic adjustments, particularly in merchandising and marketing, may be beginning to resonate with consumers.

The company's debt-free balance sheet and solid liquidity provide a degree of stability and flexibility as it pursues its turnaround. Strategic initiatives focused on optimizing the store footprint, controlling costs, enhancing digital capabilities, and refining the product assortment are critical levers being pulled. However, the path forward remains challenging, shadowed by macroeconomic uncertainty, intense competition, and the inherent volatility of fashion retail.

For investors, the core thesis centers on whether Tillys can sustain and build upon the recent signs of stabilization. Key factors to monitor will be the trajectory of comparable net sales throughout the crucial back-to-school and holiday seasons, the impact of cost control measures on operating leverage, the effectiveness of new merchandising and marketing strategies, and the company's ability to navigate the persistent headwinds in the retail environment. While the Q2 guidance offers a glimmer of hope for reaching breakeven or slight profitability, a sustained return to consistent net sales growth and profitability will require continued diligent execution and favorable market conditions. Tillys is charting a course towards stabilization, but it remains a journey through turbulent waters.