S-1 1 ds1.htm FORM S-1 Form S-1
Table of Contents

As filed with the Securities and Exchange Commission on July 1, 2011

Registration No. 333-            

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

TILLYS, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   5600   45-2164791

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification Number)

 

 

10 Whatney

Irvine, California 92618

(949) 609-5599

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

 

 

Daniel Griesemer

President and Chief Executive Officer

Tilly’s, Inc.

10 Whatney

Irvine, California 92618

(949) 609-5599

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

Copies to:

 

Cary K. Hyden, Esq.

Michael A. Treska, Esq.

Latham & Watkins LLP

650 Town Center Drive, 20th Floor

Costa Mesa, California 92626

 

Patrick Grosso, Esq.

Vice President, General Counsel & Secretary

Tilly’s, Inc.

10 Whatney

Irvine, California 92618

 

Robert E. Buckholz, Esq.

Patrick S. Brown, Esq.

Sullivan & Cromwell LLP

125 Broad Street

New York, New York 10004

 

 

Approximate date of commencement of proposed sale to the public:

As soon as practicable after the effective date of this registration statement.

 

 

If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  ¨

If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration number of the earlier effective registration statement for the same offering.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer     ¨    Accelerated filer     ¨
Non-accelerated filer     þ  (Do not check if a smaller reporting company)    Smaller reporting company     ¨

 

 

CALCULATION OF REGISTRATION FEE

 

 

Title of each class

of securities to be registered

 

Proposed

maximum

aggregate

offering price(1)

 

Amount of

registration fee(2)

Class A Common Stock, $0.001 par value per share

  $100,000,000   $11,610
 

 

(1) Estimated solely for the purpose of calculating the amount of the registration fee in accordance with Rule 457(o) under the Securities Act of 1933, as amended.

 

(2) Calculated pursuant to Rule 457(o) based on an estimate of the proposed maximum offering price.

 

 

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, or until the Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


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The information in this preliminary prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

 

Subject to Completion, dated July 1, 2011

             Shares

LOGO

Class A Common Stock

 

 

This is an initial public offering in which we are selling                      shares of Class A common stock of Tilly’s, Inc.

Following this offering, we will have two classes of authorized common stock, Class A common stock and Class B common stock. The rights of the holders of Class A common stock and Class B common stock are identical, except with respect to voting and conversion. Each share of Class A common stock is entitled to one vote per share. Each share of Class B common stock is entitled to 10 votes per share and is convertible into one share of Class A common stock upon the occurrence of certain events. Upon completion of this offering, holders of our Class B common stock will control common stock representing    % of the total voting power of our common stock.

We expect the public offering price to be between $             and $             per share. Currently, no public market exists for the Class A common stock. After pricing of the offering, we expect that the Class A common stock will trade on the New York Stock Exchange under the symbol “TLYS”.

 

 

Investing in our Class A common stock involves risks that are described in the “Risk Factors” section beginning on page 9 of this prospectus.

 

 

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

 

 

    Per Share     Total  

Initial public offering price

    $                      $                    

Underwriting discount

    $        $   

Proceeds, before expenses, to us

    $        $   

The underwriters have agreed to reimburse us for a portion of our out-of-pocket expenses in connection with this offering. See “Underwriting”.

To the extent that the underwriters sell more than              shares of Class A common stock, the underwriters have the option to purchase up to an additional              shares of Class A common stock from us at the initial public offering price, less the underwriting discount.

 

 

The underwriters expect to deliver the shares of Class A common stock against payment in New York, New York on or about                     , 2011.

 

Goldman, Sachs & Co.   BofA Merrill Lynch     Piper Jaffray   

 

William Blair & Company   Stifel Nicolaus Weisel

 

 

Prospectus dated                     , 2011.


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Table of Contents

TABLE OF CONTENTS

Prospectus

 

     Page  

Prospectus Summary

     1   

Risk Factors

     9   

Forward-Looking Statements

     26   

Use of Proceeds

     28   

Dividend Policy

     29   

Capitalization

     30   

Dilution

     31   

Selected Consolidated Financial and Other Data

     33   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     35   

Business

     61   

Management

     74   

Executive Compensation

     82   

Related Party Transactions

     101   

Principal Stockholders

     105   

Description of Capital Stock

     107   

Shares Eligible for Future Sale

     113   

Material U.S. Federal Income Tax Consequences to Non-U.S. Holders of our Class A Common Stock

     115   

Underwriting

     119   

Legal Matters

     125   

Experts

     125   

Where You Can Find Additional Information

     125   

Index to Financial Statements

     F-1   

 

 

Through and including              (the 25th day after the date of this prospectus), all dealers effecting transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to a dealer’s obligation to deliver a prospectus when acting as an underwriter and with respect to an unsold allotment or subscription.

 

 

You should rely only on the information contained in this prospectus or any free writing prospectus filed with the U.S. Securities and Exchange Commission, or SEC. We have not, and the underwriters have not, authorized any other person to provide you with different information. We and the underwriters take no responsibility for, and can provide no assurance as to the reliability of, any other information that others may give you. Neither this prospectus nor any free writing prospectus is an offer to sell, nor is it seeking an offer to buy, these securities in any jurisdiction where the offer or sale is not permitted. The information in this prospectus is complete and accurate only as of the date on the front cover, regardless of its time of delivery or of any sale of shares of our common stock. The information may have changed since that date.

Persons who come into possession of this prospectus and any such free writing prospectus in jurisdictions outside the U.S. are required to inform themselves about and to observe any restrictions as to this offering and the distribution of this prospectus and any such free writing prospectus applicable to that jurisdiction.

 

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Basis of Presentation

We operate on a fiscal calendar which results in a 52- or 53-week fiscal year ending on the Saturday closest to January 31st. The reporting periods contained in our financial statements included in this prospectus contain:

 

  Ÿ  

53 weeks of operations in fiscal year 2006, which ended on February 3, 2007;

 

  Ÿ  

52 weeks of operations in fiscal year 2007, which ended on February 2, 2008;

 

  Ÿ  

52 weeks of operations in fiscal year 2008, which ended on January 31, 2009;

 

  Ÿ  

52 weeks of operations in fiscal year 2009, which ended on January 30, 2010; and

 

  Ÿ  

52 weeks of operations in fiscal year 2010, which ended on January 29, 2011.

Fiscal years are identified in this prospectus according to the calendar year prior to the calendar year in which they ended. For example, references to “2010”, “fiscal 2010”, “fiscal year 2010” or similar references refer to the fiscal year ended January 29, 2011.

Tilly’s, Inc., the issuer of the Class A common stock to be sold in this offering, is a newly formed Delaware corporation that was incorporated in May 2011. Tilly’s, Inc. was formed solely for the purpose of reorganizing the corporate structure of World of Jeans & Tops, a California corporation. Pursuant to a reorganization transaction that we will effect prior to the completion of this offering, referred to as the Reorganization Transaction, World of Jeans & Tops will become a wholly owned subsidiary of Tilly’s, Inc. In connection with the Reorganization Transaction, the shareholders of World of Jeans & Tops will contribute all of their equity interests in that corporation to Tilly’s, Inc. in return for shares of Tilly’s, Inc. Class B common stock on a one-for-one basis. Prior to the completion of the Reorganization Transaction, Tilly’s, Inc. has not conducted any activities other than those incidental to its formation and the preparation of this prospectus. Accordingly, our consolidated financial statements and other financial information included in this prospectus as of dates and for periods prior to the date of the Reorganization Transaction reflect the results of operations and financial position of World of Jeans & Tops. Our consolidated financial statements and other financial information, if any, as of dates and for periods from and after the date of the Reorganization Transaction reflect the results of operations and financial condition of Tilly’s, Inc. and its wholly owned subsidiary, unless otherwise expressly stated.

  

 

Market and Industry Data

We obtained the industry, market and competitive position data throughout this prospectus from our own internal estimates and research, as well as from industry and general publications and research, surveys and studies conducted by third parties. Industry publications, studies and surveys generally state that they have been obtained from sources believed to be reliable, although they do not guarantee the accuracy or completeness of such information. While we believe that each of these studies and publications is reliable, we have not independently verified market and industry data from third-party sources. While we believe our internal company research is reliable and the definitions of our market and industry are appropriate, neither this research nor these definitions have been verified by any independent source.

 

 

 

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PROSPECTUS SUMMARY

This summary highlights selected information contained in greater detail elsewhere in this prospectus and does not contain all of the information that you should consider before investing in our Class A common stock. You should carefully read the following summary together with the more detailed information regarding us and our Class A common stock being sold in this offering, including “Risk Factors” and our financial statements and the accompanying notes, appearing elsewhere in this prospectus before making an investment decision. As used in this prospectus, 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 after the Reorganization Transaction.

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 stores are designed to be a seamless extension of our teen and young adult consumers’ lifestyles with a balance of guys and juniors merchandise in a stimulating environment. We believe our success across a variety of real estate venues and geographies in the United States demonstrates Tilly’s portability. Our motto “If it’s not here…it’s not happening” exemplifies our goal to serve as a destination for the latest, most relevant merchandise and brands important to our customers.

As of April 30, 2011, we operated 126 stores in 11 states, averaging approximately 7,800 square feet. We also sell our products through our e-commerce website, www.tillys.com. Our business is characterized by the following key elements:

 

  Ÿ  

Extensive assortment of relevant merchandise in a larger store format.    Our larger stores allow us to carry a more extensive selection of the most relevant, established and emerging brands and offer a greater assortment of apparel styles, sizes and price points across multiple categories. This broad selection enhances our ability to rapidly identify and respond to trends and consistently offer our customers both proven fashion items and core styles. We strive to keep our merchandising mix current by introducing additional brands and styles in response to the ever-evolving desires of our customers.

 

  Ÿ  

The Tilly’s experience.    Tilly’s is a customer-driven lifestyle brand. We are energized and inspired by our customers’ individuality and passion for action sports, music, art and fashion. Our stores bring these interests together in a vibrant, stimulating and authentic environment that is an extension of our customers’ high velocity, multitasking lifestyle. We do this by blending the most relevant brands and styles with music videos, product-related visuals and a dedicated team of store associates. We believe the Tilly’s experience drives customer awareness, loyalty and repeat visits while generating a buzz and excitement for our brand.

 

  Ÿ  

Flexible real estate strategy across real estate venues and geographies.    We currently operate stores in 34 markets in 11 states across a variety of real estate venues including malls, power centers, neighborhood and lifestyle centers, outlet centers and street-front locations. Our geographic portability and real estate flexibility provide us with a wider scope of opportunities and enhance our ability to open new stores.

Our West Coast heritage dates back to 1982 when our founders, Hezy Shaked and Tilly Levine, opened our first store in Orange County, California. Over the last five years, we have demonstrated an

 

 

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ability to grow rapidly, having more than doubled our store count while entering 25 new markets. During this same period, we invested approximately $20 million in infrastructure and systems to support our recent and long-term growth. We believe our team’s passion for the West Coast inspired and action sports lifestyle, sense of urgency and pursuit of excellence enables Tilly’s to consistently deliver a superior customer experience and positions us to successfully execute our long-term growth strategy. In fiscal 2010, we increased net sales to $332.6 million from $282.8 million in fiscal 2009, or 17.6%, and we increased operating income to $24.9 million from $21.4 million in fiscal 2009, or 16.4%.

Competitive Strengths

We believe that the following competitive strengths contribute to our success and distinguish us from our competitors:

 

  Ÿ  

Destination retailer with a broad, relevant assortment.    We believe the combined depth and breadth of apparel, footwear and accessories offered at our stores exceeds the selection offered at many other specialty retailers. We strive to combine proven fashion trends, core styles and a vibrant in-store experience that is engaging for our core customers. As a result, we believe we capture more shopping trips and generate higher sales per visit.

 

  Ÿ  

Dynamic merchandise model.    We believe our extensive selection of third-party and proprietary merchandise allows us to identify and address trends more quickly, offer a greater range of price points and manage our inventories more dynamically. By closely monitoring trends and shipping product to our stores at least five times per week, we adjust our merchandise mix with a frequency that promotes a current look to our stores and encourages frequent visits.

 

  Ÿ  

Flexible real estate strategy across real estate venues and geographies.    Our stores have proven to be successful in different real estate venues and geographies. We operate profitable stores in malls, power centers, neighborhood and lifestyle centers, outlet centers and street-front locations across 34 markets in 11 states. We believe our success operating in these different retail venues and geographies demonstrates the portability of Tilly’s and provides us with greater flexibility for future expansion.

 

  Ÿ  

Multi-pronged marketing approach.    We utilize a multi-pronged marketing strategy to connect with our customers and drive traffic to our stores and website, including our catalog, in-store events and contests, social media and grass roots community programs. These initiatives are complemented by email marketing as well as traditional radio and print advertising to build customer awareness and loyalty, highlight key merchandise offerings, drive traffic to our stores and website and promote the Tilly’s brand.

 

  Ÿ  

Sophisticated systems and distribution infrastructure to support growth.    Over the last five years we have invested approximately $20 million in our highly automated distribution center and information systems to support our future growth. We believe our distribution and allocation capabilities are unique within the industry and can support a national retail footprint in excess of 500 stores with minimal incremental capital investment.

 

  Ÿ  

Experienced management team.    Our senior management team, led by Hezy Shaked and Daniel Griesemer, has extensive experience across a wide range of disciplines in the specialty retail and direct-to-consumer industries, including store operations, merchandising, distribution, real estate and finance.

 

 

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Our Growth Strategy

We are pursuing several strategies to continue our profitable growth, including:

 

  Ÿ  

Expand Our Store Base.    We believe there is a significant opportunity to expand our store base from 126 locations as of April 30, 2011 to more than 500 stores across the United States. We plan to add 13 net stores in fiscal year 2011, approximately 20 net stores in fiscal year 2012, and to continue opening new stores at an annual rate of approximately 15% for the next several years thereafter. Our stores generate compelling economics. We expect net sales of approximately $2.2 million and cash flow of $300,000 from new stores in the first year and a cash-on-cash payback period of approximately 18 months.

 

  Ÿ  

Drive Comparable Store Sales.    We seek to maximize our comparable store sales by consistently offering new, on-trend and relevant merchandise across a broad assortment of categories, increasing our brand awareness through our multi-pronged marketing approach, providing an authentic store experience for our core customers and maintaining our high level of customer service. We believe our comparable store sales will benefit as stores opened in the last few years continue to mature and we continue to build brand awareness in new markets.

 

  Ÿ  

Grow Our e-Commerce Platform.    We believe our e-commerce platform is an extension of our brand and retail stores, providing our customers with a seamless shopping experience. We believe we can grow our e-commerce platform by continuing our successful catalog and online marketing efforts, offering a wider selection of internet-exclusive merchandise and expanding our online selection to ensure a broad and diverse offering of brands and products relative to our competition. We also believe we will see continued growth in our e-commerce sales as we open additional stores and build brand awareness in the communities surrounding those locations. In fiscal 2010, e-commerce sales increased 46% and represented approximately 10% of our total net sales. We believe e-commerce sales will continue to outpace our total sales growth and reach 15% of net sales over time.

 

  Ÿ  

Increase Our Operating Margins.    We believe we have the opportunity to drive margin expansion through scale efficiencies and continued process improvements focused on lowering our unit costs and improving operational efficiency throughout our organization.

Risk Factors

There are a number of risks and uncertainties that may affect our financial and operating performance and our growth prospects. You should carefully consider all of the risks discussed in “Risk Factors”, which begins on page 9, before investing in our Class A common stock. These risks include, but are not limited to, the following:

 

  Ÿ  

we may not be able to identify and respond to changing customer preferences and fashion-related trends;

 

  Ÿ  

we may face intense competition and we may not be able to compete effectively;

 

  Ÿ  

we could be negatively impacted by changes in consumer confidence and spending;

 

  Ÿ  

we have expanded rapidly in recent years and we may not be able to effectively manage our operations or our future growth;

 

  Ÿ  

we may not be able to execute on our growth strategy if we are unable to locate suitable locations or attract customers to our stores;

 

  Ÿ  

we may not be able to successfully expand into new geographic markets in the United States;

 

 

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  Ÿ  

we may not be able to maintain and enhance our brand image, particularly in new markets;

 

  Ÿ  

our operating results fluctuate on a quarterly basis due to the seasonal nature of our business; and

 

  Ÿ  

we rely on key relationships with our suppliers and we may not be able to maintain or add to these relationships or obtain sufficient inventory to support our growth.

Corporate Information

Tilly’s, Inc. was incorporated in Delaware in May 2011. We are a holding company, and all of our business operations are conducted through World of Jeans & Tops, a California corporation, which, following the Reorganization Transaction, will be our wholly owned subsidiary. Our founders opened their first store in 1982 and formed World of Jeans & Tops in 1984. World of Jeans & Tops operates under the name “Tilly’s”.

Office Location

Our principal executive office is located at 10 Whatney, Irvine, California 92618. Our telephone number is (949) 609-5599 and our fax number is (949) 609-5508. Our website address is www.tillys.com. The information contained on our website does not constitute part of, nor is it incorporated into, this prospectus.

Certain Trademarks

This prospectus includes references to trademarks such as, but not limited to, BLUE CROWN®, FULL TILT®, “IF IT’S NOT HERE…IT’S NOT HAPPENING®, INFAMOUS®, RSQ® and TILLY’S®, which are protected under applicable intellectual property laws and are our property and/or the property of our subsidiary. This prospectus also contains trademarks, service marks, copyrights and trade names of other companies, which are the property of their respective owners. We regard our trademarks as valuable and intend to maintain such marks and any related registrations. Solely for convenience, our trademarks and trade names referred to in this prospectus may appear without the ® or ™ symbols, but such references are not intended to indicate, in any way, that we will not assert, to the fullest extent under applicable law, our rights to these trademarks and trade names.

 

 

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THE OFFERING

 

Common stock offered by us

                 shares of Class A common stock
                 shares of Class A common stock

 

Underwriters’ option to purchase additional shares

We have granted the underwriters a 30-day option to purchase up to              additional shares of Class A common stock at the initial public offering price less the underwriting discount.

 

Class A common stock to be outstanding after this offering

                 shares

 

Class B common stock to be outstanding after this offering

                 shares

 

Use of proceeds

We estimate that the net proceeds to us from this offering will be approximately $         million, after deducting the underwriting discount and estimated expenses payable by us.

 

  We intend to use approximately $         million of the net proceeds from this offering to pay in full the principal amount of the undistributed earnings notes held by our existing shareholders in connection with World of Jeans & Tops’ final “S” Corporation distribution. We expect proceeds in excess of the final “S” Corporation distribution to be $         million and we intend to use such proceeds for working capital and general corporate purposes. See “Use of Proceeds” for additional information.

 

Voting rights

After the completion of this offering, our common stock will consist of two classes: Class A common stock and Class B common stock. Purchasers in this offering will acquire Class A common stock. Class A and Class B common stock are identical, except with respect to voting and conversion rights. Holders of Class A common stock are entitled to one vote per share, and holders of Class B common stock are entitled to 10 votes per share, on all matters to be voted on by our common stockholders. Shares of Class A and Class B common stock vote together as a single class on all matters submitted to a vote of stockholders.

 

 

Immediately following completion of this offering, all of the Class B common stock will be beneficially owned by Hezy Shaked, Tilly Levine and their children through related trusts, which we collectively refer to in this prospectus as the Shaked and Levine family entities. The Shaked and Levine family entities will control approximately     % of the total voting power of our outstanding common stock following the completion of

 

 

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this offering. As a result, the Shaked and Levine family entities will be able to control the outcome of all matters submitted to a vote of our stockholders, including, for example, the election of directors, amendments to our certificate of incorporation and mergers or other business combinations. See “Description of Capital Stock”.

 

Class B common stock conversion rights

Shares of Class B common stock may only be held by the Shaked and Levine family entities and non-profit or other corporations, partnerships or trusts controlled by Mr. Shaked, Ms. Levine or their children. Shares of Class B common stock that are transferred to a holder other than a Hezy Shaked Entity (as defined in “Description of Capital Stock”) will automatically convert into a like number of shares of Class A common stock. In addition, all of the Class B common stock will convert into Class A common stock on a one-for-one basis on the date upon which the number of shares of Class A common stock and Class B common stock beneficially owned by Hezy Shaked and any Hezy Shaked Entity, in the aggregate, represents less than 15.0% of the total number of shares of Class A and Class B common stock then outstanding. See “Description of Capital Stock”.

 

Dividend policy

We do not anticipate paying dividends on our common stock after completion of this offering. We intend to retain all available funds and any future earnings for use in the operation and expansion of our business.

 

Proposed New York Stock Exchange symbol

TLYS

 

Risk factors

See “Risk Factors” and other information included in this prospectus for a discussion of factors you should carefully consider before deciding to invest in shares of our Class A common stock.

The number of shares of Class A common stock that will be outstanding after completion of this offering excludes:

 

  Ÿ  

                 shares of Class A common stock issuable upon exercise of outstanding stock options, of which              were vested as of             ; and

 

  Ÿ  

                 additional shares of Class A common stock that we expect to reserve for future issuance under our 2011 Equity and Incentive Award Plan, which we intend to adopt upon consummation of this offering.

Except as otherwise noted, all information in this prospectus:

 

  Ÿ  

assumes that our shares of Class A common stock will be sold at $         per share, which is the mid-point of the price range set forth on the cover page of this prospectus;

 

  Ÿ  

assumes that the underwriters do not exercise their option to purchase additional shares; and

 

  Ÿ  

gives effect to the completion of the Reorganization Transaction described elsewhere in this prospectus, which will occur prior to consummation of this offering.

 

 

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SUMMARY CONSOLIDATED FINANCIAL AND OTHER DATA

The following table presents summary consolidated financial and other data and pro forma information to reflect our conversion from an “S” Corporation to a “C” Corporation for income tax purposes. The summary consolidated statement of operations data for the fiscal years ended January 30, 2010 and January 29, 2011 are derived from our financial statements audited by Deloitte & Touche LLP, our independent registered public accounting firm, included elsewhere in this prospectus. The summary consolidated statements of operations data for the thirteen weeks ended May 1, 2010 and April 30, 2011 and the summary consolidated balance sheet data as of April 30, 2011 are derived from our unaudited financial statements included elsewhere in this prospectus. The historical results presented below are not necessarily indicative of the results to be expected for any future period. You should read the following information together with the more detailed information contained in “Selected Consolidated Financial and Other Data”, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements and the accompanying notes appearing elsewhere in this prospectus.

 

    Fiscal Year Ended     Thirteen Weeks Ended  
    January 30,
2010
    January 29,
2011
      May 1,  
2010
      April 30,  
2011
 
    (in thousands, except per share data)  

Consolidated Statements of Operations Data:

       

Net sales

  $ 282,764      $ 332,604      $ 64,344      $ 83,131   

Cost of goods sold(1)

    195,430        229,989        45,718        56,922   
                               

Gross profit

    87,334        102,615        18,626        26,209   

Selling, general and administrative expenses

    65,912        77,668        16,867        21,244   
                               

Operating income

    21,422        24,947        1,759        4,965   

Interest income (expense), net

    (284     (249     (78     (49
                               

Income before provision for income taxes

    21,138        24,698        1,681        4,916   

Provision for income taxes

    275        282        22        56   
                               

Net income

  $ 20,863      $ 24,416      $ 1,659      $ 4,860   
                               

Net income per common share:

       

Basic

  $ 1.04      $ 1.22      $ 0.08      $ 0.24   

Diluted

  $ 1.04      $ 1.21      $ 0.08     

Weighted average shares outstanding:

       

Basic

    20,000        20,000        20,000        20,000   

Diluted

    20,014        20,098        20,048     

Pro Forma Income Information (unaudited)(2):

       

Historical income before provision for income taxes

  $ 21,138      $ 24,698      $ 1,681      $ 4,916   

Pro forma provision for income taxes

    8,455        9,879        672        1,966   
                               

Pro forma net income

  $ 12,683      $ 14,819      $ 1,009      $ 2,950   
                               

Pro forma basic income per common share(3)

       

Pro forma diluted income per common share(3)

       

 

 

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    Fiscal Year Ended     Thirteen Weeks Ended  
    January 30,
2010
    January 29,
2011
    May 1,
2010
    April 30,
2011
 

Operating Data (unaudited):

       

Stores operating at beginning of period

    99        111        111        125   

Stores opened during the period

    13        16        1        1   

Stores closed during the period

    1        2                 
                               

Stores operating at end of period

    111        125        112        126   

Comparable store sales change(4)

    -3.1     6.7     2.2     18.2

Total square feet at end of period

    862,971        967,011        870,423        977,164   

Average square footage per store at end of period

    7,775        7,736        7,772        7,755   

Average net sales per store (in thousands)(5)

  $ 2,479      $ 2,528      $ 528      $ 596   

Average net stores sales per square foot(5)

  $ 318      $ 326      $ 68      $ 77   

Capital expenditures (in thousands)

  $ 17,514      $ 15,674      $ 4,722      $ 3,001   
                         
    Actual
April 30,
2011
    Pro Forma
April 30,
2011(7)
    Pro Forma
as adjusted
April 30,
2011(8)
       
    (unaudited)     (unaudited)     (unaudited)        
    (in thousands)        

Consolidated Balance Sheet Data:

   

Cash and cash equivalents

  $ 28,770         

Working capital

    38,631         

Total assets

    133,579         

Total long-term debt(6)

    4,475         

Stockholders’ equity

    65,103         

 

(1) Includes buying, distribution and occupancy costs.
(2) The unaudited pro forma income information for all periods presented gives effect to an adjustment for income tax expense as if we had been a “C” Corporation at an assumed combined federal, state and local effective income tax rate, which approximates our statutory income tax rate, of 40%.
(3) Reflects the increase in the number of shares which would be sufficient to replace the capital in excess of current year earnings being withdrawn pursuant to the Reorganization Transaction and the related distribution of notes and cash (see footnote 8 below). The pro forma adjustment to basic and diluted weighted average shares outstanding for the fiscal year ended January 29, 2011 and for the thirteen weeks ended April 30, 2011 is              and             , respectively.
(4) Comparable store sales are net sales from stores that have been open at least 12 full fiscal months as of the end of the applicable 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.
(5) The number of stores and the amount of square footage reflect the number of days during the period that new stores were open. E-commerce sales, e-commerce shipping revenue and gift card breakage income are excluded from our sales in deriving net sales per store and net sales per square foot.
(6) Comprised solely of a capital lease for our corporate headquarters and distribution center.
(7) This column gives effect to the Reorganization Transaction and stock split as described under “Description of Capital Stock—Reorganization Transaction”, including (i) the issuance by World of Jeans & Tops of the undistributed taxable earnings notes to its existing shareholders in the aggregate principal amount equal to 100% of World of Jeans & Tops’ undistributed taxable income from the date of its formation up to the date of termination of its “S” Corporation status, as a final distribution prior to the termination of its “S” Corporation status, equal to $            , and (ii) a change in net deferred tax asset of approximately $             assuming its “S” Corporation status terminated on             .
(8) This column gives effect to (i) the sale by us of                  shares of our Class A common stock in this offering assuming an initial public offering price of $             per share, the mid-point of the price range set forth on the cover page of this prospectus, after deducting the underwriting discount and estimated offering expenses payable by us and (ii) the application of the estimated proceeds from this offering as described under “Use of Proceeds”.

 

 

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RISK FACTORS

An investment in our Class A common stock involves a high degree of risk. You should carefully consider the risks described below, together with the financial statements and other information contained in this prospectus, before making a decision to buy our Class A common stock. If any of the following risks actually occurs, our business, financial condition and results of operations could suffer. As a result, the trading price and value of our Class A common stock could decline and you could lose all or part of your investment in our Class A common stock.

Risks Related to Our Business

Our business depends upon identifying and responding to changing customer fashion preferences and fashion-related trends. If we cannot identify trends in advance or we select the wrong fashion trends, our sales could be adversely affected.

Fashion trends in the West Coast inspired and action sports related apparel, footwear and accessories market can change rapidly. We need to anticipate, identify and respond quickly to changing trends and consumer demands in order to provide the merchandise our customers seek and maintain our brand image. If we cannot identify changing trends in advance, fail to react to changing trends or misjudge the market for a trend, our sales could be adversely affected and we may be faced with a substantial amount of unsold inventory or missed opportunities. As a result, we may be forced to mark down our merchandise in order to dispose of slow moving inventory which may result in lower profit margins, negatively impacting our financial condition and results of operations.

We face intense competition in our industry and we may not be able to compete effectively.

The retail industry is highly competitive. We currently compete with other retailers such as Abercrombie & Fitch Co., Aeropostale, Inc., American Eagle Outfitters, Inc., The Buckle, Inc., Forever 21, Inc., Hot Topic, Inc., Pacific Sunwear of California, Inc., The Wet Seal, Inc., Urban Outfitters, Inc. and Zumiez, Inc. In addition, we compete with independent specialty shops, department stores and direct marketers that sell similar lines of merchandise and target customers through catalogs and e-commerce. Competition with some or all of these retailers noted above could require us to lower our prices or risk losing customers. In addition, significant or unusual promotional activities by our competitors may cause us to respond in-kind and adversely impact our operating cash flow. Because of these factors, current and future competition could have a material adverse effect on our financial condition and results of operations.

Furthermore, many of our competitors have greater financial, marketing and other resources than we currently do, and therefore may be able to devote greater resources to the marketing and sale of their products, generate national brand recognition or adopt more aggressive pricing policies than we can, which would put us at a competitive disadvantage. Moreover, we do not possess exclusive rights to many of the elements that comprise our in-store experience and product offerings. Our competitors may seek to emulate facets of our business strategy and in-store experience, which could result in a reduction of any competitive advantage or special appeal that we might possess. In addition, most of our products are sold to us on a non-exclusive basis. As a result, our current and future competitors may be able to duplicate or improve on some or all of our in-store experience or product offerings that we believe are important in differentiating our stores and our customers’ shopping experience. If our competitors were to duplicate or improve on some or all of our in-store experience or product offerings, our competitive position and our business could suffer.

 

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Our sales could be severely impacted by declines in consumer confidence and decreases in consumer spending.

We depend upon consumers feeling confident to spend discretionary income on our product offering to drive our sales. Consumer spending may be adversely impacted by economic conditions such as consumer confidence in future economic conditions, interest and tax rates, employment levels, salary and wage levels, general business conditions, the availability of consumer credit and the level of housing, energy and food costs. These risks may be exacerbated for retailers like us who focus on specialty apparel and accessories. Our financial performance is particularly susceptible to economic and other conditions in regions or states where we have a significant number of stores, such as the southwestern U.S. and Florida. If periods of decreased consumer spending persist, our sales could decrease and our financial condition and results of operations could be adversely affected.

We have expanded rapidly in recent years and have limited operating experience at our current size.

We have significantly expanded our operations in the last six and a half years, increasing from 32 stores in June 2004 in the state of California to operating 126 stores in 11 states as of April 30, 2011. If our operations continue to grow, we will be required to expand our sales and distribution functions, marketing, support services, management information systems and administrative personnel. This expansion could increase the strain on our existing resources, causing operational difficulties such as difficulties in hiring, obtaining adequate levels of merchandise, delayed shipments and decreased customer service levels. These difficulties could cause our brand image to deteriorate and lead to a decrease in revenues, income and the price of our common stock.

Our continued growth depends upon our ability to successfully open a significant number of new stores.

We have grown our store count rapidly in recent years and that has contributed to our growth in profits. However, we must continue to open and operate new stores to help maintain this revenue and profit growth. We opened 16 stores in 2010 and 13 stores in 2009. As of April 30, 2011, we have opened one store during 2011 and plan to open an additional 13 stores in the remainder of the year. We plan to open approximately 20 net stores in 2012. However, there can be no assurance that we will open the planned number of new stores in fiscal year 2011 or thereafter. Our ability to successfully open and operate new stores is subject to a variety of risks and uncertainties, such as:

 

  Ÿ  

identifying suitable store locations, the availability of which is beyond our control;

 

  Ÿ  

obtaining acceptable lease terms;

 

  Ÿ  

sourcing sufficient levels of inventory;

 

  Ÿ  

selecting the appropriate merchandise that appeals to our customers;

 

  Ÿ  

hiring and retaining store employees;

 

  Ÿ  

assimilating new store employees into our corporate culture;

 

  Ÿ  

effectively marketing the new stores’ locations;

 

  Ÿ  

avoiding construction delays and cost overruns in connection with the build-out of new stores;

 

  Ÿ  

managing and expanding our infrastructure to accommodate growth; and

 

  Ÿ  

integrating the new stores with our existing buying, distribution and other support operations.

Our failure to successfully address these challenges could have a material adverse effect on our financial condition and results of operations, causing the market price of our Class A common stock to decline.

 

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Expanding into new geographic markets may present challenges that are different from those we currently encounter. Failure to effectively adapt to these new challenges could adversely affect our ability to profitably operate those stores and maintain our brand image.

We operate stores in a variety of different geographic markets in the U.S. and do not significantly differentiate between our stores by visual display or by the product offering. We also currently do not significantly differentiate our general store business plan from store to store. As we expand store locations, we may face challenges that are different from those we currently encounter. Our expansion into new geographic markets could result in competitive, merchandising, distribution and other challenges. In addition, as the number of our stores increases, we may face risks associated with market saturation of our product offerings and locations. Our vendors may also restrict their sales to us in new markets to the extent they are already saturating that market with their products through other retailers or their own stores. There can be no assurance that any newly opened stores will be received as well as, or achieve net sales or profitability levels comparable to those of, our existing stores in the time periods estimated by us, or at all. If our stores fail to achieve, or are unable to sustain, acceptable net sales and profitability levels, our business may be materially harmed and we may incur significant costs associated with closing those stores and our brand image may be negatively impacted.

Our business largely depends on a strong brand image, and if we are not able to maintain and enhance our brand, particularly in new markets where we have limited brand recognition, we may be unable to increase or maintain our level of sales.

We believe that our brand image and brand awareness has contributed significantly to the success of our business. We also believe that maintaining and enhancing our brand image, particularly in new markets where we have limited brand recognition, is important to maintaining and expanding our customer base. As we execute our growth strategy, our ability to successfully integrate new stores into their surrounding communities, to expand into new markets or to maintain the strength and distinctiveness of our brand image in our existing markets will be adversely impacted if we fail to connect with our target customer. Maintaining and enhancing our brand image may require us to make substantial investments in areas such as merchandising, marketing, store operations, community relations, store graphics, catalog distribution and employee training, which could adversely affect our cash flow and which may not ultimately be successful. Failure to successfully market our brand in new and existing markets could harm our business, results of operations and financial condition.

Our sales can significantly fluctuate based upon shopping seasons, which may cause our operating results to fluctuate disproportionately on a quarterly basis.

Because of a traditionally higher level of sales during the back-to-school and winter holiday shopping seasons, our sales are typically higher in the third and fourth fiscal quarters than they are in the first and second fiscal quarters. Accordingly, the results of a single fiscal quarter, particularly the third and fourth fiscal quarters, should not be relied on as an indication of our annual results or future performance. In addition, any factors that harm our third and fourth fiscal quarter operating results could have a disproportionate effect on our results of operations for the entire fiscal year.

We depend on cash generated from our existing store operations to support our growth which could strain our cash flow.

We primarily rely on cash flow generated from existing stores to fund our current operations and our growth plans. It takes several months and a significant amount of cash to open a new store. If we continue to open a large number of stores relatively close in time, the cost of these store openings and the cost of continuing operations could reduce our cash position. An increase in our net cash outflow for new stores could adversely affect our operations by reducing the amount of cash available to address other aspects of our business.

 

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In addition, as we expand our business, we will need significant amounts of cash from operations to pay our existing and future lease obligations, build out new store space, purchase inventory, pay personnel, pay for the increased costs associated with operating as a public company, and, if necessary, further invest in our infrastructure and facilities. If our business does not generate sufficient cash flow from operations to fund these activities, and sufficient funds are not otherwise available from the net proceeds we receive from this offering or our existing revolving credit facility or future credit facilities, we may need additional equity or debt financing. If such financing is not available to us on satisfactory terms, our ability to operate and expand our business or to respond to competitive pressures would be limited and we could be required to delay, curtail or eliminate planned store openings. Moreover, if we raise additional capital by issuing equity securities or securities convertible into equity securities, your ownership may be diluted. Any debt financing we may incur may impose on us covenants that restrict our operations, and will require interest payments that would create additional cash demands and financial risk for us.

Our ability to attract customers to our stores depends significantly on the success of the retail centers where the stores are located.

We depend on the location of our stores to generate a large amount of our customer traffic. We try to select well-known and popular malls, power centers, neighborhood and lifestyle centers, outlet centers and street-front locations, usually near prominent retailers, to generate customer traffic for our stores. Customer traffic at these retail centers, and consequently our stores, could be adversely affected by economic downturns nationally or regionally, competition from Internet retailers, changes in consumer demographics, the closing or decrease in popularity of other retailers in the retail centers in which our stores are located, our inability to obtain or maintain prominent store locations within retail centers or the selection by prominent retailers and businesses of other locations. A reduction in customer traffic would likely lead to a decrease in our sales, and, if similar reductions in traffic occur at a number of our stores, this could have a material adverse effect on our financial condition and results of operations.

Some of our new stores may open in locations close enough to our existing stores that sales at those existing stores may be negatively impacted.

As we continue to open additional locations within existing markets, some of our new stores may open close enough to our existing stores that a segment of customers will stop shopping at our existing locations and prefer to shop at the new locations, and therefore sales and profitability at those existing stores may decline. If this were to occur with a number of our stores, this could have a material adverse effect on our results of operations.

We purchase merchandise in advance of the season in which it will be sold and if we purchase too much inventory we may need to reduce prices in order to sell it, which may adversely affect our overall profitability.

We must actively manage our purchase of inventory. Generally, we order merchandise months in advance of it being received and offered for sale. If there is a significant decrease in demand for our products or if we fail to accurately predict fashion trends or consumer demands, we may be forced to rely on markdowns or promotional sales to dispose of excess inventory. This could have an adverse effect on our margins and operating income.

We buy and stock merchandise based upon seasonal weather patterns and therefore unseasonable weather could negatively impact our sales.

We buy select merchandise for sale based upon expected weather patterns during the seasons of winter, spring, summer and fall. If we encounter untimely aberrations in weather conditions, such as warmer winters or cooler summers than would be considered typical, these weather variations could

 

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cause some of our merchandise to be inconsistent with what consumers wish to purchase, causing our sales to decline. Furthermore, extended unseasonable weather conditions in the southwestern U.S., particularly in California and Arizona, will likely have a greater impact on our sales because of our store concentration in that region.

If we fail to maintain good relationships with our suppliers or if our suppliers are unable or unwilling to provide us with sufficient quantities of merchandise at acceptable prices, our business and operations may be adversely affected.

Our business is largely dependent on continued good relations with our suppliers, including vendors for our third-party branded products and manufacturers for our proprietary branded products. We operate on a purchase order basis for our proprietary branded and third-party branded merchandise and do not have long-term contractual relationships with our suppliers. Accordingly, our suppliers can refuse to sell us merchandise, limit the type or quantity of merchandise they sell us or raise prices at any time, which can have an adverse impact on our business. Deterioration in our relationships with our suppliers could have a material adverse impact on our business, and there can be no assurance that we will be able to acquire desired merchandise in sufficient quantities on terms acceptable to us in the future. Also, some of our vendors are vertically integrated, selling products directly from their own retail stores, and therefore are in direct competition with us. These vendors may decide at some point in the future to discontinue supplying their merchandise to us, supply us less desirable merchandise or raise prices on the products they do sell us. If we lose key vendors or are unable to find alternative vendors to supply us with substitute merchandise for lost products, our business may be adversely affected.

A rise in the cost of raw materials, such as cotton, and the cost of labor and transportation could increase our cost of sales and cause our results of operations and margins to decline.

Fluctuations in the price, availability and quality of fabrics or other raw materials used to manufacture our products, as well as the price for labor and transportation, could have adverse impacts on our cost of sales and our ability to meet our customers’ demands. In particular, because a key component of our clothing is cotton, any increases in the cost of cotton may significantly affect the cost of our products and could have an adverse impact on our cost of sales. We may not be able to pass all or a portion of these higher costs on to our customers, which could have a material adverse effect on our profitability.

Any inability to balance merchandise bearing our proprietary brands with the third-party branded merchandise we sell may have an adverse effect on our sales and gross margin.

Our proprietary branded merchandise represented approximately 29% of our net sales for the fiscal year ended January 29, 2011. Our proprietary branded merchandise generally has a higher gross margin than the third-party branded merchandise we offer. As a result, we may determine that it is best for us to continue to hold or increase the penetration of our proprietary brands in the future. However, carrying our proprietary brands limits the amount of third-party branded merchandise we can carry and, therefore, there is a risk that the customers’ perception that we offer many major brands will decline. By maintaining or increasing the amount of our proprietary branded merchandise, we are also exposed to greater fashion risk, as we may fail to anticipate fashion trends correctly. These risks, if they occur, could have a material adverse effect on sales and profitability.

Most of our merchandise is produced in foreign countries, making the price and availability of our merchandise susceptible to international trade and other international conditions.

Although we purchase our merchandise from domestic suppliers, these suppliers have a majority of their merchandise made in foreign countries. Some foreign countries can be, and have been, affected by political and economic instability and natural disasters, negatively impacting trade. The

 

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countries in which our merchandise currently is manufactured or may be manufactured in the future could become subject to new trade restrictions imposed by the U.S. or other foreign governments. Trade restrictions, including increased tariffs or quotas, embargoes and customs restrictions, against apparel items, as well as U.S. or foreign labor strikes, work stoppages or boycotts, could increase the cost or reduce the supply of apparel available to us and have a material adverse effect on our business, financial condition and results of operations. In addition, our merchandise supply could be impacted if our suppliers’ imports become subject to existing or future duties and quotas, or if our suppliers face increased competition from other companies for production facilities, import quota capacity and shipping capacity. Any increase in the cost of our merchandise or limitation on the amount of merchandise we are able to purchase could have a material adverse effect on our financial condition and results of operations.

If our vendors and manufacturing sources fail to use acceptable labor or other practices our reputation may be harmed, which could negatively impact our business.

We purchase merchandise from independent third-party vendors and manufacturers. If any of these suppliers have practices that are not legal or accepted in the U.S., consumers may develop a negative view of us, our brand image could be damaged and we could become the subject of boycotts by our customers and/or interest groups. Further, if the suppliers violate labor or other laws of their own country, these violations could cause disruptions or delays in their shipments of merchandise. For example, much of our merchandise is manufactured in China and Mexico, which have different labor practices than the U.S. We do not independently investigate whether our suppliers are operating in compliance with all applicable laws and therefore we rely upon the suppliers’ representations set forth in our purchase orders and vendor agreements concerning the suppliers’ compliance with such laws. If our goods are manufactured using illegal or unacceptable labor practices in these countries, or other countries from which our suppliers source the product we purchase, our ability to supply merchandise for our stores without interruption, our brand image and, consequently, our sales may be adversely affected.

If we lose key management personnel our operations could be negatively impacted.

Our business and growth depends upon the leadership and experience of our key executive management team, including our co-founder, Hezy Shaked, who currently serves as our Chief Strategy Officer and Chairman of our board of directors, and Daniel Griesemer, our President and Chief Executive Officer, and we may be unable to retain their services. We also may be unable to retain other existing management personnel that are critical to our success, which could result in harm to our vendor and employee relationships, loss of key information, expertise or know-how and unanticipated recruitment and training costs. The loss of services of any of our key personnel could have a material adverse effect on our business and prospects, and could be viewed in a negative light by investors and analysts, which could cause our Class A common stock price to decline. None of our employees, except for Mr. Griesemer, have employment agreements and we do not intend to purchase key person life insurance covering any employee. If we lose the services of any of our key personnel or we are not able to attract additional qualified personnel, we may not be able to successfully manage our business.

If we cannot retain or find qualified employees to meet our staffing needs in our stores, our distribution center, or our corporate offices, our business could be adversely affected.

Our success depends upon the quality of the employees we hire. We seek employees who are motivated, represent our corporate culture and brand image and, for many positions, have knowledge of our merchandise and the skill necessary to excel in a customer service environment. The turnover rate in the retail industry is high and finding qualified candidates to fill positions may be difficult. If we cannot attract and retain corporate employees, district managers, store managers and store associates

 

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with the qualifications we deem necessary, our ability to effectively operate and expand may be adversely affected. In addition, we rely on temporary personnel to staff our distribution center, as well as seasonal part-time employees to provide incremental staffing to our stores in busy selling seasons such as the back-to-school and winter holiday seasons. We cannot guarantee that we will be able to find adequate temporary or seasonal personnel to staff our operations when needed, which may strain our existing personnel and negatively impact our operations.

Our corporate headquarters, distribution center and management information systems are in a single location in southern California, and if their operations are disrupted, we may not be able to operate our store support functions or ship merchandise to our stores, which would adversely affect our business.

Our corporate headquarters, distribution center and management information systems are in a single location in Irvine, California. If we encounter any disruptions to our operations at this building or if it were to shut down for any reason, including by fire or other natural disaster, then we may be prevented from effectively operating our stores, shipping and processing our merchandise and operating our e-commerce business. Furthermore, the risk of disruption or shut down at this building is greater than it might be if it were located in another region, as southern California is prone to natural disasters such as earthquakes and wildfires. Any disruption or shut down at this location could significantly impact our operations and have a material adverse effect on our financial condition and results of operations.

Our stores are mostly located in the southwestern U.S. and Florida, with a significant number of stores located in California, putting us at risk to region-specific disruptions.

Out of a total of 126 stores as of April 30, 2011, we operated 72 stores in California, 17 stores in Arizona, six stores in Nevada and 16 stores in Florida. Sales in these states could be more susceptible than the country generally to disruptions, such as from economic and weather conditions, demographic and population changes and changes in fashion tastes, and consequently, we may be more susceptible to these factors than more geographically diversified competitors. For example, because of the negative economic impact caused by the downturn in the housing market, sales in these states may have slowed more than sales would have in other regions or the country as a whole. Compared to the country as a whole, stores in California are exposed to a relatively high risk of damage from a major earthquake or wildfires, while stores in Florida are also exposed to a relatively high risk from hurricane damage. Any negative impact upon or disruption to the operations of stores in these states could have a material adverse effect on our financial condition and results of operations.

We are required to make significant lease payments for our store leases and corporate offices and distribution center, which may strain our cash flow.

We lease all of our retail store locations as well as our corporate headquarters and distribution center. We do not own any real estate. Leases for our stores are typically for terms of ten years and many can be extended in five-year increments. Many of our leases have early cancelation clauses which permit us to terminate the lease if certain sales thresholds are not met in certain periods of time. Our costs under these leases are a significant amount of our expenses and are growing rapidly as we expand the number of locations and existing locations experience expense increases. In fiscal year 2010, our total operating lease rent expense was $26.3 million and our common area maintenance expense was $9.5 million. This increased from $22.4 million and $8.0 million, respectively, in fiscal year 2009 and can be expected to continue to increase as we open more stores. We are required to pay additional rent under many of our lease agreements based upon achieving certain sales plateaus for each store location. In addition, we must make significant payments for common area maintenance and real estate taxes. Many of our lease agreements also contain provisions which increase the rent payments on a set time schedule, causing the cash rent paid for a location to escalate over the term of

 

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the lease. In addition, rent costs could escalate when multi-year leases are renewed at the expiration of their lease term. These costs are significant, recurring and increasing, which places a consistent strain on our cash flow.

We depend on cash flow from operations to pay our lease expenses and to fulfill our other cash needs. If our business does not generate sufficient cash flow from operating activities, and sufficient funds are not otherwise available to us from borrowings under our available revolving credit facility or from other sources, we may not be able to service our operating lease expenses, grow our business, respond to competitive challenges or to fund our other liquidity and capital needs, which would harm our business.

Additional sites that we lease are likely to be subject to similar long-term leases. If an existing or future store is not profitable, and we decide to close it, we may nonetheless be committed to perform our obligations under the applicable lease including, among other things, paying the base rent for the balance of the lease term. In addition, as our leases expire, we may fail to negotiate renewals, either on commercially acceptable terms or at all, which could cause us to close stores in desirable locations. If we are unable to enter into new leases or renew existing leases on terms acceptable to us or be released from our obligations under leases for stores that we close, our business, profitability and results of operations may be harmed.

We rely on Integrity Retail Distribution and Federal Express to deliver merchandise to our stores located outside of southern California and therefore our business could be negatively impacted by disruptions in the operations of these third-party providers.

We rely on Integrity Retail Distribution to ship our merchandise from our distribution center in Irvine, California to our stores located in northern and central California, Arizona and Nevada, and we rely on Federal Express to ship our merchandise to stores in all other states. We also rely on Federal Express and the U.S. Postal Service to ship all e-commerce sales packages to our customers. Relying on these third-party delivery services puts us at risk from disruptions in their operations, such as employee strikes, inclement weather and their ability to meet our shipping demands. If we are forced to use other delivery services, our costs could increase and we may not be able to meet shipment deadlines. Moreover, we may not be able to obtain terms as favorable as those received from the transportation providers we currently use, which would further increase our costs. These circumstances may negatively impact our financial condition and results of operations.

We may not be able to maintain comparable store sales or sales per square foot, which may cause our results of operations to decline and the price of our Class A common stock to be volatile.

The investing public may use comparable store sales or net store sales per square foot projections or results, over a certain period of time, such as on a quarterly or yearly basis, as an indicator of our profitability growth. Our comparable store sales can vary significantly from period to period for a variety of reasons, such as the age of stores, changing economic factors, unseasonable weather, changing fashion trends, pricing, the timing of the release of new merchandise and promotional events and increased competition. These factors could cause comparable store sales or net store sales per square foot to decline period to period or fail to grow at expected rates, which could adversely affect our results of operations and cause the price of our Class A common stock to be volatile during such periods.

If our management information systems fail to operate or are unable to support our growth, our operations could be disrupted.

We rely upon our management information systems in almost every aspect of our daily business operations. For example, our management information systems serve an integral part in enabling us to order merchandise, process merchandise at our distribution center and retail stores, perform and track

 

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sales transactions, manage personnel, pay vendors and employees, operate our e-commerce business and report financial and accounting information to management. In addition, we rely on our management information systems to enable us to leverage our costs as we grow. If our management information systems fail to operate or are unable to support our growth, our store operations and e-commerce business could be severely disrupted, and we could be required to make significant additional expenditures to remediate any such failure.

Our internal operations or management information systems could be disrupted by system security failures. These disruptions could negatively impact our sales, increase our expenses, and harm our reputation and the price of our Class A common stock.

Hackers, computer programmers and internal users may be able to penetrate our network security and create system disruptions, cause shutdowns and misappropriate our confidential information or that of third parties, including our customers. Therefore, we could incur significant expenses addressing problems created by security breaches to our network. This risk is heightened because we collect and store customer information for marketing purposes, as well as credit card information. We must, and do, take precautions to secure customer information and prevent unauthorized access to our database of confidential information. However, if unauthorized parties, including external hackers or computer programmers, gain access to our database, they may be able to steal this confidential information. Our failure to secure this information could result in costly litigation, adverse publicity or regulatory action that could have a material adverse effect on our financial condition and results of operations. In addition, sophisticated hardware and operating system software and applications that we procure from third parties may contain defects in design or manufacture that could unexpectedly interfere with our operations. The cost to alleviate security risks, defects in software and hardware and address any problems that occur could negatively impact our sales, distribution and other critical functions, as well as our financial results.

If we are unable to protect our intellectual property rights, our financial results may be negatively impacted.

Our success depends in large part on our brand image. Our company’s name, logo, domain name and our proprietary brands and our registered and unregistered trademarks and copyrights are valuable assets that serve to differentiate us from our competitors. We currently rely on a combination of copyright, trademark, trade dress and unfair competition laws to establish and protect our intellectual property rights. We cannot assure you that the steps taken by us to protect our proprietary rights will be adequate to prevent infringement of our trademarks and proprietary rights by others, including imitation and misappropriation of our brand. We cannot assure you that obstacles will not arise as we expand our product lines and geographic scope. The unauthorized use or misappropriation of our intellectual property could damage our brand identity and the goodwill we created for our company, which could cause our sales to decline. Moreover, litigation may be necessary to protect or enforce these intellectual property rights, which could result in substantial costs and diversion of our resources, causing a material adverse effect on our business, financial condition, results of operations or cash flows. If we cannot protect our intellectual property rights, our brand identity and the goodwill we created for our company may diminish, causing our sales to decline.

We have not registered any of our intellectual property outside of the U.S. and cannot prohibit other companies from using our trademarks in foreign countries. Use of our trademarks in foreign countries could negatively impact our identity in the U.S. and cause our sales to decline.

We may be subject to liability if we, or our vendors, infringe upon the intellectual property rights of third parties.

We may be subject to liability if we infringe upon the intellectual property rights of third parties. If we were to be found liable for any such infringement, we could be required to pay substantial damages and

 

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could be subject to injunctions preventing further infringement. Such infringement claims could harm our brand image. In addition, any payments we are required to make and any injunction we are required to comply with as a result of such infringement actions could adversely affect our financial results.

We purchase merchandise from vendors that may be subject to design copyrights, design patents, or otherwise may incorporate protected intellectual property. We are not involved in the manufacture of any of the merchandise we purchase from our vendors for sale to our customers, and we do not independently investigate whether these vendors legally hold intellectual property rights to merchandise that they are manufacturing or distributing. As a result, we rely upon vendors’ representations set forth in our purchase orders and vendor agreements concerning their right to sell us the products that we purchase from them. If a third party claims to have licensing rights with respect to merchandise we purchased from a vendor, or we acquire unlicensed merchandise, we could be obligated to remove such merchandise from our stores, incur costs associated with destruction of such merchandise if the distributor or vendor is unwilling or unable to reimburse us and be subject to liability under various civil and criminal causes of action, including actions to recover unpaid royalties and other damages and injunctions. Although our purchase orders and vendor agreement with each vendor require the vendor to indemnify us against such claims, a vendor may not have the financial resources to defend itself or us against such claims, in which case we may have to pay the costs and expenses associated with defending such claim. Any of these results could harm our brand image and have a material adverse effect on our business and growth.

We will enter into tax indemnification agreements with our existing shareholders and could become obligated to make payments to them for any additional federal, state or local income taxes assessed against them for fiscal periods prior to the completion of this offering.

World of Jeans & Tops has historically been treated as an “S” Corporation for U.S. federal income tax purposes. Effective upon completion of the Reorganization Transaction, World of Jeans & Tops’ “S” Corporation status will terminate and it will thereafter be subject to federal income taxes and increased state income taxes. In the event of an adjustment to World of Jeans & Tops’ reported taxable income for a period or periods prior to termination of its “S” Corporation status, its shareholders during those periods could be liable for additional income taxes for those prior periods. Therefore, we will enter into tax indemnification agreements with the former shareholders of World of Jeans & Tops prior to consummation of this offering. Pursuant to the tax indemnification agreements, we will agree to indemnify, defend and hold harmless each such shareholder on an after-tax basis against additional income taxes, plus interest and penalties resulting from adjustments made, as a result of a final determination made by a competent tax authority, to the taxable income World of Jeans & Tops reported as an “S” Corporation. Such indemnification will also include any losses, costs or expenses, including reasonable attorneys’ fees, arising out of a claim for such tax liability.

Acts of war or terrorism could negatively affect our business.

All of our stores are located in public areas where large numbers of people typically gather. Any terrorist attacks, or threats of terrorists attacks, to public areas could cause people not to visit areas where our stores are located. Further, armed conflicts or acts of war throughout the world may create uncertainty, causing consumers to spend less on discretionary purchases, including on apparel and accessories, and disrupting our ability to obtain merchandise for our stores. Such decreases in consumer spending or disruptions in our ability to obtain merchandise would likely decrease our sales and materially adversely affect our financial condition and results of operations.

Litigation costs and the outcome of litigation could have a material adverse effect on our business.

From time to time we may be subject to litigation claims through the ordinary course of our business operations regarding, but not limited to, employment matters, compliance with the Americans

 

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with Disabilities Act of 1990, apparel, footwear and accessory safety standards, security of customer and employee personal information, contractual relations with vendors, marketing and infringement of trademarks and other intellectual property rights. Litigation to defend ourselves against claims by third parties, or to enforce any rights that we may have against third parties, may be necessary, which could result in substantial costs and diversion of our resources, causing a material adverse effect on our business, financial condition, results of operations or cash flows.

Management does not believe the nature of any pending legal proceeding will have a material adverse effect on our financial condition and results of operations. However, management’s assessment may change at any time based upon the discovery of facts or circumstances that are presently not known to us. Therefore, there can be no assurance that any pending or future litigation will not have a material adverse effect on our financial condition and results of operations.

We may be subject to unionization, work stoppages, slowdowns or increased labor costs.

Currently, none of our employees are represented by a union. However, our employees have the right under the National Labor Relations Act to form or affiliate with a union. If some or all of our workforce were to become unionized and the terms of the collective bargaining agreement were significantly different from our current compensation arrangements, it could increase our costs and adversely impact our profitability. Moreover, participation in labor unions could put us at increased risk of labor strikes and disruption of our operations.

Violations of and/or changes in laws, including employment laws and laws related to our merchandise, could make conducting our business more expensive or change the way we do business.

We are subject to numerous regulations, including labor and employment, customs, truth-in-advertising, consumer protection and zoning and occupancy laws and ordinances that regulate retailers generally and/or govern the importation, promotion and sale of merchandise and the operation of stores and warehouse facilities. If these regulations were violated by our management, employees or vendors, the costs of certain goods could increase, or we could experience delays in shipments of our goods, be subject to fines or penalties or suffer reputational harm, which could reduce demand for our merchandise and hurt our business and results of operations.

Similarly, changes in laws could make operating our business more expensive or require us to change the way we do business. For example, changes in laws related to employee healthcare, hours, wages, job classification and benefits could significantly increase operating costs. In addition, changes in product safety or other consumer protection laws could lead to increased costs for certain merchandise, or additional labor costs associated with readying merchandise for sale. It may be difficult for us to foresee regulatory changes impacting our business and our actions needed to respond to changes in the law could be costly and may negatively impact our operations.

We will incur significant expenses as a result of being a publicly traded company, which could negatively impact our earnings.

As a result of becoming a public company, and of being a public company, we expect to incur significant incremental legal, accounting, insurance and other expenses. Compliance with the Sarbanes-Oxley Act of 2002 and the rules implemented by the SEC and New York Stock Exchange, or NYSE, require changes to corporate governance practices of public companies that did not apply to us prior to becoming a public company. In addition, the reporting requirements of the Securities Exchange Act of 1934, as amended, will require, among other things, that we file annual, quarterly and current

 

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reports with respect to our business and financial condition. Our compliance with these laws, rules and regulations have increased, and will continue to increase, our expenses, including legal and accounting costs, and make some of our operations more costly and time consuming. In addition, it may also be more difficult for us to find and retain qualified persons to serve on our board of directors or as executive officers. Further, any additional expenses in legal, accounting, insurance and other related expenses could reduce our earnings and have a material adverse effect on our financial condition and results of operations.

Our failure to maintain adequate internal controls over our financial and management systems may cause errors in our financial reporting. These errors may cause a loss of investor confidence and result in a decline in the price of our Class A common stock.

Our public company reporting obligations and our anticipated growth will likely strain our financial and management systems, internal controls and our employees. In addition, pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, or Section 404, we are required to finish documenting and testing our internal controls so our management can certify the effectiveness of our internal controls over financial reporting and our independent registered public accounting firm can render an opinion on our internal controls over financial reporting by the time our annual report for fiscal year 2012 is due and annually thereafter.

We are currently taking the necessary steps to comply with Section 404. However, this process is time consuming and costly. If during this process we identify one or more material weaknesses in our internal controls, it is possible that our management may not be able to certify that our internal controls are effective by the certification deadline. We cannot be certain we will be able to successfully complete the implementation, certification and attestation requirements of Section 404 within the time period allowed.

Moreover, if we identify any material weaknesses or significant deficiencies in our internal controls, we will have to implement appropriate changes to these controls, which may require specific compliance training for our directors, officers and employees, require the hiring of additional finance, accounting, legal and other personnel, entail substantial costs to modify our existing accounting systems and take a significant period of time to complete. Such changes may not, however, be effective in maintaining the adequacy of our internal controls, and any failure to maintain that adequacy, or consequent inability to produce accurate financial statements on a timely basis, could increase our operating costs and could materially impair our ability to operate our business. Effective internal controls are necessary for us to produce reliable financial reports and are important to prevent fraud. As a result, our failure to satisfy the requirements of Section 404 on a timely basis could result in us being subject to regulatory action and a loss of investor confidence in the reliability of our financial statements, both of which in turn could cause the market value of our Class A common stock to decline.

Prior to this offering, World of Jeans & Tops was treated as an “S” Corporation under Subchapter S of the Internal Revenue Code, and claims of taxing authorities related to its prior status as an “S” Corporation could harm us.

Concurrent with and as a result of the Reorganization Transaction, World of Jeans & Tops’ “S” Corporation status will terminate and World of Jeans & Tops will be treated as a “C” Corporation for federal and applicable state income tax purposes. As a “C” Corporation, World of Jeans & Tops will become subject to federal and increased state income taxes. In addition, if the unaudited, open tax years in which World of Jeans & Tops was an “S” Corporation are audited by the Internal Revenue Service, and World of Jeans & Tops is determined not to have qualified for, or to have violated, its “S”

 

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Corporation status, World of Jeans & Tops will be obligated to pay back taxes, interest and penalties, and the company will not have the right to reclaim tax distributions it made to its shareholders during those periods. These amounts could include taxes on all of World of Jeans & Tops’ taxable income while it was an “S” Corporation. Any such claims could result in additional costs to us and could have a material adverse effect on our results of operations and financial condition.

The terms of our planned revolving credit facility impose operating and financial restrictions on us that may impair our ability to respond quickly to changing business and economic conditions. This impairment could have a significant adverse impact on our business.

Upon completion of our initial public offering, we plan to have a $25 million revolving credit facility with Wells Fargo Bank, NA, which we may use to finance working capital or other needs, including the purchase of inventory and equipment, capital expenditures and funding for other general corporate purposes. The planned revolving credit facility will contain a number of restrictions and affirmative and negative covenants, such as restrictions on liens, annual capital expenditures, additional indebtedness, dispositions, dividends or stock repurchases and changes in the nature of our business, as well as requirements for certain levels of tangible net worth, liquidity and profitability. Obligations under the revolving credit facility will likely be secured by substantially all of our assets. Our ability to comply with these restrictions and covenants may be affected by events beyond our control. A breach of any of these restrictions and covenants could result in a default under the revolving credit facility. If a default occurs, the lender may elect to terminate the availability of undrawn amounts, increase the interest rate on all borrowings outstanding and declare all borrowings outstanding, together with accrued interest and other fees, to be immediately due and payable. If we are unable to repay outstanding borrowings when due, whether at their maturity or if declared due and payable by the lender following a default, the lender will have the right to proceed against the collateral granted to it to secure the indebtedness. As a result, any breach of these restrictions and covenants could have a material adverse effect on us.

We may engage in strategic transactions that could negatively impact our liquidity, increase our expenses and present significant distractions to our management.

We may consider strategic transactions and business arrangements, including, but not limited to, acquisitions, asset purchases, partnerships, joint ventures, restructurings, divestitures and investments. Any such transaction may require us to incur non-recurring or other charges, may increase our near and long-term expenditures and may pose significant integration challenges or disrupt our management or business, which could harm our operations and financial results.

Our e-commerce business subjects us to numerous risks that could have an adverse effect on our results of operations.

For fiscal year 2010, sales from our e-commerce business increased 46% over the previous year and represented approximately 10% of our total net sales. Our e-commerce business and its continued growth subject us to certain risks that could have an adverse effect on our results of operations, including:

 

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diversion of traffic from our stores;

 

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liability for online content;

 

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government regulation of the Internet; and

 

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risks related to the computer systems that operate our website and related support systems, including computer viruses, electronic break-ins and similar disruptions.

 

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We may incur substantial expenses related to our issuance of stock-based compensation, which may have a negative impact on our operating results for future periods.

We follow the provisions of the Financial Accounting Standards Board, or FASB, Accounting Standards Codification, or ASC, 718, Compensation-Stock Compensation, for stock-based compensation. Our stock-based compensation expenses may be significant in future periods, which could have an adverse impact on our operating and net income. FASB ASC 718 requires the use of subjective assumptions, including the options’ expected lives and the price volatility of our Class A common stock. Changes in the subjective input assumptions can materially affect the amount of our stock-based compensation expense. In addition, an increase in the competitiveness of the market for qualified employees could result in an increased use of stock-based compensation awards, which in turn would result in increased stock-based compensation expense in future periods.

Risks Related to this Offering and Ownership of Our Class A Common Stock

Our founders control a majority of the voting power of our common stock, which may prevent other stockholders from influencing corporate decisions and may result in conflicts of interest that cause the price of our Class A common stock to decline.

Upon consummation of this offering, our common stock will consist of two classes: Class A and Class B. Holders of Class A common stock are entitled to one vote per share, and holders of Class B common stock are entitled to 10 votes per share, on all matters to be voted on by our common stockholders. Immediately following completion of this offering, all of the shares of Class B common stock will be beneficially owned by the Shaked and Levine family entities. As a result, the Shaked and Levine family entities will control approximately     % of the total voting power of our outstanding common stock, assuming no exercise by the underwriters of their option to purchase additional shares of Class A common stock in this offering. In addition, Mr. Shaked serves as Chairman of the Board of Directors, and is the voting trustee, pursuant to a voting trust agreement, covering the shares owned by Ms. Levine. As a result, Mr. Shaked is in a position to dictate the outcome of any corporate actions requiring stockholder approval, including the election of directors and mergers, acquisitions and other significant corporate transactions. Mr. Shaked may delay or prevent a change of control from occurring, even if the change of control could appear to benefit the stockholders. Mr. Shaked may also have interests that differ from yours and may vote in a way with which you disagree and which may be adverse to your interests. This ownership concentration may adversely impact the trading of our Class A common stock because of a perceived conflict of interest that may exist, thereby depressing the value of our Class A common stock.

We will be a controlled company within the meaning of the NYSE rules, and, as a result, we may rely on exemptions from certain corporate governance requirements that provide protection to stockholders of other companies.

Upon completion of this offering, Mr. Shaked will control more than 50% of the total voting power of our common stock and we will be considered a controlled company under the NYSE corporate governance listing standards. As a controlled company, certain exemptions under the NYSE listing standards will exempt us from the obligation to comply with certain NYSE corporate governance requirements, including the requirements:

 

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that a majority of our board of directors consist of independent directors, as defined under the rules of the NYSE;

 

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that we have a corporate governance and nominating committee that is composed entirely of independent directors with a written charter addressing the committee’s purpose and responsibilities; and

 

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  Ÿ  

that we have a compensation committee that is composed entirely of independent directors with a written charter addressing the committee’s purpose and responsibilities.

Although we intend to comply with these listing requirements even though we will be a controlled company, there is no guarantee that we will not take advantage of these exemptions in the future. Accordingly, so long as we are a controlled company, holders of our Class A common stock may not have the same protections afforded to stockholders of companies that are subject to all of the NYSE corporate governance requirements.

There has been no public market for our Class A common stock and an active trading market for our Class A common stock may never develop following the offering.

Prior to this offering, there has been no public market for our Class A common stock and we cannot guarantee that an active trading market will develop or be sustained after the offering. If an active market does not develop or is not sustained, it may be difficult for you to sell your Class A common stock at a favorable price or at all. We cannot predict the future value of our Class A common stock. The initial public offering price will be based upon negotiations between us and the underwriters and may not bear any relationship to the market price our Class A common stock may trade at after the offering. As a result, the value of our Class A common stock may decline below the initial public offering price, based upon the market for our Class A common stock or changes in our financial condition and results of operations, and you may not be able to resell your shares of our Class A common stock at or above the initial public offering price.

If securities or industry analysts do not publish research or publish inaccurate or unfavorable research about our business, the price and trading volume of our Class A common stock could decline.

The trading market for our Class A common stock will depend in part on the research and reports that securities or industry analysts publish about us or our business. We do not currently have and may never obtain research coverage by securities and industry analysts. If no securities or industry analysts commence coverage of us, the trading price for our Class A common stock would be negatively impacted. If we obtain securities or industry analyst coverage and if one or more of the analysts who covers us downgrades our Class A common stock or publishes inaccurate or unfavorable research about our business, the price of our Class A common stock would likely decline. If one or more of these analysts ceases coverage of us or fails to publish reports on us regularly, demand for our Class A common stock could decrease, which could cause the price of our Class A common stock and trading volume to decline.

The price of our Class A common stock may be volatile and decline in value.

The market for retail apparel stocks can be highly volatile. As a result, the market price of our Class A common stock is likely to be volatile and investors may experience a decrease in the value of the Class A common stock, unrelated to our operations. The price of our Class A common stock could fluctuate significantly in response to a number of factors, as discussed in this “Risk Factors” section and such as those listed below:

 

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variations in our operating performance and the performance of our competitors;

 

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publication of research reports or recommendation by securities analysts about us, our competitors or our industry, or a lack of such securities analyst coverage;

 

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our failure or our competitors’ failure to meet analysts’ projections or guidance;

 

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our levels of comparable store sales;

 

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changes to our management team;

 

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  Ÿ  

regulatory developments negatively affecting our industry;

 

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changes in stock market valuations of our competitors;

 

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the development and sustainability of an active trading market for our Class A common stock;

 

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the public’s response to press releases or other public announcements by us or third parties, including our filings with the SEC;

 

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the performance and successful integration of any new stores that we open;

 

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actions by competitors or other mall and non-mall tenants;

 

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announcements by us or our competitors of new product offerings or significant acquisitions;

 

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ratings downgrades by any securities analysts who follow our common stock;

 

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fluctuations in the stock markets generally;

 

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changes in general market and economic conditions; and

 

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changes in fashion trends that we did not anticipate.

Further, securities class action litigation has often been initiated against companies following periods of volatility in their stock price. This type of litigation could result in substantial costs and divert our management’s attention and resources, and could also require us to make substantial payments to satisfy judgments or to settle litigation. The threat or filing of class action litigation lawsuits could cause the price of our Class A common stock to decline.

Future sales of our common stock by existing stockholders could cause the price of our Class A common stock to decline.

Any sales of a substantial number of shares of our common stock in the public market after this offering, or the perception that such sales might occur, may cause the market price for our Class A common stock to decline. Upon completion of this offering, we will have                  shares of Class A common stock and                  shares of Class B common stock outstanding, excluding any shares of Class A common stock that may be issued pursuant to the underwriters’ option to purchase additional shares, and                  shares of Class A common stock issuable upon the exercise of outstanding stock options. All of these shares, other than the                  shares of Class B common stock held by the Shaked and Levine family entities and the                  shares of Class A common stock held by our directors and officers and other “affiliates”, as defined in Rule 144 of the Securities Act of 1933, as amended, or Rule 144, will be freely tradable without restriction under the Securities Act of 1933, as amended, or Securities Act. The shares held by the Shaked and Levine family entities and our directors, officers and other affiliates are restricted securities under the Securities Act, and may not be sold in the public market unless the sale is registered under the Securities Act or an exemption from registration is available.

Each of our executive officers, directors and certain of our stockholders have agreed, subject to certain exceptions, to be bound by a lock-up agreement that prevents us and them from selling or transferring shares of our common stock during the 180-day period following this offering. However, these shares will be freely tradable, subject to the limitations of Rule 144, in the public markets after the expiration of the lock-up period, which could depress the value of our Class A common stock. Moreover, Goldman, Sachs & Co. and Merrill Lynch, Pierce, Fenner & Smith Incorporated may, in their sole discretion, release any of the shares held by our executive officers, directors and other current stockholders from the restrictions of the lock-up agreement at any time without notice, which would allow the immediate sale of these shares in the market, subject to the limitations of Rule 144. See “Underwriting”.

 

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Our corporate organizational documents and Delaware law have anti-takeover provisions that may inhibit or prohibit a takeover of us and the replacement or removal of our management.

In addition to the effect that the concentration of ownership and voting power the Shaked and Levine family entities may have, the anti-takeover provisions under Delaware law, as well as the provisions contained in our corporate organizational documents, may make an acquisition of us more difficult. For example, our certificate of incorporation includes a provision authorizing our board of directors to issue blank check preferred stock without stockholder approval, which, if issued, would increase the number of outstanding shares of our capital stock and make it more difficult for a stockholder to acquire us. In addition, our certificate of incorporation provides for a staggered board of directors, dividing the board members into three classes, permits removal of a director only for cause and provides that director vacancies can only be filled by an affirmative vote of a majority of directors then in office. Furthermore, our bylaws require advance notice of stockholder proposals and director nominations. Finally, Section 203 of the Delaware General Corporation Law may prevent large stockholders from completing a merger or acquisition of us. These provisions may prevent a merger or acquisition of us which could limit the price investors would pay for our common stock in the future.

We do not intend to pay cash dividends on our common stock, which may make our Class A common stock less desirable to investors and decrease its value.

We intend to retain all of our earnings to finance our operations and growth and do not anticipate paying any cash dividends on our common stock for the foreseeable future. Therefore, you may only receive a return on your investment in our Class A common stock if the market price increases above the price at which you purchased it, which may never occur.

You will experience immediate and substantial dilution.

Purchasers of Class A common stock in this offering will pay a price per share that is substantially higher than the pro forma net tangible book value per share of our outstanding Class A common stock immediately after this offering. As a result, purchasers of our Class A common stock in this offering will suffer immediate and substantial dilution. Based on an assumed initial public offering price of $         per share, the mid-point of the price range set forth on the cover page of this prospectus, and our pro forma net tangible book value as of             , the dilution will be $         per share of Class A common stock to new investors in this offering. If the underwriters sell additional shares of Class A common stock following the exercise of their option to purchase additional shares or if option holders exercise outstanding options to purchase shares of Class A common stock, further dilution could occur.

 

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FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements that are subject to risks and uncertainties. All statements other than statements of historical or current fact included in this prospectus are forward-looking statements. Forward-looking statements refer to our current expectations and projections relating to our financial condition, results of operations, plans, objectives, strategies, future performance and business. You can identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. These statements may include words such as “anticipate”, “estimate”, “expect”, “project”, “plan”, “intend”, “believe”, “may”, “might”, “will”, “should”, “can have”, “likely” and other words and terms of similar meaning in connection with any discussion of the timing or nature of future operating or financial performance or other events. For example, all statements we make relating to our estimated and projected earnings, revenues, costs, expenditures, cash flows, growth rates and financial results, our plans and objectives for future operations, growth or initiatives, strategies or the expected outcome or impact of pending or threatened litigation are forward-looking statements. All forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those that we expected, including:

 

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our ability to successfully open a significant number of new stores;

 

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effectively adapting to new challenges associated with our expansion into new geographic markets;

 

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our ability to maintain and enhance a strong brand image;

 

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generating adequate cash from our existing stores to support our growth;

 

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identifying and responding to new and changing customer fashion preferences and fashion-related trends;

 

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competing effectively in an environment of intense competition;

 

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containing the increase in the cost of mailing catalogs, paper and printing;

 

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the success of the malls, power centers, neighborhood and lifestyle centers, outlet centers and street-front locations in which our stores are located;

 

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our ability to attract customers in the various retail venues and geographies in which our stores are located;

 

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adapting to declines in consumer confidence and decreases in consumer spending;

 

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our ability to adapt to significant changes in sales due to the seasonality of our business;

 

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price reductions or inventory shortages resulting from failure to purchase the appropriate amount of inventory in advance of the season in which it will be sold;

 

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natural disasters, unusually adverse weather conditions, boycotts and unanticipated events;

 

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changes in the competitive environment in our industry and the markets we serve, including increased competition from other retailers;

 

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our dependence on third-party vendors to provide us with sufficient quantities of merchandise at acceptable prices;

 

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increases in costs of fuel or other energy, transportation or utility costs and in the costs of labor and employment;

 

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our ability to balance proprietary branded merchandise with the third-party branded merchandise we sell;

 

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most of our merchandise is made in foreign countries, making price and availability of our merchandise susceptible to international trade conditions;

 

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  Ÿ  

failure of our vendors and their manufacturing sources to use acceptable labor or other practices;

 

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our dependence upon key executive management or our inability to hire or retain the talent required for our business;

 

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our ability to effectively adapt to our rapid expansion in recent years and our planned expansion;

 

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failure of our information technology systems to support our current and growing business, before and after our planned upgrades;

 

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disruptions in our supply chain and distribution center;

 

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our indebtedness and lease obligations, including restrictions on our operations contained therein;

 

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our reliance upon independent third-party transportation providers for certain of our product shipments;

 

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our ability to maintain comparable store sales or sales per square foot, which may cause our operations and stock price to be volatile;

 

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disruptions to our information systems in the ordinary course or as a result of systems upgrades;

 

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our inability to protect our trademarks or other intellectual property rights;

 

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acts of war or terrorism;

 

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the impact of governmental laws and regulations and the outcomes of legal proceedings;

 

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our ability to secure the personal financial information of our customers and comply with the security standards for the credit card industry;

 

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our failure to maintain adequate internal controls over our financial and management systems; and

 

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increased costs as a result of being a public company.

We derive many of our forward-looking statements from our operating budgets and forecasts, which are based upon detailed assumptions. While we believe that our assumptions are reasonable, we caution that it is very difficult to predict the impact of known factors, and it is impossible for us to anticipate all factors that could affect our actual results.

See “Risk Factors” for a more complete discussion of the risks and uncertainties mentioned above and for discussion of other risks and uncertainties. All forward-looking statements attributable to us are expressly qualified in their entirety by these cautionary statements as well as others made in this prospectus and hereafter in our other SEC filings and public communications. You should evaluate all forward-looking statements made by us in the context of these risks and uncertainties.

We caution you that the risks and uncertainties identified by us may not be all of the factors that are important to you. Furthermore, the forward-looking statements included in this prospectus are made only as of the date hereof. We undertake no obligation to publicly update or revise any forward-looking statement as a result of new information, future events or otherwise, except as otherwise required by law.

 

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USE OF PROCEEDS

We estimate that the net proceeds from our sale of                  shares of our Class A common stock in this offering will be approximately $             million, assuming an offering price of $             per share (the mid-point of the price range set forth on the cover page of this prospectus) and after deducting the underwriting discount and estimated offering expenses payable by us. A $1.00 increase (decrease) in the assumed initial public offering price of $             per share would increase (decrease) the net proceeds to us of this offering by $             million, assuming the sale by us of                  shares of our Class A common stock and after deducting the underwriting discount and estimated expenses. A 1.0 million increase (decrease) in the number of shares offered by us, assuming an initial public offering price of $             per share, which is the mid-point of the price range set forth on the cover page of this prospectus, would increase (decrease) the net proceeds to us by $             million, after deducting the underwriting discount and estimated expenses.

Prior to completion of this offering, World of Jeans & Tops will issue notes to its then existing “S” Corporation shareholders, bearing a market rate of interest, which will reflect the amount of undistributed cumulative earnings remaining in World of Jeans & Tops from the date of its formation up to the date of termination of its “S” Corporation status. We expect to use approximately $             million of the net proceeds from this offering to pay in full the principal amount of the notes. Therefore, our stockholders immediately following this offering, who were also the shareholders of World of Jeans & Tops prior to termination of its “S” Corporation status, will receive most of the net proceeds from the sale of shares offered by us. We expect proceeds in excess of the final “S” Corporation distribution to be approximately $             million and we will use such proceeds for working capital and other general corporate purposes. Pending their use, we intend to invest the balance of our net proceeds from this offering in short-term, investment-grade, interest-bearing instruments.

We may also use a portion of the net proceeds to acquire other businesses, products or technologies. However, we do not have agreements or commitments for any specific acquisitions at this time. The amounts actually spent for these purposes may vary significantly and will depend on a number of factors, including our operating costs and other factors described under “Risk Factors”. Our management will retain broad discretion as to the allocation of net proceeds of this offering.

 

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DIVIDEND POLICY

We do not anticipate paying dividends on our common stock after the completion of this offering. We intend to retain all available funds and any future earnings for use in the operation and expansion of our business. Any determination in the future to pay dividends will depend upon our financial condition, capital requirements, operating results and other factors deemed relevant by our board of directors, including any contractual or statutory restrictions on our ability to pay dividends.

As an “S” Corporation, World of Jeans & Tops distributed to its shareholders every year an amount sufficient to cover their tax liability due to the income that was reported by the shareholders on their individual tax returns. Additional amounts were distributed to its shareholders at the discretion of the board of directors of World of Jeans & Tops. For fiscal years 2009 and 2010, World of Jeans & Tops paid distributions to its shareholders of $16.0 million and $22.2 million, respectively. World of Jeans & Tops expects to pay, prior to the consummation of this offering, an additional $             million on behalf of its shareholders in connection with their quarterly estimated tax liability. In connection with the Reorganization Transaction, World of Jeans & Tops will issue to its existing shareholders notes in an aggregate principal amount equal to approximately $             million. This represents 100% of World of Jeans & Tops’ undistributed taxable income from the date of its formation up to the date of termination of its “S” Corporation status. Upon completion of this offering, we will use a majority of the net proceeds from this offering to pay in full the principal amount of these undistributed earnings notes as described under “Use of Proceeds”. We do not anticipate paying any additional distributions to our “S” Corporation shareholders subsequent to the consummation of this offering.

 

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CAPITALIZATION

The following table sets forth our cash and cash equivalents and capitalization as of April 30, 2011:

 

  Ÿ  

on an actual basis;

 

  Ÿ  

on a pro forma basis to give effect to the Reorganization Transaction as described under “Description of Capital Stock—Reorganization Transaction”, including (i) the issuance by World of Jeans & Tops of the undistributed taxable earnings notes to its then shareholders in the aggregate principal amount equal to 100% of its undistributed taxable income from the date of its formation up to the date of termination of its “S” Corporation status, (ii) a change in net deferred tax assets of approximately $             assuming World of Jeans & Tops’ “S” Corporation status terminated on              and (iii) upon consummation of our initial public offering, a change in additional paid-in capital and retained earnings as a result of the recognition of stock-based compensation expense, net of tax effect at the statutory rate; and

 

  Ÿ  

on a pro forma basis as adjusted to give effect to: (i) the sale of                  shares of our Class A common stock in this offering at an assumed initial public offering price of $             per share, which is the mid-point of the price range set forth on the cover page of this prospectus, after deducting the underwriting discount and estimated offering expenses payable by us and (ii) the application of the estimated proceeds from this offering as described under “Use of Proceeds”.

You should read this table in conjunction with “Use of Proceeds”, “Selected Consolidated Financial and Other Data”, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this prospectus.

 

     As of April 30, 2011  
     Actual      Pro Forma      Pro Forma
as adjusted(2)
 
     (unaudited)      (unaudited)      (unaudited)  
     (in thousands, except per share amounts)  

Cash and cash equivalents

   $ 28,770         
                          

Debt:

        

Existing line of credit(1)

             

Other debt (capital lease liability)

     5,113         
                          

Total debt

     5,113         

Stockholders’ equity:

        

Common stock, $0.001 par value; 21,600 shares authorized, 20,000 shares issued and outstanding

     20         

Common stock (Class A), $0.001 par value; 100,000 shares authorized, shares issued and outstanding

             

Common stock (Class B), $0.001 par value; 35,000 shares authorized,
shares issued and outstanding

             

Preferred stock, $0.001 par value; 10,000 shares authorized, no shares issued or outstanding

             

Additional paid-in capital

     150         

Retained earnings

     64,933         
                          

Total stockholders’ equity

     65,103         
                          

Total capitalization

   $ 70,216       $                $            
                          

 

(1) The existing line of credit with Wells Fargo Bank, NA provides for borrowings of up to $15.0 million, of which $15.0 million was available to borrow as of April 30, 2011. Upon consummation of the initial public offering, the existing line of credit will terminate and a new line of credit with Wells Fargo Bank, NA is expected to go into effect. We expect the new line of credit to contain substantially the same terms as the previous line of credit, but provide for borrowings of up to $25.0 million.
(2) A $1.00 increase (decrease) in the assumed initial public offering price of $         per share, which is the mid-point of the price range set forth on the cover page of this prospectus, would increase (decrease) each of additional paid-in capital, total stockholders’ equity and total capitalization by approximately $         million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the underwriting discount and estimated offering expenses payable by us. Similarly, each increase (decrease) of 1.0 million shares in the number of shares offered by us, would increase (decrease) additional paid-in capital, total stockholders’ equity and total capitalization by approximately $         million. The pro forma as adjusted information discussed above is illustrative only and will be adjusted based on the actual public offering price and terms of this offering determined at pricing.

 

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DILUTION

If you invest in our Class A common stock, your investment will be diluted immediately to the extent of the difference between the public offering price per share of our Class A common stock and the pro forma net tangible book value per share of our Class A common stock after this offering.

Our pro forma net tangible book value as of              was approximately $             million, or $             per share of common stock. Pro forma net tangible book value per share represents the amount of our total tangible assets reduced by the amount of our total liabilities, divided by the number of shares of our common stock outstanding, on a pro forma basis after giving effect to the Reorganization Transaction as described under “Description of Capital Stock—Reorganization Transaction”, including (i) the issuance by World of Jeans & Tops of 100% of its undistributed taxable earnings to its then shareholders resulting from the termination of its “S” Corporation status, equal to approximately $             million, (ii) a change in net deferred tax assets of approximately $             assuming the “S” Corporation status of World of Jeans & Tops terminated on              and (iii) compensation expense of $             resulting from prior stock options issued under our 2007 Stock Option Plan becoming exercisable upon completion of this offering.

After giving effect to (i) the sale of the              shares of Class A common stock offered by us assuming an initial public offering price of $             per share, which is the mid-point of the price range set forth on the cover page of this prospectus, less the underwriting discount and estimated offering expenses payable by us and (ii) the application of the estimated proceeds from this offering as described in “Use of Proceeds”, our pro forma as adjusted net tangible book value as of              would have been approximately $             million, or $             per share. This represents an immediate increase in pro forma net tangible book value of $             per share to existing stockholders and an immediate dilution of $             per share to new investors. The following table illustrates this dilution.

 

Assumed initial public offering price per share

      $     
           

Pro forma net tangible book value per share as of                     

   $        
           

Increase in pro forma net tangible book value per share attributable to this offering

     
           

Pro forma net tangible book value per share as of                     , as adjusted for this offering

     
           

Dilution per share to new investors

      $     
           

After this offering and assuming the exercise in full of all options outstanding and exercisable as of             , pro forma net tangible book value per share as of             , as adjusted for this offering, would have been approximately $         million, representing an immediate increase in pro forma net tangible book value of $             per share to existing stockholders and an immediate dilution of $             per share to new investors.

A $1.00 increase (decrease) in the assumed initial public offering price of $             per share, which is the mid-point of the price range set forth on the cover page of this prospectus, would increase (decrease) our pro forma as adjusted net tangible book value by approximately $             million, or $             per share, and the dilution per share to investors in this offering by approximately $             per share, assuming no change to the number of shares offered by us as set forth on the cover page of this prospectus, and after deducting the underwriting discount and estimated offering expenses payable by us. We may also increase or decrease the number of shares we are offering. A 1.0 million

 

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increase (decrease) in the number of shares offered by us would increase (decrease) our pro forma as adjusted net tangible book value by approximately $             million, or $             per share, assuming an initial public offering price of $             per share, which is the mid-point of the price range set forth on the cover page of this prospectus, and the dilution per share to investors in this offering by approximately $             per share after deducting the underwriting discount and estimated offering expenses payable by us. The pro forma as adjusted information discussed above is illustrative only.

If the underwriters exercise their option to purchase up to              additional shares of Class A common stock in this offering from us, our pro forma as adjusted net tangible book value as of              and dilution per share to new investors will not change.

 

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SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA

The following tables present selected consolidated financial and other data as of and for the periods indicated and certain unaudited pro forma information to reflect our conversion from an “S” Corporation to a “C” Corporation for income tax purposes. The selected consolidated statement of operations data for the fiscal years ended January 31, 2009, January 30, 2010 and January 29, 2011 and selected consolidated balance sheet data as of January 30, 2010 and January 29, 2011 are derived from our financial statements audited by Deloitte & Touche LLP, our independent registered public accounting firm, included elsewhere in this prospectus. The selected consolidated statement of operations data for the fiscal years ended February 3, 2007 and February 2, 2008 and the selected consolidated balance sheet data as of February 3, 2007, February 2, 2008 and January 31, 2009 are derived from our audited financial statements that have not been included in this prospectus. The selected consolidated statement of operations data for the fiscal quarters ended May 1, 2010 and April 30, 2011 and the selected consolidated balance sheet data as of April 30, 2011 are derived from our unaudited financial statements that are included elsewhere in this prospectus. The historical results presented below are not necessarily indicative of the results to be expected for any future period. You should read this selected consolidated financial data in conjunction with the financial statements and accompanying notes and the information under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere in this prospectus.

 

    Fiscal Year Ended(1)     Thirteen Weeks Ended  
    February 3,
2007
    February 2,
2008
    January 31,
2009
    January 30,
2010
    January 29,
2011
      May 1,   
2010
      April 30,   
2011
 
    (in thousands, except per share data)  
Consolidated Statements of
Operations Data:
                                         

Net sales

  $ 199,229      $ 245,913      $ 254,983      $ 282,764      $ 332,604      $ 64,344      $ 83,131   

Cost of goods sold(2)

    125,390        154,357        172,107        195,430        229,989        45,718        56,922   
                                                       

Gross profit

    73,839        91,556        82,876        87,334        102,615        18,626        26,209   

Selling, general and administrative expenses

    42,336        51,840        59,043        65,912        77,668        16,867        21,244   
                                                       

Operating income

    31,503        39,716        23,833        21,422        24,947        1,759        4,965   

Interest income (expense), net

    298        607        35        (284     (249     (78     (49
                                                       

Income before provision for income taxes

    31,801        40,323        23,868        21,138        24,698        1,681        4,916   

Provision for income taxes

    436        416        262        275        282        22        56   
                                                       

Net income

  $ 31,365      $ 39,907      $ 23,606      $ 20,863      $ 24,416      $ 1,659      $ 4,860   
                                                       

Net income per common share:

             

Basic

  $ 1.57      $ 2.00      $ 1.18      $ 1.04      $ 1.22      $ 0.08      $ 0.24   

Diluted

  $ 1.57      $ 2.00      $ 1.18      $ 1.04      $ 1.21      $ 0.08     

Weighted average shares outstanding:

             

Basic

    20,000        20,000        20,000        20,000        20,000        20,000        20,000   

Diluted

    20,000        20,000        20,000        20,014        20,098        20,048     

Pro Forma Income Information(3):

             

Pro forma provision for income taxes

  $ 12,720      $ 16,129      $ 9,547      $ 8,455      $ 9,879      $ 672      $ 1,966   

Pro forma net income

    19,081        24,194        14,321        12,683        14,819        1,009        2,950   

Pro forma basic net income per common share(4)

             

Pro forma diluted net income per common share(4)

             

 

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    Fiscal Year Ended     Thirteen Weeks Ended  
    February 3,
2007
    February 2,
2008
    January 31,
2009
    January 30,
2010
    January 29,
2011
      May 1,  
2010
      April 30,  
2011
 

Operating Data (unaudited):

  

           

Stores operating at beginning of period

    51        61        73        99        111        111        125   

Stores opened during the period

    10        13        26        13        16        1        1   

Stores closed during the period

           1               1        2                 
                                                       

Stores operating at end of period

    61        73        99        111        125        112        126   

Comparable store sales
change(5)

    17.3     8.7     -12.5     -3.1     6.7     2.2     18.2

Total square feet at end of period

    480,781        576,156        775,832        862,971        967,011        870,423        977,164   

Average square footage per store at end of period

    7,882        7,893        7,837        7,775        7,736        7,772        7,755   

Average net sales per store (in thousands)(6)

  $ 3,472      $ 3,452      $ 2,750      $ 2,479      $ 2,528      $ 528      $ 596   

Average net store sales per square foot(6)

  $ 440      $ 439      $ 351      $ 318      $ 326      $ 68      $ 77   

Capital expenditures (in thousands)

  $ 11,748      $ 14,817      $ 23,406      $ 17,514      $ 15,674      $ 4,722      $ 3,001   

 

     As of  
     February 3,
2007
     February 2,
2008
     January 31,
2009
     January 30,
2010
     January 29,
2011
     April 30,
2011
 
     (in thousands)  

Consolidated Balance Sheet Data:

                 

Cash and cash equivalents

   $ 12,369       $ 25,359       $ 24,535       $ 25,705       $ 29,338       $ 28,770   

Working capital

     9,360         24,354         22,779         29,639         33,907         38,631   

Total assets

     68,963         93,449         110,142         115,454         130,974         133,579   

Total long-term debt(7)

     6,933         6,412         5,857         5,267         4,638         4,475   

Stockholders’ equity

     29,755         46,637         55,053         59,896         62,092         65,103   

 

(1) Except for the fiscal year ended February 3, 2007, which includes 53 weeks, all fiscal years presented include 52 weeks.
(2) Includes buying, distribution and occupancy costs.
(3) The unaudited pro forma income statement for all years presented gives effect to an adjustment for income tax expense as if we had been a “C” Corporation at an assumed combined federal, state and local effective income tax rate, which approximates our statutory income tax rate, of 40%.
(4) Reflects the increase in the number of shares which would be sufficient to replace the capital in excess of current year earnings being withdrawn pursuant to the Reorganization Transaction. The pro forma adjustment to basic and diluted weighted average shares outstanding for the fiscal year ended January 29, 2011 and the thirteen weeks ended April 30, 2011 is              and             , respectively.
(5) Comparable store sales are net sales from stores that have 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. The comparable store sales increase for the period ended February 3, 2007 is compared to the corresponding 53-week period in the previous fiscal year. The comparable store sales increase for the period ended February 2, 2008 is compared to the corresponding 52-week period in the previous fiscal year.
(6) The number of stores and the amount of square footage reflect the number of days during the period that new stores were open. E-commerce sales, e-commerce shipping revenue, and gift card breakage income are excluded from our sales in deriving net sales per store. Average net sales per store and average net store sales per square foot for the fiscal year ended February 3, 2007 are adjusted to reflect a 52-week year for comparability to the amounts shown for the other years.
(7) Comprised solely of a capital lease for our corporate headquarters and distribution center.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion in conjunction with the consolidated historical financial statements and the accompanying notes included elsewhere in this prospectus, as well as the information presented under “Selected Consolidated Financial and Other Data”. The statements in the following discussion and analysis regarding expectations about our future performance, liquidity and capital resources and any other non-historical statements in this discussion and analysis, are forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, those described under “Risk Factors”, “Forward-Looking Statements” and other matters included elsewhere in this prospectus. Our actual results could differ materially from those contained in or implied by any forward-looking statements.

We operate on a fiscal calendar widely used by the retail industry that results in a given fiscal year consisting of a 52- or 53-week period ending on the Saturday closest to January 31 of the following year. References to “fiscal year 2010” or “fiscal 2010” refer to the fiscal year ended January 29, 2011, references to “fiscal year 2009” or “fiscal 2009” refer to the fiscal year ended January 30, 2010 and references to “fiscal year 2008” or “fiscal 2008” refer to the fiscal year ended January 31, 2009. Each of fiscal years 2010, 2009 and 2008 consisted of a 52-week period.

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 April 30, 2011, we operated 126 stores in 11 states, averaging approximately 7,800 square feet. We also sell our products through our e-commerce website, www.tillys.com.

Our strong growth and operating results reflect initiatives taken by our management team as well as our customers’ increasing awareness of our brand and merchandise assortment as we have expanded our presence in both existing and new markets. We increased net sales 29%, from $64.3 million in the thirteen weeks ended May 1, 2010 to $83.1 million in the thirteen weeks ended April 30, 2011. We increased operating income 178%, from $1.8 million in the thirteen weeks ended May 1, 2010 to $5.0 million in the thirteen weeks ended April 30, 2011. Our comparable store sales increased 18.2% in the thirteen weeks ended April 30, 2011, which followed a 6.7% increase for the full fiscal year 2010. Since the beginning of fiscal 2006, we more than doubled our store count from 51 stores to 125 stores at fiscal year-end 2010.

We expect to continue our strong growth in the future. We believe there is a significant opportunity to expand our store base to more than 500 stores over time. As of April 30, 2011, we have added one net new store in fiscal year 2011 and plan to add a total of 13 net new stores by the end of the year. We plan to open approximately 20 net stores in fiscal year 2012 and to continue opening new stores at an annual rate of approximately 15% for the next several years thereafter. We believe our success operating in different retail venues and geographies demonstrates the portability of Tilly’s and provides us with flexibility for future expansion. We also expect to continue to support our comparable store sales by consistently offering new, on-trend and relevant merchandise, increasing our brand awareness, providing an engaging store experience for our core customers and maintaining our high level of customer service.

Our unit growth is supported by our new store economics, which we believe to be compelling. Our store model assumes a target store size averaging 7,500 to 8,000 square feet. In the first year, our

 

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new store model targets net sales of approximately $2.2 million and cash flow of $300,000. The target net investment to open our stores is between $500,000 and $550,000, including build-out, pre-opening and initial inventory, net of landlord allowances and payables. As a result, the cash-on-cash payback period on our investment averages about 18 months.

Over the last five years, we have invested approximately $20 million in infrastructure and systems to support our recent and long-term growth. We believe our distribution and allocation capabilities are unique within the industry and allow us to quickly sort and process merchandise and deliver it to our stores in a floor-ready format for immediate display. In fiscal year 2012 we expect to open an additional distribution facility across the street from our existing facility to support our e-commerce fulfillment operations. We believe our distribution infrastructure can support a national retail footprint in excess of 500 stores with minimal incremental capital investment.

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 for new stores and that we may not be able to effectively manage our future growth. See “Risk Factors” for other important factors that could adversely impact us and our results of operations. We strive to ensure that addressing these risks does not divert our attention from continuing to build on the strengths that we believe have driven the growth of our business.

How We Assess the Performance of Our Business

In assessing the performance of our business, we consider a variety of performance and financial measures.

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

Comparable store sales are net sales from stores that have 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.

 

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Comparable store sales include sales through our e-commerce store, but exclude gift card breakage income. Some of our competitors and other retailers may calculate comparable or “same store” sales differently than we do. As a result, data in this prospectus 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:

 

  Ÿ  

overall economic trends;

 

  Ÿ  

our ability to identify and respond effectively to consumer preferences and fashion trends;

 

  Ÿ  

competition;

 

  Ÿ  

the timing of our releases of new and seasonal styles;

 

  Ÿ  

changes in our product mix;

 

  Ÿ  

pricing;

 

  Ÿ  

the level of customer service that we provide in stores;

 

  Ÿ  

our ability to source and distribute products efficiently;

 

  Ÿ  

calendar shifts of holiday or seasonal periods;

 

  Ÿ  

the number and timing of store openings and the relative proportion of new stores to mature stores; and

 

  Ÿ  

the timing and success of promotional and advertising efforts.

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 inbound freight costs as well as 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

 

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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 expect to incur as a result of being a public company. Among other things, we expect that compliance with the Sarbanes-Oxley Act of 2002 and related rules and regulations could result in significant incremental legal, accounting and other overhead costs.

Our stock-based awards contain a performance condition whereby the company’s common stock must be publicly traded in order to exercise vested options. Unrecognized cumulative stock-based compensation expense through April 30, 2011, before any related tax benefit, was $4.2 million. We will recognize this non-cash deferred compensation as an SG&A expense upon the consummation of our initial public offering.

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.

Income Taxes

Historically, World of Jeans & Tops has elected to be taxed under the provisions of Subchapter “S” of the Internal Revenue Code of 1986, as amended, or the Code, for federal tax purposes. As a result, its income has not been subject to U.S. federal income taxes or state income taxes in those states where the “S” Corporation status is recognized. In general, the corporate income or loss of an “S” Corporation is allocated to its stockholders for inclusion in their personal federal income tax returns and personal state income tax returns in those states where the “S” Corporation status is recognized. No provision or liability for federal or state income tax has been provided in our financial statements except for those states where the “S” Corporation status is not recognized and for the 1.5% California franchise tax to which we are also subject as a California “S” Corporation. The provision for income tax in the current period consists of these taxes. World of Jeans & Tops has distributed funds to its shareholders in an amount necessary to satisfy the shareholders’ estimated personal “S” Corporation income tax liabilities.

 

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As a result of the Reorganization Transaction, World of Jeans & Tops’ “S” Corporation status will terminate and World of Jeans & Tops will be treated as a “C” Corporation under Subchapter C of the Code. The revocation of World of Jeans & Tops’ “S” Corporation election will have a material impact on our results of operations, financial condition and cash flows. Our effective income tax rate will increase and our net income will decrease since we will be subject to both federal and state taxes on our earnings.

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of the change in tax rates resulting from our being a “C” Corporation will be recognized in income in the quarter such change takes place. This difference between the financial statement carrying amounts of assets and liabilities and their respective tax basis would have been recorded as a net deferred tax asset of $1.4 million if it had been recorded at the balance sheet date of January 29, 2011.

All pro forma provisions for income taxes and pro forma net income data reflect estimated adjustments for federal and state income taxes as if we had been taxed as a “C” Corporation, rather than an “S” Corporation, at an estimated 40% effective tax rate in all years presented.

Results of Operations

The following tables summarize key components of our results of operations for the periods indicated, both in dollars and as a percentage of our net sales.

 

    Fiscal Year Ended     Thirteen Weeks Ended  
    January 31,
2009
    January 30,
2010
    January 29,
2011
      May 1,  
2010
      April 30,  
2011
 
    (in thousands)  

Statements of Income Data:

         

Net sales

  $ 254,983      $ 282,764      $ 332,604      $ 64,344      $ 83,131   

Cost of goods sold

    172,107        195,430        229,989        45,718        56,922   
                                       

Gross profit

    82,876        87,334        102,615        18,626        26,209   

Selling, general and administrative expenses

    59,043        65,912        77,668        16,867        21,244   
                                       

Operating income

    23,833        21,422        24,947        1,759        4,965   

Interest income (expense), net

    35        (284     (249     (78     (49
                                       

Income before provision for income taxes

    23,868        21,138        24,698        1,681        4,916   

Provision for income taxes

    262        275        282        22        56   
                                       

Net income

  $ 23,606      $ 20,863      $ 24,416      $ 1,659      $ 4,860   
                                       

Percentage of Net Sales:

         

Net sales

    100.0     100.0     100.0     100.0     100.0

Cost of goods sold

    67.5     69.1     69.1     71.1     68.5
                                       

Gross profit

    32.5     30.9     30.9     28.9     31.5

Selling, general and administrative expenses

    23.2     23.3     23.4     26.2     25.5
                                       

Operating income

    9.3     7.6     7.5     2.7     6.0

Interest income (expense), net

    0.1     -0.1     -0.1     -0.1     -0.1
                                       

Income before provision for income taxes

    9.4     7.5     7.4     2.6     5.9

Provision for income taxes

    0.1     0.1     0.1     0.0     0.1
                                       

Net income

    9.3     7.4     7.3     2.6     5.8
                                       

Pro Forma Data (unaudited)(1):

         

Income before provision for income taxes

  $ 23,868      $ 21,138      $ 24,698      $ 1,681      $ 4,916   

Pro forma provision for income taxes

    9,547        8,455        9,879        672        1,966   
                                       

Pro forma net income

  $ 14,321      $ 12,683      $ 14,819      $ 1,009      $ 2,950   
                                       

 

(1) The unaudited pro forma income statement for all periods presented gives effect to an adjustment for income tax expense as if we had been a “C” Corporation at an assumed combined federal, state and local effective income tax rate of 40%.

 

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The following table presents store operating data for the periods indicated.

 

    Fiscal Year Ended     Thirteen Weeks Ended  
    January 31,
2009
    January 30,
2010
    January 29,
2011
      May 1,  
2010
      April 30,  
2011
 

Store Operating Data:

         

Stores operating at end of period

    99        111        125        112        126   

Comparable store sales change(1)

    -12.5     -3.1     6.7     2.2     18.2

Total square feet at end of period

    775,832        862,971        967,011        870,423        977,164   

Average net sales per store
(in thousands)(2)

  $ 2,750      $ 2,479      $ 2,528      $ 528      $ 596   

Average net sales per square foot(2)

  $ 351      $ 318      $ 326      $ 68      $ 77   

E-commerce revenues
(in thousands)(3)

  $ 15,434      $ 22,511      $ 32,804      $ 5,685      $ 8,300   

 

(1) Comparable store sales are net sales from stores that have 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.
(2) 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.
(3) E-commerce revenues include e-commerce sales and e-commerce shipping fee revenue.

Thirteen Weeks Ended April 30, 2011 Compared to Thirteen Weeks Ended May 1, 2010

Net Sales

Net sales increased from $64.3 million in the thirteen weeks ended May 1, 2010 to $83.1 million in the thirteen weeks ended April 30, 2011, an increase of $18.8 million, or 29%. A portion of this increase was due to net sales of $7.4 million from stores open in the first thirteen weeks of fiscal year 2011 that were not open during the same period last year, as well as fees charged to customers for shipping merchandise sold through our e-commerce store. Net sales also increased due to a comparable store net sales increase of 18.2%, or $11.4 million. The comparable store net sales increase reflected the general improvement in the economy, and stemmed mostly from increased net sales of accessories and guys’ apparel and, to a lesser extent, footwear and juniors’ and girls’ apparel. These increases were partially offset by lower net sales of boys’ apparel. There were 108 comparable brick-and-mortar stores and 18 non-comparable brick-and-mortar stores open at April 30, 2011.

Net sales, including shipping and handling fees, from our e-commerce store increased from $5.7 million in the thirteen weeks ended May 1, 2010 to $8.3 million in the thirteen weeks ended April 30, 2011, an increase of $2.6 million, or 46%.

Gross Profit

Gross profit increased from $18.6 million in the thirteen weeks ended May 1, 2010 to $26.2 million in the thirteen weeks ended April 30, 2011, an increase of $7.6 million, or 41%. As a percentage of net sales, gross profit was 28.9% in the thirteen weeks ended May 1, 2010 and 31.5% in the thirteen weeks ended April 30, 2011. Nearly all of the increase in gross profit as a percentage of net sales reflected occupancy cost leverage as sales increased faster than occupancy costs.

Selling, General and Administrative Expenses

SG&A expenses increased from $16.9 million in the thirteen weeks ended May 1, 2010 to $21.2 million in the thirteen weeks ended April 30, 2011, an increase of $4.3 million, or 25%. As a percentage of net sales, SG&A expenses were 26.2% and 25.5% during the thirteen weeks ended May 1, 2010 and April 30, 2011, respectively.

 

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Store selling expenses increased from $11.3 million in the thirteen weeks ended May 1, 2010 to $14.1 million in the thirteen weeks ended April 30, 2011, an increase of $2.8 million, or 25%. As a percentage of net sales, store selling expenses were 17.6% and 17.0% during the thirteen weeks ended May 1, 2010 and April 30, 2011, respectively.

The following contributed to the decrease in store selling expenses as a percentage of net sales:

 

  Ÿ  

store and regional payroll, payroll benefits and related personnel costs increased $1.5 million, but decreased 1.1% as a percentage of net sales, reflecting cost leverage as these costs increased more slowly than sales;

 

  Ÿ  

marketing costs increased $1.0 million, or 0.7% as a percentage of net sales, which partially offset the decrease in store payroll expenses as a percentage of net sales, reflecting growth in the size and number of marketing campaigns, including the frequency and distribution of catalog mailings as well as marketing costs incurred to support and drive the growth of our e-commerce business; and

 

  Ÿ  

all other selling expenses increased a total of $0.3 million, but decreased 0.2% as a percentage of net sales.

General and administrative expenses increased from $5.6 million in the thirteen weeks ended May 1, 2010 to $7.1 million in the thirteen weeks ended April 30, 2011, an increase of $1.5 million, or 27%. As a percentage of net sales, general and administrative expenses were 8.7% and 8.5% during the thirteen weeks ended May 1, 2010 and April 30, 2011, respectively.

The following contributed to the decrease in general and administrative expenses as a percentage of net sales:

 

  Ÿ  

depreciation, legal and other office expenses decreased $0.1 million, a 0.7% decrease as a percentage of net sales; and

 

  Ÿ  

this was partially offset by an increase in payroll, payroll benefits and related costs for corporate office personnel of 0.5% as a percentage of net sales. In absolute amounts, payroll, payroll benefits and related corporate office personnel costs increased $1.6 million with the addition of staff to support company growth, pay increases, and an increase in incentive pay reflecting much stronger company-wide profit performance compared to the same period in the prior year.

Operating Income

Operating income increased from $1.8 million in the thirteen weeks ended May 1, 2010 to $5.0 million in the thirteen weeks ended April 30, 2011, an increase of $3.2 million, or 178%. As a percentage of net sales, operating income was 2.7% and 6.0% during the thirteen weeks ended May 1, 2010 and April 30, 2011, respectively. This increase in operating income as a percentage of net sales was mostly due to the cost leverage associated with the significant increase in comparable store sales.

Interest Income (Expense), Net

Net interest expense decreased from $78,000 in the thirteen weeks ended May 1, 2010 to $49,000 in the thirteen weeks ended April 30, 2011, a decrease of $29,000. Net interest expense reflects interest paid on a capitalized lease of our corporate office and distribution center as well as costs related to maintaining our unused line of credit bank facility, net of interest income earned on cash balances and on tenant construction allowances due from landlords.

Provision for Income Taxes

Income taxes increased from $22,000 in the thirteen weeks ended May 1, 2010 to $56,000 in the thirteen weeks ended April 30, 2011. This reflected the increase in operating income as discussed above.

 

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Historically, World of Jeans & Tops has recognized income taxes as an “S” Corporation for federal and state income tax purposes and therefore, with the exception of a limited number of state and local jurisdictions, it has not been subject to income taxes. The shareholders of World of Jeans & Tops, and not World of Jeans & Tops itself, have been subject to income tax on their share of its earnings. In connection with the Reorganization Transaction, World of Jeans & Tops will convert to a “C” Corporation. On a pro forma basis, if World of Jeans & Tops had been taxed as a “C” Corporation at an estimated 40% effective tax rate, income taxes would have increased from $0.7 million in the thirteen weeks ended May 1, 2010 to $2.0 million in the thirteen weeks ended April 30, 2011, an increase proportional to the increase in income before provision for income taxes.

Net Income

Net income increased from $1.7 million in the thirteen weeks ended May 1, 2010 to $4.9 million in the thirteen weeks ended April 30, 2011, an increase of $3.2 million, or 188%, due to the factors discussed above. Applying a pro forma 40% “C” Corporation effective tax rate to both years, rather than the “S” Corporation tax rate that actually applied to us, pro forma net income increased from $1.0 million in the thirteen weeks ended May 1, 2010 to $3.0 million in the thirteen weeks ended April 30, 2011, an increase of $2.0 million, or 200%.

Fiscal Year 2010 Compared to Fiscal Year 2009

Net Sales

Net sales increased from $282.8 million in fiscal year 2009 to $332.6 million in fiscal year 2010, an increase of $49.8 million, or 18%. Much of this increase was due to net sales of $20.0 million from new stores opened in fiscal year 2010. Also, $11.4 million of the increase in net sales resulted from the additional portion of the year that stores opened during fiscal year 2009 were operating in fiscal year 2010, as well as fees charged to customers for shipping merchandise sold through our e-commerce store. Net sales also increased due to a comparable store net sales increase of 6.7%, or $18.4 million. The comparable store net sales increase stemmed from higher net sales of accessories and guys’ apparel, which was partially offset by lower net sales of footwear and girls’ apparel. There were 109 comparable stores and 16 non-comparable stores open at January 29, 2011.

Net sales, including shipping and handling fees, from our e-commerce store increased from $22.5 million in fiscal year 2009 to $32.8 million in fiscal year 2010, an increase of $10.3 million, or 46%. This increase reflects higher sales in all major product categories (guys’ and juniors’ apparel, footwear and accessories), which was attributable at least partially to the greater marketing efforts that directly supported the e-commerce business.

Gross Profit

Gross profit increased from $87.3 million in fiscal year 2009 to $102.6 million in fiscal year 2010, an increase of $15.3 million, or 18%. As a percentage of net sales, gross profit was 30.9% in both years. A small decrease in product costs as a percentage of net sales was offset by an increase in distribution costs as a percentage of net sales as we invested in distribution center infrastructure to support future store base expansion.

Selling, General and Administrative Expenses

SG&A expenses increased from $65.9 million in fiscal year 2009 to $77.7 million in fiscal year 2010, an increase of $11.8 million, or 18%. As a percentage of net sales, SG&A expenses were 23.3% and 23.4% during fiscal years 2009 and 2010, respectively.

 

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Store selling expenses increased from $43.8 million in fiscal year 2009 to $53.7 million in fiscal year 2010, an increase of $9.9 million, or 23%. As a percentage of net sales, store selling expenses were 15.5% and 16.1% during fiscal years 2009 and 2010, respectively.

The following contributed to the increase in store selling expenses as a percentage of net sales:

 

  Ÿ  

marketing costs increased $2.9 million, or 0.6% as a percentage of net sales, reflecting growth in the size and number of marketing campaigns, including the frequency and distribution of catalog mailings as well as marketing costs incurred to support and drive the growth of our e-commerce business;

 

  Ÿ  

credit and debit card processing fees increased $0.9 million, or 0.1% as a percentage of net sales, and supplies and other support costs increased $0.8 million remaining constant as a percentage of net sales; and

 

  Ÿ  

store and regional payroll, payroll benefits and related personnel costs increased $5.3 million, which represents a decrease of 0.1% as a percentage of net sales, reflecting slight cost leverage as these costs increased more slowly than sales.

General and administrative expenses increased from $22.1 million in fiscal year 2009 to $24.0 million in fiscal year 2010, an increase of $1.9 million, or 9%. As a percentage of net sales, general and administrative expenses were 7.8% and 7.2% during fiscal years 2009 and 2010, respectively.

The following contributed to the decrease in general and administrative expenses as a percentage of net sales:

 

  Ÿ  

depreciation, legal and other office expenses decreased $1.1 million, a 0.7% decrease as a percentage of net sales;

 

  Ÿ  

payroll, payroll benefits and related costs for corporate office personnel decreased 0.1% as a percentage of net sales. This decrease as a percentage of net sales reflects slight cost leverage as these costs increased more slowly than sales. In absolute amounts, payroll, payroll benefits and related corporate office personnel costs increased $2.2 million with the addition of staff to support company growth and to fund pay increases and an increase in incentive pay reflecting individual and company-wide performance; and

 

  Ÿ  

a charge for the impairment of the fixed assets at one store location in fiscal year 2010 of $0.8 million, an increase of 0.2% of net sales, which partially offset the above decreases as a percentage of sales. There was no impairment charge in fiscal year 2009.

Operating Income

Operating income increased from $21.4 million in fiscal year 2009 to $24.9 million in fiscal year 2010, an increase of $3.5 million, or 16%. As a percentage of net sales, operating income was 7.6% and 7.5% during fiscal years 2009 and 2010, respectively. This decrease in operating income as a percentage of net sales was mostly due to the increase in marketing costs as discussed above.

Interest Income (Expense), Net

Net interest expense decreased slightly from $0.3 million in fiscal year 2009 to $0.2 million in fiscal year 2010, a decrease of $0.1 million. Net interest expense reflects interest paid on a capitalized lease of our corporate office and distribution center as well as costs related to maintaining our unused line of credit bank facility, net of interest income earned on cash balances and on tenant construction allowances due from landlords.

 

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Provision for Income Taxes

Income taxes were $0.3 million in both fiscal years 2009 and 2010. This reflected a higher pre-tax income in fiscal year 2010, offset by a slight drop in the effective tax rate, from 1.30% of income before provision for income taxes in fiscal year 2009 to 1.14% of income before provision for income taxes in fiscal year 2010.

Historically, World of Jeans & Tops has recognized income taxes as an “S” Corporation for federal and state income tax purposes and therefore, with the exception of a limited number of state and local jurisdictions, it has not been subject to income taxes. The shareholders of World of Jeans & Tops, and not World of Jeans & Tops itself, have been subject to income tax on their distributive share of its earnings. In connection with the Reorganization Transaction, World of Jeans & Tops will convert to a “C” Corporation. On a pro forma basis, if World of Jeans & Tops had been taxed as a “C” Corporation at an estimated 40% effective tax rate, income taxes would have increased from $8.5 million in fiscal year 2009 to $9.9 million in fiscal year 2010, an increase proportional to the increase in income before provision for income taxes.

Net Income

Net income increased from $20.9 million in fiscal year 2009 to $24.4 million in fiscal year 2010, an increase of $3.5 million, or 17%, due to the factors discussed above. Applying a pro forma 40% “C” Corporation effective tax rate to both years, rather than the “S” Corporation tax rate that actually applied to us, pro forma net income increased from $12.7 million in fiscal year 2009 to $14.8 million in fiscal year 2010, an increase of $2.1 million, or 17%.

Fiscal Year 2009 Compared to Fiscal Year 2008

Net Sales

Net sales increased from $255.0 million in fiscal year 2008 to $282.8 million in fiscal year 2009, an increase of $27.8 million, or 10.9%. A significant portion of this increase was due to net sales of $14.5 million from new stores opened in fiscal year 2009. Also, $22.0 million of the increase in net sales resulted from the additional portion of the year that stores opened during fiscal year 2008 were operating in fiscal year 2009, as well as fees charged to customers for shipping merchandise sold through our e-commerce store. Partially offsetting these increases was a comparable store net sales decrease of 3.1%, or $7.7 million. The comparable store net sales decrease reflected deteriorating macro-economic conditions. This decrease was largely due to lower net sales of footwear, accessories and juniors’ apparel. There were 98 comparable brick-and-mortar stores and 13 non-comparable brick-and-mortar stores open at January 30, 2010. Finally, there was $1.0 million less in gift card breakage revenue compared to fiscal year 2008.

Net sales, including shipping and handling fees, from our e-commerce store increased from $15.4 million in fiscal year 2008 to $22.5 million in fiscal year 2009, an increase of $7.1 million, or 46%. This reflects increases in all major product categories, which was partially attributable to the greater marketing efforts that directly supported the e-commerce business.

Gross Profit

Gross profit increased from $82.9 million in fiscal year 2008 to $87.3 million in fiscal year 2009, an increase of $4.4 million, or 5%. The increase of $4.4 million was due largely to greater net sales. As a percentage of net sales, gross profit decreased from 32.5% in fiscal year 2008 to 30.9% in fiscal year 2009. Gross profit as a percentage of net sales decreased 1.9% due to fixed cost de-leveraging from net sales declining faster than buying and occupancy expenses, as well as an increase in distribution costs due to investment in distribution center infrastructure to support additional store growth in the future. Partially offsetting these increases as a percentage of net sales was a 0.3% decrease in product costs as a percentage of net sales.

 

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Selling, General and Administrative Expenses

SG&A expenses increased from $59.0 million in fiscal year 2008 to $65.9 million in fiscal year 2009, an increase of $6.9 million, or 12%. As a percentage of net sales, SG&A expenses were 23.2% and 23.3% during fiscal years 2008 and 2009, respectively.

Store selling expenses increased from $38.1 million in fiscal year 2008 to $43.8 million in fiscal year 2009, an increase of $5.7 million, or 15%. As a percentage of net sales, store selling expenses were 14.9% and 15.5% during fiscal years 2008 and 2009, respectively.

The following contributed to the increase in store selling expenses as a percentage of net sales:

 

  Ÿ  

store and regional payroll, payroll benefits and related personnel costs increased $4.3 million, or 0.4% as a percentage of net sales, reflecting cost de-leveraging resulting from average store sales decreasing faster than these costs decreased;

 

  Ÿ  

marketing costs increased $1.3 million, or 0.3% as a percentage of net sales, with nearly all of this increase attributable to marketing efforts to enable and support the significant increase in e-commerce net sales; and

 

  Ÿ  

store supplies and other costs increased $0.1 million, a decrease of 0.1% as a percentage of net sales, partially offsetting the increases noted above.

General and administrative expenses increased from $20.9 million in fiscal year 2008 to $22.1 million in fiscal year 2009, an increase of $1.2 million, or 6%. As a percentage of net sales, general and administrative expenses were 8.2% and 7.8% during fiscal years 2008 and 2009, respectively.

The following contributed to the decrease in general and administrative expenses as a percentage of net sales:

 

  Ÿ  

corporate office support costs decreased $0.1 million, and 0.3% as a percentage of net sales; and

 

  Ÿ  

payroll, payroll benefits and related costs for corporate office personnel increased $1.3 million, but decreased 0.1% as a percentage of net sales, reflecting cost leverage on the increase in total net sales.

Operating Income

Operating income decreased from $23.8 million in fiscal year 2008 to $21.4 million in fiscal year 2009, a decrease of $2.4 million, or 10%. As a percentage of net sales, operating income was 9.3% and 7.6% during fiscal years 2008 and 2009, respectively. The decline in operating income as a percentage of net sales was largely due to a 3.1% decrease in comparable store sales without a corresponding decrease in fixed costs as discussed above.

Interest Income (Expense), Net

Net interest expense increased, from $35,000 in net interest income in fiscal year 2008 to $0.3 million in net interest expense in fiscal year 2009. Net interest expense reflects interest paid on a capitalized lease of our corporate office and distribution center as well as minor costs related to maintaining our unused line of credit bank facility, net of interest income earned on cash balances. The increase in net interest expense from fiscal year 2008 to fiscal year 2009 reflects a decline in interest income earned on cash balances due to a decline in interest rates.

 

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Provision for Income Taxes

Income taxes were unchanged between fiscal year 2008 and fiscal year 2009, at $0.3 million both years. The effective tax rate increased slightly, from 1.10% of income before provision for income taxes in fiscal year 2008 to 1.30% of income before provision for income taxes in fiscal year 2009.

On a pro forma basis, if we had been taxed as a “C” Corporation both years at an estimated 40% effective tax rate rather than being taxed as an “S” Corporation, income taxes would have decreased from $9.5 million in fiscal year 2008 to $8.5 million in fiscal year 2009. This decrease is proportional to the decrease in income before provision for income taxes.

Net Income

Net income decreased from $23.6 million in fiscal year 2008 to $20.9 million in fiscal year 2009, a decrease of $2.7 million, or 11%, due to the factors discussed above. Applying a pro forma 40% “C” Corporation effective tax rate to both years, rather than the “S” Corporation tax rate that actually applied to us, pro forma net income decreased from $14.3 million in fiscal year 2008 to $12.7 million in fiscal year 2009, a decrease of $1.6 million, or 11%.

Quarterly Operating Results and Seasonality

We have historically experienced and expect to continue experiencing seasonal and quarterly fluctuations in our net sales and operating results. Our net sales and operating income are typically lower in the first and second quarters of our fiscal year, while the third and fourth quarters contain the back-to-school and winter holiday periods that historically have accounted for a larger proportion of our annual net sales and a larger than proportionate share of annual operating income. Our full year net sales have generally split 40% to 45% in the first half and 55% to 60% in the second half of the fiscal year. Quarterly sales and operating income may also fluctuate significantly as a result of a variety of factors, including but not limited to the timing of store openings and the relative proportion of our new stores to mature stores, fashion trends and changes in consumer preferences, calendar shifts of holiday or seasonal periods, changes in merchandise mix, timing of promotional events, general economic conditions, competition and weather conditions.

 

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The following table sets forth selected unaudited quarterly statements of operations data for the two most recent fiscal years and the current fiscal year. The unaudited quarterly information has been prepared on a basis consistent with the audited financial statements included elsewhere herein. This information should be read in conjunction with our audited consolidated financial statements and the accompanying notes included elsewhere in this prospectus. The operating results for any fiscal quarter are not indicative of the operating results for a full fiscal year or for any future period and there can be no assurance that any trend reflected in such results will continue in the future.

 

    Fiscal Year 2009     Fiscal Year 2010     Fiscal Year 2011  
    First
Quarter
    Second
Quarter
    Third
Quarter
    Fourth
Quarter
    First
Quarter
    Second
Quarter
    Third
Quarter
    Fourth
Quarter
    First
Quarter
 
    ($ in thousands)  

Net sales

  $ 57,425      $ 65,296      $ 74,754      $ 85,289      $ 64,344      $ 70,053      $ 91,498      $ 106,709      $ 83,131   

Gross profit

    16,714        18,119        24,323        28,178        18,626        18,762        30,379        34,848        26,209   

Operating income

    2,114        2,430        7,511        9,367        1,759        665        10,823        11,700        4,965   

Net income

    2,038        2,333        7,352        9,140        1,659        597        10,625        11,535        4,860   

Percentage of Annual Results:

                 

Net sales

    20.3     23.1     26.4     30.2     19.3     21.1     27.5     32.1     n/a   

Gross profit

    19.1     20.7     27.9     32.3     18.2     18.3     29.6     34.0     n/a   

Operating income

    9.9     11.3     35.1     43.7     7.1     2.7     43.4     46.9     n/a   

Net income

    9.8     11.2     35.2     43.8     6.8     2.4     43.5     47.2     n/a   

Percentage of Net Sales:

                 

Gross profit

    29.1     27.7     32.5     33.0     28.9     26.8     33.2     32.7     31.5

Operating income

    3.7     3.7     10.0     11.0     2.7     0.9     11.8     11.0     6.0

Net income

    3.5     3.6     9.8     10.7     2.6     0.9     11.6     10.8     5.8

Store Data:

                 

Total stores open at end of quarter

    100        106        107        111        112        120        121        125        126   

Comparable store sales change(1)

    -9.9     -9.5     3.7     1.5     2.2     -3.6     10.3     14.6     18.2

 

(1) Comparable store sales are net sales from stores that have 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.

Liquidity and Capital Resources

General

Our business relies on cash flow from operating activities as well as cash on hand as our primary sources of liquidity. In addition, we have had access to additional liquidity through a $15.0 million revolving credit facility with Wells Fargo Bank, NA. We have never drawn funds from or issued letters of credit financing from the revolving credit facility. The existing revolving credit facility will terminate at the time of the initial public offering. Upon consummation of our initial public offering, we plan to have a $25 million revolving credit facility with Wells Fargo Bank, NA. However, there can be no assurance that we will be able to consummate a new revolving credit facility agreement consistent with management’s expectations.

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 and shareholder distributions. 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 flow from operating activities, the availability of cash under our

 

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anticipated revolving credit facility and net proceeds from this offering will be sufficient to cover working capital requirements and anticipated capital expenditures for the next 12 months. If cash flows from operations, borrowings under our existing or anticipated revolving credit facility and net proceeds from this offering 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 then-current stockholders.

A summary of operating, investing and financing activities is shown in the following table.

 

    Fiscal Year Ended     Thirteen
Weeks Ended
 
    January 31,
2009
    January 30,
2010
    January 29,
2011
      May 1,  
2010
      April 30,  
2011
 
    (in thousands)  

Cash Flows from Operating Activities:

         

Net income

  $ 23,606      $ 20,863      $ 24,416      $ 1,659      $ 4,860   

Adjustments to reconcile net income to net cash provided by operating activities:

         

Depreciation and amortization

    10,923        13,915        14,292        3,577        3,718   

(Gain) loss on disposal of assets

    (2     784        224        60        19   

Impairment of long-lived assets

    593               1,985                 

Changes in assets and liabilities

    3,156        (306     785        1,013        (4,180
                                       

Net cash provided by operating activities

  $ 38,276      $ 35,256      $ 41,702      $ 6,309      $ 4,417   
                                       

Cash Flows from Investing Activities:

         

Purchase of property and equipment

  $ (23,406   $ (17,514   $ (15,674   $ (4,722   $ (3,001

Insurance proceeds from casualty loss

                  375                 

Proceeds from disposal of property and equipment

    17        3        41               18   
                                       

Net cash used in investing activities

  $ (23,389   $ (17,511   $ (15,258   $ (4,722   $ (2,983
                                       

Cash Flows from Financing Activities:

         

Payment of capital lease obligation

  $ (521   $ (555   $ (591   $ (144   $ (153

Distributions

    (15,190     (16,020     (22,220     (5,031     (1,849
                                       

Net cash used in financing activities

  $ (15,711   $ (16,575   $ (22,811   $ (5,175   $ (2,002
                                       

Change in cash and cash equivalents

  $ (824   $ 1,170      $ 3,633      $ (3,588   $ (568

Cash and cash equivalents at beginning of Period

    25,359      $ 24,535      $ 25,705      $ 25,705      $ 29,338   
                                       

Cash and cash equivalents at end of period

  $ 24,535      $ 25,705      $ 29,338      $ 22,117      $ 28,770   
                                       

Net Cash Provided By Operating Activities

Operating activities consist primarily of net income adjusted for non-cash items that include depreciation and asset impairment write-downs, plus the effect on cash of changes during the year in our assets and liabilities.

Net cash provided by operating activities decreased from $6.3 million in the thirteen weeks ended May 1, 2010 to $4.4 million in the thirteen weeks ended April 30, 2011, a decrease of $1.9 million. Net income was $3.2 million more during the thirteen weeks ended April 30, 2011 than during the comparable thirteen week period of the prior year. Non-cash components of net income such as

 

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depreciation and loss on disposal of assets also increased $0.1 million compared to the comparable thirteen week period in the prior year. However, cash used in changes in assets and liabilities increased $5.2 million in the thirteen weeks ended April 30, 2011 as the decrease in accounts payable and accrued expenses more than offset the increase in deferred rent due to operating additional stores.

Net cash provided by operating activities increased from $35.3 million in fiscal year 2009 to $41.7 million in fiscal year 2010, an increase of $6.4 million. Net income increased by $3.6 million during fiscal year 2010 as discussed above. In addition, non-cash components of net income such as depreciation, asset impairment reserves and loss on disposal of assets increased $1.8 million. Cash provided by changes in assets and liabilities increased $1.1 million in fiscal year 2010 as the increase in deferred rent due to operating additional stores more than offset increased inventory net of payables.

Net cash provided by operating activities decreased from $38.3 million in fiscal year 2008 to $35.3 million in fiscal year 2009, a decrease of $3.0 million. Net income decreased $2.7 million from fiscal year 2008 to fiscal year 2009. This decrease was offset by a $3.2 million increase in non-cash components of net income such as depreciation and amortization, asset impairment and loss on disposal of assets. Cash provided by changes in assets and liabilities decreased by $3.5 million from fiscal year 2008 to fiscal year 2009 largely due to slower inventory turns and therefore a decline in vendor payables despite growth in inventory for new store expansion.

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.

Capital expenditures related to stores represent the bulk of this spending. Spending on new stores and the remodeling and other improvements of existing stores were $3.8 million and $2.4 million in the thirteen weeks ended May 1, 2010 and April 30, 2011, respectively. The remaining capital expenditures in each period were primarily for our investment in information technology systems and distribution and corporate facility enhancements.

Capital expenditures for the opening of 26, 13 and 16 new stores and the remodeling and other improvements of existing stores were $16.4 million, $11.1 million and $13.3 million in fiscal years 2008, 2009 and 2010, respectively. The remaining capital expenditures in each period were primarily for our investment in information technology systems and distribution and corporate facility enhancements.

Capital expenditures during fiscal year 2011 are expected to be between $21 million and $25 million, the substantial majority of which will be devoted to the opening of new stores, remodels and changes in fixtures and equipment at existing stores, and enhancements to the distribution center and information technology systems which will be funded from cash provided by operations.

Net Cash Used in Financing Activities

Financing activities consist of distributions to our shareholders and payments on our capital lease obligation.

Net cash used in financing activities was $5.2 million and $2.0 million in the thirteen weeks ended May 1, 2010 and April 30, 2011, respectively. This included $5.0 million and $1.8 million, respectively, in distributions to our shareholders, and $0.1 million and $0.2 million, respectively, for payments on our capital lease obligation.

 

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Net cash used in financing activities was $15.7 million, $16.6 million and $22.8 million in fiscal years 2008, 2009 and 2010, respectively. This included $15.2 million, $16.0 million and $22.2 million, respectively, in distributions to our shareholders, and $0.5 million, $0.6 million and $0.6 million, respectively, for payments on our capital lease obligation.

In addition, immediately before the termination of its “S” Corporation status, World of Jeans & Tops will establish notes payable, bearing a market rate of interest, due to its “S” Corporation shareholders which will reflect the amount of undistributed cumulative earnings remaining in the company from the date of its formation up to the date of termination of its “S” Corporation status. We will use a significant portion of the proceeds from this offering to pay such notes, representing the final distribution to the shareholders of World of Jeans & Tops, who are also our existing stockholders. We expect this distribution to be approximately $         million.

Line of Credit

We have been operating with a $15.0 million revolving credit facility with Wells Fargo Bank, NA that expires on the earlier of December 31, 2011 or the consummation of our initial public offering. Upon consummation of our initial public offering, we expect to have a $25.0 million revolving credit facility with a two-year term with Wells Fargo Bank, NA. We anticipate that the interest charged on borrowings will either be at the London Interbank Offered Rate, or LIBOR, plus 1.75% or at the bank’s prime rate. We expect to have the ability to select between the prime or LIBOR-based rate at the time of a cash advance. Similar to the existing credit facility, we expect that advances will be secured by substantially all of our assets, and that as a sub-feature under the line of credit the bank may issue stand-by and commercial letters of credit up to $15.0 million. We would be required to maintain certain financial and nonfinancial covenants in accordance with the new revolving credit facility. These covenants will include maintaining a minimum current ratio, not exceeding a maximum funded debt to earnings before interest, taxes, depreciation, amortization and annual rent expense (“EBITDAR”) ratio, capital expenditures not exceeding established limits and achieving a minimum pre-tax profit on a rolling four quarter basis. There can be no assurance that Tilly’s will be able to consummate this new revolving credit facility agreement consistent with management’s expectations.

Contractual Obligations

We enter into long-term contractual obligations and commitments in the normal course of business, primarily non-cancellable capital and operating leases.

We lease approximately 172,000 square feet for our corporate headquarters and distribution center from a company that is owned by the co-founders of Tilly’s. This lease expires on December 31, 2012, with three five-year renewal option periods. The land component of this lease is accounted for as an operating lease and the building component is accounted for as a capital lease. Because the company initially guaranteed the related-party lessor’s debt obligation with respect to this leased property through December 31, 2017, the depreciation of the long-lived leasehold assets and the amortization of the capital lease liability were determined to be 15 years to correspond to the timing of the company’s guarantee. As of March 9, 2011, the financial institution holding the mortgage guaranty cancelled the guaranty. The portion of the lease related to land represents an operating lease and is included in the contractual obligations schedule below. The initial obligation at inception under the capital lease was $9.2 million, with an outstanding balance of $5.1 million as of April 30, 2011. The value of the capital lease assets was $7.8 million as of April 30, 2011. The accumulated depreciation of the building under the capital lease was $4.3 million as of April 30, 2011.

 

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We also lease approximately 24,000 square feet of office and warehouse space located at 15 Chrysler, Irvine, California from a company that is owned by one of our co-founders. This lease is accounted for as an operating lease. The lease began on November 1, 2010 and terminates on October 31, 2014. We sublease approximately 17,000 square feet of the building to an unrelated third party. The sublease began December 1, 2010 and terminates on May 31, 2014. The rental income paid to us with respect to the sublease, per square foot, is slightly above the rental expense paid by us with respect to the master lease.

With the exception of the corporate headquarters and distribution center and warehouse leases discussed above, our leases are generally non-cancelable operating leases expiring at various dates through 2022. Certain leases provide for additional rent based on a percentage of sales and annual rent increases based upon the Consumer Price Index. In addition, many of our store leases contain certain co-tenancy provisions that permit us to pay rent based on a pre-determined percentage of sales when the occupancy of the retail center falls below minimums established in such lease.

As of April 30, 2011, our contractual cash obligations over the next several periods are set forth below (in thousands).

 

     Payments Due by Period  
     Total      Less Than 1
Year
     1 - 2
Years
     3 - 5
Years
     More Than
5 Years
 

Capital Lease Obligations(1)(3)

     6,270       $ 940       $ 1,880       $ 1,880       $ 1,570   

Operating Lease Obligations(2)(3)

     237,308         31,235         65,934         53,717         86,422   

Purchase Obligations(4)

     90,382         90,382                           
                                            

Total

   $ 333,960       $ 122,557       $ 67,814       $ 55,597       $ 87,992   
                                            

 

(1) The capital lease is for the building portion of our corporate headquarters and distribution center, including interest.
(2) Our store leases generally have initial lease terms of 10 years and include renewal options on substantially the same terms and conditions as the original lease. Also included in operating leases is the land portion of the corporate headquarters and distribution center lease, as well as the warehouse lease described above.
(3) Amounts represent commitments for minimum lease payments under non-cancellable leases.
(4) Purchase obligations consist primarily of inventory purchase orders for goods not yet received.

Off-Balance Sheet Arrangements

We are not a party to any off-balance sheet arrangements, except for the operating leases, purchase obligations and revolving credit facility as discussed above.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity 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.

We believe the application of our accounting policies, and the estimates inherently required therein, are reasonable. Our accounting policies and estimates are reevaluated on an ongoing basis and adjustments are made when facts and circumstances dictate a change.

The policies and estimates discussed below involve the selection or application of alternative accounting policies that are material to our consolidated financial statements. With respect to critical accounting policies, even a relatively minor variance between actual and expected experience can

 

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potentially have a materially favorable or unfavorable impact on subsequent results of operations. However, our historical results for the periods presented in the consolidated financial statements have not been materially impacted by such variances. Our accounting policies are more fully described in Note 2 of the notes to the audited financial statements, “Summary of Significant Accounting Policies”. Management has discussed the development and selection of these critical accounting policies and estimates with our board of directors.

We have certain accounting policies that require more significant management judgment and estimates than others. These include our accounting policies with respect to revenue recognition, merchandise inventories, long-lived assets, stock-based compensation and accounting for income taxes, which are more fully described below.

Revenue Recognition

Sales are recognized at the time of purchase by customers at our retail store locations. Sales are recorded net of taxes collected from customers. For online sales, revenue is recognized at the estimated time goods are received by customers. On average, customers receive goods within three days of being shipped. The estimate of the transit times for these shipments is based on shipping terms and historical delivery times. Shipping and handling fees billed to customers for online sales are included in net sales and the related shipping and handling costs are classified as cost of goods sold in the Consolidated Statements of Operations. For fiscal years 2008, 2009 and 2010, shipping and handling fee revenue included in net sales was $1.3 million, $1.9 million and $2.6 million, respectively.

We reserve for projected merchandise returns based upon historical experience and various other assumptions that we believe to be reasonable. Customers can return merchandise within 30 days of the original purchase date. Merchandise returns are often resalable merchandise and are refunded by issuing the same tender as in the original purchase. Merchandise exchanges of the same product and price are not considered merchandise returns and, therefore, are not included in the population when calculating the sales returns reserve. The total reserve for returns was $0.4 million and $0.5 million at January 30, 2010 and January 29, 2011, respectively. Should the returns rate as a percentage of net sales significantly change in future periods, it could have a material impact on our results of operations.

We recognize the sales from gift cards as they are redeemed for merchandise. Prior to redemption, we maintain an unearned revenue liability for unredeemed gift card balances. Our gift cards do not have expiration dates; however, over time, the redemption of some gift cards is remote and there is no obligation to remit the unredeemed gift cards to relevant jurisdictions (gift card breakage). An assessment of the ultimate non-redemption rate of gift cards is performed when enough time has passed since the activation of the cards to enable a determination of the ultimate breakage rate based upon our historical redemption experience. This date of assessment has historically been two full fiscal years after the fiscal year in which the cards were activated. At the time of assessment a breakage estimate is calculated and recorded in net sales. Breakage revenue for gift cards was $1.5 million, $0.5 million and $0.4 million in fiscal years 2008, 2009 and 2010, respectively. If the gift card breakage experience were to change significantly in future periods, it could have a material impact on our results of operations.

Merchandise Inventories

Merchandise inventories are stated at the lower of cost or market. Market is determined based on the estimated net realizable value, which generally is the merchandise selling price. Cost is calculated using the retail inventory method. Under the retail inventory method, inventory is stated at its current retail selling value and then is converted to a cost basis by applying a cost-to-retail ratio based on

 

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beginning inventory and the fiscal year purchase activity. The retail inventory method inherently requires management judgments and estimates, such as the amount and timing of markdowns needed in order to sell through slow-moving inventories.

Markdowns are recorded when the sales value of the inventory has diminished. Factors considered in the determination of markdowns include current and anticipated demand, customer preferences, age of the merchandise and fashion trends. When a decision is made to mark down merchandise, the resulting gross margin reduction is recognized in the period in which the markdown is recorded. During each accounting period, we record adjustments to our inventories, which are reflected in cost of goods sold, if the cost of specific inventory items on hand exceeds the amount we expect to realize from the ultimate sale or disposal of the inventory. This adjustment calculation requires us to make assumptions and estimates, which are based on factors such as merchandise seasonality, historical trends and estimated inventory levels, including sell-through of remaining units.

Total markdowns, including permanent and promotional markdowns, on a cost basis were $16.7 million, $20.8 million and $22.8 million and represented 6.5%, 7.4% and 6.9% of net sales in fiscal years 2008, 2009 and 2010, respectively. We accrued $0.4 million and $0.3 million for planned but unexecuted markdowns, including markdowns related to slow moving merchandise, as of January 30, 2010 and January 29, 2011, respectively.

To the extent that management’s estimates differ from actual results, additional markdowns may be required that could reduce our gross margin, operating income and the carrying value of inventories. Our success is largely dependent upon our ability to anticipate the changing fashion tastes of our customers and to respond to those changing tastes in a timely manner. If we fail to anticipate, identify or react appropriately to changing styles, trends or brand preferences of our customers, we may experience lower sales, excessive inventories and more frequent and extensive markdowns, which would adversely affect our operating results.

We also record an inventory shrinkage reserve calculated as a percentage of net sales for estimated merchandise losses for the period between the last physical inventory count and the balance sheet date. These estimates are based on historical percentages and can be affected by changes in merchandise mix and changes in shrinkage trends. We perform physical inventory counts twice a year for the entire chain of stores and our distribution center and adjust the inventory shrinkage reserve accordingly. If actual physical inventory losses differ significantly from the estimate, our results of operations could be adversely impacted. The inventory shrinkage reserve reduces the value of total inventory and is a component of inventories on the consolidated balance sheets. The inventory shrinkage reserve at January 30, 2010 and January 29, 2011 was not material.

Long-Lived Assets

We evaluate the carrying value of our long-lived assets, consisting largely of leasehold improvements, furniture and fixtures and equipment at store, distribution center and corporate office locations, for impairment whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. Factors that are considered important that could result in the necessity to perform an impairment review include a current-period operating or cash flow loss combined with a history of operating or cash flow losses and a projection or forecast that indicates continuing losses or insufficient income associated with the realization of a long-lived asset or asset group. Other factors include a significant change in the manner of the use of the asset or a significant negative industry or economic trend. This evaluation is performed based on estimated undiscounted future cash flows from operating activities compared with the carrying value of the related assets. If the undiscounted future cash flows are less than the carrying value, an impairment loss is recognized, measured by the difference between the carrying value and the estimated fair value of the assets,

 

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based on discounted cash flows using our weighted-average cost of capital, with such estimated fair values determined using the best information available. Quarterly, we assess whether events or changes in circumstances have occurred that potentially indicate the carrying value of long-lived assets may not be recoverable.

During fiscal year 2008 the net book value of fixed assets at one store was impaired with a charge of $0.6 million. Similarly, in fiscal year 2010 the net book value of fixed assets at another store was impaired with a charge of $0.8 million. These charges were recorded as the assets were not projected to generate sufficient cash flows to recover the carrying values. In addition, we recorded an impairment charge of $1.2 million in fiscal year 2010 due to smoke damage to assets resulting from a fire in the mall where one of our stores is located. We have an insurance policy covering the assets that were destroyed. There were no impairment charges during fiscal year 2009.

The estimation of future cash flows from operating activities requires significant estimates of factors that include future sales and gross margin performance. Factors used in the valuation of long-lived assets with finite lives include, but are not limited to, discount rates, management’s plans for future operations, recent operating results and projected future cash flows. If our net sales or gross profit performance or other estimated operating results are not achieved at or above our forecasted level, or inflation exceeds our forecast and we are unable to recover such costs through price increases, the carrying value of certain of our retail stores may prove to be unrecoverable and we may incur additional impairment charges in the future.

Stock-Based Compensation

In June 2007 our board of directors adopted the 2007 Stock Option Plan, or 2007 Plan, which authorized the issuance of options to purchase up to 1.6 million shares of common stock for employees, consultants and directors. These share-based awards are granted at an exercise price equal to the fair market value of our common stock at the date of grant. These awards vest in equal installments over a four year period (service period) and generally expire at the earlier of 30 days after employment or services are terminated or ten years from the date of grant. The awards also include a performance condition that prevents the awards from becoming exercisable until the consummation of an initial public offering by us. As the awards contain both a service requirement and a performance condition, compensation expense is not recognized in the financial statements until the later of the consummation of an initial public offering by us or completion of the requisite service period.

We account for stock-based compensation in accordance with the provisions of ASC Topic 718, Compensation-Stock Compensation (“ASC 718”), which establishes accounting for equity instruments exchanged for employee services. Under the provisions of this statement, stock-based compensation expense is measured at the grant date, based on the calculated fair value of the award, and is recognized as an expense on a straight-line basis over the employee’s requisite service period (generally the vesting period of the equity grant). As required under this guidance, we estimate forfeitures for options granted which are not expected to vest. Changes in these inputs and assumptions can materially affect the measurement of the estimated fair value of our stock-based compensation expense.

 

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Determining the fair value of stock-based awards at the grant date requires judgment. We use the Black-Scholes option-pricing model to determine the fair value of stock options. The determination of the grant date fair value of options using an option-pricing model is affected by a number of assumptions, such as our estimated common stock fair value, our expected stock price volatility over the expected term of the options, stock option exercise and cancellation behaviors, risk-free interest rates, and expected dividends, which we estimate as follows:

 

  Ÿ  

Fair Value of Our Common Stock.    Because our common stock is not publicly traded, we must estimate the fair value of our common stock, as discussed in “Determination of the Fair Value of Common Stock on Grant Date” below.

 

  Ÿ  

Expected Term.    We have limited historical information regarding expected option term. Accordingly, we determined the expected stock option term of the awards using the latest historical data available from comparable public companies and our expectation of exercise behavior.

 

  Ÿ  

Volatility.    As we do not have a trading history for our common stock, the expected stock price volatility for each grant is measured using the average of historical daily price changes of comparable public companies’ common stock over the most recent period equal to the expected term of our stock option awards. We intend to consistently apply this process using the same or similar public companies until a sufficient amount of historical information regarding the volatility of our own common stock share price becomes available. However, if the circumstances change so the identified companies are no longer similar to us, we will select companies we believe are more suitable and use their publicly available share prices in the calculation.

 

  Ÿ  

Risk-Free Rate.    The risk-free interest rate is based on the yields of U.S. Treasury securities with maturities similar to the expected term of the stock options for each stock option group.

 

  Ÿ  

Dividend Yield.    We have never declared or paid any cash dividends and do not plan to pay cash dividends in the foreseeable future. Consequently, we used an expected dividend yield of zero.

If any of the assumptions used in the Black-Scholes model change significantly, stock-based compensation for future awards may differ materially compared with the awards granted previously.

The following table presents the weighted-average assumptions we used to estimate the fair value of stock options granted during the periods presented:

 

     Fiscal Year Ended     Thirteen
Weeks Ended

April  30,
2011
 
     January 31,
2009
    January 30,
2010
    January 29,
2011
   

Expected option term

     5.0 years        5.0 years        5.0 years        5.0 years   

Expected volatility factor

     42.3     45.5     61.0     59.7

Risk-free interest rate

     3.0     1.8     1.0     2.2

Expected annual dividend yield

     0.0     0.0     0.0     0.0

Our estimate of pre-vesting forfeitures, or forfeiture rate, was based on our internal analysis, which included the award recipients’ positions within the company and the vesting period of the awards. The result of the Black-Scholes calculation was compensation expense, cumulative through April 30, 2011, for all options granted under the 2007 Plan and before any related tax benefit, of $4.2 million. This compensation expense has not been recognized in our financial statements as the stock options contain both a service requirement and a performance condition. Therefore, we will recognize this deferred compensation expense upon the consummation of the initial public offering.

 

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Determination of the Fair Value of Common Stock on Grant Date

We have been a private company with no active public market for our common stock. The fair value of the common stock underlying our stock options was determined by our board of directors, which intended all stock options granted to be exercisable at a price per share not less than the per share fair value of our common stock underlying those stock options on the date of grant. We have determined the estimated per share fair value of our common stock using a contemporaneous valuation consistent with the American Institute of Certified Public Accountants Practice Aid, “Valuation of Privately-Held Company Equity Securities Issued as Compensation”, or the Practice Aid. In conducting this valuation, we considered all objective and subjective factors that we believed to be relevant, including our best estimate of our business condition, prospects and operating performance at the valuation date. Within this contemporaneous valuation performed by management, with the assistance of third-party valuation specialists hired by us, a range of factors, assumptions and methodologies were used. The significant factors included:

 

  Ÿ  

the fact that we are a private retail company with illiquid securities;

 

  Ÿ  

our historical operating results;

 

  Ÿ  

our discounted future cash flows, based on our projected operating results;

 

  Ÿ  

the hiring of key personnel;

 

  Ÿ  

the likelihood of achieving a liquidity event for the shares of common stock underlying these stock options, such as an initial public offering or sale of our company, given prevailing market conditions;

 

  Ÿ  

any adjustment necessary to recognize a lack of marketability for our common stock;

 

  Ÿ  

valuation of comparable public companies at the time of grant;

 

  Ÿ  

the U.S. and global capital market conditions; and

 

  Ÿ  

outlook for our industry at the time of grant.

After review of the fair value analysis, our board of directors authorized the use of that fair value as the exercise price for options granted on the date of that valuation report.

Common Stock Valuation Methodologies

For the contemporaneous valuation of our common stock, management estimated, as of January 29, 2011, the latest valuation date, our enterprise value on a continuing operations basis primarily using the income and market approaches which are both acceptable valuation methods in accordance with the Practice Aid. The income approach utilized a discounted cash flow methodology based on our financial forecasts and projections, as detailed below. The market approach utilized both the guideline public company and the guideline merged and acquired methodologies based on data obtained on comparable public companies, as detailed below. Management considered both objective and subjective factors, including information provided by a third-party valuation firm, to determine its best estimate of the fair market value of our common stock.

For the discounted cash flow methodology, we prepared detailed annual forecasts of cash flows for future years, which we refer to as the “discrete forecast period”. The value of the cash flows beyond the discrete forecast period was derived by applying a capitalized earnings approach, in which such cash flows are assumed to grow at a constant annual long-term growth rate and in which the terminal-year cash flow is capitalized at a rate equal to the estimated discount rate less the estimated constant annual long-term growth rate. Our forecasts of future cash flows were based on our estimated net

 

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debt-free cash flows and were discounted to the valuation date at an estimate of our weighted average cost of capital. We weighted the discounted cash flow method 50% in determining the total fair value of our equity as this approach was determined to represent the best indication of value.

The guideline public company method of the market approach is based on the market prices of stock for comparable companies. Indications of value were estimated by deriving multiples of equity or invested capital to various measures of revenue, earnings or cash flow for the selected guideline companies and then applying such multiples to the metrics of our business. When selecting comparable companies, consideration was given to industry similarity, their specific products offered, financial data availability and capital structure. We weighted the guideline public company method 40%, less than the discounted cash flow method, as the stock price and earnings estimates for the comparable public companies were relatively volatile as of the valuation date.

The guideline merged and acquired method of the market approach follows the same basic methodology as the guideline public company method. However, instead of deriving multiples based on stock prices of guideline companies, indications of value are estimated by deriving multiples of equity or invested capital from sales of entire companies. We weighted the guideline merged and acquired method only 10% as most of the observed industry transactions occurred in a different economic environment and we had higher EBITDA margins than many of the target companies.

We believe that the procedures employed in the discounted cash flow, guideline public company and guideline merged and acquired methodologies are reasonable and consistent with the Practice Aid.

We granted stock options with the following exercise prices between May 2, 2010 and the date of this prospectus:

 

Option Grant Date

   Number of
Shares
Underlying
Options
     Exercise
Price Per
Share
     Common Stock
Fair Value Per
Share at

Grant Date
     Fair Value of
Stock Options
Granted
 

October 2010(1)

     762,500       $ 8.98       $ 8.98       $ 4.57 - $7.01   

March 2011

     578,000         16.26         16.26         8.52   

 

(1) Includes 739,500 stock options that were re-priced on a one-for-one basis to $8.98 per share. See the section below titled “Stock Option Re-Pricing”.

Based upon the assumed initial public offering price of $             per share, which is the mid-point of the price range set forth on the cover page of this prospectus, the aggregate intrinsic value of stock options outstanding as of              was approximately $             million, of which approximately $             million related to vested stock options and approximately $             million related to unvested stock options.

Significant factors considered by our board of directors in determining the fair value of our common stock at these grant dates included:

October 2010

We performed a valuation of our common stock as of fiscal month ended August 28, 2010 which included the back-to-school shopping season that peaks in August. Although the United States economy had been recovering from recession in 2010, the recovery was weaker than in many past recovery periods. The financial results of many of our comparable companies reflected weak performance driven generally by either negative or only modestly positive year-to-date

 

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comparable store sales through August. Our comparable store sales trends for this same period were consistent with our comparable companies, with close to zero comparable store sales growth, lower income than the same year-to-date period in the prior year, and sales and income running well below the forecast for fiscal 2010 that was incorporated in the prior valuation of our common stock. As a result of these factors, we lowered our financial forecast and expectations for growth in fiscal 2010 and, because they were building upon 2010 expected results, the forecasted sales and income in fiscal 2011 and beyond. This valuation determined the value of our common stock to be $8.98 per share. Our board of directors granted stock options with exercise prices at $8.98 per share on October 8, 2010, the date the valuation was finalized, after determining that the fair value of our common stock would not have materially changed between the valuation date and the date of the grant. In addition, stock options previously granted with exercise prices greater than $8.98 per share were re-priced to $8.98 per share as of October 8, 2010 by our board of directors. See “Stock Option Re-Pricing” section below.

March 2011

We performed a valuation of our common stock as of the fiscal year end date of January 29, 2011. Over the previous quarter the national economy grew more quickly than earlier in fiscal 2010 and our comparable companies’ results generally improved substantially in the fourth quarter of fiscal 2010. Our results, similarly, improved substantially, with a double-digit comparable store sales increase in the fourth quarter of fiscal 2010 compared to the fourth quarter of fiscal 2009 and profitability for the quarter well above the prior year’s fourth quarter. Therefore, profitability for fiscal 2010 ended up being well above the revised forecast used in the August 2010 valuation. This greatly improved sales and profit trend continued into February and March of fiscal 2011. As a result, we increased the financial forecast and expectations for growth in fiscal 2011 and beyond. Concurrently, our comparable companies’ financial results led to, in many cases, increased market prices for their common stock. This valuation determined the value of our common stock to be $16.26 per share. Our board of directors granted stock options with exercise prices at $16.26 per share on March 31, 2011, the date the valuation was finalized, after determining that the fair value of our common stock would not have materially changed between the valuation date and the date of the grant.

Stock Option Re-Pricing

In October 2010, our board of directors approved a common stock option re-pricing whereby previously granted stock options held by current employees with exercise prices above $8.98 per share were re-priced on a one-for-one basis to $8.98 per share with no modification to any other terms of the previously issued stock options. As a result, 739,500 stock options originally granted to purchase common stock at prices ranging from $9.64 to $14.47 were re-priced in order to continue maintaining an equity incentive for our employees and reflect a significantly different economic environment.

We treated the re-pricing as a modification for accounting purposes of the original awards and calculated additional compensation costs for the difference between the fair value of the re-priced award and the fair value of the original award on the re-pricing date. The re-pricing affected 48 optionees and resulted in incremental unrecognized stock-based compensation expense of $0.6 million. Expense related to vested stock options will be recognized upon the consummation of our initial public offering, and expense related to unvested stock options will be amortized over the remaining vesting period of the stock options. Our assumptions used to estimate the fair value of the original awards immediately before the re-pricing and the fair value of the re-priced awards required significant judgment.

 

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Accounting for Income Taxes

Historically, World of Jeans & Tops has recognized income taxes as an “S” Corporation for federal and state income tax purposes. As such, with the exception of a limited number of state and local jurisdictions, it has not been subject to income taxes. The shareholders of World of Jeans & Tops, and not World of Jeans & Tops itself, are subject to income tax on their distributive share of its earnings. World of Jeans & Tops paid distributions to the shareholders to fund their tax obligations attributable to taxable income of World of Jeans & Tops, in addition to any discretionary distributions paid to its shareholders. As a result of the Reorganization Transaction, World of Jeans & Tops’ “S” Corporation status will terminate and World of Jeans & Tops will be treated as a “C” Corporation for federal and applicable state income tax purposes.

In July 2006, the FASB issued an interpretation which clarifies the accounting for uncertainty in income taxes recognized in the financial statements. This interpretation provides that a tax benefit from an uncertain tax position may be recognized when it is more-likely-than-not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits. Income tax positions must meet a more-likely-than-not recognition threshold at the effective date to be recognized, and in subsequent periods. This interpretation also provides guidance on measurement, derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. We adopted this interpretation effective February 4, 2007. As a result of the implementation of this interpretation, we did not recognize any change in liability for income taxes.

Recently Issued Accounting Pronouncements

In October 2009 the FASB issued Accounting Standards Update, or ASU, No. 2009-13, Multiple-Deliverable Revenue Arrangements—a consensus of the FASB Emerging Issues Task Force. This ASU provides amendments to the criteria for separating consideration in multiple-deliverable arrangements. The amendments in this ASU replace the term “fair value” in the revenue allocation guidance with “selling price” to clarify that the allocation of revenue is based on entity-specific assumptions rather than assumptions of a marketplace participant. The amendments in this ASU also establish a selling price hierarchy for determining the selling price of a deliverable. The amendments in this ASU eliminate the residual method of allocation and require that arrangement consideration be allocated at the inception of the arrangement to all deliverables using the relative selling price method. The amendments in this ASU are effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning after June 15, 2010. The initial adoption of this ASU did not have a material impact on the Company’s revenue recognition policies.

In January 2010 the FASB issued guidance and clarifications for improving disclosures about fair value measurements. This guidance requires enhanced disclosures regarding transfers in and out of the levels within the fair value hierarchy. Separate disclosures are required for transfers in and out of Level 1 and 2 fair value measurements, and the reasons for the transfers must be disclosed. In the reconciliation for Level 3 fair value measurements, separate disclosures are required for purchases, sales, issuances, and settlements on a gross basis. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements, which are effective for interim and annual reporting periods beginning after December 15, 2010. Effective January 31, 2010, the Company adopted the new and updated disclosure guidance, aside from that deferred to periods after December 15, 2010, and this did not significantly impact the Company’s financial statements. The Company does not believe adoption of the remaining guidance on disclosures will have any material effect on its consolidated financial statements.

 

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The FASB issues ASUs to amend the authoritative literature in the Accounting Standards Codification. There have been a number of ASUs to date that amend the original text of the Accounting Standards Codification. Except for the ASU listed above, those issued to date either (i) provide supplemental guidance, (ii) are technical corrections, (iii) are not applicable to the Company or (iv) are not expected to have a significant impact on the Company.

Quantitative and Qualitative Disclosure of Market Risks

Interest Rate Risk

We are subject to interest rate risk in connection with borrowings, if any, under our line of credit, which bears interest at variable rates. As of January 30, 2010 and January 29, 2011, we had no outstanding borrowings under our line of credit.

Impact of Inflation

Our results of operations and financial condition are presented based on historical cost. While it is difficult to accurately measure the impact of inflation due to the imprecise nature of the estimates required, we believe the effects of inflation, if any, on our results of operations and financial condition have been immaterial.

Foreign Exchange Rate Risk

We currently source all merchandise through domestic vendors and all purchases are denominated in U.S. dollars. We do not hedge using any derivative instruments and historically have not been impacted by changes in exchange rates.

 

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BUSINESS

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 stores are designed to be a seamless extension of our teen and young adult consumers’ lifestyles, with a balance of guys’ and juniors’ merchandise, in a stimulating environment. As we have grown, we believe our success across a variety of real estate venues and geographies in the United States has demonstrated Tilly’s portability. We believe our distinctive store experience combined with our extensive selection of merchandise positions us to exceed our customers’ expectations. Tilly’s is a passionate lifestyle brand and our motto, “If it’s not here…it’s not happening” exemplifies our goal to serve as a destination for the latest, most relevant merchandise and brands important to our customers.

As of April 30, 2011, we operated 126 stores in 11 states, averaging approximately 7,800 square feet. We also sell our products through our e-commerce website, www.tillys.com. Our business is characterized by the following key elements:

 

  Ÿ  

Extensive assortment of relevant merchandise in a larger store format. Our larger stores allow us to carry a more extensive selection of brands and products. Our stores feature third-party brands, including Billabong, Element, Hurley, Levi’s, LRG, Neff, RVCA, Uggs, and Volcom, to name just a few, complemented by our proprietary brands, such as RSQ, Full Tilt, Blue Crown, and Infamous. Our larger stores also allow us to offer a greater assortment of apparel styles, sizes and price points across multiple categories as well as a strong assortment of footwear, backpacks, hats and other accessories. This broad selection focused on guys and juniors enhances our ability to rapidly identify and respond to trends and positions us as a destination for both proven fashion items and core styles. We strive to keep our merchandising mix current by introducing additional brands and styles in response to the ever-evolving desires of our customers.

 

  Ÿ  

The Tilly’s experience. Tilly’s is a customer-driven lifestyle brand. We derive our energy and inspiration from our customers’ individuality and passion for action sports, music, art, and fashion. Our stores bring these interests together in a vibrant, stimulating and authentic environment that is an extension of our customers’ high velocity, multitasking lifestyle. We do this by blending the most relevant brands and styles with music videos, product-related visuals and a dedicated team of store associates. Our associates share the same passion as our customers for action sports, music, art and fashion, enabling them to easily engage with our customers and make shopping at Tilly’s a fun, social experience. Outside of our stores, we connect with our consumers using the same authentic approach, including social media, community outreach and sponsorship of contests, demos and other events. We believe the Tilly’s experience drives customer awareness, loyalty and repeat visits while generating a buzz and excitement for our brand.

 

  Ÿ  

Flexible real estate strategy across real estate venues and geographies. We currently operate stores in 34 markets in 11 states across a variety of real estate venues including malls, power centers, neighborhood and lifestyle centers, outlet centers and street-front locations. Our geographic portability and real estate flexibility provide us with a wider scope of opportunities and enhance our ability to open new stores. As we continue our national store expansion, we focus on identifying the most attractive locations within relevant trade areas to ensure our stores are located where our customers want to shop.

Our West Coast heritage dates back to 1982 when Hezy Shaked and Tilly Levine opened our first store in Orange County, California, the center of the surf and skate lifestyle. Over the last 29 years, we

 

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have built and nurtured strong relationships with our customers, brand partners and vendors while expanding our business. We have also demonstrated an ability to grow rapidly, having more than doubled our store count while entering 25 new markets in the last five years. During this same period, we invested approximately $20 million in infrastructure and systems to support our recent and long-term growth, and enhanced our senior management team while protecting the entrepreneurial culture that we believe makes Tilly’s unique. We believe our corporate culture facilitates our ability to attract and retain high quality employees and is a critical driver of our performance. We believe our team’s passion for the West Coast inspired and action sports lifestyle, sense of urgency and pursuit of excellence enables Tilly’s to consistently deliver a superior customer experience and positions us to successfully execute our long-term growth strategy.

We increased net sales 29%, from $64.3 million in the thirteen weeks ended May 1, 2010 to $83.1 million in the thirteen weeks ended April 30, 2011. We increased operating income 178%, from $1.8 million in the thirteen weeks ended May 1, 2010 to $5.0 million in the thirteen weeks ended April 30, 2011. Our comparable store sales increased 18.2% in the thirteen weeks ended April 30, 2011 as compared to the thirteen weeks ended May 1, 2010.

Competitive Strengths

We believe that the following competitive strengths contribute to our success and distinguish us from our competitors:

 

  Ÿ  

Destination retailer with a broad, relevant assortment. We believe the combined depth and breadth of apparel, footwear, and accessories offered at our stores exceeds the selection offered at many other specialty retailers. We offer an extensive selection of third-party, West Coast inspired and action sports brands complemented by our proprietary brands. Our merchandise includes a wide assortment of brands, styles, colors, sizes and price points to ensure we have what our customers want every time they visit our stores. We offer a balanced mix of merchandise across the guys and juniors categories, with additional merchandise in the boys, girls, footwear and accessories categories. We believe that by combining proven fashion trends and core style products with a vibrant blend of carefully selected music and visuals, we provide an in-store experience that is authentic, fun, and engaging for our core customers. As a result, we believe we capture more shopping trips and generate higher sales per visit.

 

  Ÿ  

Dynamic merchandise model. We believe our extensive selection of third-party and proprietary merchandise allows us to identify and address trends more quickly, offer a greater range of price points and manage our inventories more dynamically. By closely monitoring trends and shipping product to our stores at least five times per week, we are able to adjust our merchandise mix based on store size and location. We also keep our merchandise mix relevant by introducing emerging brands not available at many other retailers. Our merchandising capabilities enable us to adjust our merchandise mix with a frequency that promotes a current look to our stores and encourages frequent visits.

 

  Ÿ  

Flexible real estate strategy across real estate venues and geographies. Our stores have proven to be successful in different real estate venues and geographies. We operate profitable stores in malls, power centers, neighborhood and lifestyle centers, outlet centers and street-front locations across 34 markets in 11 states. We believe our success operating in these different retail venues and geographies demonstrates the portability of Tilly’s and provides us with greater flexibility for future expansion.

 

  Ÿ  

Multi-pronged marketing approach. We utilize a multi-pronged marketing strategy to connect with our customers and drive traffic to our stores and website. First, we distribute catalogs to potential and existing customers from our proprietary database to familiarize them with the Tilly’s brand and our products and to drive sales to our stores and our website. Second, we partner and collaborate with our vendors on exclusive events and contests to build credibility

 

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with our target customers, actively involve them in our brands, and enhance the connection between Tilly’s and the West Coast lifestyle. Third, we use social media to communicate directly with our customers while also encouraging customers to interact with one another and provide feedback on our events and products. Fourth, through our “We Care Program”, we support and participate in various academic, art, and athletic programs at local schools and other organizations in communities surrounding our stores. All of these programs are complemented by email marketing as well as traditional radio and print advertising to build customer awareness and loyalty, highlight key merchandise offerings, drive traffic to our stores and website and promote the Tilly’s brand.

 

  Ÿ  

Sophisticated systems and distribution infrastructure to support growth. Over the last five years, we have invested approximately $20 million in our highly automated distribution center and information systems to support our future growth. We believe our distribution and allocation capabilities are unique within the industry and allow us to operate at a higher level of efficiency than many of our competitors. Our distribution center allows us to quickly sort and process merchandise and deliver it to our stores in a floor-ready format for immediate display. Our systems enable us to respond to changing fashion trends, manage inventory in real time and provide a customized selection of merchandise at each location. We believe our distribution infrastructure can support a national retail footprint in excess of 500 stores with minimal incremental capital investment.

 

  Ÿ  

Experienced management team. Our senior management team, led by Hezy Shaked and Daniel Griesemer, has extensive experience across a wide range of disciplines in the specialty retail and direct-to-consumer industries, including store operations, merchandising, distribution, real estate, and finance. Mr. Shaked, our Co-Founder, Chairman of the Board of Directors, and Chief Strategy Officer, plays an important role in developing our long-term growth initiatives and cultivating our unique culture. Mr. Griesemer, our President and Chief Executive Officer, joined Tilly’s in February 2011 with 28 years of retail experience. He served in various roles with Coldwater Creek, Inc. from 2001 to 2009 including most recently as Chief Executive Officer. During his tenure, Coldwater Creek increased the store base from 13 to approximately 400 and increased revenues from approximately $340 million to approximately $1.1 billion. Mr. Griesemer also served in leadership positions at Gap, Inc. and Macy’s, Inc.

Our Growth Strategy

We are pursuing several strategies to continue our profitable growth, including:

 

  Ÿ  

Expand Our Store Base. We believe there is a significant opportunity to expand our store base from 126 locations as of April 30, 2011 to more than 500 stores across the United States. We have a proven ability to expand the number of stores we operate, as we have more than doubled our store count over the last five years from 51 stores at the beginning of fiscal 2006 to 126 stores at April 30, 2011. We plan to add 13 net new stores in fiscal year 2011, approximately 20 net new stores in fiscal year 2012 and to continue opening new stores at an annual rate of approximately 15% for the next several years thereafter. Our plan includes new store openings in both existing and new markets, and in both mall and off-mall locations.

 

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As of April 30, 2011, we operated stores in 11 states. Over the past five years we have grown our presence in existing markets and successfully expanded into 25 new markets. We have entered new markets by opening stores in high traffic malls relevant to our core customer in order to establish the Tilly’s brand, as well as in off-mall locations that effectively cover trade areas where our customers want to shop. The opportunity exists to continue to significantly broaden our national footprint by entering new markets through both mall and non-mall locations. The following shows our store locations as of April 30, 2011:

LOGO

Our new store model targets a store size averaging 7,500 to 8,000 square feet and a cash-on-cash payback period of about 18 months. In the first year, we target net sales of approximately $2.2 million and cash flow of $300,000.

 

  Ÿ  

Drive Comparable Store Sales. We seek to maximize our comparable store sales by consistently offering new, on-trend and relevant merchandise across a broad assortment of categories, increasing our brand awareness through our multi-pronged marketing approach, providing an authentic store experience for our core customers and maintaining our high level of customer service. We believe our comparable store sales will benefit as stores opened in the last few years continue to mature and we continue to build brand awareness in new markets.

 

  Ÿ  

Grow Our e-Commerce Platform. We believe our e-commerce platform is an extension of our brand and retail stores, providing our customers a seamless shopping experience. Our e-commerce platform allows us to provide an expanded product offering relative to our stores, reach new customers and build our brand in markets where we currently do not have stores. In fiscal 2010, our e-commerce net sales increased 46% relative to fiscal 2009 and represented approximately 10% of our net sales, up from 2% of net sales in fiscal 2006. We believe that our target customer regularly shops online and we see continued opportunity to grow our e-commerce business to approximately 15% of total net sales over time. Key factors driving growth include continuing our successful catalog and online marketing efforts, offering a wider selection of Internet-exclusive merchandise and expanding our online selection to ensure a broad and diverse offering of brands and products relative to our competition. We also believe we will see continued growth in our e-commerce sales as we open additional stores and build brand awareness in the communities surrounding those locations. To support this growth, we plan to open a new dedicated e-commerce fulfillment facility in 2012.

 

  Ÿ  

Increase Our Operating Margins. We believe we have the opportunity to drive margin expansion through scale efficiencies and continued process improvements. We believe

 

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comparable store sales increases combined with our planned store growth will permit us to take advantage of economies of scale in buying and to leverage our existing infrastructure, corporate overhead and fixed costs. We also will continue to use established business processes to identify and execute initiatives focused on lowering our unit costs and improving operational efficiency throughout our organization.

Our Market

Our core consumers include teens and young adults that participate in action sports, as well as those that identify with the West Coast and action sports lifestyle. We believe interest in and awareness of the action sports and West Coast lifestyle continues to grow and influence a broader consumer base that shop at our stores.

According to Euromonitor International, U.S. retail and e-commerce sales of apparel, footwear and accessories totaled $334.2 billion in 2010, which represents an increase of 5.5% from $316.9 billion in 2009. According to Board-Trac, U.S. retail and e-commerce sales of skateboard and surf apparel, footwear and accessories alone were estimated to be approximately $7.1 billion in 2010. Our core customer demographic is 14 to 24 year old teens and young adults. According to the U.S. Census Bureau, this segment of the population grew approximately 10% from 2000 to 2010.

Merchandising, Purchasing, and Planning and Allocation

Merchandising

We seek to be viewed by our customers as the destination for West Coast inspired and action sports related apparel, footwear and accessories. We believe we offer an unparalleled selection of relevant brands, styles, colors, sizes and price points to ensure we have what our customers want every time they visit our stores. Our extensive selection of third-party and proprietary merchandise allows us to identify and address trends more quickly, offer a greater range of price points and manage our inventories more dynamically. We offer a balanced mix of merchandise across the guys and juniors categories, with additional merchandise in the boys, girls, footwear and accessories categories. We believe this category mix contributes to our broad demographic appeal. Our apparel merchandise includes branded, fashion and core styles for tops, outerwear, bottoms, and dresses. Accessories merchandise includes backpacks, hats, sunglasses, headphones, handbags, watches, jewelry and more. We focus on our merchandise presentation and vary the visual displays in our stores and windows multiple times per month, presenting new looks and fashion combinations to our customers.

Our ability to maintain an image consistent with the West Coast inspired and action sports lifestyle is important to our branded vendors and provides us better access to a wide assortment of products and styles. Our third-party branded merchandise features established and emerging brands. We strive to keep our merchandise mix current by continuously introducing emerging brands and styles not available at many other specialty retailers in order to identify and respond to the evolving desires of our customers. Within our diversified portfolio of hundreds of third-party brands, which represented a little more than 70% of our net sales in 2010, our largest brand accounted for approximately 5% of our net sales in each of the last two fiscal years.

 

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Selected third-party brands include, in alphabetical order:

 

Ÿ   Billabong

Ÿ    DC Shoes

Ÿ   Element

Ÿ    Etnies

Ÿ   Fox

Ÿ    Hurley

Ÿ   Levi’s

  

Ÿ   LRG

Ÿ    Metal Mulisha

Ÿ   Neff

Ÿ    Nike

Ÿ   O’Neill

Ÿ    Quiksilver

Ÿ   Roxy

   Ÿ    RVCA

Ÿ    Skullcandy

Ÿ    UGG

Ÿ     Volcom
…and many more

We supplement our third-party merchandise assortment with our own proprietary brands across many of our apparel and accessory product categories. We utilize our own branded merchandise to expand our price point range, identify and respond to changing fashion trends quickly, fill merchandise gaps and provide a deeper selection of styles and colors for proven fashion items. Our own brands represented approximately 25% and 29% of our net sales for fiscal years 2009 and 2010, respectively.

Our proprietary branded merchandise includes:

 

Brand

  

Category

LOGO    Guys’, boys’ and juniors’ denim apparel and cologne
LOGO    Juniors’ and girls’ apparel, footwear and accessories
LOGO    Guys’ and boys’ apparel
LOGO    Guys’, boys’ and juniors’ apparel and cologne

We believe that our extensive selection of merchandise, from both established and emerging brands as well as our proprietary brands, caters to a wide demographic of core customers and enhances our store image as a destination that carries the most sought-after apparel, footwear and accessories.

Merchandise Purchasing

Our merchandise purchasing staff is organized by category and product type and consists of a Vice President/General Merchandise Manager, divisional merchandise managers, buyers, associate buyers and assistant buyers. We believe a key element of our success is our team’s ability to identify and source the latest proven fashion trends and core styles that are most relevant to our customers.

Our purchasing approach focuses on product relevance, availability, cost and speed of production in order to provide timely frequent delivery of merchandise to our stores. Our purchasing group and planning and allocation team are highly coordinated and maintain a disciplined buying strategy.

To ensure a relevant assortment, our teams:

 

  Ÿ  

perform comprehensive analysis of sales trends from our stores and e-commerce site;

 

  Ÿ  

gather feedback from our customers and our staff;

 

  Ÿ  

maintain regular dialogue with our existing vendor network and potential new vendors;

 

  Ÿ  

utilize trend and color forecasting services;

 

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  Ÿ  

participate in trade shows and action sport related events;

 

  Ÿ  

review trade publications; and

 

  Ÿ  

evaluate merchandise assortments offered by other retail and online merchants.

We have developed and maintain strong, long-standing relationships with our third-party vendors and we have a history of identifying and growing with emerging brands. We believe the Tilly’s brand, shopping experience and core customer lifestyle is highly consistent with the image and philosophy of our key vendors. This, in addition to our customer connectivity, facilitates a partnership culture with our key vendors and provides us access to an extensive variety of products and styles, as well as certain merchandise that is exclusive to our stores and website. Our merchandise purchasing group also works closely with independent third parties who design and procure merchandise for our proprietary brands. Our proprietary brand capabilities enhance our ability to rapidly identify and respond to trends and consistently offer our customers proven fashion items. We source merchandise for our own brands both domestically and internationally in order to benefit from shorter lead times associated with domestic vendors and lower costs associated with foreign manufacturing.

Planning and Allocation

Our merchandise planning and allocation team consists of a Vice President, directors, managers, planners and analysts. We have developed an inventory planning and allocation process to support our merchandise strategy. Working closely with our merchandise purchasing team, the planning and allocation team utilizes a disciplined approach to buying, forecasting, inventory control and allocation processes. Our planning and analysis team continually analyzes information from our management information system, including inventory levels and sell-through data, to regularly adjust the assortment at each store and the inventory levels for our company as a whole. Our broad third-party vendor base allows us to shift merchandise purchases to react quickly to changing consumer preferences and market conditions. Furthermore, the vendor base for our proprietary products provides us flexibility to develop our own branded products to quickly address emerging fashion trends and provide a deeper selection of styles, colors, and price points for proven fashion items. We modify our merchandising mix based upon store size, the season, and consumer preferences in different parts of the country. We are also able to react quickly to changing customer needs due to our shipment of merchandise to our stores at least five days per week. Finally, we coordinate closely with our visual merchandise managers and marketing group in order to manage inventory levels in connection with our promotions and seasonality.

Stores

As of April 30, 2011, we operated 126 stores throughout the United States. Our stores are located in mall and off-mall locations. Our stores averaged approximately 7,800 square feet and generated average net sales per store of $2.5 million and net sales per square foot of $326 for fiscal year 2010.

The table below indicates certain historical information regarding our stores by type of retail center as of fiscal year end for each of the years indicated below:

 

     2006    2007    2008    2009    2010

Regional Mall

   23    28    42    55    62

Off-Mall(1)

   38    45    57    56    63
                        
   61    73    99    111    125
                        

 

(1) Includes power centers, neighborhood and lifestyle centers, outlet centers and street-front locations.

 

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During the thirteen weeks ended April 30, 2011, one additional off-mall store was opened in California, bringing the total number of stores open as of April 30, 2011 to 126.

The following table shows the number of stores in each of the 11 states we operated in as of April 30, 2011:

 

State

   Number of
Stores
 

Arizona

     17   

California

     72   

Colorado

     2   

Delaware

     1   

Florida

     16   

Maryland

     1   

Nevada

     6   

New Jersey

     7   

New York

     1   

Pennsylvania

     1   

Virginia

     2   
        
     126   
        

Distinctive Store Experience

Tilly’s is a customer-driven lifestyle brand. We are energized and inspired by our customers’ individuality and passion for action sports, music, art, and fashion. Our stores bring these interests together in a vibrant, stimulating and authentic environment that is an extension of our customers’ high velocity, multitasking lifestyle. We do this by blending the most relevant brands and styles with music videos, product-related visuals and a dedicated team of store associates. Our associates share the same passion as our customers for action sports, music, art and fashion, enabling them to easily engage with our customers and make shopping at Tilly’s a fun, social experience. Outside of our stores, we connect with our consumers using the same authentic approach, including social media, community outreach and sponsorship of contests, demos, and other events. We believe the Tilly’s experience drives customer awareness, loyalty and repeat visits while generating a buzz and excitement for our brand.

Expansion Opportunities and Site Selection

As of January 29, 2011, the end date of our most recently completed fiscal year, over 60% of our stores had been opened within the previous five years. The following table shows the number of stores opened and closed in each of our last five fiscal years:

 

Fiscal Year

   Stores
Opened
     Stores
Closed
   Total Number
of Stores at
End of Period
 

2006

     10            61   

2007

     13       1      73   

2008

     26            99   

2009

     13       1      111   

2010

     16       2      125   
                
     78       4   
                

 

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We plan to open approximately 13 net new stores in fiscal year 2011. In fiscal year 2012 we expect to open approximately 20 net new stores and to continue to open stores at an annual rate of approximately 15% for the next several years thereafter. Our new store openings are planned in both existing and new markets, for both mall and off-mall locations. We focus on locations that have above average incomes and an ability to draw from a sufficient population with attractive demographics. We have entered new markets by opening stores in high traffic malls relevant to our core customer in order to establish the Tilly’s brand, as well as opening stores in off-mall locations that effectively cover trade areas where our customers want to shop.

In selecting a location for a new mall store, we typically target high productivity malls that dominate their respective trade areas. In most cases, these malls are located in suburban areas. We use landlord provided information to assess our sales potential, while also considering the number of other teen-oriented retailers located in the mall. We prefer to position our stores in areas with the highest visibility and mall traffic.

In selecting a location for a new off-mall store, we typically target power and neighborhood centers consisting of nationally recognized large box apparel and non-apparel retailers. In most instances, the centers are located in suburban or high growth areas. We prefer to position our stores in-line among the mid-size to large-size boxes. We also consider proximity to other destinations such as restaurants, movie theaters or other attractions for our core customer. We will also target street-front locations in prominent well-known cities, outlet centers and lifestyle centers provided there is a strong teen-oriented component.

Our store model, which is based on our historical performance, assumes a target store size averaging 7,500 to 8,000 square feet. In the first year, our new store model targets net sales of approximately $2.2 million and cash flow of $300,000. The target net investment to open our stores is between $500,000 and $550,000, including build-out, pre-opening and initial inventory, net of landlord allowances and payables. As a result, the cash-on-cash payback period on our investment averages about 18 months.

e-Commerce

Our e-commerce platform was established in 2004 and has grown significantly in every year of operation. In the thirteen week period ended April 30, 2011, our e-commerce net sales increased 46% relative to the thirteen week period ended May 1, 2010. In fiscal 2010, our e-commerce net sales increased 46% relative to fiscal 2009 while traffic at www.tillys.com increased 33% and page views increased 37%. We grew our e-commerce business to approximately 10% of our total net sales in fiscal 2010 from 2% of net sales in fiscal 2006. We believe that our target customer regularly shops online and we see continued opportunity to grow our e-commerce business to approximately 15% of total net sales over time. In fiscal 2010 we sold merchandise to customers in all 50 states and approximately one-third of our e-commerce net sales were to customers in states without brick-and-mortar stores. Our website serves both as a sales channel and a marketing tool to our extended customer base, including those customers in markets where we do not currently have stores. We also believe our website reinforces the Tilly’s brand image and serves as an effective advertising vehicle for our retail stores. Our website provides an expanded product offering relative to our stores and includes web exclusive merchandise. Similar to the merchandising approach in our stores, we frequently change the look of our website to highlight new brands and products and to encourage frequent visits. We utilize multiple channels to drive traffic to our website, including our catalog, marketing materials in our retail stores, search engine marketing, internet ad placement, shopping site partnerships, third-party affiliations, email marketing, mobile marketing and direct mail. In addition, we utilize the website to offer current information on our upcoming events, promotions and store locations.

 

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Our current e-commerce fulfillment is operated out of our distribution center in Irvine, California. To accommodate our growth, in 2012 we plan to transition to a new e-commerce dedicated fulfillment facility located across the street from our current headquarters and distribution center.

Store Management, Culture and Training

We believe that a key to our success is our ability to attract, train, retain and motivate qualified employees at all levels of our organization. Each of our stores typically operates with a three to five member store management team. In addition, each store has 10 or more full time equivalent store associates who represent the West Coast lifestyle and promote the Tilly’s brand not only inside the store, but also in their schools and communities. The number of store associates we employ generally increases during peak selling seasons, particularly the back-to-school and the winter holiday seasons, and will increase to the extent that we open new stores.

We have developed a corporate culture that we believe empowers the individual store managers to make store-level business decisions and we reward them when they exceed sales targets. We are committed to improving the skills and careers of our workforce and providing advancement opportunities for employees. We evaluate our store associates weekly on measures such as sales per hour, units per transaction and dollars per transaction to ensure productivity, to recognize top performers and to identify potential training opportunities. We endeavor to design incentive programs for store associates that promote a competitive, yet fun, culture that is consistent with our image.

We provide our managers with the knowledge and tools to succeed through comprehensive training programs, focusing on both operational expertise and supervisory skills. Our training programs and workshops are offered at the store, district and regional levels, allowing managers from multiple locations to interact with each other and exchange ideas to better operate stores. Store associates receive training from their managers to improve their product expertise and selling skills.

Marketing and Advertising

Our marketing approach is designed to create an authentic connection with our customers by consistently generating a buzz and excitement for our brand while staying true to our West Coast inspired, action sports heritage. We utilize a multi-pronged marketing strategy to connect with our customers and drive traffic to our stores and website, comprised of the following:

 

  Ÿ  

Catalog.    We view our catalog primarily as a sales and marketing tool to drive online and store traffic from both existing and new customers. We also believe our catalog reinforces the Tilly’s brand and showcases our comprehensive selection of products in settings designed to reflect our brand’s lifestyle image. In fiscal 2010, we mailed approximately 4.1 million catalogs to addresses included in our growing proprietary database, which currently includes key information on over 1.5 million customers. We send these catalogs, which include coupons that can be redeemed at stores or online, to the customers in our database several times a year, primarily around key shopping periods such as spring break, back-to-school, and the winter holidays.

 

  Ÿ  

Brand Partnerships.    We partner and collaborate with our vendors for exclusive events such as autograph signings, in-store performances, contests, demos, giveaways, shopping sprees and VIP trips. In fiscal year 2010, we organized over 75 events, many involving musicians, celebrities and athletes in the entertainment, music and action sports industries. For example, we partnered with Hurley and Alternative Press Magazine to host a nationwide autograph signing tour that included live music performances at 10 stores from coast to coast. Through these partnerships, we are able to connect with and engage our customers in an exciting, authentic experience.

 

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Social Media.    We believe our core customers rely heavily on the opinions of their peers, often expressed through social media. Therefore we use our website blog as well as Facebook and Twitter posts as a viral marketing platform to communicate directly with our customers while also allowing customers to interact with one another and provide feedback on our events and products.

 

  Ÿ  

Community Outreach.    Through our “We Care Program” and in partnership with our vendors, we support and participate in various academic, art, and athletic programs at local schools and other organizations in communities surrounding our stores.

 

  Ÿ  

Radio, Print and Email Marketing.    We utilize traditional radio and print advertising as well as email marketing to build awareness, drive traffic to our stores and website and to promote local in-store promotions and events. We periodically send emails to the customers in our proprietary database to introduce new brands and products, offer promotions on select merchandise, highlight key events and announce new store openings. We believe there is an opportunity to use national print advertising to drive new traffic among potential customers.

Distribution

We centrally distribute all of our merchandise through a 126,000 square foot distribution facility co-located with our headquarters in Irvine, California. Our lease expires in December 2012 and we have three five-year renewal option periods. We moved to our current location in January 2003 and have invested nearly $30 million in our highly automated distribution center and information systems. We designed this state-of-the-art facility to allow us to manage our distribution operations in an efficient, cost-effective manner and to provide support for our growth initiatives. Extensive investments as recently as this past year have been made to the distribution-center infrastructure, focused around systems automation, material-handling equipment, RF technologies, and automated sortation in order to further enhance our processing speed and long term scalability. We believe the automation systems we utilize in our facility allow us to operate at a higher level of efficiency and accuracy than many of our competitors.

We ship merchandise to our stores at least five times per week, providing them with a steady flow of both new and replenishment products. Merchandise is shipped in a floor-ready format (carrying price tickets, sensor tags and with hangers where appropriate) which allows store employees to spend less time processing the merchandise and more time with our customers. We use our own fleet of trucks to ship merchandise to our local (Southern California) stores and third-party distributors to ship merchandise to stores outside our local area.

In fiscal year 2012 we expect to open an additional distribution facility across the street from our existing facility to support our e-commerce fulfillment operations. We believe our distribution infrastructure can support a national retail footprint in excess of 500 stores with minimal incremental capital investment.

Management Information Systems

Our management information systems provide a full range of business process support and information to our store, merchandising, financial, real estate and other business teams. We selected, customized and integrated our information systems to enable and support our dynamic merchandise model. We believe our systems provide us with improved operational efficiencies, scalability, management control and timely reporting that allow us to identify and quickly respond to trends in our business. We believe that our information systems are scalable, flexible and have the capacity to accommodate our current growth plans.

 

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We have made significant investments in our management information systems over the last several years and believe we are utilizing “best of breed” technology. We use software licensed from JDA Software Group, Inc. for merchandise planning and allocation, business intelligence, SKU classification, inventory tracking, purchase order management and sales audit functions. We utilize Manhattan Associates Inc.’s warehouse management systems to handle merchandise distribution. In addition, we utilize technology from Strategic Distribution, Inc. in our distribution center enabling us to automate our merchandise sortation process, allowing us greater flexibility in scaling our operations for new store expansions and peak season operations. Our financial systems are licensed from Lawson and our payroll system uses a third-party platform provided by Automatic Data Processing, Inc.

We update our sales daily in our merchandising reporting systems by collecting sales information from each store’s point-of-sale, or POS, terminals utilizing software from Micros Systems, Inc. Our POS system consists of registers providing processing of retail transactions, price look-up, time and attendance and e-mail. Sales information, inventory tracking and payroll hours are uploaded to our central host system. The host system downloads price changes, performs system maintenance and provides software updates to the stores through automated nightly two-way electronic communication with each store. We evaluate information obtained through nightly polling to implement merchandising decisions, including product purchasing/reorders, markdowns and allocation of merchandise on a daily basis.

Competition

The teenage and young adult retail apparel, accessories and footwear industry is highly competitive. We compete with other retailers for customers, store locations, store associates and management personnel. We currently compete with other teenage-focused retailers such as, but not limited to, Abercrombie & Fitch Co., Aeropostale, Inc., American Eagle Outfitters, Inc., The Buckle, Inc., Forever 21, Inc., Hot Topic, Inc., Pacific Sunwear of California, Inc., The Wet Seal, Inc., Urban Outfitters, Inc. and Zumiez, Inc. In addition, we compete with independent specialty shops, department stores and direct marketers that sell similar lines of merchandise and target customers through catalogs and e-commerce.

Competition in our sector is based, among other things, upon merchandise offerings, store location, price and the ability to identify with the customer. We believe that we compete favorably with many of our competitors based on our differentiated merchandising strategy, store environment, flexible real estate strategy and company culture. However, many of our competitors are larger than we are and have substantially greater financial, marketing and other resources than we do. See “Risk Factors—We face intense competition in our industry and we may not be able to compete effectively”.

Properties

We lease approximately 172,000 square feet for our corporate headquarters and retail support and distribution center located at 10 Whatney and 12 Whatney, Irvine, California. Our lease began January 1, 2003 and terminates December 31, 2012, with three five-year renewal option periods.

We lease approximately 24,000 square feet of office and warehouse space located at 15 Chrysler, Irvine, California. Our lease began November 1, 2010 and terminates October 31, 2014. Approximately 17,000 square feet of this building is subleased to a third party and we use the remaining space.

We plan to enter into a build-to-suit lease for approximately 26,000 square feet of office and warehouse space located at 11 Whatney, Irvine, California. We anticipate construction will be completed during fiscal year 2012. We intend to use this property as our e-commerce distribution center.

 

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All of our stores, encompassing approximately 977,000 total square feet as of April 30, 2011, are occupied under operating leases. The store leases generally have a base lease term of 10 years and many have renewal option periods, and we are generally responsible for payment of property taxes and utilities, common area maintenance and mall marketing fees.

Trademarks

“Ambitious”, “Blue Crown”, “Division 7”, “Eldon”, “Full Tilt”, “If it’s not here…it’s not happening”, “Infamous”, “RSQ”, “Tilly’s”, “Vindicated”, and logos related to some of these names, are among our trademarks registered with the U.S. Patent and Trademark Office. We regard our trademarks as valuable and intend to maintain such marks and any related registrations. We are not aware of any claims of infringement or other challenges to our right to use our marks in the U.S. We vigorously protect our trademarks.

Employees

As of April 30, 2011, we employed approximately 900 full-time and approximately 2,200 part-time employees, of which approximately 400 were employed at our corporate office and distribution facility and over 2,700 were employed at our store locations. However, the number of employees, especially part-time employees, fluctuates depending upon our seasonal needs and, in fiscal year 2010, varied between approximately 2,600 and 4,400 employees. None of our employees are represented by a labor union and we consider our relationship with our employees to be good.

Legal Proceedings

From time to time, we become involved in litigation relating to claims arising from our ordinary course of business. Management believes, after considering a number of factors and the nature of legal proceedings to which we are subject, that the outcome of current litigation will not have a material adverse effect upon our results of operations or financial condition. However, see “Risk Factors—Litigation costs and the outcome of litigation could have a material adverse effect on our business”.

 

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MANAGEMENT

Executive Officers and Directors

The following table sets forth certain information about our executive officers, directors and other key employees as of June 15, 2011. In the biographical paragraphs that follow, service with our operating subsidiary, World of Jeans & Tops, prior to our holding company formation as described elsewhere in this prospectus, is reflected as service with us.

 

Name

 

Age

  

Position

Hezy Shaked

  56    Co-Founder, Chief Strategy Officer and Chairman of the Board of Directors

Daniel Griesemer

  51    President, Chief Executive Officer and Director

William Langsdorf

  54    Senior Vice President and Chief Financial Officer

Listed in alphabetical order:

    

Debbie Anker-Boetes

  52    Vice President and General Merchandising Manager

John Burgess

  58    Vice President of Real Estate

Craig DeMerit

  41    Vice President, Chief Information Officer and Chief Operating Officer

Patrick Grosso

  38    Vice President, General Counsel and Secretary

Shelly Johnson

  41    Vice President of Stores

Tilly Levine

  55    Vice President of Vendor Relations

Carolyn McNamara

  46    Vice President of Merchandise Planning and Allocation

Rochelle Myers

  44    Vice President of Finance and Controller

Cheryl Rudich

  50    Vice President of Marketing

Non-employee directors:

    

Seth Johnson(1)(2)

  57    Director

Janet Kerr(2)(3)

  56    Director

Jerold Rubinstein(1)(3)

  72    Director

Bernard Zeichner(1)(2)(3)

  67    Director

 

(1) Member of Audit Committee
(2) Member of Compensation Committee
(3) Member of Nominating and Corporate Governance Committee

Hezy Shaked co-founded the Tilly’s concept in 1982 and formed our company in 1984. He has served as Chairman of the Board of Directors since our inception and has served as our Chief Strategy Officer since February 2011. Mr. Shaked will continue to serve as Chairman of our Board of Directors following completion of this offering. From September 2008 to February 2011, Mr. Shaked served as our President and Chief Executive Officer. From September 2006 to September 2008, Mr. Shaked served as our Co-Chief Executive Officer. From our inception to September 2006, Mr. Shaked served as our President and Chief Executive Officer. As our Co-Founder and former President and Chief Executive Officer, Mr. Shaked has an in-depth knowledge and understanding of all facets of our business and has developed extensive professional relationships during his 29 years of experience in the retail industry. Through his experience and knowledge of our operations and the industry in which we compete, Mr. Shaked is well-suited to serve as Chairman of our board of directors.

Daniel Griesemer has served as our President and Chief Executive Officer since February 2011, and has served on our board of directors since April 2011. Mr. Griesemer previously served as President, Chief Executive Officer and Director at Coldwater Creek, Inc., a publicly traded national specialty retailer, from October 2007 through September 2009. Prior to that, Mr. Griesemer served as

 

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Coldwater Creek, Inc.’s President and Chief Operating Officer from March 2007 through October 2007, its Executive Vice President of Sales and Marketing from January 2005 through March 2007, its Executive Vice President of Retail from April 2004 through January 2005 and its Senior Vice President of Retail from October 2001 through April 2004. From 1989 through 2000, Mr. Griesemer held a number of progressively more responsible positions with Gap, Inc., and ultimately served as Divisional Merchandise Manager for Gap, Inc. From 1983 to 1989, Mr. Griesemer worked in a variety of positions at Macy’s, Inc. Mr. Griesemer holds a Bachelor of Science degree in Business Administration from the University of Dayton. Mr. Griesemer brings to the board of directors extensive experience and demonstrated leadership capabilities, including leadership of a public company in the retail industry. Serving as a director and our President and Chief Executive Officer will allow Mr. Griesemer to act as a bridge between management and the board of directors to help ensure that both groups act with a common purpose.

William Langsdorf has served as our Senior Vice President and Chief Financial Officer since February 2007. From 2004 to February 2007, Mr. Langsdorf served as the Senior Vice President and Chief Financial Officer of Anchor Blue Retail Group, Inc., or Anchor Blue, a specialty retailer. From 2002 to 2004 Mr. Langsdorf served as the Senior Vice President and Chief Financial Officer of The Wet Seal, Inc., or The Wet Seal, a specialty retailer. From 1986 to 2002, Mr. Langsdorf served in various management positions at House2Home, Inc. (formerly Home Base, Inc.), which filed for bankruptcy in November 2001, with the last position held of Executive Vice President and Chief Financial Officer. Prior to joining Home Base in 1986, Mr. Langsdorf was a Manager in the consulting practice of Ernst & Young LLP (formerly Arthur Young & Co.). Mr. Langsdorf holds a Bachelor of Arts in Business Administration from California State University, Fullerton and a Masters of Business Administration from the Kellogg Graduate School of Management at Northwestern University. Mr. Langsdorf is a Certified Public Accountant (inactive).

Debbie Anker-Boetes has served as our Vice President and General Merchandising Manager since May 2004. Prior to that, she held various senior management positions with Anchor Blue (1998-2004), Petrie Stores (1992-1997) and Charming Shoppes (1988-1991). Ms. Anker-Boetes graduated from the Fashion Institute of Technology with a degree in Fashion Buying and Merchandising and has over 30 years of experience in the retail industry.

John Burgess has served as our Vice President of Real Estate since May 2007. From June 2004 to March 2007, Mr. Burgess served as Vice President of Real Estate at Pacific Sunwear of California, Inc., or Pacific Sunwear, a specialty retailer. Prior to that, Mr. Burgess worked in various positions over 29 years at Anchor Blue, with the last position held of Senior Vice President of Real Estate and Construction from 1996 to 2003. Mr. Burgess has a Bachelor of Science in Architecture from the University of Southern California.

Craig DeMerit has served as our Vice President of Information Systems since April 2004, our Chief Information Officer since 2008, and our Chief Information Officer and Chief Operating Officer since February 2011. From 1998 to 2004, Mr. DeMerit held various senior executive positions for Guess?, Inc., or Guess, an apparel company, the most recent of which was Vice President and Chief Information Officer. Prior to 1998, Mr. DeMerit was employed by Ticketmaster where he managed corporate technology. Mr. DeMerit has over 20 years of experience in the management of information systems, including 14 years of retail experience encompassing supply chain, technology and e-commerce.

Patrick Grosso has served as our Vice President and General Counsel since March 2008 and as Secretary since April 2010. From 2007 to 2008, Mr. Grosso served as General Counsel to ECC Capital Corporation, a mortgage real estate investment trust. From 2005 to 2007, Mr. Grosso served as General Counsel to a former mortgage lending company. From 2001 to 2005, Mr. Grosso served in

 

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various positions with Aames Investment Corporation, a mortgage real estate investment trust, with the last position held of Vice President and Senior Counsel. Prior to that, Mr. Grosso was an associate with the international law firm of Latham & Watkins LLP and an attorney with the U.S. Securities and Exchange Commission, Division of Corporation Finance. Mr. Grosso holds a Juris Doctorate from Pepperdine University and a Bachelor of Science in Economics from California State Polytechnic University, Pomona. Mr. Grosso is licensed to practice law in California, Texas and Washington, D.C. and is a Certified Public Accountant (inactive).

Shelly Johnson has served as our Vice President of Stores since November 2006. Prior to that, Ms. Johnson served as our Director of Stores since April 2006 and our Director of Training and Development since January 2004. Prior to that, Ms. Johnson served in multiple management capacities at The Wet Seal from 1989 to 2003, with the last position held of Director of Training and Development.

Tilly Levine co-founded the Tilly’s concept in 1982 and formed our company in 1984. She has served as a Vice President and Director since our inception. Ms. Levine will no longer serve as a Director upon completion of this offering. Ms. Levine currently serves as our Vice President of Vendor Relations and has served in that capacity since 2007. From 2004 to 2007, Ms. Levine was responsible for the buying of guys’ and boys’ apparel. Ms. Levine has over 29 years of experience in the retail industry.

Carolyn S. McNamara has served as our Vice President of Merchandise Planning and Allocation since September 2006. From September 2005 to September 2006, Ms. McNamara was with Pacific Sunwear as the Senior Manager overseeing the company’s Merchandise Planning team. From September 1996 to August 2005, Ms. McNamara held various management roles at the Limited Brands Inc. in Project Management, Change Management, Training Design, and in Merchandise Planning and Allocation. Ms. McNamara holds a Bachelor of Science from California State Polytechnic University, Pomona.

Rochelle Myers has served as our Vice President of Finance and Controller since October 2006. From February 2002 to October 2006, Ms. Myers served as our Controller. From 1994 to 2002, Ms. Myers was with The Wet Seal in various capacities including Assistant Controller, Director of Special Projects and Director of Financial Reporting. From 1991 to 1994 Ms. Myers was an Internal Auditor for Canon USA, and from 1989 to 1991 she was a Staff Auditor with Ernst & Young LLP. Ms. Myers holds a Bachelor of Arts in Economics and Finance from the University of California, Los Angeles and is a Certified Public Accountant (inactive).

Cheryl A. Rudich has served as our Vice President of Marketing since October 2006. From 1994 to 2003, Ms. Rudich served as the Director of Marketing and Vice President of Marketing for The Wet Seal. From 1985 to 1994, Ms. Rudich was a Co-Creative Director at The Mednick Group, a design and advertising firm in Los Angeles. Ms. Rudich holds a Bachelor of Arts in Design from the University of California, Los Angeles, and a Bachelor of Fine Arts from the Art Center College of Design. Ms. Rudich has over 25 years experience in branding, creative direction and retail marketing.

Seth Johnson has served on our board of directors and as Chairperson of our Compensation Committee since April 2011. Prior to that, Mr. Johnson served as a member of the advisory committee to our board of directors from July 2008 through 2011. Mr. Johnson has recently been an instructor in business strategy at Chapman University’s Argyros School of Business and Economics. From 2005 to 2006, Mr. Johnson served as the Chief Executive Officer of Pacific Sunwear. From 1999 to 2004, Mr. Johnson was the Chief Operating Officer of Abercrombie & Fitch, a specialty retailer, and was its Chief Financial Officer from 1992 to 1998. During that time period, Mr. Johnson led Abercrombie & Fitch’s initial public offering and participated in business growth from sales of $85 million to over

 

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$2 billion. Mr. Johnson is currently a member of the board of directors of True Religion Apparel, Inc., a publicly traded company. With over 30 years of apparel retail experience, including significant executive experience, Mr. Johnson will provide our board of directors with operational, financial and strategic planning insights.

Janet E. Kerr has served on our board of directors and as Chairperson of our Nominating and Corporate Governance Committee since April 2011. Prior to that, Ms. Kerr served as a member of the advisory committee to our board of directors from July 2008 through 2011. She is the founder and currently a professor of law and the Executive Director of the Geoffrey H. Palmer Center for Entrepreneurship and the Law at Pepperdine University School of Law in Malibu, California. Ms. Kerr has served as a consultant to various companies regarding Sarbanes-Oxley Act compliance and corporate governance. She has founded several technology companies and is a well-known author in the areas of securities, corporate law and corporate governance, having published several articles and a book on the subjects. Ms. Kerr was a co-founder of X-Labs, a technology company co-founded with HRL Laboratories. Ms. Kerr is currently a member of the board of directors of La-Z-Boy, Inc., a publicly traded furniture retailer and manufacturer, where she serves as the Chairperson to the Nominating and Corporate Governance Committee. Additionally, she is a member of the board of directors of TCW Funds and TCW Strategic Income Fund, Inc., a NYSE listed closed-end registered investment company. From 2004 to 2010, Ms. Kerr served as a director to CKE Restaurants, Inc., a quick service restaurant company. Ms. Kerr is licensed to practice law in California and New York and occupies The Laure Sudreau-Rippe Endowed Chair at Pepperdine University School of Law. With over 30 years of corporate governance experience, Ms. Kerr contributes to our board significant expertise in the regulatory, governance and legal matters of public companies.

Jerold H. Rubinstein has served on our board of directors and as Chairperson of our Audit Committee since April 2011. Mr. Rubinstein is a member of the board of directors and Chairman of the Audit Committee of CKE Restaurants, Inc., a privately held quick service restaurant company. He is Non-Executive Chairman of U.S. Global Investors, Inc., a publicly traded mutual fund advisory company. He is also a member of the board of directors and Chairman of the Audit Committee of Stratus Media Group, Inc., a publicly traded company that owns and operates live entertainment events. Mr. Rubinstein has started and sold many companies over the years, including Bel Air Savings and Loan, United Artist Records, an international music recording and distribution company, DMX, a cable and satellite music international distribution company, and XTRA Music Ltd., a satellite and cable music distribution company in Europe. Recently, Mr. Rubinstein has consulted for many companies on various transactions. Mr. Rubinstein is both a Certified Public Accountant (inactive) and licensed to practice law in California. With over 45 years of experience starting and managing the growth of companies in a variety of industries, including significant financial management experience, Mr. Rubinstein brings to our board of directors extensive management experience and business understanding on issues facing growth companies.

Bernard Zeichner has served on our board of directors since April 2011. Mr. Zeichner served as Chairman of the Board of Directors of Charlotte Russe Holdings, Inc., or Charlotte Russe, a specialty retailer, from 1996 until May 2008, and was its President from May 1996 to June 2001 and its Chief Executive Officer from September 1996 to July 2003. Prior to joining Charlotte Russe, Mr. Zeichner was President of the retail division of Guess from 1993 to 1995. Prior to that, Mr. Zeichner was employed by Contempo Casuals, serving as President from 1982 to 1993 and as Chief Executive Officer from 1989 to 1993. From 1977 to 1982, Mr. Zeichner was Executive Vice President of Joske’s of Texas, a department store chain. With over 30 years of apparel retail experience, including significant executive and board experience, Mr. Zeichner provides our board of directors with operational, financial and strategic planning insights.

 

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Composition of the Board of Directors of Tilly’s, Inc.

Our bylaws provide that our board of directors shall consist of at least one member, with the exact number of directors to be determined by resolution of our board of directors. Upon consummation of our initial public offering, we intend for our board of directors to consist of six members. Based upon information requested from and provided by each director concerning his or her background, employment and affiliations, including family relationships, with us, our senior management and our independent registered public accounting firm, our board of directors has determined that all but two of our directors, Messrs. Shaked and Griesemer, are independent directors under the applicable listing standards of the NYSE and the rules of the SEC. We expect that our independent directors will hold at least two executive sessions per year.

Effective upon the completion of this offering, the members of our board of directors will be divided into three classes, with each director serving a three year term and one class being elected at each year’s annual meeting of stockholders. Our directors will hold office until their successors have been elected and qualified or until their earlier death, resignation, disqualification or removal. Executive officers are appointed by and serve at the direction of our board of directors.

Pursuant to the offer letter entered into between us and Mr. Griesemer dated January 15, 2011, Mr. Griesemer was appointed to serve as a member of our board of directors.

The following table sets forth the name of each director and the positions and offices held by each director with Tilly’s upon consummation of this offering, and the term of each director.

 

Name

 

Position with Tilly’s

Class I—Term Expiring at 2012 Annual Meeting  
Jerold Rubinstein   Director
Bernard Zeichner   Director
Class II—Term Expiring at 2013 Annual Meeting  
Daniel Griesemer   President and Chief Executive Officer and Director
Janet Kerr   Director
Class III—Term Expiring at 2014 Annual Meeting  
Seth Johnson   Director
Hezy Shaked   Chairman of the Board of Directors and Chief Strategy Officer

Committees of the Board of Directors

We currently have three standing committees: an Audit Committee, a Compensation Committee and a Nominating and Corporate Governance Committee. We intend to make the charters of all three of our standing board committees available on our website, www.tillys.com, under the Investor Relations section, upon the effective date of this offering. The inclusion of our website address in this prospectus does not include or incorporate by reference the information on our website into this prospectus.

Audit Committee

Our Audit Committee consists of Mr. Rubinstein (Chairperson), Mr. Johnson and Mr. Zeichner. Our board of directors has determined that each of these directors is independent as defined by the applicable rules of the NYSE and the SEC, and that each member of the Audit Committee meets the

 

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financial literacy and experience requirements of the applicable SEC and NYSE rules. In addition, our board of directors has determined that Messrs. Rubinstein and Johnson each qualify as an “audit committee financial expert” under the rules and regulations of the SEC. Our independent auditors and our internal finance personnel regularly meet privately with, and have unrestricted access to, our Audit Committee. We will adopt an Audit Committee charter intended to satisfy applicable SEC and NYSE rules, to be effective upon the consummation of this offering.

Our Audit Committee charter requires that the Audit Committee oversee our corporate accounting and financial reporting processes. The primary duties of our Audit Committee are to, among other things:

 

  Ÿ  

evaluate our independent registered accounting firm’s qualifications, independence and performance;

 

  Ÿ  

determine the engagement and compensation of our independent registered accounting firm;

 

  Ÿ  

approve the retention of our independent registered accounting firm to perform any proposed, permissible non-audit services;

 

  Ÿ  

monitor the rotation of partners and managers of the independent registered accounting firm on our engagement team as required;

 

  Ÿ  

review our consolidated financial statements;

 

  Ÿ  

review our critical accounting policies and estimates;

 

  Ÿ  

meet periodically with our management and internal audit team to consider the adequacy of our internal controls and the objectivity of our financial reporting;

 

  Ÿ  

establish procedures for the receipt, retention and treatment of complaints regarding internal accounting controls or auditing matters and the confidential, anonymous submission by employees of concerns regarding questionable accounting or auditing matters;

 

  Ÿ  

review on an ongoing basis and approve related party transactions, as defined in SEC and NYSE rules;

 

  Ÿ  

prepare the reports required by the rules of the SEC to be included in our annual proxy statement; and

 

  Ÿ  

discuss with our management and our independent registered accounting firm the results of our annual audit and the review of our quarterly consolidated financial statements.

Compensation Committee

Our Compensation Committee consists of Mr. Johnson (Chairperson), Ms. Kerr and Mr. Zeichner. Our board of directors has determined that each of these directors is independent under NYSE rules and qualifies as a non-employee director and an outsider director for purposes of Rule 16b-3 under the Securities Exchange Act of 1934, as amended, or the Exchange Act, and Section 162(m) of the Code, respectively. We will adopt a Compensation Committee charter intended to satisfy applicable SEC and NYSE rules, to be effective upon the consummation of this offering. The primary duties of the Compensation Committee are to, among other things:

 

  Ÿ  

establish overall employee compensation policies and recommend to our board of directors major compensation programs;

 

  Ÿ  

review and approve the compensation of our corporate officers and directors, including salary and bonus awards;

 

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  Ÿ  

administer our various employee benefit, pension and equity incentive programs;

 

  Ÿ  

manage and review any employee loans; and

 

  Ÿ  

prepare an annual report on executive compensation for inclusion in our proxy statement.

Nominating and Corporate Governance Committee

Our Nominating and Corporate Governance committee consists of Ms. Kerr (Chairperson), Mr. Rubinstein and Mr. Zeichner. Our board of directors has determined that each of these directors is independent under NYSE rules. We will adopt a Nominating and Corporate Governance Committee charter to be effective upon the consummation of this offering. The primary duties of the Nominating and Corporate Governance Committee are to, among other things:

 

  Ÿ  

establish standards for service on our board of directors and nominating guidelines and principles;

 

  Ÿ  

identify individuals qualified to become members of our board of directors and recommend director candidates for election to our board of directors;

 

  Ÿ  

consider and make recommendations to our board of directors regarding its size and composition, committee composition and structure and procedures affecting directors;

 

  Ÿ  

establish policies regarding the consideration of any director candidates recommended by our stockholders, and the procedures to be followed by the stockholders in submitting such recommendations;

 

  Ÿ  

evaluate and review the performance of existing directors;

 

  Ÿ  

review executive officer and director indemnification and insurance matters;

 

  Ÿ  

evaluate and review the company’s enterprise risk management policy and risk exposure; and

 

  Ÿ  

monitor our corporate governance principles and practices and make recommendations to our board of directors regarding governance matters, including our certificate of incorporation, bylaws and charters of our committees.

Other Committees

Our board of directors may establish other committees as it deems necessary or appropriate from time to time.

Risk Considerations in our Compensation Program

Prior to the completion of this offering, we intend to analyze our compensation programs and policies to determine whether those programs and policies are reasonably likely to have a material adverse effect on us.

Code of Ethics and Business Conduct

Our board of directors will adopt a code of ethics and business conduct, to be effective upon consummation of this offering, which will apply to all of our employees, executive officers and directors. Upon consummation of this offering, the full text of our code of ethics and business conduct will be posted on our website, www.tillys.com, under the Investor Relations section. We intend to disclose future amendments to certain provisions of our code of ethics and business conduct, or waivers of such provisions, applicable to our directors and executive officers, at the same location on our website identified above. The inclusion of our website address in this prospectus does not include or incorporate by reference the information on our website into this prospectus.

 

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Compensation Committee Interlocks and Insider Participation

Prior to April 2011, we did not have a formal compensation committee or other board committee performing equivalent functions. During our 2010 fiscal year, management compensation was determined by our President and Chief Executive Officer. None of the members of our Compensation Committee has at any time been one of our executive officers or employees or an executive officer or employee of our subsidiary. None of our executive officers has ever served as a member of the board of directors or compensation committee of any other entity that has or had one or more executive officers serving on our board of directors or our Compensation Committee.

Director Compensation

In fiscal year 2010, we did not pay our directors any compensation for their service as directors.

In April 2011, we adopted a non-employee director compensation program in which each non-employee director, consisting of Messrs. Johnson, Rubinstein and Zeichner and Ms. Kerr, will receive an annual retainer of $40,000. In addition, they will each receive an annual restricted stock award grant under our 2011 Equity Incentive Plan having a fair value at the time of grant equal to $80,000, which will vest in two equal installments on each of the succeeding two anniversaries of the grant date. The first grant will be made upon consummation of this offering. An annual retainer is paid to the Chairperson of each of our respective standing committees of the board of directors as follows: $15,000 to the Audit Committee Chairperson; $12,000 to the Compensation Committee Chairperson; and $12,000 to the Nominating and Governance Committee Chairperson. All members of our respective standing committees of the board of directors are paid an annual retainer for their committee service as follows: $8,000 to each member of the Audit Committee; $5,000 to each member of the Compensation Committee; and $5,000 to each member of the Nominating and Corporate Governance Committee. Annual service for retainer purposes relates to the approximate 12-month period between annual meetings of our stockholders and all retainers are paid in quarterly installments. A prorated annual retainer will be paid to any person who becomes a member of our board of directors, a committee chair or a member of any committee on a date other than the date of the annual meeting of our stockholders. Additionally, we will reimburse directors for reasonable expenses incurred in connection with their duties.

 

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EXECUTIVE COMPENSATION

Compensation Discussion and Analysis

This Compensation Discussion and Analysis section discusses the material elements of the compensation programs and policies in place for our named executive officers, or NEOs, during 2010. For fiscal year 2010, we had three NEOs, as follows:

 

  Ÿ  

Hezy Shaked, our Co-Founder, Chairman of the Board of Directors, Chief Strategy Officer and former President and Chief Executive Officer(1);

 

  Ÿ  

Bill Langsdorf, our Senior Vice President and Chief Financial Officer; and

 

  Ÿ  

Craig DeMerit, our Vice President, Chief Information Officer and Chief Operating Officer(2).

 

(1) Mr. Shaked served as our President and Chief Executive Officer during all of fiscal year 2010, and he was succeeded in such role upon our hiring of Daniel Griesemer as our President and Chief Executive Officer effective February 21, 2011. Mr. Shaked was appointed as Chief Strategy Officer, a newly created position, effective on February 21, 2011, and he continues to serve as Chairman of our board of directors. The terms of Mr. Griesemer’s employment are set forth in an offer letter dated January 15, 2011 as described further below at “Employment Agreements and Severance Benefits—Offer Letter with Daniel Griesemer”.
(2) During fiscal year 2010, Mr. DeMerit served as our Vice President and Chief Information Officer. On February 21, 2011, in addition to maintaining these titles, Mr. DeMerit was appointed as our Chief Operating Officer.

Specifically, this section provides an overview of our executive compensation philosophy, the overall objectives of our executive compensation program and each compensation component that we provide. Each of the key elements of our executive compensation program is discussed in more detail below. Our compensation programs are designed to be flexible and complementary and to collectively serve the principles and objectives of our executive compensation and benefits program.

Historical Compensation Decisions and Changes Going Forward

Historical Compensation Decisions as a Private Company

Our historical compensation approach has been reflective of our stage of development. Prior to this offering, we were a privately held company and our controlling shareholders and, until April 2011, our entire board of directors consisted of our two co-founders, Hezy Shaked and Tilly Levine. As a result, we have not been subject to any listing exchange or SEC rules requiring a majority of our board of directors to be independent or relating to the formation and functioning of board committees, such as the compensation committee. Accordingly, our board of directors historically has not maintained a compensation committee, and most, if not all, of our compensation policies and determinations, including those made for fiscal year 2010, have been discretionary decisions made by our Co-Founder and former President and Chief Executive Officer, Mr. Shaked, as approved by our board of directors.

Such historical compensation decisions have been based on Mr. Shaked’s informal review process considering factors such as our financial condition and available resources, our need for a particular position to be filled, the compensation levels of our other executive officers, and Mr. Shaked’s general knowledge regarding compensation paid to certain executive officers of other companies in our industry. Thus, historically, we have not formally benchmarked executive compensation against a particular set of comparable companies or used a formula to set the compensation for our executives in relation to survey data.

Role of our Compensation Committee and President and Chief Executive Officer in Compensation Decisions Going Forward

In connection with this initial public offering, we established a compensation committee to review and approve the compensation of our NEOs and oversee and administer our executive compensation programs and policies. As we gain experience as a public company, we expect that the specific

 

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direction, emphasis and components of our executive compensation program will continue to evolve. Accordingly, the compensation paid to our NEOs for fiscal year 2010 is not necessarily indicative of how we will compensate our NEOs following this offering.

The Compensation Committee will review annually and meet outside the presence of all of our executive officers, including our NEOs, to consider appropriate compensation for our President and Chief Executive Officer. Our President and Chief Executive Officer will review annually each other NEO’s performance with the compensation committee and recommend appropriate compensation levels, which the Compensation Committee will take into account as one factor in its determinations regarding executive compensation. In addition, we anticipate that Mr. Shaked, given his tenure with the company and his role in shaping compensation historically, will have a purely advisory role in discussions with the Compensation Committee with respect to NEO compensation. In the context of such annual reviews and further periodic reviews as deemed necessary, in addition to a review of other factors discussed below, the Compensation Committee will assess the proper mix of base salary, cash incentive awards and grants of long-term equity incentive awards, levels of compensation and appropriate individual and corporate performance metrics in furtherance of the objectives and principles described below.

We anticipate that our Compensation Committee will consider additional factors in determining executive compensation, including, potentially, more formally benchmarking executive compensation against a peer group of comparable companies. In furtherance of this objective, we have engaged J. Richard & Co., an executive compensation and consulting firm, to advise management in its efforts to construct, from publicly available data, a peer group of companies to be used for compensation purposes in preparation for an initial public offering and to provide market compensation data on such peer group companies, supplemented by survey data, as appropriate, and general market trends and developments. Management intends to use the information provided by J. Richard & Co. and other resources and tools to develop recommendations to be presented and approved by our compensation committee. J. Richard & Co. has not yet recommended specific compensation amounts or the form of payment for our NEOs moving forward, and management’s review and analysis of its executive compensation program is ongoing.

Compensation Philosophy and Objectives

Going forward, our compensation committee will strive to create an executive compensation program that balances short-term versus long-term payments and awards, cash payments versus equity awards and fixed versus contingent payments and awards in ways that we believe are most appropriate to motivate our executive officers. Our philosophy is that executive compensation should be competitive in the marketplace in which we compete for executive talent, and structured to emphasize incentive-based compensation as determined by the achievement of both company and individual performance objectives. The retail industry is extremely competitive and in order to continue to succeed we believe we need a highly talented and seasoned team of sales, marketing, buying, financial and other business professionals. We recognize that our ability to attract and retain these professionals, as well as to grow our organization, largely depends on how we compensate and reward our employees.

The goals of our executive compensation program will be to:

 

  Ÿ  

attract and retain talented and experienced executives in our industry;

 

  Ÿ  

motivate and reward executives whose knowledge, skills and performance are critical to our success;

 

  Ÿ  

align compensation incentives with our business and financial objectives and the long-term interests of our stockholders;

 

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  Ÿ  

foster a shared commitment among executives by aligning their individual goals with the goals of the executive management team and our company; and

 

  Ÿ  

ensure that our total compensation is fair, reasonable and competitive.

Elements of 2010 Compensation

During fiscal year 2010, our NEOs’ total direct compensation, which was determined by Mr. Shaked and approved by the board of directors, included both fixed components (base salary, other executive benefits and perquisites) and variable components (discretionary annual cash bonuses and stock option grants). The following describes each component of compensation, the rationale for that component and how the compensation amounts were determined.

Base Salary

Base salaries historically have been the most heavily weighted component of compensation for our executive officers as a percentage of total compensation, and this remained true in fiscal year 2010. Base salary levels are designed to be competitive in order to induce talented executives to join our company. In addition, base salaries support our retention objective by providing our executive officers with steady cash flow during the course of the fiscal year that is not contingent on short-term variations in our corporate performance.

The base salary established for each of our NEOs is intended to reflect each individual’s professional responsibilities, the skills and experience required for the job, their individual performance, the performance of our business, labor market conditions and competitive market salary levels. In past years, including fiscal year 2010, Mr. Shaked conducted an annual review of executive compensation to set the base salary level for each executive officer, including himself, for that fiscal year, which levels were approved by the board of directors. This annual review process typically occurred near the beginning of the fiscal year. Base salaries were also occasionally established or reviewed at other times during the year in the case of new hires, promotions, extraordinary events or other significant changes in responsibilities. In each case, Mr. Shaked made a determination of the competitive market level for base salaries based on his experience in the retail apparel industry and knowledge of base salaries of similarly situated executives in other companies of similar size and stage of development operating in our industry. This determination was informal and based primarily on the general knowledge of Mr. Shaked. Upon completion of this offering, and as described above, the compensation committee will determine the base salaries of our executive officers.

Base salary levels for our NEOs in fiscal year 2010 were determined by Mr. Shaked as part of his annual review process, and were set as follows:

 

  Ÿ  

Mr. Shaked: $640,000, which was the same base salary as he received in fiscal year 2009;

 

  Ÿ  

Mr. Langsdorf: $357,000, which was 2% higher than the base salary he received in fiscal year 2009; and

 

  Ÿ  

Mr. DeMerit: $260,000, which was approximately 11% higher than the base salary he received in fiscal year 2009.

The base salary increases for Messrs. Langsdorf and DeMerit were, in part, designed to reward these executives for their management activities during the 2009 fiscal year, to maintain their level of income with respect to cost of living increases and, with respect to Mr. DeMerit, to reflect the growth of our e-commerce business.

For fiscal year 2011, Mr. Griesemer, who was hired as our President and Chief Executive Officer effective as of February 21, 2011, will earn an annual base salary of $700,000, pursuant to the terms of his offer letter with us dated January 15, 2011.

 

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Annual Cash Bonus

Historically, we have not had a formal written bonus plan, and the overall bonus pool and amounts to be awarded to our NEOs and other employees have been determined at the discretion of Mr. Shaked based upon his subjective consideration of individual and company performance and other factors. In fiscal year 2010, Messrs. Langsdorf and DeMerit each were awarded a discretionary annual bonus of $100,000 for fiscal year 2009, which was determined by means of a subjective analysis by Mr. Shaked. Mr. Shaked determined that the bonus awarded to Mr. Langsdorf was merited in part due to Mr. Langsdorf’s management of our company’s finances during a growth period, and that the bonus awarded to Mr. DeMerit was merited in part due to the continued growth of our e-commerce business.

Upon completion of this offering, we intend for our compensation committee to take a significant role in developing an annual bonus plan that will establish bonus target levels. We anticipate that the target bonus levels will be based on the achievement of corporate objectives, such as operating income and other company or individual performance metrics. We believe that establishing cash bonus opportunities will help us attract and retain qualified and highly skilled executives, and tying such bonuses to the achievement of corporate performance goals will further our pay-for-performance philosophy moving forward as a public company. The compensation committee may also determine that from time to time it is in the best interests of the company and its stockholders to provide additional discretionary bonuses outside of the annual bonus program based on individual performance or any other performance factors it deems relevant.

For fiscal year 2011, our board of directors has adopted an incentive annual bonus plan based upon relative achievement of operating income and comparable store sales targets. The bonus amounts are based upon a percentage of each officer’s base salary, other than Mr. Griesemer.

For fiscal year 2011, Mr. Griesemer’s offer letter makes him eligible to receive a target cash bonus, expressed as a percentage of base salary. Mr. Griesemer’s target bonus amount is set at 100% of his base salary, with the ability to receive up to a maximum of 200% of his base salary. Payment of Mr. Griesemer’s bonus for fiscal year 2011 will be based on the company’s actual operating income for fiscal year 2011 as a percentage of the budgeted operating income set at the beginning of fiscal year 2011. Mr. Griesemer’s bonus payout will be calculated in linear interpolations between 80% and 130% of achievement of the target operating income level.

Long-Term Equity-Based Compensation

We believe that long-term equity-based compensation is an important component of our executive compensation program. In addition, providing a portion of our NEOs’ total compensation package in long-term equity-based compensation aligns the incentives of our executives with the interests of our stockholders and with our long-term corporate success. To that end, we have awarded long-term equity-based compensation in the form of options to purchase shares of our common stock under the Tilly’s 2007 Stock Option Plan, or the 2007 Plan. The grants awarded under the 2007 Plan have had no public market and no certain opportunity for liquidity, making them inherently long-term compensation. The awards have been used to motivate executives and employees to individually and collectively build long-term stockholder value that might in the future create a liquid market opportunity.

Historically, Mr. Shaked recommended the amount of all stock option grants with respect to our executive officers, and such recommendations were approved by our board of directors. Stock option grants under the 2007 Plan historically have been timed to coincide with the completion of third-party valuation reports, which the board has considered in setting the exercise price for such options. In deciding the amount of options to be awarded, Mr. Shaked engaged in an informal review process and considered the executive officer’s position with our company, the size of his or her total compensation package and the amount of existing vested and unvested stock options, if any, then held by the executive officer.

 

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We made only one grant of stock options to an NEO in fiscal year 2010, which was a grant of non-qualified stock options on April 13, 2010 to Mr. DeMerit to purchase 50,000 shares of our common stock. Like all options granted to our NEOs under the 2007 Plan, these grants vest over the course of four years, with shares vesting in equal annual installments. We believe that the four-year vesting schedule aligns our executive officers with our stockholders in achieving our long-term objectives and facilitating executive retention. In addition, options granted under our 2007 Plan are not exercisable until we complete our initial public offering.

In addition, on March 31, 2011, Mr. Griesemer received a grant of non-qualified stock options under the 2007 Plan to purchase 400,000 shares of our common stock at an exercise price of $16.26 per share. The stock options were granted in accordance with our 2007 Plan pursuant to Mr. Griesemer’s offer letter. This grant will vest annually in four equal installments with the first installment vesting on February 21, 2012, the first anniversary of his employment with the company.

In connection with this offering, the board of directors intends to adopt a 2011 Equity and Incentive Award Plan, or the 2011 Plan. For further information regarding our 2011 Plan, see the discussion below under the heading “Equity Incentive Plans—2011 Equity and Incentive Award Plan”.

Other Executive Benefits and Perquisites

We provide the following benefits to our executive officers on the same basis as other eligible employees:

 

  Ÿ  

health insurance;

 

  Ÿ  

holidays and sick days; and

 

  Ÿ  

a 401(k) plan with matching contributions.

The vacation benefit for executive officers is determined on an individual basis. We believe these benefits are generally consistent with those offered by other companies in our industry.

In addition, during fiscal year 2010, Mr. Shaked received benefits in the form of automobile expenses and tax services paid by us. For the 2011 fiscal year, Mr. Griesemer will receive an annual automobile allowance of $18,000 and will be reimbursed for all reasonable moving expenses incurred as a result of his and his family’s relocation to California pursuant to the terms of his offer letter.

Retirement Savings

We have established a 401(k) retirement savings plan for our employees, including the NEOs, who satisfy certain eligibility requirements. Under the 401(k) plan, eligible employees may elect to contribute pre-tax amounts, up to a statutorily prescribed limit, to the 401(k) plan. For 2010, the prescribed annual limit was $16,500. In addition, the company matches pre-tax contributions on behalf of eligible employees, up to a certain percentage of the individual’s contribution. We believe that providing a vehicle for tax-preferred retirement savings through our 401(k) plan adds to the overall desirability of our executive compensation package and further incents our employees, including our NEOs, in accordance with our compensation policies.

2010 Option Re-Pricing

In connection with a stock option grant during fiscal year 2010, the company performed a valuation with the assistance of a third-party valuation specialist and determined that its current stock price was $8.98 per share. Concurrently with this valuation and stock option grant, our board re-priced

739,500 stock options, some of which were held by certain of our NEOs, in order to continue

 

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maintaining an equity incentive for its employees. For further information regarding the re-pricing of such stock options, see note 11 to our audited financial statements included elsewhere in this prospectus.

Employment Agreements and Severance Benefits

The employment of our NEOs historically has been at will, and we did not have any employment agreements or other severance arrangements with our NEOs for fiscal year 2010. Certain of our senior executives, including Mr. Langsdorf, are party to a Stock Option Grant Agreement in connection with option grants under our 2007 Plan that provides for certain severance benefits in the form of accelerated vesting of outstanding stock options, as described in further detail under the heading “Potential Payments Upon Termination and Change in Control”.

Offer Letter With Daniel Griesemer

In January 2011, we entered into an offer letter with Daniel Griesemer related to our hiring of him as our President and Chief Executive Officer effective February 21, 2011, which includes certain provisions related to his compensation including severance benefits and change-in-control provisions. The compensation amounts and other terms of Mr. Griesemer’s offer letter were highly individualized and resulted from arm’s length negotiations and consideration of numerous factors as well as input from an independent third-party compensation consultant. Under the offer letter, Mr. Griesemer’s annual base salary was set at $700,000. The offer letter further provides that Mr. Griesemer is eligible to receive an annual cash bonus for 2011 based upon our achievement of certain levels of operating income, as more fully discussed under “Elements of 2010 Compensation—Annual Cash Bonuses”. Pursuant to the offer letter, Mr. Griesemer was granted stock options covering an aggregate of 400,000 shares of Class A common stock, as more fully discussed under “Elements of 2010 Compensation—Long-Term Equity-Based Compensation”. The offer letter also provides for participation in our existing employee benefit programs, plus an annual automobile allowance of $18,000, a temporary housing allowance and the reimbursement of certain of his and his family’s reasonable travel and moving expenses to relocate to the Orange County, California area during 2011. Pursuant to the offer letter, Mr. Griesemer may not solicit any of our employees during the term of his employment and for one year following his date of termination.

In addition, under the terms of his offer letter, Mr. Griesemer is entitled to the following severance and change in control benefits:

 

  Ÿ  

Severance if his employment is terminated by us without “Cause” or by him for “Good Reason”, equal to:

 

  Ÿ  

accrued but unpaid base salary, including accrued but unused vacation time;

 

  Ÿ  

12 months of his base salary in effect at termination;

 

  Ÿ  

his annual incentive bonus for the most recently completed fiscal year, or if that year’s bonus has already been paid, then the current year’s annual incentive bonus based on the company’s performance, pro-rated for the number of days employed during the year of termination;

 

  Ÿ  

one year acceleration of vesting of any outstanding unvested stock option or other equity awards;

 

  Ÿ  

to the extent permitted, continuation of employee benefits for the earlier of 12 months following termination or until re-employed, or at the option of the company, one lump sum payment; and

 

  Ÿ  

90 days to exercise any unexercised and exercisable stock options, but in no event later than the expiration date of the stock options.

 

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Severance, if his employment is terminated because of death or disability, equal to:

 

  Ÿ  

accrued but unpaid base salary, including accrued but unused vacation time;

 

  Ÿ  

12 months of his base salary in effect at termination;

 

  Ÿ  

his annual incentive bonus for the most recently completed fiscal year, or if that year’s bonus has already been paid, then the current year’s annual incentive bonus based on the company’s performance, pro-rated for the number of days employed during the year of termination; and

 

  Ÿ  

to the extent permitted, continuation of employee benefits for 12 months following termination, to the extent permitted, or at the option of the company, one lump sum payment.

 

  Ÿ  

Severance, if his employment is terminated because of a Change in Control, equal to:

 

  Ÿ  

accrued but unpaid base salary, including accrued but unused vacation time;

 

  Ÿ  

18 months of his base salary in effect at termination;

 

  Ÿ  

one and a half times his annual incentive bonus for the most recently completed fiscal year, or if that year’s bonus has already been paid, then one and half times the annual incentive bonus for the current year at the target rate;

 

  Ÿ  

full acceleration of vesting of any stock option or other equity grants; and

 

  Ÿ  

to the extent permitted, continuation of employee benefits for the earlier of 12 months following termination or until re-employed, or at the option of the company, one lump sum payment.

For purposes of the offer letter, “Cause” is defined as having:

 

  Ÿ  

been determined by a court of law to have committed any felony;

 

  Ÿ  

been convicted, or entered a plea of no contest, for violation of any criminal statute constituting a felony, provided that our board of directors reasonably determines that the continuation of his employment after such event would have an adverse impact on the operation or reputation of the company or its affiliates;

 

  Ÿ  

engaged in an act of fraud, theft, embezzlement, or misappropriation against the company;

 

  Ÿ  

committed one or more acts of gross negligence or willful misconduct, either within or outside the scope of his employment that has the effect of materially impairing the goodwill or business of the company or causing material damage to its property, goodwill or business, or would, if known, subject the company to public ridicule;

 

  Ÿ  

failed to materially perform the duties commonly associated with the position of President and Chief Executive Officer (continuing without cure for 10 days after receipt of written notice by him from our board of directors of the need to cure);

 

  Ÿ  

allowed the company’s performance to be materially weaker than its competitors and the retail industry generally (as determined by our board of directors);

 

  Ÿ  

materially breached the company’s Code of Ethics and Business Conduct or other written company policies;

 

  Ÿ  

breached the terms of his employment agreement, after we have provided him notice and given him a reasonable opportunity to cure; or