Summary of Significant Accounting Policies

Information regarding our significant accounting policies is contained in Note 2, “Summary of Significant Accounting Policies”, of the consolidated financial statements in our Annual Report on Form 10-K for the fiscal year ended February 1, 2020.

Revenue Recognition

Revenue is recognized for store sales when the customer receives and pays for the merchandise at the register, net of estimated returns. Taxes collected from our customers are recorded on a net basis. For e-commerce sales, we recognize revenue, net of sales taxes and estimated sales returns, and the related cost of goods sold at the time the merchandise is shipped to the customer. Amounts related to shipping and handling that are billed to customers are reflected in net sales, and the related costs are reflected in cost of goods sold in the Consolidated Statements of (Loss) Income.

The following table summarizes net sales from our retail stores and e-commerce (in thousands):



	Thirteen Weeks Ended
	May 2, 2020		May 4, 2019
Retail stores	$	46,953	$	110,636
E-commerce	30,336		19,667
Total net sales	$	77,289	$	130,303

The following table summarizes the percentage of net sales by department:



	Thirteen Weeks Ended
	May 2, 2020		May 4, 2019
Mens	34	%	34	%
Womens	27	%	26	%
Accessories	15	%	17	%
Footwear	14	%	14	%
Boys	5	%	5	%
Girls	5	%	4	%
Total net sales	100	%	100	%

The following table summarizes the percentage of net sales by third-party and proprietary branded merchandise:



	Thirteen Weeks Ended
	May 2, 2020		May 4, 2019
Third-party	75	%	74	%
Proprietary	25	%	26	%
Total net sales	100	%	100	%

We accrue for estimated sales returns by customers based on historical sales return results. As of May 2, 2020, February 1, 2020 and May 4, 2019, our reserve for sales returns was $1.7 million, $1.4 million and $1.7 million, respectively.

We recognize revenue from gift cards as they are redeemed for merchandise. Prior to redemption, we maintain a current liability for unredeemed gift card balances. The customer liability balance was $8.1 million, $9.3 million and $7.4 million as of May 2, 2020, February 1, 2020 and May 4, 2019, respectively, and is included in deferred revenue on the accompanying Consolidated Balance Sheets. Our gift cards do not have expiration dates and in most cases there is no legal obligation to remit unredeemed gift cards to relevant jurisdictions. Based on actual historical redemption patterns, we determined that a small percentage of gift cards are unlikely to be redeemed (which we refer to as gift card “breakage”). Based on our historical gift card breakage rate, we recognize breakage revenue over the redemption period in proportion to actual gift card redemptions. Revenue recognized from gift cards was $2.7 million and $4.2 million for the thirteen week period ended May 2, 2020 and May 4, 2019, respectively.

We have a customer loyalty program where customers accumulate points based on purchase activity. Once a loyalty member achieves a certain point level, the member earns awards that may be redeemed for merchandise. Unredeemed awards and accumulated partial points are accrued as deferred revenue and awards redeemed by the member for merchandise are recorded as an increase to net sales. Our loyalty program includes the ability for customers to redeem their awards instantly rather than build up to an award over time. We currently expire unredeemed awards and accumulated partial points 365 days after the last purchase activity. A liability is estimated based on the standalone selling price of awards and partial points earned and estimated redemptions. The deferred revenue for this program was $2.6 million, $2.4 million and $1.7 million as of May 2, 2020, February 1, 2020 and May 4, 2019, respectively. Revenue recognized from our loyalty program was $0.9 million and $0.3 million for the thirteen week period ended May 2, 2020 and May 4, 2019, respectively.

Leases

We conduct all of our retail sales and corporate operations in leased facilities. Lease terms for our stores are generally for ten years (subject to elective extensions) and provide for escalations in base rents. Many of our store leases contain one or more options to renew the lease at our sole discretion. Generally, we do not consider any additional renewal periods to be reasonably certain of being exercised.

Most store leases include tenant allowances from landlords, rent escalation clauses and/or contingent rent provisions. Certain leases provide for additional rent based on a percentage of sales and annual rent increases generally based upon the Consumer Price Index. In addition, most of our store leases are net leases, which typically require us to be responsible for certain property operating expenses, including property taxes, insurance, common area maintenance, in addition to base rent. 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 the lease. For non-cancelable operating lease agreements, operating lease assets and operating lease liabilities are established for leases with an expected term greater than one year and we recognize lease expense on a straight-line basis. Contingent rent, determined based on a percentage of sales in excess of specified levels, is recognized as rent expense when the achievement of the specified sales that triggers the contingent rent is probable.

In response to the COVID-19 pandemic, we elected to withhold payment of our contractual lease obligations in the aggregate amount of $13.3 million for the months of April and May 2020. We are currently attempting to negotiate COVID-19-related rent concessions for these withheld payments on our store leased properties. As of the date of this filing, the Company remains in discussions with its landlords with respect to these potential rent concessions, and thus the nature and scope of these concessions, if any, remains uncertain. The Financial Accounting Standards Board (“FASB”) issued guidance in April, which allows COVID-19-related rent concessions to be accounted for as if no change was made to the contract or as variable lease payments. We did not recognize any material COVID-19-related rent concessions as of May 2, 2020, as we have not yet finalized negotiations with our landlords. In addition, we continue to assess and hold ongoing conversations with landlords for various properties in seeking commercially reasonable lease concessions given the current environment.

We lease approximately 172,000 square feet of office and warehouse space (10 and 12 Whatney, Irvine, California) from a company that is owned by the co-founders of Tillys. The lease expires on December 31, 2027. During each of the thirteen week period ended May 2, 2020 and May 4, 2019, we incurred rent expense of $0.5 million related to this lease.

We lease approximately 26,000 square feet of office and warehouse space (11 Whatney, Irvine, California) from a company that is owned by one of the co-founders of Tillys. During each of the thirteen week period ended May 2, 2020, and May 4, 2019, we incurred rent expense of $0.1 million related to this lease. Pursuant to the lease agreement, the lease payment adjusts annually based upon the Los Angeles/Anaheim/Riverside Urban Consumer Price Index, with the adjustment not to be below 3% nor exceed 7% in any one annual increase. The lease expires on June 30, 2022.

We lease approximately 81,000 square feet of office and warehouse space (17 Pasteur, Irvine, California) from a company that is owned by one of the co-founders of Tillys. We use this property as our e-commerce distribution center. During each of the thirteen week periods ended May 2, 2020 and May 4, 2019, we incurred rent expense of $0.2 million related to this lease. Pursuant to the lease agreement, the lease payment adjusts annually based upon the Los Angeles/Anaheim/Riverside Urban Consumer Price Index, with the adjustment not to be below 3% nor exceed 7% in any one annual increase. The lease expires on October 31, 2021.

The maturity of operating lease liabilities as of May 2, 2020 were as follows (in thousands):



Fiscal Year
2020	$	49,542
2021	61,446
2022	54,508
2023	45,400
2024	34,732
Thereafter	75,088
Total minimum lease payments	320,716
Less: Amount representing interest	36,649
Present value of operating lease liabilities	$	284,067

As of May 2, 2020, additional operating lease contracts that have not yet commenced are immaterial.

Lease expense for the thirteen week period ended May 2, 2020 and May 4, 2019 was as follows (in thousands):



	Thirteen Weeks Ended May 2, 2020						Thirteen Weeks Ended May 4, 2019
	Cost of goods sold		SG&A		Total		Cost of goods sold		SG&A		Total
Fixed operating lease expense	$	15,514	$	401	$	15,915	$	15,459	$	385	$	15,844
Variable lease expense	3,819		22		3,841		3,865		43		3,908
Total lease expense	$	19,333	$	423	$	19,756	$	19,324	$	428	$	19,752

For the thirteen weeks ended May 4, 2019, we corrected an immaterial error of $3,221, which consisted solely of an understatement of amounts disclosed for fixed operating lease expense and an overstatement of amounts disclosed for variable lease expense with no changes in reported total lease expense.

Supplemental lease information for the thirteen weeks ended May 2, 2020 was as follows:



Cash paid for amounts included in the measurement of operating lease liabilities (in thousands)	$5,615
Weighted average remaining lease term (in years)	6.0 years
Weighted average interest rate (1)	4.01%

(1) Since our leases do not provide an implicit rate, we used our incremental borrowing rate on date of adoption or at lease inception in determining the present value of future minimum payments.

Income Taxes

Our income tax benefit was $(10.6) million, or 37.9% of loss before taxes, compared to $0.3 million, or 30.6% of income before taxes for the thirteen weeks ended May 2, 2020 and May 4, 2019, respectively. The increase in the effective income tax rate is primarily due to the anticipated benefit from the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act") enacted on March 27, 2020, which provides for net operating losses in fiscal 2020 to be carried back to earlier tax years with higher tax rates than the current year. As a result of the operating losses being carried back, an income tax receivable of $7.2 million is included in receivables on the accompanying Consolidated Balance Sheet as of May 2, 2020.

New Accounting Standards Not Yet Adopted

In June 2016, the FASB issued Accounting Standards Update ("ASU") No. 2016-13, Measurement of Credit Losses on Financial Instruments (ASU 2016-13), which modifies or replaces existing models for impairment of trade and other receivables, debt securities, loans, beneficial interests held as assets, purchased-credit impaired financial assets and other instruments. The new standard requires entities to measure expected losses over the life of the asset and recognize an allowance for estimated credit losses upon recognition of the financial instrument. ASU 2016-13 will become effective for us in the first quarter of fiscal 2023, with early adoption permitted and must be adopted using the modified retrospective method. We expect the new rules to apply to our fixed income securities recorded at amortized cost and classified as held-to-maturity and our trade receivables. We do not expect the adoption of this new standard to have a material impact on our consolidated financial statements and related disclosures.

In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. The new rules reduce complexity by removing specific exceptions to general income tax accounting methodology including an exception for interim periods showing operating losses in excess of anticipated operating losses for the year. The new rules will be effective for us in the first quarter of 2021. We are currently evaluating the impact this guidance may have on our consolidated financial statements and related disclosures.

In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting, which provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The amendments apply only to contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. The amendments are effective for all entities as of March 12, 2020 through December 31, 2022. We are currently evaluating the impact this guidance may have on our consolidated financial statements and related disclosures.