tts-20190331 10Q_Taxonomy2017

 









UNITED STATES

SECURITIES AND EXCHANGE COMMISSION 

Washington, D.C. 20549

_____________________________



FORM 10-Q

_____________________________

(Mark One)



 

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934



For the quarterly period ended March 31, 2019



OR





 

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934



 For the transition period from – to –

 

Commission file number: 001-35629

_____________________________



TILE SHOP HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

_____________________________





 

Delaware  

45-5538095

(State or other jurisdiction of incorporation)

(I.R.S. Employer Identification No.)







 

14000 Carlson Parkway

 

Plymouth, Minnesota 

55441

(Address of principal executive offices)  

(Zip Code)



(763) 852-2950 

(Registrant’s telephone number, including area code)

_____________________________



Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes     No



Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  Yes     No



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





 

 

 

 

 

Large  accelerated  filer

Accelerated  filer

Non-accelerated filer

Smaller  reporting  company



Emerging growth company



If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.



Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes     No



Securities registered pursuant to Section 12(b) of the Act:



 

 

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Common stock, $0.0001 par value

TTS

The Nasdaq Stock Market LLC



As of May 2, 2019, there were 52,951,217  shares of the registrant’s common stock, par value $0.0001 per share, outstanding.







 

 

 


 

Table of Contents

 

TILE SHOP HOLDINGS, INC.

Table of Contents

 



 

 



 

Page

PART I. FINANCIAL INFORMATION

 

Item 1.

Financial Statements



Consolidated Balance Sheets



Consolidated Statements of Income



Consolidated Statements of Comprehensive Income



Consolidated Statements of Stockholders’ Equity (Deficit)



Consolidated Statements of Cash Flows



Notes to Consolidated Financial Statements

Item 2.

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

17 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

23 

Item 4.

Controls and Procedures

24 

PART II. OTHER INFORMATION

 

Item 1.

Legal Proceedings

24 

Item 1A.

Risk Factors

25 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

26 

Item 3.

Defaults Upon Senior Securities

26 

Item 4.

Mine Safety Disclosures

26 

Item 5.

Other Information

26 

Item 6.

Exhibits

27 

Signatures

28 



 

 

2


 

Table of Contents

 

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

  

Tile Shop Holdings, Inc. and Subsidiaries

Consolidated Balance Sheets

(dollars in thousands, except share and per share data)

 





 

 

 

 

 

 



 

 

 

 

 

 



 

March 31,

 

December 31,



 

2019

 

2018



 

(unaudited)

 

(audited)

Assets

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

Cash and cash equivalents

 

$

7,936 

 

$

5,557 

Restricted cash

 

 

825 

 

 

825 

Receivables, net

 

 

5,942 

 

 

3,084 

Inventories

 

 

110,804 

 

 

110,095 

Income tax receivable

 

 

3,086 

 

 

3,548 

Other current assets, net

 

 

7,904 

 

 

7,181 

Total Current Assets

 

 

136,497 

 

 

130,290 

Property, plant and equipment, net

 

 

143,785 

 

 

158,356 

Right of use asset

 

 

141,791 

 

 

 -

Deferred tax assets

 

 

7,249 

 

 

7,225 

Other assets

 

 

1,606 

 

 

1,759 

Total Assets

 

$

430,928 

 

$

297,630 



 

 

 

 

 

 

Liabilities and Stockholders' Equity

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

Accounts payable

 

$

31,811 

 

$

25,853 

Income tax payable

 

 

64 

 

 

179 

Current portion of lease liability

 

 

25,236 

 

 

 -

Other accrued liabilities

 

 

28,727 

 

 

24,484 

Total Current Liabilities

 

 

85,838 

 

 

50,516 

Long-term debt

 

 

50,000 

 

 

53,000 

Long-term lease liability, net

 

 

138,550 

 

 

 -

Financing lease obligation, net

 

 

398 

 

 

436 

Deferred rent

 

 

 -

 

 

43,579 

Other long-term liabilities

 

 

3,857 

 

 

3,752 

Total Liabilities

 

 

278,643 

 

 

151,283 



 

 

 

 

 

 

Stockholders’ Equity:

 

 

 

 

 

 

Common stock, par value $0.0001; authorized: 100,000,000 shares; issued and outstanding: 52,901,733 and 52,707,879 shares, respectively

 

 

 

 

Preferred stock, par value $0.0001; authorized: 10,000,000 shares; issued and outstanding: 0 shares

 

 

 -

 

 

 -

Additional paid-in-capital

 

 

170,306 

 

 

172,255 

Accumulated deficit

 

 

(17,997)

 

 

(25,857)

Accumulated other comprehensive income (loss)

 

 

(29)

 

 

(56)

Total Stockholders' Equity

 

 

152,285 

 

 

146,347 

Total Liabilities and Stockholders' Equity

 

$

430,928 

 

$

297,630 



See accompanying Notes to Consolidated Financial Statements.



 

3


 

Table of Contents

 

Tile Shop Holdings, Inc. and Subsidiaries

Consolidated Statements of Income

(dollars in thousands, except per share data)

(unaudited)







 

 

 

 

 

 



 

 

 

 

 

 



 

Three Months Ended



 

March 31,



 

2019

 

2018

Net sales

 

$

86,908 

 

$

91,134 

Cost of sales

 

 

25,066 

 

 

27,096 

Gross profit

 

 

61,842 

 

 

64,038 

Selling, general and administrative expenses

 

 

58,948 

 

 

57,927 

Income from operations

 

 

2,894 

 

 

6,111 

Interest expense

 

 

(978)

 

 

(554)

Other income

 

 

15 

 

 

35 

Income before income taxes

 

 

1,931 

 

 

5,592 

Provision for income taxes

 

 

(611)

 

 

(1,581)

Net income

 

$

1,320 

 

$

4,011 



 

 

 

 

 

 

Income per common share:

 

 

 

 

 

 

Basic

 

$

0.03 

 

$

0.08 

Diluted

 

$

0.03 

 

$

0.08 



 

 

 

 

 

 

Weighted average shares outstanding:

 

 

 

 

 

 

Basic

 

 

51,961,780 

 

 

51,881,681 

Diluted

 

 

52,037,996 

 

 

51,899,210 



 

 

 

 

 

 

Dividends declared per share

 

$

0.05 

 

$

0.05 



See accompanying Notes to Consolidated Financial Statements.

 

 

4


 

Table of Contents

 

Tile Shop Holdings, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income

(dollars in thousands)

(unaudited)







 

 

 

 

 

 



 

 

 

 

 

 



 

Three Months Ended



 

March 31,



 

2019

 

2018

Net income

 

$

1,320 

 

$

4,011 

Currency translation adjustment

 

 

27 

 

 

30 

Other comprehensive income

 

 

27 

 

 

30 

Comprehensive income

 

$

1,347 

 

$

4,041 



See accompanying Notes to Consolidated Financial Statements.



 

5


 

Table of Contents

 

Tile Shop Holdings, Inc. and Subsidiaries

Consolidated Statements of Stockholders’ Equity (Deficit)

(dollars in thousands, except share data)

(unaudited)







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Common stock

 

 

 

 

 

 

 

 

 

 

 

 



 

Shares

 

Amount

 

Additional
paid-in
capital

 

Retained
earnings
(deficit)

 

Accumulated
other
comprehensive
income (loss)

 

Total

Balance at December 31, 2017

 

52,156,850 

 

$

 

$

180,109 

 

$

(36,239)

 

$

(1)

 

$

143,874 

Adoption of revenue recognition standard

 

 -

 

 

 -

 

 

 -

 

 

(60)

 

 

 -

 

 

(60)

Balance at January 1, 2018

 

52,156,850 

 

$

 

$

180,109 

 

$

(36,299)

 

$

(1)

 

$

143,814 

Issuance of restricted shares

 

281,945 

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

 -

Cancellation of restricted shares

 

(9,638)

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

 -

Stock based compensation

 

 -

 

 

 -

 

 

617 

 

 

 -

 

 

 -

 

 

617 

Dividends paid

 

 -

 

 

 -

 

 

(2,600)

 

 

 -

 

 

 -

 

 

(2,600)

Foreign currency translation adjustments

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

30 

 

 

30 

Net income

 

 -

 

 

 -

 

 

 -

 

 

4,011 

 

 

 -

 

 

4,011 

Balance at March 31, 2018

 

52,429,157 

 

$

 

$

178,126 

 

$

(32,288)

 

$

29 

 

$

145,872 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2018

 

52,707,879 

 

$

 

$

172,255 

 

$

(25,857)

 

$

(56)

 

$

146,347 

Adoption of lease standard (see Note 1)

 

 -

 

 

 -

 

 

 -

 

 

6,540 

 

 

 -

 

 

6,540 

Balance at January 1, 2019

 

52,707,879 

 

$

 

$

172,255 

 

$

(19,317)

 

$

(56)

 

$

152,887 

Issuance of restricted shares

 

281,173 

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

 -

Cancellation of restricted shares

 

(87,319)

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

 -

Stock based compensation

 

 -

 

 

 -

 

 

739 

 

 

 -

 

 

 -

 

 

739 

Tax withholdings related to net share settlements of stock based compensation awards

 

 -

 

 

 -

 

 

(82)

 

 

 -

 

 

 -

 

 

(82)

Dividends paid

 

 -

 

 

 -

 

 

(2,606)

 

 

 -

 

 

 -

 

 

(2,606)

Foreign currency translation adjustments

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

27 

 

 

27 

Net income

 

 -

 

 

 -

 

 

 -

 

 

1,320 

 

 

 -

 

 

1,320 

Balance at March 31, 2019

 

52,901,733 

 

$

 

$

170,306 

 

$

(17,997)

 

$

(29)

 

$

152,285 



 

See accompanying Notes to Consolidated Financial Statements.

 a

 

6


 

Table of Contents

 

Tile Shop Holdings, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

 (dollars in thousands)

(unaudited)



 



 

 

 

 

 

 



 

 

 

 

 

 



 

Three Months Ended



 

March 31,



 

2019

 

2018

Cash Flows From Operating Activities

 

 

 

 

 

 

Net income

 

$

1,320 

 

$

4,011 

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

 

 

 

 

 

 

Depreciation & amortization

 

 

7,964 

 

 

7,000 

Amortization of debt issuance costs

 

 

149 

 

 

167 

Loss on disposals of property, plant and equipment

 

 

82 

 

 

71 

Stock based compensation

 

 

739 

 

 

617 

Deferred income taxes

 

 

64 

 

 

426 

Changes in operating assets and liabilities:

 

 

 

 

 

 

Receivables

 

 

(2,858)

 

 

(504)

Inventories

 

 

(709)

 

 

(3,058)

Prepaid expenses and other assets

 

 

(806)

 

 

(1,771)

Accounts payable

 

 

8,429 

 

 

(6,085)

Income tax receivable / payable

 

 

457 

 

 

1,135 

Accrued expenses and other liabilities

 

 

4,848 

 

 

7,849 

Net cash provided by operating activities

 

 

19,679 

 

 

9,858 

Cash Flows From Investing Activities

 

 

 

 

 

 

Purchases of property, plant and equipment

 

 

(12,198)

 

 

(4,846)

Proceeds from insurance

 

 

610 

 

 

 -

Net cash used in investing activities

 

 

(11,588)

 

 

(4,846)

Cash Flows From Financing Activities

 

 

 

 

 

 

Payments of long-term debt and financing lease obligations

 

 

(18,054)

 

 

(16,904)

Advances on line of credit

 

 

15,000 

 

 

15,000 

Dividends paid

 

 

(2,606)

 

 

(2,600)

Employee taxes paid for shares withheld

 

 

(82)

 

 

 -

Net cash used in financing activities

 

 

(5,742)

 

 

(4,504)

Effect of exchange rate changes on cash

 

 

30 

 

 

Net change in cash

 

 

2,379 

 

 

511 

Cash, cash equivalents and restricted cash beginning of period

 

 

6,382 

 

 

7,476 

Cash, cash equivalents and restricted cash end of period

 

$

8,761 

 

$

7,987 



 

 

 

 

 

 

Cash and cash equivalents

 

$

7,936 

 

$

7,152 

Restricted cash

 

 

825 

 

 

835 

Cash, cash equivalents and restricted cash end of period

 

$

8,761 

 

$

7,987 



 

 

 

 

 

 

Supplemental disclosure of cash flow information

 

 

 

 

 

 

Purchases of property, plant and equipment included in accounts payable and accrued expenses

 

$

1,478 

 

$

1,895 

Cash paid for interest

 

 

934 

 

 

558 

Cash paid (received) for income taxes, net

 

 

 -

 

 



 

See accompanying Notes to Consolidated Financial Statements.

 

 

 

7


 

Table of Contents

Tile Shop Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(unaudited)

 

Note 1: Background



Tile Shop Holdings, Inc. (“Holdings,” and together with its wholly owned subsidiaries, the “Company”) was incorporated in Delaware in June 2012.



The Company is a specialty retailer of natural stone and man-made tiles, setting and maintenance materials, and related accessories in the United States.  The Company manufactures its own setting and maintenance materials, such as thinset, grout, and sealers. The Company’s primary market is retail sales to consumers, contractors, designers and home builders. As of March 31, 2019, the Company had 140 stores in 31 states and the District of Columbia, with an average size of approximately 20,200 square feet. The Company has distribution centers located in Michigan, New Jersey, Oklahoma, Virginia and Wisconsin. The Company has a sourcing operation located in China.



The accompanying Consolidated Financial Statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the rules and regulations for reporting on Form 10-Q. Accordingly, they do not include certain information and disclosures required for comprehensive financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included and are of a normal recurring nature, including the elimination of all intercompany transactions. Operating results for the three months ended March 31, 2019 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2019.



These statements should be read in conjunction with the Consolidated Financial Statements and footnotes included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2018. The accounting policies used in preparing these Consolidated Financial Statements are the same as those described in Note 1 to the Consolidated Financial Statements in such Form 10-K.



Recently Adopted Accounting Pronouncements



In February 2016, the Financial Accounting Standards Board (“FASB”) issued a final standard that primarily requires organizations that lease assets to recognize the rights and obligations created by those leases on the consolidated balance sheet.  This standard also requires expanded disclosures to help financial statement users better understand the amount, timing and uncertainty of cash flows arising from leases.  The Company adopted this standard effective January 1, 2019 using a modified retrospective approach through a cumulative effect adjustment to retained earnings as of the beginning of the period of adoption. 



The Company determines if an arrangement is a lease at inception. Operating leases are included in right of use assets and lease liabilities on the consolidated balance sheets. The right of use assets and lease liabilities are recognized as the present value of the future minimum lease payments over the lease term at commencement date. As most of the leases do not provide an implicit rate, the Company uses its incremental borrowing rate based on the information available at commencement date in determining the present value of future payments. The right of use asset is also adjusted for any lease payments made and excludes lease incentives and initial direct costs incurred. The Company’s lease terms may include options to extend or terminate the lease typically at the Company’s own discretion. The Company regularly evaluates the renewal options and when they are reasonably certain of exercise, the Company includes the renewal period in its lease term.



This standard provides a number of optional practical expedients in transition.  The Company elected the package of three practical expedients permitted under the transition guidance within this standard, which among other things, allows the Company to carryforward the historical lease classification.  The Company did not separate non-lease components from lease components by class of underlying assets and the Company did not apply the recognition requirements of the standard to short-term leases, as allowed by the standard.



The Company also elected to apply the hindsight practical expedient.  Its election of the hindsight practical expedient resulted in the shortening of lease terms for certain existing leases and the useful lives of corresponding leasehold improvements.  In its application of the hindsight practical expedient,  the Company considered recent investments in leased properties and its overall real estate strategy, which resulted in the determination that most renewal options would not be reasonably certain in determining the expected lease term.  



Upon adopting this standard, the Company established a right of use asset of $147.2 million and lease liabilities of $169.9 million, reduced deferred rent by $44.6 million, and recorded a cumulative effect adjustment to retained earnings of $22.0 million. This retained earnings impact was due to the election of the hindsight practical expedient which resulted in a decrease in the cumulative difference between the straight-line rent expense and rental payments that had been made between the inception of each lease and January 1, 2019. The change in the useful life assigned to certain leasehold improvements resulted in a $15.3 million reduction in

 

8


 

Table of Contents

Tile Shop Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(unaudited)

 

fixed assets and retained earnings.  The adoption of this standard did not have a material impact on net income or cash flows during the three months ended March 31, 2019. See Note 8 for further details.



Accounting Pronouncements Not Yet Adopted



In June 2016, the FASB issued a final standard on accounting for credit losses. The standard is effective for the Company in fiscal 2020 and requires a change in credit loss calculations using the expected loss method. The Company is evaluating the effect of this standard on its consolidated financial statements and related disclosures.  



In August 2018, the FASB issued a final standard which provides guidance on the accounting for costs of implementation activities performed in a cloud computing arrangement that is a service contract. The standard requires customers of cloud computing services to recognize an intangible asset for the software license and, to the extent that payments attributable to the software license are made over time, a liability is also recognized. The standard also allows customers of cloud computing services to capitalize certain implementation costs. The standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The standard will become effective for the Company at the beginning of its 2020 fiscal year, although early adoption is permitted for all entities. The Company is evaluating the effect of the standard on its consolidated financial statements.





Note 2: Revenues



Revenues are recognized when control of the promised goods or services is transferred to the Company’s customers, in an amount that reflects the consideration received in exchange for those goods or services. Sales taxes are excluded from revenues. 



The following table presents revenues disaggregated by product category:





 

 

 

 

 

 



 

 

 

 

 

 



 

For the three months ended



 

March 31,



 

2019

 

2018

Man-made tiles

 

46 

%

 

45 

%

Natural stone tiles

 

29 

 

 

29 

 

Setting and maintenance materials

 

13 

 

 

13 

 

Accessories

 

11 

 

 

11 

 

Delivery service

 

 

 

 

Total

 

100 

%

 

100 

%



The Company generates revenues by selling tile products, setting and maintenance materials, accessories, and delivery services to its customers through its store locations.  The timing of revenue recognition coincides with the transfer of control of goods and services ordered by the customer which falls into one of three categories described below:



·

Revenue recognized when an order is placed – If a customer places an order in a store and the contents of their order are available, the Company recognizes revenue concurrent with the exchange of goods for consideration from the customer.

 

·

Revenue recognized when an order is picked up – If a customer places an order for items held in a centralized distribution center, the Company requests a deposit from the customer at the time they place the order.  Subsequently when the contents of the customer’s order are delivered to the store, the customer returns to the store and picks up the items that were ordered.  The Company recognizes revenue on this transaction when the customer picks up their order.



·

Revenue recognized when an order is delivered – If a customer places an order in a store and requests delivery of their order, the Company prepares the contents of their order, initiates the delivery service, and recognizes revenue once the contents of the customer’s order are delivered.



The Company determines the transaction price of its contracts based on the pricing established at the time a customer places an order.  The transaction price does not include sales tax as the Company is a pass-through conduit for collecting and remitting sales tax.  Any discounts applied to an order are allocated proportionately to the base price of the goods and services ordered.  Deposits made by customers are recorded in other accrued liabilities. Deferred revenues associated with customer deposits are recognized at the time the Company transfers control of the items ordered or renders the delivery service. In the event an order is partially fulfilled as of the end of a reporting period, revenue will be recognized based on the transaction price allocated to the goods delivered and services rendered. The customer deposit balance was $9.8 million and $7.4 million as of March 31, 2019 and December 31, 2018, respectively.  Revenues

 

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Table of Contents

Tile Shop Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(unaudited)

 

recognized during the three-month period ended March 31, 2019 that were included in the customer deposit balance as of the beginning of the period were $6.6 million.



Accounts receivable include amounts due from qualified professional customers who apply for credit.  Customers who qualify for an account receive 30-day payment terms. The accounts receivable balance was $5.9 million and $3.1 million at March 31, 2019 and December 31, 2018, respectively. The Company expects that the customer will pay for the goods and services ordered within one year from the date the order is placed.  Accordingly, the Company qualifies for the practical expedient outlined in ASC 606-10-32-18 and does not adjust the promised amount of consideration for the effects of the financing component. 



Customers may return purchased items for an exchange or refund.  The Company records a reserve for estimated product returns based on the historical returns trends and the current product sales performance.  Historically, the sales returns reserve was presented net of cost of sales in other current liabilities. The Company presents the sales returns reserve as an other current liability and the estimated value of the inventory that will be returned as an other current asset in the Consolidated Balance Sheet.  The components of the sales returns reserve reflected in the Consolidated Balance Sheet as of March 31, 2019 and December 31, 2018 are as follows:







 

 

 

 

 

 



 

(in thousands)



 

March 31,

 

December 31,



 

2019

 

2018

Other current liabilities

 

$

5,875 

 

$

5,154 

Other current assets

 

 

1,746 

 

 

1,498 

Sales returns reserve, net

 

$

4,129 

 

$

3,656 







Note 3: Inventories



Inventories are stated at the lower of cost (determined on the weighted-average cost method) or net realizable value. Inventories consist primarily of merchandise held for sale. Inventories were comprised of the following as of March 31, 2019 and December 31, 2018:





 

 

 

 

 

 



 

 

 

 

 

 



 

(in thousands)



 

March 31,

 

December 31,



 

2019

 

2018

Finished goods

 

$

102,501 

 

$

98,776 

Raw materials

 

 

2,647 

 

 

2,114 

Finished goods in transit

 

 

5,656 

 

 

9,205 

Total

 

$

110,804 

 

$

110,095 



The Company provides provisions for losses related to shrinkage and other amounts that are otherwise not expected to be fully recoverable. These provisions are calculated based on historical shrinkage, selling price, margin and current business trends. The provision for losses related to shrinkage and other amounts was $0.9 million and $0.3 million as of March 31, 2019 and December 31, 2018, respectively. 



Note 4: Income taxes



The Company's effective tax rate on net income before income taxes for the three months ended March 31, 2019 and 2018 was 31.6% and 28.3%, respectively. The difference between the Company’s effective rate of 31.6% and the expected federal statutory rate of 21.0% for the three months ended March 31, 2019 is primarily due to state income taxes and stock based compensation tax shortfall charges. For the three months ended March 31, 2019 and 2018, the Company recorded a provision for income taxes of $0.6 million and $1.6 million, respectively. The decrease in the provision for income taxes is due to lower pretax earnings.



The Company records interest and penalties relating to uncertain tax positions in income tax expense. As of March 31, 2019 and 2018, the Company has not recognized any liabilities for uncertain tax positions, nor have interest and penalties related to uncertain tax positions been accrued.

 

 

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Table of Contents

Tile Shop Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(unaudited)

 

Note 5: Earnings Per Share



Basic earnings per share is calculated by dividing net income by the weighted-average number of common shares outstanding during the period. Diluted earnings per share is calculated by dividing net income by the weighted-average number of common shares outstanding, after taking into consideration all dilutive potential shares outstanding during the period. 



Basic and diluted earnings per share were calculated as follows:





 

 

 

 

 

 



 

 

 

 

 

 



(all amounts in thousands except share and per share data)



 

For the three months ended



 

March 31,



 

2019

 

2018

Net income

 

$

1,320 

 

$

4,011 

Weighted average shares outstanding - basic

 

 

51,961,780 

 

 

51,881,681 

Effect of dilutive securities attributable to stock based awards

 

 

76,216 

 

 

17,529 

Weighted average shares outstanding - diluted

 

 

52,037,996 

 

 

51,899,210 

Income per common share:

 

 

 

 

 

 

Basic

 

$

0.03 

 

$

0.08 

Dilutive

 

$

0.03 

 

$

0.08 

Anti-dilutive securities excluded from earnings per share calculation

 

 

1,639,659 

 

 

1,971,066 



Note 6: Other Accrued Liabilities



Other accrued liabilities consisted of the following:







 

 

 

 

 

 



 

 

 

 

 

 



 

(in thousands)



 

March 31,

 

December 31,



 

2019

 

2018

Customer deposits

 

$

9,783 

 

$

7,383 

Accrued wages and salaries

 

 

3,353 

 

 

3,689 

Sales returns reserve

 

 

5,875 

 

 

5,154 

Payroll and sales taxes

 

 

4,327 

 

 

2,929 

Other current liabilities

 

 

5,389 

 

 

5,329 

Total other accrued liabilities

 

$

28,727 

 

$

24,484 

 

Note 7: Long-term Debt



On September 18, 2018, Holdings and its operating subsidiary, The Tile Shop, LLC, entered into a credit agreement with Bank of America, N.A., Fifth Third Bank and Citizens Bank (the “Credit Agreement”). The Credit Agreement provides the Company with a senior credit facility consisting of a $100.0 million revolving line of credit through September 18, 2023. Borrowings pursuant to the Credit Agreement initially bear interest at a rate of adjusted LIBOR plus 1.75% and may bear interest in a range between adjusted LIBOR plus 1.50% to adjusted LIBOR plus 2.25%, depending on The Tile Shop’s consolidated total rent adjusted leverage ratio. At March 31, 2019 the base interest rate was 6.50% and the LIBOR-based interest rate was 4.49%. Borrowings outstanding consisted of $50.0 million on the revolving line of credit as of March 31, 2019.  In addition, the Company has standby letters of credit outstanding related to its workers compensation and medical insurance policies.  As of March 31, 2019 and 2018, the standby letters of credit totaled $1.2 million and $1.1 million, respectively. There was $48.8 million available for borrowing on the revolving line of credit as of March 31, 2019, which may be used to support the Company’s growth and for working capital purposes.



The Credit Agreement is secured by virtually all of the assets of the Company, including but not limited to, inventory, receivables, equipment and real property. The Credit Agreement contains customary events of default, conditions to borrowings, and restrictive covenants, including restrictions on the Company’s ability to dispose of assets, make acquisitions, incur additional debt, incur liens, or make investments. The Credit Agreement also includes financial and other covenants, including covenants to maintain certain fixed charge coverage ratios and consolidated total rent adjusted leverage ratios.  The Company was in compliance with the covenants as of March 31, 2019.  



 

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Table of Contents

Tile Shop Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(unaudited)

 

Note 8: Leases



The Company leases its retail stores, certain distribution space, and office space. Leases generally have a term of ten to fifteen years, and contain renewal options. Assets acquired under operating leases are included in the Company’s right of use assets in the accompanying Consolidated Balance Sheet. The Company’s lease agreements do not contain significant residual value guarantees, restrictions or covenants. The depreciable life of assets and leasehold improvements is limited by the expected lease term.



 

 

 



 

 

 

Leases (in thousands)

Classification

 

March 31, 2019

Assets

 

 

 

Operating lease assets

Right of use asset

$

141,791 

Financing lease assets

Property, plant and equipment, net of accumulated depreciation

 

150 

Total leased assets

 

$

141,941 



 

 

 

Liabilities

 

 

 

Current

 

 

 

Operating

Current portion of lease liability

$

25,236 

Financing

Other accrued liabilities

 

145 

Noncurrent

 

 

 

Operating

Long-term lease liability, net

 

138,550 

Financing

Other long-term liabilities

 

398 

Total lease liabilities

 

$

164,329 







 

 

 



 

 

 

Lease cost (in thousands)

 

 

March 31, 2019

Operating lease cost

SG&A expenses

$

8,013 

Financing lease cost

 

 

 

Amortization of leased assets

Depreciation and amortization

 

12 

Interest on lease liabilities

Interest expense

 

21 

Variable lease cost(1)

 

 

3,225 

Short term lease cost

 

 

264 

Net lease cost

 

$

11,535 

(1) Variable lease costs consist primarily of taxes, insurance, and common area or other maintenance costs for our leased facilities.









 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

Maturity of Lease Liabilities (in thousands)

Operating Leases

 

Financing Leases

 

Total

2019

$

26,177 

 

$

162 

 

$

26,339 

2020

 

34,252 

 

 

216 

 

 

34,468 

2021

 

32,677 

 

 

215 

 

 

32,892 

2022

 

29,741 

 

 

90 

 

 

29,831 

2023

 

24,691 

 

 

 -

 

 

24,691 

Thereafter

 

52,125 

 

 

 -

 

 

52,125 

Total lease payments

 

199,663 

 

 

683 

 

 

200,346 

Less: interest

 

(35,877)

 

 

(140)

 

 

(36,017)

Present value of lease liabilities

$

163,786 

 

$

543 

 

$

164,329 







 

 



 

 

Other Information (in thousands)

 

March 31, 2019

Cash paid for amounts included in the measurement of lease liabilities

 

 

Operating cash flows from operating leases

$

8,602 

Operating cash flows from financing leases

$

21 

Financing cash flows from financing leases

$

33 



 

12


 

Table of Contents

Tile Shop Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(unaudited)

 





 

 

 



 

 

 

Lease Term and Discount Rate

 

March 31, 2019

 

Weighted-average remaining term (years)

 

 

 

Operating leases

 

6.4 

 

Financing leases

 

3.2 

 

Weighted-average discount rate

 

 

 

Operating leases

 

6.21 

%

Financing leases

 

14.73 

%









Note 9: Fair Value of Financial Instruments



Fair value is the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. To measure fair value, the Company uses a three-tier valuation hierarchy based upon observable and non-observable inputs:



Level 1 – Unadjusted quoted prices that are available in active markets for the identical assets or liabilities at the measurement date.



Level 2 – Significant other observable inputs available at the measurement date, other than quoted prices included in Level 1, either directly or indirectly, including:

·

Quoted prices for similar assets or liabilities in active markets;

·

Quoted prices for identical or similar assets in non-active markets;

·

Inputs other than quoted prices that are observable for the asset or liability; and

·

Inputs that are derived principally from or corroborated by other observable market data.



Level 3 – Significant unobservable inputs that cannot be corroborated by observable market data and reflect the use of significant management judgment.



The following table sets forth by Level within the fair value hierarchy the Company’s financial assets that were accounted for at fair value on a recurring basis at March 31, 2019 and December 31, 2018 according to the valuation techniques the Company uses to determine their fair values. There have been no transfers of assets among the fair value hierarchies presented.









 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 



 

Pricing

 

Fair Value at



 

Category

 

March 31, 2019

 

December 31, 2018

Assets

 

(in thousands)

Cash and cash equivalents

 

Level 1

 

$

7,936 

 

$

5,557 

Restricted cash

 

Level 1

 

 

825 

 

 

825 



The following methods and assumptions were used to estimate the fair value of each class of financial instrument.  There have been no changes in the valuation techniques used by the Company to value the Company’s financial instruments.



·

Cash and cash equivalents: Consists of cash on hand and bank deposits.  The value was measured using quoted market prices in active markets.  The carrying amount approximates fair value.



·

Restricted cash: Consists of cash and cash equivalents held in bank deposit accounts restricted as to withdrawal or that are under the terms of use for current operations.  The value was measured using quoted market prices in active markets.  The carrying amount approximates fair value.



Fair value measurements also apply to certain non-financial assets and liabilities measured at fair value on a nonrecurring basis.  Property, plant and equipment and right of use assets are measured at fair value when an impairment is recognized and the related

 

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Table of Contents

Tile Shop Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(unaudited)

 

assets are written down to fair value. The Company did not recognize any significant impairment losses during the three months ended March 31, 2019 and 2018.  



The carrying value of the Company’s borrowings under its Credit Agreement approximate fair value based upon Level 2 inputs of the market interest rates available to the Company for debt obligations with similar risks and maturities.



Note 10: Equity Incentive Plans



Stock options:



The Company measures and recognizes compensation expense for all stock based awards at fair value. The financial statements for the three months ended March 31, 2019 and 2018 include compensation cost for the portion of outstanding awards that vested during those periods. The Company recognizes stock based compensation costs on a straight-line basis over the requisite service period of the award, which is generally the option vesting term. Total stock based compensation expense related to stock options was $0.3 million for both the three months ended March 31, 2019 and 2018. Stock based compensation expense pertaining to stock options is included in selling, general and administrative expenses in the accompanying Consolidated Statements of Income.



As of March 31, 2019, the Company had outstanding stock options to purchase 1,632,585 shares of common stock at a weighted average exercise price of $11.17.



Restricted stock:



The Company awards restricted common shares to selected employees and to non-employee directors. Recipients are not required to provide any consideration upon vesting of the award. Restricted stock awards are subject to certain restrictions on transfer, and all or part of the shares awarded may be subject to forfeiture upon the occurrence of certain events, including employment termination. Certain awards are also subject to forfeiture if the Company fails to attain certain performance targets. The restricted stock is valued at its grant date fair value and expensed over the requisite service period or the vesting term of the awards. The Company adjusts the cumulative expense recognized on awards with performance conditions based on the probability of achieving the performance condition. Total stock based compensation expense related to restricted stock was $0.4 million and $0.3 million for the three months ended March 31, 2019 and 2018, respectively. Stock based compensation expense pertaining to restricted stock awards is included in selling, general and administrative expenses in the accompanying Consolidated Statements of Income.



As of March 31, 2019, the Company had 916,434 outstanding restricted common shares.

 

Note 11: New Market Tax Credit



2016 New Market Tax Credit



In December 2016, the Company entered into a financing transaction with U.S. Bank Community, LLC (“U.S. Bank”) related to a $9.2 million expansion of the Company’s facility in Durant, Oklahoma. In this transaction, which was conducted under a qualified New Markets Tax Credit (“NMTC”) program, Tile Shop Lending, Inc. (“Tile Shop Lending”) loaned $6.7 million to Twain Investment Fund 192 LLC (the “Investment Fund”) at an interest rate of 1.37% per year and with a maturity date of December 31, 2046. The Investment Fund then contributed the loan to a community development entity (a “CDE”), which, in turn, loaned the funds on similar terms to Tile Shop of Oklahoma, LLC, an indirect, wholly-owned subsidiary of Holdings. In December 2016, U.S. Bank also contributed $3.2 million to the Investment Fund and, by virtue of such contribution, is entitled to substantially all of the tax benefits derived from the NMTC, while the Company effectively received net loan proceeds equal to U.S. Bank’s contributions to the Investment Fund. This transaction includes a put/call provision whereby the Company may be obligated or entitled to repurchase U.S. Bank’s interest. The Company believes that U.S. Bank will exercise the put option in December 2023 at the end of the recapture period. The value attributed to the put/call is de minimis. The NMTC is subject to 100% recapture for a period of seven years as provided in the Internal Revenue Code. The Company is required to be in compliance with various regulations and contractual provisions that apply to the NMTC arrangement. Non-compliance with applicable requirements could result in projected tax benefits not being realized and, therefore, could require the Company to indemnify U.S. Bank for any loss or recapture of NMTCs related to the financing until such time as the obligation to deliver tax benefits is relieved. The Company does not anticipate any credit recaptures will be required in connection with this arrangement.  



The Company has determined that the financing arrangement with the Investment Fund and CDEs contains a variable interest entity (“VIE”). The ongoing activities of the Investment Fund – collecting and remitting interest and fees and NMTC compliance – were all considered in the initial design and are not expected to significantly affect economic performance throughout the life of the

 

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Table of Contents

Tile Shop Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(unaudited)

 

Investment Fund. Management considered the contractual arrangements that obligate the Company to deliver tax benefits and provide various other guarantees to the structure; U.S. Bank’s lack of a material interest in the underling economics of the project; and the fact that the Company is obligated to absorb losses of the Investment Fund. The Company concluded that it is the primary beneficiary of the VIE and consolidated the Investment Fund, as a VIE, in accordance with the accounting standards for consolidation. In 2016, U.S. Bank’s contributions of $3.2 million, net of syndications fees, were included in cash, restricted cash, other accrued liabilities and other long-term liabilities in the consolidated balance sheet. The Company incurred $1.3 million of syndication fees in connection with this transaction, which were classified as other current assets and other non-current assets in the consolidated balance sheet. The Company is recognizing the benefit of this net $1.9 million contribution over the seven-year compliance period as it is being earned through the on-going compliance with the conditions of the NMTC program. As of March 31, 2019, the balance of the contribution liability was $2.2 million, of which $0.5 million was classified as other accrued liabilities on the Consolidated Balance Sheet and $1.7 million was classified as other long-term liabilities on the Consolidated Balance Sheet.



The Company is able to request reimbursement for certain expenditures made in connection with the expansion of the distribution center in Durant, Oklahoma from the Investment Fund. Expenditures that qualify for reimbursement include building costs, equipment purchases, and other expenditures tied to the expansion of the facility. As of March 31, 2019, the balance in the Investment Fund available for reimbursement to the Company was $0.8 million.



2013 New Market Tax Credit



In July 2013, the Company entered into a financing transaction with U.S. Bank and Chase Community Equity (“Chase”, and collectively with US. Bank, the “investors”) related to the $19.1 million acquisition, rehabilitation, and construction of the Company’s distribution center and manufacturing facilities in Durant, Oklahoma.  In this transaction, Tile Shop Lending loaned $13.5 million to the Tile Shop Investment Fund LLC.  The investors contributed $5.6 million to the Tile Shop Investment Fund LLC.  The investors are entitled to the tax benefits derived from the NMTC by virtue of their contribution while the Company received the proceeds, net of syndication fees, to apply toward the construction project.  This transaction includes a put/call provision whereby the Company may be obligated or entitled to repurchase the investors’ interest. The Company believes that the investors will exercise the put option in September 2020 at the end of the recapture period. The value attributed to the put/call is de minimis. The NMTC is subject to 100% recapture for a period of seven years as provided in the Internal Revenue Code. The Company is required to be in compliance with various regulations and contractual provisions that apply to the NMTC arrangement. Non-compliance with applicable requirements could result in projected tax benefits not being realized and, therefore, could require the Company to indemnify the investors for any loss or recapture of NMTCs related to the financing until such time as the obligation to deliver tax benefits is relieved. The Company does not anticipate any credit recaptures will be required in connection with this arrangement. 



The Company determined that this financing arrangement contains a VIE.  The ongoing activities of the Tile Shop Investment Fund LLC – collecting and remitting interest and fees and NMTC compliance – were all considered in the initial design and are not expected to significantly affect economic performance throughout the life of the Tile Shop Investment Fund LLC. Management considered the contractual arrangements that obligate the Company to deliver tax benefits and provide various other guarantees to the structure; the investors lack of a material interest in the underling economics of the project; and the fact that the Company is obligated to absorb losses of The Tile Shop Investment Fund LLC. The Company concluded that it is the primary beneficiary of the VIE and consolidated the Tile Shop Investment Fund LLC, as a VIE, in accordance with the accounting standards for consolidation. In 2013, the investors’ contributions, of $5.6 million, net of syndication fees, were included in cash, restricted cash, other accrued liabilities and other long-term liabilities in the consolidated balance sheet. The Company incurred $1.2 million of syndication fees in connection with this transaction which were classified as other current assets and other non-current assets in the consolidated balance sheet.  The Company is recognizing the benefit of this net $4.4 million contribution over the seven-year compliance period as it is being earned through the on-going compliance with the conditions of the NMTC program. As of March 31, 2019, the balance of the contribution liability was $0.9 million, of which $0.7 million was classified as other accrued liabilities on the Consolidated Balance Sheet and $0.2 million was classified as other long-term liabilities on the Consolidated Balance Sheet.



 

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Tile Shop Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(unaudited)

 

Note 12: Related Party Transactions



On July 9, 2018, Fumitake Nishi, the brother-in-law of the Company’s Director Robert Rucker and a former Company employee, informed the Company he had reacquired a majority of the equity of one of its key vendors, Nanyang Helin Stone Co. Ltd (“Nanyang”).  Nanyang supplies the Company with natural stone products including hand-crafted mosaics, listellos and other accessories. During the twelve months ended December 31, 2018, the Company purchased $12.0 million of products from Nanyang. During the three months ended March  31, 2019, the Company purchased $1.2 million of products from Nanyang.  Mr. Nishi’s employment with the Company was terminated on January 1, 2014 as a result of several violations of the Company’s code of business conduct and ethics policy.  Certain of those violations involved his undisclosed ownership of Nanyang at that time.  



Management and the Audit Committee have evaluated the relationship and determined that it would be in the Company’s best interests to continue purchasing products from Nanyang.  The Company believes Nanyang provides an important combination of quality, product availability and pricing, and relying solely on other vendors to supply similar product to the Company would not be in the Company’s best interests.  The Company and the Committee has and will continue to review future purchases from Nanyang and compare the pricing for products purchased from Nanyang to the pricing of same or similar products purchased from unrelated vendors.



Note 13: Subsequent Events



On April 30, 2019, the Company declared a $0.05 dividend to stockholders of record as of the close of business on May 6, 2019. The dividend will be paid on May  17, 2019.



On April 29, 2019, the Board of Directors of the Company authorized a share repurchase program (the “Program”), pursuant to which the Company may, from time to time, purchase shares of its common stock for an aggregate repurchase price not to exceed  $15,000,000. The Program began on May 2, 2019 and will continue indefinitely until the full repurchase amount has been utilized or the Board of Directors terminates the Program.

 

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Table of Contents

Tile Shop Holdings, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

(unaudited)

 

 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2018 and our consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q.



Forward-Looking Statements



This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. In some cases, you can identify these statements by words such as, but not limited to, “anticipate,” “believe,” “can,” “continue,” “could,” “depend,” “estimate,” “expect,” “intend,” “may,” “might,” “plan,” “project,” “seek,” “should,” “target,” “will,” “will likely result,” “would,” and similar expressions or variations, although some forward-looking statements are expressed differently. All statements other than statements of historical fact are statements that could be deemed forward-looking statements. The forward-looking statements in this Quarterly Report on Form 10-Q relate to, among other things, our anticipated new store openings, remodeling plans, and growth opportunities; our business strengths, marketing strategies, competitive advantages and role in our industry and markets; our expectations regarding financing arrangements; our expectations with respect to dividend payments; our expectations with respect to ongoing compliance with the terms of our credit facility; and our expectations with respect to remediation of our identified material weaknesses.



These forward-looking statements are based on current expectations and assumptions that are subject to risks and uncertainties that may cause our actual results, performance, or achievements to differ materially from any expected future results, performance, or achievements expressed or implied by such forward-looking statements. These risks and uncertainties include, but are not limited to, the level of demand for our products and our ability to introduce new products that satisfy market demand; our ability to grow and remain profitable in the highly competitive retail tile industry, our ability to access additional capital; our ability to attract and retain qualified personnel; unexpected delays or expenses related to opening new stores and maintaining or renovating existing stores; changes to economic or market conditions and customer preferences; disruptions in our supply chain or inventory management; unanticipated issues with respect to remediation of our identified material weaknesses; and those factors set forth in the section captioned “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2018 and the additional Risk Factors set forth in Part II, Item 1A of this Quarterly Report on Form 10-Q.



There is no assurance that our expectations will be realized. If one or more of these risks or uncertainties materialize, or if our underlying assumptions prove incorrect, actual results may vary materially from those expected, estimated, or projected. These statements are based on the beliefs and assumptions of our management based on information currently available to management. Furthermore, such forward-looking statements speak only as of the date of this Quarterly Report on Form 10-Q. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements. 



Overview and Recent Trends



We are a specialty retailer of natural stone and man-made tiles, setting and maintenance materials, and related accessories in the United States. We offer a wide selection of products, attractive prices, and exceptional customer service in an extensive showroom setting. As of March 31, 2019, we operated 140 stores in 31 states and the District of Columbia, with an average size of approximately 20,200 square feet.



We purchase our tile products and accessories directly from suppliers and manufacture our own setting and maintenance materials, such as thinset, grout, and sealers. We believe that our long-term supplier relationships, together with our design, manufacturing and distribution capabilities, enable us to offer a broad assortment of high-quality products to our customers, who are primarily homeowners and professionals, at competitive prices. We have invested significant resources to develop our proprietary brands and product sources, and we believe that we are a leading retailer of natural stone and man-made tiles, accessories, and related materials in the United States.



We believe that the highly-fragmented United States retail tile market provides us with a significant opportunity to expand our store base. We opened one new store and closed one store at the end of its lease in the first three months of 2019, and opened two new stores during 2018. Between April 1, 2018 and March 31, 2019, we opened one new store and closed one store. We plan to open an additional five stores in 2019, of which one is a relocation. We believe that there will continue to be additional expansion opportunities in the United States and Canada. We expect store base growth will drive productivity and operational efficiencies. Our growth plans also require us to maintain significant inventory on-hand in order to fulfill transactions at these new locations.



For the three months ended March 31, 2019 and 2018, we reported net sales of $86.9 million and $91.1 million, respectively. The decrease in sales for the three months ended March 31, 2019 compared to the three months ended March 31, 2018 was primarily due

 

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to a decline in comparable stores sales of 4.2%, or $3.8 million. In addition, we had one less store in the comparable base during the three months ended March 31, 2019, which resulted in a $0.4 million decrease in net sales. The decrease in sales at comparable stores for the three months ended March 31, 2019 was due to weaker store traffic and customer experience issues following the implementation of a new enterprise resource planning system and the launch of our new website. Poor weather in the Midwest and Northeast as well as a $0.8 million reduction in advertising spend also contributed to the decrease in traffic during the three months ended March 31, 2019.



The table below sets forth information about our comparable store sales decline for the three months ended March 31, 2019 and 2018.  



 

 

 

 

 

 



 

 

 

 

 

 







 

 

 

 

 

 



 

 

 

 

 

 



 

For the three months ended



 

March 31,



 

2019

 

2018

Comparable store sales decline

 

(4.2)

%

 

(6.8)

%



For the three months ended March 31, 2019 and 2018, we reported gross profit of $61.8 million and $64.0 million, respectively. The gross margin rate was 71.2% and 70.3% for the three months ended March 31, 2019 and 2018, respectively. The increase in gross margin rate was primarily driven by higher pricing on new products added to our assortment over the last twelve months.



For the three months ended March 31, 2019 and 2018, we reported income from operations of $2.9 million and $6.1 million, respectively.  The decrease in income from operations was primarily driven by a decrease in net sales and increased selling, general and administrative expenses.



Net cash provided by operating activities was $19.7 million and $9.9 million for the three months ended March 31, 2019 and 2018, respectively, which was used to fund operations, new store construction activities, store remodels, merchandising and information technology investment, dividends and debt repayments. We expect to continue to fund our capital expenditures and daily operations from our operating cash flows.

 

On April 29, 2019, our Board of Directors authorized a share repurchase program (the “Program”), pursuant to which we may, from time to time, purchase shares of our common stock for an aggregate repurchase price not to exceed $15,000,000. The Program began on May 2, 2019 and will continue indefinitely until the full repurchase amount has been utilized or our Board of Directors terminates the Program.



Key Components of our Consolidated Statements of Income



Net Sales –  Net sales represents total charges to customers, net of returns, and includes freight charged to customers. We recognize sales at the time that the customer takes control of the merchandise or final delivery of the product has occurred. We are required to charge and collect sales and other taxes on sales to our customers and remit these taxes back to government authorities. Total revenues do not include sales tax because we are a pass-through conduit for collecting and remitting sales tax. Sales are reduced by a reserve for anticipated sales returns that we estimate based on historical returns.



Comparable store sales growth is a percentage change in sales of comparable stores period-over-period. A store is considered comparable on the first day of the 13th full month of operation. When a store is relocated, it is excluded from the comparable stores sales growth calculation. Comparable store sales growth amounts include total charges to customers less any actual returns. We include the change in allowance for anticipated sales returns applicable to comparable stores in the comparable store sales calculation.



Cost of Sales –  Cost of sales consists primarily of material costs, freight, customs and duties fees, and storage and delivery of product to the customers, as well as physical inventory losses and costs associated with manufacturing of setting and maintenance materials.



Selling, General, and Administrative Expenses –  Selling, general, and administrative expenses consists primarily of compensation costs, occupancy, utilities, maintenance costs, advertising costs, shipping and transportation expenses to move inventory from our distribution centers to our stores, depreciation and amortization.



Pre-opening Costs –  Our pre-opening costs are those typically associated with the opening of a new store and generally include rent expense, compensation costs and promotional costs. We expense pre-opening costs as incurred and include these costs in selling, general, and administrative expenses.



Income Taxes –  We are subject to income tax in the United States as well as other tax jurisdictions in which we conduct business.

 

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Non-GAAP Measure



We calculate Adjusted EBITDA by taking net income calculated in accordance with accounting principles generally accepted in the United States (“GAAP”), and adjusting for interest expense, income taxes, depreciation and amortization, and stock based compensation expense. Adjusted EBITDA margin is equal to Adjusted EBITDA divided by net sales.



We believe that this non-GAAP financial measure provides useful information to management and investors regarding certain financial and business trends relating to our financial condition and results of operations. Our management uses this non-GAAP financial measure to compare our performance to that of prior periods for trend analyses, for purposes of determining management incentive compensation, and for budgeting and planning purposes. This non-GAAP financial measure is used in monthly financial reports prepared for management and our Board of Directors. We believe that the use of this non-GAAP financial measure provides an additional tool for investors to use in evaluating ongoing operating results and trends and in comparing our financial performance with other specialty retailers, many of which present  a similar non-GAAP financial measure to investors.



The reconciliation of Adjusted EBITDA to net income for the three months ended March 31, 2019 and 2018 is as follows:







 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 



 (in thousands)



 

Three Months Ended



 

March 31,



 

2019

 

% of sales(1)

 

 

2018

 

% of sales

Net income

 

$

1,320 

 

1.5 

%

 

 

$

4,011 

 

4.4 

%

Interest expense

 

 

978 

 

1.1 

%

 

 

 

554 

 

0.6 

%

Income taxes

 

 

611 

 

0.7 

%

 

 

 

1,581 

 

1.7 

%

Depreciation & amortization

 

 

7,964 

 

9.2 

%

 

 

 

7,000 

 

7.7 

%

Stock based compensation

 

 

739 

 

0.8 

%

 

 

 

617 

 

0.7 

%

Adjusted EBITDA

 

$

11,612 

 

13.4 

%

 

 

$

13,763 

 

15.1 

%

(1) Amounts do not foot due to rounding.



We calculate pretax return on capital employed by taking income from operations divided by capital employed. Capital employed equals total assets less accounts payable, income taxes payable, other accrued liabilities, lease liability, deferred rent and other long-term liabilities.  We believe this non-GAAP financial measure is useful in assessing the effectiveness of our capital allocation over time. Other companies may calculate pretax return on capital employed differently, which limits the usefulness of the measure for comparative purposes.



The calculation of pretax return on capital employed is as follows:







 

 

 

 

 

 

 



 

 

 

 

 

 

 

($ in thousands)

 

March 31,

 



 

2019(1)

 

2018(1)

 

Income from Operations (trailing twelve months)

 

$

13,347 

 

$

16,324 

 



 

 

 

 

 

 

 

Total Assets

 

 

328,030 

 

 

266,994 

 

Less: Accounts payable

 

 

(29,242)

 

 

(22,020)

 

Less: Income tax payable

 

 

(116)

 

 

(150)

 

Less: Other accrued liabilities

 

 

(27,035)

 

 

(24,713)

 

Less: Lease liability(2)

 

 

(67,122)

 

 

(40,670)

 

Less: Other long-term liabilities

 

 

(3,937)

 

 

(4,895)

 

Capital Employed

 

$

200,578 

 

$

174,546 

 



 

 

 

 

 

 

 

Pretax Return on Capital Employed

 

 

6.7 

%

 

9.4 

%



(1) Income statement accounts represent the activity for the trailing twelve months ended as of each of the balance sheet dates. Balance sheet accounts represent the average account balance for the four quarters ended as of each of the balance sheet dates.

(2) Represents the average lease liability and deferred rent account balances for the four quarters ended as of each of the balance sheet dates.



 

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Our management does not consider these non-GAAP financial measures in isolation or as an alternative to financial measures determined in accordance with GAAP. The principal limitation of these non-GAAP financial measures is that they exclude significant expenses and income that are required by GAAP to be recognized in our consolidated financial statements. In addition, they are subject to inherent limitations as they reflect the exercise of judgments by management about which expenses and income are excluded or included in determining these non-GAAP financial measures. In order to compensate for these limitations, management presents its non-GAAP financial measures in connection with GAAP results. We urge investors to review the reconciliation of our non-GAAP financial measures to the comparable GAAP financial measures and not to rely on any single financial measure to evaluate our business. 



 

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Results of Operations



Comparison of the three months ended March 31, 2019 to the three months ended March 31, 2018







 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 



 

(in thousands)



 

2019

 

% of sales(1)

 

2018

 

% of sales

Net sales

 

$

86,908 

 

 

 

 

$

91,134 

 

 

 

Cost of sales

 

 

25,066 

 

28.8 

%

 

 

27,096 

 

29.7 

%

Gross profit

 

 

61,842 

 

71.2 

%

 

 

64,038 

 

70.3 

%

Selling, general and administrative expenses

 

 

58,948 

 

67.8 

%

 

 

57,927 

 

63.6 

%

Income from operations

 

 

2,894 

 

3.3 

%

 

 

6,111 

 

6.7 

%

Interest expense

 

 

(978)

 

(1.1)

%

 

 

(554)

 

(0.6)

%

Other income

 

 

15 

 

0.0 

%

 

 

35 

 

0.0 

%

Income before income taxes

 

 

1,931 

 

2.2 

%

 

 

5,592 

 

6.1 

%

Provision for income taxes

 

 

(611)

 

(0.7)

%

 

 

(1,581)

 

(1.7)

%

Net income

 

$

1,320 

 

1.5 

%

 

$

4,011 

 

4.4 

%

(1) Amounts do not foot due to rounding.



Net Sales Net sales for the first quarter of 2019 decreased $4.2 million, or 4.6%, compared with the first quarter of 2018, primarily due to a $3.8 million decrease in net sales generated by comparable stores. The decrease in sales at comparable stores for the three months ended March 31, 2019 was due to weaker store traffic and customer experience issues following the implementation of a new enterprise resource planning system and the launch of our new website. Poor weather in the Midwest and Northeast as well as a $0.8 million reduction in advertising spend also contributed to the decrease in traffic during the three months ended March 31, 2019. In addition, we had one less store in the comparable store base during the first quarter of 2019, which resulted in a $0.4 million decrease in net sales. 



Gross Profit Gross profit for the first quarter of 2019 decreased $2.2 million, or 3.4%, compared with the first quarter of 2018 primarily due to a decrease in net sales. The gross margin rate was 71.2% and 70.3% for the three months ended March 31, 2019 and 2018, respectively. The increase in gross margin rate was primarily driven by higher pricing on new products added to our assortment over the last twelve months.



Selling, General, and Administrative Expenses Selling, general, and administrative expenses for the first quarter of 2019 increased $1.0 million, or 1.8%, compared with the first quarter of 2018.  Depreciation expense increased $1.0 million in the first quarter of 2019 compared to the first quarter of 2018. First quarter selling, general and administrative expenses also included approximately $2.5 million of expense related to the implementation of our new enterprise resource planning system. The increases in expenses were partially offset by lower variable expenses of approximately $1.0 million, a $0.8 million decrease in advertising expenses and a $0.6 million decrease in transportation expenses.



Pre-opening Costs During both the first quarter of 2019 and 2018, we incurred pre-opening costs of $0.1 million.



Interest Expense Interest expense was $1.0 million and $0.6 million for the first quarter of 2019 and 2018, respectively. The increase was due to higher average debt balances and higher interest rates during the first quarter of 2019.  



Provision for Income Taxes Income tax provision decreased $1.0 million for the first quarter of 2019 compared with the first quarter of 2018 due to a decrease in income before income taxes. Our effective tax rate for the three months ended March 31, 2019 and 2018 was 31.6% and 28.3%, respectively.

 

Liquidity and Capital Resources



Our principal liquidity requirements have been for working capital and capital expenditures. Our principal sources of liquidity are $7.9 million of cash and cash equivalents at March 31, 2019, our cash flow from operations, and borrowings available under our credit facility. We expect to use this liquidity for opening new stores, purchasing additional merchandise inventory, maintaining our existing stores, executing share repurchases, reducing outstanding debt, and general corporate purposes. We intend to continue our regular quarterly dividend, which will enable us to return excess cash to stockholders. Future dividend payments are subject to the approval of the Board of Directors each quarter.



On September 18, 2018, we and our operating subsidiary, The Tile Shop, LLC, entered into a credit agreement with Bank of America, N.A., Fifth Third Bank and Citizens Bank (the “Credit Agreement”). The Credit Agreement provides us with a senior credit facility consisting of a $100 million revolving line of credit through September 18, 2023. Borrowings pursuant to the Credit Agreement

 

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initially bear interest at a rate of adjusted LIBOR plus 1.75% and may bear interest in a range between adjusted LIBOR plus 1.50% to adjusted LIBOR plus 2.25%, depending on The Tile Shop’s consolidated total rent adjusted leverage ratio. At March 31, 2019, the base interest rate was 6.50% and the LIBOR-based interest rate was 4.49%.  Borrowings outstanding consisted of $50.0 million on the revolving line of credit as of March 31, 2019.  We also have standby letters of credit outstanding related to our workers compensation and medical insurance policies. As of March 31, 2019 and 2018, the standby letters of credit totaled $1.2 million and $1.1 million, respectively. There was $48.8 million available for borrowing on the revolving line of credit as of March 31, 2019, which may be used to support our growth and for working capital purposes.



The Credit Agreement is secured by virtually all of our assets, including but not limited to, inventory, receivables, equipment and real property. The Credit Agreement contains customary events of default, conditions to borrowings, and restrictive covenants, including restrictions on our ability to dispose of assets, make acquisitions, incur additional debt, incur liens, or make investments. The Credit Agreement also includes financial and other covenants, including covenants to maintain certain fixed charge coverage ratios and consolidated total rent adjusted leverage ratios.  We were in compliance with the covenants as of March 31, 2019.



We believe that our cash flow from operations, together with our existing cash and cash equivalents, and borrowings available under our credit facility, will be sufficient to fund our operations and anticipated capital expenditures over at least the next twelve months.



Capital Expenditures



Capital expenditures were $12.2 million and $4.8 million for the three months ended March 31, 2019 and 2018, respectively. The increase in capital expenditures is primarily due to increased investments in store remodels, merchandising, and information technology investments.



Cash flows



The following table summarizes our cash flow data for the three months ended March 31, 2019 and 2018.







 

 

 

 

 

 



 

 

 

 

 

 

   

 

(in thousands)



 

Three Months Ended



 

March 31,



 

2019

 

2018

Net cash provided by operating activities

 

$

19,679 

 

$

9,858 

Net cash used in investing activities

 

 

(11,588)

 

 

(4,846)

Net cash used in financing activities

 

 

(5,742)

 

 

(4,504)



Operating activities



Net cash provided by operating activities during the three months ended March 31, 2019 was $19.7 million compared with $9.9 million during the three months ended March 31, 2018. The increase is attributable to improved working capital management.



Investing activities



Net cash used in investing activities totaled $11.6 million for the three months ended March 31, 2019 compared with $4.8 million for the three months ended March 31, 2018. Net cash used in investing activities in each period was primarily for capital purchases of store fixtures, equipment, building improvements and leasehold improvements for stores opened or remodeled, asset additions in our distribution and manufacturing facilities, information technology infrastructure, and general corporate information technology assets.



Financing activities



Net cash used in financing activities was $5.7 million for the three months ended March 31, 2019 compared with $4.5