tts20170930 10Q

 









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 September 30, 2017



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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post 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

(Do not check if a smaller reporting company)

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



As of October 23, 2017, there were 52,158,065  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 Operations



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

16 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

24 

Item 4.

Controls and Procedures

24 

PART II. OTHER INFORMATION

 

Item 1.

Legal Proceedings

25 

Item 1A.

Risk Factors

25 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

25 

Item 3.

Defaults Upon Senior Securities

25 

Item 4.

Mine Safety Disclosures

25 

Item 5.

Other Information

25 

Item 6.

Exhibits

26 

Signatures

27 



 

 

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)

 





 

 

 

 

 

 



 

 

 

 

 

 



 

September 30,

 

December 31,



 

2017

 

2016



 

(unaudited)

 

(audited)

Assets

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

Cash and cash equivalents

 

$

12,429 

 

$

6,067 

Restricted cash

 

 

855 

 

 

3,000 

Trade receivables, net

 

 

2,663 

 

 

2,414 

Inventories

 

 

70,927 

 

 

74,295 

Income tax receivable

 

 

2,870 

 

 

1,670 

Other current assets, net

 

 

4,675 

 

 

8,755 

Total Current Assets

 

 

94,419 

 

 

96,201 

Property, plant and equipment, net

 

 

151,388 

 

 

141,037 

Deferred tax assets

 

 

17,919 

 

 

21,391 

Long-term restricted cash

 

 

 -

 

 

3,881 

Other assets

 

 

2,223 

 

 

2,763 

Total Assets

 

$

265,949 

 

$

265,273 



 

 

 

 

 

 

Liabilities and Stockholders' Equity

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

Accounts payable

 

$

28,406 

 

$

20,321 

Current portion of long-term debt

 

 

8,193 

 

 

6,286 

Income tax payable

 

 

157 

 

 

120 

Other accrued liabilities

 

 

23,970 

 

 

33,461 

Total Current Liabilities

 

 

60,726 

 

 

60,188 

Long-term debt, net

 

 

5,689 

 

 

22,126 

Capital lease obligation, net

 

 

608 

 

 

697 

Deferred rent

 

 

40,372 

 

 

37,595 

Other long-term liabilities

 

 

5,043 

 

 

5,768 

Total Liabilities

 

 

112,438 

 

 

126,374 



 

 

 

 

 

 

Stockholders’ Equity:

 

 

 

 

 

 

Common stock, par value $0.0001; authorized: 100,000,000 shares; issued and outstanding: 52,071,789 and 51,607,143 shares, respectively

 

 

 

 

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

 

 

 -

 

 

 -

Additional paid-in-capital

 

 

182,410 

 

 

185,998 

Accumulated deficit

 

 

(28,888)

 

 

(47,058)

Accumulated other comprehensive loss

 

 

(16)

 

 

(46)

Total Stockholders' Equity

 

 

153,511 

 

 

138,899 

Total Liabilities and Stockholders' Equity

 

$

265,949 

 

$

265,273 



See accompanying Notes to Consolidated Financial Statements.

 

 

3


 

Table of Contents

 

Tile Shop Holdings, Inc. and Subsidiaries

Consolidated Statements of Operations

(dollars in thousands, except per share data)

(unaudited)







 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 



 

Three Months Ended

 

Nine Months Ended



 

September 30,

 

September 30,



 

2017

 

2016

 

2017

 

2016

Net sales

 

$

84,421 

 

$

78,559 

 

$

266,020 

 

$

247,543 

Cost of sales

 

 

27,759 

 

 

23,400 

 

 

82,265 

 

 

73,980 

Gross profit

 

 

56,662 

 

 

55,159 

 

 

183,755 

 

 

173,563 

Selling, general and administrative expenses

 

 

52,285 

 

 

47,361 

 

 

154,245 

 

 

142,300 

Income from operations

 

 

4,377 

 

 

7,798 

 

 

29,510 

 

 

31,263 

Interest expense

 

 

(505)

 

 

(363)

 

 

(1,438)

 

 

(1,382)

Other income

 

 

34 

 

 

34 

 

 

132 

 

 

102 

Income before income taxes

 

 

3,906 

 

 

7,469 

 

 

28,204 

 

 

29,983 

Provision for income taxes

 

 

(1,468)

 

 

(2,886)

 

 

(10,034)

 

 

(11,793)

Net income

 

$

2,438 

 

$

4,583 

 

$

18,170 

 

$

18,190 



 

 

 

 

 

 

 

 

 

 

 

 

Income per common share:

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.05 

 

$

0.09 

 

$

0.35 

 

$

0.35 

Diluted

 

$

0.05 

 

$

0.09 

 

$

0.35 

 

$

0.35 



 

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

51,757,248 

 

 

51,426,104 

 

 

51,638,864 

 

 

51,388,058 

Diluted

 

 

52,053,655 

 

 

51,929,226 

 

 

52,011,208 

 

 

51,817,588 



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

 

Nine Months Ended



 

September 30,

 

September 30,



 

2017

 

2016

 

2017

 

2016

Net income

 

$

2,438 

 

$

4,583 

 

$

18,170 

 

$

18,190 

Currency translation adjustment

 

 

22 

 

 

(2)

 

 

30 

 

 

(10)

Other comprehensive income (loss)

 

 

22 

 

 

(2)

 

 

30 

 

 

(10)

Comprehensive income

 

$

2,460 

 

$

4,581 

 

$

18,200 

 

$

18,180 



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, 2015

 

51,437,973 

 

$

 

$

180,192 

 

$

(64,985)

 

$

(11)

 

$

115,201 

Reclassification of impact of ASU 2016-09

 

 -

 

 

 -

 

 

687 

 

 

(536)

 

 

 -

 

 

151 

Balance at January 1, 2016

 

51,437,973 

 

$

 

$

180,879 

 

$

(65,521)

 

$

(11)

 

$

115,352 

Issuance of restricted shares

 

73,384 

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

 -

Stock based compensation

 

 -

 

 

 -

 

 

4,333 

 

 

 -

 

 

 -

 

 

4,333 

Stock option exercises

 

95,786 

 

 

 -

 

 

786 

 

 

 -

 

 

 -

 

 

786 

Foreign currency translation adjustments

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

(35)

 

 

(35)

Net income

 

 -

 

 

 -

 

 

 -

 

 

18,463 

 

 

 -

 

 

18,463 

Balance at December 31, 2016

 

51,607,143 

 

$

 

$

185,998 

 

$

(47,058)

 

$

(46)

 

$

138,899 

Issuance of restricted shares

 

161,213 

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

 -

Cancellation of restricted shares

 

(9,939)

 

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

 -

Stock based compensation

 

 -

 

 

 -

 

 

2,759 

 

 

 -

 

 

 -

 

 

2,759 

Stock option exercises

 

313,372 

 

 

 -

 

 

1,417 

 

 

 -

 

 

 -

 

 

1,417 

Dividends paid

 

 -

 

 

 -

 

 

(7,764)

 

 

 -

 

 

 -

 

 

(7,764)

Foreign currency translation adjustments

 

 -

 

 

 -

 

 

 -

 

 

 -

 

 

30 

 

 

30 

Net income

 

 -

 

 

 -

 

 

 -

 

 

18,170 

 

 

 -

 

 

18,170 

Balance at September 30, 2017

 

52,071,789 

 

$

 

$

182,410 

 

$

(28,888)

 

$

(16)

 

$

153,511 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

See accompanying Notes to Consolidated Financial Statements.

 

 

6


 

Table of Contents

 

Tile Shop Holdings, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

 (dollars in thousands)

(unaudited)



 



 

 

 

 

 

 



 

 

 

 

 

 



 

Nine Months Ended



 

September 30,



 

2017

 

2016

Cash Flows From Operating Activities

 

 

 

 

 

 

Net income

 

$

18,170 

 

$

18,190 

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

 

 

 

 

 

 

Depreciation & amortization

 

 

19,395 

 

 

16,954 

Amortization of debt issuance costs

 

 

526 

 

 

416 

Loss on disposals of property, plant and equipment

 

 

205 

 

 

420 

Deferred rent

 

 

2,911 

 

 

1,767 

Stock based compensation

 

 

2,759 

 

 

3,394 

Deferred income taxes

 

 

3,472 

 

 

1,065 

Changes in operating assets and liabilities:

 

 

 

 

 

 

Trade receivables

 

 

(249)

 

 

(594)

Inventories

 

 

3,369 

 

 

3,499 

Prepaid expenses and other assets

 

 

4,163 

 

 

(303)

Accounts payable

 

 

5,421 

 

 

3,337 

Income tax receivable / payable

 

 

(1,163)

 

 

(1,188)

Accrued expenses and other liabilities

 

 

(9,624)

 

 

3,721 

Net cash provided by operating activities

 

 

49,355 

 

 

50,678 

Cash Flows From Investing Activities

 

 

 

 

 

 

Purchases of property, plant and equipment

 

 

(28,031)

 

 

(19,645)

Net cash used in investing activities

 

 

(28,031)

 

 

(19,645)

Cash Flows From Financing Activities

 

 

 

 

 

 

Release of restricted cash

 

 

6,026 

 

 

 -

Payments of long-term debt and capital lease obligations

 

 

(44,672)

 

 

(32,132)

Advances on line of credit

 

 

30,000 

 

 

 -

Dividends paid

 

 

(7,764)

 

 

 -

Proceeds from exercise of stock options

 

 

1,635 

 

 

620 

Employee taxes paid for shares withheld

 

 

(217)

 

 

 -

Security deposits

 

 

 -

 

 

(6)

Net cash used in financing activities

 

 

(14,992)

 

 

(31,518)

Effect of exchange rate changes on cash

 

 

30 

 

 

(10)

Net change in cash

 

 

6,362 

 

 

(495)

Cash and cash equivalents beginning of period

 

 

6,067 

 

 

10,330 

Cash and cash equivalents end of period

 

$

12,429 

 

$

9,835 

Supplemental disclosure of cash flow information

 

 

 

 

 

 

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

 

$

4,935 

 

$

816 

Cash paid for interest

 

 

1,453 

 

 

1,483 

Cash paid for income taxes, net

 

 

7,575 

 

 

12,981 

 

See accompanying Notes to Consolidated Financial Statements.

 

 

 

 

7


 

Table of Contents

 

Note 1: Background



The Tile Shop, LLC was formed on December 30, 2002, as a Delaware limited liability company and began operations on January 1, 2003. Tile Shop Holdings, Inc. (“Holdings,” and together with its wholly owned subsidiaries, the “Company”) was incorporated under the laws of the state of Delaware in June 2012 to become the parent company of The Tile Shop, LLC.



The Company is a specialty retailer of manufactured and natural stone 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 September 30, 2017, the Company had 134 stores in 31 states and the District of Columbia, as well as an on-line retail operation. The Company also 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 and nine months ended September 30, 2017 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2017.



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, 2016. 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 July 2015, the Financial Accounting Standards Board (“FASB”) issued a standard that simplifies the subsequent measurement of inventory. Previously, an entity was required to measure inventory at the lower of cost or market, whereby market can be replacement cost, net realizable value, or net realizable value less an approximately normal profit margin. The changes required that inventory be measured at the lower of cost and net realizable value, thereby eliminating the use of the other two market methodologies. Net realizable value is defined as the estimated selling prices in the ordinary course of business less reasonably predictable costs of completion, disposal, and transportation. The standard was effective for the Company at the beginning of fiscal 2017.  The adoption of this new standard did not have a material effect on the Company’s financial statements.



Accounting Pronouncements Not Yet Adopted



In May 2014, the FASB issued a final standard on revenue from contracts with customers. This new standard introduces a comprehensive revenue recognition model that requires a company to recognize revenue to depict the transfer of goods or services to a customer at an amount that reflects the consideration it expects to receive in exchange for those goods or services.  In 2016, the FASB issued several amendments to the standard, including principal versus agent considerations when another party is involved in providing goods or services to a customer, the application of identifying performance obligations, and the recognition of expected breakage amounts either proportionally in earnings as redemptions occur or when redemption is remote.  Upon adoption of the standard, the Company expects to present the gross sales returns reserve as a component of other accrued liabilities and establish a return asset that will be classified as a component of other current assets, net in the Consolidated Balance Sheet.  Currently, the Company presents its sales returns reserve net of the value of the return assets as a component of other accrued liabilities in the Consolidated Balance Sheet.  The Company continues to assess the impact of other aspects of this standard.  As the Company finalizes its assessment, the Company will take steps to finalize its accounting policies, establish new processes and controls when warranted, and ensure information is captured to conform with the disclosure requirements outlined under the new standard.  The standard is effective for the Company in fiscal 2018 and provides for either full retrospective adoption or modified retrospective adoption by which the cumulative effect of the change is recognized in retained earnings at the date of initial application.  The Company has elected to adopt this standard using the modified retrospective approach. 



In February 2016, the FASB issued a standard that primarily requires organizations that lease assets to recognize the rights and obligations created by those leases on the Consolidated Balance Sheet.  The standard is effective in 2019, with early adoption permitted. The Company is currently assessing the effect the new standard will have on its consolidated financial statements.



In August 2016, the FASB issued an accounting standards update with new guidance on how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The amendments in the standards update provide guidance on eight specific cash flow issues. The standards update is effective for the Company in fiscal 2018 and shall be applied to the Company’s financial statements retrospectively. The Company is currently assessing the effect the new standard will have on its consolidated financial statements.

 

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Table of Contents

 



In November 2016, the FASB issued new guidance on restricted cash on the statement of cash flows. The new guidance requires the classification and presentation of changes in restricted cash and cash equivalents in the statement of cash flows. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning and ending balances shown on the statement of cash flows. The new standard is effective for the Company in fiscal 2018, with early adoption permitted. The guidance should be applied retrospectively after adoption. The Company’s restricted cash balance was $0.9 million as of September 30, 2017. Upon adopting the new standard, the Company anticipates that it will no longer present the release of restricted cash as a financing cash inflow. Instead, restricted cash and long-term restricted cash balances will be included in the beginning and ending cash, cash equivalents and restricted cash balances in the statement of cash flows.





Note 2: Inventories



Inventories are stated at the lower of cost (determined on the weighted-average cost method) or market. Inventories consist primarily of merchandise held for sale. Inventories were comprised of the following as of September 30, 2017 and December 31, 2016:







 

 

 

 

 

 



 

 

 

 

 

 



 

(in thousands)



 

September 30,

 

December 31,



 

2017

 

2016

Finished goods

 

$

55,792 

 

$

61,949 

Raw materials

 

 

1,794 

 

 

2,312 

Finished goods in transit

 

 

13,341 

 

 

10,034 

Total

 

$

70,927 

 

$

74,295 



The Company records 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 $0.7 million and $0.2 million as of September 30, 2017 and December 31, 2016, respectively.

 

Note 3: Income taxes



The Company’s effective tax rate on net income before income taxes for the three months ended September 30, 2017 and 2016, was 37.6% and 38.6%, respectively. For the three months ended September 30, 2017 and 2016, the Company recorded a provision for income taxes of $1.5 million and $2.9 million, respectively.



The Company's effective tax rate on net income before income taxes for the nine months ended September 30, 2017 and 2016 was 35.6% and 39.3%, respectively. The improvement in the effective tax rate is attributable to an increase in excess tax benefits recognized in connection with the exercise of stock options during 2017. For the nine months ended September 30, 2017 and 2016, the Company recorded a provision for income taxes of $10.0 million and $11.8 million, respectively.



The Company records interest and penalties relating to uncertain tax positions in income tax expense. As of September 30, 2017 and 2016, the Company has not recognized any liabilities for uncertain tax positions, nor have interest and penalties related to uncertain tax positions been accrued.

 

Note 4: 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. 



 

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Table of Contents

 

Basic and diluted earnings per share were calculated as follows:







 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 



 (dollars in thousands)



 

For the three months ended

 

For the nine months ended



 

September 30,

 

September 30,



 

2017

 

2016

 

2017

 

2016

Net income

 

$

2,438 

 

$

4,583 

 

$

18,170 

 

$

18,190 

Weighted average basic shares outstanding

 

 

51,757,248 

 

 

51,426,104 

 

 

51,638,864 

 

 

51,388,058 

Effect of dilutive securities attributable to stock-based awards

 

 

296,407 

 

 

503,122 

 

 

372,344 

 

 

429,530 

Weighted average diluted shares outstanding

 

 

52,053,655 

 

 

51,929,226 

 

 

52,011,208 

 

 

51,817,588 

Income per common share:

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.05 

 

$

0.09 

 

$

0.35 

 

$

0.35 

Dilutive

 

$

0.05 

 

$

0.09 

 

$

0.35 

 

$

0.35 

Anti-dilutive securities excluded from EPS calculation

 

 

511,122 

 

 

347,699 

 

 

298,721 

 

 

409,599 

 



Note 5: Other Accrued Liabilities



Other accrued liabilities consisted of the following:







 

 

 

 

 

 



 

 

 

 

 

 



 

(in thousands)



 

September 30,

 

December 31,



 

2017

 

2016

Customer deposits

 

$

8,721 

 

$

7,742 

Sales return reserve

 

 

3,230 

 

 

3,080 

Payroll and sales taxes

 

 

3,174 

 

 

2,691 

Accrued wages and salaries

 

 

2,727 

 

 

4,962 

Shareholder litigation accrual

 

 

 -

 

 

9,500 

Other current liabilities

 

 

6,118 

 

 

5,486 

Total other accrued liabilities

 

$

23,970 

 

$

33,461 

 

Note 6: Long-term Debt



On June 2, 2015, the Company and its operating subsidiary, The Tile Shop, LLC, entered into a credit agreement with Fifth Third Bank, Bank of America, N.A., and Huntington National Bank (as amended, the “Credit Agreement”). On December 9, 2016, the Credit Agreement was amended to permit an additional New Markets Tax Credit Financing arrangement and on February 10, 2017, the Credit Agreement was amended to permit the Company to make certain dividend payments. The Credit Agreement again was amended on July 17, 2017 to adjust the consolidated fixed charge coverage ratio from 2.00:1.00 to 1.50:1.00 to provide greater flexibility in declaring and making dividend payments or other distributions to stockholders. The Credit Agreement provides the Company with a $125.0 million senior secured credit facility, comprised of a five-year $50.0 million term loan and a $75.0 million revolving line of credit. 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. Borrowings pursuant to the Credit Agreement bear interest at either a base rate or a LIBOR-based rate, at the option of the Company. The LIBOR-based rate will range from LIBOR plus 1.50% to 2.00%, depending on The Tile Shop’s leverage ratio. The base rate is equal to the greatest of: (a) the Federal funds rate plus 0.50%, (b) the Fifth Third Bank “prime rate,” and (c) the Eurodollar rate plus 1.00%, in each case plus 0.50% to 1.00% depending on The Tile Shop’s leverage ratio. At September 30, 2017 the base interest rate was 4.75% and the LIBOR-based interest rate was 2.73%. Borrowings outstanding consisted of $13.2 million on the term loan and no outstanding balance on the revolving line of credit as of September 30, 2017. There was $75.0 million available for borrowing on the revolving line of credit as of September 30, 2017. The Company can elect to prepay the term loan without incurring a penalty. Additional borrowings pursuant to the Credit Agreement may be used to support the Company’s growth and for working capital purposes. The term loan requires quarterly principal payments as follows (in thousands):

  





 

 

 



 

 

 

Period

 

 

 

December 31, 2017 to June 30, 2018

 

 

1,875 

September 30, 2018 to March 31, 2020

 

 

2,500 



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, make investments, or enter into transactions with affiliates on other than terms that could be obtained in an arm’s length transaction. The Credit Agreement also

 

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includes financial and other covenants including covenants to maintain certain fixed charge coverage ratios and rent adjusted leverage ratios. The Company was in compliance with the covenants as of September 30, 2017.



The Company has standby letters of credit outstanding related to its workers compensation and medical insurance policies.  As of September 30, 2017 and 2016, the standby letters of credit totaled $1.1 million.



Long-term debt consisted of the following at September 30, 2017 and December 31, 2016 (in thousands):







 

 

 

 

 

 

 

 

 

 

 

 



 

September 30, 2017

 

December 31, 2016



 

 

 

Unamortized

 

 

 

Unamortized



 

 

 

Debt Issuance

 

 

 

Debt Issuance



 

Principal

 

Costs

 

Principal

 

Costs

Term note payable - interest at 2.73% and 2.27% at September 30, 2017 and December 31, 2016, respectively

 

$

13,221 

 

$

(44)

 

$

17,721 

 

$

(114)

Commercial bank credit facility

 

 

 -

 

 

 -

 

 

10,000 

 

 

 -

Variable interest rate bonds (1.29% and 0.89% at September 30, 2017 and December 31, 2016), which mature April 1, 2023, collateralized by buildings and equipment

 

 

705 

 

 

 -

 

 

805 

 

 

 -

Total debt obligations

 

 

13,926 

 

 

(44)

 

 

28,526 

 

 

(114)

Less: current portion

 

 

8,230 

 

 

(37)

 

 

6,350 

 

 

(64)

Debt obligations, net of current portion

 

$

5,696 

 

$

(7)

 

$

22,176 

 

$

(50)

 



Note 7: 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 September 30, 2017 and December 31, 2016 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.







 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 



 

 

 

Fair Value at



 

Pricing

 

September 30,

 

December 31,



 

Category

 

2017

 

2016

Assets

 

(in thousands)

Cash and cash equivalents

 

Level 1

 

$

12,429 

 

$

6,067 

Restricted cash

 

Level 1

 

 

855 

 

 

3,000 

Long-term restricted cash

 

Level 1

 

 

 -

 

 

3,881 



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.



 

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·

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.



·

Long-term restricted cash: Consists of cash and cash equivalents held in bank deposit accounts restricted as to withdrawal and designated for expenditure in the construction of noncurrent assets.  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 is measured at fair value when an impairment is recognized and the related assets are written down to fair value.  The Company did not recognize any significant impairment losses during 2017 or 2016.  The carrying value of the Company’s borrowings under its credit agreement approximate fair value based upon the market interest rates available to the Company for debt obligations with similar risks and maturities.

 

Note 8: 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 and nine months ended September 30, 2017 and 2016 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 $0.6 million for both the three months ended September 30, 2017 and 2016. Total stock-based compensation expense related to stock options was $1.7 million and $2.6 million for the nine months ended September 30, 2017 and 2016, respectively. Stock-based compensation expense pertaining to stock options is included in selling, general and administrative expenses in the accompanying Consolidated Statements of Operations.



As of September 30, 2017, the Company had outstanding stock options to purchase 1,920,621 shares of common stock at a weighted average exercise price of $15.10.



Restricted stock:



The Company awards restricted common shares to selected employees and to non-employee directors. Recipients are not required to provide any consideration other than continued service. Restricted share 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 its adjusted EBITDA 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 September 30, 2017 and 2016, respectively. Total stock-based compensation expense related to restricted stock was $1.1 million and $0.8 million for the nine months ended September 30, 2017 and 2016, respectively. Stock-based compensation expense pertaining to restricted stock awards is included in selling, general and administrative expenses in the accompanying Consolidated Statements of Operations.



As of September 30, 2017, the Company had 198,406 outstanding restricted common shares.

 

Note 9: 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. U.S. Bank made a capital contribution to, and Tile Shop Lending, Inc. (“Tile Shop Lending”) made a loan to, Twain Investment Fund 192 LLC (the “Investment Fund”) under a qualified New Markets Tax Credit (“NMTC”) program. The NMTC program was provided for in the Community Renewal Tax Relief Act of 2000 (the “Act”) and is intended to induce capital investment in qualified lower income communities. The Act permits taxpayers to claim credits against their Federal income taxes for up to 39% of qualified investments in the equity of community development

 

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entities (“CDEs”). CDEs are privately managed investment institutions that are certified to make qualified low-income community investments.



In December 2016, Tile Shop Lending loaned $6.7 million to the Investment Fund at an interest rate of 1.37% per year and with a maturity of December 31, 2046. The Investment Fund then contributed the loan to a CDE, which, in turn, loaned the funds on similar terms to Tile Shop of Oklahoma, LLC, an indirect, wholly-owned subsidiary of Holdings. The proceeds of the loans from the CDEs (including loans representing the capital contribution made by U.S. Bank, net of syndication fees) were used to partially fund the distribution center project. 



In December 2016, U.S. Bank also contributed $3.1 million to the Investment Funds and, by virtue of such contribution, is entitled to substantially all of the tax benefits derived from the NMTCs, 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 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 $3.1 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 $1.2 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 $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 September 30, 2017, the balance of the contribution liability was $2.9 million, of which $0.5 million is classified as other accrued liabilities on the Consolidated Balance Sheet and $2.4 million is 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. During the nine months ended September 30, 2017, the Company received reimbursements totaling $6.0 million from the investment fund. As of September 30, 2017, the balance in the Investment Fund available for reimbursement to the Company was $0.9 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 a $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

 

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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 Investment Fund. 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 September 30, 2017, the balance of the contribution liability was $1.9 million, of which $0.7 million is classified as other accrued liabilities on the Consolidated Balance Sheet and $1.2 million is classified as other long-term liabilities on the Consolidated Balance Sheet.



Note 10: Commitments and Contingencies



The Company, was a defendant in a consolidated class action arising in 2013 alleging it failed to disclose certain related party transactions in the Company’s SEC filings and press releases. In January 2017, the plaintiffs and the Company agreed to settle the lawsuit for $9.5 millionThe court approved the settlement, and entered an order dismissing the action on June 14, 2017.



The Company also is a nominal defendant in three actions brought derivatively on behalf of the Company by three shareholders in 2015.  The plaintiffs allege that the defendant-directors and/or officers breached their fiduciary duties by failing to adopt adequate internal controls for the Company, by approving false and misleading statements issued by the Company, by causing the Company to violate generally accepted accounting principles and SEC regulations, by engaging in or approving alleged insider trading, and by permitting the Company’s primary product to contain illegal amounts of lead. The complaints also allege claims for insider trading and/or unjust enrichment. The Company moved to dismiss the actions, or in the alternative, to stay the actions.  Those motions have not yet been decided. 



By letter dated May 19, 2016, a shareholder of the Company demanded that the Board of Directors investigate alleged breaches of fiduciary duty related to the same matters described above and take action against certain present and former officers and directors of the Company. The Board of Directors has appointed a committee of two independent directors to investigate and evaluate the matters raised in the demand letter, and to recommend to the Company’s Board of Directors what actions, if any, should be taken by the Company with respect to the matters raised in the demand letter. 



Given the uncertainty of litigation and the current stage of the derivative actions, the Company cannot reasonably estimate the possible loss or range of loss that may result. The Company maintains directors and officers liability insurance policies that may reduce the Company’s exposure, if any. In the event the Company incurs a loss, the Company will pursue recoveries to the maximum extent available under these policies. 



The Company is also, from time to time, subject to claims and disputes arising in the normal course of business.  In the opinion of management, while the outcome of such claims and disputes cannot be predicted with certainty, the Company’s ultimate liability in connection with these matters is not expected to have a material adverse effect on the results of operations, financial position, or cash flows. 



Note 11: Subsequent Events



On October 17, 2017, the Company declared a $0.05 dividend to stockholders of record as of the close of business on October 31, 2017. The dividend will be paid on November 14, 2017.





 

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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, 2016 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” that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. The statements contained in this Quarterly Report on Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or Exchange Act. Forward-looking statements are often identified by the use of words such as, but not limited to, “anticipate,” “believe,” “can,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “might,” “plan,” “project,” “seek,” “should,” “target,” “will,” “will likely result,” “would,” and similar expressions or variations intended to identify forward-looking statements. These statements are based on the beliefs and assumptions of our management based on information currently available to management. Such forward-looking statements are subject to risks, uncertainties and other important factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, 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, competitive factors, increases to interest rates or other impacts on our ability to obtain or maintain financing, unanticipated expenses related to operating as a public company including but not limited to litigation-related expenses, and those factors disclosed in the section captioned “Risk Factors” in our Annual Report for the fiscal year ended December 31, 2016, filed with the Securities and Exchange Commission. Furthermore, such forward-looking statements speak only as of the date of this report. 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 manufactured and natural stone 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 September 30, 2017, we operated 134 stores in 31 states and the District of Columbia, with an average size of 20,500 square feet. We also sell our products on our website.



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 manufactured and natural stone 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 11 new stores in the first nine months of 2017, and opened 9 new stores in the United States during 2016. Between October 1, 2016 and September 30, 2017, we opened 14 new store locations. We plan to open approximately 15 stores in 2017. 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 and nine months ended September 30, 2017, we reported net sales of $84.4 million and $266.0 million, respectively. For the three and nine months ended September 30, 2016, we reported net sales of $78.6 million and $247.5 million, respectively. The increase in sales for the three and nine months ended September 30, 2017 was primarily due to sales generated by stores opened since September 30, 2016, as well as comparable store sales increases of 1.1% and 2.2%, respectively. 



During the three and nine months ended September 30, 2017, we experienced a decrease in the growth rate of comparable store sales compared to 2016.  Comparable store sales increased 7.6% during the year ended December 31, 2016. The deceleration in sales at comparable stores for the three and nine months ended September 30, 2017 was due to an increase in competitive activity, increased consumer demand for opening price point offerings, and a significant product transition which caused disruption to our product availability in our stores during the period.  In addition, inconsistent execution across certain markets also contributed to a lower conversion rate and lower sales.

 

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The table below sets forth information about our same store sales growth for the three and nine months ended September 30, 2017 and 2016.  







 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 



 

For the three months ended

 

For the nine months ended



 

September 30,

 

September 30,



 

2017

 

2016

 

2017

 

2016

Same store sales growth

 

1.1 

%

 

5.7 

%

 

2.2 

%

 

9.0 

%





For the three and nine months ended September 30, 2017, we reported gross profit of $56.7 million and $183.8 million, respectively.  For the three and nine months ended September 30, 2016, we reported gross profit of $55.2 million and $173.6 million, respectively.  The gross margin rate for the three and nine months ended September 30, 2017 was 67.1% and 69.1%, respectively. The gross margin rate for the three and nine months ended September 30, 2016 was 70.2% and 70.1%, respectively.  The decrease in the gross margin rate was primarily due to promotional pricing and increased demand for opening price point product. Additionally, sales growth of installation and setting materials, which carry a lower gross margin rate, outpaced the sales performance of other product categories.



For the three and nine months ended September 30, 2017, we reported income from operations of $4.4 million and $29.5 million, respectively.  For the three and nine months ended September 30, 2016, we reported income from operations of $7.8 million and $31.3 million.  The decrease in income from operations during the period was primarily driven by a deceleration in comparable store sales growth, a decrease in our gross margin rate and an increase in occupancy costs due to the opening of new stores since October 1, 2016



Net cash provided by operating activities was $49.4 million and $50.7 million for the nine months ended September 30, 2017 and 2016, respectively, which was used to fund operations, new store construction activities, and debt repayments. We expect to continue to fund our capital expenditures and daily operations from our operating cash flows. As of September 30, 2017, we had cash of $12.4 million and working capital of $33.7 million compared with cash of $9.8 million and working capital of $37.7 million at September 30, 2016.



Year to date free cash flow in 2017 of $21.3 million enabled an additional $5.0 million reduction to long-term debt during the third quarter, bringing our net debt position to $1.5 million at quarter end. See the “Non-GAAP Measures” section below for a reconciliation of these Non-GAAP measures to the comparable GAAP measures.

 

Key Components of our Consolidated Statements of Operations



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 possession of the merchandise or final delivery of the product has occurred. We recognize service revenue, which consists primarily of freight charges for home delivery, when the service has been rendered. 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.



Same store sales amounts include total charges to customers less any actual returns, and the change in the returns provision related to comparable stores. In general, we consider a new or relocated store in the comparable store sales calculation on the first day of the 13th full month of operation.



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



Selling, General, and Administrative Expenses Selling, general, and administrative expenses consists primarily of payroll and benefit costs, occupancy, utilities, and maintenance costs, advertising cost, freight expenses to move inventory from the Company’s distribution centers to the Company’s stores, depreciation and amortization.



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



Provision for 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 Measures



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, stock based compensation expense, and special charges, which consist of litigation costs. Adjusted EBITDA margin is equal to Adjusted EBITDA divided by net sales. Free cash flows is calculated by taking net cash provided by operating activities and subtracting net cash used for the purchase of property, plant and equipment. Non-GAAP net income excludes the special charges, which consist of litigation costs, and is net of tax. Net debt equals long-term debt, net, plus the current portion of long-term debt, minus cash and cash equivalents.



We believe that these non-GAAP measures of financial results provide useful information to management and investors regarding certain financial and business trends relating to our financial condition and results of operations. Our management uses these non-GAAP measures 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. These measures are used in monthly financial reports prepared for management and our Board of Directors. We believe that the use of these non-GAAP financial measures provides an additional tool for investors to use in evaluating ongoing operating results and trends and in comparing our financial measures with other specialty retailers, many of which present similar non-GAAP financial measures to investors.



The reconciliation of Adjusted EBITDA to net income for the three and nine months ended September 30, 2017 and 2016 is as follows:







 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 (in thousands)



 

Three Months Ended



 

September 30,



 

2017

 

 

% of sales

 

2016

 

 

% of sales

Net income

 

$

2,438 

 

 

2.9 

%

 

$

4,583 

 

$

5.8 

%

Interest expense

 

 

505 

 

 

0.6 

%

 

 

363 

 

 

0.5 

%

Income taxes

 

 

1,468 

 

 

1.7 

%

 

 

2,886 

 

 

3.7 

%

Depreciation & amortization

 

 

6,803 

 

 

8.1 

%

 

 

5,770 

 

 

7.3 

%

Special charges: Litigation costs

 

 

436 

 

 

0.5 

%

 

 

725 

 

 

0.9 

%

Stock-based compensation

 

 

989 

 

 

1.2 

%

 

 

930 

 

 

1.2 

%

Adjusted EBITDA

 

$

12,639 

 

 

15.0 

%

 

$

15,257 

 

$

19.4 

%







 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 (in thousands)

 



 

Nine Months Ended



 

September 30,



 

2017

 

 

% of sales(1)

 

2016

 

 

% of sales

Net income

 

$

18,170 

 

 

6.8 

%

 

$

18,190 

 

 

7.3 

%

Interest expense

 

 

1,438 

 

 

0.5 

%

 

 

1,382 

 

 

0.6 

%

Income taxes

 

 

10,034 

 

 

3.8 

%

 

 

11,793 

 

 

4.8 

%

Depreciation & amortization

 

 

19,395 

 

 

7.3 

%

 

 

16,954 

 

 

6.8 

%

Special charges: Litigation costs

 

 

1,084 

 

 

0.4 

%

 

 

1,827 

 

 

0.7 

%

Stock-based compensation

 

 

2,759 

 

 

1.0 

%

 

 

3,394 

 

 

1.4 

%

Adjusted EBITDA

 

$

52,880 

 

 

19.9 

%

 

$

53,540 

 

 

21.6 

%

 (1) Amounts may not foot due to rounding.

 

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The reconciliation of free cash flows to net cash provided by operating activities for the three and nine months ended September 30, 2017 and 2016 is as follows:







 

 

 

 

 

 



 

 

 

 

 

 

  

 

(in thousands)



 

Nine Months Ended



 

September 30,



 

2017

 

2016

Net cash provided by operating activities

 

$

49,355 

 

$

50,678 

Purchase of property, plant and equipment

 

 

(28,031)

 

 

(19,645)

Free cash flows

 

$

21,324 

 

$

31,033 



The reconciliation of GAAP income to Non-GAAP income for the three and nine months ended September 30, 2017 and 2016 is as follows:





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Three Months Ended

 

 

Three Months Ended



 

September 30, 2017

 

 

September 30, 2016

(in thousands, except share and per share data)

 

Pretax

 

Net of Tax

 

Per Share
Amounts(1)

 

 

Pretax

 

Net of Tax

 

Per Share
Amounts

GAAP income

 

$

3,906 

 

$

2,438 

 

$

0.05 

 

 

$

7,469 

 

$

4,583 

 

$

0.09 

Special charges: Litigation costs

 

 

436 

 

 

272 

 

 

0.01 

 

 

 

725 

 

 

445 

 

 

0.01 

Non-GAAP income

 

$

4,342 

 

$

2,710 

 

$

0.05 

 

 

$

8,194 

 

$

5,028 

 

$

0.10 

(1) Amounts may not foot due to rounding.







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

Nine Months Ended

 

 

Nine Months Ended



 

September 30, 2017

 

 

September 30, 2016

(in thousands, except share and per share data)

 

Pretax

 

Net of Tax

 

Per Share
Amounts

 

 

Pretax

 

Net of Tax

 

Per Share
Amounts

GAAP income

 

$

28,204 

 

$

18,170 

 

$

0.35 

 

 

$

29,983 

 

$

18,190 

 

$

0.35 

Special charges: Litigation costs

 

 

1,084 

 

 

699 

 

 

0.01 

 

 

 

1,827 

 

 

1,108 

 

 

0.02 

Non-GAAP income

 

$

29,288 

 

$

18,869 

 

$

0.36 

 

 

$

31,810 

 

$

19,298 

 

$

0.37 





The reconciliation of long-term debt, net to net debt as of September 30, 2017 is as follows:







 

 

 



 

 

 



 

 

As of



 

 

September 30, 2017

Long-term debt, net

 

$

5,689 

Current portion of long-term debt

 

 

8,193 

Cash and cash equivalents

 

 

(12,429)

Net Debt

 

$

1,453 



Our management does not consider these non-GAAP measures in isolation or as an alternative to financial measures determined in accordance with GAAP. The principal limitations of these non-GAAP financial measures are 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 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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