ITE
M 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 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
June 30, 2017
, we operated
130
stores in
31
states and the District of Columbia, with an average size of
20,800
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
7
new stores in the first six months of
2017
, and opened
9
new stores in the United States during
2016
. 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 six months ended June 30, 2017, we reported net sales of $89.5 million and $181.6 million, respectively. For the three and six months ended June 30, 2016, we reported net sales of $84.3 million and $169.0 million, respe
ctively. The increase in sales for the six months ended June 30,
2017 was primarily due to sales generated by stores opened since June 30, 2016
, as well as a comparable store sales increase of 2.7%
. During the six-month period ended June 30, 2017, we noted a decrease in the growth rate of comparable store sales compared to 2016. A slight decrease in conversion rate was the primary driver of slowed comparable store sales growth during the second quarter. We believe the most significant contributor to the decrease in conversion rate was inconsistent execution across certain markets. We anticipate a low to mid-single digit increase in comparable store sales for the year ending December 31, 2017. Comparable store sales incre
ased 7.6% during the year ended
December 31, 2016.
For the three and six months ended June 30, 2017, we reported income from operations of $11.6 million and $25.1 million, respectively. For the three and six months ended June 30, 2016, we reported income from operations of $11.7 million and $23.5 million. The decrease in income from operations during the quarter was primarily driven by a deceleration in comparable store sales
growth and an increase in occupancy costs. During the six month period, the increase in income from operations
was
driven by the 2.7% increase in comparable store sales.
Net cash provided by operating activities was
$34.8
million and
$40.8
million for the
six months ended June 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
June 30, 2017
, we had cash of
$12.0
million and working capital of
$38.2
million compared to cash of $13.4 million and working capital of $39.3 million at June 30, 2016.
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.
Comparable store sales for the
three months ended June 30, 2017
increased
$0.5
million, compared to the
three months ended June 30, 2016
.
Comparable store sales for the
six months ended June 30, 2017
increased
$4.5
million, compared to the
six months ended June 30, 2016
.
The table below sets forth information about our same store sales growth for the
three and six months ended June 30, 2017 and 2016
.
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For the three months ended
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For the six months ended
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June 30,
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June 30,
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2017
|
|
2016
|
|
2017
|
|
2016
|
Same store sales growth
|
|
0.5
|
%
|
|
8.2
|
%
|
|
2.7
|
%
|
|
10.6
|
%
|
The
increase in same store sales growth is primarily attributable to an increase in the volume of transactions. Same store sale
s
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.
Between
July
1,
2016
and
June 30, 2017
, we opened
13
new
store
locations. Incremental net sales of
$4.7
million
and
$8.1
million
occurred in the
three and six months ended June 30, 2017
, respectively,
from stores not included in the comparable store base.
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. For the
three months ended June 30, 2017 and 2016
, our cost of sales as a percentage of net sales was
30.3%
.
For the
six months ended June 30, 2017 and 2016
, our cost of sales as a percentage of net sales was
30.0%
and
29.9%
, respectively.
The increase was primarily attributable to an increased level of discounting during the
six months ended June 30, 2017
.
Selling,
G
eneral, and
A
dministrative
E
xpenses
For the
three months ended June 30, 2017 and 2016
, our selling, general, and administrative expenses as a percentage of net sales were
56.7%
and
55.8%
, respectively. The
in
crease
was primarily attributable to an increase in
occupancy,
compensation, benefit and advertising costs
, which outpaced the growth of sales during the quarter
.
For the
six months ended June 30, 2017 and 2016
, our selling, general, and administrative expenses as a percentage of net sales were
56.1%
and
56.2%
, respectively. The decrease was primarily attributable to an increase in
sales growth
, which outpaced the growth of selling, general, and administrative expenses for the
six months ended June 30, 2017
.
Provision for
Income
T
axes
We are subject to income tax in the United States as well as other tax jurisdictions in which we conduct business. Our effective tax rate for the
three months ended June 30, 2017 and 2016
was
31.1%
and
39.4%
, respectively
.
Our effective tax rate for the six months ended June 30, 2017 and 2016 was
35.3%
and 39.6%, respectively. The
decrease in the
Company’s tax rate
for the three and six month periods was due to increases in excess tax benefits recognized in connection with the exercise of non-qualified stock options and disqualifying dispositions of incentive stock options during the second quarter of 2017
.
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 shareholder and other 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 sharehol
der and other litigation costs
, and is net of tax.
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 six months ended June 30, 2017 and 2016
is as follows:
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(in thousands)
|
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|
Three Months Ended
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|
June 30,
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|
|
2017
|
|
|
% of sales
(1)
|
|
2016
|
|
|
% of sales
(1)
|
Net income
|
|
$
|
7,723
|
|
|
8.6
|
%
|
|
$
|
6,849
|
|
$
|
8.1
|
%
|
Interest expense
|
|
|
448
|
|
|
0.5
|
%
|
|
|
449
|
|
|
0.5
|
%
|
Income taxes
|
|
|
3,491
|
|
|
3.9
|
%
|
|
|
4,448
|
|
|
5.3
|
%
|
Depreciation & amortization
|
|
|
6,256
|
|
|
7.0
|
%
|
|
|
5,613
|
|
|
6.7
|
%
|
Special charges
|
|
|
298
|
|
|
0.3
|
%
|
|
|
405
|
|
|
0.5
|
%
|
Stock-based compensation
|
|
|
928
|
|
|
1.0
|
%
|
|
|
1,235
|
|
|
1.5
|
%
|
Adjusted EBITDA
|
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$
|
19,144
|
|
|
21.4
|
%
|
|
$
|
18,999
|
|
$
|
22.5
|
%
|
(1)
Amounts may not foot due to rounding.
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(in thousands)
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Six Months Ended
|
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|
June 30,
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|
|
2017
|
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% of sales
|
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2016
|
|
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% of sales
(1)
|
Net income
|
|
$
|
15,732
|
|
|
8.7
|
%
|
|
$
|
13,607
|
|
|
8.1
|
%
|
Interest expense
|
|
|
933
|
|
|
0.5
|
%
|
|
|
1,019
|
|
|
0.6
|
%
|
Income taxes
|
|
|
8,566
|
|
|
4.7
|
%
|
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|
8,907
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|
5.3
|
%
|
Depreciation & amortization
|
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|
12,592
|
|
|
6.9
|
%
|
|
|
11,184
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6.6
|
%
|
Special charges
|
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649
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0.4
|
%
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1,102
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0.7
|
%
|
Stock-based compensation
|
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|
1,770
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|
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1.0
|
%
|
|
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2,464
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1.5
|
%
|
Adjusted EBITDA
|
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$
|
40,242
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22.2
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%
|
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$
|
38,283
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22.7
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%
|
(1)
Amounts may not foot due to rounding.
The r
econciliation of free cash flow
to net cash provided by operating activities for
the
three and six months ended June 30, 2017 and 2016
is as follows:
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(in thousands)
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Six Months Ended
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June 30,
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|
2017
|
|
2016
|
Net cash provided by operating activities
|
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$
|
34,828
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$
|
40,761
|
Purchase of property, plant and equipment
|
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(20,000)
|
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(11,703)
|
Free cash flows
|
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$
|
14,828
|
|
$
|
29,058
|
The reconciliation of
GAAP
income
to Non-GAAP income
for the
three and six months ended June 30, 2017 and 2016
is as follows:
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Three Months Ended
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|
Three Months Ended
|
|
|
June 30, 2017
|
|
|
June 30, 2016
|
(in thousands, except share and per share data)
|
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Pretax
|
|
Net of Tax
|
|
Per Share
Amounts
|
|
|
Pretax
|
|
Net of Tax
|
|
Per Share
Amounts
(1)
|
GAAP income
|
|
$
|
11,214
|
|
$
|
7,723
|
|
$
|
0.15
|
|
|
$
|
11,297
|
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$
|
6,849
|
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$
|
0.13
|
Special charges:
|
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Litigation costs
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298
|
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|
205
|
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|
0.00
|
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|
|
405
|
|
|
246
|
|
|
0.00
|
Non-GAAP income
|
|
$
|
11,512
|
|
$
|
7,928
|
|
$
|
0.15
|
|
|
$
|
11,702
|
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$
|
7,095
|
|
$
|
0.14
|
(1)
Amounts may not foot due to rounding.
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Six Months Ended
|
|
|
Six Months Ended
|
|
|
June 30, 2017
|
|
|
June 30, 2016
|
(in thousands, except share and per share data)
|
|
Pretax
|
|
Net of Tax
|
|
Per Share
Amounts
|
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|
Pretax
|
|
Net of Tax
|
|
Per Share
Amounts
(1)
|
GAAP income
|
|
$
|
24,298
|
|
$
|
15,732
|
|
$
|
0.30
|
|
|
$
|
22,514
|
|
$
|
13,607
|
|
$
|
0.26
|
Special charges:
|
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Litigation costs
|
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|
649
|
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|
420
|
|
|
0.01
|
|
|
|
1,102
|
|
|
666
|
|
|
0.01
|
Non-GAAP income
|
|
$
|
24,947
|
|
$
|
16,152
|
|
$
|
0.31
|
|
|
$
|
23,616
|
|
$
|
14,273
|
|
$
|
0.28
|
(1)
Amounts may not foot due to rounding.
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.
Results of Operations
Comparison of the
three months ended June 30, 2017
to the
three months ended June 30, 2016
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(in thousands)
|
|
|
2017
|
|
% of sales
(1)
|
|
2016
|
|
% of sales
|
Net sales
|
|
$
|
89,464
|
|
|
|
|
$
|
84,270
|
|
|
|
Cost of sales
|
|
|
27,116
|
|
30.3
|
%
|
|
|
25,571
|
|
30.3
|
%
|
Gross profit
|
|
|
62,348
|
|
69.7
|
%
|
|
|
58,699
|
|
69.7
|
%
|
Selling, general and administrative expenses
|
|
|
50,748
|
|
56.7
|
%
|
|
|
46,990
|
|
55.8
|
%
|
Income from operations
|
|
|
11,600
|
|
13.0
|
%
|
|
|
11,709
|
|
13.9
|
%
|
Interest expense
|
|
|
(448)
|
|
(0.5)
|
%
|
|
|
(449)
|
|
(0.5)
|
%
|
Other income
|
|
|
62
|
|
0.1
|
%
|
|
|
37
|
|
0.0
|
%
|
Income before income taxes
|
|
|
11,214
|
|
12.5
|
%
|
|
|
11,297
|
|
13.4
|
%
|
Provision for income taxes
|
|
|
(3,491)
|
|
(3.9)
|
%
|
|
|
(4,448)
|
|
(5.3)
|
%
|
Net income
|
|
$
|
7,723
|
|
8.6
|
%
|
|
$
|
6,849
|
|
8.1
|
%
|
(1)
Amounts may not foot due to rounding.
Net Sales
Net sales for the
second
quarter of
2017
increased
$5.2
million, or
6.2%
, over the
second
quarter of
2016
. Com
parable store sales increased
$0.5
million for the
second
quarter of
2017
due to an increase in the volume of transactions. Net sales for the
13
new stores open less than twelve months were
$4.7
million during the
second
quarter of
2017
.
Gross Profit
Gross profit for the
second
quarter of
2017
increased
$3.6
million, or
6.2%
, compared to the
second
quarter of
2016
, primarily due to an increase in net sales. The gross margin rate was
69.7%
for the
second
quarter 2016 and
2017
.
Selling, General, and Administrative Expenses
Selling, general, and administrative expenses for the
second
quarter of
2017
increased
$3.8
million, or
8.0%
, compared to the
second
quarter of
2016
. The increase in selling, general, and administrative expenses was primarily due to an increase in occupancy costs of $2.4 million as a result of opening
13
new stores during the period from July 1,
2016
through
June 30, 2017
. The remainder of the increase was driven primarily by an increase in variable compensation associated with a
0.5%
increase in comparable store sales for the
three months ended June 30, 2017
. Selling, general, and administrative expenses as a percentage of net sales increased to
56.7%
for the
second
quarter of
2017
compared to
55.8%
for the
second
quarter of
2016
. The increase was primarily attributable to an increase in occupancy, compensation, benefit and advertising costs, which outpaced the growth of sales during the quarter.
Selling, general, and administrative expenses include costs of
$0.3
million and
$0.4
million for the
second
quarters of
2017
and
2016
, respectively, which relate to special charges consisting of shareholder and other litigation expenses.
Pre-opening Costs
Our pre-opening costs are those typically associated with the opening of a new store 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. During the
second
quarter of
2017
and
2016
, we incurred pre-opening costs of
$0.5
million and
$0.2
million, respectively.
Interest Expense
Interest expense was $0.4 million for the three months ended June 30, 2017 and 2016. The decrease in the average debt balance outstanding was offset by a higher interest rate during the quarter in 2017.
Provision for Income Taxes
Income tax provision decreased
$1.0
million for the
second
quarter of
2017
compared to the
second
quarter of
2016
due to a lower effective tax rate in the
second
quarter of
2017
. Our effective tax rate for the three months ended
June 30, 2017
and
2016
was
31.1%
and
39.4%
, respectively.
The decrease in the Company’s tax
rate for the second quarter of 2017
was due to increases in excess tax benefits recognized in connection with the exercise of non-qualified stock options and disqualifying dispositions of incentive stock options during the second quarter of 2017.
Results of Operations
Comparison of the
six months ended June 30, 2017
to the
six months ended June 30, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(in thousands)
|
|
|
2017
|
|
% of sales
(1)
|
|
2016
|
|
% of sales
(1)
|
Net sales
|
|
$
|
181,599
|
|
|
|
|
$
|
168,984
|
|
|
|
Cost of sales
|
|
|
54,506
|
|
30.0
|
%
|
|
|
50,580
|
|
29.9
|
%
|
Gross profit
|
|
|
127,093
|
|
70.0
|
%
|
|
|
118,404
|
|
70.1
|
%
|
Selling, general and administrative expenses
|
|
|
101,960
|
|
56.1
|
%
|
|
|
94,939
|
|
56.2
|
%
|
Income from operations
|
|
|
25,133
|
|
13.8
|
%
|
|
|
23,465
|
|
13.9
|
%
|
Interest expense
|
|
|
(933)
|
|
(0.5)
|
%
|
|
|
(1,019)
|
|
(0.6)
|
%
|
Other income
|
|
|
98
|
|
0.1
|
%
|
|
|
68
|
|
0.0
|
%
|
Income before income taxes
|
|
|
24,298
|
|
13.4
|
%
|
|
|
22,514
|
|
13.3
|
%
|
Provision for income taxes
|
|
|
(8,566)
|
|
(4.7)
|
%
|
|
|
(8,907)
|
|
(5.3)
|
%
|
Net income
|
|
$
|
15,732
|
|
8.7
|
%
|
|
$
|
13,607
|
|
8.1
|
%
|
(1)
Amounts may not foot due to rounding.
Net Sales
Net sales for the
six months ended June 30, 2017
increased
$12.6
million, or
7.5%
, over the
six months ended June 30, 2016
. Com
parable store sales increased
$4.5
million for the
six months ended June 30, 2017
due to an increase in the volume of transactions. Net sales for the
13
new stores open less than twelve months were
$8.1
million during the
six months ended June 30, 2017
.
Gross Profit
Gross profit for the
six months ended June 30, 2017
increased
$8.7
million, or
7.3%
, compared to the
six months ended June 30, 2016
due to the increase in net sales. The increases in sales was partially offset by a decrease in gross margin rate which fell from
70.1%
for the
six months ended June 30, 2016
to
70.0%
for the
six months ended June 30, 2017
. The decrease was primarily attributable to an increased level of discounting during the
six months ended June 30, 2017
.
Selling, General, and Administrative Expenses
Selling, general, and administrative expenses for the
six months ended June 30, 2017
increased
$7.0
million, or
7.4%
, compared to
six months ended June 30, 2016
. The increase in selling, general, and administrative expenses was primarily due to an increase in occupancy costs of $4.5 million as a result of opening
13
new stores during the period from April 1,
2016
through
June 30, 2017
. Selling, general, and administrative expenses as a percentage of net sales decreased to
56.1%
for the
six months ended June 30, 2017
compared to
56.2%
for the
six months ended June 30, 2016
. The decrease in selling, general, and administrative expenses as a percentage of net sales was primarily due to a maturing store base that has higher net sales levels, which outpaced the growth of selling, general, and administrative expenses.
Selling, general, and administrative expenses include costs of
$0.6
million and
$1.1
million for the
six months ended June 30, 2017 and 2016
, respectively, which relate to special charges consisting of shareholder and other litigation expenses.
Pre-opening Costs
Our pre-opening costs are those typically associated with the opening of a new store 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. During the
six months ended June 30, 2017 and 2016
, we incurred pre-opening costs of
$0.8
million and
$0.4
million, respectively.
Interest Expense
Interest expense decreased
$0.1
million for the
six months ended June 30, 2017
compared to the
six months ended June 30, 2016
. The decrease is primarily due to the decrease in the debt balance in
2017
.
Provision for Income Taxes
Our income tax provision decreased
$0.3
million for the
six months ended June 30, 2017
compared to the
six months ended June 30, 2016
due to a decrease in the Company’s tax rate for the six months ended June 30, 2017. Our effective tax rate for the
three and six months ended June 30, 2017 and 2016
was
35.3%
and
39.6%
, respectively.
The decrease in the Company’s tax rate for the six month
s ended June 30, 2017
was due to increases in excess tax benefits recognized in connection with the exercise of non-qualified stock options and disqualifying dispositions of incentive stock options during the second quarter of 2017.
Liquidity and Capital Resources
Our principal uses of liquidity have been investments in working capital and capital expenditures. Our principal sources of liquidity are
$12.0
million of cash and cash equivalents at
June 30, 2017
, 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, reducing outstanding debt, and general corporate purposes.
We also recently approved the establishment of a regular quarterly dividend that 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 June 2, 2015, we, and our 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 subsequently 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 us to make certain dividend payments.
The Credit Agreement again was amended on July 17, 2017 to amend 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 us 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 our assets, 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 our option. The LIBOR-based rate will range from LIBOR plus 1.50% to 2.00%, depending on our 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% d
epending on our leverage ratio. At
June 30, 2017
the base interest rate was
4.75%
and the LIBOR-based interest rate was
2.72%
. Borrowings outstanding consisted of
$3.0
million on the revolving line of credit and
$15.2
million on the term loan as of
June 30, 2017
. There was
$72.0
million available for borrowing on the revolving line of credit as of
June 30, 2017
. We can elect to prepay the term loan without incurring a penalty. To the extent we have an outstanding balance on our term loan, the credit agreement requires quarterly principal payments as follows (in thousands):
|
|
|
|
|
|
|
|
Period
|
|
|
|
September 30, 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 our 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 includes financial and other covenants, including covenants to maintain certain fixed charge coverage ratios and rent adjusted leverage ratios.
We were in compliance with the covenants as of
June 30, 2017
. We intend to make principal payments due in future periods using cash from operations.
We have a standby letter of credit outstanding related to our workers compensation
and medical insurance policies
. As of
June 30, 2017
and
2016
, the standby letter of credit
s
totaled
$1.1
million.
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 12 months.
Capital Expenditures
Capital expenditures were
$20.0
million and
$11.7
million for the
six months ended June 30, 2017 and 2016
, respectively. The increase in capital expenditures is primarily due to the accelerated pace of new store openings. We opened 7 and 4 new stores during the
six months ended June 30, 2017 and 2016
, respectively. Additionally, the Company made incremental investments in its distribution facilities and information technology infrastructure. During the first six months of 2017, capital expenditures included $11.6 million associated with new store build-outs, remodels of existing stores, and merchandising projects, $5.2 million for general corporate purposes, including information technology infrastructure projects, and $3.2 million for distribution facilities.
Our future capital requirements will vary based on the number of additional stores, distribution centers, and manufacturing facilities that we open and the number of stores that we choose to renovate. Our decisions regarding opening, relocating, or renovating stores, and whether to engage in strategic acquisitions, will be based in part on macroeconomic factors and the general state of the U.S. economy, as well as the local economies in the markets in which our stores are located. We plan to open approximately 15 stores during
2017
. Total capital expenditures are expected to be approximately $35 million in
2017
.
Cash flows
The following table summarizes our cash flow data for the
three months ended June 30, 2017 and 2016
.
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|
|
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|
|
(in thousands)
|
|
|
Six Months Ended
|
|
|
June 30,
|
|
|
2017
|
|
2016
|
Net cash provided by operating activities
|
|
$
|
34,828
|
|
$
|
40,761
|
Net cash used in investing activities
|
|
|
(20,000)
|
|
|
(11,703)
|
Net cash used in financing activities
|
|
|
(8,897)
|
|
|
(25,974)
|
Operating activities
Cash provided by operating activities during the
six months ended June 30, 2017
was
$34.8
million, compared to
$40.8
million during the
six months ended June 30, 2016
. The decrease is attributable to payment of the shareholder litigation settlement to an escrow account, which occurred during the
six months ended June 30, 2017
.
Investing activities
Net cash used in investing activities totaled
$20.0
million for the
six months ended June 30, 2017
, compared to
$11.7
million for the
six months ended June 30, 2016
. 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
$8.9
million for the
six months ended June 30, 2017
, compared to
$26.0
million for the
three months ended June 30, 2016
. Cash
used in financing activities during the
six months ended June 30, 2017
was primarily for the payments of long-term debt and capital lease obligations of $34.6 million and an aggregate of $5.2 million in dividends paid to stockholders, offset by advances on the line of credit of $25.0 million and the release of restricted cash totaling $6.0 million.
Cash and cash equivalents totaled
$12.0
million at
June 30, 2017
, versus
$6.1
million at
December 31, 2016
. Working capital was
$38.2
million at
June 30, 2017
, compared to
$36.0
million at
December 31, 2016
.
Off-balance sheet arrangements
As of
June 30, 2017
and
December 31, 2016
, we did not have any “off-balance sheet arrangements” (as such term is defined in Item 303 of Regulation S-K) that could have a current or future effect on our financial condition, changes in financial condition, net sales or expenses, results of operations, liquidity, capital expenditures or capital resources.
Contractual arrangements
As of
June 30, 2017
, there were no material changes to our contractual obligations outside the ordinary course of business.
Recently Adopted Accounting Pronouncements
In July 2015, the
Financial Accounting Standards Board
(
“
FASB
”
)
issued a standard which 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 require
d
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 Consolidate 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 retrospectively for fiscal years and interim periods beginning after December 15, 2017, with early adoption permitted. The Company is currently assessing the effect the new standard will have on its consolidated financial statements.
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 fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017, with early adoption permitted. The guidance should be applied retrospectively after adoption.
The Company’s r
estricted cash
balance
was
$0.9
million as of
June 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
.