Container Store Group, Inc. - Quarter Report: 2014 August (Form 10-Q)

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

(Mark One)

 

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

 

For the Quarterly Period Ended August 30, 2014

 

OR

 

o	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: 001-36161

 

THE CONTAINER STORE GROUP, INC.

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number in the United States, including area code, is: (972) 538-6000

 

None

(Former name, former address and former fiscal year, if changed since last report)

 

 

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 x No o

 

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 x No o

 

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

 

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

 

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

 

The registrant had 47,979,297 shares of its common stock outstanding as of September 26, 2014.

 

 

 

Table of Contents

 

TABLE OF CONTENTS

 

PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements
	Unaudited Consolidated Balance Sheets as of August 30, 2014, March 1, 2014, and August 31, 2013	3
	Unaudited Consolidated Statements of Operations for the Thirteen and Twenty-Six Weeks Ended August 30, 2014 and August 31, 2013	5
	Unaudited Consolidated Statements of Comprehensive Income (Loss) for the Thirteen and Twenty-Six Weeks ended August 30, 2014 and August 31, 2013	6
	Unaudited Consolidated Statements of Cash Flows for the Twenty-Six Weeks ended August 30, 2014 and August 31, 2013	7
	Notes to the Unaudited Consolidated Financial Statements	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	31
Item 4.	Controls and Procedures	31
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings	32
Item 1A.	Risk Factors	32
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	32
Item 3.	Default Upon Senior Securities	32
Item 4.	Mine Safety Disclosures	32
Item 5.	Other Information	32
Item 6.	Exhibits	32

 

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The Container Store Group, Inc.

Consolidated balance sheets

 

		August 30,		March 1,		August 31,
(In thousands)		2014		2014		2013
		(unaudited)				(unaudited)
Assets
Current assets:
Cash		$15,298		$18,046		$12,744
Accounts receivable, net		27,732		32,273		25,013
Inventory		95,708		85,595		91,165
Prepaid expenses		9,675		14,121		10,249
Forward contracts		—		—		227
Income taxes receivable		2,257		83		2,317
Deferred tax assets, net		3,967		3,967		855
Other current assets		9,798		10,322		10,583
Total current assets		164,435		164,407		153,153
Noncurrent assets:
Property and equipment, net		170,562		161,431		146,372
Goodwill		202,815		202,815		202,815
Trade names		237,821		242,290		240,434
Deferred financing costs, net		8,721		9,699		10,167
Noncurrent deferred tax assets, net		1,158		1,323		1,667
Other assets		1,064		1,184		855
Total noncurrent assets		622,141		618,742		602,310
Total assets		$786,576		$783,149		$755,463

 

See accompanying notes.

 

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The Container Store Group, Inc.

Consolidated balance sheets (continued)

 

		August 30,		March 1,		August 31,
(In thousands, except share and per share amounts)		2014		2014		2013
		(unaudited)				(unaudited)
Liabilities and shareholders’ equity
Current liabilities:
Accounts payable		$46,600		$49,282		$51,465
Accrued liabilities		56,546		60,496		51,892
Revolving lines of credit		16,779		16,033		21,215
Current portion of long-term debt		5,985		7,527		9,869
Forward contracts		486		—		—
Income taxes payable		1,305		3,474		585
Deferred tax liabilities, net		29		29		43
Total current liabilities		127,730		136,841		135,069
Noncurrent liabilities:
Long-term debt		343,264		327,724		361,108
Noncurrent deferred tax liabilities, net		83,555		85,442		88,228
Deferred rent and other long-term liabilities		36,469		35,956		31,492
Total noncurrent liabilities		463,288		449,122		480,828
Total liabilities		591,018		585,963		615,897
Commitments and contingencies (Note 7)
Shareholders’ equity:
Common stock, $0.01 par value, 250,000,000 shares authorized, 47,979,297 shares issued and outstanding at August 30, 2014; 250,000,000 shares authorized, 47,941,180 shares issued and outstanding at March 1, 2014; 3,528,280 shares authorized, 2,942,326 shares issued and 2,928,760 shares outstanding at August 31, 2013		480		479		29
Preferred stock, $0.01 par value:
Senior cumulative; no shares authorized, issued or outstanding at August 30, 2014 and March 1, 2014; 250,000 shares authorized, 202,480 shares issued and 202,182 shares outstanding at August 31, 2013		—		—		2
Junior cumulative; no shares authorized, issued or outstanding at August 30, 2014 and March 1, 2014; 250,000 shares authorized, 202,480 shares issued and 202,182 shares outstanding at August 31, 2013		—		—		2
Additional paid-in capital		854,516		853,295		455,460
Accumulated other comprehensive (loss) income		(4,543)		1,683		(569)
Retained deficit		(654,895)		(658,271)		(314,518)
Treasury stock, no shares at August 30, 2014 and March 1, 2014;14,162 shares at August 31, 2013		—		—		(840)
Total shareholders’ equity		195,558		197,186		139,566
Total liabilities and shareholders’ equity		$786,576		$783,149		$755,463

 

See accompanying notes.

 

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The Container Store Group, Inc.

Consolidated statements of operations

 

		Thirteen Weeks Ended				Twenty-Six Weeks Ended
		August 30,		August 31,		August 30,		August 31,
(In thousands, except share and per share amounts) (unaudited)		2014		2013		2014		2013
Net sales		$193,247		$183,774		$366,685		$343,419
Cost of sales (excluding depreciation and amortization)		79,581		76,377		152,167		142,818
Gross profit		113,666		107,397		214,518		200,601
Selling, general, and administrative expenses (excluding depreciation and amortization)		90,530		85,838		181,719		169,287
Pre-opening costs		2,359		1,972		5,346		3,934
Depreciation and amortization		7,567		7,580		14,823		15,050
Restructuring charges		—		120		—		361
Other expenses		282		407		807		626
Loss on disposal of assets		114		51		214		73
Income from operations		12,814		11,429		11,609		11,270
Interest expense		4,383		5,519		8,685		11,074
Loss on extinguishment of debt		—		—		—		1,101
Income (loss) before taxes		8,431		5,910		2,924		(905)
Provision (benefit) for income taxes		1,476		1,803		(452)		(217)
Net income (loss)		$6,955		$4,107		$3,376		$(688)
Less: Distributions accumulated to preferred shareholders		—		(21,851)		—		(44,150)
Net income (loss) available to common shareholders		$6,955		$(17,744)		$3,376		$(44,838)
Net income (loss) per common share - basic		$0.14		$(6.06)		$0.07		$(15.31)
Net income (loss) per common share - diluted		$0.14		$(6.06)		$0.07		$(15.31)
Weighted-average common shares outstanding - basic		47,976,500		2,929,165		47,961,558		2,929,468
Weighted-average common shares outstanding - diluted		48,539,762		2,929,165		48,611,985		2,929,468

 

See accompanying notes.

 

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The Container Store Group, Inc.

Consolidated statements of comprehensive income (loss)

 

		Thirteen Weeks Ended				Twenty-Six Weeks Ended
		August 30,		August 31,		August 30,		August 31,
(In thousands) (unaudited)		2014		2013		2014		2013
Net income (loss)		$6,955		$4,107		$3,376		$(688)
Unrealized loss on financial instruments, net of taxes of $238, $59, $223, and $170		(333)		(176)		(386)		(1,121)
Pension liability adjustment		59		34		120		34
Foreign currency translation adjustment		(3,158)		(269)		(5,960)		(2,195)
Comprehensive income (loss)		$3,523		$3,696		$(2,850)		$(3,970)

 

See accompanying notes.

 

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The Container Store Group, Inc.

Consolidated statements of cash flows

 

		Twenty-Six Weeks Ended
		August 30,		August 31,
(In thousands) (unaudited)		2014		2013
Operating activities
Net income (loss)		$3,376		$(688)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization		14,823		15,050
Stock-based compensation		546		213
Excess tax benefit from stock-based compensation		(10)		—
Loss on disposal of property and equipment		214		73
Deferred tax (benefit) expense		(442)		79
Noncash refinancing expense		—		723
Noncash interest		978		901
Changes in operating assets and liabilities:
Accounts receivable		3,495		67
Inventory		(11,494)		(9,708)
Prepaid expenses and other assets		4,921		(174)
Accounts payable and accrued liabilities		(1,751)		5,091
Income taxes payable		(4,316)		(3,865)
Other noncurrent liabilities		844		1,573
Net cash provided by operating activities		11,184		9,335
Investing activities
Additions to property and equipment		(30,917)		(23,049)
Proceeds from sale of property and equipment		6		389
Net cash used in investing activities		(30,911)		(22,660)
Financing activities
Borrowings on revolving lines of credit		45,523		31,792
Payments on revolving lines of credit		(43,383)		(23,579)
Borrowings on long-term debt		25,015		105,500
Payments on long-term debt		(10,533)		(19,771)
Payment of debt issuance costs		—		(3,046)
Proceeds from the exercise of stock options		664		—
Excess tax benefit from stock-based compensation		10		—
Purchase of treasury shares		—		(53)
Payment of distributions to preferred shareholders		—		(90,000)
Net cash provided by financing activities		17,296		843
Effect of exchange rate changes on cash		(317)		(125)
Net decrease in cash		(2,748)		(12,607)
Cash at beginning of period		18,046		25,351
Cash at end of period		$15,298		$12,744

 

See accompanying notes.

 

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The Container Store Group, Inc.

Notes to consolidated financial statements (unaudited)

(In thousands, except share amounts and unless otherwise stated)

August 30, 2014

 

1.              Description of business and basis of presentation

 

These financial statements should be read in conjunction with the financial statement disclosures in our Annual Report on Form 10-K for the fiscal year ended March 1, 2014, filed with the Securities and Exchange Commission on May 28, 2014. We use the same accounting policies in preparing quarterly and annual financial statements. All adjustments necessary for a fair presentation of quarterly operating results are reflected herein and are of a normal, recurring nature and include reclassifications and other adjustments, as discussed below.

 

Description of business

 

The Container Store, Inc. was founded in 1978 in Dallas, Texas, as a retailer with a mission to provide customers with storage and organization solutions through an assortment of innovative products and unparalleled customer service. As of August 30, 2014, The Container Store, Inc. operates 67 stores with an average size of approximately 19,000 selling square feet in 24 states and the District of Columbia. The Container Store, Inc. also offers all of its products directly to its customers through its website and call center. The Container Store, Inc.’s wholly owned Swedish subsidiary, Elfa International AB (“Elfa”) designs and manufactures component-based shelving and drawer systems and made-to-measure sliding doors. elfa® branded products are sold exclusively in the United States in The Container Store retail stores, website and call center, and Elfa sells to various retailers on a wholesale basis in approximately 30 countries around the world, with a concentration in the Nordic region of Europe. In 2007, The Container Store, Inc. was sold to The Container Store Group, Inc. (the “Company”), a holding company, of which a majority stake was purchased by Leonard Green and Partners, L.P. (“LGP”), with the remainder held by certain employees of The Container Store, Inc. On November 6, 2013, the Company completed its initial public offering (the “IPO”). Following the Company’s IPO, LGP continues to maintain a controlling interest in the ownership of the Company.

 

Seasonality

 

The Company’s business is moderately seasonal in nature and, therefore, the results of operations for the twenty-six weeks ended August 30, 2014 are not necessarily indicative of the operating results for the full year. Demand is generally highest in the fourth fiscal quarter due to Our Annual elfa® Sale, and lowest in the first fiscal quarter.

 

Reclassifications and other adjustments

 

Certain prior period amounts have been reclassified in order to provide consistent comparative information. These reclassifications do not materially impact the consolidated financial statements for the prior periods presented.

 

During the quarter ended August 30, 2014, the Company determined that it was necessary to file an amended tax return for a prior period, which resulted in a $1.8 million reduction in the provision for income taxes, as well as an increase to income taxes receivable. We evaluated the impact of the adjustment and determined that the amount was immaterial to the consolidated financial statements for the current fiscal year and prior fiscal years. As such, the entire amount was recorded during the quarter ended August 30, 2014.

 

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Recent accounting pronouncements

 

In June 2014, the FASB issued ASU 2014-12, Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period (a consensus of the FASB Emerging Issues Task Force). The ASU clarifies that entities should treat performance targets that can be met after the requisite service period of a share-based payment award as performance conditions that affect vesting. Therefore, an entity would not record compensation expense (measured as of the grant date without taking into account the effect of the performance target) related to an award for which transfer to the employee is contingent on the entity’s satisfaction of a performance target until it becomes probable that the performance target will be met. The ASU does not contain any new disclosure requirements. For all entities, the ASU is effective for reporting periods beginning after December 15, 2015. Early adoption is permitted. We currently do not have share-based payment awards with performance targets, however, our 2013 Incentive Award Plan allows for these types of awards. We expect to adopt this standard in fiscal 2016 and do not expect the adoption of this standard to have a material impact on our consolidated financial statements.

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, an updated standard on revenue recognition. ASU 2014-09 provides enhancements to the quality and consistency of how revenue is reported while also improving comparability in the financial statements of companies reporting using IFRS and US GAAP. The core principle of the new standard is for companies to recognize revenue to depict the transfer of goods or services to customers in amounts that reflect the consideration (that is, payment) to which the company expects to be entitled in exchange for those goods or services. The new standard also will result in enhanced disclosures about revenue, provide guidance for transactions that were not previously addressed comprehensively (for example, service revenue and contract modifications) and improve guidance for multiple-element arrangements. ASU 2014-09 will be effective for the Company in the first quarter of fiscal 2017 and may be applied on a full retrospective or modified retrospective approach. The Company is still evaluating the impact of implementation of this standard on its financial statements.

 

2.  Long-term debt and revolving lines of credit

 

On April 1, 2014, Elfa entered into a master credit agreement with Nordea Bank AB (“Nordea”), which consists of a SEK 60.0 million (approximately $8.6 million as of August 30, 2014) term loan facility (the “2014 Elfa Term Loan Facility”) and a SEK 140.0 million (approximately $20.1 million as of August 30, 2014) revolving credit facility (the “2014 Elfa Revolving Credit Facility,” and together with the 2014 Elfa Term Loan Facility, the “2014 Elfa Senior Secured Credit Facilities”). The 2014 Elfa Senior Secured Credit Facilities term began on August 29, 2014 and matures on August 29, 2019, or such shorter period as provided by the agreement. Elfa is required to make quarterly principal payments under the 2014 Elfa Term Loan Facility in the amount of SEK 3.0 million (approximately $0.4 million as of August 30, 2014) through maturity. The 2014 Elfa Term Loan Facility bears interest at STIBOR + 1.7% and the 2014 Elfa Revolving Credit Facility bears interest at Nordea’s base rate + 1.4%, and these rates are applicable until August 29, 2017, at which time the interest rates may be renegotiated at the request of either party to the agreement. Should the parties fail to agree on new interest rates, Elfa has the ability to terminate the agreement on August 29, 2017, at which time all borrowings under the agreement shall be paid in full to Nordea.

 

On May 13, 2014, Elfa entered into a credit facility with Nordea for SEK 15.0 million (the “Short Term Credit Facility”). The Short Term Credit Facility accrued interest at 2.53% and matured on August 28, 2014, at which time all borrowings under the agreement were paid in full to Nordea (approximately $2.2 million as of August 28, 2014). The total amount of borrowings available under the Short Term Credit Facility was used to pay a mortgage owed on the Poland manufacturing facility in full in the quarter ended May 31, 2014.

 

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3. Detail of certain balance sheet accounts

 

		August 30,		March 1,		August 31,
		2014		2014		2013
Inventory:
Finished goods		$89,787		$79,235		$83,758
Raw materials		4,419		4,677		5,064
Work in progress		1,502		1,683		2,343
		$95,708		$85,595		$91,165
Accrued liabilities:
Accrued payroll, benefits, and bonuses		$21,122		$23,679		$18,410
Accrued transaction and property tax		8,806		7,949		8,515
Gift cards and store credits outstanding		7,162		6,900		6,323
Unearned revenue		5,375		11,338		4,486
Accrued interest		2,530		2,481		3,877
Other accrued liabilities		11,551		8,149		10,281
		$56,546		$60,496		$51,892

 

4.  Net income (loss) per common share

 

Basic net income (loss) per common share is computed as net income (loss) available to common shareholders divided by the weighted-average number of common shares outstanding for the period. Net income (loss) available to common shareholders is computed as net income (loss) less accumulated distributions to preferred shareholders for the period. Diluted net income (loss) per share is computed as net income (loss) available to common shareholders divided by the weighted-average number of common shares outstanding for the period plus common stock equivalents consisting of shares subject to stock-based awards with exercise prices less than or equal to the average market price of the Company’s common stock for the period, to the extent their inclusion would be dilutive. Potential dilutive securities are excluded from the computation of diluted net income (loss) per share if their effect is anti-dilutive.

 

The following is a reconciliation of net income (loss) available to common shareholders and the number of shares used in the basic and diluted net income (loss) per share calculations:

 

		Thirteen Weeks Ended				Twenty-Six Weeks Ended
		August 30,		August 31,		August 30,		August 31,
		2014		2013		2014		2013
Numerator:
Net income (loss)		$6,955		$4,107		$3,376		$(688)
Less: Distributions accumulated to preferred shareholders		—		(21,851)		—		(44,150)
Net income (loss) available to common shareholders		$6,955		$(17,744)		$3,376		$(44,838)
Denominator:
Weighted-average common shares outstanding — basic		47,976,500		2,929,165		47,961,558		2,929,468
Weighted-average common shares outstanding — diluted		48,539,762		2,929,165		48,611,985		2,929,468
Net income (loss) per common share - basic		$0.14		$(6.06)		$0.07		$(15.31)
Net income (loss) per common share - diluted		$0.14		$(6.06)		$0.07		$(15.31)
Antidilutive securities not included:
Stock options outstanding		795,124		—		—		—

 

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5.  Pension plans

 

The Company provides pension benefits to the Elfa employees in Sweden under collectively bargained pension plans, which are recorded in other long-term liabilities. The defined benefit plan provides benefits for participating employees based on years of service and final salary levels at retirement. The defined benefit plans are unfunded and approximately 2% of Elfa employees are participants in the defined benefit pension plan. Certain employees also participate in defined contribution plans for which Company contributions are determined as a percentage of participant compensation. The Company recognized total net periodic benefit cost of $388 and $630 for pension plans in the thirteen weeks ended August 30, 2014 and August 31, 2013, respectively. The Company recognized total net periodic benefit cost of $1,314 and $1,460 for pension plans in the twenty-six weeks ended August 30, 2014 and August 31, 2013, respectively.

 

6.  Income taxes

 

The Company’s effective income tax rate for the thirteen weeks ended August 30, 2014 was 17.5% compared to 30.5% for the thirteen weeks ended August 31, 2013. The decrease in the effective tax rate is primarily due to a $1.8 million reduction in tax expense recorded during the quarter ended August 30, 2014 primarily related to an expected refund of tax paid in a prior period, partially offset by a shift in the mix of projected domestic and foreign earnings.

 

The Company’s effective income tax rate for the twenty-six weeks ended August 30, 2014 was (15.5%) compared to 24.0% for the twenty-six weeks ended August 31, 2013. The decrease in the effective tax rate is driven by a $1.8 million reduction in tax expense in fiscal 2014 primarily related to an expected refund of tax paid in a prior period, partially offset by the impact of an increase in pre-tax earnings from fiscal 2013 to fiscal 2014 and a change in mix between projected domestic and foreign earnings.

 

7.  Commitments and contingencies

 

In connection with insurance policies, The Container Store, Inc. has outstanding standby letters of credit totaling $3,136 as of August 30, 2014.

 

The Company is subject to ordinary litigation and routine reviews by regulatory bodies that are incidental to its business, none of which is expected to have a material effect on the Company’s consolidated financial statements on an individual basis or in the aggregate.

 

8.  Accumulated other comprehensive income

 

Accumulated other comprehensive income (“AOCI”) consists of changes in our foreign currency forward contracts, minimum pension liability, and foreign currency translation. The components of AOCI, net of tax, are shown below for the twenty-six weeks ended August 30, 2014:

 

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		Foreign currency forward contracts		Minimum pension liability		Foreign currency translation		Total
Balance at March 1, 2014		$53		$(1,153)		$2,783		$1,683
Other comprehensive (loss) income before reclassifications, net of tax		(333)		120		(5,960)		(6,173)
Amounts reclassified to earnings, net of tax		(53)		—		—		(53)
Net current period other comprehensive (loss) income		(386)		120		(5,960)		(6,226)
Balance at August 30, 2014		$(333)		$(1,033)		$(3,177)		$(4,543)

 

Amounts reclassified from AOCI to earnings for the foreign currency forward contracts category are generally included in cost of sales in the Company’s consolidated statements of operations. For a description of the Company’s use of foreign currency forward contracts, refer to Note 9.

 

9.  Foreign currency forward contracts

 

The Company’s international operations and purchases of its significant product lines from foreign suppliers are subject to certain opportunities and risks, including foreign currency fluctuations. The Company utilizes foreign currency forward exchange contracts in Swedish krona to stabilize its retail gross margins and to protect its domestic operations from downward currency exposure by hedging purchases of inventory from its wholly owned subsidiary, Elfa. During the twenty-six weeks ended August 30, 2014 and August 31, 2013, the Company used forward contracts for 27.9% and 76.4% of inventory purchases in Swedish krona, respectively. All of the Company’s currency-related hedge instruments have terms from 1 to 12 months and require the Company to exchange currencies at agreed-upon rates at settlement.

 

The counterparties to the contracts consist of a limited number of major domestic and international financial institutions. The Company does not hold or enter into financial instruments for trading or speculative purposes. The Company records its financial hedge instruments on a gross basis and generally does not require collateral from these counterparties because it does not expect any losses from credit exposure. The Company did not have any material financial hedge instruments that did not qualify for hedge accounting treatment as of August 30, 2014, March 1, 2014 and August 31, 2013.

 

The Company records all foreign currency forward contracts on its consolidated balance sheet at fair value. Forward contracts not designated as hedges are adjusted to fair value through income. The Company accounts for its foreign currency hedge instruments as cash flow hedges, as defined. Changes in the fair value of the foreign currency hedge instruments that are considered to be effective, as defined, are recorded in other comprehensive income (loss) until the hedged item (inventory) is sold to the customer, at which time the deferred gain or loss is recognized through cost of sales. Any portion of a change in the foreign currency hedge instrument’s fair value that is considered to be ineffective, as defined, or that the Company has elected to exclude from its measurement of effectiveness, is immediately recorded in earnings as cost of sales. The Company assessed the effectiveness of the foreign currency forward contracts and determined the foreign currency forward contracts were highly effective during the twenty-six weeks ended August 30, 2014 and August 31, 2013. The Company records the fair value of its unsettled foreign currency forward contracts as cash flow hedges. The Company had $486 as of August 30, 2014 in fair value of its unsettled foreign currency forward contracts recorded as total current liabilities in the accompanying consolidated balance sheets. The Company had $227 as of August 31, 2013 in fair value of its unsettled foreign currency forward contracts recorded as total current assets in the accompanying consolidated balance sheets. As of March 1, 2014, the Company had no unsettled foreign currency forward contracts.

 

The Company recorded $333 in accumulated other comprehensive loss at August 30, 2014. Of the $333, $38 represents an unrealized loss that has been recorded for settled forward contracts related to inventory on hand as of August 30, 2014. The Company expects the unrealized loss of $38, net of taxes, to be reclassified into earnings over the next 12 months as the underlying inventory is sold to the end consumer.

 

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The change in fair value of the Company’s foreign currency forward contracts that qualify as cash flow hedges and are included in accumulated other comprehensive income (loss), net of taxes, are presented in Note 8 of these financial statements.

 

10.  Fair value measurements

 

Under generally accepted accounting principles, the Company is required to a) measure certain assets and liabilities at fair value or b) disclose the fair values of certain assets and liabilities recorded at cost. Accounting standards define fair value as the price that would be received upon sale of an asset or paid upon transfer of a liability in an orderly transaction between market participants at the measurement date. Fair value is calculated assuming the transaction occurs in the principal or most advantageous market for the asset or liability and includes consideration of non-performance risk and credit risk of both parties. Accounting standards pertaining to fair value establish a three-tier fair value hierarchy that prioritizes the inputs used in measuring fair value. These tiers include:

 

·      Level 1—Valuation inputs are based upon unadjusted quoted prices for identical instruments traded in active markets.

 

·      Level 2—Valuation inputs are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

·      Level 3—Valuation inputs are unobservable and typically reflect management’s estimates of assumptions that market participants would use in pricing the asset or liability. The fair values are determined using model-based techniques that include option pricing models, discounted cash flow models and similar techniques.

 

As of August 30, 2014, March 1, 2014 and August 31, 2013, the Company held certain items that are required to be measured at fair value on a recurring basis. These included the nonqualified retirement plan and foreign currency forward contracts. The nonqualified retirement plan consists of investments purchased by employee contributions to retirement savings accounts. Foreign currency forward contracts are related to the Company’s attempts to hedge foreign currency fluctuation on purchases of inventory in Swedish krona. The Company’s foreign currency hedge instruments consist of over-the-counter (OTC) contracts, which are not traded on a public exchange. See Note 9 for further information on the Company’s hedging activities.

 

The fair values of the nonqualified retirement plan and foreign currency forward contracts are determined based on the market approach which utilizes inputs that are readily available in public markets or can be derived from information available in publicly quoted markets for comparable assets. Therefore, the Company has categorized these items as Level 2. The Company also considers counterparty credit risk and its own credit risk in its determination of all estimated fair values. The Company has consistently applied these valuation techniques in all periods presented and believes it has obtained the most accurate information available for the types of contracts it holds.

 

The following items are measured at fair value on a recurring basis, subject to the disclosure requirements of ASC 820, Fair Value Measurements:

 

						August 30,		March 1,		August 31,
Description				Balance Sheet Location		2014		2014		2013
Assets
Nonqualified retirement plan		Level 2		Other current assets		$3,772		$3,401		$2,892
Foreign currency hedge instruments		Level 2		Forward contracts		—		—		277
Total assets						$3,772		$3,401		$3,169
Liabilities
Nonqualified retirement plan		Level 2		Accrued liabilities		3,788		3,417		2,907
Foreign currency hedge instruments		Level 2		Forward contracts		486		—		—
Total liabilities						$4,274		$3,417		$2,907

 

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The fair values of long-term debt were estimated using discounted cash flow analyses, quoted prices, as well as recent transactions for similar types of borrowing arrangements. As of August 30, 2014, March 1, 2014 and August 31, 2013, the carrying values and estimated fair values of the Company’s long-term debt, including current maturities, were:

 

				August 30, 2014
				Carrying		Fair
				value		value
Senior secured term loan facility		Level 2		$326,722		$324,271
2014 Elfa term loan facility		Level 2		8,602		8,602
Revolving credit facility		Level 3		13,000		13,000
Other loans		Level 3		925		925
				$349,249		$346,798

 

				March 1, 2014
				Carrying		Fair
				value		value
Senior secured term loan facility		Level 2		$328,533		$330,176
Elfa term loan facility		Level 2		1,950		1,948
Other loans		Level 3		4,768		4,686
				$335,251		$336,810

 

				August 31, 2013
				Carrying		Fair
				value		value
Senior secured term loan facility		Level 2		$361,344		$363,151
Elfa term loan facility		Level 3		3,769		3,829
Other loans		Level 3		5,864		5,910
				$370,977		$372,890

 

11.  Segment reporting

 

The Company’s operating segments were determined on the same basis as how it evaluates the performance internally. The Company’s two operating segments consist of TCS and Elfa. The TCS segment includes the Company’s retail stores, website and call center, as well as the installation services business.

 

The Elfa segment includes the manufacturing business that produces the elfa® brand products that are sold domestically exclusively through the TCS segment, as well as on a wholesale basis in approximately 30 countries around the world with a concentration in the Nordic region of Europe. The intersegment sales in the Elfa column represent elfa® product sales to the TCS segment. These sales and the related gross margin on merchandise recorded

 

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in TCS inventory balances at the end of the period are eliminated for consolidation purposes in the Corporate/Other column. The net sales to third parties in the Elfa column represent sales to customers outside of the United States.

 

Amounts in the Corporate/Other column include unallocated corporate expenses and assets, intersegment eliminations and other adjustments to segment results necessary for the presentation of consolidated financial results in accordance with generally accepted accounting principles.

 

In general, the Company uses the same measurements to calculate income or loss before income taxes for operating segments as it does for the consolidated company. However, interest expense related to the Senior Secured Term Loan Facility and the Revolving Credit Facility is recorded in the Corporate/Other column.

 

						Corporate/
Thirteen Weeks Ended August 30, 2014		TCS		Elfa		Other		Total
Net sales to third parties		$174,814		$18,433		$—		$193,247
Intersegment sales		—		12,680		(12,680)		—
Interest expense, net		5		246		4,132		4,383
Income (loss) before taxes		15,441		(213)		(6,797)		8,431
Assets(1)		628,971		130,061		27,544		786,576

 

						Corporate/
Thirteen Weeks Ended August 31, 2013		TCS		Elfa		Other		Total
Net sales to third parties		$165,320		$18,454		$—		$183,774
Intersegment sales		—		11,651		(11,651)		—
Interest expense, net		15		195		5,309		5,519
Income (loss) before taxes		14,236		(225)		(8,101)		5,910
Assets(1)		593,542		135,554		26,367		755,463

 

						Corporate/
Twenty-Six Weeks Ended August 30, 2014		TCS		Elfa		Other		Total
Net sales to third parties		$324,543		$42,142		$—		$366,685
Intersegment sales		—		21,148		(21,148)		—
Interest expense, net		12		407		8,266		8,685
Income (loss) before taxes		15,339		38		(12,453)		2,924
Assets(1)		628,971		130,061		27,544		786,576

 

						Corporate/
Twenty-Six Weeks Ended August 31, 2013		TCS		Elfa		Other		Total
Net sales to third parties		$302,799		$40,620		$—		$343,419
Intersegment sales		—		19,960		(19,960)		—
Interest expense, net		32		435		10,607		11,074
Income (loss) before taxes(2)		16,958		(1,375)		(16,488)		(905)
Assets(1)		593,542		135,554		26,367		755,463

 

(1)  Tangible assets in the Elfa column are located outside of the United States. Assets in Corporate/Other include assets located in the corporate headquarters and distribution center. Assets in Corporate/Other also include deferred tax assets and the fair value of forward contracts.

(2)  The Corporate/Other column includes $1,101 loss on extinguishment of debt during the twenty-six weeks ended August 31, 2013.

 

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12.  Subsequent Event

 

On October 3, 2014, the Company completed the sale of a Norwegian subsidiary, whose primary asset was a manufacturing facility that was shut down and consolidated into a like facility in Sweden as part of Elfa’s restructuring efforts in fiscal 2012. The Company received proceeds of approximately $4.2 million and recorded a gain on the sale of this subsidiary of approximately $3.3 million in the third quarter of fiscal 2014.

 

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

 

Cautionary note regarding forward-looking statements

 

This report, including this Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements. In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “could,” “intends,” “target,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of these terms or other similar expressions. These forward-looking statements are only predictions and involve known and unknown risks, uncertainties and other important factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. These include, but are not limited to: a decline in the health of the economy and the purchase of discretionary items; risks related to new store openings; our inability to source and market our products to meet customer preferences or inability to offer customers an aesthetically pleasing shopping environment; our dependence on a single distribution center for all of our stores; the vulnerability of our facilities and systems to natural disasters and other unexpected events; risks related to our reliance on independent third-party transportation providers for substantially all of our product shipments; our dependence on our brand image and any inability to protect our brand; our failure to successfully anticipate consumer demand and manage inventory commensurate with demand; our failure to effectively manage our growth; our inability to lease space on favorable terms; fluctuations in currency exchange rates; our incurrence of net losses in the past and the risk that we will experience net losses in the future; risks related to our inability to obtain capital on satisfactory terms or at all; our inability to effectively manage online sales; risks related to a security breach or cyber-attack of our website or information technology systems, and other damage to such systems; effects of competition on our business; our inability to obtain merchandise from our vendors on a timely basis and at competitive prices; the risk that our vendors may sell their products to our competitors; our dependence on key executive management; our inability to find, train and retain key personnel; labor activities and unrest; rising health care and labor costs; risks associated with our dependence on foreign imports; risks related to violations of anti-bribery and anti-kickback laws; risks related to our indebtedness; risks related to our fixed lease obligations; risks related to litigation; product recalls and/or product liability and changes in product safety and consumer protection laws; changes in statutory, regulatory, accounting and other legal requirements; the risk that our operating and financial performance in a given period will not meet the guidance we provided to the public; risks related to changes in estimates or projections used to assess the fair value of our intangible assets; significant increases in raw material prices or energy costs; fluctuations in our tax obligations, effective tax rate and realization of deferred tax assets; seasonal fluctuations in our operating results; material disruptions in one of our Elfa manufacturing facilities; our inability to protect our intellectual property rights and claims that we have infringed third parties’ intellectual property rights; risks related to our status as a controlled company; significant fluctuations in the price of our common stock; substantial future sales of our common stock, or the perception that such sales may occur, which could depress the price of our common stock; increased costs of being a public company; anti-takeover provisions in our governing documents, which could delay or prevent a change in control; reduced disclosure requirements applicable to emerging growth companies, which could make our stock less attractive to investors; and our failure to establish and maintain effective internal controls. Other important risk factors that could affect the outcome of the events set forth in these statements and that could affect our operating results and financial condition are described in the “Risk Factors” section of our Annual Report on Form 10-K for the fiscal year ended March 1, 2014, filed with the Securities and Exchange Commission (the “SEC”) on May 28, 2014.

 

We have based these forward-looking statements largely on our current expectations and projections about future

 

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events and financial trends that we believe may affect our business, financial condition and results of operations. These forward-looking statements speak only as of the date of this report. Because forward-looking statements are inherently subject to risks and uncertainties, you should not rely on these forward-looking statements as predictions of future events. Except as required by applicable law, we do not plan to publicly update or revise any forward-looking statements contained herein after the date of this report, whether as a result of any new information, future events or otherwise.

 

Unless the context otherwise requires, references in this Quarterly Report on Form 10-Q to the “Company,” “we,” “us,” and “our” refer to The Container Store Group, Inc. and, where appropriate, its subsidiaries.

 

We follow a 5-4-4 fiscal calendar, whereby each fiscal quarter consists of thirteen weeks grouped into one five-week “month” and two four-week “months”, and our fiscal year is the 52- or 53-week period ending on the Saturday closest to February 28. Fiscal 2014 ends on February 28, 2015, fiscal 2013 ended on March 1, 2014 and fiscal 2012 ended on March 2, 2013. The second quarter of fiscal 2014 ended on August 30, 2014 and the second quarter of fiscal 2013 ended on August 31, 2013, and both included thirteen weeks.

 

Overview

 

We are the leading specialty retailer of storage and organization products in the United States. We are the original storage and organization specialty retailer and the only national retailer solely devoted to the category. Our goal is to help provide order to an increasingly busy and chaotic world. We provide creative, multifunctional, customizable storage and organization solutions that help our customers save time, save space and improve the quality of their lives. The breadth, depth and quality of our product offerings are designed to appeal to a broad demographic, including our core customers, who are predominantly female, affluent, highly educated and busy.

 

Our operations consist of two operating segments:

 

·                  The Container Store (“TCS”), which consists of our retail stores, website and call center, as well as our installation services business. As of August 30, 2014, we operated 67 stores with an average size of approximately 19,000 selling square feet in 24 states and the District of Columbia. We also offer all of our products directly to customers through our website and call center. Our stores receive all products directly from our distribution center co-located with our corporate headquarters in Coppell, Texas.

 

·                  Elfa, The Container Store, Inc.’s wholly owned Swedish subsidiary, Elfa International AB (“Elfa”), which designs and manufactures component-based shelving and drawer systems and made-to-measure sliding doors. Elfa was founded in 1948 and is headquartered in Malmö, Sweden. Elfa’s shelving and drawer systems are customizable for any area of the home, including closets, kitchens, offices and garages. Elfa operates four manufacturing facilities with two located in Sweden, one in Finland and one in Poland. The Container Store began selling elfa® products in 1978 and acquired Elfa in 1999. Today our TCS segment is the exclusive distributor of elfa® products in the U.S. Elfa also sells its products on a wholesale basis to various retailers in approximately 30 countries around the world, with a concentration in the Nordic region of Europe.

 

Note on Dollar Amounts

 

All dollar amounts in this Management’s Discussion and Analysis of Financial Condition and Results of Operations are in thousands, except per share amounts and unless otherwise stated.

 

Results of Operations

 

The following data represents the amounts shown in our unaudited consolidated statements of operations expressed in dollars and as a percentage of net sales and operating data for the periods presented (categories that are only

 

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applicable to our TCS segment are noted with (*) and to our Elfa segment with (+)). For segment data, see Note 11 to our unaudited consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q.

 

		Thirteen Weeks Ended				Twenty-Six Weeks Ended
		August 30,		August 31,		August 30,		August 31,
		2014		2013		2014		2013
Net sales		$193,247		$183,774		$366,685		$343,419
Cost of sales (excluding depreciation and amortization)		79,581		76,377		152,167		142,818
Gross profit		113,666		107,397		214,518		200,601
Selling, general, and administrative expenses (excluding depreciation and amortization)		90,530		85,838		181,719		169,287
Pre-opening costs*		2,359		1,972		5,346		3,934
Depreciation and amortization		7,567		7,580		14,823		15,050
Restructuring charges+		—		120		—		361
Other expenses		282		407		807		626
Loss on disposal of assets		114		51		214		73
Income from operations		12,814		11,429		11,609		11,270
Interest expense		4,383		5,519		8,685		11,074
Loss on extinguishment of debt*		—		—		—		1,101
Income (loss) before taxes		8,431		5,910		2,924		(905)
Provision (benefit) for income taxes		1,476		1,803		(452)		(217)
Net income (loss)		$6,955		$4,107		$3,376		$(688)

 

		Thirteen Weeks Ended				Twenty-Six Weeks Ended
		August 30,		August 31,		August 30,		August 31,
		2014		2013		2014		2013
Percentage of net sales:
Net sales		100.0%		100.0%		100.0%		100.0%
Cost of sales (excluding depreciation and amortization)		41.2%		41.6%		41.5%		41.6%
Gross profit		58.8%		58.4%		58.5%		58.4%
Selling, general and administrative expenses (excluding depreciation and amortization)		46.8%		46.7%		49.6%		49.3%
Pre-opening costs*		1.2%		1.1%		1.5%		1.1%
Depreciation and amortization		3.9%		4.1%		4.0%		4.4%
Restructuring charges+		0.0%		0.1%		0.0%		0.1%
Other expenses		0.1%		0.2%		0.2%		0.2%
Loss on disposal of assets		0.1%		0.0%		0.1%		0.0%
Income from operations		6.6%		6.2%		3.2%		3.3%
Interest expense		2.3%		3.0%		2.4%		3.2%
Loss on extinguishment of debt*		0.0%		0.0%		0.0%		0.3%
Income (loss) before taxes		4.4%		3.2%		0.8%		(0.2%)
Provision (benefit) for income taxes		0.8%		1.0%		(0.1%)		0.0%
Net income (loss)		3.6%		2.2%		0.9%		(0.2%)
Operating data:
Comparable store sales growth for the period(1)*		(0.4%)		3.1%		(0.6%)		2.9%
Number of stores open at end of period*		67		61		67		61
Average ticket(2)*		$59.65		$58.81		$58.39		$57.54
Non-GAAP measures(3):
Adjusted EBITDA(4)		$23,378		$22,128		$33,580		$32,719
Adjusted net income(5)		$5,116		$3,688		$1,537		$474
Adjusted net income per common share - diluted(5)		$0.11		$0.08		$0.03		$0.01

 

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