Container Store Group, Inc. - Quarter Report: 2017 December (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

(Mark One)

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

 

For the Quarterly Period Ended December 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: 001-36161

 

THE CONTAINER STORE GROUP, INC.

(Exact name of registrant as specified in its charter)

 

Delaware		26-0565401
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)
500 Freeport Parkway, Coppell, TX		75019
(Addresses of principal executive offices)		(Zip Codes)

 

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

 

 

(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 þ 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 þ No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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 o	Accelerated filer þ	Non-accelerated filer o (Do not check if a smaller reporting company)
Smaller reporting company o	Emerging growth company		þ

 

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. þ

 

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

 

The registrant had 48,328,840 shares of its common stock outstanding as of February 2, 2018.

 

Table of Contents

 

TABLE OF CONTENTS

 

PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements
	Unaudited Consolidated Balance Sheets as of December 30, 2017, April 1, 2017, and December 31, 2016	3
	Unaudited Consolidated Statements of Operations for the Thirteen and Thirty-Nine Weeks ended December 30, 2017 and December 31, 2016	5
	Unaudited Consolidated Statements of Comprehensive Income (Loss) for the Thirteen and Thirty-Nine Weeks ended December 30, 2017 and December 31, 2016	6
	Unaudited Consolidated Statements of Cash Flows for the Thirty-Nine Weeks ended December 30, 2017 and December 31, 2016	7
	Notes to the Unaudited Consolidated Financial Statements	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	21
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	39
Item 4.	Controls and Procedures	39
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings	40
Item 1A.	Risk Factors	40
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	40
Item 3.	Default Upon Senior Securities	40
Item 4.	Mine Safety Disclosures	41
Item 5.	Other Information	41
Item 6.	Exhibits	41

 

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The Container Store Group, Inc.

 

Consolidated balance sheets

 

		December 30,		April 1,		December 31,
		2017		2017		2016
(In thousands)		(unaudited)				(unaudited)
Assets
Current assets:
Cash		$22,653		$10,736		$18,491
Accounts receivable, net		29,548		27,476		31,344
Inventory		110,391		103,120		109,009
Prepaid expenses		11,668		10,550		10,815
Income taxes receivable		1,450		16		-
Other current assets		10,338		10,787		12,319
Total current assets		186,048		162,685		181,978
Noncurrent assets:
Property and equipment, net		160,836		165,498		166,428
Goodwill		202,815		202,815		202,815
Trade names		230,379		226,685		226,050
Deferred financing costs, net		329		320		343
Noncurrent deferred tax assets, net		2,308		2,139		1,080
Other assets		1,684		1,692		1,420
Total noncurrent assets		598,351		599,149		598,136
Total assets		$784,399		$761,834		$780,114

 

 

See accompanying notes.

 

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The Container Store Group, Inc.

 

Consolidated balance sheets (continued)

 

		December 30,		April 1,		December 31,
		2017		2017		2016
(In thousands, except share and per share amounts)		(unaudited)				(unaudited)
Liabilities and shareholders’ equity
Current liabilities:
Accounts payable		$53,757		$44,762		$49,057
Accrued liabilities		73,539		60,107		64,552
Current portion of long-term debt (see Note 3 for amounts due to related party)		9,465		5,445		5,390
Income taxes payable		1,690		2,738		4,156
Total current liabilities		138,451		113,052		123,155
Noncurrent liabilities:
Long-term debt (see Note 3 for amounts due to related party)		304,638		312,026		332,900
Noncurrent deferred tax liabilities, net		56,706		80,679		79,672
Deferred rent and other long-term liabilities		32,941		34,287		33,020
Total noncurrent liabilities		394,285		426,992		445,592
Total liabilities		532,736		540,044		568,747
Commitments and contingencies (Note 6)
Shareholders’ equity:
Common stock, $0.01 par value, 250,000,000 shares authorized; 48,072,187 shares issued at December 30, 2017; 48,045,114 shares issued at April 1, 2017; 48,003,359 shares issued at December 31, 2016		481		480		480
Additional paid-in capital		860,827		859,102		858,460
Accumulated other comprehensive loss		(14,323	)	(22,643	)	(24,047	)
Retained deficit		(595,322	)	(615,149	)	(623,526	)
Total shareholders’ equity		251,663		221,790		211,367
Total liabilities and shareholders’ equity		$784,399		$761,834		$780,114

 

 

See accompanying notes.

 

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The Container Store Group, Inc.

 

Consolidated statements of operations

 

		Thirteen Weeks Ended				Thirty-Nine Weeks Ended
		December 30,		December 31,		December 30,		December 31,
(In thousands, except share and per share amounts) (unaudited)		2017		2016		2017		2016
Net sales		$222,986		$216,380		$624,464		$598,888
Cost of sales (excluding depreciation and amortization)		92,425		90,678		263,919		250,136
Gross profit		130,561		125,702		360,545		348,752
Selling, general, and administrative expenses (excluding depreciation and amortization)		103,894		100,206		306,866		288,037
Stock-based compensation		585		599		1,589		1,355
Pre-opening costs		1,872		2,918		4,676		6,558
Depreciation and amortization		9,477		9,236		28,524		28,061
Other expenses		751		182		4,908		839
Loss on disposal of assets		83		-		236		41
Income from operations		13,899		12,561		13,746		23,861
Interest expense		7,300		4,119		17,398		12,434
Loss on extinguishment of debt		-		-		2,369		-
Income (loss) before taxes		6,599		8,442		(6,021	)	11,427
(Benefit) provision for income taxes		(21,780	)	3,350		(25,848	)	4,851
Net income		$28,379		$5,092		$19,827		$6,576
Net income per common share - basic and diluted		$0.59		$0.11		$0.41		$0.14
Weighted-average common shares - basic		48,067,754		47,999,535		48,057,974		47,992,652
Weighted-average common shares - diluted		48,167,882		48,022,499		48,128,682		48,002,495

 

 

See accompanying notes.

 

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The Container Store Group, Inc.

 

Consolidated statements of comprehensive income (loss)

 

		Thirteen Weeks Ended				Thirty-Nine Weeks Ended
		December 30,		December 31,		December 30,		December 31,
(In thousands) (unaudited)		2017		2016		2017		2016
Net income		$28,379		$5,092		$19,827		$6,576
Unrealized (loss) gain on financial instruments, net of tax (benefit) provision of $(595), $(391), $951, and $(407)		(713	)	(610)		1,687		(636	)
Pension liability adjustment		5		71		(175	)	146
Foreign currency translation adjustment		480		(4,296)		6,808		(7,721	)
Comprehensive income (loss)		$28,151		$257		$28,147		$(1,635	)

 

 

See accompanying notes.

 

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The Container Store Group, Inc.

 

Consolidated statements of cash flows

 

		Thirty-Nine Weeks Ended
		December 30,		December 31,
(In thousands) (unaudited)		2017		2016
Operating activities
Net income		$19,827		$6,576
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		28,524		28,061
Stock-based compensation		1,589		1,355
Loss on disposal of property and equipment		236		41
Loss on extinguishment of debt		2,369		-
Deferred tax benefit		(27,255	)	(1,044	)
Noncash interest		1,905		1,441
Other		326		(135	)
Changes in operating assets and liabilities:
Accounts receivable		(727	)	(9,843	)
Inventory		(2,665	)	(25,686	)
Prepaid expenses and other assets		233		2,932
Accounts payable and accrued liabilities		19,627		19,882
Income taxes		(2,461	)	5,089
Other noncurrent liabilities		(2,136	)	(4,794	)
Net cash provided by operating activities		39,392		23,875
Investing activities
Additions to property and equipment		(20,101	)	(21,010	)
Proceeds from sale of property and equipment		19		7
Net cash used in investing activities		(20,082	)	(21,003	)
Financing activities
Borrowings on revolving lines of credit		47,054		43,135
Payments on revolving lines of credit		(47,054	)	(46,653	)
Borrowings on long-term debt		335,000		30,000
Payments on long-term debt		(331,885	)	(19,121	)
Payment of taxes with shares withheld upon restricted stock vesting		(39	)	-
Payment of debt issuance costs		(11,246	)	-
Net cash (used in) provided by financing activities		(8,170	)	7,361
Effect of exchange rate changes on cash		777		(551	)
Net increase in cash		11,917		9,682
Cash at beginning of period		10,736		8,809
Cash at end of period		$22,653		$18,491
Supplemental information for non-cash investing and financing activities:
Purchases of property and equipment (included in accounts payable)		$894		$304
Capital lease obligation incurred		$178		$658

 

 

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)

 

December 30, 2017

 

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 April 1, 2017, filed with the Securities and Exchange Commission on June 1, 2017. The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”). 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.

 

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. 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”). As the majority shareholder, LGP retains controlling interest in the Company. As of December 30, 2017, The Container Store, Inc. operates 90 stores with an average size of approximately 25,000 square feet (19,000 selling square feet) in 32 states and the District of Columbia. The Container Store, Inc. also offers all of its products directly to its customers, including business-to-business 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.

 

Seasonality

 

The Company’s business is moderately seasonal in nature and, therefore, the results of operations for the thirty-nine weeks ended December 30, 2017 are not necessarily indicative of the operating results for the full year. The Company has historically realized a higher portion of net sales, operating income, and cash flows from operations in the fourth fiscal quarter, attributable primarily to the timing and impact of Our Annual elfa® Sale, which traditionally starts on or about December 24 and runs into February.

 

Recent accounting pronouncements

 

In February 2016, the Financial Accounting Standard Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-02, Leases (Topic 842), to revise lease accounting guidance. The update requires most leases to be recorded on the balance sheet as a lease liability, with a corresponding right-of-use asset, whereas these leases currently have an off-balance sheet classification. ASU 2016-02 must be applied on a modified retrospective basis and is effective for fiscal years beginning after December 15, 2018, and interim periods within those years, with early adoption permitted. The Company currently intends to adopt this standard in the first quarter of fiscal 2019. The Company is

 

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still evaluating the impact of implementation of this standard on its financial statements, but expects that adoption will have a material impact to the Company’s total assets and liabilities given the Company has a significant number of operating leases not currently recognized on its balance sheet.

 

In May 2014, the FASB issued ASU 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 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. The Company has identified certain impacts to our accounting for gift cards given away for promotional or marketing purposes. Under current GAAP, the value of promotional gift cards are recorded as selling, general, and administrative expense. The new standard requires these types of gift cards to be accounted for as a reduction of revenue (i.e. a discount). Additionally, ASU 2014-09 will disallow the capitalization of direct-response advertising costs which will impact the timing of recognition of certain advertising production and distribution costs. This standard is effective for reporting periods beginning after December 15, 2017, including interim periods within that fiscal year, with early adoption permitted for interim and annual periods beginning after December 15, 2016. The Company currently intends to adopt this standard in the first quarter of fiscal 2018 and the Company has elected to use the modified-retrospective approach for implementation of the standard. Overall, the Company does not expect the adoption of ASU 2014-09 to have a material impact on the financial statements.

 

In March 2016, the FASB issued ASU 2016-09, Compensation – Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, which outlined new provisions intended to simplify various aspects related to accounting for share-based payments, including income tax consequences, forfeitures, and classification in the statement of cash flows. Under the new guidance, an entity will no longer record excess tax benefits and certain tax deficiencies in additional paid-in capital (“APIC”). Instead, they will record all excess tax benefits and tax deficiencies as income tax expense or benefit in the income statement when the awards vest or are settled. This standard was effective for and adopted by the Company in the first quarter of fiscal 2017 and the Company now recognizes all income tax effects of share-based payments in the income statement on a prospective basis. The Company elected to continue to estimate forfeitures expected to occur to determine the amount of share-based compensation cost to recognize in each period, as permitted by ASU 2016-09. The adoption of ASU 2016-09 did not result in a material impact to the Company’s financial statements.

 

In October 2016, the FASB issued ASU 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory, which requires entities to recognize the income tax effects of intercompany sales and transfers of assets, other than inventory, in the period in which the transfer occurs. This is a change from current GAAP, which requires entities to defer the income tax effects of intercompany transfers of assets until the asset has been sold to an outside party or otherwise recognized (i.e. depreciated, amortized, impaired). The income tax effects of intercompany sales and transfers of inventory will continue to be deferred until the inventory is sold to an outside party. This ASU is effective for fiscal years beginning after December 15, 2017, and interim periods within those years, with early adoption permitted. The Company does not expect this standard to have a material impact on its financial statements.

 

In January 2017, the FASB issued ASU 2017-04, Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, which provides guidance to simplify the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test under ASC Topic 350. Under the new guidance, an entity should perform goodwill impairment testing by comparing the fair value of a reporting unit with its carrying amount. If the reporting unit’s carrying amount exceeds its fair value, an entity should recognize an impairment charge based on that difference, limited to the total amount of goodwill allocated to that reporting unit. The Company elected to

 

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early adopt this standard in the third quarter of fiscal 2017 on a prospective basis. The adoption of ASU 2017-04 did not result in a material impact to the Company’s financial statements.

 

In March 2017, the FASB issued ASU 2017-07, Compensation – Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, which provides guidance that requires an employer to present the service cost component separate from the other components of net periodic benefit cost. The update requires that employers present the service cost component of the net periodic benefit cost in the same income statement line item as other employee compensation costs arising from services rendered by participating employees during the period. The other components of the net periodic benefit cost are required to be presented separately from the line item that includes service cost and outside of the subtotal of income from operations. If a separate line item is not used, the line item used in the income statement must be disclosed. In addition, only the service cost component is eligible for capitalization in assets. This ASU will be applied retrospectively and is effective for fiscal years beginning after December 15, 2017, and interim periods within those years, with early adoption permitted. The Company does not expect this standard to have a material impact on its financial statements.

 

In May 2017, the FASB issued ASU 2017-09, Compensation – Stock Compensation (Topic 718): Scope of Modification Accounting, which clarifies when modification accounting should be applied for changes to terms or conditions of a share-based payment award. This ASU will be applied prospectively and is effective for fiscal years beginning after December 15, 2017, and interim periods within those years, with early adoption permitted. The Company does not expect this standard to have a material impact on its financial statements.

 

In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, which is intended to improve and simplify hedge accounting and improve the disclosures of hedging arrangements. This ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, with early adoption permitted. The Company is currently evaluating the impact of adopting the new standard on its financial statements.

 

2. Detail of certain balance sheet accounts

 

		December 30,		April 1,		December 31,
		2017		2017		2016
Inventory:
Finished goods		$104,714		$98,438		$104,374
Raw materials		5,139		4,183		4,288
Work in progress		538		499		347
		$110,391		$103,120		$109,009
Accrued liabilities:
Accrued payroll, benefits, and bonuses		$26,526		$20,897		$21,859
Unearned revenue		10,197		7,708		8,651
Accrued transaction and property tax		12,621		11,086		11,203
Gift cards and store credits outstanding		9,984		9,229		10,147
Accrued lease liabilities		6,329		4,767		4,815
Accrued interest		156		143		194
Other accrued liabilities		7,726		6,277		7,683
		$73,539		$60,107		$64,552

 

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3.  Long-term debt and revolving lines of credit

 

On August 18, 2017, the Company entered into a fourth amendment (the “Term Loan Amendment”) to the Credit Agreement dated as of April 6, 2012 (“Senior Secured Term Loan Facility”). The fourth amendment amended the Senior Secured Term Loan Facility to, among other things, (i) extend the maturity date of the loans under the Senior Secured Term Loan Facility to August 18, 2021, (ii) add a maximum leverage covenant of 5.0:1.0 which steps down by 0.25x on June 30 of each year commencing on June 30, 2018, (iii) increase the applicable interest rate margin to 7.00% for LIBOR loans and 6.00% for base rate loans, (iv) reduce the aggregate principal amount of the Senior Secured Term Loan Facility to $300,000, (v) increase principal amortization to 2.5% per annum, (vi) require a 3.0% upfront fee on the aggregate principal amount of the Senior Secured Term Loan Facility, and (vii) impose a 1% premium if a voluntary prepayment is made from the proceeds of a repricing transaction within 12 months after August 18, 2017.

 

On August 18, 2017, the Company also entered into a fourth amendment (the “Revolving Amendment”) to the Revolving Credit Facility, which, among other things, extended the maturity date of the loans under the Revolving Credit Facility to the earlier of (i) August 18, 2022 and (ii) May 18, 2021 if any portion of the Senior Secured Term Loan Facility remains outstanding on such date and the maturity date of the Senior Secured Term Loan Facility is not extended.

 

In connection with the closing of the Term Loan Amendment and the Revolving Amendment, the Company borrowed a net amount of $20,000 on the Revolving Credit Facility. In addition, the Company recorded a loss on extinguishment of debt of $2,369 in the thirteen weeks ended September 30, 2017 associated with the Term Loan Amendment and the Revolving Amendment.

 

The Company capitalizes certain costs associated with issuance of various debt instruments. These deferred financing costs are amortized to interest expense on a straight-line method, which is materially consistent with the effective interest method, over the terms of the related debt agreements. In the thirteen weeks ended September 30, 2017, the Company capitalized $9,640 of fees associated with the Term Loan Amendment that will be amortized through August 18, 2021 and $57 of fees associated with the Revolving Amendment that will be amortized through May 18, 2021.

 

Long-term debt and revolving lines of credit consist of the following:

 

		December 30,		April 1,		December 31,
		2017		2017		2016
Senior secured term loan facility		$296,250		$316,760		$317,666
2014 Elfa term loan facility		2,569		3,358		3,634
Obligations under capital leases		865		901		974
Other loans		49		119		140
Revolving credit facility		25,000		-		20,000
Total debt		324,733		321,138		342,414
Less current portion		(9,465	)	(5,445	)	(5,390	)
Less deferred financing costs (1)		(10,630	)	(3,667	)	(4,124	)
Total long-term debt		$304,638		$312,026		$332,900

 

(1)                      Represents deferred financing costs related to our Senior Secured Term Loan Facility, which are presented net of long-term debt in the consolidated balance sheet.

 

Under the Term Loan Amendment, the Company is now required to make quarterly principal repayments of $1,875 through June 20, 2021, with a balloon payment for the remaining balance due on August 18, 2021.

 

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Related Party Debt

 

On August 18, 2017, Green Credit Investors, L.P. funded $20,000 of the $300,000 Senior Secured Term Loan Facility based on the same terms, including interest rates, repayment terms, and collateral, as all other lenders. Green Credit Investors, L.P. is a related party due to its affiliation with LGP, the majority shareholder of the outstanding common stock of the Company.  As of December 30, 2017, the principal amount due to Green Credit Investors, L.P. is $11,800, of which $299 is classified as current.

 

4.  Net income per common share

 

Basic net income per common share is computed as net income divided by the weighted-average number of common shares for the period. Diluted net income per share is computed as net income divided by the weighted-average number of common shares 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. Potentially dilutive securities are excluded from the computation of diluted net income per share if their effect is anti-dilutive.

 

The following is a reconciliation of net income and the number of shares used in the basic and diluted net income per share calculations:

 

		Thirteen Weeks Ended				Thirty-Nine Weeks Ended
		December 30,		December 31,		December 30,		December 31,
		2017		2016		2017		2016
Numerator:
Net income		$28,379		$5,092		$19,827		$6,576
Denominator:
Weighted-average common shares — basic		48,067,754		47,999,535		48,057,974		47,992,652
Weighted-average common shares — diluted		48,167,882		48,022,499		48,128,682		48,002,495
Net income per common share - basic and diluted		$0.59		$0.11		$0.41		$0.14
Antidilutive securities not included:
Stock options outstanding		3,157,843		3,001,940		3,016,359		2,954,043
Nonvested restricted stock awards		42,541		-		40,643		-

 

5.  Income taxes

 

The Tax Cuts and Jobs Act (the “Tax Act”) was enacted on December 22, 2017. The Tax Act made numerous changes to federal corporate tax law, including reducing the U.S. federal corporate tax rate from 35% to 21%, requiring companies to pay a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred and allowing for the immediate expensing of qualified property purchases, among others. As of December 30, 2017, the Company had not completed the accounting for the tax effects of enactment of the Tax Act; however, a reasonable estimate of the effects on our existing deferred tax balances has been recorded as a provisional amount in our consolidated financial statements. The Company has not been able to reasonably estimate the one-time transition tax on the earnings of foreign subsidiaries and continues to account for foreign earnings based on the provisions of the tax laws that were in effect immediately prior to the enactment of the Tax Act. Pursuant to Staff Accounting Bulletin No. 118, the Company’s measurement period for implementing the accounting changes required by the Tax Act will close before December 22, 2018 and the Company anticipates completing the accounting under ASC Topic 740, Income Taxes, in a subsequent reporting period within the measurement period.

 

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Provisional amounts for remeasurement of deferred tax balances

 

Deferred tax balances were remeasured based on the rates at which they are expected to reverse in the future, generally 21% pursuant to the Tax Act.  However, the Company is still analyzing certain aspects of the Tax Act and refining the calculations, which could potentially affect the measurement of these balances or potentially give rise to new deferred tax amounts. In the thirteen weeks ended December 30, 2017, a provisional benefit of $24,253 was recognized related to the remeasurement of the Company’s deferred tax balances, which is included as a component of (benefit) provision for income taxes on the consolidated statement of operations.

 

One-time transition tax on earnings of foreign subsidiaries

 

The one-time transition tax is based on accumulated earnings and profits (“E&P”) from our 1999 acquisition of Elfa for which U.S. income taxes were previously deferred. The Company has not made sufficient progress on the E&P and foreign tax pool analysis for its foreign subsidiaries to reasonably estimate the effects of the one-time transition tax and, therefore, provisional amounts have not been recorded. The Company does not have all the necessary information available, prepared or analyzed as it relates to how Elfa’s intercompany and restructuring transactions impact E&P and the tax pools. In addition, the foreign cash balance at the end of the fiscal year (March 31, 2018) is unknown. Because the transition tax is based in part on the amount of earnings and profits held in cash and other specified assets as measured as of March 31, 2018, we are unable to determine a reasonable estimate of the transition tax. The Company continued to apply ASC 740 based on the provisions of the tax laws that were in effect immediately prior to the enactment of the Tax Act. No deferred taxes have been recorded because the Company has determined these amounts are indefinitely reinvested.

 

Effective tax rate

 

In the thirteen weeks ended December 30, 2017, the Company revised its estimated annual effective tax rate to reflect a change in the federal statutory rate from 35% to 21% as a result of the Tax Act. The rate change is administratively effective for fiscal 2017, using a blended rate for the annual period. As a result, the blended statutory rate for fiscal 2017 is 31.5%.

 

The Company’s effective income tax rate for the thirteen weeks ended December 30, 2017 was -330.1% compared to 39.7% for the thirteen weeks ended December 31, 2016. During the thirteen weeks ended December 30, 2017 the effective tax rate fell below the blended statutory rate of 31.5% primarily due to the estimated impact of the Tax Act, which was primarily driven by the remeasurement of deferred tax balances. During the thirteen weeks ended December 31, 2016, the effective tax rate rose above the statutory rate of 35% due to earnings mix between domestic and foreign jurisdictions.

 

The Company’s effective income tax rate for the thirty-nine weeks ended December 30, 2017 was 429.3% compared to 42.5% for the thirty-nine weeks ended December 31, 2016. During the thirty-nine weeks ended December 30, 2017, the effective tax rate rose above the blended statutory rate of 31.5% primarily due to the estimated impact of the Tax Act, which was primarily driven by the remeasurement of deferred tax balances. During the thirty-nine weeks ended December 31, 2016, the effective tax rate rose above the statutory rate of 35% due to earnings mix between domestic and foreign jurisdictions coupled with our worldwide net income position.

 

6.  Commitments and contingencies

 

In connection with insurance policies and other contracts, the Company has outstanding standby letters of credit totaling $4,023 as of December 30, 2017.

 

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 adverse effect on the Company’s financial condition, results of operations, or cash flows on an individual basis or in the aggregate.

 

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7.  Accumulated other comprehensive loss

 

Accumulated other comprehensive loss (“AOCL”) consists of changes in our foreign currency forward contracts, pension liability adjustment, and foreign currency translation. The components of AOCL, net of tax, are shown below for the thirty-nine weeks ended December 30, 2017:

 

		Foreign currency forward contracts		Pension liability adjustment		Foreign currency translation		Total
Balance at April 1, 2017		$(155	)	$(1,444	)	$(21,044	)	$(22,643	)
Other comprehensive income (loss) before reclassifications, net of tax		1,650		(175	)	6,808		8,283
Amounts reclassified to earnings, net of tax		37		-		-		37
Net current period other comprehensive income (loss)		1,687		(175	)	6,808		8,320
Balance at December 30, 2017		$1,532		$(1,619	)	$(14,236	)	$(14,323	)

 

Amounts reclassified from AOCL 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 8.

 

8.  Foreign currency forward contracts

 

The Company’s international operations and purchases of inventory products from foreign suppliers are subject to certain opportunities and risks, including foreign currency fluctuations. In the TCS segment, we utilize foreign currency forward contracts in Swedish krona to stabilize our retail gross margins and to protect our domestic operations from downward currency exposure by hedging purchases of inventory from our wholly-owned subsidiary, Elfa. Forward contracts in the TCS segment are designated as cash flow hedges, as defined by ASC 815. In the Elfa segment, we utilize foreign currency forward contracts to hedge purchases, primarily of raw materials, that are transacted in currencies other than Swedish krona, which is the functional currency of Elfa. Forward contracts in the Elfa segment are economic hedges and are not designated as cash flow hedges as defined by ASC 815.

 

During the thirty-nine weeks ended December 30, 2017 and December 31, 2016, the TCS segment used forward contracts for 100% and 75% of inventory purchases in Swedish krona, respectively. During the thirty-nine weeks ended December 30, 2017 and December 31, 2016, the Elfa segment used forward contracts to purchase U.S. dollars in the amount of $1,648 and $3,195, which represented 27% and 61% of the Elfa segment’s U.S. dollar purchases, respectively. Generally, the Company’s foreign currency forward contracts 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 foreign currency forward contracts 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 records all foreign currency forward contracts on its consolidated balance sheet at fair value. The Company accounts for its foreign currency hedging instruments in the TCS segment as cash flow hedges, as defined. Changes in the fair value of the foreign currency hedging 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

 

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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 hedge instruments and determined the foreign currency hedge instruments were highly effective during the thirty-nine weeks ended December 30, 2017 and December 31, 2016. Forward contracts not designated as hedges in the Elfa segment are adjusted to fair value as selling, general, and administrative expenses on the consolidated statements of operations. During the thirty-nine weeks ended December 30, 2017, the Company recognized a net loss of $182 associated with the change in fair value of forward contracts not designated as hedging instruments.

 

The Company had a $1,532 gain in accumulated other comprehensive loss related to foreign currency hedge instruments at December 30, 2017. The entire $1,532 represents an unrealized gain for settled foreign currency hedge instruments related to inventory on hand as of December 30, 2017. The Company expects the unrealized gain of $1,532, net of taxes, to be reclassified into earnings over the next 12 months as the underlying inventory is sold to the end customer.

 

The change in fair value of the Company’s foreign currency hedge instruments that qualify as cash flow hedges and are included in accumulated other comprehensive loss, net of taxes, are presented in Note 7 of these financial statements.

 

9.  Fair value measurements

 

Under GAAP, 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 December 30, 2017, April 1, 2017 and December 31, 2016, 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. The Company’s foreign currency hedging instruments consist of over-the-counter (OTC) contracts, which are not traded on a public exchange. See Note 8 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

 

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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:

 

						December 30,		April 1,		December 31,
Description				Balance Sheet Location		2017		2017		2016
Assets
Nonqualified retirement plan (1)		N/A		Other current assets		$5,782		$5,092		$4,735
Foreign currency forward contracts		Level 2		Other current assets		-		841		274
Total assets						$5,782		$5,933		$5,009

 

(1)          The fair value amount of the nonqualified retirement plan is measured at fair value using the net asset value per share practical expedient, and therefore, is not classified in the fair value hierarchy.

 

The fair value of long-term debt was estimated using quoted prices as well as recent transactions for similar types of borrowing arrangements (level 2 valuations). As of December 30, 2017, April 1, 2017 and December 31, 2016, the estimated fair value of the Company’s long-term debt, including current maturities, was $313,068, $295,005, and $308,463, respectively.

 

10.  Segment reporting

 

The Company’s reportable segments were determined on the same basis as how management evaluates performance internally by the Chief Operating Decision Maker (“CODM”). The Company has determined that the Chief Executive Officer is the CODM and the Company’s two reportable segments consist of TCS and Elfa. The TCS segment includes the Company’s retail stores, website and call center, as well as the installation and organization 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 in TCS inventory balances at the end of the period are eliminated for consolidation purposes in the Eliminations column. The net sales to third parties in the Elfa column represent sales to customers outside of the United States.

 

The Company has determined that adjusted earnings before interest, tax, depreciation, and amortization (“Adjusted EBITDA”) is the profit or loss measure that the CODM uses to make resource allocation decisions and evaluate segment performance. Adjusted EBITDA assists management in comparing our performance on a consistent basis for purposes of business decision-making by removing the impact of certain items that management believes do not directly reflect our core operations and, therefore, are not included in measuring segment performance. Adjusted EBITDA is calculated in accordance with the Senior Secured Term Loan Facility and the Revolving Credit Facility and we define Adjusted EBITDA as net income before interest, taxes, depreciation and amortization, certain non cash items, and other adjustments that we do not consider in our evaluation of ongoing operating performance from period to period.

 

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Thirteen Weeks Ended December 30, 2017		TCS		Elfa		Eliminations		Total
Net sales to third parties		$203,881		$19,105		$-		$222,986
Intersegment sales		-		23,495		(23,495	)	-
Adjusted EBITDA		22,550		6,374		(3,363	)	25,561
Interest expense, net		7,232		68		-		7,300
Assets (1)		673,489		116,779		(5,869	)	784,399

 

Thirteen Weeks Ended December 31, 2016		TCS		Elfa		Eliminations		Total
Net sales to third parties		$199,087		$17,293		$-		$216,380
Intersegment sales		-		20,160		(20,160	)	-
Adjusted EBITDA		22,333		4,968		(1,983	)	25,318
Interest expense, net		4,080		39		-		4,119
Assets (1)		680,287		105,008		(5,181	)	780,114

 

Thirty-Nine Weeks Ended December 30, 2017		TCS		Elfa		Eliminations		Total
Net sales to third parties		$573,261		$51,203		$-		$624,464
Intersegment sales		-		46,036		(46,036	)	-
Adjusted EBITDA		51,760		10,965		(4,218	)	58,507
Interest expense, net		17,189		209		-		17,398
Assets (1)		673,489		116,779		(5,869	)	784,399

 

Thirty-Nine Weeks Ended December 31, 2016		TCS		Elfa		Eliminations		Total
Net sales to third parties		$549,423		$49,465		$-		$598,888
Intersegment sales		-		41,982		(41,982	)	-
Adjusted EBITDA (2)		53,485		9,454		(3,289	)	59,650
Interest expense, net		12,283		151		-		12,434
Assets (1)		680,287		105,008		(5,181	)	780,114

 

 

(1)          Tangible assets in the Elfa column are located outside of the United States.

 

(2)          The TCS segment includes a net benefit of $3.9 million related to amended and restated employment agreements entered into with key executives during the first quarter of fiscal 2016, leading to a reversal of accrued deferred compensation associated with the original employment agreements.

 

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A reconciliation of Adjusted EBITDA by segment to (loss) income before taxes is set forth below:

 

		Thirteen Weeks Ended				Thirty-Nine Weeks Ended
		December 30, 2017		December 31, 2016		December 30, 2017		December 31, 2016
Adjusted EBITDA by segment:
TCS		$22,550		$22,333		$51,760		$53,485
Elfa		6,374		4,968		10,965		9,454
Eliminations		(3,363	)	(1,983	)	(4,218	)	(3,289	)
Total Adjusted EBITDA		25,561		25,318		58,507		59,650
Depreciation and amortization		(9,477	)	(9,236	)	(28,524	)	(28,061	)
Interest expense, net		(7,300	)	(4,119	)	(17,398	)	(12,434	)
Pre-opening costs (a)		(1,872	)	(2,918	)	(4,676	)	(6,558	)
Non-cash rent (b)		714		298		1,451		970
Stock-based compensation (c)		(585	)	(599	)	(1,589	)	(1,355	)
Loss on extinguishment of debt (d)		-		-		(2,369	)	-
Foreign exchange gains (losses) (e)		360		(53	)	306		211
Optimization Plan implementation charges (f)		(422	)	-		(10,742	)	-
Elfa manufacturing facility closure (g)		(335	)	-		(852	)	-
Other adjustments (h)		(45	)	(249	)	(135	)	(996	)
Income (loss) before taxes		$6,599		$8,442		$(6,021	)	$11,427

 

(a)   Non-capital expenditures associated with opening new stores and relocating stores, including rent, marketing expenses, travel and relocation costs, and training costs. We adjust for these costs to facilitate comparisons of our performance from period to period.

 

(b)   Reflects the extent to which our annual GAAP rent expense has been above or below our cash rent payment due to lease accounting adjustments. The adjustment varies depending on the average age of our lease portfolio (weighted for size), as our GAAP rent expense on younger leases typically exceeds our cash cost, while our GAAP rent expense on older leases is typically less than our cash cost.

 

(c)   Non-cash charges related to stock-based compensation programs, which vary from period to period depending on volume and vesting timing of awards. We adjust for these charges to facilitate comparisons from period to period.

 

(d)   Loss recorded as a result of the amendments made to the Senior Secured Term Loan Facility and the Revolving Credit Facility in August 2017, which we do not consider in our evaluation of our ongoing operations.

 

(e)   Realized foreign exchange transactional gains/losses our management does not consider in our evaluation of our ongoing operations.

 

(f)   Charges incurred to implement our Optimization Plan, which include certain consulting costs recorded in selling, general and administrative expenses, cash severance payments associated with the elimination of certain full-time positions at the TCS segment recorded in other expenses, and cash severance payments associated with organizational realignment at the Elfa segment recorded in other expenses, which we do not consider in our evaluation of ongoing performance.

 

(g)   Charges related to the closure of an Elfa manufacturing facility in Lahti, Finland in December 2017, recorded in other expenses, which we do not consider in our evaluation of our ongoing performance.

 

(h)   Other adjustments include amounts our management does not consider in our evaluation of our ongoing

 

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operations, including certain severance and other charges.

 

11.  Optimization Plan

 

On May 23, 2017, the Company announced a four-part plan designed to optimize its consolidated business and drive improved sales and profitability (the “Optimization Plan”), which included sales initiatives, certain full-time position eliminations at TCS, organizational realignment at Elfa and ongoing savings and efficiency efforts.

 

In the thirteen weeks and thirty-nine weeks ended December 30, 2017, the Company incurred the following charges related to the implementation of the Optimization Plan:

 

				Thirteen Weeks Ended		Thirty-Nine Weeks Ended
		Income Statement Location		December 30, 2017		December 30, 2017
Consulting fees and other costs		Selling, general & administrative		$6		$6,686
Severance - full-time position eliminations at TCS		Other expenses		-		1,836
Severance - organizational realignment at Elfa		Other expenses		416		2,220
Total Optimization Plan charges				$422		$10,742

 

 

Certain aspects of the Optimization Plan meet the definition of exit or disposal costs as defined in the Accounting Standards Codification (“ASC”) Topic 420, Exit or Disposal Cost Obligations.  The following table summarizes the exit or disposal activities during the thirty-nine weeks ended December 30, 2017:

 

		TCS Position Eliminations
		Severance
Liability Balance as of April 1, 2017		$-
Costs Incurred		1,810
Payments		(1,089	)
Liability Balance as of July 1, 2017		$721
Costs Incurred		26
Payments		(480	)
Liability Balance as of September 30, 2017		$267
Costs Incurred		-
Payments		(154	)
Liability Balance as of December 30, 2017		$113
As of December 30, 2017
Total costs incurred to date		$1,836
Total costs expected to be incurred		$1,836

 

 

The balance of $113 as of December 30, 2017 is recorded in the Accrued liabilities line item in the Consolidated Balance Sheets. The Company does not expect future severance costs to be incurred related to full-time position eliminations at TCS as the actions were completed during the first quarter of fiscal 2017.

 

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