TUESDAY MORNING CORP/DE - Quarter Report: 2017 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

FOR THE QUARTERLY PERIOD ENDED September 30, 2017

OR

FOR THE TRANSITION PERIOD FROM          TO         

Commission File Number 0-19658

TUESDAY MORNING CORPORATION

(Exact Name of Registrant as Specified in its Charter)

6250 LBJ Freeway

Dallas, Texas 75240

(Address of principal executive offices) (Zip code)

(972) 387-3562

(Registrant’s telephone number, including area code)

Not applicable

(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  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  ☒    No  ☐

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Table of Contents

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PART I — FINANCIAL INFORMATION

Tuesday Morning Corporation

Consolidated Balance Sheets

September 30, 2017 (unaudited) and June 30, 2017

(In thousands, except share and per share data)

The accompanying notes are an integral part of these unaudited consolidated financial statements.

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Tuesday Morning Corporation

Consolidated Statements of Operations (unaudited)

(In thousands, except per share data)

The accompanying notes are an integral part of these unaudited consolidated financial statements.

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Tuesday Morning Corporation

Consolidated Statements of Cash Flows (unaudited)

(In thousands)

The accompanying notes are an integral part of these unaudited consolidated financial statements.

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Tuesday Morning Corporation

Notes to Condensed Consolidated Financial Statements (unaudited)

The terms “Tuesday Morning,” the “Company,” “we,” “us” and “our” as used in this Quarterly Report on Form 10-Q refer to Tuesday Morning Corporation and its subsidiaries.

1.      Basis of presentation — The unaudited interim consolidated financial statements included herein have been prepared by us pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) have been condensed or omitted pursuant to such rules and regulations. These financial statements include all adjustments, consisting only of those of a normal recurring nature, which, in the opinion of management, are necessary to present fairly the results of the interim periods presented and should be read in conjunction with the audited consolidated financial statements and notes thereto in our Annual Report on Form 10-K for the fiscal year ended June 30, 2017. The consolidated balance sheet at June 30, 2017 has been derived from the audited consolidated financial statements at that date, but does not include all of the information and notes required by GAAP for complete financial statements. For further information, refer to the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2017. The results of operations for the three month period ended September 30, 2017 are not necessarily indicative of the results to be expected for the full fiscal year ending June 30, 2018, which we refer to as fiscal 2018.

We do not present a consolidated statement of comprehensive income as there are no other comprehensive income items in either the current or prior fiscal periods.

The preparation of unaudited interim consolidated financial statements, in conformity with GAAP, requires us to make assumptions and use estimates that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  The most significant estimates relate to: inventory valuation under the retail method and estimation of reserves and valuation allowances specifically related to insurance, income taxes and litigation. Actual results could differ from these estimates. Our fiscal year ends on June 30 and we operate our business as a single operating segment.

2.      Share-based incentive plans — Stock Option Awards. We have established the Tuesday Morning Corporation 2004 Long-Term Equity Incentive Plan, as amended (the “2004 Plan”), the Tuesday Morning Corporation 2008 Long-Term Equity Incentive Plan (the “2008 Plan”) and the Tuesday Morning Corporation 2014 Long-Term Incentive Plan, as amended (the “2014 Plan”), which allow for the granting of stock options to directors, officers and key employees of the Company, and certain other key individuals who perform services for us and our subsidiaries. Equity awards may no longer be granted under the 2004 Plan or the 2008 Plan, but equity awards granted under the 2004 Plan and the 2008 Plan are still outstanding.

On November 16, 2016, our stockholders approved amendments to the 2014 Plan to increase the number of shares of the Company’s common stock available for issuance under the 2014 Plan by 2,500,000 shares and to make additional amendments to the 2014 Plan, including (i) reducing the percentage of shares exempt from the minimum vesting requirements under the 2014 Plan, (ii) adding a clawback policy, (iii) generally eliminating the discretion of the Board of Directors to accelerate the vesting of outstanding and unvested awards upon a change of control and (iv) providing that certain shares surrendered in payment of the exercise price of awards or withheld for tax withholding would count against the shares available under the 2014 Plan.

       Stock options were awarded with a strike price at a fair market value equal to the average of the high and low trading prices of our common stock on the date of grant under the 2004 Plan. Stock options were awarded with a strike price at a fair market value equal to the closing price of our common stock on the date of the grant under the 2008 Plan and the 2014 Plan.

Options granted under the 2004 Plan typically vest over periods of one to five years and expire ten years from the date of grant, while options granted under the 2008 Plan and the 2014 Plan typically vest over periods of one to four years and expire ten years from the date of grant. Options granted under the 2004 Plan, the 2008 Plan and the 2014 Plan may have certain performance requirements in addition to service terms. If the performance conditions are not satisfied, the options are forfeited. The exercise prices of stock options outstanding on September 30, 2017, range between $1.24 per share and $20.91 per share. All shares available under the 2004 Plan have been granted. The 2004 Plan and the 2008 Plan terminated as to new awards as of May 17, 2014 and September 16, 2014, respectively. There were 3.0 million shares available for grant under the 2014 Plan at September 30, 2017.

Restricted Stock Awards—The 2004 Plan, the 2008 Plan, and the 2014 Plan authorize the grant of restricted stock awards to directors, officers, key employees and certain other key individuals who perform services for us and our subsidiaries. Equity awards may no longer be granted under the 2004 Plan and the 2008 Plan, but restricted stock awards granted under the 2004 Plan and the 2008 Plan are still outstanding. Restricted stock awards are not transferable, but bear certain rights of common stock ownership including voting and dividend rights. Shares are valued at the fair market value of our common stock at the date of award. Shares may be subject to certain performance requirements. If the performance requirements are not met, the restricted shares are forfeited. Under the 2004 Plan, the 2008 Plan and the 2014 Plan, as of September 30, 2017, there were 1,633,867 shares of restricted stock outstanding

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with award vesting periods, both performance-based and service-based, of one to four years and a weighted average grant date fair value of $4.49 per share.

Performance-Based Restricted Stock Awards and Performance-Based Stock Option Awards.  As of September 30, 2017 there were 1,641,513 performance-based restricted stock awards and performance-based stock option awards outstanding under the 2004 Plan, 2008 Plan and the 2014 Plan.  

Share-based Compensation Costs.   Share-based compensation costs were recognized as follows (in thousands):

3.      Commitments and contingencies — From time to time, we are involved in litigation which is incidental to our business.  In our opinion, no litigation to which we are currently a party is likely to have a material adverse effect on our consolidated financial condition, results of operations, or cash flows.

4.      Loss per common share — The following table sets forth the computation of basic and diluted loss per common share (in thousands, except per share amounts):

For the quarters ended September 30, 2017 and September 30, 2016,  all options representing rights to purchase shares were excluded from the diluted loss per share calculation as we had a net loss for the periods and the assumed exercise of such options would have been anti-dilutive.  

5.      Revolving credit facility — We have a credit agreement providing for an asset-based, five-year senior secured revolving credit facility in the amount of up to $180.0 million which matures on August 18, 2020 (the “Revolving Credit Facility”). The availability of funds under the Revolving Credit Facility is limited to the lesser of a calculated borrowing base and the lenders’ aggregate commitments under the Revolving Credit Facility. Our indebtedness under the Revolving Credit Facility is secured by a lien on substantially all of our assets. The Revolving Credit Facility contains certain restrictive covenants, which affect, among others, our ability to incur liens or incur additional indebtedness, change the nature of our business, sell assets or merge or consolidate with any other entity, or make investments or acquisitions unless they meet certain requirements. The Revolving Credit Facility requires that we satisfy a fixed charge coverage ratio at any time that our availability is less than the greater of 10% of our calculated borrowing base or $12.5 million. Our Revolving Credit Facility may, in some instances, limit our ability to pay cash dividends and repurchase our common stock. In order for the borrower under the Revolving Credit Facility, our subsidiary, to make a restricted payment to us for the payment of a dividend or a repurchase of shares, we must, among other things, maintain availability of 20% of the lesser of our calculated borrowing base or our lenders’ aggregate commitments under the Revolving Credit Facility on a pro forma basis for a specified period prior to and immediately following the restricted payment. As of September 30, 2017, we were in compliance with all of the Revolving Credit Facility covenants.  

At September 30, 2017, we had $43.0 million outstanding under the Revolving Credit Facility, $7.9 million of outstanding letters of credit and availability of $81.3 million. Letters of credit under the Revolving Credit Facility are primarily for self-insurance purposes. We incur commitment fees of up to 0.25% on the unused portion of the Revolving Credit Facility, payable quarterly. Any

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borrowing under the Revolving Credit Facility incurs interest at LIBOR or the prime rate, plus an applicable margin, at our election (except with respect to swing loans, which incur interest solely at the prime rate plus the applicable margin), subject to a floor of one month LIBOR plus an applicable margin in the case of loans based on the prime rate.  Interest expense for the first quarter of the current fiscal year from the Revolving Credit Facility of $0.4 million was comprised of commitment fees of $0.1 million, interest expense of $0.2 million and the amortization of financing fees of $0.1 million. Interest expense for the first quarter of the prior fiscal year from the Revolving Credit Facility of $0.3 million was comprised commitment fees of $0.1 million, interest expense of $0.1 million and the amortization of financing fees of $0.1 million.   

The fair value of the Company’s debt approximated its carrying amount as of September 30, 2017.      

6.      Depreciation — Accumulated depreciation of owned equipment and property at September 30, 2017 and June 30, 2017 was $142.8 million and $138.3 million, respectively.

7.      Income taxes — The Company or one of its subsidiaries files income tax returns in the U.S. federal, state and local taxing jurisdictions. With few exceptions, the Company and its subsidiaries are no longer subject to state and local income tax examinations for years before fiscal 2012.  The Internal Revenue Service has concluded an examination of the Company for years ending on or before June 30, 2010.

The effective tax rates for the quarters ended September 30, 2017 and September 30, 2016 were (1.5%) and 3.3%, respectively.  A full valuation allowance is currently recorded against the Company’s deferred tax assets. A deviation from the customary relationship between income tax expense/(benefit) and pretax income/(loss) results from utilization of the valuation allowance.

8.      Cash and cash equivalents — Cash and cash equivalents include credit card receivables and all highly liquid instruments with original maturities of three months or less. Cash equivalents are carried at cost, which approximates fair value. At September 30, 2017 and June 30, 2017, credit card receivables from third party consumer credit card providers were $9.2 million and $4.9 million, respectively. Such receivables are generally collected within one week of the balance sheet date.

9.      Intellectual property — Our intellectual property primarily consists of indefinite lived trademarks. We evaluate annually whether the trademarks continue to have an indefinite life. Trademarks and other intellectual property are reviewed for impairment annually in the fourth quarter, and may be reviewed more frequently if indicators of impairment are present. As of September 30, 2017, the carrying value of the intellectual property, which included indefinite-lived trademarks, was $1.0 million and no impairment was identified or recorded.

10.     Cease use liability — Amounts in “Accrued liabilities” and “Other liabilities – non-current” in the Consolidated Balance Sheet at September 30, 2017 include the current and long-term portions, respectively, of accruals for the net present value of future minimum lease payments, net of estimated sublease income, attributable to closed stores with remaining lease obligations. The short-term and long-term cease use liabilities were $0.8 and $0.4 million, respectively, at September 30, 2017. The short-term and long-term cease use liabilities were $1.0 and $0.5 million, respectively, at June 30, 2017. Expenses related to store closings are included in “Selling, general and administrative expenses” in the Consolidated Statements of Operations.

11.    Sale-leaseback — During the fourth quarter of fiscal 2016, we entered into a sale-leaseback transaction to sell two buildings and land utilized in our Dallas distribution center operations, which we do not consider part of our long-term distribution network, and leased back these facilities through December 2017. We have since exercised our option to extend the related lease through March 2018. We have no continuing involvement with the properties sold other than a normal leaseback.                                                                                                                                  

The consideration received for the sale, as reduced by closing and transaction costs, was $8.8 million, and the net book value of properties sold was $5.2 million, resulting in a $3.6 million gain. The gain recognized in fiscal year 2016 was $2.5 million, which included the portion of the gain in excess of the present value of the minimum lease payments for the leaseback, and was included in other income in our Consolidated Statement of Operations.  During fiscal 2017, we recognized $0.7 million of the gain. During the first quarter of fiscal 2018, we recognized $0.2 million of the gain. The remaining $0.2 million gain deferred on the Consolidated Balance Sheet at September 30, 2017 is classified as short-term, as it will be recognized during fiscal 2018. The leaseback is an operating lease, and we will pay approximately $0.4 million in rent, excluding executory costs, from October 2017 through March 2018.

12.  Capital Lease — During fiscal 2017, we entered into a 5-year capital lease maturing on January 31, 2022 for equipment and software. At September 30, 2017, the capital lease asset balance was $0.7 million, the current lease liability was $0.1 million and the long-term lease liability was $0.6 million. The capital lease asset is amortized on a straight-line basis. During the first fiscal quarter of 2018, the capital lease amortization was less than $0.1 million.  

13.  Recent accounting pronouncements — In August 2016, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts

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and Cash Payments (“ASU 2016-15”), which provides guidance on eight specific cash flow issues in regard to how cash receipts and cash payments are presented and classified in the statement of cash flows. ASU 2016-15 is effective for fiscal years beginning after December 15, 2017, including interim periods within those years, with early adoption permitted. The amendments in ASU 2016-15 should be adopted on a retrospective basis unless it is impracticable to apply, in which case the amendments should be applied prospectively as of the earliest date practicable. The Company currently expects to adopt this standard in the first quarter of fiscal 2019 and is currently evaluating the impact that this standard will have on its consolidated financial statements and disclosures.

In March 2016, the FASB issued ASU No. 2016-09, Compensation – Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”) to reduce the complexity of certain aspects of the accounting for employee share-based payment transactions. ASU 2016-09 involves changes in several aspects of the accounting for share-based payment transactions, including the accounting for the income tax consequences of share-based awards. For public companies, ASU 2016-09 is effective for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. The Company adopted ASU 2016-09 in the first quarter of fiscal 2018 and 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. In addition, the adoption of this standard prospectively changes the dilutive earnings per share calculation by removing excess tax benefits and deficiencies from the computation. The adoption of this standard did not materially impact our consolidated financial statements and disclosures.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (“ASU 2016-02”), which is intended to improve financial reporting in connection with leasing transactions. ASU 2016-02 will require entities (“lessees”) that lease assets with lease terms of more than twelve months to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases. Under ASU 2016-02, a right-of-use asset and lease obligation will be recorded for all leases, whether operating or finance, while the income statement will reflect lease expense for operating leases and amortization/interest expense for finance leases. Accounting by entities that own the assets leased by lessees (“lessors”) will remain largely unchanged from current GAAP. In addition, ASU 2016-02 requires disclosures to help investors and other financial statement users better understand the amount, timing and uncertainty of cash flows arising from leases. For public companies, ASU 2016-02 is effective for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years. Early adoption is permitted. A modified retrospective approach is required for all leases existing or entered into after the beginning of the earliest comparative period in the financial statements. The Company currently expects to adopt this standard in the first quarter of fiscal 2020. While the Company is currently evaluating the provisions of ASU 2016-02 to assess the impact on the Company’s consolidated financial statements and disclosures, the primary effect of adopting the new standard will be to record assets and obligations for current operating leases.

In July 2015, the FASB issued ASU No. 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory (“ASU 2015-11”), which changes the measurement principle for inventory from the lower of cost or market to the lower of cost or net realizable value, except for companies using the Retail Inventory Method which will continue to use existing impairment models. ASU 2015-11 defines net realizable value as estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The new guidance must be applied on a prospective basis and is effective for fiscal years beginning after December 15, 2016, and interim periods within those years, with early adoption permitted. The Company adopted ASU 2015-11 in the first quarter of fiscal 2018. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements and disclosures.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”), an updated standard on revenue recognition, and has since modified the standard with additional ASUs. The new guidance 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, or payment, to which the company expects to be entitled in exchange for those goods or services. In July 2015, the FASB deferred the effective date of ASU 2014-09. Accordingly, this standard is effective for reporting periods beginning after December 15, 2017, including interim periods within that year, with early adoption permitted for interim and annual periods beginning after December 15, 2016. The Company currently expects to adopt this standard in the first quarter of fiscal 2019 and does not expect this standard to have a material impact on its consolidated financial statements and disclosures, as the vast majority of its revenue is expected to continue to be generated from point-of-sale transactions that are expected to be recognized consistent with its current accounting. The Company’s current accounting for gift card breakage is consistent with the new standard. The Company is currently evaluating whether the standard will affect its current accounting for customer incentives. The Company is continuing to evaluate the impact that this standard will have on its consolidated financial statements and disclosures and expects to use the modified retrospective method when adopting this standard.

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The following discussion should be read in conjunction with our unaudited interim consolidated financial statements and the notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the fiscal year ended June 30, 2017.

Business Overview

Results of Operations

Our business is highly seasonal, with a significant portion of our net sales and most of our operating income generated in the quarter ending December 31. 

There can be no assurance that the trends in sales or operating results will continue in the future.

Non-GAAP Financial Measures

We define EBITDA as net income or net loss before interest, income taxes, depreciation, and amortization. Adjusted EBITDA reflects further adjustments to EBITDA to eliminate the impact of certain items, including certain non-cash items and other items that

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we do not believe are representative of our core operating performance. These measures are not presentations made in accordance with GAAP. EBITDA and Adjusted EBITDA should not be considered as alternatives to net income or loss as a measure of operating performance. In addition, EBITDA and Adjusted EBITDA are not presented as, and should not be considered as alternatives to cash flows as a measure of liquidity. EBITDA and Adjusted EBITDA should not be considered in isolation, or as substitutes for analysis of our results as reported under GAAP and Adjusted EBITDA should not be construed as an inference that our future results will be unaffected by such adjustments. We believe it is useful for investors to see these EBITDA and Adjusted EBITDA measures that management uses to evaluate our operating performance. These non-GAAP financial measures are included to supplement our financial information presented in accordance with GAAP and because we use these measures to monitor and evaluate the performance of our business as a supplement to GAAP measures and we believe the presentation of these non-GAAP measures enhances investors’ ability to analyze trends in our business and evaluate our performance. EBITDA and Adjusted EBITDA are also frequently used by analysts, investors and other interested parties to evaluate companies in our industry. The non-GAAP measures presented may not be comparable to similarly titled measures used by other companies.

Adjusted EBITDA.  The following table reconciles net loss, the most directly comparable GAAP financial measure, to Adjusted EBITDA, a non-GAAP financial measure (in thousands):

Three Months Ended September 30, 2017

Compared to the Three Months Ended September 30, 2016

Net sales increased $6.9 million, or 3.2%, to $218.8 million in the first quarter of fiscal 2018 from $211.9 million in first quarter fiscal 2017, primarily due to a $7.2 million increase in sales from comparable stores (stores open at least one year, including stores relocated in the same market and renovated stores) of 3.6%. The increase in comparable store sales was comprised of a 2.9% increase in customer transactions and a 0.6% increase in average ticket. While our sales results were negatively impacted by the hurricane challenges in the first quarter this fiscal year, the impact was largely offset by a planned promotional shift from October 2017 to September 2017.  Sales at the 45 stores relocated during the past 12 months increased approximately 72% on average for the first fiscal quarter of 2018 as compared to the same period last year and contributed approximately 410 basis points of comparable store sales growth, driven primarily by the better real estate and larger average store footprint.  Non-comparable store sales include the net effect of sales from new stores and sales from stores that have closed. The non-comparable store sales decrease was driven by 37 store closures, partially offset by 23 store openings, which have occurred since the end of the first quarter of fiscal 2017.

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We ended the first quarter of fiscal 2018 with 728 stores, compared to 742 stores at the end of the first quarter of the prior year.  We relocated 12 existing stores during the first quarter of fiscal 2018 and 19 stores in the first quarter of the prior fiscal year. We expanded five stores during the first quarter of fiscal 2018 and eight stores in the first quarter of the prior fiscal year.

Gross profit for the first quarter of fiscal 2018 was $78.0 million, an increase of 0.9% compared to $77.3 million in gross profit for the first quarter of fiscal 2017. Gross profit as a percentage of net sales was 35.6% for the first quarter of fiscal 2018, compared to 36.5% for the first quarter of fiscal 2017. The decrease in gross margin was primarily due to the recognition of previously capitalized supply chain and freight costs, including an approximate 140 basis point impact of elevated costs related to the supply chain issues we incurred in the prior fiscal year.  Partially offsetting this increase in costs was a continued improvement in initial merchandise mark-up along with a significant favorable shift in markdown timing as compared to the prior year period.

Selling, General & Administrative (SG&A) expenses for the first quarter of fiscal 2018 increased 3.8% to $89.9 million, compared to $86.6 million in the same period last year.  As a percentage of net sales, SG&A was 41.1% for the first quarter of fiscal 2018 compared to 40.9% in the same period last year.  This increase in SG&A as a percentage of net sales was driven primarily by higher store rent and depreciation, due in part to our strategy to improve store real estate.  Also contributing to the increase in SG&A in the current quarter were the incremental costs related to the stockholder nominations, as discussed in our recently filed proxy statements, which negatively impacted SG&A as a percentage of net sales by approximately 20 basis points.  Partially offsetting these increased costs were reductions in certain other corporate and field expenses, including labor costs, legal and professional fees, which decreased in both dollars and as a percentage of net sales in the current year quarter from the prior year quarter.

Our operating loss was $12.0 million for the first quarter of fiscal 2018 as compared to an operating loss of $9.2 million during the first quarter of fiscal 2017.  We estimate that our first quarter results were adversely impacted by the recognition within gross margin of previously capitalized supply chain and freight costs of approximately 140 basis points, or approximately $3.0 million, driven significantly by elevated costs resulting from our supply chain issues experienced in the previous fiscal year.

Net interest expense increased $0.1 million to $0.4 million in first quarter of fiscal 2018 compared to $0.3 million in the first quarter of fiscal 2017, as a result of increased borrowings on our Revolving Credit Facility during the first quarter of fiscal 2018. Other income was $0.4 million in both the first quarter of fiscal 2018 and the first quarter of fiscal 2017.

Income tax expense for the first quarter of fiscal 2018 was $0.2 million compared to an income tax benefit of $0.3 million for the same period last year. The effective tax rates for the first quarter of fiscal 2018 and fiscal 2017 were (1.5%) and 3.3%, respectively.  A full valuation allowance is currently recorded against our deferred tax assets at September 30, 2017. A deviation from the customary relationship between income tax benefit and pretax income results from utilization of the valuation allowance.

Liquidity and Capital Resources

Cash Flows from Operating Activities

Net cash provided by operating activities for the three months ended September 30, 2017 was $2.6 million compared to $39.4 million net cash used in operating activities for the three months ended September 30, 2016.  The $2.6 million of cash provided by operating activities for the three months ended September 30, 2017 was primarily due to a net loss of $12.3 million adjusted for non-cash items, including depreciation and amortization of $6.3 million and share based compensation of $0.8 million, which were partially offset by a non-cash gain on sale-leaseback of $0.2 million recorded in other income.  In the first quarter of fiscal 2018, we received $2.0 million in construction allowances from landlords related to our real estate improvement strategy.  Also impacting the cash provided by operating activities were an increase in accounts payable of $60.3 million, an increase in accrued liabilities of $6.4 million, and an increase in deferred rent of $2.9 million, which were partially offset by an increase in inventory of $61.9 million in preparation for the upcoming holiday selling season and to support sales trends along with an increase in prepaid and other current assets of $1.7 million.  There were no significant changes to our vendor payments policy during the three months ended September 30, 2017.

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The $39.4 million of cash used in operating activities for the three months ended September 30, 2016 was primarily due to a net loss of $8.9 million adjusted for non-cash items, including depreciation and amortization of $4.6 million, share based compensation of $0.7 million, as well as an increase in inventory of $81.1 million in preparation for the fiscal 2017 holiday season, which was partially offset by an increase in accounts payable of $44.0 million and an increase in accrued liabilities of $1.5 million.

Cash Flows from Investing Activities

Net cash used in investing activities for the three months ended September 30, 2017 and 2016 related primarily to capital expenditures. Capital expenditures were associated with store relocations, expansions and new store openings, capital improvements to existing stores, enhancements to our distribution center facilities, equipment, and systems along with improvements related to our corporate office and equipment.  Cash used in investing activities totaled $11.8 million and $10.8 million for the three months ended September 30, 2017 and 2016, respectively.  

We currently expect to incur capital expenditures in the range of $25 million to $30 million in fiscal year 2018.

Cash Flows from Financing Activities

Net cash provided by financing activities of $13.9 million for the three months ended September 30, 2017 relates to $12.5 million of borrowings on our Revolving Credit Facility, net of payments, along with a $1.4 million cash overdraft provision. Net cash used in financing activities of $42.3 million for the three months ended September 30, 2016 consisted of $32.5 million of borrowing on our Revolving Credit Facility borrowings, net of payments, along with a $9.8 million cash overdraft provision.

Revolving Credit Facility

We have a credit agreement providing for an asset-based, five-year senior secured revolving credit facility in the amount of up to $180.0 million which matures on August 18, 2020 (the “Revolving Credit Facility”). The availability of funds under the Revolving Credit Facility is limited to the lesser of a calculated borrowing base and the lenders’ aggregate commitments under the Revolving Credit Facility. Our indebtedness under the Revolving Credit Facility is secured by a lien on substantially all of our assets. The Revolving Credit Facility contains certain restrictive covenants, which affect, among others, our ability to incur liens or incur additional indebtedness, change the nature of our business, sell assets or merge or consolidate with any other entity, or make investments or acquisitions unless they meet certain requirements. The Revolving Credit Facility requires that we satisfy a fixed charge coverage ratio at any time that our availability is less than the greater of 10% of our calculated borrowing base or $12.5 million. Our Revolving Credit Facility may, in some instances, limit our ability to pay cash dividends and repurchase our common stock. In order for the borrower under the Revolving Credit Facility, our subsidiary, to make a restricted payment to us for the payment of a dividend or a repurchase of shares, we must, among other things, maintain availability of 20% of the lesser of our calculated borrowing base or our lenders’ aggregate commitments under the Revolving Credit Facility on a pro forma basis for a specified period prior to and immediately following the restricted payment. As of September 30, 2017, we were in compliance with all of the Revolving Credit Facility covenants.  

At September 30, 2017, we had $43.0 million outstanding under the Revolving Credit Facility, $7.9 million of outstanding letters of credit and availability of $81.3 million. Letters of credit under the Revolving Credit Facility are primarily for self-insurance purposes. We incur commitment fees of up to 0.25% on the unused portion of the Revolving Credit Facility, payable quarterly. Any borrowing under the Revolving Credit Facility incurs interest at LIBOR or the prime rate, plus an applicable margin, at our election (except with respect to swing loans, which incur interest solely at the prime rate plus the applicable margin), subject to a floor of one month LIBOR plus an applicable margin in the case of loans based on the prime rate. Interest expense for the first quarter of the current fiscal year from the Revolving Credit Facility of $0.4 million was comprised of commitment fees of $0.1 million, interest expense of $0.2 million and the amortization of financing fees of $0.1 million. Interest expense for the first quarter of the prior fiscal year from the Revolving Credit Facility of $0.3 million was comprised commitment fees of $0.1 million, interest expense of $0.1 million and the amortization of financing fees of $0.1 million.

Liquidity

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We have financed our operations with funds generated from operating activities, available cash and cash equivalents, proceeds from the sale of owned properties and borrowings under our Revolving Credit Facility. Cash and cash equivalents as of September 30, 2017 and 2016, were $11.0 million and $6.2 million, respectively. Our cash flows will continue to be utilized for the operation of our business and the use of any excess cash will be determined by the Board of Directors. Given the seasonality of our business, the amount of borrowings under our Revolving Credit Facility may fluctuate materially depending on various factors, including the time of year, our strategic investment needs and the opportunity to acquire merchandise inventory. Our primary uses for cash provided by operating activities relate to funding our ongoing business activities and planned capital expenditures. We may also use available cash to repurchase shares of our common stock. We believe funds generated from our operations, available cash and cash equivalents and borrowings under our Revolving Credit Facility will be sufficient to fund our operations for the next year. If our capital resources are not sufficient to fund our operations, we may seek additional debt or equity financing. However, we can offer no assurances that we will be able to obtain additional debt or equity financing on reasonable terms.

Off-Balance Sheet Arrangements and Contractual Obligations

We had no off-balance sheet arrangements as of September 30, 2017.

As of September 30, 2017, there have been no material changes outside the ordinary course of business from the disclosures relating to contractual obligations contained under “Contractual Obligations” in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2017.

Critical Accounting Policies

This Management’s Discussion and Analysis of Financial Condition and Results of Operations is based upon our unaudited interim consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of certain assets, liabilities, sales and expenses, and related disclosure of contingent assets and liabilities. On a recurring basis, we evaluate our significant estimates which are based on historical experience and on various other assumptions that we believe are reasonable under the circumstances. Actual results may differ from these estimates.

There were no changes to our critical accounting policies during the first quarter of fiscal 2018 from those listed in our Annual Report on Form 10-K for the fiscal year ended June 30, 2017.

Under the retail inventory method, permanent markdowns result in cost reductions in inventory at the time the markdowns are taken.  We also utilize promotional markdowns for specific marketing efforts used to drive higher sales volume and customer transactions for a specified period of time.  Promotional markdowns do not impact the value of unsold inventory and thus do not impact cost of sales until the merchandise is sold.  Markdowns during the first quarter of fiscal 2018 were 5.0% of sales compared to 6.0% of sales for the same period last year. If our sales forecasts are not achieved, we may be required to record additional markdowns that could exceed historical levels. The effect of a 0.5% markdown in the value of our inventory at September 30, 2017 would result in a decline in gross profit and earnings per share for the first quarter of fiscal 2018 of $1.4 million and $0.03, respectively.

For a further discussion of the judgments we make in applying our accounting policies, see Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, in our Annual Report on Form 10-K for the fiscal year ended June 30, 2017.

Recent Accounting Pronouncements

Please refer to Note 13 of our unaudited condensed consolidated financial statements for a summary of recent accounting pronouncements.

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Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the federal securities laws and the Private Securities Litigation Reform Act of 1995, which are based on management’s current expectations, estimates and projections.  These statements may be found throughout this Quarterly Report on Form 10-Q, particularly in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” among others. Forward-looking statements typically are identified by the use of terms such as “may,” “will,” “should,” “expect,” “anticipate,” “believe,” “estimate,” “intend” and similar words, although some forward-looking statements are expressed differently.  You should consider statements that contain these words carefully because they describe our current expectations, plans, strategies and goals and our current beliefs concerning future business conditions, our future results of operations, our future financial position, and our current business outlook or state other “forward-looking” information. Forward looking statements also include statements regarding our sales and growth expectations, our liquidity, capital expenditure plans, our real estate strategy and merchandising and marketing strategies.

Readers are referred to Part 1, Item 1A “Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended June 30, 2017 for examples of risks, uncertainties and events that could cause our actual results to differ materially from the expectations expressed in our forward-looking statements.  These risks, uncertainties and events also include, but are not limited to, the following:

•    our ability to successfully implement our long-term business strategy;

•changes in economic and political conditions which may adversely affect consumer spending;

•our failure to identify and respond to changes in consumer trends and preferences;

•our ability to continuously attract buying opportunities for off-price merchandise and anticipate consumer demand;

•our ability to successfully manage our inventory balances profitably;

•our ability to effectively manage our supply chain operations;

•loss of, disruption in operations, or increased costs in the operation of our distribution center facilities;

•unplanned loss or departure of one or more members of our senior management or other key management;

•increased or new competition;

•our ability to successfully execute our strategy of opening new stores and relocating and expanding existing stores;

•increases in fuel prices and changes in transportation industry regulations or conditions;

•our ability to generate strong cash flows from operations and to continue to access credit markets;

•increases in the cost or a disruption in the flow of our imported products;

•changes in federal tax policy;

•the success of our marketing, advertising and promotional efforts;

•our ability to attract, train and retain quality employees in appropriate numbers, including key employees and management;

•increased variability due to seasonal and quarterly fluctuations;

•our ability to comply with existing, changing and new government regulations;

•our ability to manage litigation risks from our customers, employees and other third parties;

•our ability to manage risks associated with product liability claims and product recalls;

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•the impact of adverse local conditions, natural disasters and other events;

•our ability to manage the negative effects of inventory shrinkage;

•our ability to manage exposure to unexpected costs related to our insurance programs;

•increased costs or exposure to fraud or theft resulting from payment card industry related risk and regulations.

The forward-looking statements made in this Form 10-Q relate only to events as of the date on which the statements are made.  Except as may be required by law, we disclaim obligations to update any forward-looking statements to reflect events or circumstances after the date on which the statements were made or to reflect the occurrence of unanticipated events.  Investors are cautioned not to place undue reliance on any forward-looking statements.

There have been no material changes to the Company’s market risks as disclosed in our Annual Report on Form 10-K filed for the fiscal year ended June 30, 2017.

Disclosure Controls and Procedures

Based on our management’s evaluation (with participation of our principal executive officer and our principal financial officer), our principal executive officer and our principal financial officer have concluded that our disclosure controls and procedures (as defined in Rule 13a-15(e)  under the Securities Exchange Act of 1934, as amended) were effective as of September 30, 2017 to provide reasonable assurance that information required to be disclosed by us in reports that we file or submit under  the Securities Exchange Act of 1934, as amended, is (1) recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and (2) accumulated and communicated to our management, including our principal executive and principal financial officers, as appropriate, to allow timely decisions regarding required disclosure.

A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues, if any, within a company have been detected. Accordingly, our disclosure controls and procedures are designed to provide reasonable, not absolute, assurance that their objectives are met and, as set forth above, our chief executive officer and chief financial officer have concluded, based on their evaluation as of the end of the period covered by this report, that our disclosure controls and procedures were effective to provide reasonable assurance that their objectives were met.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2017 that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

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PART II - OTHER INFORMATION

From time to time, we are involved in litigation which is incidental to our business. In our opinion, no litigation to which we are currently a party is likely to have a material adverse effect on our consolidated financial condition, results of operations or cash flows.

We believe there have been no material changes from our risk factors previously disclosed in Part 1, Item 1A “Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended June 30, 2017.

Information regarding our repurchases of equity securities during the three months ended September 30, 2017 is provided in the following table:

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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