Audit gives clean marks to Tile Shop

After a months-long investigation into allegations over undisclosed relationships and inflated earnings, an independent audit committee has found no evidence suggesting that The Tile Shop misstated its financial records, though ethics policy violations on behalf of the CEO's brother-in-law has earned him the boot.

The retailer has been subject to scrutiny since November, when shortseller Gotham City Research issued a report stating that Fumitake Nishi, the head of its largest supplier, Beijing Pingxiu, was the brother-in-law of Tile Shop CEO Robert Rucker, as well as a Tile Shop employee. Furthermore, Gotham City alleged that this covert relationship had resulted in earnings reports that were overstated by more than 200%, due in part to an artificial cost advantage.

“I am naturally extremely disappointed to learn of the nature and extent of the previously undisclosed relationships that Mr. Nishi maintained with our vendors," said Rucker in a company statement. "Our senior management team has had direct and pointed conversations with our vendors about this situation. We believe that by working together we will implement better practices to safeguard against any of these situations recurring in the future.”

The committee confirmed that Nishi was related to Rucker and was working for The Tile Shop, having acquired BP in late 2011. It was also found that Nishi had been operating an undisclosed "reseller" model whereby BP would take title to product and resell it to The Tile Shop. There was no evidence that The Tile Shop overpaid or underpaid vendors through its relationship with BP.

Additionally, there was no evidence that The Tile Shop had misstated its inventories or its cost of goods.

However, Nishi was also found to have acquired a majority ownership interest in Nanyang Helin Stone Co., a Tile Shop vendor, in 2010. He also received payments totaling approximately $1.1 million in his personal bank account from representatives of certain vendors in exchange for consulting services.

“The investigation took longer than we anticipated, but because of the diligence of the process, our company will be stronger in the future," added Rucker. "We have reexamined our business practices and have initiated the implementation of new procedures to better manage and control our vendor relationships. With that said, our entire organization can now re-focus its efforts on growing this company as we continue to build out our national network of stores in a profitable manner.”

As a result of the investigation, The Tile Shop is no longer working with BP as of Dec. 1, 2013. Additionally, Nishi's employment was terminated effective Jan. 1 for multiple violations of the company's business ethics policy. He will be held liable for any money he earned from third-party sources during his employment. The Tile Shop will continue working with Nanyang provided it end its involvement with Nishi.

New procedures, mentioned above by Rucker, include creating a new export trading company operated by Tile Shop employees to identify and control vendor invoices and relationships, installing multiple points of contact with vendors, rotating primary vendor relationships every 24 months, and reorganizing purchasing oversight responsibilities.

The investigation was conducted by Dorsey & Whitney, an independent counsel to the audit committee.