Tile Shop Holdings, Inc. Q4 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by. Welcome to the Fourth Quarter 2020 Tile Shop Holdings, Inc. Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. I would now like to turn the conference over to your speaker today, Mark Davis. Thank you, everyone, and welcome to the Tile Shop's fourth quarter earnings conference. Joining me today are Cabby Lolmaugh, our Chief Executive Officer; and Nancy DiMattia, our Chief Financial Officer. Certain statements made during our call today constitute forward-looking statements made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 as amended. Forward-looking statements are subject to known and unknown risks and uncertainties that could cause actual results to differ materially. Those risks and uncertainties are described in our earnings press release issued earlier and in our filings with the SEC. The forward-looking statements made today are as of the date of this call, and we do not undertake any obligation to update them. Today's call will also include certain non-GAAP measurements. Please refer to our earnings release for a reconciliation of those non-GAAP financial measures, which is also posted on our company website. With that, let me now turn the call over to Cabby.

Thanks, Mark. Good morning, everyone. Thank you for joining us today for an update on our business and a review of our financial results. We ended 2020 on a positive note. Our fourth quarter results continued to show progress, although we still have room to improve. Our sales increased 3.8% to $81.6 million during the fourth quarter of 2020. Sales at comparable stores increased 3.3%, primarily due to an improvement in customer conversion. Both overall sales growth and comparable store sales growth improved sequentially from the third quarter. The improvement is largely tied to an improving traffic trend we’ve observed over the last quarter, though our traffic numbers are still down year-over-year. This isn’t surprising as many customers continue to limit store trips during the pandemic. Additionally, decisions made to reduce our expense structure during the pandemic negatively impacted our traffic. For example, we have been operating most stores at reduced hours since April 2020, including all stores being closed on Sundays. This was made to optimize staffing levels and has resulted in a $12.4 million reduction in our SG&A expenses during the second half of 2020 compared to 2019. During this period, our net income increased from a net loss of $5.6 million in the second half of 2019 to net income of $3.3 million in the second half of 2020. Our adjusted EBITDA increased by $8.5 million, or 64%, to $22 million during the second half of 2020. We're pleased with the significant improvement in profitability despite the challenges in traffic and sales. In the fourth quarter, we conducted a test by adding evening hours back to select stores, ensuring customers had the option to visit stores in the evenings in their respective markets. This test proved beneficial, and we were able to incorporate evening hours in many of our stores by the end of the fourth quarter with minimal changes in staffing levels. Starting in the first quarter of 2021, we will open select stores on Sundays and increase staffing levels as necessary. However, like many retailers, our supply chain has been affected by COVID-19. We began experiencing elevated levels of back orders due to delays in replenishment from international tile suppliers. This challenge continued into the fourth quarter, adversely impacting our sales. We are collaborating closely with suppliers to secure delivery of back order products. At the beginning of 2020, we had three key priorities: focused retail execution, growing sales with our professional customers, and disciplined expense management. While COVID-19 significantly impacted our business, we were able to achieve many of these goals, ultimately generating the necessary cash to fully pay off our debt during the fourth quarter. We now have significant flexibility as a debt-free retailer with a financial model that, in our view, is built to generate substantial operating cash flow. As we enter 2021, we will focus on initiatives that drive revenue growth and leverage our expense structure. We see significant opportunities to drive sales growth within our existing portfolio of stores. Thus, our key priorities for 2021 include: focusing on retail execution, enhancing our customers’ online experience, and refining our purchasing and distribution processes. Regarding retail execution, we believe it is essential for growing revenues and profits within our existing stores to improve execution at the store level. We have made significant strides over the past year, such as increasing the number of Pros enrolled in our loyalty program, improving customer delivery collection rates, and reducing discounting, though there are still opportunities for meaningful improvement. We see an opportunity to use our technology investments to enhance customer interactions through follow-up calls and activity monitoring to ensure proactive communication. We have identified several areas to improve in our stores, and I believe that maintaining focus on retail execution will be a key catalyst for revenue growth. One of our key priorities for 2021 is to enhance our customers’ online experience. We aspire to provide the best service in our industry to every customer who visits our stores, and we hold the same high standards for our website. Now, more than ever, customers start their journey online to seek inspiration, weigh options, and choose their partners. We have identified numerous opportunities to enhance our customers' online experience and better integrate online and in-store shopping. For instance, we recently launched our Tile Visualizer, allowing customers to create a room online, simulate different tile options, save their project, and solicit advice from our talented design experts. I believe the steps we are taking to enhance our website are foundational to driving improvements in traffic and sales in future periods. Our final priority for 2021 is to refine our purchasing and distribution processes. We are currently working to address elevated levels of back orders with suppliers. We appreciate that much of this was beyond our suppliers' control due to government shutdowns and reduced hours during the pandemic, but we aim to eliminate stockouts as quickly as possible. We continue to evaluate our product assortment and ensure we source products that align with current design trends while maintaining targeted gross margin rates across all categories. Before I turn the call over to Nancy, I want to reiterate my pride in our employee base, particularly our team members in stores, for rising to the occasion despite the challenges of 2020. The theme for 2021 is focus, as we expect to increase sales in our existing stores while maintaining strong expense management controls. I’ll now turn the call over to Nancy, who will take you through some of the financial details.

Thanks, Cabby. Good morning, everyone. As Cabby mentioned, we were pleased with our fourth quarter results. Net sales increased $3 million or 3.8% from $78.6 million during the fourth quarter of 2019 to $81.6 million during the fourth quarter of 2020. Sales at comparable stores improved 3.3%, driven primarily by improved customer conversion. Our comparable store sales improved sequentially from the third quarter, thanks to traffic trends, although our traffic numbers are still down year-over-year due to reduced store hours. Product shortages also posed a challenge during the fourth quarter of 2020. For the full year, net sales decreased $15.3 million or 4.5% from $340.4 million in 2019 to $325.1 million during 2020. Sales at comparable stores decreased by 5.6%, largely due to the COVID-19 onset, which significantly decreased store traffic, especially during the second quarter. While traffic improved through the rest of the year, reduced hours and product shortages continued to impact sales. Gross profit in the fourth quarter of 2020 was $55.9 million, an increase of $2.1 million, or 3.9%, compared to the fourth quarter of 2019. Our gross margin was 68.5%, which is 10 basis points higher than in the fourth quarter of 2019 and 60 basis points better than the third quarter of 2020. The improvement in our gross margin rate in the fourth quarter, compared to the prior year, was mainly due to reduced inventory write-downs and better pricing, although these were partially offset by an increase in customer delivery mix. For the full year, we generated $221.5 million of gross profit, but our gross margin rate decreased by 130 basis points from 69.4% in 2019 to 68.1% in 2020, driven by heightened customer delivery mix and increased inventory write-downs due to routine product transitions. Selling, general, and administrative costs decreased by $5 million from $58.2 million in the fourth quarter of 2019 to $53.2 million in the fourth quarter of 2020. This decrease was primarily attributable to our reduced hours, contributing to a $1.5 million reduction in compensation and benefit expenses, as well as reductions in depreciation and professional fees. For the full year, SG&A expenses decreased by $22.3 million to $215.1 million due to lower levels of compensation stemming from the headcount reduction following COVID-19, as well as reduced variable and advertising expenses. We concluded the year with 142 stores, unchanged from the beginning of the year. We are pleased with our profitability metrics for the quarter and the year. Net income for the fourth quarter was $1.4 million, and fully diluted earnings per share was $0.03. For the full year, our net income was $6 million, with fully diluted earnings per share of $0.12. Adjusted EBITDA for the fourth quarter increased by $5.7 million from $5.1 million in the fourth quarter of 2019 to $10.8 million in 2020, representing an adjusted EBITDA margin improvement of 680 basis points compared to the fourth quarter of 2019. Full-year adjusted EBITDA was $40 million, up by $5.1 million or 15% compared to 2019, with a margin improvement of 210 basis points. Regarding our balance sheet, we ended the year with $9.6 million in cash and no debt. Our inventory at year-end totaled $74.3 million, which increased slightly from the third quarter. Cabby outlined our three priorities for 2021, which focus on improving revenues from our current store portfolio. We anticipate capital expenditures between $12 million to $15 million in 2021 to open one new store and relocate another. The new store opened in Wayne, New Jersey, on February 19, and involves the remodeling of 15 to 20 stores. We will continue to enhance merchandise presentations and our distribution fleet. While we expect an increase in inventory during 2021, we plan to keep it below $90 million. Before closing, I’d like to provide a brief update on our ongoing process to potentially relist our common stock on NASDAQ. On March 1, 2021, after receiving the recommendation of the special committee of our Board of Directors, we were authorized to apply for relisting. We have submitted our application and are committed to responding promptly to any inquiries from NASDAQ representatives. We want to remind stockholders and potential traders that there can be no assurance that NASDAQ will approve our listing application. Given the ongoing nature of this process, we will not address any questions about it on today’s call. In summary, we have a robust foundation to advance our 2021 priorities and, with no debt, we enjoy considerable flexibility and balance sheet strength. Now, Lydia, Cabby and I are ready to take any questions.

Good morning. It’s David Kanen, Kanen Wealth Management. Thanks for taking my questions. The first question is, for the quarter, could you quantify the amount of orders you received deposits for that you were unable to ship due to out-of-stock situations? In Q3, it was a few million dollars, contributing to the same-store sales numbers. So, could you help me understand that?

Hey, David, it’s Cabby. Great question. Yes, it did roll into the fourth quarter and it was primarily about the same. The challenges faced in our supply chain are not unique to us but are seen across the industry. Primarily, it was around a couple million dollars that impacted our back orders during the quarter.

Thank you. The second part of my question is regarding the investments in enhancing the online experience and virtualization. Can you provide more detail on the timeframe for those rollouts?

Absolutely. We’ve already rolled out features like the Visualizer, and we are working on various enhancements to improve our customer engagement and help guide customers through their project funnel. These changes are ongoing, and we’re continually adding new features, sometimes weekly. If you check our website, you will see new enhancements throughout the year.

One final question. Could you provide more detail on the test you ran by adding hours? What was the return on investment for those additional labor hours?

Sure. It’s a balance. When COVID hit, we had to adjust our headcounts, and it was crucial to maintain profitability while extending hours for customers. As we began adding hours during the week, we monitored traffic counts and analyzed order data for closed hours. We noted increased orders from customers who could shop after work. While I can’t give a specific percentage change, we did observe a positive impact as we allowed more customers to visit during extended hours. We have several stores now open later during the week, and we are also being strategic about Sunday hours.

Being that you’ve paid off all your debt, how does management and the Board feel about potentially buying back stock, considering you're generating significant free cash flow?

Yes, absolutely. I’ll address the employee review piece and then turn it over to Nancy for revenue outlook. Regarding employees, we indeed review comp plans, and we have a highly engaged workforce, particularly this year. Their morale is strong. Our headcount changes also contributed to excellent engagement because they interacted more with customers. We have managed to add to our leadership team, including our new CIO, Christopher Davis, who brings fresh perspectives. For the leadership ranks, comp changes in retail are evaluated every year, so we did see positive morale among our employees.

Thanks, Cabby, and thank you, David, for the question. We were very focused on paying off our debt in 2020 and we’re pleased that we achieved this goal. Thus, we believe it will position us very well and provide flexibility in the future. As previously stated, we’ve earmarked $12 million to $15 million for store remodels and other strategic initiatives. We will continue to monitor our cash position and evaluate our capital allocation strategy throughout the year. Remember, we’re still early in the year and there is a need for generating cash.

Could you speak to the momentum observed in Q4, which turned to a positive same-store sales number, and whether that has continued or accelerated in Q1?

Yes, David, we were excited about the year-over-year improvements in Q4. However, I can’t provide insights into Q1; our details will be released during the next call.

Good morning. Building on David’s query regarding the Visualizer you're developing for online applications, how are you adopting it in stores? We see it's become more conventional among some peers; how is that playing with remodels?

Eric, that’s a great question. While I spent years sketching designs on paper in stores, this tool allows for significant enhancements. We can now showcase various offerings, and there’s been notable positive feedback from the field. Our customers are increasingly using this tool and sharing their projects with us. We are thrilled about the adoption rate and how much it adds to the customer experience.

Will the remodels this year include these thematic changes?

Yes, when assessing stores for remodels, we consider a multitude of factors such as store tenure and inventory. We may opt for full remodels, scrapes, or simple updates. There’s a broad range of approaches we take to refresh stores, and we are focused on expanding design spaces and enhancing customer interaction.

To add, regarding the refresh, we’re focused on updating vineyards and displaying new design trends and enhancing visibility for new product showcases. We aim to refresh approximately 15 to 20 stores this year.

Regarding cash flow and generation, is there any thought about increasing new store openings? You opened one in New Jersey, are there plans for more given the competitive lease terms?

That’s a great question. While we desire to grow, our immediate focus in 2021 is to achieve our objectives before expanding further. We’ll explore cash flow generation and market conditions to make sound decisions. So, not in 2021 for expansion as it stands.

Congrats on a good quarter. Quick question regarding the one-time uplisting costs to NASDAQ and potential cost implications moving forward.

As indicated in our prepared remarks, we will not entertain questions about our listing status today. However, some information may be available in our previous 8-K filings.

Given the significant cash generated and debt repayment, any thoughts on a self-tender to bolster valuation ahead of the NASDAQ uplist?

Thank you for your suggestion; we appreciate the input. Overall, we’re pleased with our position and the path forward.

Hi, this is John Helander. I am new to the story, just had a basic question. How much does it cost to build a store?

Typically, it costs about $1 million to build out a store, down from historical highs of around $1.5 million.

What return should we expect from a $1 million investment?

Returns vary by market and store ramp-up, making it difficult to specify. Market conditions can shift these expectations.

Considering the slight increase in mortgage rates, how does that impact your business? What’s the mix of renovations versus new construction?

We primarily focus on remodel businesses and custom homes, which made us resilient during economic downturns. With higher remodeling activity, we have managed expenses effectively. As rates rise, we expect to continue maintaining strength as remodels generally remain steady.

Could you discuss the business trends throughout 2020? The top-line numbers seem flat.

Certainly, we’re in a fashion industry focused on home expression, and there has been a noticeable shift towards making homes more representative of personal style. Demand has shifted from traditional neutrals to stylistic choices, leading to increased sales across product segments.

Who determines the buying process? Is it contractors or customers making the selections in stores?

Customers make the final selection, but contractors play an important role in guiding their decision-making. We aim to provide an excellent experience for both by increasing product selections for Pros and ensuring guidance for retail customers.

Is there a shortage of tiling contractors affecting your business?

Yes, there is an industry-wide shortage of trades, resulting in higher installation costs. We’re positioning ourselves for a resurgence of DIY due to the virtual learning shift and are ready to assist customers seeking to tackle projects themselves.

Is there seasonal demand in your businesses?

Definitely. Q1 tends to be strong for us, with tax returns and graduation seasons driving demand, while summer typically sees a dip. However, interest in home updates generally picks up again with the return to school.

Thank you for listening to our earnings conference call. We anticipate filing our Form 10-K later today and look forward to providing our next update in May. Thank you for your interest in the Tile Shop, and have a great day.

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation. You may now disconnect.