Good day and thank you for standing by. Welcome to the Fourth Quarter 2022 Tile Shop Holdings Earnings Conference Call. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Mark Davis, Vice President of Investor Relations and Chief Accounting Officer. Please go ahead.

Thank you, operator. Good morning to everyone and welcome to the Tile Shop's fourth quarter and full year earnings call. Joining me today are Cab Lolmaugh, our Chief Executive Officer; and Karla Lunan, our Chief Financial Officer. Certain statements made during the call today constitute forward-looking statements made pursuant to and within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, as amended. Such forward-looking statements are subject to both known and unknown risks and uncertainties that could cause actual results to differ materially from such statements. 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 these forward-looking statements. Today's call will also include certain non-GAAP measurements. Please see our earnings release for a reconciliation of those non-GAAP financial measures which has also been posted to our company website. With that, let me now turn the call over to Cab.

Thanks, Mark. Good morning, everyone, and thank you for joining us today. Starting with the positive. In 2022, our company achieved our highest level of annual revenue in our 37-year history and we were able to accomplish this milestone without opening any new stores during the year. This milestone was made possible by the steps we've taken to improve inventory levels and execution across our store base in 2022. We've made significant progress. However, in the fourth quarter, we battled macro headwinds that contributed to lower levels of traffic in our stores and a modest decrease in comparable store sales. While the top line results for the quarter are short of our goals, there are a number of positive developments I'm seeing in the business. First, we're able to successfully launch our expanded line of LVT products during the fourth quarter. We've seen a nice response from our associates and our customers following the launch. As you know, we have been observing LVT for the past few years as our higher-end customers gradually accepted LVT as a viable option for their flooring needs. We believe this is due to advancements made in LVT product quality since it was first introduced. Our test of LVT earlier in the year went well. Since the full launch in October, we have continued to see customers choosing to purchase tile with LVT in the same order. We believe that we have an opportunity to grow ticket averages by cross-selling LVT to customers who are already in our stores to purchase tile. Additionally, we believe the addition of LVT gives us the opportunity to reach new customers who chose to shop elsewhere when LVT products were not available in our stores. As a reminder, LVT and other resilient flooring were projected to be approximately 30% of all industry-wide hard surface flooring sales in the U.S. in 2022. While we're just getting going, I'm pleased with the initial results and believe our LVT lines will be a key catalyst for growth in 2023. Moving to new store growth. We're on track to open two new stores in 2023. We expect one to open this summer and one in the second half of the year. Our operational teams are actively working to refine our new store opening procedures to ensure our 2023 store openings are positioned to deliver strong results. The third area I'd like to address is our supply chain. Over the last 18 months, we've seen increases in prices from our suppliers in response to rising energy, labor, and other inflationary cost pressures. These pressures were compounded by elevated international freight rates. In response to these cost pressures, we took steps to implement selective pricing adjustments across our assortment, particularly during the first half of 2022. In addition, during the second half of the year, we've tried to stay ahead of this by building stock levels in our more popular SKUs ahead of announced price increases from our suppliers. Given the macro headwinds, we took a more conservative approach to raising prices during the second half of 2022. This conservative approach, combined with increasing inventory costs, contributed to the 200 basis point sequential decline in gross margin rates between the third and fourth quarters. On a positive note, international freight rates have started to come down, which should help us as we move through 2023. Additionally, we've made great progress working with our network of suppliers to identify alternative sources for a number of our products at a lower cost. In January, I had the opportunity to travel with our purchasing team to visit suppliers across Asia who are partnering with us on our resourcing effort. I was impressed by the quality of the products we inspected on our trip and encouraged to see firsthand examples of SKUs we'll be adding to our assortment at a much lower cost compared to the price of similar items purchased in late 2022. It will take some time for the newly sourced products to make their way into the assortment. I believe the success we're having in this area will position the company to maintain a strong overall margin profile. I'd also like to take a moment to touch on our retail excellence initiative. Over the last two years, we have focused on eliminating distractions and improving core execution in our stores. We delayed initiatives such as growing stores so we can focus our efforts on developing our teams. Our focus areas include training on design, leadership, inventory best practices, and customer engagement. These efforts have translated into improvements in sales to our pros, higher conversion rates, lower discretionary discounting, and a decrease in inventory losses. While we've made great progress, our work here is never done, and we'll continue to focus on the details in providing exceptional service to every customer who walks through our doors. Before I close, I'd like to take a moment to thank the Tile Shop team. As mentioned earlier, we set an annual sales record in 2022. Our success would not be possible without the energy and passion you bring to your job every day. I look forward to continuing to build on our success in 2023. With that, I'll now hand the call over to Karla to walk us through the financial results for the fourth quarter and the full year.

Thanks, Cabby. Good morning, everyone. Fourth quarter sales at comparable stores decreased by 2.8% when compared to the fourth quarter of 2021. The decrease in sales revenue was due to decreased unit volume, which was partially offset by an increase in our average ticket value. For the full year, we set an annual sales record with $394.7 million of revenue. Sales at comparable stores increased by 6.5% due to an increase in average ticket that was partially offset by a decrease in unit volume. The gross margin rate during the fourth quarter was 64.5%. We continue to see elevated levels of inventory receipts at higher price points throughout the fourth quarter. In the first half of 2022, we effectively used price increases to offset some of the increase in inventory costs. However, we did not use that lever nearly as much during the second half of the year. The increase in inventory costs combined with a more conservative approach to adjust prices was the primary driver for the 200 basis point sequential decrease in gross margin from the third quarter to the fourth quarter in 2022. For the full year, our gross margin rate decreased by 270 basis points from 68.3% in 2021 to 65.6% in 2022. The decrease in margin rate was primarily due to rising product costs that outpaced the rate of price increases that were passed on to our customers during 2022. Fourth quarter 2022 selling, general and administrative expenses decreased by $2.8 million from 2021. The decrease is largely attributable to a $3.7 million decrease in compensation costs due to lower levels of annual incentives and variable compensation. For the full year, selling, general and administrative costs increased $3.8 million due to an $8.2 million increase in wages and benefits, primarily due to higher staffing levels, that was partially offset by a $6.5 million decrease in bonuses due to lower annual incentives and sales bonuses. Additionally, our marketing expenses increased by $2.1 million, and our IT-related expenses increased by $1.4 million in 2022 when compared to 2021. These increases were partially offset by a $2.2 million decrease in depreciation expense. Net income was $1.5 million during the fourth quarter of 2022, and adjusted EBITDA was $8.9 million. Our adjusted EBITDA margin rate decreased by 60 basis points to 10.2% during the fourth quarter of 2022, largely due to a decrease in gross margin. For the full year, net income increased $900,000 to $15.7 million. Adjusted EBITDA during 2022 was $49.6 million, which was in line with the $50.3 million adjusted EBITDA generated in 2021. Our adjusted EBITDA margin rate decreased by 100 basis points for the year to 12.6%. Full year earnings per share increased by $0.03 from $0.29 in 2021 to $0.32 in 2022. Moving to our capital allocation. We completed our $30 million share repurchase program during the fourth quarter. In total, we repurchased and retired 7.8 million shares for $30.2 million, inclusive of brokerage commissions, for an average price of $3.87 per share. We financed a large portion of the share repurchase by drawing on our line of credit. We felt using our revolver was prudent given our stock price. I will share more thoughts about our debt shortly. Turning to the balance sheet. Our inventory increased by $23.8 million to $121 million at the end of 2022 compared to the beginning of the year. This increase was driven by carrying higher inventory levels as well as an increase in inventory costs throughout the year. We made a meaningful investment in inventory over the last year. We believe this investment has us well-positioned to maintain sufficient in-stock levels to serve our customers while we work through initiatives to source portions of our assortment to lower-cost suppliers. As of the end of the quarter, we had $45.4 million outstanding on our line of credit. The $15 million sequential increase in debt from the third quarter of 2022 was largely due to the share repurchase activity that took place during the fourth quarter. We expect we will be able to use cash generated by operations to reduce our debt balance in future quarters. As we look to 2023, we have maintained our policy of not providing revenue, adjusted EBITDA, or EPS guidance. However, here are some things to think about for models. Average diluted shares should be around 45 million. The tax rate for 2023 should be around 26%. We anticipate CapEx for 2023 will be $15 million to $20 million. This includes the two new stores in 2023; one store relocation, maintenance CapEx for our existing 142 stores, five distribution centers, and our corporate CapEx, which supports our store portfolio. With that, Cabby and I are happy to take any questions.

Our first question comes from Mark Smith with Lake Street.

A couple of quick questions for you here. Can you discuss just the demand trends that you saw during the quarter, kind of how it shifted? And then just give us a reminder of kind of seasonality that's typically built in?

Absolutely, Mark. This is Cab. Thanks for the question. Typically, the fourth quarter is a bit slower than our other quarters because of the holidays and winter in the Northeast and Midwest. We expected that. However, we noticed that our retail traffic started to decline compared to our professional sales, which remained strong as we continued to perform well in that sector. Retail traffic was noticeably lower, and we observed this in our stores as well. In response to the decline in store traffic, we concentrated on improving our execution, conversion rates, and average ticket values. That’s what I observed in the trends during the fourth quarter.

Perfect. You provided some good details on the long-term expectations. Can you discuss how the initial phase has gone and what the demand looks like for that product?

Yes, absolutely. Like you said, we're in our infancy here with our launch. People are now just becoming aware that we have this line. We are happy with our initial results. We're falling into a few commercial deals. We're getting more pros transitioned into our stores in our line of LVT. It's going to take a while to ramp, but initial results are solid.

Perfect. About inventory, it has increased significantly compared to last year. However, it seems to have been stable recently. Can you share your thoughts on this? Looking back, do you still believe that your strategy of prebuying before the price increases was effective? Also, how do you plan on timing the movement of this inventory to achieve more normal levels?

Absolutely. Yes, I am happy with what we did in the past to get the inventory to our DCs to avoid some of those price increases. When we import, like we do, it takes a long time. So we have to order early for a spring selling season and to be stocked for when we know traffic will be increasing. So it's important that we have high inventory, but we're a little too high at this point. So we're focused on bringing it down. We have a lot of initiatives in place to reduce our inventory. But again, I know we did the right thing. We made the right decision to get there. I'm confident that we are well-stocked and able to serve every customer at this point, walking through our doors.

Perfect. And then I just want to look lastly just at cost a little bit here, just G&A was a bit lower than we've kind of expected during the quarter. Maybe talk about how sustainable it is. It sounds like you had $3 million, $3.5 million or so in incentive comp that was down but maybe talk about whatever you can for expectations on G&A going forward?

Right. Mark, this is Karla. Thanks for the question. As far as SG&A, we did have some decreases this year that were related to our incentive comp structure and a large portion of it is variable, and so that is directly related to our results. So as our results improve, we do expect that portion of the SG&A, we do want to pay that because we do pay on performance. And so that's something we're watching very closely. Additionally, we always watch our SG&A very closely within each of the departments to make sure that we are actively making investments that make sense and that we are rewarding our employees but at the same time, we're being very mindful of not overspending in certain areas and things like that. So it is something we're watching closely. We do expect it to increase just because if our performance holds true to what we want in 2023 when we meet our goals, we will be paying out those incentives next year.

Okay. And the last question for me, just looking at cash flow. It looks like you're in a pretty decent position that we could see some maybe better cash from operations just with changes in working capital here in 2023 but we are seeing CapEx come up a little bit. Maybe any additional insights you can give us on the cash flow and then abilities to kind of service and pay down that debt? And at the same time, just talk about kind of dry powder that you have and your ability to kind of grow and maybe use that balance sheet if you needed to or wanted to.

Right. Yes, we do feel we have a strong balance sheet and cash flow; we're seeing very strong already. We do expect to pay down that debt throughout 2023. We have plans to do so. And so far, we're able to execute on those plans. I'll let Cab speak about the dry powder left in the business, but we are very excited about our plans for growth this year and feel that we're able to fund that appropriately.

Yes, Mark, with some of the cash and capital we have, we want to focus back on the business. We took a few years off from growth. We wanted to really focus on execution, especially in times like this. If your traffic is down, you can raise your conversion, right? You can lower your discounting, you can raise your ticket average. These are things that make us confident that we can really continue to flourish in tough times. Now it's time to grow; so we're going to take some of that cash and build back some teams and get our store growth machine running. We've signed a lease already. We've got another one that we want to do by the end of the year and invest in other areas of the business as well. So we're being very responsible fiscally with what we got, and we're phasing it in. So as low as she goes, but we're moving in the right direction for sure.

Our next question comes from David Kanen, a private investor.

First question is in regards to LVT. Do you expect with that starting to ramp that we will grow at some point this year year-over-year in revenue but more importantly, gross profit dollars?

David, it's still pretty early. When we discuss traffic levels and the current housing environment, our goal is to grow revenue and profit dollars. There are various initiatives underway to improve our margins, with LVT being one of them. However, it's difficult to provide specifics at this stage, but that is ultimately our objective.

Okay. And then in terms of the comp, low single-digit decline, how much of that was traffic versus price? Can you give us a sense as to the lift we got from taking price increases? And how much percentage-wise traffic was down or volume down?

It's primarily about traffic. We closely monitor our pricing and market trends, particularly in relation to our competitors, ensuring that we don't price ourselves out of the market. We recognize that there are traffic declines across the industry. Our focus is on execution, and we aim to improve the experience for the customers who do come through our doors. We're being strategic with our price increases throughout 2023, making small adjustments to avoid further impacts on traffic. It's a careful balance, and we keep a close eye on it every day.

Okay. And then what was free cash flow for Q4? And how much debt did you pay down?

In the fourth quarter, we completed our share repurchase program, which allowed us to reduce our debt.

Okay. What was free cash flow for Q4, though, excluding the repurchase of shares, just cash flow from operations less CapEx or property, plant, equipment?

Yes. We would need to look at that number as we don't have it available right now.

Okay. When you filed the K, I could probably figure it out. And then for my last question, actually two more questions, and I apologize for taking up time. You mentioned that freight transportation costs are decreasing. Can you specify on a quarterly basis what the year-over-year savings will be? Is it a seven-figure amount?

That's difficult to determine at the moment, David. As we anticipate receiving containers heavily in the fourth quarter from various locations worldwide, evaluating that cost structure with international freight will be significant, but I can't provide a specific figure right now.

Okay. And then you guys were very aggressive in repurchasing shares and I applaud that. Few companies really understand the value of capital allocation and share repurchases. So I commend you guys for that. Is there a level in debt where you're comfortable? I mean, I know right now there is no buyback, but is there a level where we could potentially expand it and where you guys are comfortable with current business trends maintaining that debt level?

So there definitely is a level that we're comfortable with and that's one of the things that we're working through. We're actively managing the cash flow. We are reviewing it and looking at our growth plans very carefully to make sure that it's a balanced approach.

Could you comfortably take on more debt and potentially expand the buyback? That's what I'm getting at.

Yes. We believe we can.

I'm showing no further questions in queue at this time. I'd like to turn the call back to Mark Davis for closing remarks.

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

This concludes today's conference call. Thank you for participating. You may now disconnect.