Tile Shop Holdings, Inc. Q1 FY2023 Earnings Call

Good day, and thank you for standing by. Welcome to the Q1 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 Q&A session. Please be advised today's conference call is being recorded. I would now like to hand the conference call over to your speaker today, Mark Davis, Vice President of Investor Relations and Chief Accounting Officer. Mark, please go ahead.

Thank you. Good morning to everyone, and welcome to the Tile Shop's first quarter 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 been posted on our company website. With that, let me now turn the call over to Cab.

Thank you, Mark. Good morning, everyone, and thank you for joining us today for an update on our business and our first quarter results. Comparable store sales during the first quarter of 2023 were flat compared to 2022. During the quarter, we continued to face macro headwinds. Rising interest rates and slowing housing turnover created challenges across our industry. However, we still see steady demand for remodeling projects. Feedback from our customers suggests that some homeowners prefer remodeling their homes to moving. Many of our professionals report having a healthy backlog of work. Nevertheless, we expect macro conditions to remain challenging over the next several quarters. Our store teams are making progress towards our retail excellence goals. The Pro sales mix, which includes sales to professionals and Pro referrals, accounted for over 70% of our total sales during the first quarter. Additionally, we have improved the adoption of best practices in several of our historically underperforming stores. While we are making strides, we still have more work ahead. Given the difficult macro environment, I have decided to delay opening a second new store in 2023. We remain on track with our assortment and continue to execute our initiatives from the first quarter. We have identified several high-quality products that we can source for lower price points from suppliers worldwide. We believe this effort, along with recent declines in international freight rates, will help mitigate some of the inflationary price increases we have faced over the past year. Additionally, we observed an increase in clearance item sales after enhancing visibility to these items on our website last quarter. Sales of our LVT products are gaining traction. We officially launched our expanded line of LVT products in all our stores during the fourth quarter. We are excited about this addition to our assortment and believe it could significantly contribute to our overall sales mix over time. As I mentioned earlier, we began testing LVT in our stores last year due to advancements in product quality and changing consumer sentiment indicating that our core higher-end customer demographics have started to widely accept LVT as a flooring alternative in their homes. The customer feedback we have received shows we have a strong assortment and competitive prices. With that, I'll now hand the call over to Karla.

Thanks, Cabby. Good morning, everyone. First quarter sales at comparable stores were flat with 2022. We did see lower levels of traffic during the quarter that was offset by an increase in the ticket average. Our gross margin rate during the first quarter was 64.2%, which equates to a 30 basis point decrease from the fourth quarter. The sequential decrease in margin is due to continued increases in inventory costs. We value inventory at average cost and typically hold just under a year of inventory on hand. While average costs were still increasing as inventory receipts landed during the first quarter, we expect costs will start to improve as international freight rates have come down and as lower-priced products from our resourcing initiatives start to work their way into our assortment. At the same time, it's important to note that we have priced our LVT and back shelf products competitively and that these products carry a lower gross margin rate than our tile products. We anticipate the acceleration of LVT sales and continued growth of back shelf will create a headwind to our overall gross margin rate. However, we expect the incremental sales of these products will result in an increase of gross profit dollars and improve our leverage on fixed SG&A expenses. First quarter selling, general and administrative expenses decreased by $700,000 when compared to the first quarter of 2022. The decrease was largely attributed to a $1.1 million decrease in variable compensation expenses, a $900,000 decrease in shipping and transportation expenses and a $700,000 decrease in depreciation expense. These decreases were partially offset by a $600,000 increase in wages due to headcount and pay increases, a $600,000 increase in software licenses and a $400,000 increase in operating supplies. Net income was $2.5 million during the first quarter of 2023, and adjusted EBITDA was $10.3 million. Our adjusted EBITDA margin rate was 10.1%. First quarter earnings per share decreased by $0.01 from $0.07 during the first quarter of 2022 to $0.06 during the first quarter of 2023. Turning our attention to the balance sheet. Our inventory decreased by $5.5 million from the fourth quarter to $115.5 million at the end of the first quarter. Also during the quarter, we generated $25.8 million of operating cash flow. The majority of this cash was used to reduce our debt, which was $25 million at the end of the quarter. With that, Cabby and I are happy to take any questions.

Thank you. At this time, we will conduct a question and answer. Our first question comes from Mark Smith from Lake Street...

Jacob is here for Mark this morning. Could you provide an update or any additional details on the new store openings this year?

Jacob, yes, this is Cab. We're on track to open our new store here coming up in June or July, depending on some scheduling. We did delay our second new store just due to some of the macro headwinds we're experiencing at this point. The focus really is on the profitability of our business. And I thought it best to just push this at this time. So yes, I mean, we're going to relocate another store to a better area that we feel is going to generate more income, but that's pretty much it.

Okay. Maybe just kind of your balance sheet improvements are solid. How are you guys thinking about returning capital or cash to shareholders via buyback or...

This is Karla, and thank you for your question. At this point, we are not planning on any share buybacks or dividends. I mean, it's always a consideration. We are constantly looking and forecasting and trying to control our SG&A and improve our results. But at this time, we do not have any plans to do any major events such as that like we have in the past.

Yes. I know Jacob, we're pretty pleased with our reduction in our debt in Q1 that we're proud of, and we're going to continue to chip away at that, right? So that's my first goal is let's get debt-free and then figure out how we're going to return shareholder value. So that's the goal right now. Let's just generate cash and get the debt down to zero and then move forward.

Okay. I got it. That's helpful. Maybe just talk about the inflationary pressures. I know you had mentioned sea freight is coming down. But maybe could you just talk about kind of the different drivers of maybe the product costs? And are you able to pass through any price increases?

We're pleased with the reduction in freight costs we've observed recently. While product costs have increased over the last year, the ocean freight costs have played a significant role in that. As freight costs decline and our efforts lead to lower-cost products arriving in our distribution centers, we believe we are on the path to improving our margins. Typically, we maintain a year's supply of inventory, so as we move through this stock and as new products arrive, we anticipate a positive shift in our margin. However, it's still challenging. Costs are rising not just for freight but across various areas including distribution centers, store operations, and corporate marketing. Therefore, we need to be strategic and focused to ensure we are making informed decisions throughout the Company. That said, product costs are coming down, and we're beginning to see that reflected in our distribution centers, which gives us confidence in a rebound.

Okay. At this time I would like to turn it over to Mark for any closing remarks.

Thank you for listening to our earnings conference call. We anticipate filing our Form 10-Q later today. Thank you for your interest in the Tile Shop. Have a nice day.