Operator:.

Good morning to everyone on the call and welcome to the Tile Shop's second quarter earnings call. Joining me on today's call are Cabby Lolmaugh, our Chief Executive Officer; and Kirk Geadelmann, our Chief Financial Officer. Following our prepared remarks, the call will be opened for analyst questions.

Certain statements made during the call today constitute forward-looking statements made pursuant 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.

With that, let me turn the call over to Cabby.

Cabby?.

Thanks Mark, and good morning, everyone. During the quarter, we reported revenues of $88.9 million, representing a decrease of 4.3% compared to the prior period. The sales decline was driven by continued soft customer traffic. This resulted in a net loss $0.2 million for second quarter. We are very disappointed with these results.

Getting traffic back to our historical levels for both retail and pro customers will continue to be our top priority. We believe our single biggest opportunity is to drive higher awareness of unique core value propositions with prospective retail customers.

Our 6,000 tiles SKU assortment which now covers the entire spectrum value premium in luxury tile option, positions us to deliver for all types of customers and project sizes. And we believe our service and in-store experience are now back in solid ground.

So now the goal is to make sure our prospective retail customers are aware of our brand and all the great things we offer. We've made some recent changes in our retail customer marketing strategy. These changes are designed to increase brand awareness, website traffic and ultimately store traffic with all retail customers.

We believe the winning formula for mid-single digit comp sales growth as we achieve during the fourth quarter of 2018 will be one, growing our retail traffic. Two, increasing our conversion rate year-over-year and three, growing our pro sales. During our most recent quarter, we achieved two of those three goals.

However, our pro sales growth was only low single-digit positive. Our goal is for pro sales to be double-digit positive, so we clearly have some work to do. And so increased pro traffic and sales is another important focus area for us over the next several months.

Our plan is to continue to leverage our pro rewards program, team of pro market managers and pro events to reaccelerate our pro sales.

In addition, we're also working to develop and implement some additional pro marketing strategies designed to re-engage some of our pros whose frequency may have declined over the last several months due to POS checkout speed or other factors.

We made good progress improving our performance of our new enterprise resource planning system during the second quarter. As we discussed on our April call, our customer checkout times during the first quarter were elevated with some transactions taking up to two times longer than normal to complete the POS checkout process.

The slower POS had a more significant impact on pro customers who often frequent our source several times per week, and who are more accustomed to a certain expectation for POS checkout speed. In late May, we were able to roll out new POS functionality that significantly improved system speed.

As a result, we effectively cut our POS checkout times by over half, improving our customer experience. With these and a few other key improvements, we believe we were back to our normal high level of service for pro customers. And our retail customer satisfaction scores are back to all-time highs as well.

Sales for the 2,500 new products we introduced over the last 18 months continue to increase sequentially during the second quarter.

We remain confident that no other tile competitor can come close to offering the choices that we now have available to present to our retail customer, her designer and our other key pro channel partners who often serve as key influencers for retail customers.

Now that our 18-month long product assortment initiative is complete, our merchandising team has shifted a 100% of their focus on continuing to optimize and diversify our product sourcing. For nearly two years now, we have been working hard to diversify our supply sources to various parts of the world.

As we've messaged previously, we anticipate these efforts will result the significant reduction in the amount of tile products we source from China. In fact, last year the amount of product we source from China had already begun to decrease substantially with approximately 42% from China in 2018, down 8 percentage points from roughly 50% in 2017.

We expect our China product mix to continue to decrease even more significantly throughout 2019.

While this diversification strategy has required a significant amount of time and energy, we're now in the final stages of this work and we believe this works has the opportunity to deliver incremental customer and financial benefits because great tiles at great prices can be found all over the world.

I'll now turn the call over to Kirk who will take you through some of the financial details.

Kirk?.

Thanks Cabby. Good morning, everyone. As Cabby mentioned, continued week traffic trends were the primary reason for our comp sales decline of 4.2%. We are keenly aware that we need to generate a return on all of the significant investments we've made over the last 18 months. And improving traffic and sales is the key to achieving that goal.

I'll provide a brief overview of our second quarter financial performance and then we'll turn it over for questions. Net sales of $88.9 million were down 4.3% year-over-year. Gross profit was $61.4 million for the second quarter of 2019, a 6.1% decrease over the same quarter of last year.

Gross margin of 69% decreased by approximately 130 basis points compared to the second quarter of 2018. The year-over-year decline was primarily due to higher shrink and damaged costs, resulting from completing physical inventories in all stores and distribution centers during the quarter.

Shrink during the quarter was approximately 65 basis points, higher than last year and damage was approximately 45 basis points higher than last year. Both cost increases were due to increased disruption in our stores and distribution centers following our ERP conversion and the installation of new merchandising fixtures in approximately 70 stores.

Our selling, general and administrative costs for the quarter were $60.6 million. The increase of $2.7 million compared to the second quarter of 2018 was primarily due to annualized 2018 strategic investments, $1.3 million of expense related to our new ERP, and higher depreciation expense.

We also invested an additional $0.6 million in advertising compared to the prior year. These expense increases were partially offset by a decrease in variable expenses associated with lower sales. We concluded the quarter with 140 stores. We now anticipate opening four stores in the last six months of the year, including one relocation.

One store, which we originally anticipated would open in 2019 will move to the first quarter of next year. Adjusted EBITDA was $9.8 million in the second quarter. Adjusted EBITDA margin was 11%, a 520 basis point decline compared to last year during the second quarter. Turning to our balance sheet.

We ended the quarter with $5 million of cash and $63 million of long-term debt. Our debt increased approximately $10 million from the fourth quarter, due to $10.5 million of share repurchases during the second quarter. Inventory of $106.7 million decreased by approximately $3 million from the fourth quarter or 3%.

Capital expenditures were approximately $6 million, during the second quarter, primarily related to store remodel and merchandise and investment. This brings our year-to-date CapEx to approximately $18 million. We continue to focus on various cost reduction initiatives during the quarter.

These initiatives included our in-house trucking strategy, which has helped us lower the cost of moving product between our distribution centers and our stores on a year-over-year basis. We are also making some refinements to various service strategies that we deployed last year to ensure we are maximizing our efficiency and our return on investment.

With that information, we are now ready to take questions..

[Operator Instructions] And our first question is from Daniel Moore from CJS Securities. Your line is now open..

Good morning, Cabell; good morning, Kirk. Wanted to start with the gross margin. Thank you for the detail and color on shrink and the inventory issue -- damaged inventory issues.

How much of each of those would you consider kind of one-time in nature, given the true-ups or what you found in the quarter? And how much of that might be ongoing or linger into the second half?.

Good morning, Dan. It's difficult to exactly pinpoint what led to the increased shrink and damage, but I think it's fair to say that we suspect that one of the bigger factors, Dan, during the quarter was all the merchandising work we did.

We remerchandized nearly 70 stores and that work largely took place in the last couple of weeks of March throughout April, and then the first two weeks of May. And that was just a -- that was a lot of work within a pretty compressed timeframe.

And the good news there is the merchandising work not only in the 70 stores we did, during the quarter, but also the whole chain, the 140 stores, over the last six or seven months, six, seven, eight, nine months, really, I guess, it's been. That work is complete.

So I think going forward the opportunity for us will just be to just sort of get back to basics with what we do day in and day out to manage inventory control cost and we'll be focused on that..

Okay. And shifting back up the income statement, obviously, to the same-store sales, last quarter conversions impacted by the ERP system; this quarter really more of a traffic issue.

I guess, one, has the ERP implementation issues you feel like, I guess, been addressed? Two, it sounds like they're lingering, at least, in terms of the pro customer as far as an impact, but maybe drill down a little bit more on what is -- what are the key parts of the story that you feel like are just aren't clicking in order to drive traffic and any more color on steps that you might -- changes in strategy or steps that you might take to try to alleviate or improve that?.

Sure. Hey, Dan. This is Cabell. Thanks for the question. Yes, when you look at the life cycle of a lot of our customers and especially pros, when we went through our ERP implementation and had some issues with conversion and checkout speed, we do think we probably had an impact with some of our pro customers.

With our speed back in our stores, it's a lag and we believe some of the traffic declines related to that. But we're also focusing on a segment of our customer that we believe we could do a better job going out. Can I'd be that mid-level, mid-range customer whose job is usually $1,000 to $3,000 in total sales.

We're currently testing different marketing strategies to go after that customer base with different content, different pricing strategies, digital content, and that's where you see a little bit of increased media spend. We know we've got a good stronghold around what we need to do with pro.

Now, we're going after that medium-level customer, and I think that's going to help us pick up our traffic declines here in the back half of 2019..

Okay. And then kind of a different angle question, and my last and I'll jump back. But, obviously, a lot of incremental investments over the last 12 to 18 months, nothing return at this point.

At what point would you rather than kind of shifting or tweaking strategy say some of these initiatives, some of these mid-level managers, incremental costs that we've put on just aren't generating the return and look at more cost reduction mode if you don't continue to not see the return you expected?.

Yes. Absolutely, Dan. As judicial leader here, I got to make sure that we're always looking at our expense structure and we constantly are looking at what's working and what's not.

And there have already been things I've taken place to make sure that we're financially responsible with these initial investments to make sure we get the most out of them without leaving them or abandoning them, but making sure that we give the best opportunity to provide profits. And so we look at that every day and we take action every week.

So we're already looking at that, Dan..

Thank you. Our next question is from Peter Keith from Piper Jaffray. Your line is now open..

Hi. Thanks. Good morning, everyone. I wanted to follow up on that last question, but maybe drill down specifically into the decision a year ago to pull pricing from your website.

You talked about challenges now with the midsize, moderately affluent customer, so, to me, it's quite clear that that customer perhaps is intimidated by the lack of pricing and maybe isn't making the trip to the store. Maybe, I'm wrong.

But is there a view that you need to wait till end of year or some type of timeframe when that decision to pull pricing from the web is reevaluated?.

Hey, Peter. This is Cabell. Yes, we're actively testing pricing on the website right now. I don't know where you are in the country, but if you log in, in certain markets we do have pricing online as of today. So we're testing all different types of digital means to drive traffic and getting -- convert their customer.

That's going from our websites again in our stores. So, absolutely..

Okay. And then I want just to drill down to the Q1 to Q2 dynamic. Last quarter, we spent a lot of time talking about the ERP challenges and weather challenges. And so, now, with Q2, you come in at relatively the same level.

Could you parse apart, perhaps, maybe what's internal that impacting you versus macro? And do you believe that the macro backdrop for your space slowed in the recent months?.

Good morning, Peter. Yes, as always it's hard to quantify all these things specifically, but I think the main thing is what Cabby just talked about in the Q&A here and in prepared remarks; it's really just soft traffic. We do feel like we've improved our systems as we talked about in prepared remarks.

And obviously we're talking to people every single day throughout the day in various markets and stores and making sure that there's anything we can do to further improve our systems whether it's speed or any other type of functionality. We're doing that but we feel like we've made a lot of progress on that.

And I think we also feel good about retail customer satisfaction scores. The customers who are in our stores are pretty happy customers. We're back to all-time highs, and so we feel like we're serving the customers who are aware that we're here and in our stores that at a pretty high level.

And nothing with systems or other things we're doing internally is preventing us from doing that. The main challenge is just getting more customers into the stores. And we will acknowledge that, we've always talked about existing home sales being a key metric for us.

And that's, that metric existing in home sales year-over-year, the growth has been down for quite some time now. And I don't think that's been helpful. But at the same time, we've made so many investments. We need to overcome that. We need to look for ways to start growing our sales and the key thing there is growing our traffic.

And we're going to work on a variety of different things to help us try to do that here in the coming months..

Okay. And then one last follow-up just on that topic I'm trying to again assess sort of the Q1 to Q2 trend. Last quarter you talked about a 20% increase in the order book. Some delays of, with weather that perhaps shifted sales out of Q1 into Q2.

Now that those two quarters are complete can you can you quantify what you think that sales shift was between the quarters?.

It was pretty modest, Peter. Our, we tend to turn our orders over two times a month and so the elevated order at the end of April, I'm sorry at the end of March was closed out in April. We're now back to more normal levels for our open order bank. But it had a pretty modest positive impact in April..

Our next questions from Anthony Chukumba from Loop Capital Markets. Your line is now open..

Good morning and thanks for taking my question. So want to dig a little bit more into the issue with the pros because it sounds like that, it sounds like that hasn't necessarily abated. I guess I'm just what I'm trying to figure out is if the pros are not going new, where are they going? And what do you need to do to win those pros back? Thank you..

Yes. Thanks for the question, Anthony. We have our finger on the pulse of the pro pretty tight right now. We have daily communications with our pro market managers who work through different means of data and communication strategies such as our salesforce functionality, attrition reports.

And so we monitor the communications and what we're hearing is more so it was a shift in business for them as well. We're hearing that pros slow down a little bit but are picking back up. So we're happy to hear that. We're expecting that to roll into our stores.

But with pros it's getting the message out there more clear about our pro rewards, benefit package. And so we're seeing an uptick in people converting into our rewards program. And it's getting our stores more to the cadence of exactly how you present it. And so the pros that are roll into this program, we're seeing more spend out of them.

So we're going to continue to hyper focus on our rewards program, working with our pro market managers, give them the tools necessary because when we rolled out our ERP in Q1, we lost some of our --some of our tools that we had for our pro market managers. They did not get back until Q2.

So we're hoping that these tools that are running at high speed right now are going to help us bring more of the pros into our stores..

Got it, that's helpful. And just on the pro rewards program.

Can you just give us; provide just an overview of some of the benefits just to kind of at a high level for the pro?.

Absolutely. So there's different tiers, gold, platinum, diamond, and they get different discounts depending on their spend. And also other benefits that are included are sometimes free shipping. They're going to have a referral program. So they get a certain amount back in cash if they have referrals that come into our stores that we now track.

So it's a lot of different things where they can have direct communication with the pro market manager in their area delivery, like I said, discounts and then referral cash rewards as well..

Thank you. Our next question is from Joseph Feldman from Telsey. Your line is now open..

Hi, guys. Thanks for taking the question. So I wanted to ask you, Cabell, you've mentioned quite a few times you're working on getting the message out there to the pro and even the consumer to just change the value perception.

Can you give us a little more, or at least me, a better understanding of what that means? I mean, is it email marketing, is it TV, is it media? Should we see a big step up in advertising? Like how? I guess, I'm trying to get more of the tactics, how you're trying to get that message out there?.

Sure, Joe. Appreciate the question. We did see an increase in our media spend.

And what we're doing is testing a lot of different metrics when it comes to content, what we're showing on the website, what we're delivering in emails, we are trying new benefits when it comes to our in-store events, we've created our own CEU course directed just for pros to come in and get actual credits.

We don't have to use, for instance, an ASID. We can give people credits by coming to our courses partnering with all the different associations; the NKBA, NTCA, TCNA, ASID; and we're working really close directly with the heads of these organizations to promote the value of doing business with the Tile Shop, because we support them, they support us.

And in the long, we continue to work with different suppliers such as media hosting events in a lot of our stores as well on that channel. But what it comes down to is, you've got to test, test, and test. We're not testing; we're not doing our job.

So we're seeing different shift with different tests in different markets, and how do we capitalize on this. So we're going to continue to test. The digital landscape for pros today has really transformed in the last 12 months about how they interact with different brands.

And so, you'll see some different things on our website and in our emails to get them to trigger to do business with us..

Got it. Thank you.

And then I guess more broadly speaking, I know, obviously, you guys had some pressure, but was this -- do you think some of this is industry wide or obviously home sales are -- have been challenged, but where is this -- is the industry -- when you look at industries sales, are they up, are they down a little bit, or how would you view that?.

Well, Joe, currently, from what I view, I monitor all of our competitors and I've seen some very heavy promotional activity going to the foreign sector. I'm seeing larger discounts, sales, free shipping, and more so than I've seen in previous years. So I believe it is an industry issue right now..

Got it. And if I could just sneak one more in.

I wanted to ask with China I understand you guys continue to shift supply away from there or do you have a target in mind for 2019, if you were at 42% last year, like, should we see like mid-30s, low-30s for this year, how should we think about that?.

Well, I don't like to give you a specific number. We definitely want to get significantly lower than 43%. We're actively doing that. So we're going to continue to diversify our supply chain. We have great relationships all over the world. And so I think this is an opportune time to do this and to capitalize on what's available outside of Asia..

And our next question is from Justin Kleber from Baird. Your line is now open..

Yes. Hey, guys. It's Justin Kleber. Thanks for taking the questions here. Wanted to start on the top line. Last quarter, you mentioned the significant regional disparity in your sales performance with many stores in the south comping positive.

Curious how that regional spread look this quarter, particularly as weather I don't think should have been much of an issue in 2Q? And then maybe as a part of that question, just any color on the cadence of sales throughout the quarter that stood out?.

Sure, Justin. Thank you. It's kind of the same landscape. We have some markets comping and some not. I mean, it's kind of all over the place right now. We obviously focus on the ones that are struggling with our different media strategies and testing and watching that very closely, but we don't really comment on the cadence of where we are currently.

So we've got that..

Okay.

And then, I mean, is there any color you guys could share with us just in terms of how you're thinking about the back half of the year? I know you're not providing specific guidance, but the comparisons get more difficult? I mean, is it reasonable to think comp actually get a bit weaker there in the near term or do you expect some of these marketing investments to start to generate some payback for you?.

Hey, Justin. Good morning. It's a fair question, but I think it's very difficult for us to predict that. And, as you said, we're not offering top line guidance at the moment. And the key is really just traffic. It really is. I think we clearly need to start seeing a return here on the investments.

If there's a little industry softness to the existing home sales or whatever metric, we need to look for a way to overcome that and that's what we're doing. So we're doing a variety of things to try to increase traffic and that really is our primary focus.

And, hopefully, we'll be able to see a little improvement here as we move into the rest of the year..

Okay. Thanks, Kirk.

Just another question here on gross margin expectations, now that tariffs are at 25%, do you still feel comfortable in the ability to maintain around a 70% margin rate? And then maybe any color you could share on what type of unit elasticity you guys have seen? As I've seen, you've been raising some retail prices on products that have been hit with tariffs?.

Yes. Certainly I can offer some points there, Justin, on that. We continue to feel good about all the sourcing work that we've done. And, again, as we've talked about with everybody, it's not something that just got started in the latter part of last year. It's really been a two-year effort in journey.

And as Cabell talked about in his prepared remarks, I mean, diversification of our sourcing has a lot of benefits. And even with the increased tariffs in China and before that, as we've talked about many times, costs have been going up, variety of different costs, including labor costs and freights always been expensive coming out of China.

So there are just too many reasons to do -- to diversify. And we do feel like we're in the latter stages of that effort and we continue to feel good about the diversification strategy that we've deployed and feel like it should insulate us from all the changes that are happening with trade.

I think that really the opportunity for us, and, again, we noted this in our prepared remarks, is to let customers know that we have a variety of high-quality products at all different price points.

We need to do a better job of educating our prospective retail customers and, frankly, even some of our pros that we really do have a pretty nice set of good, better and best price points to serve all customers, both retail and pro. And I think that's really going to consume most of our attention is getting the message out on that.

And, hopefully, we can do a better job of that here in the next couple of months and starts to drive traffic..

Thank you. Our next question is from Daniel Moore from CJS Securities. Your line is now open..

Thank you, again. Just wanted to maybe parse out a little bit more. You mentioned, Cabell, you've got kind of stores comping all over the board. Presumably, there are some stores or locations that are down, that are well below that 4%, maybe closer to double-digits.

Any common denominators within sort of the regionally or the store base that's maybe performing at the lower-end of that range? And any thoughts around consolidation shrinkage, closures, etc?.

Yes, Dan. Thank you. What I've noticed in the trend is really the tenure of the market in some -- in most cases, not all cases. But when you have a longer tenured market, you have longer tenured relationships with pros. And so -- and -- hey, there are some new markets that are performing great as well.

But what you see is tenured markets who have had a lot more pros, who have a lot more history with us seem to weather the storm with traffic a little bit better than most..

And the only other comment I'll add to Cabell's point there, Dan, is just as we talked about on April call, it was really the first time in the last five years, at least that I can recall, that you saw such a pronounced difference between our Southern store markets, like we talked about on the call and Upper Midwest and Northeast.

This last 90 days, it's just -- as Cabell just said, it's just been more sort of up and down. It's been a lot more varied like it usually is. And, obviously, we've -- with a negative for comp; we've got more markets that are comping negative than we have markets that are accompanying positive.

But we certainly do have markets that are doing quite well and I think Cabell makes a great point, those markets, a lot of them, tend to be more mature markets, not all of the mature markets, but more mature markets where we have a little bit higher pro mix and, perhaps, deeper relationships with some of our pro customers..

Got it. Last for me, and I'll wrap up.

But the capital allocation, obviously, declared a dividend, bought back about $10 million worth of stock, debt ticked a little bit higher sequentially, what's your comfort level with debt continuing to move moderately higher over the next couple of quarters if we stay around, sort of, break-even pre-dividend?.

Yes. Dan, capital structure is always something we just continue to evaluate on a quarterly basis with our Board. I think it's fair to say in the back half the year, our main focus is going to be increasing traffic and sales and, hopefully, paying down a little debt as well..

Okay.

The expectation at least would be to be solidly free cash flow positive and maybe pay down a little debt in the back half?.

That's our goal. You'll see CapEx come down pretty substantially from our run rate over the last four quarters. So that'll help for sure. But then it's just a function after that of top line, which is really a function of traffic and our ability to increase traffic..

Thank you. Our next question is from Peter Keith from Piper Jaffray. Your line is now open..

Thanks, again, guys. I did want to get a question around the anti-dumping and kind of relating to the investigation for ceramic tile imported from China.

If you could give us some updated thoughts there and maybe some of the potential implications that could hit you by the end of this year, early next year, if there's a final ruling on the anti-dumping?.

Hey, Peter, great question. I thought this would come up. Yes, anti-dumping is on ceramic tile out of China and we've been -- we've known about it, we've actively been reacting to it, we've placed the orders we need to place to avoid any such ruling when it goes in, probably in November.

But we're -- like I said before, we have a lot of different suppliers and new suppliers all over the world that quite honestly have favorable shipping of -- in freight rates and different structures set up when it comes to burden and duty that we're going to be able to, hopefully, avoid any and all of risk.

I can't say that for sure, but that's where we're at right now. We're trending in the right way when it comes to our supply chain and avoiding any of that anti-dumping that may or probably will happen in November..

Thanks, Cabell. And you talked about that you have orders in places.

Does that mean you've already have orders in place in other countries outside of China that you can have implemented before November?.

Well, you always want to be responsible when it comes to looking at when does anything hit you? Meaning, is it when it leaves the country, when it lands here in D.C., where is the product coming from? So what I meant by that was, if we need anything out of China to make sure we're well supplied, we're making sure those orders are in, so we don't get hit with any anti-dumping.

If we're resourcing to another country, we're making the right moves to make sure we have what we need in our stores at the right time..

Okay. I understand. And, lastly, on this topic, I'm certainly not an expert in the subject, but it does seem like at times there are look-back periods of 60 to 90 days.

So as you point out, with -- maybe final determination around November, is there any risk of a look-back period that could impact some of your direct imports from September, October as well?.

Peter, I think it's really difficult to predict that, obviously, and the main thing we're trying to do, in addition to what Cabell said, is also, again, just diversify and change our sourcing, so that our replenishment going forward will be coming from other countries, most of it, for ceramic tile.

And it's not something that, again, we just started a few months ago; it's something we've been actively working on for nearly two years now. So we're -- you could always be in a better position, but I think we haven't been caught flat-footed and we've been working on it very hard for quite some time.

So as things play out and things get finalized, we'll certainly offer additional commentary. But, right now, it's not completely clear as you acknowledged in your question. End of Q&A.

Thank you. At this time, I'm showing no further questions. I would like to turn the call back over to Mark Davis for closing remarks..

Thanks to listening to our earnings conference call. We look forward to providing our next update in October. Thank you for your interest in the Tile Shop, and have a great day..

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect..