Good day and thank you for standing by. Welcome to the Third Quarter 2021 Tile Shop Holdings 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. [Operator Instructions] As a reminder, this call is being recorded.

[Operator Instructions] 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. Good morning to everyone and welcome to the Tile Shop's third quarter earnings call. Joining me today are Cabby Lolmaugh, our Chief Executive Officer; and Nancy DiMattia, 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 on our company website. With that, let me now turn the call over to Cabby.

Cabby?.

Thanks, Mark. Good morning, everyone and thank you for joining us today for an update on our business and a review of our third quarter financial results. We had an excellent quarter with great execution highlighted by the continued momentum of our revenue performance.

The $92.2 million of revenue reported this morning represents the highest level of third quarter sales in our history. What was particularly exciting was that this level of performance is more typical of the sales performance we see in the spring, which is traditionally the busiest time for home remodel project activity.

While the strength of the home improvement sector continues to provide a tailwind to our business, these results would not have been possible without the disciplined execution of our strategic priorities focused on execution in our stores, our website and our supply chain.

This focus has led us to record performance through the first nine months of the year and has us on pace to set a new annual sales record for 2021. I'd like to take a moment to discuss each of our strategic priorities. Perhaps the most important strategic priority driving our current performance is our retail execution.

Our teams continue to rise to the challenge and have done a fantastic job controlling discounts, improving our collection rate on delivery fees and keeping inventory breakage and damage losses in check. In addition, our recent investment to expand our regional leadership team has had an immediate positive impact in our stores.

Moving to our next priority. We continue to build on our success by enhancing our customers' online experience. Over the past nine months, we have made a number of enhancements to our website to improve content, the shopping experience and our multichannel capabilities.

While our online sales still represent less than 5% of our overall orders, we are seeing nice growth in this area as our e-commerce platform evolves. We feel good about the direction we are headed and how our digital experience complements our in-store experience. Our final strategic priority centers on our supply chain.

Over the last 18 months global supply chains have encountered significant challenges. Government-mandated lockdowns, labor shortages, international shipping capacity constraints and port congestion have grabbed headlines and created bottlenecks that have affected many industries.

Our sourcing teams have done an incredible job managing through these challenges affecting global supply chains. We've been working closely with our suppliers to secure inventory and with our carriers to ensure timely delivery to our distribution centers. We've made progress over the last quarter.

For example, our backorder level decreased for the first time in 2021 during the third quarter. We're also pleased to see our inventory levels increased by $7.8 million during the quarter to $76.7 million at the end of the third quarter. This progress is very encouraging given current conditions, but by no means are we out of the woods.

We anticipate that sourcing challenges will persist into 2022, but we remain confident in our ability to further manage through this to ensure we have adequate supply to meet our customers' needs. In addition to product availability, we're seeing cost pressure across our supply chain. The cost of international shipping remained a headwind for us.

Additionally, many of our suppliers are signaling cost increases due to labor shortages, rising energy costs and other inflationary factors. Collectively this cost pressure has impacted our gross margin which was 68.2% during the third quarter of 2021.

As we work with our suppliers and ways to mitigate against rising costs, we're also taking steps to adjust our pricing. Additionally, we are targeting new opportunities to shift our source of supply as the cost of sourcing goods across the world changes.

For example, we're starting to explore options to source tile from vendors based in the United States who are increasingly better able to offer competitively priced items in light of the changing landscape.

We will continue to pursue alternative sources of supply across the globe where opportunities exist to lower the cost of items we carry in our assortment while maintaining our high-quality standards. Now before I close, I'd like to offer some early thoughts on where we're headed for 2022.

While we've made great progress in 2021 and are on pace to set a new annual sales record, we are continually striving to do better.

We've made significant headway improving the performance in many of our stores and we believe the best opportunity for continued growth rests in our ability to continue focusing improvements within our existing store base. At this time, we're not planning to open any new stores during the first half of 2022.

Focused retail execution has been a key to our success in 2021 and it will continue to be a point of emphasis for us as we move into 2022.

Additionally, we plan to continue to focus on our supply chain and have several projects slated to enhance visibility to our inventory and improve our ability to have the right inventory in the right location to efficiently serve our customers. Finally, we'll continue to focus on our culture and our people. The last 18 months have been challenging.

However, I could not be more proud of our entire team who have put forth the time and gone above and beyond to lead us to the results that we deliver today. Putting our people first reengaging with one another as we emerge from the pandemic and cultivating our winning culture is an important priority of mine and our leadership team for the future.

With that, I'll now turn the call over to Nancy for further details of our financial performance.

Nancy?.

Thank you, Cabby. Good morning, everyone. Our record-setting third quarter sales of $92.2 million were driven by an increase in comparable store sales of 12.8%. The increase in comparable store sales can be attributed to stronger demand for home improvement products, the execution of our strategy and an increase in average ticket.

During the third quarter of 2021, we also made progress bringing in inventory which helped us reduce our backlog. We continue to maintain an incredibly strong order bank.

Customer deposits placed to secure delivery of product in future periods remained elevated over historical norms of $16.2 million on September 30, 2021, which was down only slightly from $16.5 million at the end of the second quarter. We were pleased with our strong gross profit during the third quarter of 2021 of $62.9 million.

Our gross margin rate was 68.2% for the quarter. This represents a 30 basis point improvement when compared to the third quarter of 2020, but a modest 90 basis point decline sequentially from the second quarter of 2021. As Cab mentioned, we're facing headwinds related to rising international freight costs and cost pressures with many of our suppliers.

We are managing through this and taking actions to adjust pricing to help offset higher costs. Additionally, we're exploring alternative sources of product from other suppliers across the globe to reduce costs, while maintaining our quality standards.

Our selling, general and administrative costs increased by $7.4 million during the third quarter of 2021, when compared to the third quarter of 2020. A portion of this increase can best be described as getting back to normal business.

Over the last year, we've increased staffing levels, marketing spend, travel, recruiting and store maintenance activities, as we returned to normal, which resulted in $3.3 million increase in selling, general and administrative expenses.

Additionally, SG&A increased due to a $1.1 million increase in variable compensation costs, a $700,000 increase in IT consulting costs and a $700,000 store asset impairment charge recorded during the third quarter of 2021. Sequentially, selling, general and administrative expenses increased by $1 million for the second quarter of 2021.

This was predominantly related to the store asset impairment charge. This impairment was related to a store that had underperformed prior to the onset of COVID, saw a notable decrease in sales during COVID and struggled to regain its footing as we emerge from the pandemic, partially due to staffing turnover.

In light of the difficulty encountered getting the store back on track, we concluded it’s appropriate to impair the store assets during the third quarter. Net income increased by $300,000 from $1.9 million during the third quarter of 2020 to $2.2 million during the third quarter of 2021.

Adjusted EBITDA decreased $700,000 from $11.1 million during the third quarter of 2020 to $10.4 million during the third quarter of 2021. The adjusted EBITDA margin decreased 240 basis points from 13.7% during the third quarter of 2020 to 11.3% during the third quarter of 2021.

Diluted earnings per share remained unchanged from the third quarter of 2020 to the third quarter of 2021 at $0.04. During the nine months ended September 30, 2021, we generated operating cash flow of $44.4 million.

We used approximately $8.9 million in cash to fund capital expenditures over the same time frame to build one new store opened during the first quarter, relocate one store during the second quarter, remodel existing stores, invest in information technology and enhanced merchandising assets.

We ended the quarter with a $44.3 million cash balance and no debt. As announced earlier this morning, our Board of Directors declared a special dividend of $0.65 per share payable on December 3 to shareholders of record on November 19.

We're very pleased to be in a position to return capital to our shareholders, based on our strong results and cash position. With that, operator, Cabby and I are happy to take any questions. .

Thank you. [Operator Instructions] And our first question comes from David Kanen with Kanen Wealth Management. Your line is open..

Good morning. Congratulations. Excellent sales number.

Hello?.

Hey, David, thanks. I really appreciate it. We're pretty happy with our results. .

Yes. I'm favorably impressed. So a couple of questions. In terms of gross margin, you alluded to shifting some of your sourcing potentially here to the U.S. and then also taking some price.

When do you think gross margins will exceed the previous peak, potentially getting back over 70%? Is that something that's doable in this environment? And if you can provide a time frame for that?.

Thanks, David. Yes, it's - we've always been really proud of our margins here at the Tile Shop. And with some of these increases that we've done in the past and we're going to do here, we feel that we're going to get back in line with our historical gross margins, but there's a lot of unknowns currently with global supply chain.

And we're seeing the energy crisis right now in Europe. We're seeing it even here in the U.S., things are going to continually impact. So there is an unknown, but we're making the changes that we feel are going to help us increase our gross margin. But I can't give you an exact time frame at this point..

Okay. And then, Nancy, digging into the SG&A. It looks like -- correct me if I'm wrong, but the $700,000 asset impairment charge from closing that store was not added back into operating income and adjusted EBITDA.

Am I correct?.

So, it does impact our SG&A and impacts the EBITDA margin..

Right. Okay. So usually, what I'm accustomed to -- and this is obviously subjective you guys are taking a very conservative approach. What I'm accustomed to is a company in adjusted EBITDA would have added back that $700,000 due to the onetime nature. So you're saying you did not add it back.

So if I take the liberty of adding it back operating income and adjusted EBITDA, we're actually higher than the reported numbers.

Is that correct?.

Yeah. Yeah, that's correct..

Okay.

And then, is there anything within the overall $7.4 million increase in SG&A? Is there anything in there that probably will come down over time, or is this "the new normal?" And going forward we should continue to expect total spend to be approximate what it was in Q3?.

Well, when we compare it year-over-year, it's up significantly. Last year, at this time we were in the middle of COVID and quite frankly we were doing everything that we could to reduce our cost and maintain as best we could during COVID.

So the escalation of the increase, if you will, in SG&A spend year-over-year is really getting back to normal business. So when we look at last year, we cut wherever we possibly could. So this year we've increased staffing levels.

We're putting money back into marketing spend, travel, recruiting, store maintenance and some other things, which is really what's driven the 3.3% increase year-over-year..

Okay. And then I believe it was up about $1 million sequentially. So you're saying that the absolute spend in SG&A in each segment that you just enumerated will continue going forward.

There's nothing -- there is not an area where potentially spend was a little higher than what you need going forward?.

Not at this time, but what I will call your attention to and just be mindful of when we're looking at the sequential, it's up $1.1 million, and sequentially that $1.1 million included the $700,000 asset impairment..

I see. Okay.

So it was really only up $400,000 sequentially, which based on such a profound increase in sales is actually quite controlled, because there's a variable component there?.

Yeah, you're thinking about it correctly..

Okay. Well, thank you. I'm going to -- I'll jump back into queue. A great job. I appreciate the special dividend. I think that's a good return of capital and will hopefully create a loyal shareholder base, and I wish you the best in the future..

Thank you so much..

Hey, thanks David..

Thank you. [Operator Instructions] Our next question comes from Jeff Moore with Burr Oak Capital. Your line is now open..

Hi. Thanks for taking my call. Great results. Quick question on the special dividend. In the press release regarding that, I saw some language that I wanted to get a little bit more clarity on.

It said after reviewing consideration of capital allocation alternatives with its financial adviser, the Independent Transaction Committee of the Board has unanimously recommended that the Board approved the special dividend.

So, I assume, it's safe to say you all have engaged with a financial adviser and have formed a committee called the Independent Transaction Committee.

What all is this committee looking at? And what are some of the discussions that are going on with that? But specifically have you retained a financial adviser to potentially sell the company?.

Thanks for the question, Jeff. I'll let Nancy take this one..

Yes. So the Independent Transaction Committee is something that was formed earlier this year. We do have a charter for it. And they took this process quite seriously. They looked at a number of different options including buyback options as well as paying a special dividend.

And yeah, they did engage with an independent financial consultant to ensure that we were getting the best advice looking at things to make the best decision and this is the recommendation that's come forward. When we talk about selling the business that is not something that we are currently looking at.

And they were -- we brought in the adviser specifically for this project..

Okay. Thank you..

Our next question comes from Jon Hollander with CAG. Your line is now open..

Hi, everybody. Congrats on another great quarter. A quick question again on the special dividend. If I look at the cash on the balance sheet, I think there's about $44 million and there's about 50 million shares outstanding at $0.65. So that's only about $32 million of that cash gets used on the special dividend.

Can you help me understand the thought process towards allocating capital to the dividend as opposed to investing in your stores?.

So we are....

Go ahead Nancy. No, go ahead..

So, it will be about $34 million going back to the shareholders and that leaves us with approximately $10 million in cash. And we do intend to use some of that money to invest back into our stores. And we anticipate at this point being able to build some of that cash back up given our cash flow performance and sales..

Jon on top of that we've kept some cash on hand. We're going to continue to do our remodels. We're going to invest in our stores. As in my prepared remarks, we're not going to open any new stores in the first half of 2022, but we will have cash on hand and we're going to continue to generate cash.

So, when we are ready to grow we can self-fund that as well..

I got that. But looking on the call last quarter we talked about very attractive store reinvestment metrics I believe in the neighborhood of payback in two years if not less on that capital.

I'm having a hard time understanding with this large -- 128 stores why we wouldn't just be reinvesting for a two-year payback as opposed to be doing a special dividend which obviously is taxable to your investors?.

No good question. Now our chain is 143 stores. And when we look at remodels we're very strategic when we do that. And it's been a very difficult environment with cost pressure on product and availability. So, with intent I've dialed that back. And I want to see where this shakes out here in the coming quarter but we're remodeling stores today.

We're remodeling stores next month. So, we're going to continue to invest in our stores next year. But at this point we thought it prudent to return the capital to shareholders knowing that what we had in the bank. .

Just a final follow-up on that.

How many stores are you intending to remodel during 2022?.

That hasn't been defined yet Jon. We continue to look at the environment. And when we look at product costs and product availability not just tile but everything goes into a remodel that will help us define going into our budgeting season here. But it's definitely one of our strategic objectives here in 2022 to continue to refresh in our stores.

Listen our chain looks good. We're pretty happy with our chain. This stuff doesn't spoil look bad. What we do we're strategic when we do a remodel and why we do it. So, I'm pretty confident in how we look today and what we're going to be doing in Q4 and in 2022. .

And we'll also provide insight into 2022 capital plans on our next call. As Cab mentioned we need to get through a budgeting process and work through some other things. But we will provide some insight for 2022 in our next call. .

Okay. Thank you for that. I'll get back in the queue..

Thanks Jon..

And I have a follow-up with David Kanen with Kanen Wealth Management. Your line is open..

Okay. Just a quick follow-up on the previous caller's question in regards to ROI on store refreshes. Am I correct in assuming that we can "have our cake and eat it too" in other words receive the special dividend? And with the remaining cash on the balance sheet and future free cash flow generation we'll be able to do both.

Is that accurate?.

That's very accurate David. We're doing that right now. So, we can continue to do that going forward..

Okay. And then in the prepared remarks in the press release you talked about the 12% or so growth and the drivers continued improvement in the home improvement sector. And then you specify execution of the company strategy.

Could you speak to that a little bit exactly what you're doing executionally to get more productivity out of each box?.

Yes, absolutely. Reinvesting in our people has been a big -- that's a priority of mine. For the last year and a half, two years I mean it's been a struggle during a pandemic. But what we decided was let's get our investment back from these stores. And what does that take? That takes leadership. So, expanding our regional leadership team.

So, bringing the store count down expanding our training and our trainings in each market expanding our recruiting team helping our stores recruit the best talent. Looking at everything from benefits to comp all these things to reinvest in our people. And what we're finding is our execution has gotten a lot better and it will continue to get better.

And that's where we're focused right now. And it's led to good results thus far and I believe it will continue to do so going forward. .

Okay.

Could you touch a little bit on that same subject just about emphasis on professionals on Pros and how that how you would grade that during the quarter?.

Yes sure. We launched our Pro market managers a couple of years ago and we've expanded that as well. We've also kind of modeled a new Pro marketing campaign and our assortment. So, we're hitting it on all levels with Pros. We're marketing to them differently.

We have different product assortment forum and we have a specialized sales force just for Pros along with our loyalty and rewards program. So, we're seeing that the Pros are responding favorably to everything we're doing. And we're going to continue to invest there knowing the return we get with the Pro customer.

So, yes, we're getting the results that we're hoping to get and it can grow a lot more from here..

Okay.

Cabby would you include designers in that category with Pros or is that a separate segment?.

No that's definitely--.

interior designers..

Yes, designers are definitely a segment within our Pro business. And we partner with them very well. If you look at our website you look at some of our direct mail you look at our inspiration in-store we get a lot of feedback from designers. They share a lot of their work with us. So, they're excited to partner with The Tile Shop as we are with them.

And we've had quite a few successful partnerships with tile lines with designers in the past. And that's another strategic move that we've made and has paid off well. We're going to continue down that path. So, designers are a very important part of our business David. .

Okay. All right. That’s all I have. Thanks again guys. Good luck next quarter..

Thanks David..

Thank you,. Our next question comes from Saidal Mohmand with B. Riley. Your line is open..

Hi Cabby. Appreciate great quarter. Just two quick questions. So, one the asset impairment that you guys mentioned I think it was like $700,000. Just to confirm that has not been added back to adjusted EBITDA. And I'm sorry I think that would make the comparison a lot better.

If it's not -- or it looks like it's not in there?.

It has not been added back. .

You're correct. It's not. .

Okay. So you guys actually have done probably better than what the numbers expect in terms of managing the cost inflation. So okay no that's great.

And then the second question I was wondering if you could just provide greater details on some of the maybe growth initiatives you guys are exploring, I think the potential store opportunities to kind of infill some of the geographies you're currently in. Any color would be great..

Yes. We continually evaluate our portfolio and we look at opportunities. But again, like in my prepared remarks we're not going to open any new stores in the first half. We have our finger on the pulse though across the country. We've done analysis. We've partnered with other vendors to look at what looks good out there.

And what's the pricing looking like and site selection and all that. So we're very engaged in that process. But as I said we're going to hold off and continue to invest in our existing store base to get our investment back with our existing footprint. But again, if we see something super attractive we can move if we want to..

Got it. Great. And then just a follow-up on that.

So what's the remodels? I mean, on average can you guys quantify what type of same-store sales uplift you're seeing?.

It really varies Saidal. When you look at a store and the tenure of the store when you remodel it, it's something where you look at the customer base, you look at the location you look at a lot of different variables. So when you invest in that store it could be 1.5 years it could be three to four years.

But typically we've said in the past around 2.5 years, but that's – again, it varies depending on the market location. .

All right. Great. Appreciate it. Thank you..

Hey, thank you..

Thank you. And I have a follow-up with Mr. Hollander with CAG. Your line is open..

Hi everybody. I wanted to spend a quick few minutes on working capital.

Could you please comment on your inventory levels? I saw they're up obviously quarter-to-quarter but just in general about working capital needs of the business for this quarter and what you're thinking about going forward?.

Thanks Jon. Nancy I'll throw that one over to you. .

Yes. So our inventory is currently -- it's 76.7% that $7.8 million -- it's currently $76.7 million, which is up about $7.8 million. And with any luck we're hoping to see that increase. As Cabby mentioned, we're still having some challenges in this current environment. Our procurement team has really done a fantastic job to get us product.

They continue to search all over the world, including domestically to fill in those gaps. We do expect that level of inventory to increase as things continue to open up and it will probably level off sometime we're expecting mid-2022. And that would be funded just out of our natural cash flow. .

Thank you. Our next question comes from Greg Cohen. Greg Cohen with Rambleside. Your line is open..

Hey, guys. Great quarter. Specific question on e-commerce.

Can you kind of give us some color on what percentage of our revenue comes from e-commerce today? And where you see that kind of in the next few years? And sort of also as an ancillary the margin differential on e-commerce sales versus in-store sales and then sort of how you see that impacting overall profitability in the future?.

Sure. Thanks for the question Greg. Yes, we're pretty excited about our e-commerce. Again in my prepared remarks it's less than 5% of our total sales but the investments we've made into the design.

And when you look at some of our pages when you look at the easibility of consumer working through the website we're seeing the results that we were hoping to see. And we're going to continue to invest in the website. When you think about margin we don't run sales on our website. You're not going to see any flash sales or 20% 25% off on our website.

So it is a good cost -- good store for us. There is some freight expense so we charge the customer for that as well. So we're hoping to see our e-commerce scale continue to scale going into Q4 and in the next few years. But it has ramped quite a bit in the last few quarters than it has in the previous few years. .

The other piece that we find really fascinating about the e-commerce sites is more and more of our customers are using that as a launch pad for inspiration and looking at options that are available. So when they come into the store they're much more informed and they're further down in their purchasing funnel if you will.

So that's been a great augment for inspiration and customer knowledge as well. And into Cabby's point it often translate in sales at the store level even though that is exerted at our website..

Okay. Yes that's helpful. And just kind of as a follow-up I think that your social media strategy is amazing and you can clearly see the customer engagement and that goes along with kind of the collaborations that you guys do with designers and kind of tile specialists. So I think that's playing really well.

Are we seeing -- I mean, just kind of more specifically do you think that this could become a 50% e-commerce company over time, or do you kind of just view it as a side business like, how do you think about e-commerce strategically for the long-term?.

Yes. Greg, it's amazing how the consumer has really changed in the last few years and it really accelerated through the pandemic. And we want to reach our consumer at any point during the process. And we want to give them the ability to come into the store get the in-store experience and the knowledge and get the touch it and feel it.

But if they want to stay home and get it online that's what we're investing too. Let's meet them there. And we would love to see, our e-commerce continue to grow and be a major portion of percentage-wise, who knows. I can't tell you that going into the environment that we have today.

But I do know as the consumer changes, we're going to change as well to meet them..

Thanks Cabell. Thanks for the great color on this. I’ll hand over..

Thank you. Your next question comes from Jeff Moore with Burr Oak Capital. .

Yes. I think it was last quarter that you guys started to sell luxury vinyl plank.

And I was curious as to kind of, how that's going for you all?.

Sure, Jeff. We're pleased with our sales results of our luxury vinyl right now. And we've made some significant reorders as well. So it's not something that we're going to take away. We've added a few SKUs to that assortment. But we're going to continue to monitor it, as we work through the next few quarters. But we're happy right now. .

Okay.

And is that something that you all generally carry a store? Is that in the distribution centers? And I mean, what kind of volumes are you seeing with it?.

It's a heavier volume material, meaning, they do larger areas typically with it kitchen floors, basements, things like that. We do carry it at the DCs. We don't carry too much in stores. We want to be able to get it where it needs to be quickly without overloading inventory in each store.

So yes we're seeing larger volumes of it for sure, but it's based in the DCs. .

Right.

But I mean as a percent of sales, can you give any clarity on what revenue share you're seeing from it?.

It's not a significant percent of sales at this point. We just started testing it, but we're happy with the limited SKU count that we have the results that we're seeing. .

Okay. Great. Thank you..

Thank you. And I'm currently showing no further questions in the queue at this time. I'd like to hand the conference back over to Mr. Mark Davis, for any closing comments. .

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 and have a great day. .

This concludes today's conference call. Thank you for your participation. You may now disconnect. Everyone have a wonderful day..