Good day. And thank you for standing by. Welcome to the Second Quarter 2023 Tile Shop Holdings, Inc. Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions]. Please be advised that 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..

Thank you. Good morning to everyone and welcome to the Tile Shop's second 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 also been posted on 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 for an update on our business and our second quarter results. Over the last several quarters, I've shared how rising interest rates and slowing housing turnover have presented challenges for the industry.

In the second quarter, these challenges contributed to lower levels of traffic in our stores, which negatively impacted our comparable store sales. While we anticipate that macro headwinds will persist in the near term, we have been implementing measures to allow us to better navigate these headwinds.

For instance, we're taking steps to improve our reach to potential retail customers who are considering a remodeling project, as well as providing different options for customers financing. Additionally, we continue to expand our relationships with professional customers.

As of the end of the second quarter, nearly 75% of our sales mix is either referred by one of our pros or sold directly to a professional customer. We believe we still have untapped potential to continue to grow our pro sales, especially given the recent introduction of our expanded line of LVT products.

In addition to our pro business, we're also seeing continued traction with our e-commerce initiatives. We saw sequential growth in e-commerce orders from Q1, which was fueled by an investment in digital advertising as well as an improvement in conversion rates stemming from enhancements we have made to the online shopping experience.

The improvement in online conversion helped grow e-commerce orders by over 30% during the second quarter this year when compared to the same period last year. I'm encouraged by the increase we've seen in the e-commerce orders and believe we continue to have significant room for growth in this area. Turning our attention to our assortment.

We continue to have the industry's best assortment of tile products, now augmented with the recent launch of our expanded LVT lines. This has long been a competitive advantage of our company, and I expect that to continue.

Our store teams continue to bring energy to our customers' buying experience, which helped us make progress against our retail excellence goals. Average ticket prices continue to trend positive this quarter, and we were able to maintain strong conversion rates despite the challenging macro conditions.

We also closed the quarter with our strongest month of LVT orders since our launch and continue to believe this category has the potential to grow into a meaningful portion of our sales mix over time. We were pleased to open our new store in Colorado Springs in June, which I mentioned last quarter will be our only store opening of this year.

This is our fifth store in the Colorado market. We're still on track to relocate one additional store in 2023 and continue to look for growth opportunities in 2024 within our existing distribution area. With that, I'll now hand the call over to Karla..

Thanks, Cabby. Good morning, everyone. Second quarter sales at comparable stores decreased by 8% from the second quarter last year. The decrease in comparable store sales was due to lower levels of store traffic and partially offset by an increase in average ticket value.

Our gross margin rate during the second quarter was 64.2%, which is in line with the gross margin rate we reported last quarter, but 180 basis points lower compared to the same quarter last year. The decrease in gross margin is due to an increase in the cost of our products that was partially offset by price increases implemented over the last year.

Looking ahead, we believe the company is well positioned to see an improvement in gross margin during the second half of 2023, given the decrease in international freight rates combined with opportunities to source quality products at better pricing in connection with our resourcing initiatives.

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 increases in LVT sales and continued growth of back shelf will likely put pressure on our overall gross margin rate over time.

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. Second quarter SG&A expenses decreased by $5.7 million when compared to the second quarter of 2022.

The decrease was largely attributable to a $3 million decrease in variable compensation at a store level, a $1.1 million decrease in shipping and transportation and a $900,000 decrease in depreciation. These decreases were partially offset by a $500,000 asset impairment charge that was recorded for underperforming stores.

During the second quarter, we adjusted our reserves for amounts that had been set aside for annual incentives, given our performance relative to the financial targets required to achieve bonuses under our annual incentive plan.

Additionally, we reversed share-based compensation expense on certain restricted share awards containing performance vesting conditions that had been granted earlier in 2023. These adjustments reduced our SG&A expense from what it otherwise would have been inclusive of incentive-based compensation at target levels by approximately $1.8 million.

Net income was $5.1 million during the second quarter of 2023 compared to $6.9 million in the same period last year and adjusted EBITDA was $13.6 million compared to $16.8 million in the same period last year. Second quarter earnings per share decreased by $0.01 from $0.13 during the second quarter of 2022 to $0.12 during the second quarter of 2023.

We continue to have a strong balance sheet. Inventory decreased sequentially by $8.6 million from the first quarter to $106.9 million at the end of the second quarter. We also continued to deliver strong cash flow. Year-to-date, we have generated $41.4 million of operating cash flow.

This has helped us reduce our outstanding debt from $45.4 million at the beginning of the year to $20 million at the end of the second quarter. Additionally, we have been able to grow our cash reserves by $8.6 million during the first six months of the year and ended the second quarter with a cash balance of $14.6 million.

We continue to expect to use excess cash to pay down our debt in the near term. With that, Cabby and I are happy to take any questions..

[Operator Instructions]. Our first question comes from Mark Smith of Lake Street..

First question for me is, and I know it's probably early for this, but any updates you can give us or thoughts around the new store and how it's going out of the gate, anything that you guys have learned with this first new store in a while..

Yes, absolutely, Mark. This is Cab. I was actually able to visit our new store last week and had a nice pro event and very happy with that location. We're positioned well for traffic and for our pros and the retail customer. I think we've tested a few things in other stores and put them into action there in Colorado Springs, and we have high hopes.

And so far, so good. We're happy..

You spoke a fair amount about LVT, kind of initial thoughts on how that's going? Is it kind of hitting expectation? Is it outperforming? Any additional insights you can give us on LVT would be great..

It's continuing to get awareness, and we're continuing to see more and more sales out of that segment of our assortment. I always want more, and I always will. But I'm happy with the results thus far through the summer. And I don't see it slowing down..

I wanted to ask about inventory. You guys had gone out and bought pretty heavy kind of ahead of some price increases kind of coming down the pipe here.

Walk us through – and it's come down here in the last couple of quarters, but walk us through kind of your comfort level with your inventory today? And how much maybe you still have of, we'll call it, kind of prebought inventory that you can still sell through at a pretty attractive margin. Any insights there would be great..

We've been able to bring down our inventory quite a bit. We're still over $100 million. I think we have opportunity to bring it down even more in the future. As our resource product continues to hit our DCs, that's good. It's a better cost structure with lower freight.

So we're going to continue to get some of that higher-priced inventory out of our system. We're starting to see the newer stuff come through and more of that is landing in the coming weeks, months. So I feel we can lower inventory even more. But what we're going to have is the same amount of units, right? So we're buying at a better price.

So, even though our inventory number comes down, our units are going to be the same or somewhere around there. But that gives us confidence in our margin that we're going to see, hopefully, an increase here in the coming quarters..

And the last question for me is really just what you're seeing in consumer behavior. I know you guys called out in the press release macroeconomic environment still being pretty tough here.

What is it that you think it takes to maybe spur or drive some more consumer spending on your products?.

We trend well with housing turnover. And it's getting better or, as we say, less worse and it's starting to trend in the right direction. There's still remodeling activity. Our pros are still busy, but it's not what it was last year. And I think with rising interest rates, that's going to put a wet blanket on that.

But as we get through Q3 and Q4, I feel that the pressure is going to be on. We hear about these larger homebuilders opening up more and more houses like the Hortons and the Pultes, things of that nature. But the high-end custom builds are still slow. And I feel that they're going to start ramping up.

We're seeing more permits go through for those, but that has impacted our retail traffic to our stores. We're hoping to see a little bit more in the back half of 2023 with better priced inventory and things will go well. But it's still a challenge, no doubt..

I am showing no further questions at this time. I would now like to turn the conference 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. Thank you for participating. You may now disconnect..