Tile Shop Holdings, Inc. (NASDAQ:TTSH) Q3 2023 Earnings Conference Call November 2, 2023 9:00 AM ET
Company Participants
Mark Davis – Vice President, Investor Relations and Chief Accounting Officer
Cabell Lolmaugh – President and Chief Executive Officer
Karla Lunan – Senior Vice President and Chief Financial Officer
Conference Call Participants
Maxwell Michaelis – Lake Street Capital Markets
Operator
Good day. And thank you for standing by. Welcome to the Quarter Three 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].
I would now like to hand the conference call over to your first speaker today, Mark Davis, Vice President of Investor Relations and Chief Accounting Officer. Please go ahead.
Mark Davis
Thank you. Good morning to everyone and welcome to the Tile Shop’s third 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 non-GAAP financial measures, which has also been posted on our company website.
With that, let me now turn the call over to Cab.
Cabell Lolmaugh
Thanks, Mark. Good morning, everyone. And thank you for joining us today for an update on our business. While the macro environment continues to present challenges, we continue to make changes to our assortment, expand services, and invest in e-commerce capabilities to help mitigate the impact on our business.
As we have discussed previously, the challenging economic environment exacerbated by significantly higher interest rates has created headwinds across our industry over the last year. These factors have contributed to lower levels of traffic in our stores, which negatively impacted our sales during the third quarter.
Despite these challenges, I am pleased with the progress we have made implementing changes to adapt to the current environment. For example, we took steps to improve our offering to middle-market end customers by adding new tile products for assortments that looked great, performed well, and are priced competitively.
We also expanded our line of luxury vinyl tile products over the past few quarters that provide options for customers seeking to refresh their homes while making more economical choices.
Additionally, we believe the services we offer in our stores are a key point of differentiation. We continue to invest in training and tools to ensure our associates are equipped with the latest design trends and installation techniques to help our customers.
By taking these steps and pairing our offering with competitive financing options, we believe we are well-positioned to appeal to both higher-end and budget-conscious customers.
We continue to pursue opportunities to enhance our relationship with our professional customers. For example, our expanded assortment of competitively priced tile suits, combined with our luxury vinyl tile offerings, provide budget-friendly options for our pros to present to the homeowners they serve.
Our pro-market managers play a key role in cultivating relationships with professional customers and hosting in-store trainings with industry experts. The combination of these benefits, paired with our pro-loyalty program, extensive assortment, and exceptional service, help us strengthen our relationship with this customer segment.
I am pleased with our go forward plan and confident that our value proposition remains a strong endeavor to both retail and professional customers. Turning to our assortment, we have made nice progress against our goal in 2023.
Around this time last year, we incurred unprecedented cost increases across our supply chain due to a variety of factors. We have worked with both existing and new suppliers to source our tiles at lower cost, while maintaining, or in some cases, exceeding our high-quality standards.
We believe our vast assortment of over 6,000 tile products is another key point of differentiation when compared to big-box, regional, and local players with a more limited tile assortment. Our supplier base is global and diversified, which we believe is a competitive advantage.
Our e-commerce initiatives continue to gain traction. The step we’ve taken to invest in digital advertising, improving our sampling program, and enhance the online shopping experience, help us grow our e-commerce orders by over 25% during the third quarter, when compared to the same quarter in the prior years.
I am encouraged by the results we have seen today and believe that the investments we’re making in our website position us for continued e-commerce order growth. Earlier this summer, we opened a new store in Colorado Springs. The store is off to a nice start, and I am pleased with the early results.
At this time, I do not insist any additional new store openings in 2023. We completed a project to relocate one of our stores near Milwaukee, Wisconsin last month. We also made the decision to close one store during the fourth quarter, which will bring the store count to 142 at the end of the year.
I remain enthusiastic about the prospects for our business. While we expect macro headwinds to persist in the near term, I believe we have a great team that is doing an excellent job navigating the challenges presented in the current environment. I would like to thank the entire Tile Shop team for their hard work and dedication.
With that, I will now hand the call over to Karla.
Karla Lunan
Thanks, Cabby. Good morning, everyone. Third quarter sales at comparable stores decreased by 4.9% from the third quarter last year. This was due to lower levels of store traffic and partially offset by an increase in average ticket values.
Our gross margin rate during the third quarter was 64.7%, which represents a 50 basis point improvement in gross margins sequentially from the second quarter of 2023, and a 180 basis point decline compared to the same quarter last year. The year-over-year decrease in gross margin is due to an increase in the cost of our product that was partially offset by price increases implemented over the last year.
The inflationary cost pressures have seemingly subsided and we believe the company is well-positioned to see sufficient improvement in gross margin in the near term, especially if we continue to have success sourcing quality products at better costs as Cabby mentioned.
However, it’s important to remember that several of our products, like our luxury vinyl tiles and back shelf products, carry lower gross margin rates than most of our tile products. We anticipate increases in luxury vinyl tile sales, and continued growth of back shelf items will likely put pressure on our overall gross margin rate over time.
However, it’s an exchange we are comfortable making, as this should increase gross profit dollars and improve our leverage on fixed SG&A expenses. Third quarter SG&A expenses decreased by $2.4 million when compared to the third quarter of 2022, the decrease was largely due to a $1.7 million decrease of variable compensation at a store level, a $1.1 million decrease in depreciation expense, and a $1 million decrease in shipping and transportation expenses.
These decreases were partially offset by a one-time lease exit benefit of $800,000 that was recognized in the third quarter of 2022 and not repeated in 2023, and a $700,000 increase in marketing expenses.
We continue to have a strong balance sheet. Inventory decreased sequentially by $8.2 million from the second quarter to $98.7 million at the end of the third quarter. We’re pleased with the progress we have made working inventory levels down this year to free up capital to invest in other areas of the business.
In the near-term, we anticipate inventory will trend downwards as we continue to optimize inventory levels, and as inventory received at lower costs, replace this inventory we had purchased at higher price points. We also continue to deliver strong cash flow.
Year-to-date, we generated $56.2 million of operating cash flow. This has helped us reduce our outstanding debt from $45.4 million at the beginning of the year to $10 million at the end of the third quarter, fund $11 million of capital expenditures year to date, and grow our cash balance on the balance sheet to $16.4 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.
Question-and-Answer Session
Operator
Thank you. At this time, we will conduct the question and answer session. [Operator Instructions] Our first question comes from the line of Maxwell Michaelis with Lake Street Capital Markets. Your line is now open.
Maxwell Michaelis
Hey guys, thanks for taking my questions. First one from me. I was wondering if you could discuss any changes in consumer trends, maybe from Q2 to Q3, and then maybe now what you’re seeing in Q4?
Cabell Lolmaugh
Hi, good morning. This is Cabby. Thanks for the question. The consumer continues to be with the heightened interest rates. We’re seeing a decrease in traffic, but we are still increasing our average order, which is great. We’re selling more of our LVT product lines, so we’re seeing more of a budget conscious consumer. And that’s why we’re tailoring a lot of our assortment to that, while providing our high-end and designed forward assortment to our other designers and pros that really like this stuff, continuing to focus on remodels. So yes, decreasing traffic, and we’re not surprised by that with the interest rates and where the housing is at right now, but overall, it’s pretty much been the same, Maxwell.
Maxwell Michaelis
Alright. Thank you. Next one for me. It sounds like the new store opening has been going well. Just wondering if there’s any new learnings from that opening in Colorado?
Cabell Lolmaugh
That’s a good question. We focused on a little bit of a smaller footprint, and there are more designed forward approach to working directly with our pro customers and our retail customers. So we’re monitoring that carefully, looking at different segments of the business and the sales that are coming out of that store in a smaller footprint, but so far so good. We’re going to continue to experiment with our remodels across the chain, and we’re happy with the results.
Maxwell Michaelis
Alright. Thank you. Couple more for me. It sounds like inventory has worked down over this past quarter. I just want to get a sense of where you’re comfortable at. How low can inventory get?
Cabell Lolmaugh
Yes. We feel we have some more room to burn on inventory as prices come down, and we still carry a healthy amount of units for our customers. What we watch is our order for fulfillment rate, and we feel we can lower our inventory and continue to have a 95%, 98% fulfillment rate to our customers. So we monitor that closely and feel there is still room to go on our inventory balance.
Maxwell Michaelis
Okay. And then last one for me. Just looking at traffic over the quarter, I want to get a sense of how much of the decrease in same-store sales decline was from volume-driven or price-driven?
Cabell Lolmaugh
Yes. It’s mainly volume-driven, Maxwell. I mean, it is — we all performed our declines, which I’m proud of the team for executing, but I don’t think it’s pricing. I mean, pricing is up, but our traffic has been declining just due to the macro environment.
Maxwell Michaelis
Alright. Thank you, guys. That’s it for me.
Cabell Lolmaugh
You bet.
Operator
Thank you so much for that. All right. I am showing no further questions at this time. I would now like to turn it back to Mark Davis for closing remarks.
Mark Davis
Thank you for listening to our earnings conference call. We appreciate your interest in the Tile Shop, and have a great day.
Operator
Thank you for your participation in today’s conference. This does conclude the program. You may now disconnect.
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