Tile Shop Holdings Inc (TTSH) 2013 Q3 法說會逐字稿

Greetings and welcome to the Tile Shop third-quarter 2013 earnings conference call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Brad Cohen, of ICR. Thank you, Mr. Cohen. You may begin.

Thank you, operator. Good afternoon, everyone. Thank you for joining us today for Tile Shop's third quarter of 2013 earnings conference call.

Let me remind you that certain statements made during the call today may 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 words as but, not limited to, plan, expect, anticipate, believe, goal, estimate, potential, may, will, might, could, target, and any other similar words to identify forward-looking statements may be made. 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 the Company's earnings press release issued today in the Tile Shop's latest filings with the Securities and Exchange Commission. The forward-looking statements made today are as of the date of this call, and the Company does not take any obligation to update these forward-looking statements.

Also, during the call today, the Company may make additional comments discussing adjusted EBITDA or EBITDA, which are non-GAAP financial measures. Please see the Company's earnings press release issued for reconciliation of these non-GAAP financial measures to net income, the most directly comparable GAAP measure. If you do not have a copy of today's press release, you may obtain one by linking through the investor relations page on the company's website at www.tileshop.com. With that, I will turn the call over to Tile Shop's Chairman of the Board, Mr. Bill Watts. Bill?

Good afternoon. This is Bill Watts, the Company's Chairman. I am here today with Bob Rucker, Founder and CEO; Chris Homeister, our new COO; Tim Clayton, CFO; Carl Randazzo, our Senior VP of Retail, and Joe Kinder, Senior VP of Retail Operations.

Let me jump in and touch on a few of the unique and intriguing attributes of Tile Shop. Our business has the opportunity to become the only national chain in the tile industry ultimately with hundreds of retail locations. Given that the industry itself currently does $5 billion in annual revenue at wholesale, having a meaningful first mover advantage, coupled with the longer-term opportunity to be the major player, is compelling, especially in light of our strong EBITDA margins and returns on new store investments. In order to maintain this advantage, we will continue to make the investments that are necessary to better position the Company to fulfill this long-term potential.

Let me now give you some specific data that will help further validate the long-term opportunity I've described. The strong and consistent performance of the Company is being driven not only by our new stores, but also by the consistent and accelerating performance of our mature store base. Let me comment on both.

First, new stores. Through the third quarter, the Company has opened 12 new stores -- actually, 15 through today. Since the beginning of 2012, a total of 30 stores have been opened. Let me now make a couple of broad-based statements about those 30 stores.

Twenty of the 30 are in new markets; 10 in existing. The new markets are very diverse and include markets like New York City, Buffalo, Toledo, Denver, Dallas, Jacksonville. All of the new stores are located in trade zones with at least 400,000 in gross population. Obviously, in the new markets, the Company has no brand awareness. All stores are opened with virtually no external advertising, although we do use the Internet, primarily to assist customers in locating the stores. Almost all the new stores are profitable within the first full quarter after they open. And, as a group, the new stores remain on track to deliver against our stated objective of a 40% IRR per year over the life of the lease. And I will remind you that we are defining that as all cash in versus all cash out, including inventory.

The consistency of these new store results is very encouraging. As soon as customers interact with our retail format, business quickly ramps both in sales and four-wall contributions. Not many retailers can make this statement.

To further validate the power of our brand and retail concept, in the third quarter the mature stores -- and I am defining that as stores four years or older, also comped double digits. Given that the entire chain produced a 14.8% same-store sales growth, I want to make that point that the comp is not being driven solely by new stores. With that, let me now turn the call over to Carl Randazzo.

Thank you, Bill. It is quite exciting for our team to produce another quarter of comp store sales growth this strong. With sales at same stores up 14.8% in the third quarter, and total sales up 28.3%, we are demonstrating the power of our business model.

Regarding our split between sales growth by ticket and store traffic, it was 44.4% and 55.6%, respectively, in the third quarter.

Let me spend a few minutes on markets and store openings. Our team continues to focus on finding the best locations to open stores in the markets that best fit our demographics. While we know new markets will open and produce initial sales at a slower rate than existing markets, that difference dissipates quickly over the first two years.

We continue to grow sales built on four pillars. First, opening stores in markets with suitable demographics. Second, leveraging our strength to take market share from the competition. Third, offering a vast selection of products designed to inspire, customers. And, fourth, training our sales managers and their associates to deliver exceptional customer service.

Let me now provide an update on new stores. We are well on our way toward meeting our goal of opening 20 stores this year. During the third quarter, the Company opened three stores in new markets -- Dallas, Texas; Greenwood Village, Colorado; Littleton, Colorado; and two stores in existing markets -- Timonium, Maryland, and Skokie, Illinois. In October, we opened three additional stores in Danbury and Norwalk, Connecticut, Tulsa, Oklahoma; the Company now operates 83 stores in 27 states.

Let me now provide an update on our marketing test we discussed on our last quarterly call. The test market program started in mid-September 2013 in three markets. The focus of the campaign was to increase consumer awareness and set the tone for what the stores provide. The campaign is called Beautiful Made Easy. It is too early to provide definitive feedback, but the initial results are favorable.

And, with that update, I would like to turn the call over to Bob Rucker, our CEO.

Thanks, Carl. We were quite pleased with the quarterly results and the progress we continue to make in fortifying the Company for the long-term. As Bill mentioned, we understand the power and potential this brand has to become the leading national tile and stone retailer coast to coast. We also recognize that, in order to ensure success, we must continue to make investments now in order to be positioned to accomplish our long-term goals. We are focused on infrastructure where we have made major investments in order to stay ahead of our projected store expansions. To that end, our third distribution center located in Durant, Oklahoma, is up and running and already supplying some of our newest locations with product. That said, it did cause us to incur some additional costs in the quarter, but the long-term benefits will far outweigh these initial expenses.

We also were on time and on budget in getting this center up and running. This DC will initially service 18 stores by the year-end. We also opened a setting material manufacturing plant on October 1 in Durant. The last thing we will do is add unnecessary overhead, but what is critical is to evaluate our strategy and understand and commit the necessary resources to support our growth.

This growth goes beyond just opening new stores. What is so powerful about our Company is actually the sales of the mature stores and the growth of new markets over time. Our stores' sales actually grow well into the fourth year of operation and beyond. So it is critical to have the right technology, sales support, merchandising, purchasing, accounting, marketing, and human resources to enable and support all of the growth that is in front of this Company.

From a human resources perspective, we have created a new position, chief operating officer and have filled the position with Chris Homeister. Chris has extensive retail experience at Best By, leading an effort that grew to $6 billion in annual sales.

In his new role, Chris will oversee supply chain, retail operations, and merchandising. While he has only been here a few weeks, he has already spent a great deal of time in the stores and has accompanied me and my product team overseas to meet some of our key suppliers. We recognize the need for farther strength in operations, and Chris's broad array of skills and extensive experience and successes in leading and growing multibillion dollar organizations at prominent retailers, coupled with his comprehensive experience in product development, retail, direct sourcing, and business development, will translate well at our Company. While Chris is here with us today, he will have greater perspective and insight to share on our year-end call rather than today.

With full-time employees on the ground in key markets such as in Asia, Turkey, and Mexico constantly searching for additional suppliers and working with our existing suppliers to expand production, we believe we are positioned to supply our needs for the foreseeable future and beyond.

We continue to utilize mentors in the opening of new stores. These are former store managers whose job it is to spend 2 to 4 weeks with each new store staff as the stores open. This has led to better productivity in the new stores and, again, gives us confidence that we can support the planned growth.

Also, we continue to invest in our online business. And, while it is not yet a large component of total sales, it is growing quite fast and we are working hard to capitalize on what could turn into a very important part of the business one day.

Before turning the call over to Tim for some financial color on our results, I would like to spend just a few minutes before we take questions on the issue of our product quality and our product safety, which has been questioned recently. Let me first say that I take these matters very seriously and, frankly, personally.

When I started the Tile Shop 28 years ago, my mission was to provide customers with not only an exciting shopping experience, but to also provide our customers with unique, all-natural tile products for their homes. I take great pride in the fact that all of our products are produced from natural substances.

With the use of natural substances, however, comes the possibility that they may contain trace amounts of inorganic metals. Also, glazing compounds used in ceramics may contain small quantities of these elements. However, during the ceramic tile manufacturing process, the process of firing the tile and the glaze at extremely high temperatures fuses any of these elements into the tile. As a result, they pose no health or safety risk.

However, in an abundance of caution over the past 10 days, we have worked with our vendors around the world to revalidate that no unnatural substances are used in the manufacture or fabrication of the products that we purchase. We have also tested a number of these products ourselves.

In addition, we have engaged URS, who is the worldwide provider of engineering, construction, and technical services, and a leading provider of environmental services, to validate our understanding and conclusions with respect to the overall safety of our products. Based on all of the evidence we have accumulated from these procedures, coupled with the information provided by our third-party experts, we are able to reaffirm our long-standing conclusions that the products we sell pose no health or safety risk.

We are committed to providing our customers with the highest quality natural stone, ceramic, and glass tile products. We will continue to expand our quality control procedures and we will provide more information on this matter on our website. With that, let me turn over the call to Tim, our CFO.

Thanks, Bob. We are very pleased to report net sales of $56.8 million for the third quarter of 2013, which represents growth of 28.2% over sales of $44.3 million in the third quarter of last year. The $12.5 million improvement was driven by a 14.8% increase in comp store sales, which accounted for $6.6 million of the increase. The remaining increase of $5.9 million was from sales of the 18 new stores that had been opened during the past year that were not in the comp store base. We opened five new stores in the quarter and one store entered the comp store group during the third quarter.

The 14.8% growth in comp store sales represents a meaningful improvement over comp store sales in the third quarter of 2012 of 5.9%, as well as an improvement from the same-store sales increase of 14.3% achieved in the second quarter of this year.

For the nine-month period, our comp store sales increased at 13.1%. This is on top of a 6.2% comp store sale increase for the nine months of 2012.

With respect to the 18 new stores that are not in our comp store group, 12 of these stores were opened in new markets and six stores were opened in existing markets. Historically, and perhaps obviously, new stores in new markets have first-year revenues that are slightly lower than new stores that open in existing markets. The mix of our new stores in the quarter is more heavily weighted to new market stores than in the past.

Gross profit increased $7.7 million or 24.1% for the third quarter, compared to the prior year. Our gross profit margin of 70.1% continues to be in line with the expectations previously communicated. As in prior quarters, we have seen our gross margins affected by selective price-related promotions. We continue to believe that a more aggressive approach to capturing market share, while impacting gross margins slightly in the short term, serves to enhance our long-term prospects.

Our selling, general, and administrative costs for the quarter were $32.2 million as compared to $26.5 million in the third quarter of last year, an increase of $5.7 million. As a percentage of sales, our SG&A costs in the third quarter this year was 56.7% of sales, compared with 54% on an adjusted basis in the third quarter of last year.

The SG&A costs in 2013 include the following items, which were not incurred in 2012. First, we have 18 more stores now than in the third quarter of last year. As we open new stores, the store-related SG&A costs are disproportionately higher as a percentage of sales than on a more normalized basis.

Second, this year we had a full quarter of public company costs as compared to the third quarter of last year.

Third, stock-based compensation costs were $900,000 higher in the third quarter of this year versus last year.

Fourth, the cost of 23 new employees that have been hired since the end of the third quarter of 2012 to support more rapid growth of the Company is also included. In addition, preopening costs in the quarter were $560,000 as compared to $75,000 in the third quarter of last year.

And, finally, we incurred incremental startup and operating costs related to the new Durant distribution center of approximately $400,000 in this quarter.

All of these items are necessary investments for the future of the Company.

Adjusted EBITDA in the quarter was $12.7 million, which represented a 13.4% increase over adjusted EBITDA of $11.2 million reported in the third quarter of 2012. The adjustments to EBITDA in this quarter relate primarily to payroll-related taxes on the deferred compensation payments that we made in the quarter. Adjusted EBITDA for the nine months was $44.9 million, 16% higher than the first nine months of 2012.

Our adjusted EBITDA margin in the third quarter this year was 22.3%, which is 300 basis points down from the adjusted EBITDA margin of 25.3% achieved in the third quarter of 2012. This decrease from prior-year margin levels is in the range we expected and previously communicated. Our expectations were that margins would decrease 200 to 300 basis points from historical levels as we absorb public company costs, the investments in people to support our growth, and the lower EBITDA margin levels related to new stores. This effect will be greater in some quarters than in others, depending upon the number of new stores opened in any given quarter and depending on the quarter in which we open those stores.

In this regard, the third quarter, which is our seasonally slowest quarter, has traditionally been a more challenging quarter for new store openings. However, stores opened in the third quarter will serve us well when the first quarter of the new year rolls around.

In the third quarter of this year we opened five new stores and effectively six, if you consider the store we opened on June 29. This compares to one new store in the third quarter of last year. If we were to isolate the EBITDA drag from just these last six stores, our overall EBITDA margins would have been approximately 80 basis points higher than reported.

Further, new stores generate lower four-wall margins for up to six quarters. To quantify that, the typical new store will generate, on average, a very small four-wall margin for the first quarter that it is open. The margin will then increase to approximately 20% in the fourth full quarter and to approximately 25% after six quarters of operation. Obviously, when you add a lot of new stores in a short period of time, the impact of these new stores on our historical EBITDA margins is much more pronounced.

As of September 30, we had 18 stores that were open less than one year and a total of 24 stores that were opened within the past 18 months. This represents 30% of our stores, which, while operating fully as expected, produced results that are below the historical EBITDA four-wall margin levels of mature stores.

As the number of newer stores increases, in relation to the total number of stores the EBITDA drag effect will increase as well. The most significant effect of this will be in the third and fourth quarters of this year, but it will continue to impact 2014 results, but to a lesser extent. This effect should begin to reverse late in 2014 as the number of new stores becomes a smaller percentage of the total.

We have included a pro forma non-GAAP net income presentation in the press release, which adjusts our GAAP quarterly results by eliminating non-cash expenses related to warrant liability, unusual and nonrecurring costs, and which utilizes a normal tax rate of about 40%. This presentation results in pro forma net income for the quarter of $4.2 million, which translates into basic and fully diluted earnings per share of $0.08. These amounts were computed using 50.9 million and 51.9 million shares for the basic and fully diluted calculation, respectively. The 50.9 million shares used in the basic calculation represents the actual number of common shares outstanding at September 30, excluding only the restricted shares outstanding, which have not yet vested. The fully diluted share count of 51.9 shares includes that dilutive effect of outstanding options and the restricted stock.

With respect to the balance sheet as of September 30, let me make a few additional comments. We ended the quarter with approximately $3.9 million of cash, $2.1 million of restricted cash, and $90.1 million of debt. The increase in debt in the quarter of $15 million is the result of, first, an increase in inventory of $10 million, primarily related to the opening of the Durant distribution facility, and in preparation for the expected increase in revenues in the upcoming months.

In addition, capital expenditures were $11 million in the quarter, related to new store build out, remodeling, and expansion of distribution facilities. We made a payment of $6.3 million for deferred compensation obligations in the quarter and $2.1 million is in temporarily restricted cash that relates to our Durant facility build out.

Our long-term debt to trailing 12-month adjusted EBITDA leverage ratio, as of September 30, was approximately 1.6 times. At quarter end, we had approximately $18 million of borrowings available under our long-term credit facility.

With respect to capital expenditures in the quarter of $11.1 million, approximately $7.4 million was for new store build out and remodels of existing stores, $3.2 million was for the expansion of our distribution and manufacturing facilities, and the remainder was for corporate purposes.

Capital expenditures for the fourth quarter of 2013 are expected to range from $12 million to $14 million, which primarily relates to store-related capital expenditures.

With respect to our future guidance, we continue to believe that we will open 20 new stores this year and that our full-year revenues will be in the range of $227 million to $237 million for the quarter -- I mean, for the full year. With respect to our revenue expectations for the fourth quarter and beyond, we want to provide an update on our new store productivity.

In view of the increasing number of new market stores, we have updated our analysis of new store performance to provide a better understanding of our store productivity across all markets. In the past, we have based our new store productivity on our historical average of $1.9 million of sales for a new store in its first year of operation. Following that year, our new stores would generally grow at 20% the second year, 8% to 10% the third year, and 6% to 8% the fourth year, and then, reverting to our norm for mature store sales of 3% to 5%.

Based on updated averages, which focus on more recent data, and now includes a heavier mix of new stores in new markets, our revised guidance for first-year performance for our new stores is $1.8 million. While the first year is slightly lower than historical averages, again, because of the number of new market stores, the performance of our stores in subsequent years is growing at a faster rate than previously discussed. We now find that, on average, our new stores grow at a 22% to 23% rate the second year, 12% to 14% the third year, and 7% to 9% in the fourth year.

Let me conclude by saying that we continue to be comfortable with the expectation of $60 million of adjusted EBITDA for the year. And, with that, operator, we can open the call up for questions.

(Operator Instructions)

Operator, while you are polling for questions, if you don't mind, let me clarify and expand a couple comments that I made with respect to capital expenditures in the quarter and for the year and then add a couple other brief comments.

Our capital expenditures in the third quarter were approximately $14.5 million versus the $11 million I mentioned earlier. Of that amount spent in the quarter, approximately $9.2 million was for the new store build outs and remodels; $4 million was for expansion of our distribution and manufacturing facilities; and the remaining $1.3 million was for our corporate offices and other corporate purposes. Our CapEx spend for the year through September 30 is $36.4 million.

With respect to our expectations on capital expenditures for the year, we've stated that we expect our CapEx in the fourth quarter to be between $12 million and $14 million. This will bring our full-year CapEx to approximately $48 million to $50 million. This amount is higher than previous estimates for the following reasons.

First, we are now including in our full-year estimates expenditures for stores that we expect to open early in 2014. In addition, the range provided does not reflect the offset of $3 million of cash we received from the tax incentives associated with the build out of our Durant facility. We are making this change in our discussion of the CapEx amounts so to be consistent with the presentation of capital expenditures in our cash flow statement.

Finally, included in the range are expenditures we have incurred to date and expect to incur in the fourth quarter related to CapEx that were not anticipated earlier in the year. This includes expansion of our corporate offices so that we can continue to house our corporate staff in our Plymouth store building, modifications of our existing distribution facilities, and building of display boards and cabinets for new stores that will be opened in 2014.

And our CapEx estimates for the year is approximately $7 million for the Durant, both distribution and manufacturing facility. If you were to split our CapEx spend between growth and maintenance CapEx, it would be approximately 95% growth related. We also need to reconcile between our cash outflow estimates per store of $1.4 million, and our presentation of that amount in our financial statement. The amounts we discuss as cash outlay of $1.4 million is net of cash received for tenant allowances, which average about $100,000 per store. However, this is not netted against our capital expenditure amounts presented in our cash flow statement. Accordingly, the CapEx per store as presented in our cash flow statement will be about $1.5 million per store.

Finally, let me just make a couple other final comments. With respect to the fourth quarter, in view of the recent issuances of restricted stock and stock options, we expect that our stock-based compensation in the fourth quarter will be approximately $1.4 million. Further, in view of the fact that most of the options granted our incentive stock options and, therefore, not deductible for taxes, this will increase our effective tax rate, which we expect to approximate 41% going forward.

We plan to provide more guidance with respect to our 2014 full-year results on our next conference call. If there are any questions, we would be happy to entertain them now.

Peter Keith, Piper Jaffray.

Congratulations on the continued success and welcome to Chris. I wanted to ask a little bit around the gross margin dynamic. Clearly, what you saw in Q3 isn't really that different from what we saw earlier in this year, but just wanted to get some clarity on the drivers behind that. You had called out the selective price promotions that you are running. Is that primarily related to the new market entries, which seem to represent the majority of your store growth at this time? In other words, could we expect that the gross margin pressure to ease as the number of new market entries sort of settles out over the next couple of years?

Hey, Peter. Thanks. The promotions that we run are probably weighted to the new market stores. We are, obviously, doing some across existing markets as well. So I guess there should be some easing of that, but I wouldn't expect it to be maybe as significant as you might be anticipating in regards if it is only related to the new market stores.

Okay. And what are the types of promotions that you are running so we can just get a little bit better sense of that?

Well, in the third quarter we ran the Labor Day and Fourth of July promotions, which was mainly to push some of our slower movers; get some people in the store when other people are out buying. And it seemed to work out pretty good.

Okay. Just moving on to the advertising test, understanding it is early, it sounds like it is going well thus far. Is there a time next year that we can think about as sort of your go forward when you might decide you are going to expand the advertising across the broader chain? And what time period might that be?

Right now, we are testing television advertising in a few select markets to replicate a national advertising budget and, as you said, the initial feedback is very positive. Once we get all the feedback and numbers in, I will present it to our board and they will make a decision when we will go forward in the future with it.

I guess even just to follow on, on that, do you have kind of a -- some time period circled on the calendar when you would be presenting it to the board to provide your thoughts?

Yes, Peter, I think the expectation is that, at the time of our next conference call, which is following our year-end results in the mid February timeframe, we would be able to provide a much better update on how this whole advertising program may roll out and what our timing looks like.

Okay. Fair enough. One last question for you, Tim. Appreciate the details on the new store maturity model. That is helpful. If we were incorporating this into our models, is this something we should use on a go forward or do you think this is more of like the maturity curve on stores opened up in the last year and a half?

Well, it is frankly based upon our historical performance, you know, more recent, over the last three to four years. So I do think it is something that you would look at as incorporating into the model for the stores that we have opened over the past 12 months or so.

I appreciate the feedback. Good luck this coming quarter.

Justin Kleber, Robert Baird.

First, just on revenues, maintaining the revenue plan for the full year, it seems to imply a pretty wide range here in the fourth quarter. I mean, I am coming up with something in the range of like a flat to a 20% comp. So just help me understand the decision, maybe not to tighten that range a bit. I mean, is it any reflection of what is going on in your business today, given the government shutdown, or are you guys just being conservative on the low end of that guidance range?

Well, Justin, I think we are being conservative with respect to that and with respect to the fact that our policy has not really been to provide quarterly guidance. And so, therefore, that is why we kind of maintain that annual range that was out there that was set at the end of the third quarter -- at the end of the second quarter -- in that call. I think you can kind of look at that as you will, but we are still comfortable with that range. And, based upon our results for the nine months, you can kind of get a sense of where that might fall.

Okay. Thanks, Tim. Just following up on the EBITDA guidance, $60 million for the year. So I mean, that implies a pretty material inflection in the EBITDA growth rate in the fourth quarter relative to what the experience has been year to date.

I guess just understanding what is driving the delta, is it less gross margin pressure or is it more SG&A related as you guys I guess now have fully cycled the introduction of public company costs into the model?

You know, Justin, it's probably -- it is a little bit of all of that. Typically, the fourth quarter is a better quarter for us from a seasonal standpoint anyway. Third quarter, we really tend to de-lever, just even on the base SG&A that we have in the Company. We get better leverage, much better leverage in Q1, deleveraging on the base G&A in Q3, and so it ticks up from between Q3 and Q4.

We also have more of the stores that were opened earlier in the year and late last year are maturing, which will tend to help kind of drive some of that EBITDA improvement. And then, obviously, we are doing some other things internally that we think will help contribute EBITDA dollars to the bottom line as well.

Okay. Thanks. And then just the last one here. Just a point of clarification, did you guys say traffic was up 55% or was that the ticket?

That was the traffic.

Okay. So that seems to be a pretty material acceleration from how that metric had been trending in the past. Is that correct? And, maybe, what do you guys attribute that to? Is that just the health of the overall industry or a combination of what you guys are doing internally?

Well, I think in the last quarter we indicated that it was about one-third, two-thirds, one-third traffic, two-thirds ticket. So it is a slight change, if you will. I wouldn't necessarily indicate it being that much of a meaningful change. And I think it may relate more to the quarter -- the seasonality of the quarter than anything else.

Best of luck, guys.

Seth Sigman, Credit Suisse.

Maybe just the first, a question on expenses. I think you were planning $1 million of incremental advertising costs in the back half of this year. How much of that actually hit the third quarter and how should we think about it for the fourth quarter?

You know, Seth, we haven't really -- we don't really get into detailing out a lot of that. I think what Carl indicated to you was that we have just started that rollout of that program late in the third quarter so you can kind of draw from that that we probably have not incurred a substantial part of that $1 million as yet.

Okay. And just to kind of ask Peter's question a different way, based on the updated new store performance that you talked about, any thoughts on maybe accelerating advertising to get the stores up the curve quicker?

Well, I think that's really what we are looking at this test to try to determine. And the thought is that, if the test results are -- do continue to indicate some positive results, then if that will drive the traffic and that will drive performance, then, frankly, that is why we are looking at doing the test, to help spend that money and drive that performance.

Okay. And maybe just any comments in general on consumer spending behavior. Any notable trends in bigger ticket products or do-it-for-me maybe picking up? Any color there would be helpful. Thanks.

Nothing that we can point to that would indicate any significant changes in patterns of behavior, spending levels, nothing to really -- has driven any of that. Nothing really significantly changing along those lines from what we have seen.

Daniel Moore, CJS Securities.

Wondering, as you opened up some of the newer markets -- the Dallases and Denvers -- and move into new regions of the country, are you seeing any meaningful differentiation in consumer tastes? In other words, are you needing to stock different types of products for different new areas or is it pretty much status quo?

This is Carl. I can answer that. Pretty much status quo. I think we offer a vast selection of many different types of products, which I think everybody around the country seems to look at it very good. I mean, they like what we offer in the stores. There is nothing in Dallas you would think -- they seem to like the same stuff that we carry in the Midwest and the New York seems to carry -- or the East Coast seems to like the same stuff we carry throughout. So we have quite a number of different types of definitely natural stone and ceramic tile. And I think it tends to cater to everybody's design tastes.

In some of the markets like Texas, we are adding items that we feel that they haven't done a good job with. We have added significant wall tiles -- ceramic wall tiles in that area, for instance. And we feel we can capitalize on that. But I think the tastes generally do run similar. And in a large part because of the way we market, we can be in charge of that taste.

Very good. And appreciate the commentary regarding product quality and safety. I think you mentioned you engaged URS. I wasn't familiar with them. Did I hear that correct and who exactly is that organization?

Yes, we did. We engaged URS. If you go out there, they are a $10 billion global provider of technical construction engineering, environmental services, rated number two in the ENR ratings with respect to their environmental service activities. And, yes, so they are a very substantial firm. I hadn't heard of them either, but they do quite a bit of this type of work.

We'll find that any quantifiable incremental expense in Q4 and beyond with regard to that?

You know, nothing that I would consider to be significant, Dan.

Okay. And then, lastly, are there any -- I guess the returns that you have seen have been consistent in terms of the conclusions. Is there anything that you are still waiting for in terms of feedback with regard to that engagement?

No. No. Their feedback was very clear and confident and that was very consistent with the internal work that we have done. And basically the historical understanding that the Company has always had, which supports the conclusion that the products are safe and healthy.

(Operator Instructions) John Baugh, Stifel.

Just to circle back on the availability question and just ask in general, any capital thoughts? Does the DC in Durant, if you filled that out with inventory at this point, I was just curious how we think about free cash flow or capital needs going forward? Thank you.

Yes, sure. No, that's a good question. We spent the summer basically filling out the Durant facility with inventory to be able to support all the stores that we are going to be shipping to from that facility. So that is step function if you will in terms of our inventory build has been completed. So from that standpoint, we don't expect a lot of use of capital in that regard. I assume that -- I think I may have addressed the principal part of your question, John?

Yes. And then, I wanted to get a little more color on the store management process and training. You mentioned, I think, mentoring or some weeks involved. I just wondered if you could give us a little more color along precisely how you do it with the rapid growth you are seeing. Thank you.

Well, the group of managers that we have on our bench are very good. And I feel very confident putting any of them in there to run a store.

However, opening up a new store and doing everything that it takes to get the store ready for the customers walking in the door, it is a lot. And I think getting these guys in there with experience, that have done it before, just to back them up and guide them in the right direction the first two -- if they show up there in the first two weeks it helps them. If they show up the second two weeks the store is open. They are just there to support the manager, kind of review what they have done, still what they need to do in regards to building a contractor base, building a staff, merchandising the store. Kind of everything that a store manager does. And I think it is a great program. We hear great things about it and our new managers tend to gain momentum professionally faster than in the past, I think.

So Carl, just to be clear, you are taking an existing store manager out of the store and -- I am not clear on that then.

No. The position is, we call it, sales support, manager support. They were store managers at one point in their career at the Tile Shop. And then they probably, for some reason, stepped back into another role at the Tile Shop, but still understand the basic mechanics of running a store and then we put them in this position to not so much -- they are not running a store, they are helping -- they are coaching somebody to run a store. And it is a little bit different than running a store. They are actually doing very well doing that.

So you have a few people -- a handful of people that their full-time job is to go to newly opened stores -- that is their primary role. Is that correct?

New stores and sometimes even existing stores if we have to put a new manager in an existing store. So it is not necessarily for new stores. They go to existing stores as well, but for some reason maybe they didn't want to be a store manager or something didn't work out, but they stepped back, they still know how to be a store manager, and these people are very good, like I said, teaching the mechanics of running a store to these new managers.

Anthony Lebiedzinski, Sidoti & Company.

First question is just in regards to your new store productivity. Some of the newer stores have been opening in the Northeast, which are currently a higher population, higher income type of markets. So are you just not seeing the sales from these new stores quite up to your productivity because of just [land] of brand equity or maybe you could just reconcile that?

Sure. I would like to because the averages that we communicated which drive the $1.8 million first-year performance are based upon all of the stores that we have opened over the last two, three, four years. Only seven of those stores were in the Northeast. In fact, those stores, frankly, have increased the average for the new stores because they actually are opening at about what we would expect for an existing store -- you know, a new store in an existing market.

The differential may come, frankly, from some of the vast array of the other markets that we are opening stores in and it just takes a little longer in those markets for the stores to get up to the same level of productivity that the existing market stores do.

Okay. That's helpful. And also, previously, you had guided for gross margins to be between 70% to 72%. This quarter you are at the low end of that. Do you still feel comfortable with having gross margins within that range?

Yes. Over a longer term, we are definitely comfortable with the 70% to 72%, given the nature of our vertical integration and distribution system. I think, as we go forward, you will see opportunity for it to be at the higher end. And, in some quarters, where we have a lot -- we have stores opening with a new distribution center, not a lot of throughput, other kind of just turnover issues from a volume standpoint, it might be at the lower part of that range. But it is a fairly narrow range and we continue to be comfortable with that on a long-term basis.

Okay. And, turning to SG&A expenses, and obviously understand the build up as a new public company and just giving up your rate of growth in terms of your store base. So should we expect you to be able to leverage SG&A expenses in 2014, or is that more of a 2015 type of a event?

Well, I think you need to break it down. Because we definitely expect to be leveraging the incremental public company costs and even the infrastructure costs -- the additional people costs that we've added during 2013 people. That will be -- we will leverage that as we enter 2014.

What will be the continuing EBITDA drag, if you will, and I think what we need to just clarify some more is the fact that as we add new stores the SG&A costs associated with the new stores, as they open up and ramp up, is a higher percentage than what seems to be anticipated.

That will -- we will gain leverage on that towards the end of 2014 as the number of new stores becomes a smaller part of the overall total, and then we expect to see some nice leverage as we move into 2015.

Okay. So for the year as a whole, you probably won't be able to leverage SG&A. Is that safe to say?

Well, I think what we will do is talk about 2014 guidance as part of our next quarter call and we will probably be able to get a little better visibility to everybody on that.

Okay. And a couple of final questions. So you did mention as far as part of the higher CapEx is the CapEx for 2014, some of that. Some of the stores for 2014 are going to be within this year's CapEx, so can you sort of ballpark estimate for next year's CapEx budget?

You know, again, I think we have generally talked preliminarily in that 25-store range for next year. And that would be consistent with what we've said for the past whatever it is, 18, 24 months in terms of our expected growth pattern. And I think you can kind of just do the math with respect to that number. But we will get much more clarity on that as we get into our next quarter call.

Okay. And, lastly, Tim, can you just repeat how much that you have left on your revolving, as far as your available capacity on your revolver?

Sure. At the end of September, it was about $18 million.

Okay. Thank you.

That is all the time we have for questions today. I would like to turn the call back over to management for any additional remarks.

Thank you very much for joining us on this call this evening. Have a good night.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time and thank you for your participation.