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Tile Shop Holdings, Inc. (NASDAQ:TTS)

Q2 2013 Earnings Conference Call

July 30, 2013 05:00 p.m. ET

Executives

William E. Watts – Chairman

Robert A. Rucker – President & CEO

Timothy C. Clayton – SVP & CFO

Carl Randazzo – SVP Retail

Brad Cohen – ICR (Investor Relations)

Analysts

Justin Claveron – Robert W. Baird & Co.

Seth Sigman – Credit Suisse

Joan Storms – Wedbush Securities

Daniel Moore – CJS Securities

Anthony Lebiedzinski – Sidoti & Company

John Baugh – Stifel Nicolaus

Joe Feldman – Telsey Advisory Group

Operator

Greetings, and welcome to the Tile Shop Second Quarter 2013 Earnings Conference Call. (Operator instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Brad Cohen of ICR. Thank you, Mr. Cohen, you may begin.

Brad Cohen

Thank you, Operator. Good afternoon, everyone. Thank you for joining us today for Tile Shop’s second quarter 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. Words such as not limited to “plan,” “expect,” “anticipate,” “believe,” “goal,” “estimate,” “potential,” “may,” “will,” “might,” “could,” “target,” and other similar words could 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 earnings press release issued today and in Tile Shop’s latest filing with the SEC. The forward-looking statements made today are as of the date of this call and the company does not undertake any obligation to update these forward-looking statements.

Also during the call today the company may be discussing adjusted EBITDA or EBITDA, which are non-GAAP financial measures. Please see the company’s earnings press release issued for a 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 to the Investor Relations page on the company’s website at www.tileshop.com.

With that I’ll turn the call over to Tile Shop’s Chairman of the Board, Mr. Bill Watts.

Bill?

William E. Watts

Good afternoon. I’m here with Bob Rucker, the company’s Founder and CEO; Carl Randazzo, Senior VP of Retail Operations; and Tim Clayton, our CFO.

Before I review some strategic initiatives at the company, I want to start by discussing the highlights of the second quarter. Same-store sales increased 14.3% exceeding expectations and representing a very nice sequential increase over the 10.4% achieved in Q1. The two key drivers of our comps are first, the macroeconomic tailwinds driven by improving consumer confidence and increasing housing turnover.

And secondly, continued outperformance by the new stores. In terms of earnings guidance we are reaffirming our previous EBITDA expectation of $60 million, but we now are now going to accomplish this while incrementally investing above and beyond original expectations in two key areas designed to further enhance the long term growth rate of the company.

The first is new stores. The number of new stores we expect to open in 2013 is up to 20 from 17, Carl will provide details and where we stand against that new objective. Let me focus on why we are opening more stores.

First, results of the 24 new stores opened since January 1st of 2012 are consistent and meeting all expectations. Second, with the ongoing infrastructure investments being made throughout the company, we are confident that we can support the additional growth, Bob will give you detail on the scope on these infrastructural investments. A little more color on the 24 stores that have opened since January 1st of 2012. And by the way 10 of them are in new markets with 14 in existing.

Keep in mind that the stores opened in new markets have virtually no brand awareness and were opened with limited marketing and advertizing support. Even so, these new stores are meeting expectations under these circumstances which lead us to conclude that the value proposition is compelling and resonating with consumers once they experience our stores. Increase in our range of our new stores again 17 to 20 coupled with the second half waiting, 13 in the second half versus seven in the first half will cause some reduction in EBITDA margins in Q3 and Q4 as we have consistently explained on past calls. Tim will provide you with more detail.

Looking forward to 2014, we’re currently anticipating opening approximately 25 stores. Beyond 2014 rather than working at a fixed percentage of new store growth we will focus on ensuring the new stores continue to meet expectations while also expanding our infrastructure capabilities to be consistent with the number of stores that we open.

The second strategic initiative is based on the success of the Tile Shop value proposition not only in the new stores, but across the system. In this regard after an extensive search we’ve retained a Minnesota based advertizing agency, Pocket Hercules is their name and have charged them with running tests in select markets over the balance of this year. We are building the test programs around the following opportunities.

First, consumers truly appreciate the Tile Shop retail experience once they have interacted with it, remember approximately 50% of our business is repeat sales. Our goal is try to externally communicate the essence of that retail experience that being our broad assortments, unique presentation and knowledgeable sales force for wider audience designed to increased traffic in our stores and at our website.

Second thing we want to try is that our top volume stores have a percentage of business done through professional tile installers. We want to organize programs through reach out and establish additional relationships possibly some form of loyalty programs with installers throughout the retail network. And third, the company has historically like all retailers run promotions on major holidays Labor Day, Black Friday etcetera. We want to improve the returns on these promotions.

Against these initiatives the company plans to proactively spend approximately $1 million in the third and fourth quarters, which will be slightly diluted from margins, but again we believe this investment long term will further strengthen the Tile Shop brand and distance us from our completion.

To summarize we are reiterating our earlier guidance of $60 million of EBIDTA, but will now absorb the incremental cost of three additional stores as well as the $1 million investment in the advertizing tests I just described.

Let me now turn the call over to Bob Rucker, the company’s founder and CEO.

Robert A. Rucker

Thank you, Bill. Let me start as always by giving you an update on purchasing, pricing and supply chain. In terms of pricing we see pockets across treasure and trade into a lesser degree in product but nothing we see as significant. The dollar has actually strengthened in certain markets namely Turkey and India and has stabilized in China.

Let me tell you again, we continue to pursue the world markets to ensure that we can now and in the future supply our expanding our store base. To that end we have added a full time personnel on the ground in Mexico and India to search out new suppliers mainly in the stone category which represents over 50% of our sales.

We also continue to work with our existing suppliers to expand production. Given our knowledge of the markets we believe, we’re up to the challenge of feeding our growth, this is the core competency.

Let me now focus on infrastructure where we have made major investments in order to stay ahead of our projected store expansion specifically, our Durant distribution center has now started chipping the stores. The setting material manufacturing at this facility will be completed by October 1st. We expect to be shipping 18 stores from the facility by year end with the Durant DC open we can comfortably handle at least 200 stores with the existing four distribution centers.

We’ve expanded our cabinet shop to accommodate the construction of cabinets for the 60 vignettes in each new store. That department is located in Spring Valley, Wisconsin, the additional capacity now gives us the capability to support up to 40 new stores per year.

Our sample board department to supply their approximately 1,700 display boards in every new store, we recently completed a major expansion of the display department located in Ottawa Lake, Michigan. This gives us capability to produce enough display boards to support up to 40 new stores per year.

The home office, we have added 22 additional associates across the support functions at the home office in Plymouth. Well, I am not a big fan of overhead, I realize we have to continue to expand these ahead of the expected store growth. Specifically, we have added people in IT, sales and support, merchandizing, purchasing, accounting, marketing and human resources.

In sales, Paralito has already added one additional regional manager and will have one more next month bringing that total to four. In addition, he has added three full time training people which are former store managers and whose job it is to spend two to four weeks with each new store staff as the store is open. This has led to better productivity in the new stores and again gives us this confidence that we can support the planned growth.

Internet sales, while online business is not yet that significant as it growing rapidly, therefore, we have added three full time customer service representative that all prior tile shop store experience to better capitalize on what may evolve into a meaningful part of our business.

Let me now turn the call over to Carl to give you more color on the retail business.

Carl Randazzo

Thank you, Bob. Let me say again how proud we are that comp store sales were up 14.3% in the second quarter and total sales were up 25.59%. From the data that we have available two-thirds of the sales growth was driven by ticket and the other third by increased store traffic.

Our strategy for continuing to grow sales in built on four pillars, first opening stores in market with suitable demographics. Second, leveraging our strength to take market share from the competition. Third, offering a vast selection of products incredibly presented to grab consumers from the moment they walk through our doors, and fourth, early training our sales managers and their associates to deliver exceptional customer service.

Let me now provide an update on new stores. We’re well on our way toward meeting our goal of opening 20 new stores this year. During the second quarter, we opened four new stores. These include one in Warwick, Rhode Island, which continues to boost our presence in the Boston market. Another store along the Baltimore-Washington DC corridor in Glen Burnie, Maryland, a store in Greenville, South Carolina and our first store in Texas located in the Dallas suburb of Plano.

In addition to these four new stores, so far this quarter we added another store in Dallas and a store in the Baltimore suburb of Timonium. So, as of today, we have opened nine new stores so far this year. In addition, we’re currently have four more stores under construction and an additional seven leasing sites. In other words, all 20 of the projected openings already accounted for.

As we continue our aggressive growth plans we understand that part of our success rests with our sales managers who set the pace for our stores. To ensure that our sales managers are positioned to succeed, we have initiated a mentor program to get new managers up to seed faster and to focus them on serving our customers. This is a major contributor to the success of the new stores.

Lastly, Bill’s earlier comment on enhancing our marketing efforts, we are testing marketing programs in three test markets this Fall with our new agency Pocket Hercules. Having worked with them over the last 90 days I am confident that it will result in incremental traffic in sales in our stores and through our website. These initiatives are planned to kick off on Labor Day.

With that update, I’d like to turn the call over to Tim Clayton, our CFO.

Timothy C. Clayton

Thanks, Carl. We are very pleased to report net sales of $58.1 million for the second quarter of 2013 which represents a 25.5% increase over sales of $46.3 million in the second quarter of last year.

The $11.8 million improvement was driven by a 14.3% increase in comp store sales which accounted for $6.6 million of the increase. The remaining increase of $5.2 million was from sales of the 16 new stores that had been opened during the past year that were not in the comp store base.

We opened four new stores in the quarter and two stores entered the comp store group during the second quarter. The 14.3% growth in comp store sales represent a meaningful improvement over comp store sales in the second quarter 2012 of 3% as well as an improvement from the same store sales increase at 10.4% achieved in the first quarter of this year.

For the six months period, our comp store sale increased to 12.4%. This is on top of 6.4% comp store sale improvement in the first half of 2012. The increase in sales for the first half of 2013 was $22.8 million. Of this, the comp sale increase was $11.4 million and new stores contributed $11.4 million also.

Gross profit increased $7.2 million or 21.4% for second quarter compared to the prior year. Our gross profit margin of 70.3% was lower than the prior year, but continues to be in line with the expectations previously communicated. When comparing our gross margins to the prior year, we have seen slightly increases in product acquisition freight and distribution cost. In addition, we have used selective product related promotions and shipping discount to generate or secure incremental sales.

All of these actions are specifically designed to drive traffic and enhance customer satisfaction. In view of our overall strong gross margins, we believe that in a drastic approach to capturing market share while impacting gross margin slightly in the short term, serves to enhance our long term prospects.

Importantly, these actions have not adversely impacted our EBIDTA margins. Our selling general administrative cost for the quarter on a GAAP basis was $30.4 million as compared to $22.6 million in the second quarter of last year, an increase of $7.8 million.

As a percentage of sales, our SG&A cost in the quarter were 52.3% of sales compared to 49.1% in the second quarter last year. The SG&A cost in 2013, however, include the following items that were not incurred in 2012. First, we have 14 more stores than in the second quarter of 2012 as well as full quarter of cost associated with two additional stores that we opened during the second quarter of last year. As we open new stores, the store related SG&A cost are disproportionally higher as a percentage of sales than on a normalize basis.

In Q2 of 2012, we had only give more stores than in the second quarter of 2011.

Second, public company unusual transaction related cost. In addition to incurring normal public company cost in a quarter we also have our share of unusual nonrecurring cost related to the recent secondary offering, the warrant exercise or redemption process that occurred at the beginning of the quarter. And the 1.9 million share repurchase that was implemented with the cash proceeds from the warrant exercises. And even some cost related to the initial merger transaction that were build in the quarter. The total of these unusual nonrecurring costs was $785,000 in the quarter.

Third, stock base compensation cost of $1.2 million recorded in the second quarter of this year with non-recorded last year.

And fourth, the cost of the 22 new people that we have hired since the completion of the merger as well as other similar costs that had been incurred to support the more rapid growth of the company. We believe we have achieved the necessary starting level to support our growth plans and at future quarters will see a much more normal increase in these areas.

Adjusted EBITDA in the quarter was $15.8 million which represented a 16.6% increase over adjusted EBITDA of $13.6 million reported in Q2 2012. Adjusted EBITDA for the first half of 2013 was $32.2 million or a 17.3% increase over the first half of last year.

Our adjusted EBITDA margin in the Q2 was 27.2% which is approximately 200 basis points down from that same margin of 29.3% achieved in the Q2 2012. Again, this decrease from the prior-year margin levels within the range we expected.

Let me take a minute to discuss two items that will affect our EBITDA margins for the remainder of the year. First, it’s the seasonality of the business. As we have discussed before, the first quarter of the year has traditionally been the home improvement quarter for our business.

And we see higher sales proportionally during the first quarter each year as compared to later quarters of the year. In this regard the third calendar quarter of the year is our seasonally slowest quarter, the second and fourth quarters have been relatively consistent. Over the past two years this seasonality has been met somewhat because of the number of new stores that we have opened throughout the year. However, underlying seasonal buying patterns of our customers remain an affect and the effective these seasonal patterns, is that we get leverage on our SG&A cost in the first quarter of the year which result in a higher EBIDTA margin in that quarter and we see the opposite adverse impact on EBITDA margins in the third quarter of each year.

The second item that is affecting our EBITDA margin percentage relates to our new store opening. As you know, when we open a new store, we incur an average $80,000 of pre-opening cost for that store. In addition, a new store generates lower four wall margins for up to six quarter. To quantify this, the typical new store will generate on average, a 3% four wall margin for the first quarter that is open. The margin will then increase to approximately 25% after six quarters of operation on a reasonably ratable basis.

This EBIDTA drag represents an important investment today that will produce substantial returns for the company in the years ahead. However, when you add a lot of stores in a short period of time, the impact that these new stores will temporarily adversely impact our EBIDTA margins.

In the second quarter along, we had 18 stores that were in pre-opened stage or opened less than one year and another eight stores that were opened within the past 18 months. Nearly one-third of our stores are in pre-opened or ramp up mode. We will add another 13 stores in the second half of 2013.

As we have said before, as the number of newer store increases in relation to the total number of store, the EBIDTA drag will adversely impact our EBIDTA margins. The most significant effect of this will be in the third and fourth quarter of this year, but it will continue to impact the 2014 quarterly results however to a lesser extent.

As a result of these seasonal and growth related dynamics, we would expect our EBIDTA margins to range between 23% and 25% in the third and fourth quarters of this year. The second quarter was a busy one also with respect to equity activities. We started the quarter by calling for the exercise for redemption of the remaining outstanding warrants. We then took the action to address share demand by implementing and completing a secondary offering which moved approximately $4.9 million shares from the former tile shop ownership group to new public shareholders. We completed the trifecta by utilizing $46 million of the cash we received from the exercise of warrants.

The repurchase approximately 1.9 million shares of stock from our major shareholders. As a result of these actions, we have now firmly established our outstanding share base at 50852974 shares.

There are also 295,000 restricted shares issued in outstanding that will vest over the next two years. There are no warrants outstanding. In addition over the past year, we have transitioned our ownership group and substantially increased our public flow. We currently have approximately 50% of outstanding shares in the public flow.

In order to provide a basis for a more normalize historical results, we have included in the press release, a pro forma, non-GAAP net income presentation which adjusts our GAAP quarterly results by eliminating the noncash expense related to the warrant liability, and the unusual transaction and nonrecurring cost in the quarter and also utilizes a more normalize tax rate of approximately 40%.

This non-GAAP pro forma presentation results in a pro forma net income for the quarter of $6.4 million, which translates into a basic and fully diluted earnings per share of $0.13. These amounts were computed using 50.9 million and 51.7 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 as of June 30th, 2013 excluding only the restricted shares outstanding which are not yet vested. The fully diluted share amount to 51.7 million shares includes the diluted effect of outstanding options and the restricted start.

These amounts should represent a stable basis for our basic and fully diluted share counts going forward. With respect to the balance sheet at June 30th, we ended the quarter with approximately $3.8 million of cash and $75 million of debt. Our long-term debt to trailing twelve-month adjusted EBITDA leverage ratio as of June 30 was approximately 1.4 times. At quarter-end we had approximately $23 million of borrowings available under our long-term credit facility.

Cash flow from operations in the second quarter was a use of cash of $3.6 million, as we added substantial amounts of inventory to prepare the new distribution center for operation. Capital expenditures in the quarter were $11.1 million, approximately $7.4 million of that was for new store build out and remodels of existing stores. $3.2 million was for expansion of our distribution facilities and the remainder was for corporate purposes.

Capital expenditures for 2013 are expected to range from $37 million to $40 million which primarily includes store related CapEx and CapEx related to the expansion of our manufacturing and distribution capabilities.

Notably, in the past week, we closed on our tax incentives related to our investments in the Durant distribution center which will result in $3 million of cash for us. We will use this cash to offset the CapEx cost of the new setting and maintenance material manufacturing operations that is currently under construction at the Durant distribution facility.

The cash for the tax incentive program has been offset against our estimate of CapEx for the year that was discussed above. As indicated earlier we are raising our guidance with respect to the number of new stores that will open this year to 20 new stores. Also as previously indicated we expect to exceed the original revenue guidance of $222 million for the year. Our current expectation is that our revenues will be between $227 and $237 million. We continue to be comfortable with the expectation of $60 million of adjusted EBITDA for the year. This includes the effect of three incremental new stores and then $1 million investment for advertizing tests that were discussed earlier.

And with that let’s open the call up for questions.

Questions-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions) Our first question is coming from the line of Mr. Peter Benedict with Robert W. Baird. Your line is now open, you may proceed with your question.

Justin Claveron – Robert W. Baird & Co.

Hey guys this is actually Justin Claveron for Pete thanks for taking the question. Congrats on the quarter.

Robert A. Rucker

Thanks.

Justin Claveron – Robert W. Baird & Co.

Just first of on thinking about the store growth longer term you mentioned I think 25 stores next year that maybe non-fixating on a target going forward, Bob had mentioned some investments that you made to support I think up the 40 stores, I guess the question I have is you guys, you have team in place today, to add 40 stores for you is that going to require additional human capital and infrastructure investments going forward?

Robert A. Rucker

This is Bob Rucker, I would say we’re setup very well for what we’re anticipating next year. I think the infrastructure we have built now which may be very incremental growth of personnel could reach that 40. I don’t think we’re going to need much. I think the bases that we put in now will stretch quite a way.

Justin Claveron – Robert W. Baird & Co.

Okay. And then, obviously the category, I think it’s pretty hot right now, so just maybe on the competitive dynamics in the marketplace, have you guys noticing any other of the specialty players in the space, trying to also ramp their unit growth or you running into them as in real estate discussion etcetera?

Robert A. Rucker

Not really, but competition exists in all of our markets, it just very slight degree from one market to another, but we feel very confident in our model and we feel it allows us to compete head on with a variety of competitors from the big box stores of the local distributors. But, I think that’s our energy going into these markets and in fact when you go into a market you do go as close as you can to the competitors, we try to be across the street that allows us override traffic for us. Yeah. So, I mean that’s kind of been our launch for going forward.

Justin Claveron – Robert W. Baird & Co.

Okay and then Tim just a questions on the gross margin, you mentioned some of the pressure points could you may be just may be help us rank order the magnitude of what’s driving the decline, and then, are you still countable then in that 70% to 72% range or do you think that the gross margins may be slipped a little bit more in the near term as you -- you're really going for market share at this point?

Timothy C. Clayton

Well, I guess Justin, that’s a good question because we are still comfortable in that 70% to 72% range, we may be at the lower end of that range, but to your point and I think what’s really important to focus on is that if you look at our gross margin, reduction year-over-year of 240 basis points, our EBITDA margin only dropped 210 basis points and that includes all the public company and infrastructure cost. So, we are clearly gaining some of that leverage as we go after the share to improve our business and as Bob said 1,000 times in the years that I have been here, we won't lose the deal, but we’re going to do it smartly, I think you see that coming through. We see some discounts, we some shipping promotions, those types of things are working to help us gain share and improve our top line.

Justin Claveron – Robert W. Baird & Co.

Okay, so it sounds like that is probably the bigger driver than the pressure that you may be seeing on the freight or the product acquisition cost?

Robert A. Rucker

Actually that’s fair.

Justin Claveron – Robert W. Baird & Co.

Okay, thanks guys, best of luck.

Robert A. Rucker

Thanks.

Operator

Thank you. Our next question is coming from the line of Seth Sigman with Credit Suisse, your line is now open you may proceed with your question.

Seth Sigman – Credit Suisse

Okay, great. Thanks and congrats on a good quarter. I had a couple of follow up questions on some of the tests that you mentioned, I guess first can you may be elaborate on some of the changes that you are thinking about making on the advertizing front and historically it’s been a low percentage of your sales, how do you think about how that could may be change overtime?

Robert A. Rucker

Well, I just want to clarify, we haven’t done anything yet at that work kind of looking at few market to test our advertizing in, we’re looking at all options like we’ve stated, we are going to test, you know, a lot of different mediums in a few different markets, and measure the results and decide, you know, how we want to move forward in the future.

William E. Watts

We will keep you posted as we see anything by the next quarter for the next two quarters at least, whether there is some traction here or not, we don’t know yet.

Seth Sigman – Credit Suisse

Okay. And I also just wanted to touch on the comment you made about the pro installers. You mentioned that in some of your better stores, it seems like that is a little bit more of an established business, how does that relationship work today with those installers and is there a way to quantify the opportunity from -- growing that part of the business?

Robert A. Rucker

Usually as time goes on we create a larger base of installers just through being in the market, our store managers getting to know the local installers. That is important because that does drive our mainstay homeowner customer in. If we have the support of the contractor that raises -- you know, that raises that clientele. What we are looking at is ways to speed up that process in the new stores. So we are looking at that with some of this advertising to see how we can market to them to pick up the pace rather than just let it happen naturally.

Seth Sigman – Credit Suisse

Okay got it. Thanks and good luck.

William E. Watts

Thanks.

Operator

Thank you. Our next question is coming from the line of Ms. Joan Storms with Wedbush Securities. Your line is now open. You may proceed with your question.

Joan Storms – Wedbush Securities

Hi everybody. Congratulations on a great quarter.

William E. Watts

Thanks Joan.

Joan Storms – Wedbush Securities

Great sales momentum. So I guess heading into the third and the fourth quarter, as we know you have some pressures on adjusted EBITDA, but how are you feeling about, you know, the new stores you are opening and the sales momentum continuing, the comparisons get a little bit tougher, but can you guide us a little bit to comp for Q3 and or Q4 just, or two halves overall?

William E. Watts

Yes, we can’t. We are not giving any guidance on comps. But as Tim mentioned, this is Bill Watts, that we have now increased the range of revenue for the year to $227 million to $237 million. So you will have the back end of the comps. In terms of your first part of your question on the new stores, what has impressed me and continues to impress me now after looking at this for a little over a year is the consistency of these new stores.

It almost doesn’t seem to matter whether they are in existing markets, new markets, they just are performing right on the expectations in either situation. And again, I think that comes back to the strength of the retail concept and the consumer experience once we get them into the stores. And remember, half the business, once you get going is repeat business, so this is part of why we are so enthused about the external marketing test with Pocket Hercules, can we do things to proactively move the dial a little bit quicker.

Joan Storms – Wedbush Securities

Okay, and then just as a follow-up on, I know you guys have commented earlier on the call as well in your comments about that you’re starting to see some benefit from some of the macroeconomic conditions, and you know, some of us that follow you also follow some of the home goods retailers and home furnishings versus some of the remodeling sort of projects. So, in most of the home goods, excuse me, you said that they really haven’t seen any real benefit yet from the economy, so I was wondering if you could tell then to that a little bit more, and obviously and maybe comment too about your -- obviously you are going after more contractors about the whole DIY comment?

William E. Watts

Again, the two macro trends that this company has historically followed are the consumer confidence and housing turnover, not new housing starts, but housing turnover. Housing turnover, assuming we get remodels that is what is behind the business. Both of those trends are continuing, you know, upward. So we cannot directly connect the dot, but the assumption is that those two macro trends are certainly contributing to the acceleration in revenue and comps that you are seeing.

Joan Storms – Wedbush Securities

Okay. Thank you very much.

Operator

Thank you. Our next question is coming from the line of Mr. Daniel Moore with CJS Securities. Your line is now open. You may proceed with your question.

Daniel Moore – CJS Securities

Thank you. I appreciate it. It looks like average ticket was up close to double-digits. It is kind of a follow on question, but how much of that would you attribute to the success of the sales professionals and up selling and how much from those improved macro trends that you just mentioned?

William E. Watts

I’m not sure we can relate it to either one. We could just simply tell you what it is, and you know, as Carl said, Carl why don’t you jump in here?

Carl Randazzo

Well, I think we have always focused on our number one thing in training with any new person up to a veteran player in the stores, you know, get as much as he can on the ticket. You know, it is good for the customer, it is good for the salesperson, it is good for the company. If the customer can go home with everything they need then they went to the right place, and anything that they don’t use, you know, they can bring back. But they usually use most of it.

But no, we really focus on you know, getting as much, getting as many full tickets as possible and if those were the numbers, then we did a pretty good job in doing that.

Daniel Moore – CJS Securities

And secondly based on the guidance for ’13 and assuming you hit 25 new stores next year in ’14, should we think about some recovery in EBITDA margin next year, or should we expect margins to remain sort of down in that 23% to 25% range with the new store opening costs maybe some additional advertising et cetera.

William E. Watts

You know, Dan, what I would tell is that -- we talked about that, you know, 23% to 25% range really relating to the Q3 and Q4 numbers here. You know, going forward we are going to have some impact to the new store, this EBITDA drag that I talked about in Q1 and Q2 next year as well, but not nearly to the same extent. You know, we will have some margin compression next year from these types of things. We have talked about that from the beginning that that was one of the factors that was going to affect our EBITDA margins by 200 to 300 basis points. So yes, you will still see some of it going into ’14, but as we have said before towards the end of ’14, in the last part of that year we do expect to see some leverage being obtained over all these different items as we continue to grow.

Daniel Moore – CJS Securities

That is helpful and lastly just to clarify the spending for advertising is it 1 million a quarter in the back half of the year, or 1 million overall for Q3 and Q4?

William E. Watts

It is just 1 million in the aggregate.

Daniel Moore – CJS Securities

Okay, thank you.

Operator

Thank you. Our next question is coming from the line of Mr. John Baugh with Stifel Nicolaus. Your line is now open. You may proceed with your question.

John Baugh – Stifel Nicolaus

Thank you and good afternoon. I was wondering, as it gets bigger, you mentioned product procurement costs were up slightly, is that currency, is that mix, I was thinking you might get a little leverage on that as you get larger with your primary vendors?

William E. Watts

We can -- you know, I would -- there is not a lot of currency issues in that from that standpoint. You know, we are pretty large with our vendors as it is. I’m not quite sure how much, we never really communicated the expectation that we’re going to have some margin expansion because of our incremental purchasing power.

Timothy C. Clayton

Incrementally you have some cost raises in freight, it ebbs and flows, you have some currency changes like right now, I stated that the dollar has actually gotten stronger in a couple of countries, you know, over the last few years as the dollar has gotten weaker in China, but that has stabilized.

All in all, it has been pretty quiet the last quarter, and going into the future now looking at cost, we -- I would say we are able to keep up with any cost increases by incrementally also increasing sale prices. So, we are in pretty good shape there. I don’t see anything dramatic.

John Baugh – Stifel Nicolaus

And the reference I think within gross margin, again, the higher distribution cost, if that’s only a function of the additional DC or is there something else going on?

Carl Randazzo

Oh, I think it’s really just incremental people moving more products around as part of it. The new DC hasn’t really come online yet. That will come online here in the third quarter.

John Baugh – Stifel Nicolaus

Okay. And then, finally, could you just give us a feel for the stores next year of the mix of new versus the existing? Thank you.

Carl Randazzo

New markets compared to existing markets…

John Baugh – Stifel Nicolaus

Correct.

Carl Randazzo

But I can give you – I mean, we’re going to continue to look in Texas, continue to expand in Colorado, I guess…

Timothy C. Clayton

It’s been running close to 50:50 probably no reason to assume anything different.

Robert A. Rucker

Right.

John Baugh – Stifel Nicolaus

Right. Thank you.

Operator

Thank you. Our next question is coming from the line of Joe Feldman with Telsey Advisory Group. Your line is now open. You may proceed with your question. Oh, pardon me, one second. Our next question is from Anthony Lebiedzinski with Sidoti & Company. Your line is now open.

Anthony Lebiedzinski – Sidoti & Company

Good afternoon, a couple of questions. First, on the higher traffic, are you able to convert more people into buyers? I just wanted to get a little bit more detail as to what’s driving the traffic, is it just the macro factors or is it anything else that you’re doing?

Timothy C. Clayton

Yeah, it’s more – again, we don’t know exactly, so we assume it’s the macro factors and the numbers that Carl was quoting isn’t traffic into the store, it’s transactions. It’s the number of transactions. We don’t know into the store versus converting.

Anthony Lebiedzinski – Sidoti & Company

Okay, got it. Okay. And a couple of questions in regards to just new stores. For 2014, should we assume that new stores will open at a similar pace as to what you’ve opened as far as your 2013 store openings?

Carl Randazzo

Yeah, pretty evenly. Yeah.

Timothy C. Clayton

Yeah, we’ve roughly – again, I think – I think from what Carl has told us, we are in very good shape to finish this year. He already talked about that and the – his – the amount of locations and leases in the pipeline also looks very good. So, it looks like – you could assume rapidly the right way to go.

Carl Randazzo

Yeah.

Anthony Lebiedzinski – Sidoti & Company

Okay, and also just looking at the second quarter, I was wondering if there was anything unusual with the timing of the new store openings. As I look at the delta between total sales and same-store sales between first and second quarters, it looks like there was a little bit of a slowdown in terms of just that difference between, again, total sales and comp sales, even though you did accelerate your store growth.

Timothy C. Clayton

Well, we’re accelerating the number of stores, as we talked about, from 17 to 20, but in the first half of the year, you also recall that we opened 15 stores last year, and so that took some of the timing. In the quarter, the stores opened more towards the second half of the quarter than, kind of, 00:00:10 over the quarter. So, that would have had an impact and that was the same issue in the first quarter. So, both of those probably would have had an impact on how you might model out the new store revenue component of our sales.

Anthony Lebiedzinski – Sidoti & Company

Got it, okay. And so for this quarter, you’ve already opened to in July?

Timothy C. Clayton

Right.

Carl Randazzo

And then there’s four more under construction that will open within the quarter for sure.

Anthony Lebiedzinski – Sidoti & Company

All right. Thank you.

Operator

Thank you. Our next question is now coming from Joe Feldman with Telsey Advisory Group. Sir, your line is open, you may proceed with your question.

Joe Feldman – Telsey Advisory Group

Yeah, hi guys. Good afternoon. So, a question about – you guys mentioned that you put two new people on the ground in, I think, India and Mexico to help source stone and I guess I was wondering if that’s – you know, is that a signal of you need more stone effectively, I mean, to support the stores or you’re concerned about your current infrastructure from a supply network, or is it – I guess, how should we think about that?

Robert A. Rucker

No, this Bob Rucker, it’s basically business as usual. We are constantly looking to find new supply. We’ve actually been in India for years, but we’re digging in deeper and we feel we can use a person there to dig. Mexico, we pulled away from it several years ago because of transportation problems, but the supply there is very good and we want to get back into it. So, we have a Spanish speaker, Mexican national on the ground there digging for us, but it’s really business as usual. Just like we’ve been, over the last years, moving away from our concentration on China and moving into Vietnam, moving into Indonesia, diversifying.

Joe Feldman – Telsey Advisory Group

Right, makes sense. Okay, and there’s some quality stone in those places, so that makes sense. I guess on the sort of the accelerated store growth, I know it’s not a huge number to go from 17 to 20, but for you guys it added a small base, it kind of is. I’m just wondering why accelerate the stores to bring in earlier? I get it that they are terrific stores, but you guys can kind of have a nice steady controlled growth and I’m just curious as to why you’d want to speed it up a little bit?

William E. Watts

It’s really confounded – it’s two things. They’re working, and they’re consistently working and we now are really comfortable with the infrastructure that Bob outlined. It’s in place to make it happen, so the question becomes why not?

Joe Feldman – Telsey Advisory Group

Got you. Another question I had was, you guys talked a little bit about gaining share which is terrific and I have no doubt you guys are doing, I guess I was just curious how you’re measuring that? Are you guys looking at a particular data source and I guess how it’s just being benchmarked, just so we can kind of maybe on the self-side, start tracking that as well.

Robert A. Rucker

Yeah. There isn’t definitive data so here’s where we are. We know we’re gaining share because with our revenue up 25% we know the industry is not growing anywhere near that level i.e. we’re gaining share. But until we get there at the end of the year, I can’t give you much better than that but we know the industry is not growing 25%.

Joe Feldman – Telsey Advisory Group

Got you, and then the last thing I want to ask you guys is, and I agree with you, I am sure you guys are gaining share but the last question was on the marketing. You guys said you’ve three different kinds of tests and I was wondering if there was any more color you’d be willing to share at this time, what those might be? I mean it’s like one like a loyalty program and one is just more of straight up advertising or what are the differences maybe?

William E. Watts

In that, like I said earlier, the different mediums we’re looking at is across the board. We are going to test the bunch, see which ones work and put into place which ones give us the best results.

Timothy C. Clayton

Yeah, it’s still a work-in-process. So this all kicks off on Labor Day so we’re not sitting here looking at any results at this point. All we know is we’re going to do it and we thought it through until like you know as investors that were…you are going to see some different things in several markets.

Joe Feldman – Telsey Advisory Group

Got you. Thanks guys. Good luck with this quarter.

William E. Watts

Thanks Joe.

Operator

Thank you. Ladies and gentleman, our final question of the session will be coming from Daniel Moore with CJS Securities. Sir, your line is open. You may proceed with your question.

Daniel Moore – CJS Securities

Thank you again. What shall we think about beyond around Oklahoma? Are we two years away from thinking about adding that next distribution facility or too early to contemplate at this point?

Robert A. Rucker

We are looking right now again, this is Bob Rucker. My goal is to reach across the country and I see that eminently possible. We are looking for sites right now to cover that West Coast. Right now we’re looking in some specific areas and if we find the ideal site we’ll act on to it and develop it, but we want to be able to reach that entire West Coast.

Daniel Moore – CJS Securities

And would you need to get to a certain level of critical mass in Durant before you would go ahead and begin construction there?

Robert A. Rucker

I would say this, we’re looking now in the type of sites that we’re looking for, if we can find a cost effective one, I think it would be prudent for us to take and then decide when to actually kick it in gear. Right now, as I said, Durant will be at 18 by the end of the year and that’s all prime to find new stores and 14 in fact, we’ve got quite a few of those in the hopper so to speak that we’re dealing on, so I would say, I think we have great potential to raise our number of stores service.

It gives us a lot more fruit to pick out there, Durant does and the west coast from Washington, Oregon all the way down San Diego is just great territory.

Daniel Moore – CJS Securities

I appreciate it.

Operator

Thank you. Ladies and gentlemen that does conclude our question-and-answer session, I would now like to turn the floor back over to Mr. Rucker for any closing comments.

Robert A. Rucker

Thank you for joining our call today, we’re proud of our progress and look forward to updating you on our next call, have a good evening.

Operator

Ladies and gentlemen, this concludes today’s teleconference, you may disconnect your lines at this time, thank you very much for your participation.

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