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Tile Shop Holdings, Inc. (NASDAQ:TTS)

Q3 2013 Earnings Conference Call

October 30, 2013 5:00 PM ET

Executives

Brad Cohen – Investor Relations

William E. Watts – Chairman

Carl Randazzo – Senior Vice President - Retail

Robert A. Rucker – Chief Executive Officer and President

Timothy C. Clayton – Chief Financial Officer and Senior Vice President

Analysts

Peter J. Keith – Piper Jaffray, Inc.

Justin Kleber – Robert W. Baird & Co.

Seth I. Sigman – Credit Suisse Securities LLC

Daniel Moore – CJS Securities, Inc.

John Baugh – Stifel Nicolaus

Anthony Lebiedzinski – Sidoti & Co. LLC

Operator

Greetings and welcome to The Tile Shop’s 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.

Brad Cohen

Thank you, operator. Good afternoon, everyone. Thank you for joining us today for Tile Shop’s third 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.

Such words add but not limited to, plan, expect, anticipate, believe, goal, estimate, potential, may, will, might, could, target and any other similar words identify forward-looking statements made today.

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 and 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 undertake 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 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 through 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, this is Bill Watts, the Company’s Chairman. I’m 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 adding 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 our 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 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 matured store base.

Let me comment on both. First new stores, due to 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. 20 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 growth population.

Obviously in the new markets, the Company has no brand awareness. All stores are open 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 40% IRR per year over the life of the lease and I’ll remind you that we’re defining that is 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 the statement. To further validate the power of our brand in retail concept in the third quarter, the matured stores and I’m defining that as stores four years or older also comp double-digits.

Given that the entire chain produced to 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.

Carl Randazzo

Thank you, Bill. It is quite exciting for a team to produce another quarter of comp store sales growth as strong with sales at same store is 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 are best with our demographics. While we know new markets we’ll 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 of the initial results are favorable. And with that update, I would like to turn the call over to Bob Rucker, our CEO.

Robert A. Rucker

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 become the leading national tile and stone retailer coast to coast.

We also recognized 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 cost in the quarter but the long term benefits will far outweigh these initial expenses, we also were on time and on budget in getting the center up and running, [indiscernible] will initially serve us 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 a necessary 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 far the company is actually the sales of the matured stores and the growth of new markets over time, our store sales actually grow well into the fourth year of operation and beyond, so what is critical to have the right technology, sales support, merchandizing, 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 Buy leading an effort that through to $6 billion in annual sales and his new role Chris will receive supply chain, retail operations and merchandizing while he has only been here few weeks, he has already spent the 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 part of their strength and operations in Chris’s broad array of skills and extensive experience in successes in leading and growing multibillion dollar organizations at prominent retailers coupled with this comprehensive experience and product development, retail, direct sourcing and business development will translate well at our company. While Chris is here with us today, he will have a 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 two to four weeks with each new store staff as the stores opened.

This has led to better productivity in the new stores and again gives us confidence that we can support the plan growth. Also we continue to invest in our online business and while it is not yet a large component of total sales that 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. So 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 among some 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 uses any of these elements into the tile as the 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, our fabrication of the products that we purchased, we have also tested a number of these products ourselves, in addition we have engaged URS was the worldwide provider of Engineering, Construction and Technical Services and the 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 longstanding conclusions that the products we sell pose no health or safety risk, we are committed to providing our customers with the highest quality of 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 the call over to Tim, our CFO.

Timothy C. Clayton

Thanks Bob. We’re 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 the sales of the 18 new stores that have 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 represent 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 months 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 and 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 cost 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 includes 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 opened new stores, the store related SG&A cost 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 cost as compared to the third quarter of last year. Third, stock based compensation cost 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, pre-opening cost in the quarter were $560,000 as compared to $75,000 in the third quarter of last year. And finally, we incurred incremental startup in 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 of 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 basis points 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 in fact will be greater in some quarters than others – than others depending upon the number of new stores opened in any given quarter and depending on the quarter in which we opened 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 this, the typical new store will generate on average a very small four-wall margin for the first quarter that is open, the margin will then increase to approximately 20% in the fourth full quarter into approximately 25% after six quarters of operations. Obviously, when you had 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 opened 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 produce results that are below the historical EBITDA four-wall margin levels of matured 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 suggest our GAAP quarterly results by eliminating non-cash expenses related to warrant reliability unusual and non-recurring 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 shares 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 you have not yet vested. The fully diluted share count of 51.9 million shares includes a 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 months adjusted EBITDA leverage ratio as of September 30 was approximately 1.6 times. At quarter end, we had approximately $118 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 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 then our full year revenues will be in the range of $227 million to $237 million 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 20% in the second year, 8% to 10% in the third year and 6% to 8% in the fourth year and then reverting to our norm for material store sales of 3% to 5%.

Based on updated averages, which focus on more recent data and now includes the 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 as previously discussed.

We now find that on average, our new stores grow at 22% to 23% rate in the second year, 12% to 14% in the third year and 7% and 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

Thank you. We will now be conducting a question-and-answer session (Operator Instructions)

Robert A. Rucker

Hi, operator, while you are polling for questions, if you don’t mind, let me clarify and expand a couple of comments that I made with respect to capital expenditures in the quarter and for the year and then add a couple of 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 is 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 and 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 previously 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 a 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 [ph] store buildings. 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 Durant both distribution and manufacturing facility.

If you were to split our CapEx spent 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 discussed as cash outlay of $1.4 million is net of cash received per tenant allowances which average about a $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 is presented in our cash flow statement will be about $1.5 million per store. Finally let me just make a couple of 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 are 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.

Question-and-Answer Session

Operator

Thank you. The first question comes from Peter Keith of Piper Jaffray. Please go ahead.

Peter J. Keith – Piper Jaffray, Inc.

Hi, thank you 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 I just want to get some clarity on the drivers behind that we called out the selective price promotions that you’re running is that primarily related to the new market entries which seem to represent the majority of your store growth at this time and in other words could we expect that the gross margin pressure to ease as the number of new market entries sort of settled out over the next couple of years?

Timothy C. Clayton

Hey, Peter thanks the promotions that we run are probably weighted to the new market stores that 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 of this only related to the new market stores.

Peter J. Keith – Piper Jaffray, Inc.

Okay, and what are the types of promotion that you’re running so we can just get a little bit better sense of that?

Robert A. Rucker

Well in the third quarter we ran the Labor Day and 4th of July promotions which was now mainly to push some of our slower movers get some people in the store when other people are out buying and seem to workout pretty good.

Peter J. Keith – Piper Jaffray, Inc.

Okay, just moving on to the advertising test understanding it certainly sounds like it’s going well thus far, did you’re at time next year that we can think about as sort of your go forward when you might does not if you’re going to expand the advertising across the broader chain and look what type here might that be?

Robert A. Rucker

Eric, right now we’re testing television advertising in a few select markets to replicate a national advertising budget and as you’ve said at the initial feedback is very positive once we get all the feedback and numbers in all presented to our board and they will make the decision when will go forward in the future with it.

Peter J. Keith – Piper Jaffray, Inc.

I guess given just a follow-on that is there do you have a kind of at some time period certainly in the calendar when you would be presenting to the board to provide your thoughts?

Timothy C. Clayton

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

Peter J. Keith – Piper Jaffray, Inc.

Okay, fair enough one last question for you Tim, I appreciate the details on the new store maturity model that is helpful, we are incorporating this into our model 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 half?

Timothy C. Clayton

Well it’s frankly based upon our historical performance more recent over the last three years 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’ve opened over the past 12 months or so…

Peter J. Keith – Piper Jaffray, Inc.

Okay all right, that’s great. I appreciate your feedback, good luck for this coming quarter.

Timothy C. Clayton

Thanks Peter.

Operator

Thank you. The next question is from Justin Kleber of Robert Baird. Please go ahead.

Justin Kleber – Robert W. Baird & Co.

Hey, guys thanks for taking the question. First just on revenues maintaining the revenue plan for the full year, it seems to imply pretty wide range here in the fourth quarter, I mean I’m 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 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?

Timothy C. Clayton

Well, Justin, I think we’re being conservative in with respect of that and with respect to the fact that our policy has not really been to provide quarterly guidance. And so therefore that’s why we kind of maintain that annual range that we got there that we’ve said 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’re still comfortable with that range. And based upon our results for the nine months, you can kind of get a sense for where that might fall.

Justin Kleber – Robert W. Baird & Co.

Okay, thanks. And 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 it’s the experience been year-to-date. I guess just understanding what’s driving the delta I mean 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 cost into the model?

Timothy C. Clayton

Justin it’s probably it’s a little bit of power that typically the fourth quarter is a better quarter for us from a seasonal standpoint anyway. Third quarter, we really tend to deleverage just given on the base SG&A that we have in the company. We get better leverage, much better leverage in Q1, deleverging on the base G&A in Q3 and so it picks up from in between Q3 and Q4. We also have more of the stores that we’re opened earlier in the year and late last year on maturing, which we’ll tend to help kind of drive some of that EBITDA improvement and then obviously they were doing some other things internally that we think will help contribute EBITDA dollars at the bottom line as well.

Justin Kleber – Robert W. Baird & Co.

Okay, thanks. And then just last one here, just a point of clarification. Did you guys say traffic was up 55% or was that tick in?

Timothy C. Clayton

That was traffic.

Justin Kleber – Robert W. Baird & Co.

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

Timothy C. Clayton

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’s a slight change if you will I wouldn’t necessarily indicate that much of a meaningful change and I think it may relate more to the quarter, the seasonality of the quarter than anything else.

Justin Kleber – Robert W. Baird & Co.

All right, thanks Tim. Best of luck guys.

Timothy C. Clayton

Thank you.

Operator

Thank you. The next question is from Seth Sigman of Credit Suisse. Please go ahead.

Seth I. Sigman – Credit Suisse Securities LLC

Okay, thank you. Maybe just a first 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?

Timothy C. Clayton

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

Seth I. Sigman – Credit Suisse Securities LLC

Okay. And just to kind of ask Peter’s question in different way I mean 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?

Timothy C. Clayton

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

Seth I. Sigman – Credit Suisse Securities LLC

Okay. And maybe just any comments in general on consumer spending behavior or any notable trends in bigger ticket products or Do-It-for-Me, maybe picking up, any color there would be helpful? Thanks.

Robert A. Rucker

Nothing that we can point to that would indicate any significant changes and patterns of behavior, spending levels, nothing to really…

Carl Randazzo

Has driven any of that?

Robert A. Rucker

Nothing really significantly changing on otherwise from what we’ve seen.

Seth I. Sigman – Credit Suisse Securities LLC

Okay, thanks.

Operator

Thank you. The next question is from Daniel Moore of CJS Securities. Please go ahead.

Daniel Moore – CJS Securities, Inc.

Good afternoon, thanks for taking the questions. Wondering as you opened up some of the newer markets in Dallas and Denver and move into new regions of the country, are you seeing any meaningful differentiation in consumer tastes? In other words do you needing to stock different types of products for different new areas or is it pretty much status quo?

Carl Randazzo

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 looked it very good, I mean they like what we offer in the stores, there is nothing in Dallas you would think it facing the like of 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. We have quite a number of different types of definitely natural stone and ceramic tile and I think it tend to caters, cater to everybody’s design taste.

Robert A. Rucker

In some of the markets, this is Bob and some of the markets like Texas, we are adding items that we feel that they haven’t done a good job with, we’ve added significant wall tiles, ceramic wall tiles in that area for instance and we feel we can capitalize on that, but I think the taste generally do run similar and in a large part, because of the way we market, we can be in charge of that taste.

Daniel Moore – CJS Securities, Inc.

Very good and I appreciate the commentary regarding products quality and safety. I think you mentioned the gauge you were after just I wasn’t familiar with them, did I hear that correctly, who actually is at organization?

Robert A. Rucker

Yes, we did. We engage 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 the environmental service activities and yes, there are very substantial firm. I haven’t heard of neither, but they do quite a bit of this type of work.

Daniel Moore – CJS Securities, Inc.

We will find that, any quantifiable incremental expense in Q4 and beyond with regard to that?

Robert A. Rucker

Nothing that I would consider to be significant Dan.

Daniel Moore – CJS Securities, Inc.

Okay. And then lastly, are there any I guess the returns that you’ve 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?

Robert A. Rucker

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’s always had, which supports the conclusion of the products are safe and healthy.

Daniel Moore – CJS Securities, Inc.

Very good, I appreciate it.

Operator

(Operator Instructions) The next is from John Baugh of Stifel. Please go ahead.

John Baugh – Stifel Nicolaus

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

Robert A. Rucker

Yeah. We spend the summer basically filling out the Durant facility with inventory to be able to support all the stores that we’re going to be shipping to from that facility, so that step function if you will in terms of 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 principal part of your question, John.

John Baugh – Stifel Nicolaus

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

Carl Randazzo

Well, the group of manager that we have in our bench are very good and I feel very confident putting any of them in there to a run store. However, opening up a new store and doing it everything that it takes to get the store ready for customers walking in the door, it’s a lot. And I think getting these guys in there with experience that have done it before just to back them up and guiding in the right direction.

If they shop there in the first two weeks, it helps them to show up the second two weeks of stores open. They are just 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 merchandizing the store, kind of everything that a store manager does and I think it’s a great program. We hear great things about in and our new managers tend to gain momentum professionally faster than in the past I think.

John Baugh – Stifel Nicolaus

So Carl just to be clear, you’re taking an existing store manager out of the store and clear on that?

Carl Randazzo

No, they were the position is we call it sales support, manager support they where store mangers at one point in the carrier at the Tile Shop. And then they probably for some reasons step 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 not so much – they are not running a store. They’re coaching somebody to run a store. And it’s a little bit different in running a store and they’re actually doing very well doing that.

John Baugh – Stifel Nicolaus

So you have a few people handful of people that are full time job is to go to newly open stores, that’s the primary role, is that correct?

Carl Randazzo

New stores and sometimes even existing stores if we have to put a new manager in existing stores, so it’s not necessarily for new stores they go to existing stores as well but they for some reason they really didn’t want to be a store manager, something didn’t worked 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 through these new managers.

John Baugh – Stifel Nicolaus

Great, thank you for that color.

Operator

Thank you. We have time for one final question, it comes from the line of Anthony Lebiedzinski of Sidoti & Company. Please go ahead.

Anthony Lebiedzinski – Sidoti & Co. LLC

Yes good afternoon. First question is just in regards to your new store productivity. Some of the newer stores have been opening in the Northeast which are generally higher population, higher income capital markets. So are you just not seeing the sales from these two stores quite up to your productivity because of just like the brand equity or maybe you can just reconcile that?

Robert A. Rucker

Sure. I’d 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’ve 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, our new store in existing market. The differential may come frankly from some of the best of the array of the other markets that we’re 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.

Anthony Lebiedzinski – Sidoti & Co. LLC

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

Robert A. Rucker

Yes.

Anthony Lebiedzinski – Sidoti & Co. LLC

Okay.

Robert A. Rucker

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

Anthony Lebiedzinski – Sidoti & Co. LLC

Okay, and turning to SG&A expenses and obviously understand the build-up as a new public company and it’s speeding 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.

Robert A. Rucker

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, additional people costs that we’ve added during 2013.

That we will leverage that as we enter 2014. What will be the continuing kind of 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 that the SG&A costs associated with the new stores as they open up and ramp up is a higher percentage of what seems to be anticipated. That 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.

Anthony Lebiedzinski – Sidoti & Co. LLC

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

Robert A. Rucker

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

Anthony Lebiedzinski – Sidoti & Co. LLC

Okay. And couple of final questions, so you did mentioned as for as part of the higher CapEx for 2014, some of the stores for 2014 are going to be within this years CapEx. Any sort of ballpark estimates for next years CapEx budget?

Robert A. Rucker

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

Anthony Lebiedzinski – Sidoti & Co. LLC

Okay. And lastly can you just repeat how much that you less than your revolving – as far as your available capacity on your revolver?

Robert A. Rucker

Sure, at the end of September it’s about $80 million.

Anthony Lebiedzinski – Sidoti & Co. LLC

Okay, thank you.

Robert A. Rucker

Yep.

Operator

Thank you. That is all the time we have for questions today. I’d like to turn the floor back over to management for any additional remarks.

Robert A. Rucker

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

Operator

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

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