In a bit of a surprise Tuesday morning, Tile Shop Holdings (TTSH -1.61%) announced that co-founder and CEO Robert Rucker will retire at the end of the year, and COO Chris Homeister will be taking over as CEO in January. This, coupled with a mixed earnings release, caused the stock to trade with considerable volatility as investors digested the news.
Let's take a closer look at the earnings release, and the management transition, and see what we can learn. Is this good news or bad news?
Gorilla in the room
One of the -- at least for me -- reasons to invest in Tile Shop Holdings, was that it was a founder-led company. Bob Rucker co-founded the company some 30 years ago, and has led it from just a handful of stores, all the way to the current 105 stores open today. The thing is, it's still incredibly early in the expansion process, not to mention the worst housing market since the economic crisis, so a CEO transition right now seems quite scary.
Furthermore, Rucker's personal wealth is still highly tied to Tile Shop, while Homeister only holds 50,000 shares, though he will receive options for up to 150,000 more shares that would vest over five years. Considering that Homeister has only been with the company for about a year, this is a big change in leadership, and will undoubtedly lead to further changes in the company's internal culture.
However, that's not necessarily a bad thing. The company has known its share of scandal under Rucker, especially over the past year. A former employee -- who was also Rucker's former brother-in-law -- apparently had an undisclosed financial interest in an Asian Tile Shop supplier. The fact that this was partly uncovered in a report published by an anonymous short seller who was also calling foul on a lot of other things that were egregious and untrue didn't help the company's reputation. Homeister, 45, has worked for Best Buy, Gateway, and Amoco oil company. While he doesn't seem to have spent any significant amount of time at any one place, this is his first CEO gig, and his insight and experience with larger companies could be what Tile Shop needs to move beyond its small-time roots.
Back to the business: Comp growth remains muted
Same store sales, or comps, increased 0.6% in the quarter, a bare improvement from last quarter. Management gave guidance for the fourth quarter of comps between 1% up or down, as existing home sales remain poor. Furthermore, the fourth quarter is historically a slow period for the company. The reality is, until the housing market rebounds, Tile Shop stores, just like those of peer Lumber Liquidators, are unlikely to see a rebound in traffic and sales.
Expansion slowed a little, but still aggressive
The company also reported that it would open 19 total stores in 2014, which is one less than it was targeting last quarter. Since it is using cash from operations, and not debt, to finance the new stores, this is a reasonable move and not something that investors should be concerned about. Over the past 12 months, the company has added nearly 30% more stores, so moderating the pace of expansion based on the current market environment is a responsible step.
In the earnings release, the newly appointed CEO said that the focus under his leadership will be growth, as it should be. The question that won't be answered until next year, is what -- if anything -- will change about the company's growth strategy.
Cash, debt, and funding the growth
If there's any one thing that's a clear positive about Homeister's appointment as CEO, is that his tenure with the company as Chief Operations Officer is a critical role during this period of growth. He may have only been with the company for a year, but he's been key to the company doing a better job with its inventory, which was down $4.7 million from the beginning of the year. This is up from the second quarter, but still far down, considering that the store count is up 20% this year, seeing inventory that many considered bloated fall almost 7% is good capital management.
Furthermore, the company's estimated $95 million debt level has remained pretty flat, and until the housing market rebounds, it's probably good that the company isn't tapping debt to fund accelerated store growth. This is best reflected in the SG&A expense, which is up about 30% versus the year-ago period, and largely -- as I wrote about in the pre-earnings article -- a product of the expanded store count. Retail stores are expensive to open and operate, and because Tile Shop's percentage rate of store growth is still so high, SG&A expense as a percentage of sales is probably going to remain relatively high.
Most importantly, the company remains profitable, though not by a whole lot. Management guidance for net income for the year is $0.23-$0.25 earnings per share, or about $11.5 million-$12.5 million.
Looking ahead
I think it's fair to say that Bob Rucker's retirement probably changes the game a little bit, especially if -- like me -- your thesis was tied to the founder-led business. However, he will remain on the board, and his personal wealth is still tied in a large way to the company. Additionally, he was probably quite involved in the decision to bring Homeister on board, and promote him to CEO. Chances are, since he's only been with the company a short time, this very well could have been part of a longer-term plan. But that's just speculation.
While I'm not making any changes -- neither buying or selling -- I'm shortening the leash, so to speak. Most likely, the company is going to be in good hands, and it's just a matter of a steady hand on the rudder while the housing market corrects, but if there are any major changes in strategy or how the company is financing growth, it might be worth moving on. For now it remains a solid business that happens to operate in a terrible housing environment. Eventually, that will change.
