Adam Hauser - Director of Investor Relations Chris Homeister - President and Chief Executive Officer Kirk Geadelmann - Chief Financial Officer.

Peter Keith - Piper Jaffray Daniel Moore - CJS Securities John Baugh - Stifel Nicolaus Peter Benedict - Robert W. Baird & Company, Inc..

Good day, ladies and gentlemen, and welcome to the Tile Shop Holdings, Inc. Q3 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. [Operator Instructions] I would now like to turn the conference call to Mr.

Adam Hauser, Director of Investor Relations. You may begin..

Thank you, operator. Good morning to everyone on the call and welcome to the Tile Shop’s third quarter earnings call. Following our prepared remarks, the call will be open for analysts’ questions. Questions will be limited to analysts, and we would appreciate if participants would limit themselves to one question with one follow-up.

As a reminder, 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, but not limited to, plan, expect, anticipate, believe, estimate, target, and any other similar words to identify forward-looking statements may be made. Such forward-looking statements are subject to both known and unknown risks and uncertainties that could cause actual results to differ materially from such statements.

Those risks and uncertainties are described in the earnings press release issued today, and in the Tile Shop’s 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.

Today’s presentations may also include certain non-GAAP measurements. Please see the company’s earnings release for a reconciliation of those non-GAAP financial measures, also available on the Investor Relations section of our website at investors.tileshop.com. With that, let me now turn the call over to our Chief Executive Officer, Mr.

Chris Homeister..

Thanks, Adam. Good morning, everyone, and thank you for joining us today. I’m here with Kirk Geadelmann, our CFO, and we appreciate you joining us this morning as we report our results from the third quarter.

We’re very pleased about the results our stores and business teams drove in the third quarter, results that continue to signal strong progress on our key initiatives. We have now completed several quarters during which we have continued to refine and build upon the same set of fundamental initiatives and our results continued to improve each quarter.

We’re proud of these results as these efforts have been broad and significant. At the same time, we’re continuing to refine these actions and we know we still have opportunity to further improve the strength of our business.

We continue to gain new and [actionable] insights as we execute our initiatives and these learnings will serve us well as we enter into the fourth quarter of 2015 and beyond. Turning our attention to the third quarter, we were able to over-deliver on many key metrics. Sales for the quarter were $72.4 million.

$72.4 million of revenue represent a growth of 15.3% versus last year, including comparable store sales growth of 9.7%.

Strong comparable store sales growth occurred throughout the entire quarter and our efforts to improve sales at our stores that were opened in 2013 and 2014 continued to lead the strong results for these stores which Kirk will explain in greater detail shortly.

Additionally, our comps were strengthened by the strongest quarter of growth since 2013 from our more mature stores. Importantly, our top line strength was coupled with a 70% gross margin rate in the quarter.

Our adjusted earnings per share in the quarter was $0.08, adjusted EBITDA grew 40% and adjusted EBITDA margin was 19.3% during the quarter, an improvement from the prior year of 340 basis points. Now, let me walk you through some of the specific highlights of Q3 in relation to our key initiatives.

I’ll begin by discussing our progress on retail talent identification and training. We added five additional market managers during the third quarter and we now have approximately three-fourths of the store base being led by market managers.

Stores under their leadership again exceeded sales expectations during the quarter and also played a strong role in continued turnover reductions. The recent additions had been in the less mature markets and we’re excited to see the continued impact these leaders will have on the performance in these markets.

Employee turnover continue to decline for store managers, system manages and sales associates. From prior year levels, turnover rates were down significantly across all three of these groups in the third quarter. During 2015, we feel reduced turnover has played a significant role in our success and we look forward to continued progress on this front.

Every store manager tenure continues to be at a level not experienced since 2012. Manager tenure continues to be an important driver in successfully deploying our in-store strategies.

Our bench of manager candidates continues to strengthen as a result of our ongoing training and development efforts, which is critical as we plan to open three to four stores in the fourth quarter and increase our store openings in 2016. Our next key initiative is expanding our focus on the professional customer.

During the quarter, we continued to execute on various efforts to build our pro business, including direct marketing, employee training, additional new product offerings, improved in-store merchandising and store hosted events.

In the third quarter, our pro sales growth again outpaced the balance of our business by a meaningful factor, ultimately leading to an increase in our 12 pro sales mix of over 300 basis points from Q3 of last year. The mix increase continues to be driven by less mature markets where our emphasis on building the pro business has been most focused.

The opportunity for greater penetration with this customer segment is still very significant as we move forward. Finally, we continue to be very pleased with the progress of improving our marketing effectiveness.

In the third quarter, we again invested advertising dollars towards some of our 2013 and 2014 new store markets as we continue to build increased awareness and traffic. Consistent with prior quarters, we were highly encouraged by the sales results in these markets and we will continue to invest in a wide array of local media in our newest markets.

In addition to the details related to our key initiatives, there were several other accomplishments in the third quarter that I’d like to highlight. Our gross margin rate was 70%, which was the first time we have achieved this rate since the third quarter of 2013.

Gross margin rate was a significant improvement from both Q2 and the third quarter of last year. Free cash flow was over $8 million in the quarter, bringing our year-to-date free cash flow to nearly $40 million. We paid down approximately $6 million of long-term debt during the quarter, bringing our debt reduction of 2015 to nearly $30 million.

Our quarter-ending inventory decreased 1% versus the third quarter of 2014, despite [50%] sales growth and 7% store unit growth. Our adjusted EBITDA margin percentage increased significantly, 340 basis points better from the prior year. As discussed previously, we continue to believe we can deliver many years of adjusted EBITDA margin expansion.

Finally, as indicated in our press release this morning, we increased our guidance range for sales and improved the range for both adjusted EBITDA and EPS. During the third quarter, we opened one new store in the Dallas, Texas market and still expect to open a total of seven to eight stores this year.

As we look towards 2016 and beyond, we continue to feel that 8% to 12% annual store unit growth is a solid expectation for the foreseeable future, with openings focused largely in existing markets and major new market expansion expected in 2016.

From a product category perspective, we are very pleased with the performance of the new SKUs we’ve added to the assortment this year, including a variety of SKUs allowing [to compete at all price rates] within a product family allowing us to attract customers in the market place at a wide array of price points.

We will continue to augment our assortment with additional colors and geometric patterns that fit the latest design and building trends. We are very enthusiastic about the results of our third quarter and the first nine months of 2015.

We continue to diligently work on making additional progress in the quarters ahead on our journey to becoming the nation’s leading specialty tile retailer. And with that, let me now turn the call over to Kirk for further discussion on the quarter and our outlook for 2015..

Thanks, Chris. Today, we reported net sales of $72.4 million for the third quarter of 2015, which represents an increase of $9.6 million or 15.3% over sales of $62.8 million in the same quarter of last year. Comparable store sales growth was 9.7% in the quarter, which represented significant sequential improvement from the second quarter of 5.7%.

Importantly, we were very pleased with sales results across all vintage classes in the quarter. Our 2013 vintage stores improved from high teens comparable store sales growth in Q2 to greater than 20% in Q3.

Our 2014 vintage stores had comparable store sales growth of greater than 50% as they are still very new to the comp base and as we discussed, they achieved lower year one sales were normal, but their weighted contribution to the company’s overall comp continues to increase as more of these stores enter the comp base and their sales dollar volume increases.

Perhaps, most significantly, our more mature stores opened in 2012 or earlier improved from low single digit growth in the first half of the year to mid single digit growth in Q3.

The strength of revenue performance across all vintages was an important accomplishment during our third quarter and a testament to the impact of the work done on our key initiatives throughout the year. Gross profit increased $7.3 million in the [second] quarter or 16.7% over last year.

Gross margin of 70.0% represented a significant increase from Q2 and approximately 80 basis points from Q3 of last year. The strong gross margin performance was driven by several factors. First, as we discussed on our last call, pricing tests conducted during Q2 had an unfavorable impact to our overall gross margin in the second quarter.

As we discussed on the second quarter earnings call, we significantly reduced the number of stores and product SKUs included in those pricing tests towards the end of the second quarter. The third quarter also included more disciplined discounting.

And finally, the negative mix impact of customer deliveries moderated through both increased collection of customer delivery revenue and lower customer delivery volumes. Our selling, general and administrative costs for the quarter were $44.0 million as compared to $39.8 million in the third quarter of last year.

Third quarter 2015 SG&A included approximately $0.2 million of non-recurring costs related to litigation expenses. We concluded the third quarter with 111 stores, a 7% increase versus the conclusion of last year’s third quarter when our store count was 104.

Depreciation and amortization, rent, property taxes, utilities and other occupancy costs related to store growth represented approximately $1.5 million of SG&A growth versus the prior year during the quarter. Growth in variable compensation related to improved business performance was also a key driver of SG&A growth in the quarter.

Finally, stock compensation and benefit costs were higher than normal in the quarter due to lower employee turnover. Pre-opening expenses were approximately $114,000 in the quarter. Adjusted EBITDA was $13.9 million in the third quarter, representing growth of 40% versus the prior year period.

Adjusted EBITDA margin was 19.3%, an increase of 340 basis points versus the prior year, driven by enhanced operating leverage from sales growth that exceeded 15% while SG&A cost grew less than 11% as well as gross margin of 70%.

The non-GAAP net income presentation in the earnings release adjusts our GAAP quarterly results by eliminating unusual or nonrecurring costs, and then applies the tax rate to the result. This presentation results in non-GAAP net income for the quarter of approximately $3.9 million, growth of 139% versus the prior-year period.

The current year non-GAAP net income translates into a basic and fully diluted Q3 earnings per share of $0.08, growth of 167% versus Q3 of last year. Turning to our balance sheet as of September 30, we ended the quarter with $14.6 million of cash and $57.6 million of long-term debt.

Our free cash flow of over $8 million during the quarter allowed us to pay down $6.2 million of debt in Q3. We are pleased with our $63.2 million quarter-ending inventory, which represented a 1% decrease from last year during a quarter with over 15% sales growth and finishing the quarter with seven more stores than the prior period.

Capital expenditures were approximately $5.8 million in the quarter, primarily related to new store investments, store remodel, and merchandising activity. Year-to-date capital expenditures are $12.8 million.

As detailed in our earnings release this morning, we are providing updated expectations for the full-year based on where we are through the conclusion of the third quarter and our current outlook for the remainder of the year. I’ll highlight a handful of items that were updated this morning from our last guidance provided in July.

First, from a top line perspective, our full-year sales expectation has increased from $280 million to $290 million to $289 million to $292 million. From a bottom line perspective, the starting point of our expected range for both full-year non-GAAP earnings per share and adjusted EBITDA were again increased.

We now expect non-GAAP earnings per share of $0.31 to $0.33 versus previous guidance of $0.28 to $0.33 and we now expect adjusted EBITDA of $57 million to $60 million versus previous guidance of $55 million to $60 million.

Finally, our capital spending expectation is now $18 million to $20 million versus our prior expectation of $17 million to $20 million. From a modeling perspective, we expect Q4 SG&A growth from the prior year to be in a range of high single digit to approximately 10%. With that, operator, we can now turn the call over for questions..

[Operator Instructions] Our first question comes from Peter Keith with Piper Jaffray..

I did want would dig into the improvement you saw in your mature stores to a positive mid single digit comp.

I know there is a lot of things going on at the store level, but could you maybe point to one or two or three things that you think helped to drive that fundamental improvement or perhaps do you think the industry backdrop has strengthened a bit for you?.

I think it’s all of the things we’ve been talking about primarily. I think all the work we’ve done on our talent initiative certainly has played a big role there. I think the focus on the pro business has also helped. And those are really the main drivers.

Obviously with existing home sales being up year-over-year in July and August, 8%, that certainly hasn’t hurt either..

And then just looking at your comp and revenue guidance for the full year, it seems to imply fairly wide range for the fourth quarter and even with putting the potential that Q4 could be your lowest comp of the year, could you just frame up, have you not changed your expectations for Q4 or is there something that might keep you a little concerned about the Q4 revenue outlook?.

I think we feel good about the position we are in. The Q4 comp is implied at 3% to 8%. I think the main thing is just the first half of the year our more mature stores did a low single digit comp as we talked about on the last couple of calls.

We certainly had a stronger quarter in Q3 with the mature stores doing a mid single digit comp, but one quarter doesn’t make a trend and so we are watching that, but we like where we are at and we feel like we are gaining momentum..

Our next question comes from Daniel Moore with CJS Securities..

Just looking at SG&A, you mentioned preopening expense, I think, was just over $100,000, what are your expectations built into the guidance for Q4 for preopening expense?.

Preopening expense, opening three to four stores in Q4, Dan, will likely be a little higher than that. As we talked about a little bit in the scripted remarks, the SG&A ticked up a little bit due to lower turnover. We had higher stock comp expense and some other items related to lower turnover as well..

With the strides you’ve made already, you’ve reiterated obviously for 2016 your outlook in terms of new store openings, are you tempted at this stage to think about the higher end of the range? Has your thinking changed at all with regard to the speed or acceleration potentially of new store openings going forward?.

I really don’t have any further color to add pertaining to new store growth openings outside of the 8% to 12% store unit growth that I talked about in my prepared remarks. It’s clear that we are very pleased with the quarter and the progress that we’ve had throughout the course of 2015.

We’ll continue to look at opportunities that we see that fit within our model, but also having all the other elements that go along with opening stores, it’s just not having real estate, but having a strong team to go into it, having our marketing plan well scripted, have our inventory plans in place.

So we feel really, really confident in our ability to execute on our 8% to 12% unit growth for next year. But at this point in time, I [wouldn’t bottom] anything further on the upside from that..

And one last one, just one of the biggest improvements underneath the surface of the balance sheet here, continue to pay down cash at a pretty quick clip, you could be debt free in a year or two, have you started to think about capital allocation beyond just new store openings on a go forward basis?.

We certainly have had quite a few discussions on that. Right now, our near-term focus is going to be to continue to pay down debt. We certainly wouldn’t mind having a little bit of excess cash just to have some flexibility in the future, but our focus will be on organic growth..

Our next question comes from John Baugh with Stifel..

I wanted to dig into advertising a little bit; I’m curious on several fronts.

Did you increase the ad spend at all in mature markets or was it strictly in the newer markets? And maybe some color on what kind of contribution of return you are getting on your ad spend and thoughts about how that may change – historically it’s been kind of a low ad spend model..

We did not increase within the quarter our total advertising spend in really any capacity.

These results were driven upon really the initiatives that we talked about on the call, one certainly is certainly on our team and teams that we have within the stores at the store manager level, system manager level, and sales associate level as well as having stability within our warehouse team as well, which is important part of our execution within the store.

Second certainly will be on our professional sales which increased significantly during the quarter. And we are very pleased on the – as I mentioned – on the advertising effectiveness happening within our newer markets. We continue the same plan in playbook that we’ve executed well from – through 2015.

In mature markets, really the focus was relatively unchanged across the board. And as I indicated, the total percentage of ad spend dollars was actually less in this quarter than other quarters in 2015.

So as far as our return, our return continues to be above our expectations internally and we will certainly continue to execute upon our strategy for 2015..

And then any color on the mix ticket traffic, all those kind of metrics?.

The driver really for us right now is transactions. Our average ticket is also up, it’s been up all year, but the real driver is transactions..

Our next question comes from Peter Benedict with Robert W. Baird..

Follow-up on John’s question on the ad spend, because I don’t know if you mentioned this, particularly in aggregate, how are you guys thinking about the ad spend ratio this year versus last year? I think last year was like 2.2% of sales.

Is that still expected to delever? I think that was the initial plan that obviously sales are coming in better, so just curious how you think about that line item..

Similar to historical trend, we should be right around that 2.5%-ish percent of sales, but we do feel like, as Chris said, we feel we are really making a lot of improvement on getting a more higher return out of our ad spend, but it clearly – we are not – other than Q1 where we had some advertising tests going on, we spent a little bit higher as a rate of sales, for the year and for all the other quarters, I’d say it’s right around that 2.5%-ish of sales mark..

Peter, if I would add something on that as well, if you go back to Q1, the advertising test that we completed, it certainly helped us in our positioning throughout the entire course of the year.

So remember back in Q1, we spent slightly above our historical rate of 2.5% of sales within that quarter, that was down [because of those test and those] outcomes certainly helped position us well for Q2 and Q3, it’s helping us increase our organic search results certainly on a line basis.

We’ve been also focusing on the most important elements of driving in-store traffic as well, which certainly paid off handsomely within our mature markets in Q3..

On the expense trend, with the sales getting better, Kirk, you gave some info on variable versus fixed, as we think about going forward, how should we think about that variable component? Any benchmark you can give us either percentage of SG&A that’s variable or how should we think about that flexing as we got these comps at the higher level?.

I still think Peter that 50% to 55% flow through that we’ve talked about with you all is intact there. I don’t think that’s changing. We have made – obviously as we’ve been focusing on talent, we’ve made some modest investments in market manager incentive compensation in recruited and training and some other things, benefits-related things.

But there are sort of a mix of fixed and variable and they have been relatively modest and I still think the flow through that we talked about is the same. It really remains unchanged..

The last question, just on the lower delivery volumes, what’s driving that? Is that related to the fact that the pro has increased as a percentage of the sales? Do they take less deliveries, pick it up more on their own, or what’s the dynamic there?.

Not really, not really. I mean, there really isn’t a big difference between retail and pro customers in terms of delivery, because often even if it’s a pro customer, we are delivering it to the customer’s house. It’s really more about education.

We talked about – it ticked up in the mix in Q2, but part of it is we need to be smart about collecting the revenue associated with that customer delivery. If the customer truly values it, we should be able to collect the revenue. And we did a much better job at that in Q3.

We did a number of things working with our regional managers and our marketing managers, also our store managers directly to just educate them about what the expectation is in terms of when they do a delivery and also whether they can collect the revenue on it or not.

And then we also – another thing we introduced within the quarter is a new store scorecard and that provided a lot better visibility to margin drivers in each of the stores including customer delivery and where each store ranked compared to everybody else in the chain and I think that was very helpful..

And I’m not showing any further questions at this time. I’d like to turn the call back over to our hosts..

Thank you very much for joining us. Have a great day..

Ladies and gentlemen, this does conclude today’s presentation. You may now disconnect and have a wonderful day..