Adam Hauser - Director of Finance - Planning, Analysis, Investor Relations Chris R. Homeister - Chief Executive Officer, President and Director Kirk Geadelmann - Chief Financial Officer.

Peter Jacob Keith - Piper Jaffray & Co (Broker) Daniel Moore - CJS Securities, Inc. John Baugh - Stifel, Nicolaus & Co., Inc. Kate McShane - Citigroup Global Markets, Inc. (Broker) Peter S. Benedict - Robert W. Baird & Co., Inc. (Broker) Joseph Isaac Feldman - Telsey Advisory Group LLC.

Good day, ladies and gentlemen, and welcome to the Tile Shop Holdings Fourth Quarter 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we'll conduct a question-and-answer session, and instructions will be given at that time. As a reminder, this conference is being recorded.

I would now like to hand the conference over to Adam Hauser, Director of Investor Relations. Please go ahead..

Thank you, operator. Good morning to everyone on the call and welcome to the Tile Shop's fourth quarter earnings call. Following our prepared remarks, the call will be opened 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 these 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..

our fifth store in the Dallas, Texas, market; our third in the Cincinnati, Ohio, area; and our second location in San Antonio, Texas. For the full year, there were numerous financial achievements I'd also like to highlight. Our sales for the year were $293 million, representing growth of 14%. Our comparable store sales growth was 7.4%.

Our gross margin was 69.5%. Adjusted earnings per share were $0.32, representing growth of 39%. Adjusted EBITDA was $58.4 million, representing growth of 23%. Adjusted EBITDA margin increased 150 basis points to 19.9%.

We generated approximately $41 million of free cash flow, which allowed us to pay down nearly $36 million of long-term debt, a reduction of approximately 40%. And finally, our inventory finished up only 1% in the year with 14% sales growth and 7% store growth, and our in-stock availability remains very high. Now, let's turn our attention to 2016.

Retail talent development will continue to be a major focus area for the company. We will strive for additional reductions in turnover levels in the coming year, primarily at the sales associate level. We also believe average manager tenure can also increase.

We have created a senior assistant store manager position for those seeking opportunities within sales management.

A small number of assistant store managers who complete all requisite training programs and also distinguish themselves from their peers will become high-profile candidates for store manager opportunities and also earn a base salary once obtaining this position.

Finally, as I mentioned earlier, you will have market managers covering all of our stores in early 2016. Next, continuing to grow our pro-business will be key to delivering another successful year.

As we conclude various efforts from 2015, we are able to draw upon those learnings and apply them to our strategies to grow our professional customer segment in 2016 and beyond. And once again have a thorough and distinct marketing plan for targeting and retaining tile contractors, custom homebuilders and designers.

Our 2016 plans include direct marketing, dozens of store-hosted events and partnership with pro associations, and continually refining and improving our periphery of product assortment.

Our final initiative for 2016 that I'll highlight today is our focus on increasing our unit growth at an increased rate from 2015 still at a manageable pace that will range between nine stores and 12 stores in 2016.

After the success of 2015 and the current positioning of our retail talent, we strongly believe that increasing our store growth is a great decision for long-term value creation. Our 2016 openings will be focused mostly in markets where we already compete, where we will leverage economies of scale in marketing, distribution and store talent.

Over the next several years, we feel that 8% to 12% unit growth is an appropriate target for our business.

As we build upon a strong foundation of success from 2015 and as we accelerate our unit growth in pursuit of becoming America's first national specialty tile retailer, eventually entering into several new markets longer term, I am pleased to announce the following organizational change in addition to my leadership team that will become effective on March 1.

Carl Randazzo, our Senior Vice President of Retail, will become the Senior Vice President of Real Estate and Development. In this role, Carl will be responsible for identifying all new real estate sites across the country, negotiating lease renewals for existing stores and managing store build-out expenses.

Carl is uniquely qualified to lead this important work by leveraging his 20-plus years of retail experience at the Tile Shop and his intimate knowledge of our business. I'm also pleased to announce that Lynda Stout will join the Tile Shop in the role of Senior Vice President of Retail Stores and Sales.

Lynda will be responsible for all elements of retail sales and operations, which will include sales training, customer service and recruiting. Lynda joins the Tile Shop from Heritage Home Group where she was the Senior Vice President of Retail Sales.

Prior to that, Lynda led retail sales at Ethan Allen beginning as a store manager and ultimately leading over 150 stores and 1,900 sales associates. Lynda has over 25 years of leading commission sales teams, has deep knowledge of design and growing both consumer and professional business lines.

We are very enthusiastic about the results we delivered in 2015. We are also encouraged by our sales performance in the early weeks of 2016.

Despite headwinds facing the global economy, macro factors in the U.S., more specific to our industry such as housing turnover, home price appreciation, and remodeling activities, have remained relatively positive.

Despite a potentially challenging environment, we believe we can deliver a year of strong growth in 2016 as we take another step in 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 2016..

Thanks, Chris. Today, we reported net sales of $71.9 million for the fourth quarter of 2015, which represents an increase of $8.6 million or 13.5% over sales of $63.3 million in the same quarter of last year. Comparable store sales growth was 9.8% in the quarter, which represented a second straight quarter of nearly 10% comparable store sales growth.

We were once again very pleased with sales results across all vintage classes in the quarter. Our 2013 vintage stores had high-teens comparable store sales growth in the quarter. Our 2014 vintage stores had comparable store sales growth of approximately 50%.

And for a second straight quarter, our more mature stores opened in 2012 or earlier achieved mid-single-digit growth in Q4. The strength of revenue performance across all vintages in the second half of 2015 is a strong indication of the health of our model within the industry and the momentum we carry into 2016.

Gross profit increased $6.6 million in the fourth quarter or 15.1% over last year. Gross margin of 70.4% represented an increase of approximately 90 basis points from Q4 of last year.

The strong gross margin performance was driven primarily by increased focus and process improvements initiated by our store and distribution center teams that resulted in reduced damaged product and shrink cost during the quarter.

In addition, customer delivery margin continued to improve primarily due to increased collection of customer delivery revenue. We were pleased to finish the year with 69.5% gross margin, which was the midpoint of our original outlook for the year.

Our selling, general and administrative costs for the quarter were $43.7 million as compared to $40.2 million for the fourth quarter of last year. Fourth quarter 2015 SG&A included approximately $0.3 million of special charges related to litigation expenses.

We concluded the fourth quarter with 114 stores, a 7% increase versus the conclusion of last year's fourth quarter when our store count was 107.

Depreciation and amortization, rent, property taxes, utilities and other occupancy costs related to store growth represented approximately $0.8 million of SG&A growth versus the prior year during the quarter. Stock compensation increased $0.6 million primarily due to a lower forfeiture rate associated with lower employee turnover.

Variable compensation, benefit costs and shipping and transportation expenses were also a key driver of SG&A growth in the quarter, driven by growth in sales and employee head count. Pre-opening expenses were approximately $200,000 in the quarter.

Adjusted EBITDA was $14.2 million in the fourth quarter, representing growth of 39% versus the prior-year period. Adjusted EBITDA margin was 19.8%, an increase of 360 basis points versus the prior year, driven by enhanced operating leverage from sales growth of 13.5%, while SG&A costs grew less than 9% as well as a gross margin of 70.4%.

For the full year of 2015, we increased our adjusted EBITDA margin approximately 150 basis points, driven by sales growth of approximately 14% combined with SG&A growth of less than 11%.

The non-GAAP net income presentation in the earnings release adjusts our GAAP quarterly results by eliminating special charges and then applies the tax rate to the result. This presentation results in non-GAAP net income for the quarter of approximately $4 million, growth of 139% versus the prior year period.

The current year non-GAAP net income translates into a basic and fully diluted Q4 earnings per share of $0.08, growth of 167% versus Q4 of last year. Non-GAAP net income for the year was approximately $16.6 million, growth of 42% versus 2014.

The 2015 full-year non-GAAP net income translates into a basic and fully diluted earnings per share of $0.32, growth of 39% versus last year. Turning to our balance sheet as of December 31, we ended the quarter with $10.3 million of cash and $51.3 million of long-term debt.

We paid down $6.3 million of debt during the quarter, bringing our full-year debt reduction to $35.8 million, which can be attributed to free cash flow generation of approximately $41 million in 2015.

We were once again pleased with our quarter-end inventory of $69.9 million, which represented 1% growth from last year, during a quarter with 13.5% sales growth and seven more stores than the prior-year period.

Capital expenditures were approximately $6.1 million in the quarter, primarily related to new store investments, store remodel and merchandising activity, and some IT investments. Full-year capital expenditures were $18.8 million. Now let's shift gears to discuss our full-year outlook for 2016 in greater detail.

From a macro perspective, year-over-year growth in existing home sales did slow during the fourth quarter of 2015, and we are expecting low-single-digit growth in 2016 based on various available estimates and commentary.

We expect home prices to continue to see solid appreciation given estimates highlighting tight inventories relative to underlying demand. These factors are certainly encouraging as we consider our expectations for 2016.

However, the volatility and uncertainty of the global environment and financial markets have to be taken into consideration as we consider potential impact on consumer discretionary spending and our range of potential outcomes. As Chris indicated earlier, we have been encouraged by our results through the first six weeks of the year.

For the full-year 2016, the company expects the revenue will range between $312 million and $325 million. Comparable store sales growth is expected to be in the low- to mid-single digits. We expect half one comparable store sales growth to be modestly stronger than half two primarily due to easier comparisons.

Gross margin is expected to be between 69% and 70%, consistent with each of the past three years. While our recent gross margin trend and exchange rate favorability presents some opportunity, we also expect a consistently competitive environment.

Non-GAAP earnings per share will range between $0.37 per share and $0.43 per share, representing year-over-year growth between 16% and 34%. This assumes an effective tax rate of approximately 41% and approximately 52 million fully diluted shares outstanding.

As Chris discussed, we expect to open nine stores to 12 new stores in 2016, with one opening expected in the first quarter. Capital expenditures are expected to range between $25 million and $30 million. Our expectation for depreciation and amortization is approximately $24 million.

And stock-based compensation is expected to be approximately $5 million. We expect to generate $15 million to $20 million of free cash flow and further reduction of our debt balance will continue to be high priority. With that, operator, we can now turn the call over for questions..

Our first question comes from the line of Peter Keith from Piper Jaffray..

Hi. Thanks. Good morning, everyone, and congratulations on wrapping up a good year here. I wanted to take a look at your comp outlook for the coming year, low-single-digit to mid-single-digit. I would think that with the store maturity curve benefit, you could probably get at least low-single-digit comp benefit from that.

So, I guess the guidance seems to imply that mature stores might decelerate back down to flat.

So, I guess just trying to understand if that's just more caution on the economic environment, being prudent with conservatism or if there's something here that as you begin to lap the mature (21:04) store performance in the second half that that should naturally flatten out? Thank you..

Good morning, Peter. This is Kirk. Yes. I think we would characterize it more as just being cautious as we head into the new year. With the deceleration of housing turnover in Q4, we just want to make sure we're being prudent.

But as we said, we feel good about where our business is at, and we did have – the last couple of quarters we were very pleased with the results across all vintages..

Okay, great. Turning to another topic; I think in the fall you had launched a store scorecarding initiative to look at stores across a number of different metrics. It's been a couple of months now, I'm wondering if you're beginning to see any behavioral changes or process improvements at the store level from that initiative..

Hi, Peter. This is Chris. We're pleased with the store scorecard now being out in the field, as you mentioned, for a few quarters now.

I think, number one, I would classify the information that we give to the store leaders and the leadership team and the field leadership team is very robust and immediate where they can look at their business on a real-time basis that they didn't have before. So I think, one, having information in front of them has been well received.

I think the other is looking at it not necessarily as a negative, but looking at it as a positive about the opportunities that they have within their store, within their store environment, and also I would couple it with the market manager having that information in front of him or her is also an important tool that has helped the markets identify trends across the particular metropolitan area where we could see an opportunity that could apply to not just one store but a handful of stores.

So I think the combination of the two, the immediacy of information and, number two, having in the place of our market manager team and allowing for them to identify trends within the market and then acting on them in a real-time basis I think has been very fruitful and beneficial to our business certainly in Q4, and I expect it to have many benefits to us as well as we go into 2016 and beyond..

Okay, that's helpful. Thank you. And then a last question I had was just regarding your pro customer.

I think you said that the mix shift towards pro is the largest of the year, but I didn't hear quantification of that? And then I was wondering with regard to the pro customer growth, is that coming primarily from new pro customers or are you driving increased transactions from your existing pro customer base?.

Hi, Peter. This is Kirk. Yes. We continue to be very pleased with the growth in our pro customer business and we're continuing to refine and improve our strategies. The mix throughout the year increased 300 basis points, little higher than that in Q4 and as we think about how we achieve that, a good chunk of that is acquiring new pros.

So as we head into 2016, we're going to be focused on continuing to do that certainly but also retaining the pros, the newly acquired pros that we were able to attract in 2015. Both of those will be a focus..

Thank you. And our next question comes from the line of Daniel Moore from CJS Securities..

Good morning, and quick congratulations to Carl and Lynda. You mentioned obviously the free cash flow generation, really exceptional in the year, two to three times net income.

Beyond inventories, what are some of the other drivers of free cash? And now that we're significantly below one turn of leverage, are you starting to think about alternative uses of capital over the next couple of years beyond simply new store openings?.

Good morning, Dan. This is Kirk. That was multiple questions, I think and I'll take a shot at answering them. Yeah. We were very, very pleased with the $40 million plus of free cash flow generation this year.

Obviously, a solid business trend was a big part of that, making working capital improvements was a big part of that, and then having a little bit slightly lower store growth obviously helped as well.

And as we head into 2016, we're only moderately increasing store growth, so we still feel good that we're going to be able to generate some very solid free cash flow on top of that.

I think we'll continue to focus on working capital improvements, and we believe we still have some room there particularly with the inventory and increasing inventory turns. That's certainly a focus.

And then in terms of the opportunities with excess cash, we're going to continue to focus on paying down debt in the near term, but we've certainly talked about other possibilities such as a buyback program, that type of thing. We have an ongoing dialogue on that subject..

Okay. That's helpful.

And then the nine new store to 12 new store openings expected, maybe talk about the factors that might cause you to go closer to the low end or the high end of that range as the year unfolds?.

Hey, Dan. This is Chris. I mean, I think, the biggest factor, obviously, the obvious factor is the broader macro environment. Certainly, what we see around the 31 states that we market and do business in, I would say, it's relatively strong. And as I mentioned in our prepared remarks, relatively positive on the metrics that we follow very closely.

So, I think that would be the number one element impacting our guidance around nine stores to 12 stores. Certainly, we anticipate being right in the middle of our range. We feel our businesses is strong across the board. Our retail talent identification and placements, I don't feel has ever been stronger.

And so, I think, it's always the combination of the two events of having talented individuals to go into store leadership positions and perform in a very positive and strong manner out of the gates, coupled with a real estate strategy that's anchored in on data and also in understanding about how we can gain efficiencies in both marketing distribution and certainly talent and training..

Thank you. Our next question comes from the line of John Baugh from Stifel..

Thank you. Congratulations, Chris, Kirk, team, great job. I was just wondering on the gross margin guide, which is flat, I believe, year-over-year for 2016. You mentioned you had improvement in shrink, I think, and better collection of delivery revenue from customers. So, I'm wondering does that provide a little bit of tailwind going into this year.

I'm not sure how you year-over-year anniversary those benefits and maybe give you a little bit more room to be aggressive if you need to on the promotional side?.

Good morning, John. Thanks for the question. This is Kirk. Yeah. I would say, we've had a very early trend developing on the customer delivery revenue that's been a focus of ours as we talked about a little bit over the last two quarters now, two quarters or three quarters. So, I like the trend. I think we feel good about it.

The scorecard has also helped there. And then, a more recent trend with making some improvements around damaged products and shrink, that's the early trend. So, with those positive trends, we were able to land at that 70-ish point in terms of gross profit rate.

And so, I hope we can keep those trends going, which would help us be at the higher end of our range for 2016. But you're right. I mean, we don't really see anything new in the competitive environment, but we certainly want to make sure we're doing the right thing in terms of running our business.

So, it gives us a little flexibility there to continue to do that..

And then staying on that margin-leverage question, if you're going to open stores mostly in existing markets, which I think I heard correctly – correct me if I'm wrong – do we get leverage elsewhere on the business through distribution centers, marketing, et cetera?.

That's correct, John. We get leverage in a number of different ways, but it's, I think, leveraging things like depreciation and certain other expenses as we continue to do a moderate increase to our unit growth and hopefully drive a strong business trend.

And again, as long as the macro cooperates and housing turnover is in a normal state, we feel good about our opportunity to drive that leverage. And that certainly is going to be a focus..

Thank you. And our next question comes from the line of Kate McShane from Citi Research..

Hi. Thanks. Good morning. Thanks for taking my question. My question too is just on the sourcing environment, from where you're getting your product.

Anything on the horizon or expectations for 2016 that may differ from 2015?.

Hi, Kate. This is Chris. I'd say the sourcing environment continues to be very robust and dynamic.

I feel that while we talked about the currency exchange slight tailwind that we're getting from existing vendors, I think it also has the big benefit of us with currency devaluation scenarios across the world right now, it's allowing us to go into markets where we haven't been for many years, such as South America, Eastern Europe, and Western Europe to a certain degree as well.

So, I think, the opportunities that are in front of us around the world are very robust. I'm excited about opportunities to source new products from areas of the world that we haven't been in over a decade because of pricing concerns or their own economies consumed much of the manufacturing capacity that existed in those bigger countries.

As those countries' economies have slowed, the opportunity for exports out of the country as well as the very favorable currency exchange equation right now is very exciting for our business.

And I think the types of products, the sizing of products, and also there's some new design trends coming into the assortment, I feel will continue to place us at the forefront and in a leadership position pertaining to our product assortment..

Thank you..

Thank you. And our next question comes from the line of Peter Benedict from Robert Baird..

Hi, guys. First question on the 2015 class, can you give us a sense of what they're tracking in terms of the year one volumes and are they all the smaller footprint? I think, they were, just wanted to confirm that.

And related to that, I wanted to get some color on how the CapEx and the rent profile of those smaller formats compare to the previous format?.

Good morning, Peter. This is Kirk..

Hey, Kirk..

For the three stores that were opened earlier in 2015, I would say we're very pleased with their performance. They seem to be tracking pretty well. The four stores that were opened later in the year, it's still really early to tell, but overall, as Chris talked about, we feel really good about the way we opened up those stores.

We had the talent pipeline set. We got the managers in those stores ahead of time. And so, we had a very orderly process as we opened the stores. So, we feel like we're in a good place with those stores. And as we get more months under our belt, we'll certainly give you updates on that. You're right. Those stores generally are smaller size.

We've been able to continue to reduce our footprint well under the 20,000 square foot range. And with that, we've been able to see some reduction in CapEx.

And so, again, that's another area where we're focused on continuing to maximize the customer experience in our stores as priority number one, but also try to get a little bit better financial profile as well. And so, we see a good trend developing there..

Okay. That's great.

So, when we think about the occupancy ratios, I mean, do these pencil out to be similar to the larger stores or do you think they'll actually be better, more favorable on the occupancy ratio?.

I think occupancy could be an opportunity. We really haven't seen significant changes there yet. We need to get more stores open. Rent varies by location. So, to the extent that we're in a little bit better real estate spot, we might be paying more rent per square foot. But I do think that's an opportunity.

It's something that we're certainly looking at as we head into 2016 and beyond. I think the CapEx opportunity, we've seen more movement there. Historically, our CapEx was right in the neighborhood of $1.4 million per store. We've been able to reduce that somewhat with the latest batch of openings in 2015.

And again, as we head into 2016, that'll also be a focus of ours..

Thank you. And our final question for today comes from the line of Joe Feldman from Telsey Advisory Group..

Yeah. Hi. Good morning, guys, and congratulations on the quarter.

Wanted to ask real quick – on sales, were there any regional trends to note, and drivers, traffic versus ticket, if there's anything you can share on those two items?.

Hi, Joe. This is Chris. I wouldn't call out any significant regional differences across our business. Business was strong across the quarter and across, really every geographic market for the Tile Shop in the markets in which we compete in. And I wouldn't view significant differences on traffic or mix or size of ticket either.

I feel our business consistently performed across, again, as I said, every geography, as we expected throughout the quarter..

That's great. It sounds well-balanced. The other follow-up I had was, can you talk a little bit about the mix of what you were selling, meaning, I always like to ask you guys, are you seeing any differences in people going a little more upscale or downscale in what they're buying? Clearly, I guess, this kind of gets the ticket.

But I'm concerned more about the health of the consumer and are you seeing a bigger appetite for more luxury tile and products?.

Yeah. I think I would quantify it as similar which would be continuing the trends that the consumer continues to buy goods that are a little big higher end. I think we've been very pleased with the types of products that we brought into the assortment in 2015 that carry a higher price point on a per-square-foot basis.

And stone continues to be very high in demand across really every category. Marble certainly is in vogue, white and gray, in particular, and it continues to be a top seller for the Tile Shop in really every market across the board, and I see that being consistently the same throughout 2016 as well..

Thank you. And that concludes our question-and-answer session for today. I would like to turn the conference back over to management for any additional comments..

Thank you for joining us today. Have a great day..

Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program, and you may now disconnect. Everyone, have a good day..