Chris Homeister - CEO Kirk Geadelmann - CFO Adam Hauser - VP, IR.

Daniel Moore - CJS Securities Peter Keith - Piper Jaffray John Baugh - Stifel Nicolaus Joseph Feldman - Telsey Advisory Group Matthew Larson - Robert W. Baird.

Good day, ladies and gentlemen, and welcome to the Tile Shop Holdings, Inc. First Quarter 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session. Instructions will be given at that time. [Operator Instructions]. As a reminder, this conference call maybe recorded.

I would like to turn the conference over to Adam Hauser, Vice President, Investor Relations. You may begin..

Thank you, operator. Good morning to everyone on the call, and welcome to the Tile Shop's first 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 participates 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 may be used to identify forward-looking statements. 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 Web site 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 first quarter of 2017.

I’ll begin by recognizing and thanking our store leaders, sales associates and all of our operational teams for delivering a very strong start to 2017.

During the first quarter, we continued to refine and build upon our key initiatives that have driven our success over the past years and also successfully began our plans to increase our store unit growth in 2017.

Our confidence and ability to serve all of our customers at a very high level allowed us to deliver very positive results, despite a difficult comparison versus a highly successful first quarter of last year. Let me share some specific highlights from our first quarter.

Sales for the quarter were a record $92.1 million surpassing our previous high quarterly revenue by $7.4 million. The $92.1 million of revenue represented growth of 8.8% versus last year including comparable store sales growth of 4.9%.

We delivered this top line strength while also delivering a 70.3% gross margin rate for the quarter, our seventh consecutive quarter with a gross margin rate of 69.6 or better. Adjusted earnings per share in the quarter was $0.16 representing growth of 14%. Adjusted EBITDA grew 9% and adjusted EBITDA margin was 22.9% during the quarter.

We generated over $10 million of free cash flow and our ending inventory was $69 million which equaled our plan and allowed for strong in-stock levels during the quarter. Retail talent development remains a key focus area and opportunity for the company and our efforts in this area continue to yield strong results.

In the first quarter, sales associate turnover was down approximately 25% from the prior year period and nearly 50% from two years ago.

Assistant and senior assistant managers, key roles for successful store operations in providing a source of future store manager candidates had turnover levels that were down approximately 40% from prior year period and nearly 60% from two years ago.

Employee turnover has also made strong improvements in our distribution centers and store warehouses and this continued in the first quarter of 2017. We continue to feel there is a need to make additional progress on employee turnover which we feel has broad benefits in serving our custom base and driving efficiencies in our store operations.

Average store manager tenure continues to be at its highest level in several years. The continued growth of our business with the professional customer segment has been instrumental in our success for the past two years and our Pro mix increased over 300 basis points in both 2015 and 2016.

Our tactics to continue driving strong growth with our Pro customers included direct marketing, store-hosted events and Pro-specific product assortment improvements again led to strong results during our first quarter. Sales growth with Pro customers strongly outpaced overall growth leading to a meaningful increase in Pro mix during Q1.

Strong sales growth occurred across a variety of product categories during the first quarter with particular strength in all varieties of subway tile, faux wood, marble, porcelain, glass and cement tile products. We are excited to be launching a category of outdoor paver products for the first time at the Tile Shop beginning in April.

We remain very pleased with our ability to bring in new on-trend products while strongly managing overall inventory levels and offering in our view one the broadest assortments in the industry. Strong execution of increasing our store unit growth is another key focus area for the company in 2017.

In the first quarter, we opened three new store locations. Our first store located along the New Jersey shore in Oakhurst, New Jersey brings our total New Jersey store count to seven. We also added our third store in the Phoenix, Arizona market.

And finally, we increased our presence in Maryland with our fifth location which is located in Bel Air, Maryland. These locations averaged less than 14,000 square feet as we continue to target store sizes in the low-to-mid teens. Since 2015, our average new store is less than 15,000 square feet.

As previously discussed, we have reduced the average capital outlay from new store openings significantly from our previous historical average of approximately $1.4 million. For our last nine store openings, we have reduced this amount by over 30% on average.

We continue to be excited about the benefits this will have to long-term cash flow and return of capital for the company. We have great visibility to our store openings for the remainder of the year and we are confident we will be at the high end of our range of 12 to 15 new stores for 2017.

Finally, as some of you have already noted, we added to our senior leadership team during the first quarter by welcoming Joyce Maruniak as Senior Vice President of Supply Chain, Transportation and Manufacturing Operations.

Joyce comes to the Tile Shop with extensive supply chain and manufacturing operations leadership experience at industry leading specialty retailers. We are excited to add her talents to the organization as we continue to grow our operations across the country. We are very pleased with our start to 2017.

We continue to make meaningful improvements with all of our focus areas and remain incredibly energized by identifying and implementing additional improvements to our strong business model as we move forward. We are excited about the remainder of 2017 and taking another step in our journey to become 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..

Thanks, Chris. This morning, we reported net sales of $92.1 million for the first quarter of 2017, which represents an increase of $7.4 million or 8.8% over sales of $84.7 million in the same quarter of last year. Comparable store sales growth was 4.9% in the quarter.

Our mature stores opened more than four years delivered a solid sequential improvement in comparable store sales growth from the fourth quarter, while stores opened less than four years drove comparable store sales growth that was very consistent with the previous three quarters.

Additionally, we saw strong results at stores opened less than one year and in our online channel during the quarter. Given our plan to increase our unit growth in 2017, we were very pleased with new store productivity during the quarter. Traffic growth and average ticket growth played the largest role in comp growth from an organics perspective.

Gross profit increased $5 million in the first quarter or 8.4% over last year. Gross margin of 70.3% represented a decrease of approximately 20 basis points from Q1 of last year.

The sequential improvement in gross margin in the first quarter as compared to the fourth quarter of 2016 was the result of solid execution of our normal spring promotional calendar, which tends to be slightly less promotional than the fourth quarter which included a successful Black Friday weekend.

Our selling, general and administrative costs for the quarter were $51.2 million as compared to $47.9 million in the first quarter of last year. First quarter 2017 SG&A included approximately $350,000 of special charges related to litigation expenses.

We concluded the first quarter with 126 stores, a 10% increase versus the conclusion of last year’s first quarter when our store count was 115.

Depreciation and amortization, rent, property taxes, utilities and other occupancy costs, primarily related to store growth, represented approximately $2 million of SG&A growth versus the prior year during the quarter.

The remainder of SG&A growth was driven primarily by variable compensation, benefit costs, advertising and shipping and transportation expenses resulting from growth in sales, locations and employee headcount as well as continued investments to reduce turnover and drive retail talent development.

We also held our national sales meeting during the quarter which did not occur in the prior year period. We were very pleased to drive over 100 basis points of SG&A leverage during the quarter, given the significant leverage gained in the first quarter of last year.

Adjusted EBITDA was $21.1 million in the first quarter representing growth of 9.4% versus the prior year period. Adjusted EBITDA margin was 22.9%, an increase of 14 basis points versus the prior year, driven by enhanced operating leverage from sales growth of 8.8% while SG&A costs grew 6.8% partially offset by a modest decline in gross margin.

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 $8.2 million, growth of 14.6% versus the prior year period.

The current year non-GAAP net income translates into a basic and fully diluted Q1 earnings per share of $0.16, growth of 14.3% versus Q1 of last year. Turning to our balance sheet, as of March 31, we ended the quarter with $13.6 million of cash and approximately $27 million of long-term debt, a reduction of over 30% from the prior year period.

We paid down $1 million of debt during the quarter with free cash flow generation of approximately $10 million in the first quarter. We were pleased with our quarter end inventory of $69.3 million which represented 8% growth from last year during the quarter with nearly 9% sales growth and 10% more stores than the prior year period.

As Chris mentioned, we believe the strong in-stock levels enjoyed during the quarter contributed to our sales results and we believe we are well positioned for the second quarter.

Capital expenditures were approximately $10 million in the quarter primarily related to new store openings, store remodel and merchandizing activity, store IT investments and DC projects. As detailed in our press release this morning, our outlook for the year is unchanged from what we provided on our last call in February.

From a modeling perspective, as you look at our second quarter, our low-to-mid-single digit comparable store sales growth outlook for the full year applies, although we believe we are in a position to continue to drive strong sales results.

We expect second quarter SG&A growth to increase from Q1 levels largely due to more new store openings but we still hope to drive modest sequential improvement in year-over-year adjusted EBITDA margin in Q2 with more substantial leverage planned for the second half of the year. With that operator, we can now turn the call over for questions..

Thank you. [Operator Instructions]. Our first question comes from the line of Daniel Moore of CJS Securities. Your line is now open..

Good morning. Thanks for taking the questions..

Good morning, Dan..

Typically Q1 is slightly back-end loaded with March kind of driving results.

Maybe just talk about what did comp store sales look like in March and how is that momentum carried over into April thus far?.

Good morning, Dan. This is Kirk. We have strong quarter overall. I won’t get into the specifics of the phasing but I think it’s fair to say we were happy with all three months of the year, finished very strong in the quarter as well..

Okay.

And you mentioned at the end of your remarks, Kirk, SG&A growth in Q2, is it growth that’s going to be up from Q1 levels or absolute dollars, both I assume but maybe anymore color there just to help us kind of phase in those expenses in Q2 and the rest of the year?.

Yes, right, Dan. As we try to modestly increase our unit growth this year and hopefully we’d like to finish at the upper end of our 12 to 15 store opening range that we provided in our guidance, our focus is really to open up stores more ratably throughout the year. As we noted, we opened three in the quarter.

We’ve taken possession of a number of other leases and so we started incurring some occupancy expense for stores that we will open in Q2. And we expect to open probably more than three in quarter two so that we have a good number of stores opened as we get to the midpoint of the year. As you said, it’s both growth percent as well as dollars.

That would be accurate..

Got it. And lastly, maybe just progress on some of your younger markets, particularly Phoenix, Albuquerque and Texas, obviously overall it appears to be – it certainly appears like the new stores are tracking as would be expected but any color that you might add would be great..

Dan, this is Chris. I would view our progress in our newer markets as very solid. I think with any new market and any new markets we continue to go through and grow our teams and really bring the Tile Shop customer experience into that market.

I’m very pleased about how we’ve been able to attract both employees to our retail showrooms but also more importantly having a very exciting reception for our model in our overall business of what we bring to the marketplace in all our new markets.

So I’m [indiscernible] when I look at the new markets as a whole and quite pleased with their progress and it gives us a lot of great enthusiasm as we expand throughout the course of the year..

I appreciate it. Congrats on a great start to the year. I look forward to seeing you in Boston next week..

Thanks, Dan..

Thank you. Our next question comes from the line of Peter Keith of Piper Jaffray. Your line is now open..

Good morning and also my congratulations on a very solid quarter. I was curious if you could just expand upon the new hire with Joyce Maruniak. It seems like a pretty important addition to the team.

And maybe Chris, could you address some of the operating metrics that you’d like to maybe improve with that new hire?.

Yes, sure thing, Peter. We’re very pleased to have Joyce be part of our team. We felt that as we continue to grow our business across the country having a robust supply chain and manufacturing operations is going to be a key component of our success.

As many of you are aware, we’ve opened a DC in New Jersey and we’ll plan on continuing to open new DCs as we go across the country, especially as we go into the West Coast.

But the cornerstone metrics of us from a supply chain efficiency and also importing our goods from the dozen countries that we imported from now is just having what I’ll classify as the on-time – the right quantity on-time all the time.

And I think those as we get into broader assortments and also as we go into additional product lines such as our paver line that was just announced here this morning, we feel that’s going to be an important element for her to focus on as we go into 2017 and beyond..

Okay. Thank you very much on that. And I know you were pleased with new store productivity. At least in my model it looks like it has been improving the last two quarters.

Is there something that seems to be working with the new store prototype or it’s just a function of the timing of the openings?.

Hi, Peter. This is Chris. I’ll address it. I’ll let Kirk add any color that he wants. But I think the biggest thing that – let me start with we’re certainly pleased with the new store prototype. It’s had great reception from both customers as well as our employees.

Operating a smaller showroom is much easier for an employee to navigate in a 14,000 to 15,000 square foot store versus a 25,000 square foot store. Obviously, we’ve talked about our capital outlay being smaller in that front as well here this morning.

But I think the biggest thing that I would attribute the success to is having a well prepared store manager and a well prepared assistant store manager, having their ability to bring on their team and train their team from day one, become comfortable with how we sell, what’s the process and understanding the product in different product lines.

So I would really look at it’s twofold. Certainly the new concept had great reception across the board but just as important of having the right person that’s well trained and positioned for success to hit the ground running on day one I think has led to a lot of success for us on our new stores that we’ve opened up the last two years..

I’ll just add to Chris’ comments. This is Kirk. The only thing I’d add is we also feel very comfortable with the overall playbook that we’ve established over the last couple of years for new store openings. And I think we’re in a position now where we’re highly confident that we can continue to repeat the success with each and every store opening.

And as Chris mentioned, we’ve gotten very, very good results both in terms of revenue as well as the reduction in the overall capital outlay, so very pleased overall with the results..

Okay, sounds good. And one last quick one.

Did you guys say that cement was a product category that outperformed during Q1?.

Yes, it’s a new product line that we brought in the middle part of last year that has had broad reception across the country..

And that’s outside of the pavers that you’re bringing in now?.

That’s correct, Peter..

Okay, very good. Thanks a lot. Good luck..

Thank, Peter..

Thanks, Peter..

Thank you. Our next question comes from John Baugh of Stifel. Your line is now open..

Thank you. Good morning. Congratulations on a great quarter. I was curious on the mix and ticket. I believe you mentioned traffic was up and ASP was up. Maybe you could give a little more color there.

And then curious as to how you mentioned the Pro mix going up, how is it changing mix of your customer influencing your product mix and your ticket? Thank you..

Good morning, John. This is Kirk. As we’ve talked about over the last several quarters, we’ve enjoyed an increase in average ticket pretty consistently over the last couple of years. And I would attribute that to the growth in Pro in part.

I think I’d also attribute it to all of our efforts around increasing our talent with training and reducing turnover. Our employees are in a position and our store managers are in a position where they can provide a very high level of service to customers which tends to result in an increase in average ticket. I’ll go back to the Pro comment.

Our Pros typically also have a higher average ticket. So naturally as you mix into Pro and increase that part of our business, you see that average ticket go up.

So average ticket was definitely a tailwind for the quarter; it helped us get to that five comp as well as we were pleased to see traffic rebound from the latter part of Q4 where we experienced a little bit of softness and traffic was I would say back to normal in Q1.

And particularly since we annualize such a difficult comparison last year Q1 where we generated a 13 comp, it was very good to see the growth in both of those metrics..

Great. And then you mentioned the importance of more seasoned both store manager and assistant store manager when you’re opening the new store.

And you mentioned all these turnover numbers and I was curious is there a way to compare say when you’re opening a new store today, what kind of seasoning of that store manager and assistant store manager have versus when you say opened the store two or three years ago?.

John, this is Chris. I would look at it as it’s a dramatic difference. I won’t go into the number of months that they’ve had as an assistant manager between now and then. In my view it’s significant not just in the tenure with the company but also the tenure that they had on the job and also the training that they’ve led through.

We want them trained under several different managers before they go into a new store. We want to have an assistant manager be part of the team that opens our store. And then I think also just the entire trainee modules have changed remarkably to the positive for the type of training about what we expect of the manager.

Because we look at the store manager as they need to be the recruiter, they need to be the teacher, they need to be their mentor that’s leading the sales team.

And I think the differences between back in '13 to now here in '17 are starkly different and think we feel that we still have certainly more room to improve both on continuing to – from a training standpoint and we feel that we have more room to reduce our turnover even further.

But the differences between then and now I think are incredibly positive and gives us great confidence to continue opening our stores at a more aggressive pace as we continue on throughout the course of the year..

Great.

Last quickie, advertising I think you mentioned but is there a change in strategy to your percentage of revenue goals, et cetera?.

John, this is Kirk again. No, no change. We just continue to focus on optimizing it. But in terms of level of investment, it’s pretty much the same..

Great. Thank you. Good luck..

Thanks, John..

Thank you. Our next question comes from Joseph Feldman of Telsey Group. Your line is now open..

Hi, guys. Congratulations on the quarter. I wanted to ask a little bit about the competitive environment and what you’re seeing out there just from others.

And obviously with the strength that you guys have had, it seems like you’re taking share and just kind of curious as to where you think that’s coming from if it’s more independent or if it’s other big box type retailers or direct competition in this space?.

Hi, Joe. Good morning. This is Chris.

I think certainly as I’ve talked many times before, I feel the competitive environment is very robust ranging from I’ll say big box home centers across the country to original players operating both warehouse type formats as well as boutique formats and then going down to independent distributors as well as retailers that have had footholds in markets for in some cases decades and had great success.

So I feel that we are taking share. I feel that we are taking share in all areas of the country. I feel that our model and concept has been received quite well by consumers both professional customers as well as retail customers. I guess I would look at from a share standpoint of where do we feel that we’re taking share from? I think it’s parts of all.

I really feel that we compete well with every competitor in the value chain right now. We feel that against larger players with our level of success. We feel that’s a core differentiator for our company.

We feel that we can be very competitive on price where we need to be and we feel that the breadth of assortment gives us another point of differentiation versus anyone in the marketplace with clearly all of our products in country providing another substantial difference between us and many other players.

Again I think the competitive environment for our category is robust and very dynamic but we feel very good about our competitive positioning..

Got it. That’s great. Thanks.

And then I don’t know if you guys have ever shared it, but when you guys think about sort of the store plan for the long-term, do you guys have a target in mind and I apologize if I’ve just forgotten it, but I’ve always thought of it like a 400, 500 area stores at least sort of that nearer term goal but do you guys have a goal that you’re thinking about?.

I think what you’ve stated, Joe, is right on target with what we’re thinking as well. We feel that the success of the smaller footprint model gives us great excitement about where we can place it.

And certainly the early successes that we’ve seen in Washington DC and the continued success that we’ve seen in Chicago in an urban environment continues to give us great enthusiasm of where we can place our stores and have a great amount of success..

That’s great. Thanks. And if I could just sneak in one more. The debt level has definitely come down and you guys are generating nice free cash flow.

Should we think about that getting reduced even further or are you comfortable kind of where you’re at, at the moment?.

Hi, Joe. This is Kirk. Good morning. I would say we’re definitely comfortable with where we’re at. But as we said in the Q4 call two months ago, our plan is to pay down long-term debt by the end of the year to the neighborhood of about $15 million.

So currently as we noted we’re at about $27 million of long-term debt, a substantial reduction from last year and over the last couple of years. Our net debt right now is about $14 million when you factor in the cash balance. And by the end of the year, our total long-term debt should be around $15 million in that neighborhood..

Thank you. Our next question comes from the line of Peter Benedict of Baird. Your line is now open..

Hi, guys. It’s Matthew Larson on for Pete. Just wanted to first focus on the mature store reacceleration, I believe that was against a sequentially tougher mature store comp.

Is there anything that you’re doing kind of within this store to drive sales or was it more so on whether store remodels, new product additions, maybe progress with the Pro, just kind of speak to mature store trends..

Good morning, Matthew. This is Kirk. I’ll make a couple of comments and then if Chris wants to chime in, he can. You’re correct. Last year Q1 we really had an outsized comp of course and a big factor in that was an outsized mature store comp. We were very pleased with that result. And so we had a very difficult compare year-over-year in Q1 for our stores.

They’re over four years old. And so that I think – it was one of the things in Q1 of '17 here that was particularly pleasing. And I wouldn’t say it’s any one thing in particular.

I think it’s all the various strategic work that we’ve been doing around talent and training, the investments we’ve been making in talent and training, the focus on the Pro business as well as continuing to optimize our marketing spend.

I think all of those were primary factors in contributing to the overall result for Q1 but also the very favorable mature store result as well..

That’s great to hear. And then secondarily on the online business, it seems like you guys continue to see strong growth there.

Can you update us just on what percent of overall sales online is today? And then maybe share some color as to what you’re doing to enhance kind of capabilities and assortments online? And then also how you maybe think about pursuing larger categories outside of tile online over time?.

Good morning, Matthew. It’s Chris. As we’ve talked about before the Internet while growing significantly, we’re pleased with our overall online business, still remains a very small percentage of our total sales. The product assortment that we have online is identical to what we have in-store.

We certainly are looking at other ways of how we might want to expand that assortment over the course of time. But at this juncture, no change in strategy versus our store assortment versus our online assortment..

Okay, that’s great. Good luck, guys..

Thanks..

Thank you. Our next question comes from the line of Daniel Moore of CJS Securities. Your line is now open..

Thank you again. Just one follow up.

Looking at pavers as you mentioned, is that very just to the opportunistic category specific or is it maybe a precursor to a larger move into the outdoor patio and out-of-home categories?.

Hi, Daniel. This is Chris. I would look at the outdoor paver category as something that I feel that we can have success with. I’ve always felt that our products – many of our products right now, especially in the natural stone side, can be used outside right now.

We feel this is a category that’s had high interest from customers, direct feedback from customers about a category that they’re interested in and seeing here at the Tile Shop. So we’ve made an effort to source this product both domestically as well as internationally to bring into the stores in two different dimensions as well.

So we feel – certainly there’s a growing trend within home improvement to bring outdoor living to a year-around event for most homes regardless of their climate. And I feel that this is a natural extension of our business into a category that I feel that we can have great success over the course of time.

I wouldn’t necessarily view it as a precursor to all outdoor products but I do view this as a growing category for the industry and I feel that we’re in a leadership position of the assortment that we’re carrying here today..

Thank you. I’m showing no further questions at this time. I’d like to hand the call back over to Mr. Adam Hauser for any closing remarks..

Thank you for joining us on the call today. We look forward to chatting with many of you soon..

Ladies and gentlemen, thank you for participating in today’s conference. That does conclude today’s program. You may all disconnect. Everyone, have a great day..