Good morning, ladies and gentlemen, and welcome to the First Quarter 2019 Tile Shop Holdings 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] As a reminder, this call will be recorded.

I would now like to introduce your host for today's conference Mr. Ken Cooper with Investor Relations. You may begin..

Thank you, Catherine. Good morning to everyone on the call and welcome to the Tile Shop's first quarter earnings call. Joining me on today's call are Cabby Lolmaugh, our Chief Executive Officer; and Kirk Geadelmann, our Chief Financial Officer. Following our prepared remarks, the call will be opened for analyst questions.

Certain statements made during the call today constitute forward-looking statements made pursuant and within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995, as amended.

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 our earnings press release issued earlier and in our filings with the SEC.

The forward-looking statements made today are as of the date of this call and we do not undertake any obligation to update these forward-looking statements. Today's call will also include certain non-GAAP measurements. Please see our earnings release for a reconciliation of those non-GAAP financial measures.

With that, let me turn the call over to Cabby.

Cabby?.

Thanks, Ken, and good morning, everyone. While we continue to make good progress during the first quarter on many of our strategic initiatives, this progress was overshadowed by continued weakness in traffic trends in the quarter. During the quarter, we were able to complete all of the unfinished work outstanding for our 2018 strategic initiatives.

We also went live with two new systems in January, including our new ERP system on January 1 and our new website platform in mid-January. We believe this ERP upgrade gives us the ability to expand our business nationwide over the next 10 years and target 400 stores as our long-term opportunity.

I cannot be more proud of our store teams, our distribution center teams and our team here in the Plymouth, Minnesota office for how they handle these significant system upgrades. New systems do typically present some unique challenges and, in our case, this had a negative impact on our traffic, customer experience and sales during the quarter.

Initially, we experienced issues with our POS system functionality immediately after conversion on January 1. While most of these issues were fixed in January, we began to encounter some additional problems particularly with system speed and performance as our business picked up seasonally.

This impacted our customer checkout times in certain cases by a factor of up to 2 times longer. Our pro customers, many of whom frequent to our stores multiple times per week, are generally accustomed to a relatively quick checkout process.

Unfortunately, in some cases during the first quarter, we did not meet our pro's expectation for checkout speed, which we believe temporarily reduced our frequency of visits to our stores. Our retail customer experience was negatively impacted as well, particularly in January immediately after conversion.

This poor customer experience was reflected in our Net Promoter Scores in January. After reaching all-time highs in NPS during the fourth quarter of 2018, our scores dipped in January primarily due to challenges of new systems. Subsequent to January, we saw our NPS scores bounce back.

And by March, our NPS results were back close to the high levels we expect. Our action item here is continued performance tuning of our POS system. We've made some good improvements to-date and we are currently testing some additional enhancements that we hope to have in place in all stores in early May.

As we look forward to the remainder of 2019, our strategy will continue to be to deliver the best assortment, the best presentation and the best service in our industry. Our product assortment initiative is now complete, but it will remain our top priority as it is one of our key points of differentiation from competitors.

Our overall sales for the 2500 new products we've introduced over the last 15 months continue to climb with total sales for these products now representing a significant portion of our overall sales mix. Our results for the stone category continue to improve as well.

As a reminder, average selling prices for stone are typically about 2 times the ASPs for man-made products. So this should continue to provide nice support to our average ticket growth. Finally, we're very excited about the man-made ceramic and glass color collections we've recently introduced.

The last group of these new SKUs just arrived in the last few weeks and we expect them to be all in our stores by the end of May.

We're confident that no other competitor can come close to offering the choices that we now have available to present to our retail customer or designer and our other key pro-channel partners who often serve as key influencers for our retail customers. Let me now turn to traffic.

Getting traffic back to our historical levels for both pro and retail customers will continue to be one of our top priorities. Weak traffic during the quarter was driven by three factors. The first factor was our new website platform in ERP systems.

We estimate conversion to these new systems account for approximately one-third of our traffic decline during the quarter. Second, we estimate poor weather accounted for approximately one-third of our overall traffic decline during the quarter as it caused delays in the completion of customer projects.

When we looked at our comp performance by geography, it was very clear where weather had an impact. The past few quarters, our performance nationwide was fairly consistent. This was not the case in the first quarter.

In fact, our Southern store markets generally delivered positive comp sales growth with many in the double-digit positive range, while our Midwest and Northeast store markets generally delivered negative comp sales growth during the quarter.

Another important data point is that our open sales order balance at the end of March was approximately 20% higher than last year. We are in order business not a transactional business like some of our other competitors.

So our sales results are a function not only of open orders created but also of how many of these orders we are able to close and deliver. Many of our pro customers simply hadn't been ready to pick up their orders yet due to project delays caused by unseasonal weather.

If our open order balance would have been more in line with normal levels at the end of March, we would have ended up much closer to our estimated sales range for the first quarter.

Our action item here is to proactively schedule pickup or delivery for outstanding sales orders and coordinate with these pros to ensure that they know their tile and installation materials are ready to go. It's important to note that we don't have a formal policy forcing pro customers to pick-up within the specified time duration.

It's a value proposition that our customers really appreciate, and this is a great example of our industry-leading customer service. The third factor was our decision not to reallocate approximately $1 million in traditional media that we spent last year.

We felt there was so much going on in our stores with final product assortment still arriving, store remerchandising and new fixtures being completed and system upgrades appearing that to put those media dollars into play would not have delivered the return we expect. We are considering using these dollars through the remainder of 2019.

In addition, our recent retail brand marketing efforts have been dedicated primarily to higher end and premium brand building initiatives such as new product catalogs and ads and high-end design magazines.

This work has been very content intensive and took some time to implement as we had to internally develop all the exclusive content required to enable this strategy.

We intend to continue this work as we believe our core retail customer typically takes extensive time to carefully research our project because her investment is greater and she views it as something that will last for decades.

At the same time, we believe we can supplement this work with the addition of retail marketing targeted to customers with slightly lower household income.

This is based upon some recent analysis we completed using our new CRM tools, which have provided us with greater insight on our retail customer segmentation as well as recent traffic and sales trends for these customer segments. Now keep in mind, this data did not exist prior to last year's investment.

Based upon this data, we are in the process of adjusting our media mix accordingly. Perhaps most importantly, we believe our new CRM tools have helped confirm great product selection and excellent service are the top two most important value considerations for our core retail customers.

We believe with all the investments we've recently made in product and service, we are very well positioned to appeal to a wide range of pro and retail customers. Over the next several quarters, we intend to invest more in various forms of marketing to drive more immediate results and drive better retail customer traffic.

Kirk will discuss some of the implications of these investments and how we intend to fund this marketing expense in a few minutes. Our third top priority continues to be ensuring we have the best product presentation in our stores and on our website. During the first quarter, we installed extensive new merchandise fixtures in 64 stores.

This work will be 100% complete with all stores having the new fixtures by mid-May. At that point, we can finally say we're fully showcasing all 2500 new products that have recently entered our assortment.

We've seen some good improvement in customer conversion and we believe the investments we've made in merchandising have certainly contributed to these improved conversion results.

Finally, our new website platform now does a great job of presenting our product in a more effective and efficient manner, making the research and overall shopping experience for our customers much easier and more fun. The images and content on our website are powerful and very consistent with our in-store signage and our brand marketing messaging.

Our ultimate objective is to inspire our customers through a seamless experience whether she is opening over new product catalogs, researching your project on our website or shopping in one of our stores. Our fourth top priority is service.

During 2018, we made substantial investments in both store and distribution center compensation, regional sales leadership and new pro market managers. Our primary goal in 2019 is to fully leverage all these investments and generate return.

I continue to work closely with our operations team to focus on sales excellence, increased traffic and improved conversion. As I mentioned, we are seeing some good improvement in conversion and we will work hard to ensure that continues. Our fifth top priority is store unit growth.

Our current expectation is that the majority of our new store openings over the next two to three years will continue to be in existing markets. Our regional sales leaders, trained support team and store talent pipeline have us well positioned.

We finalized our real estate plans for the year and now expect to open six stores, one of which is a relocation. So we expect to end the year with 145 stores. Our focus is now on 2020 and beyond. I'll now turn the call over to Kirk who will take you through some of the financial details.

Kirk?.

Thanks, Cabby. Good morning, everyone. As Cabby mentioned, weak traffic trends were the primary reason for our comp sales decline of 4.2%.

Generating positive comp store sales growth is critical for us to achieve our plans for 2019 as well as begin to make some progress on our long-term objectives of 20% adjusted EBITDA margin and 20% return on capital employed. We remain optimistic that we are on the right path.

Although we fell short of our comp sales expectations during the quarter, we believe we are well-positioned for this to bounce back relatively quickly. As Cabby mentioned, it was an extremely busy quarter with several significant company initiatives either being implemented or wrapping up.

This was combined with weather factors that affected our ability to close out orders. We feel like we're close to hitting our stride and having a stable business as it relates to things we can't control. Nearly all of our new products is now in our stores.

Our stores are looking great with the new merchandising fixtures, signage and end caps, and we appear to be past the toughest parts of each of our system upgrades. Finally, we have a strong sales team who are laser-focused on providing excellent customer service and converting sales.

We believe the winning formula for mid-single-digit comp sales will be growing our pro traffic and sales, growing our retail traffic and sales with our more affluent customer who is doing a large-sized project, and growing our retail traffic and sales for moderately affluent customers doing a mid-sized project.

From an industry perspective, mid-sized projects and large-sized projects make up approximately 70% of sales and 85% of the total annual industry profit. This is our sweet spot. Small projects comprise 30% of industry sales and 15% of total industry profit. We will continue to serve this group as well.

Our 6000 tile SKU assortment, which now covers the entire spectrum of good, better, best options, positions us to deliver for all types of customers and project sizes. I'd now like to provide a brief overview of our first quarter financial performance and update our current outlook for 2019. Net sales of $86.9 million were down 4.6% year-over-year.

Comparable store sales decreased 4.2% in the quarter driven by weak traffic. As Cabby mentioned, we generally experienced much better sales results in our Southern store markets. These markets were less impacted by poor weather conditions. Gross profit was $61.8 million for the first quarter of 2019, a 3.3% decrease over the same quarter of last year.

Gross margin of 71.2% continued to increase sequentially. The year-over-year improvement of approximately 90 basis points from the first quarter of last year was primarily the result of higher pricing on new products that have entered the assortment. We expect to deliver a gross margin rate in the 70% range going forward.

Our selling, general and administrative costs for the quarter were $58.9 million. Depreciation expense increased $1 million from the first quarter of 2018. First quarter SG&A expense also included approximately $2.5 million of extra expense related to the implementation of our new enterprise resource planning system.

These expenses were mostly offset by a $0.8 million reduction in advertising expense and $1.6 million in more variable expenses, including shipping and transportation costs. We concluded the quarter with 140 stores. In January, we closed one store in Kansas City, that was at the end of its lease, and we opened one store in Chantilly, Virginia.

Adjusted EBITDA with $11.6 million in the first quarter. Adjusted EBITDA margin was 13.4%, a 170 basis point decline compared to last year during the first quarter. Net income for the first quarter was $1.3 million and earnings per share was $0.03. Turning to our balance sheet.

We ended the quarter with $7.9 million of cash and $50 million of long-term debt. Our debt decreased approximately $3 million from the fourth quarter due to improved operating cash flow. Inventory of $110.8 million increased by approximately $0.7 million from the fourth quarter or 0.6%.

We expect inventory levels will begin to normalize as we move through 2019. We have a nice opportunity to leverage some of the new tools available with our new ERP system.

These tools will enable us to better optimize our inventory levels and receipts flow, communicate more effectively with key suppliers and reduce our inventory investment while maintaining an industry-leading assortment and good in-stock levels.

Capital expenditures were approximately $12.2 million during the first quarter primarily related to store merchandising, new store opening and technology investments. We expect our level of capital investment to moderate for the remainder of 2019 as we continue to expect approximately $25 million in CapEx for the year.

In addition to a normalization of inventory and capital spending levels, we also believe we have the opportunity to reduce our SG&A slightly below the current run rate, while we work to improve our traffic trends.

Based upon some activities we've been working on over the last nine months, including our in-house trucking strategy, we have identified some good G&A savings opportunities that we plan to execute over the remainder of 2019.

A portion of these savings will enable us to make the additional investments in retail marketing initiatives that Cabby just mentioned with the primary goal of improving retail customer traffic.

We believe our current pro customer marketing strategy is very sound based upon our 2018 results and sequential improvement in pro sales we experienced over the course of last year. Our new CRM tools will help us ensure this additional retail customer investment is targeted, and we believe we should be able to generate a good return in the near-term.

One last update regarding our ERP upgrade. While we are still completing our assessment on the effectiveness of our internal controls over financial reporting as of March 31, 2019, we expect to report two material weaknesses in internal controls over financial reporting arising from the ERP implementation on January 1.

We also expect the remediation of the material weaknesses will be completed prior to the end of fiscal 2019. Moving to our long-term outlook. Our internal long-term target for comps continues to be mid-single-digit sales growth.

If we are able to sustain sales growth at those levels we believe we will achieve our ROCE and adjusted EBITDA margin goals within the next several years.

Over the last 12 months we believe we've made all the necessary strategic expense, inventory and capital investments that we needed to be highly competitive and to serve our pro and retail customers at a very high level. Finally, our board has authorized a $15 million dollar share repurchase program.

We believe the combination of a share repurchase program and the dividend we established a few years ago will provide us with a nice set of tools to help us maximize shareholder return over the remainder of 2019 and beyond. With that information, Catherine, we are now ready to take questions..

Thank you. [Operator Instructions] And our first question comes from Geoff Small with Citi. Your line is open..

Hello, Geoff. Good morning..

Move past the European website issues. So you mentioned in the prepared remarks today, those were persistent headwind through the quarter.

Can you help us understand how traffic evolves through the first quarter? What you're now seeing early in the second quarter? And what gives you confidence that trend will in fact improve through the year?.

Hey, Geoff, this is Cabby. I missed the first part of your question. There must have been a mute issue there. But cut to the second half, and talking about traffic after our ERP implementation, yes, when we first launched it that was the most significant impact we saw through January. It was a battle with weather and the ERP implementation.

Now we did see traffic improve sequentially through Q1 into February and into the March. We're happy of the trend that we're seeing in traffic as our systems continue to be improved day by day. So we're confident where it's going and what we're going to see in Q2..

I think the only other thing I'd add, Geoff -- good morning -- is that it's still generally pretty weak though. While we think we're past the biggest challenges Cabby just said with the systems in January, our biggest opportunity here is to first reaccelerate the frequency of our visits with our pro customers.

We felt that throughout last year between Q2, Q3 and Q4, we really saw some nice progress with pro sales growth and pro traffic. And it decelerated in Q1 due to some of the challenges that we talked about in our opening remarks and also in Cabby's comments here. So, the first order of business is to increase the frequency with our pros.

And that's where the -- we're still not happy with the system speed and performance, we're still doing some additional work as Cabby said. And that goes hand-in-hand with reaccelerating that pro traffic..

Understood. That's helpful.

And regarding the share buyback authorization, can you help us understand that decision? Why that's the right to use the cash rather than debt pay down or capital preservation in light of the sales challenges you're seeing?.

Well, we think we have a very good strategy in place, and we certainly have done a tremendous amount of work over the last 15 months. We sort of feel like we've done several years worth of work in about a year time frame and work. We're confident that these things will pay off over the long-term.

So we feel like we might have a good investment opportunity here with the share repurchase program..

Understood. Thanks again guys, and best of luck in the second quarter..

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

Good morning. Thanks for taking the questions. Maybe just talk, Kirk, about -- and Cabby -- a little bit about your ability and confidence to evaluate and measure the returns and effectiveness of all the store refurbishments and more specifically the new SKUs given the ERP implementation challenges.

I guess, as you look out over the next six to 12 months, what's your confidence that you're going to be able to know what's working, what isn't and what's ERP, what's weather, et cetera, et cetera?.

Good morning, Daniel. Yes, we monitor pretty much everything especially when it comes to the new SKU counts in our stores and how they perform. And we've been pretty excited with how the new SKUs are adding to our sales mix month in and month out. As we continue to give some tenure to these SKUs, we see them improving.

So when we monitor the new SKU count, it gives us the ability to change direction on what customers are after and how the trends are changing. When it comes to remodels and updating our stores, especially with the remerchandising that we put in all the stores, we see conversion going up.

And that's something that we can tell is working for our customers. They can come in and see all of the SKUs at one time and really see that the Tile Shop is the place to go when it comes to assortment. So, we're pretty excited when we see the results. Once those pop-ins hit the stores, you can see the immediate impact..

Okay.

And can you give any specificity in terms of the issues, challenges with regard to checkout times in metrics around those? How much do they increase? How much does that come back down now that some of these issues have been handled when we get back to normal?.

I think the best way to measure that, Dan, is in terms of the time for checkout for pros, and Cabby indicated that in his opening remarks. I mean, if we have a retail customer that we're checking out and typically it's a pretty complex transaction, whether it's a retail customer or a pro.

But if she is working with one of our sales and design staffs and she might have 15, 20, 25 lines on her order, she has been into the store several times, she has probably spent six, seven hours working with some of our people.

So when she is at checkout and she is ready to do the main part of her purchase transaction, she is probably not picking it up at that time and that's probably a later time where pro will probably pick that up for her or maybe her husband. If it's a little longer for her, she doesn't really notice it too much. And we did see a dip in January for sure.

In January, even our retail customers were frustrated at times with some of the system stuff going on, but it improved throughout the quarter. And so retail customers by the time we got to the end of the quarter, we were sort of back to normal from a retail customer satisfaction perspective.

But our pros know -- our pros are in the stores three, five, 10 times a week sometimes, and they have -- they're a little frustrated when it takes them longer. And so, while we don't think that we certainly didn't lost any pros permanently due to new systems, their frequency went down a little bit in the quarter, and we can understand that.

We got it worked to get our system speed back down or back up to normal high levels of speed, and then we think that frequency will increase. And on top of that, Daniel, we monitor our NPS scores and we saw that as in January was the biggest impact.

Now we worked seamlessly through February and March to add enhancements to pick up the speed for our customers, and we saw that feedback. And we're continuing to tune the system to get more and more speed. And so, we saw where it went and then where it is now.

And as I mentioned in my comments of NPS scores and how they came right back to where we were in Q4, we believe we're close. Like I said, there's still work to do..

Okay. And any -- I guess obviously can you give us granularity in terms of time, but where we are in the process of getting those speed back to normal. Is that a -- are we back to normal by the end of Q2? Is it a longer term issue? Just help us understand that..

We've tested some things here in a few stores over the last week. We're going to test a market here in the next week. And if everything goes according to plan, we should have all stores up and running with a little bit of -- not a little bit, hopefully a lot of speed improvement by mid-May. That's our goal..

Helpful. And lastly from me and I'll jump back in. Mid-single-digit comps are still the goal obviously. Is that something that's realistic in Q2, and if not what time frame is reasonable given comps are more normal and maybe not as easy as you look at the back half the year..

I don't want to get into any specifics by quarter but we still feel that you know we're well positioned to have a solid year the rest of the year. Obviously others got to improve here and systems have been improving and we're, we feel like we're close to being back to where we want to be with that..

I'll jump back in thank you..

Alright thanks Dan..

Thank you. And our next question comes from Joseph Feldman with Telsey. Your line is open..

Yeah. Hi, guys. Thanks for taking my questions. Wanted to -- just to begin. So, I understand the comments on the traffic is still not quite where you'd like it to be.

But just to be clear, I guess what changed from mid-February when you guys had reported fourth quarter and you guys had indicated that the trends had improved, even the Net Promoter Scores were even picking up at that point. And yet -- and I think we at that time we were targeting more like that low-single-digit comp.

Did something change in the second half of the quarter than -- and our comps actually back to positive right now in April?.

Hi, Joe, this is Cabby. Thanks for the question. Yeah, it was -- when we did our Q4 earnings call, we had overcome a lot of big hurdles when we first launched our ERP, and we felt that things were getting back to normal. But as these ERP things unwind, you run into new issues and some lingering ones.

What happened as our business increased seasonally, I mean we get really busy in February and March. The system speed really hurt us, I believe. And and I think that was after our Q4 call. And so, we found some new issues that were impacting.

And then on top of that, weather did not improve in the Midwest and Northeast, so we continued to battle store closures and the system speed. So, where we were at that call and what we figured out the next few months, it was all new to us..

Yeah. Joe, the only thing I would add is, if we only would have just had our order bank back to normal levels, Cabby mentioned in his opening remarks that it was about 20% higher from the prior year. If it would have been in line with historical levels, we would have been very close to our estimated range for the quarter..

Got it. That's helpful. Thanks guys. And then, if I could just follow up with one other one, just on the SG&A, wanted to better understand you guys -- I understand the ERP expenses and the web platform and all the expense related to that, and you also had that offset of the $1 million reduction in ad spending.

I guess how should we think about it going forward, because I think is there still some ERP expenses that we'll see in the second and third quarters here or is that all just kind of behind us at this point?.

It's certainly possible, Joe. And I think the G&A savings that I talked about, our intention is that that savings will fund any additional marketing investment that we feel like we can get a good return on, particularly with mid-sized project retail customers. That's really our target. That's where we need the most improvement.

And then also, it will fund any additional ERP expenses that are necessary, because our main goal is getting our traffic back to good levels and both the marketing investment as well as any additional necessary investment in systems are both important for that..

Got it. And then, if I could just sneak one more in, any comment -- additional comment you can make about the material weakness. I know what you said in the prepared remarks and in the press release, but I guess what -- how did that occur in the first place where you guys had those two issues come up.

Is there anything that you, I guess, could have done differently and it sounds like you'll have it kind of remediated quite soon, but just wanted to clarify that?.

Yeah. Nothing really additional to add. I mean, just things didn't go exactly as planned. And we have some things to improve from a control perspective. In the last month or two, we did some additional work working with our auditors to get comfortable with our numbers. And hopefully we'll have the control improvements in place relatively soon.

That's our goal..

Okay. Thanks, guys. Good luck with this quarter..

Thanks, Joe..

Thank you..

Thank you. And our next question comes from Justin Kleber with Baird. Your line is open..

Hey, guys. It's Justin Kleber. Thanks for taking the question. Wanted to first ask about just pricing online. It's been about a year since you made the decision to remove pricing on the site.

Looking back, is that -- do you think that's been the right strategy or any of these traffic -- store traffic challenges related to pulling price from the website, maybe just providing feedback you've gotten from customers on that decision?.

Hey, Justin, this is Cabby. Good question. The answer is, absolutely the right decision to pull pricing. Our customer -- our targeted core customer is someone who is more aspirational who is going to come to our stores. And we feel that we've done very well targeting that core customer and the metrics that we see.

When you look at how people are driven to our stores, it's by our pro customer mainly. And then we also work on driving people through our website obviously, but they're going there to get inspiration. And the people that were there looking for pricing, that's what we targeted a few years back with all of our price promotions.

And we realized quickly that was not our strategy. So, no, I believe it was the right decision to pull pricing off the website..

Okay. Thanks for that, Cabby. Kirk, you mentioned again just in the Q&A that the order balance being up 20% at the end of the quarter.

I guess where does that typically sit at quarter end? Can you help us out there just trying to get a sense as to what the recognition of that revenue could potentially mean for the second quarter?.

Yeah, it was definitely heightened. I don't want to give a specific number, Justin. But as I said, if we were to add that in line with normal levels, we would have been pretty close to our original estimated range for the quarter that we gave back 60 days ago.

And we think that largely is weather-related as we're looking at -- Cabby gave some pretty good color on sales results by geography, and it was really kind of the most notable differential between geographical markets that we've seen as we've looked at our quarterly results over the last four or five years.

And that goes for the open order balances as well. We had higher -- certainly higher year-over-year order balances by market in the Northeast and the upper Midwest. And I mean, it is what it is. If pro projects are delayed, we're not going to force them to pick their stuff up.

We can proactively work with them and try to coordinate, scheduling and pick-up and things like that, but sometimes our pros just aren't ready to pick it up. And I think that was part of it..

Okay. Now that makes sense. Last question I had just on the transportation cost decline you called out related to the new outbound trucking strategy that you implemented last year. Is that something that you're doing in all markets? Is it a test? Can you just maybe provide a little bit more color on what's going on with that? Thank you..

Yes. Sure, Justin, I can do that. It's not in all markets but our biggest markets and our biggest DCs are where we deployed that. And generally those markets are also busier from a demand perspective.

And going back to early last year, we were not only seeing increased costs for shipments between our DCs and stores primarily like many retailers have talked about over the last year in particular, but we were also unfortunately experiencing some drop shipments as well.

And while trying to search for the best and most efficient route and provider for that route, certain providers were getting bids that were significantly higher and at the last minute we would lose that service. And it would result in some customer disappoints.

So it was both a customer service opportunity to take some of this activity in-house, but it was also a cost savings opportunity as well. And we started talking about it, I think, back in -- maybe even Q3 but for sure in Q4, and Q4 is really when we started to see a little bit of benefit.

And then, obviously here in Q1, we saw some good benefit as well. So, we feel like we should be able to see that continue..

Okay. Thanks, guys. Best of luck going forward..

Thank you. And our next question comes from John Baugh with Stifel. Your line is open..

Thanks. Good morning. I apologize I joined late. So, you may have answered these.

Again, apologies, but did you address gross margin outlook for the year? And are there any tariff implications embedded in your inventory or your outlook?.

Good morning, John. We did. In my comments, I articulated that we expect approximately 70% gross margins going forward. We feel good about our sourcing strategy that we've been working on. We feel very good about our inventory position. And we've been doing some price changes here and there as well.

So, we continue to feel good about that 70%, and we don't believe that tariffs will have a very big impact for us going forward. We think we're well-positioned..

Okay. And again, apologies if you have addressed it, but when you look at Q1 and/or April trends, is there a way to -- I don't know -- separate the weather issues, which could be the cold stuff we had in the Midwest or maybe there are some tough comparisons still in Texas with hurricanes. Obviously you had ERP challenges. So there's an impact there.

And then, from what you think the overall consumer is doing, certainly it sounds to us like the consumer was very weak in January and February, but has picked up subsequently to that.

Is there any way to discern or break apart those or is it just too cloud because you had ERP challenges?.

John, there is so many variables in play this quarter. I can't imagine any more that we could have experienced. But we did try to quantify it as best we could. And again, to boil it down to very simple terms, I think the impacts were largely on traffic. So let's just start with that being the primary opportunity we have going forward.

And to the extent that our traffic was negative year-over-year, we're not going to offer a specific number necessarily but that's the main factor. About a third of the traffic decline to the best of our ability we estimate was weather. About a third of the traffic decline we estimate was new systems.

And then the rest, I think, is just customer mix changing and, as you said, some softness potentially in consumer spending. And on that piece, we really need to just get after certain retail customer segments and do a little bit different strategy to make sure we get our share of their traffic.

And that's what we tried to explain in some of Cabby's remarks..

And is there any way on the competitive front, I'm thinking particularly at Depot and Lowe's, there seem to be a little bit of a slugfest in flooring, along with flooring decor of how you're seeing the behavior. You mentioned your pro business was weak even since your ERPs improved. It's still not the traffic you want to see on pro.

Is that self-inflicted totally and do you think that will recover or do you think there's some kind of spillover from the ongoing battles in your competition? Thank you..

Thanks, John. It's an excellent question. I know -- because we saw such good improvement with our pro traffic and sales last year, and in Q4 it was the highest we saw all year along.

And we think it was that improvement directly tied to launching our pro rewards program, launching our pro market manager strategy, continuing to increase the number and the quality of pro events.

And then obviously having all this new great product in and the designers in particular really have given us some incredible feedback on the new product assortment. We think those things are all still intact.

And any deceleration in pro traffic and sales we saw, and it was still positive year-over-year in terms of sales growth for pros, but it certainly decelerated. We think the main factors there are really related to weather and systems, and weather has got to improve here. And I think -- we think it has, to some extent at least.

And systems is getting better and better, but we've still got some things we need to work on. So, once we get to that point where we're good, we should you know get all those pros back. And I think those foundational elements for our pro strategy that we put in place last year should continue to help propel that part of the business..

Thank you. Our next question comes from Anthony Chukumba with Loop Capital. Your line is open..

Good morning and thanks for taking my question. So, I just had a question on the decision to pull back a bit on advertising year-over-year, the $1 million that you mentioned. I guess I'm just trying to understand the thought process there given the fact that traffic has been a challenge for quite some time.

Just kind of what you're thinking what's there in terms of pulling back on that. Thanks..

Hey, Anthony. It's Cabby. Good question. As our strategy continued to change from promotional and going back to our core customer and going back to the pro and our brand marketing efforts, it shifted strategy and where the buckets of spend fell. So, what we did is, in my remarks, we went after different medias high-end design magazines.

We invested into some of the internal operations here to do the work ourselves, so photo studios and things like that and saving some of that money is something we felt was the best way when we knew everything that was going on in Q1, with the website, with the ERP, with the pop-ins going in, with the new products arriving.

It was kind of a chaotic quarter for us. So we decided as our strategy that was with intent, and I believe we wouldn't have gotten the best return on that investment through Q1..

Okay. That's helpful, that makes sense.

And then, I guess I just want to understand obviously you spent a lot of time talking about the weather and talking about the fact that that point-of-sale system was sort of slow, and that could be impacted sales particularly with pros, I'm just trying to understand how did the ERP system, like how does that contribute to that? Like in other words like why were the ERP -- how did these problems in mainly ERP, how did that affect other parts of this? I'm just trying to make sure I completely understand that.

Thank you..

Well, Anthony, our POS is a subcomponent of ERP, so it's a fully integrated system, including POS and all other aspects of our business. But the POS functionality was the place that we were having the most challenges as we flip to the new system on January 1st..

Got it. That's very helpful. Thank you..

You're welcome, Anthony. Thanks..

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

Hey. Good morning, everyone. I wanted to ask a strategic question just around, as you said, some of -- maybe you lost some pro business in the quarter. So, I guess, it's interesting to me that the gross margin was exceptionally strong, in fact looking back, it was the best gross margin you've reported in six years.

And so, why wasn't there a decision made to maybe give discounts to pros in order to retain that business? And thinking about this forward, you lose some of the business that is hard to get them back.

So, is there a consideration that maybe you have to give discounts to get people to come back in and regain their trust?.

Hey Peter, this is Cabby. Yes, I believe knowing that our new pro loyalty program has positioned us very well to continue to give discounts and increased discounts to our best pro customers, while also making other pros attain those discounts. Now pros always are going to get discounts with the Tile Shop, they always have.

But when we launched our new pro rewards program, it was more structured. And what that did was, it enabled us to really fall into buckets what pros deserved what discount. And I believe that has helped our gross margin and will continue to help our gross margin going forward..

I guess, Cabby, with that structure though, why not give someone an extra 5% when they're standing at the checkout for 15 minutes and getting frustrated? I just don't -- I'm concerned that you're going to have trouble getting these people back in with marketing.

I think you have to give -- I personally think you'll have to give them discounts, further discounts to win them back.

Where am I correct in that thinking?.

No, you're absolutely right, Peter. And our store managers and sales staff have the autonomy to do whatever it takes to make sure that pro is happy. Now, you can give them an extra 5%, 10% off, which we did in many cases, to make sure that they understood we knew that we were frustrating them at that point.

But it's also, you can give all the money away, it's not going to take care of that pro relationship. What we want to do is make sure they were taken care of at that point. But we did see maybe some less frequent visits for the small items.

If they knew we were suffering from a system issue at that point, they may have gone somewhere else to get a bag [Indiscernible] of a bag of grout. So, but we -- they're back as we monitor our pro sales mix and our growth in that segment. But no, absolutely right.

We made sure our pros, if they're in front of us and they were having problems, we did everything we could to make sure they were happy. I'm a big proponent of given the sponge, given the bucket, given the 5% off, whatever it takes to make sure that they know we understand their frustration, and they're going to come back..

Okay. Thank you. And then I guess I'm still a little confused at maybe some of the comments that Kirk was making. So, I guess, the order amounts you have on the books, pros have not come to pick those up because of the weather challenges/delays in the quarter.

Am I interpreting those comments correctly?.

Yeah that's right Peter. That's a that's our best guess. I mean....

Okay..

And we have height in the order banks particularly in markets like the Twin Cities here, Minneapolis-St. Paul, where we set a record for snow in March. And that's just our guess, that's got to be part of the factor.

We've had some anecdotal feedback from many pros that their projects have been delayed particularly in the cold weather markets like Minneapolis, St. Paul, Chicago, Detroit in particular..

Okay.

And then, does that -- if you're saying you would have probably hit your guidance with all of that had been collected, doesn't that support a strong start here in April or a shift of sales into Q2?.

We don't want to get into specifics on April or Q2, but again I think a big part of it for us is going to be able to get our systems back to where they need to be. And if we can do that and everything else cooperates, things we can't control largely, obviously there's other things going on with macro, and we should be able to see some improvement.

That's our goal for sure..

Okay.

And maybe just -- I'm going to ask this again from someone else, but seeing that improvement, when do you think it's going to show up in Q2 where you're kind of back to a normalized positive comp or do we have to wait till back half a year now for some of the marketing to kick in and the ERP issue to settle down?.

Peter, I just don't want to get into specifics about Q2. I mean, we're trying to deal with all the variables that we had in Q1, and certainly our goal internally is to get back to mid-single-digit comps. And we're going to work very, very hard to do that as fast as we can..

Okay. Thank you very much, guys..

Thanks, Peter..

Thank you. And our next question comes from Daniel Moore with CJS Securities. Your line is open..

Thank you. Sorry to kind of pick at this one last question as it relates to that open order book. Is there any penalties for the pros for canceling? I guess my question is, how do you -- you mentioned it's your best guess, Kirk.

How do you know that they didn't go somewhere else to put all those orders given some of the customer service challenges?.

Daniel, this is Cabby. Good question. There is no penalty for canceling order, but our store managers and sales associates are in tune with every order they have on the books. So there is constant communication and -- about timelines, deliveries, and the feedback we've gotten is that they are waiting.

A lot of them have closed out, but a lot of them continue to sit. And as we have transitioned more and more to a pro business, we've seen larger individual orders that have skewed a store's open order bank. We're getting bigger and bigger orders more commercial jobs that we've never seen before.

So, I think that has also had an impact to these large orders sitting is that they're big jobs. They're not just a residential home. So that's part of the reason as well..

Got it. Thank you..

Thank you and I'm showing no further questions. I'd like to turn the call back to Mr. Ken Cooper for closing remarks..

Thanks for listening to our earnings conference call. We are looking forward to seeing many of you while we're on the road in May and June and in providing our next update in July. Thank you for your interest in Tile Shop and have a great day..

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day..