TTS: Reflections on Q1 2015

Hi all,

My notes on Q1 2015 for TTS are appended below. Hope some of this is useful and may be it will spur some interesting discussion. This is a long post, so if you don’t care for the details, consider the top level summary and the concluding remarks.

This is an interesting one for me - not really the quality company I like to hold, but its a simple business that if executed at even modest competency levels should yield decent results. Couple that with high short interest, high insider stake, and we have a good recipe for stock price appreciation. We got a 18% pop today on earnings release. Go figure.

Of course, as always, please read anything that I say or write with great caution.

Cheers,

Anirban

Earnings release: http://investors.tileshop.com/phoenix.zhtml?c=241568&p=i…

Transcript: http://seekingalpha.com/article/3086166-tile-shop-holdings-t…

Quick Q1 2015 Takeaways

o TTS has 109 locations in 31 states. As discussed in the Q4 2014 call, management has decided to take it slow and steady for this year, taking time to address staffing, branding, and advertising before increasing the pace of store growth. The company opened two new stores in Q1 2015 both in new markets.

o Net sales grew 13.3% to $73M up from $64.4M in Q1 2014.

o Gross profit margins remain high at 69.9%.

o Comparable store sales growth for Q1 15 was solidly back in the black showing 4.5% growth. About $2.9M of the sales growth came from same store sales growth from the comparable base, while about $5.7M came from stores previously not in the comp base. In my Q4 2014 (FY) notes, I had noted the following with respect to the -0.4% same store sales growth compared with the revenue growth of 12%:
“So, this essentially says that the revenue growth came all because of new store openings. It also says that 2013 was a good year and 2014 was a bad year, which means the comps for 2015 are with respect to a weaker set of numbers. 2013 benefitted from strong home sales growth, while, 2014 was hurt by a decline in home sales growth and other macro-economic factors.”
Good to see the thinking coming through this quarter! Management did indicate that the comps growth was mostly via traffic growth although there was a nice uptick in the sales ticket as well.

o Non-GAAP net income was $4M versus $4.4M in Q1 14; non-GAAP eps was $0.08 versus $0.09 in the prior quarter.

o Adjusted EBITDA grew to $14.6M up 6% versus Q1 14. Margin improvement of 100 to 200 bps is expected in 2015.

o As of 31 March 2015, TTS had $9M cash, up from about $5.8M in Q4 14, and $73.7M long-term debt down from $88.5M in the preceding quarter. The company paid down $18M of debt this quarter. They had about $35M available under their long-term borrowing facility.

Notes from Conference Call

In the Q4 2014 conference call, CEO Chris Homeister stressed on management’s three pillars for the next phase of TTS’ growth. The three pillars were”:
(1) Training and retention of sales staff,
(2) Growing the professional customer segment, and
(3) Sustainable store opening plan.
This quarter, we got an update on the company’s progress. Here are the key points, and I though all of these augur well for the future of TTS.
Homeister noted that stores led by ‘market managers’ outperformed the other stores in the chain, with respect to same store sales growth and staff turnover numbers. One market manager manages multiple stores. Average store manager tenure went up to the highest levels since 2012. These ‘market managers’ are developing talent for taking on future market manager roles when the store rollout gathers pace. This seems like an obvious initiative but it appears the previous management led by the founder CEO focussed on store growth and took his eyes off the issues with making new stores successful. TTS plan stop have the entire chain covered by ‘market managers’ by the end of 2015; they anticipate needing another 5 to 8 ‘market managers’ to cover their entire store base. The pause in store growth over 2015 should help TTS with store growth in 2016 and beyond.

With respect to the professional customer segment, the CEO noted that this segment grew much faster than the rest of the business. No numbers were specifically given so I ‘m guess this growth is really off a small base. Management believes this segment can be a meaningful driver of growth. If this does work well, it will be great as growth will be squeezed out from existing stores alleviating the need for a rapid expansion of store footprint.

The company has also focussed on advertising to drive foot traffic and online traffic. They allocated marketing dollars to a subset of 2013 and 2014 stores and it appears this can meaningfully driven sales growth. Online sales went up by double digits with respect to Q1 2014.

It also appears inventory management has improved. Overall, inventory was down 4% from Q1 2014 levels. When looked in concert with the fact that store count has increased 17% since Q1 14, this is good, provided inventory levels are strong enough to support demand (which management claims is the case).

The COO gave us a bit more colour on the store level growth. Some details:

  • 2013 stores that have been open for about 1.7 years had mid teens comparable store sales growth. Sequentially, these stores had about a 20% increase in sales from Q4 to Q1, while stores that opened in 2012 or earlier had sales growth of about 12%.
  • 2014 sores except those that opened in Q4 14 experienced sequential sales increase of 36% from Q4 to Q1, with all outpacing the more mature stores.
    Further, in response to a question in the call, CFO Kirk Geadelmann noted that ideally they want to be at $1.8M/year sales volume for a store, a little less if its in a new market. He did note that the 2013 stores are getting there but there’s some work to be done on the 2014 group. I guess the data suggests that the new stores are getting there in terms of reaching a steady state of sales volume and it could be that this ‘good’ bump was partially a byproduct of advertising dollars allocated to some of the 2013/2014 stores plus staffing improvements made by the management team. Overall, this looked encouraging to me, and taking the pedal of the store growth to stabilise the sales volume makes a lot of sense.

The call also had some discussion around store size and capital expenditure management. It looks like TTS is honing in on the 16,000 to 18,000 square foot range, which require about $1.4M to open, and some of the early stores in this size are doing very well.

Advertising spend is expected to stay around the 3% of sales levels. However, they do continue to look at better use of the advertising dollars.

Guidance for the Remainder of 2015

The company reiterated their 2015 guidance. Only one new store is to be opened in Q2. However, management added a hint that may be Q2 will also be good. They noted that Q2 is historically their biggest quarter, so they should have much better clarity on 2015 once Q2 is done. I think management is simply being conservative.

I would expect to see a bump in guidance after Q2 is released :wink: In response to a question in the call, the CEO noted that things look good right until mid-April. However, in response to another question, he did acknowledge that Q1 2015 was easy for comps because year ago was just bad. So they are taking a cautious wait and see approach until the more data become available. Anyways, till then, here’s a reminder on the guidance:
o Revenue b/w $275M and $290M. At mid-point, this represents about 9.7% revenue growth.
o They expect low single digit comparable store sales growth.
o Gross margin is expected to be b/w 69 and 70%, so more or less inline with 2014.
o Non-GAAP EPS is expected to be b/w $0.27 and $0.33, so a wide range representing b/w 17% and 43% YoY growth. At mid-point, this represents about a 30% YoY growth.
o They expect to open b/w 8 and 10 stores in 2015.

Valuation and Concluding Remarks

The strong quarter gave TTS shares a solid boast today. I suspect some of that was short covering. I haven’t seen any insider sales yet; these are the guys who were buying lots when the shares were sub $10. Today, the shares closed at $14.85, with trailing non-GAAP eps of $0.22, giving us the following valuation points:
P/E (TTM) of 67.5, and
P/S (TTM) of about 2.4.
Looking out to end of 2015, I think TTS is likely to hit the upper end of its guidance.
P/E (end of 2015) of 45, assuming forward eps of $0.33
P/S (end of 2015) of about 2.2.

So, how does this place the long term share holder. It looks to me as if TTS management is doing the things they need to do to make the concept scale. I would say that the brand itself has zero moat but as it grows it gets some scale advantages and that should help its bottomline. Management doesn’t come with a bright record but may be a business like this doesn’t need a bright record. All you need is consistent diligent work to keep the system chugging at a decent pace. With over 100 stores and 30 years behind them, this is not a spring chicken so I think continuing on the path at a modest pace should be enough.

This bring me to the next point about valuation. Is the valuation rich? As I noted in the last set of notes following Q4 2014, I think the forward valuation of 45 is may be a bit rich but still probably okay if they can maintain a 30% earnings growth, manage store growth without major blunders, and keep working on staff improvements. Professional customers and advertising should help bump up the numbers. They still have a big opportunity in terms of store growth.

With TTS, I like keeping an eye on the short interest data:
http://www.nasdaq.com/symbol/tts/short-interest
It appears short interest is at 7.1M shares (out of the 51M shares out). The days to cover is sitting at 19 days. It appears short interest went up since the last report came out. When Q4 came out, I had noted short interest at 6.7M shares. Note that insiders hold about 7.7M shares. So I guess, this quarter’s pop following the release was probably due to short covering. It will be interesting to see how the shorts cover (or see if they don’t!).

I now have a pretty large exposure to TTS. With today’s pop TTS has become my largest holding at about 3.9% exposure. Ideally, I would like something like WFM, AAPL, SBUX, NFLX etc to be my top exposure but it’s not … WFM us a close second at about 3.8%, followed by INBK at 3.5%, AAPL at 3.4%, WETF at 3.3%, and SBUX at 3%. TTS certainly doesn’t measure up to the quality of SBUX, WFM, AAPL, and NFLX, but my plan is to continue to hold TTS. Management is taking good steps towards sustainable growth, insiders have a good chunk of the shares, Q2 should be good, and a short squeeze should be on its way. I guess, I ‘m a happy camper.

I guess I should thank my erstwhile MDP membership for this position. I started this one based on some thorough MDP research.

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This is an interesting one for me - not really the quality company I like to hold, but its a simple business that if executed at even modest competency levels should yield decent results. Couple that with high short interest, high insider stake, and we have a good recipe for stock price appreciation. We got a 18% pop today on earnings release. Go figure.

Hi anirban, I’m really puzzled to see you owning such a sub-par company, and for it to be your largest position astounds me. Last year their adjusted earnings were 23 cents, down from 39 cents. In the 4th quarter they made 3 cents, down from 4 cents. This quarter they made 8 cents, down from 9 cents the year before. Their trailing earnings are 22 cents, so with a price of $14.85, they have a PE of 67.5. I grant that you see it as a possible turn-around, but if you got an 18% pop, why not take advantage and get out of it? Or at least reduce your position? I’m just wondering.

Saul

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I think it’s got a bit more to go. Watching the insiders and shorts.

Anirban.

I’ve fallen behind on my reading of this board, so I’m just now catching up on threads that probably aren’t getting much attention at this point.

But Saul, I just have to take note of your incredibly reliable pragmatism. I’m astounded that so many apparently astute folks (i.e. Anirban) seem to miss your point, or make an excuse for not paying attention or whatever. From what I’ve read here, Anirban has made a whole lot more money investing than I have, so I don’t mean this to be personal, just an observation.

But it seems to me that Saul repeatedly just applies unbiased, unemotional, logical analytical thought to these various scenarios. Is that infallible? Of course not, this is the stock market where anything goes and the irrational often dominates (so much for the rational market theory). But, that’s generally in the short term, longer term, the logical outcome is generally the winner. I think it was Buffet who said something like in the short term the market is a voting machine, longer term it’s a weighing machine.

TMF has built their entire investing strategy around that long term outcome. Unfortunately, the long term can be a long wait. And a lot of things can change in the long term. The short term is volatile and crazy. A day trader (IMO) is not an investor, he’s (or she’s) a poker player, meaning you can consistently win if you’re really good at the game, but it’s still gambling.

Saul has an uncanny ability to play the middle against both ends. He doesn’t gamble. He has often said that he always invests with the intention of holding long term, yet he’s impatient with inferior performance and is always on the look out for a better opportunity to deploy his resources, which I presume at this time far exceed any reasonable level of providing a “comfortable” lifestyle which is my 10 year goal. I am comfortable at present by virtue of a corporate pension and social security. Should those things vanish (always a possibility), I would suddenly become very uncomfortable.

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Thanks, Brittlerock, for your kind words!
Saul

Anirban,

Thanks for the detailed write-up. I don’t have a position in TTS and likely will not take one. But I did take one on INBK based on your initial work. Thanks for the write-up on INBK as well.

TTS was a rec on HG in 2012 and again in 2013 and in RB as well.
And from your post it was in MDP as well.
Hindsight is 20/20 but I guess they saw a lot of potential in TTS that did’nt pan out?

BTW, could you share your experience on MDP?
http://discussion.fool.com/1081/mdp-million-dollar-portfolio-joi…

Thanks,
Kris

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Kris,

I think the investment thesis is rather straightforward. I see brittlerock calling me ‘astute’ and ‘confused’ both in the same post. That’s fine. But I think what some folks seem to miss is that every successful investor ultimately has to have their own mantra. I can’t be Saul because I am not Saul. I have different perspective, mindset, risk tolerance, patience level, and so does everyone else.

So what is it that I saw and still see in TTS? Well, in a nutshell it’s a combination of ‘qualitative’ and ‘quantitative’ factors, not just quantitative factors. Let’s see:

  1. TTS stumbled because they tried to grow faster than they could handle.

  2. The growth pain points are being addressed by new management and its shoring in same store sales results.

  3. People who have much more clarity than us, the insiders, have bought tons of shares when the price was low and continue to hold those shares.

  4. There’s high short interest, which means we will probably get another pop with the next earnings.

  5. It’s a simple business that will deliver better results as it continues to scale.

So to my mind, this was an opportunity with odds nicely stacked in my favor as per my judgement. So in about 6 months I nearly have a 60% gain.

Anirban.

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Hi anirban, this evaluation of losers from Sppernova sees TTS a lot the way you do, perhaps not quite as positively as you, but close. Thought you’d like to see it.

Saul

#5. Tile Shop Holdings (NASDAQ: TTS) (1% allocation, down 39%)

Tile Shop is another mediocre company where we’re betting on a rebound. Macro conditions have been tough, growth has slowed, and a new CEO has taken over. I like the recent moves management has made to intelligently manage operations, which is part of why the stock is up nearly 60% since the start of the year. If the company beats pessimists’ expectations and fixes its operations, then we should see solid returns in the next couple years. Are there better places to put our money? Probably, but, honestly, if the company reverts back to normal operations, then there is probably a lot of room to run over the next several quarters.

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Cool, I guess Supernova and I are on the same page.

I have studied this company in some detail and I think the point about insiders and shorts is interesting. Directors started buying shares just before the new CEO announced the slowdown in store additions and the ‘market manager’ program. I think what they are doing is kind of the obvious. The business itself has solid gross margins, and there’s not much scale in the existing solo tiles business, so these guys can grab market and have scale benefits.

Simple business, management taking remedial action, tons of opportunity for scale advantages, insiders with 15% of the shares, and a good amount of shorts. I think this stock will continue to do well for a while.

My position wasn’t big to start with. I didn’t buy at nose bleed valuation. My cost basis is around $8.5, and that’s why the position has become big with the stock at $14. That’s about 65% gain in less than a year.

I think we will see improvement throughout the year. There were hints in the earnings call that the next quarter will be good as well. So watching and holding …

Anirban.

anirban,

I don’t get it. There is something I’m missing. Could you help? When you say There were hints in the earnings call that the next quarter will be good as well that implies that this quarter was good. But it was a down quarter from 9 cents to 8 cents year over year. Do you mean it wasn’t as bad as people were thinking?

At a run rate of 8 cents a quarter or 32 cents a year, they have a PE of 44. As Supernova pointed out this is a mediocre company, and they could probably find better places for their money. They just sell tile in the housing business which is very cyclical, however they are priced like an internet company. What am I missing that would make you let it grow to your biggest position?

Saul

Hi Saul,

I think with this one you need to look beyond the numbers. But, let’s just start with the earnings numbers. They made $0.23 in 2014, and are guiding for $0.30 at mid-point. So, we are looking for 30% growth rate. I think they are low balling, but I will come to that in a minute. At a stock price of $14, the forward PE would be around 45. That doesn’t seem to be a lot for a company growing earnings at 30%, with tons of whitespace to open new stores, and essentially be the king of tile because of scale. They are effectively competing against the much smaller tile stores (small mom & pop stores, some regional chains etc).

Now, let’s revisit why this might be a reasonable investment opportunity. I 'm focusing on more ‘qualitative’ assessment in this sort of turnaround investments, as the ‘quantitative’ measures will trail qualitative pointers. This was a good quarter in that many things happened. One, they showed positive comps. Two, they told us that stores with ‘market managers’ are doing really well and that they plan to cover all their stores with market managers by the end of 2015. Three, they had excellent cash flow this quarter, so they paid down some $18M of their long term debt. Forth, a new initiative focussed on professional customers grew very fast … it must be from a small base but this is very encouraging for topline and bottomline growth.

I think they had a simple problem, namely that they opened too many stores too fast, more than they could chew. That caused comps to go negative. The simple plan for them was to slow down, fix the required training for staff, create some bench strength than move on. This is not a complicated business, not rocket science, just need a decent execution, which these guys seems to be getting done. They have slowed down the store opening and this should be good for them.

I suspect many folks out there are looking at the numbers and thinking this is just not working, but the numbers will lag by a quarter or two because the changes take time to show up in the numbers. It’s a gradual improvement process. Now, the bears had about 7M shares short out of 51M or about 14% shares. The insiders hold 8M shares, or about 16% of the shares outstanding. The insiders who have a much better view of things have been buying shares, and they haven’t sold. All of these point to an opportunity, and it’s not an obvious one, which is why I think this is a good opportunity.

As I said, I think TTS will be surprising to the upside in 2015. Here are some hints from the conference call:

  1. SG&A will moderate later this year because of slowdown in opening of new stores.
  2. With respect to traffic versus ticket growth, they pointed out that they got both and it continued until mid April … so it is looking good.
  3. It looks like stores opened in 2013 have more or less gotten to the levels they expect but many 2014 stores are struggling, but they did say that they have seen solid improvements in stores opened in Q4 2013 and Q1 2014. This looks like work in progress but in the right direction, and they should be seeing steady improvements in 2015.

With respect to this being my biggest position, it’s still under 4%, so in absolute terms is not very big. But, just like INBK I 'm quite comfortable with the position. Actually, today INBK became my biggest position, because of the 8% or so pop.

Hope this clarifies.

Anirban

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