When specialty tile retailer Tile Shop Holdings, Inc. (NASDAQ:TTS), reported fourth quarter earnings before the market opened on Feb. 14, the market wasn't happy with the results, dropping the stock by more than 13% by the end of the day. As of this writing, shares have rebounded a little, but are still well below the 2017 high. 

The company did fall short of Wall Street analyst expectations for revenue and profits, but that's really not what investors should focus on -- this is particularly true, when considering Tile Shop's results were well inline with the guidance its management set a few months ago. Bottom line: Tile Shop may have come up short of what the analysts were hoping for, but it delivered solid results to wrap up 2016, and management described steps they are taking to build on that momentum. 

Professional contractor installing wall tile.

Efforts to grow sales to professionals has lifted Tile Shop's sales. Image source: Getty Images.

Here's a closer look at Tile Shop's results, and three big takeaways. 

Tile Shop's growth did slow in Q4 (and the reason why deserves watching)

Tile Shop reported full-year sales grew 10.6% to $324.2 million, comparable store sales growth of 7.6%, and adjusted earnings of $0.45 per share, a 41% increase. Gross margin percent was 70% up 50 basis points from the year before. 

However, the company saw its growth rates in every one of those metrics recede in the fourth quarter. Revenue was only up 6.5%, comps increased 3.1%, and adjusted income of $0.07 per share was lower than the fourth quarter of 2015. 

According to management, the reason why sales growth slowed in the fourth quarter was tied to traffic. According to CFO Kirk Geadelmann, the company saw the traffic growth it had experienced in the first three quarters of the year flatten out, resulting in growth rates that underperformed the rest of the year. Specifically, management said that the traffic-challenged stores were older locations, and that they saw consistent traffic growth at stores opened for less than four years in the fourth quarter. 

Geadelmann also said that management is relatively pleased with sales so far in the first quarter, while cautioning that the company is up against a very big 13% comp last year, and the timing of its national sales kickoff meeting (in January) will play a role in how the final results look at quarter-end. 

Management continues to invest in retaining its best people in order to retain its best customers

While many retailers consistently look for ways to cut store operating expenses, often resulting in reducing labor costs at the expense of customer service, CEO Chris Homeister has taken a decidedly different approach since taking over at Tile Shop two years ago. During his tenure, the company has made store-level employee retention, training, and compensation a core focus, having added multiple store management and marketplace support roles in an effort to enhance the level of service for customers, and improve the career path for store employees. 

Tile Shop employee helping customers select tile.

Image source: Tile Shop.

On the earnings call, Homeister provided several metrics that indicate those efforts are paying off, reporting that store associate and manager tenures continue to increase to the highest levels in company history, and turnover continues to fall. He also said that warehouse employee turnover has improved as a result of efforts to prioritize store-level support. 

Management isn't standing pat. The company announced that it was doubling its 401(k) matching contributions starting in 2017, and also enhancing the amount of paid time off employees get. 

One of the primary payoffs management has seen -- and anticipates will continue -- from its focus on providing its best employees with a sustainable career opportunity, has been a steady increase in sales to tile professionals, including kitchen and bath contractors, homebuilders, and interior designers. The company's efforts to retain its best employees, combined with strategic marketing and pricing support for pros, helped Tile Shop grow the share of sales to professionals more than 300 basis points in 2016.  Having a more tenured, better-trained staff has so-far shown to help build better working relationships with the best kind of repeat customers -- industry professionals. 

Improved capital allocation, balance sheet, has company ready for faster store growth and a dividend

Tile Shop only opened nine new stores in 2016, less than the 10 management was targeting at the end of the third quarter, yet more than it opened in 2015. But after having taken a serious bite out of its debt -- down 57% to $22 million at year-end -- and freeing up a lot of cash flows, management is targeting 12-15 new store openings in 2017. Furthermore, management has been clear that operating cash flows will fund store expansion, not debt as in the past. And while this moderate rate of expansion may not be as exciting as some would like, it means the company will be better-prepared to deal with an eventual weak period in demand. 

TTS Total Long Term Debt (Quarterly) Chart

TTS Total Long Term Debt (Quarterly) data by YCharts.

How confident is management in its capital structure and cash flow capabilities? Confident enough to initiate a modest $0.05 per-share dividend, worth a 1.1% yield at current share prices. 

Looking ahead

Despite a slowdown in growth in the fourth quarter, Tile Shop wrapped up a very good 2016. The company paid down a huge chunk of debt, continued to invest in key initiatives aimed at keeping its best people and growing sales with its best potential customers, and made enough financial progress that management felt it was time to start returning some of its cash flows back to shareholders with a dividend. 

2017 guidance is for sales between $350 million to $370 million, representing 8%-14% growth from 2016, 12-15 new store openings, up sharply from nine in 2016, and adjusted earnings between $0.50-$0.57 per share, which would be 11%-27% higher than last year. Just how much the company can build on a pretty successful 2016 remains to be seen, but there's no arguing that since Homeister took over there has been a clear strategy, and management has consistently executed on its goals. 

 

Jason Hall owns shares of Tile Shop Holdings. The Motley Fool owns shares of and recommends Tile Shop Holdings. The Motley Fool has a disclosure policy.