Floor & Decor Holdings, Inc.
Q2 2018 Earnings Call Transcript

Published: 5 Aug 2018

[Operator:]

Good morning ladies and gentlemen. This is Floor & Decor’s, Second Quarter 2018 Earnings Call. At this time all participants are in a listen-only mode. As a reminder, this conference is being recorded today, Thursday, August 2, 2018. I would now like to turn the call over to Matt McConnell, Manager of Investor Relations at Floor & Decor. Please go ahead.

[Matt McConnell:]

Thank you. Good morning everyone. Joining me on our call today are Tom Taylor, Chief Executive Officer, and Trevor Lang, Executive Vice President and Chief Financial Officer. Also in the room is Lisa Laube, Executive Vice President and Chief Merchandising Officer, who will join us for the Q&A session. Before we get started, I would like to remind you of the company’s Safe Harbor language. Comments made during this conference call and webcast contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and are subject to risks and uncertainties. Any statement that refers to expectations, projections or other characterizations of future events, including financial projections or future market conditions is a forward-looking statement. The company’s actual future results could differ materially from those expressed in such forward-looking statements for any reasons, including those listed in our SEC filings. Floor & Decor assumes no obligation to update any such forward-looking statements. Please also note that past performance or market information is not a guarantee of future results. During this conference call, the company may discuss non-GAAP financial measures as defined by SEC Regulation G. A reconciliation of each of these non-GAAP measures to the most directly comparable GAAP financial measure can be found in the earnings press release, which is available on our Investor Relations website, ir.flooranddecor.com. A recorded replay of this call, together with related materials, will be available on our Investor Relations website, ir.flooranddecor.com. Now, let me turn the call over to Tom.

[Tom Taylor:]

Thank you, Matt, and thank you to everyone joining our call. We are pleased with the performance of our business in the second quarter as we generated comparable same-store sales growth of 11.4% and total sales growth of 26%. For nine and a half years, our same-store sales growth has been above 10%, demonstrating the strength of our business model over a long time. The investments we have made in our stores, a broad trend-right assortment of good, better and best in-stock inventory, combined with a unique low cost direct sourcing supply chain that allows us to offer everyday low prices has consistently worked. Over the last several years, we have focused on improving our assortment, technology investments, including a connected customer experience, materially enhancing our supply chain and increasing a regional leadership to support our decentralized service oriented culture. We opened our 90th store today in Port St. Lucie, Florida, and I feel fantastic about our historical performance and even better about our future whitespace opportunity as we continue our path to 400 stores in the U.S. Our success is a direct result of the terrific team and their hard work. Now turning to our second quarter results; total sales increased 26% to $434 million. Comparable store sales increased by 11.4%, driven primarily by transaction growth of 12%, and our adjusted diluted earnings per share increased 35% to $0.27. With the exception of Stone, all of our categories had positive comps with laminate, luxury vinyl plank, decorative accessories and installation materials comping above the company average. As expected, we saw an estimated 280 basis points comp benefit due to demand from Hurricane Harvey, which moderated from last quarter’s estimated 400 basis points tailwind. Excluding the comparable stores impacted by Hurricane Harvey, second quarter comps increased by 8.6%. We opened four new stores during the quarter, ending with a total of 88 stores at the end of June, and we remain on pace to grow our store footprint by 20% in 2018. Now let me briefly highlight recent accomplishments and outline our key strategic priorities for 2018. As a reminder, our priorities are new store growth, increasing comparable store sales growth, expanding the connected customer experience and continuing to invest in the Pro customer. First, new store growth

[Trevor Lang:]

Thanks Tom and good morning everyone. I will review our second quarter 2018 results and then discuss our outlook for the third quarter and the remainder of fiscal 2018. We delivered another strong quarter, further demonstrating that our differentiated business model is a competitive advantage that continues to resonate with both our Pro and DIY consumers. As Tom outlined, we believe the strategies we have been pursuing over the last five years are working well and are especially proud of our new store first year sales and profit performance. Net sales in the second quarter of 2018 increased 26.2% to $434.3 million from $344 million in the second quarter of 2017. We ended the quarter with 88 total warehouse format stores, an increase of 15 stores or 20.5% versus the end of the prior year period. Our second quarter comparable store sales increased 11.4%. Our comp was again driven by transaction growth, while our dollars per transaction declined slightly. Our comparable store sales, excluding the Houston market, which continues to benefit from post-Hurricane Harvey flooding-related building efforts, increased approximately 8.6%. Now on to profitability; gross profit increased 24.9% to $177.6 million in the second quarter from $142.2 million in the second quarter of fiscal 2017. Gross margin decreased approximately 40 basis points to 40.9% from 41.3% in the second quarter of fiscal 2017. This decrease in gross margin rate was primarily due to factors we outlined last quarter, higher domestic trucking, primarily due to higher fuel costs and our Miami distribution center relocation and product mix. As a percentage of sales, total SG&A deleveraged approximately 90 basis points to 32.3% compared to the second quarter of 2017 due to new stores. Our total operating expenses de-leveraged due to the preopening and operating expenses of opening four new stores in the second quarter of 2018 versus one new store in the second quarter of 2017. Our stores opened more than two years obtained approximately 100 basis points of leverage. In addition, as previously we discussed in the last two calls, we are opening a new, more densely populated markets that have higher preopening and operating cost. This also impacted our second quarter operating expenses, but we believe the long-term potential of these markets is worthy and making the investment worthwhile. Operating income increased 9.2% during the second quarter to $37.2 million as compared to $34.1 million in the second quarter of fiscal 2018. Operating margin decreased 130 basis points to 8.6% versus the prior year period. Our interest expense for the second quarter was $2.1 million compared to $3.4 million in the prior year period. The decrease in interest versus last year is primarily due to using the IPO proceeds from the second quarter of 2017 to pay down debt. Our reported provision for income taxes for the second quarter was a benefit of $4.7 million compared to an expense of $4.9 million in the second quarter of 2017. The decrease in our effective tax rate was primarily due to the recognition of excess tax benefits related to stock options exercised, as well as tax reform passed in December 2017. We have adjusted the stock option benefit out of our calculation of adjusted earnings in today’s release. Before I discuss net income and 2018 guidance, please note that I will discuss both GAAP and non-GAAP measures. As described in our earnings release, we believe our non-GAAP disclosures enable investors to better understand our core operating performance on a comparable basis between periods. A reconciliation of these non-GAAP metrics to their most directly comparable GAAP financial measures can be found in our earnings release issued in connection with this call. Adjusted net income and adjusted diluted earnings per share were $28.4 million or $0.27 per diluted share for the second quarter 2018 compared to $20.6 million or $0.20 per diluted share in the second quarter of 2017. This represents an increase in adjusted net income of $7.8 million or 37.7%. Adjusted EBITDA for the second quarter increased 16% to $50.7 million compared to adjusted EBITDA of $43.7 million in the second quarter of fiscal 2017. We ended the quarter with $176.5 million in cash and available liquidity under our revolving credit facility, and $164.4 million of borrowings outstanding. Our inventory balance at the end of the second quarter was $432.4 million up $4.5 million from the end of fiscal 2017 and up 17.7% versus the second quarter of 2017. Now turning to our guidance. As you saw from our press release, given our performance for the first half of the year and our expectation for the remainder of 2018, we are revising our 2018 annual guidance range as a result of the following three factors

[Operator:]

[Operator Instructions] Our first question comes from the line of Elizabeth Suzuki with Bank of America Merrill Lynch.

[Elizabeth Suzuki:]

Great, good morning. From a sales standpoint, were there any categories or things that underperformed relative to your expectation or that have now started to slow more recently that resulted in the lower comp guidance?

[Tom Taylor:]

From a category perspective and a geography perspective, everything slowed like you know consistently. There wasn’t – it’s not a particular category. Stone has been a category all year that’s been a challenge, but more that’s a shift of people buying other parts or performing categories in the store, but I’d say the trend is broad based.

[Elizabeth Suzuki:]

Okay. And just then one quick one on the tariffs on imported goods from China. What percentage of your product, [inaudible] 47% in the first half that you import, but what percentage of those products are on the most recent list of proposed items for tariffs?

[Tom Taylor:]

Almost all of them.

[Elizabeth Suzuki:]

Okay, alright Thanks.

[Operator:]

Our next question comes from the line of Michael Lasser with UBS. Please proceed with your question.

[Michael Lasser:]

Good morning. Thanks a lot for taking my question. Floor & Decor’s success has not gone unnoticed by its competition. We’re starting to see some others emulate the attributes of your model that are so successful, such as Lumber Liquidators, holding more job lock quantities or Home Depot rearranging some of the vignettes associated with flooring. So do you think that part of the reason you’re experiencing a bit of a slowdown is due to the competitive factors or is this just we’re getting later in the cycle and flooring is – demand for flooring overall is slowing a touch as a result?

[Tom Taylor:]

Yes Mike, look I’ll touch on a couple of thoughts. I mean first look, our total sales grew 26%. We comped over 11% for the quarter. If things do get harder, if you’d look at our comp – and I’ll get to the competition point in a second, but you know the comps get harder. If you go back five years ago, the average mature Floor & Decor did $13 million; 10 years ago it did $10 million. We’ve averaged over the last five years over 15% comps. Our average mature store-to-date is $20 million. It does get harder to lap those stores, and if you put that in combination with our new stores, over the last three years each class of new store has gotten a little bit better and as they enter the comp base, those volumes have increased, that gets a little bit harder to comp too. So look, we’ve got a healthy business, 26% growth is terrific and if you go look back over the last few years at kind of what we’ve been doing and our comps are terrific. So I’m proud of what we’ve accomplished. The second thing, from a competitive standpoint, look, our competition – as long as I’ve been here six years, the competition is always reacting, changing, whether it be the big boxes or the independents; this is a very fragmented market and they are always changing and they are always getting better, at the end that helps the consumer get a better value proposition, but when you look at Floor & Decor, we’re changing, too. So it’s not like the competitors aren’t changing and we’re not. In the first half of this year we’ve added a Pro app, we’ve enhanced the pickup times at the back of our store, we’ve continued to add new products, so we’re not seeing [ph] our hands. We think the competition is good. We have a lot of respect for the competition. We learn from the competition, but we change at the same pace.

[Michael Lasser:]

Tom, it seems like you’re suggesting maybe you’re just getting closer to peak or realistic ongoing volumes in some of your locations. Do you have an updated view on what a targeted sales-per-store number is for the long run? And my second part of that question is, have sales slowed faster than what you expected? Presumably they have, because you took down the guidance from where it was 90 days ago?

[Tom Taylor:]

Look, it’s – there’s a lot of uncertainty as we go into the back of the year. I’m confident with what we’re doing. I have a tremendous belief in the amount of stores that we can open. This is a whitespace story. The comps will get difficult, but you know look, we comped for 11% in the quarter; our total growth is 26%. So I feel good about the strategy we have in place.

[Michael Lasser:]

Okay, good luck with the second half.

[Operator:]

Our next question comes from the line of Zach Fadem with Wells Fargo.

[Zachary Fadem:]

Hey, good morning guys. On the gross margin line in terms of magnitude, could you help us bridge the gap between product margin mix and then the impact of higher freight and DC costs in the quarter? And on these items you mentioned product mix going forward, but what should we anticipate in terms of magnitude just for the second half of the year?

[Trevor Lang:]

This is Trevor. It’s really when you look at the details, it’s both. I don’t think we can quantify it by one, because obviously, domestic transportation affects all of our categories, and the mix impact, we had a lot of benefits last year in all of our businesses. As you look at the strongest businesses we had this year, with our laminate business, our LVP business, you know some of those categories are lower margin and because some of those categories also have things like underlayment included in them, you know it affects some of our insulation accessories where we were not selling us much underlayment and stuff. So I think we said for the back half of the year, we’re planning on 40 to 60 basis points of slightly lower gross margin, and it’s a combination of both.

[Zachary Fadem:]

Got it, and could you talk a little more about the innovation in a category? How much has this been a benefit over the past couple quarters, and is there anything newer in the pipeline that you’re excited about, and with respect to that, anything we should keep in mind just from a mix or margin perspective going forward?

[Tom Taylor:]

Sure. This is Tom. I’ll start, and then Lisa is here, I’ll let her follow. I’ll try not to take all of her points, but first look innovation across the hard surface flooring has been a tremendous driver of certainly our performance over the last five years. You know we try to be first to market in innovation, so whether it be water-resistant products, whether it be fashion, whether it inkjet tile we always try to be kind of on the fashion forefront and on the durability forefront; they’ve been big drivers. We’ve had water-resistant products now for going on three years, and that product category has continued to expand and do very well, but we’ve had it for three years. So it’s kind of like that store point that I made earlier. When you’re lapping those numbers, it gets a little bit more difficult, because we’re doing so much. But innovation, you know we do a product line review across every department and every category frequently. So we’re always bringing in the newest, latest, greatest things. I’ll let Lisa talk a little bit at what else is coming on the horizon.

[Lisa Laube:]

I think the two biggest trends that we’ve been seeing, certainly durability is one, which is led by the water-resistant and waterproof, but there are other factors there as well. So we continue to try to find new durability stories for our customers; they appreciate that value. And then the other piece is just being really trend right, better and best, we’ve talked about that before and we still don’t know how high is high there. The higher prices we bring in, we still have incredible values in all of that products and our customers are really responding very positively. So I would say, both from a kind of trend perspective, as well as a durability perspective, our merchants are throughout there every day, working on developing new and exciting products.

[Zachary Fadem:]

Thanks guys. I appreciate the time.

[Operator:]

Our next question comes from the line of Christopher Horvers with JPMorgan. Please proceed with your question.

[Christopher Horvers:]

Thanks, good morning. So I was trying to dig into the sort of implied underlying ex-hurricane rates. So do you expect to get the 250 basis points of hurricane headwinds back in the third quarter and then in the fourth quarter you had an eight point benefit from Harvey. So what’s sort of implication of what we have to give back there and what’s the underlying trend that the guidance reflects?

[Trevor Lang:]

Hey, good morning Chris, this is Trevor. Let’s talk about Q3 first, then we’ll talk about Q4. So for Q3 if you just talk about the Houston Harvey hurricane, the impact is about flattish for the third quarter. We lost a bunch of sales in kind of late August and early September, but then the business got very strong in kind of mid-September on through the end of the fourth quarter, so just Houston alone is flattish. But you’re right, there was Hurricane Irma as well as last year, and that really impacted our Florida stores, which is a substantial portion of our sales and so you’re right. Last year we said there was some portion of 250 basis points. Our current expectation for the third quarter excluding Houston is that we’re going to be in that kind of 9% to 10.5% range as we think about the third quarter. As you move on to the fourth quarter, you guys will recall we called out the benefit in Houston. It was over 100% comp individually, and you’re right, it was an 800 basis point benefit in last year’s fourth quarter. As we’ve modeled the fourth quarter this year we currently think that will be a headwind of approximately 650 to 850 basis points as we think about the fourth quarter, because we’re obviously going up against a huge comp in that Houston market. For the year interestingly enough, when all of that shakes out, that 400 basis points in Q1, some portion of 300 or just under 300 basis points in Q2, flattish for Q3 and Q4, it worked out pretty kind of flattish for the year and that’s all reflected in our comps, so a lot of confusion going on with the two different hurricanes in there. But if you just break out the back half of the year, if you just look at our back of the year expectations, that kind of 9% to 10.5% comp range is what to expect excluding the Houston stores.

[Christopher Horvers:]

I got you. So it excludes – so right, that fourth, it looks like your sort of 9-ish in terms of expectations. So the cadence of the year has decelerated. So you should hit a peak in terms of the underlying ex-weather trend in the fourth quarter and you back that out, it’s decelerated and it looks like based on what you just said, you’re assuming sort of this 9-ish trend stays going forward and you’re sort of holding, actually slightly accelerating on the stack basis. So can you talk about how the cadence has been over the first half of the year? I know you don’t like to talk about it when you see the decelerating trend; it’s something that investors care about. And then secondarily, as you think about 2019, this nine to 10-ish kind of growth in the back half, originally you – I think ahead of the IPO you talked about 100 basis point decay rate in comp as you look out by year gear. So do you still expect that to be the case?

[Trevor Lang:]

So, just a quick reminder for last year. If you exclude the hurricanes last year, our comps have essentially accelerated throughout the year. We comped up 12% in Q1 last year, there was obviously no hurricanes in. Then we comped up close to 14% in Q2 and in the back of the year, excluding both the hurricanes, we comped up about 16%. So our business progressively got better each of the quarters last year, excluding the hurricanes. This year, as we’re looking forward, yes, again we’re basically excluding the hurricanes, we’re assuming kind of 9% to 10.5% up against higher comps as we think about the last half of this year. Again in ‘19, we’re not ready to talk about the guidance yet, but we do believe that we can continue to grow our business at a higher rate than the industry. Most of industry forecasts we’ve seen do assume some moderation. You guys will remember, we’ve called out over the last five years; the industry has grown at some portion of 9% on average per year over the last five years and most of the industry experts think that’s going to be more in the mid-single-digit comp range and that’s obviously affecting, we think current business as well as we look to the future. So our model is predicated on a mid to upper-single digit comp, getting a slight amount of leverage out of gross margin and that would lead to some portion of, hopefully a 25% net income growth. We are working to that. We still believe that’s true on average. There’ll always be some noise in our numbers just because of the timing of distribution center openings or new store openings, but over a longer term basis, we’re still committed to those goals and believe those goals are achievable that we’ve put out when we did the IPO.

[Tom Taylor:]

Yes, I would just follow on Chris, just echoing kind of what Trevor said. We believe in the strategies that we’re doing. Our new stores are performing terrific. It’s a healthy business. I mean, we grew it 26% for the quarter. So we’re comped and we like what’s going on with our new stores. We like the cadence of our new stores next year and we like the locations of our new stores next year. So we’re excited about what that could bring.

[Christopher Horvers:]

So just to try to pinpoint on the cadence question. So you guided 11% to 13% at the start of the quarter. You still ended with an 11.4%. So it would appear that there was a deceleration. So what gives you the confidence that things are stabilizing as implied into the back half outlook?

[Trevor Lang:]

So this is Trevor, again. So when we gave guidance, our April comps were in line with what we gave guidance at that time. We obviously knew what our results were at that point. So you’re right, the back part – after the earnings release, is when our business slowed a bit, and it’s been pretty consistent subsequent to that, and that’s all reflected in the comp guidance that we’ve given. We’re fortunate and we still only have you know just over 80 stores. We have the ability to look at every store by month, by week and through the rest of the year. Two things to call and as you think about it, you’re right, we are expecting that that comp gets a little bit better into Q3 and Q4, as we mentioned. We lost $7 million to $8 million in sales last year due to the two hurricanes. We’re not expecting any hurricane loss, so we should have a bit of a pick-up relative to where we were in Q3 and Q4. And then as we get to Q4, again excluding the Houston business, we’ve got the most amount of new stores coming into the comp base than we’ve ever had. We’ve got five new stores coming in Q3, another five stores coming in Q4, and our new stores generally provide a comp base. So that’s also why we feel a little bit better as we look into Q4 as well. So hopefully that helps explain why we would assume business – you know comps, excluding Houston, are a little bit better as we get into Q3 and Q4.

[Christopher Horvers:]

Super helpful. Thanks very much.

[Operator:]

Our next question comes from the line of Seth Sigman with Crédit Suisse. Please proceed with your question.

[Seth Sigman:]

Thanks, good morning guys. Just a couple follow-up questions here. First, just in terms of the gross margin. You know for the quarter it actually came in a little bit better than what you laid out last quarter. Can you just give us a sense of what the delta was there, and then you’re suggesting more pressure in the third quarter and then in the back half overall. Can you just clarify what is exactly changing? What’s incremental in the back half versus what you just saw in the second quarter? Thank you.

[Tom Taylor:]

Second quarter product margins came in a little bit better than we thought they would. So in the back half, it strayed somewhere to what we talked about in the last earnings call, Trevor?

[Trevor Lang:]

Yes. Basically it’s based on current trends and when we look at that mix of what’s selling, as well as higher domestic transportation costs, we’re seeing fuel cost go up obviously like a lot of other folks. And so as we see the current trends in the business, that’s what’s reflected in there. So hopefully that answers your question.

[Seth Sigman:]

Okay, and then just a couple follow-up questions on the comps here. So when you look at the product category disclosure that you provided in the filings, it does suggest that there are some shifts happening here. It seems like the biggest deceleration this year has been in tile and then how you break out laminate and LVT categories. Just anymore color on why that would be – is that an industry or consumer trend or do you think the competitive offering in those categories specifically maybe changing? Thank you.

[Tom Taylor:]

Seth, I mean I addressed it a little bit earlier; just a couple of points. One, we have had water-resistant products now; we’re going into our third year of water-resistant products. They have expanded significantly. I mean we start out with a handful of SKUs and laminate, and now it’s turned to NuCore and DuraLux and more in AquaGuard. As those have expanded, if you think about that category, that pulls from tile. People were buying – my opinion is that water-resistant category, people were using tiles in their bathrooms and in their kitchens and this category is made specifically so you can put it in and comply it into those places, so we’re absolutely seeing a shift. Our tile comps are still decent, they are still good, but you can clearly see customers are electing to put water-resistant categories into places in the home where they would have originally put tile and that has a couple effects on us. So one is, we’re fortunate we carry everything under one roof and we want to provide the customer what they need, so we can go from department to department and make those elections, but when they buy those categories they sell it a little bit less per square foot. So the comps are a little bit affected by that, there could be a little bit of drag on that. And then two, if they buy tile, everything that goes along with that tile project runs in a pretty decent margin rate, and you lose that particularly if they are electing to the vinyl SKUs. So we’ve seen great strength in those vinyl and laminate categories, and there’s kind of a double effect. It affects our mix, so there’s some margin pressure with that, and then it affects the total sales just because of – it sells a little bit less.

[Seth Sigman:]

And then on the other hand, you’ve seen a nice acceleration in decorative accessories and even more so in actual accessories and tools. Just any initiatives specifically targeted around those categories that you think that may be helping?

[Tom Taylor:]

I think that our merchants continue to do an outstanding job of finding better and best products. If you walk the decor departments today, we’ve expanded and gone into much better products than we had three years ago, that’s continued to evolve. Tile deco has been a huge success for us as well, and we put a lot of energy into that deco department. We reset it every year, and we’re constantly bringing new stuff in. So the initiatives is really around newness, one; and then the second initiative is our designer initiative. We hired a design czar – a head of design for our company about a year ago, and she’s really getting traction within our stores and you know we’re putting a real emphasis on our designer capabilities within that design center in the store. So that certainly is helping our deco business as well. On the installation accessory, it’s the same, a similar story. We’ve got a terrific merchant in there who’s done a nice job of adding some additional categories and upgrading the categories we’ve had. Our Pro business is healthy, so that’s also going to drive that section of the store as well. So I think our energy is around the Pro customer, are helping that. I think our energy is around the product that we’re putting into that accessory, the installation accessories department is helping it as well.

[Seth Sigman:]

Okay, thanks guys.

[Operator:]

Our next question comes from the line of Matt Fassler with Goldman Sachs. Please proceed with your question.

[Matthew Fassler:]

Thanks a lot and good morning everybody. My first question relates to working capital and specifically to inventory which came in a bit lower than we expected. You obviously talked about the sales trends over the course of the quarter. Presumably you may have moved it in that direction deliberately. Can you talk about the delta and inventory growth from Q1 to Q2? How much of that was pre-medicated and kind of where that inventory sits mix-wise versus where you’d like it to be?

[Trevor Lang:]

Matt, this is Trevor. We feel great about our inventory position. We will always have some timing, especially in the first half of the year, based on when Chinese New Year receipts hit. We knew we would have a big increase last year. We talked about that just based on the timing of when we wanted to land things relative to getting those into our stores and the product categories. But Lisa is here as well. Her team does a great job managing our inventory and we feel good about the quality of our inventory and what we need for the rest of the year.

[Tom Taylor:]

Yes, in-stock rates, our in-stock rates are as high as they’ve been in five years.

[Matthew Fassler:]

To the extent that you’re up I think 18% in total at quarter-end and on a per square foot basis, I haven’t done the math, but it looks like you’re probably down year-on-year. Is this sort of the bottom for the inventory cycle? Do you ramp on a square-foot basis from here? Is this a growth rate that you think can persist through year-end?

[Tom Taylor:]

Yes, through the end of the year our current expectation is that inventory, from a year-end specifically, but then our year-end inventory will grow to slightly low rate than sales is our current expectation.

[Matthew Fassler:]

Okay, understood. Secondly, I think you answered this when you spoke just a moment ago about the mix shift to LVP and water-proof technologies from ceramic and tile. But would that be where the contraction in ticket comes from? I think your ticket was up about 2% in Q1. I think down was slightly in Q2. Is that all about mix in your view?

[Trevor Lang:]

Yes. That’s a fair assumption.

[Matthew Fassler:]

And also, just trying to discern between essentially customer interest in the category, and what we could tie in to macro more broadly and some of the dynamics that you just discussed within the category, which seems like they’re quite important when you think about the mix shift, the fashion shift if you will within the business. What’s your sense about the vitality of the flooring business, if you take out the mix and margin dynamics associated with some of the fairly rapid changes in customer taste and product evolution?

[Tom Taylor:]

I think product evolution continues to be good. I think that there is still a good amount of consumers who are just getting themselves aware about the new stuff that’s coming to the marketplace over the course of time. You know the market, the compounded annual growth rate in the market over the last five years has been pretty robust, over 9%. I mean, so that’s a very healthy market that doesn’t last forever. Our comps have been – you know they average a lot more than – our total growth average is a lot more than that and that doesn’t last forever. So I still think that there’s – look, I’ve said it a couple of times, good comps and 26% growth, there’s still a lot of energy around the category.

[Matthew Fassler:]

And then finally you spoke about different remedies in case, in the event that the tariff regime that’s currently being discussed goes through. One thing you spoke about was essentially moving production to other countries. How long does it take to do that in your category? Are we talking quarters; are we talking years, and is there capacity out there that could accommodate this relatively quickly?

[Tom Taylor:]

Yes, I’ll let Lisa touch on that, and I’ll add in.

[Lisa Laube:]

Yes. We actually feel really good about it. We source today from about 20 countries and most of our categories, not all, but most of our categories are sourced in multiple countries, and so we think that we will be able to move things fairly easily. There’s a couple of categories that can only be [inaudible] and we will find – all of our competition will find the same issue. In some of those cases, that’s where the retail would be past along. But in some of our big categories, tile for instance, we actually source a lot of product out of the U.S., out of Spain, Italy, South America, Mexico, and so we have a lot of options and those things can be moved fairly quickly.

[Tom Taylor:]

Yes. And I would say a couple other things, Matt. This isn’t new, whether it’s been a border tax or a tariff, it’s been talked about for a while. So we didn’t have the first conversation about this a month ago, we’ve been talking about it for a while. I would also say that some of our bigger Chinese suppliers have made investments in rest of the world. So we’re able to switch some production there too. So it depends on the category to the rate of speed that we can do it, but it’s certainly things that can happen and it is one of those uncertainties at the back half of the year that we’re certainly paying attention to.

[Matthew Fassler:]

Thank you guys.

[Operator:]

Our next question comes from the line of Seth Basham with Wedbush Securities. Please proceed with your question.

[Seth Basham:]

Thanks a lot and good morning. My first question is just around product margins. Q2 you mentioned that came in better than expected, and you are basing your guidance based on what’s selling. Are we expecting a bigger shift away from the higher margin tile category in the second half to add the pressure on product margins in the second half that you guided to?

[Tom Taylor:]

Yes, this is Trevor again. I mean, all those factors that we said are based on the current trends of the business that are factored in there, and that’s part of the reason we took the margins down. Again, Q3 is fairly consistent with what we said last time, but as we looked at those trends for the fourth quarter, we are planning on fourth quarter being slightly below what we said last time. So again to summarize, it’s based on current trends and the mix of what we’re selling now versus what we were reselling for most of last year and into the first quarter of this year.

[Seth Basham:]

Got it. That fourth quarter dynamics, do they relate to what you’re selling in Houston and you’re getting more margin there than you are anticipating going forward?

[Trevor Lang:]

No.

[Seth Basham:]

No. Okay, great, and then the second question is just thinking about the sales outlook. You touched on this a bunch, but not taking anything away from your strong absolute and relative performance, but can you isolate what’s leading to a lower comp growth outlook? Is it simply category growth slowing or do you think that there’s something else that might be impacting your sales growth rate?

[Trevor Lang:]

I’d go back to what I said in the beginning. There’s a lot of uncertainty in the back half of the year. Our numbers have gotten significantly larger, right, so you know five years ago those stores averaged $13 million, 10 years ago they averaged $10 million, now they average $20 million; those get harder. Our new store performance over the last three years is continuing to get better and better and better, and those stores, you know having them comped at the historical rates that has happened gets harder. So, but that’s the reason for our reflection in our guidance.

[Seth Basham:]

Got it, and my last question is seeing that kind of product category trends, you’ve spoken to your success with AquaGuard. I think you introduced the new HydroShield product not too long ago. Can you comment on how that’s performing and whether it’s cannibalistic or not?

[Tom Taylor:]

It’s performing very well. It is meant to be an option for a customer to step up from vinyl and get a laminate product at a lesser price, and it’s different than the initial AquaGuard that we brought in, but it’s performing well. We wanted to cannibalize off of regular laminate, and we want customers to step up from vinyl categories and that’s how it’s behaving so far.

[Seth Basham:]

Great, thank you very much.

[Tom Taylor:]

Thank you.

[Operator:]

Our next question comes from the line of Peter Keith with Piper Jaffray. Please proceed with your question.

[Peter Keith:]

Hey guys, thanks. Good morning. On this mix shift, and Trevor your Q4 maybe the mix is going to be a little bit different than you thought. I can understand, I think LVP is taking share, but that’s not really a new dynamic. So I guess I’m still unclear as to what’s really changed from, I don’t know, this year but even last year, and then is there something that’s changing that may continue for a while?

[Trevor Lang:]

Peter, this is Trevor. When you looked at last year, we had most of our categories margins increasing as well as a favorable mix. So just like you know for example the tile business last year, now the tile business is doing better, but the margins were increasing within tile, and so we had both a mix benefit from a macro perspective and a mix benefit in each of the departments themselves, and that’s part of the reason we had higher gross margins. When you fast-forward to what’s going on this year, as we mentioned on the last call and again this call, is we are seeing higher domestic transportation costs. You know a big piece of that is because of the Miami move that we think we’ll work through over time, but we’re also seeing higher fuel costs. I mean that’s somewhat new news relative to what we have seen for last year and into the first quarter as well. And then where we are now too, if you look at the back of the year, the acceleration in tile and some of those businesses is not as strong as it was last year and then maybe within some of those categories again, the mix in there, we’re not seeing the same higher margin categories growing at the rates they were in the past. So that’s why we really tried to summarize it as the domestic transportation cost as well as the mix, both at a category level and then within the categories as well.

[Peter Keith:]

Okay. And so it looks like it’s mostly on the tile category in terms of mix and product. Are like-for-like margins holding in tile or is it – it sounds like there is kind of a mix shift within that tile category that’s changed?

[Trevor Lang:]

It’s both, on tile specifically as part of the Miami move, because you know Miami is a huge seller of tiles. They sell a lot of tiles and stone down there and so there’s a mix because of distribution center move. And then within – if you look at other areas within tile as well, just what the customers are buying is not the same margin as we’ve seen in the past.

[Peter Keith:]

Okay. On a separate question, we know that waterproof is becoming increasingly important for the consumer and we’re seeing that now with all of your competition advertising waterproof pretty aggressively. I will give you guys credit, you classify things as water-resistant, not waterproof, which is the more appropriate characterization. But do you feel that maybe that increased [audio gap] of waterproof has maybe caused a little bleed out with competition here in the recent weeks to months?

[Tom Taylor:]

No, I mean, I think that they are bringing awareness to the category; that can be a good thing, because customers are going to shop at multiple places before they buy their flooring. So I think the more the consumer gets aware that water-resistant exists, then we’re likely to benefit from that.

[Lisa Laube:]

And I think that our associates, they well understand the characteristics of our product as well as that sold in other places, and they can easily articulate that to customers so that they understand that the quality differences are they are and it’s simply what someone’s choosing to call it does not necessarily make it better.

[Peter Keith:]

Okay, very good. Thank you very much.

[Operator:]

Our next question comes from the line of John Baugh with Stifel. Please proceed with your question.

[John Baugh:]

Thank you. Good morning. Just driving again at this mix shift, which we all know about, but within all of your categories, are you seeing a degradation of product margin on a like-for-like basis? And if not what categories are holding up or going up or are they all sort of shifting to a like-for-like, not to mix shift, some kind of lower product margin?

[Trevor Lang:]

This is Trevor again. The domestic freight obviously affects all of our products as we see higher fuel costs, and because the Eastern part of the country is the largest portion of our sales and a lot of those are impacted by that Miami distribution center move, you know that’s affecting most of our categories because most of our inventory goes through our distribution centers, so that’s part of the largest portion of it. And just I’m saying it again, within categories where people are buying tile and installation accessories, the mix within those categories is also what people are buying as a slightly lower margin as well. So that’s why it’s both a mix component as well as a domestic transportation component.

[John Baugh:]

Thank you. And then as we think about that, the ticket which I think you alluded to earlier being down due to the mix shift, I assume we don’t anticipate this mix shift changing in the next few quarters that will continue. So how do we think about the tick generally been up, and now it’s down, influencing comp of I don’t know, two, three, four quarters? Thank you.

[Trevor Lang:]

Yes, this is Trevor, again. The ticket is a very minor, and I think we disclosed the amount in our 10-Q. It’s an incredibly minor. Most of it is traffic, therefore driving transactions. We just have less traffic coming into the stores and therefore less transactions. The ticket component as Tom mentioned, when you have some of the water-resistant categories, you can have a lower ticket because a lot of the products have underlayment and things like that included versus other products that didn’t have that where you have add-on sales with that.

[Tom Taylor:]

Yes, our ticket was flat for the quarter. I mean, it’s not – it’s slightly down, but it’s just a hair. Our comps are driven by transactions because we’re taking share.

[John Baugh:]

Alright, and then my last question which is SG&A. If I read it right in the Q, you breakout sort of the comp store SG&A and G&A component, and I believe compared to the first quarter, the quarter de-levered on both. Is that just timing relating to store openings, because in my mind if we’re talking comp store, that’s excluded, but help me with the moving pieces within SG&A. Thank you.

[Trevor Lang:]

Yes, you’re right, John. You want to break those two apart. If you look at our existing stores, our comp stores, we’re getting leverage in SG&A there as you would expect on an 11.4% comp, but because we opened four new stores in the second quarter this year versus one new store, the overall SG&A is the highest when those new stores open. And so since we had 4x the number of these stores opened in the second quarter of this year relative to last year, those early months of higher SG&A impacted. And then the final thing I mentioned, I said this in my prepared comments, is as we’re entering these more densely populated markets, they have higher advertising, higher labor, higher occupancy costs and that’s also a function of it as well.

[John Baugh:]

Great, thanks. Good luck.

[Operator:]

Our next question comes from the line of Anthony Chukumba with Loop Capital Markets. Please proceed with your question.

[Anthony Chukumba:]

Good morning. Thanks for taking my question. I guess my first question is on the Pro customer. You mentioned that you have the new Pro app and the Pro customer loyalty program will be coming later this year. Just any – I was wanting to see if there is any learning that you had over the last several months from the Pro app and from the other relatively new Pro initiatives?

[Tom Taylor:]

So when we introduced our Pro app to some of our best Pro customers a while back, we want to ensure before we roll the app out across the country that it’s been piloted, that we get the feedback from our customers to understand what works, what doesn’t work, what the customers are going to use and what they are not going to use. So we feel we’ve got a lot of learnings on what’s important to them. Certainly, it helps keeps our Pros organized. They have the ability to look at their product purchases over real time, to be able to go in and plan and see inventory across our stores, and then most importantly, to be able to communicate within our stores to get it in and out of the back. To our Pros being able to pick up their product quickly behind the stores is very important, and we’ve made significant investments in that area of the store to speed them up and get them out. So we spend lots of time with them, with lots of focus groups and lots of discussion and feel like our app is on the right track, and we’re rolling it out now across the country. Secondarily, the Pro Loyalty is something else. We piloted that. Going back now, it’s been over 18 months ago we started the pilot on that, just doing the same thing, learning. Our loyalty program is a partnership program with our professional customers. It gives them the ability to access things that help their business, as well as access and recognize them and let them access gifts and things like that for when they purchase more. We’ve learned what they like about it, what they don’t like about it, and it’s rolling out. So both of the programs we feel really good about and we think our investments within the Pro customer continue to pay off.

[Anthony Chukumba:]

Got it, that’s helpful. And then just one last question, I mean you mentioned that the overall category growth that sort of slowed from sort of high-single digit to kind of mid-single digit. I mean, how much of that do you think is due to the slowing – slowdown in the existing home sales?

[Trevor Lang:]

Yes, Anthony, this is Trevor. I mean we’ve been very fortunate for most of the last five to six years, where most of the macro tailwinds were in our favor. We had low interest rates, housing turnover is getting better, household appreciation was getting better, and all of that led to an industry growth of some portion of 9% on average per year. We as Americans were only adding 1% new homes and – less than 1% new homes, and the value of the homes is going up. So you’re seeing a headwind for the first time and turnover has not increased I think now for three or four months; it’s actually declined. Interest rates are obviously going up and some of the new tax laws are not as beneficial as they were in certain states. And so for the first time really in most of our history, for the last six or seven years, we’ve got some headwinds in macroeconomics, and certainly I think that has some play on the overall macro home sector, as well as the foreign sector.

[Tom Taylor:]

I think the thing with us is we will outperform the market, we have outperformed the market. We’re still – our awareness level is still not very high, people don’t know who Floor & Decor is. The more stores we open, the more awareness will improve, the more we’ll drive people into our stores and when we drive them into our stores, we think we can convert them. So whatever the housing market dictates, we’re in a good place because of how we’re growing and people are finding us.

[Anthony Chukumba:]

That’s helpful. Thank you.

[Operator:]

Our final question comes from the line of Jonathan Matuszewski with Jefferies.

[Jonathan Matuszewski:]

Hey guys, thanks for taking my questions. First one is on new store economics. Obviously, they’ve continued to surpass prior vintages. What are some of the changes you’re making that are positively influencing the initial performance here from a sales and profitability standpoint, just beyond greater brand awareness?

[Tom Taylor:]

So I mean, we’ve learned a lot, right? So we ran app, opened over 20% units now for over five years, and as we’ve gotten better each year, because we’ve learned. So I would say that the events surrounding our grand openings, the energy around our grassroots marketing, how we train the people within our stores, I certainly think we’re seeing tremendous benefit to getting customers familiar with our stores as they open, and not most of that is belly-to-belly grassroots, and we’ll just do it better than we’ve historically done if we get more people at those grand opening events than we’ve ever gotten in the past. Two, I would say that our locations, they’ve improved. We tried lots of things in the first couple of years is where we would put the locations of our stores and I think that we’ve done a better job of getting bigger stores, certainly the store size has increased a little bit, making them visible, finding the right locations, visible from the highway, easy access in and out of our Pros, I think that’s helping the ramp of the store as well, and then we’ve learned a lot in the way we market in the stores as well. We’ve continued to evolve in a way we tell customers about our stores and get them in. So it’s really not one thing. We’ve learned a lot over the last five years and applying them all is helping our grand openings and our first year store sales to just be incredible versus what they historically where.

[Jonathan Matuszewski:]

Great, that’s helpful. And then just secondly, I believe the CRM software is aimed at understanding the Pro a little bit better, I think that’s targeted to be done in 3Q. But any early learnings there, any tweaks you’re thinking of making in terms of targeting that Pro?

[Lisa Laube:]

I wouldn’t say there is anything yet that we’ve really learned. We will have the technology done by probably end of third quarter, and fourth quarter we’ll really start to be able to analyze that data and see what it shows us. So we really – we do look forward to being able to get that access to that information for all of our customers, because we do believe that will help us to be more efficient and more effective with the marketing that we do.

[Jonathan Matuszewski:]

Great. Thanks so much guys.

[Tom Taylor:]

Okay, well thank you. Listen, I appreciate everyone’s interest in joining the call and we’ll talk to you next quarter. Thank you.

[Operator:]

This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.