Floor & Decor Holdings, Inc. (FND) Q3 2018 Earnings Report, Transcript and Summary

Greetings and welcome to the Floor & Décor Holdings Inc. Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host today, Mr. Matt McConnell, Director of Investor Relations. Please go ahead.

Thank you and 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 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.

Thank you, Matt and thanks to everyone joining our call today. Let me start by saying that I am very pleased with our third quarter results. We achieved total sales growth of 26.7% from the third quarter of 2017 to a record $435.9 million. Comparable store sales grew 11.1% on top of 13.5% growth last year and adjusted EPS grew 41% from the same period of fiscal 2017, all exceeding our expectations. Our third quarter results reflect the ongoing strength of our differentiated business model and compelling value proposition that continue to resonate with our consumers and pros. This further drives market share gains and in the very fragmented $20 billion hard surface flooring industry. In the third quarter, we opened 7 new stores, including 6 openings in new markets. We are excited about our openings in densely populated markets like Boston and our second store in Seattle. In addition, we successfully rolled out our Pro Premier Loyalty Program companywide and are enthusiastic about the program’s potential. Our teams focus gives me the confidence in our future. I believe that our current size where only a fraction of what we can ultimately achieve and we have significant growth opportunities ahead of us. It’s an exciting time here at Floor & Décor. I also want to thank our associates for all their hard work in serving our customers and communities. Now, turning to the third quarter results, we continued our nearly decade-long history of double-digit comp store sales growth. At the same time, we have been making substantial investments to support our growth. Despite these investments, we delivered third quarter operating income growth of nearly 20% and adjusted diluted EPS growth of 41% from the third quarter of 2017. We are especially pleased to have exceeded our third quarter revenue and earnings outlook. This occurred during the period that was particularly difficult to forecast due to the last year’s unprecedented impact to one-third of our stores by Hurricane Irma and Harvey. Our business during the third quarter outside of storm affected areas comped 10%. Looking to the future, we continue to see significant market share gain opportunities as we expand our footprint and build brand awareness. We will continue to invest in our connected customer, Pro, designer and DIY strategies. We are enhancing our marketing efforts to drive more traffic both online and in our stores. With our brand awareness still low and our market share still small, we are well-positioned to build on our share gains given the fragmented nature of our industry. The key to our success has been and continues to be our people and the disciplined investments we make across all areas of our business. A bit later I will touch on several of the investments that are increasing returns and driving growth. To reiterate our key growth priorities and area of investments are; one, opening new stores, two, increasing comparable store sales, three, expanding the connected customer experience and four, improving the Pro customer experience. Now let me briefly highlight the progress we made in the third quarter in each of these areas. Number one, we continued to invest in new store growth which remains our top priority. We continue to see a path towards at least 400 nationwide Floor & Decor stores. We have made a number of important changes in the way we invest in and open our new stores. These enhancements along with strong site selections have led to our class of ‘16 and projected 2017 new stores four-wall EBITDA to more than double previous years and are above our pro forma expectations. While our 2017 new stores have collectively not yet cycled past our 1 year anniversary, we continue to believe they will represent the best class of new stores in our history. We opened seven new stores in the third quarter and remain on track to open 17 new stores in 2018. This represents 20% growth from last year and is in line with our long-term targets. We are excited about the class of 2018 stores including those opened in densely populated metro markets like Long Island, Boston, San Francisco Bay Area and Seattle. We believe these stores will drive substantial growth and profitability over time. Our class of 2018 stores are opening favorably and our work around the class of 2019 stores is well underway. We expect another year of 20% unit growth and this is a direct reflection of the strength and capabilities of our real estate team. Number two, we continued to invest in driving comparable store sales growth. We remain focused on key comp store sales growth driving initiatives including product innovation, digital merchandising improvements, better training for our associates, Pro and designer strategies. We are also focused on investing in technology to provide superior experiences online and in-store for both our Pro and DIY customers, a few examples of investments we believe will serve the customers better. We are in the early stages of standing up our customer relationship management or CRM solution to smartly identify our customer from multiple sources, which should help us better segment, message and serve these customers over the coming years. We implemented a system for scheduling online appointments with our in-store designers. The increase in online appointments has far exceeded our expectations. We know that when a customer spends time with one of our designers, it has been far more than our average ticket. We also see both improved customer satisfaction stores and favorable customer reviews on social media when a designer is involved. We are still early in adopting these new solutions to learn and serve our customers, but we are excited with the early results. From a product and merchandising perspective, our expansive SKU offering visually inspiring design centers and displays, along with our breadth of assortment continue to set us apart. This allows us to flex with the ebbs and flows both within and across product categories. An example is our rigid core locking LVP within our LVP laminate category. The same competitive advantages that have led to our industry leading comparable store sales for a decade are clearly on display in this important category, Rigid core locking LVP has been our fastest growing product category for 3 years. Our in-stock assortment is materially higher than the competition. Our analysis shows that our products are better when compared with the competition when collectively comparing price, thickness, wear layer and warranty. Moreover, we have large visually inspiring displays that show our product on 8 foot by 3 foot display doors. So customers can appreciate how products will look in their homes. We consistently hear from our customers and employees that customers wanted to see, touch and feel product as well as have someone explain the features and benefits to them. This is an increase in purchase and customers like help in making the right decision for their project. In short, our entire value proposition is different, hard to replicate and has been working consistently for a long period of time as witnessed by our strong comp same-store sales growth over the past 10 years. Next, we continued to invest in expanding the connected customer experience. Sales originating through our website continue to grow at a much faster rate than our total sales growth. Online sales accounted for over 8% of our total sales in the third quarter with over half of all of our web traffic coming from mobile. About 75% of our e-commerce customers pickup in-store which demonstrates the synergy between our fiscal footprint and e-commerce business. We expect continued expansion of our store footprint to be a key driver of e-commerce growth. Recently, we made investments in machine learning on our website to help customers better identify products they are looking for thereby improving their online shopping experience. We launched a redesign of our mobile website and a new tool called My Project. This allows associates to build orders in the eye with the customer which helps our customers to expedite the checkout process. Alternatively, we can e-mail the order to our customers, so they can evaluate, change and transact on our website in the convenience of their home or on their mobile device. It is important to note that 70% of customers who ultimately buy from us will visit our website during the buying process. It is critical that our site is informative, inspirational and offers customers the ability to shop Floor & Décor however and whenever it is convenient for them. We continue to invest in the Pro customer experience. We completed the rollout of our Pro Premier Rewards Loyalty Program companywide and believe over the long-term that will generate a greater share of wallet and build loyalty with our pros. We have received very positive feedback. We tested and tweaked the solution for over 2 years to get it right and we believe our Pro Premier Rewards program is an industry leader. We saw favorable lift in sales in two different test environments in Phoenix and West Florida. Also for Pros, time is money and we have improved our pickup time to approximately 16 minutes, a substantial improvement from a few years back. We now have technology in all of our stores and training to help our stores understand how to safely and quickly get our customers through the checkout process. Now, I want to take a minute to address tariffs. Our experienced merchandising team has made meaningful strides in mitigating the risks of the imposed tariffs that were recently announced. Our strategy involves three distinct initiatives. First, we immediately began negotiations with our Chinese vendor partners and have made substantial progress in lowering the cost of the goods we purchase from them. Second, we continue to make progress to diversify the country of origin from all products where it makes sense to do so. This will happen over time. Finally, in areas where we are not able to completely offset the increase in tariffs with cost reductions, we will judiciously adjust retail pricing with a focus on achieving our overarching objective of maintaining our strong and competitive value proposition. In summary, we continue investing back in the business to provide both our customers and professional customers a truly unique customer experience. We remain focused on multiple areas across the business to support our growth and drive returns higher. We have a long and attractive runway of growth ahead of us. We believe we will continue to gain market share as we leverage our wooding retail formula of growing our store base 4 times across the U.S. I now would like to turn the call over to Trevor Lang, our CFO and Head of Pro Services to go over our financial results and guidance.

Thanks, Tom and good morning everyone. I will review our third quarter 2018 results and then discuss our outlook for the remainder of fiscal 2018. We delivered another very solid quarter opening 7 new stores, entering 6 new markets, continuing our track record of growing adjusted EPS at a faster rate in sales growth, while continuing to make important and significant investments to support our sustained long-term growth. Our new stores should continue to perform very well and are providing a great return on investment and our comparable store sales growth in our new stores in densely populated markets are outperforming the chain average, which is encouraging as we opened more stores in the Northeast and the West Coast. Net sales in the third quarter of 2018 increased 26.7% to $435.9 million from $343.9 million in the third quarter of 2017. We ended the quarter with 95 total warehouse format stores, an increase of 15 stores or 18.8% versus the year end of the prior year period. Our third quarter comparable store sales increased 11.1%. Our comparable store sales growth were driven by transaction growth partially offset by a slight decrease in average ticket. We estimate that our third quarter 2018 comparable store sales growth, excluding the stores impacted by Hurricane Harvey and Irma would have been approximately 10%. Now, on the profitability, gross profit increased 25.1% to $178.2 million in the third quarter from $142.5 million in the third quarter of fiscal 2017. Gross margin decreased by approximately 50 basis points to 40.9% from 41.4% in the third quarter of fiscal 2017. The year-over-year decline in gross margin rate was primarily due to higher domestic freight cost and higher inventory shrink. As a percentage of sales, total operating expenses declined 10 basis points to 33% compared to the third quarter of 2017. The 10 basis points in year-over-year decline was driven by our general and administrative expenses, which are store support center expenses typically incurred outside of our stores. We slightly de-leveraged our store expenses due to opening 15 new stores in the third quarter of 2017. Our comparable store sales continued to demonstrate solid operating expense leverage of approximately 90 basis points in the third quarter. As previously discussed, we are opening new stores in new more densely populated markets that have higher pre-opening and operating costs. For fiscal 2018, we expect an increase of over $10 million in store operating and pre-opening expenses compared to fiscal 2017 given our entry into these new more densely populated and expensive markets. Operating income increased 19.7% during the third quarter to $34.2 million as compared to $28.6 million in the third quarter of fiscal 2017. Operating margin decreased 40 basis points to 7.9% versus the prior year period. Our interest expense in the third quarter was $2.2 million compared to $2.6 million in the prior year period. The decrease in interest expense versus last year is due to a combination of debt pay-down and a decrease in average interest rate year-over-year. Our reported provision for income taxes for the third quarter was $5.5 million for an effective tax rate of 17.1% compared to $2.7 million or 10.5% effective tax rate in the third quarter of 2017. The increase in our effective tax rate was primarily due to recognition of excess tax benefits related to stock options exercised in the prior year period. We have adjusted the stock option benefits out of our calculation of adjusted earnings today. Before I discuss net income in 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 the 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 $25.5 million or $0.24 per diluted share for the third quarter of 2018 compared to $17.3 million or $0.17 per adjusted diluted share in the third quarter of 2017. This represents an increase in adjusted net income of $8.2 million or 47.2% compared to the prior year period. Adjusted EBITDA for the third quarter increased 23.2% to $48.9 million compared to adjusted EBITDA of $39.7 million in the third quarter of fiscal 2017. We ended the quarter with $190 million in cash and available liquidity under our revolving credit facility, $150 million of borrowings outstanding and no revolver debt. Our inventory balance at the end of the third quarter was $403.8 million, down $24.2 million for the end of fiscal 2017 and up 2% versus the third quarter of 2017. Now, turning to our earnings guidance. As you saw in our press release given our year-to-date performance and our expectation for Q4 we are raising the low end of our full year sales range reiterating our full year comp and adjusted earnings per share outlook and trimming our full year adjusted EBITDA range by a little over $1 million. Versus the annual guidance we gave on our last call, fiscal 2018 gross margins stayed consistent at an estimated 41%. Store operating and pre-opening expenses are slightly favorable, but we are taking on an additional $1 million in cost as we work towards Sarbanes-Oxley compliance this year. We expect fourth quarter fiscal 2018 net sales to be in the range of $429 million to $437 million, which represents a 10% to 12% growth from last year. This fourth quarter outlook contemplates comparable store sales to be flat to up 2% from last year. Recall, comparable store sales increased 24.4% last year in the fourth quarter as our sales in our Houston market increased over 100% due to Hurricane Harvey. Our Houston stores alone accounted for 800 basis points of the 24.4% comparable store sales increase last year. As we built our guidance for the fourth quarter of 2018, we are assuming our Houston market stores experience a comparable store sales decline in the mid-40% range, which is modestly higher than our previous expectations. We estimate that our Houston market will create a 900 basis points headwind on our fourth quarter 2018 projected comparable store sales growth. Importantly, we expect our non-Houston comparable store sales to remain strong and grow at an estimated 9% to 10.5%. Our fourth quarter outlook also assumes a year-over-year decline in operating margin rate of over 200 basis points due to the following factors in priority order. First, hiring new store pre-opening expenses which is planned to be approximately $7.5 million versus $2.7 million last year. Second, the de-leveraging of our store operating expenses by over 100 basis points due entirely to new stores as well as the natural de-leveraging that occurs when comparing against the Houston led 24.4% comp last year and finally an expected decline in gross margin due to higher domestic supply chain cost and higher shrink in damage. As a result of these factors, we expect adjusted EBITDA for the fourth quarter of 2018 to be in the range of $40.3 million to $44.2 million versus $43.5 million last year. Adjusted diluted earnings per share for the fourth quarter of 2018, is expected to be in the range of $0.16 to $0.19 versus $0.19 last year. This assumes approximately 104,800,000 weighted average diluted shares outstanding for the fourth quarter of 2018. For the year, we expect sales to be in the range of $1.702 billion to $1.710 billion, an increase of 23% to 24% from fiscal 2017. This outlook is based on 17 warehouse store openings or 20% new store growth and an assumed comparable store sales increase of 9% to 10%. Excluding Houston, we expect our comparable store sales to be approximately 10%. We anticipate fiscal 2018 adjusted EPS of $0.93 to $0.96, an increase of 35% to 39% over fiscal 2017. Diluted weighted average shares outstanding are estimated to be approximately 104,800,000 and our fiscal 2018 normalized effective tax rate is estimated to be 23.4% for the remainder of the year. As a reminder, this guidance does not consider the tax benefit due to the impact of stock option exercises that may occur in fiscal 2018 or possible discrete tax adjustments. We expect fiscal 2018 adjusted EBITDA to be in the range of $188 million to $192 million, an increase of 18% to 21% over fiscal 2017. CapEx for the year is expected to be in the range of $161 million to $167 million in total with $103 million to $105 million of this capital budget being spent on the 17 new store openings in 2018 as well as the construction of stores opening in early 2019. $33 million to $35 million is earmarked for store remodels, including one relocation and our distribution centers. The remainder of our CapEx approximately $25 million to $27 million is directed towards our IT, e-commerce and other store support center initiatives. We signed a new lease for our store support center which is located only a few miles away from our current store support center. We are still evaluating our options related to our current store support center. If we decide to exit our current lease, we can create unique lease exit cost of up to $10 million. Our intention would be to call these costs out and a reconciliation of non-GAAP metrics in our quarterly earnings release, so there will be no impact on our adjusted earnings. We are still in the planning process for 2019 and consistent with last year we plan to discuss our projections for 2019 when we have our year end earnings call in late February next year. With that operator, we would like to turn it over to the Q&A portion of the call.

Thank you. [Operator Instructions] Our first question comes from Seth Sigman with Credit Suisse. Please proceed with your question.

Hey, good morning guys. Thanks a lot for taking the question and nice quarter. My first question is just around the tariffs and Tom, thanks for the color on how you are planning through that, but just wondering how do you think about your ability to pass through pricing while still maintaining the price leadership in the category that works for so long? As you see your competitors are looking to pass through pricing also giving you room to also take up pricing if you need to while still maintaining the price gap or do you ultimately see that price gap narrowing?

While our goal is to maintain the price, the price spread that we have enjoyed during the time here, if you think about the market and kind of the way people buy, a lot of the market is independent hard surface flooring stores which are already buying through middleman and there is certainly the home improvement centers, but our philosophy has not changed. We buy direct from the stores and a big part of buying direct from the stores is taking the middlemen out. So, now tariffs can mean that the best source is not always in China, so you know I will let Lisa talk a little bit about where we are moving, but from a pricing perspective, we have really been thoughtful we go through and we try to really look at where the product originates from. In some of our products, the same situation is going to exist across everyone to sell that product, because the only place you can get is China and those are the type of products that we will look at, but we are a value retailer first and we will do all we can to maintain the price spread that we have enjoyed. We think this led to a lot of success. I would add one thing to access and that is when you look at the total flooring project if you kind of deconstruct a flooring project and you look at how much of it is the SKU that’s coming from China versus how much of it’s installation accessories which are domestic versus how much of it’s labor. The real impact even with the 25% tariff is still mid single-digits to the end user who is for doing a flooring job.

And have you guys embedded any sort of impact on sales or margins for the fourth quarter as it relates to tariffs and then just ultimately what is going to be the net effect of all these initiatives, all the planning you are doing around tariffs in terms of the impact it could have on sales and margins I guess under the 10% scenario and then under the potential 25% scenario?

Hi, this is Lisa. I will speak to the 10% scenario and just the fourth quarter that’s right in front of us. So we have adjusted a few prices not a lot, but we don’t believe that the 10% tariff that we have been seeing since September 24 will have any impact on the margin for the fourth quarter. As we get into the 25% I will let Trevor speak to that a little bit more.

Yes. So I do think we will not have much of an impact in the fourth quarter, so we have modeled it. Lisa’s team has done an incredible job and being aggressive with our partners to get lower costs as soon as the tariffs were announced. And also our inventory, weighted average costing inventory system because our inventory turns about two times a year by the time some of those costs flee in, it just won’t have much of an impact. As we look forward to 2019 we are not going to give guidance or talk about that in detail, but our plans are to work through the three initiatives that Tom mentioned, right, we are going to aggressively take out costs with our vendors. We are going to look at sourcing products elsewhere where it makes sense. And then the last resort is we will raise prices to the extent the market will bear.

Yes. I would just say one thing, the raise in prices, the last resort, our merchants have been, if you think about our category or our company, we have a lot of merchants dedicated to hard surface flooring. We have a sourcing office and our step one is negotiate with the supplier and our partners have been with us the long time and we have been very fortunate that we have been able to negotiate a lot of cost out to help us. So I wouldn’t get so caught up. We are not offsetting tariffs completely with price. It’s just something that is a lever that we will look at.

Understood. Thanks very much, very helpful.

Our next question comes from Matt McClintock with Barclays. Please proceed with your question.

Hi, yes. Good morning everyone and congrats on pretty impressive comp on difficult comparisons. I was wondering just as a follow-up to the last question you said that a 25% tariff would drive a mid single-digit increase in the total job costs, how does that compare with just how labor inflation over the last several years has driven the cost inflation for the total cost of doing a flooring project?

This is Trevor. When you look at the overall total cost, Lisa’s team has done a great job analyzing those for us. Its mid-30% is the actual cost of the product itself that goes into it. But you didn’t have to have all the installation accessories underlayment, grout, thin sets, motors, sealers, things like that. Most of those things are sourced domestically and so we won’t have much of an impact there. And its rough math, but approximately the cost of the product per square foot, let’s say you put in 250 a square foot, you get another 250 a square foot for labor and so maybe half of the cost is the labor. We don’t control the labor, but we frankly have not seen massive increases really significant increases in the cost of install per square foot, it’s still competitive environment. The program to compete for business and so I do think there will be an increase in price a little bit as Lisa said even the 25% tariff if we didn’t do anything, the overall impact is about 5%. We do think that there will be some slight increases there, but we have not seen to-date significant increases in labor from the Pros that we talk with.

Yes. And if there has been an increase in labor over the last few years, it hasn’t affected us.

Okay, that’s helpful. And then just we have heard across the industry that there seems to be a broader shift or a broader trading down trend within flooring to-date and I was just wondering when you think about your business how it’s positioned in the value channel and the results, the strong results that you put up this quarter, could you talk to your thoughts on how much your business is benefiting from this broader trading down turn that we are starting to see?

This is Trevor. Lisa just hand me another, our better and best products are increasing as a percentage of our total sales. I think what you are referencing is the product attributes that have come out we will just pick out a high growth department as Tom said for the last 3 years is our rigid core LVP, that can be a less expensive product relative to higher in wood for example or higher in wood-look tile. But when you consider the overall install cost per square foot with installation accessories, the overall retail per square foot is not meaningfully different and the overall gross margin profile isn’t meaningfully different. And evidenced by that, if you look at our comps for fiscal ‘17 and look at our total sales in comps for fiscal ‘17 and ‘16 that also was our best performing department at that time our comps were fantastic. Our gross margins were good as well. And so our view is as long as the hard surface flooring market is growing, we’re going to have the best products and we’ll then continue to lead with both sales and productivity.

I’d add – I just would add quick – two quick points. One is, when you peel apart our numbers are better and best SKUs are comping better than our good SKUs. So, we’re not seeing consumers step-down and ours – the benefit of our model is that our store can flex to whatever selling in the stores, so we react to that on a local store level.

Perfect. Thank you very much.

Our next question comes from Elizabeth Suzuki with Bank of America. Please proceed with your question.

Great. Thanks. Just Laminate and LVPs gone from 12% of sales in 2016 to now running at about 18% of sales year-to-date. How high do you think that ultimately gets and do you view that as a net positive trend as a retailer or are there product categories that aren't growing as fast that would typically generate higher margins for you?

Yes. So that category for the third year in a row continues to do really well for us. As I said in my pre-prepared remarks, all of the competitive advantages that we have across the categories we sell in the store exists within this category. For us we’ve got initiatives in place. When I talked in the last call, I talked a little bit about the total – the total sale and if we don't attach all of the attachments that go with it like molding and vapor barrier and things like that of that nature, then the margin can be a bit challenged, not a lot, but a bit, but we’ve made good progress in the last quarter and we’ve got initiatives in place narrow that gap. So for us whatever the customer wants, our stores are – we’ve got a unique culture here. Our stores are merchandised at the local level and we have teams in place that flexes space in the stores, so if that continues to increase that’s not a bad thing for us.

Great. And then last quarter you guys had mentioned that you saw that slowing existing home turnover might be a pressure to the business over time. And one of your large retail peers mentioned that strong home price appreciation is a positive offset to that pressure. Do you think flooring is the type of category where homeowners are more likely to undertake that project when they're moving into a new home or does turnover not necessarily have as big – as big of an impact as like rising home price appreciation?

I mean, we always cite that housing turnover helps and we always cite that rising housing value helps, people want best back in their homes as they go up and value, I think they are both important to us. But we’re not economists and what happens in the markets – happens in the markets, I’d just pivot back to as our company continues to grow, we continue to like share. Our unaided awareness is less than 10%, 44% of our stores are less than three years old, hard surface flooring growing faster than carpet. Innovation across the category has driven sales. So whatever the market does, we think we can take share and outperform what's happening within the market.

Great. Thank you.

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

Good morning. Thanks a lot for taking my question. I know it’s early and you – you guys also provide any outlook for 2019, but just directionally in light of all the uncertainties with housing tariff, the competitive environment that seems becoming a little bit more intense. Do you think you can keep your margins flat in 2019?

We’re not prepared to talk about 2019 at this time.

Okay. And presumably part of the reason why you're getting better deals from your vendors is because they’re moving the RMB. If the RMB were to reverse, would you have to give back some of the advantageous purchasing that you’ve gotten from them?

No. This is Lisa. I – we certainly go and think so. That is certainly helping the negotiations, but the bigger thing that is helping the negotiations with our Chinese suppliers is that we have really great longstanding relationships with these guys and they don't want to lose this business. They see the growth opportunities that we have as a company. They see where their business could be with us in five years and so they’re finding ways to be more efficient. They're finding ways to get us to cross that we need so that we can continue to be competitive. So, I don't believe that, that was helping me, currently we keep there. I have currency, we do pay in U.S. dollars and it helped over time, but I would not say that it’s – that we would anticipate that happening at all.

And Michael –

In my –

Go ahead. I just want to go back to one thing just – so I was kind of – we do not really talk about 2019 and we’re not. But I would just say that 2019 is a moment in time for a company that’s growing like ours. We’re still 20% to 25% of what we can be, we still believe we can have more than 400 stores, so there is nothing changed in our confidence. We’ll open up 20% new units next year. We’ll continue to invest in the business, but we just don’t have the detail yet on 2019, but we’ll get to it.

Yes. What was your take on to those, who are you look, Floor & Decor has really made its niche on direct sourcing and expensive products in China being little sales below competition and building that around really impressive store experience, if there – the 25% tariff go through even if the tariff goes within – remain in place for a while, does that significantly impact the Floor & Decor business model?

No, as I said earlier, I mean, when we talk about, look we bought from more than just China, right. So we buy from 20 countries. We have 225 suppliers now around the world and we’ll continue to diversify where we buy from. Our goal has always been to go where we get the best price, so we can pass it along to the consumer. And when you think about the supply chain particularly that the independents have to deal with, there is a distributor in that, there is multiple hands in the margin slice because they don't – they're not able to buy direct. We have a team in place to be able to buy direct from whatever is the cheapest in the world. So, I don't believe that tariffs will – are going to change the way that Floor & Decor does business and what our competitive advantages are.

Michael, this is Trevor. Just one last thing. Lisa’s team has done a pretty exhaustive study of where we believe our competition is getting their products and because we direct source it, we're very transparent that about half of what we sell comes from China, but as we’ve looked at the competition both the big box and the independents, we believe a lot of what they're buying as well is coming from China. And so everybody is going to have to deal with this. Don't think of this as such that it's very disproportionate to Floor & Décor, because about 50% of what we buy we think a lot of what our competitors are buying this from China as well.

Thank you very much.

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

Thanks. Good morning, guys. Two questions on the hurricane. First, as you – you’re thinking about the new outlook for the fourth quarter up in terms of the impact. Could you help us through how you’re thinking about that in terms of – because we’re trying to think about the first half of next year where you still have a benefit. Is it that the – there is more comp dollars that you’re anniversarying, is it that the trends that you're seeing are just – are moderating in the Houston market, how do you think about that?

This is Trevor. I’ll start off. So, you guys probably recall from last year, we called out that the Houston market comped up over 100% in the fourth quarter last year. We thought originally going into this looking at a two-year and three-year trend. When we looked at IKEA decade ago we thought maybe that would comp down in the negative 35%. We were incredibly accurate in our forecasting for the first nine months of the year as we got to the fourth quarter when we saw the actual results, it looks like it’s going to be more like the mid-40s, and so we’re just obviously updating you guys. We do think as we get into the first half of next year, there will be continued headwinds in Houston although albeit a lot less than what they are now. Houston comp I think up 60% in Q1, and I think maybe at 40% in Q2. So, they will abate the first we go along. And so I do think we’re not ready to give guidance for next year, but I do think when we ultimately roll up our guidance mathematically, our comps will accelerate throughout 2019 for two reasons. One, we will not be going up against the Houston headwinds, and two, as you looked at the cadence of our openings of our stores this year, they’re very backend loaded again, and as those new stores coming up with a comp base they still provide a substantial comp lift and because we'll have more of those new stores coming into the comp in the back half of 2019 we will – we should have higher comps as we get to the back half of 2019.

Understood. That's very helpful. So, in terms of the third quarter you had talked about 150 basis point to 180 basis point potential, so tailwind from the two hurricanes in September, so it seems like you ended up at sort of the low-end of that range. Is that fair?

Yes. I think we called out in my prepared comments that if you exclude it both Hurricane Harvey in Houston, Hurricane Irma in Florida, we think – had about 110 basis points impact to the business. So, the 111 comp that we actually performed at would have been closer to a 10% comp.

Got it. And then can you talk about just the overall category trends, appreciate that the customer continues to trade up and clearly an encouraging sign. So how did sort of Luxury Vinyl versus Natural Stone and Tile and Porcelain and so forth? Thank you.

Sure. So I mean for the third year in a row luxury vinyl has been one of our fastest growing categories. That customer we believe is shifting a little bit from certainly from the wood categories the most, a little bit from tile maybe, but that’s – it’s kind of hard to know where they are shifting from. But our strength is continues to be in the laminate and in the vinyl products more than decorative accessories and regular accessories, all have been strong for us. So wood is a little – is a challenge for us, but again we think that’s a shift in customers, Chris. And stone has been the challenge that softness in travertine to a certain extend and customer shifting to Porcelain tiles.

Thank you.

Thanks Chris.

Our next question comes from Jon Matuszewski with Jefferies. Please proceed with your question.

Great. Thanks for taking my question. I guess to start off clearly the unit growth is still intact and comps are really robust, 25% 2 years back this quarter, could you just spend some time elaborating on that productivity opportunity ahead, I think that’s probably underappreciated and I know you mentioned the loyalty program better scheduling of designer appointments, what levers are you guys most excited about and what other levers do you think could be pulled in the coming quarters to drive sales per square foot?

Yes. I will talk about the productivity first. I mean I think our average sales per square foot today is somewhere in the – I think the $270 range. If you look at our best, 20% of our stores they are close to $400. So we have gotten substantial upside in the sales productivity per store. As Tom mentioned over 40% of our stores are less than 3 years old, our new stores in the start with slightly lower volume. But as we get better brand awareness, Pro shopping with us people understand what we are trying to accomplish. We see substantial comps from our new stores that’s been as high as 400 basis point lift to our total comps comes from our new stores. So we think there is plenty of productivity, we are always making enhancements the way we handle with technology back into the store technology actually help our sales associates, the website, all of those things also help our productivity. And so we think there is substantial upside to the overall productivity per store and through our website as we look to the future.

Yes. And I will talk a little about some of the things we are excited about you mentioned and I mentioned a lot of them in my script. And there is too much the list of things that we are – kind of things that we are doing. But I will just talk about four quickly. Our emphasis on the designer part of our store, the last few years we put in design centers, they are almost 2,500 square feet in size on average. We have got some bigger and some smaller. But we are – we have spent a lot of time upgrading our design services and what our designer’s capabilities are and that is a big initiative that we will talk more about as we get into the next couple of years, but certainly we are excited about what they are able to deliver. We have given them great tools and we are investing in them and we feel like we know when our designers are with and with the customer the average ticket is much larger than our normal average ticket. We know that they sell the whole project, so we are excited about that. As we are still in the middle innings and what we can do with our professional customers while we have done a lot over the last 5 years to 6 years there is evidence in this quarter we finished rolling our Pro from here. We finished rolling out a Pro app, that’s getting great reviews. We are enhancing our delivery capabilities, but we are still – we can still be a lot better. We are excited about that will bring us. And then we have you a huge – a large initiative around kind of how we sell the customers and what the customer experiences in the store, we have got some pilots underway that staff a store differently than we have historically staffed it, we are excited about that will bring. And then the last thing I would say is that innovation within this category continues to be a driver of business and there is continued Lisa and her team have done a really nice job continuing to find great products and we are excited about the products that continue to come in our store all of them should be drivers to help us continue to take share.

Great. And then just a quick follow-up, so despite some softer existing home sales data you guys have been really able to buck the trend and gain share in the industry, did your data suggest that’s continuing to come from those 15,000 independents out there and then also just anything to call out on regional trend, I am thinking just given the overall healthy comp number this quarter, it’s probably broad based and you could very well be posting some numbers in areas where housing may even be a bit softer, so any color there will be helpful? Thanks.

So, the first part of the question was yes, from a share standpoint look we are taking – we believe we are taking share from everywhere that we compete we think we take share from the independents, we take share from big box and then we think we grow the market to a certain extent. So there is nothing new to report on kind of how we think we grow our market share. And then from a regional perspective, as Trevor mentioning and as I have mentioned in my script, if you just minus out the Irma and Harvey impacts, we are still double digit across the country, so we are seeing good trends.

Great. Thank you.

Our next question comes from Zach Fadem with Wells Fargo. Please proceed with your question.

Hi, good morning guys, could you talk a little bit about your approach to inventory ahead of the January tariffs, it looks like your inventory levels grew only about 2% in Q3 which is surprisingly low given the new store growth, so maybe if you could talk about the drivers there and then whether we should anticipate inventory build in Q4 as you look to get ahead of the 25% tariff next year?

Hi Zach, this is Trevor. Just a quick reminder, last year our inventory was up 47% at the end of the year. We had two very important distribution center moves. We relocated our Savannah distribution center in late Q4. We have shutdown our Miami distribution center in early Q1 and so we really built up our inventory to stay in stock with those two large distribution center moves. And because that inventory was so elevated, we just did need to make the same level of investment as we got to the end of Q3. I don’t want to take away from our inventory team, they have done a fantastic job of managing our inventory, they keep us in stock and not grow our inventory and yes, like every other retailer we are doing everything we can to bring in as much of our inventory before the end of the year such that we can assuming those 25% share is going to place that we will receive those. But we still even with that our current projections are that our inventory at the end of year will grow to slower rate than our sales growth.

Got it. And then for your Q4 guidance it looks like you are expecting new store productivity at least by the way I calculated to take a little bit of a step down, I know you are opening some stores later in the quarter, but maybe you could walk us through just the moving parts whether there will be consideration you are giving to the macro or competitive environment perhaps in some of your new markets.

Yes. This is Trevor again. It’s actually a very simple story, Houston. So we had a new store in Houston that was part of the new store sales last year and if you like look at our Q4 new store productivity, it was the highest it’s been. But again, it’s a little misleading because one of our new stores was in Houston that itself went up substantially just like the comp store, so as I mentioned we are up over 100%. That Houston store comps came in at a comp base in Q1 this year and so that’s what is – has been indicating that our new store productivity is not as strong.

Got it, that makes sense. Thanks Trevor. I appreciate the time.

Thank you. [Operator Instructions] Our next question comes from Steve Forbes with Guggenheim Securities. Please proceed with your question.

Good morning, I wanted to focus on the Pro customer and specifically right as it relates to the rollout of Pro from here, can you comment on the overall acceptance of rewards were some financial incentives and maybe your willingness right to transition if there is one right to financial incentive over timing, what are the Pros saying as this program continues to build and you guys build up that customer base?

Sure. This is Tom. I will start and then hand it over to Trevor as he is in charge of Pro. So far the acceptance has been terrific. As we approached Pro premier program our so called loyalty program, we approached it with a plan to we treat our professionals like partners, we don’t compete with them, we don’t offer installed sales in the store, we want them to be our partner, so we approached it from a partnership standpoint. So we have an emphasis on services that a Pro can get for their business and we think that’s a unique approach to kind of how we go about it. But there is a gift program in there where they can take trips and they get recognized for how much they spend within our stores. And so far the acceptance has been great. Trevor, I don’t know if you want to…

Yes. I think Tom hit the points, right. I mean it’s a dual pronged approach where we offer about 13 different business services things like e-mail, website, lower workers comp and general liability cost, payroll services. And then there is a points based component, the more you spend, the more points we had a customer take a very nice cruise with this here recently and he has got pictures posted all over social media, all of his clients – of to his clients. And so we think it’s a great program. As Tom mentioned we were very slow to roll this out we kept it for over 2 years in two markets and saw a nice lift in sales. And so it is an expensive program, but we think there is a good ROI in there.

Thank you. I’ll keep it to one. Thank you.

Thank you.

Our next question comes from Geoff Small with Citi. Please proceed with your question.

Good morning. Thank you for taking my questions. I want to ask about expenses. It looks as though you did a nice job controlling costs across both COGS and SG&A in the quarter. With your gross margin coming in better than forecasted despite the product margin pressure and some nice leverage in terms of comparable store operating expenses, I was hoping you could provide some color on the drivers of those results across the two line items?

Yes, this is Trevor. The teams did a good job. There’s probably nothing more to say about than that. I think distribution centers manage their costs closely, store operations, we watch their labor every single week, they manage their costs closely especially in the back of the quarter, all the operating expenses travel across the board.

It demonstrated discipline.

The teams did a good job of chipping in and watching it closely.

Terrific. Thank you for the color, and best of luck in the fourth quarter.

Thanks, Geoff.

Our next question comes from Charles Grom with Gordon Haskett. Please proceed with your question.

Hey, thanks. Good morning, everybody. Just a question on the consumer, we just got up the Wayfair call and they talked about a little bit more of a wall to market and some opaqueness in the consumer backdrop. Just wondering, if you're seeing any of that new business, I presume no given the guide? And then just one quick one. If you could just maybe hold our hand on gross margins for the fourth quarter? Thanks.

I’ll do the consumer first and it kind of pivots back to what I said. I mean, what we look for in our businesses, we look around where housing markets would slow quicker California, Phoenix, Vegas et cetera, we're not seeing weakness there. The other part I would say is that, our transactions actually – if you took Houston out, our transactions accelerated during the quarter, so more customers are coming into the stores. So, the consumer may be pinched, but we have a disruptive model that takes share. As I said earlier 44% of our stores are less than three years old, 10% unaided brand awareness. We think people are finding our concept and it resonates with them. So even if the consumers pinched, we think we can perform through that.

Yes. This is Trevor. The only other thing I would say is, my experience in retail is when things get tighter the value player takes market share and we certainly experienced that in 2008 and 2009. Business is very different than it was 10 years ago, but I do think we will take more market shares if the market continues to – it’s doing well, but if it continues to decelerate. Specifically, on Q4 gross margins, we are planning them down some portion to 70 basis points. As we mentioned, we think the teams done a great job on tariffs. We don’t think most of the margin deceleration in Q4 is much different than what we talked about for the year. Most of that lower gross margin is coming from product margin, which we believe is mostly attributed to higher domestic supply chain costs. As you guys know trucking costs are higher, fuel surcharges are higher and that’s the majority of the gross margin decline that we’re seeing as we get into the fourth quarter.

Great. Thank you very much.

Our next question comes from David MacGregor with Longbow Research. Please proceed with your question.

Yes. Good morning. Congratulations on all the progress. Just wanted to talk about the experience in some of these more densely populated urban markets as you’ve been moving into resilience. It sounds like things are going well, but can you talk about maybe where things are – you maybe are little surprised, you’re seeing things that you didn’t quite anticipate and what you’ve learned from that and just how you might tweak the model going forward as a result of that experience?

Yes. This is Tom. They are going well. We’re pleased with their entrance into Boston and into Seattle what we do resonates there. We’ve been in bigger markets. Our – we’ve been in New Jersey and Washington D.C. for several years and we're really excited about the performance of those markets and kind of how they have – how they’ve ranked since we've opened them, it's been pretty substantial, and we’re anticipating similar things to happen in those markets. We – I don't think there's much we change at this point. We’ve got a good real estate strategy in those markets. We’re going to infill those markets at a pretty nice rate, but they’ve opened up as we expect and we’re fortunate to get a lot of people to attend our opening events and find the brand and it’s resonating. So, we've learned a lot. We've opened a lot of stores in the last six years. So, we think we’ve – we certainly have the strategies in place to have successful openings no matter where they are.

Yes. And if you look at the – this is Trevor, if you look at the comps in those stores in Washington D.C., New Jersey, Los Angeles in their second and third years, they’re incredibly encouraging as we think about comps for the second and third years of these stores in these new and densely populated markets that comes into play over the next few years.

Thanks.

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

Thanks a lot and good morning. My first question is around product mix, last quarter you called about product mix being a negative impact to gross margins, how is that this quarter and what’s your expectation for the next couple of quarters?

Yes. I think this is Trevor, Seth. We have done some more exhaustive studies of that mix and the overall margin impact for the back half of the year we think has more to do with the overall higher supply chain costs. As you look at the total mix of what we have sold where we have adjusted retails and the costs that we have obtained we don’t see mix being as much of a headwind as we think about the back half of the year.

Yes. And I would say that rigid core vinyl is what we talked about in the last call. And we have got initiatives in place to do a better job of selling them in store of the whole project and we have seen progress in that.

That’s good. And my follow-up question if I may relates to tariffs, so you guys have done a great job offsetting some of the 10% tariff that we have seen thus far with reduced price from vendors currency and shifting sources, how much you can offset in the case of 25% tariff?

We are working on that and we are not –our goal is to offset as much as we can. We are anticipating that that happens. We did a good job of going through and buying Chinese New Year orders early. And we will continue – we are back working with our suppliers right now in anticipation of that happening and we will try to continuing to take cost out and we will continue to diversify where we go to get our product. We have got lots of things underway. We will talk more about that as we get into 2019 with our goal is to if the tariffs go through is to diversify outside of China, we got plans in place to do that.

Fair enough. Thank you.

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

Nice execution here. I wanted to dig in on I thought to Seth’s question on the mix so that the topic last call is a lot around the mix shift with LVP and maybe losing some of the accessory sales, that mix seem to accelerate rather meaningfully in Q3, but it sounds like mix isn’t as bad as you thought on the gross margin standpoint, so just following-up on that, can you give us a little more specific so we can understand what’s happening and presumably that mix shift is going to continue in the coming quarters?

Yes. This is Trevor here. I think we have had a mix shift, but again we are continually evaluating costs and retails within those. And as we evaluate those things we have gotten the good – done a good job on costs and we have also adjusted some retails. And so as we have now done all of that work, we have effect of that and that’s reflected in the guidance we have given and what happened in Q3.

I think from a mix standpoint though it is not a pricing thing. We have done a much better job Peter over the course of this quarter in raising the training level within our associates of what they need to sell, when they sell rigid core locking vinyl. And it’s been growing at a really rapid rate that there is some product that a customer has to have when he walk out of the store and quite frankly we can execute better. And we did execute better in the fourth quarter. I think that will continue to happen. The other thing that I would say is as that mixes continue to grow when we offer if you look at just rigid core locking plank, our stores have, while I am getting to the number, I mean we have close to 50 SKUs available and Lisa’s team has done a good job of bringing better and best into that category. So we are not just selling off of the low price points that the big boxes may carry, we are able to sell a better product that comes with a little bit better margin. And we think between our initiatives around selling the whole job and our initiatives around selling a better and best in that category that we can offset any challenges that we may have.

Okay, great feedback. Thanks a lot guys. Good luck.

Our last question comes from John Baugh with Stifel. Please proceed with your question.

Thank you and my congrats on the share gains. You mentioned judicious pricing and I guess through either walk-in competitor stores or technology or both you can see what competitors are doing daily I guess. I am curious on those imported tariff affected products, what you have done versus what your competition done if you are able to give us any kind of early read on that front? Thank you.

This is Trevor. Yes, I would just say, you haven’t seen a lot so far. I think on the cost side we have been very aggressive and we have taken cost out to offset that, but we have not nor have seen our competition do a lot so far with significantly affecting retail. But I mean, as those – that products are received in the board and it’s going into ours and our competitors’ cost. There will likely and we expect to be some retail impact.

The majority of our offset on that imposed tariff now is on cost negotiations. So we keep a close eye on the competition. As you know, this category is a bit different. There is not a lot of brands in this category, features and benefits are different within products. So we are best to monitor how we are pricing if we feel confident within our pricing.

Thank you. Good luck.

Thank you. At this time, I would like to turn the call back over to Tom Taylor for closing comments.

I appreciate everyone’s interest in joining our call today. I want to again thank all of our associates for the hard work. It was a tremendous quarter. We are really excited about what the future will bring. We are in the early stages of what Floor & Decor can be. So we look forward to talking to you on the next call.

Thank you. This does conclude today’s teleconference. You may disconnect your lines at this time and thank you for your participation.