Floor & Decor Holdings, Inc. (NYSE:FND) Q2 2023 Earnings Call Transcript

Floor & Decor Holdings, Inc. (NYSE:FND) Q2 2023 Earnings Call Transcript August 3, 2023 Floor & Decor Holdings, Inc. reports earnings inline with expectations. Reported EPS is $0.66 EPS, expectations were $0.66. Operator: Good afternoon, and welcome to the Floor & Decor Holdings Incorporated Second Quarter 2023 Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. At this time, I would like to hand the call to Wayne Hood, Vice President of Investor Relations. Thank you. You may begin. Wayne Hood: Thank you, operator, and good afternoon, everyone. Welcome to Floor & Decor's fiscal 2023 second quarter earnings conference call. Joining me on our call today are Tom Taylor, Chief Executive Officer; Trevor Lang, President; and Bryan Langley, Executive Vice President and Chief Financial Officer. Before we start, I want to remind everyone 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.

Lukiyanova Natalia frenta/Shutterstock.com The company's actual future results could differ materially from those expressed in such forward-looking statements for any reason, including those listed in its 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 will discuss non-GAAP financial measures as defined by SEC Regulation G. We believe non-GAAP disclosures enable investors to understand better our core operating performance on a comparable basis between periods. 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 at ir.flooranddecor.com. A recorded replay of this call and related materials will be available on our Investor Relations website. Let me now turn the call over to Tom. Tom Taylor: Thank you, Wayne, and everyone, for joining us on our fiscal 2023 second quarter earnings conference call. During today's call, Trevor and I will discuss some of our fiscal 2023 second quarter highlights, then Bryan will provide a more in-depth review of our second quarter financial performance and share our thoughts about our projections for the remainder of fiscal 2023. Let me start by saying how pleased we are that amidst the economic challenges of rising mortgage rates and near record low existing home sales, we delivered fiscal 2023 second quarter diluted earnings per share of $0.66, which exceeded our expectations. These financial results reflect our team's intense focus on what we can control during this challenging period. We are executing our growth in customer service strategies at an elevated level, investing in new and existing stores and effectively managing our profitability when sales are modestly below our expectations. There have now been 22 consecutive months of year-over-year declines in existing home sales from rising mortgage rates, which continues to create intermediate term headwinds to our sales growth. Notwithstanding these headwinds, we continue to deliver on our growth plans by opening nine new warehouse stores in the second quarter, including our 200th store opening in Metairie, Louisiana. We are proud that our growth led us to open a New England region, which creates exciting promotional opportunities for our field organization. Moreover, we are fortunate that the strength of our balance sheet and cash flows allows us to continue invest in our existing stores and drive inspiration and newness at a time when the industry is contracting. In the second quarter of fiscal 2023, we executed 49 design center refreshes, including 34 exciting new XL slab vignettes, 153 decorative accessory resets and by the end of 2023, we expect that all stores will have an updated wood inspiration center. When industry demand turns, we believe these investments will position us for accelerated market share growth. We continue to successfully execute our plans to strategically reduce retail prices on specific SKUs, while at the same time growing our gross margin rate sequentially and year-over-year. Our product price gaps are as strong as ever and on like items, they sequentially widened during the second quarter. Moreover, we have been successfully diversifying our product sourcing away from China. In 2022, our products sourced from China declined to approximately 29% of sales from 50% in 2018, and we see a path FERC to further reduce this percentage meaningfully over time. Through our agile diversification strategies, we have demonstrated that we can reduce our product cost, drive product innovation and newness, achieve optimal economies of scale and lower our geopolitical risks from tariffs and more recently, ULPA enforcement efforts. Turning to commercial. Not only are we pleased with the emerging organic growth at Spartan Surfaces, but we were able to build on their successes by acquiring Sales master for solutions in June. As we look forward, we expect existing home sales to be more challenging than we previously contemplated and customers increasingly prioritize value and savings, seeking out those retailers that best meet these needs. We believe we are well positioned to navigate a longer duration of weak existing home sales headwinds and grow our market share even as the flooring industry contracts in 2023. Let me now turn the call over to Trevor to discuss our second quarter sales and growth pillars. Trevor Lang: Thanks, Tom. We are incredibly pleased with how our stores are executing strategies to grow our market share during this challenging period. We are focused on driving top line sales growth in the second half of 2023 through new product introductions, compelling bulk out price displays at the front of our stores, basket selling, open quote conversion, select SKU price reductions and engagement and loyalty strategies, particularly amongst our top pros. We will continue emphasizing our everyday low prices on a broad assortment of top quality and trend forward products, our in-stock job lot quantities and in-store online customer experience. We are pleased our second quarter service scores remain at all-time highs. At the same time, we are protecting our profitability by flexing payroll hours to align with transactions, improving operational efficiencies across the organization, optimizing our media mix and advertising spend for the most effective return and moderating discretionary spending. Let me turn my comments to fiscal 2023 second quarter sales. Total sales increased 4.2% to $1.100 billion from last year, and comparable store sales declined 6%, which was modestly below our expectations. Comparable store sales fell 6.6% in April, 5.5% in May and 6% in June. From a regional perspective, and like the first quarter, sales in our Western division remained the weakest. Our fiscal 2023 third quarter to date, comparable store sales are down 8.4%, which is reflected in our updated earnings guidance provided in today's press release. Turning to our fiscal 2023 second quarter transaction and average ticket performance. Comparable store transactions declined 7.1% from last year, which was modestly below our expectations, but an improvement from the 9.9% decline in the first quarter and a 10.4% decline I in the fourth quarter of fiscal 2022. Our second quarter average ticket growth of 1.1% sequentially decelerated from 7.3% in the first quarter and 14.4% in the fourth quarter of 2022. The sequential decelerating growth in our average ticket is mainly due to retail increases last year that we are now starting to anniversary in a more meaningful way as well as customers purchasing less square footage and our strategic decision to selectively lower retail prices on specific SKUs. Overall, homeowners and pros are engaging in fewer projects and undertaking smaller-scale flooring projects and are very intentional in their purchase decisions. For example, they are choosing a single bathroom project rather than a bathroom in kitchen project or a full room project rather than a 5-room project. Additionally, the cost of financing projects has risen due to the increase in interest rates fewer subsidized financing programs and tighter lending standards. Collectively, we believe these factors are contributing to us selling less square footage when compared with last year. That said, when the consumers are considering a flooring project, we continue to see an ongoing customer preferences towards our better and best price point products where we offer industry-leading innovation trends and styles at everyday low prices. Indeed, we are excited about the new SKUs landing in our stores in the second half of the year. Consequently, we believe we can grow our market share even while the industry is contracting. I will now discuss our new store pillar of growth. In the second quarter of fiscal 2023, we opened nine new warehouse format stores towards our goal of opening 32 warehouse format stores for the year. Among the nine new warehouse store openings, three opened in each month of the quarter with one opening on the last day of the quarter. We celebrated a milestone in our compelling growth story in early May by completing our 200th warehouse store opening in Metairie, Louisiana. I want to take a moment to recognize all of the people that made this possible. Each year, I believe we get better at opening new stores, and they are better than the previous class. And I'm excited about the new stores we have in the pipeline to open towards achieving our 500 U.S. store potential. We have a busy 11 new warehouse store opening plan for the third quarter of fiscal 2023, including a record-setting monthly store opening plan of nine new stores in the month of September. Moreover, we are excited about our plan to open four new stores in new markets in the third quarter, including Buffalo, Rochester and Albany, New York and Minneapolis, Minnesota. Among the 32-warehouse format stores we intend to open in fiscal 2023, 59% will be an existing and 41% in new markets. As a reminder, we consider any market where our stores have been opened less than three years to be a new market. Looking beyond 2023, we expect construction delays to ease and anticipate a more balanced quarterly store opening cadence, which will lead to more warehouse store operating weeks. Turning to our Pro business. Our fiscal 2023 second quarter total sales to Pros increased by 8.3% and accounted for 43% of total sales. Pro comparable store sales declined 1.1% from last year, driven by a decline in transactions. While second quarter comparable store sales to Pros declined slightly from last year, we are pleased with our engagement metrics where our top Pros continue to spend more with us compared with last year, resulting in a growing wallet share. Furthermore, we are pleased that our Pros continue demonstrating a strong appreciation for the value of our industry-leading Pro Premier Rewards loyalty program. Over 80% of our Pro sales are from PPR members, and second quarter PPR points redeemed increased by 73% from last year. We continue to grow our Pro context and are excited about the refinements we are making in our customer relationship management or CRM dashboard tools, which will further allow us to optimize and enhance our lead capabilities and drive engagement. We also build sticky relationships and lifetime value with Pros through education and training about flooring products, insulation and design solutions. As discussed in prior earnings call, we aim to be the premier destination for our Pro education by expanding industry partnerships. In the second quarter of 2023, we had 27 educational workshops training over 500 Pros. We have 121 pro educational workshop events planned for the year compared to 71 in 2022. We believe these investments are working as those trained pros have significantly increased their spending with us from last year. Turning to our e-commerce business. Our e-commerce team continues to focus on executing strategies to drive traffic and optimizing our customers' digital experience. In the second quarter, we drove 20 million clicks to our website. Our fiscal 2023 second quarter e-commerce sales increased 12.6% from last year and accounted for 19.1% of our sales compared to 17.5% in the previous year and 18% in the first quarter of 2023. Importantly, our digital and physical assets are working together. 79% of customers who purchased in stores say they have been to our website. Importantly, about 80% of our online sales are picked up in store. From a merchandising perspective, we continue to be focused on current trends, adding inspirational and user-generated content and expanding into new categories. Moving on to our design services. We believe our design services strategies are working. We're driving an elevated level of service versus our competition from trained designers capable of managing any size project with any customer. We are now -- we now have about five designers per store, which gives us coverage for all days and hours of business. We have equipped designers with hardware and design software, which allows us to give customers a better and more consistent experience. Our in-home design test is now in six markets, and we are pleased with the results. The in-home design allows us to work with the project space, including reviewing samples, taking measurements and defining the customer style. This experience also allows us to produce better visualization tools to help customers make the buying decision. In the second quarter of 2023, our design sales penetration increased 335 basis points from last year. We now have about 930 designers working in our stores with plans to have over 1,000 designers by the end of the year. Moving on to commercial flooring business. Spartan Services reported another strong quarter, further reaffirming that our strategies to grow our commercial market share are working. Spartan's fiscal 2023 second quarter total sales increased by 40.5% from last year. We are pleased that Spartan's gross margin and EBITDA margin rate continues to be better than expected, which was partially offset by transaction costs from Sales Master in the quarter. We are equally pleased with the regional account managers, or our RAMs that work with stores and that are not included in Spartan's financial results. Our RAM second quarter total sales increased 39% from last year. In June, we took another step towards growing our commercial business when Spartan Services acquired Sales Master Flooring Solutions, a top distributor of commercial flooring in the New York City market. The acquisition significantly expands and deepens our presence in the large and highly fragmented New York City and New England markets. We're excited about leveraging Sales Master strong contractor relationships in their core markets, large sundries offerings, delivery and logistics network and great customer service. As we expand in the Northeast, we believe these attributes will result in higher win rates. We expect Sales Master to benefit from increased purchasing power, better inventory levels and logistics, enhancing the value they deliver to their customers. As discussed in prior earnings calls, we remain excited about the commercial market opportunity and our strategies. Finally, we are operating from a position of strength and are excited about the opportunity to continue to grow our market share in fiscal 2023 and beyond. We are confident that we have the right people, strategies and business models to continue navigating this challenging macroeconomic environment successfully. I will now turn the call over to Bryan discuss our fiscal 2023 second quarter financial results in more detail and to share our outlook for the remainder of the year. Bryan Langley: Thank you, Tom and Trevor. I want to begin by thanking all of our associates and vendor partners for their hard work and dedication to serving our customers every day. I'm particularly proud of our fiscal 2023 second quarter financial results as they demonstrate how we can grow our market share and manage our profitability during a period of industry contraction. We are executing new store growth in gross margin recapture plans and effectively managing our expenses. Importantly, we successfully managed our inventory and other working capital, which led to a $469 million positive swing in operating cash flow from the same period last year. We accomplished these results despite rising mortgage rates during the quarter, leading to existing home sales that took a step back from where they were at the end of the first quarter of 2023 to near record lows. Let me turn my discussion to some of the changes among the significant line items in our second quarter income statement, balance sheet and statement of cash flows. Then I will discuss our outlook for the remainder of the year. We are successfully executing our plans to grow our gross margin rate. Second quarter margin rate grew sequentially and year-over-year. Our second quarter gross margin rate increased approximately 220 basis points to 42.2% from 40.0% last year, exceeding our expectations and sequentially improving from 41.8% in the first quarter of fiscal 2023. The increase in gross margin rate is primarily due to retail price increases we took last year to mitigate higher year-over-year supply chain and product costs. As a reminder, we are on the weighted average cost method of accounting, and as such, the supply chain cost reductions we started to experience late last year and into this year are still working their way through our income statement and will continue to benefit the back half of 2023. Second quarter selling and store operating expenses increased 16.1% to $311.4 million, in line with our expectations. The growth is primarily attributable to higher occupancy costs related to 29 additional warehouse stores operating since June 30, 2022, wage rate increases and higher credit card transaction processing fees. As a percentage of sales, selling and store operating expenses increased approximately 290 basis points to 27.4% from last year. The 290 basis points increase was modestly above our expectations primarily due to deleverage in occupancy and other fixed costs from the decline in our comparable store sales. Second quarter general and administrative expenses increased by 19.2% from last year, modestly above our expectations. The growth is due to investments to support our store growth, including increased store support staff, higher depreciation related to technology and other store support center investments and operating expenses related to our Spartan subsidiary including approximately $900,000 of transaction costs associated with the acquisition Sales Master. As a percentage of sales, general and administrative expenses deleveraged 60 basis points to 5.5% from 4.9% last year primarily due to the decline in our comparable store sales. Preopening expenses increased by 16.5% to $10.0 million from last year, in line with our expectations. The increase primarily resulted from an increase in the number of future stores we were preparing to open compared to the priority. Second quarter net interest expense increased to $2.9 million from $1.7 million in the same period last year. The $1.2 million increase in interest expense is primarily due to an increase in average borrowings outstanding under our ABL facility and interest rate increases on outstanding debt partially offset by increases in capitalized interest and interest income from our interest rate cap derivative contracts. Our second quarter income tax expense was $20.6 million compared to $22.9 in the same period last year. The effective tax rate increased by 50 basis points to 22.4% from 21.9% in the previous year, primarily due to 162M limitations. Excluding the impact of excess tax benefits, our second quarter tax rate was approximately 24.5% compared to 23.9% in the same period last year. While second quarter sales were modestly below our expectations, we demonstrated that we can effectively manage our profitability as industry growth contracts. Second quarter adjusted EBITDA grew 1.7% to $152.8 million and diluted earnings per share of $0.66, which exceeded our expectations. In today's earnings press release, you can find a complete reconciliation of our GAAP to non-GAAP earnings. Moving on to our balance sheet and cash flow. We are pleased that our inventory as of June 29, 2023, decreased by 12.8% to $1.2 billion from last year and decreased by 9.3% from the end of fiscal 2022. The decline in inventory, coupled with an increase in trade accounts payable along with other working capital initiatives, enabled us to report a $468.8 million positive swing in year-over-year operating cash flow and a significant year-over-year increase in free cash flow. The improvement in our cash allowed us to reduce borrowings under our ABL facility, which in turn enabled us to reduce our debt by $35.2 million to $238.4 million from the same period last year. Consequently, we have an even stronger balance sheet, which will be a benefit to us as we weather the industry's contraction and make strategic investments like our recent acquisition of Sales Master. We ended the second quarter with $703.3 million of unrestricted liquidity, consisting of $4.2 million in cash and cash equivalents and $699.1 million available for borrowing under the ABL facility. Let me now turn my comments to how we are thinking about the second half of 2023 and how this compares with our previous expectations. First, the Federal Reserve has continued tightening financial conditions by raising the federal funds rate to 5.25% to 5.5% in July and continue shrinking its balance sheet to bring inflation under control to achieve its 2% inflation rate objective over time. These ongoing monetary policy decisions led to mortgage interest rates rising to over 7% in the second quarter and 7.34% in July, which led to existing home sales slipping back to 4.16 million units in June from the prior recent peak of 4.55 million units in February and 4.43 million units in March when we reported our fiscal 2023 first quarter. As we think about the long and variable lag impact of these ongoing monetary policy actions and the likelihood that mortgage rates are now less likely to fall to 5% 6% over the next five months. We now prudently expect existing home sales to exit 2023 around 4.1 million to 4.3 million units and remain near record lows. This unit level is below our previous 2023 exit rate assumption of 4.7 million to 4.9 million units annualized, as we discussed in the first quarter. Second, while home price appreciation has moderated they remain elevated from previous years, which coupled with rising mortgage rates, makes housing affordability challenges. According to NAR, the median price of the existing single-family home was $416,000 in June 2023, up 39% from $300,000 in 2020. And monthly payment is now 26.7% of income compared with 14.7% in 2020. Taking these intermediate term headwinds and our recent sales trends into consideration, we prudently revised our fiscal 2023 sales and earnings guidance lower to reflect these ongoing headwinds. While the macroeconomic environment does present some near-term challenges, we believe the long-term secular trends that underpin growth in home improvement spending and our potential market share and 500 store opportunity in the U.S. remain as relevant as ever. We remain committed to making the investments that we believe will further expand our competitive moat and drive market share gains during this downturn to better position ourselves in the existing home sale cycle terms. The well-established factors supporting long-term home improvement spending include significant home equity, a historically low inventory of new and existing homes for sale and an aging housing stock, where over 80% of homes are 20-plus years old. Furthermore, as more millennials enter their prime homebuying years, we are well positioned to capitalize on this growing market. Now I will provide some more detail pertaining to our updated fiscal 2023 full year outlook. Net sales of approximately $4.460 billion to billion to $4.530 compared with our prior guidance of $4.610 billion to $4.750 billion. Comparable store sales decline of approximately 7% to 5.5% compared with our prior guidance of down 3% to flat. We expect Q3 to be the lowest comp of the year. As a reminder, we are lapping 10.4% decline in transactions in Q4 of 2022 versus a 6.7% decline in transactions in Q3 of 2022. The earnings flow-through impact from a one percentage point change in comp is approximately $0.10 per share for the full year and approximately $0.05 for each comp point for the remaining two quarters of the year. Diluted earnings per share of approximately $2.30 to $2.50 compared with our prior guidance of $2.55 to $2.85. We expect Q4 earnings to be the lowest of year. Adjusted EBITDA of approximately $570 million to $595 million compared with our prior guidance of $605 million to $650 million. Depreciation and amortization expense were approximately $200 million compared with our prior guidance of $199 million. Net interest expense of approximately $16 million to $17 compared with our prior guidance of $17 million to $18 million, tax rate of approximately 22% compared with our prior guidance of 23% and diluted weighted average shares outstanding of approximately $108 million, unchanged from our prior guidance. We opened 32 new warehouse format stores from our prior guidance of 32 to 35 stores, capital expenditures of approximately $590 million to $630 million compared with our prior guidance of $620 million to $675 million. Let me now pass the call back to Tom for some closing remarks. See also 25 Most Powerful Passports in the World and 20 Cheapest Places to Retire in Europe.

Tom Taylor: Thanks, Bryan. These are challenging times for everyone in our segment of the home improvement industry, but we believe we have a proven, differentiated business model and the right talent to execute our growth strategies to continue to grow our market share. We believe our ability to continue to make strategic investments in a year marked by sales contraction in the industry will enable us to accelerate our market share in 2023 and beyond, particularly among Pros. We expect 2023 could be particularly difficult for independents to manage pricing, inventory and marketing in a contracting sales period when compared to our larger scale direct sourcing business model. We believe we are managing our business to accelerate market share and deliver significant earnings power when the industry returns to growth. We believe our long-term earnings growth algorithm remains intact. I want to thank all of our associates and vendor partners for their hard work and dedication to serving our customers every day. Operator, we would now like to take questions. Operator: [Operator Instructions] Our first questions come from the line of Michael Lasser with UBS. Please proceed with your questions. Michael Lasser: Good evening. Thanks a lot for taking my question. What are the trends at your most mature stores? And the reason why I ask is because there's a debate about the degree to which Floor & Decor might have been over-earning for the last few years because of things like whole house renovation or the excessive money that's been flowing to the consumers. So the key is what is realistic level of sales productivity for your most mature stores. Trevor Lang: Michael, this is Trevor. I'll take a crack at that, and Bryan may weigh in as well. I think our mature stores are maybe 200 basis points below our total comp that we reported there. And as to how much was over earned during the COVID period, I mean there's something to that. I don't know that know that we can specifically know what number is. But obviously, we went through that back then, people were stuck at home and they couldn't travel, and they invested in their homes because they were working from home. So there's probably some truth to that, but I'm not sure we can tell you exactly how much of that was part of our -- when we had the strong results in '20 and '21 in the first half of '22? Tom Taylor: Yes. Michael, I'll jump in. I'll just -- I'll kind of unbundle the comp a little bit and then talk a little bit about the mature stores as well. So if you think about it, if you follow the story, we were down 3.3% in Q1, down 6% in Q2. What Trevor said in the call is we're down 8.4% now. That would imply that the back half on the high end is around 6.3% in the back half on the low end is 9.3%. The reason that we believe Q4 will improve from Q3 is we're stacking against our weakest transactions. In Q4, if you remember, they were down 10.4%. And in Q3, they were down 6.7%. The other reason really is that we also opened 13 over 32 stores or 40% were in Q4 of last year. So, all of those are going to start to enter into the comp base in Q4 as well. And then to pay back on Trevor's point, embedded in this guide is high single digit to low double-digit declines for mature stores. So that's embedded within kind of the numbers that we gave you. So, our new store classes are still comping positive to Trevor's point, so they're our new stores are a little bit lower than what we guided to -- our mature stores. Michael Lasser: So, Bryan, when the dust settles, what do you think your mature stores on average are going to be doing from a sales per store heading into 2024. And then as you think about 2024, is your change to the guidance just simply pushing off the time of the recovery? Or is this more of an acknowledgment that our stores were overearning and they're going to -- it's going to take some time for them to find a sustainable level. Bryan Langley: Yes. It's more of a push off, we would say. We don't think that they've come down any reason. Obviously, they're negative comp in this year, but there's no reason they wouldn't earn back to where were. We don't believe they overachieved to their long-term goals. Tom Taylor: As long as existing home sales are staying at this level. It puts -- gives us some challenge. And we've got to continue to try to take market share during this time. But this is just a pushout to when things would get better. Operator: Our next questions come from the line of Steven Zaccone with Citi. Please proceed with your questions. Steven Zaccone: I wanted to ask about the market growth rate with your guidance calling for down mid-singles to down 7%. How do you expect the market overall is performing. And then when you think about the change in guidance across DIY versus Pro and maybe product categories and then even the size of the project, what do you think is really coming in weaker than expected by the biggest magnitude?

Tom Taylor: I'll take the first part, and then Trevor, you can take the second part. This is Tom. So, I would say the market is growing at a slower pace than we are. We're still growing. I mean we have a negative comp environment, but as we open stores, we're still growing. So, our -- in the quarter, we were up 4%. And year-to-date, I think we're up somewhere around 6%. So, we're growing. And when you just look at people that we compete with that are publicly traded, there -- their growth is significant. Tile Shop reported today. There were a negative 8.4% lumber in the first period. And the first quarter was negative 15. Mohawk reported North America was down 9%. So we're growing. So, we believe we're taking market share at a pretty good clip, and the market is absolutely in much worse condition than we are. Trevor Lang: And if I understand the second question, our Pro business continues to do well relative to the rest of the business. We talked about our commercial small, but our commercial business continues to do incredibly well, both on the Spartan side and our regional account managers on the retail side. The consumer, the DIY, that's the part that's struggling. And we measure that closely. That's the part of the business that's least the ability to control. And as Tom mentioned, you've had, call it, 5.5 million to 6 million existing home sales turnover for much of the last 50 years. You're now at $4 million, and this cycle is now 22 months into it. And it hasn't gotten any better. Interest rates are rates are back -- our mortgage back above 7%. And so it's just, a time of compression on the -- just the housing cycle. We feel as good as ever about our medium- and long-term outlooks we just need to get past the cycle. Steven Zaccone: Okay. Great. The follow-up I had was on just the competitive dynamics that you're seeing in the market right now given your comments about value and savings, how do you feel about your price gaps? And do you see the competitive dynamic changing as we get into the back half of the year and into next year? Tom Taylor: I'll take that. This is Tom. I feel good about our price gaps versus our competition. We monitor those on a -- feels like a daily basis. But we model them on a weekly basis, and we feel as good as ever about how we're competing in the marketplace. And as I look forward, do I think it's going to I think it's going to get worse, so get more challenging. I mean, as Trevor said, this is the 22nd consecutive month of negative existing home sales. This has been a tough market for people to sell our category for a while. And so -- we're going to continue to monitor that. We're going to continue to protect our moat. We know we're getting new customers every day that are looking for value in this type of environment. So we feel good about our price gaps and we'll continue to make sure that they stay good. Operator: Our next questions come from the line of Steven Forbes with Guggenheim. Please proceed with your questions. Steven Forbes: I wanted to focus on the updated capital spending plan. So, I guess, first, I just wanted to confirm that the reduction for the year is solely tied to the three stores that were pulled out. And I'm curious if you can maybe give us a preview on how you're thinking about 2024 in terms of the store pipeline and/or what level of capital spending you're sort of comfortable planning for as we think through the free cash flow implications of the guidance revision? Trevor Lang: Steven, I'll start and then Tom and Trevor will jump in. So, on the very first question, the reduction is actually more tied to fewer land purchases that we had contemplated in the original guide and then a little bit for the spin of '24. Those three stores, we're still spending on. They're really just kind of pushing into next year. So, it's not that we've cut that or anything else. It's really tied to more just spending for the future class of '24 and land purchase that we have. And we're still looking to own probably 5% to 10% of any given class. So, it's just a little bit less than we had kind of predicted at the beginning of the year. Tom Taylor: That's right. I'll take the second part of the question. As we said through our script, I said in the last couple of calls, we know this is a cycle. Things will be difficult. We're running the business the best of our ability, but we're trying to gain market share, and we know that nothing's changed in our 500-store algorithm. So we plan to open at least 35 stores next year. As we sit here today, that's how we see the world is that we plan to open at least 35 stores next year. We may update that as we get into the next quarter. But we've got -- our class of '24 pipeline is terrific. We got a store in Brooklyn that we're going to open up more stores in the Northeast stores in our good markets. So we're excited about that pipeline are going to continue down that path. Steven Forbes: And then maybe just a quick follow-up for Bryan. As we think back to sort of a selling store operating expense deleverage, you've experienced, revenues experienced year-to-date, can you help break that down into comparable store deleverage versus the weight of new growth? Trevor Lang: Yes. Yes, the majority of it is going to be in the mature stores. And so when you think about it, what I said in the prepared remarks, we are seeing wage rate increases, higher credit card transaction processing fees. And so the new stores are still layering in the same way that they have. We've been able to combat kind of that inflation, but the cost on a like-for-like store is almost equal from where it was last year. So the deleverage is almost all due to just the decrease in sales. So it's all because we're negatively comping at those stores. We've been able to kind of hold costs flat even with inflation coming in by flexing our store hours and cutting discretionary spend.

Operator: Our next questions come from the line of Chuck Grom with Gordon Haskett. Please proceed with your questions. Charles Grom: My question is on the recent uptick in rates. And if that's having any impact on what you're hearing from the Pros and current plans for projects over the next, call it, six to nine months? Trevor Lang: We have talked to a lot of pros over the last several months. And they still have decent backlogs is what they tell us. We're talking hundreds and hundreds of Pros across the United States. They saw decent backlogs, but it has slowed a little bit. And when you're turning over 5.5 million, 6 million homes, there's a lot bigger projects that are being done, right? There's -- when someone is going to sell a home, they may have invested in multiple bedrooms and bathrooms and kitchens. Now that existing home sales is bumping along at $4.1 million, which again is one of the lowest we've seen in last 50 years. People are just doing much smaller projects as opposed to doing a whole floor, maybe they just do a bathroom or a kitchen. And so they've also said the size of their projects has come down too. That's probably the biggest thing that's changed for us relative to when we started the year, our transactions are pretty close to what we thought. The ticket is pretty close to what we thought. But some of the square footage size of the jobs has come down, and I don't know that we would have thought to think that was going to happen. So that's probably the biggest changes people are just doing smaller jobs as a lot less houses are turning over. Charles Grom: Okay. Great. And then my second question is just on new store productivity. You opened 9 stores. I think you said three within a month of each month of the quarter. And I think there was one store that you opened up on the last day. But the NSP is much lower than it's been -- were calculated around 61%. Just -- so is there anything going on there that that would drive lower? Trevor Lang: The way I always think about that is we disclosed in our 10-K. We think new stores should do anywhere from $14.5 million to $16 million, $16.5 million in sales in the first year. And we sort of build our portfolio of stores around those metrics. When things were incredible, we doing $16.5 million as you look at the class of '19, '20 and '21. The class of '22 and early in '23, that number is probably more around $14.5 million in sales. And so as you've seen our same-store sales come down just because there's less people in the market. You've seen our new store sales productivity come down. So do I think that number is going to go back up to -- I think as the economy recovers, it will. And those stores are those stores we're making probably over -- they were making over $3 million in full all EBITDA in year 1. And now that you're going to do $1 million or so less, maybe a little bit more million or so less than that in this current environment, you can pull that through kind of in the mid- to high 30s, and so they're going to make still a really good just under $2 million or just over -- just under $3 million, maybe $2.5 million, but they're still very productive stores, and they're going to give us a return on invested capital well above our cost of capital. Bryan Langley: And this is Bryan. It gives us more of a maturation curve as well they mature. Trevor Lang: Yes, because they're an ultimate get to the same. Ultimately get to the same to your point. Operator: Our next questions come from the line of Simeon Gutman with Morgan Stanley. Please proceed with your questions. Simeon Gutman: I want to ask first about gross margins. They're still benefiting, and I think you mentioned there's a little bit of a benefit through the back half of the year. Does it flip to a headwind? I think part of the question is what happens with price? And you mentioned there were some selective, I guess, taking price down. But curious how it wraps into '24. I know it's early to talk about it, but curious if it does flip over. Tom Taylor: Yes, it is early to talk about '24. We're -- our margin -- I've been very pleased with our ability to protect our value pass some price along back to our professional customers who saw us taking price up and just continuing to improve margin, like as I said in the script, and we've been able to do it sequentially and then year-over-year. And I think that that goes into 2024. I do believe we have the ability to continue to improve our margin rates. We're going -- we're watching where we have taken price down and measuring unit elasticity seen if we're getting a benefit. It's inconclusive now, but we're watching it. But I think between our own initiatives are selling better and best products and design initiatives and continuing to watch our supply chain do a great job of getting costs out. Our merchants buying better. I think we have the ability to exceed our historical gross margin rates. How quick that comes, that is yet to be determined. We'll talk about '24 as we get closer to it, but I do think we'll have improvement. Simeon Gutman: Yes. And then it's actually -- it's another '24. I'm hesitant to talk about it, but it's more about the housing market because Trevor mentioned that the consumer just spending a little bit less. There was a debate in this industry that the wealth and homeowners that lock in or stay in effect would continue to drive the industry, not necessarily support it, but create not avoid negative comps. But it looks like, let's say, existing home sales don't grow in '24, which some are forecasting. Like how do you -- I know it's early again, but how do you think about this wealth effect, is there enough for this business or the industry to grow or it could be a longer transition period. Tom Taylor: I mean I think that's difficult to answer. I'll take a stab. We're kind of looking at each other who's going to answer that one. I would say -- I mean as I look into next year, even if we just need -- existing home sales have been running in the negative 20% range. So if we get to -- as we start lapping as we get into the fourth quarter, there won't be -- if they stay at this 4.1, 4.2, like we think we're going to exit the year, then they're not negative 20%. They're flat or slightly up. And as we go into next year, we think that could get better. And if existing home sales are better than they were year-over-year, we think that benefits us. Now -- and I also think there's going to be some pent-up demand with this amount of slowdown in the business as you get to next year, I think people will become more inpatient and they may take on more projects.

And our consumers are -- they slant to a little higher end. Their balance sheets look pretty good. So, we do think that hopefully, that will -- as time goes on and people are going to say, you know what, I've waited long enough, I'm going to redo that bathroom. I'm going to redo that kitchen. So, I think between existing home sales probably slight, maybe low, but they're not going to be 20% year-over-year low. And then I think as time goes on, I do think people will take on more because the value of their homes is pretty good. Bryan Langley: Look, this is Bryan. I mean if the duration lasts longer as you're alluding to, if it does, it's going to put a lot more pressure on our independent competitors, which could also allow us to gain even more market share. So, just one way to think through it. Operator: Our next question come from the line of Zach Fadem with Wells Fargo. Please proceed with your questions. Zach Fadem: I want to follow up a bit on that last question. And maybe you could talk about the historical correlation between your business and existing home sales and how that relationship has held up or changed over the years? And then just considering the current dynamics around rates and home prices and all the folks who've locked in low mortgage rate I mean, is there any reason to believe that the historical correlation is still the right way to think about modeling your business? Or could that actually change? Trevor Lang: I do think that's been the highest macroeconomic factor that correlates to our business. You go back and look at kind of late '17, '18 or '18 and '19 when existing home sales slowed when interest rates went up and our business decelerated some. Obviously, you've seen that same thing happen, starting last year July. Existing home sales fell a lot. They were for 20% to 35% per month for – as we said in the last 12 months. And you saw our business slowdown and actually turn negative for the first time. So yeah, I think that’s right. I think as Tom mentioned though, doesn't feel like we are going to way below four million existing home sales, a tweak over last 50 years. I think that’s only happened once. So, we just need them to quickly turn into negative. And I think then we can grow from there, is our view. When we look at our model and what we’re doing versus the competition we’ll continue to make huge strides forward. I think we feel as good about our people, our turnover is low. Our customer service scores are high. Our innovation and the assortment is fantastic. So, that’s my best answer. Bryan Langley: Yeah, I wouldn’t say much different. I don’t think that there’s anything that’s happened in the last year or two that’s going to change. Existing home sales are positive year-over-year that’s a good thing for Floor & Décor. Zach Fadem: Got it. I appreciate the color. And then I think you made a change to your private label credit card. Curious if you are seeing any impact from the change of the tightening credit terms as a whole, specifically on that card as well as for your customers in general as well the Pro. Trevor Lang: Very perceptive. We did make a change in May. We went with a bigger vendor that we felt was more aligned with us. Early reads, it looks like their approval rate is slightly better than the previous provider and we feel good about it. And they're a big partner. They do a lot of private in in the largest private label credit card company in United States that they're a good partner with us, and we're optimistic about it. Zach Fadem: Got it. Appreciate, thanks guys. Trevor Lang: Thanks Zach. Operator: Thank you. [Operator Instructions] Our next question comes from the line of Seth Sigman with Barclays. Please proceed with your questions. Seth Sigman: Okay. Great. So a lot of the slowdown here is happening through average ticket. And I guess we're all trying to figure out where that settles your average ticket is up, let's say, 25% versus 2019. And it seems like a portion of that was same SKU price increases, but maybe a bigger piece of that was the impact from larger projects and mix. S So I was hoping you can maybe break that down for us a little bit more. How much upside to ticket came from that increase in average square footage per project? And then how do you think about where that normalizes. So -- does it go back to 2019 levels? Does it go lower based on EHS? How do you think about that? Trevor Lang: I think our ticket will bounce -- round out where it's going it's going to be this year. And then I think to grow in the future because our e-commerce business is our highest ticket and that will hopefully continue to grow at a faster rate themselves like it has for the last 12 years. Our Pro ticket is higher than our homeowner business that we're hopeful will continue to grow our design ticket is higher. Design is a big focus for us, as Tom mentioned, that's up 330 basis points. So, I think we're just going to kind of level out and see what this year is. Our RAM sales, which really -- most of those get tendered through the stores, those are big commercial sales. Those are all higher tickets. So, my expectation is once we get through this arguably one of the worst housing markets we've seen in the last 50 years, those strategic initiatives that we're focused on will drive ticket growth.

And the final thing I'll mention is our merchants continue to do a great job. People are doing less square footage, but they're still continuing to focus on better and best. And our pricing generally speaking, when you look at our pricing versus better invest, we're not competing as much with the home centers there, we're competing against the independents. And our value equation goes up a lot. And that's why that part of our business continues to take market share is because our better and best assortment is incredible and our pricing differential versus our competition is also very high. Tom Taylor: And then the last thing I would say, along with all those benefits is once existing home sales go positive, then people start doing -- they get back to doing a -- mentioned earlier in the call, and one of the questions, people will do more rooms in their house. When people move into a house, they do more rooms. And today, when they're staying in the same house, we're in a room at time. So, when that gets back into the blend of the average ticket, that's a good thing. Operator: Our next question comes from the line of Jonathan Matuszewski with Jefferies. Please proceed with your questions. Jonathan Matuszewski: So, my question has two parts. So strong gross margin results this quarter, it exceeded what we had been thinking for late '23. So as such, how should we be thinking about 3Q and 4Q gross margin? Should we be planning for sequential improvements from recent levels? And then relatedly for gross margin, Tom, you mentioned that the pricing rollbacks have been inconclusive. Can you just share any more detail maybe where you've seen success, maybe where you haven't. Bryan Langley: Jonathan, this is Bryan. I'll start it and then pass it over to Tom. So for the gross margin, Q1, we were at 41.8%, Q2 42.2%. So obviously, we did exceed our own internal expectations as well. We do think the back half is going to be at, if not slightly better than that 42.2%. So for the full year, we should be around kind of that 42.2% on a full year basis, which tells you the back half should be slightly better than where we just exited. Tom Taylor: Yes. I think -- and then just the -- I mentioned earlier that our test results are inconclusive. I would say, that remains the case. They are inconclusive. It's very hard. Some appear to have worked well, some appear to have not made a difference. It's hard to ascertain if we've just shifted a customer within our own store to a different SKU because our assortments are so broad, they come in and we -- the price on one thing and it takes them from one SKU to another. So there's some difficulty. We do see some benefits to certain departments that we see more benefit than others, and we're going to continue to lean on that learning and apply that as we think about more price reductions in the future. Operator: Our next question comes from line of Karen Short with Credit Suisse. Please proceed with your questions. Karen Short: Two research division questions. So first is when we think about comp deleverage as it relates to EBIT deleverage, can you remind me what the actual relationship is on that. So like if you have 1% comp down, what EBIT. Tom Taylor: Yes. So this year, every component is worth about $40 million. So when you flow that through, it's usually in the mid-30s. So for each comp point flex, that's where we get that $0.10 in EPS that we paid for the full year. So for the back half, every comp point change is worth about $0.05, it would be about half of that. So it's worth $20 million in the back half. Operator: Our next question comes from the line of Chris Bottiglieri with BNP Paribas. Please proceed with your questions. Christopher Bottiglieri: So I read that Spartan is creating a new home construction division. I guess why now? I mean historically, what have been some of the constraints that prevented. Florida court self from the end market work Spartan into that matter. Bryan Langley: I didn't get the question of the question. You're talking about the new builder? Tom Taylor: He's talking about commercial -- or excuse me, the new builder within Spartan. Trevor Lang: Yes. So in -- Tom Taylor: So, it's a Sales Master, no. So. Christopher Bottiglieri: Press release that Spartan was getting into the new home construction channel not that's accurate. Tom Taylor: Yes, we -- Spartan did a press release on someone that they've hired that's going to help them with the -- we weren't sure if it was a Sales Master question or a recent hire question. Sorry about that. So yes, Spartan recently did a press release on a person that we've hired that's helping us think about our new construction opportunities. It is a segment that Spartan has not really focused on historically. We do a good job at Floor & Decor through our RAMs with custom homebuilders, but we really don't do much on the new construction side. So we wanted to get some horsepower in there to help us. We think it's a big opportunity. We've got a Board member from Pulte Homes who's helped us think about that about that business differently and help us educate us business differently. So we think it's a big opportunity. And if you look at what's going on with new home sales today, as the existing home inventory is so low, that's a sector that's doing well, and we think we can provide good opportunities there. So we want to make it a more meaningful part of our business in the future. Thus, we hired someone really good. Operator: Our next question comes from the line of Seth Basham with Wedbush Securities. Please proceed with your questions. Seth Basham: I just want to follow up on a couple of your comments regarding increased focus on value by consumers, but you're still seeing a mix shift to better invest. First of all, is that accurate? Can you square that away? And second of all, as you move forward, are you adding more merchandise to service that opening price point? Tom Taylor: So when we talk about value, I'll start with the first -- my first kind of feelings about it when a customer elects to do the job in their house, they're still electing to buy the best product that we have in the stores, the better and best the better and best product. The value is still important to them and value proposition on our products because mainly we compete with the independence on that the spread is really significant. So we think when someone is going to do the job, they're still going to be looking for when they're going to want the better and best products in their stores and we think -- in their homes, and we think that our competitive moat around those products is better. So we are paying attention to opening price point.

We always do. We know that's very important for particularly in the flipper business. We know that, that's significant. So we pay attention. Our merchants do a good job of always updating our opening price points. I wouldn't say we've added to our opening price points. I'd say it's pretty much consistent to what we've historically done. Operator: Our next question comes from the line of Justin Kleber with Baird. Please proceed with your questions. Justin Kleber: Can you guys just talk about what's driving the deceleration in comps quarter-to-date. Is it transactions taking a step back? Or is it related to ticket? And then kind of part of that question on the sequential improvement you've seen in in transactions here 2Q. Did you comment on Pro specifically, I'm curious how that trended relative to 1Q? Trevor Lang: Justin, I'll take the first part of it, and maybe Trevor can jump in on the pro side. So the minimal thing that led to the deceleration is around transactions. It's all tied to the existing home sales step down that we're kind of seeing. So if you remember, existing home sales in January were $4 million, they stepped up $4.6 million in Feb $4.4 million in March and then started to decline back down $4.3 million in May and down to $4.2 million in June. That's really around transactions that are leading to that negative four more so. The average ticket is actually in line with our expectations. Trevor Lang: And on the Pro side, it has decelerated as well, but it's still outperforming the homeowner or the DIY business. Operator: Our next question comes from the line of Keith Hughes with Truist Securities. Please proceed with your questions. Keith Hughes: Yeah, this is building on the last question. So in the guidance in the second half, is ticket and add subtraction? What kind of numbers are we looking at? And are you expecting? Bryan Langley: So ticket in the back half will actually be negative. And so it's been sequentially declining as we expected kind of throughout the year. And so you have that inflect your crossover point. Transactions will get better, but really, they're less worse. So they'll stay down as well, but ticket will cross over and cut into negative for the back half of the year. Operator: Our final question will come from the line of Greg Melich with Evercore. Please proceed with your question. Greg Melich: I'd love to follow up and if you already answered this, please just tell me, I dropped off there in the middle. But on category mix, just because it's changed so much over the years. I'd love to get an update on how the mix is really driven between categories. I think you said you're still seeing trade up, but I'd love to know what it's doing, laminates versus wood and what that does to your gross margins. Trevor Lang: Yes. So we do see the, what I'm going to call the man-made products continue to outperform the natural products. So on the wood look side of the business, laminate and rigid core vinyl are taking share from wood. And on the, call it, the tile side of the business, mostly porcelain tile, but force ceramic tile versus the natural stone businesses are continuing to perform better than the stone businesses. So the answer is the manmade products are better in almost all regards. Same thing is going on in Deco. And the margin profile for those categories and the man-made products are better than the natural products, the ticket is lower, but the margin profile in the genre is higher for the natural products. I'm sorry, for the manmade products. Bryan Langley: This is Bryan. Before the call end, I just want to jump in and kind of help you guys a little bit with the modeling. You couldn't find an natural way to make it transition in. Just -- I know if that’s the question that was asked, but the original guide had store and selling or selling store operating expenses at 27% of sales. We now feel like that's going to be 27.5% to 28% for the year. General and administrative was 5% of sales on the original guide. That's going to be closer to 5.6% to 5.7% for the year. Pro opening expenses will still be maintaining around that 1%. And so I just wanted you guys to have that as well as just to kind of help with the modeling. Tom Taylor: So that concludes our question-and-answer portion of the call. I appreciate everyone's interest in our second quarter earnings and our outlook for the year. We appreciate everything that everyone is doing. This is -- we feel like we're doing everything we can to balance our profitability, while at the same time, taking market share and ready for the other side of a down cycle. So we look forward to updating you on the next call. Operator: Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and enjoy the rest of evening.

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