Floor & Decor Holdings, Inc. Q2 FY2022 Earnings Call

Good day, ladies and gentlemen, and welcome to the Floor & Decor Holdings, Inc. Conference Call. All lines have been placed on a listen-only mode, and we will open the floor for questions and comments following the presentation. At this time, it's my pleasure to turn the floor over to your host, Wayne Hood, Vice President of Investor Relations. Sir, the floor is yours.

Thank you, operator, and good afternoon, everyone. Joining me on our second quarter earnings conference call today are Tom Taylor, Chief Executive Officer; Trevor Lang, Executive Vice President and Chief Financial Officer; and Ersan Sayman, Executive Vice President of Merchandising. Before we get started, I would like 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. 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 better understand 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, together with the related materials will be available on our Investor Relations website. Let me now turn the call over to Tom.

Thank you, Wayne, and everyone for joining us on our fiscal 2022 second quarter earnings conference call. During today's call, I will discuss some of the highlights of our 2022 second quarter earnings. Trevor will then review our financial performance in more detail and discuss how we are thinking about the remainder of 2022. Before we get started, I wanted to take a moment to comment on our exciting announcement today that Trevor will be promoted to the role of President from Executive Vice President and Chief Financial Officer of Floor & Decor. Following Lisa's announced retirement last summer, we conducted an extensive internal and external search for this important role. We concluded that Trevor's deep knowledge and passion for our company, culture, strategies, products, and industry knowledge make him the right person for this critical role. In addition to being an outstanding CFO over the last 11 years, Trevor has been a vital thought leader and responsible for our information technology strategies and the strong growth of our Pro and commercial RAM businesses. We are enthusiastic about continuing to partner with Trevor as we execute our long-term plan towards $17 billion in sales and 500 stores. The company will conduct a search of internal and external candidates for a new Chief Financial Officer, and Trevor's promotion will be effective upon the appointment of a new CFO. Turning to our second quarter earnings results. We are pleased to deliver better than expected fiscal 2022 second quarter adjusted diluted earnings per share of $0.76 per share. These earnings results are particularly gratifying to us when we consider our previous year's record sales and profits, the current operating environment, which includes extraordinarily high inflation, rising mortgage rates, 10 months of declining year-over-year existing home sales, and higher global supply chain costs and congestion. We are proud of our teams and how they consistently execute our growth strategies and successfully manage our profitability. I want to thank our associates and vendor partners for their hard work and dedication as we navigate the near-term macroeconomic challenges. We believe our competitive moat from people, product, price, and access to inventory is strong, giving us added confidence in our ability to continue to grow our market share even in a difficult macroeconomic environment. During the second quarter of fiscal 2022, we opened nine warehouse format stores compared with seven stores during the same period last year, including six warehouse stores in new markets. We opened six stores in April, two in May, and one in June. We continue to build out our existing markets with openings in Atlanta, Chicago, and Houston. As noted in our first quarter earnings call, we closed our South Lake warehouse store in Atlanta in the second quarter. Therefore, we ended the quarter with 174 warehouse stores in 34 states. We plan to open eight warehouse-format stores in the third quarter of fiscal 2022, including our first store in Minneapolis. Most of these third-quarter warehouse store openings will be in existing markets and will open later in the third quarter of fiscal 2022. We have successfully opened 15 warehouse stores year-to-date and are pleased that 47% of our planned openings were opened in the first half of this year, leading to more operating weeks. We intend to open 32 new warehouse format stores in fiscal 2022, eight of which will be owned locations, and the opening of our Atlanta Design Studio, which is expected in the fourth quarter, will bring six design studios in operation at the end of fiscal 2022. Turning to our fiscal 2022 second quarter sales growth. Total sales increased 26.7% to a record of nearly $1.1 billion, and comparable store sales increased 9.2% compared with 68.4% growth in comparable store sales in the same period last year. On a three-year compound annual geometric growth rate basis, our second quarter comparable store sales increased 13.4% versus 15.4% in the first quarter and 13.4% in the fourth quarter of fiscal 2021. Our second quarter comparable store sales results were slightly below our expectations of about 10%, primarily due to transaction headwinds from homeowners returning to traveling over summer weekends and federal holidays and slowing macroeconomic demand. Our weekday sales from our Pros and homeowners remain strong. Monthly, our comparable store sales increased 9.9% in April, 8.5% in May, and 9.3% in June. We are pleased with the start to the third quarter of fiscal 2022, where our comparable store sales are up 13% quarter-to-date. As expected, second quarter comparable store sales were driven by 17.9% growth in our average ticket. Our average ticket benefited from the following factors: an increase in retail prices to mitigate cost pressures, an increase in sales penetration of laminate and vinyl, and an increase in the sales penetration of our higher-ticket Pro, e-commerce, and designer-led initiatives. Additionally, we continue to see ongoing customer preferences towards our better and best price point. Our second quarter comparable store customer transactions declined 7.3% from last year. As a reminder, we are comparing with comparable store transaction growth of 62.1% in the second quarter of fiscal 2021. Moving to our Pro business. We are successfully executing a holistic Pro strategy to grow our wallet share among Pros. Our second quarter total and comparable store Pro sales growth were significantly above the company's growth rate. Consequently, Pros accounted for approximately 39% of our sales growth in the second quarter of 2022, up 500 basis points from the previous year. Notably, Pro comparable transactions increased by over 6% from the same period last year, validating that our strategies to grow our market share among Pros are working. We are pleased that the top 20% of our Pros have spent 20% more with us year-to-date. A key strategy to driving this growth rests on building the awareness and value of our Pro Premier Rewards program or PPR. The program's value is demonstrated in the enrollment and points redeemed. Today, over 80% of our Pro sales come from PPR members, and points redeemed increased 45% year-over-year in the second quarter. We are also pleased to offer the opportunity to our Pros to redeem points towards social good. One recent example is our partnership with RestoringVision, a global nonprofit working to ensure that people living in impoverished communities have equitable access to glasses. Turning to our growth from our e-commerce business. As discussed during prior calls, our e-commerce team continues executing strategies that we believe will further optimize our customers' digital experience, including focusing on product, inspirational content, and conversion. Our second quarter e-commerce sales increased 34% from last year and accounted for 17.5% of sales compared with 16% in the previous year's period. Let me now discuss the exciting progress we are making with design services. As we have discussed in prior calls, we are focused on building a consistent, high-touch, best-in-class, and seamless designer service experience for our homeowners and Pros. To that end, we have been doubling down on our investments in technology and people and design. We now have over 800 designers in our stores with clear roles and exciting career paths and we plan on continuing to grow these teams. In the second quarter, we rolled out our in-home design service offering in the Washington, D.C. market, which follows in-home design offering launches in Houston, Dallas, and Miami. In the third quarter, we will launch our in-home design services in Atlanta. We are pleased that our designer strategies are working. In the second quarter of fiscal 2022, design total and comparable store sales growth were significantly above the company's growth rate. Design sales penetration increased almost 500 basis points from last year, with all regions posting the strongest sales penetration ever. The design comparable store sales growth was well balanced between transaction and average ticket. We continue to find that when a designer becomes involved with the project, we see a higher customer satisfaction score, a higher average ticket, higher basket selling attachment rates, higher penetration rates for our adjacent categories, and a higher gross margin. We're in the early stages of benefiting from these initiatives and are excited about building awareness and familiarity with our design services. Let me turn my comments to our growth in commercial, which includes Spartan surfaces and our regional account managers or RAMs that work with our stores. As a reminder, Spartan Surfaces focuses primarily on the A&D community and large commercial contractors for end flooring installers. Our RAMs focus is more downstream on smaller owner-operators, smaller commercial contractors, and flooring installers. We have completed the integration of critical functional areas with Spartan Surfaces and are implementing strategies to accelerate growth in 2022 and beyond. We are leveraging Floor & Decor's access to products, logistics, and distribution centers. Additionally, through Spartan, we are continuing to expand nationally by acquiring smaller experienced commercial flooring sales distributors. In the second quarter, we acquired Ohio-based Source Contract Group. They are another example of how we can expand nationally when we find the right opportunity and partners. We are excited about Spartan's growth prospects and its financial performance. Their second quarter sales and earnings results once again exceeded our expectations following a very strong first quarter. We are also pleased that our second quarter sales from our regional account managers or RAMs increased 80% year-over-year and 34% from the first quarter. We continued building out our regional account managers by adding four RAMs in the second quarter of fiscal 2022, with the intent of onboarding 16 RAMs in 2022. Overall, we remain excited about the commercial market opportunity and our commercial strategy. Let me update you about global supply chain. At this juncture, we believe we are past the peak pain from the capacity constraints in the overall global supply chain. We have been able to reduce our overall ocean and trucking spend and effectively manage our TEU ocean capacity needs, while at the same time, improving our merchandise in-stock levels. As a reminder, we do not have inventory subject to the seasonal markdown risk that some other retailers have reported. We continue to monitor labor contract negotiations between West Coast ports and the International Longshoremen and Warehouse Union. The labor union at West Coast Ports did not come to a labor agreement before the contract expired on July 1. However, both sides continue to negotiate, and we have not experienced any disruption. We are encouraged by recent trends in the global supply chain, but we are planning on higher ocean year-over-year freight rates throughout 2022. Most of the benefit from these current trends will likely impact our results in fiscal 2023 as our inventory is on the weighted average cost method of accounting. In closing, I would like to reiterate how pleased we are with our second quarter and our year-to-date financial results. We are excited to be on track to report our 14th consecutive year of comparable store sales growth. We are demonstrating that we have the right teams, strategies, and agile business model to navigate the global supply chain challenges, inflationary pressures, and a weakening housing market. I'll now turn the call over to Trevor to discuss more in detail our fiscal 2022 second quarter financial results and our outlook for the remainder of the year.

Thanks, Tom. I want to thank Tom and the board for my promotion to President. I'm incredibly excited to take on this new role, and this is only possible because of the fantastic group of leaders I get to work with every day. The entire executive team is blessed to work with some of the best leaders in retail, and I believe we have clarity on our growth opportunities and Floor & Decor's best days lie in the future. I would also like to recognize Luke Olson being promoted to our Chief Accounting Officer, also announced today. In his three years with us, Luc has done a fantastic job and is well deserving of this new role. Turning to our results. I will discuss some of the changes among the significant line items in our fiscal 2022 second quarter income statement, balance sheet, and cash flow statement. I will then discuss how we are thinking about the remainder of fiscal 2022. Our fiscal 2022 second quarter gross profit increased 19.4% to $436.3 million from last year. The gross margin rate decreased a less-than-expected 250 basis points to 40%. Lower merchandise margins drove the decline due to higher year-over-year supply chain and freight costs. All of our teams continue to do an outstanding job managing our gross profit in this complex global supply chain and inflationary environment. We are pleased to continue executing our stated strategy to grow our gross margin rate sequentially versus the fourth quarter of 2021. Selling and store operating expenses increased 30.8% to $268.2 million from last year, in line with our expectations. The increase was primarily attributable to 27 net new warehouse stores opened since July 1, 2021, additional staffing required to align with our sales growth, higher depreciation, credit card transaction processing fees, and advertising expense. As a percentage of sales, selling and store operating expenses increased 70 basis points to 24.5% from 23.8% in the same period last year, driven entirely by our new stores. As a reminder, in the second quarter of last year, we leveraged our selling and store operating expenses at 610 basis points due to strong sales growth. We are pleased that our second quarter selling and store operating expenses rate was flat with the same period on a comparable store basis. Second quarter general and administrative expenses increased 0.5 percentage points, and as a percentage of sales, leveraged approximately 120 basis points to 4.9% from 6.1% last year. The expense leverage was primarily due to lower accruals for employee incentive compensation, the absence of current year period acquisition and integration expenses, and lower year-over-year consulting expenses. As a reminder, we incurred $3.2 million in acquisition-related expenses related to Spartan Surfaces last year. Pre-opening expenses decreased 4.7% to $8.6 million from $9 million last year due to favorable occupancy rates and other new store operating expenses. Second quarter net interest expense increased $400,000 or 29.3% from the same period last year. The increase in interest expense was primarily due to an increase in interest rates on our outstanding debt and ABL borrowings, partially offset by an increase in capitalized interest. Moving on to our profitability. Second quarter adjusted EBITDA grew 9.7% to $150.3 million from last year's record $137 million. On a rate basis, our second quarter EBITDA margin declined 210 basis points to 13.8% from last year's record 15.9%, primarily due to the decline in our gross margin rate. Second quarter GAAP net income and diluted earnings per share declined 1.3% to $81.8 million and $0.76 per share, respectively. Our second quarter adjusted net income increased 3.5% to $81.1 million from $78.3 million last year. We are pleased that our second quarter adjusted diluted earnings per share increased 4.1% to $0.76 from last year's record $0.73 per share last year, exceeding our expectations. We ended the second quarter with 107,300,000 diluted weighted average shares outstanding. A complete reconciliation of our GAAP to non-GAAP earnings can be found in today's earnings release. Moving on to our balance sheet. Our inventory at the end of the second quarter of fiscal 2022 was $1.3 billion, an increase of 97% from the same period last year and 33.3% from the end of fiscal 2021. The inventory growth reflects our new store growth, intentional investments we have been making to improve our in-stock inventory, inflation, additional new innovative SKUs, and higher in-transit inventory. As we think about the purchase orders, receipt flow, and inflation in the second half of 2022 we expect our year-end inventory to be moderately above our fiscal 2022 annual sales growth, primarily due to inflation. As Tom mentioned, we do not have inventory subject to seasonal merchandise markdowns that other retailers have reported. For the 26 weeks ended June 30, 2022, net cash provided by our operating activities was $7.9 million compared to $256.6 million in the same period last year. The decrease in operating cash flow was primarily the result of our growth in inventory. Our investing outflows increased 7.8% to $210.6 million from $195.5 million last year due to investments to support our store growth as well as investing more in existing stores. These investments caused us to increase our net borrowings under our ABL loan facility to $68.6 million at the end of the second quarter of 2022. At the end of the second quarter, we had $315.1 million in unrestricted liquidity immediately available to us, including $6.2 million in cash and cash equivalents and $308.9 million available borrowing under our ABL. Subsequent to the end of the second quarter, we prudently increased the size of our ABL facility to $800 million from $400 million and extended the term from February 2025 to July 2027 due to the macroeconomic uncertainty. We want to maintain maximum financial flexibility to continue our growth plans and maximize the leverage from our growth in our asset borrowing base. We expect ABL borrowings to peak in the third quarter before going down at the end of the year. Let me turn my comments to how we're thinking about the second half of fiscal 2022. In our first quarter 2022 earnings conference call, we said that achieving the top end of our earnings guidance of $2.75 to $3 that we provided at the beginning of 2022 could be more challenging. We have seen accelerating inflation affect consumers and tightening monetary policy slow economic growth in the housing market. Existing home sales have declined for 10 months in a row with steeper declines in recent months and mortgage rates are about double what they were a year ago. We expect continued aggressive tightening of monetary policy and high inflation to result in a more challenging macroeconomic backdrop for the second half of 2022. We are planning for continued year-over-year declines in transactions in the second half of 2022. Our second quarter 7.3% decline in transactions compared with the first quarter's 2.1% decline reaffirms this view. We are pleased with the start of the third quarter of 2022, where our quarter-to-date comparable store sales are up about 13% and transaction declines are slightly better than the second quarter's decline of 7.3% as we begin cycling past easier transaction comparisons. That said, we believe it's prudent to prepare for slightly lower comparable store sales in the second half of 2022 relative to our original forecast due to the declining macroeconomic environment. With that in mind, we are planning on comparable store sales growth to decelerate from the third-quarter-to-date comps of 13% to a high single-digit comp as we approach the end of the year. We now expect our fiscal 2022 adjusted diluted earnings per share could be in the range of $2.65 to $2.80. At the midpoint of this range, the updated guidance would represent about a 5% reduction from our prior guidance and 12% growth from last year's adjusted diluted earnings per share, demonstrating the agility and durability of our business during a challenging economic period. Let me provide some other building blocks to consider in the second half of 2022. We are still working to achieve sequential improvement in our gross margin rate in the second half of 2022. The sequential improvement is primarily the result of price increases we are making to mitigate the cost pressures primarily in the global supply chain and to restore our gross margin rate. We expect the sequential improvement in our gross margin rate to drive most of the accelerating EBIT dollar growth in the second half of 2022. We hope to achieve high single-digit to low double-digit adjusted EBIT growth in the third quarter following the 2.9% growth we reported in the second quarter of fiscal 2022. The fourth quarter of 2022 is expected to be our strongest growth rate in EBIT for the year as we cycle past last year's 370 basis points decline in gross margin rate. Let me now provide some of the revised guidance pertaining to our fiscal 2022 full-year outlook. We expect sales to be approximately $4.29 billion to $4.30 billion compared with our prior guidance of $4.285 billion to $4.375 billion. Comparable store sales growth of approximately 10% to 11% compared with our prior guidance of 10.5% to 13%, adjusted diluted earnings per share to be in the range of $2.65 to $2.80 compared with our prior guidance of $2.75 to $3. Adjusted EBITDA in the range of $565 million to $580 million compared with our prior guidance of $575 million to $610 million. Depreciation and amortization expense of approximately $153 million compared with our prior guidance of $151 million. Net interest expense of $9.5 million compared with our prior guidance of $7 million due to higher borrowings and interest rates. Tax rate of approximately 25%, excluding tax benefits, resulting from stock option exercises and the vesting of restricted stock and restricted stock units, unchanged from our prior guidance. Diluted weighted average shares outstanding of 107,500,000 compared with our prior guidance of 108,400,000 shares. We plan to open 32 new warehouse format stores and four small design studios unchanged from our prior guidance. We lowered our capital expenditure expectations to $480 million to $500 million from our prior guidance of $550 million to $590 million primarily due to not acquiring only real estate and not spending as much on noncritical capital spending projects. We still intend to own more stores, but the opportunities are not likely to come up this year. In closing, these are challenging times for everyone, but we believe we are in a unique and agile business model and have the right talent to execute our growth strategies to continue to grow our market share. With that, I'd like to thank all of our associates and our partners for their hard work and dedication to serving our customers every day.

Thank you. The floor is open for questions. Our first question comes from Zach Saham from Wells Fargo. Go ahead, Zach.

Hi. Good afternoon, guys. This is John Parke on for Zach. I guess can you just share the latest on the pricing environment? I guess, how much price you guys took in the quarter and what you're seeing out there from both the big box and independents?

Yes, I'll take that. This is Tom. We don't give out how much price we've taken, but we have taken price. We feel very confident on how we're competing in the marketplace versus the big boxes and the independents. We feel like the moat around our pricing cost is still pretty good. Next.

Sorry about that. Our next question comes from Steven Zaccone from Citi. Go ahead, Steven.

Great. Thanks for taking my question. Trevor, congrats on the promotion. I wanted to talk about second half expectations in a bit more detail. Could you talk about how you think about ticket versus transactions? It sounds like slightly better than what you saw in the second quarter from a transaction standpoint. And then just higher level, the macro clearly getting weaker, you referenced, but your guidance still looks like above algo comps in the back half. So how do we bridge the difference between the macro weakening and maybe same-store sales guidance still looking pretty good overall?

Thank you very much. One correction I want to make. I think in the prepared comments, I might have said a 25% tax rate, and I want to just clear that up and then it's in the release, we're expecting a 24% tax rate. So I apologize; I think in the prepared comments, I didn't get that. So as we think about the next six months that are in front of us, as Tom mentioned, first off, we're comping 13%. Business is better in July. And obviously, comp stores are also a reflection of what happened last year. And on just a gross sales basis, we believe our compares are a little easier in Q3 relative to what they were in Q2, just on a gross basis, our Q2 numbers were the hardest numbers we were up against. So that's part of the reason we think Q3. And then listen, we're not economists, but we obviously read a lot. We pay attention to existing home sales are, as Tom mentioned, have slowed, especially in the last few months. Mortgage rates are back down a little bit now, but they were up at close to 6%. Inflation is high, and we know people are spending out of their savings, and eventually that will stop as well. So we're just trying to be prudent and expect that as we go into the fourth quarter, that things may slow a bit. We hope we're wrong, and we're not economists, but we feel like it just made sense to plan the business a little bit conservatively to get our cost structure in line such that if things are slower, our cost structure is appropriately weighted towards that. And if things are better, then we'll have some upside.

And our next question comes from Simeon Gutman from Morgan Stanley. Go ahead.

Hi. This is Jackie for Simeon. Thank you for taking our question. Can you provide any insight into what percentage of the business comes from existing home sales compared to non-turnover units? We understand you may not have exact figures, but any indication of changes would be appreciated.

I mean I'll start, Trevor, then you can answer. We don't know exactly, but as you said, it's very hard to say where the sales come from. Historically here over the last 10 years when existing home sales have been good we've outperformed the market in a meaningful way. And when existing home sales have slowed, our business has been more challenged. So it's hard to anticipate exactly as Trevor said, we're not economists. We don't know exactly what's going to happen, but we're just trying to be prudent in kind of the way we think about things. So like I said, we're off to a good start in this quarter, but we're not sure about the back half. So we want to just make sure you're thoughtful.

Yes. I would agree with Tom that every cycle is unique. What distinguishes this cycle is that 95% of homes in the U.S. have appreciated in value and are unlikely to be sold. Homeowners are benefiting from favorable mortgage rates. Those who choose to remain in their homes have discretionary income available. Typically, when negative trends in existing home sales occur, it coincides with declining home equity or values. This situation is different in the current environment. Homeowners who are staying put have the means to invest, and we believe we offer an outstanding selection and can meet their needs.

Thank you. And our next question comes from Chuck Grom from Gordon Haskett. Go ahead, Chuck.

Thank you very much. Congratulations, Trevor, on the well-deserved promotion. Regarding the Pro sector, conversations throughout the quarter suggest that backlogs remain strong. I'm interested in what feedback you've received from Pro customers. Additionally, I'd like to follow up on the monthly improvement in July related to the three-year geo stack, which showed a few hundred basis points of improvement. I'm curious about what contributed to the acceleration in the business. Did you raise prices slightly in July or were there more transactions? If you could clarify that for us, I would appreciate it. Thank you.

I'll address the Pro aspect, and Trevor can handle the second part. This is Tom. Regarding the Pro segment, we're receiving consistent feedback. Our Pros are quite active, as we've gathered from store visits and conversations with our teams; they remain busy. When we assess our business throughout the week compared to the weekend, the weekdays show stronger performance. Pros are frequenting the stores and making purchases. Additionally, part of the average ticket growth we've noted is related to the increasing share of our Pro, design, and e-commerce segments. All these areas are performing well, which gives us confidence in the backlog our Pros have and the opportunities ahead of them.

Yes. In terms of sales, the comparisons have improved and transactions are actually performing slightly better than the negative 7% we saw in July. This improvement is partly due to last year's performance, as this year is showing strength, but we had a more favorable comparison from July of last year.

And our next question comes from Greg Melich from Evercore. Go ahead, Greg.

Hi. Thanks. I just quickly follow up on the inflation and then with gross margin we’re coming there. It sounds like ASP was the biggest driver of the ticket, but was it a majority? And would inflation be the number one part of that? And then on gross margin linked to that, are we still on path to approach 41%. I think that was the number you gave last quarter, Trevor, 41% gross margin. Is that still in the cards? Or do you think it's below that?

I believe we have specific strategies that are positively impacting our ticket. As I mentioned last quarter, our rigid core vinyl business remains strong. We are noticing customers upgrading to higher quality products, and our overall better and best category is also seeing improvements, which is contributing to an increase in ticket amounts. Our e-commerce segment continues to perform exceptionally well, with online tickets significantly exceeding in-store tickets. Our design strategies are successfully taking off, and we are more satisfied with our performance in that area than we have been in the past, achieving a higher ticket level. Additionally, our Pro business is performing strongly, likely the best it has been during my time here, which also leads to higher ticket amounts. We are also raising retail prices, although I haven't specified the details yet. Of the 17% increase in ticket, a significant portion is associated with this ticket growth as well as core-centric factors I mentioned. What was the second part of your question?

What does it mean for gross margins? I know you discussed gross margins in the past.

Yes, we obviously intentionally didn't put that in. I think if we hit the high end of the guidance, we probably will get closer to approaching 41, which obviously is our goal. But if we're at the low end of the guidance, then we might be just a tick below approaching 41.

Got it. Thanks and good luck.

Thanks, Greg.

Thank you. And our next question is from Steve Forbes from Guggenheim Securities. Go ahead, Steve.

Good afternoon, Tom, Trevor. And congrats, Trevor as well. Maybe just a follow-up on Chuck's question regarding the Pro sales outlook. I appreciate the color in the quarter, 39% of sales. But curious if you could help us sort of frame the full year outlook as implied by the guide is mid- to high 30s percent of sales the right level to expect for Pro sales for the full year as we move throughout.

Yes, I think so.

I mean, I don't know how much more specific. We don't really break it apart like that, but there's nothing that I see that says that the penetration of our business from the Pro perspective is going to change, gotten better as the year has gone and I anticipate that, that continues.

Thank you. And our next question comes from Peter Keith from Piper Sandler. Go ahead, Peter.

Hi. Thanks. Good afternoon everyone. And my congratulations to Trevor as well. So Pro business sounds like it's as strong as ever. I was wondering if you could just provide a little more detail on the DIY side. Does that continue to hold it pretty strong? Or have you seen any traffic slow down on DIY?

Tom mentioned this in his prepared comments. I think after two years, people decided to take vacations, go to ball games. I've certainly heard that from other retailers as well. We saw that, as Tom mentioned, kind of on the weekend business on some of the holiday business. But then we see the business be stronger. And so I do think that consumer after not being able to enjoy nice long vacations and maybe other services that they haven't done, they enjoyed it this summer. And I think as people get back to school and not taking as many holidays, we'll see how that plays out.

Yes. I mean the only thing I'd add is as August has started when in the first week of August now, and it feels like people are ongoing vacation and business continues to be pretty good for us. So I’ll just add.

Thank you. And our next question comes from Christopher Horvers from JPMorgan. Go ahead.

Hi. Good evening. It's Christian Carlino on for Chris. Big congrats to Trevor. Could you speak to the cadence of traffic through the quarter? Any way you look at it excluding the impact of comparisons, whether it's not just at three years. And then as you look to the back half, are you taking more price than you originally anticipated given an expected traffic? And any color on how you’d expect staff to evolve in the back half would be helpful.

Yes. I can provide information on transactions as I have reliable insights on that traffic. We noticed a moderate decline in transactions every month during the second quarter. We reported a 4.4% decrease in transactions in March, the fiscal month of March, and a 7.7% drop for the quarter. It has been a gradual decline in transactions. Regarding pricing for the remainder of the year, we anticipate that retail prices will continue to rise. Supply chain costs, while more stable than before, are expected to include higher international container costs, possibly offset by slightly lower domestic transportation costs, although there remains congestion with demurrage and detention across the U.S. We expect these costs to persist. Reports indicate that this situation affects everyone importing goods into the United States. Thus, we expect retail prices to increase. Our goal remains to sequentially improve our gross margins, and if we reach the high end of our guidance, we hope to achieve close to a 41% gross margin.

I want to mention that we are pleased with how our pricing spread has remained competitive throughout this year. Additionally, many publicly traded manufacturers are implementing price increases at a quicker pace than we are, which allows us to compete more effectively against independent retailers. As consumers shift towards higher-end products, we find ourselves in stronger competition with independent hard surface stores, and we are confident in our pricing relative to theirs.

Sorry about that. Thank you. And the next question comes from Liz Suzuki from Bank of America. Go ahead, Liz.

Great. Thank you. So you had mentioned that you don't have the problem of markdown risk from sitting on seasonal inventory. But in your anticipation of a softer demand environment, are you slowing your orders from suppliers at this point?

Yes, we are definitely paying attention to that and have taken a cautious approach, making adjustments as we look toward the latter half of the year. That’s why, if you review our prepared comments, we expect inventory to be slightly above our sales growth by the end of the year. We feel confident about our inventory position. I would encourage you to visit our stores today and see if you can identify any discontinued items; it's hard to tell. Our inventory is solid and often matches the quality of the new products we introduced. We're not concerned about needing to mark down products to get rid of them because they are good products that will sell.

Right, right. And then just thinking about the product mix that you're planning for the second half, I would assume that the anticipation of stronger Pro demand versus DIY is likely to continue to impact the mix that you're bringing into stores?

Sure. Yes. Pros purchase across the store and they buy for the end user who shops in all departments. We definitely pay attention to that and feel confident about what we're bringing in; we are pleased with our inventory position. Our in-stock levels, as you'd expect with that type of inventory increase, have been as strong as they've been all year.

And our next question comes from Jonathan Matuszewski. Go ahead, sir.

Great. Thanks for taking my question. Could you help us walk through the near and medium-term impact of a potential repeal in 301 tariffs? Specifically interested in when you would think to roll back pricing potentially if something were announced? And when do you expect to see lower COGS flowing through onto the P&L. Thanks so much.

We believe that repealing those tariffs would be beneficial since there is currently limited domestic manufacturing for most of the affected products. Consumers would benefit from this situation, not only from Floor & Decor but across the board. However, it will take some time for these changes to affect our margins due to the inventory in our distribution centers, which has already incurred tariffs because it was received in the U.S. Consequently, this inventory would likely face a 25% tariff. As merchants, we will monitor the reduction in costs over time. When costs decrease, we expect to lower our retail prices accordingly. We will also observe market trends and our competitors' actions. In the past, everyone has generally acted rationally during similar situations, including ourselves. Throughout this year of inflation, our competitors have remained rational as well. If a tariff repeal occurs, it may take several months for consumers to see benefits because retail prices usually don’t drop as quickly as costs do. Ultimately, we anticipate that as costs decrease, retail prices will follow suit, leading to improved gross margins. We are hopeful for this outcome, as it aligns with what is best for the American consumer.

Thank you. And the next question comes from Chris Bottiglieri from BNP Paribas. Go ahead, sir.

Hi. Great. Steve McManus on for Chris. Thanks for taking our questions. And congrats, Trevor. So I was just curious if you could speak to your exposure to the new homebuilding channel, what's the exposure to that end channel? And is that largely through your stores or more so through the RAM business?

This is Tom. It's insignificant. We do very little new home building. Currently, we don't sell in that market, and while we see potential for the future, our sales are not directed toward large builders. When we engage in new home building, it's typically with custom homebuilders who purchase from our stores, and they are generally less affected by situations like this. So it's insignificant.

Okay. Great. Thanks a lot. Appreciate it, guys.

Yeah. Good afternoon. Tom and Trevor. It’s Justin Kleber of Baird. Wanted to ask just a follow-up to your response there to Jonathan's question. If costs continue to decline or if tariffs are removed, and you guys ultimately lower retails. I mean would you expect a favorable unit response from lower retail? I'm just trying to understand how the top line looks if and when average ticket growth returns to more historic levels in that low single-digit range.

I'd say it depends on what happens with the competition, right? So if we passed along that tariff savings and our competition decided not to pass on that tariff savings, and I think our unit sales would go up. So in the natural environment, we'll have to wait and see.

Okay. Just to confirm though, as you guys have been raising retailers, do you feel like you've seen any negative elasticity?

I would just say from a macro perspective that this is the first time in our history that transactions have been negative in the company.

Partially macro, partially comparable.

Thank you guys. And our next question comes from David Bellinger from MKM Partners. Go ahead, David.

Hi. Thanks and congrats to Trevor as well. So my question, coming at this given some of your comments that Q2 comps tracked a little below internal expectations. So when you step back and look at some of the leading indicators of the business like web traffic or the number of samples consumers are requesting, what are those telling you about the next several quarters? And if, in fact, a slower housing market could have more of an impact on the forward outlook, not just in the back half of the year, but for 2023 as well. Thanks, guys.

I wish I had a clear answer for you. It's a mixed situation. The sample business is performing well, which is a positive sign. Our sample sales are strong. However, our website traffic has slowed down. This trend isn't unique to us; we see similar patterns with others in the industry. Everyone's web traffic in the Pro business has declined. While some aspects of our Pro business remain strong, we have received feedback indicating that their performance metrics have also slowed. So, it's a mixed picture: there are positive signs in samples, but there's also a decline in web traffic, as well as slowing measurements from the Pros, which ultimately affects sales. On the positive side, our Pros have shown great resilience, and their closing rates have improved. Although they may be encountering fewer customers, they are becoming more effective at closing deals.

When you're talking Pros, to be specifics, that's our installation made easy. It's not all of the process.

That's people we have visibility to.

Thank you. And our next question comes from Joe Feldman from Tesley Advisory. Go ahead, Joe.

Hey, guys. Good afternoon. Wanted to ask about merchandise a little bit. I didn't hear you guys comment too much on maybe the color of what was selling. You often mentioned laminates or subway tile or just some color there. And to tie that with your comment about the inventory seeing some of the increase relating to innovation in the product and I was just curious if there are some new things that you guys are seeing out there that you're bringing in for the customer. Thanks.

This is Ersan. We continue to see our large-format products like bigger, wider, and longer products gain acceptance by our customers. Of course, laminate and vinyls still exceed more than company average sales, and also we continued newness and innovation in every category as much as we can.

Great. Thanks. And congrats Trevor.

Sorry about that. Thank you. The next and last question comes from Anthony Chukumba from Loop Capital Markets. Go ahead, Anthony.

Thank you for taking my question. Firstly, Trevor, congratulations on your well-deserved recognition. From the moment I first met you, I believed you were perfectly suited for the CEO role, so your success is not surprising to me. There have been many topics covered in the call, but I was curious if you could provide an update on the performance of the five design studios compared to your expectations, any key learnings thus far, and if you have insights into what the long-term store footprint might look like. Thank you.

I don't have a long-term update on how many stores we'll have. It's still a work in progress. Currently, we have five stores operational, and we are set to open another one in Atlanta in the next month or so. I’m pleased to share that the stores that have been open for a longer period, such as our Dallas location, have seen a solid increase in performance similar to Floor & Decor. What’s encouraging is that the new stores are starting off stronger than the Dallas store did initially. We're learning a great deal about attracting designers and architects to our locations, and we believe we're appealing to a slightly different customer base, which aligns with our expectations for these stores. As a company, we are continually testing and exploring new ideas. We are not rushing into expansion; rather, we want to ensure we get it right. So far, so good. I would just ask for your patience as we open the next store, and then we'll provide you with updates on our long-term outlook.

Thank you. So that was the last question, so I'll close the call by thanking you all for your interest in Floor & Decor. Thank you for your questions. Congratulations again to Trevor on a well-deserved promotion. We're excited about what he can do as he transitions into his next role with Floor & Decor. To those associates who are listening, thank you for all your hard work, incredible job, greatly appreciated. And we'll talk to you guys all on the next call. Thank you.

Thank you. This does conclude today's conference. We thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.