Good afternoon, and welcome to the Floor & Decor Holdings Incorporated Second Quarter 2023 Conference Call. 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.

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. 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.

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 on our growth and 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 continue 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 in the 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 to 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 forward 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 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.

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 among 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 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 and kitchen project or a full room project rather than a five 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 consumers are considering a flooring project, we continue to see 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 in existing markets 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.

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 of 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 prior year. 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 benefit 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 continuing to shrink 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% to 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 challenging. 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. The 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 $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 a 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 the 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.

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.

Our first questions come from Michael Lasser with UBS. Please proceed with your questions.

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.

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 we can specifically know what number that 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 strong results in '20 and '21 in the first half of '22.

Yes, Michael, I'll elaborate on the comparisons and discuss the mature stores as well. If you follow the story, we experienced a decline of 3.3% in Q1 and 6% in Q2. As Trevor noted in the call, we are currently down 8.4%. This suggests that in the latter half of the year, the decline could range from 6.3% at the high end to 9.3% at the low end. We anticipate improvement in Q4 compared to Q3 because we are comparing against our weakest transactions, which were down 10.4% in Q4 and down 6.7% in Q3. Another factor is that we opened 13 out of 32 new stores, which accounts for 40% of our openings last Q4. These new stores will start contributing to the comparisons in Q4 as well. Additionally, to support Trevor's earlier comments, our guidance includes high single-digit to low double-digit declines for mature stores, which are reflected in the numbers we provided. Our new store classes continue to show positive comparisons, although they are performing slightly lower than what we projected for our mature stores.

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 over-earning and it's going to take some time for them to find a sustainable level?

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 we were. We don't believe they overachieved to their long-term goals.

As long as existing home sales are staying at this level, it 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.

Our next questions come from the line of Steven Zaccone with Citi. Please proceed with your questions.

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?

I'll take the first part, and then Trevor can handle the second part. This is Tom. I would say the market is growing at a slower pace than we are. We're still experiencing growth despite a negative comp environment. As we open stores, we continue to grow. In the quarter, we increased by 4%, and year-to-date, I think we're up around 6%. We're growing, and when we compare ourselves to publicly traded competitors, their growth rates are notably lower. For instance, Tile Shop reported a negative 8.4% in the first period and a negative 15% in the first quarter. Mohawk indicated that North America was down 9%. Thus, we believe we're capturing market share at a significant rate, while the overall market is in much worse condition than we are.

Our Pro business continues to perform well compared to the rest of the company. While we discussed our commercial small business, it is important to note that our commercial sector is thriving, both in the Spartan segment and through our regional account managers in retail. However, the consumer and DIY segments are facing challenges, which we are monitoring closely. This part of our business has the least control over external factors. As Tom pointed out, historical data shows that there have typically been about 5.5 million to 6 million existing home sales annually for the past 50 years. Currently, that number has dropped to 4 million, and we are 22 months into this cycle without improvement. With mortgage rates exceeding 7% again, we are experiencing a period of pressure within the housing market. Nonetheless, we maintain a positive outlook for both the medium and long term; we just need to navigate through this cycle.

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?

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, 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.

Our next questions come from the line of Steven Forbes with Guggenheim. Please proceed with your questions.

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?

Steven, I'll start and then Tom and Bryan 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 guidance 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.

I'll address the second part of your question. As mentioned in our previous calls, we recognize that we are in a cycle where challenges are present. We are managing the business to the best of our abilities while working to capture market share, and our plans regarding our 500-store strategy remain unchanged. We intend to open at least 35 stores next year. That's our current outlook, and we might provide updates as we progress into the next quarter. Our pipeline for 2024 looks promising, with a new store in Brooklyn and additional locations in the Northeast and other strong markets, which we are excited about as we continue to move forward.

Yes, they ultimately lead to the same point you made.

Our next questions come from the line of Chuck Grom with Gordon Haskett. Please proceed with your questions.

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?

We have spoken with many professionals over the past few months, and they report having decent backlogs. We are in touch with hundreds of them across the United States. While they still see decent backlogs, there has been a slight slowdown. When you are working on 5.5 million or 6 million homes, there are larger projects occurring. For instance, when someone is preparing to sell a home, they might have invested in multiple bedrooms, bathrooms, and kitchens. Currently, existing home sales are hovering around $4.1 million, one of the lowest figures we have seen in the last 50 years. As a result, people are opting for much smaller projects instead of renovating an entire floor; they may only remodel a bathroom or kitchen. Additionally, they have indicated that the size of their projects has decreased. This is probably the most significant change we have observed relative to the beginning of the year. Our transactions are aligning closely with our expectations, and the ticket sizes are also consistent. However, the square footage of the jobs has diminished, which we did not anticipate. So, the key change is that people are engaging in smaller projects as significantly fewer houses are changing hands.

Okay, great. My second question is about new store productivity. You opened nine stores, with three openings in each month of the quarter, and one on the last day. However, the new store productivity is significantly lower than usual, calculated at around 61%. Is there anything causing this decline?

We disclosed in our 10-K that we expect new stores to generate between $14.5 million and $16.5 million in sales during their first year. Our store portfolio is structured around these figures. Historically, in exceptional years like '19, '20, and '21, sales hit approximately $16.5 million. However, for the class of '22 and early '23, the sales figure has likely dropped to around $14.5 million. Consequently, we've observed a decrease in same-store sales due to fewer customers in the market, which has also impacted new store sales productivity. I believe that as the economy improves, those numbers will rebound. Even in the current climate, these stores are expected to generate about $3 million in full EBITDA in their first year. Now, with a decrease of about $1 million in that figure, they're projected to still generate between $2 million and $2.5 million in EBITDA. They remain productive and will provide returns on invested capital that surpass our cost of capital.

And this is Bryan. It gives us more of a maturation curve as well they mature.

Our next questions come from the line of Simeon Gutman with Morgan Stanley. Please proceed with your questions.

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.

It is indeed early to discuss 2024. I'm happy with our efforts to maintain value and pass some price increases back to our professional customers, which has allowed us to continue improving margins, as stated earlier. We have achieved this sequentially and year-over-year. I believe we can keep enhancing our margin rates going into 2024. We're monitoring where we've reduced prices and assessing unit elasticity to determine the impact, although results are inconclusive at this point. We're focusing on selling better and premium products, implementing design initiatives, and ensuring our supply chain efficiently reduces costs through better purchasing. I am confident we can surpass our past gross margin rates, but the timing for this improvement is still uncertain. We will discuss 2024 as we approach it, but I am optimistic about our progress.

Yes. It's actually related to '24. I'm hesitant to discuss it, but it revolves around the housing market because Trevor pointed out that consumers are spending a bit less. There has been a discussion in this industry that the wealth of homeowners who remain in their homes would continue to influence the sector, not necessarily in a supportive way, but in a manner that avoids negative comparisons. However, if existing home sales do not increase in '24, which some are predicting, how do you view this wealth effect? Is there enough of it for the business or the industry to grow, or could we be facing a longer transition period?

I find it challenging to provide a straightforward answer, but I will give it a try. As I look ahead to next year, existing home sales have been declining by about 20%. If we enter the fourth quarter and home sales remain around 4.1 or 4.2, as we expect, they won't be down 20%. They will likely be flat or perhaps show a slight increase. We anticipate that conditions may improve next year, and if existing home sales perform better year-over-year, it should benefit us. Additionally, I believe there will be some pent-up demand due to the slowdown in the business; I expect that people might become more eager to take on projects. Our consumers tend to skew toward the higher end, and their financial situations are relatively solid. Therefore, we are hopeful that as time progresses, people will decide to undertake renovations, like updating their bathrooms or kitchens. While existing home sales may show slight low figures, they will not drop by 20% year-over-year, and I believe that over time, people will engage in more home projects since the value of their homes remains strong.

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.

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

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 rates, 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?

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 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, it 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.

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 & Decor.

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 as the Pro.

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 the largest private label credit card company in the United States that they're a good partner with us, and we're optimistic about it.

Got it. Appreciate, thanks guys.

Thanks Zach.

Thank you. Our next question comes from Seth Sigman with Barclays. Please proceed with your questions.

A significant part of the slowdown is related to the average ticket. We're trying to understand how this settles, as your average ticket has increased by approximately 25% compared to 2019. It appears that some of this increase is due to same SKU price hikes, but a larger portion likely results from larger projects and product mix. I would appreciate if you could elaborate on this. How much of the increase in average ticket is attributed to the rise in average square footage per project? Additionally, how do you anticipate this will normalize? Will it return to levels seen in 2019, or could it decline based on EHS? What are your thoughts on this?

I believe our ticket will stabilize this year, and I expect it to grow in the future as our e-commerce business, which has the highest ticket, continues to expand at an accelerated pace like it has for the past 12 years. Our Pro ticket is higher than our homeowner segment, and we're optimistic about its continued growth; our design ticket is also elevated, reflecting a significant focus on design, which is up 330 basis points. I anticipate that we'll level off this year. Our RAM sales, primarily generated through the stores, consist of substantial commercial sales and also come with higher tickets. My expectation is that after navigating one of the toughest housing markets in the last 50 years, our strategic initiatives will foster ticket growth. Additionally, our merchants are performing exceptionally well. While customers are opting for smaller square footage, they still prioritize better quality. Comparatively, our pricing doesn't heavily align with home centers; instead, we compete more with independents, which enhances our value proposition. This strength in our better and best assortment, alongside our significant pricing advantage over competitors, is why that segment of our business continues to capture market share.

The last point I want to make is that when existing home sales increase, people will start renovating their homes more. When individuals purchase a new house, they typically add more rooms. Currently, many are staying in the same house and making changes one room at a time. Once we see more activity in home sales, this will positively impact the average ticket size in our business.

Our next question comes from the line of Jonathan Matuszewski with Jefferies. Please proceed with your questions.

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?

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.

Yes, I mentioned earlier that our test results are not conclusive, and that still holds true. They remain inconclusive. It's quite challenging; some tests seem to have been effective, while others did not show any impact. It's difficult to determine whether we simply shifted a customer from one product to another within our store, given the wide variety of options we offer. So, there is some complexity here. We do observe some advantages in certain departments where we see more benefits than in others, and we plan to continue leveraging that knowledge as we consider future price reductions.

Our next question comes from the line of Karen Short with Credit Suisse. Please proceed with your questions.

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.

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 pay 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.

Our next question comes from the line of Chris Bottiglieri with BNP Paribas. Please proceed with your questions.

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 Floor & Decor from the end market work Spartan into that matter?

I didn't get the question of the question. You're talking about the new builder?

He's referring to the new builder within Spartan.

Yes. Spartan recently announced the hiring of someone to assist us in exploring new construction opportunities, a segment we haven't historically focused on. While we effectively work with custom homebuilders at Floor & Decor, our involvement in new construction has been limited. We wanted to strengthen this area, as we believe it represents a significant opportunity. A member of our Board from Pulte Homes has been instrumental in reshaping our perspective on this business and enhancing our understanding. Given the current climate of new home sales, particularly due to the low inventory of existing homes, we see potential. We aim to integrate new construction as a more significant part of our business moving forward, which is why we brought on an experienced individual for this role.

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

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?

When we discuss value, it's important to note that customers choosing to do jobs in their homes still want to purchase the best products available in our stores. Value remains a key factor for them, particularly as we compete with independent retailers where the difference in offerings can be quite pronounced. When customers decide to undertake a project, they are inclined to seek out the superior products. We believe we have a strong advantage in that area. We're attentive to our opening price points, which are crucial, especially in the flipper segment of business. Our merchants consistently work on updating these price points without necessarily increasing them, maintaining a consistency with our historical practices.

Our next question comes from the line of Justin Kleber with Baird. Please proceed with your questions.

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 transactions here 2Q. Did you comment on Pro specifically, I'm curious how that trended relative to 1Q?

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 to $4.6 million in February, $4.4 million in March and then started to decline back down to $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. And on the Pro side, it has decelerated as well, but it's still outperforming the homeowner or the DIY business.

Our next question comes from the line of Keith Hughes with Truist Securities. Please proceed with your questions.

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?

So ticket in the back half will actually be negative. And so it's been sequentially declining as we expected 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.

Our final question will come from the line of Greg Melich with Evercore. Please proceed with your question.

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.

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 man-made products.

This is Bryan. Before we wrap up the call, I want to provide some clarity on the modeling. I know there was a question about it. Originally, we projected store operating expenses to be 27% of sales, but we now anticipate it will be between 27.5% and 28% for the year. General and administrative expenses were initially expected to be 5% of sales, but we're now looking at a range of 5.6% to 5.7% for the year. Pro opening expenses will remain around 1%. I wanted to share this information to assist you with the modeling.

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 value all the efforts being made. We believe we are effectively balancing our profitability while also capturing market share and preparing for the eventual recovery from a downturn. We look forward to updating you on the next call.

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 the evening.