Floor & Decor Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
November 2, 2023

There are 13 speakers on the call.

Operator

Note this conference is being recorded. At this time, I'll now turn the conference over to Wayne Hood, Vice President of Investor Relations. Mr. Hood, you may begin.

Speaker 1

Thank you, operator, and good afternoon, everyone. Welcome to Fluor and Decora's fiscal 2023 3rd quarter earnings Conference call. Joining me on our call today are Tom Taylor, Chief Executive Officer Trevor Lang, President And Brian Langley, Executive Vice President and Chief Financial Officer. Before we start, I wanted 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.

Speaker 1

Any statement that refers to expectations, Projections or other characterizations of future events, including financial projections or future market conditions

Speaker 2

This is a

Speaker 1

forward looking statement. The company's actual future results could differ materially from those expressed in such forward looking statements For any reason included in those listed in its SEC filings, Floor and Decora 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 mostly directly comparable GAAP financial measure can be found in the earnings press release, Which is available on our Investor Relations website at ir.

Speaker 1

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.

Speaker 3

Thank you, Wayne, and everyone for joining us On our fiscal 2023 Q3 earnings conference call. During today's call, Trevor and I will discuss some of our fiscal 2023 3rd Quarter earnings highlights, then Brian will provide a more in-depth review of our Q3 financial performance and share our thoughts About some of our financial projections for the remainder of fiscal 2023. We are proud to deliver 3rd quarter diluted earnings per share of $0.61 Especially amidst the continuing economic challenges posed by 30 year mortgage interest rates that are now at about 8%, near record low existing home sales Of 3,960,000 units annualized in September, the ongoing pressures on housing affordability and the slowing sales of large ticket discretionary products, Our fiscal 2023 Q3 financial results are a testament to our company's agility and commitment to executing our Key growth and customer engagement strategies, which we believe will continue to widen our competitive moat. As many of you know, Our industry and company have been affected by the Federal Reserve's current interest rate policies aimed at curbing economic growth and moderating inflation to 2% over The lagged effect of these policies is exerting greater than expected pressure on existing home sales and in turn Our sales than we previously expected.

Speaker 3

We were expecting that existing home sales would approximate 4 point 1,000,000 to 4,300,000 units annualized as we moved into the second half of twenty twenty three, but Regrettably, this has not materialized to date. As Brian will discuss in more detail, we have experienced an unexpected Accelerated decline in comparable store sales from the lagged effect of these policies in the early part of the Q4 of 2023 And have begun to tighten expenses further in November to align with the recent accelerated decline. We believe the ongoing impact of these monetary policies will continue to suppress home remodeling into fiscal 2024, Which could lead to a decline in our comparable store sales for the year. Therefore, we believe it is prudent to approach fiscal 2024 With more rigor in our expense management and added discipline in our growth investments and capital spending. Additionally, we think it is important to add a level of And optionality to our operating in store opening plans in 2024 given the current macroeconomic environment.

Speaker 3

I am proud of how our teams have stepped up to this short term challenge. We are not standing still and see evidence that our strategies to grow our market share in this Balancing period are working even when industry sales are contracting.

Speaker 1

We

Speaker 3

are fortunate that the strength of our business model, balance sheet And cash flow allow us to continue in investing in the new stores and merchandising growth initiatives in the face of these near term headwinds. For example, we intend to test An outdoor department within our stone department in 10 to 12 serves early next year, including full outdoor focused vignettes and select Design centers to better show our assortment. I believe that our demonstrated history of strong and agile execution, Coupled with the investments we continue to make in new warehouse stores and merchandising will position us for accelerating sales, Market share and strong earnings growth when the industry growth returns. Let me now turn the call over to Trevor.

Speaker 1

Thanks, Tom. I also want to express my appreciation to all of our associates for their dedication to serving our customers and executing our key growth initiatives Towards operating at least 500 stores in the U. S. It is important to note that we view ourselves as a young disruptive growth company with only 207 warehouse stores in the U. S.

Speaker 1

At the end of the Q3 of fiscal 2023, we continue to make important long term investments as we have conviction that over the long term, we can achieve Turned above our weighted average cost of capital, just as similar investments have allowed us to be approximately 20 times the size we were just over a decade ago when Tom and I arrived at Floor and Decor. We have demonstrated that we can manage a growth business focused on long term profitability and return on capital during difficult periods such As in 2018, when existing home sales declined, in 2019 when the U. S. Government imposed tariffs as well as antidumping and countervailing duties on many of our products from China, And in 2020 'twenty one, during the COVID-nineteen shutdown and the related supply chain disruptions. As Tom mentioned, we are not standing still as we navigate this challenging period of Our growth and profit have never been a straight line, but when measured over the long term, we believe we are well positioned.

Speaker 1

We intend to continue growing through this cyclical housing downturn by capitalizing on our everyday load prices, value driven options, trend right product assortments, In stock job log quantities and exceptional customer service provided by our store associates. Turning to our fiscal 2023 3rd quarter sales, total sales increased by 9 percent to $1,100,000,000 from the same period last year. Our fiscal 2023 3rd quarter comparable store sales fell 9.3% from last year. Comparable store sales declined 8.2% in July, 10.1% in August and 9.7% in September. As a reminder, our fiscal 2022 Q3 comparable store sales increased 11.6% due to a 19.5% growth in our average ticket.

Speaker 1

Our fiscal 2023 3rd quarter comparable transactions declined 6.8% and our comparable store average ticket declined by 2.8%. While we are encouraged the sequential decline in transactions improved from the peak declines of 10.4% in the Q4 of fiscal 2022 At 9.9% in the Q1 of fiscal 2023, our average ticket remains under pressure. The pressure reflects Cycling past retail increases last year, customers continuing to purchase less square footage and the impact of strategic decisions to lower retail pricing selectively on specific We continue to see homeowners and pros engaging in fewer and smaller scale flooring projects and they are very intentional in their purchase decisions. For example, they are choosing a single bathroom project rather than a bathroom and a kitchen project or a 2 room project rather than a 3 room project. Additionally, the cost of financing projects has risen due to increased interest rates, fewer subsidized financing programs and tighter lending standards.

Speaker 1

Collectively, we believe these factors are contributing to us selling less square footage when compared to last year. That said, when consumers Considering a flooring purchase, we continue to see ongoing customer preferences towards our better and best product price point products We offer industry leading innovation, trends and styles at everyday low prices. From a regional perspective, comparable Store sales in our Western and Southern divisions were the weakest in the Q3 of fiscal 2023. From a merchandising perspective, our initiatives in tile, Installation materials and adjacent categories led to comparable store sales that were meaningfully above the company average. We are pleased that our total sales Our e commerce store increased 8.3% year over year.

Speaker 1

As a result, the sales penetration rate increased 160 basis points to 18.9% 17.3% last year, further reaffirming that our connected customer strategies to drive engagement are working. We are also continuing to invest in design service To drive engagement with homeowners and pros by further expanding our in home design test in the Q3. We have found that when our designers engage with homeowners in their homes, we increase our ability to Turning to our early fiscal 2023 4th quarter sales trends, Our 4th quarter to date comparable store sales are down 11.9%, below what we expected coming into the quarter and greater than the 3rd quarter's decline of 9.3%. Consequently, we updated our fiscal 2023 earnings guidance in today's press release to take into consideration the slowing sales trends. I will now discuss our new store pillar of growth.

Speaker 1

In the Q3 of fiscal 2023, we opened 5 new warehouse stores, including 2 new warehouse store openings in Upstate New York And Buffalo and Rochester, both new markets for us. We ended the 3rd quarter by operating 2 0 7 warehouse stores and 5 design studios across Since the beginning of this year through today, we have opened 22 new warehouse stores, including 5 new warehouse stores in October, Moving us closer towards achieving our 32 new store opening plan for fiscal 2023. In early October, we continued our Upstate New York store building Build out by opening a new warehouse store in Albany. We are excited to continue building our presence and brand awareness in New York and New Jersey In the Q4 of fiscal 2023 with planned openings in 5 new warehouse stores in these states. These planned openings will include new warehouse stores in Ocean Township, Avanal, Princeton and Springfield, New Jersey and Port Chester, New York.

Speaker 1

We plan to continue building our New York expansion in 2024 with a new warehouse As we continue our growth, we also decided to close an older warehouse store in Houston due to strategically placing stores in the market Surrounding the store in the Q3 as the lease expired. Due to ongoing industry wide construction delays in the Q3, we had to push some of our late September 2023 warehouse store openings into the Q4. These construction delays are due to general contractors struggling to secure qualified subcontractors And local government municipalities remaining understaffed, particularly in the Northeast. In some cases, municipal government staffing levels are below pre pandemic levels. Consequently, obtaining all the necessary building inspections and approvals sometimes takes as much as 3 times longer.

Speaker 1

Moreover, we have recently begun experiencing delays with utility companies, missing dates and delaying work due to the constrained capacity of their workforces. As a result, these delays have been outside of our control when connecting power, water and sewer and gas services Turning my comments to our PROs, which accounted for approximately 44% of our 3rd quarter tendered sales compared with 43% in the same period last year And 44% in the Q2 of fiscal 2023, we are leveraging our Pro dashboard and CRM tools and celebrating Pros with events like our Annual Pro Appreciation Month in September. This annual event which generated 68,000 pro registrations including year giveaways, in store prizes, Nationwide sweepstakes, free installation materials and educational webinars. We were pleased with the incremental new pro business generated from this event and its impact on our installation material sales, Where we have seen a significant where we see a significant market share opportunity with our PROs. While our overall fiscal 2023 Q3 comparable store sales declined 9.3 From last year, our Pro comparable store sales continue to outperform our homeowner sales and our insulation materials grew modestly As we focused on increasing our market share in a contracting market.

Speaker 1

Additionally, we continue developing our other strategies to deepen our relationship with our pros. For example, we are participating in the National Tile Contractors Association or the NCCA with educational events enabling our pros to use Pro Premier points for NCCA membership. The membership includes a range of benefits, including training and vouchers to be used in our stores. Similarly, we partnered with the National Wood Flooring Association in the Q3 to build on our brand awareness as a destination store for wood. This allows with our plans to have all of our stores with updated wood inspiration centers by the end of 2023.

Speaker 1

Providing educational events is increasingly important to pros As the installation in certain large format categories is new and more complex to install. Year to date, we have trained over 2,000 pros by working with the NCCA and we're on track 128 educational events in 2023 compared with 71 in 2022. Our CRM data affirms that our pro wallet share growth initiatives are working in Working in the Q3, we saw growth in our returning Pro customers and spending growth among our top Pros engaged in foreign projects. From an operational standpoint, we have process improvements underway that will make it easier for our top pros to interact with us and build quotes on large projects. To manage our profitability, we continue aligning our store payroll hours with the decline in sales and are rigorously managing our corporate G and A spends.

Speaker 1

Importantly, we believe we are doing this in a way that does not compromise customer facing service. In fact, we are very pleased that our customer service scores remain high. Laura, we continue to manage our total inventory effectively and are glad that our merchandise in stock level is better than they have been in the years. Finally, we are continuing to fortify our strong pricing move by strategically adjusting retail prices on specific SKUs Using a portfolio approach, while at the same time improving our gross margin rate year over year. Turning to our commercial business, our Subsidiary, Spartan Services reported another strong quarter with fiscal 2023 Q3 total sales increasing by 47.5% from last year.

Speaker 1

Additionally, the company announced an exciting new line of flooring and wall tiles under the Umori brand name in October. The Umori line This exemplifies how Spartan can work with Flooring to Core merchants and supply chain teams to design and curate exclusive flooring and wall top products for commercial specifiers That is supported by a deep inventory that is available nationally. Tile is a higher margin business that we believe is mostly incremental business Spartan, as historically they have not sold much tile. We are continuing to build out our regional account managers where our 3rd quarter sales increased 32% from the same period last year. Looking forward, we see growth in new quoted projects and sample requests as remaining healthy, but moderating.

Speaker 1

The moderating growth is consistent with the September ABI index, which saw a 44.8 reading down from 48.1 last month, moving below the positive territory of above 50. In response, we are rigorously managing our administrative expenses and investment plans in commercial. As discussed in prior earnings calls, we remain excited about the long term commercial market opportunity and our We are confident that we have the right people, strategies, business model to continue to successfully navigate this challenging macroeconomic environment. I will now turn the call over to Brian to discuss our fiscal 2023 Q3 financial results in more detail and share our outlook for the remainder of the year.

Speaker 2

Thanks, Trevor. As Tom mentioned, we are proud to report fiscal 2023 Q3 diluted earnings per share $0.61 which was at the high end of our expectations despite 3rd quarter sales that were modestly below our expectations. Like the previous quarters in 2023, we achieved these results by delivering on our commitment to growing our gross margin rate year over year, while managing our competitive price gaps in growing our market share. As CFO, I am equally pleased with how we are managing our inventory and merchandise and stock levels, Which enabled us to report a $691,700,000 positive swing in year over year operating cash flow and a significant increase in free cash flow. Now, let me turn my discussion to some of the changes among the significant line items in our Q3 income statement, balance sheet And statement of cash flows, in each case compared to the same period last year unless otherwise stated.

Speaker 2

Then I will discuss our outlook for the remainder of the year and provide a framework How we are thinking about fiscal 2024. 3rd quarter total sales increased 0.9% from last year. However, gross profit grew 4.5 percent due to a 140 basis points increase in our gross margin rate to 42.2% From 40.8% last year. The increase in gross margin rate is primarily due to retail price increases we took last year, Coupled with a decrease in supply chain costs starting in late 2022 that continued into the Q3 of 2023. 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 through the remainder of 2023.

Speaker 2

3rd quarter selling and store operating expenses increased 9.9% To $308,600,000 the growth is primarily attributable to higher occupancy costs related to an increase in the number of warehouse stores operating since September 29, 2022, wage rate increases and higher credit card transaction processing fees. As a percentage of sales, Selling and store operating expenses increased approximately 230 basis points to 27.9% from last year. The increase was primarily due to the deleverage in occupancy and other fixed costs from a decrease in comparable store sales. 3rd quarter general and administrative expenses increased 9.5% to $59,900,000 from last year. The growth is due to investments to support our store growth, including increased store support staff, higher depreciation related Technology and other store sports center investments and operating expenses related to our Spartan subsidiary.

Speaker 2

As a percentage of sales, General and administrative expenses deleveraged 30 basis points to 5.3% from 5.0% last year, The expense rate improved from the 2nd and 1st quarters of 2023. The year over year increase in expense rate is primarily due to a decrease in comparable store sales, Partially offset by lower incentive compensation accruals. 3rd quarter pre opening expenses increased by 37.0% To $14,200,000 from last year. The increase primarily resulted from an increase in the number of future stores that we were preparing to open Compared to the same periods a year ago as well as costs related to delays in new store openings. 3rd quarter net interest expense decreased to $1,200,000 from $3,000,000 last year.

Speaker 2

The $1,800,000 decrease in interest expense is better than planned And primarily due to a decrease in average borrowings outstanding under our ABL facility and an increase in interest capitalized, Partially offset by interest rate increases on outstanding debt. 3rd quarter income tax expense was $17,600,000 Compared to $22,500,000 from last year, the effective tax rate decreased by 170 basis points to 21.1% from 22.8% the previous year, primarily due to increased tax benefits related to stock based compensation. Excluding the impact of excess tax benefits, Our 3rd quarter tax rate was approximately 23.7% compared to 23.9% last year. 3rd quarter adjusted EBITDA decreased by 4.7 percent to $140,900,000 from last year, primarily from expense deleverage From the 9.3% decline in our comparable store sales. However, EBIT declined by a larger 16.6% from last year Due to a 27.1% increase in depreciation and amortization expense, 3rd quarter net income Declined by a more moderate 13.5% from last year due to a lower effective income tax rate and lower interest expense than the previous year.

Speaker 2

Diluted earnings per share fell 14.1 percent to $0.61 from $0.71 last year. You can find a complete reconciliation of our GAAP to non GAAP earnings in today's earnings press release. Moving on to our balance sheet and cash flow. We are continuing to maintain a strong balance sheet during this uncertain period. Our total inventory as of the end of the third quarter decreased by 16.3 percent To $1,100,000,000 from the end of the Q3 last year and decreased by 14.5% from the end of fiscal 2022.

Speaker 2

The decline in inventory, Coupled with an increase in trade accounts payable and other working capital initiatives enabled us to report a 691,700,000 dollar favorable swing in year over year operating cash flow and a significant year over year increase in free cash flow. The improvement in our cash flow allowed us to reduce borrowings under our ABL facility to 0 at the end of the 3rd quarter, which enabled us To reduce our debt by $178,500,000 to $202,900,000 from last year. The strength of our balance sheet will benefit us As we remain committed to making investments that we believe will drive further market share gains during a period of industry interaction. We ended the 3rd quarter with $758,900,000 of unrestricted liquidity consisting of $61,600,000 in cash and cash equivalents And $697,300,000 available for borrowing under our ABL facility. Let me now turn my comments to how we are thinking about the remainder of the year and And how it compares with our previous expectations.

Speaker 2

During the Q3 of 2023, 30 year mortgage interest rates continue to rise and are touching 8% Up from the prior peak of 7.34 percent in July. At the same time, the July Federal Reserve Senior Loan Officer Survey Reported that lending standards across all categories of residential real estate tightened and we expect further tightening of loan standards in the second half of twenty twenty three. Meanwhile, demand weakened for all residential real estate loan categories. Home prices have moderated, but they remain elevated from previous years. According to the National Association of Realtors, the median price of an existing single family home in September increased 2.8 percent to $394,000 from last year, which still represents a 26.3% increase From 312,000 in September of 2020.

Speaker 2

These increased costs coupled with increases in property taxes and insurance And following savings buffers continue to erode housing affordability for many homeowners, leaving all but the highest income cohorts able to afford homeownership. Consequently, existing home sales reached a near record low of $3,960,000 annualized in September, which was below our expectations $4,100,000 to 4,300,000 annualized units that supported our prior outlook for the second half of twenty twenty three. We are prudently Expecting these trends to continue to create headwinds for our sales in the short term. Taking this into consideration, let me reframe how we are thinking about the Q4 of 2023 And provide some preliminary guardrails to take into consideration for 2024. As Tom mentioned, we have experienced an unexpected Accelerated decline in our comparable store sales from the lagged effect of these policies in the early part of Q4 of 2023.

Speaker 2

To take this into account, we have updated our 2023 sales and earnings guidance, which now reflects the potential that the accelerated decline in our comparable store sales could be sustained for the remainder of the Q4. We hope we are wrong, but we now expect 2023 4th quarter comparable store sales Could decline in the range of 12% to 15% from last year. In response, we have already initiated Expense tightening measures in November and will further tighten them in December with an eye towards not adversely impacting our customer base. Let me now provide some more details. We now expect fiscal 2023 total sales to approximate 4,345,000,000 To $4,385,000,000 compared with our prior guidance of $4,460,000,000 to 4,530,000,000 Comparable store sales are expected to decline 7.8% to 8.5% compared with our prior guidance of 5.5% to 7.0% We expect our 2023 4th quarter gross margin to be flat or modestly improve Sequentially, leading to an annual and 4th quarter improvement year over year.

Speaker 2

We expect fiscal 2023 diluted earnings per share To be in the range of $2.14 to $2.24 which implies 4th quarter diluted earnings per share of $0.20 To 0 point 3 $0 The updated 2023 annual earnings guidance compares with our prior guidance of $2.30 to 2 $0.50 Fiscal 2023 adjusted EBITDA is expected to be in the range of $535,000,000 to 550,000,000 Compared with our prior guidance of $570,000,000 to $595,000,000 depreciation and amortization expense of approximately 200,000,000 Unchanged from our prior guidance. Net interest expense of approximately $11,500,000 compared with our prior guidance of $16,000,000 to 17,000,000 Tax rate of approximately 21.5 percent, diluted weighted average shares outstanding of approximately 108,000,000 Unchanged from our prior guidance. Opened 32 new warehouse stores, unchanged from our prior guidance. And we've reduced our 2023 planned Capital expenditures to $550,000,000 to $575,000,000 from our prior guidance of 590,000,000 to $630,000,000 At this juncture, we believe it is prudent to moderate and add optionality to our 2024 new warehouse store openings With a revised opening plan of 30 to 35 warehouse stores compared with our prior expectations of at least 35 stores. It is important to recognize that this still would represent mid teen store growth.

Speaker 2

We are still developing our detailed sales plans for 2024, But we expect that if existing home sales remain at the current levels, our comparable store sales could decline next year. In particular, we anticipate our comparable store sales could decline more in the first half versus the second half of the year given our sales comparisons from 2023. As such, we have action plans to align our expense structure with this potential near term decline. We continue to modest improvement in our gross margin rate next year from our fiscal Q4 exit rate.

Speaker 3

Let me turn the call back to Tom for some closing remarks. Thanks, Brian. In the short term, we see opportunity amid the uncertainty. We believe that we have demonstrated that we can manage through uncertainty And seek to use this opportunity to seize more market share as the industry contracts. While the timing of a sustained recovery in existing home sales And growth in our industry continues to be elusive and pushed out by most of the economists.

Speaker 3

We believe the longer term outlook for home improvement spending remains bright. That said, we believe we should be prudent when approaching 2024 with more rigor towards managing our controllable expenses and discretionary capital spending. That does not mean we are not making growth investments. We expect to continue to invest in 2024 by opening new warehouse stores, Which we believe will further widen our competitive moat and leave us in an even stronger position for significant earnings power when the industry fundamentals improve. Our longer target of operating at least 500 warehouse stores in the U.

Speaker 3

S. And achieving a mid to high teen EBITDA margin is unchanged. Operator, we would now like to take questions.

Operator

Thank you. At this time, we'll be conducting a question and answer session. Thank you. And our first question comes from the line of Simeon Gutman with Morgan Stanley. Please proceed with

Speaker 1

your questions.

Speaker 4

Hey, guys. Good afternoon. My question is, in the Q4, Some of the expense rationalization that's happening, is that the run rate that we run into 2024 or does it get better? Meaning, If you annualize the earnings from the Q4 and I guess the decremental margins, it paints

Speaker 5

a pretty tough picture and

Speaker 4

I want to try to see why that's wrong.

Speaker 1

Yes. Jimmy, this is Trevor. That's a good question. So we're not done with our planning process For 2024, given the current economic headwinds and comparable store sales are likely to be negative next year based on current sales trends and as Brian mentioned, probably have larger Negative comps in the 1st part of the year versus the 2nd part of the year. We are focused on continuing to resize our expense structure based on the slower sales trends and we believe We can have a moderate increase in gross margin next year, but we don't believe that you take the Q4 run rate and extrapolate That's the fiscal 2024 annualized EPS.

Speaker 1

We think we will do better than that and we're working through that as we speak. Obviously, a lot of unknowns out there with mortgage rates and where the consumer is and how they're going to invest in renovation today. But we are creating optionality and scenario planning that If things get better or worse, and we'll give you a more detailed update in 2024.

Speaker 4

Is there anything on the vendor side that's Are they getting more aggressive, meaning are they lowering price or getting more aggressive in some of the deals that you're seeing?

Speaker 3

This is Tom. So I'll take that. So part of our improvement in gross margin that we're seeing now And that we will continue to see next year is in our merchants doing a good job of working with our suppliers and getting first cost reductions. So it's when we're moving suppliers, we're getting better buys with our existing suppliers businesses. It's It's tougher for them, so they're making concessions and our merchants do a good job of negotiating.

Speaker 3

So yes, we should see some benefit from that. We're seeing it now and it should continue into next year. Thanks, guys. Good

Speaker 2

luck.

Operator

The next question is from the line of Chris Horvers with JPMorgan. Please proceed with your questions.

Speaker 6

Thanks. Good evening, guys.

Speaker 7

So thinking about what just happened in the past month in terms of the deceleration in the business, can you deconstruct that a little bit Is it traffic and ticket breaking sort of the stacks? You're implying that the monthly is really If you're looking on a monthly on a multiyear basis. So what changed in terms of traffic versus ticket? You also mentioned that The southern region also was in the worst category, which was not true in the Q2. So is there a change in Texas and Florida that you're seeing in, I guess the last part of that question is, as you think about the cadence of the month, was there anything observable around, Let's say the war or any sort of shock that you saw on a sort of weekly basis?

Speaker 2

So I'll take the first part and this is Brian and then Tom will kind of take the second and third part. So just I think it's easier if I talk about what was in the Prior guidance versus what we're seeing today kind of to unbundle Q4 a little bit and the trends we're seeing. So our comp was obviously negative mid single digits is what we were thinking. Now that's At a negative 12% to negative 15%. To talk about transaction and ticket, we had transactions in Q4 in the prior guidance were going to be about Now we're expecting that to be mid single digits to high single digit decline.

Speaker 2

So you're seeing a bigger drop in transactions from the expectation That we were at and then ticket was a low single digit decline that we had previously guided to. Now that's more like a mid single digit decline. So you can see the biggest, I guess deviation from our expectation in Q4 is really around transactions. And so we think about that 2 year stack or anything else, transactions are really going to see The bigger deviation from Q3 to Q4 on some of that.

Speaker 1

And the only thing I'd say, Chris, that's probably a bit different than when we were, what It was 3 months ago is mortgage rates have now tipped up and closer to 8%. Existing home sales are now below $4,000,000 which hasn't happened that often in the last It has not happened that often in the last 40 plus years. And so it's just it's been a bit of a deteriorating environment since We talked last.

Speaker 2

Yes. No, go ahead. I was going to say and just on the average ticket, our square foot per project is continuing to go down. So that's what's Driving down a lot of that average ticket to go from the low single digit to kind of mid single digit declines. So a lot of it's around that project size.

Speaker 3

Yes. So and Chris, I'll try to hit the last Two parts of the question. We're going up against easier compare, so you think you would think that things would have been better. But as Trevor mentioned, with interest rates being higher than we thought, existing home sales deteriorating worse than we thought, and then What's happening with the world, with the conflicts around the globe, they're all probably having an effect on the consumer and And hurting their ability to shop. So I don't know exactly like I can't pinpoint our deterioration.

Speaker 3

It's been all through since the quarter started. So I'm not sure Which one of those is affected at the most? I'm sure it's a little bit of each. And as far as the comment on the South, South was performing pretty well And we started seeing deterioration in the West first and the South is just kind of getting to where the West the challenges that the West We think we're seeing them a little bit more now than we were at the beginning part of the year.

Speaker 7

Got it. And then my follow-up is, Tommy, you I mentioned earlier this year that if existing home sales were flat, you could see a positive outcome on the comp side. You're leaning towards Less negative in the back half of the year. So presumably, you'll get to a point of flat existing home sales In the back half, so is the difference now, is it the you have to annualize through the project size headwind?

Speaker 3

I mean, you have a little bit of the project size headwinds. I think that's a fair point. We're still not getting to Existing home sales, when we look out, existing home sales, what we're up against is still we're going to be below that by all anticipation at $3,900,000 annualized in September. We don't we're not planning for that to get much better, which would still be we'd still be in a declining home sales environment. I do believe that if we can get to Flat existing home sales year over year, but we can comp or existing home sales are comping positive.

Speaker 3

That's good for our business, may not immediately, But in time, but as we look forward, if you look to next year, you got in the first half of the year, February, there was 4.6 1,000,000 homes annualized March, dollars 4,400,000 annualized April 4,300,000 May 4,300,000 with what we saw in September and even though interest rates are coming Not going up as of right now and people are excited about that. We're not anticipating them to go down. And so we think that that's going to put a challenge on to the business.

Speaker 7

Got it. Thanks very much.

Operator

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

Speaker 8

Good evening. Thanks a lot for taking my question. Tom, in your remarks, you noted how you have So under what conditions would Floor and Decor choose to slow down store growth in 2024 and 2025, and then what would you need to see in order to reaccelerate it? And does this have any bearing on the ability to have 500 stores over the long term?

Speaker 3

I'll take the last part. That's the easy one. No, there's no change in our outlook as I said in the script. There's no change in our 500 store plans. No change in our mid teen EBITDA margins.

Speaker 3

I mean, we don't see much change over the long term. It's just the pace of getting there. What would make me change or reconsider store growth, as we've said historically and Trevor and Brian can weigh in, is if the So if our liquidity became a challenge and we had to push back capital expenditures, we'd certainly that would give us a moment of pause We're up to returns on the stores. Right now, to be in this macro environment and still have our new store class at the low end of the pro form That's not horrible and considering this macro environment. So if that deteriorated further, then that would give us pause.

Speaker 3

But as we sit here today And as we see the world, we're comfortable giving a range of 30% to 35%. If things deteriorate from here to the next quarter, then we'll let you know.

Speaker 1

Yes, Michael. The only thing I was just going to add to that is, if you look at our mature class of stores, our stores are 5 years or older. They're still doing $26,000,000 in sales and making $6,100,000 in 4 wall EBITDA. And if you look at our stores that are 10 years older, Some of our best class of stores, they're doing almost $28,600,000 in sales and $7,000,000 in 4 wall EBITDA. So this is a point in time.

Speaker 1

It's a rough point in time, arguably other than the housing recession in 2007 through 20 10. This is one of the worst ones. And so We're very confident that we're going to get well above a 25% cost of capital return on cost of capital long term as you think about These are obviously 15, 20 year investments. So as Tom said, we're going to watch it. We'll be close, but we feel good about

Speaker 8

My follow-up question is, it's really anyone's guess Right now, what the comps might be next year, but you have given us a rule of thumb that decremental margins Are around 35%. So if you lost $100,000,000 of sales, you'd lose $35,000,000 of profit. Are there any locations or Close to any locations where you're running into minimum staffing levels or other constraints such that if you count down next year at the same rate That you are this year, the decremental margins would be worse than your rule of thumb. And does it change at all if More of your comp decline next year is ticket driven rather than traffic driven?

Speaker 1

Yes. About 20 this is Trevor. About 20% of our stores, maybe just a nudge above that are on minimum hours today And our gross margin rate is higher now than it was then 2. So, yes, I think if things are not at our expectations or things are worse, I think it's likely you'd see that flow through rate be a little bit higher. I don't know if it gets to 40%, but I think that is a reasonable expectation.

Speaker 1

Hey, Michael, this

Speaker 2

is Brian. So that $0.10 per comp point, 35% flow through rate, that's usually against the plan, not necessarily year over year. To Trevor's point, we do expect modest improvement in gross margin, which will help offset some of that. So when you guys are thinking about your model and you're thinking about the comp, It's really a change in comp against the plan, not necessarily year over year because you always have step investments or you have changes that we can go in and do, but that gross margin is the lever that will help kind of offset some of that.

Speaker 1

I just want

Speaker 3

to make one comment on the store labor that we pay very close attention to our customer service And how they feel about their experience within our stores. And as we adjust ours, we're trying to do it where we can take tasks away from the store Or we can change the way we operate, bring things in during the day, do tasking during the day that we've historically done at night, so that we've got good presence on the floor. So As we adjust those hours, we're going to do certainly pay attention to customer experience because this is Trevor said, this is a moment in time We'll get through this and then when we come out on the other side, we don't want our brand damaged anyway.

Speaker 8

Thank you very much and good luck.

Speaker 2

Thanks, Michael.

Operator

Our next question is from the line of Chuck Grom with Gordon Haskett. Please proceed with your question.

Speaker 9

Hey, thanks. Thanks a lot. I'm curious what you're seeing from the competition over the past few months and maybe even in October, particularly independents. Is pricing still rational or have things started to change?

Speaker 3

I'll start and I'll let Ursan weigh in. I think from the big box perspectives, The big box are always they're always trying to improve, always trying to compete. I wouldn't say that it's Much different than it's historically been. So it's just some there are people there are certainly we have to pay attention to them. It's just Difficult with the square footage that they dedicate for them to compete with us.

Speaker 3

On the independents, yes, I think they're being more aggressive. They're desperate. This is a Tough market and by all indications, if we're struggling on the top line, they're struggling worse. So, yes, I think they're being a little bit more aggressive, but Them being aggressive doesn't really bother us because our spread against them is so significant that we still feel like we compete with them very well. I don't know, Ursan, if you're seeing anything No,

Speaker 6

that's absolutely right. I think the changes that we see are not irrational at all. And then also in some cases, when there is a promotional activity that we see, there is a We see there's definitely an interior quality of the product, not in comparison to what we do, but we're paying close attention to it, nothing irrational.

Speaker 2

Okay, great.

Speaker 9

And then just holistically, Tom, you talk about holding the 42% gross margin rate, but at one point would you sacrifice To invest in price and try to induce activity or do you feel like the price actions and price reduction efforts that you've made over the past year would tell you that Not that potentially wouldn't be successful. How are you thinking about that longer term?

Speaker 3

Yes. I would say we certainly have played around with price And multiple tests in multiple markets and we tend to price against ourselves. So our customer comes within the store and they're trading Down to something that we adjust price on. So the only place where we see good traction is in installation materials, which is what the pro buys often. We have been more aggressive on the pricing side on that.

Speaker 3

We'll continue to be aggressive there because we know that pros in the store every other week and we want to make sure that we're getting them taken care of. So in our ability to grow gross margin, we can still be aggressive within installation materials and be aggressive With price, because we're getting gross margin from 1st cost reduction, we're getting it from lower freight expense. Our better and best Penetration has really remained unchanged. It's still driving business. That's growing gross margin and innovation in Newnan.

Speaker 3

So this isn't a category where This is there's lack of traffic in the marketplace buying the category versus this is a pricing issue. So I feel very comfortable with where our pricing is at. We'll We continue to be aggressive with Installation Materials, but we'll drive gross margin improvement through our other levers.

Speaker 1

Okay. Thanks, Tom. Thanks, Doug.

Operator

Our next question is from the line of Seth Sigman with Barclays. Please proceed with your question.

Speaker 10

Hey, everyone. Thanks for taking the question. I wanted to follow-up on the slowing performance that you saw in the Q3 and then again into the Q4. What are you seeing in terms of mature stores versus newer stores? And Part of that is just context around how you have a lot of new stores that are supposed to come into the comp base here in the Q4.

Speaker 10

I think they were expected to contribute positively. So I'm curious whether that is part of what's changed here as well.

Speaker 2

Hey, this is Brian. So I'll kind of start and let Tom or Trevor jump in if we need to. I mean, look, it's it was kind of broad based across. We still were positive comps Glass of 22, so the new stores coming into the base were positive in Q3, albeit kind of low single digits where they were. It's our when you think about it, we comped to 9.3%, So keep that same kind of waterfall that's always there in that 3 to 4 point range.

Speaker 2

And so if you think about our most mature stores, they were comping down in that low double digit range. So that's kind of held true across the board. So it's again just we've seen it across. It's not that our most mature stores are deviating from that trend at all.

Speaker 10

Got it. Okay. And then just one follow-up question around the Q4 thinking about the margins here. Just trying to go through the math. I mean, you said gross margin should be similar, maybe up sequentially.

Speaker 10

I mean, does that imply more deleverage than you typically would see? I mean, is there any other reason why You would see that impact. Is that just weighted store openings in the Q4 or anything else that you would highlight there?

Speaker 2

Yes, this is Brian Hance. I'll jump in. So yes, I mean, look, it's all around the sales decline. So when comps go from 9.3 The down 12, your most mature stores are going to see a little bit more deleverage. That's really what's driving it.

Speaker 2

So you're right, we should be at, if not modestly above, sequentially in gross margin. So So we will delever a little bit more. That's kind of where Tom and Trevor alluded to is there are things we're going to action. It's just hard to change your business over 30 days. So we're taking a hard look at it.

Speaker 2

We're taking those actions Today in November and into December, but again, we're halfway through the quarter. So that's going to cause a little bit more deleverage, but again, we feel confident It's not the proxy for next year in each quarter.

Speaker 1

Just one other thing I would call out is we're opening 15 of our 30 plus stores and our new stores SG G and A is materially higher than our mature stores. So we're opening almost not quite half of our stores in 1 quarter and Q4 is a little bit lower volume on a relative basis Because of the holidays of Thanksgiving and Christmas, and so it's both what Brian is saying plus we have a disproportionate amount of new stores opening in Q4 this year even lower than last year.

Speaker 10

Got it. Okay. Thank you.

Operator

Our next question is from the line of Steve Forbes with Guggenheim. Please proceed with your question.

Speaker 11

Good evening, everyone. Tom, maybe just a follow-up on a comment you made about the new class stores performing at the low end of performance Or maybe for Brian as well. Can you guys just reframe the cost to build year 1 sales and EBITDA for us? And then comment on how the 2024 class of stores is currently being planned relative to those metrics given the 4Q to date earnings?

Speaker 1

Yes, this is Trevor. I'll jump in and Brian and Tom may as well. I mean, and we've said for years That we think new stores do somewhere between $14,000,000 to $16,000,000 in sales and around $3,000,000 in 4 wall EBITDA. We're probably going to be slightly below that $14,000,000 in sales. So there's obviously a little bit of profitability, but fortunately our gross margin rate has gone up.

Speaker 1

And so our profitability is not going to be down that much, because our gross margin rate is performing nicely. And so our overall profitability is not going to be that far off. I think today we're spending it depends on whether it's a build to suit or second use facility, but call it $10,000,000 ish in CapEx. We We don't have to spend much on working capital because of our days payable. We put inventory in the stores, but we have pretty long days payable.

Speaker 1

So it's not much above that $10,000,000 And our performance, we feel very confident again after opening 200 plus stores over the last 12 years we've been here, we're going to get above a 12% return on invested Capital when you measure it over a 20 year period of time. And we've done much better than that in most of our history, but there's been inflation and our sales were a little bit lower right now. So Hope that answers your question, but I think the sales will be lower than that $14,000,000 for a year or so, but the profitability will not be That much off the $3,000,000 because our

Speaker 2

gross margin rate is higher. And what we've seen historically for the stores that open a little bit below that pro form a, For them to get to that $28,000,000 to $30,000,000 obviously that's going to be a comp tailwind kind of just going to put wind in our sales throughout the next couple of years. You guys think about that too.

Speaker 11

And then just a quick follow-up on the pro. You mentioned comps for pro above DIY or where the company average. Any specificity there on how the pro comp is trending in the quarter?

Speaker 1

It was slightly negative.

Speaker 2

Thank you.

Operator

Thank you.

Speaker 1

It's closer to a mid single digit negative. I apologize, I was looking at Wrong number. Yes. Q3 from Q2, we did see a little

Speaker 2

bit more deceleration in our probe because it was down about I think we quoted it was down 1% In Q2 and in Q3, it's down roughly about 5.5%.

Operator

Thank you. Our next question is from the line of Jonathan Matuszewski with Jefferies. Please proceed with your question.

Speaker 9

Great. Thanks so much. One question with 2 parts. The first part is on 2024 units, so 2023 has been an odd year in terms of warehouse opening cadence. I think we have around half of them opening in 4Q.

Speaker 9

And I know it's early, but could you give us a ballpark view of The cadence for 2024 and how you're thinking about the split between new and existing, that's the first part.

Speaker 1

Yes, this is Trevor. Our cadence will be moderately better. We'll do more in the first half of the year, but we're still probably going to have A decent amount of stores to open in September December. So the cadence will be better. We'll give you more details on that in the February call as we finalize up those.

Speaker 1

But we still have have a little bit more in the back half of the year. What was the second part of the question?

Speaker 9

Yes, second part was on the comments about 2024 gross margin being up. And it sounds like supplier concessions may be a primary driver. Just curious whether we need To see flat behavior from the consumer in terms of mix, Basically, is gross margin expansion possible if we do see a potential trade down from better and best products?

Speaker 3

I still think so. We haven't seen that yet and we're in I feel like we're in the worst of it. And we still haven't seen the customer shift down to buying they're doing smaller projects, but they're not stepping into the opening price point, The good products are still buying more of the better and best. Those are continues to lead the way. So I and with all of the Strategic things that we're doing ourselves between innovation within the category, we'll bring that in to better margin rate Between designer influence on sales, you've got 935 designers in 200 stores.

Speaker 3

It's that and they're getting better and better. So their influence Gross margin selling more additional items to the project that come with higher margin, whether it's trims or drains or whatever. I think those things along with supplier concessions give us the ability even if the consumer were to trade, which I don't think would happen, This

Speaker 2

is Brian. So just don't forget to, as I mentioned in the previous remarks, we're on the weighted average cost. All the savings that still continued into this year from supply chain and product costs are going to work their way through into early next year as well. So it's not necessarily you need additional concessions next year to even see that kind of sequential step up a little bit.

Operator

Thank you. Our next question is from the line of Steven Sicone with Citi. Please proceed with your question.

Speaker 9

Yes, thanks for taking my question. I wanted to follow-up On that last point, so the fact that we've seen this better best side of the business still holding up well, are you concerned that flows into next year. I mean, do you think that we'll likely see trade down? And I guess, in that environment, how do you think about your competitive positioning?

Speaker 3

So as I've said for this call and a few calls, I don't see it changing. I think that When a consumer, when the end user elects to do a project in our category, I think the difference in buying to better invest isn't all that significant. If Think about if they're buying for a bathroom to step up to the better and best product isn't all that significant. So I think the difference is within the looks of the product, The size of the product, I just think I see consumers that elect to do that job to continue to buy the better and best stuff. It just looks that much better within the store.

Speaker 3

Doug, before Trevor goes, sorry, just the other thing I was just going to say is that from a competitive standpoint, that's the good thing for us because On the real better and better stuff, we're competing against the independents and no matter how irrational, if they get aggressive in their price, we're still going to be so much better The mode against them is just so wide. So I think the projects may continue the size of projects may continue to be a challenge Until this passes, but I don't think Better Investor is going to change significantly. So far it hasn't.

Operator

The next question is from the line of Seth Basham with Wedbush Securities. Please proceed with your question.

Speaker 8

Hi, this is Nathan Friedman on for Seth. Thanks for taking my question. Just wanted to ask about 2024. You mentioned the risk for potentially negative Based on the broader environment, can you help us understand how operating margins would look on low single digit comps even after all the cost cuts You are going to take?

Speaker 1

Yes. This is Kurt. I think we're just too early to talk about that. Yes, we're still We kind of gave some of the comments around sales and gross margin and stuff. But I mean, If comps are negative, I would expect our operating margins to be under pressure.

Operator

Thank you. Our next question is from the line of Keith Hughes with Truist Securities. Please proceed with your question.

Speaker 1

Thank you. I've A lot of talk in the industry on LVT and issues with importing. I just was that an issue for you in the quarter? And I noticed that the Laminate LVT category well underperformed the average sales, just generally where that product is going?

Speaker 3

It has nothing to do with in stock. I mean our in stock within the store and in that category is at all time highs. Our in stock is great. So, you want to talk about the capital?

Speaker 6

I mean, on the lemons and vinyl side, I think it could be related to those of the job sizes as well. The lemons vinyl mainly go to a bigger room, Especially the job sizes get smaller and laminate vinyl would be the immediate impact category compared to the others.

Speaker 2

Yes, that's exactly why you see tile increasing as a percentage as well, more bathrooms

Speaker 3

and other things like that.

Speaker 1

Just to put a bow on it, yes, we're doing a lot more smaller projects. We know that's going into In the bathroom, we usually do tile. So that's why the tile business one of the reasons the tile business is performing so much better than the laminate is you're much more likely to put

Operator

Our next question is from The line of Andrew Carter with Stifel. Please proceed with your question.

Speaker 9

Hey, thanks. Building upon that, you're not worried about out of stocks right now. I think your purchases You're down 8%. How much more could you continue with kind of negative purchases? And then kind of building on that for cash flow, are you still committed to the kind of 3 year CapEx targets you laid out at the Investor Day, therefore, big step up next year or does next year look kind of similar to this year in terms of CapEx?

Speaker 9

Thanks.

Speaker 1

Yes. The vast majority of our inventory is replenishment based. So we buy based on what we sell. And so I don't think there'll be any big changes. As we mentioned earlier, we made some aggressive moves late last year that are benefiting us on the inventory line.

Speaker 1

As As we get to the end of the year, I would expect our inventory levels to be down kind of in the mid single digit range is what we're thinking about And the second part of the question again?

Speaker 2

CapEx. Yes, so for next year, as we talk about it, just think about our the only thing that's going to cause a step up and if you remember from the Analyst Today is the 2 distribution centers that will have to come online. Right now, those are one is going to be late 'twenty four, early 'twenty five and the other one is going to be kind of more of middle of 2025. Those are the only two reasons that you would see a step investment next year. So you'll see a little bit towards the back half in capital expenditures just for that.

Operator

Our next question comes from the line of Greg Melich with Evercore ISI. Please proceed with your question.

Speaker 5

Thanks. I want to follow-up on the store openings into next year. You said that, given this is also an optionality, it makes a lot of sense, But there's still more front end loaded. Is that because there's a natural cadence of where you're already pregnant with a store and you're going to have to do it? And what is that lead time as you think about flexibility into the back half of next year and beyond?

Speaker 12

Repeat

Speaker 3

the question again. I want to make sure I understand it.

Speaker 5

Well, I just you were going to do 35 plus stores next year. Now it's 30 to 35. So I'm wondering, How if you decide to not open a store, how much in advance do you have to make that decision before the balls are rolling?

Speaker 3

Yes, like 9 months. And so we have the ability to still we're working on all of our sites for next year. We have optionality to do The 35 sites, we could push those sites into the following year if we had to towards the back. So we have optionality on On a good majority of the sites, but it takes 9 months to make that decision. Yes.

Speaker 2

So the ones that are opening earlier, obviously, they're under construction. We feel good about them. They're in great So those are the ones that you want to try to pull in as fast as you can, because again some sales are better, no sales are pushing them out.

Operator

Thank you. Our last question comes from Justin Kleber with Baird. Please proceed with your question.

Speaker 12

Hey, thanks. Good evening, everyone. Just wanted to follow-up on that new store performance question. My math would suggest your recent stores are annualizing at Maybe $10,000,000 or so in year 1. It sounds like you pushed back against that given your comments about the stores being at the low end of your pro form a.

Speaker 12

So just want to clarify Where do you think year 1 sales are going to land for recent stores? And then what type of AUV do you need in order to breakeven On a forward basis in year 1? Thank you.

Speaker 2

Yes. So I'll take the first part of that and then Sam and Trevor can jump in I want any clarity, right now we're looking at this year's class is probably going to average about 13% to 14%. So whenever we say kind of at or below That pro form a range. So I would say that this year's class is looking at 2013, which again we're still happy with and pleased with given the macro environment that they're opening in today. And then I would say from a breakeven standpoint, it really depends on location, depends on everything.

Speaker 2

And so because the cost structure amongst the class can be significantly different. So from a breakeven standpoint, we haven't really given that, but most of the time it's around $8,000,000 to $10,000,000 depending on where the location is From a breakeven standpoint, just given the cost structure.

Speaker 3

Okay. Well, we appreciate the questions and appreciate your interest. We look forward to updating you throughout the quarter and we'll talk to you on the next call. Thank you, everybody.

Speaker 9

Goodbye.

Operator

This will conclude today's conference. You may disconnect your lines at this time. Thank you for your participation.

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Earnings Conference Call
Floor & Decor Q3 2023
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