Floor & Decor Holdings Inc

NYSE:FND

Earnings Call Transcript 2018-Q2

[Operator]

Good morning, ladies and gentlemen. This is Floor & Decor's Second Quarter 2018 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded today, Thursday, August 2, 2018.

I will now like to turn the call over to Matthew McConnell, Manager of Investor Relations at Floor & Decor. Please go ahead.

[Matthew Mcconnell, executive]

Thank you. Good morning, everyone. Joining me on our call today are Tom Taylor, Chief Executive Officer; and Trevor Lang, Executive Vice President and Chief Financial Officer. Also in the room is Lisa Laube, Executive Vice President and Chief Merchandising Officer, who will join us for the Q&A session.

Before we get started, I would like to remind you of the company's safe harbor language. Comments made during this conference call and webcast contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and are subject to risks and uncertainties. Any statement that refers to expectations, projections or other characterizations of future events, including financial projections or future market conditions, is a forward-looking statement. The company's actual future results could differ materially from those expressed in such forward-looking statements for any reasons, including those listed in 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 may discuss non-GAAP financial measures as defined by SEC Regulation G. 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, ir.flooranddecor.com.

A recorded replay of this call, together with related materials, will be available on our Investor Relations website, ir.flooranddecor.com.

Now let me turn the call over to Tom.

[Thomas Taylor, executive]

Thank you, Matt, and thank you to everyone joining our call. We are pleased with the performance of our business in the second quarter as we generated comparable same-store sales growth of. 11.4% and total sales growth of 26%. For 9.5 years, our same-store sales growth has been above 10%, demonstrating the strength of our business model over a long time. The investments we have made in our stores, a broad trend-right assortment of good better and best in-stock inventory, combined with a unique low-cost direct sourcing supply chain that allows us to offer everyday low prices has consistently worked. Over the last several years, we have focused on improving our assortment, technology investments, including a connected customer experience, materially enhancing our supply chain and increasing regional leadership to support our decentralized service-oriented culture. We opened our 90th store today in Port St. Lucie, Florida, and I feel fantastic about our historical performance and even better about our future whitespace opportunity as we continue our path to 400 stores in the U.S. Our success is a direct result of the terrific team and their hard work.

Now turning to our second quarter results. Total sales increased 26% to $434 million. Comparable store sales increased by 11.4%, driven primarily by transaction growth of 12%. And our adjusted diluted earnings per share increased 35% to $0.27. With the exception of stone, all of our categories had positive comps with laminate, luxury vinyl plank, decorative accessories and installation materials comping above the company average. As expected, we saw an estimated 280 basis points comp benefit due to demand from Hurricane Harvey, which moderated from last quarter's estimated 400 basis points tailwind. Excluding the comparable stores impacted by Hurricane Harvey, second quarter comps increased by 8.6%. We opened 4 new stores during the quarter, ending with a total of 88 stores at the end of June, and we remain on pace to grow our store footprint by 20% in 2018.

Now let me briefly highlight recent accomplishments and outline our key strategic priorities for 2018. As a reminder, our priorities are new store growth, increasing comparable store sales growth, expanding the connected customer experience and continuing to invest in the Pro customer. First, new store growth. The 4 new stores opened in the quarter are off to a very good start, including our first store in Seattle, 1 of the 3 densely populated new markets we are entering this year. We plan on opening 7 new stores in the third quarter, several of them in new markets, including Boston, a second store in Seattle, Oklahoma City, Indianapolis and Albuquerque. For the year, we plan to open a slightly higher mix of new stores in new markets.

Our class of 2016 and projected 2017 new stores first year sales and 4-wall EBITDA has improved substantially from previous years and is above our pro forma expectations. To better illustrate this, our class of 2015 new stores saw first year sales of approximately $10.4 million and 4-wall EBITDA of $800,000. While our class of 2016 new stores saw first year sales of approximately $12.7 million and 4-wall EBITDA of $1.9 million, shortening the payback period to 1.7 years from 2.4 years. Not all of our 2017 new stores have hit their 1-year anniversary yet, but it appears they will do even better than the class of 2016, our best new store class performance ever. While it is still very early, the class of new stores have opened in 2018 are performing very well. As we continue opening new stores and increasing the awareness of the Floor & Decor brand, we believe there is a significant opportunity to gain market share and continue generating great returns. It is worth noting that as our new store sales performed 20% to 30% higher in their first year compared to prior vintages, this affects our comparable store sales growth.

Second, increasing comparable store sales. A distinct advantage at Floor & Decor is our product dominance centered around low-cost enabled by direct sourcing, innovation, trend-right products and in-stock job lock quantities. These advantages are enabled by the significant investments we have made in our global supply chain and distribution centers, which we continue to invest and build upon. We are getting better at finding and bringing new products to the market even faster. We believe our free design consultation services are unique to the industry. Our stores are staffed with a team of designers that help our customers create a unique project. And we have given our stores technology tools to enable them to better serve customers, including online scheduling, design tools and tablets. Our average ticket and customer satisfaction is much higher when a designer is involved in a sale. And we believe we are in the early innings of more fully developing this strategy.

Third, expanding the connected customer experience. Our integrated connected customer strategy is working well as online sales continue to grow at a much faster rate than our total sales growth. Sales tendered through our website accounted for approximately 7% of total sales in the second quarter, about 200 basis points more than the second quarter last year. Regardless of how our customer shops, in-store or online, these investments are focused on providing a positive experience for both our consumers and our Pro customers. Our research tells us that if a customer is in the market to buy hard surface flooring and we can get them to visit a Floor & Decor, we convert them over 80% of the time. Our research also indicates approximately 70% of customers that ultimately buy from us visit our website during their research period. The majority of our customers prefer to pick up their website orders in our stores, which tells us having a physical presence to see, touch and learn more about our products is critical. As we expand our physical footprint, this will increase our digital reach, increasing an advantageous omnichannel cycle. We are upgrading our chat and call center services, all of which work to educate and inspire new and existing customers, prior to or after shopping in our stores. Consumers today want an integrated experience, and we will continue investing in and improving that experience. We believe these investments are working as we have consistently seen our website sales conversion rates increasing.

Fourth, continuing to invest in the Pro customer. Many of our Pro customers shop with us often, and their average spend is greater than that of a typical end user. They shop with us because we are a one-stop shop for everything they need, most importantly, in-stock job quantities of the best trend-right products and installation materials. We have invested in multiple solutions to help our Pros run their business -- businesses better, such as a dedicated in-store and web Pro services team, dedicated registers, a new Pro app that simplifies their business with us, CRM technology to manage our relationship, technology to get them in and out of our stores faster, delivery, a dedicated Pro phone line, enhanced credit solutions, free storage and many others. We're excited that by the end of the third quarter, we'll have our Pro Premier Loyalty Program rolled out into all of our stores. We believe this is one of the industry's best total loyalty solutions and should allow us to continue to see increases in comp sales. This does not happen overnight. It takes time to get adoption from the Pros, but we believe this will enhance and produce more loyalty. Keep in mind, less than half of our customers are likely to participate in this program as it is designed for our Pro customers.

In summary, it was another solid quarter, and we continue to make good progress against each of our strategic priorities by further improving our capabilities and customer value proposition.

Before turning the call over to Trevor, I want to acknowledge the revision we provided to our full year outlook. We complete a thorough forecast each quarter, and we felt it prudent to slightly adjust our guidance based on current trends and uncertainty due to lapping unprecedented hurricane impact on our stores last year. That said, we continue to believe the industry will grow in the mid-single digit growth rate and that our model will continue to outperform this growth rate over the long term as we continue to grow our store base by 20% per year and our comparable same-store sales. I believe we are well positioned to continue to take market share for the foreseeable future like we have done for a decade.

It is an exciting time here at Floor & Decor, and we feel really good about the culture and talent to drive our growth for years to come. I want to thank our associates for another strong quarter, and turn the call over to Trevor Lang, our CFO, and Head of Pro Services, to go over our financial results and guidance.

[Trevor Lang, executive]

Thanks, Tom, and good morning, everyone. I will review our second quarter 2018 results and then discuss our outlook for the third quarter and the remainder of fiscal 2018.

We delivered another strong quarter, further demonstrating that our differentiated business model is a competitive advantage that continues to resonate with both our Pro and DIY consumers. As Tom outlined, we believe the strategies we have been pursuing over the last 5 years are working well and are specially proud of our new store first year sales and profit performance.

Net sales in the second quarter of 2018 increased 26.2% to $434,300,000 from $344 million in the second quarter of 2017. We ended the quarter with 88 total warehouse format stores, an increase of 15 stores or 20.5% versus the end of the prior year period. Our second quarter comparable store sales increased 11.4%. Our comp was again driven by transaction growth, while our dollars per transaction declined slightly. Our comparable store sales, excluding the Houston market, which continues to benefit from post-Hurricane Harvey flooding-related building efforts, increased approximately 8.6%.

Now on to profitability. Gross profit increased 24.9% to $177,600,000 in the second quarter from $142,200,000 in the second quarter of fiscal 2017. Gross margin decreased approximately 40 basis points to 40.9% from 41.3% in the second quarter of fiscal 2017. This decrease in gross margin rate was primarily due to factors we outlined last quarter, higher domestic trucking, primarily due to higher fuel costs; and our Miami distribution center relocation; and product mix.

As a percentage of sales, total SG&A deleveraged approximately 90 basis points to 32.3% compared to the second quarter of 2017 due to new stores. Our total operating expenses deleveraged due to the preopening and operating expenses of opening 4 new stores in the second quarter of 2018 versus 1 new store in the second quarter of 2017. Our stores opened more than 2 years obtained approximately 100 basis points of leverage. In addition, as previously we discussed in the last 2 calls, we are opening in new, more densely populated markets that have higher preopening and operating cost. This also impacted our second quarter operating expenses, but we believe the long-term potential of these markets is worthy and making the investment worthwhile.

Operating income increased 9.2% during the second quarter to $37,200,000 as compared to $34,100,000 in the second quarter of fiscal 2017. Operating margin decreased 130 basis points to 8.6% versus the prior year period.

Our interest expense for the second quarter was $2,100,000 compared to $3,400,000 in the prior year period. The decrease in interest versus last year is primarily due to using the IPO proceeds from the second quarter of 2017 to pay down debt. Our reported provision for income taxes for the second quarter was a benefit of $4,700,000 compared to an expense of $4,900,000 in the second quarter of 2017. The decrease in our effective tax rate was primarily due to the recognition of excess tax benefits related to stock options exercised, as well as tax reform passed in December 2017. We have adjusted the stock option benefit out of our calculation of adjusted earnings in today's release.

Before I discuss net income and 2018 guidance, please note that I will discuss both GAAP and non-GAAP measures. As described in our earnings release, we believe our non-GAAP disclosures enable investors to better understand our core operating performance on a comparable basis between periods. A reconciliation of these non-GAAP metrics to their most directly comparable GAAP financial measures can be found in our earnings release issued in connection with this call.

Adjusted net income and adjusted diluted earnings per share were $28,400,000 or $0.27 per diluted share for the second quarter 2018 compared to $20,600,000 or $0.20 per diluted share in the second quarter of 2017. This represents an increase in adjusted net income of $7,800,000 or 37.7%. Adjusted EBITDA for the second quarter increased 16% to $50,700,000 compared to adjusted EBITDA of $43,700,000 in the second quarter of fiscal 2017.

We ended the quarter with $176,500,000 in cash and available liquidity under our revolving credit facility, and $164,400,000 of borrowings outstanding. Our inventory balance at the end of the second quarter was $432,400,000, up $4.5 million from the end of fiscal 2017 and up 17.7% versus the second quarter of 2017.

Now turning to our guidance. As you saw from our press release, given our performance for the first half of the year and our expectation for the remainder of 2018, we are revising our 2018 annual guidance range as a result of the following 3 factors: First, we expect our comparable store sales, excluding Houston, to be 9% to 10.5% range for the second half of 2018, reflecting recent trends in our business. Second, we have had some stores opening later than we'd original planned in the fourth quarter. And third and final, due to the reduction of sales expectations, combined with lower assumed product margins, primarily due to anticipated mix changes and domestic freight costs, we now expect gross margins to be down 50 to 60 basis points for the second half of the year.

As discussed in our first quarter call, we continue to expect an increase of over $10 million in store operating and preopening expenses for the year as a whole given our entry into new, more densely populated and expensive markets like Boston, Seattle and Long Island. As an example, we are planning on our fiscal 2018 preopening expenses to increase approximately 60%.

Taking these factors into account for the third quarter of fiscal 2018, we expect net sales to be in the range of $427 million to $433 million, an increase of 24% to 26% versus the third quarter of fiscal 2017. This growth outlook is based on comparable store sales increase in the 9.5% to 10.5% range. Our third quarter outlook assumes year-over-year operating margin decline of approximately 70 to 110 basis points, 60 to 80 basis points of this decline is due to lower expected gross margin in the third quarter, as I discussed on our last call, resulting from higher domestic trucking, primarily due to higher fuel cost and our Miami distribution center relocation and product mix, with the remaining decline due to our lower sales expectations and updated product margin forecast.

Adjusted diluted earnings per share for the third quarter of 2018 are expected to be in the range of $0.21 to $0.23, an increase of 24% to 35%. We are assuming 105,200,000 weighted average diluted shares outstanding for the third quarter of 2018. We expect adjusted EBITDA for the third quarter of 2018 to be $46 million to $48 million, an increase of 16% to 21% over the third quarter of fiscal 2017.

Based on current trends, our fourth quarter guidance assumes a low single-digit comparable store sales increase against the 24.4% Houston-driven fourth quarter 2017 comparable store sales increase. We have also reflected the later new store openings in our non-comp sales outlook. The lower expected fourth quarter sales, combined with slightly lower planned gross margin as well as the timing of store preopenings since the shifting into the fourth quarter, have all been factored into our outlook.

For the full year, we now expect sales to be $1,696,000,000 to $1,710,000,000 an increase of 23% to 24% versus fiscal 2017. This net sales growth outlook is based on 17 new warehouse store openings, or 20% new store growth, and an assumed comparable store sales increase of 9% to 10%. We now anticipate adjusted diluted earnings per share of $0.93 to $0.96, an increase of 35% to 39% over fiscal 2017. Diluted weighted average shares outstanding are estimated to be approximately 105,100,000 and our fiscal 2018 normalized effective tax rate is expected to be 23.4% for the remainder of the year. As a reminder, this guidance does not consider the tax benefit due to impact of stock option exercises that may occur in fiscal 2018 or other possible discrete tax adjustments. We expect fiscal 2018 adjusted EBITDA to be in the range of $189 million to $193 million, an increase of 19% to 22% over fiscal 2017.

I also want to note that we are also still evaluating opportunities as it relates to our planned 2019 store support center relocation and would call out any material related cost to the store support center relocation and our reconciliation of non-GAAP metrics in our quarterly earnings release, so that it would not be an impact on our adjusted earnings.

CapEx for the year is now expected to be in the range of $160 million to $167 million in total, with $99 million to $102 million of this capital budget being spent on 17 new store openings in 2018 as well as construction of stores opening in early 2019. $34 million to $36 million is earmarked for store remodels, including 1 relocation in our distribution centers. The remainder of our CapEx approximately $27 million to $29 million will be directed towards IT, e-commerce and other store support center initiatives.

Finally, I want to touch on the Chinese tariffs currently being proposed. Through the second quarter of 2018, we imported approximately 47% of our products from China. The situation is still fluid, and we continue to watch it closely as negotiations continue. We believe we have multiple avenues for addressing rising input cost, including raise retails; second, we can renegotiate cost with our vendors; and third, source from a different country. We have an experienced merchandising team and have great relationships around the world, and we are moving quickly to mitigate this potential cost increase as best possible. We have options, and we will update you on our next call as this plays out.

With that, operator, I think we'd like to turn it over to Q&A.

[Operator]

[Operator Instructions] Our first question comes from the line of Elizabeth Suzuki with Bank of America Merrill Lynch.

[Elizabeth Lane, analyst]

From a sales standpoint, were there any categories or [indiscernible] that underperformed relative to your expectation? Has -- or that have now started to slow more recently that resulted in the lower comp guidance?

[Thomas Taylor, executive]

From a category perspective and a geography perspective, everything slowed like consistently. There wasn't a -- it's not a particular category. Stone has been a category all year that's been a challenge, but more of that's a shift of people buying other hard surface [indiscernible] categories in the store. But I'd say that the trend is broad based.

[Elizabeth Lane, analyst]

Okay. And just then one quick one on the tariffs on imported goods from China. What percentage of your product [indiscernible] 47% in the first half that you import, but what percentage of those products are on the most recent list of proposed items for tariffs?

[Thomas Taylor, executive]

Almost all of them.

[Operator]

Our next question comes from the line of Michael Lasser with UBS.

[Michael Lasser, analyst]

Floor & Decor's success has not gone unnoticed by its competition, and we're starting to see some others emulate the attributes of your model that are so successful, such as Lumber Liquidators, holding more job lock quantities or Home Depot rearranging some of the vignettes associated with flooring. So do you think that part of the reason you're experiencing a bit of a slowdown is due to the competitive factors? Or is this just we're getting later in the cycle and flooring is -- demand for flooring overall is slowing a touch as a result?

[Thomas Taylor, executive]

Yes, Mike, look, I'll touch on a couple of thoughts. I mean, first, look, our total sales grew 26%. We are -- we comped over 11% for the quarter. If things do get harder, if you'd look at our comp -- and I'll get to the competition point in a second. But yes, the comps get harder. If you go back 5 years ago, the average mature Floor & Decor did $13 million. 10 years ago, it did $10 million. We've averaged over the last 5 years over 15% comps. Our average mature store to date is $20 million. It does get harder to lap those stores. And if you put that in combination with our new stores, over the last 3 years, each class of new store has gotten a little bit better. And as they enter the comp base, it's -- those volumes have increased, that gets a little bit harder to comp, too. So look, we've got a healthy business, 26% growth is terrific. And if you go look -- back over the last few years kind of what we've been doing and our comps are terrific. So I'm proud of what we've accomplished. The second thing, from a competitive standpoint, look, our competition -- as long as I've been here 6 years, the competition is always reacting, changing whether it's be the big boxes or the independents, this is a very fragmented market. And they're always changing and they're always getting better, at the end, that helps the consumer get a better value proposition. But when you look at Floor & Decor, we're changing, too. So it's not like the competitors aren't changing and we're not. In the first half of this year, we've added a Pro app, we've enhanced the pickup times at the back of our store, we've continued to add new products, so we're not seeing our hands. I think the competition is good. We have a lot of respect for the competition, we learn from the competition, but we change at the same pace.

[Michael Lasser, analyst]

Tom, it seems like you're suggesting maybe you're just getting closer to peak -- realistic ongoing volumes in some of your locations. Do you have an updated view on what a targeted sales per store number is for the long run? And my second part of that question is, have sales slowed faster than what you expected? Presumably, they have because you took down the guidance from where it was 90 days ago?

[Thomas Taylor, executive]

Look, it's -- there's a lot of uncertainty as we go into the back of the year. I'm confident in what we're doing, tremendous belief in the amount of stores that we can open. This is a whitespace story. The comps will get difficult. But look, we comped at over 11% in the quarter. Our total growth is 26%. So I feel good about the strategy we have in place.

[Operator]

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

[Zachary Fadem, analyst]

On the gross margin line, in terms of magnitude, could you help us bridge the gap between product margin mix and then the impact of higher freight and DC costs in the quarter? And on these items you mentioned product mix going forward, but what should we anticipate in terms of magnitude just for the second half of the year?

[Trevor Lang, executive]

This is Trevor. It's really -- when you look at the details, it's both. I don't think we can quantify it by one, because obviously, domestic transportation affects all of our categories. And the mix impact, we have a lot of benefits last years in all of our businesses. As you look at the strongest businesses we have this year with our laminate business and our LVP business, those -- some of those categories are lower margin. And because some of those categories also have things like underlayment included in them, it affects some of our installation accessories where we were not selling us much underlayment and stuff. So I think, we said for the back half of the year, we're planning on 40 to 60 basis points of slightly lower gross margin, and it's a combination of both.

[Zachary Fadem, analyst]

Got it. And could you talk a little more about the innovation in a category? How much has this been a benefit over the past couple quarters? And is there anything newer in the pipeline that you're excited about? And with respect to that, anything we should keep in mind just from a mix or margin perspective going forward?

[Thomas Taylor, executive]

Sure. This is Tom. I'll start, and then Lisa is here, I'll let her follow. I'll try not to take all of her points. But first, look, innovation across hard surface flooring has been a tremendous driver of certainly our performance over the last 5 years. And over the last -- we try to be first to market in innovation. So whether it'd be water-resistant products, whether it'd be fashion and whether it's inkjet tile, we always try to be kind of on the fashion forefront and on the durability forefront. They've been big drivers. We've had water-resistant products now for going on 3 years, and that product category has continued to expand and do very well, but we've had it for 3 years. So it's kind of like that store point that I made early, when you're lapping those numbers, it gets more -- a little bit more difficult because we're doing so much. But innovation we do a product line review across every department and every category frequently. So we're always bring in the newest, latest, greatest things. I'll let Lisa talk a little bit at the -- what else is coming on the horizon.

[Lisa Laube, executive]

I think the 2 biggest trends that we've been seeing, certainly durability is one, which is led by the water-resistant and waterproof, but there are other factors there as well. So we continue to try to find new durability stories for our customers, they appreciate that value. And then the other piece is just being really trend right better and best, we've talked about that before. And we still don't know how high is high there. The higher prices we bring in, we still have incredible values in all of that products, and our customers are really responding very positively. So I would say, both from a kind of trend perspective as well as a durability perspective, our merchants throughout there every day, working on developing new and exciting products.

[Operator]

Our next question comes from the line of Christopher Horvers with JPMorgan.

[Christopher Horvers, analyst]

So I was trying to dig into the sort of implied underlying x-hurricane rates. So do you expect to get the 250 basis points of hurricane headwinds back in the third quarter? And then in the fourth quarter, you had an 8-point benefit from Harvey. So what's sort of implication of what we have to give back there and what the underlying trend that the guidance reflects?

[Trevor Lang, executive]

Chris, this is Trevor. Let's talk about Q3 first, then we'll talk about Q4. So for Q3, if you just talk about the Houston Harvey hurricane, the impact is about flattish for the third quarter. We lost a bunch of sales in kind of early August and -- I'm sorry, late August and early September, but then the business got very strong in kind of mid-September on through the end of the fourth quarter. So just Houston alone is flattish. But you're right, there was Hurricane Irma as well as last year, and that really impacted our Florida stores, which is substantial portion of our sales. And so you're right, last year, we said it was some portion of 250 basis points. Our current expectation for the third quarter excluding Houston is that we're going to be in that kind of 9% to 10.5% range as we think about the third quarter. As you move on to the fourth quarter, you guys will recall we called out the benefit in Houston was over 100% comp individually, and you're right, it was an 800 basis point benefit the last year's fourth quarter. As we've modeled the fourth quarter this year, we currently think that will be a headwind of approximately 650 to 850 basis points as we think about the fourth quarter because we're obviously going up against a huge comp in that Houston market. For the year interestingly enough, when all of that shakes out, the 400 basis points in Q1, some portion of 300 or just under 300 basis points in Q2, flattish for Q3 and Q4, it work out to be kind of flattish for the year, and that's all reflected in our comps. So lot of confusion going on with the 2 different hurricanes in there. But if you just break out the back half of the year, if you just look at our back of the year expectations, that kind of 9% to 10.5% comp range is what to expect excluding the Houston stores.

[Christopher Horvers, analyst]

I got you. So it excludes -- so right, that fourth -- it looks like your -- yes, sort of 9-ish in terms of expectation. So the cadence of the year has decelerated. So you sort of hit a speak in terms of the underlying ex weather trend in the fourth quarter. And you back that out, it decelerated. And it looks like, based on what you just said, you're assuming sort of this 9-ish trends stays going forward, and you're sort of holding, actually slightly accelerating, on the stack basis. So can you talk about how the cadence has been over the first half of the year? I know you don't like to talk about when you see the decelerating trend, it's something that investors care about. And then secondarily, as you think about 2019, this 9- to 10-ish kind of growth in the back half, originally, you -- I think in the -- ahead of the IPO, you talked about 100 basis point decay rate in comp as you look out to -- by year. So do you still expect that to be the case?

[Trevor Lang, executive]

So just a quick reminder for last year. If you exclude the hurricanes last year, our comps have essentially accelerated throughout the year. We comped 12% in Q1 last year excluding -- there was obviously no hurricanes in, then we comped up close to 14% in Q2 and in the back of the year, excluding both the hurricanes, we comped up about 16%. So our business progressively got better each of the quarters last year, excluding the hurricanes. This year, as we're looking forward, yes, we're -- again, we're basically excluding hurricanes, we're assuming kind of 9% to 10.5% up against higher comps as we think about the last half of this year. Getting into '19, we're not ready to talk about the guidance yet, but we do believe that we can continue to grow our business at a higher rate than industry. Most of industry forecast we've seen do assume some moderation. You guys will remember, we've called out over the last 5 years, the industry has grown at some portion of 9% on average per year over the last 5 years. And most of the industry experts think that's going to be a more than mid-single-digit comp range. And that's obviously affecting, we think, current business as well as we look to the future. And so our model is predicated on a mid to upper-single-digit comp. Getting a slight amount of leverage out of gross margin. That would lead to some portion of hopefully 25% net income growth. We are working to that, we still believe that's true on average. There'll always be some noise in our numbers just because the timing of distribution center openings or new store openings, but over a longer-term basis, we're still committed to those goals and believe those goals are achievable that we've put out when we did the IPO.

[Thomas Taylor, executive]

Yes, I would -- just follow on, Chris, just echoing kind of what Trevor said. We believe in the strategies that we're doing. We're -- our new stores are performing terrific, it's a healthy business. I mean, we grew it 26% for the quarter. So we're comped, and we like what's going on with our new stores, we like the cadence of our new stores next year, we like the locations of our new stores next year. So we're excited about what that could bring.

[Christopher Horvers, analyst]

So I -- just want to try to pinpoint on the cadence question. So what you guided 11% to 13% at the start of the quarter. You ended with an 11.4%. So it would appear that there was a deceleration. So what gives you the confidence that things are stabilizing as implied into the back half outlook?

[Trevor Lang, executive]

So this is Trevor, again. So when we gave guidance, our April comps were in line with what we gave guidance at that time. We obviously knew what our results were at that point. So you're right, the back part, after the earnings release, is when our business slowed a bit. And it's been pretty consistent subsequent to that. And that's all reflected in the comp guidance that we've given. We're fortunate we still only have just over 80 stores. We have the ability to look at every store by month, by week and by through the rest of the year. Two things to call on. As you think about, you're right, we are expecting that, that comp gets a little bit better in Q3 and Q4, as we mentioned. We lost $7 million to $8 million in sales last year due to the 2 hurricanes. We're not expecting any hurricane loss, so we should have a bit of a pick up relative to where we were in Q3 and Q4. And then in Q3, and then as we get to Q4, again excluding the Houston business, we've got the most amount of new stores coming into the comp base than we've ever had, we've got 5 new stores coming in Q3, another 5 stores coming in Q4, and our new stores generally provide a comp base. So that's also why we feel a little bit better as we look into Q4 as well. So hopefully that helps explain why we would assume business -- comps, excluding Houston, are a little bit better as we get into Q3 and Q4.

[Operator]

Our next question comes from the line of Seth Sigman with Crédit Suisse.

[Seth Sigman, analyst]

Just a couple follow-up questions here. First, just in terms of the gross margin, for the quarter, actually came in a little bit better than what you laid out last quarter. Can you just give us a sense of what the delta was there? And then, you're suggesting more pressure in the third quarter and then in the back half overall. Can you just clarify, what is exactly changing? What's incremental in the back half versus what you just saw in the second quarter?

[Trevor Lang, executive]

Second quarter product margins came in a little bit better than we thought they would. So in the back half, it's very similar to what we talked about in the last earnings call, Trevor?

[Trevor Lang, executive]

Yes. We base things based on current trends. And when we look at that mix of what's selling as well as higher domestic transportation cost, we're seeing fuel cost go up, obviously, like a lot of other folks. And so as we see the current trends in the business, that's what's reflected in there. So hopefully that answers your question.

[Seth Sigman, analyst]

Okay. And then just a couple follow-up questions on the comps here. So when you look at the product category disclosure that you provide in the filings, it does suggest that there are some shifts happening here. It seems like the biggest deceleration this year has been in tile and then how you break out laminate and LVP categories. Just any more color on why that would be -- is that an industry or consumer trend? Or do you think the competitive offering in those categories specifically may be changing?

[Thomas Taylor, executive]

Seth, I mean, I addressed it a little bit earlier. Just a couple of points. One, we have had water-resistant products now, we're going into our third year of water-resistant products. They have expanded significantly. I mean, we start out with a handful of SKUs and laminate, and now it's turned to NuCore and DuraLux and more in AquaGuard. So as those have expanded, if you think about that category, that pools from tile. People were buying -- my opinion is that water-resistant category, you can use -- people were using tiles in their bathrooms and in their kitchens, and this category is made specifically so you can put it in [indiscernible]. So we're absolutely seeing a shift. They sell the -- our tile comps are still decent, they're still good. But you can clearly see customers are electing to put water-resistant categories into places in the home where they would have originally put tile. And that has a couple effects on us. So one is, we're fortunate we carry everything under one roof and we want to provide the customer what they need, so we can go from department to department and make those elections. But when they buy those categories, they saw it a little bit less per square foot, so the comps are little bit affected by that, there could be a little bit of drag on that. And then two, if they buy tile, everything that goes along with that tile project runs in a pretty decent margin rate, and you lose that particularly if they are electing to the vinyl SKUs. So we've seen great strength in those vinyl and laminate categories, and there's kind of a double effect, it affects our mix, so there's some margin pressure with that, and then it affects the total sales just because of -- it sells a little bit less foot.

[Seth Sigman, analyst]

And then on the other hand, you've seen a nice acceleration in decorative accessories and even more so in actual accessories and tools. Just any initiatives specifically targeted around those categories that you think that may be helping?

[Thomas Taylor, executive]

I think that our merchants continue to do an outstanding job of finding better and best products. If you walk the decor departments today, we've expanded and gone into much better products than we had 3 years ago, that's continued to evolve. Tile deco has been a huge success for us as well. And we put a lot of energy into that deco department. We reset it every year, and we're constantly bringing new stuff in. So the initiatives is really around newness, one, and then the second initiative is our designer initiative. We hired a design czar -- what is design czar, a head of design for our company about a year ago, and she's really getting traction within our stores. We're putting a real emphasis on our designer capabilities within that design center in the store. So that certainly is helping our deco business as well. On the installation accessory, it's the same -- a similar story. We've terrific merchant in there who's done a nice job of adding some additional categories and upgrading the categories we've had. Our Pro business is healthy. So that's also going to drive that section of the store as well. So I think our energy is around the Pro customer are helping that, and I think our energy is around the product that we're putting into the accessory -- the installation accessories probably helping it as well.

[Operator]

Our next question comes from the line of Matt Fassler with Goldman Sachs.

[Matthew Fassler, analyst]

My first question relates to working capital and specifically, to inventory, which came in a bit lower than we expected. You, obviously, talked about the sales trends over the course of the quarter. Presumably you may have moved it in that direction deliberately. Can you talk about the delta and inventory growth from Q1 to Q2? How much of that was pre-meditated? And kind of where that inventory sits mix-wise versus where you'd like it to be?

[Trevor Lang, executive]

Matt, this is Trevor. Feel great about our inventory position. We will always have some timing on, especially in the first half of the year, based on when Chinese New Year receipts hit. We knew we would have a big increase last year, we talked about that just based on the timing of when we land things relative to getting those into our stores and the product categories. But Lisa is here as well. Her team does a great job managing our inventory. And we feel good about the quality of our inventory and what we need for the rest of the year.

[Thomas Taylor, executive]

Yes, in-stock rates -- our in-stock rates are as high as they've been in 5 years.

[Matthew Fassler, analyst]

To the extent that you're up, I think 18% in total at quarter-end and on a per square foot basis, I haven't done the math, but it looks like you're probably down year-on-year. Is this sort of the bottom for the inventory cycle? Do you ramp on a square-foot basis from here? Is this a growth rate that you think can persist through year-end?

[Thomas Taylor, executive]

Yes, through the end of the year, our current expectation is that inventory, from a year-end specifically, but then our year-end inventory will grow to slightly low rate than sales is our current expectation.

[Matthew Fassler, analyst]

Okay. Understood. Secondly, I think you answered this when you spoke, just a moment ago, about the mix shift to LVP and water-proof technologies from ceramic and tile. But would that be where the contraction in ticket comes from? I think your ticket was up about 2% in Q1. I think that was slightly in Q2. Is that all about mix in your view?

[Trevor Lang, executive]

Yes. That's a fair assumption.

[Matthew Fassler, analyst]

And also, just trying to discern between essentially customer interest in the category, and what we could tie in to macro more broadly and some of the dynamics that you just discussed within the category which seems like they're quite important when you think about the mix shift, the fashion shift, if you will, within the business. What's your sense about the vitality of the flooring business if you take out the mix and margin dynamics associated with some of the fairly rapid changes in customer taste and product evolution?

[Thomas Taylor, executive]

I think product evolution continues to be good. I think that there is still a good amount of consumers who are just getting themselves aware about the new stuff that's coming to the marketplace over the course of time. The market, the compounded annual growth rate in the market over the last 5 years has been pretty robust, over 9%, I mean, so it's -- that's a very healthy market, that doesn't last forever. Our comps have been -- they average a lot more than -- our total growth averages about more than that, that doesn't last forever. So I still think that there's -- look, again, I've said it a couple of times, with good comps and 26% growth, there still a lot of energy around the category.

[Matthew Fassler, analyst]

And then finally, you spoke about different remedies in case, in the event that the tariff regime that's currently being discussed, goes through. One thing you spoke about was essentially moving production to other countries. How long does it take to do that in your category? Are we talking quarters? Are we talking years? And is the capacity -- is there capacity out there that could accommodate this relatively quickly?

[Thomas Taylor, executive]

Yes, I'll let Lisa touch on that, and I'll add in.

[Lisa Laube, executive]

Yes. We actually feel really good about -- we source today from about 20 countries in most of our categories, not all, but most of our categories are sourced in multiple countries. And so we think that we will be able to move things fairly easily. There's a couple of categories that can only be [indiscernible] we will find -- all of our competition will find the same issue. And in some of those cases, that's where the retail would be past along. But in some of our big categories, tile is, for instance, we actually source a lot of product out of the U.S., out of Spain, Italy, South America, Mexico. And so we have a lot of options, and those things can be moved fairly quickly.

[Thomas Taylor, executive]

Yes. And I would say a couple other things, Matt. This isn't new...

[Lisa Laube, executive]

Yes.

[Thomas Taylor, executive]

Whether it's been a border tax or a tariff, it's been talked about for a while. So it's -- we didn't have the first conversation about this a month ago. We've been talking about it for a while. I would also say that some of our better -- our bigger Chinese suppliers have made investments in rest of the world. So we're able to switch some production there, too. So it depends on the category to the rate of speed that we can do it, but it's certainly things that can happen and it's -- it is one of those uncertainties at the back half of the year that we're certainly paying attention to.

[Operator]

Our next question comes from the line of Seth Basham with Wedbush Securities.

[Seth Basham, analyst]

My first question is just around product margins. Q2, you mentioned that came in better than expected, and you are basing your guidance based on what's selling. Are we expecting a bigger shift away from the higher margin tile category in the second half to add the pressure on product margins in the second half that you guided to?

[Thomas Taylor, executive]

Yes, this is Trevor again. I mean, all those factors that we said based on the current trends of the business were factored in there, and that's part of the reason we took the margins down. Again, Q3 is fairly consistent with what we said last time. But as we looked at those trends for the fourth quarter, we are planning on fourth quarter being slightly below what we said last time. So again to summarize, it's based on current trends and the mix of what we're selling now versus what we were reselling for most of last year and into the first quarter of this year.

[Seth Basham, analyst]

Got it. That fourth quarter dynamics, do they relate to what you're selling in Houston and you're getting more margin there than you are anticipating going forward?

[Trevor Lang, executive]

No.

[Seth Basham, analyst]

No. Okay, great. And then the second question is just thinking about the sales outlook. You touched on this a bunch, but not taking anything away from your strong absolute and relative performance, but can you isolate what's leading to a lower comp growth outlook? Is it simply category growth slowing? Or do you think that there's something else that might be impacting your sales growth rate?

[Trevor Lang, executive]

I'd go back to what I said in the beginning. There's a lot of uncertainty in the back half of the year. There is -- our numbers have gotten significantly larger, right? So 5 years ago, those stores averaged $13 million, 10 years ago, they averaged $10 million, now they average $20 million. Those get harder. Our new store performance over the last 3 years is continuing to get better and better and better, and those stores -- having them comped at the historical rates that has happened gets harder. So -- but that is -- that's the reason for our reflection in our guidance.

[Seth Basham, analyst]

Got it. And my last question is thinking about some of the product category trends. You've spoken to your success with AquaGuard. I think you introduced the new HydroShield product not too long ago. Can you comment on how that's performing? And whether it's cannibalistic or not?

[Thomas Taylor, executive]

It's performing very well. It is meant to be an option for a customer to step up from vinyl and get a laminate product at a lesser price, and it's different than our -- the initial AquaGuard that we brought in, but it's performing well. We wanted to cannibalize off of regular laminate, and we want to customers to step up from vinyl categories and that's how it's behaving so far.

[Operator]

Our next question comes from the line of Peter Keith with Piper Jaffray.

[Peter Keith, analyst]

On this mix shift, and Trevor, [ yours ] Q4 maybe the mix is going to be a little bit different than you thought. I can understand, I think LVP is taking share. But that's not really a new dynamic. So I guess, I'm still unclear as to what's really changed from, I don't know, this year but even last year? And then is there something that's changing that, that may continue for a while?

[Trevor Lang, executive]

Peter, this is Trevor. When you looked at last year, we had most of our categories margins increasing as well as the favorable mix. So just like, for example, the tile business last year, not only was the tile business doing a better, but the margins were increasing within tile. And so we had both a mix benefit and from a macro perspective and a mix benefit in each of the departments themselves, and that's part of the reason we had higher gross margins when you fast-forward to what's going on this year, as we mentioned on the last call and again this call, is we are seeing higher domestic transportation costs, a big piece of that is because of the Miami move that we think we'll work through over time. But we're also seeing higher fuel costs, that's somewhat new news relative to what we have seen for last year and into the first quarter as well. And then where we are now too, if you look at the back of the year, the acceleration in tile and some of those businesses is not as strong as it was last year and then maybe within some of those categories again, the mix in there, we're not seeing the same higher margin categories growing at the rate they were in the past. So that's why we really tried to summarize it as the domestic transportation cost as well as the mix, both on a category level and then within the categories as well.

[Peter Keith, analyst]

Okay. And as the -- so it looks like it's mostly on the tile category in terms of mix and product. Are like-for-like margins holding in tile? Or is it -- it sounds like is it kind of a mix shift within that tile category that's changed?

[Trevor Lang, executive]

It's both on tile specifically as part of the Miami move because Miami is a huge seller of tiles. They sell a lot of tile and stone down there. And so there's a mix because of distribution center move. And then within -- if you look at other areas within tile as well, just what the customers are buying is not the same margin as we've seen in the past.

[Peter Keith, analyst]

Okay. Separate question, we know that waterproof is becoming increasingly important for the consumer. And we're seeing that, that now as all of your competition advertising waterproofed pretty aggressively. I will give you guys credit, you classify things as water-resistant, not waterproof, which is the more appropriate characterization. But do you feel that maybe that increased [indiscernible] of waterproof has maybe caused a little bleed out with competition here in the recent weeks to months?

[Thomas Taylor, executive]

No. I mean, I think that they're bringing awareness to the category, that can be a good thing because customers are going to shop at multiple places before they buy their flooring. So I think the more the consumer gets aware that the water-resistant exists that we'll likely to benefit from that.

[Lisa Laube, executive]

And I think that our associates, they well understand the characteristics of our product as well as that sold in other places, and they can easily articulate that to customers so that they understand that the quality differences are they are and it's simply what someone's choosing to call it does not necessarily may get better.

[Operator]

Our next question comes from the line of John Baugh with Stifel.

[John Baugh, analyst]

Just driving again at this mixed shift, which we all know about. But within all of your categories, are you seeing a degradation of product margin on a like-for-like basis? And if not, what categories are holding up or going up? Or are they all sort of shifting to a like-for-like, not to makeshift, some kind of lower product margin?

[Trevor Lang, executive]

This is Trevor, again. The domestic freight, obviously, affects all of our products, as we see higher fuel costs. And because the Eastern part of the country is the largest portion of our sales and a lot of those are impacted by that Miami distribution center move, that's affecting most of our categories because most of our inventory goes through our distribution centers. And then again -- so that's probably the largest portion of it. And just I'm saying it again, within categories, what people are buying tile and installation accessories, the mix within those categories is also what people are buying as a slightly lower margin as well. So that's why it's both a mix component as well as a domestic transportation component.

[John Baugh, analyst]

Okay. And then as we think about the ticket, which I think, you alluded to earlier, being down due to the mix shift. I assume we don't anticipate this mix shift changing in the next few quarters that will continue. So how do we think about the tick generally been up, and now it's down, influencing comp [indiscernible] 2, 3, 4 quarters?

[Trevor Lang, executive]

Yes, this is Trevor, again. The ticket is a very minor, and I think we disclosed the amount in our 10-Q. It's an incredibly minor. Most of it is traffic, therefore, driving transactions. We just have less traffic coming into the stores and therefore, less of transactions. The ticket component, as Tom mentioned, when you have some of the water-resistant categories, you can have a lower ticket because a lot of the products have underlayment and things like that included versus other products that didn't have that when you have add-on sales with that.

[Thomas Taylor, executive]

Yes, our ticket was flat for the quarter. I mean, it's not -- I mean, it's slightly down, but it's just -- it's a hair. Our comps are driven by transactions because we're taking share.

[John Baugh, analyst]

Great. And then my last question was SG&A. If I read it right in the Q, you breakout sort of the comp store SG&A and G&A component, and I believe compared to the first quarter, the quarter delevered on both. And is that just timing relating to store openings? Because in my mind, if we're talking comp store, that's excluded. But help me with the moving pieces within SG&A.

[Trevor Lang, executive]

Yes, you're right, John. You want to break those 2 apart. If you look at our existing stores, our comp stores, we're getting leverage in SG&A there, as you would expect on an 11.4% comp. But because we opened 4 new stores in the second quarter this year versus 1 new store, the overall SG&A is the highest when those new stores open. And so since we had 4x the number of new stores opened in the second quarter of this year relative to last year, those early months of higher SG&A impacted. And then the final thing, I'd mentioned, I said this in my prepared comments, is as we're entering these more densely populated markets, they have higher advertising, higher labor, higher occupancy costs and that's also a function of it as well.

[Operator]

Our next question comes from the line of Anthony Chukumba with Loop Capital Markets.

[Anthony Chukumba, analyst]

I guess, my first question is on the Pro customer. You mentioned that you -- that you have a new Pro app and the Pro customer loyalty program will be coming later this year. Just any -- wondering if there is any learnings that you had over the last several months from the Pro app and some -- from the other relatively new Pro initiatives?

[Thomas Taylor, executive]

So when we introduced our Pro app to some of our best Pro customers a while back, we want to ensure before we roll the app out across the country that it's been piloted that we get the feedback from our customers to understand what works, what doesn't work, what the customers are going to use and what they are not going to use. So we feel we've got a lot of learnings on what's important to them. Certainly, it helps keeps our Pros organized. They have the ability to look at their product purchases over real time to be able to go in and plan and see inventory across our stores. And then most importantly, to be able to communicate within our stores to get in and out of the back. To our Pros being able to pick up their product quickly behind the stores is very important, and we've made significant investments in that area of the store to speed them up and get them out. So we spend lots of time with them, with lots of focus groups and lots of discussion and feel like our app is on the right track, and we're rolling it out now across the country. Secondarily, the Pro Loyalty is something else. We piloted that for -- going back now, it's been over 18 months ago we started the pilot on that. Just doing the same thing, learning. Our loyalty program is a partnership program with our professional customers. It gives them the ability to access things that help their business as well as access and recognize them, let them access gifts and things like that for when they purchase more. We've learned what they like about it, what they don't like about it, and it's rolling out. So both of our programs we feel really good about and our -- we think our investments within the Pro customer continue to pay off.

[Anthony Chukumba, analyst]

Got it. That's helpful. And then just one last question. I mean, you mentioned that the overall category growth has sort of slowed from sort of high-single digit to kind of mid-single digit. I mean how much do you -- of that do you think is due to the slowing -- slowdown in the existing home sales?

[Trevor Lang, executive]

Yes, Anthony, this is Trevor. I mean, we've been very fortunate for most of the last 5 to 6 years, where most of the macro tailwinds were in our favor. We had low interest rates, housing turnover is getting better, household appreciation is getting better, and all of that led to an industry growth of some portion of 9% on average per year. We, as Americans, are only adding 1% new homes and -- less than 1% new homes, and the value of the homes is going up. So you're seeing headwind for the first time and turnover has not increased, I think, now for 3 or 4 months, it's actually declined. Interest rates are obviously going up. And some of the new tax laws are not as beneficial as they were in certain states. And so for the first time really, in most of our history for the last 6 or 7 years, we've got some headwinds in macroeconomics, and certainly, I think, that has some play on the overall macro home sector as well as the foreign sector.

[Thomas Taylor, executive]

I think that the thing with us is, our -- we will outperform the market, we have outperformed the market. We're still -- our awareness level is still not very high, people don't know who Floor & Decor is. The more stores we open, the more awareness will improve, the more will drive people into our stores, when we drive into our stores, we think we can convert them. So whatever the housing market dictates, we're in a good place because of how we're growing and people are finding us.

[Operator]

Our final question comes from the line of Jonathan Matuszewski with Jefferies.

[Jonathan Matuszewski, analyst]

First one is on new store economics. Obviously, they've continued to surpass prior vintages. What are some of the changes you're making that are positively influencing the initial performance here from a sales and profitability standpoint, just beyond greater brand awareness?

[Thomas Taylor, executive]

So I mean, we've learned a lot, right? So we ran app, opened over 20% units now for over 5 years, and as we've gotten better each year because we've learned. So I would say that the events surrounding our grand openings, the energy around our grassroots marketing, how we train the people within our stores, I certainly think, we're seeing tremendous benefit to getting customers familiar with our stores as they open. We -- and not most of that is belly-to-belly grassroots, and we just feel better than we've historically done. And we get on more people at those grand opening events than we've ever gotten in the past. Two, I would say that our locations are -- they've improved, we tried lots of things in the first couple of years is where we put the locations of our stores. And I think that we've done a better job of getting bigger stores, certainly the store size has increased a little bit, making them visible, finding the right locations, visible from the highway, easy access in and out of our Pros, I think that's helping the ramp of the store as well. And then we've learned a lot in the way we market in the stores as well. We've continued to evolve in a way we tell customers about our stores and get them in. So in fact, it's not really not one thing, we've learned a lot over the last 5 years and applying them all is helping our grand openings and our first year store sales to just be incredible versus what they historically were.

[Jonathan Matuszewski, analyst]

Great. That's helpful. And then just secondly, I believe the CRM software aimed at understanding the Pro a little bit better, I think that's targeted to be done in 3Q. But any early learnings there, any tweaks you're thinking of making in terms of targeting that Pro?

[Lisa Laube, executive]

I wouldn't say there is anything yet that we've really learned. We will have the technology done by probably end of third quarter, and fourth quarter, we'll really start to be able to analyze that data and see what it shows us. So we really -- we do look forward to being able to get that access to that information for all of our customers because we do believe that will help us to be more efficient and more effective with the marketing that we do.

[Thomas Taylor, executive]

Okay. Well, thank you. Listen, I appreciate everyone's interest in joining the call, and we'll talk to you next quarter. Thank you.

[Operator]

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