Matt McConnell - Manager, IR Tom Taylor - CEO Trevor Lang - EVP & CFO Lisa Laube - EVP & Chief Merchandising Officer.
Michael Lasser - UBS Seth Sigman - Credit Suisse Matt McClintock - Barclay's Sheth Bhushan - Wedbush Securities Alan Ruskin - BTIG Zack Standum - Wells Fargo Peter Keith - Piper Jaffray Matt Fassler - Goldman Sachs Joe Feldman - Telsey Advisory Group.
Good afternoon, ladies and gentlemen. This is Floor & Décor's Second Quarter 2017 Earnings Call. At this time, all participants are in a listen-only mode. As a reminder, this conference call is being recorded today, Thursday, July 27, 2017. I will now turn the call over to Matt McConnell, Manager of Investor Relations at Floor & Décor. .
Thank you, Stephanie. Good afternoon, everyone. I am Matt McConnell, Manager of Investor Relations. Joining me on the 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'd 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 statement for any reason including those listed in the SEC filings. Floor & Décor 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.
The reconciliation of each of these non-GAAP measures to the most directly comparable GAAP financial measure can be found in the company's 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..
Thank you, Matt. Good afternoon, everyone. And thanks for joining us today. We are very pleased to report a strong second quarter that once again demonstrates the positive response customers have to our highly differentiated, multi- channel, hard surface flooring and accessories business.
During the second quarter, we continue to elevate and improve all aspects of our business and customer experience. Based after continued strength of the first half of the year, we are very raising sales and profit guidance for the rest of fiscal 2017.
I'll begin today's call by discussing the highlights of our second quarter results and then update you on the progress we are making against our key growth initiatives.
Net sales in the second quarter increased 29.4% to $344 million from $266 million in the second quarter of fiscal 2016, or 14.7% second quarter comp comes on top of the 22.6% comp in the second quarter of 2016.
Diluted earnings per share increased 233% from the second quarter of 2016 to $0.20 and adjusted diluted earnings per share grew 42.9% to $0.20.
The acceleration of our business in the second quarter was not the result of just one thing, but we believe it was due to a number of our strategies working in concert, as well as continued industry tailwinds. The newness and innovation in hard surface flooring over the past year is exciting.
And flooring isn't what it used to be 10 to 15 years ago or even five years ago. Our merchants are doing a remarkable job finding the best products and newest trends. Our supply chain is getting inventory to our stores faster and at a lower cost, and our stores merchandizing and selling the product very well.
With 74 stores today, a nationwide potential for 400, our growth opportunity is substantial. Supporting our growth and unit growth goals of approximately 20% for the next several years. With these openings, balance between new and existing markets.
We now open five of the planned 14 stores for 2017 while still early I am excited about the performance of our class 17 stores. In addition to store growth, driving comparable store sales is a key growth initiative.
In the second quarter, our 14.7% comp was again primarily driven by increased transactions and all regions once again achieving positive comparable store sales increases.
We believe this illustrates how our broad, in-stock, locally assorted hard surface flooring assortment offered at everyday low prices is resonating with customers across new and existing markets. From a category perspective, laminate, decorative and installation accessories performed above the company comp average.
Tile, stone and wood performed below. Our broad and diverse mix of hard surface flooring across product categories provides us the flexibility to expand the contract product categories in response to innovation or trend driven shifts. New SKUs at the higher end of the price quality spectrum in a decorative area as well as laminate performed very well.
As we look to the rest of 2017 and beyond, we remained focused on building on our progress. Our growth strategy is centered around one, new store growth in new and existing markets. Two, increasing comparable store sales growth. Three, expanding the connected customer experience and four, continuing to invest in the pro customer.
First, new store growth. With a wide space opportunity across the country that we believe supports more than a five fold increase in our store base over the next 15 years. We are focused on disciplined execution of our store growth plan.
As we've shared previously, this plan is to grow our store count by approximately 20% a year over the next several years, consistent with our annual growth rate over the past four years with openings balance across new and existing markets.
With the opening of our Paramus New Jersey location in late June, we now operate just two stores in the very attractive northeast region. And we are still very under penetrated in California where we only operate eight stores.
We continue to see strong customer response to our new stores across both new and existing market alike, reinforcing our excitement around the growth potential of our very unique business.
Our second growth strategy is increasing comparable store sales in addition to the natural complete provided by the maturation of our new stores, we are focused on driving continued comparable store sales increase through our brand awareness building campaigns, commitment to product innovation and newness, visual merchandizing enhancements both in-store and online, as well as our strategies to drive further gains in our professional business.
Our years of supply chain investment have benefited our steeped market and lower product cost. Our localized merchandizing investment have provided a more relevant and compelling assortment for our customers and our investments in-store design centers helped deliver inspiration to our end users.
Our commitment to being one stop shop for the hard surface flooring needs of our customers including the important pro customer is reflected in the investments we've made in people, training, inventory, technology and our dedicated pro zones.
Our next goal is expanding the connected customer experience, given what we know about the pre purchase behavior of customer shopping our categories, it's important that the web experience for our customers and potential customer effectively inspires, engages and educate, while we simultaneously elevate the store experience through better training.
Our research indicates that approximately 70% of our in-store purchases have first been researched on flooranddecor.com, making a seamless omni channel connected customer experience is crucial component of our long-term growth strategy. We believe this strategy is working as our web sales continue to grow at a faster rate than total sales.
And in the second quarter, our web sales increased to 6% of our total sales versus 5% in the first quarter of 2017. As we've noted, 90% of our web orders are picked in the store due to the high cost of shipping and in some cases the customer's desire to see the product.
Getting the customers into our stores or back into our stores allows us to show them our full assortment of accessory SKUs that they may add to enhance the project. Lastly, our fourth goal is to continue to invest in the professional customer.
Given the high project frequency and the associated higher spending of the pro customer, effectively fulfilling their unique need has been a key focus for us. As a reminder, we estimate approximately 60% of our sales are influenced by our professional customer.
We have invested to build capabilities to further improve the service we provide to our professional customers from dedicated in-store resources, technology to make their purchase process more efficient, training to make them better at their jobs, free design storage services, delivery, different credit solutions and much more.
We are also doing more in the marketing front to target this very attractive customer segment and build their awareness of Floor & Décor. We know once they visit a store, our assortment, everyday low price points and service level drag very high conversion rates.
So we are focused on doing the even better job of getting pros into our stores for the first time. Finally, I'd like to mention that annually we measure our pro customer satisfaction. We are happy to see that our scores continue to increase once again in 2017. So in summary, we are very pleased with our performance this quarter.
And the progress we continue to make against each of our growth strategies. To ensure continued solid execution we remain disciplined and consistent with our investments into the business across marketing and merchandizing supply chain stores, website, technology and talent.
It is this philosophy of consistent disciplined reinvestment that continues to help fuel our market share gain. Most importantly, I'd like to thank our 5,000 associates who wake up and think about how they can serve their customers and each other better everyday. They are the real key to our long-term success.
I'll now turn the call over to Trevor, our CFO and Head of Pro Services to go over financial results and guidance.
Trevor?.
Thanks, Tom, and good afternoon, everyone. I will begin my remarks with the review of the second quarter 2017 results and then discuss our outlook for the third quarter and the remainder of fiscal year 2017.
Our focus on high quality, hard surface flooring at everyday low prices, great customer service by our associates, and efficient operation along with continued investment in our supply chain marketing connected customer Pro and show strategy the record sales for the second quarter and the first half of fiscal 2017.
Our net sales in the second quarter of fiscal 2017 were $344 million, up 29.4% from $266 million in the second quarter of 2016. We ended the second quarter with 73 total warehouse stores, an increase of 10 stores or 16% versus the 63 stores at the end of second quarter of fiscal 2016.
In our last EBIT quarter, we opened Paramus New Jersey stores which was the only new store opened during this quarter.
Our new non comparable stores which we define as stores that have been opened in the past year continued to deliver very strong performance across both new as well as existing markets reinforcing our confidence in 400 stores nationwide potential that we believe exist for Floor & Decor over the next 15 years.
Our second quarter comparable store sales increased 14.7% and as Tom noted this top of the 22.6% comparable store sales increase in the second quarter of fiscal 2016. June 2017 was our 100 month of comparable store sales increases. Year end would be our 9th consecutive year of double digit comparable store sales.
The strength of our comp was again broad based and driven primarily by transaction growth. We believe having high quality, hard surface flooring; consistent with introducing new trend wide products for every budget at low prices is why we've been able to drive sales increases to transactions for almost a decade now. On the profitability.
Gross profit increased 29.7% to a $142,200,000 in the first quarter from $109,700,000 in the second quarter of fiscal 2016. This increase was primarily result of the increased sales volume. Gross margin increased by approximately 10 basis points to 41.3% in the second quarter, as improved margin was largely offset by higher distribution cost.
Our product margins increased approximately 40 basis points due to lower capitalized supply chain cost and a parallel shift in the product mix of product categories that carry higher gross margin, increase in product gross margin was partially offset by 30 basis points of higher distribution center cost due to increased volumes of inventory to support our sales growth, as well as cost related to the ongoing process of expanding our distribution square footage by over 90% in fiscal 2017 to 2.9 million square feet.
As a percentage of sales, total operating expenses decreased about 580 basis points to 31.4% from 37.2% in the second quarter of 2016.
Excluding the $14 million lawsuit in settlement accrued in the second quarter of 2016, and approximately $0.3 million accrued in the second quarter of 2017 for our secondary offering that we completed in early July 2017, our operating expenses leveraged down about 60 basis points to 31.3%.
All of our operating expenses came from our stores opened greater that one year and our store supports in a leveraging cost on higher sales, somewhat offset by the 10 new stores we opened since the second quarter of 2016.
As a reminder, our new stores operating expenses generally run about 50% higher as a percentage of sales in their first year of operation than older stores. And since we added about 20% new stores which mitigate the large operating expense leverage we are getting from our older stores.
Our strong sales growth, modest growth margin expansion and expense leverage drove a 221% increase in operating income from the second quarter to $34.1 million as compared to $10.6 million in the second quarter of fiscal 2016.
Excluding the $14 million charge related to litigation settlement last year, and approximately $0.3 million of cost associated with our July 2017 seconding offering this year, operating margin increased about 70 basis points to 10% for the second quarter.
Our reported tax rate for the second quarter is 19.3% compared to 37.4% in the second quarter of 2016. This decrease in effective tax rate was primarily due to $4.4 million excess tax benefit related to the stock option exercise in the second quarter of 2017 and accordance with new option accounting rules ASU 2016-09.
And to a lesser extent due to a lower state income rate due to changes in our corporate structure. We have adjusted this $4.4 million excess tax benefit related to stock option exercise out of our calculation of adjusted earnings per share. Before I discuss net income or guidance, please note that I'll discuss both GAAP and non-GAAP measures.
As described in our earnings release, we believe our non-GAAP disclosure enables investors to better understand our core business on a comparable IPO adjusted basis between periods.
A reconciliation of these the non-GAAP metrics and their most directly comparable GAAP financial measure can be found in our earnings release issued in connection with this call.
Adjusted net income in EPS which includes a normalized tax rate was $20.5 million or $0.20 per adjusted diluted share, as compared to $13.8 million or $0.14 per adjusted diluted share in the second quarter of 2016. This represents an increase in adjusted net income of $6.6 million or 48%.
Adjusted EBITDA for the second quarter increased 36.5% to $43.7 million compared to adjusted EBITDA of $32 million in the second quarter of fiscal 2016. We ended the quarter with $156 million in cash and available liquidity under our revolving credit facility and $186 million outstanding on our borrowings.
As of the end of the second quarter, our leveraged ratio is 1.2x as we use approximately $192 million of net proceeds from our ITO to pay down our debt. Our inventory balance in the second quarter was $307.5 million up $68.6 million or 23% from the second quarter of fiscal 2016. Now turning to our third quarter and full year fiscal 2017 guidance.
For the third quarter fiscal 2017, net sales are expected to be in the range of approximately $331 million to $337 million, an increase of 22% to 24% versus the third quarter of fiscal 2016. Currently we are planning to open 6 to 7 warehouse store opening this quarter and three of our four warehouse format stores opening in the fourth quarter.
Sorry versus the four stores in fiscal 2017.
Net sales growth outlook is based on the same comparable store sale increase in the range of 9% to 11%, excluding $3.5 million contribution to legal settlement from one of our vendor's recorded in the third quarter of 2016, we are planning for operating margin to be flat when compared to fiscal -- in the third quarter of 2017 to the same period of last year.
There are two main reasons for this planned flat operating margin. First, we are working on expanding our distribution center by over 90% this year to 2.9 million square feet and our distribution center cost are increasing an estimated $1 million relative to the same time last year.
This distribution center expansion is an important step function investment and we believe this will allow us to get [Technical Difficulty] 110 stores or having to open another distribution center. We plan to open six to seven new stores secondly in the third quarter of 2017 versus four in the third quarter of 2016.
Our store start up cost which includes things like rent and advertising and labor that are incurred before the store opens are planned to increase by $1.7 million higher than the same period of last year.
GAAP diluted earnings per share for the third quarter of 2017 are expected to be in the range of $0.12 to $0.14 and adjusted EPS is also planned to be in the range of $0.12 to $0.14 based on an annual assumed diluted weighted average share of 104.1 million.
We expect adjusted EBITDA for the third quarter of 2017 to be $33.8 million to $36.5 million, an increase of 20% to 29% over the third quarter of fiscal 2016. For the full year 2017, net sales are expected to be in the range of $1,318 million to $1,331 million, an increase of 25% to 27% versus fiscal 2016.
Net sales growth outlook is based on 14 new warehouse store opening and an assumed comparable store sales increase of 10% to 12%. For the year, we continue to expect a slight improvement in our gross margin even while expanding our distribution center after over 90% with large distribution center relocations in Los Angeles and Savannah.
We continue to plan for our modest leverage of our operating expenses through the continued reinvest in the business and therefore modest improvement in our operating margin, as well as our EBITDA margin.
Diluted EPS for fiscal 2017 is expected to be $0.57 to $0.60 with an adjusted diluted EPS also being at $0.57 to $0.60, based on an adjusted diluted weighted average shares outstanding of 103.1 million. We expect fiscal 2017 adjusted EBITDA to be in the range of $143.1 million to $147.5 million, an increase of 32% to 36% over fiscal 2016.
We expect our tax rate to be approximately 37% for the remainder of 2017. As a reminder, this guidance is not consider the impact of new stock based compensation accounting standard that may occur after the second quarter of 2017. With respect to capital expenditures in fiscal 2017, we expect to spend about $100 million to $104 million.
As a reminder, we plan to devote about $53 million to $54 million of this capital budget of 14 plan 2017 stores, as well as towards construction of stores that will open in early 2018. $33 million to $35 million is earmarked for the six to eight remodels and relocations of our two -- and two of our core distribution centers.
Remaining of our CapEx approximately $14 million to $15 million will be directed towards IT infrastructure, eCommerce and store supports in our initiatives. I'd also like to mention again as I did last quarter that our year end 2017 inventories plan to grow somewhere between 30% to 35% over fiscal 2016.
We are making a strategic investment to prepare for our larger Savannah and mining distribution center relocations at the end of this year and to improve key infra acquisition. While we calculate our results and the guidance, please refer to our earnings release. I think with that, operator we'd like to turn it over to Q&A portion of the call..
[Operator Instructions] And we will take our first question from Michael Lasser with UBS. Please go ahead. Your line is open..
Good evening, guys. Thanks a lot for taking my question. If we look at our guidance for upcoming quarter, the third quarter at the high end of the comp range.
Do we mark a substantial slowdown on virtually all the stock measures? Is there anything going on aside from your typical conservatism and how you look at the outlook?.
No. Business is performing -- as evidenced in the second quarter, the business is performing well. We took our guidance up as you know as Trevor mentioned during the call, business is good, and we are stronger across all regions. But we just don't plan the business that way.
And we try to keep our expenses in line and if we are fortunate enough to beat our comp guidance you should expect us as we've been saying the flow through incremental sales a profit of between 20% and 25%. .
Michael, its Trevor. Just one thing, Michael it's Trevor, one thing I'd just add to that is not everybody knows all that well because very fairly new public company. What we told people who may have not heard this from us in the past is we tend to plan our business in that comps that kind of high single digit range for the foreseeable future.
And that allows us to make sure we keep our structures and our cost structure in line, as low as making sure it prioritizes our investments. So we just want to -- that's way we think about the future but as Tom mentioned the business continues to perform well and Q2 was frankly a great quarter.
One thing I did want to mention too, the operator let me know a part of my conversation was scramble. Our leveraged at the end of the second quarter was 1.2x leverage. So I just want to make sure that's clear for the record. .
Thank you. That's helpful. My follow up question is on the second quarter comp. As you reflect on it, it accelerated from the first quarter. Was that across all the vintages of stores? I know you said that you saw good results across all the region.
So did the new store accelerating more than the older stores? Are you still seeing the good comp contribution from the early stores that you opened?.
We got better acceleration out of our newer stores but all the general still performed well. So all age group of stores performed well but we did see more strength in the newer stores as they matured during the quarter. .
Our next question comes from Seth Sigman with Credit Suisse. Please go ahead. Your line is open..
Thanks a lot and congrats on the quarter guys. I just want to follow up on that last question about the acceleration in the second quarter. Do you feel like -- I mean it sound likes some of those company specific but you feel like the industry may have accelerated a bit too. We are just trying to assess the overall health of the category. .
I think the health of the category is good. I think as I mentioned multiple times I think the continued innovation across all the categories we participate and is driven demand, I think the tailwinds within the category have been pretty consistent. Certainly they were in going to the second quarter, I think we are in a healthy space.
I wish I could say look at this one thing that's driven our comp store sales. But it's -- as I've said multiple times, it's across everything that we do is improved a little bit. So we think we are taking shared a pretty in a quicker rate. But I think the health of the category is good. .
Michael, this is Trevor. The only I'd add to that is the overall metrics actually was slightly I think stronger in the first quarter relatively strong by housing turnover and household appreciation and things like that .So but not material different..
Are you seeing within your business any evidence that consumers are willing to take on bigger projects than perhaps in the past? And maybe in that context, can you also talk about some of your own efforts to expand your better and best product categories and price point and maybe how receptive the consumer has been to that? Thanks. .
Yes. So I'd say, look, we think we democratize the category. We do believe that when customers come in to our stores and see our value proposition, it's likely that they will do more than have plan to do. So they may do another room, they may do a little bit bigger of a project, to buy a little bit better project.
I can't say there is anything specific I can look at and say, look, I think the consumer is automatically spending more this year or not. I jus think that for us it's been pretty consistent. The second thing I'd say to the second part of your question, we are doing very well with the higher end products that we brought in.
We've gone across the deco department, we've gone with in the deco department we've added lot of water jet mosaic that are doing well. In the laminate department, we continue to expand our aquaguard category, that's a higher price point laminates that's done well. We see our larger profile tiles which are little bit higher ticket.
We see them doing very well. So the customer, the consumer is certainly going to step up. We've been pleasantly surprised on our higher end product. Originally we thought that some of our stores would select them. We had more and more stores that want to dab on that.
And they have all done very well and so I feel good that the customers willing to step up with inside Floor & Décor. The only thing I just would revert-- one thing I'd go back to, if you look at how our comp store sales are made up, it was really driven by transaction. Again, our average ticket had stayed flattish.
We got a little bit better during this quarter but it's generally stayed flattish. So whether or not the customer is going to step up for much bigger projects, I don't know but we feel good about what's going on here. .
And our next question is from Matt McClintock from Barclay's. Please go ahead. .
Hi, yes, good afternoon, everyone. So couple questions. The first one just is on Paramus; I know it's only been open for I guess less than a month now. But can you maybe compare and contrast the success or what's been going in that store within that month to when you open Wayne New Jersey? Any meaningful differences call out there..
Look, we are pleased with both. The Wayne was the first store, no one knows who we were but even though its close miles wise, it's completely different customer base. So lot people didn't know who we were in Paramus. We are thrilled with what happened on the night before we open the store. We had as many people as we did the night before we open Wayne.
The store has been off to a terrific start. We are really pleased with what's going on. We are excited about what's going to happen in the northeast for us. Paramus is a pretty congested area, route 17 is not easy to get in and off often as we open more stores in better locations we are just excited about what they can contribute.
So we are really pleased. .
Okay. And then if I could actually ask question to Lisa. Just from a merchandizing perspective, high level when you identify a trend and able to go after that trend and get that product to a store in a quick and speedy manner.
How long do you typically wait or how long did it take before you see or typically see a competitive response from either some of your larger competitors or maybe some of the smaller competitors. Thanks. .
Sure, no problem. It's an interesting question because there is not just one answer to that. It's totally depends on the category and the trend. And a category like aquaguard which is our water dis- laminate program where we brought that program in first. We didn't see our competitor bring that program in for about a year later.
So that was a pretty long exclusivity time period that we had on that product. There are other things that everyone is going to the same shows, that everybody is listening to similar vendors and so there are other trends there where the timeline is much more similar.
So it's hard to give you an exact answer but certainly for us, we are trying, pushing envelop and develop those trends and create things that other haven't got off yet as often is tempt..
And we'll take our next question from Sheth Bhushan from Wedbush Securities. Please go ahead. .
Thanks a lot and good afternoon.
My question on the Pro, if you could give us a sense how strong Pro comps was relative to the LI comp? Is there much difference in the quarter?.
Unfortunately we don't measure or pro comps versus our do your self comp so I would say its strong right. So 60% of our business is generated either by the professional or some other professional working with and so we feel -- when you are comping like this we feel all customer segments are doing pretty well. .
Yes, understandably.
As we think about some of the market efforts you have towards the Pro and some of your great offerings for Pro, can you give a sense for your learnings from those early on?.
Trevor talked a little bit about some of our credit offerings. You want to talk on that first. .
Yes. I think I can't say early results or comp I mean there is over a dozen attributes that we are providing to our Pros. Tom mentioned some of those in his prepared comments is whether it's technology to give them an out faster, it's more clear designation of where our Pros can shop.
Lisa team bringing in some super high quality installation accessories that make that Pros life easier for installing.
A dedicated sales team, we have put in some great new credit solutions that are growing very fast for our big customers but don't pay with credit card or more in terms and elevated talks across the board having SKUs that are hard to find, the most important thing is really having that in stock quantity that really non of our competitors have.
So I think much like our overall business, you can't just say our Pro business is growing because of this one thing. It has to do with probably dozen maybe as many as 20 different attributes that we've invested in over the last two or three years.
From technology to people to inventory to process to help and drive that Pro customer to spend more and more with us. .
Yes. I think we are marketing -- we don't really do all that but different I mean we are -- we spend very little on marketing as you guys are aware, it's total company or right around 3%, in our existing stores arre less than 2%. And the marketing that we get we do towards our Pro customer is really value to value.
It's kind of -- we have Pro guys that are on the street trying to introduce our concept to customers and invite them into store. We do lots of vendor events where we have vendors in the store and we bring our Pros and we try to train the Pros so they can take on bigger projects.
I'd say that our events that we are doing which are focused on building relationship with the Pros and again we vision them as partner. We don't install a floor under core; we don't compete with our professional customer so we look at it a little bit differently.
But the attendance of those events that we do on the store is growing significantly in the last few years. For a new store we get 4x the amount of people that we used to get for a new store. And for our existing stores, I mean we are getting double to triple the amount of people that we usually get at that event.
So that hand to hand going to find the customers is working very well for us. .
And we'll take our next question from Alan Ruskin with BTIG. Please go ahead..
Thank you very much. Tom, as you said each of your successive vintages is getting better and better and more productive.
I was wondering if you could may be shed a little bit of color as to what you think is behind that? Do you think you are seeing greater initial awareness out of the customer or do you think you are picking that a real estate or are there other variables that maybe contributing? Then I have a follow up please. .
Yes. I think look we are fortunate that our -- from a real estate perspective our sites can -- they can be in different areas. I mean where we are focused on trying to find locations where our customers can get in and get out of the stores easier.
We don't like real congested areas because of the professional and time is money, so professionals so we try to be thoughtful there. But, look, some of our best stores are really in bad site so we are fortunate that it doesn't matter. I think the classes as I have said Alan a bunch of time, I mean it's not one thing.
I mean we've taken our older stores and we've invested in our older stores. We improve training across all of our stores. We do market differently when we do market we go to market differently. We've improved our website. There is just investment that's been made across everything that we do which is help all of the stores get better.
I think the other interesting thing for us is in our existing markets where our older stores, we've opened stores in those markets. And as we open stores in those markets it's kind of reintroduced the brand the customers who may have not experienced.
So the more stores you open in this older market the better the older stores do because we are raising the awareness of our brand in the market. .
Okay. Thank you.
And as we are getting closer to the expansion of the Savannah DC which I believe is in Q4, could you maybe just share with us what did you learn from LA expansion? How much risk is they really involve in expanding the DC? And what should we look for as you expand the DC in terms of knowing whether it came without a hatch or not?.
No hatch and we are getting very good in moving DCs.
We move DCs multiple times during -- close to 10 times we move DCs in time that I have been here just because of our rapid sales growth we have to get more square footage quickly and we scramble but we have an excellent supply chain team with very experienced leadership and associates and honestly seamless.
We know how to get the inventory into the store ahead of the move and we are down for a short period of time when we know how to execute that very well. So no issue we get at it and not worried about when we do in Savannah. .
So for the past 10 time that you move the DC, did you see any temporary sales slowdown for the store that is supported by that respective DC?.
As Trevor mentioned earlier we are on 9th consecutive year double digit comps and since I have been here we've averaged over 15% comps and the DC is removed there. So long around no..
Yes. Alan this is Trevor. I was just going to say one thing, this is Trevor, when you think of Savannah DC it will be slight amount easier because when we move the LA DC we are going from support all the way to Inland Empire which is a fairly long distance and difficult where in Savannah we are actually more closer to existing DC.
Not so much larger DC, we are going to really big DC but we feel fairly good about Brian who runs our supply chain and I talked about it today and feeling pretty good about both the side, the Savannah DC which happens late this year as well as the Miami moving up to Savannah in early 2018..
We'll take our next question from [Zack Standum] with Wells Fargo. Please go ahead..
Hey, good evening. I like to follow up on the matured stores.
Is there any color you can provide on the number of remodels you've done for the older vintages? And what kind of impact our comp list could you call out there? And is there any opportunity here to upgrade some of the older fleet or is that pretty much exhausted for now?.
Not exhausted. We've done probably close to 12 remodels in the last three years. So we've a disciplined approach on how many stores we can remodel during the course of the year. This year we are doing seven stores this year. We have gotten the plans next year to do about seven. So we are not done. We still want to bring all of our stores.
I mean all of the store is better because we've invested into pieces and components but we still have stores that we need to bring to all the way up to new store standard.
So the lift we get out -- we get a return on that investment as we improve the store and create more inspiration in the store and make the store more productive the way product flows. We see a benefit there.
So we know in this category I think it's important to keep the stores inspirational and keeping the store inspirational means we got to invest back in. So we are no where near where we need to be. We are not satisfied with our -- as good as we can get. We think we get better. .
Great. And that’s helpful.
And I know a big picture Tom more longer term question but can you tell us a little bit more about how your commercial business is trending? I know it's very small part of the equation today but when thinking about the long-term opportunities, how should consider that the size and growth of that market relative to your retail business?.
Yes, I'll let Trevor -- Trevor is responsible for commercial so I let him tackle that one. .
Yes. So we started that business essentially at the end of the last year. And this year it will do a nice contribution for us. It's really immaterial in the grand thing of $1.3 billion sales. We do think that business will grow in a nice clip for the next four to five years.
We are investing clearly heavily in systems and in talent; it's completely different than the retail business. So I don't think it's going to be meaningful to overall sales or profitability.
It's completely incremental basically 100% diverse from the retail business although on the back of the supply chain in the merchandizing team, I think really that's really about three to four years from now when we think that will start to hopefully give more meaningful and we'll have more conversations about that.
But I'll say the early read as that team is gone to a lot of conferences, we are talking to these large institutions, buyers of flooring that they very intrigue and they like what we are doing and essentially when we were founded 16 years ago when we kind of democratize and so cocked out of the business and offer high quality flooring at the lowest cost possible.
Those commercial guys are very interested in the same thing. And it just take your time to get those relationships and even if we had a big book of business right those building trying get build over the next 12 to 18 months. So it's a much longer term business. Short answer is we are very pleased with that business.
We have a small contribution in sales and profitability this year. It will continue to grow on a faster rate than the retail business because it is on small base over the next three to five years. But really probably don't get meaningful to the overall sales and profitability the business released couple of years. .
Yes, I agree. .
We will take our next question from Peter Keith with Piper Jaffray. Please go ahead. .
Hey, good afternoon, guys. I wanted to explore a little bit on the competitive dynamic. So what's interesting to me is that both home people and those have been advertising national TV commercials on the hard surface flooring space this last month is probably the first time that I can see that both of them.
Are you seeing any changes in the stores I guess maybe people asking about the product or the product that they are advertising driving interest or maybe more price awareness? So just curious on how that might be having any impact if any?.
I give you my point of view and maybe that lead to happen after so I think when we Big Box's advertise the category it brings awareness to the category and I do think in this category people shop around. And so we have stores near their stores and they create inspiration like customer is going to look at multiple places for about a category.
So for us it creates a little demand. If we get someone in the job for a flooring project and we get him into our store, we feel like we got a pretty good ability to convert them. So it does about -- we've seen no real impact from that if anything.
Like I said if you create demand and it will be helping so beyond that, is there anything you want to add to that. .
No. We really -- I mean we have lots of great local and national competitors but I wouldn't say that we've seen anything very different than what they have done in the past. .
I think Peter I've said it before, look, we've got a ton of respect for everyone that we compete with and we try to learn what everyone does right and when everyone -- and people are always doing something different every quarter different competitors tend to do something different and we react to when it make sense and we learned from it when it make sense.
But the end of the day we feel like our models are little bit different, a little bit unique and our total value proposition is just better than what lot of others can offer. .
Okay, very good. And then on a separate topic, I wanted to ask about some of the adjacent categories that you've been testing.
So specifically the candle tops and frameless shower doors, could you frame up maybe how many stores those categories are offered in at this point?.
Sure. Frameless shower door is reining over half of our stores. They continue to rollout and -- slab counter tubs are in about 20% of our stores, it's about 20% of stores and that will continue to rollout too few more stores if the year goes on well. Pleased with both, customer reception been well.
We are continuing to learn so that we can execute better and at higher level. But so far we are pleased with the progress.
It's not meaningful -- it's not an impact, not to our comp, it's not helping -- it's not that big yet but we think is just like the commercial business we as a company we think about planting seeds for the future and we are going to get better in that year. .
We will take our next question from Matt Fassler with Goldman Sachs. Please go ahead..
Thanks a lot, good afternoon, everyone.
I just want to dig a bit deeper into some of the moving pieces in Q3 and just try to size some of the -- I think you are going to hold back the EBIT margin relative to trend particularly given that the sales remains a quite strong and then Q4 it looks like the implied market guidance kind of back to the prior cadence.
So if you just going to more a little detail about how to compartmentalize and breakout, I think you talked about the DCs anything else that my hold back incremental margins in the third quarter..
Sure, Trevor..
Matt, this is Trevor. So really two or three things I'll call out as I mentioned the DC, we are having very large expansion in those DC expense relative taken on over 90% more square footage cost. And so that from our estimate is some portion of $1 million that's affecting the quarter.
As we mentioned we think we get leveraged about to 110 stores so it's just step investment that we got to make. As we mentioned we are going to open 6 to 7 stores, our new stores are not nearly as profitable in the first two months of operation actually can be a drag on earnings.
So because we are having so many new stores if we open seven stores just to pick a number for next quarter versus the four stores, that store startup cost which is the cost incurred before the store opens, that's one $1.7 million. Those of the two I mentioned in my prepared comments.
And then to a lesser extent another important factor is as we mentioned before the class of 16 was an extremely strong class of stores, and lot of those store, lot of the gate were strong well ahead of our expectations. We are not just planning our new store to perform like that this year right out of the gate.
It could happen and there is some upside if that does happen then that number probably a low seven figures number as well. So those are the main things I'd say.
If you kind of backed out those for the fact they were really increasing our distribution center square footage and the fact they were going from opening four stores last year to 6 to 7 stores this year, our profits will be growing at a fast rate in sales and our operating margin would as well..
Got it. And just to be clear the line items that those impact presumably the pre opening ways to bid on, ways on SG&A you break that out.
Did you see cost --would that going to gross margin or cost to good?.
Yes. That's gross margin..
Okay. And all of these sound like they fade as drag pretty immediately so should that Q4 there should be very little kind of residual impact from it. .
For that but I think in Q4 we are actually planning on our operating margins being slightly lower in Q4 this year.
And really for the same reasons but even more so the distribution center expenses because we are actually opening that distribution center in Q4, and we are doing a lot of relocation, you take lot of trucks to move all of inventories from one distribution center to the other distribution center.
We are expecting some portion of $2 million of incremental cost in the DC relative to the same time last year. Again that all close to our gross margin so we'll have some pressure on our gross margin if we taken on additional $2 million cost.
Our store startup cost because we are opening 3 to 4 stores this year versus only opening two stores last year, some portion of $1 million and again it's a minor of the two in the fourth quarter is the fact that those new stores will -- last year it was so strong, we think the stores will be strong this year but we just not going to plan into the same level of last year and so that new store profitability relative to last year weigh on our profitability little bit as well.
So I know it's a lot of [pravhan], I am happy to go back over that quickly but those are the really key same things. .
I wont' do that to the people on the phone. But I appreciate the color, congratulation on the terrific quarter. Thank you. .
I think just probably just to be helpful too, just one more thing I'd add to that is that as Tom mentioned we've been fairly good over my six years here and certainly this year has been fantastic year. If we are fortunate enough to be on the top line we think we pull that through in the mid 20% range.
So we are focused on keeping the accelerated on and continue to drive business forward. .
And our final question comes from Joe Feldman with Telsey Advisory Group. Please go ahead..
Hi, guys. Good afternoon. Thanks for taking the question. Sorry just getting my act together here. I wanted to ask you about again on the competitive environment.
Are you seeing anything where you line up directly with the other tile competitor or I know people ask about home depot loans but is there anything in particular where you see any variance like is it our comps actually lower in those markets where there is little more competition or do you still kind of comp at the same rate where regardless when you own the market yourself.
.
We like with this type of sales performance we are strong everywhere. As I mentioned earlier, we think we got a unique value proposition that's different than anyone else we saw. The more you learn about our concept I mean we are in all hard surface categories not just one or two. We have everything in stock not just six or eight SKUs.
We have everything to complete the project which is just different than what everyone else does. We commit a lot more space than the home centers are able to commit. So we perform strong everywhere.
And so longer around with this type of comp performance that we were -- have been delivering we are able to compete and be able to do well no matter where our store sits and no matter who sits near us. .
Yes, thanks. And then one follows up on the online side of the business. So I know that -- as you mentioned your 90% of the orders are picked up at store which makes sense to me having been through the experience for myself.
That being said, a lot of other big ticket categories especially big bulky item categories, Time's furniture, you name it, people are pretty comfortable having that delivered and obviously those other industries get away with delivery fees for that. I am curious as to why you think maybe tile could be a little bit different.
I would think once I've made my choice and maybe I may even go to your store to select some of the items but not everybody has -- I don't know mini van or truck or some form of delivery to get it to there house.
And is that something that we should worry about down the road or how you would think about that and how you might charge for delivery down the road?.
We delivered today so if a customer wants to order online and they want it--they elect to get it delivered, we certainly offer that service and we can do that in some cases. By theory and why the customers come back to the store, lot of the time it is a complicated purchase.
You need to get all of the accessories that are going to along with the tile or hard surface flooring purchase and it's complicated to do. And sometimes you don't know everything you need so you want to engage with someone perhaps to do that.
It's also we believe a lot of times a customer even though they bought a sample, they may want to come back to the store and see it before they take it home because not a permanent purchase but it's close to a permanent purchase right. When you put tile down it's not easy to take up.
So there is dial lot issue and colors can change in tile and if it's a natural product you want to make sure that the sample that you got looks like the palette that you are getting. So there is just lot of reasons why we think customers come back to the store.
And there is -- the last thing I'd say why they would come to store too, it's hard to shop on my existing -- just not lot of brands in the category which is much more among the shopping side but once they elect to make a purchase online, that's why we think they are coming back. .
We appreciate everyone joining us on the call. And your interest in the company. We'll talk to you next quarter..
And that's concludes today's call. We appreciate your participation. You may now disconnect..