Floor & Decor Holdings Inc (FND) 2017 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen.

This is Floor & Decor's Second Quarter 2017 Earnings Call.

(Operator Instructions) 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 & Decor.

Thank you, Stephanie.

Good afternoon, everyone.

I'm 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 the 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 contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and are subject to risks and uncertainties.

Any statements that refers to expectations, projections, or other characterizations of future events, including financial projections or future market conditions, is a forward-looking statement.

The company's actual future results could differ materially from those expressed in such forward-looking statements for any reason, including those listed in its SEC filings.

Floor & Decor assumes no obligation to update any such forward-looking statements.

Please also note that past performance or market information is not a guarantee of future results.

During this conference call, the company 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 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, multichannel, 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 off the continued strength of the first half the year, we are raising sales and profit guidance for the rest of fiscal 2018 -- -- 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.

Our 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 few years is exciting.

And flooring isn't what it used to be 10 to 15 years ago or even 5 years ago.

Our merchants are doing a remarkable job finding the best products in the newest trends.

Our supply chain is getting inventory to our stores faster and at a lower cost, and our stores are merchandising and selling the product very well.

With 74 stores today and nationwide potential for 400, our growth opportunity is substantial, supporting our growth and our unit growth goals of approximately 20% for the next several years, with these openings balanced between new and existing markets.

We've now opened 5 of the planned 14 stores for 2017.

While still early, I'm excited about the performance of our class of 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, 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 per trend-driven shifts.

New SKUs at the higher end of the price quality spectrum in the decorative area as well as laminate performed very well.

As we look to the rest of 2017 and beyond, we remain 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 whitespace 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 plans.

As we have 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 4 years, with openings balanced across new and existing markets.

With the opening of our Paramus, New Jersey, location in late June, we now operate just 2 stores in the very attractive Northeast region.

And we're still very underpenetrated in California, where we only operate 8 stores.

We continue to see strong customer response to our new stores across both new and existing markets 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 comp lift provided by the maturation of our new stores, we are focused on driving continued comparable store sales increases through our brand-awareness-building campaigns, commitment to product innovation and newness, visual merchandising 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 speed to market and lower product costs.

Our localized merchandising investments have provided a more relevant and compelling assortment for our customers, and our investments in in-store design centers help deliver inspiration to our end users.

Our commitment to being a one-stop shop for the hard surface flooring needs of our customers, including the important Pro customer, is reflected in the investments we have 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 prepurchase behavior of customers shopping our categories, it's important that the web experience for our customers and potential customer effectively inspires, engages and educates 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 a 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 have noted, 90% of our web orders are picked up 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 accessories SKUs that may add to enhance their project.

Lastly, our fourth goal is 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 needs has been a key focus for us.

As a reminder, we estimate approximately 60% of our sales are influenced by a 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 on the marketing front to target this very attractive customer segment and build their awareness of Floor & Decor.

We know once they visit a store, our assortment, everyday low price points and service level drive very high conversion rates.

So we're focused on doing even better job of getting Pros into our stores for the first time.

Finally, I'd like to mention that annually, we measure our Pros customer satisfactions, and we're happy to see that our scores continued 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, merchandising, supply chain, stores and website, technology and talent.

It is this philosophy of consistent disciplined reinvestment that continues to help fuel our market share gains.

Most importantly, I would like to thank our 5,000 associates, who wake up and think about how they can serve their customers and each other better every day.

They are the real key to our long-term success.

I will now turn the call over to Trevor, our CFO and Head of Pro Services, to go over our financial results and guidance.

Trevor?

Thanks, Tom, and good afternoon, everyone.

I will begin my remarks with a 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, efficient operations, along with continued investment in our supply chain, marketing, connected customer Pro and store strategies led to the record results 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 the second quarter of fiscal 2016.

On our last day of the quarter, we opened our Paramus, New Jersey store, which was the only new store opened during this quarter.

Our new noncomparable stores, which we define as stores that have been open to the past years, 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 400 core over the next 15 years.

Our second quarter comparable store sales increased 14.7%, and, as Tom noted, this is on top of the 22.6% comparable store sales increase in the second quarter of fiscal 2016.

June 2017 was our 100th month of comparable store sales increases, we are in what would be our 9th conservative year 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, consistently introducing new trend-right products for every budget at low prices is why we've been able to drive sales increases through transactions for almost a decade now.

Now on to profitability.

Gross profit increased 29.7% to $142,200,000 in the second 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 costs.

Our product margins increased approximately 40 basis points due to lower capitalized supply-chain costs and a favorable shift in the product mix of product categories that carry higher gross margins.

The increase in product gross margins was partially offset by 30 basis points of higher distribution center costs due to the increased volumes of inventory to support our sales growth as well as costs 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 loss in settlement accrued in the second quarter 2016, and approximately $300,000 accrued in the second quarter of 2017 for our secondary offering that we completed in early July 2017, our operating expenses leveraged down by about 60 basis points to 31.3%.

All of our operating expenses came from our stores opened greater than 1 year and our store support centers leveraging cost on higher sales, somewhat offset by the 10 new stores 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 our older stores.

And since we added about 20% of new stores, this mitigate the large operating expense leverage we are getting from our older stores.

Our strong sales growth, modest gross margin expansion and expense leverage drove a 221% increase in operating income from the second quarter to $34,100,000 as compared to $10,600,000 in the second quarter of fiscal 2016.

Excluding the $14 million charge related to a litigation settlement last year and approximately $300,000 of cost associated with our July 2017 second effort offering this year, operating margin increased about 70 basis points to 10% for the second quarter.

Our reported tax rate for the second quarter was 19.3% compared to 37.4% in the second quarter of 2016.

This decrease in effective tax rate was primarily due to a $4,400,000 excess tax benefit related to the stock options exercised in the second quarter of 2017 in accordance with the new option accounting rules 2016 09.

And to a lesser extent, due to lower state income tax rate due to changes in our corporate structure.

We have adjusted this $4,400,000 excess tax benefit related to stock option exercises out of our calculation of adjusted earnings per share.

Before I discuss net income or guidance, please note that I will discuss both GAAP and non-GAAP measures.

As described in our earnings release, we believe our non-GAAP disclosure enabled investors to better understand our core business on a comparable IPO-adjusted basis between periods.

A reconciliation of these non-GAAP metrics and their most directly comparable GAAP financial measures can be found in our earnings release issued in connection with this call.

Adjusted net income and EPS, which includes a normalized tax rate, was $20,500,000 or $0.20 per adjusted diluted share as compared to $13,800,000 or $0.14 per adjusted diluted share in the second quarter of 2016.

This represents an increase in adjusted net income of $6,600,000 or 48%.

Adjusted EBITDA for the second quarter increased 36.5% to $43,700,000 compared to adjusted EBITDA of $32 million in the second quarter of fiscal 2016.

We ended the quarter with a $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 leverage ratio was 1.2x as we used approximately $192 million of net proceeds from our IPO to pay down our debt.

Our inventory balance at the end of second quarter was $367,500,000, up $68,600,000 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're planning to open 6 to 7 warehouse store openings this quarter and 3 of our 4 warehouse-format stores are opening in the fourth quarter -- sorry, versus 3 to 4 stores in fiscal 2017.

Net sales growth outlook is based on an assumed comparable increase in the range of 9% to 11%.

Excluding a $3.5 million contribution to legal settlement from one of our vendors recorded in the third quarter 2016, we are planning for our operating margin to be flat when compared to fiscal -- in the third quarter of 2017 to the same period last year.

There are too many reasons for this planned flat operating margin.

First, we are working on expanding our distribution centers by over 90% this year to 2.9 million square feet, and our distribution center calls 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 to approximately 110 store before having to open another distribution center.

We plan to open 6 to 7 new stores, secondly in the third quarter 2017 versus 4 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 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 annual, assumed diluted weighted-average share of 104.1 million.

We expect adjusted EBITDA for the third quarter of 2017 to be $33,800,000 to $36,500,000, 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, 318,000,000 to $1,331,000,000, an increase of 25% to 27% versus fiscal 2016.

Net sales growth outlook is based on 14 new warehouse store openings and an assumed comparable stores sale 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 capacity by over 90% with large distribution center relocations in Los Angeles and Savannah.

We continue to plan for a modest leverage of our operating expenses with continued reinvestment 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 103,100,000.

We expect fiscal 2017 adjusted EBITDA to be in the range of $143,100,000 to $147,500,000, 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 does not consider the impact of new stock-based compensation accounting standards 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 to the 14 planned 2017 stores as well as stores -- construction of stores that will open in early 2018.

$33 million to $35 million is earmarked for the 6 to 8 remodels and relocations of our 2 -- and 2 of our core distribution centers.

The remainder of our CapEx, approximately $14 million to $15 million, will be directed towards IT, infrastructure, e-commerce and store support center initiatives.

I would 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're making a strategic investment to prepare for a large Savannah and Miami distribution center relocations at the end of this year and to improve key in-stock positions.

For all the details related to the results and the guidance, please refer to our earnings release.

I think with that, operator we like to turn it over for Q&A portion of the call.

(Operator Instructions) I will take our first question from Michael Lasser with UBS.

If we look at your guidance for the upcoming quarter, the third quarter, at the high-end of the comp range, do we mark a substantial slowdown on virtually all the stacked measures?

Is there anything going on aside from your typical conservatism in how you look at the outlook?

No.

Business is performing -- the evidence in the second quarter, the business is performing well.

We took our guidance up.

As Trevor mentioned during the call, business is good, we're strong across all regions, but we just don't plan the business that way.

We try to keep our expenses in line.

And if we're fortunate enough to beat our comp guidance, you should expect this, as we've been saying, this to flow through incremental sales a profit of between 20% and 25%.

Michael, this is Trevor.

Just one thing -- Michael, this is Trevor.

One thing I would just add to that is not everybody knows us all that well because we are a fairly new public company.

What we have told people who may not heard from us in the past is we've tend to plan our business in net comps in the kind of high single-digit range for the foreseeable future and that allows us to make sure we keep our structures -- our cost structure in line as well as making sure prioritizes our investments.

So we just want to -- that's the 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 scrambled.

Our leverage at the end of the second quarter was 1.2x leverage.

So I just want to make sure that's clear for the record.

That's helpful.

My follow-up question is on this 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 you saw that good result across all the regions, but -- did the newest stores accelerate more than the older stores?

Are you still seeing the good comp contribution from the earliest stores that you opened?

We got better acceleration out of our newer stores, but all the genres 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 Crédit Suisse.

I want to just follow up on that last question about the acceleration in the second quarter.

Do you feel like -- I mean, it sounds like some of that is company-specific, but do you feel like the industry may have accelerated a bit too?

I'm just trying to assess the overall health of the category?

I think the health of the category is good.

I think, the -- -- as I had mentioned multiple times, I think, the continued innovation across all the categories we participate in has driven demand.

I think the tailwinds within the category have been pretty consistent.

Certainly, they were going to the second quarter.

I think we're in a healthy space.

I wish I could say there's one thing that's driven our comp store sales, but it's -- as I've said a multiple times, it's across everything that we do has improved a little bit.

So we think we are taking share at a pretty --- at a quicker rate, but I think the health of the category is good.

Michael, this is Trevor.

The only thing I would add to that is the overall metrics actually were,- slightly, I think, stronger in the first quarter relative housing turnover, household appreciation and things like that.

So --- but not materially 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 points and maybe how receptive the consumer has been to that?

Yes.

So I would 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 they had planned to do.

So they do may another room.

They may do a little bit bigger of a project buy a little bit better of a project.

I can't say there's anything specific.

I can look at and say look the consumer is automatically spending more this year or not.

I just think that for us, it's been pretty consistent.

The second thing I would say on -- to the second part of your question, we're doing very well with the higher-end products that we brought in.

We've gone across the decor department.

We've gone -- in the decor department, we've added a lot of waterjet mosaics that are doing well.

In the laminate department, we've continued to expand our AquaGuard category.

That's a higher price point laminate that's done well.

You see our larger profile tiles, which are a little bit higher ticket, we see them doing very well.

So the customer -- the consumer is certainly willing to step up.

We've been pleasantly surprised on our higher-end products, that originally we thought just some of our stores will select and we had more and more stores that want to dabble in that and they've all done very well in it.

So I feel good as the customer's willing to step up within site of Floor & Decor, but the only -- the thing I just would revert -- one thing I would go back to, if you look at how our comp store sales were made up, it was really driven by transaction.

Again, our average ticket has stayed flattish.

We got little bit better during this quarter, but it's generally stayed flattish.

So whether or not, the customers gone to step up much-bigger projects, I don't know, but feel good about what's going on here.

And the next question is from Matt McClintock from Barclays.

So a couple of 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 on in that store within that month to when you opened Wayne, New Jersey?

Any meaningful difference to call out there?

I -- look, we're pleased with both.

The Wayne was first store.

No one knew who we were, but even though it's close miles wise, it's a completely different customer base.

So a lot of people didn't know who we are in Paramus.

We're thrilled with what's happened.

On the night before we opened the store, we had as many people as we did the night before we opened Wayne.

The store has been -- is off to a terrific start.

We're really pleased with what's going on.

We're 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 of.

And as we open more stores in better locations, we're just excited about what they can contribute.

So we're really pleased.

Okay.

And then if I could actually ask a question to Lisa, I was just from a merchandising perspective, high level.

When you identify a trend and are able to go after that trend and get that product to a store in a quick and speedy manner, how long do you -- do you typically wait or how long before you see or typically see a competitive response from either some of your larger competitors or maybe some of the smaller competitors?

Sure, no problem.

It's an interesting question because there is not just one answer to that.

It totally depends on the category and the trend.

In a category like AquaGuard, which is our water resistant laminate program, where we brought that program in first.

We didn't see a 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, and everybody is listening to the similar vendors.

And so there are other trends there where time line is much more similar.

So it's hard to give you an exact answer, but certainly for us, we are trying to push the envelope and develop those trends and create things that others haven't thought of yet as often as we can.

And we'll take our next question from Seth Basham with Wedbush Securities.

My question is on the Pro.

If you could give us a sense of how strong Pro comps were relative to the DIY comps much difference in the quarter?

Unfortunately, we don't measure our Pro comps versus our Do-It-Yourself comps.

So I would -- I'd say it's strong, right?

So 60% of our business is generated either by the professional or someone the professional is working with.

And so we feel -- when you are comping like this, we feel all customer segments are doing pretty well.

Understandably.

As we think about some of the marketing efforts you have towards the Pro and some of the new credit offerings for the Pro, can you give us a sense what you're learning from those early on?

Trevor talked a little bit about some of our credit offerings.

Do you want talk about them first?

Yes.

I think -- like Tom said, earlier with our overall 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.

It's whether it's technology to get them in and out faster.

It's a more clear designation of where our Pros can shop.

Lisa's 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 going very fast for our big customers that don't pay with credit card or more on terms.

Elevated products across the board; having SKUs that are hard to find; the most important thing is really having that in-stock quantity that really none of our competitors have.

So I think much like overall business, you can't just say our Pro business has grown because of this one thing.

It has to do with probably a dozen to maybe as many as 20 different attributes that we've invested in over the last 2 to 3 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 from a marketing, we don't really do all that much different.

I mean, we are a -- we spend very little on marketing, as you guys are aware.

As a total company right around 3% and our existing stores less than 2. The marketing that we get -- -- we do towards our Pro customers is really belly-to-belly.

It's kind of we have Pro guys that are on the street, trying to introduce our concept to consumers and buy them into the store.

We do lots of vendor events where we have vendors in the store and we bring our Pros in and we try to train the Pros so that they can take on bigger projects.

I would say that our events that we're doing, which are focused on building relationships with our Pros.

And again, we vision them as partners.

We don't install in Floor & Decor.

We don't compete with our professional customers.

So we look at it little bit differently, but the attendance of those events that we do on the stores has grown significantly in the last few years.

For a new store, we just get -- we get 4 times the amount of people that we used to get for a new store, and for our existing stores, I mean, we're getting double or triple the amount of people that we usually get at those events.

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 Rifkin with BTIG.

Tom, as you see each of the successive vintages are getting better and better and more productive, I was wondering if you can maybe shed a little bit of color as to what you think is behind that?

Do you think you're seeing greater initial awareness out of the customer?

Or do you think you're begin better real estate or there other variables that may be contributing?

And then I have a follow-up, please.

Yes.

I think -- look, we're 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 store easier.

We don't like real congested areas because as a professional, time is money for the professional, so we try to be thoughtful there.

But I -- look, some of the -- some of our best stores are in really bad sites.

So we're fortunate that it doesn't matter.

I think the classes -- as I've said on a bunch of times, it's not one thing.

I mean, we've taken our older stores and we've invested in our older stores.

We've improved 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's just investment that's been made across everything that we do, which has helped all of the stores get better.

I think the other interesting thing for us is, in our existing markets where our older stores are, we've opened stores in those markets.

And as we've opened stores in those markets, it's kind of reintroduced the brand to customers who may not have experienced this.

So the more stores we've opened in this older markets the better the older stores do because raising the awareness of the -- of our brand in the market.

Okay.

And as we're getting closer to the expansion of the Savannah DC, which I believe is in Q4, could you just maybe share with us, what did you learn from the LA expansion?

How much risk is there really involved in extending this DC?

And what should we look for as you expand the DC in terms of knowing whether it came off without a hitch or not?

No hitch, and we're getting very good at moving DCs.

We've moved multiple times during the -- close to 10 times we've moved DCs in time that I've been here.

Just because of our rapid sales growth, we've had to get more square footage quickly and we've scrambled, but our -- we have a excellent supply chain team with very experienced leadership and associates.

And honestly, it's seamless.

We know how to get the inventory into the stores ahead of the move.

And we're down for a short period of time, we know how to execute that very well.

So no issue.

We're good at it and I'm not worried about it when we do it in Savannah.

Okay.

So for the past 10 times that you've moved the DC, did you see any temporary sales slowdown for the stores that are supported by that respective DC?

As Trevor mentioned earlier, we're in our 9th consecutive year double-digit comps.

And since I've been here, we've averaged over 15% comps and the DCs are moved there.

So all around, no.

Yes, Alan, this is Trevor.

I was just going to say one thing.

This is Trevor.

If anything, the Savannah DC will be a slight amount easier because when we moved the L.A. DC, we're going from the port all the way to the Inland Empire, which is a fairly long distance and difficult.

Whereas, in Savannah, we're actually much closer to the existing DC, not so much a larger DC.

We're going to a fairly big DC.

But we feel fairly good about it.

Brian, who runs our supply chain, and I talked about it today and feeling pretty good both 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 Zach Fadem with Wells Fargo.

I'd like to follow up on the mature 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 or 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 3 years.

Something like that.

So we've -- we have a disciplined approach on how many stores we can remodel during the course of the year.

This year, we're doing...

7.

7 stores this year.

We've got in the plans next year...

7.

About 7. So we're not done.

We still want to bring all of our stores -- I mean, all the stores are better because we've invested into pieces and components, but we still have some stores that we need to bring to all the way up to new-store standards.

So -- and the lift we get out of them, we get great return on investment as we improve the store and create more inspiration in the store and make the store more productive in the way the 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've got to invest back in.

So we'll -- we're nowhere near where we need to be.

We're not satisfied with our -- as good as we can get.

I think we can 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 a very small part of the equation today, but when thinking about long-term opportunities, how should we consider in the size and growth of that market relative to your retail business?

Yes, I'll let Trevor -- -- Trevor is responsible for commercial, so I'll let him tackle that one.

Yes.

So we started that business essentially at the end of last year.

And this year, it will do a nice contribution for us.

It's really immaterial in the grand scheme of $1.3 billion in sales.

We do think that business will grow at a nice clip.

For the next 4 to 5 years, we're investing fairly 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% divorced from the retail business, although we -- on the backs of the supply chain and the merchandising team.

I think that's really about 3 to 4 years from now is where we think that will start to be meaningful and we'll have more conversation about that.

But I will say the early reads as that team has gone to a lot of conferences, we are talking to large institutional buyers of flooring, that they're very intrigued.

And they like what we're doing.

And essentially, when we were founded 16 years ago, when we kind of democratized and took cost out of the business and offered high-quality flooring at the lowest cost possible, those commercial guys are very interested in the same thing.

And it just takes time to get those relationships.

And even if we had a big book of business, right, those buildings have to get built over the next 12 to 18 months and so it's a much longer-term business.

So short answer is we're pleased with that business.

So we'll have a small contribution to sales and profitability this year.

It will continue to grow at a faster rate than the retail business because it's on a small base over the next 3 to 5 years.

But really it probably doesn't get meaningful to the overall sales and profitability of the business for at least a couple of years.

We'll take our next question from Peter Keith with Piper Jaffray.

I wanted to explore little bit on the competitive dynamics.

So what's interesting to me is that both the Home Depot and Lowe's have been advertising national TV commercials on the hard surface flooring space this last month.

This is probably the first time that I can see that from both of them.

Are you seeing any changes in the stores?

I guess, maybe people asking about the product or the products that they are advertising driving interest or maybe more price awareness?

So just curious on how that might be having any impact, if any.

So I'll give you my point of view and maybe Lisa can hop in after.

So I think that when the big boxes advertise a category, it brings awareness to the category.

And I do think in this category, people shop around.

And so we have stores near stores and they create inspiration, a customer is going to look at multiple places.

So for us, it creates a little demand.

It's -- if it gets someone on the job for a flooring project and we get him into our store, we feel like we've got pretty good ability to convert them.

So it doesn't bother me.

We've seen no real impact from that.

If anything.

Like I said, it could create demand and be helping.

So -- and beyond that, is there anything you want to add to?

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've done in the past.

Yes.

I think -- and, Peter, I've said this before -- look, we've got a ton of respect for everyone that we compete with.

And we have -- we try to learn what everyone does right and what everyone -- when people are always doing something different every quarter.

Different competitors can do something different and we react to it when it makes sense and we learn from it when it makes sense.

At the end of the day, we feel like our models are a little bit different, a little bit unique, and our total value proposition's just better than lot 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, specifically the countertops and the frameless shower doors.

Could you frame up maybe how many stores those categories are offered in at this point?

Sure.

Frameless showers doors are running over half our stores.

They continue to rollout and counters -- slab countertops are in about 20% of our stores -- about 20% of our stores and that will -- we will continue to roll that out in a few more stores as the year goes on well.

Pleased with both.

Customer reception's been good.

We're continuing to learn so that we can execute better and at a higher level, but so far, we're pleased with the progress.

It's not meaningful.

It's not an impact, not to our comps.

It's not something that's not that big yet, but we think it's, just like the commercial business, we, as a company, we think about planting seeds for the future and how we get better in the out years.

We'll take our next question from Matt Fassler with Goldman Sachs.

I just want to dig a bit deeper into some of the moving pieces in Q3.and just try to size some of the bulges that you think are going to hold back the EBIT margin relative to trend particularly given that the sales remain quite strong.

And then Q4 looks, it like the implied margin guidance is kind of come back to the prior cadence.

So if you could just go into to a little bit more detail about how to compartmentalize and break out -- I think you've talked about the DCs -- and anything else that might hold back incremental margins on the third quarter?

Sure.

Trevor?

Matt, this is Trevor.

So we're -- 2 or 3 things I would call out.

As I mentioned, the DCs, we're having a very large expansion in those DC expenses relative to taken on over 90% more square footage costs.

And so that from our estimate is some portion of $1 million that's affecting the quarter.

As we mentioned, we think we can leverage up to about 110 stores.

So it's a just step investment that we got to make.

As we mentioned, we're going to open 6 to 7 stores.

Our new stores are not nearly as profitable.

And in the first few months of operation, they actually could be a drag on earnings.

And so because we're having so many new stores if we open 7 stores, just to pick a number, for next quarter versus the 4 stores, that store startup cost, which would be the costs incurred before the store opens, that's $1.7 million.

Those are the 2 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 a lot of those stores right out of the gates were strong, well ahead of our expectations.

I mean, we're just not planning our new stores to perform like that this year right out of the gate.

It could happen and there is some upside if that does happen.

And that number is probably a low-7-figure number as well.

So those are the main things, I would say.

And if you kind of backed out those for the fact that we're really increasing our distribution center square footage and the fact that we're going from opening 4 stores last year to 6 to 7 stores this year, our profits would be growing at a faster rate (inaudible) than our operating margin is -- -- would as well.

Got it.

And just to be clear, the line items that those impact, presumably the preopening weighs a bit in -- weighs on SG&A.

But net out the DC cost.

Would that go into gross margin or cost of goods?

Yes.

That's gross margin.

Okay.

And all of these sound like they fade as drags pretty immediately, so that in Q4 there should be very little kind of a residual impact from them, yes?

For that, but I think in Q4, we're actually planning on our operating margins being slightly lower in Q4 this year.

And really for the same reasons, but even one more so, the distribution center expenses, because we're actually opening that distortion center in Q4 and we're doing get a lot of relocation, it takes a lot of trucks to move all that inventory from one distortion center to the other distribution center.

We’re expecting some portion of $2 million of incremental cost in the DC relative to the same time last year.

Again, that also flows through our gross margin, so we'll have some pressure on our gross margin as we're taking on additional $2 million cost.

Our store startup costs because we're opening 3 to 4 stores this year versus only opening 2 stores last year, some portion of $1 million.

And again, just it's the minor of the 2 in the fourth quarter, is the fact that those new stores last year were just so strong.

We think the stores -- the new stores will be strong this year, but we're just not going to plan at the same level last year.

And so that new-store profitability relative to last year will weigh on our profitability a little bit as well.

So that's a lot to throw at you.

I'm happy to go back over that quickly but those are really the key things.

I won't do that to the people on the phone, but I appreciate the color.

Congratulations on the terrific quarter.

Just probably to be helpful too, one more thing I would add is -- to that, as Tom mentioned, we've been fairly good over my 6 years here and, certainly, this year has been a fantastic year, is if we're fortunate enough to be on top line, we think we'll flow that through in the mid-20% range.

So we're focused on keeping the accelerator down and continuing to drive the business forward.

And our final question comes from Joe Feldman with Telsey Advisory Group.

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 asked about the Home Depot and Lowe's, but is there anything in particular that you see any variance?

Is that our comps actually lower in those markets where there is a little more competition?

Or do you still kind of comp at the same rate, where regardless when you own on the market yourself?

We, looks like, with this type of sales performance, we are strong everywhere.

As I mentioned earlier, our -- we think we got a unique value proposition that's different than anyone else you sell.

The more you learn about our concept, I mean, we're in all hard surface categories, not just 1 or 2. We have everything in stock, not just 6 or 8 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 a long way around, of -- with this type of comp performance that we were -- have been delivering, we're able to compete and be able to do well no matter where our stores sit and no matter who sits near us.

And then one follow-up on the online side of the business.

So I know that -- as you mentioned, you -- 90% of the orders are picked up at store, which makes sense to me having been through the experience myself.

That being said, a lot of other big-ticket categories, especially big, bulky item categories, appliances, furniture, you name it, people are pretty comfortable having that delivered.

And obviously, those other industries get away with delivery fees for that.

I'm curious as to why you think may be tile could be a little bit different?

I would think once I've made my choice and may be go do store to select some of the items, but not everybody has, I don't know, a minivan or a truck or some form of delivery to get it to their house.

And is that something we should worry about down the road or how to think about that, how you might charge for the delivery down the road?

We deliver today.

So if customer wants to order online and they want -- they elect to get it delivered, we certainly offer that service.

And we can get in and we do that in some cases.

My theory on why the customers come back to the store a lot of the times is it's a complicated purchase.

You need to get all of the accessories that are going to go along with the tile or hard surface flooring purchase efforts complicated to do.

And sometimes, it you don't 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 it's 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's dye lot issues and colors can change in tile.

If it's a natural product, you want to make sure the sample that you got looks like the tiles that you're getting.

Sot there's just a lot of reasons why customers come back to the store.

And the last thing I would say why they would come to a store too, I mean, it's hard to shop online.

There's just not a lot of brands in the category, which is much more on the shopping side, but once they elect to make a purchase online, that's why we think they are coming back.

Okay.

Thank you.

Look, we appreciate everyone joining us on the call and your interest in the company.

We'll talk to you next quarter.

And this concludes today's call.

We appreciate your participation.

You may now disconnect.