Good morning, ladies and gentlemen. This is Floor & Decor's first quarter 2018 earnings call. At this time, all participants are in a listen-only mode. As a reminder, this conference call is being recorded today, Thursday, May 3rd, 2018. I will now turn the call over to Matt McConnell, Manager of Investor Relations at Floor & Decor. Thank you. You may begin.
Thank you, Danielle. Good morning, everyone. I'm Matt McConnell, Manager of Investor Relations. Joining me on our call today are Tom Taylor, Chief Executive Officer, and Trevor Lang, Executive Vice President and Chief Financial Officer. Also in the room is Lisa Laube, Executive Vice President and Chief Merchandising Officer, who will join us for the Q&A session. Before we get started, I'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 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. Reconciliation of these non-GAAP measures to the most directly comparable GAAP financial measure can be found in the earnings press release, which is available on our investor relations website, ir.flooranddecor.com. A recorded replay of this call, together with related materials, will be available on our investor relations website, ir.flooranddecor.com. Let me turn the call over to Tom.
Thank you, Matt, and thank you to everyone for joining our call. Our first quarter results demonstrated the strength of our business model as we continue to gain market share and disrupt the residential hard surface flooring industry with our innovative, fashion-forward, and trend-right products. We have a tremendous opportunity this year as we'll be opening new stores in new densely populated markets in Boston, Long Island, and Seattle. I am confident in our strategy and the team we have in place to execute our initiatives. Our success is a credit to all of our associates, and we like to thank them for all of their hard work and dedication to our customers. Turning to our first quarter results. Total sales increased 31% to $403 million. Our comparable store sales increase of 15.6% was driven primarily by transaction growth of 13.4%.
Our adjusted diluted earnings per share doubled to $0.26. All categories had positive comps with laminate, luxury vinyl plank, and installation accessories comping above the company average. As expected, we saw an estimated 400 basis point comp benefit due to the demand from Hurricane Harvey, which moderated from last quarter's estimated 800 basis points tailwind. Excluding the comparable store sales impacted by Hurricane Harvey, our first quarter comps increased just over 11%. Our consistent comparable store sales growth over the last nine years has not come from one just initiative or strategy. There are many talented people and initiatives responsible for our growth, and we are constantly challenging ourselves to change, to evolve, and better serve our customers. The strength of our business reflects the fact that our differentiated concept is resonating as we continue to build brand awareness and gain market share.
Let me briefly outline our key strategic priorities and progress for 2018. As a reminder, our priorities are new store growth, increasing comparable store sales growth, expanding the connected customer experience, and continuing to invest in the pro customer. First, new store growth. In the first quarter, we opened one new store in St. Petersburg, Florida, for a total of 84 warehouse format stores. In the second quarter, we plan to open four new stores, including two new markets, Seattle and Virginia Beach, as well as opening new stores in the existing markets of Denver and Salt Lake City. We're looking forward to serving these communities as we continue expanding our store base and increasing awareness of the Floor & Decor brand. We have signed leases for all 17 new stores planned for 2018, and we're excited to be entering some of the best housing markets in the country.
Our improving new store economics gives us the confidence that this is the right time to enter these densely populated markets. We believe these stores will be more productive over time and a good return on investment. Our strong new store performance is evidenced in our class of 2017 stores, which is on track to exceed the record performance of our class of 2016 stores in both first-year sales and store operating profit, illustrating the great execution of our real estate and store operating teams. Second, increasing comparable store sales. A distinct advantage at Floor & Decor is our product dominance centered around innovation as well as our trend-right products, broad assortment, and in-stock job lot quantities across every hard surface flooring category we sell.
We continue investing to enhance our customer experience by focusing on our service, improve visual merchandising, both in-store and online, optimize marketing strategies, free design consultation, and new technology to further integrate our connected customer experience. Regardless of how a customer shops in-store or online, these investments are focused on providing a positive experience for both our consumers and our pro customers. As we continue opening new stores and increasing awareness of the Floor & Decor brand, we believe there is significant opportunity to gain market share. We remain confident we will grow faster than the market and capture market share in the residential hard surface flooring industry. Third, expanding the connected customer experience. Our integrated connected customer strategy is working well and gaining traction as our online sales continue to grow at a faster rate than our total sales growth.
Sales tendered through our website accounted for 6.5% of total sales in the first quarter. We have become even more convinced that our multi-channel strategy builds confidence in the buying process, that each channel builds on the other. The vast majority of our customers prefer to pick up their website orders in our store, which tells us having the physical presence to see, touch, and learn more about our products is very important. Our website chat services and call center serve as important education and research tools as well as a source of inspiration for new and existing customers, prior to and after shopping in store. Our research indicates that approximately 70% of customers that ultimately buy from us visit our website during their research period.
Our research also indicates that if a customer is in the market to buy hard surface flooring, we can get shoppers to visit a Floor & Decor store, we can convert them over 80% of the time. Given the reach of our site, it broadens the exposure of our brand by helping introduce new customers to Floor & Decor and offers existing customers the convenience of an additional channel. We are continuing to add content like how-to videos to help educate the do-it-yourself and pro customer. We also want to inspire and engage customers through vignettes, as well as interacting on popular social media sites. Consumers today want an integrated experience, we will continue investing and improving the integrated offering that we provide them. Fourth, continuing to invest in the pro customer. Many of our pro customers are in our stores every week.
Their average spend is greater than that of a typical end user, the pros are very important to us. We're working on many initiatives to better cater to this important repeat customer base. These initiatives include a pro app, an expanded rewards program, faster delivery, and improved credit offerings. We expect it will take time to fully roll out these initiatives, the initial results from our test markets are encouraging. We believe we are in the middle innings of our pro opportunity with a long runway ahead and look forward to providing updates throughout the year. Finally, over the last five years, we have grown our new stores at an average growth rate of 22%, comparable store sales at an average rate of 17.5%, and sales and adjusted EBITDA at a 33% and 44% annual growth rate, respectively, over that same time period.
Reinvesting back into the business to support future growth has become core to our philosophy. As a growth company, we continually analyze our needs and try to plan investments ahead of when they become necessary. A great illustration of our philosophy of reinvesting back into the business is the recent transition of our Miami DC to our newly expanded Savannah DC. Additionally, we expanded our Houston DC by 150,000 square feet during the first quarter. We also plan to increase our L.A. DC by an additional 350,000 square feet in the back half of 2018. These investments are critical to support our 20% new unit growth strategy in the years ahead. As we look to our next decade of growth, we need to expand our store support center, we will very likely relocate or enlarge our current store support center.
Trevor will share in a moment, but we believe this new solution will serve us for at least the next decade. In summary, it was a great quarter, and we continue to make good progress against each of our strategic priorities, further improving our capabilities and customer value proposition. Before I end, I want to thank all of our team members for the great job they do day in and day out. It is their commitment and dedication to Floor & Decor which enables the strong and consistent performance you have seen us deliver. I'll now turn the call over to Trevor, our CFO and Head of Pro Services, to go over our financial results and guidance.
Thank you, Tom, and good morning, everyone. I will review our first quarter 2018 results and then discuss our outlook for the second quarter and the remainder of fiscal 2018. We delivered another strong quarter, continue to see positive momentum across all product categories and regions, and we continue to make key strategic investments. First quarter again demonstrates that our business model provides a distinct competitive advantage that creates a positive customer experience, whether in-store or through our website. Net sales in the first quarter of 2018 increased 31.1% to $402,900,000, compared to $307,300,000 in the first quarter of 2017. We ended the quarter with 84 total warehouse format stores, an increase of 12 stores or 17% versus the end of the prior year period.
Our first quarter comparable store sales increased 15.6% and was driven by a combination of post-hurricane demand in Houston market, estimated to be approximately 400 basis points, as well as the continued positive momentum in our other markets outside of Houston. Our first quarter comp increase was driven largely by transaction growth, though both transactions and average ticket increased year-over-year. Now on to profitability. Gross profit increased 31.8% to $165,400,000 in the first quarter from $125,500,000 in the first quarter of fiscal 2017. Gross margin increased by approximately 20 basis points to 41%, from 41.8% in the first quarter of 2017. The increase in gross margin rate was primarily due to leveraging our distribution center costs across increased sales worth approximately 10 basis points. Another approximately 10 basis points due to lower shrink and damage.
As a percentage of sales, total SG&A leverage approximately 150 basis points to 31.9% compared to the first quarter of 2017, primarily due to leveraging our store and pre-opening expenses. As I mentioned previously, we opened one store in the first quarter of 2018 versus three in the first quarter of 2017, which partially contributed to the year-over-year leverage of our SG&A costs. Additionally, in the first quarter, we had lower than planned expenses in a number of areas, including marketing and operating expenses, which benefited SG&A for the quarter. However, this primarily was timing due to the spending. The majority of this spending will come in the later three quarters. Our strong sales growth, gross margin expansion, and SG&A leverage drove a 61% increase in operating income during the first quarter to $36.5 million, as compared to $22,700,000 in the first quarter of fiscal 2017.
Operating margin increased 170 basis points to 9.1% versus the prior year period. Our interest expense for the first quarter was $1,800,000 compared to $5,400,000 in the prior year period. The decrease in interest expense versus last year is primarily due to using the IPO proceeds from the second quarter of 2017 to pay down our debt, as well as a lower average interest rate. In the first quarter of 2018, we also recognized the benefit of approximately a half a million dollars due to a mark-to-market adjustment on an interest rate cap, which was not contemplated in our guidance. Our reported provision for income taxes in the first quarter was $2,900,000 compared to $6,100,000 in the first quarter of 2017.
The decrease in the effective tax rate was primarily due to the exercise of stock options in the first quarter of 2018 and due to tax reform passed in December 2017. We have adjusted the stock option benefit out of the calculation of adjusted earnings today. Before I discuss net income and 2018 guidance, please note that I will discuss both GAAP and non-GAAP measures. As described in our earnings release, we believe our non-GAAP disclosures enable investors to better understand our core operating performance on a comparable basis between periods. A reconciliation of these non-GAAP metrics to their most directly comparable GAAP financial measures can be found in our earnings release issued in connection with this call.
Adjusted net income and adjusted diluted earnings per share were $26,700,000 or $0.26 per diluted share in the first quarter of 2018, compared to $13,200,000 or $0.13 per share in the first quarter of 2017. This represents an increase in adjusted net income of $13,600,000 or 103%. Adjusted EBITDA in the first quarter increased 49.9% to $47,800,000 compared to adjusted EBITDA of $31,900,000 in the first quarter of 2017. As I reflect on the quarter, I would explain the better-than-planned adjusted EPS as approximately $0.01 due to better operating performance, $0.01 due to the timing of spending, and approximately $0.01 due to the favorable mark-to-market adjustment on one of our interest rate caps. We ended the quarter with $160,900,000 of cash and available liquidity under our revolving credit facility and $177,600,000 of borrowings outstanding.
Our inventory balance at the end of the first quarter was $427 million, which was down $1 million from the end of fiscal 2017, but up about 35% versus the first quarter of 2017. Now turning to our guidance. As you saw from our press release, we are raising our sales and adjusted EPS guidance for the year following a very strong first quarter. A few points I want to make about our outlook. First, for fiscal 2018, we continue to expect our comparable store sales, excluding Houston, to be in the high single digits to low double digits, and for the Houston benefit to moderate as we move throughout the year. Second, our outlook now assumes a modest decline in gross margin for fiscal 2018. Like other businesses, we are absorbing higher transportation costs, mainly due to actively locking in excess capacity of contracted domestic trucking assets.
While our contracts significantly mitigate the higher cost versus being entirely on the spot market, they require us to lock in adequate capacity to support our projected growth, and we are still working to fully utilize these trucking assets. We are also seeing some product mix headwinds in the Houston market, and lastly, we will be selling through the remainder of our higher landed cost Miami DC inventory over the remainder of this year. These headwinds are reflected in the assumption that our gross margins will be down about 70-80 basis points in the second quarter, improving from this level in the third quarter, and by the time we get to the fourth quarter, we believe gross margins will be about flat to last year. Third, as mentioned on the last call, we've made the strategic decision to enter Boston, Long Island, and Seattle.
Our success in markets like Chicago, New Jersey, Washington D.C., and Los Angeles, along with improved performance from our class of 2016 and 2017 new stores relative to our previous classes of new stores, gives us confidence that now is the right time to step into these larger and denser markets. However, since these are more expensive markets relative to prior store openings, we estimate these will require an additional investment of more than $10 million in store operating and pre-opening expenses compared to what we've invested in fiscal 2017 and previous years. Even with this much higher investment in new store operating and store startup expenses relative to prior years, we believe we can manage to obtain moderate operating expense leverage for fiscal 2018, which should lead to flat operating margins for fiscal 2018.
Finally, as Tom mentioned, we are evaluating various opportunities as it relates to our store support center here in Atlanta, and we will provide further details on our second quarter call this summer. Our team has done a fantastic job assessing options, and we currently believe our ongoing store support center cost will be below what we had forecasted in our long-term financial plan completed last year, even as we take on additional space. A relocation could result in non-recurring lease buyout, move, non-cash write-up costs of up to $13 million, the vast majority of which would be recognized this year, with some portion occurring in the first half of 2019. Our intention would be to call out these unique costs in our reconciliation of non-GAAP metrics in our quarterly earnings release so there would be no impact on adjusted earnings.
Taking these factors into account, for the second quarter of fiscal 2018, we expect net sales to be in the range of $430 million-$437 million, an increase of 25%-27% versus the second quarter of fiscal 2017. This growth outlook is based on a comparable store sales increase in the range of 11%-13%. Our second quarter outlook assumes a year-over-year operating margin decline of approximately 140-160 basis points. 70-80 basis points of this decline is due to the lower expected gross margin in the second quarter due to the factors I just discussed.
We're also planning on our second quarter store startup expenses to increase to $8 million versus $3 million last year, due to planned opening of four stores in the second quarter and eight stores in the third quarter, the most number of new stores we've ever opened in a six-month period. Also, as I previously mentioned, we are also entering new, more expensive markets. This is not only increasing our store startup costs, but also increasing our new store operating costs. Adjusted diluted earnings per share for the second quarter of 2018 are expected to be in the range of $0.23 to $0.25, an increase of 15%-25%. We're also assuming just over 105 million weighted average shares outstanding for the second quarter of 2018.
We expect our adjusted EBITDA for the second quarter of 2018 to be $46.4 million to $49.1 million, an increase of 6%-12% over the second quarter of fiscal 2017. For the full year, we now expect net sales to be in the range of $1.705 billion to $1.735 billion, an increase of 23%-25% versus fiscal 2017. The net sales growth outlook is based on 17 new warehouse store openings, a 20% new store growth, and an assumed comparable store sales increase of 9.5%-11.5%. We are modestly increasing the high end of our adjusted EPS and narrowing the bottom end of the range for fiscal 2018. We now anticipate our adjusted EPS to be in the range of $0.93 to $1.01.
Diluted weighted average shares outstanding are still estimated to be in the range of 105 million. Our fiscal 2018 normalized effective tax rate is estimated to be 23.4% for the remaining three quarters of fiscal 2018. As a reminder, this guidance does not consider the tax benefit due to the impact of stock option exercises that may occur in fiscal 2018, or other possible discrete tax adjustments. We expect fiscal 2018 adjusted EBITDA to be in the range of $191 million to $201 million, an increase of 20%-27% over fiscal 2017. CapEx for the year is planned to be in the range of $150 million to $158 million in total, with $91 million to $93 million of this capital budget being spent on the 17 new store openings in 2018. $34 million to $36 million is earmarked for store remodels and distribution centers.
The remainder of our CapEx, approximately $25 million to $29 million, will be directed towards IT, infrastructure, e-commerce, and store support center initiatives. The higher CapEx versus what we discussed on March 1st is due to the potential store support center relocation. For all other details related to the results and guidance, please refer to our earnings release. With that, operator, I think we'll turn it over to questions.
Thank you. At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. You may press star 2 if you need to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset prior to pressing the star keys. Our first question comes from the line of Seth Sigman with Credit Suisse. Please proceed, your line is live.
Hey, guys. Thanks for taking the question. Nice quarter. A couple clarifications. I guess just first on the hurricane benefit, it seems to be tracking pretty much as expected, but just curious, is there anything that leads you to believe that the impact for the year is going to be different than you expected previously, either better or worse at this point?
Yeah, from the top line, it is absolutely tracking like we predicted, which is hard to believe considering it was a historic flood. We hadn't dealt with something like that as a company before. It's kind of a one-time event, our team did a really good job predicting what's happening on the top line. As Trevor mentioned, we've got some mix issues that were hard to predict on as people rebuild exactly what they were going to buy, when they were going to buy, and this put some margin pressure in the market. Overall, we're pleased with what's gone on there. It hasn't changed our yearly outlook. Again, it's kind of a one-time event. We'll see how it plays out, but as of today, what we thought was going to happen is happening.
Okay, that's helpful. Then, just as we think about the margin bridge for the second quarter, Trevor, you zipped through a lot of the different drivers there. I guess I'm trying to figure out on a comparable store basis, what is really implied here. If we look at the first quarter, your store level operating expenses look like they leveraged 80 basis points on a consolidated basis, but actually 160 basis points on a comparable store basis. As we look at the guidance for the second quarter, it seems to imply a lot less leverage on a comparable store basis. Is that just conservative? Is that math right? I'm just trying to figure out what some of the moving pieces would be within that. If you could walk us through that, it would be helpful.
Yeah, good question. I'll apologize in advance for the confusion of our P&L, it's all due to the new store timing. If you just looked at our stores that are pre-2017, we're getting nice operating leverage out of that, fairly consistent with the operating leverage we got in Q1 because the comps are pretty close. What appears to be the deleveraging of it, 100% of that has to do with the new stores that we're opening in 2018 and the timing of some of those new stores when we're coming in there.
For example, as I mentioned, this is a different line item on our P&L, we break it out to be clear, our store startup costs are going from $3 million to $8.2 million, that's 173% increase, again, that has to do with opening the most number of new stores we've ever opened in a six-month period of time. Associated with that is, we'll be taking on occupancy costs and labor costs and marketing costs.
As I mentioned in my prepared comments for the year, that's some portion of $10 million step up just because we're in those expensive markets. To simply say that, to back out the pre-2017 stores, the operating leverage that you saw in Q1 would be fairly consistent in Q2. All of the de-leveraging you're seeing comes from the newer stores that we're opening and just opening in these more expensive, densely populated markets.
Okay. All right. Thanks for clarifying. Thank you.
Our next question comes from Elizabeth Suzuki with Bank of America Merrill Lynch.
Hey, good morning, guys. Can you just quantify the year-over-year increase in freight costs as well as raw materials, if any, and your ability to pass through those cost increases to your customers? I think your product category is obviously quite heavy and expensive to move around, I'd imagine those costs are going up quite a lot. Just wanted to get some clarification on how you manage that.
Sure. This is Tom. I will tackle some of that question and let Trevor talk about domestic freight. We're seeing headwinds in domestic freight from a price, from a commodity increase standpoint, really haven't been all that affected. We've seen a little bit in the solid wood side of our business, it's nothing that we can't deal with or that we're unable to pass along if we have to. The activity's been a little bit more than historic, nothing that's out of the realm. On supply chain, on domestic freight, we do have some headwinds. Trevor, you want to just touch on that?
Yeah. I would call it two things as we think about the rest of the year. The Miami distribution center relocation is a fair amount of this. The overall gross margin we expect to be higher when we get all of that inventory, which we've now done, out of that Miami DC into our Savannah DC. The landed margins will be slightly lower because of the domestic trucking costs to get that product down to Florida. Because our new Savannah distribution center is so large and so efficient and so much less costly, the overall gross margin impact is better. There are going to be some headwinds as we move throughout the rest of the year to move through that higher Miami distribution center landed cost inventory.
I know that's a bit confusing, but we do see that as kind of a 5- to 6-month issue as we move through that Miami inventory that's moving up to our Savannah distribution center. On the domestic transportation costs, I think you're right. If you look at our international costs, our drayage costs, our duties, all those things, they're not changing materially. We were fortunate that we were very aggressive in leasing and taking ownership of over 70% of our domestic transportation costs through a dedicated fleet. We aggressively leased into or kind of procured those assets. We didn't need quite as many as we had, that's got some excess capacity in those. As our sales continue to grow, we're maybe going to give back some of those assets. We also see that mitigating as we get towards the end of the year.
As we think about our gross margins, and I said this in the prepared comments, but just to mention it, we call it 70-80 basis points in Q2, coming down from that as we get into Q3, and by the end of the year, we think gross margins will be closer to flat. These are issues that are, we think, kind of effective in Q2 and Q3, and as we get to the end of the year, we think we've worked through those.
Great. That's really helpful. Can you just talk about the growth rate of sales to pros versus DIY in the quarter and whether there was an appreciable difference between the two? Any big potential MRO opportunities you could talk about?
Yeah, this is Tom. I will talk about the DIY versus the pro. We don't break that apart yet. We're getting to the point. We're working aggressively on CRM, where we'll have better visibility to what goes on and with each segment of customer. When you're comping at the double-digit rate, both consumers appear to be doing very well. As we look at the pro activity in the backside of our store has remained consistent, if not increased. Again, we don't have specific measures. Again, I said it on the last call as well, when we're comping at this kind of rate, all customers have good demand for the product, and our awareness continues to get better. If you think about our awareness levels, unaid awareness is at about 10% for our company. People are just getting to know who we are.
As we open more stores, I think we get more do-it-yourselfers in the store and more people learn about the brand. Those do-it-yourselfers will drag more pros in the stores because a lot of them use pros who don't know about us. Both segments are doing well, and we anticipate that will continue to happen.
Just one thing I would add to that, Liz, we have done two fairly large studies in the last six months through surveys and exit interviews and talking to our customers, and we think that mix has not changed meaningfully over the last five years. You guys probably recall, but about 40% of our customers we see as DIY purchasers, about 40% where the pro pays for the product and 20% buy-it-yourself customers, which are customers we define that the consumer paid for it, but they were influenced by some professional customer, and that hasn't changed a lot. We don't think that's changed either. On the MRO space, we are also growing that business. It's a much smaller base, but we do see our larger sales to our bigger corporate customers growing at a faster rate, but again, albeit from a much lower base.
That's within the commercial division that we started. That is ramping nicely. We're getting a lot of bigger sales from that. In the stores, we've always sold to hotels, motels. That customer's always been a core staple to our professional business that runs through the registers in our stores. That business, I think our pro teams in the stores do a better job of going out and networking within their own areas to sell to more of that maintenance repair person.
Great. Thanks very much.
Next question comes from Michael Lasser with UBS.
Good morning. This is Atul Maheshwari filling in for Michael Lasser. Thanks a lot for taking our questions. Your SG&A per store and the SG&A per square feet growth was meaningfully below the last several quarters. What really changed in the first quarter compared to what you were seeing in the past several quarters that drove this outperformance?
It's pretty simple. We only opened one store versus opening a lot of stores. Those new stores, because they do less volume than our mature stores and they have higher costs than our new stores, when you open fewer stores relative to previous periods, that will give factually an appearance that our SG&A is more efficient. Again, it really just had to do with, we opened a lot of stores in the back half of last year, we only opened one store in the first quarter of this year.
Okay. Thank you. As we follow up, can you provide some thoughts on how rising rates specifically impacts your category, what you're seeing in the marketplace now that rates have risen a bit? How much would rates really have to rise before it begins to act as an impediment for category growth?
No, it's a good question. There's a number of macro factors we watch. Certainly, interest rates are one of them, and interest rates rising is a bit of a headwind. When you look at overall household appreciation, household formation, GDP, low unemployment, rising consumer discretionary income, and the fact that two-thirds of Americans' homes are over 30 years old, when you balance all of those headwinds and tailwinds out, we still think it's going to be a good market and will continue to grow for the foreseeable future.
As I said earlier, our unaided awareness is 10%. People still don't know who our brand is. As we open stores and we grow that awareness, we'll take share no matter what happens with rates.
Thank you, and good luck for the rest of the year.
Thank you.
Our next question comes from Matthew McClintock with Barclays.
Hi, yes. Good morning, everyone. Tom, I was wondering if we could focus on your efforts to improve the time to service the pros when they get to your store. Can you talk a little bit about what you've done there? How does that correlate with sales in the pro business? Does that have an immediate impact on sales in the pro business, or is it something that just builds over time as pros get used to you being very speedy with helping them out?
Yep. I'll give you some thoughts on that. We have spent a lot of energy on getting professional customers in and out of our stores quickly. Time is money for a professional, so we have to invest to make it easier for them to get their product out. We've done a few things. One, and I'm going to go through it because it's been over several years, we've made lots of investments. We created a pro zone within the back of the store that has a desk, it has an area for them. We have a command center in all the stores where people can check in when they come to get their product out of the store. About two years ago, we invested in technology in the back of our stores so that our teams could know when a pro was entering.
We could get them in and out quicker. Today, we average getting a pro out of the back of the store less than 15 minutes. When someone checks in, our average pickup rate has dropped down to 15 minutes of getting a pro out. If you think about that, pros buying a couple pallets at a time. Being able to get a forklift, get it out of a rack, get it out to their truck in that timeframe, we're pretty pleased with the results. The second part is we're not done. The pro app that we are in pilot on, it really focuses on better communication for the professional to get ahold of the pro desk and get in and out of the store quickly.
They'll have an app that says, "I'm on my way, I'm in the parking lot, I'm here," and we can have the product and get it out even quicker. We have monitors in the back of the store that customers can see, so they know where they're at in the pecking order of getting their order pulled and getting it out to their truck. Just lots of investments that have happened and lots of investments still coming to us, which will help speed that pro up. Now, how does that turn into sales? The better we can make the experience-- I mean, the pros love our broadest assortment in stock every day because we don't have any special order. We don't compete against them. Their shopping experience on the buying side is really good. We give them also free design services.
We just do a lot to cater to them. It has been a frustration of theirs that we can't get them out quicker. I think the quicker we get them out the back of the store, the happier they'll be and the more they'll buy from us. I don't know if it's an instantaneous sales lift, but I think in time, we'll definitely get more of their wallet as we execute better with these initiatives. Long answer, but we've done so much that it's just worth going through the whole story.
A lot going on here. I guess my other question would be just high level. One of the interesting aspects of your story upon the IPO was that it really seems like you haven't found a mature store yet to date. I was wondering, conceptually, are we still at that point where your older stores are growing? I'm not trying to get to a point where you break growth by vintage out every year or anything like that, but just how have your thoughts on maturity, store maturity evolved over the past year and a half relative to when you came out to the original markets? Thanks.
Yeah. We're in our 10th year of double-digit same store sales growth, when our unaided awareness is still at a very anemic level, all stores are still maturing. When you're comping at this rate, we're getting growth out of our oldest stores. We're getting growth out of all of our stores that we're not cannibalizing. Whether or not you can define that as do we understand maturity. We're investing a lot. We've taken a lot of the tax-- Not a lot, but a portion of the tax reform benefit that we've got, and we're investing in better marketing campaigns and
Trying to spread the word of our brands. As we open more stores, that helps our awareness. I think the more awareness we can get, there's still a lot of share to be taken. There's still a ton of independent flooring stores that we compete against, the publicly traded people that sell our product, we compete against them. There's still more share to be had. A long way around of, we've been comping this rate in our 10th year. When you're comping like that, all stores continue to do well.
Thanks a lot for the color. Best of luck.
All right. Thanks.
Our next question comes from Christopher Horvers with J.P. Morgan.
Thanks. Good morning, guys. You swung the gross margin outlook by about 100 basis points relative to the prior guide, but you also raised the outlook for earnings for the year. My question is, what are the offsets? Are you dialing back previously planned investments? Is there a little bit of incentive comp swing? Is it a change in posture to the extent that the earnings outlook is less conservative than perhaps where you started the year?
This is Trevor. Sales are a little bit higher in the current forecast. We're obviously a little further through the year. We've now completed our first quarter. You're right, we did take our gross margin expectations down. We went through, as we saw what we really felt like we needed to spend this year, we tightened that up a little bit. You're right, margin is down, sales are up, and we've taken SG&A costs out of the business. This is kind of how we got there.
I guess where you saw those pools of SG&A opportunity to offset?
Really across most of the business. A little bit out of the stores, not a lot. Probably more of it here in the corporate office. We've been investing at a very high clip for going on my seven years here. There's areas where we felt like we didn't have to invest quite as heavily this year. As we get throughout the year, we've just pulled back things. Incentive comp is a very immaterial impact so far. We're fairly close on what we thought when we built the original forecast.
Understood. Just sort of a general cadence, not only within the quarter but relative to last year, there's been some modest moderation in sort of the underlying growth rate in the market. Can you talk about, is that sort of broadly felt across the categories, or is it any particular category stand out? You did see some nice ticket improvement in this quarter, and was there any sort of stand out on the cadence within the first quarter as well?
Not really. The trends have been relatively consistent. The businesses that have grown at a faster rate continue to be the same businesses as we've seen in previous quarters. We haven't seen anything from a category perspective. I think that still the durability components that have been added to a lot of our wood categories, continue to drive people into the stores, and I still think that innovation's relatively new. I think the innovation around inkjet technology and the fashion components of the product we carry continue to resonate as well. We're not seeing any difference in department performance than we've seen over the last few quarters.
My last question is on the luxury vinyl plank category, how do you think your value prop stands out there in the market? Have you seen competition step up from an assortment and a promotion perspective? Thanks very much.
I'll let Lisa
Yep. Certainly, it's one of the fastest-growing categories for the industry and for us as well. We think that our value proposition is one of the best out there. We were first to market on water-resistant laminate. We followed that up with NuCore. We've now got a new program, DuraLux, that is in that waterproof space, and the customers really, really like that product. Yes, we see it all over from a competitive perspective, but we are very confident in what we're doing and the new programs that we're introducing.
Excellent. Thanks.
Our next question is from Matt Fassler with Goldman Sachs. Your line is live.
Thanks so much. Good morning, guys.
Good morning.
My first question relates to the Pro loyalty program. You spoke about the Pro app and Pro loyalty and starting to get traction. Can you talk about the pace at which you would expect this program to start to move the needle on the top line? Do you feel there was some benefit to the business here in Q1? If not, at what point would you start to see it really impact the numbers?
Yeah. We're not fully rolled out on the Pro loyalty program. It's in progress. We have, in our pilot markets, seen a benefit versus control markets. We're thoughtfully rolling that out. We should have it within all markets by the end of the year. It takes time to get benefit from it. While we saw improvements versus a control market, there's an enrollment period where we get people involved in it. There's an education period where once we get them enrolled, we've got to really teach them the benefits of it. We think the real benefit comes in the out years. Our goal is to get more of the share of our Pros' wallets by creating this loyalty program, trying to do more of their spend with us.
Long way around though, we're getting some benefit now, when we get it rolled out in the rest of the country, it's going to provide benefit over the years to come.
The only thing I would add to that, Matt, 100% agree with what Tom said, we're also integrating in with a holistic CRM strategy. CRM, not just for our professional customers, but also for our do-it-yourself customers. We're putting in some world-class technology and talent to help us manage that process. As Tom mentioned, those processes are all about the next three to five years. You don't just see a quick lift in those. We are very encouraged with the technology, we are very encouraged with the team that's putting it in. We are very encouraged, as Tom mentioned, on the test versus control markets, where we've been testing the loyalty program. We'll be giving you guys a fairly detailed update on that, probably in Q3 and Q4 as we get more traction there. It looks very encouraging at this point.
Great. I have a couple of follow-ups on expenses. The first is thinking about the leverage point. I'm looking out to next year when presumably Houston will no longer be aiding the comps. You'll be comping against it to some degree. What do you think the leverage point is for the business, or what do you think it will look like next year in terms of what kind of same-store sales you'll need to hold the SG&A ratio flat? I'm asking that question considering what you said about the cost of market entries, along with the fact that clearly you have some expense levers, as you said in answer to a question a couple of minutes ago.
I'll break it in two. I think when you look at our stores, let's call it the pre-2017 stores, just with inflation and things of that nature, we probably need a 3-ish plus %, just to make sure we're getting flat operating margins. To the extent we do better than 3%, we should get operating margins out of the pre-2017 stores. As you think about the stores that we're opening in 2018 and 2019, those 2018 stores are going to need to perform well. Historically, as you guys know, our new stores have comped at two to three times the rate, therefore, we've got a substantial amount of leverage in that next year. I do think that will continue to happen as we think about those stores.
From a blended perspective, when you roll that all together, you're going to need, in order to get operating leverage, in the mid to maybe just above mid-single digit comp on a consolidated basis, to "pay for" the class of 2019 stores because those new stores are a very negative impact on our overall operating margin. I would say you're going to need that mid to upper single-digit comp to get leverage. We're not ready to sign up for the 2019 budget yet, that's how I would set it today.
That's super helpful. Finally, and briefly, just as I look at what you told us about Q2 and trying to solve for the rest of the year, you gave us color on gross margin. We can look at the sales stacks. It seems like to solve for the low end to the midpoint of the 2018 guidance in Q4, the expense performance just from year on year would need to be pretty tight. I just want to make sure that's reasonable given that last year your expenses really ripped in Q4 along with gross profits. Is the right way to directionally get there, I know you didn't break out the last two quarters of the year, to really think about that expense compare as being one that you can cycle pretty easily year on year?
You're exactly right, Matt. Our current expectations are that we'll actually have a modest improvement in operating margins when we get to the fourth quarter, because we did ramp up with all the DC expenses and everything we did in Houston and the timing of new store openings, some big corporate investments there at the end of the year as well. Yeah, our expectation is even with a flattish gross margin that I said in Q4, we're going to get leverage out of our SG&A expenses and have a modest increase in operating margin as we get to Q4.
Thank you so much, guys. Appreciate it.
Thank you.
Our next question comes from Peter Keith with Piper Jaffray.
Hey, thanks. Good morning, everyone. Just digging into a little bit more on the gross margin puts and takes. Certainly, transportation cost inflation seems to be pretty widespread for a lot of companies. Could you maybe frame up how big of an impact that is, looking at Q2, Q3, when you think about the 70-80 basis points of pressure in Q2?
This is Trevor again. I'm just going to harken back to what we said. It's really those three things, the Miami costs, that higher landed cost inventory in Miami that we've got to push through for the remainder of this year, and then that will subside. Our domestic trucking costs are one of the overall lowest of our supply chain costs, they are increasing. Again, that didn't have anything to do with the spot markets are increasing. It's just that we wanted to go out there and procure that capacity to make sure we could support ourselves because it's hard to get trucks in this day and age, and we probably procured more capacity than we needed at the time.
It's mostly those two and the third of those, the smaller of those, as we mentioned, is the Houston market as it kind of shakes itself out and people come back to buying different products than what they bought during the storm. That's the minor of those three.
Okay, thanks for that. Also just want to talk about the class of stores. Good to hear that 2017 running above 2016, and you guys seem like you're showing stronger and stronger improvement each year. When you look back maybe at 2016 now, and how 2017 is cycling, are you still seeing the same maturity curve dynamic where, like in that year 2, when it enters a comp base, it comps about 20%, and then year 3, it comps 10%. Is that the general trajectory that's still in place?
Yes. That is the general trajectory that's still in place. It's going to get harder. I mean, the new stores are doing better and better. As of today, that is still happening.
Okay, very good. One last quick one for me. Your publicly traded peers, one called out weather as a headwind, one said it wasn't a headwind. How did you guys shake out with Q1, granted some of your northern stores are newer, but how does that look for you?
Weather doesn't really affect our category. It shifts sales in our mind. For us, it was definitely a colder winter, and it was definitely more impactful maybe in the Northeast, but it doesn't have a meaningful impact in the first quarter.
We saw more closed days, to Tom's point, our view is that the pros come in the week before or the week after.
It comes later. Right.
Yep. Okay, very good. Thanks a lot, and good luck.
Our next question comes from Seth Basham with Wedbush Securities.
Thanks a lot, good morning.
Morning.
My question is on gross margin. As you think about the outlook for 2019, obviously you're not providing guides now, given the headwinds you're facing this year, would you expect to recover a lot of those pressures in 2019?
Yeah.
We're not ready to sign up for them yet, yes.
Yeah, absolutely.
We'll also get leverage out of our distribution center expenses next year, right? Yeah, there's a number of things that would give us optimism as we look to 2019.
Got it. We should be thinking about gross margins growing again in 2019. As it relates to this year in gross margin, how are you considering mix into the equation? Is mix a benefit or a headwind to you guys from a product standpoint?
Right now, it's a little bit of a headwind, mostly because of Houston, but not meaningful. The bigger issues, as I mentioned, is that the Miami inventory, selling the higher cost of Miami inventory and the overlay of the domestic trucking costs are the bigger ones.
We are doing a lot to benefit our mix going forward. If you think about two initiatives, we have the designer initiative going on within the stores, we hired a head of design services about almost a year ago now. She's doing a terrific job of evolving how we serve on the designer side and inside of our design centers within our store. When those designers are involved in the sale, we tend to have a higher margin rate. Also, Lisa and her team have done a really good job of bringing better and best products. We like the trajectory of our better and best. Customers are coming in and buying that, and we can help our margin rates with that as well. We have some in-store initiatives that we're doing that should help our overall mix, also.
Got it. Last question from me. When you think about the payback period on the new stores you're opening in the larger markets, would you plan that to be the same as a typical store that you open?
Yeah. They're densely populated markets. Some of the biggest markets that we'll be in. They're some of the best housing markets that we'll enter. They'll do a good volume, and we anticipate the payback will be good.
Thank you.
Our next question comes from John Baugh with Stifel.
Thanks. Good morning. I wanted to follow up on the mix question. Let's leave Houston out of it. We're seeing waterproof laminates grow nicely and LVT grow nicely. How do we think about how that trend impacts both the top line and the gross margin?
I would say on the top line, we've called out the laminate category as our best comping probably for almost two years now. That's been a nice benefit to our comps, is what that Lisa's team has done in that category and how the stores have sold it as well. That category of itself, margin is improving a bit as well, so that helps.
Yeah, I think that, as I mentioned earlier too, that the water-resistant innovation is still relatively new. It's getting certainly marketed a lot more across the country, and that brings awareness to that into the consumer, and we think that'll drive more traffic into the store. We should get some good benefit of that for the foreseeable future.
I guess the question was, I assume what we're hearing, ceramic and wood are being impacted a little bit in terms of share and how the margin dynamics, whether you're indifferent to that or it's a slight headwind or a benefit.
Yeah. No, I don't think it's a headwind. I think it would be a benefit. I don't know that it's impacting tile as much as it's probably impacting solid wood and engineered wood. Certainly, that's probably the case, but for us, it's not a headwind.
Yeah. As Tom mentioned, if you look at the last five years, our comps have averaged 17.5%, and all of our departments have been comping positive. There's always winners and losers, but for the most part, when you're comping 17.5% year over year over year, you're seeing all of your departments do better.
Mm-hmm. My second question is just on China, specifically in imports, all the saber-rattling going on. Is there anything you're seeing and/or concerned about from a sourcing perspective with all this trade war talk?
No, not yet.
Great. Thank you.
Our next question comes from Daniel Fannon with Jefferies.
Thanks. I was just wondering if you could comment on what your expectation is for the Houston market in terms of the added comp in Q2 coming up within that guidance you provided.
Dan, this is Trevor. Just as a quick reminder for everybody, we called out 800 basis points in Q4. We called out a 400 basis points in Q1, we'd guess some estimate would be somewhere between 200 or 300 basis points benefit in Q2, about flat for Q3. As we get to Q4, as we called out last quarter earnings release, we had an over 100% increase in that market. We think could be as much as a 800 basis points headwind just because we had such a huge lift in Q4 of last year. For the year actually, Houston's not really It's a little bit of a detriment, because that Q4 is so large for us. That's it. There's your very specific answer.
Thanks. Then, I may have missed it, but what specifically was the product mix issue in Houston that caused some I know it wasn't the major part of your margin pressure, but what's going on there?
I wouldn't call it an issue. I just think that a lot of uniqueness happens when your sales go up like they did in Q4. Customers come in, they buy whatever they can get their hands on. We had a lot of great product, so our margins were higher in the fourth quarter and the early part of this year. Now that that's going back to probably a more normalized base, people are buying not as much as maybe of the better and best product and more of the good product.
They were buying anything they could get their hands on in the fourth quarter, the margin blend was better in the fourth quarter than it is now because we're back in stock on everything. They're buying more of the good product than they had been in the fourth quarter.
Understood. Then just two more items. On just broader pricing and promotion in the industry, have you seen any changes? Is it status quo? Are you doing anything unique there? Then, Trevor, you did mention that there were some lower expenses than expected in Q1 that would shift to Qs 2 through 4. I was wondering if you could just clarify a little bit more on what those were.
I'll talk about the competitive environment, Trevor can talk about the shift in expense. Promotional cadence, I'd say, is similar to what we've seen. It hasn't changed. I can tell you, we're not doing anything different. You asked that question. All of our marketing is geared towards brand awareness. We are investing more in marketing as part of that tax reform benefit. We're putting more into marketing to help build our awareness. We'll continue to do that. The competitive environment from a promotional standpoint feels the same to me. Pricing is always a challenge in different markets by different players at different times. We pay attention to that. We react to that when we need to react to that. I don't believe it's any different than it's been in the 5 years that I've been here, 5-plus years that I've been here.
All the competitors do good things. We watch what they do. We try to learn from what they do. If it's something that we can do better, we try to do that. We still believe that our total value proposition, having the broadest in-stock assortment, not competing with the pros, not installing, just having the real catering to that professional customer, we think our total value proposition is just a lot better. There's evidence as all of our surveys say if we can get a consumer into the store, we convert them 80% of the time. We think we've got a better mousetrap. As our awareness builds, we can do pretty well.
Dan, this is Trevor. The second answer to your question, the expenses that were lower are pretty mundane type things, remodeling expenses, maintenance expenses, marketing, and distribution center. Those came in earlier. We're going to finish our remodels. We're going to get the maintenance done. We're going to spend the marketing to get the customers into our stores. Fairly mundane stuff that just didn't spend as much in March. We'll end up spending that in Q2 and Q3.
Great. Thank you.
Our final question comes from Zachary Fadem with Wells Fargo.
Hey, guys. Thanks for squeezing me in. Within the context of your good, better, best strategy, how would you say the higher-end products are performing relative to your other offerings? As you add newer laminate decorative products, is it your intent to take the higher-end product mix further upward in terms of overall sales?
I'll start with the first part, then Lisa can jump in if I miss something. I am pleasantly surprised with how the higher-end product we brought in across each category has performed. In fact, a little bit surprising. When I joined the company, we were an outlet center. We've invested a lot in the presentation of our stores, trying to really create inspiration. As we've done that, as we've invested in inspiration, put design centers in, show the products differently, we've been able to show better product. It shows well, and it's at a tremendous value. When we bring in higher-end product, the value equation of what we do, it holds true in the higher-end products and we're finding consumers in all stores.
I think that's probably one of my bigger surprises that we're able to sell high-end in every store no matter where the store is. Along the way around, I'm very pleased with what we're doing. We are going to continue to bring higher-end stuff in. It's not our major focus. We want to appeal to everyone. It's not going to be like we're not going to turn into a high-end shop by any stretch of the imagination, but as we find good higher-end products that are as good values for our customers, we'll bring them in. Our goal is to democratize the category. We want people to be able to come in and be inspired in our stores and be able to get things they didn't think were possible.
If Lisa and her team can buy them right, we can price them right, then we'll sell them well.
Great. Could you also talk a little bit about the importance of brands in your category? When your customer considers all the variables, things like price, what's on trend, what's in stock, where would you say the brand falls in the pecking order?
Depends on what they're buying. I think brands are really important in the back corner of our store where we have our accessories department, which is what you use to install the product, the tools that you use, the grouts that you use. We think brand is really relevant there, and we think our merchants have done a really good job of acquiring the right brands that our customers are asking for. As you venture out into the different departments, it becomes a little less relevant, in my opinion. We don't have a lot of customers come in asking for specific brands, say, "I'm looking for X brand or Y." It's more of, "Hey, I'm looking for water-resistant laminate. I'm looking for wood plank look tile." There's just not as much brand relevance.
That's why we spend a lot of time working on our private brand strategy because, to the consumers, that approach has worked for us when we don't have a lot of people coming in saying they want a specific brand. It's more they want a specific product.
Got it. Thanks, Tom. I really appreciate the time, guys.
No problem. We appreciate it. All right. Thanks, everybody. We appreciate you joining our call today, and thank you for your interest in Floor & Decor.
Thank you. Ladies and gentlemen, this concludes today's conference. You may disconnect your lines at this time. Thank you all for your participation.