Floor & Decor Holdings, Inc. (FND) Q3 2022 Earnings Report, Transcript and Summary

Good afternoon, and welcome to the Floor & Decor Holdings Third Quarter 2022 Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator instructions] Please note this event is being recorded. I would now like to turn the conference over to Wayne Hood, VP Investor Relations. Please go ahead.

Thank you, operator, and good afternoon, everyone. Joining me on our third quarter earnings conference call today are Tom Taylor, Chief Executive Officer; and Trevor Lang, Executive Vice President and Chief Financial Officer. Before we get started, I would like to remind everyone of the company's safe harbor language. Comments made during this conference call and webcast contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and are subject to risks and uncertainties. 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 will discuss non-GAAP financial measures as defined by SEC Regulation G. We believe non-GAAP disclosures enable investors to better understand our core operating performance on a comparable basis between periods. A reconciliation of each of these non-GAAP measures to the most directly comparable GAAP financial measure can be found in the earnings press release, which is available on our Investor Relations website at ir.flooranddecor.com. A recorded replay of this call, together with the related materials will be available on our Investor Relations website. Let me now turn the call over to Tom.

Thank you, Wayne and everyone for joining us on our fiscal 2022 third quarter earnings conference call. During today's call, I will discuss some of the highlights of our fiscal 2022 third quarter earnings. Trevor will then review our financial performance in more detail and discuss how we are thinking about the remainder of 2022. We are pleased with our fiscal 2022 third quarter and year-to-date financial results and excited about approaching 14 consecutive years of comparable store sales growth, a significant accomplishment considering the current macroeconomic challenges. Additionally, we are pleased with the execution of our growth strategies and gross margin rate recapture, which enabled us to deliver better than expected third quarter 2022 adjusted diluted earnings per share of $0.70 per share, an increase of 16.7% from last year's $0.60 per share. These solid financial results reflect the strength of our business model and the outstanding work that all of our associates do to serve our Pros and homeowner customers better every day as demonstrated in our recent customer satisfaction scores. Our three-month customer satisfaction service score was one of the highest in our history, further validating that the investments we are making in associate wages and training are working. I want to take a moment to particularly express my sincere gratitude to our associates in Florida for their hard work and deep dedication to their communities and each other. Because of their efforts, we quickly reopened our stores to serve our customers impacted by Hurricane Ian as they begin recovery and rebuilding efforts. Turning to our new store growth. We opened four new warehouse format stores in the third quarter of fiscal 2022, including one store in fiscal August and three in fiscal September. Compared with our planned eight warehouse store openings in the third quarter, the lower than expected openings is primarily due to industry construction delays and Hurricane Ian, which pushed our Fern Park, Florida opening into the fourth quarter. As a result of these factors we now intend to open 13 warehouse format stores in the fourth quarter of fiscal 2022, achieving our 32 warehouse store annual opening plan and ending the year with 191 warehouse stores. Fourth quarter to-date, we have opened seven of our planned 13 warehouse store openings. We are excited to open a design studio in Atlanta, Georgia in October. We now operate six design studios including studios in Dallas, Houston, Miami, Washington D.C. suburb Tyson's Corner, New Orleans and Atlanta. As we think about our new warehouse store openings in fiscal 2023, we believe it is prudent to plan a range of 32 to 35 stores and for the openings to be weighted in the second half of the year. By doing so, we can take into account potential ongoing construction delays and be patient about finding the best real estate opportunities for our long-term goal of 500 US warehouse stores. Third quarter total sales increased 25.2% from last year to approximately $1.1 billion. Our third quarter comparable store sales increased 11.6% compared to the third quarter of 2021, including 12% in July, 13.7% in August and 9.6% in September. As expected, laminate and vinyl remain our strongest merchandise category. As we look forward, we expect a weak housing market and a slowing economy will continue to weigh on our transactions into the fourth quarter of fiscal 2022 and throughout fiscal 2023. As a reminder, our fiscal 2021 fourth quarter comparable store sales increased by 14%, making for a moderately more difficult sequential comparison versus 10.9% growth in the third quarter of fiscal 2021. Our fourth quarter, to-date comparable store sales are up about 5% as compared to the same period last year. Let me comment on the impact Hurricane Ian has had on us since it made landfall on September 28, 2022. We were fortunate that none of our stores were materially damaged. In the third quarter, we had 26 closed store days and 19 partially closed days. It was gratifying to see our associates take immediate operational and merchandising actions to quickly reopen our stores to serve our customers as they begin recovery and rebuilding. For example, we quickly positioned 1,400 pallets of vinyl in South Florida to help those needing to replace their flooring from flooding. Our quick actions are remarkable for a company of our size. We estimate the storm was a drag on our comparable store sales growth by 130 basis points in September and 50 basis points for the third quarter. At this juncture, it is difficult to estimate with any degree of precision the potential benefit over the coming months and years from the billions of dollars in residential and commercial flood loss damage from Hurricane Ian. We are, however, well positioned for the rebuilding demand due to our substantial market share and value position in Florida, not to mention being able to deliver sufficient job lock quantities at the lowest price. Our third quarter comparable store sales were driven by a 19.5% growth in our average ticket, compared with 17.9% growth in the second quarter of fiscal 2022. Our average ticket growth continues to benefit from an increase in retail prices to mitigate cost pressures, an increase in the sales penetration of laminate and vinyl, and an increase in sales penetration from our high-ticket, Pro, e-commerce and designer-led initiatives. We continue to see ongoing customer preferences towards our better and best price points where we offer industry-leading innovation, trends and styles at the lowest price. The third quarter comparable store transactions declined 6.7% from last year, slightly improving from a 7.3% decline in the second quarter of fiscal 2022. As a reminder, our transactions turned negative in late November of fiscal 2021 and were down 0.7% for the fourth quarter of fiscal 2021. We will start cycling past mid to high single -- singles transaction declines in the second quarter of fiscal 2023. Turning to our Pro business. We are successfully executing a holistic strategy to grow our wallet share among Pros. In the third quarter, total and comparable store sales to Pros exceeded the company's total sales growth of 25.2%. Consequently, Pros accounted for 40.7% of our third quarter sales, up from 39% in the second quarter of fiscal 2022. Notably, Pro comparable transactions continue to be strong increasing by 7.4% from the third quarter of 2021. Moreover, we are pleased that the Pros that make up the top 10% of sales, spent 24% on average more than last year. So we are excited about our growing engagement with Pros and the opportunity to continue growing our Pro contacts. In the third quarter, we created 29,000 new Pro contacts supported by events like our third annual Pro appreciation event. This year this yearly event celebrates pros everywhere with giveaways and free weekly virtual installation classes. This year the event generated a 67% increase in net new opted in Pro contacts from last year. The growth was significantly above our expectations and reflected our growing brand awareness. As we look to the fourth quarter of fiscal 2022 and beyond, we are focused on further strengthening our teams at the Pro desk to build on the execution of our key priorities and objectives. To that end, we are investing resources in Pro leadership training and development, including an initial framework of Pro career path. We are fortunate that the growth ahead of us gives our Pro team members a unique career opportunity. Additionally, we are refreshing our Pro certification programs and expect all team members to be certified by the end of fiscal 2022. We are excited about launching our new Pro Connect account management tool enabling deeper tracking and account management of Pros by our associates. These among other strategies and tools are aimed at building relationships and lifetime value with Pros. Turning to our e-commerce business. As discussed during prior calls, our e-commerce team continues executing strategies that will further optimize our customers' digital experience, including focusing on product, inspirational contact and conversion. Our third quarter e-commerce sales increased 31% from last year and accounted for 17.3% of sales compared with 16.4% in the same period last year. We are pleased that the e-commerce average ticket comp grew at a faster rate year-over-year in the third quarter than the company average ticket comp. Turning to the growth opportunities in design services. We believe there is significant opportunity with design services to strengthen our competitive moat and are continuing to commit resources to this free service. We now have over 900 designers in our warehouse stores or about five designers per store. Additionally, we believe there is an opportunity to become involved with whole home or multi-room renovations by offering in-home design services. As such, we now provide in-home design services in Washington D.C., Houston, Dallas, Miami and Atlanta. As we have discussed in prior calls, when designers are involved in projects we see higher customer service scores, average tickets, installation material sales, adjacent category sales and gross margins. For these reasons, we are focused on designer staffing requirements to ensure we have the right designers in the right place at the right time and are executing follow-up and elevated service behaviors that maximize converge. We believe our strategies are working. Both third quarter total and comparable store design sales growth were significantly above the company's growth rate. We are pleased to see strong growth in both transactions and average ticket. Let me turn my comments to growth in our commercial flooring business, which includes Spartan Surfaces and our regional account managers, or RAMs, which work with our stores. We are very pleased that the sales and earnings growth at Spartan Surfaces where third quarter sales and earnings results, once, again exceeded our expectations. Spartan's third quarter sales increased by 45.3% compared to the third quarter of 2021 and EBIT increased by 63.3% from the same period last year. Our non-Spartan commercial sales also remained strong. As we have discussed in prior earnings calls, we remain excited about the commercial market opportunities and our commercial strategies. In closing, we believe that we have demonstrated that we have the right teams, strategies and agile business model to navigate the challenging macroeconomic environment successfully. As we approach the end of this year, we're focused on setting ourselves up for continued success into fiscal 2023 and beyond. I will now turn the call over to Trevor to discuss in more detail our fiscal 2022 third quarter financial results and our outlook for the remainder of the year.

Thanks Tom. We delivered another very solid quarter and nine months of financial results growing our sales and our operating income, while up against record performance in each of the last two years and amid a housing downturn caused by rising interest rates and persistently high inflation. Our results are a testament to the strong execution of our growth strategies, the strength of our business model and most importantly our people. We are particularly proud that these results were achieved in a period of four-year high inflation, supply chain cost volatility, increase in mortgage rates and 13 months of year-over-year declines in existing home sales with September existing home sales down 23.8% versus the same period last year, representing the largest year-over-year decline over the last 13 months. Let me now turn my comments to some of the changes among our significant line items in our fiscal 2022 third quarter income statement, balance sheet and statement of cash flows. I will then discuss how we are thinking about the remainder of fiscal 2022. We are pleased with the sequential improvement we are making towards recapturing our gross margin rate. Our third quarter gross margin rate decreased a better than expected 90 basis points to 40.8% from 41.7% last year, increasing our confidence in achieving a target of approaching 41% by the end of fiscal 2022. The better-than-expected sequential improvement in our gross margin rate, is primarily due to lower supply chain costs as well as strategic retail price increases. As expected selling and store operating expenses increased 28.4% to $28.7 million from $21.7 million during the same quarter last year, due to new store openings and additional staffing to support our sales growth. Our selling and store operating expenses rate deleveraged 70 basis points to 25.6% from 24.9% last year, due entirely to new stores as our comparable stores leveraged 10 basis points versus last year. We experienced higher credit card transaction processing fees, wage rate pressure and higher depreciation expense associated with new stores partially offset by leveraging our rent cost on higher sales. Third quarter general and administrative expenses increased 4.2% to $54.7 million from $52.5 million last year, leveraging 100 basis points from the same quarter last year. The general and administrative expense growth is primarily due to higher personnel and operating costs to support our store growth, including increased store support staff. The majority of the leverage came from lower incentive compensation accruals. Preopening expenses decreased 3.2% to $10.4 million from $10.7 million, during the same quarter last year. The decrease was primarily due to the shift in the timing of new store openings compared to the previous year's period. Third quarter net interest expense increased $1.9 million or 169.8% from the same period last year. The increase in interest expense was primarily due to an increase in our ABL facility borrowings, and interest rate increases on our outstanding debt partially offset by an increase in capitalized interest. Our third quarter adjusted EBITDA increased a better-than-expected 23% to $147.9 million from $120.2 million last year, primarily due to our sales performance and managing our cost structure well. We were pleased that our third quarter EBITDA margin declined by a less-than-expected 20 basis points to 13.5% from 13.7% last year, given the inflationary cost pressures we face. Third quarter GAAP net income increased 2% to $76.2 million and diluted earnings per share increased 2.9% to $0.71 per share. Third quarter adjusted net income increased 17.2% to $75.3 million and adjusted diluted earnings increased 16.7% to $0.70 per share. Our third quarter weighted average diluted share count was 107.5 million, unchanged from the same period last year. A complete reconciliation of our GAAP to non-GAAP earnings can be found in today's earnings release. Moving on to our balance sheet and cash flow. We ended the third quarter of fiscal 2022, with $1.3 billion in inventory on our balance sheet, an increase of 58.5% from the same period last year and a 31% increase from the end of fiscal 2021. The inventory growth was in line with our expectations and reflected our new store growth, intentional investments we have been making to improve our in-stock inventory, inflation and the addition of new innovative SKUs. As discussed in our fiscal 2022 second quarter earnings call, we expect our year-end fiscal 2022 inventory growth to be moderately above fiscal 2022, annual sales growth primarily due to inflation. For the 39 weeks, that ended September 29, 2022, net cash provided by operating activities was $7.3 million compared to $364.9 million in the same period last year. The decrease in operating cash flow was primarily, a result of a 31% growth in our inventory and the timing of inventory receipts and payments. At the end of the third quarter of fiscal 2022, we ended with $601.8 million in unrestricted liquidity and available including $7.7 million of cash and equivalents as well as $594.1 million for borrowings under our ABL facility. Let me now update you on our 2022 capital expenditure plans. We previously estimated fiscal 2022 capital expenditures to approximate $480 million to $500 million. We now expect our fiscal 2022 capital expenditures to approximate $445 million to $465 million, down about 7% from our prior guidance primarily due to construction delays for new store openings in 2022. I will now turn my comments to, how we're thinking about the fourth quarter of fiscal 2022. The Federal Open Market Committee's unprecedented interest rate increases this year are having a direct impact on the housing market and will have a lag effect on slower broader economic growth and inflation well into 2023. Therefore, we are prudently expecting our transactions to continue to decline in the high single to low double-digit range in the fourth quarter of fiscal 2022, unchanged from our prior expectations. We expect our fiscal 2022 annual comparable store sales to increase within a range of 9% to 10%. Our annual fiscal 2022 total sales are now expected to approximate $4.25 billion to $4.285 billion compared with our prior guidance of $4.290 billion to $4.330 billion primarily due to a more difficult macroeconomic environment, and the associated slight lowering of our comparable store sales expectations and the timing of our new store openings. The improvement we are experiencing in our product margin from favorable supply chain costs relative to our internal plans gives us more confidence that we can achieve a target of approaching a 41% gross margin rate in the fourth quarter of 2022. Our annual adjusted EBITDA is now expected to be $565 million to $575 million compared with our prior guidance of $565 million to $580 million. We expect depreciation and amortization expense to approximate $153 million unchanged from our prior guidance. Net interest expense of $11 million compared with our prior guidance of $9.5 million due primarily to higher interest rates, a tax rate of approximately 24%, which excludes tax benefits resulting from stock option exercises and the vesting of restricted stock and restricted stock units unchanged from our prior guidance. Diluted weighted average shares outstanding are now expected to be $107,500,000 also unchanged from our prior guidance. And we expect fiscal 2022 annual adjusted diluted earnings per share to be in the range of $2.65 to $2.75 compared with our prior guidance of $2.65 to $2.85. Let me close, by saying how proud our executive team has been of the performance of our business, given the external challenges we have to navigate. I would also like to acknowledge our associates and our vendor partners for their commitment, to serving our customers each and every day. Operator, we will now take your questions.

Thank you. We will now begin our question-and-answer session. [Operator Instructions] First question will be from Chuck Grom with Gordon Haskett. Please go ahead.

Okay. Thanks. Congrats on a good quarter. Curious when you look at the earliest of early leading indicators for the business whether that's website searches product samples. I'm curious, what you're seeing and how is that influencing your planning assumptions for the next couple of years both from a comp and store growth perspective?

Hi, Chuck, this is Trevor. I mean I think you've seen us have a deceleration in our comps, as we move through the year deceleration in transactions as the macro environment has gotten a little bit more difficult. Based on the guidance we gave, we just were up a double-digit comp. And I think Tom said we were up 5% quarter-to-date so far. So our view is as things get tougher, we're going to see a deceleration comp and almost all of that driven by transactions.

Okay. Fair enough. And then on the inventory build, Trevor, is there any way to unpack that 58% increase across the four buckets that you gave, the new stores improving in-stocks inflation and new SKUs. And just to remind us you expect to get back to close to sales growth by the end of the fourth quarter. Is that correct?

Yeah. I'll answer the second one first, which is yeah our expectation is that we're going to have a mid-20% sales growth and we would expect our inventory to grow at a slightly higher rate than that. And most of that as you get to the end of the year, the growth above the sales will be due to inflation. Our actual number of units will not be up more than our sales growth just the inflationary impact of it. I don't think we went through and reconciled the inventory growth across those categories. Probably inflation in new SKUs is going to be the largest driver of that increase in inventory for the third quarter that we just ended.

Okay, great. Thank you.

Thank you. And our next question will come from Steven Zaccone from Citigroup. Please go ahead.

Great. Good afternoon, everyone. Thanks for taking my question. I wanted to ask around the quarter-to-date commentary regarding up 5%. Could you talk a little bit more about what you're seeing in the business? Maybe what's driving that deceleration on a month-over-month basis? Are there any big differences by region to call out?

I'd say a couple of things. First off, October of last year was a difficult compare where our comp last year in the month of October was 16.2% versus September was 10.8% last year. So we're lapping a little bit more difficult October. As Trevor mentioned and as we said the transactions continue to decelerate the effects of what's going on within the macroeconomic environment or we're not immune to that. So we're seeing some of that. And with this thought to be prudent if we're a little bit below what we thought we would be during the month of October. But if we're -- so we thought it'd be prudent to make sure that we were thoughtful about the rest of the year. From a regional standpoint, we're pretty consistent across the country. I would say there's maybe a little bit of deceleration in the West Coast of the United States is a little bit different, a little bit slowing, a little bit faster than some of the other parts but not materially enough. It's just -- it's a little different than historical.

Thank you. The next question will be from Zack Fadem with Wells Fargo. Please go ahead.

Hey, good afternoon. Could you walk us through the average ticket drivers in a little bit more detail and perhaps carve out the impact of incremental pricing the new SKU innovation you called out versus the impact of your initiatives such as Design and Pro. And then as we look forward to Q4 and into 2023, how should we think about the average ticket versus transaction trend?

Yeah, this is Trevor. The first half of the year more of our ticket, because we've had a strong ticket all year. More of our ticket was coming from the initiatives that we were driving. You guys probably heard us say on the last two calls, our Pro business continues to be exceptionally strong. That's a higher ticket. Our e-commerce and design businesses are strong. That's a materially higher ticket. As our rigid core vinyl business continues to be strong. That's one of the highest tickets we have in the company. And consumers are still to this point still picking better and best. And so for the first half of the year, it had more to do with those initiatives and less to do with the inflationary retail increases. The back half of the year is probably becoming more on some of the retail increases we've had to push through because of the inflationary environment. A lot of those higher supply chain costs working through our weighted average cost system was projected and is coming to fruition that we're passing along more of those retail increases. So as you think about the back half of 2022, a bigger component of that high ticket is being driven by the retail increases, although I will mention all of those four initiatives Pro, Design e-commerce and good, better, best continue to be a big part of our ticket. I think as we think about next year, I would expect that we're going to have a lot of the same, meaning that I would expect if we said on the call that our transactions are going to be down in the high single digits to low double digits as we exit this year. Our Q1 compares are pretty difficult. It's probably the hardest compare we have as we get into 2023. So I would expect those transaction trends to continue. From a ticket perspective though as I mentioned earlier, we didn't have a lot -- a very material increase in ticket in the early part of the year. So we still should have some ticket upside as we start next year because where we started with pricing increases was pretty modest. Where we're going to end with pricing increases is going to be higher. So I think similar to the trends you've seen most of this year, I would expect our transactions to continue to be negative at least through the first half of the year until we come up against easier comparisons in the second half of the year, but somewhat offset by a higher ticket because of the retail increases at the end of 2022 are going to be higher than when we started in 2022.

Got it. That's helpful. And second, could you talk through the latest class of new store metrics relative to where things were trending a year or two ago when housing fundamentals were much more robust. And then since this is the first time we've seen your business in this particular housing backdrop to what extent should we expect the new store model to moderate in terms of 2023 new store productivity, as well as the comp waterfall impact?

Yeah. If you look at the class of 2020 and the class of 2021 they're basically -- well the 2020 fully anniversaried the class of 2021 is pretty much anniversaried, I mean those stores are great. They're doing close to $16 million in sales and doing over $3 million in four-wall EBITDA in the first year. So they're doing exceptionally well. I think the class of 2022 we got a lot to open. We're opening 13 of the 32 stores this quarter. So we, obviously, have a lot to weight on those. But I think they're going to be similar. I mean we'll see how that plays out. The volume is maybe a little bit lower just because the backdrop is what it is. But I'm still hopeful that those stores are going to be somewhere in the high $15 million to low $15 million sales range and hopefully keeping around that $3 million in four-wall EBITDA. So it looks like the class is going to be good. And the stores that we had to open this quarter, they're really good markets that we know how to operate very well. And so we're feeling good about the class of 2022. And we'll see on class 2023 but as we look at it from a pro forma basis, I realize we're walking into a tougher macro environment. But from a pro forma basis we feel like the class of 2023 also looks at a good class of stores.

Got it. Appreciate the time.

Yeah.

And the next question is from Christopher Horvers from JPMorgan. Please go ahead.

Thanks. Good evening guys. So my first question is how do you think about the long-term structural gross margin of the business? You talked about approaching 41% and there was some upside in the third quarter. If we went back to 2019, it was 41.8% and 2020 it was 42.5%. So I guess what are the puts and takes around getting back to that? And is there any, sort of, concern that if as, sort of, the effect of housing causes a category to slow down that maybe the independents become more promotional, especially, if they're now sourcing some product that's arriving with less freight?

Hi, Chris, this is Tom. I'll start on the question. There's a lot there. I still think that over time, we can get back to the historical margin rate. We're not talking about next year yet, but we saw a nice improvement this year. We've been able to achieve what we wanted to achieve in getting our margins coming up from -- we ended last year in the 3.5% range and we're going to end this year as Trevor said approaching 41. As we get to next year, as we get to the middle part of the year we're going to get continue to get some benefit from the supply chain costs. We're seeing some of that now versus what we anticipated, but when you look at year-over-year comparison as you get to the back half we'll see some of that. So that should give us some help on the margin side. And we have our initiatives things that we're doing with the designers. We talked about it where we have 900 designers in the stores. That's still -- I think we're still in the early innings of how we're going to serve customers with the design initiative. When they get involved we do get a better average -- I mean, excuse me a better gross margin on those sales. We've got better and best continues to do well. We'll continue to push on that. That will help our margins. So long way around it, we've got some internal initiatives and then we should get some supply chain benefit which can help us start getting back to historical margin rates. The time of getting back to them is a bit of a question mark. We're still working on what 2023 will look like and then we'll talk about it as we get closer to it. But I certainly have every intention of getting back there. From a competitive standpoint, we're in a difficult environment now. I mean you can look at our publicly traded competitors and kind of how they're performing. And the independents I feel like they often perform like our publicly traded independents -- excuse me our publicly traded peers. So I think, they're in a difficult environment Chris and if they're promotional, we're seeing some of that now, but it's nothing that gives us any alarm. Our price spread is still significantly better. So I'm less worried about that affecting our gross margin than anything else. Trevor do you want to add anything to that?

I mean, the only thing, I'll just give also credit. I mean, I think, the proprietary nature of some of the products that we have in the categories that we're performing well in are very difficult to emulate. We own a lot of those brands and technologies for some of the best categories that will make it very difficult for certainly the smaller competitors which is 60% of the industry, but it's probably more of that than ourselves because that's where you get the better and best products. I just think our assortment and our sourcing and our team have done just a much better job there and it will be hard for the independents to compete with those products.

So then just as a follow-up. I know this has been asked a lot of you in the past few months. But your price gaps relative to the independents, I mean, should have widened given how you've passed price on the lag with the inventory turn. So can you maybe talk about how you see how your price gaps have widened over the past year? Just to put into context Tom's earlier comment.

Yes. I mean, I feel and Ersan chime in if you want to chime in, but I -- we feel very good about our spreads versus the independents. We check our competition on a weekly basis. And this is a difficult category to compare price. But as we look at it and as we see the world the spreads in our opinion are better today than they've been historically. So we feel really good about the moat around pricing.

Got it. Thanks very much, guys. Best of luck.

The next question is from Michael Lasser from UBS. Please go ahead.

Good evening. Thanks a lot for taking my question. Understanding that you don't have any more insight into what the macro is going to bring than we do. But you do have more insight into the sensitivity of your P&L for 2023 into how your sales might respond? So if you were to comp down 5% next year what do you think your operating margin would look like in that type of outcome?

You're saying if our comps were actually negative 5% next year just to understand the question, Michael.

That's exactly right, Trevor.

I don't think that's going to happen, I guess, would be my first answer. But if that were to happen, I mean, as you would expect our operating margins are going to go down. We literally would have to run that through the model. There's a lot of variables to do that. But yes our operating margins would be down.

And I just would comment too that this is a -- it's a potential valley, right? And we're looking over the valley. We're playing in for the long game. We're not going to we're still opening 32 to 35 stores next year and we've got a long way to get to 500 stores and grow a big commercial business. So we're not going to overreact and do anything stupid that jeopardizes our long-term strategies in the event that that much more difficult.

I do think too just I guess one thing helping on the model if that were to happen I think we just hopefully said kind of a mid-30s to maybe a slight higher mid-30 on a downside scenario from a flow-through perspective. So if somebody really wanted to model that negative of a comp you could use a mid-30s to above a mid-30 flow-through on whatever that math would look like.

Would that change at all just given some of the gross margin drivers that you have and your ability to recapture some of the gross margin that you've lost?

Yes. I mean, that's why we -- that's exactly why we need to run through the model and to get to that level of negativity which again I don't that doesn't we don't currently see that being the case for next year. But, yes, especially if things are that bad for us what they're going to be like in the industry is going to be a lot worse. Supply chain costs would likely be coming down a lot more. There are probably more abundant labor than all those things. So that would be something that that hopefully we would do hopefully we could possibly do a bit better than that.

And then my follow-up question is on the fourth quarter outlook the comp outlook. So you said that you did not change your transaction guidance or your transaction assumption. So inevitably that means you lowered your ticket assumption. So a, why would that be the case? And b, could there be upside to the fourth quarter comp outlook if you start to see the hurricane-related spending come through? And is there any way to inform what the arc of that looks like based on the experience that you had back in Houston a few years ago?

On the first question I would say a big part of the sales reduction had to do with the new stores. As Tom mentioned, we opened fewer new stores than we thought and that been cascaded later into the quarter. So about half of that reduction in sales in the fourth quarter versus what -- where the Street was before just due to the timing of the new stores. The other piece of it is yes, we are not going to raise our retails as much as we would have thought back in July and August when we created guidance partly because our teams have done a good job on cost so we don't have to pass along some of those retail increases. And those are the two main reasons. As far as Hurricane Ian that's just a very different hurricane than hurricane -- the one we had in Houston Hurricane Harvey back in 2017, in that case the hurricane came in and it parked over Houston and it just poured rain and we saw our business take off immediately. As we all know about Hurricane Ian it was much more destructive a lot of stuff got destroyed. And it's really it's only affecting a small portion of our stores in Southwest Florida maybe up a little bit through the Orlando market as well. We're going to get a little bit of benefit up through Central Northern and Central Florida as well. But also we're three times the size we were as a company then as well. So it will be much less impactful. So it's going to have a little benefit. It's less than -- it's currently running I think less than 50 basis points benefit to October. But again I think as Tom can give us more detail it's going to be a long tail because the destruction was a lot worse than it was in Harvey. So there'll be a modest benefit for a period of time but currently it's pretty small

Thanks very much.

Thank you. The next question is from Steven Forbes from Guggenheim. Please go ahead.

Good morning, Tom, Trevor. I want to focus on the Pros. So curious if you can give us an update on the number of Pro from your members you have on the platform today. And then maybe just comment on any high-level thoughts in terms – or high-level sort of indications that you're seeing from the behavior – how are they engaging? Is it any different how are they speaking to their sort of pipeline of jobs, et cetera? Any insight there would be helpful.

Yes. I don't have a specific number but I think 80% of our active Pros are part of the loyalty program and we sort of define that as an active Pro someone who's purchased from us within the last 12 months. So the vast majority of our Pros are on the PPR program. We've talked about historically, I think the PPR members again it's 80% of our transactions now. So this is a hard number to quote but historically, they spend three times as much as they have in the past. Tom quoted this number our Pro business where the Pro is actually transacting with us with their credit card is over 40% of our sales. Just over a year ago that was like 33%, 30%. So we've had a meaningful increase. Pro Premier is one of the solutions why they buy from it. There's many things why they buy from us. It's in-stock quantities, it's the quality of the product, it's the quality of the sales team. It's the inspirational nature of the website, it's free design services, store your product with us, liberal return policies. And so while the loyalty program is one of many important solutions and is performing exceptionally well, it's part of a holistic strategy to continue to service those Pros. One other thing I'll mention we did this year that's been a huge home run is we're one of the only retailers that gives very detailed training on how to install products like large format tile is an example. And that's been tremendously well received. We see the sales after we give those trainings for those Pros grow up a lot.

So I think a couple of things to add to Trevor is pro transactions were up 7% during the quarter, which was good. And the top 10% of our PPR members spent 24% more than they did a year ago. So the longer they get in the program the more that they spend with us. That's an encouraging sign. And then the last thing is we signed up 29,000 new pros. If you think about that that's 185 stores in a really difficult macro to be able to sign up another 29,000 Pros during the quarter, that's all good for the long term. So the Pro businesses we're pleased with it. We're fortunate to have it because in a difficult macro environment. Pros got to eat and they're going to find business, they're going to lower their prices to consumers to get that business. So the better we can be with the Pro, the better off they can help us muscle through a difficult macro.

And then maybe just a follow-up on that right because they obviously have to eat have to stimulate demand and they could do with their labor. So what can you do strategically to really drive loyalty and be there for your Pro partners here during a challenging macro as you think about really shoring up that loyalty wallet share dynamic as we head in the next cycle?

I'll mention a few. Trevor mentioned one like a training of our Pros. We do – we're doing training classes with our professionals to teach them how to install things they haven't installed before. That helps them grow their business. Our loyalty program has over 20 different service components that help them figure out how to grow their business better. So they can get access to help with payroll, help to build a website, whatever it is to help them grow the business. Our prices are better than everybody, so they can come in and they can access inventory at the best price of the market. All of those things help our Pros grow their business. So – and we've always treated our process partner. We don't install the product. They know that they don't have to worry about sending their customers into our stores and losing the customer because someone is going to offer them install. So I think we do a lot to help them grow the business and I think our efforts it shows in our results.

Thank you.

And the next question is from Simeon Gutman from Morgan Stanley. Please go ahead.

Hey, Tom, hey, Trevor. A theoretical macro question. This time is different argument the consumers staying in homes because of high mortgage rates. Is there anything empirical why that could support a better macro? And where do you stand on this? Because we're struggling with this concept, I'm curious how you guys think about it?

I think that's right. I mean since 2019 home prices are up 46%, $4 trillion more value in those homes that that's likely to come down some as the appreciation kind of slows a little bit with mortgage rates going up and less homes being sold. But people have got a lot of value. And I think if you were in a three3-bedroom ready to get that four-bedroom because your family is growing, but you can't afford to then I think you're more likely to invest in the existing home you have. And I know some of our larger competitors have talked about that being a piece of why their business continues to be strong as well. So our view is that, if it wasn't for the home equity value yes, this would be a much tougher environment. But the people have got money. And the other thing for us when you look at the existing home sales data when you really dig into the details of it, the big reductions are in the lower income housing. And you have much less of a reduction in the moderate to higher income housing. And we have an average consumer income of $100,000. So that feels better to us. And then I looked at some data today. If you look at where the majority of our sales come from, we have over – I think 50%, 60% of our sales are coming from net migration stakes, meaning Nevada, Arizona, Texas, Florida, Georgia, the Carolinas and so we have a disproportionate amount of our sales in some of those good states as well. So listen, it's going to be a tough macro environment for who knows how long, but I think we're well positioned from where our stores are, what our assortment looks like and what we can do for Pros that others can't that will put us in a better position than most.

I'd add just one thing to that Trevor. The point about people not moving and staying within their homes and deciding to invest in their flooring, this is going to be a different cycle for us. Just the innovation within the products is so much different that if you bought flooring five years ago, there's so much better options today like that innovation and bastions changes. So your flooring feels older quicker just from a parent standpoint. So hopefully that can stimulate some demand and help again offset some of the challenges the macro presents.

And this topic either was covered in prepared remarks or maybe on a question. Can you frame how much price – and I know not an exact number but how much of 2022 is priced, do you carry into 2023? And you said I think transactions are flattening out. Within that what's happening I guess with units, meaning are people buying as big projects? Is if that's the right way to look at it? Thinking if units are actually stabilizing. And I don't know if you look at the business that way.

Yes. We watch square footage pretty closely. And it's a similar trend to the transactions. We actually were doing better for the first kind of seven months of the year. But here recently we've seen a bit of a deceleration in our square foot per transaction as well. But part of the reason that our ticket was stronger is the fact that people were doing – especially with our Pros being a bigger piece of our business, our overall square footage was doing a bit better but that has decelerated a bit as of the last three months as well.

Thanks. Good luck.

Ladies and gentlemen, in the interest of time, we please ask that you limit yourself to just one question. At this time, we'll move to our next question, which is from David Bellinger with MKM Partners. Please go ahead.

Hey guys. Thanks for the question. Another one on quarter-to-date. I appreciate the tougher comp in last year's October that you called out. But it's still a pretty meaningful deceleration on a three-year geometric stacked basis here. So, your comments are on the Pro seem pretty constructive to date. Is that deceleration all from DIY? And was there anything different in price, call it late in the Q3 period or early into Q4 that led to that quick downshift in comps?

I think -- I mean, I'm just looking at my own three-year geometrics, assuming I did my math right. I think we had a 13 -- or a 15% in Q1, 13.4% in Q2, 13.6% in Q3 and we're probably going to be a little bit below that in Q4. On a number basis, yes, that mid-single-digit comp was a pretty -- it was definitely lower than it was previous quarter. The other thing to take in mind is for most of this year, we weren't going up against retail increases. As we got into Q4 last year, we started seeing those heavy supply chain cost increases in kind of September, August and so we started having price increases modestly, but we started having some price increases. So now we're going up against last year, when we were actually raising retails. So there's a ticket component of that, where we won't have quite as much ticket just because we're raising prices at this point last year. But I think the bigger portion of it, just has to do with the transaction deceleration going into the negative high single digits versus low double digits. And as we said in the quarter, we just finished, our transactions were down just over 6%.

And that mostly has to do with the DIY versus Pro. Is that correct?

Sure.

100%. Our Pro business is actually positive.

Got it. Appreciate it. Thank you, guys.

The next question is from Anthony Chukumba with Loop Capital. Please go ahead.

Good afternoon. Thanks for taking my question. Just a real quick one. Anything that you would call out in terms of store associate turnover and/or wages?

Yes. Our wage rate, we continue like most retailers are investing into wage rate. Our wage rate continues to go up. For us to hire and retain the top talent that we need, we've continued to make investments. We also designer has become a bigger initiative for us. I think Tom mention this quarter or last quarter I think we have over 900 designers in our stores as you'd expect we pay a higher designer. Now, they have a much higher ticket, better gross margin, better customer interaction, so you get a good return on those investments. And so our average wage rate continues to increase. Our turnover is higher than it's been historically. We're working hard to see, how we can improve upon that, but we're definitely running at a higher turnover rate than we've run historically.

That’s helpful. Thank you.

And the next question will be from Joe Feldman with Telsey Advisory. Please go ahead.

Hi. Good afternoon guys. Wanted to ask about the commercial business for a minute. I know, it's not as big a part and everybody. You've given us a lot of info on the kind of the consumer side and the pro side. But with the commercial side of the business, I mean, what was driving the growth, it was pretty significant? Is it just off a small base, but it seems like something more is going on there that I was hoping you could just share a little more color on.

Yes. I mean a few things. So Spartan has -- we've had a couple of small bolt-on acquisitions to our Spartan business that have made that growth more meaningful. Spartan has -- we began -- initially was we bought them, we were working on helping them mainly on the supply chain side, but over the last quarter, they're starting to get access to more of our products. So they're getting to be able to sell out a broader assortment. We've encouraged Spartan to invest quicker in outside salespeople, which they have done and that has also contributed. So, I think on the two on the commercial side, there was a bit of pent-up demand different than the homeowner during COVID, commercial kind of slowed. And in the segments that we're in in commercial through Spartan, those are seeing some benefit aftermarket. So we feel good about how it's performed so far and we feel good about how we anticipate it to perform looking forward.

All right. Thanks, guys.

And our final question today will come from Jonathan Matuszewski with Jefferies. Please go ahead.

Great. Thanks for squeezing me in. Just a quick question on in-stock inventory levels Tom or Trevor. Any update there in terms of improvement and where any categories where you may be seeing out of stocks persist? Thanks so much.

Our in-stock is the best it's been all year. Stores look good. Service levels are good. No categories, we've seen nice recoveries across all our categories. So we feel really good about our in-stock and combined with really what's going on with the service centers I mentioned it in my prepared comments, the service scores are the highest they've ever been. So, we feel like we're executing at a really high level to capture share in this difficult market.

Okay. So that's -- that concludes the questions. We have no more questions in the queue. So I will close the call. I do want to say that this -- we anticipate that guarantee that we anticipate that this is Trevor's final call as the CFO. He's asked not to participate in the calls going forward, but we have to that -- he will be on all the calls, but he may talk a little bit less. So, we certainly appreciate all of his efforts as CFO and getting us as a public company to today. We look forward to what he's going to do as President, but definitely want to recognize as he transitions. We'll have more to comment on our announcement on our CFO soon and you'll hear it when we're ready to announce it. I appreciate all your interest. Talk to you on the next call.

Thank you, sir. The conference has now concluded. Thank you for joining today's presentation. You may now disconnect.