Floor & Decor Holdings, Inc. Q3 FY2022 Earnings Call

Good afternoon, and welcome to the Floor & Decor Holdings Third Quarter 2022 Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. 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 August and three in September. Compared with our planned eight warehouse store openings in the third quarter, the lower than expected openings are 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 U.S. 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 transactions 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 content 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 conversion. 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, an 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.

We will now begin our question-and-answer session. 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.

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 want to mention a few points. Firstly, October of last year was a tougher comparison because our comp for that month was 16.2%, compared to 10.8% in September of the previous year. So, we're dealing with a more challenging October this time. As Trevor noted, we continue to see a slowdown in transactions due to the macroeconomic environment, and we are affected by that. Therefore, we expect to be slightly below our initial expectations for October. We think it's wise to be cautious when looking at the rest of the year. Regionally, our performance is fairly consistent across the country, although we are observing some deceleration on the West Coast, which is behaving differently and slowing down a bit more than other regions, but it's not significantly different from past trends.

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. In the first half of the year, our ticket sales were driven largely by the initiatives we implemented, which has led to strong performance overall. You may recall from our previous calls that our Pro business has remained exceptionally strong, contributing significantly to our ticket sales. Our e-commerce and design segments are also performing well, which has resulted in a higher ticket average. Additionally, our rigid core vinyl business is robust, yielding some of the highest ticket averages within the company. Consumers continue to choose higher-quality options during this period. Therefore, the strong performance in the first half of the year was more influenced by these initiatives and less by inflation-related retail increases. Looking ahead to the second half of the year, we expect that retail price increases, due to inflationary pressures, will play a larger role in our ticket composition. We have been passing on higher supply chain costs to customers, which will be reflected in our pricing. Consequently, as we approach the second half of 2022, a significant portion of our high ticket sales will stem from these retail price increases. However, I want to emphasize that our four key initiatives—Pro, Design, e-commerce, and good, better, best—will continue to significantly influence our ticket sales. For the upcoming year, I anticipate that the trends will remain similar. I expect our transactions to decline in the high single digits to low double digits as we finish this year. The comparisons for Q1 will be quite challenging, presenting a significant hurdle as we enter 2023. Therefore, I expect the transaction trends to persist. On the ticket side, we did not experience a substantial increase in ticket prices early this year, which indicates that we may have some upward potential in ticket averages as we start next year. We began with relatively modest pricing increases, but we expect to end with higher prices. Thus, while our transactions may remain negative at least through the first half of the year, we should see a higher ticket average due to the retail price increases that were implemented at the end of 2022, compared to the beginning of 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?

If you consider the class of 2020 and the class of 2021, the 2020 stores have fully matured, and the 2021 stores are nearly there as well. These stores are performing exceptionally well, generating close to $16 million in sales and over $3 million in EBITDA within the first year. We have a lot of openings planned for the class of 2022, with 13 out of 32 stores expected to open this quarter. We are optimistic about these stores, expecting performance similar to the previous classes, although sales volume might be slightly lower given the current environment. I anticipate they will reach the high to low $15 million sales range while maintaining around $3 million in EBITDA. Overall, it appears the class will perform well. The stores set to open this quarter are in strong markets where we have operational expertise, so we are confident about the class of 2022. Looking ahead to class 2023, we acknowledge the tougher macro conditions but still view this class as promising based on our projections.

Got it. Appreciate the time.

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 address your question. There's a lot to unpack. I believe that over time we can return to our historical margin rate. We're not discussing next year just yet, but we have seen a nice improvement this year. We achieved our goal of increasing margins from 3.5% at the end of last year to about 41% as Trevor mentioned for this year. As we move into next year, especially through the middle of the year, we expect to benefit from reduced supply chain costs. We're already noticing some positive changes compared to our earlier expectations, and as we look at the latter half of the year, those improvements will be reflected in our numbers, benefiting our margins. Additionally, we have internal initiatives underway, particularly with our design initiative that involves 900 designers in our stores. We are still early in implementing this initiative, but it tends to improve our average gross margin on those sales. Our better and best product categories continue to perform well, and we will keep focusing on that to support our margins. So, to summarize, we have internal strategies in place, and we anticipate supply chain benefits that should help us return to historical margin rates. The timeline for achieving this remains uncertain, but I am committed to making it happen. From a competitive perspective, the current environment is challenging. Our publicly traded competitors and independents are facing difficulties as well. If they become more promotional, we’ve noticed that, but it doesn’t raise any red flags for us. Our price spread remains significantly better, so I'm not overly concerned about this impacting our gross margin. Trevor, would you like to add anything?

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 believe we feel very confident about our pricing spreads compared to the independents. We monitor our competition on a weekly basis, and while it's challenging to make direct price comparisons, we believe our spreads are currently better than they have been historically. Therefore, we are quite optimistic about the competitive advantage we have in 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.

I would like to point out that we are currently facing a potential challenge. However, we are focused on the long-term strategy. We plan to open 32 to 35 stores next year, and we have a significant goal of reaching 500 stores to expand our commercial business. Therefore, we won't make any rash decisions that could compromise our long-term objectives, even if the situation becomes more challenging.

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. That's why we need to analyze the model to understand that level of negativity, which we currently do not anticipate for next year. However, if our situation is that severe, the industry's condition is likely to be much worse. Supply chain costs would probably decrease significantly, and labor availability may increase. We hope to potentially perform 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 significant part of the sales decline was related to the new stores. As Tom mentioned, we opened fewer new stores than we anticipated, and that affected sales later in the quarter. About half of the decrease in sales in the fourth quarter, compared to previous expectations, was due to this timing issue. Additionally, we will not be increasing our retail prices as much as we had expected back in July and August when we set our guidance. This is partly because our teams have effectively managed costs, so we don’t need to pass along some price increases. These are the two primary reasons. Regarding Hurricane Ian, it was a very different situation compared to Hurricane Harvey in 2017. In Harvey, the hurricane stalled over Houston, leading to heavy rainfall and an immediate surge in business. In contrast, Hurricane Ian was much more destructive, damaging many areas, but it only impacted a small number of our stores in Southwest Florida and a bit in the Orlando market. We will see some benefits in Central and Northern Florida as well, but we are also three times the size we were back then, which will lessen the impact. Currently, the benefit is running at less than 50 basis points for October. However, as Tom can elaborate on, this impact will likely have a lasting effect because the destruction was far worse than during Harvey. Therefore, while there will be a modest benefit for a time, it's currently quite 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 partners. 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.

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 three-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.

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 my assessment of the three-year growth rates shows that we had a 13% or 15% increase in Q1, 13.4% in Q2, and 13.6% in Q3, and we are likely to be slightly below that in Q4. In terms of numbers, the mid-single-digit comparison was definitely lower than the previous quarter. It's important to note that for most of this year, we weren't facing retail price increases. As we reached Q4 last year, we began to experience significant supply chain cost increases around September and August, leading to some modest price hikes. Now we are comparing against the previous year when we were actually increasing retail prices. This means we might not see as much growth in ticket size due to those price increases last year. However, the primary reason for the deceleration in transactions is moving from negative high single digits to low double digits, as we observed in the last quarter when our transactions were down just over 6%.

Thank you. 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 mentioned 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.

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, there are a few points to discuss. Spartan has made a couple of small acquisitions that have contributed to our growth. Initially, after we acquired them, we focused on enhancing their supply chain, but in the last quarter, they’ve started accessing more of our products, allowing them to offer a wider range. We’ve also encouraged Spartan to invest more in outside salespeople, which they’ve successfully done. This has further contributed to their growth. Unlike homeowners during COVID, where we saw some slowdown, there has been pent-up demand in the commercial sector. The segments we operate in through Spartan are benefiting from this after-market demand. Overall, we are pleased with its performance thus far and are optimistic about its future prospects.

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, that concludes the questions. We have no more questions in the queue, so I will close the call. I want to mention that we believe this is Trevor's final call as the CFO. He has chosen not to participate in future calls, but he will join us on all the calls and may speak less. We truly appreciate all his efforts as CFO and for guiding us to where we are as a public company today. We look forward to his role as President and want to acknowledge his transition. We will provide more details about our new CFO announcement soon, and you will hear it when we are ready to share. Thank you for 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.