Greetings. Welcome to Floor & Decor Holdings, Inc. Fiscal 2023 Third Quarter Conference Call. At this time, I'll now turn the conference over to Wayne Hood, Vice President of Investor Relations. Mr. Hood, you may begin.

Thank you, operator, and good afternoon, everyone. Welcome to Floor & Decor's fiscal 2023 Third Quarter Earnings Conference Call. Joining me on our call today are Tom Taylor, Chief Executive Officer; Trevor Lang, President; and Bryan Langley, Executive Vice President and Chief Financial Officer. Before we start, I want 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, included in 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 and 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 2023 third quarter earnings conference call. During today's call, Trevor and I will discuss some of our fiscal 2023 third quarter earnings highlights. Then Bryan will provide a more in-depth review of our third quarter financial performance and share our thoughts about some of our financial projections for the remainder of fiscal 2023. We are proud to deliver third quarter diluted earnings per share of $0.61, especially amidst the continuing economic challenges posed by 30-year mortgage interest rates that are now about 8%, near record low existing home sales of 3.96 million units annualized in September, the ongoing pressures on housing affordability and the slowing sales of large ticket discretionary products. Our fiscal 2023 third quarter financial results are a testament to our company's agility and commitment to executing our key growth and customer engagement strategies, which we believe will continue to widen our competitive moat. As many of you know, our industry and company have been affected by the Federal Reserve's current interest rate policies aimed at curbing economic growth and moderating inflation to 2% over time. The lagged effect of these policies is exerting greater-than-expected pressure on existing home sales, and in turn, our sales, more than we previously expected. We were expecting that existing home sales would approximate 4.1 million to 4.3 million units annualized as we move into the second half of 2023. But regrettably, this has not materialized to date. As Bryan will discuss in more detail, we have experienced an unexpected accelerated decline in comparable store sales from the lagged effect of these policies in the early part of the fourth quarter of 2023 and have begun to tighten expenses further in November to align with the recent accelerated decline. We believe the ongoing impact of these monetary policies will continue to suppress home remodeling into fiscal 2024, which could lead to a decline in our comparable store sales for the year. Therefore, we believe it is prudent to approach fiscal 2024 with more rigor in our expense management and added discipline in our growth investments and capital spending. Additionally, we think it is important to add a level of flexibility and optionality to our operating and store opening plans in 2024, given the current macroeconomic environment. I am proud of how our teams have stepped up to this short-term challenge. We are not standing still and see evidence that our strategies to grow our market share in this challenging period are working even when industry sales are contracting. We are fortunate that the strength of our business model, balance sheet, and cash flow allows us to continue investing in new stores and merchandising growth initiatives in the face of these near-term headwinds. For example, we intend to test an outdoor department within our stone department in 10 to 12 stores early next year, including full outdoor-focused vignettes in select design centers to better show our assortment. I believe that our demonstrated history of strong and agile execution, coupled with the investments we continue to make in new warehouse stores and merchandising, will position us for accelerating sales, market share, and strong earnings growth when the industry growth returns. Let me now turn the call over to Trevor.

Thanks, Tom. I also want to express my appreciation to all of our associates for their dedication to serving our customers and executing our key growth initiatives towards operating at least 500 stores in the U.S. It is important to note that we view ourselves as a young disruptive growth company with only 207 warehouse stores in the U.S. at the end of the third quarter of fiscal 2023. We continue to make important long-term investments as we have conviction that over the long term, we can achieve returns above our weighted average cost of capital, just as similar investments have allowed us to be approximately 20 times the size we were just over a decade ago when Tom and I arrived at Floor & Decor. We have demonstrated that we can manage a growth business focused on long-term profitability and return on capital during difficult periods such as in 2018, when existing home sales declined; in 2019, when the U.S. government imposed tariffs and antidumping and countervailing duties on many of our products from China; and in 2020 and '21 during the COVID-19 shutdown and the related supply chain disruptions. As Tom mentioned, we are not standing still as we navigate this challenging period of contracting industry sales. Our growth and profit have never been a straight line, but when measured over the long term, we believe we are well positioned. We intend to continue growing through this cyclical housing downturn by capitalizing on our everyday low prices, value-driven options, trend-right product assortments, insight job lot quantities, and exceptional customer service provided by our store associates. Turning to our fiscal 2023 third quarter sales. Total sales increased by 0.9% to $1.100 billion from the same period last year. Our fiscal 2023 third quarter comparable store sales fell 9.3% from last year. Comparable store sales declined 8.2% in July, 10.1% in August, and 9.7% in September. As a reminder, our fiscal 2022 third quarter comparable store sales increased 11.6% due to a 19.5% growth in our average ticket. Our fiscal 2023 third quarter comparable transactions declined 6.8%, and our comparable store average ticket declined by 2.8%. While we are encouraged that the sequential decline in transactions improved from the peak decline of 10.4% in the fourth quarter of fiscal 2022 and 9.9% in the first quarter of fiscal 2023, our average ticket remains under pressure. The pressure reflects cycling past retail increases last year, customers continuing to purchase less square footage, and the impact of strategic decisions to lower retail pricing selectively on specific SKUs. We continue to see homeowners and pros engaging in fewer and smaller-scale flooring projects, and they are very intentional in their purchase decisions. For example, they are choosing a single bathroom project rather than a bathroom and a kitchen project or a two-room project rather than a three-room project. Additionally, the cost of financing projects has risen due to increased interest rates, fewer subsidized financing programs, and living standards. Collectively, we believe these factors are contributing to us selling less square footage compared to last year. That said, when consumers are considering a flooring purchase, we continue to see ongoing customer preferences towards our better and best price point products, where we offer industry-leading innovation, trends, and styles at everyday low prices. From a regional perspective, comparable store sales in our Western and Southern divisions were the weakest in the third quarter of fiscal 2023. From a merchandising standpoint, our initiatives in tile, installation materials, and adjacent categories led to comparable store sales that were significantly above the company average. We are pleased that our total sales to our e-commerce store increased 8.3% year-over-year. As a result, the sales penetration rate increased 160 basis points to 18.9% from 17.3% last year, further reaffirming that our connected customer strategies to drive engagement are working. We are also continuing to invest in design services to drive engagement with homeowners and pros by further expanding our design test in the third quarter. We have found that when our designers engage with homeowners in their homes, we increase our ability to become involved with larger projects. Turning to our early fiscal 2023 fourth quarter sales trends. Our fourth quarter-to-date comparable store sales were down 11.9% below what we expected coming into the quarter and greater than the third quarter's decline of 9.3%. Consequently, we upgraded our fiscal 2023 earnings guidance in today's press release to take into consideration the slowing sales trends.

Thanks, Trevor. As Tom mentioned, we are proud to report fiscal 2023 third quarter diluted earnings per share of $0.61, which was at the high end of our expectations, despite third quarter sales that were modestly below our expectations. Like the previous quarters in 2023, we achieved these results by delivering on our commitment to growing our gross margin rate year-over-year while managing our competitive price gaps and growing our market share. As CFO, I'm equally pleased with how we are managing our inventory and merchandise in-stock levels, which enabled us to report a $691.7 million positive swing in year-over-year operating cash flow and a significant increase in free cash flow. Now let me turn my discussion to some of the changes among the significant line items in our third quarter income statement, balance sheet, and statement of cash flows in each case compared to the same period last year unless otherwise stated. Then I will discuss our outlook for the remainder of the year and provide a framework for how we are thinking about fiscal 2024. Third quarter total sales increased 0.9% from last year. However, gross profit grew 4.5% due to a 140 basis point increase in our gross margin rate to 42.2% from 40.8% last year. The increase in gross margin rate is primarily due to retail price increases we took last year coupled with a decrease in supply chain costs starting in late 2022 that continued into the third quarter of 2023. As a reminder, we are on the weighted average cost method of accounting, and as such, the supply chain cost reductions we started to experience late last year and into this year are still working their way through our income statement through the remainder of 2023. Third quarter selling and store operating expenses increased 9.9% to $308.6 million. The growth is primarily attributable to higher occupancy costs related to an increase in the number of warehouse stores operating since September 29, 2022. Wage rate increases and higher credit card transaction expenses are also contributing factors. As a percentage of sales, selling and store operating expenses increased approximately 230 basis points to 27.9% from last year. The increase was primarily due to the deleverage in occupancy and other fixed costs from a decrease in comparable store sales. Third quarter general and administrative expenses increased 9.5% to $59.9 million from last year. The growth is due to investments to support our store growth, including increased store support staff, higher depreciation related to technology and other store support center investments, and operational expenses related to our Spartan subsidiary. As a percentage of sales, general and administrative expenses deleveraged 30 basis points to 5.3% from 5.0% last year, but the expense rate improved from the second and first quarters of 2023. The year-over-year increase in expense rate is primarily due to the decrease in comparable store sales, partially offset by lower incentive compensation pools. Third quarter preopening expenses increased by 37.0% to $14.2 million from last year. The increase primarily resulted from an increase in the number of future stores that we were preparing to open compared to the same period a year ago, as well as costs related to delays in new store openings. Third quarter net interest expense decreased to $1.2 million from $3.0 million last year. The $1.8 million decrease in interest expense is better than planned and primarily due to a decrease in average borrowings outstanding under our ABL facility and an increase in interest capitalized, partially offset by interest rate increases on outstanding debt. Third quarter income tax expense was $17.6 million compared to $22.5 million from last year. The effective tax rate decreased by 170 basis points to 21.1% from 22.8% the previous year, primarily due to increased tax benefits related to stock-based compensation. Excluding the impact of excess tax benefits, our third quarter tax rate was approximately 23.7% compared to 23.9% last year. Third quarter adjusted EBITDA decreased by 4.7% to $140.9 million from last year, primarily from expense deleverage from the 9.3% decline in our comparable store sales. However, EBIT declined by a larger 16.6% from last year due to a 27.1% increase in depreciation and amortization expense. Third quarter net income declined by a more moderate 13.5% due to a lower effective income tax rate and lower interest expense than the previous year. Diluted earnings per share fell 14.1% to $0.61 from $0.71 last year. You can find a complete reconciliation of our GAAP to non-GAAP earnings in today's earnings press release. Moving on to our balance sheet and cash flow. We are continuing to maintain a strong balance sheet during this uncertain period. Our total inventory as of the end of the third quarter decreased by 16.3% to $1.1 billion from the end of the third quarter last year and decreased by 14.5% from the end of fiscal 2022. The decline in inventory, coupled with an increase in trade accounts payable and other working capital initiatives, enabled us to report a $691.7 million favorable swing in year-over-year operating cash flow and a significant year-over-year increase in free cash flow. The improvement in our cash flow allowed us to reduce borrowings under our ABL facility to zero at the end of the third quarter, which enabled us to reduce our debt by $178.5 million to $202.9 million from last year. The strength of our balance sheet will benefit us as we remain committed to making investments that we believe will drive further market share gains during a period of industry contraction. We ended the third quarter with $758.9 million of unrestricted liquidity, consisting of $61.6 million in cash and cash equivalents and $697.3 million available for borrowing under our ABL facility. Let me now turn my comments to how we are thinking about the remainder of the year and how it compares with our previous expectations. During the third quarter of 2023, 30-year mortgage interest rates continued to rise and are touching 8%, up from the prior peak of 7.34% in July. At the same time, the July Federal Reserve Senior Loan Officer Survey reported that lending standards across all categories of residential real estate tightened, and we expect further tightening of loan standards in the second half of 2023. Meanwhile, demand weakened for all residential real estate loan categories. Home prices have moderated, but they remain elevated from previous years. According to the National Association of Realtors, the median price of an existing single-family home in September increased 2.8% to $394,000 from last year, which still represents a 26.3% increase from $312,000 in September of 2020. These increased costs, coupled with increases in property taxes and insurance and following savings buffers, continue to erode housing affordability for many homeowners, leaving all but the highest-income cohorts able to afford homeownership. Consequently, existing home sales reached a near record low of 3.96 million annualized in September, which was below our expectations of 4.1 million to 4.3 million annualized units that supported our prior outlook for the second half of 2023. We are prudently expecting these trends to continue to create headwinds for our sales in the short term. Taking this into consideration, let me reframe how we are thinking about the fourth quarter of 2023 and provide some preliminary guardrails to consider for 2024. As Tom mentioned, we have experienced an unexpected accelerated decline in our comparable store sales from the lagged effect of these policies in the early part of the fourth quarter of 2023. To take this into account, we have updated our 2023 sales and earnings guidance, which now reflects the potential that the accelerated decline in our comparable store sales could be sustained for the remainder of the fourth quarter. We hope we're wrong, but we now expect the 2023 fourth quarter comparable store sales could decline in a range of 12% to 15% from last year. In response, we have already initiated expense tightening measures in November and will further tighten them in December, aiming at not adversely impacting our customer experience.

In the short term, we see opportunity amid the uncertainty. We believe that we have demonstrated that we can manage through uncertainty and seek to use this opportunity to seize more market share as the industry contracts. While the timing of a sustained recovery in existing home sales and growth in our industry continues to be elusive and has been pushed out by most economists, we believe the longer-term outlook for home improvement spending remains bright. That said, we believe we should be prudent when approaching 2024 with more rigor towards managing our controllable expenses and discretionary capital spending. That does not mean we are not making growth investments. We expect to continue to invest in 2024 by opening new warehouse stores, which we believe will further widen our competitive moat and leave us in an even stronger position for significant earnings power when the industry fundamentals improve. Our longer target of operating at least 500 warehouse stores in the U.S. and achieving a mid- to high-teen EBITDA margin is unchanged. Operator, we would now like to take questions.

And our first question comes from the line of Simeon Gutman with Morgan Stanley.

My question is in the fourth quarter, some of the expense rationalizations that are happening; is that the run rate that we run into '24? Or does it get better? Meaning if you annualize the earnings from the fourth quarter and, I guess, the decremental margin, it paints a pretty tough picture, and I want to know why that's wrong.

Simeon, this is Trevor. That's a good question. So we're not done with our planning process for 2024. Given the current economic headwinds and that comparable store sales are likely to be negative next year based on current sales trends, and as Bryan mentioned, probably having larger negative comps in the first part of the year versus the second part of the year. We are focusing on continuing to resize our expense structure based on the slower sales trends, and we believe we can have a moderate increase in gross margin next year. But we don't believe that you can take the Q4 run rate and extrapolate that to fiscal 2024 annualized EPS. We think we will do better than that, and we're working through that as we speak. Obviously, there are a lot of unknowns out there with mortgage rates and where the consumer is and how they're going to invest in renovation today. But we are creating optionality and scenario planning that if things get better or worse, and we'll give you a more detailed update in 2024.

Is there anything on the vendor side that's changing? Are they getting more aggressive, meaning, are they lowering prices or getting more aggressive in some of the deals that you're seeing?

This is Tom. I'll take that. Part of our improvement in gross margin that we're observing now and will continue to see next year results from our merchants effectively collaborating with our suppliers to achieve cost reductions. By switching suppliers, we are obtaining better deals. Our existing suppliers are facing tougher conditions, so they are making concessions, and our merchants are negotiating well. Therefore, we expect to see some benefits from this. We're already experiencing them, and we anticipate this will persist into next year.

The next question is from the line of Chris Horvers with JPMorgan.

Can you explain the recent slowdown in business over the past month? Is it related to traffic and ticket sales? It seems like the situation is worsening when looking at long-term trends. What changes have you noticed in terms of traffic compared to ticket sales? You also mentioned that the Southern region is now performing the worst, which wasn't the case in the previous quarter. Are there specific changes happening in Texas and Florida? Lastly, as you consider the flow of the month, did you notice any significant events, like the war, impacting your weekly performance?

So I'll take the first part. This is Bryan, and Tom will kind of take the second and the third part. Just I think it's easier if I talk about what was in the prior guidance versus what we're seeing today, kind of to unbundle Q4 a little bit and the trends we're seeing. So our comp was obviously negative. Mid-single digits is what we were thinking, and now that's at a negative 12% to negative 15%. To talk about transaction and ticket. We had transactions in Q4. In the prior guidance, we were going to be about flat. Now we're expecting that to be mid-single digits to high single-digit decline. So you're seeing a bigger drop in transactions from the expectation that we were at. And the ticket was a low single-digit decline that we had previously guided to; now that's more like a mid-single-digit decline. So you can see the biggest, I guess, deviation from our expectation in Q4 is really around transactions. And so when you think about that two-year stack or anything else, transactions are really going to see the bigger deviation from Q3 to Q4 on some of that.

And the other thing I'd say, Chris, that's probably a bit different than when we were, what it was, three months ago is mortgage rates have now tipped up and are closer to 8%. Existing home sales are now below 4 million, which hasn't happened that often in the last 40-plus years. And so just it's been a bit of a deteriorating environment since we talked last.

I was going to say just on the average ticket, our square foot Pro projects are continuing to go down, so that's what's driving down a lot of that average ticket to go from the low single digit to kind of mid-single-digit declines. So a lot of it is around that project size.

Yes. Chris, I'll address the last two parts of your question. We are facing easier comparisons, so we would expect things to improve. However, as Trevor noted, with higher than anticipated interest rates and a sharper decline in existing home sales, along with global conflicts, all of these factors are likely impacting consumer sentiment and their shopping capabilities. It's difficult for me to identify the exact cause of the decline; it has been a continuous trend since the quarter began. I presume that it stems from a combination of these factors. Regarding the South, it was initially performing well, but we observed a decline beginning in the West, and now the South seems to be experiencing similar challenges. We believe those issues are becoming more pronounced compared to the beginning of the year.

Got it. And then my follow-up is, Tom, you had mentioned earlier this year that if existing home sales were flat, you could see a positive outcome on the comp side. You're leaning towards less negative in the back half of the year. So presumably, you'll get to a point of flat existing home sales in the back half. So is the difference now? Is it that you have to annualize through the project size headwind?

There are some challenges related to the size of the projects. That's a valid observation. We’re still falling short of existing home sales. When we look ahead at existing home sales, we expect to remain below the projected 3.9 million annualized in September. We don’t foresee much improvement, which means we will continue to experience a decline in home sales. However, I believe that achieving flat existing home sales year-over-year, or when they start to show positive trends, would benefit our business, though perhaps not immediately. Looking ahead to next year, if we consider the first half, we saw annualized numbers of 4.6 million in February, 4.4 million in March, 4.3 million in April, and 4.3 million again in May, based on what we witnessed in September. Even though interest rates are stable and people seem optimistic about that, we do not expect them to decrease. We anticipate that this will pose challenges for the business.

Next question comes from the line of Michael Lasser with UBS.

Tom, in your remarks, you noted how you have optionality to change your store growth. So under what conditions would Floor & Decor choose to slow down store growth in 2024 and 2025? And then what would you need to see in order to reaccelerate it? And does this have any bearing on the ability to have 500 stores over the long term?

I'll address the last part; it's straightforward. Our outlook remains unchanged, as I mentioned earlier. We still plan to open 500 stores and maintain our mid-teen EBITDA margins. We don't foresee significant long-term changes; it's really about the pace to achieve these goals. The only reasons we might reconsider our store growth, as we've stated before, are if our liquidity faced challenges, leading us to delay capital expenditures, or if the returns on our stores weren't satisfactory. Currently, given the economic climate, having our new store class at the low end of the pro forma isn't too discouraging. However, if the situation worsens, it could cause us to reconsider. Right now, we're comfortable with a range of 30 to 35 new stores, and if there's any decline in the next quarter, we will update you.

Yes, Michael. I just want to add that our mature stores, those five years or older, are generating $26 million in sales and $6.1 million in EBITDA. The stores that are over ten years old, which are among our best, are achieving nearly $28.6 million in sales and $7 million in EBITDA. This is a challenging period, arguably one of the worst since the housing recession from 2007 to 2010. However, we are very confident that, in the long run, we will achieve a return on cost of capital well above 25%, as these investments are typically for 15 to 20 years. As Tom mentioned, we will monitor the situation closely, but we feel positive about the long-term returns.

My follow-up question is; it's really anyone's guess right now, what the comps might be next year? But you have given us a rule of thumb that decremental margins are around 35%. So if you lost $100 million of sales, you lose $35 million of profit. Are there any locations or close to any locations where you're running into minimum staffing levels or other constraints such that if you cut down next year at the same rate that you are this year, the decremental margins would be worse than your rule of thumb? And does it change at all if more of your comp decline next year is ticket-driven rather than traffic-driven?

Yes. About 20% of our stores, maybe just a nudge above that, are on minimum hours today, and our gross margin rate is higher now than it was then, too. So yes, I think if things are not in our expectations or if things are worse, I think it's likely you'd see that flow-through rate be a little higher. I don't know if it gets to 40%, but I think that is a reasonable expectation.

Michael, this is Bryan. So that $0.10 per comp point, 35% flow-through rate. That's usually against the plan, not necessarily year-over-year; to Trevor's point, we do expect modest improvement in gross margin, which will help offset some of that. So when you guys are thinking about your model and you're thinking about the comp, it's really a change in comp against the plan, not necessarily year-over-year because you always have step investments where you have changes that we can go in and do. But that gross margin is the lever that will help kind of offset some of that.

I would like to make a brief comment regarding store labor. We carefully monitor our customer service scores and their feedback on their experiences in our stores. As we make adjustments, we're focusing on tasks that can be removed from the store or altering our operational methods, such as performing tasks during the day that we previously did at other times, in order to maintain a strong presence on the sales floor. As we modify those hours, we are committed to ensuring the customer experience remains a priority, because we understand that, as Trevor mentioned, this is a temporary situation, and we will navigate through it. When we emerge from this period, we want to ensure that our brand remains intact.

Our next question is from the line of Chuck Grom with Gordon Haskett.

I'm curious what you're seeing from the competition over the past few months and maybe even in October, particularly independents. Is pricing still rational? Or have things started to change?

I'll start, and then Ersan can add his thoughts. From the perspective of the large retailers, they are always looking to improve and stay competitive. I wouldn't say their approach has changed significantly over time. We need to keep an eye on them, but their limited square footage makes it hard for them to compete with us. Regarding independent retailers, I believe they are becoming more aggressive out of desperation in this challenging market. If we're seeing struggles at the top line, it's likely they're experiencing even greater difficulties. So yes, they are becoming a bit more assertive, but their aggressiveness doesn't concern us because our competitive advantage over them remains substantial, allowing us to compete effectively.

No, that's absolutely right. I think the changes that we see are not irrational at all. And then also, in some cases, when there is a promotional activity that we see, there's definitely an inferior quality of the product, not in comparison to what we do. But we're paying close attention to it. Nothing irrational.

Okay. Great. And then just holistically, Tom, you talked about holding the 42% gross margin rate. But at what point would you sacrifice that to invest in price and try to induce activity? Or do you feel like the price actions and price reduction efforts that you've made over the past year would tell you that potentially wouldn't be successful? I guess how are you thinking about that longer term?

Yes, we have experimented with pricing in various tests across multiple markets and primarily price ourselves. When a customer comes into the store and opts for a lower-priced item that we’ve adjusted, we see good traction specifically with installation materials, which are frequently purchased by professionals. We have adopted a more aggressive pricing strategy for these materials and will continue to do so since we know that professionals shop with us regularly. Our goal is to ensure we support them effectively. While we aim to grow gross margin, we can afford to be aggressive with installation materials pricing. We're achieving margin growth through first cost reductions and lower freight expenses. Our better and best product offerings remain strong and continue to drive business, which in turn supports gross margin along with innovation and new product introductions. This situation isn’t due to insufficient traffic in the category but rather a pricing matter. I am confident in our current pricing strategy and will maintain our aggressive stance on installation materials while pursuing gross margin improvement through other means.

Our next question is from the line of Seth Sigman with Barclays.

I wanted to follow up on the slowing performance that you saw in the third quarter and then again into the fourth quarter. What are you seeing in terms of mature stores versus newer stores? And part of that is just context around how you have a lot of new stores that are supposed to come into the comp base here in the fourth quarter. I think they were expected to contribute positively. So I'm curious whether that is part of what's changed here as well.

This is Bryan. So I'll kind of start and let Tom or Trevor jump in if you need to. Yes. I mean, look, it was kind of broad-based across. We still have positive comps to the class of '22. So the new stores coming in the base were positive in Q3, albeit kind of low single digits where they were. So when you think about it, we comp to 9.3, still keeping that same kind of waterfall that's always there in that three to four-point range. And so if you think about our most mature stores, they were comping down in that low double-digit range. And so that's kind of held true across the board. So again, just we've seen it across. It's not that our most mature stores are deviating from that trend at all.

Got it. Okay. And then just one follow-up question around the fourth quarter, thinking about the margins here. Just trying to go through the math. I mean, you said gross margin should be similar, maybe up sequentially. I mean does that imply more deleverage you typically would see? I mean, is there any other reason why you would see that impact? Is that just weighted store openings in the fourth quarter or anything else that you would highlight there?

Yes, this is Bryan again on I'll jump in. So yes, I mean, look, it's all around the sales decline. So when comps go from 9.3 to down 12, your most mature stores are going to see a little bit more deleverage. That's really what's driving it. So you're right; we should be at, if not modestly above sequentially in gross margin. So we will delever a little bit more. That's kind of where Tom and Trevor alluded to is there are things we're going to action. It's just hard to change your business over 30 days. So we're taking a hard look at it. We're taking those actions today in November and into December. But again, we're halfway through the quarter. So that's going to cause a little bit more deleverage. But again, we feel confident that that's not the proxy for next year in each quarter.

The only additional point I want to highlight is that we are opening 15 out of more than 30 stores, and the selling, general, and administrative expenses for our new stores are significantly higher than those for our established stores. We are launching nearly half of our new stores in this one quarter, and Q4 typically sees lower volume relative to other periods due to the holiday season with Thanksgiving and Christmas. This means that, in addition to what Bryan mentioned, we are experiencing an unusually high number of new store openings in Q4 this year compared to last year.

Our next question is from the line of Steve Forbes with Guggenheim.

Tom, maybe just a follow-up on a comment you made about the new class of stores performing at the low end of pro forma or maybe for Bryan as well. Can you guys just reframe the cost to build year one sales and EBITDA for us, and then comment on how the 2024 class of stores is currently being planned relative to those metrics given the four Q-to-date earnings?

Yes, this is Trevor. I'll go ahead and speak, along with Bryan and Tom if needed. We have stated for years that we expect new stores to generate sales of approximately $14 million to $16 million and around $3 million in EBITDA. We are likely to slightly fall short of that $14 million in sales, which affects profitability, but our gross margin rate has improved. This means our overall profitability won’t decline significantly because of the better gross margin. Currently, our capital expenditures are around $10 million, depending on whether it's a custom build or a facility set for secondary use. Our working capital requirements are manageable due to our long base payables, so we won't spend much over that $10 million. Based on our experience from opening over 200 stores in the past 12 years, we are confident we will achieve over a 12% return on invested capital when assessed over a 20-year period. Historically, we've performed better than that, though factors like inflation and slightly lower sales are affecting us now. In summary, while sales might be lower than $14 million for the next year, profitability will remain close to $3 million due to our improved gross margin rate.

And what we've seen historically for the stores that opened a little bit below that pro forma, for them to get to that $28 million to $30 million, obviously, that's going to create a comp tailwind. That's going to put wind in our sales throughout the next couple of years. You guys think about that too.

And then just a quick follow-up on the Pro. You mentioned comps for Pro above DIY where the company averaged. Any specificity there on how the Pro comp is trending in the quarter?

It was slightly negative, closer to a mid-single-digit decline. I apologize; I was referencing the incorrect figure.

In Q3 compared to Q2, we experienced a bit more deceleration in our Pro segment, which was down about 1% in Q2 and down approximately 5.5% in Q3.

Our next question is from the line of Jonathan Matuszewski with Jefferies.

Great. One question with two parts. The first part is on 2024 units. So 2023 has been an odd year in terms of warehouse opening cadence. I think we have around half of them opening in 4Q. And I know it's early, but could you give us a ballpark view of the cadence for 2024 and how you're thinking about the split between new and existing? That's the first part.

This is Trevor. Our opening schedule will improve somewhat. We'll focus on more openings in the first half of the year, but we still expect to have a significant number of stores to launch in September and December. Our pace will definitely be better, and we will provide more information on this during the February call as we finalize the details. Additionally, we anticipate having a bit more activity in the latter half of the year. What was the second part of your question?

Yes. Second part was on the comments about 2024 gross margin being up, and it sounds like supplier concessions may be a primary driver. Just curious whether we need to see flat behavior from the consumer in terms of mix. Basically, is gross margin expansion possible if we do see a potential trade down from better and best products?

I still believe that's the case. We haven't observed that yet, and I feel like we're experiencing the toughest phase. Customers are engaging in smaller projects but are not moving towards the lower price points for quality products. They continue to purchase more of the higher-end options. With all the strategic initiatives we're implementing, such as innovation within our product category, we expect to improve our margin rates due to the influence of our designers on sales. We have 935 designers across 200 stores, and their performance keeps getting stronger. Their impact on gross margin, by selling more additional items that come with higher margins, like trims or drains, is significant. I believe these factors, along with adjustments from suppliers, enable us to grow our gross margin even if consumers were to trade down, although I don't anticipate that happening.

This is Bryan. So just don't forget, too, as I mentioned in the pre-remarks, we're on the weighted average cost. All the savings that still continued into this year from supply chain and product costs are going to work their way through into early next year as well. So it's not necessarily you need additional concessions next year to even see that kind of sequential step a little bit.

Our next question is from the line of Stephen Zaccone with Citi.

I wanted to follow up on that last point. So the fact that we've seen this better, best side of the business still holding up well, are you concerned that flows into next year? I mean, do you think that will likely see trade down? And I guess, in that environment, how do you think about your competitive positioning?

As I've mentioned in previous calls, I don't expect any changes. When a consumer decides to undertake a project in our category, I believe the distinction between buying better versus best isn't very pronounced. For example, when they are purchasing for a bathroom, upgrading to the higher-quality products doesn't make a significant difference. The variations are mainly in the aesthetics and size of the products, and I observe that consumers who choose to tackle these projects tend to continue investing in higher-quality items. They simply look better in store displays. Additionally, from a competitive perspective, this is advantageous for us because in the higher-end market, we are up against independent retailers. Even if they adopt aggressive pricing strategies, our value remains substantially superior. The gap between us and them is considerable. While the size of projects might pose a challenge until the current situation improves, I don't foresee major changes in the demand for better and best products, as we haven't seen any significant shifts so far.

Our next question is from the line of Seth Basham with Wedbush Securities.

This is Nathan Friedman on for Seth. I just wanted to ask about 2024. You mentioned the risk for potentially negative comps based on the broader environment. But can you help us understand how operating margins would look on low single-digit comps even after all the cost cuts that you're going to take?

Yes, this is Trevor. I think we're just too early to talk about that yet. We're still in the planning process. We kind of gave some of the comments around sales and gross margin and stuff. But I mean if comps are negative, I would expect our operating margins to be under pressure.

Our next question is from the line of Keith Hughes with Truist Securities.

There has been a lot of discussion in the industry about LVT and the challenges with importing. Was that an issue for you this quarter? I also noticed that the laminate LVT category significantly underperformed compared to average sales; could you provide some insight into the direction of that product?

It has nothing to do with in-stock. I mean, our in-stock within the store and in that category is at all-time high, so our in-stock is great. So do you want to talk about the category?

On the laminate and vinyl side, it seems linked to the size of jobs. Larger spaces tend to result in smaller special job sizes, which immediately affects laminate more than the other categories.

Yes, that's exactly why you see tile increasing as a percentage as well; more bathrooms and other things like.

To summarize, we are focusing on more smaller projects, particularly in bathrooms where tiles are commonly used. This preference for tiles over laminate is a key factor in the strong performance of the tile business, as tiles are more likely to be installed in bathrooms, even though some of our laminate options can also be used there.

Our next question is from the line of Andrew Carter with Stifel.

Building upon that, you're not worried about out of stocks right now. I think your purchases were down 8%. How much more could you continue with kind of negative purchases? And then kind of building on that for cash flow, are you still committed to the kind of 3-year CapEx targets you laid out at the Investor Day, therefore big step-up next year? Or does next year look kind of similar to this year in terms of CapEx?

Yes. The vast majority of our inventory is replenishment based. So we buy based on what we sell. And so I don't think there'll be any big changes. As we mentioned earlier, we made some aggressive moves late last year that are benefiting us on the inventory line. As we get to the end of the year, I would expect our inventory levels to be down kind of in the mid-single-digit range is what we're thinking about for that. And the second part of the question again?

For next year, the only reason we anticipate an increase in capital expenditures is due to the two distribution centers that will be brought online. One is expected to start operating in late 2024 or early 2025, and the other will come online around the middle of 2025. These are the sole factors contributing to any increase in our investment, so you can expect to see some capital expenditures in the latter half of the year related to that.

Our next question comes from the line of Greg Melich with Evercore ISI.

I want to follow up on the store openings in the next year. You said that giving yourself some optionality makes a lot of sense, but they're still more front-end loaded. Is that because there's a natural cadence of where you're already fragmented with a store and you're going to have to do it? And what is that lead time, as you think about flexibility into the back half of next year and beyond?

Yes. So repeat the question again. I want to make sure I understand it.

You mentioned you were planning to open over 35 stores next year, but now it's between 30 and 35. I'm curious how far in advance you need to decide against opening a store before plans are set in motion.

We have a timeframe of about nine months for our decision-making. We're currently working on all our sites for the upcoming year and have the option to move up to 35 sites into the next year if necessary. This flexibility applies to most of our sites, but we need nine months to finalize those decisions.

Yes. So the ones that are opening earlier, obviously, they're under construction. We feel good about them. They're in great locations. And so those are the ones that you want to try to pull in as fast as you can because again, some sales are better than no sales to push out.

Our last question comes from Justin Kleber with Baird.

Just wanted to follow up on the new store performance question. My math would suggest your recent stores are annualizing at maybe $10 million or so in year one. It sounds like you pushed back against that given your comments about the stores being at the low end of your pro forma. So I just want to clarify where you think year one sales are going to land for recent stores. And then what type of AAV do you need in order to break even on a 4-wall basis in year one?

I'll address the first part of your question, and Tom and Trevor may want to add to it. Currently, we anticipate this year's class will average around 13% to 14%. So when we mention being at or below that pro forma range, I would say this year's class looks to be in that 13% to 14% range, and we are satisfied with that, especially considering the current macro environment they are entering. Regarding breakeven, it really varies by location and other factors, as the cost structures can differ significantly. Generally, we haven't pinpointed a specific breakeven point, but typically it hovers around $8 million to $10 million depending on the location and associated costs.

Okay. Well, we appreciate the questions and appreciate your interest. We look forward to updating you throughout the quarter, and we'll talk to you in the next call. Thank you, everybody.

This will conclude today's conference. You may disconnect your lines at this time. Thank you for your participation.