Floor & Decor Holdings, Inc.

Greetings and welcome to the Florin Decor Third Quarter 2024 earnings conference call. At this time, all participants are in a listen-only mode. The question and answer session will follow the formal presentation. If anyone should require operator assistance, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce Wayne Hood, Senior Vice President of Investor Relations. Thank you. You may begin.

Thank you, operator, and good afternoon, everyone. Welcome to Florin Decor's fiscal 2024 Third Quarter earnings conference call. Joining me on our call today are Tom Taylor, Chief Executive Officer, Trevor Lange, President, and Brian Langley, Executive Vice President and Chief Financial Officer. Before we get started, I wanted 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 risk 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. Florin Decor assumes no obligation to update any such forward-looking statements. Please also note that past performance for 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 understand better 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 .FlorinDecor.com. The 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 2024 Third Quarter earnings conference call. During today's call, Trevor and I will discuss some of our Fiscal 2024 Third Quarter earnings highlights. Then, Brian will provide a more in-depth review of our Third Quarter financial performance and share our thoughts about our updated outlook for the remainder of Fiscal 2024. We are incredibly proud of how our store and store support teams successfully executed our plans and managed costs during a period when demand for large projects, discretionary home improvement, and hard surface flooring spending remains challenging. I particularly want to thank our associates affected by the hurricanes for their hard work and dedication to their communities. Due to their efforts, we quickly reopened our stores to serve customers affected by the hurricanes as they began their recovery and rebuilding efforts. In the face of these challenges, our associates' hard work and dedication enabled us to deliver better than expected Fiscal 2024 Third Quarter diluted earnings per share of 48 cents compared with 61 cents in the same period last year. These results exceeded our expectations primarily due to the tight expense management across the company. As Brian will discuss in more detail, we are narrowing our Fiscal 2024 diluted earnings per share guidance range from 165 to 175 from 155 to 175. Looking ahead, the Federal Reserve finally began its much anticipated easing cycle in September of 2024, which leads us to believe that existing home sales and hard surface flooring spending could potentially grind higher over the next 12 to 18 months. However, our optimism is tempered by the recent increase in 30-year mortgage rates. Moreover, September existing home sales declined 1% sequentially and .5% -over-year to $3.84 million, while meeting existing home sales price growth, according to the National Association of Realtors, moderated to 3% -over-year in September from its peak 2024 growth of .6% in February. Housing affordability remains a headwind to increased demand due to the secular imbalance in the housing stock, which is pressuring home prices. Finally, personal consumption expenditures still indicate that consumers are shifting more of their wallet share spending to services from goods. In short, we remain optimistic yet mindful of the challenges. Let me shift my comments to the hurricanes that made landfall in fiscal 2024 and affected some of our stores in the third and early four quarters of the year. First and foremost, our hearts and prayers go out to the families and communities impacted by these hurricanes. Turning to the first hurricane of the season, Hurricane Barrel made landfall on the Texas coast in early July as a Category 1 storm. As we mentioned during our fiscal 2024 second quarter earnings call, we estimated that our 2024 third -to-date comparable store sales were adversely impacted by approximately 70 basis points due to Hurricane Barrel. Because the storm caused mostly wind damage and not flooding, we did not see an offsetting increase in demand as the stores reopened. Turning to Hurricane Helene, which made landfall on September 26, this hurricane caused catastrophic in-land damage across a wide area impacting six states and brought substantial flooding to the affected regions. Broadly, 35 stores were closed or partially closed for one or more days after Hurricane Helene as it moved across a wide area of the southeast. In contrast, Hurricane Milton made landfall 13 days later on October 9, mostly impacting Florida and causing more wind than flood damage. The storm resulted in 29 stores being closed or partially closed for one or more days. Combining, both hurricanes impacted 45 of our stores or about 19% of our store base. In response, we took a broad range of steps in the affected communities where we operate stores to support rebuilding efforts by adding additional staffing. Furthermore, we introduced a solution for deliveries over 60 miles for those stores impacted by Hurricane Helene and implemented an 18-month credit program for all impacted stores. We also delivered additional truckloads of key SKUs and important job lock quantities at everyday low prices to the affected stores. Our store teams postponed projects to focus on inventory, pack-out, and customer service. Additionally, we are working with our national restoration partners to be a single source for the rebuilding efforts. Looking ahead, we expect the benefit from the rebuilding spend from the destructive flooding caused by Hurricane Helene and Milton. However, at this point, the extent and duration of this benefit are difficult to forecast with any degree of precision, other than to say we believe it could extend over multiple quarters in 2025. Let me shift my comments to new store growth. We continue to grow our market share and brand awareness by prudently opening new warehouse format stores, even as growth in the flooring industry remains challenging. These challenging industry fundamentals have recently forced some of our retail and distributor competitors to close stores and rethink their strategies. We are using this period of disruption as an opportunity to grow our market share by actively engaging with homeowners and pros in the affected trade areas who need support for their current and future projects. Furthermore, we are recruiting managers and sales associates who may be displaced by industry consolidation. We are in a favorable position due to our significant investments over the last decade to build our business model with substantial competitive advantages. Our dedicated teams and strategic investments position us well to navigate these challenges and continue our growth. Third quarter of fiscal 2024, we opened 11 new warehouse format stores, including eight openings in fiscal September. As a result, we ended the third quarter operating 241 warehouse format stores and five design studios, compared with 207 warehouse format stores and five design studios in the same period last year. We now operate stores across 38 states. We plan to open 10 warehouse format stores in the fourth quarter of fiscal 2024 to achieve our 30 new warehouse format store opening plan in fiscal 2024. To date, in the physical fourth quarter, we have opened one warehouse store in Daytona, Florida, and expect most of the remaining openings to occur in late November and December. As discussed in our prior quarter earnings conference calls, depending on market conditions, we intend to open approximately 25 new warehouse format stores in fiscal 2025, mainly in the second half of the year and in existing markets. Our long-term goal of operating 500 stores is unchanged. However, we believe the slope and timeline of reaching 500 stores will be influenced by when we return to a historical normal level of existing home sales. Moving to our third quarter sales. Our fiscal 2024 third quarter sales total sales increased .9% to ,000,000 from the same period last year. Comparable store sales decreased by 6.4%, which is in line with our expectations. We are encouraged that the sequential rate of decline in our fiscal 2024 comparable store sales improved as we cycled past easier comparable store sales comparisons. Comparable store sales declined .6% in the first quarter, 9% in the second quarter, and .4% in the third quarter of fiscal 2024. On a monthly basis, our third quarter comparable stores, comparable store sales declined .6% in July, .4% in August, and .4% in September. We estimate the negative impact on our comparable store sales from hurricanes was approximately 70 basis points in July, 10 basis points in August, and 40 basis points in September. We estimate the full third quarter impact was approximately 40 basis points. Fiscal 2024 fourth quarter to date comparable store sales declined 4.2%. From a regional perspective, we continue to see encouraging comparable store sales trends emerging from our western division where comparable store sales were well above the company average. Let me comment about our comparable stores average ticket and transaction trends. In the third quarter of fiscal 2024, our comparable average ticket decreased .4% compared to the same period last year, which is in line with our range of expectations. Comparable transactions were at the low end of our range of expectations due to the impact of the hurricanes, declining by .1% from the same period last year. As a reminder, our third quarter comparable transactions and average ticket benefited from cycling past easier comparisons. We will continue to benefit from an easier sequential average ticket and transaction comparison in the fourth quarter of fiscal 2024. Comparable store sales and installation materials, decorative accessories, and adjacent categories were better than the company average. Like prior quarters, our merchandising efforts continue to successfully drive sales towards our better and best price points, which offer industry-leading innovation, trends, and styles at everyday low prices. Furthermore, these strategies continue leading to a shift in sales to higher margin products, enhancing our profitability. Let me now turn the call over to Trevor to discuss a few more of our pillars of growth.

Thanks, Tom. I also want to express my gratitude to our associates for their hard work and dedication to serving our customers. We are tightly managing costs in our stores and store support center while ensuring this does not come at the expense of customer experience in our stores and online. Our teams are consistently executing our customer engagement plans at a high level, which resulted in record customer service scores in September. We are proudly moving the needle on this important customer engagement metrics like greeting, assisting, and addressing customer questions. We achieve this with training and role playing. We know foreign projects come with complex questions, and knowledgeable and engaging associates allow us to grow our market share despite challenging industry conditions. Their knowledge and commitment sets us apart and helps us thrive in the competitive market. Shifting to our connected customer pillar of growth, our fiscal 2024 third quarter connected customer sales increased by .4% and accounted for approximately 19% of sales. As previously discussed, we continue executing strategies for driving organic and paid traffic growth to our website. We continue to integrate our processes and technology solutions to further develop a seamless in-store and personalized online experience. We plan to achieve this by continuing to improve the quality of website search, adding inspiring and user-generated content for customers, and refining our online merchandising process to increase efficiency. The execution of these strategies is essential to growing our design services. Let me turn my comments to our design services. Our design services teams are committed to delivering an elevated and personalized design experience to our homeowners and pros across in-store, online, and in-home channels. Their hard work and focus on high value opportunities resulted in notable sequential growth in design total and comparable store sales during the third quarter of fiscal 2024. Consequently, our fiscal 2024 third quarter design total sales penetration increased significantly from the same period last year. To continue building on this growth, we developed strategies to build awareness and project credibility for design services on our website. We have enhanced design scheduling and functionality and created online design galleries. These galleries provide an extensive source of inspiration for interior design by showcasing real-life and designer-inspired projects with room-specific imagery. We are excited about how these galleries serve as sources of inspiration, providing beautiful ideas for any space or project. Turning my comments to pro, total sales to our pros continue to grow in the third quarter of fiscal 2024, accounting for approximately 48% of retail sales. We continue to deliver sales and market share growth with a grassroots supply house mindset that focuses on nurturing strong relationships with our existing pros and attracting new ones from outside of our warehouse stores. Our top priority is to build these relationships and elevate the -to-floor brand in a marketplace by consistently executing a set of priorities that delivers exceptional customer service with speed and precision. To achieve this, our pro services managers are increasingly spending more time outside of our stores and in new zip codes, directly engaging with pros to understand their needs and provide tailored solutions. They are focused on minimum weekly pro engagement targets, including facilitating a store tour that includes a meet and greet with our store chief executive merchant. From a new store perspective, we have strengthened our new warehouse store pro blitz process with a larger team. This process involves intensive local marketing and community outreach efforts to build brand awareness and customer relationships quickly, which helps new stores get off to a stronger start in markets where our brand awareness is not fully developed. In our stores, we continue to focus on staffing, training, and scheduling that best aligns with demand. We prioritize having bilingual support at our pro desks to reflect specific market needs and to enhance customer service. We are also driving growth by successfully partnering with native advertising platforms within bank digital channels to provide us with a practical and cost-efficient way to attract and retain new pros. We continue to drop loyalty with our pro premier rewards loyalty program and our successful annual September pro appreciation month, which included free classes, giveaways, and nationwide sweepstakes. We successfully held 29 educational events in the third quarter of fiscal 2024 with over 425 attendees. These educational events have consistently driven higher sales with pros who attend, demonstrating a notable uptick in their purchasing activity, especially in installation materials. We remain excited about hosting approximately 145 educational events in 2024, which we believe is industry leading in the flooring industry. Finally, we are pleased that our sales from a regional account managers in third quarter fiscal 2024 exceeded our expectations. Let's now discuss our commercial business. Fiscal 2024 third quarter sales at Spartan services continue to grow faster than the company average. Leadership team continues to execute on a set of disruptive strategies in the health care, education, senior living, and hospitality sectors to the commercial flooring market. These are high specification sectors of the commercial flooring market where the opportunity for long-term growth and profitability are the greatest. These sectors generally have high quote conversion rates, recurring revenue, and more attractive profitability. Over the long term, Spartan services aims to become a disruptive leader in the specified commercial flooring industry by establishing a comprehensive nationwide sales network. This network would prioritize high specification products and leverage strong relationships to provide superior availability, delivery, and service across the country. Over the next several years, we will continue making investments, sales representatives growth and infrastructure to build out to support our growth at scale and achieve our market share and profitability objectives. To conclude, we believe we have the right teams, strategic growth initiatives, and resilient business model enabling us to navigate this challenging period. Let me now turn the call over to Brian.

Thank you, Tom and Trevor. I am proud of how our teams have successfully executed our strategies to grow our gross margin rate, control expenses, manage our inventory and supply chain, and generate strong free cash flow. These achievements are a testament to our team's commitment and strategic approach to managing our profitability when industry growth is challenging. Now let me discuss some of the changes among the significant line items in our third quarter income statement, balance sheet, and statement of cash flows. Our fiscal 2024 third quarter gross margin rate increased by 130 basis points, .5% from .2% in the same period last year in line with our expectations. Year over year and sequential increase in gross margin rate is primarily due to favorable supply chain costs. Fiscal 2024 third quarter selling and store operating expenses increased by .9% to 339.1 million from the same period last year. The growth in selling and store operating expenses is primarily driven by an increase of 37.3 million from operating 34 additional warehouse stores compared to the same period last year and 1.0 million at Spartan Services. Partially offset by a decrease of 7.7 million at our comparable stores. The percentage of sales, selling, and store operating expenses increased by approximately 240 basis points to .3% from the same period last year. This performance exceeded our expectations due to our stores successfully managing store payroll and other operating expenses. Fiscal 2024 third quarter general and administrative expenses increased by .1% to 67.7 million from the same period last year. This growth is attributed to higher incentive compensation of 7.0 million and additional staffing cost of 1.6 million to support our store growth. Percentage of sales, V&A expenses, fee leveraged by approximately 80 basis points to .1% primarily due to the decline in our comparable store sales. Fiscal 2024 third quarter pre-opening expenses decreased by .5% to 12.7 million from the same period last year. The decrease was primarily due to a decrease in the number of future stores that we were preparing to open compared to the prior year period. Fiscal 2024 third quarter net interest expense decreased .8% to 0.2 million from the same period last year. The reduction in interest expense is due to a decrease in average amounts outstanding under our AVL facility, higher interest income from higher cash balances, and an increase in interest capitalized, partially offset by lower interest income from our interest cap derivative contracts. Fiscal 2024 third quarter effective tax rate increased 70 basis points to .8% from .1% in the same period last year primarily due to decrease in excess tax benefits related to stock-based compensation work. Fiscal 2024 third quarter adjusted EBITDA declined .7% to 132.9 million primarily due to expense de-leverage from the decline in our comparable store sales. De-re appreciation and amortization increased .9% and driven into net income declining by .6% to 51.79 and diluted earnings per share of $0.38, falling by .3% from the same period last year. Moving on to our balance sheet and cash flow. We continue to maintain a strong balance sheet which allows us to continue to prudently grow within our existing capital structure even during a period of industry contraction. We ended the third quarter with 803.1 million of unrestricted liquidity, consisting of 180.8 million in cash and cash equivalents and 622.3 million available for borrowing under the AVL facility. As of September 26, 2024, our inventory decreased by .4% to 1.0 billion from the same period last year. Let me now turn my comments to how we are thinking about full-year fiscal 2024 and how it compares with our previous expectations. Sales are expected to approximate $4.4 billion to $4.4 billion to $4.4 billion, compared with our prior guidance of $4.4 billion to $4.4 billion to $4.4 billion. Terrible store sales are estimated to decline .5% to .5% compared with our prior guidance of down .5% to 8.5%. Gross margin is expected to be approximately .2% to .3% unchanged from our prior guidance. Selling and store operating expenses as a percentage of sales are expected to be approximately 31%. We expect the fourth quarter expense rate to be the most pressured of the year due to the timing of new store openings late in the third quarter and the fourth quarter. Reopening expenses as a percentage of sales are expected to be approximately 1%. General and administrative expenses as a percentage of sales are expected to be slightly above 6%. We expect the fourth quarter expense rate to be the most pressured of the year due to approximately 3 million of estimated ERP expenses. Appreciation and amortization expense is expected to be approximately $235 million unchanged from our prior guidance. Net interest expense is expected to be approximately $4 million compared with our prior guidance of $6 million to $7 million. Tax rate is expected to be approximately 18% unchanged from our prior guidance. The estimated earnings per share are estimated to be in the range of $1.65 to $1.75 compared with our prior guidance of $1.55 to $1.75. The estimated weighted average shares outstanding of approximately 108 million shares on January 1, 2021 are estimated to be approximately $1.75. We expect the fourth quarter expense rate to be approximately $3.5 million unchanged from our prior guidance. Capital expenditures are expected to be approximately $360 million to $390 million compared with our prior guidance of $360 million to $410 million. The decline in capital expenditures is due to a change in the timing of new warehouse store openings for the class of 2025. We continue making prudent investments that we believe will result in strong earnings growth when industry fundamentals improve. I want to thank our associates and vendor partners for their dedication and contributions to serving our customers every day. Operator, we would now like to take questions.

Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. The confirmation tone will indicate your line is in the question queue. You may press star 2 to remove yourself from the queue. For participants using speaker equipment, it may be necessary to pick up the handset before pressing the star keys. One moment, please, while we poll for your questions. Our first questions come from the line of Simeon Gutman with Morgan Stanley. Please proceed with your question.

Hi, everyone. Good afternoon. Hope you can hear me okay. My first question, Tom mentioned in the prepared remarks, he described the environment as maybe grinding higher over the next 12 to 18 months. Can I ask what does that look like for Florindacore? Does that mean you'd open the 25 stores and are you leaning in to invest into the grind higher or are you protecting margin?

So, hey, Simeon, this is Tom. So we said in the last call, 25 stores is what we're planning for next year. That has not changed. As I said, we've got flexibility if we get into next year and we want to push out some of those openings, we have the ability to do that. But as we sit today, the plan is still to do 25. We are prepared in the event that the market were to turn fast. We've got plenty of inventory in the system, the ability to react and get product quicker. Our stores are well staffed. We're ready to handle that if that were to be the case. We're being cautious and prudent and it's nice to see the Fed taking some action and lowering interest rates. We hope that that continues to happen and we hope that that spurs existing home sales to start to be positive. And we haven't seen that yet, but we're prepared for it in the event that it occurs. And when it occurs, we believe that our sales will follow that.

And Simeon, this is Trevor. I think it's worth adding that we're not sitting idly by. We are taking costs out of the capex of the stores. Our gross margins are performing higher than they've historically been. And we're taking operating costs out of the new stores as well. So definitely, if we're going to be in a bit more muted environment, we've done a lot of research and a lot of work over the last six months to take costs out of the stores so that if we are in this muted environment, we can operate successful new stores at a lower operating cost and a higher gross margin to still give us a good return on capital.

And a quick follow-up on the macro, the level versus growth in existing home sales, which I'm sure you've had many times this question. When Tom mentioned the 500 stores over time, it was referenced that assuming existing home sales reaches some normalized level. But in the next month, quarter, years, it's all about the rate of change, growth. That should be enough to get this business moving in the right direction. It's growth, not a certain number that may take several years to get back to.

That's right, Simeon. I believe it's existing home sales turn positive. That's a net benefit for us. That gives us the ability to start seeing our business trajectory improve.

Thank you. Take care.

Thank you. Our next questions come from the line of Christopher Horvitz with JP Morgan. Please proceed with your questions.

Thanks and good evening. So a couple of follow-up questions. So the first question is, are your West Coast stores comping positively? If you look at some of the home price indexes and the existing home sales in certain markets in the West Coast, they are positive. I don't think that your West Coast stores have been positive prior to this, but are you seeing that inflection?

Hey, this is Brian. I'll take this one. We haven't inflected a positive yet, but they're immediately outperforming the rest of the chain. That's really the way we're talking about it right now, but we're hopeful that we cross that bridge. We like

the existing home sales that we saw in the month of September that are coming out of the West. It is starting to show improvement, and we should see benefit from that. They're better than the company. We think that will continue.

Existing home sales in the West were up over 5% in September.

Right. Up over 5%. So you did a down 6. So you're getting close to flat at this point in the West.

Yep.

Got it. So I guess a little bit of lag off of a positive existing home sales dynamic. So you sort of look at it from like a trend following up in the prior question that it's not a comparison anymore. It's just more like we're coming to the bottom. The trend is the trend, and if we can get back to positive existing, then we can be up. But if we stayed flat for an extended period of time, it's been very volatile. Do you think what factors would lead you to come positive in that environment, or is that just not how you don't think that could happen?

I would say, well, I mean, look, our compares continue to ease, so the comparisons are going to get easier. And if existing home sales do turn positive, as I said, I think that that's a net benefit for our business. The more homes that are turning over, the better it is for our category. I think in the event that that doesn't happen, let's say that there's a scenario where things stay flat, if interest rates continue to come down, then I think because of what's happened with household appreciation that more people will take cash out of their houses, they'll refi or cash out, and then they'll apply that. Historically, that's been applied into home improvement. And so I can't think of a better thing to do than redo your bathroom in the event that you take money out of your house. So I'm hoping that in the event we don't see existing home sales, if they stayed in that flat place, Chris, then the hope is that the rates continue to come down, and because of what's happened with household appreciation, people take cash out and apply that to the category.

This is Trevor. This is a bit short-term, but with Hurricane Helene and Hurricane Milton coming through, there's going to be some stores on the west side of Florida, maybe a few other markets that we believe will get a benefit. It's just really happened, but some of the early signs are we're going to get a bit of a benefit. Now, we're obviously a lot bigger than we were when we had the huge benefit in Houston back in 2017 and 18, and certainly, but there likely is going to be some benefit because of the destruction of those two hurricanes that was very recent.

Well, I guess you read my mind on the follow-up, which is you talk about 90 percent of stores. Harvey was 6 percent of stores. On a 12-month basis, you saw a 400 basis point benefit from Harvey. Now, granted, I think maybe Milton is the one we should focus on, and it's not quite that level of stores, but it's like 4 percent of stores. So do you think that we should just take that ratio, 4 percent of stores affected by Milton versus the 6 in Harvey, versus that 4-point lift that you saw on a subsequent 12 months from Harvey?

I think it's going to be much smaller. We were 8 or 20 percent the size we are now when Harvey hit, and today what we're seeing is really, again, that west coast of Florida, Tampa down to Sarasota is where we're seeing the bigger impact. Over time, obviously, we went through the Carolinas, there may be a little bit more opportunity for some of the stores in there, but it will be a lot less impacted than Harvey. I won't pile

on, but I would say first, it's a bit too early to know for sure. I think Harvey was a bit different. Harvey was a flooding event over a very much more significant geographical area. But, you know, look, it's early. We're prepared. We're seeing good things come out of those stores now, but it's just a little bit too early. In a month from now, I think we'll know a lot more, but we're doing everything we can to capture that rebuild as it's coming to us.

Thanks, guys. I appreciate it.

Thanks, Ben. Thank you. Our next questions come from the line of Stephen Forbes with Guggenheim Securities. Please proceed with your questions.

Good evening. Tom Trevobrein. Maybe just following up to start on ROIC, you know, lots of questions with investors on how to think about ROIC for the business, you know, just especially given the challenging macro that you're operating it within. You talk about the 25 stores you're planning for next year. Any way to help frame how the Performa is modeled around year one ROIC versus cost of capital? And maybe on that point, can you remind us sort of some of the work you've done to reduce the initial capital cost behind the new stores that you're planning for next year?

Yeah, I will. This is Tom. I will go first, and I'm sure Trevor and Brian will weigh in after. We have done a tremendous amount of work to reduce the cost of our new store openings. So we've done that by right sizing the stores. We've done that by taking non-customer facing things out of the store to reduce the costs, while at the same time we've reduced the cost of operating the store. So we've taken a really good approach in bringing it down. And then as we selected the 2025 stores, as we said earlier, we're trying to shoot with a bit more precision, going to more markets that we know, going to voids that we know will perform better than going into a new market. So there's less new markets, more of a sure thing. So we think with what we've done with the cost of the store and the operating cost of the store and how our gross margins are improving and selecting better stores, that that will improve as we get through 2025. Yeah, it will help alleviate

some of the pressure. Obviously in this macro environment today, we've been very transparent that our stores are starting off a little bit lower than our former target that we were shooting for in that 14 to 16 million year one. So given the macro backdrop, that will put pressure on ROIC, but everything Tom just mentioned will help offset some of that. It won't fully offset it, but it will help offset and mitigate some of that.

Thank you both. Brian, maybe just a quick follow up. As we think about the growth burden on the margin structure of the business, as you sort of work through the environment, any way to help frame sort of how to think through selling and store operating expenses for next year, given the growth plans for stores? I don't know if you can maybe talk through what level of comp is sort of needed to hold the expense ratio at that 31% level that you guided this year to, or any way to sort of think through how we measure the growth burden next year.

We're not ready to comment on 2025 yet. Obviously, we'll take some sort of growth to hold just given the pressure of the late store openings in Q3 and the late store openings in Q4 of this year. Those will put a little bit of a drag next year on store and selling expenses, but more to come. We're just now getting into the detailed budgeting process on our side, so more to come on the next call for that. We'll give you guys, you know, obviously guidance and transparency around that, but we're not ready to commit to the comp.

Thank you. Thank you. Our next questions come from the line of Chuck Brown with Cordon Ask It. Please proceed with your questions. Chuck, can you see if you're self-muted,

please? Go to the next question. Next caller, please.

Our next questions come from the line of Zach Fadum with Wells Fargo. Please proceed with your questions.

Good afternoon, guys. When you look at your operating margin outlook this year, which is implied about 5%, how much would you say this is constrained by the new stores opened over the last year? And how does that drag compare to the margin drag in the past? And then as you start to think about a recovery scenario, how should we think about just snap back potential for your operating margins?

Hi, guys. This is Brian Alstair, and then Trevor and Tom can jump in. I mean, it's heavy pressure from the new stores that have come in, but there is still some also from a decline in comps. I mean, you've got negative sales coming through, which will put pressure, but a lot of the pressure is still from our new stores. This is the first environment where I've been here for over 10 years, the first environment where I've seen our mature stores de-lever, so the sales pressure has put a little bit there, but still a lot from our new stores. And even the new stores causing cannibalization on our existing stores without giving specifics on those two. As far as when it will snap back or what kind of glide path it's going to be, it won't snap back immediately. It will take time, but we should have significant earnings power given any sort of growth environment. So if we get into the next year and there's any sort of growth environment, you will see significant earnings power, but I don't think it goes back to historical levels overnight. I think this

is Tom, and I would say that we have learned to be more disciplined in our spending within our store support center, within the amount of projects that we undertake, within the amount of investment that we make. Those lessons will continue to apply as sales rebound, so we should see benefit in kind of how we operate within our store support center and the investments that we make there. We should see the benefit as sales turn around. We would be more thoughtful in those investments. And then the last thing is 25% of our stores are running at minimum hours, so as soon as we see sales start to kick around, we get really good flow throughout our stores, so that would be very helpful. Yeah,

I think just to put numbers out, and you guys will see in the release and in the 10Q, we were able to decrease 7.7 million out of our comp stores in Q3. Year to date that number is 30.8 million that we've taken out. But you know, I've got to give credit to our store associates because as Trevor mentioned on the call, our customer service scores are as high as they've ever been. So we're doing this in a way that it's not impacting the customer experience. Got

it.

Sorry, go ahead. I

was modeling, and we have to set the plan, so this is once the plan is set, like once we give guidance next year, if there's upside, I think we feel pretty confident that you're going to flow through in the mid to upper 30s on that incremental sales above a plan. And you know, when you're operating at just above the 5% operating margin, if your sales are above that plan, you know, pulling that through in the mid to upper 30s is obviously very accretive to the operating margin and income.

Got it. And just if we enter call it the first half of 25 and comps remain negative, similar to where we are today, and the new store drag on the operating margins remains negative as it is today, curious just to what extent you would push out new store openings into 26.

Well, as I said at the beginning of the call, today we're still planning on opening 25 stores. We put those stores to the back half of the year to give us flexibility in the event that we want to push stores out, we will make that

decision.

My guess is we'll make it by the time the next time we're on the call, we'll have better visibility to that, and it will depend on how our top line is trending. If things improve, we get benefit from the hurricane. We see some benefit from existing home sales turn a little bit positive. Then. Yeah, we would continue to with our plan. If things were to get worse, then. Yeah, certainly we rethink that and pull stores out.

Got it. Thanks for the time guys.

Thank you. We ask that you please limit yourself to one question. Our next question comes from the line of Seth segment with Barclays. Please proceed with your question.

Hey guys, thanks for taking the question. As you think about exiting what seems to be an air pocket, right? How do you think about how the industry has changed over the last couple of years versus pre pandemic? And I'm really thinking about from a competitive perspective. Is there anything that you see is different? You know, have you seen the industry shake out as you would have expected from the downturn? Because it does feel like we're starting to see a wider range of results. So just any context there. Thanks so much.

I would say and I'll let earth on can chime in after I go or Trevor. If you see anything different, I would say that there will be less competitors as we come out of this cycle there. You know, we've already seen some closures. Within your bumper liquidators had to close stores. We had this noise of distributors closing noise of independence closing. So I believe that there'll be less competitors. When we enter the market, I think that the will continue to have to deal with home improvement centers ebbing and flowing getting better, getting worse. And we'll continue to have to deal with that like we always have. I don't think that's too much different than pre covid. And I don't think the independence have changed so much in how they go about their business. So I think the competitive advantages that we have today are similar to the competitive advantage. We had pre covid and I think they'll be the same as this as this bubble passes. And I'm getting some from earth on the deck. The answer was sufficient.

Thank you. Our next question comes from the line of Michael Lasser with UBS. Please proceed with your question.

Good evening. Thank you so much for taking my question. Given if you assume the midpoint of your guide for this year, where will your purse store transactions and purse store traffic end up this year versus 2019? And how is that compared to what your perception of the industry might be? Obviously, the question is related to market share. Your stores are being burdened with more cannibalization. But if transactions and traffic are flattish versus 2019 and there's been some closures across the market, why wouldn't that metric be better than it is?

This is Brian. I'll start and then Trevor and Tom can weigh in. When I look at kind of like the five year geocacher, what's implied in there is that we would exit at almost a flat transaction. It's our transactions are basically in line with where we would have, you know, exited 2019 from an average ticket or higher. But that's because of all the inflationary things that have happened post 2019. So when you think about that, our tickets are higher, but transactions are almost flat. And so that is burdened with cannibalization as we have opened a lot of stores during this down macro environment. But yeah, transactions against that time period on a purse store basis are basically flat today from where they were, which historically in our long term algorithm that we would have given back at the analyst day, we would have said mid to high single digits driven by mainly transactions. So it tells you that we believe there's a lot of pent up demand and some of those kind of things within the stores, given the fact that we are relatively flat where we were back in 2019.

Thank you. Our next question comes from the line of Chuck Graham with Gordon Haskett. Please proceed with your question.

Hey, guys, sorry about that. First call, I guess. With the category under duress, can you help us think about innovation and the pipeline on innovation products? What areas you're excited about over the next few years and then installation materials were

up

21% nicely here in the quarter. Can you talk about the success there? How much of that may be attributable to price actions and any other areas? Thank you.

Sure. This is Tom. I'll start and then Ersan can jump in. I think from an innovation standpoint, you know, we are trying to do more things than we've historically done. We've got a good program going on with the outdoor pilot where we're bringing in more outdoor products into our stores. We try to expand the amount of things we can sell to our customer. We've continued down the path on our newness. Even since COVID, we've done the same amount of product line reviews that we've historically done. So there's constantly new products coming into the store. And, you know, I think we're continuing to add adjacent categories, add to our adjacent categories that make sense. So, you know, all of those things should help kind of on that out cycle. I

just want to add a few other things that porcelain slabs that we've been expanding to more stores and this year as well. And we continue to add those unique items such as 4x8, 4x9, 5x10 feet porcelain slabs to more stores to get the market going. On top of this, we also started the acoustic wood panels. And it's totally incremental business to our business. Such as these are 1x7 to 7.7 wood panels that reduces the sound. And we are constantly trying to do this and innovation is going to be critical for the next year as well.

And there's more coming. We have another big adjacent category that we're going to pilot in the first quarter. So, you know, we're not sitting still. We're trying to be innovative and trying to continue to add to our offering to satisfy our customers. And as we come out of this and the market turns, it will even give us more ammunition to do better.

This is Trev. Your question on insulation materials. You know, several years ago, we made a very strategic decision to go after supply house strategies. So we added brands that really mattered to the professional customer. And we're seeing very good success with our professional customer, especially in that insulation materials category. And so we really just try to become a one-stop shop and have everything that the brand needs. And again, that's probably going on two years now, but that's been our best performing big category.

Thank you. Our next question comes from the line of Keith Hughes with Truist Securities. Please proceed with your question.

Thank you. You talked earlier about the ticket getting less negative, particularly the comps. But I guess we dig down into that. Are you seeing any product categories or seeing average selling price for score for whatever metrics start to move up? Are you seeing any kind of levels of inflation coming in?

I'm

not sure I completely

got the question. I don't know,

Trevor. Yeah, I think it's around ticket. I mean, our ticket is getting better. That's been, I think, a bigger component of our comp. Improving each of the last three quarters is our ticket relative to each quarter has gotten better. The biggest issue we face with ticket today, you know, Wood & Laminate are our largest ticket categories in the company. And when our business was very strong and we had six and a half million existing homes back in 2022, you had a lot of house flipping going on and people generally do much larger Wood & Laminate projects. And you've got that many houses flipping. Now that we're down, you know, whatever, there's 42% down to 3.8 million existing home sales. You don't have nearly as many houses flipped. So people are staying in-house and they're focused much more on bathrooms and half bathrooms. And those are much smaller jobs. And so the ticket issue that we're facing is predominantly almost completely driven by Wood & Laminate businesses, as I said, because people just aren't flipping homes at the same rate that they were when the economy was stronger in housing.

Yeah, and we still are seeing when the customers elect to do the project that they're still stepping into the better and best product as continue to outperform the better of the good.

Thank you. Our next question comes from the line of Oliver Wintermantel with Evercore ISI. Please proceed with your question.

Yeah, thanks very much. On the gross margin line, looks like the fourth quarter gross margin implied guidance is still up year over year. If you could maybe talk a little bit about the drivers in the fourth quarter, then just conceptually, I know you're not going to guide to 2025, but conceptually, how do you think about gross margins into next year? Is there an opportunity to reinvest in the business to drive traffic? A little bit of how you think about gross margins next year. Thank you.

We're continuing to see good benefits to our gross margin line from supply chain costs and seeing the benefits of that and from customers electing to buy better and best products, which makes better gross margin on. So those things continue to be a driver of gross margin. We think that will continue into the fourth quarter. As we look to next year, yes, this is still a challenging market for the categories. We're putting a lot of pressure on our merchants to buy as good as they can. As we do product line reviews and we get products from new vendors or new products from existing vendors, we're certainly challenging them on the cost side, make sure that we're trying to get our first cost to be as low as it possibly can and pass that on to the bottom line. So yes, we are planning on to have gross margins improve

again next year. Just as a reminder, too, on top of that, this is Brian. So just as a reminder, we do have optionality as we move into 2025, but when you're modeling, don't forget that we will open one distribution center in the second half of 2025 in Seattle. And then there's another one we're planning to open in the very beginning of 2026. Both of those will put pressure on our gross margin rate as we're in the back half and then entering into 2026. And then just as you get something about the model, Q4 should relatively be in line with Q3.

Thank you. Our next question comes from the line of Jonathan Matuszewski with Jeffreys. Please proceed with your question.

Good afternoon. Thanks for taking my question. Historically, I think you've shared your conversion levels are around 80% on average. Obviously, traffic is challenged with housing turnover and stretched household budgets. But for the footsteps you are seeing in stores, how has conversion been trending? And is that still holding up even with the stores on minimum labor hours? Thanks so much.

Yeah, this is Trevor. We recently just conducted a pretty detailed brand tracker that we do quite often. And those trends continue. If you look at the customers that are aware, the shop, and then they convert, those numbers that you quoted are very consistent with what we've seen previously. The issue is just the size of the people that are entering the market is just a lot less. But once we get them exposed to the brand, either online or in stores, then the conversion is very high for us. Not just the conversion, the brand tracker scores on customer

service amongst the pros. Anyone else that do it yourself will continue to show improvement. So not just the way we're measuring it on a monthly basis within our stores, but the brand tracker shows similar results. We're pleased with how our stores are executing.

Thank you. Our next question comes from the line of Peter Keith with Piper Sandler. Please proceed with your question.

Hi, this is Alexia Morganon for Peter Keith. We are hearing about headwinds on big ticket durables from election distraction. We were wondering if you've noticed this dynamic within your business. And then are you seeing any sales opportunity from the 90 or so lumber liquidator stores that are closing?

This is Trevor. I'll go first. And then Tom or Brian can weigh in. We said this on the script. Our Q4 today comps have gotten better. And so we don't know that we've seen that yet. I mean, that's certainly a reasonable expectation that happens every four years. But today, again, our Q4 numbers have continually gotten better throughout the quarter.

So we haven't seen that yet. And the lumber liquidators benefit as they close. We think that's a net positive for us. Depending on where their stores are located, how close they are to ours, the ones that are closing, it's good. We've been fortunate to be able to help place some of the displaced associates. We've been able to get higher them and give them employment in the event that a store is closed down and they've been affected. So again, that business will go somewhere. We think when we compete in that category, when you look across what they sell versus what we sell, our offerings are better than most. So we should be a net beneficiary.

Thank you. Our next question comes from the line of Karen Short with Mellius. Please proceed with your question.

Hi, thanks very much. Good to talk to you again. So my question is just on the implied 4Q guidance range. I mean, it's a pretty wide range. So just wondering if you can give puts and takes on comps in general, but also EBITDA margins. I mean, everything is a pretty wide range. So wondering if you could just talk to that a little more.

Yeah, I mean, it's still a macro environment that we're in. There's still a lot of volatility out there. Existing home sales just came in at 3.84 million readout for September. So there's still a little bit of movement in the macro that gives us just a little bit of pause to hold that range. I mean, we did compress the range in half from the last readout. And so just the most of it is around that, which is why we think about our comp. What's implied in there is about a two and a half to six and a half down Q4 to achieve seven and a half to eight and a half down for the full year. Most of that is around transactions or transactions would be implied around down mid-single digits with our ticket approximately flying Q4. So most of the variability is just around transactions as we look at our business.

Thank you. Our next question comes from the line of Philip Lee with William Blair. Please proceed with your question.

Hey, good afternoon, guys. You previously spoke a bit about the impact of rising freight costs having a minimal impact on fiscal 2024. How does that play out though in 2025 if rates don't abate? And then would contract to capacity keep you inflated from the spot market if demand begins to be more meaningfully inflated? Thank you.

This is Trevor. As we said, the majority of our rates are on rolling long term rates in the spring, kind of late winter, early spring timeframe is when we'll find out what those new rates are going to be. If the rates are higher because the spot market stays higher, then we and everybody else will have to deal with those higher rates in the past. You know, I've been here on 14 years at Florida Corps. When we've seen higher rates, we've seen the market be rational and those higher rates are passed along. And, you know, we would probably expect that to be a similar case for us. One of the benefits we do have is we're not paying spot market rates at all today. Even if they do go up, we still have some of our contracts that will save us some money. And you really, because we turn our inventory just over two times a year, we really wouldn't see those retail increases come until probably later Q3 and Q4.

Thank you. Our next question comes from the line of Molly Baum with Bank of America. Please proceed with your question.

Hi, thanks for taking my question. Robby had another earnings call this evening, but I wanted to follow up on Seth's question about the competitive dynamics specifically as it relates to your EDLP strategy. So I'm curious, you know, how you feel about your price positioning at present and specifically as it relates to kind of the good categories and your breadth of opening price points. And I guess the last one on that piece, you know, if you're still seeing, you know, relative inelasticity from any price reductions. Thank you.

So this is Tom. We still feel good about our price spread versus the competition at the good level. We mainly compete with the home improvement centers. When we look apples for apples and features for features and line them up, we still feel like we're in a good position versus the competitor. So, you know, it's a moving target. You know, things go up and things go down. We pay attention to that just like I'm sure they do. And but I feel good about kind of how we compete within the category against them. We mentioned on previous calls, we've seen good reactions to adjusting price for products that are specific for pros, so particularly in our installation materials. We've seen benefit as we've become more aggressive in that department to try to lure pros to give us more of their wallet. So, you know, we'll continue to pilot with that and continue to move that within that department as looking at our results as paying some dividends.

Our last question will come from the line of Justin clever with Baird. Please proceed with your question.

Thanks for sticking in here. Just a clarification on the quarter to date comp. Does that include a drag from the hurricanes and store closures or has that headwind been offset by some early demand creation in those markets? And I guess even more directly, does your implied four Q comp guide include any lift from initial hurricane rebuild? Thank you.

Hey, Justin. Thanks for the question. This is Brian. So our quarter today, just your reminder was down 4.2 percent. That is kind of neutral from storm impacts. We did have a little bit of headwinds early on in the quarter. Obviously, when the storms hit, it's kind of neutralized that throughout that, as Tom and Trevor have mentioned that we've seen a little bit of business pick up. It's just too hard to tell right now. So it's not implied within our guidance is any sort of material pick up within that. There's a little bit implied between that range of high and low, but there's no material amounts that we've included. Tom,

you need to release like the storms came and then people have to clean up so that there is a drag during the time. And as we've seen over since that's passed, things are better, but we'll see. You know, we don't know for sure what the impact will be. So I appreciate everyone joining us on the call. So we look forward to updating you on the next call. Thank you.

Thank you. That does conclude today's teleconference. We appreciate your participation. May disconnect your lines at this time. Enjoy the rest of your day.