Earnings Call: Q3 2020

Oct 29, 2020

Greetings, and welcome to Floor and Decor Holdings, Inc. 3rd Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn this conference over to Mr. Wayne Hood, Vice President of Investor Relations. Thank you. You may begin. Thank you, operator, and good afternoon, everyone. Joining me on our earnings call today are Tom Taylor, Chief Executive Officer Lisa Laube, President and Trevor Lang, Executive Vice President and Chief Financial Officer. Before we get started, I would like to remind everyone of the company's Safe Harbor language. Comments made during this conference call and webcast contain forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and are subject to risks and uncertainties. Any statement that refers to expectations, projections or other characterizations of future events, including financial projections or future market conditions, is a forward looking statement. The company's actual future results could differ materially from those expressed in such forward looking statements for any reason, including those listed in its SEC filings. Floor and Decora 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 the 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 irwaranddecor.com. A recorded replay of this call, together with related materials, will be available on our Investor Relations website. Let me now turn the call over to Tom. Thank you, Wayne, and thanks to everyone for joining us on our fiscal Q3 2020 earnings conference call. On today's call, I will discuss the highlights of our strong Q3 as well as the progress we are making on some of our strategic growth initiatives that we believe will enable us to continue to grow our market share in 2020 beyond. Trevor will then review our Q3 financial performance and discuss how we are thinking about the remainder of 2020, and then we will open the call for your questions. We are very pleased with our fiscal 20 2Q3 earnings results, which reflected broad based accelerating sales momentum, strong earnings flow through, as well as strong cash generation. Our fiscal 20 2Q3 total sales increased 31.4 percent to $684,800,000 from $521,100,000 in fiscal 2019. Our Q3 fiscal 2020 comparable store sales increased 18.4 percent exceeding our expectations. We are very pleased with our Q3 comparable store sales growth exit rate and the start to our Q4. Our year to date comparable store sales through the Q3 of fiscal 2020 are flat with last year, which is a remarkable accomplishment considering COVID-nineteen's impact to our store operations, which began in late March. Our Q3 adjusted EBITDA meaningfully improved to a quarterly record $106,700,000 an increase of 86.8 percent from $57,100,000 in the Q3 of fiscal 2019 and almost 1.5 times higher than our annual adjusted EBITDA in fiscal 2015. Our fiscal 2020 adjusted third quarter earnings per share increased 1 107.4 percent to $0.56 from $0.27 in the Q3 of fiscal 2019. We ended the Q3 of fiscal 2020 with no net debt on our balance sheet and remain in the strongest liquidity position in our company's history. Let me now provide an update on each of our 5 strategic pillars of growth, beginning with new store growth. We successfully opened 3 new warehouse stores in the Q3 of fiscal 2020, including new warehouse store openings in Salt Lake City, Utah and Toms River, New Jersey in fiscal August and San Diego, California in September and a small design studio in Dallas, of Texas in August. The fiscal Q3 2020 store openings brought the total number of warehouse stores that we operate to 128 stores, up 13.3% from 113 warehouse stores at the end of the Q3 of fiscal 2019. As we look forward to the Q4 of fiscal 2020, we plan to open 5 new warehouse stores with most of the openings in November. This will bring the total number of warehouse stores that we operate at the end of fiscal 2020 to 133, an increase of 10.8% from fiscal 2019. We are very pleased with the performance of our new stores, including those new stores opened in the Q3 as we successfully opened them in atypical ways due to COVID-nineteen pandemic. We are also pleased with the sales waterfall among our store vintages, particularly our most mature stores. We look forward to resuming 20% new warehouse format store growth in fiscal 2021 after having to temporarily slow our new store growth in fiscal 2020 due to the COVID-nineteen pandemic. We have long wanted to open our new stores in a more balanced cadence throughout the fiscal year and we believe we'll accomplish this in fiscal 2021. We also believe the class of 2021 will be a strong class of new stores. Moving on to our 2nd pillar of growth, growing our comparable store sales. We are very pleased with the broad based sequential acceleration in our sales that emerged throughout our Q3. On a monthly basis, our comparable store sales increased 15.7% in July to 18% in August and to 20.8% in September, which led to an 18.4% comp growth in the Q3 of fiscal 2020. Adjusting for the impact of Hurricane Dorian in the Q3 of fiscal 2019, we estimate our fiscal 20 2Q3 comparable store sales would have increased approximately 17.8%. On a 2 year stack basis, our comparable store sales increased 23%. Fiscal 20 2Q3 comparable store transactions increased 18.9% and comparable store average ticket declined 0.5% from the Q3 of fiscal 2019. We believe the decline in our comparable store ticket reflects a higher growth from our homeowner versus pro and designer influence business as well as being aggressive in the clearance of discontinued inventory in our highest ticket category, which is our natural wood category. We are making room for what we believe will be an improved natural wood assortment. Among our 6 key merchandising categories, our top performing categories were decorative accessories, laminate luxury vinyl plank and natural stone. That said, there was strong growth across all of our merchandising categories in the Q3 of fiscal 2020, which is the direct result of our ability to lead the market with differentiated and innovative trend right products at everyday low prices and having in stock job lock quantities that homeowners are looking for today. Our 3rd strategic pillar of growth is expanding our connected customer experience. Our fiscal 20 20 3rd quarter e commerce sales remained strong, increasing 111.5% from the Q3 of fiscal 2019 and accounted for 16.6% of our sales versus 10.2% last year. We continue to see strong double digit growth from paid and organic search as well as direct traffic to our website as homeowners contemplate flooring projects. In the Q3, traffic to our website increased 50% year over year. The combination of changing consumer behavior due to COVID-nineteen as well as investments we have made to further optimize our website experience and build out our content leads us to believe our e commerce performance metrics will continue to be strong. That said, our stores remain a critical part of our connected customer experience. In the Q3 of fiscal 2020, 87% of website orders were picked up in our stores. Our 4th pillar of growth rests on the successful investments we are making in our pro and commercial customers. In September, we further created excitement in our stores by successfully launching our 1st digitally executed pro appreciation month, where there was no purchase necessary to enter or to win prizes relevant to the professional customer. We are pleased that over 36,000 pros signed up for the Sweepstakes event and the feedback about the event and our virtual webinar training forms was overwhelmingly positive. We believe recognition events like this one are very important to building long term relationships and engagement with our pros. We also drive engagement through our Pro Premier Rewards PPR program where almost 75% of our pro sales are from PPR members. PPR pros spend nearly 3 times more and shop 2.5 times more frequently than non PPR members. We were pleased that enrollment in our PPR program in the Q3 of fiscal 2020 increased 30% year over year despite the impact of COVID-nineteen. The value of our PPR program is not only measured by growth in PPR members, but also by points earned and redeemed. In the Q3 of fiscal 2020, points redeemed increased 70% from last year, validating the value of our PPR program and engagement with our pros. To continue to drive engagement and points earned in the Q4 of fiscal 2020, we the that the more engaged we get our pros with floor and decor, the more wallet share we can obtain. And PPR is just one avenue to do this. As we move into 2021, we will further enhance our PPR program and build on our segmentation and personalization efforts to drive engagement and lifetime loyalty. We are nearing the completion of updating our homeowner and pro demographic and segmentation information and look forward to sharing the results early next year. Our CRM investment has resulted in a very successful tool as we are learning a lot about not only our pros, but homeowners, which better informs us of who customers are and the strategies we need to implement to obtain more wallet and market share. Let me now discuss the progress we're making on our free design services, the 5th pillar of our growth. We are pleased that the number of design appointments increased 44.5% in the Q3 of fiscal 2020 from the Q3 of fiscal 2019, and that is well above the fiscal 2020 Q1 pre COVID-nineteen growth rate of 34.3%. This was particularly gratifying considering we were not able to quickly return to pre COVID-nineteen designer staffing levels as many were furloughed in the Q2 of fiscal 2020. It's important to note that our design services are not only important to homeowners, but to pros. We believe we have significant runway ahead of us with design services and are focused on building awareness of our services to homeowners and pros, internally driving the value of using our system to increase our already high conversion rate and growing our pipeline of designers to support our growth objectives. Let me now turn my comments to how we are thinking about the macroeconomic environment. We are operating in unprecedented times with homeowners nesting at home more due to COVID-nineteen and having additional discretionary income due to not spending as much on leisure activities like travel, hotels, eating out and sporting events. This has caused a substantial increase in the savings rate, and fortunately, people are investing those dollars in the home. We are also seeing some of the strongest growth in both new and existing home sales. In September, existing home sales grew for the 4th consecutive month to a seasonally adjusted annual rate of $6,500,000 up 9.4% from the prior month and nearly 21% from last year. The housing market is clearly benefiting from what looks to be a sustained period of low mortgage interest rates that are hovering at or below 3%. We expect to continue to benefit from this lower, longer interest rate environment and the secular demand for housing. Carpet continues to seed market share to hard surface flooring. 79% of the 123,000,000 occupied housing units in the United States were built before 1999, which is a lot of homes that need to be invested in and maintained. And flooring is a great way to improve the look of a home and increase the value. Millennials, the nation's largest adult population at 72,100,000 now outnumber baby boomers, and they are entering their prime household formation years. This demographic trend is contributing to the demand for housing exceeding supply and is partly responsible for the home price appreciation we continue to experience. The COVID-nineteen pandemic has also impacted consumer behavior. Homeowners are undertaking projects to repurpose and personalize their homes to work, learn, exercise and play. The combination of homeowners investing, a high savings rate, low interest rates, rising housing demand, rising housing values, homes that are aging and a preference for hard surface flooring is a great backdrop for our industry and our company. Collectively, these factors, among others, leave us optimistic about the remainder of 2020 and the long term opportunity ahead of us. We are also pleased to announce today that Ryan Marshall, CEO of Pulte Group Cammy Scarlett, Chief Human Resources Officer at Best Buy and Charles Young, Executive Vice President and Chief Operating Officer of Invitation Homes have been appointed to Floor and Decor's Board of Directors effective January 1, 2021. We are thrilled to welcome Ryan, Cammy and Charles to our Board. They are outstanding executives with broad operational, commercial and strategic expertise that we believe will assist us in our growth plans. They will also add diverse perspectives and skills to our board discussions. We also announced that John Roth, Chief Executive Officer of Freeman Spogli Rachel Lee, Partner at the Private Equity Group of Ares Management Corporation and Brad Bruticove, Partner of Freeman Spogli have resigned from our Board effectively at the same time. We want to thank John, Rachel, Brad for their extraordinary contributions to Floor and Decor over the 10 years. Let me close by saying that our strong fiscal 20 2Q3 earnings are the direct result of our associates responding tirelessly to the surging demand and cross functional collaboration of our teams. Our entire executive leadership team would like to thank them for their hard work and dedication to serving our customers. I will now turn the call over to Trevor to discuss in more detail our Q3 financial results. Thanks, Tom. The unique operating environment we find ourselves in combined with a distinctive business model and great associates has allowed us to swing from a 50% decline in comparable store sales just a few months ago due to COVID-nineteen to strong 18.4% growth in Q3 of fiscal 2020. Tom already discussed how pleased we are with our solid Q3 fiscal 2020 sales momentum and a great start to the Q4. So I'm going to concentrate my comments on some of the changes among the major line items in our Q3 2020 income statement, balance sheet and statement of cash flows and then discuss how we're thinking about the remainder of 2020. Let me begin with our gross margin. We are very pleased that our fiscal 20 20 3rd quarter gross profit increased 37.8% to $294,600,000 driven by a 31.4% increase in total sales and a 200 basis point increase in our gross margin rate to 43% from 41% in the same period last year. The 200 basis point increase in gross margin rate from the same period last year was primarily due to higher product margins, driven by continued enhancements to our merchandising strategies and improved leverage of our distribution center and supply chain infrastructure on higher sales, partially offset by higher clearance markdowns in our natural wood department. Turning to our fiscal Q3 2020 expenses, our 3rd quarter selling and store operating expenses increased 25.2 percent to 171,500,000 from 137,000,000 in the same period last year and leveraged 130 basis points. Our comparable store selling and store operating expenses leveraged 220 basis points from the same period last year. The improvement in our expense leverage was primarily the result of better than expected 31.4 percent growth in total sales that enabled us to experience outsized leverage in our store fixed and variable payroll expenses, as well as store operating and occupancy costs. More specifically, the outsized near term expense leverage that is the direct result of our sales exceeding our planned store labor hours as customer demand accelerated. As we move through the Q3, we took actions to further accelerate the hiring of more associates to meet the surging demand. As a result, our payroll hours were better aligned with our sales trends as we exited the Q3, but they were still below where we think they should be to serve our customers well. As we continue to add labor hours to meet the demand and open more new warehouse stores, our Q4 2020 expense leverage will not look similar to the Q3 of fiscal 2020. Our fiscal 2020 Q3 general and administrative expenses increased 5.5 percent to 39,300,000 dollars from $37,200,000 during the same period last year due to higher depreciation associated with IT investments as well as our new store support center that we moved into the Q4 of 2019 and higher incentive compensation accruals. As a percentage of sales, our G and A expense rate leveraged 140 basis points to 5.7% from 7.1% during the same period last year. Excluding the impact of COVID-nineteen and secondary offering expenses in 2020 and costs associated with our distribution center closure and store support center relocation in 2019, our G and A expense rate leveraged approximately 20 basis points from last year due to our strong sales and lower year over year expenses for travel, mills and meetings. More detail about these adjustments are provided in our Q3 10 Q and the reconciliation of GAAP net income to adjusted net income in our Q3 earning choice. Our fiscal Q3 2020 pre opening expenses declined 38.6 percent to 5,000,000 dollars from $8,200,000 last year and leveraged 90 basis points year over year. The decline in expenses is primarily the result of the decline in the number of stores that we either opened or are preparing to open when compared with the Q3 of fiscal 2019. We opened 3 new warehouse stores and 1 small design center in the Q3 of 2020 compared with 7 new warehouse stores in the Q3 of fiscal 2019. Our fiscal 20 20 3rd quarter effective income tax rate was 10.4% compared with a negative 39.3 percent benefit during the same period last year. Our effective income tax rate is lower than the statutory federal income tax rate of 21% due to recognition of income tax benefits from tax deductions and excess book expense related to stock option exercises and other discrete items. Moving to our fiscal 2020 3rd quarter EBITDA profitability, the 31.4% increase in total 3rd quarter sales coupled with a 200 basis point increase in our gross margin rate and broad expense leverage drove a record fiscal 20 3rd quarter EBITDA profitability. 3rd quarter fiscal 2020 adjusted EBITDA increased 86.8 percent to a record 106,700,000 dollars from $57,100,000 during the same period last year. Our adjusted EBITDA margin rate increased 4 60 basis points to 15.6% from 11% last year. Our fiscal 20 2Q3 GAAP net income increased 67.8 percent to $68,800,000 from $41,000,000 during the same period last year. Our fiscal 20 2Q3 GAAP diluted earnings per share increased 66.7 percent to $0.65 from $0.39 per share last year. Our adjusted 3rd quarter net income increased 111.8 percent to $59,400,000 from $28,100,000 last year. Our adjusted diluted earnings per share increased 107.4 percent to $0.56 from $0.27 last year. We ended the Q3 of fiscal 2020 with 106,400,000 diluted weighted average shares outstanding compared with 105,200,000 during the same period last year. Moving to our fiscal 2023rd quarter balance sheet and cash flow statements. We're very pleased that during these unprecedented times we have been able to maintain a strong balance sheet and have the strongest liquidity position in our company's history to support our growth plans. As of September 24, 2020, our unrestricted liquidity was 628,500,000 consisting of 271,000,000 in cash and cash equivalents and 357,400,000 immediately available for borrowing under our ABL facility without violating any covenants. For the 39 week ended September 24, 2020, we generated 269,700,000 in operating cash flow, a 28.7% increase from the $209,600,000 in the same period last year. The increase reflects growth in our fiscal 2020 earnings, improvement in our working capital and cash paid for income taxes. The improvement in our working capital is largely due to the improvement in our inventory productivity from accelerations in our sales trends. Year to date, our fiscal 2020 net inventory grew by 2.9 percent to 598,500,000 from $581,900,000 at the end of fiscal 2019, which is below our 12.1% growth in total sales over the same period. In the Q3 of fiscal 2020, our net inventory increased 23.7% to $598,500,000 from $484,000,000 during the same period last year, which is below our 31.4% growth in 3rd quarter sales. Our fiscal 2020 capital expenditures for the 39 weeks ended September 24, 2020, declined 22.2 percent to $109,700,000 from $141,000,000 during the same period last year. The decline is primarily related to the decrease in new stores opened or were under construction as a result of COVID-nineteen when compared with the same period last year. Our strong fiscal 2020 operating cash flow coupled with lower year over year capital expenditures enabled us to generate $160,000,000 in free cash flow for the 39 weeks ended September 24, 2020, or more than double fiscal 20 nineteen's free cash flow of $68,600,000 during that same period. Let me now turn to our revised expectations for fiscal 2020 capital expenditures. We now expect fiscal 2020 annual capital expenditures to be approximately $200,000,000 to $208,000,000 which is slightly more than the 6% increase from our prior expectations of $188,000,000 to $196,000,000 Our fiscal 2020 capital spending plans reflect the following growth investments and will be funded from cash flow from operations and borrowings under our ABL facility. We plan to open 13 warehouse stores and 1 small design center in fiscal 2020 and start construction on several stores in the Q4 of fiscal 2020 that are expected to open early 2021. Capital spending associated with these plans is expected to be 132,000,000 to 136,000,000. We are investing in existing story modeling projects in our distribution centers and expected capital spending associated with these projects is expected to be approximately 27,000,000 to 28,000,000 dollars We are planning to enlarge and relocate our Houston distribution center in the second half of twenty twenty one and are expecting capital expenditures in 2020 associated with this project to be approximately $19,000,000 to 20,000,000 dollars We continue to make investments in our new store support center, information technology infrastructure, e commerce and other store support center initiatives to support our growth and look for capital spending of approximately $22,000,000 to $24,000,000 to support our growth in these functional areas. Let me now discuss how we're thinking about the remainder of fiscal 2020. From a macroeconomic perspective, we are cautiously optimistic that the Federal Reserve's action to inject liquidity into the market and lower interest rates will continue to support the economy and provide a positive housing backdrop as well as consumers nesting and spending less on leisure activities will serve to support growth for the remainder of 2020 and into early 2021. That said, there is still significant uncertainty related to COVID-nineteen, including a rise in infections in many markets, which raises concerns of another wave heading into the fall and winter. While we are optimistic about the economic recovery and the momentum of our business, we recognize that these business risks remain elevated and we could have to close stores in certain markets if necessary. For that reason, we are continuing the practice of not providing specific sales and earnings guidance for fiscal 2020, but we would like to provide some direction as we approach the end of fiscal 2020. Our better than expected third quarter sales growth created selling and store expense leverage as we benefited from the aggressive actions we took to reduce our cost structure in the Q2 of fiscal 2020 due to the COVID-nineteen pandemic. As we exited the Q3 and entered the Q4, our expense growth is becoming more balanced with our sales growth and is likely to lead to less expense leverage in the Q4 of fiscal 2020 than we experienced in the Q3 of fiscal 2020. Consequently, we are planning on strong profit growth in the Q4 of fiscal 2020 relative to last year, but we do not anticipate the same rate of outsized profitability we experienced in the Q3 of fiscal 2020. As a reminder, fiscal 2020 includes a 53rd week, which for us means the 4th quarter will include 14 weeks versus the normal 13 weeks we have in each quarter. We estimate this additional week will continue to contribute between $0.03 to $0.04 in diluted earnings per share. The remaining comments about the Q4 of 2020 are on a comparable 13 to 13 week basis. Our reported Q4 2019 gross margin benefited from a one time Section 301 tariff refund primarily related to rigid core vinyl of $14,000,000 Adjusting last year's 4th quarter for this benefit, our gross margin rate would have been approximately 41%. Our current expectation is for our Q4 fiscal 2020 gross margin rate to increase meaningfully from last year, but less than the 200 basis point increase in the gross margin rate we experienced in the Q3 of fiscal 2020. In dollars, we are planning on mid single digit sequential growth in our selling and store operating expenses from the Q3 of fiscal 2020 to the Q4 of fiscal 2020 due to a more normalized cost structure and more new stores. We are planning on meaningful increase in our fiscal 2020 Q4 pre opening expenses when compared to the Q3 as we plan to open 5 new stores in the Q4 versus 3 in the Q3. Additionally, in 2021, we are planning to open the highest number of new stores in any Q1 in our history. As a result, we will incur some of the pre opening expenses for these new 2021 stores in the Q4 of 2020. We expect our general and administrative and interest expense to be about flat with the Q3 of fiscal 2020. We would expect our 4th quarter tax rate to be approximately 23.7%, higher than previously contemplated due to higher net income. This of course does not contemplate any stock option exercises that may benefit our provision for taxes. We expect our annual depreciation and amortization to be approximately $90,000,000 The executive team is incredibly proud of how we performed in 2020. We are a better company than before the pandemic occurred, and I would like to thank all of our associates for their great work. With that, we'd like to turn the call over to the operator for questions. Our first question comes from the line of Seth Sigman with Credit Suisse. You may proceed with your question. Thanks for taking the question and congrats on the quarter. Great results. I wanted to talk about the improvement that you spoke to each month of the quarter. Can you just elaborate on the trends that you were seeing throughout the quarter? And how consistent was that improvement across geographies? And then I guess just related, you mentioned the mix shift to the homeowner, I think, in some of your prepared remarks. What's going on there? If you could elaborate on DIY versus pro, that would be helpful too. Thanks. Sure. Thank you, Seth. This is Tom. As we said in the prepared remarks, each month we got better, and we exited at an incredible and people repurposing the space in their homes and people not spending on travel due to COVID-nineteen and entertainment and sports and things of that nature, that money is being put back into the home. And we're seeing the homeowners as evidenced in our weekend business. It's been terrific and consistent across regions. It's just been a lot better than it has historically been. The other thing I'd say just on the homeowner side is, we mentioned that our web traffic was up 48% during the quarter. There is a lot of people researching. Our purchase cycle is long in our category and there is a lot of people researching to do projects in the future. So we're really pleased with the tone of business. Okay. It sounds like the leading indicators in the business remain very strong as well. I wanted to follow-up also on the gross margin. For the Q4, Trevor, I think you just talked about it being up year over year. I want to clarify that's against that 41% the adjusted. And then I think you're saying less it would be up less than the Q3. Just any differences to call out there, that would be helpful. Yes. I think you got that right. Last year's was abnormally high because of that $14,000,000 benefit we got from the Section 301 tariff refund. And so the adjusted gross margin last year backing that out is 41%. And so yes, that comment was relative to the 41%, we're assuming a nice gross margin. Last quarter, we had a 200 basis point increase in gross margin. So we don't think it's going to be that high, but as I said in the prepared comments, we think it's going to be up nicely. And it's coming from continued product margin, but we're also starting to get fairly significant leverage out of that Baltimore distribution center. You guys will recall, in November of last year, we opened that big Baltimore DC, and we're getting 2 benefits. 1, we're lapping it on much higher sales. And 2, the domestic transportation costs to about just under a third of our stores is lower because we're now shipping to the Mid Atlantic, the Northeast and the Midwest out of Baltimore versus Savannah. And so that we're also getting the benefit there. So it's pretty balanced between supply chain and product margins is what we're expecting. Our next question comes from the line of Michael Lasser with UBS. You may proceed with your question. Good evening. Thanks a lot for taking my question. Tom, you mentioned that the home system in focus compare the flooring category to some other categories, it has been growing a bit slower than seemingly what other categories within home improvement have been growing. Can you offer your perspective on why that might be the case? Do you think it's related to consumers having apprehension about letting installers into their home or the potential need to dislocate during a flooring project? And does that bode well into next year, meaning this will have legs to a recovery whereas other categories might fade within the home broader home business? Michael, the beginning part of your question came out a little blurry not blurry, but I couldn't hear it as well. Can you just I think I got the gist of it, which is the perception of is flooring all of home improvement is performing nicely, is flooring performing consistent? Is that the nature of the question? Yes. I mean Home Depot and Lowe's are comping up mid to high 20s. The at home comps up 40% today. So clearly, home's in focus, but flooring seems to be doing maybe a little bit below average within the broader housing ecosystem. Is that because this requires pros to be in a consumer's home, the consumer to be just Sure. Yes, I don't think that has anything to do with it. We have not heard we've talked about the surveys in the last quarterly call. Consumers are letting professionals into their homes. Our pros, whether it's the pros that are in our affiliate program or whether it's the pros that are shopping in our stores on a normalized basis, they're booked. They're backed up. Their backlog is strong. They're out far before they can get into homes. Consumers are showing no evidence of that worry. I think that we've tried to do a good job of educating our pros early on, on how to protect themselves and how to ensure the consumer feels good about letting them into their homes, and they are. So that is the least of our concern. Okay. And it seems like on the gross margin, I recognize that it's just product margins that are you're seeing higher product margins. Is that so presumably pricing is just going up in excess of cost. So is this a sustainable trend? And should we be modeling standing gross margins for the next several quarters given some of what's happening right now? Yes, Michael, this is Trevor. It's a mix, right? The team has done a great job on the assortment. We called out our decorative accessories as comping above the company average, that's a higher product margin for us. And then within each of the categories, with the exception of wood we called out, we're seeing people gravitate towards better, best. And then also, as I mentioned, we have that Baltimore DC reopened last year that we're getting leverage from this year. So it's a the biggest driver is the product margin. Within the product margin, it's the better and best driving it. And then again, within the mix to that is the decorative accessories, which is a higher margin category for us, is one of our better performing product margins. Our next question comes from the line of Steve Forbes with Guggenheim Securities. So Tom, you spoke about Pro in great detail in your prepared remarks. But I was hoping you could maybe expand on the commercial initiative, right? As we think about the regional account managers and how that's been scaling, Are you leaning into the channel just given the strength in the end market here? And any color on how we should be thinking about the maturation profile behind that initiative looking out over the next couple of years? Yes, we feel good. We started adding a position called a regional account manager a little over a year ago. We now have 21 of them going around the country, and we're adding them aggressively currently and we will in the next year. These are managers that work with commercial customers that are unlikely to come into our store or that the orders could be too big for our stores to handle appropriately. When we started the process, we started we started with just a couple of them to see how it would go. Again, very pleased with what they've been able to bring to the table. We've done a good job of recruiting some excellent talent to help lead the effort. And it's a strategy we feel good and we'll continue to work towards. We're also excited, as I said in my prepared remarks, we're adding 2 Board members that have really good commercial experience and we're looking forward to their insight on how we can penetrate the commercial market in even a more meaningful way in the future. Thanks. And then just a quick follow-up, right? You think about just the underlying demand in the end market here. Curious about whether you're seeing anything from a competitive dynamic. I mean, are people chasing or sort of trying to catch up to you as far as it relates to driving innovation? Or how would you speak to sort of the separation between F and D and the competitive landscape as it relates to sort of driving that product innovation cycle? Sure. Lisa will go ahead and answer that and then I'll chime in. Okay. Yes, so this is Lisa. It's interesting apart from the vinyl and laminate categories where we've seen a lot of innovation over the last 2 or 3 years with water resistant and the new the SPC and WCC product, there has not been a ton of innovation that we have seen out there from a competitive perspective. We think it is a real differentiator for us and it is something that we focus on a lot. We just brought in our new core performance line in the last month or 2, which is our highest end vinyl, which offers really great features for the customers. So that's been something that's been very good for us and we've got more things coming down the pipe. So I would say that from a competitive perspective, our goal is always to be out front and leading on the innovation side, especially where it pertains to durability and those things that the customers are really looking for. As I said, I'll chime in. The other thing that makes us unique when it comes to the competitive landscape and COVID did not slow us down is our approach to newness within each category that we participate in. Our merchants have continued to do product line reviews across the board and bring new products all throughout COVID. We were able to do that virtually and we've got great new stuff hitting the store every day. And in this category, the latest and greatest product innovation from the standpoint of durability is really important, and we've done a lot of good work there. And I think we are ahead there. But in newness is where I think we really continue to widen our gap. Our next question comes from the line of Steve Forbes with Guggenheim Securities. Thank you for your question. Our next question comes from the line of Chris Hulvers with JPMorgan. You may proceed with your question. Thank you. Good evening, everyone. Great quarter. Can you seasonally, looking back, gross margin rate tends to be better in the Q4 than the Q3. I'm guessing that's mix driven. So can you share your thoughts there? And related to that, with tariffs, I think back on, what have you seen in the pricing environment? Yes, Chris, this is Trevor. It has more to do with the clearance event in the Q4. Yes, Chris, this is Trevor. It has more to do with the clearance event in Q3 than it does with really mix between Q3 and Q4. We have our biggest clearance event of the year in Q3. So that's historically been a lower margin category as we grab our clearance then. As regards to the tariffs, most of you guys may recall on August 7, the government reinstituted 25% tariffs on rigid core vinyl, water resistant laminate and a few other categories. So we're now again paying 25% tariffs. We didn't know how that was going to happen. So we sort of bought ahead. So we're not really feeling a lot of that impact today. And we're using the same playbook that we've used for the 2 years we've been dealing with this. We're working with our vendors to see what costs we can take out. We're working with our vendors to see where we can do sourcing, not a lot in this category currently. And then there's probably going to be some retail increases. And our goal is to monitor it and see what's going on in the marketplace. At least that keeps us surprised and we're not seeing a lot today, but we would expect marketplace. Lisa keeps us surprised and we're not seeing a lot today, but we would expect as people are starting to feel some of those cost increases that you likely would see some retail increase because in those two categories today still the vast majority of that product is manufactured out of China. Got it. And then as a of China. Got it. And then as a follow-up, I understand you've been chasing labor to catch up with demand. But on other side, there's probably some sort of one time ish type expenses. You talked about incentive comp, maybe quantify that and any other COVID related expenses or special bonuses or PTO that you paid? Yes. When we came into the year, we were obviously accruing. We got to Q1 and we weren't incurring much, just not knowing how bad COVID was. So that actually was a bit of a benefit. You may recall, we had a really strong operating margin component in Q1, part of it was because of that. And then as the year has progressed on, we're actually getting closer to accrual. So our incentive comp as a percentage of our total sales is pretty small. So it's in the single bps, small bps range that it's impacting us. And I wouldn't call it any big big things. We have invested in some consulting and some other things, just trying to grow and invest in future strategies, but nothing very significant relative to our overall sales that we've incurred. Understood. Best of luck. Thank you. Our next question comes from the line of Seth Basham with Wedbush. You may proceed with your question. Thank you and good afternoon. My question is around transportation costs. You guys talked about distribution and supply chain leverage in the quarter. As those higher transportation costs that we're seeing now get baked into your product costs and work their way through the P and L, what kind of impact do you expect on gross margin? And related to that, if you could help us better understand the types of contracts you have and mitigation strategies you have as it relates to transportation costs? Yes, this is Trevor again. We're very fortunate. Our supply chain team has done a really good job in locking in long term contracts, both domestically and internationally. That helps us in 2 ways. One, it allows us to get capacity when there are certain places it's very difficult to get capacity out of just because there's so much demand, things came out of Asia, for example, and then there's some capacity can transfer in the States. So that's one thing is, A, we can get capacity is an important part of it. And then, 2, because we do have longer term contracts and the majority of our transportation is going through these contracts, we're not feeling those spot increases today. Now those contracts come up over the next 12 to 18 months and if the rates stay high, we're going to have to deal with that more next year. But currently, because we've got these longer term contracts, we're not feeling those cost increases. Our next question comes from the line of Jonathan Mattski with Jefferies. You may proceed with your question. Hey guys, next quarter. Thanks for taking my question. You mentioned in the release you're pleased with the start to 4Q. Care to share how October is trending versus September's exit rate? Yes, I said we're very pleased with the start to the Q4. It's very consistent to the way we exited September. Our next question comes from the line of Simeon Gutman with Morgan Stanley. You may proceed with your question. Thanks. Hey, everyone. I wanted to ask I'll make it one question, but with 2 parts. First, I don't know, Trevor, I know you were answering Chris' question on gross margin. Is it are you ruling out the possibility that the Q4 growth can't be higher sequentially this year than Q3 because of those factors? Or is there still a possibility of an outcome? And then the second question is, even with the tougher start to this year, it looks like you're still going to do a roughly mid single digit comp this year. And you've told us the biggest driver or one of the biggest drivers is housing turnover. And I don't know if you've lined up the existing home sales estimates for next year, but they look pretty robust. So I'm curious if next year could look normal in your algo? I realize it's early for this, but just high level or if it can look outsized. Yes. On the first one, the gross margin, we are planning on growing nicely versus the 41% we had last year. It would be very hard to imagine it would get to the 3rd quarter level. That 43% is just a very large rate for us. And then on as we're thinking about next year, we're in the planning stages now. We've done a lot of work around this. We're preliminarily thinking about it kind of on a 2 year basis because there's so much noise going on right now. I do think from a macro perspective, we have a lot of wind at our tails with all the things that are going with existing home sales and the fact that home values are going up and the aging demographics. I mean, all those things are going to be beneficial to us. And I think from a longer term perspective, most of you guys probably have read by now in our proxy statement, we had a goal for 2022 to get to $329,000,000 in operating income, which would be a doubling of our operating income over a 3 year period from 2019 to 2022. And we're still focused on that. It's a little harder because we didn't open 24 stores this year, right? We opened 13. But that's something that's in our sights and in our goals and we're focused on achieving. So we know this year and next year will be a little bit choppy, but as we get to 2022, we still have our eyes set on those goals. Our next question comes from the line of Chuck Grom with Gordon Haskett. You may proceed with your question. Hey, thanks. Good afternoon. Taking a step back despite all the volatility on gross margin, it looks like they're going to finish the year at or above all time high levels. So I think when you look ahead, how are you guys thinking about the trajectory here, particularly as you continue to compound growth at 20% a year? And then just as a quick follow-up, Trevor, can you just clarify your guidance for the Q4 selling expenses? I think you said up mid single digits sequentially. I just wanted to clarify that. I think as we think about the next 3 years, because we're going to get back to 20% unit growth next year, there's going to be some headwinds on store level SG and A and preopening expenses, right? Just we're going to open roughly 27 stores next year versus 13 stores, we incur anywhere from $1,200,000 to $1,500,000 for pre opening. So that expense is going to grow at a much faster rate. Our new stores, as we've said, for the 3 years that we've been public, their SG and A as a percentage of sales is roughly 50% higher, mid to low 30s versus low 20s for our more mature stores. So we're going to have some deleveraging on the store level SG and A component because we're getting back to 20% unit growth. But we do think we have some continued margin opportunities as we continue to execute better, best, as we continue to get leverage out of the supply chain and the distribution centers, shrink damage, all those kind of things, we think we can continue to grow gross margin. And then the corporate side, we have the ability that we think we can leverage in corporate. And again, back to that comment of if you look at our 2019 results to what is the goal for 2022, we don't plan on doubling ourselves during that period of time. So we are planning on getting operating margin and EBITDA margin leverage. There was another part of that question. You think that was it? Okay. Just a clarification on the 4th quarter selling expense. Yes, I did say sequentially. And the reason I view sequentially versus last year is just that was through COVID versus post COVID. So now that we're in this post COVID environment, I thought it was more relevant to talk about how we're operating. And you heard me correct, it's sequential from Q3 to Q4 this year, we think it's a mid single digit increase. I have to say this, I guess I'm the only one, but Tom, those are some pretty good board announcements you made today, I have to say. I've never said that before. The question I have is one question clearly, but it's just you actually brought up the home demographic and segmentation analysis that you're doing right now and that you're going to give the results of, I guess, in next year, early next year. And I don't think you talked too much about that. And I already thought that your stores are pretty segmented, decentralized. So could you at least, without feeling your thunder, give us kind of a sense of what that thought is about? Tom, over to Jamie. Yes. So we've been talking for a year or 2 about our new CRM system, its Salesforce. And we have been the Pro desk has used parts of it, for the last couple of years. And what we've been able to do over the last year is put all of our data in there, connect all of the customer information that we have from all the various touch points that they have with the company. And we've cleansed all that data and are now starting to be able to use that to understand homeowner versus pro, what are the demographics of each. And then now we're starting to just initially to personalize messaging and starting to go after where we see opportunity. So it's a little early to reveal just yet, but we definitely are learning some interesting things about our customers and things that we think will really help us to drive the business forward in the future. So, we look forward to sharing that maybe Q1. And Matt, this is Trevor. I'll just add one thing is having that data is just incredibly useful to us because we've missed out now we have so much more information. And then we're using some of that with data scientists to then correlate what stores are over or underperforming relative to what they should be doing. And that then gives us a roadmap for the regional team and even down to the store level for them to focus on design or pro or pat them on the back because they're exceeding our expectations in those levels. And so just we're going to have a whole we are finishing up having just a level of information and data that we've never had in our past and information is power. We're going to be able to use that to make better decisions corporately, of course, but even down to the region and the store level. So we are pretty excited about having this and it's just a powerful tool that we've not really had access to in the past. Our next question comes from the line of David Bellinger with Wolfe Research. You may proceed with your question. Hey, guys. Great quarter and quarter. So just on average ticket down 50 basis points this quarter, that broke a trend of up 2 to 3 percentage points over the last year or so. What are you seeing there? Any type of trade down on the DIY side? And also maybe just some commentary on the in store design services. Are customers still engaging that service as much as they were pre COVID? Or have you seen any consumer apprehension there that's weighing on potentially higher ticket trends? Yes. So, 2 parts to that question. I'll take them both. The first part about our average ticket, as we said in our prepared comments, really a few reasons for a little bit of that. One is you mentioned design services and our design services are just getting back up to speed. We were slow. We had a lot when we did a furlough of our part time associates, we have a lot of our designers that are part time and it took a while to get them back into the fold. They're getting here now and our design appointments are where we want them to be and our designers are engaged in the sale. But during the Q3, it took time to get them there. So we didn't have those big tickets that we always have. Secondarily, we've been really aggressive in clearing out some old of our wood products that our average sale in our wood department has gone down. That's purposely. We've done that to get our new stuff. We've got great new wood looks come they're in now and more on the way, and we had to get that clear. And then the last part is with the homeowner increase that we're seeing, we're seeing the homeowners are attacking a lot of small jobs. When they're nesting at home and they're looking around and they're looking at their backsplash, as evidenced, if you look at our deco department, it was the best comping department during the Q3. And that's an evidence that we think people are nesting, they're looking, they're sitting in their kitchen, they're working out of their kitchen, they're on conference calls, they look up and they see an ugly backsplash and they change it. So a backsplash that's a lot less than average tickets in the bathroom. So I think combination of those things are what's challenged the average ticket. But overall, I feel good about where we're going in design. I feel good about our staffing levels in design. I feel good about what we're doing in design as we enter into this quarter. Our next question comes from the line of Alex Maroccia with Berenberg Capital Markets. You may proceed with your question. Good evening, guys. Thanks for taking my question. With the net cash position in mind, in addition to the dry powder you have from the ABL, would you be willing to accelerate the store opening cadence or remodel older stores more rapidly in the coming quarters? Yes, this is Trevor. I think Tom may have something to add to this. We are going to be spending a lot more on CapEx next year as we get this year we opened 13 stores versus 27 stores. We're also investing more in our stores. We've seen a nice return. It wasn't that long ago that our 1st year new stores were doing $800,000 in 1st year EBITDA. Now they're getting close to $2,500,000 of EBITDA. And we're getting some of that because the stores just are bigger. They're in better locations. We spend a lot more on the inside and the outside of the aesthetics of the store. We're going to own a few locations. We've got some areas where we've got a number of stores, very high volume, very profitable stores that we think we've got a really good investment in individual locations. And then our Houston DC that I talked about, we're going to spend some capital in that Houston DC. Every single one of those has a very detailed ROI associated with it that we think is going to be well above our cost of capital. And so we are going to be more aggressive in deploying that capital next year as we get back to 20% unit growth. Yes. You hit mostly everything. I'd add one thing that we've been asked for a while, would we accelerate the growth of our new stores and that's never been a cash decision as much as it's been a cultural decision. We keep our growth to 20% units, which is a lot of growth that more than most of retail does, but that's purposeful. Culture is very important to us. We have a unique culture. It's difficult to run a floor and decor store. We want to make sure that people are trained to do that. And they have a lot of autonomy at the store level to make decisions for their own, and that takes time to get them ready to do that. So we pace our openings purposely. Our next question comes from the line of Elizabeth Suzuki with Bank of America. You may proceed with your question. Great. Thanks, guys. So I guess as COVID cases start to rise again in some markets and there's talk about potential lockdown again, how do you think about how the business could perform if stores did have to close again? And what do you think you learned from the last go around that you would bring into a second round of potential closers? Close? Well, I think it depends. When we closed the stores in the first time, we really didn't have to close all the stores and take them to curbside delivery. We were classified as essential retail in a lot of the markets that we elected to shutter our doors. And we shuttered our doors purposely because we wanted to make sure that we could protect our associates. We shuttered our doors purposely because we wanted to make sure that we could protect our associates. We needed to get the stores ready. We needed to get the right protective product in so that everyone could feel good and we needed to learn. And as we learned and as we got our stores prepared, we began to reopen. So it depends on the severity of the closure and if it's all of retail or essential retail is allowed to open. But if it's essential retail allowed to open, we would stay open and follow-up on tariffs follow-up on tariffs. Based on your inventory position and turns, when do you think you will see the peak pressure point on margin rate? And it doesn't sound like tariffs will prevent you from expanding gross margins next year, but just wanted to kind of confirm how you're thinking about that? Thanks. Yes. I mean, sometime early next year is when we're going to start to have to see how that plays itself out. So I think that's right. And I do think that the merchants are great and they've got ideas on how and where we raise retails to deal with it. So the plan is in place. We have fantastic systems to get the move base every single day from our inventory position and our margin position as to how we're doing. And so we watch it very closely. Like to I'd like to again thank all of our associates for all the hard work, our associates on the front line and our associates behind the scenes that are in our store support center and that are in our distribution centers. It's just excellent execution across the board. It was just an amazing quarter. I'd like to thank all of you for your interest in our company and your excellent questions. And we appreciate that, and we look forward to talking to you on our next quarterly update. Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation. Have a great rest of your evening.