Floor & Decor Holdings Inc

NYSE:FND

Earnings Call Transcript 2020-Q3

[Operator]

Greetings and welcome to Floor & Decor Holdings, Inc.'s Third 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. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to Mr. Wayne Hood, Vice President of Investor Relations. Thank you. You may begin.

[Wayne Hood, Vice President, Investor Relations]

Thank you, operator, and good afternoon, everyone. Joining me on our earnings conference 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 & Decor assumes no obligation to update any such forward-looking statements. Please also note that past performance or market information is not a guarantee of future results. During this conference call, the company will discuss non-GAAP financial measures as defined by 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 ir.flooranddecor.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.

[Thomas Taylor, Chief Executive Officer]

Thank you, Wayne, and thanks to everyone for joining us on our fiscal third quarter 2020 earnings conference call. On today's call, I will discuss the highlights of our strong third quarter 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 and beyond. Trevor will then review our third quarter 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 2020 third quarter earnings results, which reflected broad-based accelerating sales momentum, strong earnings flow-through as well as strong cash generation. Our fiscal 2020 third quarter total sales increased 31.4% to $684.8 million from $521.1 million in fiscal 2019. Our third quarter fiscal 2020 comparable store sales increased 18.4% exceeding our expectations. We are very pleased with our third quarter comparable store sales growth exit rate and the start to our fourth quarter. Our year-to-date comparable store sales through the third quarter of fiscal 2020 are flat with last year, which is a remarkable accomplishment considering COVID-19 impact to our store operations, which began in late March. Our third quarter adjusted EBITDA meaningfully improved to a quarterly record $106.7 million, an increase of 86.8% from $57.1 million in the third quarter of fiscal 2019 and almost one and a half times higher than our annual adjusted EBITDA in fiscal 2015. Our fiscal 2020 adjusted third quarter earnings per share increased 107.4% to $0.56 from $0.27 in the third quarter of fiscal 2019. We ended the third quarter of fiscal 2020 with no net debt on our balance sheet and the remained strongest liquidity position in our company's history. Let me now provide an update on each of our five strategic pillars of growth, beginning with new store growth. We successfully opened three new warehouse stores in the third quarter 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, Texas in August. The fiscal third quarter 2020 store openings plus the total number of warehouse stores that we operate to 128 stores up 13.3% from 113 warehouse stores at the end of the third quarter of fiscal 2019. As we look forward to the fourth quarter of fiscal 2020, we plan to open five 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 third quarter as we successfully opened them in the atypical ways due to COVID-19 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 temporary slow our new store growth fiscal 2020 due to the COVID-19 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 these stores. Moving onto our second pillar of growth, growing in our comparable store sales. We are very pleased with the broad-based sequential acceleration in our sales that emerge throughout our third quarter. 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 third quarter of fiscal 2020. Adjusting for the impact of Hurricane Dorian in the third quarter of fiscal 2019, we estimate our fiscal 2020 third quarter comparable store sales would have increased approximately 17.8%. On a two-year stack basis, our comparable store sales increased 23%. Fiscal 2020 third quarter comparable store transactions increased 18.9% and comparable store average ticket declined 0.5% from the third quarter of fiscal 2019. We believe the decline in our comparable store ticket reflects a higher growth from our homeowner versus pro and designer influenced 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 six 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 third quarter of fiscal 2020, which is a 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 lot quantities that homeowners are looking for today. Our third strategic pillar of growth is expanding our connected customer experience. Our fiscal 2020 third quarter e-commerce sales remain strong, increasing 111.5% from the third quarter 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 third quarter traffic to our website increased 50% year-over-year. The combination of changing consumer behavior due to COVID-19 as well as the 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 third quarter of fiscal 2020, 87% of website orders were picked up in our stores. Our fourth pillar of growth rests on the successful investments we are making in our pro and commercial customers. In September, we've further created excitement in our stores by successfully launching our first 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 event and our virtual webinar training forums 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 three times more and shop 2.5 times more frequently than non-PPR members. We were pleased that enrollment in our PPR program in the third quarter of fiscal 2020 increased 30% year-over-year despite the impact of COVID-19. The value of our PPR program is not only measured by growth in PPR members, but also by points earned and redeemed. In the third quarter of fiscal 2020, points redeemed increased 70% from last year, validating the value of our PPR program and engaging with our pros. To continue to drive engagement and points earned in the fourth quarter of fiscal 2020, we are incentivizing our most loyal pros from third quarter of fiscal 2020 with an opportunity to earn fourth quarter incremental bonus points for growing their sales with that relative to their third quarter spend. Our research is clear that the more engaged we get our pros with Floor & 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 entertain more wallet and market share. Let me now discuss the progress we're making on our free design services, the fifth pillar of our growth. We are pleased that the number of design appointments increased 44.5% in the third quarter of fiscal 2020 from the third quarter of fiscal 2019. And that is well above the fiscal 2020 first quarter pre-COVID-19 growth rate of 34.3%. This was particularly gratifying considering we were not able to quickly return to pre-COVID-19 designer staffing levels, as many were furloughed in the second quarter 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 macro economic environment. We are operating in unprecedented times with homeowners nesting at home more due to COVID-19 and having additional discretionary income to do 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. Unfortunately, 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 fourth consecutive month to a seasonally adjusted annual rate of $6.5 million, 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 million occupied housing units in the United States were built before 1999, which is a lot of homes that need to be invested in and maintain. 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 72.1 million 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 it's partly responsible for the home price appreciation we continue to experience. The COVID-19 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 nesting, 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 PulteGroup, Kamy 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 & Decor’s Board of Directors, effective January 1, 2021. We are thrilled to welcome Ryan, Kamy 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 Brutocao, Partner of Freeman Spogli have resigned from our Board effective the same time. We want to thank John, Rachel, Brad for their extraordinary contributions to Floor & Decor over the last 10 years. Let me close by saying that our strong fiscal 2020 third quarter earnings are the direct result of our associates responding tireless to the surge in 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 third quarter financial results.

[Trevor Lang]

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-19 to strong 18.4% growth in third quarter fiscal 2020. Tom already discussed how pleased we are with our solid third quarter fiscal 2020 sales momentum and a great start to the fourth quarter, so I'm going to concentrate my comments on some of the changes among the major line items in our third quarter 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're very pleased that our fiscal 2020 third quarter third quarter gross profits 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 rates of 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 the higher product margin 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 for our natural wood department. Turning to our fiscal third quarter 2020 expenses. Our third quarter selling and store operating expenses increased 25.2% to $171,500,000 from $137 million 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 is primarily the result of better than expected 31.4% growth in total sales that enabled us to experience outsize leverage in our store fixed and variable parallel expenses, as well as store operating and occupancy costs. More specifically the outsized near term expense leverage that is the direct result of our selling exceeding our plans for labor hours as customer demand accelerated. As we move through the third quarter, we took actions to further accelerate the hiring of more associates to meet the surge in demand. As a result, our payroll hours were better aligned with our sales trends as we exited the third quarter, 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, open more new warehouse stores, our fourth quarter 2020 expense leverage will not look similar to the third quarter of fiscal 2020. Our fiscal 2020 third quarter general and administrative expenses increased 5.5% to $39,300,000 from $37,300,000 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 fourth quarter of 2019, and higher incentive compensation accruals. As a percentage of sales, our G&A expense rate levered to 140 basis points to 5.7% from 7.1% during the same period last year. Excluding the impact of COVID-19 and secondary offering expenses in 2020 and costs associated with our distribution center closure and store support center relocation in 2019, our G&A expense rate leveraged approximately 20 basis points from last year due to our strong sales and lower year-over-year expenses for travel meals and meetings. More detail about these adjustments are provided in our third quarter 10-Q and a reconciliation of GAAP net income to adjusted net income in our third quarter earnings release. Our fiscal third quarter 2020 preopening expenses declined 38.6% to $5 million from $8,200,000 last year and leveraged 90 basis points year-over-year. The decline in expenses primarily the results of the decline in the number of stores that we either opened or are preparing to open when combined -- when compared with the third quarter of fiscal 2019. We opened three new warehouse stores and one small design center in the third quarter of 2020 compared with seven new warehouse stores in the third quarter of fiscal 2019. Our fiscal 2020 third quarter effective income tax rate was 10.4% compared with a negative 39.3% 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 in excess book expense related to stock option exercises and other discrete items. Moving to our fiscal 2020 third quarter EBITDA profitability. The 31.4% increase in total third quarter sales coupled with a 200 basis point increase in our gross margin rate and broad expense leverage drove a record fiscal 23rd quarter EBITDA profitability. Third quarter fiscal 2020 adjusted EBITDA increased 86.8% to our record $106,700,000 from $57,100,000 during the same period last year. Our adjusted EBITDA margin rate increased 460 basis points to 15.6% from 11% last year. Our fiscal 2020 third quarter GAAP net income increased 67.8% to $68,800,000 from $41 million during the same period last year. Our fiscal 2020 third quarter GAAP diluted earnings per share increased 66.7% to $0.65 from $0.39 per share last year. Our adjusted third quarter net income increased 111.8% to $59,400,000 from $28,100,000 last year. Our adjusted diluted earnings per share increased 107.4% to $0.56 from $0.27 last year. We ended the third quarter 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 2020 third quarter balance sheet and cash flow statements. We were very pleased that during these unprecedented times we have been able to maintain a strong balance sheet and have the strongest liquidity position in company's history to support our growth plans. As of September 24, 2020, our unrestricted liquidity was $628,500,000 consisting of $271 million 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 $269,007,000 in operating cash flow, a 28.7% increase from the $209,600,000 in the same year 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% 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 third quarter of fiscal 2020, our net inventory increased 23.7% to $598,500,484 during the same period last year, which is below our 31.4% growth in the third quarter sales. Our fiscal 2020 capital expenditures for the 39 weeks ended September 24, 2020 declined 22.2% to $109,700,000 from $141 million during the same period last year. The decline is primarily related to the decrease in new stores opened or are under construction as a result of COVID-19 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 million in free cash flow for the 39 weeks ended September 24, 2020, or more than double fiscal 2019 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 million to $208 million, which is slightly more than the 6% increase from our prior expectations of $188 million to $196 million. 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 one small design center in fiscal 2020 and start construction on several stores in the fourth quarter of fiscal 2020 that are expected to open early 2021. Capital spending associated with these plans is expected to be $132 million to $136 million. We are investing in existing story modeling projects and our distribution centers and expected capital spending associated with these projects is expected to be approximately $27 million to $28 nine. We are planning to enlarge and relocate our Houston distribution center in the second half of 2021, and are expecting second capital expenditures in 2020 associated with this project to be approximately $19 million to $20 million. 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 we look for capital spending of approximately $22 million to $24 million to support our growth in these functional areas. Let me now discuss how we're thinking about the remainder fiscal 2020. From a macro perspective, we are cautiously optimistic that the Federal Reserve's actions 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 early 2021. That said, there are still significant uncertainty related to COVID-19, including a rise in infections in many markets, which raises concerns of another wave heading into the fall and the 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 the closed doors in certain markets if necessary. For that reason, we are continuing to practice of not providing specific sales and earnings guidance for fiscal 2020, but we would like to provide some direction as we approached the end of fiscal 2020. Our better than expected third quarter sales growth created outside of selling and store expense leverage as we've benefited from the aggressive actions we took to reduce our cost structure in the second quarter of fiscal 2020 due to the COVID-19 pandemic. As we exited the third quarter and enter into the fourth quarter, our expense growth is becoming more balanced with our sales growth and is likely to lead to less expensive leverage in the fourth quarter of fiscal 2020 that we experienced in the third quarter of fiscal 2020. Consequently, we are planning on strong profit growth in the fourth quarter of fiscal 2020 relative to last year, but we do not anticipate the same rate of outsized profitability we experienced in the third quarter of fiscal 2020. As a reminder of fiscal 2020, the 53rd week, which for us means a fourth quarter will include 14 weeks versus a 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 main comments about the fourth quarter of 2020 on a comparable 13 to 13 week basis. Our reported fourth quarter 2019 gross margin benefited from a one-time Section 301 tariff refund, primarily related to rigid core vinyl of $14 million. Adjusting last year's fourth quarter for this benefit, our gross margin rate would have been approximately 41%. Our current expectation is for our fourth quarter 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 third quarter of fiscal 2020. In dollars, we're planning on mid single digit sequential growth in our selling and store operating expenses from third quarter of fiscal 2020 to the fourth quarter of fiscal 2020 due to a more normalized cost structure and more new stores. We're planning on meaningful increase in our fiscal 2020 fourth quarter pre-opening expenses when compared to the third quarter, as we plan to open five new stores in the fourth quarter versus three in the third quarter. Additionally, in 2021, we are planning to open the highest number of new stores in any first quarter in our history. As a result, we will incur some of the pre-opening expenses for these new 2021 stores in the fourth quarter of 2020. We expect our general and administrative and interest expense to be about flat with the third quarter of fiscal 2020. We would expect our fourth 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 million. 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 brave work With that, we'd like to turn the call over to the operator for questions.

[Operator]

At this time, we will be conducting a question-and-answer session. [Operator Instructions] The first question comes from the line of Seth Sigman of Credit Suisse. You may proceed with your question.

[Seth Sigman, Credit Suisse]

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 can elaborate on DIY versus pro, that'd be helpful. Thanks.

[Thomas Taylor, Chief Executive Officer]

Sure. Thank you, Seth. This is Tom. As we said in the prepared remarks, each month we got better and we exited at an incredibly strong rate with September being at 20.8%. So, it really was across all geographies. We've seen the same type of performance across the country. Very pleased with that to see that consistency. Our homeowner strength is definitely good. That we we've talked about in the script and you guys know -- with everyone, with all the nesting at home and people repurposing the space in their homes and people not spending on travel due to COVID-19 and entertainment and sports and things of that nature that, that money is being put back into the home. And we're seeing the homeowners is evidence 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.

[Seth Sigman, Credit Suisse]

Okay. So, 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 fourth quarter, 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 third quarter. Just any differences to call out there. That would be helpful. Thanks.

[Trevor Lang]

Yeah. Seth, I think you got that right. The last year was abnormally high because of that $14 million benefit we got from the Section 301 tariff refund. And so the adjusted gross margin last year, backing that out is this 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 a continued product margin, but we're also starting to get purely 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 were getting two benefits, one the lapping on much higher sales and two, the domestic transportation costs to about -- just under a third of our stores is lower, because we're now shipping to the mid Atlantic and Northeast and the Midwest out of Baltimore versus Savannah. And so, that we're also getting a benefit there. So, it's pretty balanced between supply chain and product oranges as what we're expecting.

[Seth Sigman, Credit Suisse]

Great. Thanks guys. Best of luck.

[Operator]

Our next question comes from the line of Michael Lasser with UBS. You may proceed with your question.

[Michael Lasser, UBS]

Good evening. Thanks a lot for taking my question. Tom, you mentioned that the whole business has been in focus, compare the flooring category to some other categories, anything 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 consumer is 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, like stay within the home -- broader home business.

[Thomas Taylor, Chief Executive Officer]

Michael, the beginning part of your question came on a little blurry, not blurry, but I couldn't hear it as well. Could you just -- I think I got the gist of it, which is, the perception of is flooring. The all of home improvement is performing nicely as is flooring performing consistent. Is that the nature of the question?

[Michael Lasser, UBS]

Yeah. I mean, Home Depot and Lowe's are comping up mid to high 20s. At-home comped up 40% today. So, clearly home can focus. The flooring seems to be doing -- maybe a little bit below average within the broader housing ecosystem. Is that because this requires pro to be in a consumers home [technical difficulty].

[Thomas Taylor, Chief Executive Officer]

Sure. Yeah. I don't think that has anything to do with it. We have not heard -- we 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 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 try 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.

[Michael Lasser, UBS]

Okay. And it seems like -- on the gross margin, recognizing that your product margins that are -- you're seeing higher product margins, is that -- so presumably the pricing as is going up in excess of cost. So, is this a sustainable trend? And should we be modeling expanding gross margins for the next several quarters, given some of what's happening right now?

[Trevor Lang]

Yeah. 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 with the -- in each of the categories with the exception of wood we called out, we're seeing people gravitate towards better and 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 -- the biggest drivers, the product margin within the product margins, 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.

[Michael Lasser, UBS]

Okay. Thank you very much.

[Thomas Taylor, Chief Executive Officer]

Thanks, Michael.

[Operator]

Our next question comes from the line of Steven Forbes with Guggenheim Securities. Please proceed with your question.

[Steven Forbes, Guggenheim Securities]

Good evening, everyone. 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 this trend 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 year?

[Thomas Taylor, Chief Executive Officer]

Yeah. 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 are -- they 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 with just a couple of them to see how it would go, again very pleased 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 two board members that have really good commercial experience, and we're looking forward to their insight on how we can penetrate the commercial market and even a more meaningful way in the future.

[Steven Forbes, Guggenheim Securities]

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 relates to driving innovation? Or how do you -- how would you speak to sort of the separation between FND and the competitive landscape as it relates to sort of driving that product innovation cycle?

[Thomas Taylor, Chief Executive Officer]

Sure. Lisa will go ahead and answer that. And then I'll chime in.

[Lisa Laube, President]

Okay. Yeah. So this is Lisa. It's interesting apart from the vinyl and laminate category where we've seen a lot of innovation over the last two or three years with water resistant and the new the SPC and WPC 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 focused on a lot. We just brought in our new core performance line in the last month or two, which is our highest end vinyl, which offers really great features for the customer. 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.

[Thomas Taylor, Chief Executive Officer]

Like I said, I'll chime in. The other thing that makes us unique when it comes to the competitive landscape and COVID did that slow us down is, 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 at a newness is where I think we really continue to widen our gap.

[Steven Forbes, Guggenheim Securities]

Thank you. Best of luck. Stay safe.

[Operator]

[Operator Instructions] Our next question comes from the line of Steven Forbes with Guggenheim Securities. Thank you for your question. Our next question comes from a line of Chris Horvers with JPMorgan. You may proceed with your question.

[Chris Horvers, JPMorgan]

Thank you. Good evening, everyone. Great quarter. Can you -- seasonally, it looks -- looking back the gross margin rate tends to be better in the fourth quarter than the third quarter. I'm guessing that's mixed 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 and are expecting some incremental gross pressure -- gross margin pressure there in the fourth quarter relative to 3Q?

[Trevor Lang]

Yeah. 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 the third quarter. So that's historically been a lower margin category. As you know, we got our [ph] clearance event. As it 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. And 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 two 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 move 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. Lisa, it keeps us apprised 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'd likely would see some retail increases because in those two categories today, still the vast majority of that product is manufactured out of China.

[Chris Horvers, JPMorgan]

Got it. And then as a follow-up. Understanding, you've been chasing labor to catch up with demand, but on another 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.

[Thomas Taylor, Chief Executive Officer]

Yeah. When we -- tail end of 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 is a percentage of our total sales is pretty small, so it's in the single bips, small bips range that it's impacting us.

[Chris Horvers, JPMorgan]

Understood.

[Thomas Taylor, Chief Executive Officer]

I wouldn't call it any big. There's no 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 relatives to our overall sales that we've incurred.

[Chris Horvers, JPMorgan]

Understood. Best of luck. Thank you.

[Operator]

Our next question comes from the line of Seth Basham with Wedbush. You may proceed with your question.

[Seth Basham, Wedbush]

Thank you and good afternoon. My question is on transportation costs. You guys talked about distribution, supply chain leverage in the quarter. As those higher transportation costs seeing now that baked into your product costs and what's the rate through see now. What kind of impact do you expect on gross margin? And relate to that if you could help us better understand the types of contracts you had and mitigation strategies you had as it relates to transportation costs.

[Trevor Lang]

Yeah. This is Trevor. We're very fortunate. Our supply chain teams has done a really good job of locking in long-term contracts, both domestically and internationally. That helps us in two ways. One, it allows us to get capacity when there are certain places it's very difficult for capacity out, just because there's so much demand. Things seem out of Asia, for example, and then there's some capacity constraints here in the States. So, that's one thing is, Hey, we can get capacity is an important part of it. Then two, because we do have longer term contracts and the majority of our transportation is going through this contracts. We're not getting those spot increases today. 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.

[Operator]

Our next question comes from the line of Jonathan Matuszewski with Jefferies. You may proceed with your question.

[Jonathan Matuszewski, Jefferies]

Hey, guys. Nice quarter. Thanks for taking my question. You mentioned in the release, you're pleased with the start to 4Q, can you share how October is trending versus September's exit rate?

[Thomas Taylor, Chief Executive Officer]

As I said, we're very pleased with the start to the fourth quarter. It's very consistent to the way we exited September.

[Operator]

Our next question comes from the line of Simeon Gutman with Morgan Stanley. You may proceed with your question.

[Simeon Gutman, Morgan Stanley]

Thanks. Hi, everyone. I wanted to ask -- I'll make it one question with two parts. First, I don't know, Trevor, I know you were answering Chris's question on gross margin. Is it -- are you ruling out the possibility that the Q4 gross 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 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 nest year, but they look pretty robust. So, I'm curious if next year could look normal in your outlook. I realized, it's early for this, but just high level, or if it can fit [ph] with outside?

[Trevor Lang]

Yeah. On the first one the gross margin, we are planning on it growing nicely versus the 41% we had last year. It'd be very hard to imagine it would get to the third quarter level that 43%, just a very large -- late for us so. 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 two-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 and 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 million in operating income, which would be a doubling of our operating income over a three-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 sites and in our goals, and we're focused on achieving. So, we know this year and next year we'll be a little bit choppy, but as we get to 2022, we still have our eyes set on those goals.

[Operator]

Our next question comes from the line of Chuck Grom with Gordon Haskett. You may proceed with your question.

[Chuck Grom, Gordon Haskett]

Hey, thanks. Good afternoon. Taking a step back, despite all the volatility, gross margins look like they're going to finish the year at or above all time high levels. 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 fourth quarter selling expenses? I think you said up mid single digit sequentially. I just wanted to clarify that.

[Trevor Lang]

Yeah. I think as we think about the next three 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&A and pre-opening expenses, right? Just if we're going to open roughly 27 stores next year versus 13 stores. We incur anywhere from 1.2 million to 1.5 for pre-opening. So that expense is going to grow at a much faster rate. Our new stores, as we've said for the three years that we've been public, their SG&A as a percentage of sales is roughly 50% higher, mid to low 30s versus low 20s for our more mature store. So, we'll want to have some be leveraging on the store level SG&A component, because we're getting back at 20% unit growth. But we do think we have some continue margin opportunities. 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 kinds of things. We think we can continue to grow gross margin. And then the corporate side, we have the ability to -- we think we can leverage some 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 our sales during that period of time. So, we are planning on getting operating margin and EBITDA margin leverage. And there was another part of that question. Okay.

[Chuck Grom, Gordon Haskett]

Just a clarification on the fourth quarter selling expense.

[Trevor Lang]

Yeah. I did say sequentially. And the reason I've used sequentially versus last year is just -- that was -- pre-COVID versus post-COVID. So now we're in this post-COVID environment, I thought it was more relevant to talk about how we're operating. And you've heard me correct. It's sequential from Q3 to Q4 this year. We did get the mid single digit increase.

[Operator]

Our next question comes from the line of Matt McClintock with Raymond James. You may proceed with your question.

[Matt McClintock, Raymond James]

Hi. Good afternoon, everyone. And clearly great results. But I have to say this, but I am not the only one that -- Tom, those are some pretty good awards announcements you made today. I have to say you never said that before. The question I have is -- I've got 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 get the results I guess in next year, early next year. And I don't think you've talked too much about that. And I already thought that your stores are pretty segmented decentralized. So, can you, at least, without stealing your thunder, give us kind of a sense of what that topic's about? Thank you.

[Lisa Laube, President]

Yeah. So, I -- we'd been talking for a year or two about our new CRM system. It's 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, connects 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 first quarter.

[Thomas Taylor, Chief Executive Officer]

And Matt, just trying to -- I just had one thing is, is having a data is just incredibly useful to us because we've -- 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 under performing 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 core 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. And 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're pretty excited about having this and it's just a powerful tool that we've not really had access to in the past.

[Operator]

Our next question comes from the line of David Bellinger with Wolfe Research. You may proceed with your question.

[David Bellinger, Wolfe Research]

Hey guys. Great quarter and thanks for taking the question. So, just on an average ticket down 50 basis points this quarter, that broke a trend of up two to three 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? The customer is 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?

[Thomas Taylor, Chief Executive Officer]

Yeah. So, there's two 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 our 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 full. They're getting here now. And our design appointments are where we want them to be. And our designers are engaged in the -- during the third quarter, 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 and clearing out some old wood products so that our average stay on a wood department has gone down. That's purposely. We've done that to get our new stuff. We 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. They're -- when they're nesting at home and they're looking around and they're sitting -- they're looking at their backsplash is evidence. And if you look at our deco department, it was the best comping department during the third quarter. And that's an evidence that -- we think people are nesting. They're looking at -- they're sitting in their kitchen, they're working out of their kitchen. They're on conference calls, they'd look up and they see an ugly backsplash and they change it. So the 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 stacking levels in design. I feel good about what we're doing in design, as we enter into this quarter.

[Operator]

Our next question comes from the line of Alex Mahylis with Baron Group Capital Markets. You may proceed with your questions.

[Alex Mahylis, Baron Group Capital Markets]

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 up in cadence or remodel older stores more rapidly in the coming quarters?

[Trevor Lang]

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. 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 first year new stores were doing $800,000 in first year EBITDA. Now they're getting close to $2.5 million in EBITDA, and we were 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 only -- 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 in the Northeastern DC that I talked about. We're going to spend some capital in that case in 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.

[Thomas Taylor, Chief Executive Officer]

Yeah. You hit mostly. I mean, I'd add one thing that we've been asked for a while will be accelerated the growth of our new stores. And that is -- 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 retail -- 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're -- 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.

[Operator]

Our next question comes from the line of Elizabeth Suzuki with Bank of America. You may proceed with your question.

[Elizabeth Suzuki, Bank of America]

Great. Thanks, guys. So, I guess, as COVID cases start to rise again in some markets and there is 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 -- second round of potential closes?

[Thomas Taylor, Chief Executive Officer]

Well, I think it depends. When we close the stores in the first time, we really didn't have to close all the stores and taken the curbside delivery. We were classified as a central retail and a lot of the markets that we elected to shut our doors. And 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's about to open, but if it's a essential retail allowed to open, we would stay open and operate so that we could effectively serve our professional customers.

[Operator]

And final question comes from the line of Justin Kleber with Baird. You may proceed with your question.

[Justin Kleber, Baird]

Yeah. Hey, guys. Thanks for sneaking me in here. Just had a 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 would prevent you from expanding gross margins next year, but just wanted to kind of confirm how you're thinking about that. Thanks.

[Thomas Taylor, Chief Executive Officer]

Yeah. 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 got ideas on how -- where we raise retails to deal with it. So, the plan is in place. We have fantastic systems to get there. Move based -- every single day in our inventory position and our margin position as to how we're doing. And so, we'll watch it very closely.

[Operator]

Ladies and gentlemen, we have reached the end of today's question-and-answer session. I would like to turn this call back over to Mr. Tom Taylor for closing remarks.

[Thomas Taylor, Chief Executive Officer]

Yeah. Well, first, I'd like to, again, thank all of our associates for all the hard work. Our associates on the frontline 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.

[Operator]

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.