Floor & Decor Holdings, Inc. (FND) Earnings Call Transcript

Great, thank you, Tony. Good morning from the U.S., good afternoon to those in Europe. Thanks for joining us today at the Citi global consumer conference. I'm Steve Zaccone, Citi hardlines retail analyst. We have the privilege of hosting Floor & Decor this morning. I'm joined by the company's CFO, Trevor Lang, as well as Wayne Hood and Matt McConnell from IR. I'll pass it over briefly to Wayne for a safe harbor statement and then we'll jump right into the Q&A.

Yes, Steve, thanks for hosting us -- for us today. I did have to make a brief safe harbor statement, so let me do that. Before we get started I'd like to refer you to the standard safe harbor language included in our press releases as we may make forward-looking statements within the meaning of the Private Litigation Securities Act of 1995 throughout the course of our presentation today. So, Steve, I'll turn it back over to you and Trevor.

Great, thanks, Wayne. Trevor, why don't we start off with a discussion about near-term business momentum this fall? I think strong results in the third quarter. You talked a little about an acceleration thus far in the fourth quarter. What do you think are the factors kind of driving the continued strength in the business?

Yes. And Steve, just to echo with what Wayne said, thank you so much for having us. It's a great franchise you work for, and we appreciate the time to talk with you and our investors or potential investors. So I think our business has been strong now for a long time. When we opened our stores in May and June of 2020, ever since then, our business has been strong and really accelerated through the second quarter. We knew we'd be up against very high numbers in Q3 and Q4, and I heard some of our larger competitors say the same thing, which is we thought our business would probably decelerate in the back half of 2021, just because of -- we were so strong last year, people were focused so much on the home, they weren't spending on services. All that government money that came into the economy. And we just didn't see that. Our business stayed strong. We -- through the first 3 quarters of this year, if you look at our business kind of on a 2-year basis because there's so much noise in 2020 when COVID started. We were kind of right around 15% same-store sales on a 2-year basis. And as of the call, just over a month ago, that accelerated, I think, closer to 18%. And I think from a macro perspective, as you guys have seen, the existing home values have gone up a lot. I think on a 2-year basis, they're may be up close to 25%. So that's created a ton of wealth effect for everybody, the 126 million homes that are lived in and then condos and things that are lived in throughout the United States. Existing home sales have stayed very robust. I think we're at $6.3 million. That's above the normal amount. And people have record levels of cash. I think there's something like $2 trillion sitting in cash in people's account, and then their equity portfolios are up a lot. We also serve a higher end customer. We estimate our income levels are $100,000, $125,000. As we all know, unfortunately, we're still dealing with some uncertainty around COVID, so maybe people aren't spending as much on services. And so I think all those things are macro factors that are outside of our control that are allowing for a robust environment for us. And obviously, a lot of other people that are servicing the home or sporting goods or furniture, all those types of things that --. And then I think centric to us, what we've done a good job of is working to increase our in-stock levels. If you look at our increase in inventory in Q3 relative to Q3 last year versus Q2, we had a fairly nice increase in inventory. So we started working hard. And as we saw our business continue to be strong in Q1 and Q2 of last year, that was to increase our in-stock levels. And our merchants have just done a fantastic job in continuing to execute a better and a best strategy. We've got big stores. Our average stores are 77,000 square feet now. So that gives us the space to really invest in product versus a lot of the independents which almost 60% of the industry. They may have a 5,000 or 10,000 or 15,000 square foot store, and even our larger competitors, they may only dedicate 3,000, 5,000, maybe 7,000 square feet to the space. And so as we've been thoughtful about where do we see opportunities, especially in -- and you guys can see this in our SEC filings, but in our laminate, which includes rigid core vinyl and water-resistant laminate, that's been an incredible category. The teams have done a fantastic job investing in that. Our decorative products, so all the things that would go on a wall or on a floor and a shower, that business is great. And also in our installation categories, things you used to put our products in. As we've sort of looked at the landscape and looked at our customers, we have great CRM data now that we didn't have a couple of years ago. We've sort of continued to elevate the brand and, by that, we'll put in products with more features and attributes and those are resonating with our customers. The other thing that's helped us now that we're a year beyond this business being very strong in Q3 and Q4 of this year is our PRO business has been very strong. It's comping well above our consumer business. The PRO ticket is about 25% higher than the consumer ticket. And I think we've done a good job in sort of catering to that PRO. And I think the last thing I'd say that's a little bit centric to us, maybe 2 last things is the investments we made in the website. We just -- we think we've done a really good job on the website, educating, inspiring and making it easy to transact whenever you're ready. And then the design. We're really one of the only companies out there at scale that has free design services. And you can walk into a store, assuming it's not a busy Saturday, you can get a design, you can actually schedule a design appointment and that's all free as well. And then all the attributes of a lot of inventory, liberal return policies, I mean, all those things really help our PROs and our homeowners as they think about doing it. So a lot macro but also a lot centric to us that's allowed us to continue to outperform what we see in the broader foreign market.

Yes. That was a thorough response and very helpful. If I pick apart some of those factors, like if we start with the macro, or is there something you're focused on in particular into 2022 because we've had this elevated spend on kind of home improvement. Are you watching existing home sales? Are you paying attention to rates? Like is there anything you're primarily focused on from a macro or consumer backdrop standpoint as we get into next year?

For sure. We spend a lot of time waiting and spend a lot of time looking at a lot of different numbers. There's probably 3 or 4 really big ones that we watch. And I think there's more probably tailwinds and headwinds. There’s probably one big headwind I'll talk about last, but tailwinds are probably hopefully going to continue at our back for a bit of time. I think the complexity and the difficulty of the supply chain is frankly helping us, I think a little. Yes, our costs are going up. But again, 60% of who we compete with are smaller competitors. There's a great article in the journal just even a day or 2 ago about how difficult it is for people who are getting any kind of imports, especially if you're a small player, to get your product. And so I think because we made those investments to get our in-stocks up, and it's come at a price. But because we made those investments to get our in-stocks up and our inventory levels up, you've seen our business accelerate. And so I think if you -- said simply, if you were to go to one of our smaller competitors, they probably don't have the inventory, or if they do, they're paying materially more. So I think this complex supply chain that we're operating in helps bigger players just because we have more scale and infrastructure and the ability to get products here. I think the overall macro seems like it's going to be good. The home sector seems like it's going to be good. As I said, the 126 million homes that are -- the [ homing ] housing units that exist in the United States, the values are up, I think, 25% on a 2-year basis. So that's going to give people a lot of equity in their homes to invest. We serve a higher-income customer. Again, that customer has record cash, record equity portfolios, record house values. We think they've done some -- some of them have done some projects, and they've enjoyed it. And so they're going to maybe do another bathroom or kitchen. I think there's opportunity there. In some cases, this is more of a theory than known, but if I was ready to get that second or third house as I'm moving up my family and my family is getting bigger. Well, if I can't do it now because just the homes have gotten so expensive, then I'm going to maybe invest back into my existing home more because I can't afford to get to that next home. So that's maybe more of a theory. And existing home sales at 6.3 million is still a very healthy number. My guess is existing home sales are going to start to decline. That's probably the one headwind I mentioned earlier. Home buyers are up 25%. Now it looks like mortgage rates are going to start to go up as the Fed gets more aggressive on the lack of bond buying. So that probably will drive up the long end of the interest rate and the mortgage rates. And so my guess is existing home sales will be a bit of a headwind. Well, what's interesting is on this side of our stores opening again starting in May and June of 2020, it feels like we've decoupled a little bit from existing home sales, and it appears that more of our business is being driven by just the wealth effect that exists for that higher-end customer. And so we'll see, if existing home sales decline, I don't know for sure, but it certainly would seem that way if interest rates go up and the house prices are up. But hopefully, there's enough equity in the other 120 million homes that aren't getting turned over that people could go ahead and invest in their home as well. So it feels like more head -- tailwinds -- then the final thing I would say is price. As you guys, I'm sure we'll talk about this a bit. We're in this inflationary environment. And our prices are going up. We don't think they're going up as much as they are in the independents and some of our smaller competitors, and we have the inventory. And so I think that as -- if inflation continues to run its course like it has been, prices maybe become more important to people. And as price becomes more important, that's obviously great to be the low price leader.

Yes. Maybe that's a good place to kind of dig in there on pricing. Just elaborate a little bit more on what you're doing with pricing. I think you started to take price up, but you're not taking up the full amount to offset some of these incremental costs. So why do you think this is the right strategy for the business?

Yes. We love this business. Our founder created an incredible business. He had a very strong vision, and it worked incredible for the 10 years that he started the business before this management team got here, which is we're going to be materially below the competition, especially on products that people care about. That's hopefully 10%, 20%. And as you get to the independents, it's a lot more than 10%, 20%. And that's worked incredibly well for the 20 years. And then as we look at companies, we really admire Home Depot, Amazon, Walmart. These companies have had an everyday low price strategy for decades. So that has been a very strong winning strategy. So it's just part of our ethos, it's our core. So as we historically have dealt with cost increases, we've not dealt with them much until the last 3 years with tariffs and now with inflation. We've had probably more of our retail going down than going up. It just as we get better and others get better, manufacturing processes get better, but that leads to lower cost and lower retails. But what we've said in the past and we're sticking to it for now, is to the extent we get a cost increase, we feel like just passing along the cost increase. And when you work through that math, we have a low 40% gross margin. If you work through that math, you're paying $1 for a product and now you're paying $1.03 or $1.05. When you just pass along that cost increase, your gross margin rate comes down, but you're still getting to a good gross profit dollar growth. You can leverage your SG&A more effectively in that environment. And so that's the way we've managed it. And we talked kind of ad nauseam about that on the last call, when we said our gross margins will probably be in the 39% to 40% range, but we still think we're going to have good growth. And we'll see. We said on the call, we're still working through our planning process for next year. But we also said that as we sort of exit this year, if we're exiting at 39% to 40%, and we started the quarter at almost 42%, and we're exiting at 39% to 40%, right, you can imagine how that's going to cascade through in the early part of next year. And so I would expect just because January 1 is not that far away, that lower margin profile is going to be there for a bit as we're in this inflationary pressures. If anyone's an optimist, and certainly I am, you expect some of these inflation costs to go away at some point in the future. I do think there'll be more ships in the water. The global supply chain will work itself out. There's hopefully going to be more trucks here domestically. Then you can see where you're now anniversarying these costs and some of those global supply chain costs go away. So maybe as we get to the back half of next year, maybe there's more opportunity to margin because we're anniversarying these lower numbers and again, some of these complexities in the global supply chain hopefully abate a bit. So we'll see. We'll talk more about that when we have our call next -- in, I guess, February or March of this coming year. But that's my crystal ball as best I can see the future from us. But a long way around, if I go back to the macro piece and I think about what we've done centric to us, our view is we will grow sales, we will grow profits next year.

Got it. Got it. That's helpful. Okay. To follow up on an earlier point you made about in-stock levels, maybe talk about the situation in a little bit more detail in terms of where are some of the pain points in terms of your inventory levels? Like where are things getting a little bit better? Just give us an update there.

Yes. If you started at our -- the core of our business, I think it's between -- it depends on the year and what new products we're introducing. But 80% to 90% of our business is replenishment. And so we have a very large team, and we have really good technology that helps us decide how to replenish that product based on sell-through and in-stocks and how much visual presentation we want to have at the store, how much every individual store is selling, how fast the DCs can get it to the stores. So again, we've got a big team of people and a really good system. So basically, it spits out math and says, "Hey, based on your rate of sell, based on your back stock and in-stock levels, based on the visual presentation you want in the stores, this is how much you need to buy every day." And so those purchase orders kick off and then we've got an inventory team that manages that. And then we have in-stock percentages we want to be at, right? We want to be in 90% in-stock in the SKU and 87% in this SKU. So that math all works itself out. And as we viewed the back half of this year we felt like, okay, well, things are going to be pretty good relative to being up against [ strong ]. We -- as I said earlier, we took a stance in Q1 and Q2, that let's make some investments in inventory. So it's not -- I would say it's a process that we've been executing for a year, and it's easier than other retail business -- it's not easy, but it's easier than other retail businesses that you've got to pick fashion trends and you've got to have it here for that season and then you've got to go on to the next season. Our business is more replenishment-driven based on rate of sale and in-stocks and back stocks and visual presentation levels, that's what drives our inventory levels. The complexity, obviously, is the fact that there are certain parts of the world that are struggling with COVID. Vietnam I know has had a number of shutdowns; Malaysia; places in China. Some of the ports have been shut down. Our port in L.A. is obviously a point of constraint. So that's been the more complex issue for us and everyone else is just dealing with the infection rates in certain parts of -- especially Asia, a little bit in Europe, and that's causing a little bit of the complexity of getting the products in. But again, we told our teams, let's focus on cost, let's be reticent and be thoughtful about our costs, but we're more focused on in-stock levels because, as we've seen throughout our history and certainly in Q3, and as we said on the -- Q4 to date on the call, getting those in-stock levels, especially when 60% of the industry, I think, is maybe struggling more than we are, our smaller competitors, has been a winning strategy.

Okay. Great. Great. Maybe we can shift a bit to market share, just the opportunity for the business. Because you've got very high market share in some of your more mature markets, you're still a young business, but more mature markets. And you're kind of entering these new markets that have higher population density and the expectation is higher sales productivity. So how do you think about that market share opportunity? Can you still gain some market share in some of your mature markets? And how do you think about the ramp in some of these newer markets like the Northeast?

We do. We have certain stores as best we can measure. Now it's a bit of an estimate. So you don't know for sure what the market is and a store in a 45-minute drive time in Atlanta, but you can sort of cascade that down to an MSA based on some macro factors. And we think we have certain stores that could have 30%, maybe even north of 40% market share and it's, call it, a 30- or 45-minute drive time. What we've also found out is we really added more stores in our more mature markets. So places like Georgia, Florida, Texas, Arizona, Illinois, that as you add that fourth, fifth, sixth, seventh I think Dallas, now we have 11 stores. In Houston, we're getting close to that. Atlanta, we're getting close to that. It's like a high tide that rises all the boats because now more people see you, your brand recognition goes up, your marketing dollars go further because you're still spending more marketing for that new store. Your PROs love you because now you've made the stores way more convenient. The website becomes more attractive. You can be more directive on that web on how you put those advertising to get a better return on those advertising dollars. So I do think as we add more stores, there's some magic that happens when you get to over half of the stores in the market, as you add that, again, fourth, fifth, sixth, seventh store, you just -- you get a lot more visibility. And we know in the funnel, once someone visits a Floor & Decor, either online or in-store, if they're really in the market for flooring, the vast majority of time, we're going to get that sell because of our in-stocks, because our prices are low, because we have great service, great websites, free design services, free storage, I mean credit, all those things. So I do think there's going to -- we're going to continue to get a lot of market share in our most mature markets as we add stores. As we get into new markets, obviously, the market penetration is a lot higher there. And the reason it is, is because the 4 things that really -- the 4 macro factors that really drive our business, and it's been the same 10.5 years I've been here is density of population is almost always the number one driver of what makes a higher volume store. Income levels and household values are numbers 2 and 3. And then we do better with owners than we do with renters. And since we know that for all 332 million Americans, places like the Northeast, places like the Bay Area, Seattle, Portland, L.A., they have a lot of density. They have a lot of income household values. And there's a lot of owners in those markets as well. So I do think as we get into those markets that are a little bit outside of our southern and southwestern roots, we've got great opportunities. And we've talked openly about our stores in Washington, D.C. and New Jersey and Long Island and Boston. We've got a handful of stores in Seattle now that have been open for a bit. They're doing fantastic. And so I do think as we get to those markets and get again that third, fourth, fifth store, our brand recognition goes up, we have more advertising dollars to spend in those markets, we can be more directive on our advertising dollars online, we've got a CRM system, a loyalty for those. So those are all things that encourage us. And then the final thing that I would just mention, and we worry about this, and we think a lot about it. But today, we don't have a fast follower. And if you look at our 2 larger competitors, between the 2 of them and the broader home remodeling environment, we understand they have about 45% market share -- 45% market share between the 2 of them. And so is it possible that we could get high 20s, low 30s, maybe mid-30s market share if there's not a fast follower today? Certainly seems doable based on what our 2 larger competitors and the amount of market share that they have.

Yes. That's a great point. We don't have a fast follower. It's interesting. When you think about expanding -- the last point on this market share discussion, when you think about expanding into some of these newer markets, are the competitive dynamics, any different? Like it seems like you're actually getting better at like the grand opening strategy and kind of driving traffic to the box in year 1. Like has the competitive dynamics any different in these markets versus where you've been successful in your mature markets?

Yes, we have gotten a ton better at that. When we -- when I first got here and we started opening stores, we went out to L.A., for example, that was our first store in L.A. And that new store volume was less than $10 million. And versus our stores in our home markets, we were close to 20 or could be as close to 25 back then. Now we have stores to do way more than that. But just like any great company, right, like that didn't quite meet our expectations. How do we -- why didn't we hit the mark? Well, we didn't focus on the PRO. We had to tweak the assortment. We needed to look at what the assortment needed to be in L.A. versus our Phoenix stores, which we had stores in the market. So we've invested a ton in people and technology. So we have a big visual merchandising team. We have a very large regional merchandising team. A new store construction team. We will go into markets almost a year in advance, look at what the assortment is for competitors, see that, hey, this is more of a wood market or a tile market. Think about how we lay out the store, how big should the store be. If it's going to have the big demographics I talked about earlier, we're going to try to make the store bigger. Where do we want the store to be located? Can we be -- we generally do better when we have lots of eyeballs going by the store from a traffic perspective. And so we've just done a lot over the last decade. And we -- if you look at the last 6 years, we've been public for almost 5 years, we called out our new store performance getting better every year. And we said this year, class of '20 and '21 is likely to be the best class of stores both from a top line and a bottom line perspective. Part of that is because the macro environment is really good. But part of it is, just like any great company and management team, we're thoughtful and we get a lot right, but we also made mistakes and then we learn from those mistakes and we do a lot better. So we're done with -- we believe the class of '22. We think it's going to be a fantastic new class of stores. We try to keep it as close to 50-50 new markets, new stores in new markets and new stores in existing markets. [ Taking ] maybe a little bit more new markets next year. But we're excited about that and we're coming off, again, the class of '20 and '21, which are going to be the most productive stores we've ever opened. So we're hitting on most if not all cylinders and feel good about the future as we think about where stores are going in '22 and '23.

That's great. That's great. How about -- just a general market share question on just thinking about PRO versus DIY. I think you've got a nice balance. You've got reasons to appeal to both of those different customer subsectors. But how do you think about the opportunity to maybe gain some market share with PROs versus gaining market share with DIY?

Yes. I mean I think we still have a lot of opportunity to do both. I -- most of what we sell today is going into a residential application. We also believe most of what we're doing today is kind of modular in nature. I'm going to do a bathroom or I'm going to do a kitchen or I'm going to do a basement or an outdoor living space. We don't -- I mean there's certainly some massive construction where they're doing the whole home. And a lot of what we do is, again, doing a bathroom or kitchen or something along those lines. And so we estimate -- as I mentioned, a vast majority of what we're selling is going into the residential applications. But we also estimate 85% of what we sell, there is some form of professional installation going on. And so we've got this nice mix of -- it's mostly going into a home, but again, we estimate 85% [ is used ] for professional installation. And so we're putting in all kind of strategies to figure out ultimately who that PRO is, and we were just -- Lisa and Tom and I were in stores just late last week and just getting there early, walking around, here in our home market where we've been in forever, we've got a great new store south of town. We probably saw 5 PROs that didn't know who we are walking through the door. And we're like how can that be? We've been here forever. We've done a great job. We've got great PRO recognition. It's just -- there's just a lot of opportunity to get to know those PROs and to get them shopping with us. And many of them, and this is what we're working on from an advertising and kind of a boots on the ground, belly to belly conversation. They're just busy. They don't have time to go realize, "Oh, you've got a loyalty program. Well, wait, you mean I can use your design services for free. I mean I can return things, I don't have a restocking fee, which your competitors charge me. You've got credit solutions." So it's -- what we're working on aggressively is how to get more associates in the stores, to then get out of the stores and meet those people. How do we get them exposed to our loyalty program, our credit solutions to -- again the free design services, the in-stock levels that we have, the new products that we're bringing in -- LATICRETE, a product we brought in this year, which is very important to the professional installer. So it's really just executing on what we know works, getting the brand out. We found out here recently, too, that there's a lot of our design services. We weren't communicating over to our PRO team that, "Hey, this -- I'm working on -- this bathroom, but business Smith is using an XYZ PRO." Well, now we put it in our CRM tools to find out who that PRO is, so the PRO team can follow up with them and talk about all these features and services. So we're in the early innings of what we can do from both PRO and Design. And because we have this really strong CRM tool that allows that information to come into the system, is it a PRO we know? Is it not a PRO we know? If it's a PRO we know, make sure they're signed up for rewards, make sure they understand all the features and benefits, credit, all those things. If it's a PRO we don't know, then that's even better. Let's give them a -- we call it a boots on the ground $25 gift card, give them a bucket, give them the tour of the store, talk about all the things we do. And now we're just -- because we've integrated those 2 it's just 1 example, that's one area where we can start getting a lot more exposure to PROs, so we can explain to them all the things we can do for them. So we're still probably in the early innings of growing. We -- one last metric then I will be quiet is, we have done -- because we have a loyalty programming on a CRM solution now, we've done some pretty detailed dives on what is our market share with that PROs. And over 50% of the PROs that shop with us spend less than $10,000 a year with us. And we've had just incredible success for 20 years, but that means they're spending a lot of time and money elsewhere. And so even though we've had a lot of success, we have a lot of opportunity to grow that market share with our PRO customers. And then on the homeowner, just quickly because you asked, I mean, there, it's all about, again, education, inspiration, in-stock levels, great website that allows them to do a lot of research on themselves, great sales associates, visual inspiration in the stores and on the website. And again, we've got a good team of folks who help us do that.

Got it. Got it. Maybe we can segue to commercial. Maybe you can talk a little bit about how Spartan Surfaces is performing versus expectations? And I know you don't disclose commercial, but just like how do you think about the ramp of maybe revenue or profitability contribution? Like how can investors think about that over the next couple of years?