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

Good afternoon, everyone. This is Wayne Hood with Floor & Decor, and I'm the Vice President of Investor Relations and want to welcome you to the call today that's being hosted by Dan and William Blair. But before we get started, I just needed to make a couple of safe harbor statements. 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 our Private Litigation Securities Act of 1995 throughout the course of our presentation today. Having said that, I'll turn it over to Dan now, and we'll begin the conversation.

Thanks very much, Wayne. Thanks, everyone from Floor & Decor. Thank you all, clients, for attending our first virtual conference. My name is Dan Hofkin. I'm the analyst covering hardlines and specialty retail companies, including Floor & Decor. I should remind everyone that for a complete list of disclosures, please consult williamblair.com. We are delighted to have, from the company, Trevor Lang, CFO. And just maybe kick off with, if we can, with some questions.

Maybe if you could start with where you're at today as a company in terms of your store base, how many you've fully reopened at this point in the reopening process. How many remained closed to in-store traffic? And when do you expect you might have all stores reopened?

Yes. Thanks for having us, Dan. It's a great conference. It's a great franchise you guys work at, and we really appreciate you having at this. And just again, thanks a lot for everybody who's participating. So just as a quick reminder, on Saturday, March 21, we made a proactive decision. We didn't have to, but for the safety of our customers and our associates, we decided to proactively to shut our doors, what we call curbside assistance on March 21, Saturday, March 21. On our last call, at the end of April, and then we had a follow-on call a couple of days later on a different conference, at that time, we said we thought we could -- we would be able to have about 70% of our stores or at least 70% of our stores opened by the end of May and the rest of them open up in June. And we're really following a simple guideline. As the local jurisdiction, the government authority says it's safe, then we'll open our stores. And so as the shelter-in-place is removed or revised, we'll open our stores. And so we're fortunate today, as of today, all of our stores are open, so we are ahead of schedule. We did open our stores earlier in the month of May than we were expecting. And because of the strength of the business, we -- and because the shelter-in-place was either augmented or removed, very happy to say that we had all of our stores opened by late May or the first few days of early June.

Great. Maybe if you could also discuss, perhaps any -- sort of how the reopening process is going so far? What -- now that you've been open for a little bit, are you -- you are lucky in a number of ways, actually, to have much larger format stores that can really display your product in a spread-out way, allow customers to spread out. Are the new guidelines from various levels of government and health officials placing any additional constraints on how much business you otherwise might be having? Or do you feel like you're able to stay under those levels anyway and sort of operate given your typical level of business and/or how customers are maybe choosing to distance?

Yes. And just as a context, and to answer that question, we really protected everything that was customer-facing. And so when we went into COVID, not knowing how difficult this is, we made the decision to keep all of our managers, on average, a store can have 6 to 11 managers, and all of our full-time associates, people that are full-time employees, those 2 groups combined are 70% of our store hours, historically have been 70% of our store hours. So we did have to furlough some part-time associates, but 70% of the hours we protected so -- because we knew this would pass, and we want to have those associates ready for us when the stores open back up. So our labor was there. Our in-stock levels remained high throughout the period of time. We were aggressive in investing in security measures to be in concert with the CDC, plexiglass to keep the customers and the associates distanced apart. Signage, you can actually -- if you're looking at this online, you can see some of the signage behind me that talks about be smart, stay 6 feet apart; audio cues, talking about the importance of keeping socially distanced. We trained our employees on how to make sure we kept our employees and our customers socially distanced, PPE for all of our employees. And so we've been very aggressive in making sure we're a leading retailer and making sure our customers feel safe. And we've like -- we've done a really good job of doing that. And I think our customers are telling us that they appreciate that, both on what we've seen socially and just how we're seeing our business perform. Specific to the guidelines, every jurisdiction is a little bit different. But roughly, it's about 5 people per 1,000 square feet. So we have -- we have 76,000 square feet. So that works out to be just under 400 people we can allow in the building, which is a lot. And in many cases, we are keeping the -- we're not really having to limit the number of people into our stores because it's a big ticket, and we don't necessarily need to have that many people in our stores at a time. It's possible that on a Saturday, on a high-volume store, there may be a line to get into our stores because we are limiting it to what we -- generally, about 50 people groups, meaning a family would be 1 people group, 4 individuals if there's 4 people in that family. But that's really not been much of an issue for us. So the short story is, again, we're pleased that we've got our stores opened sooner than we had expected. And we are pleased that from an operating perspective, it was not easy. But because we protected everything that was closest to the customers and we didn't furlough the vast majority of our employees, as that stores were opened, our employees were happy to have more customers coming back into the business. And so far, again, we've had -- majority of our stores opened for a long period of time now, we've not had any issues or any code violations or any customer complaints to speak of. Our stores have been executing in this socially distanced, safe environment very well.

Great. Obviously, times like these are trying for everyone, but they do also potentially provide an opportunity for a company like Floor & Decor with significant competitive advantages to further differentiate yourself, build deeper relationships with customers, potentially, in particular, professional installer customers. Just curious what your thoughts are as far as that goes? And any ways that you were able to maybe take advantage of that. And maybe also tying in the loyalty program that you guys introduced, I think, about 1.5 years ago, how that's going so far, and any additional tweaks you're making to that.

I think it sort of starts with, we're in a very different environment than we were pre-COVID, obviously. Customers have always cared about safety and security, but that's got a heightened level of sense in this environment. And we're fortunate, we're blessed that we have very big stores, and we don't have a lot of traffic. If you go into a home center, they've got substantially higher traffic than we do. If you go into a grocery store, they've got substantially higher traffic. Just because our ticket is so big, we just don't have that much traffic. And so our customers feel safe in our stores because they are big, and we just don't have as many customers in there. We add to that, again, all the plexiglass that we put up, like a lot of retailers have done, all the personal PPE, the visual and the audio cues to be socially distanced, the training we've had with our associates, both to handle customers and our associates. And I think customers are really appreciating that we're safe. So we've executed -- I'm biased because I work here, but we've executed at a very high level to make sure our associates and our customers are safe in our stores in the COVID environment. So we kind of check that box. Big stores, obviously, help too because you're not going to be bumping into customers, as we just talked about. Then it's really back to the core basics of what has made this business great for a long period of time. It really starts with having a trend-right assortment in large quantities to meet the needs of our DIY and professional customers. It comes back to having this everyday low price, where we're not going to be beat on price. Whether it's the Home Centers or, certainly, the independents, our prices are lower. We've really done a good job over the last 5 years with these visually inspiring stores. And I know you've been to many of our stores, but every store has got 3,000 to 5,000 square feet with 30 to 50 vignettes of -- that are -- that help people think about, oh, my bathroom could look like this, or my kitchen could look like that, or I can build an outdoor barbecue area like this. And so we have very visually inspiring, big displays. You can actually see what the product looks like, helpful staff, free design services, free storage, great credit options. And so those core strengths are situated during this period of time. And then when you get to the pro, again, really no trick placed there. We're really just executing there. It starts with a dedicated desk and really a dedicated team to take care of that professional customer. A small volume store may have 3 or 4 employees dedicated to the pro team. A big volume store can have 10 or even 12 associates dedicated to that team. We get them in, we give them out fast. We do have this great loyalty program, which I'll come back and speak to in a minute. Business services like discounts with FedEx, discounts on computers, discounts on websites, health insurance, payroll services, all of those kind of business-building tool sets. And then on your specific question on the loyalty program, we are very proud of our loyalty program. I think we've got about 134,000 participants in our loyalty program. We're enrolling 6,000 to 7,000 every single month. We continue to see more traction with our loyalty program. We've now run 2 promotions. We did one in the winter where you've got more points the more you spend, and we saw a very good return on that. It happens -- that was part of the reason that our fourth quarter was our best-performing comp quarter. Those comps accelerated a little bit as we got into Q1 as we did more programs on the pro. If you look at our top pros, 95% of them are in the pro program. If you look at our top decile of pros, 70% are participating. Within those pros, they're earning more points and they're -- the key is they're actually redeeming those points for -- pre-COVID, they were taking trips. Post-COVID, they're probably getting iPads or golf clubs as opposed to going to sporting events and taking trips. And so we're super pleased that we've got this tool in there, and we're executing well and we're learning. When you combine that with the CRM solution that we've put in place, that really is going to allow us to now know much more about our customers, know which customers are trading up, know which customers quit shopping with us, know which customers are buying tower products but not buying all of the installation and setting materials. The same thing with wood, they're buying their wood, but they're not buying the underlayment from us. Those tools are going to be incredibly powerful for us as we move forward because we can learn and have knowledge about our customers that we haven't had in the past so that we can market to them, we can follow back up with them if we've lost them, God forbid, what happened that we lost that customer. If the customer is trading up, how do we get them possibly even more points to get more of their loyalty. And so all of that complex technical plumbing from a technology perspective, for our CRM database and our PPR, Pro Rewards program, database is there, and now we're going to harvest that over the coming years.

Great. I guess, maybe one question. Obviously, in this environment, especially if it's a meaningful remodel project, flooring or whatnot, it involves having a contractor into your home in many cases. How is the current environment with the pandemic affecting, from what you can tell, people's comfort, customers' comfort, homeowners' comfort with that?

I think if you go back, again, pre-COVID, let's talk about February, early March time frame, our contractors had as much business as they wanted. The economy was good. People were investing in their homes. Home values were increasing. Existing home sales were increasing as well. And so our contractors were as busy as they've ever been. They had a big, long backlog. You got to get mid-March and things are getting concerning. Late March, a lot of the states and the jurisdictions are shutting down. And what we heard during that period of time was that our -- from our contractors is that they were still busy. They had work, they weren't having to lay off people, but their backlog had shrunk, which makes sense, right? Because we were all glued to the TV set, and we were all staying in our homes and not leaving. And so it's difficult for contractors to get into customers' homes. But during that period of time, our sales were 50% of what they were, and we think the majority -- a big chunk of those sales were actually the professional customer because DIY customers were probably not buying because we weren't letting them in our stores. You fast forward now that we've got all of our stores open. And our pros are telling us they're busy again. Their backlog is building back up. I think they're smart, savvy business people, and therefore they are doing smart, savvy things, wearing personal protective gloves, taking off their shoes, staying 6 feet apart, wearing masks. And because of that, from what we can tell, their backlogs are building back up from what they've been telling us. Now this is all anecdotal information. It's not something we have in our detailed CRM databases. But based on what our pros are telling us, is that they are getting into consumers' homes, and that they have -- their backlog is building up.

Any just quick sense of what share of your business, it's actually the professional installer doing the installation versus a homeowner?

Historically, what we have said is 40% is procured by the contractor, 40% is bought by the DIY, and then another 20% is what we call a buy-it-yourself, which is a consumer. But realistically, they bought from us because the pro influenced them. They have a relationship with a pro, and the pro said, "Hey, go down to the store and buy the product, and I'll pick it up and put it up." So historically, we'd say 60% of our business is pro or pro-influenced and 40% would be the consumer. Even that consumer, though, that 40%, there's probably a pro involved, and we just don't know about it. And so we don't think there's a lot of our products -- there certainly are some, there's certainly some technical DIYers who could put in our product. But we think even the majority of that 40%, there's a contractor involved. We're just not -- we just don't know who that contractor is.

You talked about your pros' backlog starting to build back up. Any sense at this point for how much of the increase in demand that you've seen so far is maybe pent-up demand, so to speak, or pull forward of future demand versus just intrinsic improvement?

I don't know that we have detailed knowledge. Some of our early CRM data tells us that the type of customer that's coming in, whether they're pro, whether they're a new customer or a returning customer, because, again, we have a lot of that information with our CRM system, it appears to us to be very consistent with what it was pre-COVID, meaning we've got the same number of new customers coming in. We've got a good mix of DIY and pro. So it doesn't feel like there's been some major change in our business now that our stores are back open. The other thing that's interesting, and I know you and your firm have -- you've put some of this information out here, if you look at the overall retail segment and consumers' discretionary income, people are not spending currently. Now this may change, but people over the last 2 or 3 months and currently are not spending nearly as much at restaurants. People are not spending nearly as much at apparel retailers because they're not going to the mall. Obviously, retailers are closed. People are not spending nearly as much on travel and entertainment and hotels and things like that. And because of that and because of the unprecedented level of government intervention to help either small businesses or individuals, the consumer, I think, is in a pretty good place. And because we're spending a lot more time in our homes and because we are hopefully looking at that bathroom that we should have done 3 or 4 years ago, hopefully, the home is going to benefit from that. Whether that's paint or blinds or flooring, I think there is going to be some benefits to the home sector and the home value. Now home -- household turnover, sales have gone down just because of the pandemic and people couldn't get in the homes. But the overall value of people homes has held up nicely throughout this period of time. And so I do think there's -- because of all that discretionary income that would normally be spent on travel or food or apparel, there is the ability to have that, plus the level -- unprecedented level of government intervention, gives the ability for the consumer to invest in their home. And so we're optimistic because, again, we've got these in-stock inventories, very inspirational stores, that flooring is going to be hopefully high on that list, and that could actually create some demand, I guess, is what I'm trying to say.

Great. Maybe can you talk about competition, just near term from a competitive standpoint, but also coming out of this period and as you look out over the next couple of several years? Anything that you see kind of changing at the margin in terms of categories or types of competitors?

I think if you break them, our competitors are really -- we have 2 big competitors we deal with. You have the home centers, big box home centers. We estimate they're maybe 28% of the hard surface flooring. During COVID-19, they were doing what they thought was appropriate, which I think I tend to agree with. They kind of weren't emphasizing flooring because, in many cases, they have one of their installers or one of their affiliates going into our customers' homes. They were more focused on the necessary products. And so in Home Depot's case, they publicly said they deemphasized the installation piece of their business, and therefore, their hard surface flooring actually comped negative. And that was probably the right decision because they were focused on the essential categories that customers needed. So the home centers have not done anything aggressive or promotional in this period of time. If you look at the rest of the industry, which is, we estimate about -- the smaller players, the independents, smaller companies like Lumber Liquidators, The Tile Shop and the independents, we think that's about 65% of the industry. And I think because, currently, of the unprecedented government intervention, whether it was the Paycheck Protection Act, whether it was small business loans, direct payments and unemployment insurance, so companies can lay off their employees and not feel bad about it because they're getting protected by the unemployment insurance, we have not seen irrational behavior from the independents either. And we haven't seen a lot of liquidation events where they're selling products at a low price because, again, just the government has stepped in, in a way that's really never happened before. So you're not seeing a lot of bankruptcies of these independents either. So the simpler answer is, we have not seen an overly promotional environment for the reasons I just outlined. And I think on a go-forward basis, as we look to the future, I mean my crystal ball is no better than anybody else's, but I think if it's -- it kind of feels like, currently, that the economy is going to recover pretty nicely based on everything I'm kind of seeing and reading today. And if that's the case, you probably won't have a big change in the competitive landscape. If we're all -- if we're wrong and you end up having a long, protracted downturn, that won't be enjoyable for that period of time, of course. But long term, that wouldn't be a bad thing for us because you'll have the weaker players go away. And part of the reason that we had such a 10-year growth where we had -- our comps averaged 15% for 10 years in a row, part of that was you had a 2.5-year period of time from kind of 2008 to 2010 where the flooring industry contracted 35% from $25 billion down to $16 billion. And then once that happened, you had like 4,000 independents go away. Well, then when the economy started growing and housing started to do good again, there weren't as many competitors out there, and that was part of the reason we had the first 5 years of our growth, that's probably the reason we had such successful growth. It's not only we have a great business model, but we just didn't have the same competitive set. So we're poised to win either way, I guess, is the -- hard for us to guess, but I think we're poised to win, either way.

Great. You obviously lowered your store growth target for this year, but it sounds like you're planning to, at least at this point, return to a 20% type of growth again, starting in 2021. Assuming that we are in a prolonged or more prolonged downturn in the flooring category overall, would that change your long-term store target at all? And maybe if you could talk about opportunities that you're seeing from a real estate standpoint in terms of rent and deferments, but also maybe locations that, would be helpful.

Yes. I guess I'll start with -- I don't ascribe to we're going to have a prolonged downturn in flooring, so -- but if that were the case, I think our view is, as long as we are producing new stores that are giving us a very high return on invested capital, which they are, we're kind of -- we're getting our cash back in about 2 years. We're getting over a 20% IRR over above the 10- and the 20-year period, over 30% 30-year cash-on-cash returns. So as long as those return metrics are there, we're going to continue to grow our store count because it's a very high return on capital. If indeed, we were to see something where there was a big dislocation in the economy and our new store performance started to suffer, then I think we'd have to evaluate at that time. But we're absolutely not seeing that, and I don't think we're going to be seeing that any time soon. But one of the benefits of this, on a real estate perspective, one of the things we're seeing that will be a silver lining of this pandemic is, both on the demand and the supply side of real estate, is we've all read the headlines about companies like Kmart, Sears, JCPenney. Macy's is not really -- they're going to be shedding stores as well. And those are going to be big box opportunities that we might not have had as much opportunity to get in the past if there wasn't a pandemic. So I think on the supply side, we're going to have more big box availability available to us. And then on the demand side, the people we would be competing with to get those big boxes, there's going to be a lot less of them growing in the future, whether you talk about some of the big fitness centers, some of our other competitors that have big boxes that aren't in the same financial shape we are. And so I think that one of the silver linings of this pandemic is that we're going to be able to get real estate in probably B and C markets, which is where we have the majority of our stores today at lower costs. And then in the A markets, places like New Jersey, Connecticut, Long Island, Boston, Seattle, Portland, L.A., San Francisco, we will likely have the opportunity to open stores in those markets that we wouldn't have had otherwise. And so we see it -- listen, we wish this had never happened. But I do think it's going to help us from a real estate perspective because of the reasons I just outlined about having more availability and not competing with as many people to get real estate.

Great. In terms of tariffs, there's obviously kind of increased discussion about that very recently. Again, any -- what would your plans potentially be in the event that the List 3 tariffs that are set to expire, in the event that they do come back or resume, if you will? And where -- can you talk about where you are at this point on the journey in terms of reducing your exposure to China? And where else you're getting that supply that was coming from China?

Yes. And just, I think it may help if I just give you a little bit of context of the history on this, just before I answer that question. So if you go back to September of 2018, that's when List 3 tariffs went to 10%. We were on List 3 so and so. At that time, we were sourcing half of our products from China and 10% tariffs went into effect. We were able through negotiation and through moving and sourcing and really not to feel that too much. We fast forward to June of 2019, and those tariffs went from 10% to 25%. And at that time, because we've already negotiated most of the cost out when the 10% tariffs went into effect and we've been aggressive in moving our sourcing, we went from about half of our sourcing being from China to kind of mid-30% sourcing from China. What was left is we did have to raise retails. And we saw the second half of our comps in 2019 be better than the first half of our comps partly because we did have to raise retails. Then you fast forward to November, and the government made the, we believe, the appropriate correct decision to remove the 25% tariffs on the rigid core vinyl water-resistant laminate and a handful of other SKUs that were not nearly as significant. And they made that determination because there's not enough domestic manufacturing capabilities to produce this product. Best case, 20% or 30% of the demand could be produced, we think, domestically. And therefore, the person who was paying for that increased price was just the consumer. So there was us and a bunch of other petitioners petitioned to have the government remove those, and they did remove it in November. As you said, that had a sunset provision in early August, August 7, I believe. And as unless the government reinstitute that, those tariffs will snap back to 25%. If you look at the facts that we have today, because the growth of that category continues to be one of the highest categories we and the industry has, and the domestic manufacturing capability just has not caught up, we think the correct decision would be to extend those. And we and 26 other petitioners have supported that and we all just filed that yesterday. You had 2 manufacturers suggest that, that shouldn't be the case. But I think if the government follows the same line of thinking that they did when they changed it in November, they should come to the same conclusion, where there's just not enough domestic manufacturing capability to support the demand because the demand has grown so much. So we're optimistic that those will get extended for at least 6 months, maybe hopefully a year. If they don't, we do think, in this case, we'll certainly negotiate as hard as we can to get some costs out. The dollar appreciating against the RMB certainly helps. But there will likely have to be retail increases because it really just is not the capacity outside. We're also doing things about thinking how much we're buying currently to get in front of that August 7 deadline. And so we're doing all the things you would expect us to do to plan for that, but we're optimistic that the government will come to the same conclusion because the facts on the ground support it.

Great. Maybe I'll take a couple of questions from investors that we've been fielding. What portion of your business right now is online sales? How fast is that growing? And maybe can you talk about how susceptible the hard flooring category is to online competition? Or how can you kind of protect against that because you've got an omnichannel business?

Yes. I think the ending statement you gave is the right one, Dan. This really is an integrated experience. It's -- it can be an expensive purchase. There's really no brands to speak of. People need to see the product to make sure it goes with their furniture, goes with their paint, goes with the theme of their house. And because it's -- there's no brands like Sony or DEWALT or Ralph Lauren or Tide or any of those brands that people love, they really need to talk to someone. It's also difficult based on the type of floor. Are you above grade? Are you below grade? Is your floor completely flat? In most cases, it's not. And so because of all those things, that tends to lead consumers to need to see the product, to work with their installer and to talk with a professional salesperson. The way we thought about the website and the way we think great omnichannel retailers do is that our website is really there to educate and to inspire and to help make that purchasing decision. And so all of the strategies and the solutions, and we've been putting millions into that strategy and a lot of talent into that strategy over a number of years, and we think we have one of the best integrated multichannel experiences in, certainly, specialty retail. And we've been rewarded because of that. And so I don't think that there's any pure-play competition that could come in. You have on top that the complexity of the assortment. A lot of these people who have lots of online success don't really manage the assortment at a micro level. Whereas if you were to walk in to our store in Tennessee, it's materially different than you're going to be in South Florida, and that's a -- people are willing to be educated. They want to be inspired based on what's right for their local house, and that's another huge advantage we have. And I think when you think about all those technologies and the fact that customers will want to see it, that you're going to need an omnichannel experience, and we think we're best positioned to do that. The other thing I'd say on the negative is we did shut our doors, right? And when we shut our doors, our sales went down by 50%. And we are actually one of the best retailers in specialty retail. And that also, I think, vindicates the fact you actually need a physical presence to help those customers make the stores.

Great. Maybe time for one more quick one. If the tariff increase did go into effect, List 3, and if you had to take price to offset the cost increase, how much do you think you could raise price? What would be the sort of gross profit per transaction type of a relationship? And how much -- you talked about this a little bit, but how much more production do you think you could move out of China over the next 2, 3 years?

I think if retail is -- or the cost is going to go up by 25%, again, we're going to try to negotiate as much as we can on that and try and get some of it down that way. And I think we will work to move as much sourcing as possible. I think if the trade tensions between the U.S. and China continue at the rate they're at today, ultimately, we could see -- again, I think your time frame probably over 2 or 3 years period, we could possibly get some of that down to maybe in the mid-20s to low 20s over a 2- or 3-year period of time. I mean, we've got good, smart Chinese companies that, in many cases, have the abilities to build manufacturing capabilities in Taiwan, in Vietnam, in Cambodia and sometimes in India, and actually here in the United States. One of the big tile manufacturers we buy from today, their tile manufacturer is in Tennessee, but it's actually owned by a Chinese national. And so I do think over time that these smart, savvy Chinese businesses will figure out how to help produce products elsewhere. So we see it as a short-term issue. I do think the reason the government should not institute that is the exact same reason we'll all deal with it is everybody will have to take price up across because there really isn't the opportunity in Europe or America or Asia or other parts of Asia or South America to buy these products. So I do think retails are going up.

Thanks so much, Trevor, Matt and Wayne, thank you as well. Guys, thanks so much.

All right. Thanks, Dan. Appreciate it.