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

Good morning, everyone. Thank you again for joining us at Goldman Sachs 27th Annual Global Retailing Conference. This is Kate McShane, Goldman hardlines and broadlines Analyst, and it's my pleasure today to introduce members of management team of Floor & Decor Holdings to our fireside chat. Floor & Decor has a unique retail model of larger stores with deeper selection and specialty offerings at everyday low prices. It operates in over 120 stores, generating revenue of over $2 billion. Today, we have with us, Tom Taylor, Chief Executive Officer of Floor & Decor, since December 2012. And we also have with us Lisa Laube, who joined the company as Executive Vice President, Chief Merchant in 2012 and was promoted to President this past February. And finally, Trevor Lang, Executive Vice President and Chief Financial Officer of the company since October 2014. I'm going to turn the call over quickly to Wayne Hood of Investor Relations, who will walk through the safe harbor.

Yes. Thank you, Kate, for hosting us today. Before we get started, I just would 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 discussion. But as I said that, I'll turn it back over to Kate to begin the fireside chat.

Thank you. And thanks Tom, Lisa and Trevor for joining us today.

We're grateful to be here.

I was hoping we could kick off our conversation by talking about the momentum you saw coming out of the second quarter as states and job sites and your stores started to reopen. You saw some nice momentum with comps improving to 7.7% in June and then 16% in July. Granted, there was probably some pent-up demand helping as your stores reopened. But in general, how do you feel about the outlook of your business coming out of Q2? And was the recovery better or faster than you expected?

So thanks, Kate. And we're -- Lisa and I are together in a store and then Trevor is in Atlanta. So I'll play quarter back on the Q&A, and I'll take the first one, and if you think there's something to add, we'll add. Yes, we're pleased and a bit surprised at the rebound of the business, as we shared on our second quarter call, going from negative [ 50 ] in April to negative 26 in May, to positive [ 7 7 ] in June. And the [ 7 7 ] in June isn't really the real number. If you just took the stores that were open for a month [indiscernible] been over double-digit and then it accelerated to [ 16% ] in the month of July. That is -- it's hard to know. We haven't been through a pandemic before, the business hasn't. So it's hard to understand exactly how the consumer is going to react. But I would say that, that caught us by surprise, the rebound of the business. And it's a pleasant surprise. It was very apparent that consumers want to engage with our product and want to make repairs in their home. And I think as you think about it, you kind of -- as you look and there's so much money that's historically spent on travel, on entertainment, on food -- on restaurants, and people just aren't doing those things. And as evidence, not just by performance, but if you look at Home Depot and Lowe's, they had just terrific quarters. And people are wanting to invest in their homes. So we're seeing lots of customers that are having to repurpose their homes, is one reason. So if they got 2 spouses that work and they both need office space. So you got to do a little repurposing. You also have where consumers have been stuck in home in a lot of cases through March, and they're identifying projects that they want to do. And fortunately, Floor is one of them. So yes, we are pleased with the momentum of the business.

That's great to hear. I guess when it comes to one of the bigger questions that were asked when it comes to your business. And this question is tapering down a little bit. But we still hear it a bit in terms of how much do you think is pent-up demand from when you were closed, pull forward demand? And what are some of the performance indicators or signs you look for that give you confidence in the sustainability of the demand here?

Well, I think the pent-up demand question, yes, certainly, there had to be some of that, right? So -- but if you look, we never really completely closed. We made the decision to shut our stores to curbside model. We didn't have to -- we were a central retailer in lots of places, but we needed to get our stores prepared, make sure that our associates were safe. And we made the decision to shut our stores. But we still retained 50% of our volume in the month of April when we were operating curbside. So customers were finishing projects at that time. And maybe at that time, they put out projects. And certainly, as we've seen what's happened through the -- when we did our earnings call, when we gave you July's comp numbers, there are customers that are taking on new projects. And so I think some of it was pent up, but I think there is definitely, for all the reasons I mentioned earlier: on repurposing the home; on identifying spots where you wanted to improve the home, we're seeing new customers in there. And I also -- think I mentioned on the last call, too, that one of the things we watch is our weekend business. And our weekend business is really -- has just been terrific, where we're getting a lot more end users in our stores over the weekend, which also would be an indicator that we're getting new business. So I don't know, Trevor, if you think there's anything else that I missed that you want to add?

Well, I think you hit the big ones, Tom.

Okay.

That's great. And then if we could maybe dive into the composition of the demand that you're seeing, have you seen any changes in the demand distribution across the price range of categories? Are you noticing any trading up or trading down versus what you were seeing prior to the pandemic? And are there any things to note that are different about different geographies or how things are going in different store maturities.

Yes, I'll let Lisa go ahead, if she can tackle that one.

So interestingly, prior to curbside prior to COVID, we had been talking a lot about how the better and best parts of our business have been driving our comp. Very encouraged side when we had to bring just select SKUs outside for the customers to choose from unless they bought something online. We did see that trade down some. Just would we weren't able to bring all of our products out onto the parking lot. And because our design services business had to switch over to virtual, and so our designers weren't involved and they tend to drive a higher average ticket. So we did see a little bit of that drop off during curbside. As soon as the stores opened back up, we bounced right back to where we were pre-COVID and pre-curbside. So better and best is still driving the business across all of the categories for our store. Our laminate and our vinyl business is still the strongest business as it's been. But as we've talked about, our tile business underwent a major transition because of the ADD and CVD, and we had to get products out of China quickly. And we had, as we called out last year, some in-stock issues that impacted that tile business. So we've been very happy that our tile business transition is done. And so that tile business has really popped back up, which we're excited to see. As far as regions go, the business that we have seen is the same as always, which is our less mature stores and our newer markets are comping higher than some of our more mature markets, but we are seeing strength across the country.

The only thing I'd add to what Lisa said, all that's right. The other thing -- we really never stop -- a big part of what we do is bringing in new products for customers. And we never stopped, even during COVID, we've done a lot of that virtually and the stores are receiving new, exciting, better and best stuff every day. And as the customers can come in, they come in the store and as they get and they see that new stuff, particularly in the better and best lines, they gravitate to it. So we didn't change our strategy or change our execution because of COVID.

Okay. And if I can finish my demand, top line-related questions with a couple of questions around the housing market. Right now, there's a lot of positive signs around home sales and housing starts. But we're starting to hear more questions from clients on just lack of overall inventory. So how do you think about housing inventory and its impact on existing home sales as a driver of your business?

Yes. I'll start, and then I'll let Trevor go a little bit. But I think on -- if customers -- if there's not a lot of inventory for customers to go and get new homes, then it's going to -- they're going to prepare the homes that they're in. So a lack of inventory should be good for home improvement and should be good for our category. We've always trended good. The more houses turnover. We know that existing home sales are good, either they are fixing up their floors before they sell their house when they buy their house. But I believe that now that more consumers are staying home, and they're deciding they're going to stay within their own house, they're going to do more home improvement projects. And I think that, that's going to be good for us. That lack of inventory will also drive the value of the houses up, and I think that's also been a core benefit for us as housing values increase, people are more apt to put more money into their homes, and I think that, that's good for us. So I don't know, Trevor, if you think any differently or anything to add on housing.

Yes, I think that's right. I mean the majority of the homes that people are investing in are not being turned over, right? I think there's something like between houses and condos were something like 120 million units out there. And on a good year, we're turning over 5.5 million a year. And so as the value of the house goes up -- and interest rates are really low, which means people are willing to refinance and invest back in their home, that may take a more significant prominence over the years just because they can't move to a new location. So I do think that as long as the house values are going up and interest rates stay at a very low rate, which, as we all know, the Fed has sort of changed his position recently, those things bode well for us because maybe I didn't want to upgrade to a new home, but I can't. Well, guess what, I'm going to make the best out of the home I can and I'm going to make improvements to it.

Okay. That's great. And are you able to measure or are you at a point where you have seen existing homeowners versus recent homebuyers becoming a bigger part of your mix?

I don't think we know that. It's not -- Lisa, do you know?

No. I don't know that we know that. We are doing a bit of research right now, and that may tell us some of these things. I think anecdotally, we are hearing from the stores that, as Tom said earlier, or as Trevor said, it is a lot of people renovating the existing homes that they have. However, we've done some research in the past that does say that customers after they buy and before they sell, are likely to do some projects just to get ready to sell or to make their house like they want it, once they buy. But I don't think we know that tentatively.

Yes, I'd just say go back, Kate, to the first -- what we said a little earlier that people are staying at home. They've been home since March. They're investing in existing homes at a higher rate. I mean they're having to repurpose space. Like I said earlier, if you think about it, if the spouse works and the husband works and you're trying to do it out of one office in a house, it doesn't work. You've got to create a new space for you to work out of. That could stimulate a flooring sale. Same thing with kids going back-to-school. That's been slow across the country, and that's going to make more people stay at home. And again, just make homes have to be repurposed. So I think it's a lot more in the existing homes.

Thank you for that. Switching over to the conversation around inventory. It's been a big theme in day 1 of our conference because many of the retailers we cover our having challenges with their inventory given outside sales growth during the pandemic. In stock and inventory has always been a strength and competitive advantage for you. Could you maybe talk to us about how you're feeling about your current inventory positioning? And are there any areas where you have maybe too much or too little? And where -- when can that be balanced out?

Sure. I'll start on that. I feel good about our in stock position. If you remember, going back to the -- end of the third and fourth quarter, we cited that we had in stock challenges due transition of SKUs that Lisa mentioned earlier. During COVID, a lot of that transition got complete, so our in stocks got a bit better. The other thing I would mention is that, if you remember, at the end of last year, we added a 1.5 million square foot DC, up in the Northeast, which gave us a lot more capacity and a lot more inventory. I think -- so I would say, 2 other things that I think are relevant. We're not having to chase inventory. We purposely -- our inventory turned slow. We've got a lot of multiple jobs within the store. This is a company that comped 10% or greater for 10 years in a row. And it has a replenishment system that knows how to keep up with those spikes in demand. So we're in a good position. There's always a challenge. Typically, where we have -- where we're chasing inventory, and this is not COVID-related. This is some historical thing. As we bring in new stuff, sometimes it's hard to predict how well a new product will do. And so it will come in, and it will blow out, and we're chasing it and it's only because of the long lead times, it takes time. But I've been fortunate that I've been able to get out in a good majority of our stores over the last couple of months. And I feel really good about our in-stock position versus pre-COVID. I think we're just in better shape.

Okay. That's helpful. And again, part of the tighter inventory environment across retail has fueled a lot of discussion around promotions and the pricing environment. So we're wondering if you've had to adjust at all to maintain the pricing gaps that you typically try to target, both during the pandemic and now kind of in the later stages of pandemic, and we'll start there, I guess, and I'll go to my next question.

Sure. Interestingly, through the whole COVID thing, we have seen very little price movement in the industry. I think that there was very little. Most of the things that people were buying when it was -- everything was shut down back in March and April, it may not have been as much flooring. It was other types of product and so far and just didn't have much activity. And even as we've seen everything open back up, we have really not seen any changes in retail. So I would say that our gap is the same or maybe even a little bit better in some cases than it was pre-COVID. The one thing that we will all be facing is the tariffs on the laminate -- or excuse me, on the vinyl category, did go back into effect on August 7. And so that remains to be seen how that pricing plays out. But we are very confident with our pricing gap, and we will approach that just the way we have other tariffs, and we were trying to resource whatever we can, we will negotiate with our vendors to get whatever cost out is possible. And then we'll raise retails where we need to. But as I said, we remain very confident and we'll be able to keep the gap that we have or maybe even better.

Another thing that's come up in our conversations is the state of the competitive landscape, especially when it comes to independence. I think prior to the pandemic, there was some thought that you could see more opportunity for consolidation as independents were acquired or went away. But it does seem like in certain categories, especially home improvement that perhaps a lot of these independents have gotten a second breast here. Just if you could comment at all if there's been any kind of change in the competitive landscape, particularly among the independents? And how you're thinking about that now that we're 6 months into the pandemic?

Yes. I don't see much of a change in the independent landscape. Yes, I -- you wonder, like could they survive being shut down, we were had to shut down for the month of April, and they didn't have the -- they didn't have the website capabilities that we had. They didn't have the opportunity to curbside and you wonder, did they have the balance sheet to withstand that type of closure. But it looks like they have. We haven't seen a significant increase in closings. And because of the demand in the category, maybe that is giving them a breadth of life, we do believe that our model is better. And over time, we're going to -- as we continue to fill out our markets, we'll take share at a fast rate from the independents, and they'll have a hard time competing with us, and we'll see some follow over the years. But this may have given them a bit of a second breath. We haven't really seen a lot more closures.

Okay. Moving on to real estate. It was mentioned on the second quarter earnings call that you're identifying attractive real estate opportunities when it comes to new store locations. We wondered if you could talk a little bit more about this. Are you seeing better location availability? Or is it also better prices and negotiations with landlords?

I'll take the first part. I'll let Trevor talk about the second part. And a short answer, yes, on both. We -- due to COVID, and we're only going to be able to open 13 stores this year. But as we get to next year, we'll open 20% new unit growth. We'll get back to what we were doing. Because we had to push some of the stores back this year, it helps next year from the standpoint of we're going to have good cadence with our store openings. So for the first time in my 8 years here, we'll open a lot more stores earlier in the year, and not have lumpiness in the back half of the year that we've always had. So that's a positive benefit. The other thing, we just -- there's been closures particularly in the Northeast that have given us more opportunities to get some stores up there that we didn't think, we're able to get. So we're seeing deals come our way for sites that we didn't think would be possible. And they're able to come into our '21 and '22 lineup. So that's from the deal side. We are seeing things, particularly in the Northeast that have opened up that are good for us. And then I'll let Trevor talk about the rent implications.

Yes, we are seeing better rents. So it's not only that our retailers are going out of the business. There's also not as much demand, right? They just big-box retailers that were growing before COVID have stopped growing. So we're sort of getting double benefit that there's certainly more supply coming on. But there's not the same demand. We're not competing with the same number of people to get some of those big boxes. And because of that, we are seeing our rents come down really for 2 main reasons. Probably the bigger reason is we've been more proactive with many of our landlords to make it simple for them and say, just give us the keys, let us handle everything. And that then, therefore, means we're going to have a little bit higher CapEx on our stores. But for that, we're going to get pretty materially lower rents. So we were -- the last few years, we've probably been paying rents closer to somewhere in the $12 to $15 range. And it looks like the class of '21 is going to be sub-$10 per square foot in rent. And so we are seeing lower rents. Now again, we're going to spend a little bit more in CapEx to get some of that rent. But it's a combination of those 2, us taking a more proactive role in building out the second use facility or building the store from the ground up. And the fact that just supply and demand is helping us as well.

Trevor, I wanted to ask you about cost control. In the second quarter, you were able to pull OpEx growth down to 2% compared to 22% in 2019. We assume a big piece of that savings is probably labor. But I wondered if you could walk through the other areas where you were able to pull back?