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

Hi, everyone. I'm Michael Lasser, the hardline, broadline and food retail analyst from UBS. We are really excited to have the team from Floor & Decor with us today. With us from the company are Lisa Laube, the company's President, and she's been with Floor & Decor for many years and is responsible for merchandising, marketing, training, e-commerce and store operations. We also have Trevor Lang, who is Floor & Decor's Executive Vice President and Chief Financial Officer. He's been CFO since 2011. And prior to this, he was with Zumiez. Finally, we have Wayne Hood, Anacor's Vice President of Investor Relations; and Matt McConnell, the Senior Manager of Investor Relations. I'm going to turn it over to Wayne, who's going to provide a few disclosures, and then we're going to start with our discussion. Wayne?

Yes, yes. Thanks, Michael, for having us. Just let me make some remarks here. 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 Private Litigation Securities Act of 1995 throughout the course of our presentation today. So I'll turn it back to you, Michael, after those remarks.

Thank you very much, Wayne. I want to start with a very high level picture of what's happening in the flooring industry, and I'll direct this to Lisa maybe, Trevor, you can offer your perspective as well. There have been a lot of changes in the consumer, in the housing market over the last year. How do you see the different changes impacting the demand for flooring over the next few years? And historically, there's been a few key indicators that would be closely correlated with the demand for flooring like housing turnover. Do you see that steel as the critical driver of the flooring market overall?

Michael, thank you also for including us today. We appreciate it. The -- it's an interesting question and Trevor, I'm sure, will have a lot to add here as well. But we have seen, as everyone has, as everyone stayed home for the last year, there has been an uptick in consumer demand for the category as well as most categories. For us, a lot of it has to do with people having to build out second offices and playrooms and gyms at home as well as everybody is just sitting at home looking around, oh, my gosh, I wish we'd redone that powder room a year ago. And so I think that, that has all contributed to demand in the category. As well as there's an awful lot of disposable income right now between the stimulus and people not spending money on travel and entertainment and things that they would have spent money on in the past. There's a lot of income -- or a lot of free money going over to housing-related projects. So I think we've been a real beneficiary of those things that have been happening. And as you look forward and Trevor would be better to answer this maybe than I will, but with the new stimulus that's going on out there and as much as people have in savings these days, we do feel good about the macro indicators, I guess, of what our category would be. Existing home sales has always been one of the strongest correlations, and I think going forward, it will continue to be. We'll see what happens with the interest rates. As Trevor will tell you, it's one of the reasons why we haven't provided guidance. It's often hard know what happens as people get their vaccines and start to get back out in the world. But we feel bullish about our business and our ability, no matter what's happening in the macro, for our ability to take share. So Trevor, what else did I miss there?

I think you hit the highlights. Yes. We were performing well and bringing an incredibly strong backdrop, which leads to continued strength.

If the Lasser family is any representation of what a lot of consumers are experiencing, we're spending a lot of time at home. There's more scratches in our floor and it's very likely that the instances of working from home will be higher post pandemic than they were previously. It's going to put more wear and tear on the key elements of one's home like flooring. So does that -- is there a good argument to be made? And should we ascribe to it that because of more wear and tear, more usage of one's home post pandemic than prepandemic, the overall demand for flooring and hard surfaces should be higher moving forward than it was previously?

I don't know about higher. I mean, I think you could draw that conclusion. I think we just don't know for sure. And so to what we talked about a few minutes ago, the strongest correlation in the past had been around existing home sales, around interest rates and that kind of thing. Whether or not [ this forms yet ] another correlation in the future kind of remains to be seen. But I definitely believe yes, that as people are staying more, then, yes, I think that they will spend more money on their homes as we've seen in the last year.

Okay. And Lisa, you probably spend more time with the investment community talking about innovation and the move to serving product areas like EVP and EVT, you could probably recite some of the perspectives in your sleep at this point. But has the pandemic inspired any new product innovation, any new trends that external observers should be mindful of? You mentioned that people are a little tired of some of the existing elements of their homes. What are the big product trends that are going to be influential not only this year but in the next couple of years?

It's interesting. We have not seen any huge shifts between categories because of the pandemic. We have seen over the last several months that if you look at our fourth quarter results by category, with the exception of wood, which the wood industry has been lagging for years for a lot of different reasons, but all the rest of our categories were pretty tightly clustered from a comp perspective, all of in that kind of home in that mid-20s. So we're really excited actually that it's not just all about rigid floor vinyl, that category is still doing extremely well for us. We think it's kind of sorted plateaued as far as penetration goes to our business. Tile has been extremely strong in the last 6 months due, I think in large part, to a lot of the initiatives that we've had in place. And I think decorative accessories has been terrific. It's one of our highest comping categories in the fourth quarter and that's partly I do think because of more people staying at home, it's an easier project. It's a smaller project to replace a backsplash or an accent wall, that kind of thing. But overall, I don't think in my 9 years here that I've seen the comp as tightly clustered by department. So it's interesting, customers are really interested in all of those things. As far as the new technology goes, we have a new brand that we're launching now through probably middle of April coming in called OptiMax. And OptiMax is brand-new technology that we are launching. There'll be a little bit out in distribution as well, but we'll have the exclusivity as far as big box goes. And it's an interesting kind of hybrid of the kind of vinyl and a laminate. It's an eco-resilient floor, so it's 50% wood. And lots of people like the wood from the environmental perspective, but also just you feel like it's got a little bit more heft to it than vinyl so some people like that feeling, but it has all the benefit of vinyl. So it's waterproof, it's pet-proof, it's very scratch-resistant. So it's a very interesting product. It comes in kind of at the best price point in our lineup. And so that will be in, in the next month and we are excited about that new technology.

I want to ask Trevor another macro. Before I do, this is a good point to ask about consumer preferences because it does seem that some of the -- there's been some trade up within the flooring category over the last few quarters. Would you attribute that as consumers, they're spending more time at the home so they're realizing that if you're going to get more usage out of this, it makes sense to spend a little bit more on it? Or would you attribute it to some of the wallet share shifts? How do you think about that?

I think both. So I do think that people spending more time at home, I'm sure, and they have a bit more disposable income, as we talked about. So I do think where people can trade up, that they will. And I think as we've continued to offer better and best product and up our game in those spaces have given customers more options at price points that they probably didn't think they -- or product they probably didn't think they could afford, and now they can. So even though our better and best are higher end for us, they're still offering a significant price gap between the independents and ourselves. So I think that, that's also given people the opportunity to buy into things that they might not have thought they could afford before.

And has the assortment tilted a little bit more to the better invest end of the products like maybe they were 2/3 of the assortment a year ago and now they're 70% of the assortment, any context that you can provide on how Floor & Decor has been leaning into that?

Yes. I don't think we've published the numbers, but it does continue to go up. So the percentage of our sales represented by better and best products every quarter with the exception of second quarter last year, which was a whole different thing with the stores closed, but with the exception of that, those product categories have been trending higher than our opening price point and are good. And I think, like I said, a lot of it has to do with, one, just the technology aspects of some of the product, the visuals and the design in other products. And the fact that when someone looks at it, it's like, gosh, that's only $1 more square foot. That's not that much when I'm just doing a bathroom and look what I can get. And so I think that those are some of the reasons that we continue to be able to do that. And honestly, when we push up in price point, we think, well, this is -- it's a little scary now we're up here. But meanwhile, the customer loves it. And so we have found that we can just continue to bring in those higher priced, better product and the customer is really responding very well.

And do you think your competitors are saying the same thing? Or Floor & Decor is able to -- because of its superior merchandising, superior execution capabilities, that you've been pushing that envelope a little further than others?

I think versus the big box, for certainly, we are in a different space. I mean partly because like, for instance in tile, the large-format tile, which now we're talking about a tile that's 2 feet by 4 feet or larger. And that's difficult for a big box to carry. I mean it takes up a lot of space, it's a big commitment and so that's difficult. I would say versus an independent, it's just going to be -- the main thing will be that price differential. And so I think that we've always had a bit more of the market share in that better and best category. But based on our prices and based on the fact that we're able to offer those thing, great looks, we are definitely taking share in that space.

For sure. Trevor, speaking of the macro, the interest rate environment is historically -- is low by historical standards, for sure. But the market does seem to be concerned that we've seen the bottom in terms of interest rates. So how do you think about the potential risk to Floor & Decor from the rising rates? Do you see it as a direct risk where consumers would be more apprehensive about starting a project if rates were to rise? Or is it more of an indirect risk where rates would have an impact on housing turnover and home prices and subsequently and impact on Floor & Decor?

I think you summarized it well. I think it's a lot of, historically, housing affordability has been the main driver of existing home sales turnover. And we know existing home values were up substantially and then the other part of that equation is interest rates. While they were at bottom -- rock bottom levels not long ago, now they're still at historic lows but higher than they were. And so as those both go up, if income levels don't go up at the same rate, that's going to make household affordability to be more difficult, which, in the past, if interest rates continue to go up has led to a decline in existing home sales. And if you go back not that far in our business, the first time our comps decelerated, most people would die for a high single-digit comp but when we decelerated from a double-digit comp down to high single-digit comp, that's when interest rates went up fast, household values had been going up. Therefore, affordability went down and our business accelerated a little bit in Q2 of 2018. So we'll see. I think there are so many -- it's so different now. [ Every cycle now says a lot differently ]. As Lisa said, we serve a little bit of a higher income consumer now. Stock markets at all-time highs, the household value that they have in their home is very high relative to where it's ever been. And so maybe this cycle will be a little bit different just in the sense that people have the equity and the cash and the wealth to invest in their home and one says, if I'm not going to be able to, I don't want to upgrade to that second or third home that [ traditionally I might have taken ] on 10 or 20 years ago. Maybe I'll take some of that money and invest back into my existing home. So we'll see, but yes. We wish interest rates -- we hope they stay low. But if they go up, there's likely going to be -- there will absolutely be an impact to affordability.

Is there a level of interest rate that you would be concerned about that would start to lead to some demand diminishment or even demand disruption? And where would that be?

Yes. Again, Mike, first of all, I'm no better than anybody else's and I think every cycle is different to some extent. But you think getting them up 3.5 starts to feel like, to me, that's getting to a rate where you're going to start to -- the affordability is going to become difficult. As big as that, it's just a value of the home, right? Just if you look at where we were, I think, we're over 10% above the same home last year. It costs 10% more than it did a year ago. And so we combine that with higher interest rates, it just gets more difficult. So again, not my expertise. But if we approach that level, it seems like to me that could be a different point.

That's 3.5 on the 10-year, just to clarify?

Oh, I'm just saying on mortgage rate.

Mortgage rate. [ 36 ]. Got it.

Obviously, the treasuries will drive that, but I focus more on the mortgage rate.

Totally understood. And lastly, on the macro overall domain environment. I know that you guys didn't want to provide a whole lot on what was going on in Texas, in the South and the weather a couple of weeks ago. You've had a little bit more time to assess the situation. Is it reasonable to use the Houston flooding precedent as a reasonable basis for how widespread some of the demand is going to be based on the damage to pipes this time around? So you don't have as much of a concentrated demand disruption or disruption path, but it's more widespread. Is that the right way to think about it?

I think we'll see. I think Texas is 16% of our sales. And then the stores that were more wholly affected we're probably a little bit even smaller than that. I did get probably the same thing out in the journal that from an insurance company perspective, it looks like the damage was going to be the 10th largest in the history of the United States. So there's going to be a lot of money coming into that market. I also read that it's going to be more businesses. People were able to -- the pipes didn't burst in people's homes, but most people can hopefully get to their home and shut off before it became a bigger issue. But there was not a lot of people at the businesses. So maybe different misses, there's more businesses or schools that were damaged. We're much more residential remodel. So it feels like, to us, there's definitely going to be a positive benefit to us. And we have a great team. We know that market well. We did go through Hurricane Harvey, we've been through some other national disasters so we're prepared for it. But we'll see how that plays out. And my own view is it will be big. I don't think it will be as big as Harvey, but there's definitely going to be some -- I would be surprised if there's not some incremental business that comes through us on maybe 15% of our sales.

Is it just Texas? Or were there other?

Most of them, we read the damages in Texas, but the shutdown affected more states. It affected Louisiana, Tennessee, Oklahoma, parts of Kansas were also affected. But not nearly to the extent, as we understand it, as the Dallas and Houston, to a lesser extent, San Antonio also.

Okay. And Lisa, I'm sure you're in regular contact with the stores who would then talk to your customers. How big are the pipeline for flooring activity right now? It hasn't been comfortable closing your home. You don't want to get dislocated, it's in your home. As there is a reopening, what should we think about the tail associated with demand from some pent-up jobs that have yet to be done?

We work with a third-party called Installations Made Easy and they are service our stores, I guess, I would say, throughout the country if a customer comes in and says I don't have a professional, can you recommend someone. We refer them to Installation Made Easy, which is a third-party arrangement, and they help them find a professional. So just in talking to them, they would have said last fall that they maybe had kind of a 1- to 2-week backlog and they're now telling us it's kind of 4- to 6-week backlog. So the backlog is higher than it has been over the last 6 months or so. So -- and everything just -- I'm sure as anyone who's tried to have any work done in their home, any construction trade men is -- they're busy right now.

Yes. And either because of the storms or because of what's happening with the ports, have you had any disruptions to your supply chain from getting product to be able to service that demand?

Yes. I would certainly -- our in-stocks are lower than we'd like. I mean we hold ourselves to an extremely high standard. And we don't think that they are low enough if it's causing any kind of disruption to sales at all, but it's definitely more challenging than it's been in the past. Thankfully, it's one of those good times that I use to turn slow and have 5 million square feet of DC space out there loaded with inventories. So we have a lot of inventories. But definitely, between the port closures, between the container shortage, COVID and factories popping up, it's definitely every day is a bit of a new adventure on the supply chain front right now. So that group is working awfully hard. But so far, we don't think that it's impacted our sales. It's just getting a little bit harder to get inventory right now.

Got it. If there wasn't a good news story on the outlook for flooring and everything else, Floor & Decor is doing a tremendous job of taking share within the industry in part because of great execution and then you layer on top of that all these exciting initiatives that have been put in place over the last few years. Now I would highlight the PRO Premier Rewards. It's something that I think is particularly exciting. So, a, can you provide more perspective on that? And b, has PRO Premier Rewards hitting an inflection point where it's allowed Floor & Decor to gain more share amongst existing Pros in the ability to attract new Pros and I should say this is an important topic here because 85% of Floor & Decor sales are, in some way, shape or form, influenced by the Pro, right?

Yes.

Okay.

Yes. I think we do believe it's a great program. We actually won a minor award this year for Best loyalty -- B2B loyalty program, which we found out we were up against some pretty big names of much larger companies.

I could only imagine the awards show that you guys probably got on dolled up for it.

It was pretty cool. We're in our infancy stages with it. We have a fantastic CRM solution that we put in, really sort of finished that up in 2019. We got a good look in information throughout 2020. We've learned a lot. We put some of those disclosures in there. We expect that our research says that about 40% of the decisions are influenced by the Pro but only 30% of the tenders is by the Pro. So we know loyalty is a fantastic program. We do think it's going to help. We do allow our Pros to get credit for consumer sales so that if Michael Lasser wanted to pay, for whatever reason, Trevor was the installer, I can show that I was your installer and I can get credit for those points. So we sort of made it agnostic as to who actually pays for the product. So now we had it in 2 years. We've done a number of external studies with consulting firms. We've got a small data sciences -- science team on our group who's proven to us kind of time over time that it does drive incrementality. It just makes sense, all of our competitors have a loyalty program in some way, shape or form. So as we think about the next few years, what we're really working to is a [ bolt ] that can take us to the next step. Today it's basic vanilla program that everybody kind of gets the same benefit unless you spend over $3,000 and you get some extra points. So we're working on enhancing that and building, what would you say, maybe a silver, bronze, gold, medallion type program, such that we reward our best customers with the best solutions. We hope to make it aspirational such that if you're in silver, you want to get to gold. If you're in gold, you want to get to platinum. So we're working to some of that. We'll hopefully get some testing in the back half of this year. The other thing we have the benefit of is we rolled out this private label credit card. So a lot of our professional customers, they're not big customers, but having a $10,000 revolving line of credit or $20,000, $25,000 revolving line of credit is something that would be helpful to them. We also -- our programs you need today, nobody has matched this. We have 6 months no-interest payments, so that really helps with the cash flow component of a Pro. The cost to us of that card is materially low with a big card price. And so we're thinking about giving extra points for using that private label credit card. And that's another way to reward our Pro for their business. We just rolled out last year a tool for Pros to be able to get references, so they can get more jobs with one of the big companies that does some of that. So we're always kind of trying to think about how we can build more and more solutions for that Pro to make it more sticky and to have them win new more business with us. So the answer is yes, we're very proud of PRO Premier. We know that 7% of our actual customers are in the loyalty program. We know they spend more once they're in the loyalty program. And we're excited about what the next few years can do because, as I mentioned, it's in its infancy and we have a lot of ideas on things we can enhance it. Just talked about a few of those.

And where would your market share is with the Pro customer today? Where do you think it could go? And as someone who's toured many a Floor & Decor store, I have no idea why a Pro would not be doing all or most of his or her business with Floor & Decor. So when you hear resistance from Pros, what are the top reasons cited why they're not directing most of their business to Floor & Decor?

Yes, I do think we still have a minority wallet share, believe it or not. Part of that is just due to our size. We're just not that big yet and we don't have a dominant market presence like some of our larger competitors. We do hear one-stop shop. So if I'm doing a basic remodel, why not just get everything in one of the home centers, including flooring. So they'll get their plumbing and their lumber, might as well just [ grab some flooring ]. So we do hear convenience sometimes. If you just want a basic commodity item, might as well just get it from the home centers. Both the home centers and the independents have kind of rebate -- volume rebate kickbacks-type programs that we really -- we don't do. We have a loyalty program, which is points, but it's never as rich as some of those volume rebate programs. So we think it's a good idea, but it will never be quite as rich as those programs. Convenience is something we also hear sometimes. There's -- some of our larger competitors have, one of them has over 2,000 stores and I think around 1,600 [indiscernible] versus [ our 133 ] stores. So those are convenience aspects that sometimes our Pros would tells us. I don't know, Lisa, we just looked at this the other day. I don't know if I left anything out.

Yes, I think there are good relationships, right? I mean it's a very relationship, local business. And often, if they know the guy that they're buying from, their kids play football together, they socialize on a weekend and it's just very difficult sometimes to get a professional customer away from a relationship that they've been in for a very long time. So that just takes us a little bit of time usually to do that.

Okay. As part of this, you pushed further into the commercial market, which is just as exciting as the residential market. Where is Floor & Decor with this initiative? Can this be a meaningful growth driver over the next few years such that even if there is some volatility in underlying flooring demand, the potential from commercial can provide a lot of support to the company's overall results.

I think over time, we wanted to be more meaningful. Just to set the stage for people who maybe don't know this industry as well. We estimate the residential remodel market at about $18 billion. That's the vast majority of where our sales are going. We estimate the commercial floor and hard surface floor market at about $13 billion. So it's over 70% of the size of the residential remodel. The strengths that we have in the residential model, we're using those same strengths in the commercial, very good-looking product, sourced from all over the world, trend right, we have it available. We can get it very fast if you want it. Very good logistics support. And obviously, all at very good price. And so we are having success. We've doubled our regional account managers just last year from, I think we were at 10, 11 at the beginning of the year. We're, I think, 22 of them. And we're having great success with it. We called that -- it's coming from a very small base. Tom called out just that regional account manager, external commercial business was up 300% in the fourth quarter from a small base. And so I think as we really studied the market, our own internal goals, much like we had very detailed goals we talked about with our stores. New stores we want them to open up and do $12 million to $15 million in sales and eventually they get up to $22 million to $25 million. These regional account managers, we hire one. We want them to do maybe $0.5 million to $700,000 in sales for the first year. By year 3, we hope we take this to $2.5 million, maybe $3 million in sales. And if you look at for the bigger competitors out there that have the lion's share of market share today. Some of these firms have 3, 4, 5 salespeople doing close to $3 million apiece. Dal-Tile, for example, is a subsidiary of Mohawk and I think they do close to $1 billion in market. So if we think about the next 10 years, could we someday have $300 million, $400 million, maybe $500 million that these folks do at $2 billion, $2.5 billion in sales, that's a long way off. We've got a lot to prove between now and then. But it's a big market, and again, the strengths we have in the retail business, we think we can build upon to grow in the commercial industry and we intend to do so.

And does this influence how you think about the total number of stores that Floor & Decor has? Up until now, you sized the potential at 400. Now there were some questions about cannibalization 18 months ago in some of the California stores. But everything has transpired since then and this opportunity on the commercial side, how are you thinking about the store potential?

We think still at least 400 stores, just kind of how we phrased it. Most of the commercial business will likely not go through the stores. It will go directly from our distribution centers to the job site. And they won't even touch the stores. There are benefits of having stores and then we will do some shipping to the stores or if we want to -- if we have some projects where we'll just keep extra pallets of product and they'll just come out and pick up [ 3 ] pallets a week or a month if they need it. So there are definite benefits to having the stores, but the majority of the commercial business will go directly from our distribution centers to the job sites. So I don't know that it affects. We'll see that over time. I don't know that it affects the store count. But certainly having a bigger addressable market it's possible that we could have more.

And you've been testing a design center, smaller locations. Does that play into the addressable market as well?

Yes. I think that -- I'll talk to the design center here in a second. So we've got the one -- we have the one in New Orleans for ages. And then we've just opened the one in Dallas back last summer. That's not part of the 400 and we certainly think that it is incremental to that. I think what we're seeing in Dallas is that the sales are partly incremental. So too soon to tell exactly how incremental it is. The whole strategy behind those stores is that we would be getting to a customer that may not be as comfortable coming in through a big box. So whether that be a custom home builder, a higher-end decorator or designer, an architect, that kind of a customer would feel more comfortable in the smaller design concept. So I believe it approaches a different customer than we'd have largely in the big box. It also approaches a different space or location because, for instance, the one in Dallas is in the design center. We are not going to get an 80,000-square foot store in a design center. It's just a -- several blocks, the smaller retail. And that's where that customer is shopping. So it also is -- it is a very different model. The great thing for us, though, is it's got the benefits of an independent, whereas the smaller, more intimate shopping experience, presented a different way, but we have the advantage that it's back to the entire Floor & Decor deport infrastructure. So even though you may choose the product there, the product is in stock 20 or 30 minutes away and you can still pick it up that day. You still got the extremely low prices that we're able to offer and the rest of the assortment. So we think it's a nice add-on to what we do with the big boxes, but it doesn't impact the number of big-box stores that we will have.

And then the obvious question, you're setting me up here. At least how many design centers do you think you could have?

We don't know what. It's interesting. We've got one, that's the one in New Orleans. We're going to open 2 more the end of this year and so -- one in Miami and one in Houston. And so I think once we get past that and we can understand the incrementality, understand the numbers a little bit better, I think it's easier to see how many opportunities there we have. But we so far we're pleased with the results and I think that it's -- like it's been a nice add-on to what we're going to do between the big boxes which is the mother ship, of course, plus commercial plus this. It's a nice adjacent [ mark ] as well.

I want to pivot the conversation a little bit. We'll revisit a topic that we talked earlier, which was the customer behavior, but this time how it's impacting the gross margin because there's been a really nice gross margin story to develop over the last few quarters. The big topic, the big debate that we have with investors and shareholders is, is this sustainable? Or is it more just due to temporary factors that are unique to this period. How would you answer that question?

Trevor, I'll let you start on that.

Handing him the tough ones. Yes, I got it.

The bus rolls over, no, I'm joking. I don't know. I think, for us, we're in an incredibly strong backdrop. The interest rates are still at historic lows. Matt just sent me an interesting quote here. If you look 2006, we've averaged an 11% comp and 30-year mortgages averaged 3.8%. So we've done fairly well at much higher mortgage rates. But I think we're in this environment where mortgage interest rate is so low. Yes, they've crept up over the last 2 months, but they're still low relative to historic terms. Household value is up. Wealth is way up. We serve a customer that's in the upper income demographic. We serve an older customer and those people have the ability to make investments into their home. I think how long this will last, I think is something else that we're -- I have a thesis on that we'll see it plays out as I think people are sort of modularly thinking about doing their homes and not doing big banks. They're doing a bathroom vacuum and then like how it turns out, maybe they come back another year to do a kitchen or a different bathroom, the basement or something like that. And we'll see if that ultimately plays out. So it's hard for me to say. I know, for us, we were in this great backdrop. Our assortment is as good as it's ever been. Our store leadership is as good as it's ever been. Our website, we have spent a lot of time on that. We've made a lot of good investments into our website. I think that's a big differentiator for us as well. So I think we're in a good macro, and our businesses is separated as it's ever been.

When we're having this conversation a year from now because, hopefully, we will again, what -- and we look back on the 3 risk factors that would interrupt Floor & Decor's ability to maintain this gross margin trajectory, what are those 3 factors?

I think you're seeing a little bit of that now with the supply chain, right, the disruption. It's not just a Floor & Decor center thing, it's everybody is trying to get stuff out of China to meet the demand that exists. So I think supply chain could be something that's there. We're in a delicate environment with COVID and the macro and there's a lot of people that are hurting right now, and so depending on how things go there. But I think the things that we can control, our balance sheet have never been in better shape. Our new site selection and new stores, it looks like the class of 2021 will be the best classes of stores we've opened. The team, we've been executing together for a long time. We've got a great team around us that's helping us execute this plan. So I don't know, maybe it will be supply chain. So that's macro, hard for me to think about, I'm putting my biases, but hard for me to think about things that are Floor & Decor-centric that could throw us off guard.

Just in the last 2 quarters, Floor & Decor's averaged 175 basis points of gross margin expansion. How -- what are the big buckets? How would you unpack that, that have driven the gross margin expansion? You've turned it merchandising. Can you put some more tangible life around what that means?

Yes. It's really just a great merchants delivering incredible product. So there's 2 real mix benefits that are going on in our business right now. One, things like decorative accessories, which is close to 20% of our sales. That's a higher-margin category for us and it's performing exceptionally well in this environment. And then within each of the departments, I think almost every single department has a gross margin improvement within the department as the merchants have done a great job bringing in better and best solutions that the consumers are picking with their checkbook. They understand that this has got a thicker mill or a longer warranty for a better look or a longer plank or a rectified edge or this really looks like marble, but I can use it in a different environment that I might not be able to use marble. Just as we put out better and better projects -- products, our customers are resonating with that. I think we've done a good job of messaging that from a signage perspective where we articulate it on the website, the training we give our sales associates. And so there's no magic. It's really just better assortment. We are getting a little bit of leverage out of our supply chain. We built that big distribution center in Baltimore in the fourth quarter of 2019, so we're certainly getting some leverage out of that. We have more leverage out of that this year. But the lion's share of the product margin has come from good/better/best and then also some mix benefit as the decor category continues to be one of our best-performing departments.

I have a 2-part question. How influential are rising wages going to be on the P&L over the next couple of quarters and then the next couple of years? And two, Floor & Decor has been on quite a journey between these merchandising changes you're talking about now and the tariffs that have been a big part of the product story for the last couple of years. So what has that taught you about the ability to pass them on pricing and still maintain these pricing gaps with the competition? So you're going to experience some wage pressure, but how do you have an ability to pass on pricing and navigate through that?

Yes. As far as the wages go, I mean, our average wage is over $15 now. We have had that increase over the last several years. And I think we are watching what else is going on. We're competitive in the markets that we participate in and I think that we'll continue to be. We do watch it very closely. Thankfully, our EVP of Stores is -- he is an amazing people person and he finds great ways to make sure that all of our associates are compensated appropriately. So he has a real care about that and we do watch that closely and make any changes that we need to, to make sure that we're not only just competitive, but taking good care of the associates. I mean, even if you go back and look at the $2.5 million or so in the fourth quarter that we paid out of bonuses, I mean, things that we've done, benefits that we've added for our associates and so that is something that we pay very close attention to. On the flip side, as you asked about the pricing and the tariffs, I think that what I would say is that our sourcing model, we believe, is superior to what the competition is. And so whether there's tariffs or ADD, CVD, whatever the problem is on that day, that we've been able to weather those storms. We've been able to move products to different countries where possible. We've been able to -- where we can't move it, we've been able to absorb those tariffs and pass along. What we have to, to maintain our numbers, that's what we've been able to do. But we have not seen a -- we've not seen any kind of collapse in our pricing differentiation. In fact, it's as strong as it's ever been. So as long as everyone is kind of sourcing things similarly, which -- from similar countries, which like on LVT, which is the big one right now, there's really not much capacity here in the U.S., as we've talked about or anywhere else other than China. So everyone's suffering the same 25%. So in that situation, we are certainly able to maintain the pricing. And unfortunately, we do have to pass some of it along. We try not to. We try to keep our prices as low as we can. But when you've got a 25% tariff, it's just part of it that we have to do that as well. But we've not seen -- the price gap of the competition has stayed. So the customer is still getting an advantage by shopping us.

As we're coming up on the culmination of our conversation, I want to talk a little bit about the competitive landscape. And do you expect to see an inflection in the consolidation here, and I was talking to an industry insider who kind of stated one of the differences of Floor & Decor and everyone else is the merchants at Floor & Decor, they'll go to a sourcing trip to China and take a train with -- and a bus with chickens on their head. They go into the country and find that last quarry where no one else can find it, whereas some others might be going on their sourcing trip and just having a 5-star meal or view it differently. But this cultural difference that Floor & Decor has an advantage from, when does it start to really manifest in consolidating this, what is still a very fragmented sector?

Yes. That's interesting. I know it's a hard thing to know, right, because a lot of people thought that of the 15,000 independents out there that there might be a lot of consolidation already with what's going on with the pandemic that a lot wouldn't survive last summer. I think though that through the government stimulus packages that were provided to small businesses that helped people weather the storm, I think, with just the strength of housing, remodel, renovation, they certainly are feeling the benefit of that as well. So who knows what happens next year or if the interest rates rise or any of those things should happen, I'm not sure about that. They've still got strength at the moment, though, and they do play that role. Our sourcing though is definitely -- I haven't seen any chickens lately, although I have been on trips like that in my past, so I know exactly what you mean. But we do -- one of the biggest differences we have in our merchants, too, is our merchants, I don't know the average tenure is, but it's got to be 10 or 15 years. I mean our head merchant now, he has been with us for 17 years. I think the last time we hired a senior merchant was maybe 4 or 5 years ago. And so they have so much experience. They know where that last factory is, that last quarry is and they're able to go and source it. I mean we have relationships with so many vendors out there that are proprietary to us and it offers us a huge advantage. And so I feel that the continued strength in our business will largely come from the sourcing that we're able to do and the product and pricing we're able to offer.

Have there been any changes either on the sourcing side or we hear a lot about the big boxes as threats to the business. Have there been any changes for what the big boxes are doing?

Not that we've seen. I would say it's probably they're somewhat less aggressive than they've been lately. I mean I know they're extremely busy with lots of other parts of their business. I mean, obviously, I mean, you can look at their numbers as well and see what kind of strength they've got going on. So maybe flooring just isn't of mind right now. So we haven't seen anything change dramatically lately. So we feel very good about our ability to continue to compete with everybody that's out there.

Awesome. Well, we look forward to seeing your continued success. Lisa, Trevor, Wayne, Matt, thank you so much for your time today. We really appreciate the insight, and we wish you well.

Thank you, Mike.

Thank you, Michael.

Good to see you.

Thank you.