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

Hi, everyone. My name is Daniel Hofkin. I cover Hardlines and Specialty Retail for William Blair. We're delighted to have with us this afternoon, the management of Floor & Decor, including Trevor Lang, CFO; and we also have with us Wayne Hood and Matt McConnell in Investor Relations. Before I begin -- before we begin, I am required to inform you that a whole list of disclosures can be found at williamblair.com. With that, I'm going to quickly turn it over to Wayne just for some safe harbor language, I believe.

Yes, there's enough safe harbor language for everyone. But we do have to say 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 our Private Litigation Securities Act of 1995 throughout the course of our presentation today. So we don't really have any formal remarks, and I'll turn it over to Trevor, Dan for Q&A.

Okay. Great. So I think we'll just kick it off with some questions that we've developed and also received from clients. And we can also open it up to incoming questions, live questions along the way. Maybe to start out with last month, you announced the acquisition of Spartan Surfaces, a commercial flooring distributor serving the architectural and design community. Can you just talk a little bit about how the acquisition came to be? What you saw in Spartan specifically and how they can help accelerate your growth in the commercial flooring channel?

Yes. First, Dan, I'd like to say thank you for having us. I've known William Blair for a long time. It's an incredible franchise, and we appreciate the work you do on our behalf, on your clients behalf. So thanks again for having us. So Spartan is an entity, we've known for probably a couple of years now. Just as a little bit of history, we really started in earnest, our commercial business in 2017 and have had really good success with what we call our regional account managers. We started with one in Houston, went well. We had a number of the next year -- last year, I think we added maybe 12 or so in -- 12 or 14. And so as we were having the success with the commercial industry, we started researching the industry more to see where we could have more success. What's the size of the market was? And where we thought we could participate? So last summer, we did a fairly detailed work with one of the big consulting firms that most people would know and really dug into the market. Where were we winning? Why were we winning? What was it about our model that was attractive to our clients. And as important, where were we getting business from? Where was there opportunity for us to even get more business? And as we learned more last summer and we kind of knew this intuitively, is, where we were having and have had lots of success with the regional account managers is what they call downstream on mainstream. So this is a general contractor, a commercial flooring installer, a small owner-operator in many cases that is doing commercial flooring jobs, and we're having great success. And we think that size of the market is about $6 billion. Where we weren't focused on and really hadn't tried to address was what they call upstream and the architecture and design. So think about a big apartment complex that's either getting renovated or getting built from the ground up or a big hospital that's getting renovated or built from the ground up or a big hotel chain and so on and so forth. Those are longer-term projects that take a different relationship and sales cycle. And we thought at the time, we still think that while we probably possibly could have figured that out over time, that would be harder for us to address. And we really hadn't had much of that market, which is about $7 billion of the industry. And so because we had heard of Spartan, we've always heard good things about Kevin and the team. We started having conversations really pre-COVID. Those slowed, obviously, when COVID hit. We needed to focus on our business and so did they. But we felt like we could help them grow their business, help their reps be more productive just because of the infrastructure and the supply chain that we have behind us. Sometimes they wouldn't win jobs just because people would be concerned about the to the size of the organization. We felt like we could grow their reps a little bit faster. As you know, we're going to add 12 to 14 regional account managers ourselves. Maybe we could add 7, 8, 10 reps for them. And then the biggest reason that Spartan was attractive to us is this massive supply chain and infrastructure. As you can imagine, we're buying $1 billion of flooring. They're buying tens of millions of dollars of flooring. And so for them to be exposed to our 7,000 SKUs to have incredible product at a low-cost was very attractive to them as well. And so it was a bit of a port ship back and forth. And ultimately, we came to the terms that we announced a week or so ago and look forward to closing on the transaction shortly.

Great. Maybe just thinking about the industry overall, flooring industry has obviously been incredibly strong over the last 15 months. But we're curious kind of how you see demand for flooring over the next several years, particularly as people start to resume their pre-pandemic living and spending habits over that time?

It's an interesting question. I'm not sure my crystal ball is any better than anybody else's. What I would say that we've got this -- a lot of wind in our backs and not only us, but really everybody in the home industry. Consumers are sitting on $2.5 trillion of cash because of the stimulus household values, as you've seen, we've all seen. They're rising in the mid teens level, so people have a lot of home equity. Most amount of home equity that people have ever had in their homes. Of the 123 million housing units that exist in the United States, 80% of them are over 20 years old. So there's a natural replacement cycle for either fashion or product wearing out. And as we said, 2 years back, we served a bit of a higher income demographic. And in this macroeconomic environment, that person is doing very well. They have record stock value wealth. They have record household value wealth. And as we mentioned, they got record levels of cash on hand just because they have some of the stimulus that's come through the system as well. And so I think from that backdrop, we feel obviously very robust. Our business has gotten better each of the last full 3 quarters that we've been open. We said at the time of the earnings release that our sales have been consistently strong into the first 5 weeks of Q2. But obviously, we're in an elevated environment because of this. How long it lasts is difficult to know. I think the only headwind that's probably coming at some point as housing values continue to go up and mortgage rates have gone up some, housing affordability will decline, and that will then lead to a decline in existing home sales, which I think is around $6 million. But still, as I mentioned, you still have $123 million that have a lot more equity and book their house and just net worth of the consumer with low debt levels allow us to invest. So it's a very long [ spicuous ] (00:07:04) answer to a simple question. I can't say for sure, but it does feel like there's more macroeconomic factors at our backs right now than there is or had. The only one that, again, is likely to affect us in the near term is housing turnover just because affordability is likely to decline soon.

Got it. Okay. You've talked in some of your recent earnings calls about a favorable shift that you're seeing towards better and best price points. Can you maybe talk a little bit about what you think is driving that? And then assuming that you're able to get great values on comparable products, do you think that there's an upper limit on the quality of flooring products that Floor & Decor can ultimately offer to customers?

Yes. I mean, it's a reflection of a merchant-driven organization. Lisa and Tom are very strong merchants. They live and breathe in the stores. They are consistently working with our merchandising teams to have new products. They're doing product line reviews right now at our off-site facility. We're consistently bringing in new assortments. The other big benefit we have is these big stores. Our average store size is now 78,000 square feet. Most of our new stores are averaging 80,000 square feet. And so it allows us to really broaden the assortment and bring things to the table that aren't normally seen elsewhere. And the consumers are voting with their checkbook, right? We -- for almost every product we have, we have an opening price point. We have a median price point. And we have a better price point. And we could probably do a good job of articulating one of the features and the adjuvants of those products just to why you might pay a little bit more because of the thickness or the warranty or the mill or the uniqueness of the prints on the product. And consumers are voting with their checkbook. So we are -- we definitely feel like we still have other things we can do and will be doing. As we're getting bigger, we're working more directly with design houses to actually get products that we think are unique. We're still sourcing from 220 vendors in 24 countries. We're growing at a very fast rate. So we're obviously very attractive to our vendors, and we have a very good relationship with our vendors. So we'll see, but that has been a big part of the sales increases we've seen as well as the gross margin improvement is continually evolving and cultivating that assortment. And the other thing I'd say, Dan, that's worth mentioning is, we're getting better at micro merchandising as well. Our stores and your market there in Chicago, they all have different needs and different demographic reasons, the assortment will need to be different. And as you know, we have merchants that live and breathe there in that market to help assort that and we do that throughout the United States, across our 11 regions today. So I think we're also -- with systems and technology and talent, we're also doing as good a job with micro merchandising as well.

Great. Can you talk a bit about the cost environment, major cost categories where we're seeing inflation whether it's raw materials, lumber, other things, labor, freight, et cetera? And then also, how that's translating or not into retail price inflation and what -- kind of what you're thinking for the rest of this year about that?

Yes. So it started with more so on the supply chain side with international transportation costs are the larger of our supply chain cost, the largest part of our product cost, excluding the product itself. And so there's just not enough containers coming from Asia to the U.S. There's also demand in Europe for containers as well. And so that was the first cost increase we were starting to see. Now we have contracts that take us through most of this year, but because our sales are higher, we're going beyond the contracted number of vessels and containers. So we're actually -- we are buying some on the spot market. So that was the first time -- that was the first place we were seeing some cost increases we saw in the container costs. And then domestically, there's not enough truckers or trucks in the United States. That also is where we have a fairly dedicated capacity. But as we're adding more capacity based on our sales volumes, we're seeing cost increases there. So it started with the supply chain. As of the call a few weeks ago, we also were starting to hear about some cost increases that some vendors were seeing and so we're taking that into account. We are seeing retails change at the competitive landscape, both with our bigger and smaller competitors. We will watch that and take a market-based portfolio approach as to where we think it makes sense to possibly raise retails. We obviously will do that as little as possible and as late as possible because we like being the low price leader and providing the most value. But we are in an inflationary environment. And to the extent we see some of those cost increases, we feel like we can pass them along. The other -- the -- some of those we can pass along. The other thing that benefits, as we said this on the fourth quarter call, we reiterated it on the first quarter call is, we feel as good as we've ever felt from a competitive perspective, both on the uniqueness of the assortment, meaning it's hard for other people to price shop comparison because we have such unique items. And on the price spectrum from -- for our competitors, meaning where our prices are relative to our competitors for products that are more like-for-like. And so that gives us the ability, we think, to -- as we see their prices go up, for our prices to go up too. And again, it is more of a portfolio approach. And so said differently, as a low-cost leader and a unique assortment, we feel like we have more ability to affect prices. We see some costs coming in relative to possibly some of our competitors.

Okay. Can you talk about kind of the competitive landscape in terms of both specific product categories, but also in terms of type of competitor, just kind of what you're seeing there? And also in terms of overall promotional activity, if there's any particular categories where you're seeing more or less of that?

When business is strong like this for us and in the Home Centers, obviously, their business is obviously very strong as well. We don't have as much -- it's not generally competitive on the price front, so we don't see as many issues on pricing where someone's being super aggressive on a price point just because business is so strong by region. So we don't see a lot of that. It doesn't mean we don't watch it. We have to be cognizant of it, but we're not seeing people be very aggressive on price. And then you add to that, which is a strength of ours, the fact that you don't have a lot more inventory. So why would you mark it down, if you're just going to be out of stock and we can't get replenished for a period of time. And I'll talk about more on the independents for that last permit. And so we haven't seen people be overly aggressive on trying to take market share through price in this environment. Our stores are big. We've always had a competitive advantage that our stores average 78,000 square feet, much bigger than the independents and much bigger than the flooring sections within their Home Centers. And those strengths have accentuated in this environment where people have sold out of SKUs and they can look like they don't have anything in stock. And certainly, we have a few areas where our in-stocks are below where we'd like them. But because of the bigness of the assortment, we have other things that we can sell. And so while we do have a few areas of in-stocks that we would like to see higher, the breadth of the assortment allows us to sell other things, which is why our businesses can stay strong, even with some of our in-stock levels being below where we'd like them.

Can you talk a little bit about your loyalty program, which is I believe now 2, 2.5 years in the making? Kind of how that's progressing? What you're seeing -- how you're seeing that trending? What you expect over time in terms of both average spend per member and also a number of members and then any adjustments that you're contemplating or already have made, such as, for example, tiered membership?

Yes. We are very pleased with the loyalty program. I think our points is up at a much higher rate than our sales, and our redemption rate, which is when it really matters is we actually redeem those points for a price because that's when it's tangible to the professional customer. I think they were up something like 70% in the most recent quarter. And so our pros are really engaging with our loyalty program. I think close to 80% of our active pros, pros that have bought with us in the last year, are actively engaged with the PPR program and earning those points and redeeming those points. We've done, I don't know, maybe a dozen, maybe a little less than a half dozen maybe -- but somewhere between half-a-dozen to dozen promotional events where we will reach out to pros and say, "Hey, we know what you spent over this period of time. If you spend more, we're going to give you double the points and bonus points." And we've seen a very nice lift when we do those types of promotions that allows to get that information, put it into our CRM database along with surveys and other mechanisms to really learn about that Pro customer and hear what's important to them and what we can do better. And so it's been a home run, and we're super pleased. We actually won an award this year for B2B loyalty program that we're proud to see the team win. And I think you hit on it. The future is how do we refine that program such that we have a tier-based program and that as you work towards getting to that next year, we were[ watching ] more. And there's obviously a cost of that. And so we're figuring that all out as we speak. But we're pretty confident as we get back to the back half of this year, we'll be in a position to test that we'll want to test it for a reasonable period of time to make sure that the cost and the return on that investment is worth it. But we're fairly confident based on what we see in the marketplace and what our pros are telling us that -- hearing that $1,000 to $5,000 Pro, how can we get you to be in that $5,000 to $10,000 Pro and enhance that with more points and anniversary points and birthday points and things like that. And then also give you more value through discounts with vendors that you care about, like we have Hertz and a couple of -- Lenovo computers and websites for the Pros and things like that. So it's been growing at a much faster rate than our total sales. The engagement has been very strong throughout this entire cycle. And by the end of this year, we'll hopefully be talking about what that -- again, it's going to be a test because we have to make sure it works. But hopefully, by the end of this year, we'll be testing the tier-based program, which will give us opportunity. The other thing we're also working on, which is also interesting is the credit -- integrating that in with our credit card. We have a -- today, it's very unique that we have 6 months no interest on our credit card, which is a great cash flow, if you're a small business owner. And we pay our private label credit card much less than we pay the big card brands. So why not reward people who are using a lower cost of tender. So we give some more points for that. There's actually some bit of technology in this industry where most in our installation categories were where they'll put new great grout or fin set or mortar or sealers or underlayment. We can enhance those products by giving points for our Pros to try some of this new technology. So that's another idea as well. So we're definitely in the early innings of loyalty and CRM and learning how we can help solve our customers' problems and reward them for their business. And we see this as a -- the very early innings of what's hopefully going to be a good 3- to 5-year ride on loyalty and CRM.