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

All right. Good afternoon, everyone. I'm Justin Kleber, I cover retail, consumer products and services here at Baird. Thanks for joining us for our chat today with Floor & Decor. As most of you likely know, Floor & Decor is a real disruptor within hard surface flooring, but with only around 140 stores today, the multiyear runway for unit growth and market share gains remain significant in our view. With us today is CFO, Trevor Lang as well as Wayne Hood and Matt McConnell from IR. Before we start the fireside chat, I'm going to turn it over to Wayne just for some disclosures.

Yes. Thank you, Justin, and thanks, everyone, for joining us today. Before we get started, I'd like to refer you to the standard safe harbor language included in our press release 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 having said that, I'll turn it back over to Justin and Trevor to begin with Q&A.

All right. Thanks for that, Wayne. And if anyone does have a question you'd like me to ask, you can enter it into the portal, and I'll do my best to work it into the discussion.

So Trevor, I'd like to start with just a question on the industry backdrop, recognizing nobody has a crystal ball here, but I'm just curious what impact you think the pandemic and the likelihood for increased utilization of the home even in the post pandemic world can have on the industry's longer-term growth outlook and whether you think the business could be maybe less cyclical and less dependent on demand drivers like housing turnover as we move forward?

Yes. First off, Justin, thank you very much for having us today. It's been a great day with investors so far, and we look forward to taking your questions and other people's questions. Really, really thoughtful and a great franchise to work for. So I think we are in obviously, very unique times. Last year was very different than even this year. The business -- our business has continued to accelerate and get stronger every single quarter since we opened our stores back up last summer. A lot of momentum behind us today. Existing home sales are very robust. That should -- as those homes are turning over, there's going to be some work that needs to be done in those. Mortgage rates, even though they've risen, are still at historic lows. And probably the most important macroeconomic factor that Matt Wayne and the rest of the executive team and I are focused in on is just this wealth effect and -- that exists out there. There -- and we serve a higher income customer. We estimate our average income levels are $100,000 to $125,000 a year. And if you think about that consumer, they've got record levels of cash. I think I read the other day there's something like $2.5 trillion of cash sitting in people's checking accounts that didn't exist last year. The household value has gone up in the high single digits for a while. Now it's been more like in the mid-teens. So the value of the home that they're living in is worth a lot more. And then the stock market in 401(k), all of those equity-type investments are at record highs as well. And so that mill to higher income individual is in the best position they've ever been in. And they've seen a massive appreciation in the home that they have. And so we do think they're much more willing to invest in it. You add to that, that the pros that install, we estimate 85% of the products we sell, ultimately, a pro is going to put that in. There's only 15% that we estimate is the true DIY. That cycle has elongated. And if any of you guys have tried to have a contractor come out to your house and do some more, good luck. And so that also gives us a little bit of a tail, more so of a tail than we've seen in the past. And so still -- Jamie Dimon's word, we're in this golden box economy for a period of time. How long it's going to last, obviously very difficult for any of us to know. I think on the positive side, all those -- the wealth effect and the value of the homes is probably going to be here with us for a while. I think the only headwind that likely is to come into play in the near future is with existing home values going up in that mid- to upper teen. Mortgage rates likely to continue to rise a little bit over the longer term and went up against record existing home sales at, I think, over 6 million. That affordability is going to come down, which historically has led to a decrease in existing home sales. I think what's a little bit different about this cycle that we're optimistic about is the other 95% of the homes that aren't being sold or housing units aren't being sold, there's just record levels of wealth to be invested back into that home. And this is just a theory, but there was a great article in Journal the other day, maybe 2 or 3 days ago, that also said that there's people now that -- I'm not willing to step up and spend $300,000 or $400,000 more to move to that next bigger house than maybe I would have done in previous generations, but maybe I'll take $50,000 and go invest that back into my existing home and in that environment, flooring, especially in the kitchens and the bathroom, which we really see as a hugely positive investment for the home that gets enjoyed. They see it, it makes the value of their home go up. And so that might be an outlet as affordability goes up and existing home sales eventually probably go negative. So long [indiscernible] answer, but we're in a great backdrop. And I think just more centric to Floor & Decor, we're executing on all cylinders. We have an incredible website, great merchandising team. Our stores are executing at a high level. The supply chain is obviously stretched like it is for every company right now, but we're doing a better job than most and getting products into our stores and our distribution centers. And so -- and the assortment, the assortment is just incredible right now. When you look at some of the uniqueness of what we're doing in tile and rigid core vinyl and stone and decorative products is unique, and the customers are voting with their checkbook.

It's -- all make sense. I guess maybe just a follow-up there. As you think about market share, when we look at your results relative to some of your public peers, just taking 1Q, for example. I mean, it's pretty clear that your market share gains are accelerating. So are there 1 or 2 factors that you would point us to that have really driven this step change in the pace at which the business seems to be gaining share?

I wish there was just 1 thing I could point out that said, hey, these 2 things are what's driving our business, but I would say it's a lot. I do believe our founder was a merchant. Lisa, our President, is obviously an incredibly strong merchant; Tom, our CEO, was both an operator and a merchant. And that blood courses through our veins of product and product. We call our store -- we don't call them store managers, we call them Chief Executive Merchants because they're making product decisions at their local store. We have regional merchants in all of our 11 regions, and they manage about 12 to 15 stores. And so I think that's probably -- the most important thing I would call out is just we have a DNA waking up and thinking about how do we bring an incredible product. And then you overlay on that a great sales team and a great leadership at the store level, you layer on top of that a really strong website, layer on top of that free design services, layer on top of that much better in-stock inventory levels than most of our competitors, a great Pro team that services our Pro customers. I mean all those things are working in concert to help us in this environment. And our comparisons are a lot harder than some of those other competitors you're talking about as well. So for us to be performing at the level we're in, we're obviously very pleased. And we had to have some humility. And certainly, we're doing a good job, but there's obviously an incredibly strong backdrop building this as well.

Yes. And then I guess maybe thinking about longer-term share opportunity, if you look at your more mature markets, right, you said your share can be as high as maybe 40%, maybe even a bit more. Is that a good proxy to think about the business as you go from roughly 140 stores today to 400 or so over time, and your brand awareness continues to improve? Or is there something unique about those mature markets where you wouldn't necessarily want to extrapolate those share trends more broadly as the store base continues to build-out?

I don't think we have to get to 40% market share. I think if we did that, we would have way more than 400 stores. I think if you take that $22 billion to $23 billion and kind of grow at a 3% to 5% CAGR, right, that number -- the big number gets big faster. And even though we're -- last year, we did $2.4 billion, and we'll do, obviously, much more than that this year based on the growth rate of the business. Because the big number is growing at a fast rate, I think we probably -- our model suggests we'll be in the high 20, low 30s market share. I think the other thing that I should have known this, but I found out here recently that I think is an interesting point. As I understand, if you look at Home Depot and Lowe's, they're like 50% of the residential remodel market, the construction -- private fixed residential investment. You've got Walmart and Target and Amazon that have somewhat similar business models. You've got some of the large pet companies that do pet supplies, and there's multiple. The point I'm making is there are multiple, multiple of them. In our case, and listen, we focus on this, and we think it could happen some day, but we don't have that fast forward. We don't have someone who has the same business model. And there's lots of reasons for that and we could talk about why I think that is. And so -- so the answer is yes. So I think we can get in from 9% market share to the high 20s, low 30s, which would support the 400 stores. The answer is yes, we absolutely think we can. I've been here 10 years now, and we are a vastly better and different company than we were back then, and we've got a lot of things going in our momentum. And really, again, we don't have that fast forward that does something similar to us. So yes, I think that there's no reason. And to your point, when we look at some of our more densely populated markets, some of our stores that have been around for longer and on a very high volumes, based on the way we can measure it within a 45-minute trade area, we have, in some cases, high 30s, 40s market share. And so we don't need to get to that to get to the 400 stores. And there are some markets that we'll never penetrate just because they don't have the demographic density to support Floor & Decor, but certainly getting in the high 20s and low 30s is very doable from our perspective.

And then as you think about that store target, the 400, like, how are you guys thinking about that these days? I mean, what could lie beyond that? You've had some success densifying certain markets like Houston? And then maybe if you could also comment as a part of the answer, just on the design studio concept test that you have going on. Does that format -- is that attracting a different customer for you? How incremental do you think those sales are relative to the overall business at that local market level?

We do. We have Phoenix, Houston, Dallas, South Florida, Tampa, Atlanta. We've got a number of markets where we're starting to get to a denser store. But even in those markets, we still probably have -- even in some of those stores -- those markets, we have the most amount of stores. We probably still have 1/3 of the stores left to open in some of those markets. And we've been incredibly impressed with all of those markets, both comp store sales and certainly, the new store performance is, as you might expect, well beyond the average new store markets. And so we haven't built out a market completely to see what it's like. We do have probably close to 10 stores now where it's within a 15-minute drive time to an existing store, and both stores are performing well. So that obviously gives us a lot of confidence in the 400 store count. Hopefully, by the end of the year or next year's year-end earnings release, we'll talk more about what we think the ultimate store count is. Other ideas that we're having a lot of success with right now is adjacent categories. Those of you who've seen our SEC filings, albeit from a small base, but our adjacent categories are getting close to 2% sales, and we really just got [indiscernible] started. This is things like vanities and frameless shower doors and kitchen and bath accessories that -- tile hooks and soap dishes and things like that. Those are areas that we think pretty easily, we can get that to be 5% of sales, which would not be an extra $1 million in sales per store. The commercial opportunity is probably the biggest opportunities that were not just on the Spartan side, but -- the acquisition that we recently did, but also on the regional account managers that we're having success. That's a big industry, we think, maybe $13 billion industry that we can have -- continue to have success with. And then the one you mentioned as well, the design studio, we've got 1 store in Dallas. We're going to open 2 more this year and are excited about that business. Specifically to answer your question on that, we can't put 80,000 square foot stores in downtown metro areas, but we can put 7,000 to 12,000 square foot stores in those areas. They're very good looking. They're as good as any high-end specialty retail flooring store you've ever seen. They carry all of our product, but we sell them at our prices, not the very high prices that you would get at the high-end design studio. And so we're -- it's only been opened not even a year yet, but we're pleased with the performance. I said we'll open 2 more and we are attracting different customer. We're getting a higher income customer, the ticket's much higher, the gross margin is much higher. The professional -- believe it or not, the professional -- we're getting a lot of professional business that we hadn't seen in the past. There is a certain aspect of a homebuilder and a designer who won't shop in a big box store. It's just not as boutique as they would like to see, but they'll shop in the design studio. And so -- but we've been impressed and pleased with what we've seen on some of the commercial side of our business in that design studio. So -- but this is still a test. It's only had been opened a year. We'll get a couple more open this year. The locations are going to be a little bit different. We're testing a couple of different types of locations, but the core concept itself is exciting. And we're opening in the markets we succeed. But -- so those are lots of -- those are 4, 5 big ideas that we're executing on that we feel good about as we think about the next decade.

Yes. So maybe if we could just -- it's a great perspective to just -- to think about the commercial business. You made some very good inroads with your regional account manager strategy, as you alluded to. You also closed on the acquisition of Spartan last week. So give us an overview of how the Spartan transaction came about? What Spartan brings to the table that your existing RAM strategy was maybe lacking? And just how you think about growing the Spartan business now that they're under the Floor & Decor umbrella?

Yes, if you started, again, very simplistic. It all starts with product. And we now have the 7,000 or so SKUs that we have available to our RAMs, our regional account managers in our stores. Over time -- this will take time. It won't happen overnight. But over time, we'll be able to expose some of those SKUs, what they call upstream into the A&D community. And so we have had lots of success with RAMs. And I think we're going to end this year with maybe 30 -- maybe close to 33, 34 RAMs. We're at 14 new RAMs. And before we got engaged with Spartan in our own analysis, what we learned was we hired a regional account manager. I think they can do $0.5 million to $700,000 in sales in their first year. By the time they get up to maturity, we think they're doing, hopefully, $2.5 million, $3 million in sales. And then interestingly enough, what we've learned from Spartan was the exact same thing. It takes a while to get a book of business, plus this is construction and new developments [indiscernible] retail business where it happens as soon as [indiscernible] it takes time for those developments to occur. But those sales reps will -- they do a similar level of productivity. What Kevin and the Spartan team have built has been incredible. We were very impressed with the way they go to market. The loyalty of their customers, we spend a lot of time and money doing a lot of due diligence because we're not -- we don't have a lot of experience doing M&A. We really don't have any at Floor & Decor. And so we spent a lot of time with one of the consulting firms looking into this thing, and they have just a great way they go about solving problems for their customers, very loyal customer base in the A&D community and have done a good job of growing our top line for a very long period of time. What was attractive to them about us was the complexities of our supply chain, the fact that, again, they can get access to over 7,000 SKUs. Really good-looking trends that are happening in residential. Some of those same trends are happening in commercial. We -- they can get access to those SKUs. They can get them quickly. They can get them at a lower cost. We can help them grow in markets that are outside of their mid-Atlantic routes. And so it really was something that was very attractive to them because what we've experienced as Floor & Decor, when you go from a small company to a medium-sized company, there's a bunch of investment and complexity and difficulty that happens. And that will sort of -- we will handle a lot of that for Spartan with our big supply chain. We source from 240 vendors in 20 countries, and we can allow them to have some of that same success without having to make the same investments. And we think the RAM strategy continues to move along, too. And to answer to your question, why is it that you can have both is what we learned last summer. Again, we spent a lot of time and money with one of our strong consulting partners that helps us evaluate this. And what we learned was where our regional account managers were having success is what they call the downstream main street area. So this is a flooring general contractor where we go flip a spec or a flooring -- commercial flooring installer, where we get the spec certified or they actually put the spec or we're selling to a person who owns 3 or 4 hotels or they own a power center or they own some retail centers. That's where we have a lot of success with the RAMs. And that's about $6 billion of the $13 billion commercial flooring market. What we haven't -- weren't having as much success with, and we weren't really focused on it, and it would have been a more difficult environment for us to have longer-term success is upstream with that A&D. So this is an architectural design firm. They're helping build a big apartment complex or remodel a big hospital or renovate a high rise somewhere. That is a different sales cycle and a different process. And so as we evaluate that industry, we felt like if we found a good partner that we could help grow, that might be a faster way to success than us trying to go it alone. And we feel very blessed and fortunate that we found that partner with Kevin. So that's the reason we felt like we wanted to partner with someone to get that $7 billion A&D business. We felt like having a company like Spartan would be a better way to get to that side of the business. And again, obviously, very attractive to Kevin and the Spartan team because they now have access to a lot of product at a good cost.

That's a great overview. It seems like a transaction has a lot of long-term optionality for you guys. Just maybe pivoting to inventory and in-stock, right, given the surge in demand and the well-publicized supply chain constraints that a lot of retailers are dealing with. I mean, have product availability challenges impacted your ability to meet demand in any certain categories? Just maybe an update on how you're feeling about in-stock levels today.

The answer is yes. I mean we, like every retailer, I mean, we weren't planning ourselves to be up over 40%, but yet they were. We were asked a very pointed question on our last earnings call. And just to give context. So we have $607 million of inventory that we have on our 10-Q. If you read our 10-Q, we had $607 million of inventory. We were asked a question on the call is, are you out of stock for $50 million at least? And we said, no, it's not $50 million, it's less than that. So it's not 0, it's not $50 million, somewhere in between. It's always hard to measure exactly how much you really needed in-stock. But that's, what, 3% or 4% of our total inventory levels. It's always been a strength of ours to have substantial amounts of inventory in the store because the professional customer needs to see that. It really gives confidence in the consumer -- customers as well. And then we've got a lot of back stock in the distribution centers. And so we do think we're getting a good amount of business today because we do have better in-stocks than a lot of our smaller competitors. And I think that is -- don't get me wrong, it's difficult, and we're chasing inventory just like everybody else, getting through -- getting our vendors and getting things through, especially the West Coast port is difficult and more difficult than it was. But we just -- we're in a better position than many of our competitors because we do carry large job stock inventory quantities. What's happened over time is our stores still look -- there's certainly some holes that -- we really bled down on that distribution center is where a lot of that -- the inventory has come down. We haven't seen as much of that impact in the store quite yet. And we're working aggressively. We don't -- there's not a week goes by that we don't spend a lot of time with our team. We -- between the merchandising team and the inventory team, we probably get close to 100 people that are focused on helping us get this. And in many cases, we're our vendor's largest customer, one of their largest customers and they understand the importance of getting this done. So it's frustrating. We would like to have more in-stocks. But to date, we think we're in a much better position than most of what you find in the industry.

Okay. I had a question come in just on the adjacent categories. And whether or not those categories are less exposed to the Pro, I guess, more B2C versus B2B? And do you see any difference in price elasticity on adjacent categories relative to the core flooring SKUs?

Yes. I mean, just to give a high level overview as to how we think about it and where we've had success. So at our core, we are a specialty retailer of hard surface flooring, and that's where we want to be, and we're not going to try to be something different than that. That being said, when you are doing a bathroom or you are doing a kitchen or you're doing a basement, it's very likely you're going to do a vanity. Obviously, if you're doing a bathroom, you're probably going to do a frameless shower door. If you're doing a bathroom, you're going to have soap dishes and towel bars and towel hooks and things like that, that you're going to put in. And so where there is the need, because you're doing the flooring project, why not have those projects because then they don't have to go shop somewhere else. And we think we can bring something unique and different to those categories that is as good, if not better, than you would get in the competition. And so all of the adjacent categories that we sell, the ones that we're contemplating in the future are tied to a flooring project. And the answer is yes, we think much like it is for all of our assortment. Our products are just as good, if not better, than what you see in the competition. And you've made the process easier for the consumer because now they don't have to get that vanity or those bathroom accessories or that frameless shower door somewhere else. And we try to keep our everyday low price strategy intact. I would say the other thing we've done on that piece of our business is we've focused on the better and the best products. We don't have as many on the good, only because we just think that's working better with the assortment we have today. So that's how we think about adjacent categories. It really needs to be tied to a flooring project. And it needs to be something that we think we can add value. As a contrary to that, right, we don't do paint because we think paint has done well in the home centers, it's done well in other retailers outside of the home centers. But you're likely going to do a paint project when you do a flooring project, but that would be an area that we probably won't be taking on just because there are so many other avenues for that.

Okay. And then Trevor, one question we're asking all the companies we have at the conference is just as you think about some of the emerging cost pressures in the business, like, there's inflation in raw materials, transportation, seeing it in labor, just how are those factors trending for you guys? And what steps are you taking to manage the impact on the business?

Yes. We talked a bit about that, too, like I'm sure all your portfolio -- or all the companies were talking about today on our call. I guess it's gone about a month ago now. We saw it first in our supply chain costs, where we were seeing fairly dramatic -- we have long-term contracts with most of our international container costs, and as those were coming up in for renewal, we were taking a big gulp as to what the rates were. But because it's a bit of a service, we see what others are paying as well. So we saw first in the supply chain, and then we saw it also domestically in the supply chain. Then more recently, as of the earnings call, we talked about we actually -- our vendors were starting to suggest they'd have to have cost increases for all reasons you just outlined. The raw material costs are going up, the labor costs are going up, the inventory costs are going up. So those are coming in as we were having the earnings call, and so all those things are factoring into the costs. We turn our inventory just over 2 times a year. And because we're on a weighted average costing basis, it takes a little time to see those cost increases coming. Whereas most of our competitors turn their inventory much faster. So they're experiencing those cost increases. They're seeing those costs increase manifest in their financial statements much quicker. And because of that, we're starting to see costs -- certainly if the independents go up and even some of our bigger competitors, we're starting to see costs go up. We're fortunate in being the everyday low price strategy. We have the lowest retails against our competitors. And because we turn our inventory slower than our competitors, we'll be able to watch for a little bit longer as to what's happening out there. And we're going to use the same playbook we've been using in the previous years. When we see cost increases, we really work to try and get the cost increase dollar threshold managed, meaning if -- I use a simple example over and over again, we're paying $1 for a product and selling it for $2. If now we're paying $1.10 for that product, we will then try to sell it for $2.10. Mathematically, that will give you a lower margin rate, but you still get to the same gross profit dollars, the same operating profit dollars, same EBITDA profit dollars. Your sales will be higher, but your rate will be a little bit lower. And that's how we plan to manage it. We like being in every low priced retailer. We think that's worked in the long arc of history of retail and certainly in the 20 years that we've been in business. And we also like that others because they turn their inventory faster, we'll likely have to take -- are seeing them take retail increases faster than us. So we can manage it, but you said maybe simply is you much rather be the low cost leader in a rising price environment than someone's that's the medium price or the higher price.

A good segue to my next question is just another one we're asking everyone is just the impact that lower promotions and clearance activity have had on margins. Recognizing you guys are not a high-low retailer, but can you frame that benefit? I've seen just given the demand environment we've been in and the lack of inventory, like how much of a tailwind has lower promos and clearance been for your gross margins?

Yes. I mean, you said it right, Justin. We're not a promotional business. We're not -- we really don't have a seasonal business either. I do think because inventory is harder to come by than it has been in previous years, we're seeing less promotional activity from certainly our bigger competitors and even some of our smaller competitors. So yes, on average, that has been a net benefit to us as well as our competitors that in the environment where your sales are elevated, and it's hard to get inventory, there's certainly less need to be promotional and marketing down the inventory. So it doesn't affect us as much because we've never been a promotional business. We don't run a high-low or BOGOs or any of that type of promotional activity. And so I still think it affects us quite as much because we're very consistent. But I think in the marketplace, it probably is helping us because some of our other competitors are probably not doing as much of that as they might have done in the past.

Okay. That makes sense. So we have a couple of more minutes here. I wanted to ask -- we talked a little about commercial, but just broadly speaking, on the Pro, you guys have a very successful loyalty program in place. I think you said at the last call, 80% of your Pro sales are on the PPR program. Can you speak to some of the enhancements you have on top with the program that you think will even drive greater engagement and earn a greater share of that Pro's wallet?

Yes. We've now had our loyalty program across all of our stores now for just over 2.5 years. We actually just won an award for best loyalty program, which -- we were up against some pretty big competitors. So we were pleased to get that increase in B2B -- or get that rewarded in the B2B space of loyalty programs. It's a great program. The more you spend, the more points you get, there's also 19 or so business building tool sets like we can help you get a website or uniforms or less expensive travel and things like that, the benefit of it. As we really studied the industry, there's -- many companies obviously have loyalty programs, really good B2B programs, and then we've studied what our customers have told us. There's 3 items that we are looking to -- we're working on right now to develop to test something by the end of the year, which is a tier-based program. We have a really good CRM tool that tells us.

Justin, I think...

A bit trouble there.

Yes, I think he froze. Well, until he comes back, what he was referring to is a tier-based program that we are experimenting with, that's in response to some of the other programs that are out there in response to some of the places Pro shop give 20% to 40% off. So we think as we roll out the tier-based program and to the credit card that we have launched as well, will further strengthen our value proposition when it comes to the Pros overall. But we'll see how well that pilot goes as we move through the rest of the year.

All right. Well, thanks for finishing off that response, Wayne. I think we're going to cut it off there. Thanks again, Trevor, Wayne, and Matt, for participating. We really appreciate your time and insights today, and thanks to everyone for listening in. Hope you have a great rest of the conference.

Thank you, Justin.