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

Okay. Thank you, everyone, for joining us. We're here with floor and decor. Today, we have with us Tom Taylor, CEO; and Bryan Langley, EVP and CFO. Bryan, you're going to read the disclosure quick before we start.

Just safe harbor statement. 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 the Private Litigation Securities Act of 1995 throughout the course of our presentation today.

Okay. Well, thank you for joining us. Tom, we were just talking before about how you're getting a lot of questions on macro, and that's where we're going to...

There's going to be questions about macro again...

That's where we're going to start. It's not all the questions though.

So your fiscal year '23 guidance now reflects a slightly softer demand outlook for the second half and primarily weighed down by broader macro headwinds and the slowdown in housing turnover. How are you thinking about the overall macro environment? And do you think you'll be able to grow the top line at some point even if housing turnover remains pressured?

So lots of questions in there. I would say that, first, as we look at 2023, we had expected that interest rates would go up and that they would -- that won't kind of stop. The Feds would use interest rates to bring down inflation. And by the time we got to the middle of the year, that will subside and interest rates would stop going up. They continue to go up. There's an effect on existing home sales where in 23 consecutive months of negative existing home sales, and they've been pretty severe over the most part of this year. And existing home sales, when they're comping positive, then it's good for our -- it puts more buyers into the market and helps our business. As we look forward, it's clear that existing home sales are going to remain under pressure. The good news for us -- I don't know if it's good news, but the better news if you're the optimist is that as you get to November, you'll be lapping last year, existing home sales during the month of November were at a 4.1-ish annualized rate, and we'll start lapping that. So instead of negative 20% month-over-month, we'llll moderate, we'll be closer to flat to slightly negative existing home sales, albeit existing home sales will stay at a really soft rate. So we have been growing the question of can we grow top line in that environment? And if this lasts through next year, what does that look like? We've been growing top line at the end of the last quarter. Our total sales were up 4.6%. So that's coming off the back of new stores. But if you look across the industry and the other publicly traded peers that we compete with in this sector. We know -- we feel like we're taking market share. So we think it's going to remain difficult. We think it can grow top line sales, but it's going to -- existing home sales will be under pressure a little bit longer than we thought.

And you mentioned on the last earnings call that both pros and homeowners were engaged in fewer projects and smaller scale projects. But could you maybe level set for us what a more normalized project environment looks like? I guess, that would maybe be something pre-pandemic when you didn't have housing turnover.

Yes. I mean -- if you think about it in layman's terms, and Bryan can jump in if he wants. But if you think about it in layman's terms, when existing home sales put more sales into the market when a consumer is coming in that's involved in either selling their home or their -- they've just bought a home. They're likely to take on more than one room. So the square footage of the sale is bigger. People are going to renovate more space in that environment. And when they're staying in their existing home and they're just redoing though we do a power bath at a time when they are redoing a kitchen bath at a time. So that's what we're experiencing more of now. The reason that the pressure has been under our square footage is just less total homes being done than what's been done historically.

That's right.

So then maybe you could square for us then the smaller projects, but still what seems to be like the better, best preference by your consumer. Has this dynamic surprised you? And what do you think is driving that?

Yes. Yes, it surprised me because any time you see market pressure, historically, I've seen people in my background step down. That's not been the case here. Our better and best products are still doing terrific. That's been a trend that's gone on for the last few years. And I think there's 2 reasons that I would associate with that. I think first off is our merchants and the suppliers themselves have done a good job around innovation in fashion and durability. So I think when you come in to do the project and you see those step-ups, you'll say, if I'm going to do the project, I'm going to do -- I'm going to buy the better and best just there's a significant difference from the good product to the better and best. So it's an easier step to make. And then secondarily, when you look at our consumer spends to a little bit higher income level. And I think when they think about it, if they're going to go ahead and do the job and they're going to invest in their home, they're going to get what they want. So someone who's flipping a home, they may not care and they may buy the lower-end products. So I think those things working in combination is why our better and best has continued to perform, but it has been a bit of a surprise.

So that kind of leads us to pricing because I know there's been a lot of dynamics there pretty much since before the pandemic as we start all the way back looking at tariffs and taking it from there. But how high are your prices maybe versus 2019? And when managing prices, you mentioned wide price gaps in the second quarter. Are you trying to maintain a certain gap between you and others in the market? Or are you satisfied with these wider gaps?

So I'm just going to -- there's a lot of questions in there, so I'll kind of start and just talk pricing philosophically. So I've been at Floor & Decor for 11 years, and we really never had to take price until tariffs countervailing, anti-dumping came along. And we were fortunate that our merchandising group did a good job of offsetting tariffs by really moving and diversifying our country of origin. So our merchants did a good job of offsetting that, negotiating with suppliers, moving products. So we didn't have to take that much price during that time frame. It took a little not a lot. . Where we started to take price in a more meaningful way was when supply chain costs post COVID just went through the roof, and we were dealing with port congestion that caused demurrage and more transportation costs, we anticipate ocean freight went up, and those costs we have to pass along. So then fast forward to this year, all that subsided. So we took prices up to offset that. We didn't take the full prices up. We just took prices up to offset dollar, so we let rate come down during 2022. As we got 2023, and we saw the inverse happen. I felt it was important to -- we have a big -- we're like a supply house. We're not just a retailer, but we have a lot of trades people in the business. And I felt like it was important for our professionals who shop with this, who saw us escalate price for the first time in over 10 years, I thought it was important to them to see that, hey, we're a good business partner and as our costs come down, you're going to benefit from that. So we took prices down across the store, and we kind of watched what happened with that. And we've been able to take prices down but still get an improved gross margin rate off throughout this year. We anticipate in our guide that, that will continue through the fourth quarter. So we do monitor our pricing gaps and the good thing all along the journey of having to change prices from when we took prices up during supply chain, and we've taken them down. Our spreads have remained consistent or gotten better. And we monitor that. This is a difficult category to shop. There's a lot of features and attributes. So when a consumer is looking at it, sometimes there's not a lot of brand relevance. They have to do a little bit of research to make sure they understand the pricing. But we do. And when we look at it versus the home improvement centers or the independent channel, our spreads are as consistent as they've ever been, if not a little bit better. We don't have a clear definition of how much cheaper we want to be the one person than the next, it depends on what's selling in the store, but we feel good about our competitive pricing stance.

Okay. And you mentioned gross margins. On the last quarterly call, you noted the increase in gross margin rate is primarily due to the retail price increases you took. When do we start to lap that in fiscal year '23 and I know you're not giving guidance for '24, but how should we think about gross margins as we lapse on these pricing dynamics that you just talked through. And as supply chain costs continue to come down?

Yes. So as we said, we had the largest gross margin improvements in the first and second quarter. We still had margins improvement planned for the back half of the year as is implied in our guide. As we look to next year, I think we can have gross margin improvement. And I think the reasons for that are -- there's a few dynamics and why I think we can run a better gross margins. One is what's selling in the store. As we continue to sell the better and best products, who we compete with is mone in the independent and the spreads on our pricing versus the independent channels are pretty significant. So we feel like that from a no matter how -- if the market were to get irrational pricing our spreads still so significant, we can absorb that. So I think that helps. And then secondly, we have our own initiatives to drive gross margin rate improvement where we've got a design initiative now where we have over 1,000 designers in Floor & Decor that when our designers involve a customer, they end up selling the whole project, they end up selling a better blended gross margin rate. So that initiatives, we're making great progress, and we're seeing great benefits from that. And then our damage is, we're not -- we don't have the shrink issue that a lot of retailers have, but we have damage issues. We sell heavy stuff. And as the product's gotten bigger, as we -- large-format tiles difficult to handle within our stores and our damages probably run a bit higher than they should. So we think we can get some benefits in that, which will also help us to lead to a better margin rate. And then capacity with this in the industry is, we're getting concessions from our suppliers so we'll get the concessions from our suppliers in a more significant way, which should help our margin as well. So long way around, I do think that we'll be able to improve gross margin next year. And then in the long run, when I look at the model of what I thought the business could be, I think we'll run at a better margin than I thought when I started just seeing the evolution in our business.

And with regards to those price gaps, again, you mentioned even things -- if things were to get irrational, you're still at a really nice spot with your pricing. How should we think about market share and the opportunity? Obviously, it's a super fragmented industry. Is there a way to -- but it's -- and it's filled with independents, so I'm sure it's hard to measure. But is there a way to assess how much market share you've gained if it's been at an accelerating pace in this maybe more difficult environment?

Yes. I'm I'll put it in easy terms, so that you understand. Yes. We've said all along that in a difficult market, the value player is going to win. So the more challenging the market gets, the more share we can take. We've always been a share disruptor, right? So we've got a unique big box hard surface flooring store that's home improvement centers. They just -- they don't have the space to allocate to it and the independents are usually focused on 1 to 2 categories. So as we've opened stores, we've always taken share at a pretty good clip. As things got tougher, it feels like we're taking it faster. I'll use the simple barometer that I use, I just look at kind of the publicly traded peers that are -- report out on kind of their hard surface flooring sales. So when Mohawk reports their North American hard surface flooring sales are down in the mid-teens and Lumber Liquidators comes out and they're kind of like a barometer for what an independent hard surface flooring store performs like and they're in the negative mid-20s and tile shops and the negative close to negative double digit. And then I look at us. And while our comps are a bit challenged this year. Our total sales growth, as I said, is we're up 4.6% for the quarter. So that tells me that we're taking market share. And hopefully, we'll continue to have that benefit as we look to the future. And if you look at the great housing recession when home improvement was really under pressure, when the cycle turned, there was a lot less competition out there. And so we're continuing to open stores, knowing that as we come out of this cycle, there will be less competitive backdrop, and we'll be in a better competitive position.

Yes. From everything that we can see, historically, we were taking about 100 basis points of market share. we believe in '22 and into '23, now that's closer to 200 basis points of market share gain. And so you can tell it's accelerated kind of throughout this backdrop.

Okay. Can we talk about unit growth? Because I do think even though we've been in a tougher macro backdrop, there is still, I think, a good degree of a positive investment thesis because of your unit growth. So cyclical versus secular. And obviously, the unit growth plan is 20% per year. So can you just talk about how you're managing this growth from an operational perspective? How you think through identifying key markets? And we'll start there, I have a few more questions.

So we're slightly off 20% unit growth this year, but we -- with the exception of the COVID year, we've been at 20% unit growth since I joined the company. We've -- early on, we invested -- so operationally, how we handle that. We invested in infrastructure early on. So we've got full train departments that help get our talent ready, full developmental plans great talent pipeline. So it's never been about being able to get stores open. Culture is very important in our company. So we've kept the governor on that 20% unit by making sure that we're close to who we're promoting. Our stores are difficult to run. There's a lot of autonomy there. So we want to make sure we're people ready. But we invested enough behind that, that our talent pipeline has never been better. As far as finding locations, we've used 2 different real estate or 3 different real estate firms since I've been with the company, plus outside resources through consulting groups. We know where our 500 stores are going to go generally. So it's like the -- we generally know what city we want them to go into then it's the art that our real estate team work was to find the right corner, right location, right facility in the box, and we use local intel. I'd say that over the last 3 to 4 years, as we've filled out markets, the amount of data that we have about where we're putting stores is probably more robust than it's been because now we've got enough stores in the Northeast to understand density and we've got enough stores on the West Coast to understand density. So I'd say we have more data. But I think between the real estate firms and between our real estate team, we come up with the right locations.

And then in the past, I think you've mentioned that you'd like to own more stores versus leasing. What will higher store ownership mean for the financials of your business?

Yes. I mean it should be accretive. So the only reason we would actually buy is if the return is better. So we look at each individual location, independently, whether we want to have a preferred developer, whether we want to develop ourselves or whether we want to own a property. So if anything, it should help with that. And it also helps bring more to the operating margin just because you don't have the lease cost as well embedded within there as long as you can self-fund it.

And the mix of it now owned first lease?

Yes, we started this about 2 years ago to start getting a little heavier. And so we strive to have maybe 5% to 10% of each new vintage, each new class owned. And so we're not going to go back and change that. So it's each year, we strive to have maybe 5% to 10% of that class owned.

Okay. And then can you walk us through the basic metrics you're expecting of your new stores from a growth and cash generation perspective in this current macro environment?

I mean in the current environment we're in, if you guys go back to the 2021 Analyst Day that we had, our pro forma would say our stores opened around $14 million to $16 million, making cash-on-cash returns of 50% year 3, payback period of 2.5 to 3.5 years and return -- return on investment of 25% over a 20-year period. We still feel like our portfolio approach is going to achieve those. I think you guys heard Trevor mentioned on last earnings call that we had, but our stores are doing $14 million to $14.5 million, even in the environment we're in today. But through COVID, they ran up to above 16, but we're still within that portfolio approach. So we feel very good. And that's what gives us the confidence to commit to next year opening 35 stores to continue to grow that as we're still getting a great return on what we have today.

And then if we could pivot to the commercial side of the business because now you've made 2 acquisitions in the commercial space. Can you talk to us about if more acquisitions could be on the horizon for this -- it sounds like the acquisition pipeline might be focused by geography. Is that right? And why was the sales master flooring solution the right company for you to acquire?

So I'll start the headline with was hesitant to acquire in the commercial space. We had -- at that point, I think we had 160, 170 stores, so lots of stores to open and wasn't sure that when the timing would be right. I was convinced by our team that it was the right step to make. It's been absolutely the right decision. We acquired Spartan they have exceeded every metric that we could have hoped for and outperformed what we thought. We bolted on sides for sales force. We bolted on sales master, excuse me, we bolted on smaller acquisitions to Spartan, and all of them have been terrific. So that segment of business, the competitive advantage that exists in the commercial space is similar to the competitive advantage that exists in the real estate space -- excuse me, in the retail customer space where supply chain is important, price is important, service is important. All of those elements where we do really well on the retail side, we're doing well on the commercial side. So I do think that -- we've got a couple more acquisitions that we could do, right? I don't think that's -- we can -- we're getting to the point where we can greenfield on our own or grow it on our own without necessarily having any more. But there'll be some more on the horizon. It's partially geography related, but since sales master is not just geography related. While it's nice to be in New York and Boston serve there, where they're an industry leader there. They do service a different segment of customer than Spartan services. So they're more on the installation side. So our Spartan team's feeling was we're going to acquire them. We're going to marry them up with the A&D providers with them. So they'll be able to share customer base, they'll be able to expand product offerings and be able to offer total solutions to end users. And that's why we went with the sales faster and we're satisfied with that and the strategy is working very well.

Do you feel there are any capabilities missing from the commercial business right now that you'd look to build out or acquire from a capability standpoint?

I mean, I would say that we're taking more seriously capabilities to sell to new home construction. As you can see, new houses doing pretty well in this market because of the amount of inventory in the marketplace. So our Spartan business is made some key hires in focusing on that space, and we think that we can enter that in a more meaningful way. So that will be something that we look to. And then I think just from a geography standpoint, we'll look more to the West Coast and to the southern part of the country to make sure that we're filling those out.

Maybe we can wrap up before our lightning round here with just summary of -- we talked about some of the challenges and some of the wins, but could you maybe summarize some of the challenges for Floor & Decor in '23, some of the wins for Floor & Decor and how you're thinking about '24 relative to that?

I would say the challenges for Floor & Decor in '23 would have to -- I would just say existing home sales and we've got to the beginning part of the year. We started to see signs of life where they jumped up a little bit. We thought they'd be better and they didn't anticipate them lingering as long as they have. And this is -- we're going into unprecedented territory when you have 23 months of declining the existing homes that put challenges, just taking the best customers out of the market. And on the -- so the challenge of that is we're having to manage the P&L more closely than we have historically. We've been just an incredibly great growth story. We've had top line at our back for most of the time and haven't had to manage it. So while that's been a challenge, and we've had to make some difficult decisions, we've taken cost out and nothing to do with customer base, we're trying to be thoughtful to protect the customer experience within our store. But we've had to do that, and that's been a challenge. On the flip side of that, when you say what's positive about that, for the management team, it's terrific. We've been a winning retailer since we've come out public and even prior to that, we had 9 consecutive years of double-digit same-store sales growth. and we've been in investment mode heavily. And this has teached us more disciplined and more rigor about how we invest in the business, where we invest in the business, and it's kind of given us muscle mass that we didn't have. So that win far outweighs anything else that we face. This is a cycle, this too shall pass. It's just going to take a little bit of time, and we'll continue to manage the P&L as we look through next year.

And how have you been so successful at managing the SG&A just being a growth company? How have you thought that through in the context of this prolonged period of softness? And how do you think about that going forward?

Yes. I mean I think our teams work well together and kind of thinking about in the stores. We have certain amount of managers that are going to run the store, but we have a variable payroll model. So the store labor flexes as the payroll gets to. We're pleased we've been able to run the store with less hours than we have historically and maintained the highest customer satisfaction scores that we've had in our company's history. So we're really pleased with kind of our ability to do that in the store support center. I mean we've taken steps across all of our functions where we're not going to affect what the customer sees and we're able to make some adjustments. We're not done. This is taking a little, lasting a little bit long, so as we're looking to next year. There'll be projects that we pause, not to eliminate but that we pause and say, okay, when is the right time to invest back into those projects as long as they don't really affect the customer experience in the store, but if they're efficiency related, maybe they can wait if there things that just make us a little bit better, maybe they can wait. So I think we'll be just more thoughtful as we plan our investments for next year.

Okay. Thank you. We are asking for questions of every company that presents with us today and tomorrow. Again, we've touched on a lot of this already, but your view on the consumer or your consumer, just do you think they'll be facing more headwinds or less headwinds next year compared to this year? And you can also answer similar -- the same.

I would say that we've been in a -- I would say it's similar. We've been in a very tough existing home sales -- existing home turnover market. I think the consumer, we slam to a little bit higher end the end user is a little bit higher income consumers had the benefit of household appreciation, stock market -- stock appreciation. So I think they're in a decent place, but I think it will be similar to where it was this year.

With regards to share of wallet, obviously, we've seen a prioritization in a couple of different areas away from discretionary into consumables and then also away from goods into services. which I would imagine is having some impact on your business as well. So as you look to next year, what do you think is the one most important factor to drive higher spending into your category when it comes to share of wallet?

Existing home sales -- I hate to be repetitive. The good news is we're -- like I said earlier, we're going to start lapping really soft numbers. And so as you're lapping that 4 million to 4.1 million number, then you won't be 20% down in existing home sales. And I think if that number goes throughout the course of the year, hopefully, interest rates as we get to the middle part of next year start reversing and coming down and spurring existing home sales to be positive 5% to 10%, and we think that will be beneficial for the business when that happens.

My third question is around pricing. Again, we've talked a little bit about it. But relative to this year, would you expect your pricing to be up flat or the same?

Same.

And the last question is on inventory. Can you talk to us a little bit about where you are with your inventory, how do you feel about your in-stocks and how you're managing that again through the softer top line?

Our in-stocks are better than they've been in 5 years. So the stores are in terrific shape and in stock. We're always bringing in newness. So there's always new products coming in and old products going out. the quality level of our discontinued products has probably never been better. It's trend right for a lot of retailers. But for us, it's we're on to the next best thing. So we feel really good about that. We don't have to take markdowns. Our stuff doesn't go bad. So there's no margin risk in when we clearance out and bring in new products. And the only -- the fluctuation in our inventory levels has more to do with the timing of our new stores, adding inventory in for when they're going to open, and we have -- unfortunately, we open a lot of stores in the back half of this year, so that's elevated inventory a little bit, but we feel good about our position.

Okay. That's all I have today. Thank you so much for joining us.

Thank you.

Appreciate it.