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

We're going to get started. This is our last session of the day. Thanks for everybody for hanging around, sticking it out. We're very happy to be with Floor & Decor. Today, we have Tom Taylor, Chief Executive Officer; Trevor Lang, President of Floor & Decor; and Bryan Langley, Executive Vice President and Chief Financial Officer. Thanks, everybody, for joining us today. Trevor, your name's in the air today. A lot of people have asked me to ask you about your announcement yesterday. So I wondered if we could start off with that.

Yes. I mean I'll start by saying this is an incredible country and the best I've worked for this company, and it's been a fantastic 13 years ago when I started. And I think we were 24 stores and just over $200 million in sales. So I think we'll end this year at 240 stores and some portion of $4.5 billion in sales. I wouldn't have dreamed this. And so I think we've built an incredible company. And I'm just as proud as the management team we've built around this company. And so as my wife and I were contemplating that we want to do something outside of the business world. I do think this is my last job. You never know for sure, but I do think this is my last job, I felt comfortable with folks like Bryan, the next level of leadership that can do a fantastic job for us. And so for me, it's just personal, we're going to go spend time traveling and seeing the world and seeing family and spending a little bit more time out West as well. And because the company has made it through this in really good shape. Obviously, our sales and earnings are not what they we think they can be, but we've come through this in really good shape. And so great team, great business. It was just ready for me to go do something else. And Tom has built an incredible company that give us -- give some of us the opportunity to do so. So we'll go off and tackle other things outside of the business world.

That's great. Well, congratulations.

It's bitter sweet. We hate to see I think executive like Trevor move on, but I'm happy for him and his family. We're as much friends as we are our partners. And this is what you work for is to create opportunities for people to do what they want to do. So Trevor has earned it and it's well earned, and we wish him well in the future. He's not leaving anytime soon. So you guys may see him at another investor conference. So he's going to stick it out while we figure out what the replacement strategy is.

That's great. Well, thank you for addressing that. Glad we get you one last time here. This is nice. Most of our questions today are focused, of course, on the macro. And recently, you changed your guidance to lean towards the lower end of your guided range, just given the uncertainty around home sales and hard surface flooring demand. At what mortgage rate do you expect housing turnover to reengage? And if it weren't, do you think you'd be able to comp positive?

So I'll start with that, and then Bryan wants to jump in if I miss something. So I think for us, I think if mortgage rates get into start with the 5, then I think that, that could be beneficial for existing home sales, I think 6 is maybe it's good for existing home sales and then 7 is probably a bad thing. And household affordability is still a big part of this. And while interest rates coming down, housing prices haven't come down a whole lot. So there's still some question mark to the lowering of interest rates and how [ immediate ] of an impact that will have on existing home sales. I am not an economist, but I mean I think that, that type of mortgage rate. I think there's people on the sideline. I think more inventory will come into the market, and I think we'd see an increase in existing home sales. For our performance, I think of existing home sales are better year-over-year, and hard surface flooring is growing year-over-year, then we will grow year-over-year. And then I think that our comp sales can return to maybe not some normality or what they did historically, but they can get better than where they are today. So only time will tell. I think the only other thing with the macro and the interest rates that could happen that would work in our benefit is, let's say, that the housing values have stayed high and interest rates come down, people don't necessarily want to step into a new house, but that may encourage them to take money out of their existing house. So you could see some refi. And historically, refi has been good for home improvement. So in turn, we think it would be good for Floor & Decor, and that could help ourselves.

And then if you were to see reengagement in the housing turnover, how long is the lag between when you do start to see improvements in housing turnover and when you see it in your business?

Yes. I mean it's a bit of a guess like I don't think we have 100% certainty on it. But I look at it in terms of anywhere from 1 to 4 months, we should start seeing benefits. I think when there is an element of when more houses are going in the market, there's some hard surface flooring that's going into those homes as they prepare to go lift to get listed. But more of the activity happens when someone buys a house and the house is going to remain vacant for a period of time, they're likely to take carpet out of bedrooms and put hard surface into bedrooms. So they're likely to redo a kitchen that they wouldn't want to do while they're moving into a house or why they're living into the house. So -- and I think those things happen within 2 to 3 months of the turnover improving.

And you've talked about the project basket is smaller scale projects than it was before for obvious reasons. But what does like a typical project look like today?

Well, today, and I'll let Bryan, you can jump in kind of on the statistics on it. But -- and today, I mean, consumers with lower -- if they're not moving from one house to another and they're investing in their existing homes, the reason the projects are a bit smaller is they're tackling projects like bathrooms or they're tackling a kitchen. They're not doing multiple rooms in the house. So that's brought it down. And then combined for us, the other complexity of lower existing home sales as you lose the house flipper when this -- in the markets like this and interest rates are high and housing prices are high, [ footprint ] is going to do the whole house, and that's a really big ticket for us and really beneficial for us, and they kind of come out of the market in this environment. But, do you want to...

I mean I think as I sit back and look at it, the average basket size, if you think about it just square footage, that's what we sell is actually relatively in line with what it was pre-COVID. So we kind of had a run up post COVID where the basket size increased through those projects, and it's kind of regressed back down and have been on a glide path back to where now we're kind of in line with where we were pre-COVID. One of the things putting pressure on our basket size is actually doing much better than inflation materials. So they're using it more of that convenience store style where they're coming in for an extra bag of [ route ] or a couple of other small things. And that puts a little bit of pressure on your basket size as well in today's environment.

What about the health of the consumer. This is something that we talked about Home Depot today, too. I mean there's the housing piece of this equation, the housing market has been in a recession. But then there's just the overall health of the consumer. And I do think at least Home Depot talked about how they're starting to see some lack in confidence starting to seep into maybe their -- the rest of their business, not necessarily the big ticket finance business but smaller ticket. How do you view your consumer, the health of your consumer and if anything has changed there?

I think it's -- we're a little bit different than Home Depot. They're appealing to customers at broad levels of income who are working on different parts of their homes, and that's a bit different. I think when someone is engaging in a hard surface flooring project, they tend to be a little bit higher end of a consumer where there -- it's a higher-end demo and their income levels are a bit different. And so I think that they're less affected. So I think for us, the health of the consumers is certainly something we're paying attention to and something we have to be wary of. But when we're watching what's happening with the sales that are going on in our stores today, customers that are doing the project, they're still buying the better and best SKUs in the stores. So they're spending up on their projects, which tells me that, again, it's a higher-end consumer that we should have less of effect. I think the key -- a big portion of our improvement in our trend will be when existing home sales get better. I think that's a pretty big correlator to what happens with our sales.

And then how should we think about category trends within, again, the context of this more muted environment? I think you'd mentioned laminate and vinyl, those remain the weakest merchandise categories. But are there any categories that maybe you are seeing kind of bucking the trend or something that consumers are gravitating towards one more than the other?

So from a department standpoint, our installation materials department has been doing well all year. We've been pretty aggressive in making sure that our price spreads versus the competition are good. That's a product that the professional customer buys every week. So the sharper we are and the better offerings that we have, the better we do. And we've made a lot of investment in brands in that department and a lot of investments in inventory in the department. And so that department has been doing really well. . Within the store, like I said earlier, the better and best SKUs continue to be where the customer is gravitating to. So when they come in and they're buying a tile, they're buying a 24x48 tile or larger. And when they come in and they're buying the planks, they're buying the larger ones. So we're seeing that customer spend up. And I think that's...

Maybe if we can talk a little bit about store economics. It's a question that we get quite a bit about just the health of your new store economics, which really have been challenged. Just macro. I don't think it can be really explained anything more than that. But can you maybe talk through what the store economics look like for new stores today in the current environment? And how do mature stores look versus these new stores?

Yes, I'll jump in and then Trevor and Tom can add in. It's -- look, we've been pretty transparent about it. Our class of [ 22, 23 and now 24 ] are going to be below our pro forma targeted class average of $14 million to $16 million in sales. We traditionally see $2.5 million to $3 million and [ 4-wall ] EBITDA from those. So there will be a little bit pressured. Obviously, to your point, we believe it's all macro related. And in mature stores, at peak, they were doing somewhere around $27 million to $28 million on a trailing 12 months. They're moderately below that today. But we still are in the low 20s EBITDA percentage. And so that's really what gives us conviction in the model long term is even in this environment, the pressure that we see today are stores that are most immature, it's 5 years and older, are still performing very well and still very profitable in this environment. .

Are you seeing any meaningful difference with the store economics within existing markets versus new markets?

For newer stores or...

Yes.

Stores that are in existing markets tend to start off a little bit better for us. Again, we've got brand awareness. We've got loyalty. We're making it more convenient for our pros. And so we have seen better metrics for our existing stores versus new stores. But we've seen slow markets in the past, like newer market that started a little bit slower, but they've all come around, and Tom and Trevor can talk a little bit more about that. But each market that we've entered into has turned. It's just a matter of when not if.

Our stores have always ramped. They take a long time to ramp. And when you're in a new market or we've gotten to more smaller markets over the last couple of years, and we did that purposely made those decisions in 2021 in the markets we were entering, and it was getting tough to open stores after COVID because of municipalities and getting stores built. And so we elected to go to some easier places to build. There were smaller towns. And as the macro turn negative, we are dependent on the professional customer to help bring us business. And when they don't know who we are, it takes a minute to get them in the store. So I mean we do lots of grassroots marketing. We do huge Pro events in the stores. When we open them, we do training scenarios in the stores that we have people out on the street trying to find professionals to get them in the store, but it takes some time. And when there's no demand in the market or very little demand in the market, it gets even harder. So those stores in those towns, they just ramp differently than the stores were in existing markets where it's a pro that has been shopping at a neighboring store. Now we're closer to the job site, and they automatically come over, so those stores do better.

Right. Well, when it comes to unit growth, you did recently announced your decision to pull back on some of the store openings in '25 understandably. Probably didn't pull back as much as some people thought you're going to pull back. So could you maybe walk through that decision first, and we have a few more questions.

Sure. So we've been opening pretty aggressively throughout the downturn. And we've said, look, we're a market share grower. We're a category killer. We're going to take advantage of a down market and grow, and we did. And so during the course of the last 3 years, we've opened close to 100 stores. And as we got to this year, we said, look, we keep waiting for existing home sales to get better. This has been a long cycle of negativity. So as it wasn't happening, we said, look, we're going to grow within our existing capital structure. So we're going to be more prudent with the capital. Two, we're going to pick more of a stores that we kind of rank the opportunities that we had and said these are the stores that we thought had the best opportunity for quicker success and a better return out of the gate. And so we brought that store number down. And then secondarily, we purposely back-end loaded it so that we have even more flexibility so that we saw things step down from here and things -- or things not improve as we get to the turn of the year, we have flexibility to push some of those 25 out. So we'll make that decision as we get into the first of next year. We do not have a fast follower. So this does nothing to change our thoughts on a 500 store opportunity. It's just we don't have a fast follower. We're opening in a difficult time to get customers into the store. We'll wait till things get a bit better to accelerate that growth. And if things get a lot better and there seems to be more optimism with the conference than I felt a year. So if things tend to get better, then we have also the ability to flex the store count up that we can -- we've got enough in the pipeline. And as we've slowed our store count down, we haven't really reduced the staff of our real estate or construction teams, we still have plenty of people to go open stores. So if things get better, we can accelerate. If things get worse, we can decelerate.

And then the mix of those stores in '25 between large and smaller formats between existing and new markets, retrofit new builds, how does that all break down?

There's a lot into that, that we haven't given out publicly.

Okay.

And generally, we -- over the last several years, 60% to 70% of our stores have been in existing markets. So I think that will be the case again. Store size for the class of '25 will be similar to the store size of this year. Obviously, you're right, the stores can come in and out of that. But I don't think the overall mix and make is going to be all that different. What Tom mentioned is we sort of narrowed our aperture a little bit during this time where the environment is tougher, and we're taking less risky sites, which are generally newer markets for us or smaller markets, and we're pushing those out and focusing the stores that we are opening on markets that we have a higher degree of probability that they're going to be successful. Because we generally have stores in those markets and are pretty good at projecting what those volumes will be in those higher volume stores where we have a lot of markets or higher volume markets where we have a lot of stores.

I wondered if we could spend some time on pricing. And maybe we can just level set because I think there's been some fluctuation in pricing over the last couple of years. And in terms of managing price gaps between you and your competitors. Could you tell us maybe where we are today with any kind of pricing initiatives? How you define the gap today versus a few years ago? And can you share your thoughts on any kind of price elasticity that you've seen as a result of price reductions?

If I remember -- if I forget one of the questions, you can repeat one.

Yes, I can repeat them. Yes. It's end of the day. I'm sorry.

So I think, first, we'll talk about say, 2017, 2018 to today, price spreads versus the competition. We measure pricing. Our category is difficult to shop, right? We -- those of you who follow us know, there's not a lot of brand relevance. You really have to understand features and benefits of a product to understand kind of true pricing. We take a look at the like-for-like SKUs across the competitive landscape, and we measure that on a weekly basis, on a monthly basis and on a quarterly basis. And when we look at our spreads today versus historical, they're not too different. They ebb and flow during the course of the year. You'll get a home improvement center that gets a new merchant and they may get aggressive. And so for a quarter, that gap narrows. And then it expands and then it narrows and then it expands. But overall, from a pricing standpoint versus the big boxes and versus the independents, the spreads are pretty consistent to what they've been. We've been able to grow gross margin rate through a lot of activities, supply chain cost easing, helping our gross margin, the consumers shifting to better and best, helping our gross margins. Our merchants diversifying out of China into the other parts of the world and buying better and getting better gross margins. So lots of elements have helped that margin, but this pricing spread has remained pretty consistent historically. What's the second part of the question.

Now I don't even know what to say. I have everyone in front of me and I don't even know. I guess, really just the pricing elasticity when you have changed the prices, have you seen a response...

Where we've seen -- so we don't see -- and we piloted all the time where we'll take a SKU of a laminate or a SKU of a vinyl or SKU of a tile and we'll drop the price on it, we tend to shift customers within our own customer base. So they come in for one thing and they buy another. But we don't get a lot of unit volume increase, right? We don't get a huge sales lift because they came in to buy one SKU and then they may ship down to a SKU that we price lower. So where we see benefit versus the competition, and we tend to grow total sales is where we do it in installation materials. So something that the professional buys all the time. If we find it ourselves, there are certain parts of that department where we're more aggressive, the pro knows it and they buy up on it. They'll buy a significant amount of inventory of it, they keep on their own -- for their own job sites or their own. So we've continued to keep the pressure there and make sure that we're sharp and continue to pilot lowering prices there where it makes sense to drive volume. But that's the where we drive incremental volume for the storage and installation materials and the rest of the departments is like we ship the customer from one SKU to the other within our own mix.

One thing we wanted to focus on is you do have a unique model and that your direct sourcing most of your product. And I know a lot of that sourcing comes from Asia and then from the Middle East. And on the Asia China side of things, there's a tariff risk. And then on the Middle East side, there is the exposure to the Red Sea. So I wondered if -- rather than me asking a long list of questions, if we could maybe just approach each topic from a sourcing standpoint and how you're managing that.

Yes. On the sourcing side of it, we've dealt with, obviously, the Red Sea, that's not new news. We don't have a lot to go to that route, but that's all been rerouted and we're working through that. We -- so I think 2 calls ago, maybe it would be $1 million, which for us is not all that significant, and we've managed through that issue pretty well. . On the tariff issue, so everybody probably knows, but today, everything we buy out of China has a 25% tariff on it and those tariffs have stayed in place. Obviously, depending on who wins the election, some -- one of the candidates is much more aggressive on tariffs than the other. We have continued to minimize our -- or lower our mix in China. I think we ended last year at maybe mid-20s versus 4, 5 years ago, we were over 50. And as we exit this year, that number will be even significantly below the mid-20s. So we have continued to lower that and move that sourcing to other markets in Southeast Asia. We've moved some of it to Europe. We've moved some of it here to the United States as well. We think that if indeed, large tariffs were to go in place against China, which is where most of the rhetoric is today, everything left that we have sourced there, we think the whole industry sources there as well. So we don't think we're any -- we don't believe we'll be any more disproportionately impacted by anybody else. In the past, everything that we've seen is that if those tariffs go into place, the businesses don't have the profitability that to not pass that along. So people have been very rational about passing along those cost increases. We would expect that to happen again. If there's the broader tariff that's been talked about where kind of every country gets 10%, that affects everybody the same. So that's just inflationary by nature, I believe. And we'll deal with that just like everybody else. So the short story is, I think we've mitigated our risk down to what's available. And an average store today has 4,000 SKUs. And if we get down to whatever, 10%, 12%, 15% of that is coming out of China, we've got other things we could shift and put into that those spaces that we think will sell well. And we've got great merchants, we source from 240 vendors in 24 countries. And so we'll deal with it effectively like we did in 2017 and '18.

Okay. Bryan, I was wondering if I could ask you about the cost structure and how you're managing some of your obligations on the expense side of things as the top line continues to be pressured by the macro. What can we expect kind of through the end of this year into next year if we can still see the top line somewhat needed?

Yes. I think as the top line is muted. I mean, look, it's -- we've communicated this on prior calls, but about 1/4 of our stores are on minimum hours. So there's still a little bit that we can do to flex with transactions. And again, it's everything we've done in today's environment, even reducing labor hours. Our service scores are still as high as they've ever been. And so I think that's important to us. But they're still a little bit weak in flex with, again, ours coming down to mirror transactions. We're still pushing on discretionary spend with reflows, like reforming product, resets, those kind of things. We pulled back a little bit on advertising and some other things within there. I think you guys have heard us say it, but about 55% of our cost structure is traditionally fixed within the 4 walls and then 45% is variable. We're taking a long hard look and at self-reflecting about how we can get more efficient within the box. So all those things are still up for grab this year. So there's still a little bit more we can go after. But then on the flip side of that, if you fast forward into 2025 and beyond, when this turns, we're set up for significant earnings power again. If 25% of our stores or 1/4 of our stores are on minimum hours, they have to earn into that. And so there should be significant earnings power coming through this when the cycle turns as well. And so we -- there are certain things that we don't have to put back in, certain things we've discussed more about how we do business. We didn't talk about it here in the 4 walls today, but Tom mentioned on the last call, we have found $1.5 million in new store construction. So that's really going to take effect in 2025 like-for-like. So we're taking a long hard look at every dollar that we spend, how we spend it and how we can get more efficient.

Okay. The last question I had before we go into the lightning round of questions is the commercial business. you've made 2 successful acquisitions in the commercial space. Maybe could you just update us on how that business is going? What it looks like relative to the retail business? And how should we think about growth opportunities, both organically and from acquisitions longer term?

Yes. We've been pleasantly surprised with our approach in commercial, both on the -- on our regional account managers that sell out of our stores and to our Spartan acquisition and the bolt-ons that we've done since then, they've outperformed our expectations. We will continue to -- we challenged the management team at Spartan to continue to take a -- to cast a net and bring us ideas on ways to grow. I don't think you'd see us acquire anything the size of Spartan, but to do more bolt-on acquisitions as we get into next year. It's certainly something that we have an appetite for. The business has done better than the retail business and the sectors that we sell into commercial are better sectors. I mean we're selling into health care and to what schools and educational. So it's like those are pretty good business right now. So they've done pretty well. And then we've expanded the SKU offering at Spartan and the subsidiaries, too, to give them more stuff to sell out of stores and have [indiscernible] lineup. So between all that, we're pleased with the business and we'll continue to be aggressive in there going forward.

And I think we'll be aggressive growing organically as well. I think that was the other part of your question. So looking at bolt-on acquisitions, but also growing organically as well. So they've got a great reputation. The individual that runs that for us has a great network. And so I think we'll continue to grow both ways.

We've been asking all companies that have been on stage say 5 questions. We've touched on a lot of them already. But wanted to ask and kind of the lightning round format. So your expectations for the environment for the back half of the year relative to what you've seen in the first half, do you expect things to be the same, better or worse from a macro?

I'd say the same. So if you think about what we said on the call, the midpoint of our guidance assumes that sales trends are similar to what we saw in Q2 in the exit rate. But however, comps should improve or get less worse just because we have easier compares. So from a comp perspective, we should see things improve, but from a sales perspective and macro backdrop, we're counting on things to basically be similar to where they were in Q2.

Okay. And then we talked a little bit about cost pressures with regards to something like tariffs. But when you think about freight and materials and labor, do you expect those costs to be the same, better or worse than '25?

The same is where -- like, we're not ready to commit to anything in 2025 yet, but our house view is things should be similar to kind of where they are today.

Okay. The consumer behavior of looking for value is just something we continue to hear from all aspects of retail. And we're wondering if it's a function of the cyclicality in the macro? Or if there's maybe some kind of shift in how the consumer looks at value or prioritizes value secularly? Do you have an opinion on that?

I think it's much more cyclicality and macro than it is a change in consumer preference. I mean we still -- when the consumer is buying in the store, they're still spending up and buying what they want to put in their home. They're not stepping down to the opening price points in the store. So this is for us, it's -- we're dependent on a better housing macro backdrop.

And then first question is about more or less distribution points in the U.S. next year. Obviously, you guys are growing units, so you'll have more distribution points. What about your competition? Do you expect more or less distribution wise?

Less.

Less.

Yes, there's going to be over 400 less as of November. So there's -- yes, we are more and more of independence and some distributors under pressure. So I think that the amount of competition will lessen as we get into next year. .

Ports of entry too. I mean we'll open one distribution center for us in late 2025, and then we'll open another in 2026 as well. So we'll have 2 new ports or one new port of entry and another 1 we're expanding as well. So different distribution points there as well.

Okay. Perfect. And then promotionality, which, again, applies more to our retailers that are selling seasonal product and have a holiday season more so than anything else, but promotions, just do you expect promotions to be higher in the back half of this year versus the first half? I mean, again...

For holiday stuff for the home and prime centers, yes, for our category, no, I don't think so. I don't think it'll be -- we've been in a tough -- this category has been under a tremendous pressure for the last 3 years. And I think we've seen every value every attempt at creating type of excitement around to drive volume and I don't think we see anything different as we get to the...

Just one -- the only comment I might give to that is LL Flooring declared bankruptcy on Friday. They disclosed that they're going to try to liquidate all of their stores between now and November. So we've got to wait and see what that looks like. So that might be one thing. We're -- we don't believe we need to go -- we're not going to go to unprofitable levels. We're not trying to create cash like they are. But we just have to kind of watch that. We've never been through that where $850 million retailers liquidating pretty quickly.

One question surrounding that actually. I mean, any concern that with a liquidation like that, there's some kind of pull forward that might impact sales in the quarter or 2 ahead?

I don't -- we don't know, but I don't think so. I think that -- we've seen them -- they closed 100 stores and we haven't seen much of an impact from that first 100 batch of closing that are near our stores. So as they close the next 300, they'll be flushing some inventory out from the DC, but we don't anticipate that should impact. We think that as we get past their liquidation in November that we should be -- we have the best offering in the category and we should be right to capture more of that market next year and lose anything.

Yes, medium to long term, it's great for us, right? We can think where the next best competitor buy that, that customer should go to, and we'll be moving aggressively to do everything we can to capture that business. We're well positioned to take market share for them.

Okay. Thank you. It's the end of the day, we'll stop 5 minutes early.

Thank you so much.

Thank you so much.

Thanks for having us.

Thank you.

Thank you.