Right up here. Okay, thank you everyone for joining us. We're here with Floor & Decor. Today, we have with us Tom Taylor, CEO, and Bryan Langley, EVP and CFO. Bryan, you're going to read a disclosure quick before we start.
Yeah. So, 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 Securities Litigation Reform 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 gonna-
Yeah. There's gonna be questions about macro now?
Yeah.
All right. Very good.
That's where we're gonna start. It's not all the questions, though. So your fiscal year 2023 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?
Lots of questions in there. I would say that, first, as we look at 2023, we had expected that, you know, interest rates would go up and that they would 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 would subside, and interest rates would stop going up. That they continued to go up, there's an effect on existing home sales. We're in 23 consecutive months of negative existing home sales, and they've been pretty severe over the most part of this year. 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, you know, 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, you know, 4.1-ish annualized rate, and we'll start lapping that. So instead of negative 20% month-over-month, we'll moderate, and we'll be closer to, you know, flat to slightly negative Existing Home Sales, albeit Existing Home Sales will stay at a really soft rate. So, we have been growing... You know, 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, you know, 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 the sector, you know, we feel like we're taking market share. So we think it's going to remain difficult. We think it can grow, you know, top line sales, but it's gonna, you know, existing home sales will be under pressure a little bit longer than we thought.
You mentioned on the last earnings call that both pros and homeowners were engaged in fewer projects and smaller scale projects. 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 did have housing turnover.
Yeah, I mean-
How that compared.
If you think about it in layman's terms, you know, 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's coming in that's involved in either selling their home or 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. You know, people are going to renovate more space in that environment, and when they're staying in their existing home and they're just redoing, they'll redo a powder bath at a time, or they'll redo a kitchen bath at a time. So that's what we're experiencing more of now.
The reason that the pressure's been under our square footage is just, you know, less total homes being done than what's been done historically.
Mm-hmm. That's right.
Maybe you could square for us the smaller projects, but still what seems to be like the better, best preference?
Yeah
... by your consumer. Has this dynamic surprised you, and what do you think is driving it?
Yeah. Yes, it surprised me because, you know, anytime that you see market pressure, historically, I've seen people in my, in my background step down. That's not been the case here. Our better and best products are still, you know, doing terrific. That's been the trend that's gone on for, you know, the last few years, and I think there's two reasons that I would associate with that. I think first off is, you know, our merchants and the suppliers themselves have done a good job around innovation and fashion and durability.
So I think when you come in to do the project and you see those step-ups, you'll say: "You know, if I'm going to do the project, I'm going to buy the better best ." It's 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, you know, when you look, our consumer slants 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, you know, someone who's flipping a home, they may not care, and they may buy the lower-end product.
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, if we start all the way back, looking at tariffs-
Mm-hmm
... 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 gonna... There's a lot of questions in there, so I'll kind of ... 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 timeframe. It took a little, not a lot.
When 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, you know, demurrage and more transportation costs than we anticipated. Ocean freight went up, and those costs we had 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 dollars, so we let rate come down during 2022. As we got to 2023, and we saw the inverse happen, I felt it was important to. You know, we have a big. We're like a supply house.
We're not just a retailer, but we have a lot of tradespeople in the business, and I felt like it was important for our professionals who shop with us, who saw us escalate price for the first time in over 10 years. I thought it was important then 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, you know, we've been able to take prices down, but still get an improved gross margin rate all throughout this year, and we anticipate as 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's 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 than one person in the X. 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 2023? And I know you're not giving guidance for 2024, but how should we think about gross margins as we lap some of these pricing dynamics that you just talked through and as supply chain costs continue to come down?
Yeah. 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 was 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 in why I think we can run a better gross margins of. One, is what's selling in the store. As we continue to sell the better and best products, who we compete with is more in the independent channel, and the spreads in our pricing versus the independent channels are pretty significant.
So we feel like, no matter if the market were to get irrational, our pricing spread is 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. And when a designer is involved with the customer, they end up selling the whole project, they end up selling a better blend of gross margin rate. So that initiative, you know, we're making great progress, and we're seeing great benefits from that. And then, you know, our damages, 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've stocked, you know, 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 would also help us to lead to a better margin rate. And then capacity with this in the industries, we're getting concessions from our suppliers, or we'll get concessions from our suppliers, in a more significant way, which should help our margin as well. So long way around of, I do think that 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.
You know, with regards to those price gaps, again, you mentioned, even 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?
Yeah. I'll put it in easy terms so that we understand. Yes, we've said all along that in a difficult market, the value player is gonna 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, you know, the home improvement centers, they just, they don't have the space to allocate to, and the independents are usually focused on one to two 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. And, you know, I'll use the simple barometer that I use.
I just look at kind of the publicly traded peers that are 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-twenties, and Tile Shop in the negative, close to negative double digit. And then I look at us, and while our comps are are a bit challenged this year, our total sales growth, as I said, is, you know, we're up 4.6% for the quarter. So that tells me that we're taking market share. And, you know, hopefully, you know, we'll continue to have that benefit as we look to the future.
If you look at the great housing recession, when, you know, home improvement was really under pressure, when the cycle turned, there was a lot less competition out there. And so, you know, we're continuing to open stores, knowing that as we come out of this cycle, there'll be less competitive land, backdrop, and we'll be in a better competitive position.
Yeah, from everything that we can see, historically, we were taking about 100 basis points of market share. We believe in 2022 and into 2023. Now that's closer to 200-
Mm-hmm
basis points of market share gain. As you can tell, it's accelerated kind of throughout this backdrop.
Okay. Can we talk about unit growth? Because I do think, you know, even though we've been in, 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, you know, the, 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.
Sure.
I have a few more questions.
So, we're slightly off 20% unit growth this year, but, you know, we, with the exception of the COVID year, we've been 20% unit grower since I joined the company. So operationally, how we handle that, we invested in infrastructure early on, so, we've got full training departments, you know, that help get our talent ready, full developmental plans, great talent pipeline. So it's never been about being able to get stores open. You know, culture is very important in our company, so we've kept the governor on that 20% unit by, you know, 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've invested enough behind that, that our talent pipeline's never been better. As far as finding locations, we, you know, we've used two different real estate or three 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.
Mm-hmm.
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 with, to find the right, right corner, right location, right facility in the box, and we use local intel to do that. I'd say that over the last 3-4 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, you know, 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?
Yeah, 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 the 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 costs as well embedded within there.
Right.
As long as you can self-fund it.
And the mix of it now, own first, lease?
Yeah, it's we started this about two years ago to start getting a little heavier, and so we strive to have maybe 5%-10% of each new vintage, each new class owned.
Okay.
And so we're not going to go back and change that. So it's each year, we strive to have maybe 5%-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?
Yeah, I mean, even in the current environment we're in, if you guys go back to the 2021 Analyst Day that we had-
Yeah
... our pro forma would say our stores open around $14-$16 million. They get cash-on-cash returns of 50% in year 3, payback period of 2.5-3.5 years, and 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 mention on the last earnings call that we had, but our stores are doing $14-$14.5 million, even in the environment we're in today. So through COVID, they ran up to above $16 million, but we're still within that portfolio approach, so we feel very good. And that's what gives us the confidence to, you know, 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.
Then if we could pivot to the commercial side of the business, because I think now you've made two 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 Salesmaster Flooring Solutions the right company for you to acquire?
I'll start the headline with, I was hesitant to acquire in the commercial space. We had, you know, at that point, I think we had 160, 170 stores, so lots of stores to open and wasn't sure 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, besides from Salesforce, we bolted on Salesmaster, 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 retail customer space, where supply chain's 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 it's, 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 Salesmaster is not just geography-related.
While it's nice to be in New York and Boston and 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, you know, our Spartan team's feeling was, you know, we're gonna acquire them, we're gonna marry them up with the A&D providers with them, so they'll be able to share a customer base, we'll be able to expand product offerings and be able to offer total solutions to end users. And that's why we went with Salesmaster, 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 are doing pretty well.
Mm-hmm
... in this market, because of the amount of inventory in the marketplace. So, you know, our Spartan business has 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, you know, we'll look more to the West Coast and to the southern part of the country, to, you know, make sure that we're filling those out.
Maybe we can wrap up before our lightning round here with just a 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 2023, some of the wins for Floor & Decor, and how you're thinking about 2024 relative to that?
Some of the challenges? So I would say, you know, challenges for Floor & Decor in 2023 would have to, you know, 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 then didn't anticipate them lingering as long as they have. And, you know, this is, we're going into unprecedented territory when you have 23 months of declining existing home sales. That's put challenges, it's just taking less customers out of the market. So the challenge of that is we're having to manage the P&L more closely than we have historically. You know, 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 facing. We're trying to be really thoughtful to protect the customer experience within our store. But we've had to do that, and that's been a challenge. And on the flip side of that, when you'd say what's positive about that, for the management team, that's terrific. You know, we've been a winning retailer since we've come out public, and even prior to that, you know, we had nine consecutive years of double-digit same-store sales growth, and we've been in investment mode heavily.
This has taught us more discipline 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. You know, this too shall pass. It's just gonna take a little bit of time, and we'll continue to manage the PNLs we look to next year.
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?
Yeah, I mean, I think our teams work well together in kind of thinking about, in the stores, we, you know, we have a 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 maintain 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 gonna affect what the customer sees, and we're able to take—you know, we're able to make some adjustments. We're not done.
This is lasting a little bit longer. So as we're looking to next year, there'll be projects that we pause, not eliminate, but that we pause and say: "Okay, when's 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, or if they're 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're asking four 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 or the same.
You know, I would say that we've been in a—I'd say similar. We've been in a very tough existing home sales, existing home turnover market. I think the consumer, we slant to a little bit higher, and the end user is a little bit higher income. Consumers had the benefit of household appreciation, stock market, you know, stock appreciation. So I think they're in a, in a decent place, but I think it'll be similar to what it was this year.
With regards to share of wallet, you know, obviously we've seen a prioritization in a, 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.
Yeah.
Sales.
Yep.
I hate to be repetitive.
Yeah.
You know, the good news is, we're... You know, like I said earlier, we're gonna start lapping really soft numbers, and so as you're lapping that $4-4.1 million number, then you won't be 20% down in existing home sales. And I think, I think as 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, be positive 5%-10%, and we think that'll be beneficial for the business when that happens.
Our third question is around pricing. Again, we, 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.
The last question is on inventory. Can you talk to us a little bit about where you are with your inventory, how 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 five years, so the stores are in terrific shape and in stock. You know, 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 probably never been better. It's trend right for a lot of retailers-
Mm-hmm
... 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, so 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... You know, the fluctuation in our inventory levels has more to do with the timing of our new stores adding inventory in for when they're gonna open. And we have a -- unfortunately, we opened a lot of stores at 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.
We appreciate it.