(EDGAR Online via COMTEX) -- Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of the financial condition and results of our operations should be read together with the financial statements and related notes of Floor & Decor Holdings, Inc. and Subsidiaries included in Item 1 of this quarterly report on Form 10-Q (this "Quarterly Report") and with our audited financial statements and the related notes included in our Annual Report on Form 10-K for the fiscal year ended December 26, 2019 and filed with the Securities and Exchange Commission (the "SEC") on February 20, 2020 (the "Annual Report"). As used in this Quarterly Report, except where the context otherwise requires or where otherwise indicated, the terms "Floor & Decor," "Company," "we," "our" or "us" refer to Floor & Decor Holdings, Inc. and its subsidiaries.
The discussion in this Quarterly Report, including under this Item 2, "Management's Discussion and Analysis of Financial Condition and Results of Operations" of Part I and Item 1A, "Risk Factors" of Part II, contains forward-looking statements within the meaning of the federal securities laws. All statements other than statements of historical fact contained in this Quarterly Report, including statements regarding the Company's future operating results and financial position, business strategy and plans, objectives of management for future operations, and the impact of the coronavirus (COVID-19) pandemic, are forward-looking statements. These statements are based on our current expectations, assumptions, estimates and projections. These statements involve known and unknown risks, uncertainties and other important factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. In some cases, you can identify forward-looking statements by terms such as "may," "will," "should," "expects," "intends," "plans," "anticipates," "could," "seeks," "target," "projects," "contemplates," "believes," "estimates," "predicts," "budget," "potential" or "continue" or the negative of these terms or other similar expressions.
The forward-looking statements contained in this Quarterly Report are only predictions. Although we believe that the expectations reflected in the forward-looking statements in this Quarterly Report are reasonable, we cannot guarantee future events, results, performance or achievements. A number of important factors could cause actual results to differ materially from those indicated by the forward-looking statements in this Quarterly Report, including, without limitation, those factors described in this Item 2, "Management's Discussion and Analysis of Financial Condition and Results of Operations" of Part I and Item 1A, "Risk Factors" of Part II. Some of the key factors that could cause actual results to differ from our expectations include the following:
an overall decline in the health of the economy, the hard surface flooring ? industry, consumer spending and the housing market, including as a result of the COVID-19 pandemic;
? an economic recession or depression, including as a result of the COVID-19 pandemic;
the impacts of the COVID-19 pandemic or any natural disaster or unexpected ? event, including any impacts on the credit markets, our lenders, us, our operations, or our future financial or operational results;
? the resignation, incapacitation or death of any key personnel;
? any disruption in our distribution capabilities resulting from our inability to operate our distribution centers going forward;
? competition from other stores and internet-based competition;
? our failure to execute our business strategy effectively and deliver value to our customers;
? our inability to manage our growth;
? our inability to manage costs and risks relating to new store openings;
? our dependence on foreign imports for the products we sell, which may include the impact of tariffs and other duties;
? our inability to find, train and retain key personnel;
? violations of laws and regulations applicable to us or our suppliers;
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? our failure to adequately protect against security breaches involving our information technology systems and customer information;
? our failure to successfully anticipate consumer preferences and demand;
? our inability to find available locations for our stores or our store support center on terms acceptable to us;
? our inability to obtain merchandise on a timely basis at prices acceptable to us;
? suppliers may sell similar or identical products to our competitors;
? our inability to maintain sufficient levels of cash flow to meet growth expectations;
? our inability to manage our inventory obsolescence, shrinkage and damage;
? fluctuations in material and energy costs; and
? restrictions imposed by our indebtedness on our current and future operations.
Because forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified, you should not rely on these forward-looking statements as predictions of future events. The forward-looking statements contained in this Quarterly Report speak only as of the date hereof. New risks and uncertainties arise over time, and it is not possible for us to predict those events or how they may affect us. If a change to the events and circumstances reflected in our forward-looking statements occurs, our business, financial condition and operating results may vary materially from those expressed in our forward-looking statements. Except as required by applicable law, we do not plan to publicly update or revise any forward-looking statements contained herein, whether as a result of any new information, future events or otherwise.
Founded in 2000, Floor & Decor is a high growth, differentiated, multi-channel specialty retailer of hard surface flooring and related accessories with 123 warehouse format stores across 30 states as of March 26, 2020. We believe that we offer the industry's broadest in-stock assortment of tile, wood, laminate, vinyl, and natural stone flooring along with decorative and installation accessories at everyday low prices positioning us as the one stop destination for our customers' entire hard surface flooring needs. We appeal to a variety of customers, including professional installers and commercial businesses ("Pro"), Do-it-Yourself customers ("DIY"), and customers who buy the products for professional installation.
We operate on a 52- or 53-week fiscal year ending the Thursday on or preceding December 31. The following discussion contains references to the first thirteen weeks of fiscal 2020 and fiscal 2019, which ended on March 26, 2020 and March 28, 2019, respectively.
During the thirteen weeks ended March 26, 2020, we continued to make long-term key strategic investments, including:
? opening three new warehouse-format stores ending the quarter with 123 warehouse-format stores;
? focusing on innovative new products and localized assortments, supported by inspirational in-store and online visual merchandising solutions;
? investing in our connected customer, in-store designer, and Pro customer personnel and customer relationship technology;
? investing capital to continue enhancing the in-store shopping experience for our customers; and
temporarily adjusting operations in response to the COVID-19 pandemic to the ? protect the health of our employees and customers, including temporarily implementing a curbside pickup model and shortening store operating hours.
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The COVID-19 Pandemic is Disrupting Our Business
The COVID-19 pandemic is disrupting our business. As of April 28, 2020, our second quarter fiscal 2020 comparable store sales have declined 50% compared with the same period in the prior year. While we expect some of these disruptions and the decline in sales to be temporary, the current circumstances are dynamic and additional impacts of the pandemic on our business operations, including the duration and impact on overall customer demand, including potential changes in consumer behavior due to financial, health, or other concerns, cannot be reasonably estimated at this time. While the full impact that the COVID-19 pandemic could have on our business remains highly uncertain, we currently anticipate that disruptions from the pandemic will have a material negative impact on our results of operations, financial position, and cash flows in fiscal 2020. These potential negative effects will not be fully reflected in our results of operations and overall financial performance until future periods.
We have three priorities while navigating through this period of volatility and uncertainty:
? First, to protect the health and safety of our employees and customers.
Second, to keep our brand strong and support all of our customers, including ? the numerous small businesses that rely upon us such as general contractors and flooring installers.
Third, to ensure that Floor & Decor emerges strong from this event. The pandemic will eventually come to an end, and we believe that we will emerge a ? better company by driving our long-term strategies, responding to changing consumer behavior, and capitalizing on opportunities from our relative strength.
As of the date of this filing, we have implemented contingency planning, with most employees working remotely where possible. We are working hard to monitor and quickly respond to this situation, including communicating often throughout the organization and adapting our operations to follow rapidly evolving federal, state and local ordinances as well as health guidelines on mitigating the risk of COVID-19 transmission. We believe our rapid and thoughtful approach to serving our associates and customers in a safe manner is working well; albeit at lower sales volumes than before the pandemic. We have crisis teams in place monitoring the rapidly evolving situation and recommending risk mitigation actions; we have implemented travel restrictions as well as visitor protocols; and we are following social distancing practices. We have assessed and are implementing continuity plans to provide customers with continued supply. There has been no material impact on supply for most of our sourced merchandise, and we are also working closely with our suppliers and transportation partners.
While we have plans for fully reopening our stores in the future, these plans depend on a number of factors, including applicable regulatory restrictions, and there is substantial uncertainty regarding the manner and timing in which we can return some or all of our business to more normal operations. We may face longer term closure requirements and other operational restrictions at some or all of our physical locations for prolonged periods of time due to, among other factors, evolving and increasingly stringent federal, state, and local restrictions including shelter-in-place orders. Even once we are able to fully reopen our stores, changes in consumer behavior due to financial, health, or other concerns may reduce consumer demand for our products. As a result of these developments, the Company expects an unfavorable impact on its sales, results of operations, and cash flows in fiscal 2020. See Note 8, "Subsequent Events" to our condensed consolidated financial statements and Item 1A., "Risk Factors" for additional information.
Coronavirus Aid, Relief, and Economic Security Act
As discussed in Note 8, "Subsequent Events," on March 27, 2020, the U. S. President signed into law H.R. 748, the Coronavirus Aid, Relief and Economic Security Act (the "CARES Act"). We are currently evaluating the impact of the CARES Act on our business. While we have not yet completed this assessment at the time of this quarterly report on Form 10-Q, we anticipate that the CARES Act will result in substantial income tax benefits, including cash refunds in fiscal 2020 for income taxes paid in prior years, and allow us to conserve cash in fiscal 2020 by deferring employer social security tax payments. In addition, we expect that we may benefit from the employee retention credits and, potentially, other provisions of the CARES Act that have not yet been assessed.
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Key Performance Indicators
We consider a variety of performance and financial measures in assessing the performance of our business. The key performance and financial measures we use to determine how our business is performing are comparable store sales, the number of new store openings, gross profit and gross margin, operating income, and EBITDA and Adjusted EBITDA. For definitions and a discussion of how we use our key performance indicators, see the "Key Performance Indicators" section of "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" of our Annual Report. See "Non-GAAP Financial Measures" below for a discussion of how we define EBITDA and Adjusted EBITDA and a reconciliation of EBITDA and Adjusted EBITDA to net income, the most directly comparable financial measure calculated and presented in accordance with accounting principles generally accepted in the United States ("GAAP").
Other key financial terms we use include net sales, selling and store operating expenses, general and administrative expenses, and pre-opening expenses. For definitions and a discussion of how we use other key financial terms, see the "Other Key Financial Definitions" section of "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" of our Annual Report.
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Results of Operations
While our revenue and earnings for the thirteen weeks ended March 26, 2020 were impacted due to the COVID-19 pandemic, primarily the last week of the period, the full impact that the pandemic could have on our business remains highly uncertain. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - The COVID-19 Pandemic is Disrupting Our Business" and Item 1A., "Risk Factors" for more information about the potential impacts that the COVID-19 pandemic may have on our results of operations and overall financial performance for future periods. The following table summarizes key components of our results of operations for the periods indicated, both in dollars and as a percentage of net sales (actuals in thousands; dollar changes in millions):
Thirteen Weeks Ended March 26, 2020 March 28, 2019 Actual % of Sales Actual % of Sales $ Increase/(Decrease) % Increase/(Decrease) Net sales $ 554,937 100.0 % $ 477,050 100.0 % $ 77.9 16.3 % Cost of sales 318,905 57.5 275,676 57.8 43.2 15.7 Gross profit 236,032 42.5 201,374 42.2 34.7 17.2 Operating expenses: Selling and store operating 153,066 27.6 127,383 26.7 25.7 20.2 General and administrative 30,858 5.6 30,202 6.4 0.7 2.2 Pre-opening 5,434 1.0 4,027 0.8 1.4 34.9 Total operating expenses 189,358 34.1 161,612 33.9 27.7 17.2 Operating income 46,674 8.4 39,762 8.3 6.9 17.4 Interest expense, net 1,807 0.3 2,921 0.6 (1.1) (38.1) Income before income taxes 44,867 8.1 36,841 7.7 8.0 21.8 Provision for income taxes 7,804 1.4 6,121 1.3 1.7 NM Net income $ 37,063 6.7 % $ 30,720 6.4 % $ 6.3 20.6 %
NM - Not meaningful
Selected Financial Information Thirteen Weeks Ended March 26, 2020 March 28, 2019 Comparable store sales (% change) 2.4 % 3.1 % Comparable average ticket (% change) 3.4 % 1.1 % Comparable customer transactions (% change) (1.0) % 1.9 % Number of warehouse-format stores 123 103 Adjusted EBITDA (in thousands) $ 73,126 $ 60,068 Adjusted EBITDA margin 13.2 % 12.6 %
(1) Adjusted EBITDA is a non-GAAP financial measure. See "Non-GAAP Financial Measures" section below for additional information and a reconciliation to the most comparable GAAP measure.
Net sales during the thirteen weeks ended March 26, 2020 increased $77.9 million, or 16.3%, compared to the corresponding prior year period due to the opening of 20 new stores since March 28, 2019 and an increase in comparable store sales of 2.4%. The comparable store sales increase during the period of 2.4%, or $11.6 million, was primarily driven by a 3.4% increase in comparable average ticket, partially offset by a 1.0% decrease in comparable customer transactions. Among our six product categories, three experienced comparable store sales increases including laminate/luxury vinyl plank, decorative accessories/wall tile, and installation materials and tools. Non-comparable store sales increased $66.3 million during the same period primarily due to the increase in new stores previously described. Our comparable store sales increased 6.1% through March 20, 2020, the last day of normal operations before limiting stores to curbside services in response to the COVID-19 pandemic.
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We believe the increases in net sales and average ticket are due to the execution of our key strategic investments. We believe our continued investments and focused merchandising, connected customer, Pro, marketing, and visual merchandising strategies, along with new innovative products, led to our sales growth during the periods presented.
Gross Profit and Gross Margin
Gross profit during the thirteen weeks ended March 26, 2020 increased $34.7 million, or 17.2%, compared to the corresponding prior year period. This increase in gross profit was driven by the 16.3% increase in sales and a slight increase in gross margin to 42.5%, up approximately 30 basis points from 42.2% in the corresponding prior year period. This increase in gross margin was primarily due to higher product gross margin driven by lower costs from the elimination of certain tariffs and improved merchandising strategies, partially offset by higher distribution center costs related to our new distribution center near Baltimore, Maryland that opened in the fourth quarter of fiscal 2019.
Selling and Store Operating Expenses
Selling and store operating expenses during the thirteen weeks ended March 26, 2020 increased $25.7 million, or 20.2%, compared to the corresponding prior year period, due primarily to opening twenty new stores since March 28, 2019. As a percentage of net sales, our selling and store operating expenses increased approximately 90 basis points to 27.6% from 26.7% in the corresponding prior year period primarily driven by new stores open less than one year. Comparable store selling and store operating expenses as a percentage of comparable store sales decreased by approximately 70 basis points, as we leveraged occupancy, incentive compensation, and advertising expenses on higher net sales. Selling and store operating expenses as a percentage of revenue were also impacted by disruptions to our store operations in March 2020 caused by the unfolding COVID-19 pandemic, resulting in slower sales growth, and therefore lower expense leverage, for the first quarter of fiscal 2020.
General and Administrative Expenses
General and administrative expenses, which are typically expenses incurred outside of our stores, increased $0.7 million, or 2.2%, during the thirteen weeks ended March 26, 2020 compared to the corresponding prior year period due to our continued investments in personnel for our store support functions and increased depreciation due to technology investments to support store growth. Our general and administrative expenses as a percentage of net sales decreased approximately 80 basis points to 5.6% from 6.4% in the corresponding prior year period primarily due to lower accruals for employee incentive compensation during the thirteen weeks ended March 26, 2020 as a result of the COVID-19 pandemic.
Pre-opening expenses during the thirteen weeks ended March 26, 2020 increased $1.4 million, or 34.9%, compared to the corresponding prior year period. The increase is primarily the result of higher occupancy costs due to a longer period of possession prior to store opening as well as an increase in the number of new stores that we are preparing for opening compared to the prior year period. We opened three stores during each of the thirteen weeks ended March 26, 2020 and March 28, 2019.
Net interest expense during the thirteen weeks ended March 26, 2020 decreased $1.1 million, or 38.1%, compared to the corresponding prior year period. The decrease in interest expense was primarily due to a decrease in interest rates as well as an increase in interest income earned during the thirteen weeks ended March 26, 2020 compared to the corresponding prior year period.
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The provision for income taxes during the thirteen weeks ended March 26, 2020 increased $1.7 million compared to the corresponding prior year period. The effective tax rate was 17.4% for the thirteen weeks ended March 26, 2020 compared to 16.6% in the corresponding prior year period. The increase in the effective tax rate was primarily due to higher discrete expense for loss contingencies related to uncertain tax positions, partially offset by the recognition of higher income tax benefits related to stock option exercises.
Non-GAAP Financial Measures
EBITDA and Adjusted EBITDA are key metrics used by management and our board of directors to assess our financial performance and enterprise value. We believe that operating income, EBITDA and Adjusted EBITDA are useful measures, as they eliminate certain expenses that are not indicative of our core operating performance and facilitate a comparison of our core operating performance on a consistent basis from period to period. We also use Adjusted EBITDA as a basis to determine covenant compliance with respect to our Credit Facilities (as defined below), to supplement GAAP measures of performance to evaluate the effectiveness of our business strategies, to make budgeting decisions, and to compare our performance against that of other peer companies using similar measures. EBITDA and Adjusted EBITDA are also frequently used by analysts, investors, and other interested parties as performance measures to evaluate companies in our industry.
EBITDA and Adjusted EBITDA are supplemental measures of financial performance that are not required by or presented in accordance with GAAP. We define EBITDA as net income before interest, loss on early extinguishment of debt, taxes, depreciation and amortization. We define Adjusted EBITDA as net income before interest, loss on early extinguishment of debt, taxes, depreciation and amortization adjusted to eliminate the impact of certain items that we do not consider indicative of our core operating performance. See below for a reconciliation of EBITDA and Adjusted EBITDA to net income, the most directly comparable financial measure calculated and presented in accordance with GAAP.
EBITDA and Adjusted EBITDA are non-GAAP measures of our financial performance and should not be considered as alternatives to net income as a measure of financial performance or any other performance measure derived in accordance with GAAP, and they should not be construed as an inference that our future results will be unaffected by unusual or non-recurring items. Additionally, EBITDA and Adjusted EBITDA are not intended to be measures of liquidity or free cash flow for management's discretionary use. In addition, these non-GAAP measures exclude certain non-recurring and other charges. Each of these non-GAAP measures has its limitations as an analytical tool, and you should not consider them in isolation or as a substitute for analysis of our results as reported under GAAP. In evaluating EBITDA and Adjusted EBITDA, you should be aware that in the future we will incur expenses that are the same as or similar to some of the items eliminated in the adjustments made to determine EBITDA and Adjusted EBITDA, such as stock compensation expense, loss (gain) on asset impairments and disposals, executive recruiting/relocation, and other adjustments. Our presentation of EBITDA and Adjusted EBITDA should not be construed to imply that our future results will be unaffected by any such adjustments. Definitions and calculations of EBITDA and Adjusted EBITDA differ among companies in the retail industry, and therefore EBITDA and Adjusted EBITDA disclosed by us may not be comparable to the metrics disclosed by other companies.
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The following table reconciles net income to EBITDA and Adjusted EBITDA for the periods presented:
Thirteen Weeks Ended in thousands March 26, 2020 March 28, 2019 Net income $ 37,063 $ 30,720 Depreciation and amortization (1) 21,673 16,871 Interest expense, net 1,807 2,921 Income tax expense 7,804 6,121 EBITDA 68,347 56,633 Stock compensation expense (2) 2,908 2,250 COVID-19 costs (3) 1,310 - Tariff refunds (4) (401) - Other (5) 962 1,185 Adjusted EBITDA $ 73,126 $ 60,068
(1) Excludes amortization of deferred financing costs, which is included as part of interest expense, net in the table above.
(2) Non-cash charges related to stock-based compensation programs, which vary from period to period depending on timing of awards and forfeitures.
(3) Represents employee payroll continuation, sanitation, and other costs directly related to disruptions caused by or efforts to mitigate the impact of the COVID-19 pandemic on our business.
(4) Represents income for tariff refunds recognized during the thirteen weeks ended March 26, 2020 for engineered wood products. Interest income for the tariff refunds is included within interest expense, net in the table above.
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Apr 30, 2020
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