LL Flooring Holdings, Inc.
Q4 2020 Earnings Call Transcript

Published: 2 Mar 2021

[Operator:]

Good morning, ladies and gentlemen and welcome to the Lumber Liquidators Fourth Quarter and Full Year 2020 Earnings Conference Call. As a reminder, this conference is being recorded and may not be reproduced in full or in part without permission from the company. I would now like to turn the conference over to Julie MacMedan. Please go ahead.

[Julie MacMedan:]

Thank you, operator. Good morning, everyone and thank you for joining us. Today, I am joined by Charles Tyson, our President and Chief Executive Officer and Nancy Walsh, our Chief Financial Officer. As we begin, let me reference the safe harbor provisions of the U.S. securities laws for forward-looking statements. This conference call may contain forward-looking statements that are subject to significant risks and uncertainties, including the future operating and financial performance of Lumber Liquidators. Although Lumber Liquidators believes that the expectations reflected in its forward-looking statements are reasonable, it can give no assurance that such expectations or any of its forward-looking statements will prove to be correct. Important risk factors that could cause actual results to differ materially from those reflected in the forward-looking statements are included in Lumber Liquidators’ filings with the SEC.

[Charles Tyson:]

Thank you, Julie. A year ago, I shared with you my excitement about the opportunities ahead for us to leverage a solid foundation as a high-touch specialty flooring company, execute a transformation plan and deliver shareholder value. As I look back on 2020, I am both proud of all that our team has accomplished and energized by how much opportunity, still lies ahead. 2020 was a dynamic and challenging year. Customers demanded a safe omni-channel shopping experience, and our teams rose to the occasion. I want to thank our entire team for their commitment flexibility and perseverance throughout the entire year to deliver both strong financial results and outstanding service to our customers. I am very proud to be leading such a dedicated team who are working every day to execute our transformation strategy and elevate the experience for all customers, whether they are DIY, do it for me or our pros. I also want to thank our vendors, landlords and suppliers for helping us navigate through the COVID-19 environment to service our customers. Turning to our positive results for the quarter, we demonstrated solid progress on our transformation plan, which positioned us to take advantage of a robust home improvement spending environment. In the fourth quarter, we delivered a 10.5% increase in comp sales. We also achieved an impressive operating income of $18 million when compared to $19 million in the fourth quarter of 2019, given that the prior year fourth quarter included a one-time $11 million benefit from the retroactive exclusion of Section 301 tariffs. This underscores the underlying operating profit improvement we achieved in 2020 versus 2019. For the full year, we delivered $1.1 billion in net sales, flat to 2019, demonstrating resilience as we navigated the COVID-19 shutdown in the spring to grow comp sales 10.8% in the second half of 2020. We also achieved significantly higher profitability due to progress on our profit initiatives, with adjusted operating income of $64 million, up from $25 million in 2019, and an adjusted operating margin of 5.8%, up 350 basis points versus 2019. These strong fourth quarter and full year financial results reflect our continued execution against our strategic pillars of people and culture, improving the customer experience, driving traffic and transactions in our stores and online and improving profitability.

[Nancy Walsh:]

Thanks, Charles and good morning everyone. Please note that during my remarks, I will be discussing results on an adjusted basis. Please refer to today’s press release for reconciliation to the most directly comparable GAAP financial measures and our explanation of why the non-GAAP financial measures maybe useful. In the fourth quarter, net sales of $304.2 million increased $30.4 million or 11.1% versus 2019 due to an 11.2% increase in merchandise sales and a 10.2% increase in service sales. Comparable store sales increased 10.5% versus a year ago, primarily as a result of execution on our transformation and healthy consumer demand for home improvement projects. We saw a 1.6% increase in our average ticket due to higher installation sales and an 8.9% increase in transaction count compared to the same period in 2019. Gross profit increased 5% in the fourth quarter of 2020 to $118 million from $112 million in the comparable period in 2019 on higher sales. Gross margin of 38.8% in the fourth quarter of 2020 compared to 40.9% in the fourth quarter of 2019. During the fourth quarter of 2020, gross margin included a net $2.2 million benefit from countervailing and antidumping expense associated with the applicable prior year shipments of engineered hardwood from China compared to a net $400,000 expense in the fourth quarter of 2019. When excluding these items from both periods, adjusted gross profit for the quarter was $116 million compared to $112 million in the prior year and adjusted gross margin was 38.1% compared to 41% in the prior year. Excluding the one-time benefit in 2019 from the retroactive exclusion of Section 301 tariffs, gross margin increased 200 basis points versus the fourth quarter of 2019. This significant gross margin improvement primarily reflects merchandising, sourcing and costs out efforts, and to a lesser extent, selective retail price increases. As a reminder, our financial statements have been impacted by Section 301 tariffs on certain products imported from China in recent years. In November 2019, a subset of these imports for certain click vinyl and other engineered products received an exemption that was made retroactive to the inception of the Section 301 tariffs in September 2018. On August 7, 2020, this exemption expired. The August reinstatement of Section 301 tariffs on certain products imported from China began to flow through the income statement in the fourth quarter of 2020 as the product was sold. Cash flow in the fourth quarter was also reduced as the company began to pay tariffs on the product affected by the Section 301 tariff reinstatement. SG&A expense for the fourth quarter was $99.6 million or 32.7% of sales, leveraging 110 basis points, compared to $92.6 million or 33.8% of sales in the fourth quarter of 2019. SG&A in both quarters included certain costs related to legal matters. Additionally, the fourth quarter of 2020 included $1.2 million of costs related to Canadian and U.S. store closures, bringing the total to $3.8 million on the year. As anticipated, all 14 stores were closed by year end, although certain cleanup activities will be completed in early 2021. When excluding these items from both periods, adjusted SG&A expense for the quarter was $97 million, $4 million higher versus $93 million in the fourth quarter of 2019, due primarily to higher bonuses and commissions on strong financial performance. As a percent of sales, SG&A leveraged 200 basis points to 31.9% of sales from 33.9% of sales in the fourth quarter of 2019. For the quarter, we delivered operating income of $18.4 million compared to $19.3 million in the fourth quarter of 2019. Adjusted operating income in the fourth quarter of 2020 was $18.8 million. This compared to adjusted operating income of $19.4 million for the prior year period when we reported an $11 million one-time benefit due to the retroactive exclusion of tariffs. Excluding that non-recurring event in 2019, the significant year-over-year improvement was primarily driven by higher net sales, merchandise sourcing and costs-out efforts, and selective retail price increases and SG&A leverage in 2020. In the fourth quarter of 2020, we had other income of $68,000 compared to other expense of $0.5 million for the 3 months ended December 31, 2019. Both years reflected interest on borrowings on our credit agreement. The interest expense on borrowings in 2020 was offset by a favorable adjustment of $1.2 million for the reversal of interest expense associated with antidumping and countervailing duty rate changes. In the fourth quarter, after determining that the company was no longer in a consolidated 3-year cumulative loss position, we partially released the valuation allowance recorded against most of our U.S. deferred tax assets. As a result, we recognized an income tax benefit in the fourth quarter of $12.6 million. This was driven by the partial release of the valuation allowance of $19.6 million and year-end deferred tax true-ups, including the impact of the CARES Act. The release of the valuation allowance in Q4 has no impact on future cash taxes or effective tax rate. For the fourth quarter of 2020, net income increased by $14.7 million to $31.1 million compared to net income of $16.4 million for the fourth quarter of 2019. Finally, earnings per diluted share was $1.05 for the quarter versus earnings per diluted share of $0.57 in the year ago quarter. On an adjusted basis, fourth quarter earnings per diluted share of $1.06 compared to $0.57 for the fourth quarter of 2019. Recapping the full year results, total net sales increased $5 million to $1.1 billion in 2020. This represented a strong second half performance following the COVID-19 disruption in our second quarter. Operating income increased $40 million to $56 million and adjusted operating income was up $39 million to $64 million. 2020 adjusted operating margin was 5.8%, up 350 basis points from 2.3% in 2019. The higher operating income reflects good progress on our profit improvement initiatives, with our merchant and sourcing teams implementing strategies to improve gross margins. Our marketing team is deploying more efficient and effective digital marketing spend and our overall organization driving disciplined expense management. We had other expense of $2.6 million and $3.8 million for the years ended December 31, 2020, and 2019, respectively. The expense in both years primarily reflected interest on borrowings under our credit agreement. The expense related to borrowings in 2020 was partially offset by a favorable adjustment of $1.2 million reported in the fourth quarter of 2020 for the reversal of interest expense associated with antidumping and countervailing duty rate changes. For 2020, we reported an income tax benefit of $7.8 million, which represented an effective tax rate of negative 14.5%. Excluding the release of the valuation reserve and the CARES Act impact, income tax expense for 2020 would have been $13.6 million, which represented an effective tax rate of 25.3%. For the prior year, we recognized income tax expense of $3.3 million, which is an effective tax rate of 25.4%. Net income was $61.4 million or $2.10 per diluted share in 2020 compared to net income of $9.7 million or $0.34 per diluted share in 2019. On an adjusted basis, 2020 earnings per diluted share of $2.28 compared to $0.54 for 2019. Net income and diluted earnings per share for the fourth quarter and full year 2020 benefited from the partial release of the valuation reserve of $19.6 million. Turning to the balance sheet, inventory at the end of the fourth quarter was $244 million, up from $237 million at the end of September and compared to $286 million at the end of 2019. The 15% year-over-year reduction in inventory was primarily driven by managing our inventory purchases as a direct result of COVID-19, followed by supply chain constraints on replenishment and strong second half sales that kept inventory below our targeted level for year-end. Our teams are working diligently to receive new inventory in the face of supply chain disruption. As of January 31, inventory was $243 million. And we are working to increase inventory to a more optimal range of $270 million to $290 million in 2021. Our balance sheet is strong. We ended the quarter with cash and cash equivalents of $170 million, up from $9 million at the end of 2019. Net cash provided by operating activities was $157 million for 2020 compared to $300,000 in 2019. The increase was driven by strong operating performance, along with our disciplined working capital management program and temporary adjustments as we navigated the COVID-19 environment. And as business rebounded in the second half, we did not replenish inventory to optimal levels due to supply chain constraints, which also contributed to our above average customer deposits and accounts payable during 2020. These working capital factors favorably impacted our cash flow from operations in 2020. Also, several nonrecurring activities generated a net $13 million increase in cash in 2020. These included collection of the tariff recovery receivable, the deferred payroll taxes associated with the CARES Act and insurance settlements, which were offset by the payment of legal matters and settlements. At December 31, 2020, we had $214 million in liquidity, comprised of $170 million of cash and cash equivalents and $44 million of excess availability under the credit agreement. This represents an increase of liquidity of $103 million from December 31, 2019. At year end, we had $101 million in debt outstanding under our credit agreement, which is unchanged since we announced our ABL amendment in April 2020. Despite our strong current position, uncertainty in the near to medium-term environment will require a sustained focus on maximizing liquidity. As a result, we have chosen to maintain a high cash balance at this time to provide financial flexibility as we manage through the current uncertain environment. We will continue to review this decision each quarter. Turning now to 2021, our team remains dedicated to our transformation, driving growth and improving profitability. We are pleased with our ability to manage costs and maintain a strong and flexible balance sheet during these uncertain and challenging times. As Charles noted, uncertainty surrounding the duration and extent of the COVID-19 pandemic makes it uniquely challenging to accurately forecast our future financial performance. As a result, we are not providing annual financial guidance for 2021. I can however expand on some of the details that Charles touched on at a high level. From a sales perspective, we are planning to open 12 to 15 stores in 2021 versus closing net 9 stores in 2020. Barring any COVID1-19 related shutdowns, we expect installation sales to return to a pre-COVID mix in 2021, as we execute our initiatives to attract more customers and as our customers are more comfortable having people into their homes. This will benefit gross margin dollars, but lower the gross margin rate. With respect to SG&A, we plan to continue our expense management efforts and to invest behind our growth initiatives, including new technology and store service levels to improve the customer experience as well as opening new stores. As we demonstrated in 2020, if we see a severe downturn due to a widespread COVID-19 shutdown, we have the ability to adjust accordingly and very quickly reduce our expenses. While I cannot comment on a normal run rate for SG&A in 2021, I’d like to review several onetime events that impacted our SG&A in 2020. Recall that in the second quarter, in response to COVID-19, our adjusted SG&A expense was reduced by $16 million versus 2019, primarily due to lower advertising expense as we reduced our promotional cadence in response to the COVID crisis, but also due to significantly lowered payroll and benefits to align staffing with demand and temporary salary reductions for the corporate office personnel and the Board. In the third quarter of 2020, our SG&A expenses were favorably impacted by a $2.5 million benefit from the final settlement of the business interruption insurance claim related to the August 2019 network security incident, partially offset by $1.8 million of store closure costs. And in the fourth quarter of 2020, our higher SG&A expense versus 2019 included $1.2 million of store closure costs and higher variable expenses related to stronger financial performance. I hope this gives you a better sense of some of the impacts to our SG&A in 2020. For the full year of 2021, we expect our effective tax rate will be approximately 25%, which reflects the statutory rate. In short, we remain focused on our profitability initiatives. We will work to reduce sourcing costs and improve pricing strategies to battle increased gross margin headwinds in 2021. And we are diligently managing expenses and investing behind our growth strategies that will position us as the customer’s first choice in hard surface flooring, with the ability to adjust to the macro environment as needed. Our balance sheet and liquidity are strong, giving us the ability to invest in our growth initiatives in 2021. From a cash flow perspective, in 2021, we expect working capital to return to more traditional levels. We plan to increase our inventories to between $270 million and $290 million. And we expect our customer deposits will return to more historical levels. In 2020, our CapEx spend was $16 million, and in 2019, it was $20 million. In 2021, we currently expect CapEx investments of up to $24 million to $28 million, as our overall business results support the broad scale rebranding of our store fleet, the opening of 12 to 15 new stores and investments in digital. As Charles stated, our entire organization remains focused on continuing to execute our transformation initiatives to ultimately drive profitability. We are looking to maximize financial and operational flexibility in an uncertain environment as we execute against our strategic initiatives. Thank you all for your time this morning. With that, I’ll ask the moderator to open the call to questions.

[Operator:]

Thank you. Our first question comes from the line of Laura Champine with Loop Capital Markets. Please proceed with your question.

[Laura Champine:]

Thanks for taking my question. Can you dig in a little more to the supply chain issues that robbed you a little bit of sales growth in Q4 and sort of talk about the pathway to fixing those?

[Charles Tyson:]

Yes, Laura. As many people have commented, the – we cut back on a significant amount of inventory as the COVID crisis unrolled, obviously, to protect liquidity. And we felt that, that was the right thing to do. And of course, that’s reflective across many industries that you can see where there are shortages of raw components. And so that definitely drove a capacity constraint issue on containers, particularly out of Asia. And so we work our contracts with the carriers, and we will start to see that repair as we move through the first half of the year. Also, a lot of the mills were impacted in the production of lumber. And so on the solid domestic side, there is a tight availability on raw materials. So there is really two drivers

[Laura Champine:]

Got it. And this is just housekeeping. I may have missed it in Nancy’s comments. But can you give us the average sale in Q4?

[Nancy Walsh:]

The average sale was just under $1,400.

[Laura Champine:]

Got it. Thank you.

[Operator:]

Thank you. Our next question comes from the line of Brian Nagel with Oppenheimer. Please proceed with your question.

[Brian Nagel:]

Hi, good morning. Nice quarter. A question that I want to ask, Charles, you spent a lot of time talking about the opportunity Pro and the efforts of Lumber Liquidators to push into Pro. Can you just step back a little bit? What’s the biggest gating factor? Is it just sort of say, cultural and effort on the part of your company and your stores or are there – is there something more that was going to take investment, whether it’s from a system standpoint or some other type of infrastructure spend?

[Charles Tyson:]

Good morning, Brian. Yes. So the answer to that question, Brian, is we think it’s both. We clearly have got to move our culture from this very high, low sales transactional experience with Pros to a relationship with Pros every day that we’re there answering the phone and meeting their needs and being able to offer a specialized service that they don’t find in – necessarily in other retail environments. But we have also got to build capabilities. We started with a trial scale and retention program that has back-end reporting that allows a field leadership to be very specific in terms of, one, understanding the segmentation of our Pros, and how we connect on the data to see the progress we’re making with those Pros. And as I said in my remarks, there are other areas of value proposition that we’ll be building through the year to make it easier for Pros to be able to transact with us in a relationship fashion. So hopefully that helps.

[Brian Nagel:]

No. That’s very helpful. And then if I could just slip another one in. Look, I am asking a lot of my company – like covered companies this question. But if you look at the results reported in the fourth quarter, again, very, very strong and clearly indicative to a certain extent of the what efforts you’re taking. But how much do you think that the overall environment is – in this continued COVID environment has helped sales at your company?

[Charles Tyson:]

Yes. That’s a great question and one we look at on a regular basis. And I think the answer to that question is, as we think about taking share over the long-term, with still a highly fragmented independent space, 60% of the market is still highly fragmented. Clearly, there is a tailwind from home improvement. And again, we’re watching very carefully. There are about positive tailwinds, I think, out there from a housing and interest rate perspective and then potentially a negative based on what’s happening with COVID. But we’ve got solid foundational growth work going on in our agendas, whether it’s our new digital platform, the investments we’ve been making digitally and in-store, which is really helping our teams be more productive, the work that we are doing foundationally in Pro. And then, of course, as we move through this year, our whole brand revitalization has been a critical element of repositioning us as a hard surface specialty flooring company versus a company that’s got a name lumber and liquidator. So there is a balance there, Brian.

[Brian Nagel:]

That’s very helpful. Appreciate all the color. Thank you.

[Charles Tyson:]

Thanks, Brian.

[Operator:]

Thank you. Our next question comes from the line of Seth Basham with Wedbush Securities. Please proceed with your question.

[Seth Basham:]

Thanks a lot and good morning. My question is around tariffs, what percentage of your sales, were impacted by the reinstituted higher tariffs in the fourth quarter and as you look at 2021, do you expect all of your sales to be impacted by this?

[Nancy Walsh:]

So as we mentioned in our remarks, excluding the $13 million benefit from the retroactive exclusion of the tariffs in Q4 of last year, our gross margin rate expanded 200 basis points. That said, the impact of our weighted average cost accounting, we expect to see a bigger headwind from the reinstatement of the 25% tariffs in Q1 going forward. We are continuing to pursue our mitigation strategies, leveraging best country sourcing, which remains key to our mitigation strategy. As we noted, our imports from China were down to 34% compared to 46% during the full year of 2019. So we’re working with vendors to launch new projects – products, excuse me. And we’re also looking to offset higher sourcing costs through pricing and promotional strategies while we monitor the market to inform and guide our decisions going forward.

[Seth Basham:]

So just to follow-up on that, somewhere less than 34% of your sales were impacted by the higher tariffs in the fourth quarter. And in the first quarter of ‘21 and beyond, should we be thinking about 34% or is it significantly lower number than that?

[Nancy Walsh:]

We are not going to break out anything further for 2021. What we’re just indicating is that there is not – there is going to be a greater impact in Q1 going forward because of the way that we account for the product and the tariffs hitting it. So we had tariffs in Q4, but you won’t really see the impact of that until Q1 going forward.

[Charles Tyson:]

And Seth, let me just – as I said in my remarks, right, we’re really looking at our ability to continue to look at alternative country sourcing, but we’re also looking at government policy, and what will happen long-term to the tariff environment, what will happen with trading in China. There is a lot of discussions going on with Biden’s administration today. Will there be a change? And so that doesn’t put us on pause in terms of continuing to find a quality supplies in different tariff environment countries.

[Seth Basham:]

Understood. Thank you very much.

[Charles Tyson:]

Thanks, Seth.

[Operator:]

Thank you. Our next question comes from the line of Peter Keith with Piper Sandler. Please proceed with your question.

[Peter Keith:]

Hi, thanks and good morning everyone. So Charles, you had talked about with the 20 rebranded store tests that you were seeing, I guess, some qualitative measures of being more approachable, more relevant, is there any quantitative measures you could give us? Specifically, was there any notable change in same-store sales versus the non-rebranded stores? And then with the broader rebranding effort, at a high level, what does that look like over the next couple of months here?

[Charles Tyson:]

Yes. Peter, thanks for the question. Great question. So as we think about where we’re positioning our brand, the launch of our new website, for example, is focused on LL Flooring. And that will start to translate down through the search environment, for example, where customers will see LL Flooring, and that will continue to intensify as we move through the year. As I said in my remarks, we are intending to start a broader rollout of the rebranding of our stores because it was both qualitative and quantitative against control stores. We were happy with the results that we’re seeing. And we believe that driving this brand evolution over the next 12 to 18 months will make us more relevant in the marketplace. The feedback we got from customers is a perception of quality of expertise, and traffic results reflected that. And so again, it’s a longer journey. It’s not just the next 2 months, Peter. We see this as being part of our transformation and part of our work over the next 18 months.

[Peter Keith:]

Okay. That’s helpful. And then I know you’re not providing any guidance. You provided some – maybe some guardrails, we’ll call it. But how should we think about overall gross margin though? There does seem to be some notable puts and takes with the tariffs, to transportation, and then your ability to adjust pricing. Is there any way that gross margin would be up this year or are the headwinds too extreme?

[Nancy Walsh:]

Again, we’re not really giving specific detail in terms of gross margin. We’re just indicating that there are headwinds, both related to tariffs as well as some of the transportation disruptions that Charles talked about. But coming into or coming out of Q4, we had a 200 basis point improvement compared to 2019. So our mitigation strategies that Charles mentioned are showing good work in terms of particularly our country sourcing, but as well as we work with vendors to launch new projects – products, I cannot get that word out, excuse me, and offsetting the higher sourcing costs through pricing and promotion strategies that will monitor the market. So there is a number of headwinds and tailwinds, and we’re just moving forward with our mitigation strategies.

[Peter Keith:]

Okay, thank you. Good luck.

[Charles Tyson:]

Thanks Peter.

[Operator:]

Thank you. Ladies and gentlemen, that concludes our question-and-answer session. I’ll turn the floor back to Mr. Tyson for final comments.

[Charles Tyson:]

Thanks, everyone, for joining us today. Again, I want to thank all of our associates for everything they are doing to help us and our business during these difficult times. I want to reiterate that we’re excited by the strong sales growth and profit performance in 2020. And we are confident in a transformation strategy and our ability to quickly adapt to this dynamic operating environment. Wishing everyone good health and safety. And we look forward to talking to you at our next update. Thank you. Have a great day.

[Operator:]

Thank you. This concludes today’s conference. You may disconnect your lines at this time. Thank you for your participation.