LL Flooring Holdings, Inc.
Q2 2019 Earnings Call Transcript

Published: 7 Aug 2019

[Operator:]

Good morning, ladies and gentlemen, and welcome to Lumber Liquidators Second Quarter 2019 Earnings Conference Call. As a reminder, ladies and gentlemen, 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 Danielle O'Brien. Please go ahead.

[Danielle O'Brien:]

Thank you, Operator. Good morning, everyone, and thank you for joining us. 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. The information contained in this call is accurate only as of the date discussed. Investors should not assume that the statements will remain operative at a later time. And Lumber Liquidators undertakes no obligation to update any information discussed in this call.Now I'm pleased to introduce Mr. Dennis Knowles, CEO of Lumber Liquidators. Dennis?

[Dennis Knowles:]

Thank you, Danielle, and good morning, everyone. Today I'm joined by Charles Tyson, our Chief Customer Experience Officer; and Tim Mulvaney, our Interim Chief Financial Officer. We have been sharply focused on executing our state of transformation strategy throughout the first half of 2019, with a goal of strengthening our foundation to position our company for future growth. This quarter was our first full operating period without headwinds from legacy product-related legal issues, and in June, we entered into a memorandum of understanding in the Kramer employment litigation case discussed in our SEC filings. We are glad to have taken a meaningful step closer full resolution of this matter and with these issues behind us, we've been quickly moving to execute our transformation strategy as we work to build momentum and long-term growth.Our second quarter results were generally in line with our expectations, and we delivered net sales of $289 million, an increase of 1.8% over Q2 of 2018. Comparable store sales were flat in Q2 and improved sequentially from Q1, but we experienced softening traffic trends as the quarter progressed. Merchandise sales declined slightly but were offset by continued growth in installed sales. Additionally, our average ticket grew approximately 2.5% for the quarter. Similar to last quarter, bamboo continues to face a secular shift in the consumer demand that has pressured sales, though to a lesser extent, this quarter, we anticipate the impact of the shift away from bamboo will be significantly less of a drag in the back half of the year.On an adjusted basis, our gross margin improved 20 basis points during the quarter, as various cost out efforts and favorable mix towards higher margin Vinyl products more than offset the current impact for tariffs. We have work diligently over the past three quarters to navigate the challenging and uncertain tariff environment. As we relate last quarter, we fully offset the approximate $22 million of annualized headwind created by the 10% tariff implemented last September through cost mitigation efforts and another inventory elements. It has been far more challenging to address the incremental $34 million of annualized headwind created by the additional 15% tariff that went into effect in mid-June, but our teams have made great progress. We have doubled down our mitigation efforts and identified areas to further reduce cost within our existing initiatives. These include continued negotiations with vendors, the evaluation of our multi-country sourcing and supply chain strategy as well as our decision to selectively increase retail prices late in the quarter.We are also managing our cost structure and reducing SG&A, while continuing to maintain a high level of customer service and improve the experiences in our stores. During the quarter, we underwent a field structure reorganization, reduced overtime in the stores and identified other cost-saving initiatives. This focus on efficiency will continue during the back half of the year with the expectations of near-term benefits stemming from an ongoing deep dive into costs across the business as efficiency opportunities are realized. As we look back at the first half of the year, we are proud of the progress today that recognized we have significant work ahead of us to bring Lumber Liquidators to the next level.With legacy product-related litigation issues behind us, we have been relentless in executing on the transformation strategy. In this quarter alone, we launched new advertising that more effectively reaches consumers early in their flooring project journey; produced new creative content to be deployed across national networks through the back half of 2019; we enhanced digital and technological capabilities; expanded Pro and Installation services; leveraged learnings from our new open concept format; and continued our tariff mitigation efforts, all while delivering great value to our customers and maintaining a strong competitive position. We believe these initiatives will position us well to increase our market share and drive revenue growth.Moving on to our plans for the remainder of the year. Our strategic priorities remain unchanged as we focus on growing our top line, providing the best possible unique customer experience and optimizing margins in this challenging tariff environment. To this end, we will be making some exciting progress in the second half. We intend to activate new creative advertising content for national distribution, drive traffic with our new fore-finder digital tool, prioritize Pro and Install sales growth through our new sales associate training to identify cross-selling opportunities and highlighting Pro needs and test new display tactics to identify where the customers respond most positively, including alternate ways of displaying foreign samples.First, our new advertising agency has a full quarter under their belt with us and we've been able to activate some exciting new campaigns. This includes optimized promotional materials which drove our largest ever April sales. Additionally, as we seek to constantly improve the customer experience, we remain focused on building our omni- channel approach and utilizing our digital capabilities to meet our customers' needs at every touch point. Our picture at floor visualizer tool continues to receive rave reviews, both in stores and online, and is allowing us to attract new customers to our brand. Second, with driving store traffic as our priority for the second half of the year, we expect to enhance our digital presence, deploy our floor finder tool and build a more robust inventory of product descriptions to ensure our customers have all the pertinent information at their fingertips.We're working to identify customers earlier at the beginning of their flooring journey through ideation phase and the floor finder does just that. The tool is personalized, quiz-based product that walks customers through several sets of question to help narrow what foreign samples they may want to explore in the store.Third, both our Pro and Installed sales continue to drive growth for our business. Consistent with our focus over the past several quarters, we are developing capabilities to be more relevant to both of these customer groups. Both our Pro and Installed businesses delivered double-digit sales growth in the quarter. In the back half of the year, we will be conducting market research focused on these groups and will be launching a catalog for our Pro customers early in the third quarter. Finally, we remain on track to add 10 to 15 new stores during this year, and of that total, expect 4 to 5 to be opened or retrofit into the open concept format as we continue applying the learnings from [indiscernible]. In light of these strategic initiatives, let me take a moment to provide some color on how we're thinking about the puts and takes that contribute to our outlook for the back half of the year.First it is important to note that the new 10% tariff on list four products proposed last week do not apply to products we sell and therefore, will not have a direct impact on cost. However, we are conscious of how potential price increases on a broad set of consumer product could impact consumer sentiment and discretionary spending. That said, in the second half, we expect traction from new initiatives. And from a relative perspective, we benefited from easing year-over-year comp sales performance as our second half 2018 comps were approximately 250 basis points lower than our first half 2018 comps. We also benefit from the calendar as the second half of 2019 has one fewer Sunday, our lowest volume day, versus 2018, which should result in approximately $2 million in year-over-year benefit.Finally, as we stated previously, we expect to drag from the underperformance of bamboo to continue to lessen throughout the back half of 2019. Offsetting those expected tailwinds and as I mentioned earlier, we experienced slowing track traffic as the second quarter progressed. With weakness continuing into July, and we believe the hard surface foreign industry is in a period of frightened uncertainty on many fronts. We are mindful of the current moderating growth in many housing-related metrics that we consider drivers of the home improvement spending. Additionally, we see the potential for the uncertainty created by the tariffs influence consumer confidence, perhaps compounded by the potential 10% tariff and ultimately, rising retail prices across the variety of products that could impact consumer demand. Finally, we remain very confident in our competitive position as well as the superior value that we deliver to our customers. As a result of the uncertainty in this environment, compounded by softness in this sales trends to start the third quarter, we are reducing our full year guidance. We now are more comfortable with an outlook for low single-digit total revenue growth, down from mid-single digits previously and approximately flat comp sales, down from our previous expectation of flat to low single digits.Our operating margin outlook is a range of 1.4% to 1.9%, down 50 basis points from our previous outlook, which would equate to an operating margin of flat to down 50 basis points for the full year 2019.Our transformational work will drive more transactions in our store, and we are encouraged for the long-term opportunities we see as we execute our plans and our initiatives being to deliver results. While macro and industry uncertainty remains related to tariffs, the strength of the consumer in the competitive landscape, our ability to successfully navigate the expected and unexpected challenges, as the first half of the year give us confidence in our ability to execute our strategic initiatives and continue our progress through the rest of the year.I will now turn the call over to Charles.

[Charles Tyson:]

Thanks, Dennis. Our teams have continued their work this quarter, improving customer experience, developing our marketing plan to improve traffic and driving brand awareness of Lumber Liquidators as a national specialty, hard surface flooring provider. With the current higher tariff environment, our team is continuing to focus on impacting product cost. The sourcing and merchandising teams have continued to execute strategies to develop alternative country surfing for both manufactured and wood products to help mitigate the impact to margins and sales.And we've already started moving some production out of China, but uncertainty regarding the future of tariffs has some suppliers cautiously evaluating the commitment of capital required to build new manufacturing facilities. As the tariff issues continue, we see more of them seriously considering building new facilities that could potentially accelerate sourcing from regions other than China. But by the end of 2019, we expect to be in the mid-40% range of product purchased from China, down marginally from 2018. Driving product development at an accelerated rate in this environment is critical. Exciting customers with new styles and trends is core to driving market share. We have an aggressive new product introduction plan for the back half of 2019, building on the launch of our AquaSeal brand in multiple categories as well as expanding in number of tests that are underway in our wood business. This also provides our sourcing team increased leverage as we look to improve longer-term margin performance in this environment.As Dennis mentioned, we've adjusted prices to help offset the impact of tariffs. Our pricing team is evaluating and executing on opportunities to optimize our promotional positioning by region and category across the country. And we are confident in our current competitive position and continue to monitor the environment closely to ensure we remain competitive, observing both independent and big box industry participants. Turning to supply chain. We have accelerated initiatives to improve inventory productivity, to offset the impact of rising inventory levels, driven by the 25% tariff. We have worked with strategic vendors to reduce purchase order cycle times, which will enable reduction in safety stock in the latter part of the year. We've increased our focus on a life cycle management to improve inventory performance through product transitions. In addition, we're working to increase the breadth of certain regionally-specific in stock SKUs to drive wood sales. We've seen the benefit of stocking these high-velocity market-specific SKUs in our ultimate Spring store, and this is one example, of our teams applying learnings from this prototype to the chain.To drive traffic, our marketing team has been developing new creative assets to highlight our value proposition that is driven by high-quality products, coupled with a great in-store and online service experience. During the second quarter, we launched a new commercial starting our Picture It! floor visualizer tool, but began airing on HDTV at the beginning of July and was rolled out to other national networks later that same month. We're continuously evaluating the best mix of advertising for our business and allocating our marketing spend wisely, which will remain a central pillar of our transformational strategy. We plan to have a new creative content launching this quarter and are assessing new ways to promote store openings. We will expand on this communication strategy in the back half of the year with new creative content and optimized deployment schedules.Our teams have been focused on our preparation and development of our new e-commerce platform, which will be utilized by our in-store, DIY and Pro customers. The goal of improving our online shopping experience has been central to the work of our digital team and we are delivering enhanced performance benefit as we implement this new platform. We expect to start implementation in the fourth quarter of this year. Within this new platform, that are opportunities to incorporate some of our digital advertising initiatives. The marketing team focused on driving customer acquisition earlier in the purchase cycle is developing improved content and enhanced digital marketing programs that aim to capture customers effectively, while the ideation of purchase basis of their projects.I will now turn the call over to Tim to share of the financial details of the quarter. Tim?

[Timothy Mulvaney:]

Thanks, Charles. Good morning, everyone. In the second quarter, net sales were $289 million, an increase of 1.8% over last year, with comparable stores flat versus year ago. The overall net sales increase was driven by 10% growth in the installation sales, supplemented by 0.7% uptick in merchandise sales. The overall flat comp was the result of a 2.5% increase in average transaction volume offset by similar decrease in transactions. As Dennis stated, we continue to see strong growth in Vinyl products with offsetting softness in exotic solids, most notably in bamboo.Gross margin for the second quarter of 2019 was 35.5% compared to 35.7% in the equivalent quarter a year ago. Both periods were favorably impacted by out-of-period duty-related adjustments. Without these items, adjusted gross margin grew to 35.2% from 35% in the prior year period. And more favorable mix towards vinyl, along with higher average selling prices drove the improvement over the second quarter a year ago. Adjusted margin was up 20 basis points despite product costs that were higher due to the tariffs. The 35.2% was sequentially flat with the first quarter of 2019 as seasonally higher promotional activity, particularly during the April sale, offset other margin gains.As noted earlier, the latest tariff increases were not part of our guidance last quarter. As such, our expectations for the remainder of 2019 have changed. We now expect to see adjusted gross margin improve in Q3 due to higher average selling price and in Q4 be tempered by the flow through of inventory burdened with higher tariffs costs. This will cause some of the improvement to recede. We expect to incur the full impact of the 25% tariff on COGS late in Q4, as the tariff burden inventory flows through our supply chain, but our mitigation efforts will now fully offset the latest impact until Q1 of 2020.SG&A expense for the second quarter was $104 million compared to $102 million in the second quarter last year. SG&A in both quarters included incremental legal and other costs of about $6 million related to the lawsuits, investigations and certain other legal matters. Specifically, we booked a $4.75 million expense in the second quarter of 2019 related to the Kramer employment case that Dennis mentioned. Both periods items are tabled out in the press release. When excluding these items from both periods, adjusted SG&A expense for the quarter was $98 million or 34% of sales, an increase of $1.9 million and flat on a percentage basis versus the same quarter a year earlier. Higher payroll from new stores and advertising costs were offset by lower legal fees and professional fees.For the quarter, we recorded an operating loss of $1.4 million compared to an operating loss of $0.9 million in Q2 of 2018. After adjusting for the items noted above, we had adjusted operating income of $3.6 million in the quarter compared to last year's $3 million adjusted operating income in 2018. Improved adjusted gross margin was the single largest contributor.Before moving on to our expectations for the remainder of 2019, let me address our liquidity which remains strong. As our core operations continue to generate positive cash flow, we paid all of amounts related to the DOJ and SEC settlements early in the second quarter. As a reminder, we have also paid the cash portion of the NBL settlement from a year ago. For the Kramer employment case, where we recently reached agreement, we expect to fund that $4.75 million in the second half of this year. Our expectation related to the gold settlement remains the same with payment expected later in 2019 or into 2020. The mechanics of the payment remain unchanged and are outlined in our Form 10-Q.As a reminder, we did add $50 million of borrowing capacity at the end of Q1 by amending the company's credit agreement. This also extended the maturity to 2024. As of June 30, we had borrowings that consisted of a base term loan of $25 million and a revolving credit agreement with $64.5 million drawn. We had liquidity of $117 million consisting of availability under our credit agreement of $104 million and cash of $13 million. Inventory at the end of the second quarter was $304 million. However, with the expansion of tariffs on goods imported from China, the 25%, we anticipate that inventory will expand in the back half of the year and will end the third and fourth quarters in the $305 million to $325 million range.Turning to our outlook. We are lowering our guidance for the year, and our 2019 outlook now assumes a continuation of the 25% tariff on Chinese imports for at least the balance of 2019, which is a change from our previous guidance that only assumed 10% tariffs. We have also experienced slower traffic trends than previously expected. As a result, we now believe total revenue will increase in the low single digits as compared to mid-single digits from our previously issued guidance and comps will be approximately flat for the year as compared to flat to low single digits previously. In terms of adjusted operating margins for the year, we are now anticipating this to be in the range of 1.4% to 1.9%. The expansion of tariffs to 25% has added considerable uncertainty to the back half of the year. The macroeconomic signals are mixed and how consumers will react remains to be seen. In addition, as the industry fully digest the impact of higher tariff-related costs, we will closely monitor competitive dynamics and hard surface floor pricing.Our 2019 guidance reflects an assumption of moderating macro and consumer strength and an uncertain pricing environment in relation to rising costs. However, significant moment in any of these factors could meaningfully impact our outlook. As a reminder, we have included $2.3 million of nonrecurring expenses in 2019 in the back half of the year related to relocation of our corporate headquarters. But we do expect our ongoing evaluation of costs across the business to deliver savings this year, while also positioning us well for 2020 and beyond.On the investing side, we plan to open 10 to 15 new stores in 2019. We expect capital spending of $15 million to $18 million. We anticipate cash paid for taxes will remain nominal and that the valuation allowance on our deferred tax assets will remain in place for the year. We see cash paid for interest to be in the $3.5 million to $4 million range.Thank you for your time this morning. With that I'll hand it back to the moderator to open the call for question.

[Operator:]

[Operator Instructions]. Our first question is from the line of Beryl Bugatch from Raymond James.

[Beryl Bugatch:]

I guess, the first place I'd like to go is kind of talk a little about the traffic and the concern you have of moderating traffic and whether you can pinpoint any of the causes for that or in talking to consumers? What you've learned about that moderating traffic?

[Dennis Knowles:]

Budd, if you look at our traffic on two year stack, we actually improved in Q2 over the prior year. It actually going against the stronger -- probably our strongest traffic comp from last year. We started to see things kind of slow down a little bit towards the end of the quarter in terms of traffic. And I think a little bit of that was driven by -- we believe what's going on just in the macro environment. There's a lot of noise in the news about interest rates and there always seems to, at least in my experience what a bit of pause, waiting to see what's going to happen, seems to have some kind of impact on bigger ticket.Obviously, especially some of these planning to finance that jobs, we saw a little bit of that. As we said, we raised some retail towards the end of the quarter, but we don't believe that pricing was a factor. We just saw things kind of slow down a little bit. It was more towards the quarter. We had grateful April sale and May was down a little bit and kind of more flattish in the month of June, but it was just seems like slowdown kind of took place towards the end of the quarter and a little bit into July. Now in July, we had promotional calendar shifts. So we've got some things that are moving -- that moved to the back of the quarter of July, two events, in particular, that takes place it won't match up exactly with.So I think that was the primary driver of what we saw in July. So outside of just macro impacts, nothing material in what we did with the business. We just kind of saw that slowdown. Are much comps actually improved quarter-over-quarter and we expect that to continue? And how would say we're probably of probably through the biggest impact that will see as it relates to installation as I mentioned before, when the rollout installation, we procure that entire transaction for the customer. So they generally might make two or three trips and I think that just going to get light of for us as a headwind as the year goes along and Tim has kind of unbundled the way that we did the Pros in the past. So that will be less of an issue for us as well. But I would say probably the primary driver with their it seems like there was a bit of a slowdown or pause if you will towards the middle and end of the quarter.

[Beryl Bugatch:]

Was there any difference -- could you tell any difference in velocity of items on which you raised prices? Was there any notice will change in the velocity consumer of those products?

[Dennis Knowles:]

Well, we did it -- we did it in the -- we really did towards the end of the quarter. So I think it's a little early for us to tell you. But nothing noticeable at this point.

[Beryl Bugatch:]

Okay. And Altamonte Springs, you opened that. You talked a little bit about last quarter what it was. You had three more months under your belt. What's the early rate of the more intermediate term read on Altamonte Springs?

[Dennis Knowles:]

We really like the results. I mean, it's driving bigger ticket, it's driving product sales across -- more product sales across other categories that we quite honestly have struggled in. And we [indiscernible] as Charles said, there is a couple of things that we've been able to glean from that store early on that we can apply to our existing store base and then we are planning to open our second open format store in Colorado within the month. So we're still excited about the performance of it and just kind of pulling the things that we're learning from that store that we could rollout to our existing store base as well as making tweets for that. We'll also retrofit a couple of this year as well.

[Beryl Bugatch:]

Okay. And just for me, just two more detailed questions. Of the $68 million of your accrual on the balance sheet for legal settlements, how much of that is cash? Is it gold settlement in there? And I think the Kramer settlement is in there? Is there anything else in there NBLs and noncash right, so Tim?

[Timothy Mulvaney:]

That's correct. The remaining MDL that's in there which is $14 million is noncash. The gold has $14 million of noncash as well.

[Beryl Bugatch:]

So what's the cash portion of that $68 million and that has to rollout of?

[Timothy Mulvaney:]

Well there's still $21 million that we have at the liability -- $21.5 million related to the MDL but we have a corresponding asset on the asset side of the balance sheet. So it's still in the liability, but it's -- there is a cost corresponding, so no further cash would go forward.

[Beryl Bugatch:]

Got you. And lastly for me, on the inventory, how much of the inventory is now tariff? Can you quantify what of that $304 million of inventory is really tariff inside that inventory?

[Timothy Mulvaney:]

I don't have a specific number. But as you think about the impact on us, the 10% tariff as of June 30 had largely run through. That was approximately $22 million. And we turned it a little over 2x a year. So little bit less than half of that had been sitting on the balance sheet.

[Beryl Bugatch:]

Okay. And so then we would have the -- of the additional $30-some million will -- think about the same way and kind of figure that maybe something like $15 million of that winds up on the balance sheet?

[Timothy Mulvaney:]

Yes, somewhere between $12 million to $15 million, I think would be a good estimate.

[Operator:]

Our next question is from Simeon Gutman with Morgan Stanley.

[Simeon Gutman:]

My first question is on the merchandise the product comps. Just high level, can you talk about why you think they haven't turned yet? It sounds like it's a combination of things, but I want to hear your thoughts on that?

[Dennis Knowles:]

Yes. I would say that bamboo is probably the single largest contributor beyond a doubt for us. It's been our biggest headwind. And as Tim mentioned on the call, that will become less of a headwind for us in the second half. We'll have fully cycled but what I believe will be no more normalized trends in Q4. But it's been, Simeon, a significant headwind for the company.

[Simeon Gutman:]

Okay. Fair enough. My follow-up is on the gross margin guidance. Q3, you said up. Can you clarify that up year-over-year? Or is that a quarter versus quarter? And then related for the fourth quarter, can you give us a sense of the magnitude of the compression that you're expecting?

[Timothy Mulvaney:]

Yes. This is Tim. In terms of your first question, it should be up to both. In terms of -- we're expecting that expansion to both top and continue the quarterly progress that we have started this year as well as the prior year. It will -- in the second half -- probably the way to think about the second half is combined with the first half, we'll probably get back to about the same level as we had for 2018 for the full year, which was a little north of 36%.

[Operator:]

Our next question is from Oliver Wintermantel with Evercore ISI.

[Oliver Wintermantel:]

I had a question regarding the ASP drivers. It looks like we are up about 2.5%. What was to split with that? How much of that was tariffs? How much was installation attachments and all of that, if you could clarify that, please?

[Dennis Knowles:]

I would say I don't really have how much of the -- it's most of it was probably ASP. There was a large contribution from installation. The installation mix, its 13% penetration and grew double digits for the quarter. So that's -- that was a pretty large driver of our ASP as well.

[Oliver Wintermantel:]

Okay. And from -- if you could update us on the Pro penetration? And then maybe related to that, if traffic was down about 2.5%, was that mostly DIY or was there also a Pro component to it?

[Dennis Knowles:]

I would -- no, it's the Pro continues to penetrate north of 25% and the Pro traffic was up year-over-year as well. I would say, it was primarily the DIY traffic.

[Operator:]

Our next question is from John Baugh with Stifel.

[John Baugh:]

So I was wondering, Dennis, Charles, there was a final determination on engineered wood flooring out of China that raised rates significantly for many companies in China. Does that have any impact on you all, perspectively?

[Timothy Mulvaney:]

Prospectively it shouldn't have much impact. We've mitigated that. For what had previously run through, we had about $800,000 items that -- if it goes and sticks because it probably will be appealed, if it sticks, we would have addition $800,000.

[John Baugh:]

Okay. And then your six months molding and accessories is down a little bit more, I think close to 6% versus the year prior. I'm wondering, is that the LVT? Or what's driving molding and accessories which I think have higher margins lower?

[Dennis Knowles:]

Two things for the driver that and primarily one item is the driver that are at the seams that we sell or used to sell with our solid bamboo. There's -- it's right in the same comp performance as the solid bamboo. Another driver that will see as an impact for the next year or so will be, there's more of a -- there's a conversion from product without pad to product with pad attached, both in LVT and in the laminate business. So that's a significant headwind for us. But it's driving most of the attachment erosion.

[John Baugh:]

Okay. And then lastly, I don't expect you to discuss your pricing strategy going forward. But could you at least tell us what you took pricing on late in the June quarter? And put the magnitude this? As human Dennis, we are trying to offer wait-and-see mode, so many retailers have not yet seen the higher cost flow through, and just kind of wondering if you could offer any kind of how you think about pricing going forward as well as what you've taken so far?

[Dennis Knowles:]

You better. It's a great question. You think about there was a fair amount of pre-buying that could -- where it could be bough prior to the tariff. And I think different companies bought at different levels, so that probably impacted why you might see others will before others. But we were very conscience of that as we saw these tariffs roll through the quarter. And really Charles and the pricing team had kind of developed. We've done a lot of competitive intelligence, both with the independence as well as the national change to understand kind of where everybody was -- if there was any moment so we want to make sure we were competitive. And we applied those learnings to how we thought about adjusting price increases. Now the difference between the 10% and the 15%, as I said, earlier, but we had time to pre-buy.But for the 15%, there was really wasn't time. It was talked about and executed really within a short window and so with an order cycle, it's north of 100 days. I doubt anybody buying anything out of China was able to prebuy. So we believe that there will be a lot quicker reaction to that tariff increase and the subsequent price increases will probably, I would say, accelerate through the second half of the year. So we continue to monitor it on a daily basis and literally looking at where the competitors are. We have seen a pretty significant uptick from the independence, while the national change have been slower to move, depending on just the mix of their product. I think obviously, you can imagine there's some products from China that have a shorter order cycle and there are some that have much longer. Manufacture products, in particular, primarily manufactured in China, so they going to hit everybody pretty quick. And again, we're fortunate enough. We don't source from laminate from China, so it's not something we've really had to focus on a great deal other than just making sure we're comfortable. So we'll continue to apply those learnings through the back half of the year and adjust our retails as needed. We want to remain competitive. And I'll remind you high low retailers, so we'll maintain our competitive posture in our promotional events anyway, but our day-in, day-out pricing's where we really make sure that we're paying attention to that to the cost inbound cost from the tariff increase. I mean, it's today.

[Operator:]

[Operator Instructions]. Our next question is from Laura Champine with Loop Capital Markets.

[Laura Champine:]

I just want to make sure that I understand the full potential impact from tariffs. Your 10-Q calls out $50 million hit at the current tariff rates. Is that from what has -- is there any potential upside to that number if we go to list for or all your products on was 3? And does that include the impact of slightly reducing your exposure to China from the 45% to 50% range to the mid-40s?

[Timothy Mulvaney:]

So as far as the latest list goes, no, we are not on that list. Our products are already fully impacted there. I think Dennis called that out on his notes. As far as the mitigation from moving to alternate country sourcing know, that is a gross number before our mitigation efforts. So we're not expecting to see $50-plus million come through our income statement because we've taken significant steps to mitigate it. That is gross bill that the tariffs have put onto the company based on where we're buying.

[Laura Champine:]

Can you give us more of a split on mitigation versus price increases, meaning if $50 million is gross, what you think you can offset with mitigation efforts working with vendors? And what you think you need to pass-through in pricing?

[Dennis Knowles:]

We haven't disclosed that. But I think it's a fair mix of everything we've talked about in the prior calls, Laura. There is -- there'll be a fair amount of it, taking in cost out through our vendors. There will be an additional portion, albeit smaller the piece of it that we are removing or have already moved. And then we'll adjust the rest with retails. We currently believe we have everything in place to mitigate that cost.

[Operator:]

Our next question is from Rick Nelson [ph] with Stephens.

[Unidentified Analyst:]

Do you think that the independence source so much from China is Lumber Liquidators? And if you can comment on the big box home centers also?

[Dennis Knowles:]

It's a great question. We believe -- we do our own competitive analysis and believe that everybody is pretty much in the same boat as we are. I mean, LVT, all the vinyl products, I would say probably and this is my guess, but I would say probably north of 80% of the production currently comes out of China. So there is not much choice to move that product in the short term and there is a fair amount of emerging production in the U.S., but not enough to satisfy the demand. So I would say that probably everybody is sourcing that from China. The problem I would say the challenge for an independent is that most of them don't buy direct. They buy through either a cooperative purchasing group or they buy from a distributor. And we have seen that the distributing are passing that additional cost on to the independence, and therefore, they have an opportunity to mitigate. That's what we suspect is happening.And I think we've heard that on another call this week. So also I think the big box stores by size are typically -- they seem to be challenged across more product lines than just flooring. So I suspect that they are bringing the same product in the we are. The vinyl is primarily coming out of China. Laminate, there's a fair amount of U.S. production now laminated has been for the last couple of years. We buy laminate from Europe and the United States, and I think most of our competitors buy -- I know one competitor buys significant amount of laminate out of China. So I'd say everybody's probably in the same boat. As it relates to tile, we don't -- porcelain tile, we don't buy any tile out of China. So we're not -- we don't have to worry about that business. So -- and I know, we carry a small amount compared to everybody else. So it's not a problem for us. I would say that it's probably pretty even with the distributors and the independents kind of being at the mercy of their distributor. I suspect they buy some domestic solid wood and some engineered wood in the United States. But even that a lot of the components come from China.

[Operator:]

Our next question is from David McGregor with Longbow Research.

[Robert Aurand:]

It's Rob Aurand for David this morning. I wanted to ask you about the alternative country sourcing. You alluded to getting China down to a mid-40% by the end of the year. But I was hoping you can maybe talk about moving past the end of this year, maybe where that number could get to or maybe share what percent do you think can be moved from China?

[Charles Tyson:]

Yes, so Rob, it's Charles. As I said in my remarks, we're working with a lot of vendors who are looking at where they could potentially move production to out of China. But I think this is going to be moving quarter-by-quarter in terms of the insights we're going to get because many people are looking at pretty significant capital investment whether it's in Vietnam or Cambodia or other parts of Asia. And it's a tariffs come off and China will still remain at the lowest-cost production. So even moving to Vietnam on a net basis may not be completely beneficial to tariffs come off. So we've got a good view of where we think our balances are going to end by the end of the year. We are working with a number of suppliers, one of which has already broken ground, we closed this in 2020 to move more production out of China.But at this point, we are not prepared to give a number of the below where we're sitting at the end of 2019 because, as you know, production lead times are pretty long on some of these manufacturers. And we need to make sure that they get all their licenses, that they're going to be compliant in the country's at which they're going to operate. We spend a good amount of time doing due diligence around compliance and quality. And we need to be very careful that when we make a move, that move is to a new supply that's going to meet our new compliance rig requirements. So we have a team that's been very diligent and that's good work in the last 18 months on both the cost out component where the existing supply is, which we continue to work with; new product introductions, which gives us an opportunity to leverage across our supplier base to further improve gross margin performance; and then work strategically with vendors where they intend to make commitments, where there it's here in the United States, where some are looking at additional capacity to build it or they continue to build in Asia.

[Robert Aurand:]

Okay. And I was hoping ask you about mix. Just with the pricing, you put in late in 2Q, to what extent are you seeing trading down as a result of that?

[Charles Tyson:]

Yes. I mean, that's interesting. I mean, today we haven't seen any material change in mix between good assortment. And so this is early with wood doors prices at the end of June and we drive a significant portion of business on promotional mix. And so it will be a number of months before I think we see the insights into that to decide our customers actually trading down when they look at us, the total cost of acquisition. I think the other thing that's important to bear in mind to on this cost side, we have a good growing installation process. And when you think about installation cost is basically half the price of the projects. Those costs aren't moving. And so when you take the total project cost between material and installation, and our installation business is less impactful because getting cost increases across the whole transaction on half the transaction. So again, it's not just looking at [indiscernible] itself but it is looking at the both our installation business and DIY business.

[Operator:]

Our next question is from Brian Nagel with Oppenheimer.

[Brian Nagel:]

So my first question in bit of a follow-up to the prior question, but just trying to understand better, the sales trajectory through the second quarter into July, two questions with that. One, anything you call out geographically? And then, second, I just want to make sure I understood correctly, I think I heard you say that at this juncture, you do not think that weaker sales or weaker traffic has been a function of actions taken as a result of tariffs, is that correct?

[Dennis Knowles:]

Right. That is correct. The trajectory was -- we had a solid April and again, that's the best April sale we've ever had and I would attribute that to we had a good plan and our agency was new, and they did a really nice job for us. So May was down and then we started to rebound a little bit in June and then tailed off more in July. And so we didn't see anything from a geographic perspective. This made us feel like this was more of a macro impact than just a pause, if you will, kind of just seems like we look at several factors we look at number of measures that we do for installations we number of visits we have to decide. We look at our conversions, samples and none of that scene to fall off dramatically. It just seems like there were supporters pause, if you will. And so I just -- we saw this a bit in the fourth quarter when the interest rates went up and there was -- it seems like the pause before the action seemed to resonate with our consumer. So -- but nothing from any geographic perspective. Outside of the hurricane but we also had left in the panhandle of Florida where the hurricanes had hit earlier this year. So it's kind of our take on how the quarter progressed and what we think were the impacts.

[Brian Nagel:]

Got it. The second question I have, I am looking at tariffs and assuming that, in some cases, you will try to push forward higher prices to mitigate the effects. But if you look at the product continuum on your stores, is there a way to generalize where the tariff said it? Is there a mostly the lower priced product? If that is the case, could you see a dynamic where this would actually push consumers maybe into what had been a higher price, higher quality could be essentially margin for you?

[Dennis Knowles:]

Potentially, yes. And we are cognizant of that as we think about our pricing through our product price progression. So something that was a big gap in the past might not be such a big leap for a customer to go from engineered to solid, so to speak. There's not much in our mix, except for us, the laminate. A lot of our engineer comes out of China. We have a lot of solid domestics that don't -- won't have tempered are now the 25% impact. So it's highly likely that we could see that. And we've seen an improvement in our solid business. So just at 10%. So it's highly likely that product that might have been out of reach for somebody before, just not in our consideration, might put within reach. So we definitely have what about that and think about that as we price competitively.

[Brian Nagel:]

And there's one final question, shifting gears a little. Charles, can you talk a lot -- you've been talking about some of the new initiatives on the digital side, marketing said. How should we think about as we're looking at our models and trajectory expense trajectory for several quarters the extra investment needed to start fund and drive these initiatives forward?

[Charles Tyson:]

I think there are two major pieces of work that we have underway. One is the enhancement of our digital platform, which does not have significant incremental expense. It's a replacement of an existing platform. We've been working on that for a year. And that will have material impact on both the customer experience within the side and give us greater capability on driving greater efficiency on how we drive our current digital marketing spend. We're in the middle of looking at our 2020 plans today in terms of how we'll make greater investments in driving our brand. Activation is a very important part of our strategy. But we have to add a mix as we start to utilize our new creative.You could see us applying more of our working media into that element of the funnel. And so when we think about the purchase cycle for our customers, six months lead time, we need to make sure that we are capturing at the point of ideation and we are putting greater investments, particularly in the digital side with social and the impact that the socials has as people are out, looking at how they're going to make a decision on just what kind of flooring projects are they going do before they even get to think about the location they end up planning. And we are also looking at the efficiency of our media and how to reallocate out of -- which we continue to do this year, self-fund out of unproductive mediums into more productive mediums to drive an overall improvement in our advertising return on investment.

[Operator:]

We now have a follow-up question from Beryl Bugatch with Raymond James.

[Beryl Bugatch:]

If I could just get a little bit into the stores, I have seen some new product that was solid polymer core, the wood veneer, which I see some of the major starting to introduce to I think it's under your AquaSeal brand, but this is a different product and pretty exciting product. If you had any early read on the acceptance of that?

[Dennis Knowles:]

Yes. But we're seeing single and new innovations, and thanks for doing that. We're excited. It allows us to really provide two platforms, which is a water resistant and waterproof capability with a real wood and the feedback from our stores and last week and the feedback from our team assists our customers are excited about being able to now put those to gather and allowing us to develop a new value proposition for customers. For sure that SPC core that you saw is a strong driver of waterproof, and the vinyl category we see is continuing to be a very strong category out through the bounds of this year and into next year. And this just adds incrementality of being able to be more creative with our engineered business and that bamboo business with adding that water resistant capability on the SPC core.

[Beryl Bugatch:]

And as a product that actually are you going to be able to do that in some other vineyards and product looks like products made in China as well. So what's the capability of moving A, out of China and B, out of two other expanded other products?

[Dennis Knowles:]

So I said before, on the moving out of China, we're looking at on a daily basis. And there are supplies that are looking at SPC capacity that would allow them to do this kind of production. And obviously we will engage with them when they are ready. From a changing choice of product, yes, we're looking at multiple types of that we could put on to this product to do a different kind of finishes.

[Operator:]

We have reached the end of our question-and-answer session. I would like to turn the call back over to Dennis Knowles for closing remarks.

[Dennis Knowles:]

Thank you, Operator. Let me say thanks, again, to the LL team, our vendors, our customers and our shareholders for your continued support. Weak traffic has led to a slow start to the third quarter. But in this period, a significant uncertainty, we've remained focused on executing our transformation plan and proven initiatives that position the company for a long-term success, while also working on the drivers of near-term financial results. We look forward to updating you next quarter as well as sharing the details on our longer-term strategic and plans and financial outlook at our analyst conference planned for the fourth quarter. Thanks, again, for your interest in Lumber Liquidators, and have a great day.

[Operator:]

Thank you. This concludes today's conference. You may disconnect your lines at this time, and thank you for your participation.