LL Flooring Holdings, Inc.
Q1 2017 Earnings Call Transcript

Published: 2 May 2017

[Unknown Speaker:]

Good morning, ladies and gentlemen. Welcome to the Lumber Liquidators First Quarter 2017 Earnings Conference Call. With us today from Lumber Liquidators is Mr. Dennis Knowles, Chief Executive Officer; and Mr. Martin Agard, Chief Financial Officer. As a reminder, ladies and gentlemen, this conference call is being recorded and may not be reproduced in whole or in part without permission from the company. I would now like to turn the call over to Steve Calk. Please go ahead, sir.

[Steve Calk:]

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 R. Knowles:]

Thank you, Steve, and good morning, everyone. Thank you for joining our first quarter 2017 earnings call. I am joined by our Chief Financial Officer, Marty Agard. So, before we get started, let me take a minute to call out the people who are really working hard to move our company forward. Our store and corporate associates have been spectacular as we've been transforming and improving Lumber Liquidators over the past few quarters. So, to all of you on the LL team, I appreciate your commitment and tenacity and on behalf of the management team we applaud the momentum that you're building store-by-store, department-by-department across our organization. Okay. Let's start at the top line, for the first quarter we reported revenues of $248.4 million, an increase of 6.4% compared to the prior year period. Net sales from comparable stores increased 4.7% in the first quarter, driven by solid performance in vinyl and engineered products. We were also encouraged to see that new orders were strong, particularly late in the quarter. This tells me that our evolving brand strategy and new assortment mix have resonated with our customers. I think it's also indicative of the growing expertise for our associates around the country both in terms of product knowledge and sales training. We continue to see good growth in ProSales as we've increased our discipline and focus on this important audience over the past few quarters, and we're still excited about what we're seeing in the installation business. We continue to roll that program out, and are pleased with our progress. In the first quarter, we also continued to make progress against our goal to return to profitability. Our gross profit for the quarter was $86.6 million, a 14% increase from the prior year period. Gross margins were 34.9% up from 32.6% in the prior year period. Marty will provide some more analysis on this, but I'm encouraged that through our efforts on both the top line and disciplines around costs we're making steady progress. Let me just mention a few more highlights before I passing the call to Marty. One of our objectives is to introduce innovative flooring solutions for our customers, and the first quarter was no exception. In late March, we launched Dream Home Ultra X2O water resistant laminate, a Lumber Liquidators' exclusive. This product has a unique core technology that is a differentiator in the laminate market. We also introduced our new Waterproof Click Ceramic Plank product. This product offers the same great performance benefits of standard ceramic tile. This is a VOC-free product, that is UL Greenguard Gold, and is completely recyclable. In its first few weeks of availability, we're seeing positive reactions from our customers, who are pleased with the quality, and look of the product. We also continue to improve and refine our marketing strategy with changes both in our message and our media mix through a more focused approach to our customer strategy. My challenge to the team was to further align our merchandizing and marketing, so that we are merchandize-driven and customer-focused. In Q1, we began the execution of several marketing programs that aligned with phased launches of our merchandise strategy. An example of this was our efforts around wood-look waterproof flooring options like X2O Laminate, CoreLuxe Vinyl and Click Ceramic Plank. Focusing on an understanding of the customers' needs, we launched a marketing plan that included new branding messages, promotions and integrated media. Ensuring our marketing is aligned to our merchandise strategy is critical to our continued success. Next we continue to hone our compliance program around the world, constantly evaluating our partner network to ensure that our products meet rigorous quality standards. On the legal front, you may have seen that in April, the Virginia Court ruled on a number of counts in the multidistrict litigation case. We view this as progress, and feel that this brings better definition to the scope of the case. As a result of the company initiating settlement discussions and other developments, we have recognized an estimated liability of $18 million in the first quarter. Marty will add some color around this in his prepared comments. The DOJ SEC investigation is ongoing, so not much to add there other than to say that we continue to cooperate. Finally, we added two stores to our footprint in Q1 bringing our total to 385 stores. These new locations are very attractive and I believe they will be rapidly accretive to our bottom line. So here's how I'd sum up the quarter. I believe that we have made an important shift from triage in 2015 and 2016 to a solid focus on execution in 2017. As it relates to our turnaround journey, we have a lot of work to do. Last year, we put a significant focus on store standards, staffing and training, that will continue. We built our ProSales team and continued the rollout of our installation program. We rebuilt an assortment that is broad, on-trend and relevant to the industry. We believe this works shows in our comp sales and average ticket growth. We now feel like we have the components in place that will help us increase traffic in each of our stores. Our team is coming together nicely and we're all aligned and focused on delivering on our stated initiatives. Now we're all very excited to build on that to amplify execution across the organization. Now I'll turn the call over to Marty to provide more commentary on our financial results.

[Martin D. Agard:]

Thank you Dennis and good morning everyone. As usual I'll start with sales as Dennis stated for the first quarter net sales were $248.4 million, an increase of 6.4% over last year, with comparable stores net sales up 4.7%, marking the third consecutive quarter of positive comparisons. While the comp growth is still heavily influenced by the expansion of our installation business, this quarter was marked by positive merchandise comp at plus 2.5% versus Q1 last year. I further note, that our core flooring products units were up 4%. For those of you comparing days in the quarter compared to 2016, we lost a day due to leap year but we gained Easter Sunday, which fell in Q1 in 2016. While not a completely even trade, those two impacts are roughly a wash in our view. In terms of mix, the comp sales growth within merchandise was driven by the expansion of our engineered vinyl plank business, which has almost doubled since the prior year period. We also had a nice improvement in our engineered wood category, where we have expanded the assortment as well as growth in moldings and accessories, which not surprisingly has strong gross margins. We continued the expansion of our installation business primarily in the Northeast in Q1 and remain on track to have this available nationwide by the end of the year. Sales of installation services were up versus last year by over 60% in our comparable stores and up approximately 17% in the stores where we've offered the program for a full year, which is a subset of our comparable store universe. In terms of customers invoiced we were flat in comparable stores, with the revenue growth coming in the form of higher average ticket, which reflects the expansion of installation as an attachment and the growth in our professional business, which also carries higher average tickets. Before moving to gross margin, I want to recap our recent comparable store trends. Our total comp store sales went from plus 1% in Q3 last year to plus 2.2% in Q4 to plus 4.7% this quarter. Our merchandise comp sales have gone from minus 2% in Q3 last year to just below zero in Q4 to this quarter's plus 2.5%. While these trends are encouraging, we are eager to see the improved store experience lead to higher customer counts as well. Now, let's take a look at gross margin, which came in at 34.9% for the quarter. Last year's gross margin was 32.6% on a GAAP basis, but was impacted by the test kit charges in that period. If you exclude those, Q1 2016's gross margin would have been 33.8%, so this quarter was better by 110 basis points. The Q1 2017 gross margin was favorably impacted by the growth and improved margins of new products in the manufactured lines, improved detachment of non-flooring products with strong margins, and lower transportation costs. This was somewhat offset by the higher mix of installation sales, which carry lower margins but expand our customer market. If you look at our gross margin sequentially, you will notice it improved by approximately 200 basis points relative to Q4 2016 with improvement across all merchandize categories. Most of the improvement was driven by the manufactured and non-flooring categories that grew the fastest. While we did introduce some higher margin products in Q1 namely the water resistant X20 Laminate and the new Click Ceramic Plank line Dennis just mentioned, the more substantial margin improvement from assortment is largely reflected at this point. We continue to work toward margin expansion on several other fronts, but the pace of progress will be more modest going forward. Now, let's look at SG&A. SG&A expense for Q1 was $112.2 million compared to $117.2 million in Q1 2016. First, included in the quarter's actuals is the $18 million charge related to the Chinese laminate formaldehyde MDL and abrasion MDL litigation that is outlined in the 10-Q. I can only comment so much given these are both ongoing cases, but I do want to caution there is a lot of uncertainty still on if a settlement can be reached and the timing, amount and form of any settlement. It is the combination of changes in circumstance, including the better definition in the scope of the case offered by the recent court ruling, and our initiation of settlement discussions, among other factors, that led us to record the charge in this quarter. Further, to the extent we reach a settlement, it is our intent to do so with a mix of cash, stock and coupons such that the liquidity impact of this is fairly mitigated. In addition to this charge, SG&A in the quarter included incremental legal fees of $2.3 million, while the year-ago quarter included $18.5 million in settlement charges related to the securities litigation, $10.4 million in incremental legal fees, and $1.3 million in retention bonuses, all linked to the legal issues we faced at this time last year. These items are tabled out in the press release and the 10-Q. Excluding these items, SG&A expense for the quarter was $91.9 million, or 37% of sales, and an increase of $4.8 million from a year-ago, which was heavily driven by increased payroll-based costs related to core store staffing improvements, investments in our ProSales and installation teams, and corporate capabilities. Advertising was down compared to last year by about $800,000. Compared sequentially, SG&A increased from $89.7 million in Q4 of last year to the $112.2 million in Q1, largely due to the MDL charge exacerbated by the credit reported in Q4 related to the stock portion of the securities settlement. Excluding those and the other unusual items we summarize in the 10-Q, SG&A was up $2.7 million, driven by $3.9 million in higher advertising, netted against slight reductions across a range of other operating expenses, including lower payroll based cost by about $600,000. I would reiterate our guidance from last quarter, we expect normalized SG&A to run in the range we have reported over the last three quarters, while also maintaining the top-line driving investments in advertising and store, Pro and install personnel. This aligns to our three objectives related to SG&A; driving growth, building sustainable corporate processes and, importantly, bringing SG&A down as a percent of sales to the mid- to low-30s over time. I'll move down the P&L to operating profits. For the quarter, we incurred a pre-tax operating loss of $25.9 million compared to a pre-tax loss of $41.3 million in Q1 of 2016 and a loss of $9.4 million in Q4 of 2016. Both the current year and year ago quarters had several unusual items that impacted those results scheduled out in our 10-Q and press release. I'd also point out that we are no longer able to carry back our current losses for tax purposes and so can no longer benefit our losses in the income statement, which impacts both net income and EPS. Now, let's look at cash flow and liquidity. As of March 31, we had cash and availability under our asset-based revolver totaling $71 million, which compares to $101 million at the beginning of the quarter. Borrowings under our ABL facility were $72 million compared to $40 million drawn at the beginning of the quarter, with the increased ABL driven by the repayment of accounts payable that traced to our inventory build during Q4 and early Q1. Our inventory ended the quarter at $301 million, very close to where it began the quarter. As the second quarter has progressed, we started to bring down inventory and have used that cash to pay down the ABL such that we have $65 million drawn on the ABL today. Consistent with the guidance we provided on the February call, we expect inventory to decline steadily over the second and third quarters to a range of $250 million to $275 million. On the investing side of things, we opened two stores during the quarter bringing our total store count to 385. We expect to continue this modest pace of store openings throughout 2017. So, to wrap it up for me, I'm encouraged by how the business is improving and pleased with how the team is working together on a focused set of priorities. We're continuing to make progress in our discipline around costs and have plenty of opportunity from top-line growth to gross margin to SG&A still ahead of us. I'd now like to turn the call back to Dennis for his closing remarks.

[Dennis R. Knowles:]

Thank you, Marty. Our progress to date in 2017 represents solid achievement across our five areas of execution

[Operator:]

Thank you. Our first question comes from the line of Simeon Gutman with Morgan Stanley. Please proceed with your question.

[Simeon Ari Gutman:]

Thanks. Good morning. My first question, gross margin, you mentioned maybe not as much progress or a more moderate pace of progress going forward. I guess, if you do see meaningful progress on this line item, not just next quarter but in the next several quarters what would drive it? Is it mix at this point and your comments suggest that maybe gross margins are not going to go much higher than this sort of mid-30%s level. Is that a fair assessment or is there room to run over time?

[Martin D. Agard:]

Yes. This is Marty. We certainly see upward movement, it just I didn't want people to think that we're going to grow 200 basis points sequentially like we just did. So, we clearly brought a much richer mix that is supporting our growth and our margins. We will do some more of that, but it probably won't be or certainly won't be as significant. We're also working on some pricing discipline, we've got some opportunities in transportation. So, there are several areas we need to get this up into the upper 30%s, yeah, but just, it's not going to be that 200 basis point a quarter, yeah.

[Simeon Ari Gutman:]

Right. But upper 30%s is a long-term goal or is it a medium-term goal?

[Martin D. Agard:]

I guess, I'd call it medium term.

[Simeon Ari Gutman:]

Okay. And then my second question just on the number of transactions, which you're obviously focused on. I don't know if you look at it in that the business is building towards getting back to positive, I don't know if there is advertising around it. But is there some tipping point where you think once you get back to a positive transactions, you won't look back. What's holding them back to this point, why haven't we gotten back to that already?

[Martin D. Agard:]

Yeah. So, first the customer count is a complicated one in that we are trying to piece together visits and get more to a, I guess a project or a floor based kind of measure. So, we leave out small orders and we group together repeat visits of the same customer. This is kind of disclosed in the Q and the Ks, but so anyway the measure is not what maybe traditional retailers would see as a pure number of register rings. Now with that said, so that I bring that up, because it is a little more complicated as we attach installs and as we get better customers, and as we grow the Pro business, where these guys are coming in more often and building bigger job orders, and their jobs are probably merging together a little bit as they come in. So the measure is not perfect. Now, so we are pleased to see us developing customers that do come in into bigger customers, we do look to see the customer count grow and become positive. Not exactly sure when that's going to happen, this thing has been, while you can see it's minus 0.4%, so we think of that as basically flat. I think I'll let, hand it over to Dennis in terms of advertizing strategies and sort of tipping point ideas.

[Dennis R. Knowles:]

Yeah. I think it's a great question and, as we've both mentioned in our comments, it's something we're focused on. As we saw the health of the assortment get to where we wanted it, we did see that start to improve, and believe we'll see that continue throughout the year. It is, as we put more focus on the Pro customer, we see the tickets grow, and because we may not count them twice within the quarter if they made two trips based on the size of their purchase, we know that's going to have some impact on this as well. But in particular, Marco and the team focused heavily on making sure that our marketing strategy matched the needs of what the customers were looking for in terms of waterproof solutions. And we really saw the customer counts improve towards the end of the quarter, as we launched that new product. So, it's our expectation that we'll continue to focus on that, it's square in our sights, in terms of seeing that improve, and I don't see any reason why we won't continue to see that improvement across Q2 and beyond. That's what we're all focused on.

[Simeon Ari Gutman:]

Okay. Thank you.

[Operator:]

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

[Brian Nagel:]

Hi, good morning.

[Dennis R. Knowles:]

Good morning.

[Brian Nagel:]

I had a couple of questions, if I could. First off in your prepared comments you commented on new order strength, I think it was in the month of April. So, a nearer-term question, with that how should we think about the nearer-term comp trajectory. And coming off of the 4.7% comp you did in Q1, would that be suggestive of a potential further strengthening here into the second quarter or even beyond? And I have a follow-up.

[Dennis R. Knowles:]

Yeah. We did see new order strength as the quarter has progressed. As we mentioned in the Q4 call, we became more competitive in Q1 as we had a broader assortment that was more what I would call in line with what the customers were looking for in terms of waterproof solutions. While we don't share a new order growth, I did want – I thought it was important to let everybody know that we did see that strength in new orders as the quarter continued. Now some things that we're still trying to make sure that we're aware of and manage appropriately is kind of the incubation period of an installed sale. For example, you might see that new order cycle in the past run a two-week period. Whereas now with acclamation time we don't take credit for the installed sale until it's actually the installation is complete and the customer has signed the certificate of completion. So that will as we had a broader assortment and we're installing more product, we'll see probably a little more lag on that, but we were really pleased with new orders and the progress continues. Our stores are doing a great job, taking care of the customers across all assortments and we see no reason why that won't continue into the rest of the year.

[Brian Nagel:]

Okay very helpful. Then second with respect to liquidity, so you gave us some nice color in the release and in your comments with your liquidity position now. As head toward again, continue to push towards this return to profitability on the P&L. Is the liquidity position or the I guess the puts and takes as we look at it right now strong enough to help facilitate that?

[Martin D. Agard:]

Yeah. We should – we are at this sort of a position that where inventory is still elevated, but at least it was as of March 31. It has started come down here in the second quarter as I alluded to and we see that continuing and that is starting to free up liquidity. And then we should also be, similar to last year, pursuing a tax refund. We'll be pursuing a tax refund. Timing would be in the sort of that third quarter. So between those two kind of effects, the seasonal drawdown of inventory that troughs really at the, in sort of the late third quarter and that tax refund, we should be in good shape and we knock away at this – what I call adjusted loss of – we ran $6 million or so we were – we chip away at that we should be okay, turning into next year.

[Brian Nagel:]

Got it. Then one more if I could, with regard to litigation, we saw you took the $18 million charge here in the first quarter. Is there any guidepost you can give us with respect to how this could play out from a timing perspective, additional charges, so on and so forth, just to give us some idea of what we maybe – how we should be thinking about this in the next several quarters or so?

[Martin D. Agard:]

Yeah, we expected a lot of questions around this, and we really do appreciate your all eagerness for some clarity here. We'd love to be able to offer it, fact is, it's a bit of sensitivity subject , and we need to refer you back to the Q. We've said really what we can say in the Q, and I guess, I'll reiterate that here, and that is, that we got some clarity from the court ruling. We initiated some settlement discussions, and based on that and in consultation with our independent auditors, we thought now is the time to book this number. The $18 million is an estimate. There is uncertainty around it, there is uncertainty whether we can get a settlement done, there is uncertainty about the timing and the form of payment and so forth, and we really can't help with any more clarity around that. And then, we also commented that, our intent would not to have this be all cash. we're sensitive to our liquidity position, and using alternative payment forms around this, but that's really kind of what the Q says, and I'd ask you to rely on that.

[Brian Nagel:]

Got it. Thank you.

[Operator:]

Thank you. Our next question comes from the line of Dan Binder with Jefferies. Please proceed with your question.

[Daniel Thomas Binder:]

Great, thank you. Just wanted to focus on gross margin for a moment. If we were to look at your gross margin, pre-product issues versus where you are now, and the path to getting to this higher level, would you say that the difference today is primarily a product mix issue or is it a product sourcing issue? And where should we expect the greatest driver of gross margin to come from as we look out a couple of years?

[Dennis R. Knowles:]

I would say, that right now, it's a product of several factors. We have and we'll continue to see some benefit from our increased mix. We're also as we rebuilt the assortment, we're also watching the migration across categories to see what impact that's having. From a sourcing perspective, I think we'll continue to benefit from that as having a base of vendors that we choose to do business with and from a strategic perspective for a long time and believe as Marty has said on the call before, that will take a little more time as we continue to work with our vendors. Now, we've got some other factors, and our disciplines are better. We are managing a new installation program that while it's accretive to dollars, it is a bit of a drag on rate. However, as we rollout our installation program, we are putting more focus on our margin rate. I think we've got some opportunity to improve that as well. And then I would also mention that our Pro efforts, we're really pleased with the Pro and particularly the margin with this particular customer and how it mixes with us. While it's not as high as the overall merchandise margin. We continue to be pleased with how well we're doing managing that margin rate and are seeing that not as big a drag as we thought it might be. So, I think there is a lot there. As Marty mentioned, we'll continue through the year to see nice comparisons to last year, but there is a lot of work streams in place to see that improvement as it relates to the rest of the year and into next year as well. So, we've got to continue our disciplines with our vendors, our sourcing and compliance, we've got to continue to make sure that we've got the appropriate disciplines and our stores have done a great job with this. We had some opportunity to better manage markdowns in our store over the course of the last year and the stores have responded really well. And, so, I think, it continues to be a work in progress. We feel like we've got room to improve across several fronts and I think you'll see that over the course of the year.

[Daniel Thomas Binder:]

Obviously, the sourcing had to change and it sounds like that's had some impact. So, as you review the sourcing opportunities going forward is it a function of just doing more volume with existing vendors to get better pricing, or is it expanding the vendor base, is it expanding the geographic sourcing that you're doing today?

[Dennis R. Knowles:]

I think, it's a little bit of all of that. So, we talked about it in the past when we went back to rebuild the assortment. Some of that was done very quickly as we tried to fill holes in our assortment that were caused because of the laminate and engineered issues that we had in 2015. And so, it's fair to say that we probably didn't get the best deal and have opportunities to improve our relationship with both our vendors as well as look for additional places to source. The merchandising team has done a great job really kind of categorizing our vendors into what we would call strategic long-term vendors and we expect that we've got some area – room for improvement. As I mentioned in my prepared comments, we've built a compliance program that allows us to source anywhere we want to. So, we will continue to scour the globe to make sure that we've got a quality product that we are excited about and ready to put in our stores in a way that benefits both our margin and our customer. So, that is a room for improvement and our work to do this year. But like I said, I think, we'll continue to see the benefit of both sourcing and as well as the mix. The mix is going to have a big impact on us as well. We're also seeing some migration, the engineered wood, as you know, we've really rebuilt the assortment over the course of the last 12 months, and really like what we're seeing there in terms of the improvement of mix. So, I hope I answered your question.

[Daniel Thomas Binder:]

Yes, that's helpful. Thanks.

[Operator:]

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

[Seth M. Basham:]

Hi. Thanks and good morning.

[Dennis R. Knowles:]

Good morning, Seth.

[Seth M. Basham:]

My first question is just around the strong finish to the quarter that you talked about. You've also indicated in your results that customer deposits are up 25% year-over-year at the end of the quarter, obviously with some qualifications. But can you speak to anything that may have driven that besides the assortment. Was the end of quarter sale any different year-over-year, anymore promotional? And how did you plan the spring sale relative to last year?

[Dennis R. Knowles:]

Great question. The quarter, I would tell you, was a bit of a mixed bag. We had a – as expected, we had a really strong January. We had mentioned on the Q4 call that we were concerned that we saw a lag because of the fact that we had two weekend holidays, if you will, some of our strongest days. And then we did something intentional. We wrapped a promotion around into the New Year. And typically, we see a strong finish to those promotions, and it drove – January was very healthy. And then we got to February, and there were a lot of things going on in February. February was not our best month of the quarter by any stretch. And we felt like, suddenly, we were seeing a pull back and there were a lot of external factors we were trying to understand. We had heard some noise about delayed tax refunds. We knew that we had the weather, if you remember, the West Coast was getting pounded, but we didn't feel like that was impacting us. And so, February kind of bumped along and then we got into March, and saw the strength of our – because March was when we really launched our advertising campaign around our waterproof solutions. And we really saw the new assortment in engineered start to take off. And so I felt like we were really prepared. Now, I'll tell you, as our spring sale was really strong, one of the best April sales that we've had in sometime. So, we continue to be encouraged both – on all fronts; the Pro, the installation, and the merchandise performance. And so, we're staying intentional. As I mentioned in Q4, we're really making sure that our marketing matches what our customers are asking for, and that it's timely, and that it's supported by the new assortments and new styles. And we're also starting to see strength in our ceramic assortment. Our porcelain tile, which is – it's a small portion of our business, but we feel like it's a big opportunity. It's a growing segment of the hard surface flooring business. And we've got some really good looks. In fact, if you haven't been in our stores or if you are in our stores, I encourage you to take a look at the assortment. The customers are responding well to it and we're seeing that continue to strengthen, especially as we educate our associates on how to sell that solution. It's a pretty complex sale, but they're doing a good job with them. We think that's going to help us as well. So, good growth in engineered. We're seeing the manufactured categories continue their strength, whether it be vinyl or laminates, and our new engineered bamboo is doing well too. And so, we'll continue the course, as we have, making sure that we're matching our – we look at a lot of data points. We look at – our sample requests from our customers are a big driver of what their interest is, and so we have that both online and in the store. And so, that kind of can somewhat be Marco and his team's North Star in terms of making sure that we've got the right products and promotions. And then it's easy to kind of align our store employees around that, and Mark and our divisional VPs have done a really good job of making sure with the merchants that we've got store teams that are educated on our promotions and ready to execute, and we'll do a lot of that on our Saturday-morning training as well. So, we feel like the stores are building some good momentum for us and we're happy with the progress.

[Seth M. Basham:]

Great. That's good to hear. And secondly, as we think about the installation services rollout, can you just give us a couple of data points on the percentage of stores that had the offering at the beginning of the quarter and at the end of the quarter?

[Dennis R. Knowles:]

Yes. We can. We added – as Marty said in his comments, we started to add stores. We had 23 stores that we converted in Q1 and that was in our – up in region one which is up in kind of the Northeast, and then we started to roll out some stores in the North Florida area. So, that puts us at about 283 stores, which is about 70%, a little over 70% of our population. As I mentioned in the last call, the rollout – there are so many factors that determine the success of the rollout and we've obviously got to get our associates trained, we've got to build our installer network. There is a lot of licensing and compliance work that has to be done, and so Charles and the installation team are doing a great job making sure that we're ready to go into these new markets. So we feel comfortable that we'll be there by the end of the year, where we need to be. We're getting ready to go into the New York City and the Long Island area as part of our Q2 launch. So that will leave us kind of Florida, California, Nevada, Utah, and Arizona. And we're on track to have them all rolled out by the end of the quarter, or by the end of the year.

[Seth M. Basham:]

Got it. Okay, great. And last question from me and then I'll turn it over. Just looking at your payroll commissions and benefits as a percentage of sales, even excluding the retention bonuses from last year, it seems you still deleveraged that line item despite strong comps. How should we think about that going forward?

[Martin D. Agard:]

Yeah. I mean, we're still – we haven't anniversaried the investments we really made back in the third quarter of last year. But we think those were the right things to do for the most part, the investment in the store personnel, and the Pro team, the install team, and even some of the corporate capabilities. Sequentially, it's been flat. In fact, I made the comment, sequentially it was down $600,000, I call that flat, and we don't – we don't really see at this point unwinding any of those investments, although we do continue to sort of tweak and try to optimize the structure, put resources where they're most productive. So I would say generally kind of flattish going forward.

[Dennis R. Knowles:]

I would also tag on that, that if you remember last year, we had the 60 Minutes episode that aired in March, which really caused it – I guess, I would say it had a bigger impact on us than any of the prior in terms of just what the stores were facing, and we were experiencing high turnover. So we launched a campaign to get out stores staffed up and as Marty mentioned, we started to build the install team out and the Pro capabilities so.

[Seth M. Basham:]

Got it. Thank you. And good luck.

[Dennis R. Knowles:]

Thank you.

[Operator:]

Thank you. Our next question comes from the line of Matt Fassler with Goldman Sachs. Please proceed with your question.

[Matthew J. Fassler:]

Thanks so much and good morning.

[Dennis R. Knowles:]

Hi, Matt.

[Matthew J. Fassler:]

A couple of questions. Hi. I wanted to follow-up on customer deposits. Obviously, and this came up in a prior question, you're seeing an acceleration in the growth rate there. How should we think about the relationship between customer deposits? Should we be looking at dollars, should we be looking at percentages and how significant for that is the dynamic you spoke about for installation. Sort of a delay in booking a sale so to speak for a transaction that had already been installed. I'm not sure if that line item is big enough to really move that needle, but interested whether that factored into the customer deposit line item.

[Dennis R. Knowles:]

It had a big impact on it. I would say that as we work through that we're keenly aware of how much we've got outstanding. And it can be – Matt, it can be anything from a stick of molding to a box of flooring that if we haven't installed or we haven't delivered it we'll hold that entire ticket up. But, we know that, we know that this is a longer transaction cycle and as we get more and more stores on that, you'll probably see that kind of normalize throughout the year and we'll start to cycle that and have a better idea of what to expect on a month-to-month basis. But, we really focus on that because there is a lot of components to installation. You've got installer capacity. We've got to make sure that we're paying attention to the products that the customers are buying. Whether it be a solid product, an engineered or just all of those factors influence the installation cycle. And then we've got the success of March. March was a really strong month for us in new orders. And so all of those things. I would also mention that our stores are focused on making sure that we're getting a larger deposit as well. So, that impacts the overall deposit balance.

[Matthew J. Fassler:]

That's a deposit relative to the size of the ultimate transaction?

[Dennis R. Knowles:]

Correct.

[Matthew J. Fassler:]

Got it. A second question , if I could. So, interestingly ad dollars flat to down, and you talked – at a moment when you talked about reducing (45

[Dennis R. Knowles:]

I think you'll see a bit of growth going forward. I would tell you that as I mentioned earlier, and I think I even talked about this in Q4 in the Q&A is that when we built our 2017 plan, we completely tore down our marketing spend, and really as a team, analyzed what channels we chose to participate in from an advertising perspective. And Marty and his team continue to really look at where we're getting return on that spend. And so, as I said earlier, we're really focused on making sure that we're aligning the spend with what the customers are asking for. So that we're really being prudent with our spend, and seeing the return on it. And we'll continue to do that, but I think, if you look at last year, over the course of the year, we saw the improvement in the assortment kind of get better, but it was really slow with it really coming to fruition in Q4. So, we have the ability now to market across all the categories, but I will tell you that we'll continue to make sure that we're spending our dollars where the customers are buying, so that we can maximize that. And as I said earlier, Matt, we really, we became – we had a much better platform to compete on Q1 than we've had for the rest of the year. So, I think as we see the opportunity there, we'll continue to invest. And I would tell you that anything from a grand opening to a product launch to holiday sales, I think you'll see us probably show up a little more than we may have in the past.

[Matthew J. Fassler:]

Understood. And then finally and quickly, as we think about the seasonality of gross margin, the underlying trends associated with the volatility in the business and other factors really made gross margin kind of a quarter-to-quarter phenomenon kind of fundamentally and there was no seasonality if you will. Historically, there had been some around the promotional cadence of the business and perhaps around product mix by quarter based on the nature of customer projects. Are we yet at a point where there is any kind of seasonality that we should expect from gross margin or is that not yet a consideration as the business continues to normalize?

[Dennis R. Knowles:]

I think there will be a slight seasonality to the margin, but I would tell you that we're still learning kind of how our new mix of product is impacting the overall rate. I will tell you, we're much better today than we were a year ago managing, our obsolete inventory is at its lowest percent of total inventories since I've been here. And typically, we used those seasons in the past to kind of cleanse ourself of that discontinued inventory and as that percentage of inventory wanes, we're able to make sure that we're marketing our good inventory. So, you'll see – you'll continue to see that because we'll always want to leverage those seasonal spikes to help get rid of obsolete and out of program inventory but you should see the impact less and less as we're much more prudent in managing the sell down of an outgoing SKU as well as managing the inbound better.

[Matthew J. Fassler:]

Great. Dennis, thank you for that color.

[Dennis R. Knowles:]

Thanks Matt.

[Operator:]

Thank you. Our next question comes from the line of Greg Melich with Evercore ISI. Please proceed with your question.

[Greg Melich:]

Thanks. I wanted to maybe step back a little bit and understand where we are as the business normalizes in terms of what you think is a normal SG&A per store. In other words of the $91 million or $92 million, I guess $92 million you had this quarter, how much of that would have been store level SG&A versus more general overhead?

[Dennis R. Knowles:]

Well, I would tell you that what we've kind of seen the stores start to balance. And I think, you'll see a consistent run rate in our stores. We're starting and we'll continue to test everything from structure to format and those things will have an impact but I would not say, it would be material over the entire company. And as Marty mentioned in his calls, we have no intention and are continuing to scrutinize cost at the customer support center. But we feel we've got the team in place and we've got the structure that we need to support the business and its growth and so as a percent of sales, I think, you'll see that come down overall, over the course of the year.

[Greg Melich:]

As sales pickup, so the – that's how we leverage SG&A, we've sort of taken out what we can take out?

[Dennis R. Knowles:]

Yeah, let me – so let me give you an example. So, installation, if you look at the installation support team, which was probably the largest build that we had, it's pretty much there. And so as we add the sales, you won't see us add much expense at all. And so, that will help us drive the leverage down in the corporate headquarters. As well as the same with the Pro, we will not continue to build – we've built that team out, where we feel that we need to be. And as we grow the business, we'll continue to leverage that expense.

[Greg Melich:]

And maybe linked to that, but a separate question is, when do you think. I know you've taken down advertising and you mentioned, why. Is there a time where ultimately, you feel the assortment and everything will be right to dial that back up or do you think that that's just sort of changed, in terms of that's a number, that doesn't need to go up over time?

[Dennis R. Knowles:]

Well, I would tell you that when we get to a place, where we feel like, it's time to accelerate our store growth, you'll see us make more investment. As we do new product launches, we will invest in that more over time. One thing that we don't feel we need to invest as much in is our efforts around the Pro business. As that percent of sales grows it's a customer that requires more support then marketing. And so, we're working on that program, in terms of how we market to that customer, but my past experience has told me that the spend is not nearly needed as much. So, we'll make sure that we're spending the right marketing and advertising dollars to get them into – get customers into new stores and new product launches, but as we learned, the impact that our total Pro has on us, it will probably pull some areas of marketing back.

[Greg Melich:]

Got it. And what – and just refresh me, where are we now on Pro, if I was going to look at percentage of your sales. I know you talked about some of the comp initiatives and sort of where we are, but are we...?

[Dennis R. Knowles:]

Yeah. It's about 20% of our business now.

[Greg Melich:]

Okay.

[Dennis R. Knowles:]

I think you may remember last year, it was just slightly below 10%. So, it's growing as a percent of our business and again we like it for several reasons, it's got an attractive margin, they're a repeat customer. And we feel like we've got a value prop for that customer that fits the needs of their business. We've got inventory, we've got assortment, we've got in-store expertise, we've got expertise in the corporate headquarters and we feel that we've got a lot of upside with that customer segment.

[Greg Melich:]

That's great. Good luck, guys.

[Dennis R. Knowles:]

Thank you.

[Martin D. Agard:]

Thanks, Greg.

[Operator:]

Thank you. Our next question comes from the line of Keith Hughes with SunTrust Robinson Humphrey. Please proceed with your question.

[Keith Hughes:]

Thank you. Last year, engineered and solid hardwoods were down, they were down the most of all your categories off about 16%. Can you give us sort of an update in the first quarter. Is it still performing below the company average and what is the, you talked about engineered, maybe a question more on solid, what are your plans there?

[Dennis R. Knowles:]

Well, we – it's something we look at every day, because it's a big piece of our business. It's obviously feeling the effects of the migration to the engineered product. It will always be a big piece of our assortment, because there is a customer for the solid business and we've got a great solution with the Bellawood line. And it's so hard for us to look at this and understand what were the factors that are impacting comps. We know the migration to engineered, because we can see that. When we built our engineered assortment, we built that mirrored off the success of our Bellawood line. So, we have Bellawood engineered SKUs as well as we have Bellawood solids. And so, we know that some of that is just a more affordable solution. We continue to look at opportunities whether it's our own finishing line and how we can turn the trend that we've seen in the solid business. However, we also know that we still have a lot of noise in our comparisons. As you remember, Q4 – even last year in Q1, we didn't have engineered SKUs. So, we were really pumping a lot of customers into a solid SKU so that we could maintain some sense of a sales run rate. But we do know that we are seeing some impact from the engineered wood. Our growth in the engineered categories were really good, but we're still seeing a decline in the solid business. And while the margins...

[Keith Hughes:]

What is your mix right now...

[Dennis R. Knowles:]

I'm sorry.

[Keith Hughes:]

...between solid and engineered?

[Dennis R. Knowles:]

Our solid still remains in the mid-to-high teens and our engineered is growing as an assortment. It's about – I'd say it's probably roughly 10% of our business right now. But we still – like I said, we just really got healthy in Q4 and Q1. So, I expect as we cycle some of the noise and we'll see over the next couple of quarters how that balances out.

[Keith Hughes:]

Okay. Second question on the installed business, you've had a long history serving the professional contracts that refer the customers to your location to pick a product out. You offering install almost some ways serves as a competitor to them. How do you balance that?

[Dennis R. Knowles:]

That's a great question. It's one I've kind of worked through my entire career, and it's – what we try and ensure that we're doing is that we're giving as much business, and many of our professional customers are our installers. And so, we try to make sure that we're doing both. If they want to install for us, we're providing that opportunity, and not everybody wants it installed either. And so, we're providing them an – making sure that through referrals or just making sure that we're keeping them abreast of our promotions that we're helping the pro out as well. But it's always a balance to make sure that. You've got both. You've got to keep your installers busy and you want to make sure your pros are busy too, because they're the ones that are making repeat trips. So it's something we try to focus on, on both sides.

[Keith Hughes:]

Okay. And final question. When I just look at your SG&A spending taking out as best as possible the litigation charges, just on a dollar amount, it's a good bit higher than when it was back in the 2013-2014 when you were doing a lot more bottom-line earnings. $50 million, $60 million depending on how you want to count it. If you look back – and I know most of you guys are new here. But if you look back, what's the difference in SG&A spending now versus then? And it doesn't appear advertising has changed all that much.

[Dennis R. Knowles:]

I'll take a shot at it and then Marty can add some additional color. I think, you've got – a growth in store count is a big piece of it. A change in our store staffing structure. We've added more bodies, I think, traditionally back early on in the years when the company first started, I think, the average staffing matrix was about 2.5 heads per store. As we've expanded hours in stores, and we've also increased the average [Technical Difficulty] (59

[Operator:]

Ladies and gentlemen, please standby. It appears we're experiencing some technical difficulty. Ladies and gentlemen, please standby, our program will resume in a moment.

[Martin D. Agard:]

Yeah. Operator, this is the company. We're back on. Is there still a problem?

[Operator:]

No. One moment, I'll connect the next question. Thank you. Our next question – our final question comes from the line of John Baugh with Stifel. Please proceed with your question.

[John Baugh:]

Thank you. You might want to finish up the answer to the prior question, because you got cut off.

[Dennis R. Knowles:]

Yeah. we apologize. We're not sure what happened, but I think, when we got cut off I was talking about the staffing structure in the store changing from about an average 2.5 head count to 3.5, and then obviously a significant growth in the head count that it takes to support the install. I would mention that we have an onsite production team that manages kind of the customer experience through the installation process, and that's managed in-house as well as we've got various field support, what we call regional install sales managers, that are now on our payroll that manage the installer base, customer follow-up and things of that nature. So, I'd say those are – from my perspective, those are the biggest changes in addition to store count that you would have seen since 2013.

[Martin D. Agard:]

Yeah. And I'd just add the corporate capabilities. We had to build up a compliance team that clearly we appreciate now and it's helping from a sourcing capabilities and so forth. We've built a bit of a stronger fuller FP&A team, got more planning, got more audit capabilities and so forth. I don't have an actual breakdown of the year-over-year or from the prior to the current levels of SG&A, but I think it's all of these things.

[John Baugh:]

Okay. So, John Baugh again. My question is a broader longer term question, I guess around merchandise. You've made some comments that you felt a lot of the merchandise mix has been addressed at this point or at least the influence on margin won't be as pronounced as the changes you undertook in Q4 and Q1. As you look at the business from an optimal high-level viewpoint, are you positioned exactly where you want to be in terms of ceramic versus LVT versus engineered. And if not where would the changes come and how might that influence gross margin if the mix changes. Thank you.

[Dennis R. Knowles:]

That's a great question. And that's for us that's not necessarily something that's kind of one and done. We do that every day, and as we – one of the capabilities that we built within the merchandising organization is kind of how we review our product line both on a day-to-day basis and kind of a sequential scheduled plan to make sure that we're looking at everything. We don't look at any category. We kind of categorize things in wood, manufactured, and then what we would call non-merchandised categories. And we think we've got a really good line up. We're pleased with the progress, but as you can imagine, when you build an assortment kind of from the ground up like we did last year, you're going to make some mistakes, some things are not going to perform as well. And one thing that we're committed to is to be out in front of that to make sure we identify those quicker than we would have in the past to make sure that we're on trend and whether that's a larger format plank, whether it's a porcelain tile. And as we see the success and the adoption at our store level, we'll continue to make sure that we further invest in those categories. And then as I mentioned earlier, we're committed to the solid business too. That's a – we've got a rich history with that product line, we've got inside the company, we have capabilities with our finished line. And so that will always be core to our assortment, but we are keenly aware of the changes that are occurring in the flooring business. We believe porcelain is a big opportunity for us and we'll continue to evaluate and manage that assortment, as well as the engineered and the manufactured SKUs. So, it's more about trend and style. Our research is showing that it's becoming more and more important to our customers to make sure that the styles are on trend and relevant. And so, we'll manage our assortment from that perspective as well as understanding the formats. We are seeing the traditional plank size is, the customers are looking for wider planks, longer planks. And so from that perspective, we'll always make sure that we're managing our assortment in a way that we're on trend and have the latest styles in stock.

[John Baugh:]

Maybe just to close in following up on that. Is there, when you look at your sourcing capabilities or strengths, do you see over time the mix shifting favorably towards you or neutral or unfavorable?

[Dennis R. Knowles:]

Well. I kind of see it as favorable if you look at where we were a year ago. We've also got to make sure that we're competitive and that we're offering an assortment that we can go to market with from a competitive standpoint. But I do feel like we've got plenty of upside opportunity as it relates to making sure that from a sourcing perspective we continue to make sure that we're looking at our manufactured categories in a way that helps us improve both top line gross margin and we want to be efficient with our inventory as well.

[John Baugh:]

Thank you, good luck.

[Dennis R. Knowles:]

Thank you.

[Operator:]

Thank you. Ladies and gentlemen, we've come to the end of our time for questions. I'll now turn the floor back to Mr. Knowles for final comments.

[Dennis R. Knowles:]

Thank you all again for joining us. We appreciate your support as we continue to build a better Lumber Liquidators and we look forward to updating you on our progress next quarter.

[Operator:]

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