LL Flooring Holdings, Inc.
Q4 2017 Earnings Call Transcript

Published: 27 Feb 2018

[Operator:]

Good morning, ladies and gentlemen, and welcome Lumber Liquidators' Fourth Quarter 2017 Earnings Conference Call. With us today from Lumber Liquidators is Mr. Dennis Knowles, Chief Executive Officer; and Marty Agard, Chief Financial Officer. 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 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 these 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. I am joined by Marty Agard, our Chief Financial Officer. 2017 was an important year for Lumber Liquidators, as we took a number of important steps to establish a solid foundation for our long-term success. Let me begin by thanking those who are ultimately responsible for our progress. Our associates at each of our stores have worked tirelessly to improve at the local level and enhance our customer experience. At the same time, our teams here at the corporate headquarters have been motivated, enthusiastic and creative as we'd look for ways to make Lumber Liquidators better from sourcing all the way to the customers completed installation. Team, I'm proud of your hard work and I look forward to a successful 2018. Marty is going to walk you through some numbers, but let me touch on a few key items that I'm particularly excited about. In the fourth quarter, we reported net sales of $259.9 million, an increase of 6.1% compared to the prior year period. Comparable store net sales increased 4.5% driven by positive ticket and traffic. We also continue to improve our margins from a year ago, both at the gross and operating level. And we opened six new stores during the quarter bringing us to a total of 393 stores. In addition in Q4, we completed the rollout of installation services in all our locations across the country and are already seeing good momentum as the do-it-for-me customers continued to enjoy our complete solution to their flooring needs. The Pro business also continues to perform to our expectations and above the company average. This quarter was also a bit of a milestone in that we were finally able to see how our strategies are playing out in terms of supply chain, product mix, marketing tactics, installation and Pro. Our ability to accurately compare quarter-over-quarter results and test enhancements to our business levers have put us in a much better position to manage the company. As we have discussed last quarter, this is clearly letting us move toward a more sophisticated approach to specialty retailing with a focus on product, expertise and value, rather than our legacy deep discounting combined with heavy advertising model. Most of all, though, I'm excited about what I'm seeing at the local stores. In my store visits, I'm seeing better training, but also recruiting and retention and that is driving increased confidence among our associates. They're truly excited about having trend-right products available along with installation service and a more systemic outreach to the Pro. Remember, typically, our stores have three to four associates, all of which must be at a highly trained and enthusiastic level when the customer walks in. And that can be the difference between a lost customer and an extra sale that day. So when I see that intangible, but important enthusiasm, it tells me we have crossed a key threshold in delivering our value proposition to a growing base of customers. We have measured this and the overall customer experience historically through our secret shopper program. As we have grown our corporate capabilities, we've expanded our customer feedback protocols to include national surveys. This has given us a much wider sample set and ability to address many more topics, including the installation experience. This past quarter, we anniversaried the implementation of traffic counters in a subset of our stores. With this information, we can better understand our traffic and how it responds to a range of events to provide another dimension of measuring our marketing effectiveness. In addition, we can match that data up with close rates to ensure once the customers is in our store, we are exceeding their expectations. The result is data that is more holistic, accurate, and actionable. Let me touch on a few more things before handing it over to Marty. I mentioned last quarter that we held our first-ever vendor partner summit here in Virginia in Q4. We hosted over 80 of our vendor partners from 4 continents to discuss the industry and customer trends and to improve best practices across our supply chain. We are committed to building exceptional relationships with our partners; best-in-class sourcing; and ultimately, a market-leading trend-right product set, all of which are critical to our competitive positioning. The result of our increased focus on selection and style has been encouraging. When customers get to our stores, they are finding everything they want, and our ability to convert them is improving. I believe this focus is also transforming the image of Lumber Liquidators from a low-priced, DIY-focused shop to a more customer-focused, full service expansive experience. In particular, we've formed an in-house trends team that works with our merchants on product development. An example of this effort is a new EVP called Rose Canyon Pine. This highly scratch-resistant, waterproof floor is almost 10 inches wide with an exclusive look and unique texture that cannot be found anywhere else. On the legal front, we have no material updates, other than to say we remain committed to fully cooperating with the Government on the DOJ and SEC investigations and that the MDL settlement is progressing under the terms of the MOU previously announced, with funding likely to fall in the third quarter. So when we look at what we accomplished in 2017, I have to say that I'm extremely pleased. We've improved the assortment in our stores with style and trend-right products. We added infrastructure at the corporate level to support installed, ProSales, merchandising and customer care. We rolled out a comprehensive, nationwide installation services program. Our vendor relations have never been better. We are seeing innovative products and have worked with them to ensure all our floors are GREENGUARD Gold and FloorScore certified. We've invested significant resources to ensure our products are safe, compliant and at the highest quality for all of our customers, and were one of the first to offer phthalate safe vinyl flooring. We enhanced our marketing spend and leverage, increasingly targeting regional needs and demographics, while building better effectiveness and analytics. And we closed out a number of important legacy, legal and regulatory issues. We still have work to do, but I'm very proud of what we've accomplished in 2017. I'll be back in a moment to talk about 2018 and beyond, but will now hand it over to Marty to discuss the numbers. Marty?

[Martin D. Agard:]

Thank you, Dennis, and good morning, everyone. Let me start again by covering the top-line highlights. For the fourth quarter, net sales were $259.9 million, an increase of 6.1% over last year with comparable stores net sales up 4.5%. This consisted of merchandise comps up 2.4% and installation comps up 31%. The overall 4.5% comp growth was split between average ticket expansion of 3.4% and traffic growth of 1.1%. These results were in line with Q3's pace of growth, but a little below our initial projections, which we mostly attributed to less than expected, in fact, no meaningful storm recovery benefit in Florida; and a soft final two weeks of the year, which wasn't helped by the cold snap after Christmas. I'd also point out this is a fairly clean comparison in that it's against a fourth quarter 2016 that generally had our current full assortment and similarly lower reliance on clearance and discounting that we strived for in 2017. We did have a few milestones in two key growth strategies. First, we completed the installation rollout, entering the large markets of Florida and California in the fourth quarter and now offer that service in all of our markets nationally. Installed sales grew in our comp store set by 31% and grew 8% in the markets it's been offered in for more than 13 months. The second milestone was opening six new stores, a pace not seen since 2015, bringing us to 10 net new stores in 2017 and a total of 393. Let's take a look at gross margin, which came in at 35.4% for the quarter and had no significant unusual or legacy activity affecting it. Last year's gross margin was 32.9% and also had no significant unusual activity affecting it. So, the current quarter was better by 250 basis points driven by improved mix of manufactured products and improved margins, most notably, within the bamboo and engineered categories. Comparing sequentially to the third quarter, gross margin was down 60 basis points from Q3 2017, primarily due to increased promotional activity. Now, let's look at SG&A. SG&A expense for the fourth quarter was $91.5 million compared to $89.7 million in the fourth quarter of 2016. SG&A in the recent quarter included incremental legal costs of $3.4 million and $1.7 million of costs related to the disposal of Chinese laminate products we've been holding since discontinuing the sale of those products in 2015. The year-ago quarter included two nearly offsetting unusual items. In both periods, items are tabled out in the press release and the 10-K. When excluding these items, SG&A expense for the quarter was $86.4 million or 33.3% of sales and a decrease of nearly $3 million from a year ago. This drove over 300 basis points of leverage in terms of SG&A as a percent of sales. The reduction in spend consisted of $1 million in lower payroll-related costs, $1 million in lower advertising, and the remainder across a range of operational areas. If compared sequentially and again excluding the items tabled in the press release and the 10-K, SG&A was down slightly. I'll move down to P&L to operating profit. For the quarter, we recorded an operating profit of $600,000 compared to an operating loss of $9 million in Q4 of 2016. Both the current and year-ago quarters had several unusual items that impacted these results as scheduled in the 10-K and our press release, and we think it's useful to look at our results with these items set aside. When excluding those items, we had an operating profit of $5.7 million, in line with our third quarter's result and well ahead of last year's nearly $9 million operating loss. As you work down to net income, you'll see a credit in the provision for income taxes. This stems from the Tax Cuts and Jobs Act law changes that resulted in two main impacts. First, we revalued downward our deferred tax assets due to the lower rate, but because we've had a valuation allowance against these assets, this impact did not flow through to tax expense. Second, due to the elimination of the 20-year limit on loss carryforwards, we were able to recognize approximately $2 million in deferred tax assets we previously had a valuation allowance against. This along with other smaller adjustments did flow through as a benefit in the tax provision in the fourth quarter. On the year, this impact was partially offset by adjustments stemming from the IRS audits of years 2013 through 2016 discussed in the third quarter call and small amounts of state taxes owed, leaving us with a near-zero tax expense and effective tax rate for the year. Now, let's look at liquidity and cash flow. As of December 31, we had total liquidity of $146 million and we had borrowings under our ABL facility of $15 million, which was down from $32 million in borrowings at the beginning of the quarter. Our inventory ended the quarter at $263 million, up slightly from $253 million at the beginning of the quarter. We do expect inventory to climb through the first quarter to the $270 million to $280 million range as we prepare for the spring season. With respect to guidance, Dennis is going to walk through some of the highlights of our strategic work and we believe that the initiatives planned will sustain 2017's trend into 2018 in terms of steady, but modest comp store sales growth in the mid-single digits and gradual expansion of our gross margin. On SG&A, excluding any unusual legal costs, we expect a modest increase in dollar spend due to increases in advertising and technology initiatives and the additional SG&A related to new stores, but still expect to achieve leverage on SG&A as a percent of sales in 2018. The gross margin expansion and the SG&A leverage combined for what we expect to be 100 basis points to 200 basis points improvement in our adjusted operating margin to the low-single digits. That said, Q1 comps are looking more like low-single digits at this point, stemming from a soft January that did not benefit from the same year-end promotion ending in January a year ago coupled with particular softness in our Northern division. February has rebounded nicely and we have a strong program lined up for March, but adding it altogether points to low-single digits. On the investing side, we expect to open 20 to 25 stores in 2018 and spend $15 million to $20 million in capital during the year. Given the attention on taxes, I'll also note that while profitable on an adjusted basis, when we include the legal and settlement costs, we were in a taxable loss situation in 2017 and are likely to be in a loss position in 2018 as we fund the MDL obligation. As a result, we do not pay cash taxes currently and do not benefit from the tax law change in the near term. In terms of earnings and EPS, we continue to carry a valuation allowance on our NOLs and other deferred tax assets, which has resulted leaving us with a very low effective tax rate from a GAAP perspective. We expect that to continue in 2018 and potentially beyond, but our base outlook is that as we move through 2019, we would expect to revert to statutory rates which, for us, will be approximately 25% including state taxes. So to be clear, we will certainly benefit from the tax change within the next few years and generally expect that to flow to the bottom line and EPS. To wrap it up for me, looking at the year 2017, we're pleased with the position we now have the company in and the platform in place. We have resolved the CPSC matter and disposed of the related inventory. We fully expect to settle the MDL litigation. We expanded our installation business and we've fully restored our product assortment. Along the way, we've considerably strengthened the balance sheet. While we believe the foundation is as strong as it's been in years, we also see opportunities to build our brand and improve the company's profitability. So, let me hand it back to Dennis to cover that.

[Dennis R. Knowles:]

Thank you, Marty. Over the past few months, we've spent a good amount of time refreshing and preparing our strategy and operating plan for 2018 and beyond. I want to give you some of those highlights as we head into the new year. First, we have worked to refine our overarching mission, which is from inspiration to installation, our passion is to make beautiful floors possible and easy for all. In this statement, we are reflecting our unique business model that is well positioned to serve three key segments

[Operator:]

Thank you. At this time, we'll be conducting a question-and-answer session. Our first question is from Simeon Gutman with Morgan Stanley. Please proceed.

[Simeon Ari Gutman:]

Good morning. It's Simeon Gutman. My first question is on the product comps. It looks like if we take away the installation piece, the product comps are lagging the industry a bit. When do you expect that to turn? And more specifically, can you talk about the catalyst for this to change?

[Dennis R. Knowles:]

Well, as I said, we're still pleased. This was the first quarter, as Marty mentioned in his comments, where we had kind of comparable numbers. Still making some adjustments to our assortment, but feel really good about the performance of each of the categories. And then we went through a fair amount, as I mentioned, last year of work on our solid business, our solid hardwoods and our engineered hardwoods. So, we're expecting to see a little lift in that area this year, but are pleased with the progress we're making.

[Simeon Ari Gutman:]

Okay. And then my follow-up, it sounds like you're fairly confident about the margin expansion for next year, both SG&A leveraging and gross margin. I would ask, if there is risk to one of those items more than the other, whether it's SG&A doesn't lever as much as you think or GM doesn't expand as much as you think, which one do you think – and I was trying to hold sales constant here, which one do you think there could be more risk to, if any?

[Martin D. Agard:]

Yeah, it's Marty. I'll field that one. I would say – I hate to say it, but I'd say similar. We are looking for something like a little bit more margin leverage from the gross margin than SG&A, but some of both. And I would put the risk, I guess, probably a little bit more on the SG&A side, I guess. We feel confident about the gross margin plans.

[Simeon Ari Gutman:]

Okay. Thanks, Marty.

[Operator:]

Our next question is from John Baugh with Stifel. Please proceed with your question.

[John Allen Baugh:]

Thank you. Good morning. I wonder if you could help us roughly what the comp has assisted in 2018 from the full year of installation being available?

[Martin D. Agard:]

Yeah. I don't have a specific model, but I would say it's been running about 2 points, and I think it will still be in that north of 1 point, 1.5 point. We still have those big markets. Florida and California are big, and they will be kind of year-over-year expansion that shows up as comp tailwind. And then, as you can see, we report each quarter within the markets where the installs has been in place a full year. It's been comping well. It was 8% this quarter. And it's been in that sort of near double-digit kind of rate. So, that's also tailwind. So, I would say a point-and-a-half-ish type of range.

[John Allen Baugh:]

Okay. And then, could you walk through January in a little more detail again, discuss the timing of promotion, but I'm particularly interested, are your comps in the non-weather-impacted areas in the mid-single digit or stronger area? Thank you.

[Martin D. Agard:]

Yeah. So, the first thing is on the promotional timing. We had a promotion that wrapped into January a year ago and left us with a really strong first week of the year a year ago that this year we did not carry that promotion into the new year. So, January started off in a hole there. And then, in the North region, in particular, it was considerably different than the rest of the country. And I would say the rest of the country has been in line with our kind of guidance and our objectives for the year. So we hate to talk about weather, but this was just a notable pattern regionally in our store profile.

[John Allen Baugh:]

Okay. And then, finally on transportation costs. I know trucking in particular is tight here, but obviously there's containers and a whole host of transportation items. Could you walk through your expectations, 2018 versus 2017, on transportation costs?

[Martin D. Agard:]

Yeah. It moved up a little bit in the fourth quarter. So, sequentially, it costs us a little bit, not much. Year-over-year, it did end up costing us a bit in that comparison and it continues to be a risk. But this is the kind of risk that I would put in the 25 basis point to 50 basis point kind of thing. It's not going to overwhelm the other kind of gross margin drivers that we have in place. But it is a risk and something moving against this year in the current environment.

[John Allen Baugh:]

Thank you and good luck.

[Dennis R. Knowles:]

Thanks.

[Operator:]

Our next question is from Rick Nelson with Stephens. Please proceed.

[Rick Nelson:]

Thanks. Dennis, can you speak to the competitive environment and what you think is happening with market share now that we have a full year behind us?

[Dennis R. Knowles:]

Well, I think we saw it kind of play out similarly as we talked about in Q3. I think, arguably, the hard surface flooring category in general is probably as competitive as it's ever been. But we like that. We see lift when others promote as well as when we do. So, I think it really – what I like about what we've done to prepare ourself for this is just the complete full assortment really focusing on trend and style and then the addition of our installation services as well. So, I think that kind of gives us a leg up in terms of being able to offer a complete solution. So, we're thinking that we like our share gains in some of the emerging categories. We know we've got some work to do in other categories as well. But overall, it's really brought some good innovation to both what I would call the manufactured categories. We just went out to Las Vegas to the annual SURFACES show. And I got to tell you, both vinyl and laminate vendors are really stepping up and we're excited about what this has brought in terms of attention to this particular category. So, I think it will always be our work to do to make sure that we're staying ahead of everything in terms of fashion and innovation. But we really do like the attention that it's giving. You can definitely tell when you look at the share difference between what soft flooring had a year ago, and we've all seen this coming, but it's really giving the vendors a reason to step up their game as well. So, I expect it to remain competitive.

[Rick Nelson:]

Thank you for that color. Also like to follow-up on your comments about 3 points to 5 points of operating margin expansion over three to five years. What sort of pace are you planning for that to come off of, is that the 2018 base of operating margin, do you think we can get back to those double-digit operating margins or is there structural changes that will prevent that?

[Martin D. Agard:]

Yeah, Rick. It's Marty. Those comments are all off of the adjusted operating profit that – first, that's non-GAAP measure and it's tabled out and reconciled to GAAP in the 10-K. And for 2017, it was a little over $10 million of adjusted operating profit on $1 billion in sales. So, that's 1%. It was a little higher than that in the back half, but there's a seasonal pattern to that and so forth. So, it is off of that 1% that both Dennis and I are talking about advancing into the low- to mid-single digits. Nothing structural. It's leverage at the gross margin – back to Simeon's first question, leveraging the gross margin and leveraging SG&A. We think we can get a point, point-plus out of both, but there's some risk around it. And it just comes down to how well our top-line initiatives work and, to some degree, the competitive landscape and so forth. But that's what we're talking about. Nothing's really structural in there.

[Rick Nelson:]

Great. Thanks for that. Also like to follow-up on your promotional plan, your advertising plan, 2018 versus 2017. If the comps don't materialize as you expect, what are the tools you have to drive that better?

[Dennis R. Knowles:]

Well, as I said earlier, we spent a fair amount of 2017, really most of the year really, really extracting the data that lets us know where we're effective, when we're effective and what channels work best for us. And so, 2018 is that – as I said, 2017 was about resetting the baseline for us, understanding what our assortment looked like, how our stores worked with less turnover, focusing on training. So, we're able, as I mentioned, now that we've got the traffic counters, we've cycled that. We really can't tell what advertising vehicles are effective for us. And so, we'll be leaning into that this year. And to answer the question, if the comps don't materialize, that's a tough one for us, because we don't expect that to happen. But we'd make sure that we're leaning into the tools that we have that drive traffic. So, it's kind of what we've spent the entire year working on and we started to see that really play out like in Q3 and Q4. So...

[Rick Nelson:]

Very good. Thanks a lot and good luck.

[Dennis R. Knowles:]

Thank you.

[Operator:]

Our next question is from Matt Fassler with Goldman Sachs. Please proceed.

[Matthew J. Fassler:]

Thanks so much. Good morning. My first question is a follow-up on the promotional theme. One of your competitors obviously had a very tough time citing the promotional environment, and you said that the environment's as promotional as it's been. Why do you think that is? Is there an issue with demand? Is your recovery and the emergence of other competitors creating more capacity? Was it a seasonal thing for Q4, not that flooring should necessarily be a holiday item? What do you think is catalyzing this change in the backdrop?

[Dennis R. Knowles:]

Well, I think hard-surface flooring, Matt, has continued to gain popularity, for several reasons. But I think if you looked at the flooring industry and you look at just say the two biggest players, and the lion's share in the past in their business has been soft – has been flooring, carpet. And if carpet's on a decline, you got a lot of volume that you've got to make up. And I think the success that you've seen in the vinyl categories and even the waterproof laminates, I think, has really just made that more – it's just more competitive. So, that's my take on it. That coupled with the fact that you've got a competitor that's relatively new in the space that's gaining share purely by growth. And then, I like to think that we brought a little attention to that as well in our recovery.

[Matthew J. Fassler:]

Do consumers respond to price, what's the efficacy of – I guess you could really speak most appropriately to your own promotional calendar. What kind of promotions tend to actually earn the kind of return that you would seek as you come to market?

[Dennis R. Knowles:]

I don't know that I want to share all our detail. I would tell you that one thing that we are excited about in 2018 is that we can now advertise our services across the country. And that's been something we've seen a good response to is the installation. In fact, I think if you would talk with anybody at the Builders' Show or anybody out at SURFACES, if you talk to anyone in the industry, their big concern right now is labor. And this certainly puts us in a position where we've got kind of a curated group of installed providers that Charles (36

[Matthew J. Fassler:]

Just briefly by way of cleanup, as you look at the anticipated legal costs, not things like the multi-district settlement, but the actual legal and professional fees that you've been breaking out. That was about an $11 million item for the year. Do you have a rough sense as to where that ends up in 2018?

[Martin D. Agard:]

Matt, it's Marty. That's hard. The MDL side of that should run down and out as we get to the middle of the year, and we've got that MDL in execution mode.

[Matthew J. Fassler:]

Sure.

[Martin D. Agard:]

The DOJ one is just very open ended for us. We don't know. A Dennis said, it's hard to make any comments. We don't have a good timeframe around that. So, I would hope on balance this thing is tapering down and out over the course of the year, but it's hard to say exactly what can really happen there.

[Matthew J. Fassler:]

Understood, guys. Thank you so much.

[Dennis R. Knowles:]

Thanks, Matt.

[Operator:]

Our next question is from Dan Binder with Jefferies. Please proceed with your question.

[Daniel Thomas Binder:]

Thanks. It's Dan Binder. Couple of questions. First, within your comp outlook, I was wondering if you can give us a little more color on how much of that you would expect to be traffic versus ticket and what the drivers of ticket would be if it's as much as half? The second question was really around assortments. And obviously, in the showroom space that you have, it sounds like you've done a lot of work and the results show that. But just curious, as you think about some of the comments you made earlier about players with broader assortments and even a prior management team at this company trying new formats, where is your head now on the possibility of going beyond the current box to get bigger in the category?

[Martin D. Agard:]

I'll just quickly respond to the first question around, we would expect – it's certainly in the first quarter where we'd kind of call that down a little bit. Traffic will be very low. It's been running 1%. So, it could be in that range or, I guess, even towards zero. We continue to see good ticket growth. We've got – as the Pro business expands, that's a good ticket. And on install attached ticket, merchandise and install and all is quite a large ticket and is very good for that. So, we expect that momentum to continue through the first quarter and on into next year.

[Dennis R. Knowles:]

Yeah. And as far as the story goes, with the expansion, it gives us the opportunity to do something we haven't done in prior years and that's start to tinker with what the showroom looks like, the footprint, if you will. We have some plans for a couple of different tests that we're going to run this year; one format, one market size. So, we kind of feel like we're in that position now where we should be doing that. And looking at both, like I said, where we have our stores located as well as what they look like.

[Daniel Thomas Binder:]

Okay. If I could just squeeze one more in on the gross margin, the targets longer term, just in light of your expectation that the industry will stay competitive and certainly everything would sort of suggest that, just given growth of some of the competitors. When you think about that gross margin target longer term, how much do you think will end up being required to be reinvested in terms of better sourcing? Can you break it into buckets of how much is sourcing versus mix? And then what piece of that needs to get reinvested to drive, to keep this comp store sales train running?

[Dennis R. Knowles:]

Well, as you think about kind of our year in 2017 was really built – we were rebuilding our assortment, rebuilding our vendor base. And I would tell you, a fair amount – without giving you exact numbers for how that breaks out, we have a fair amount of opportunity as it relates to sourcing. But we also feel like the intelligence that we've gained this year from our pricing initiatives will help us manage that from a regional perspective. And so, we'll be able to continue to lean into both of those to make sure that we're optimizing our pricing as well as the other thing that we've done a much better job that won't be such a drag on margin for us is just managing our obsolescence. I would tell you that in the past few years we've had obsolete inventory that was as high as 30% of our total inventory, and we're nowhere near that now. And so, we're much more strategic in how we optimize our markdowns and prepare for incoming new assortment. So, all of those are opportunities for us to improve margin and is a big focus for us in 2018.

[Daniel Thomas Binder:]

Thanks.

[Operator:]

Our next question is from Brian Nagel with Oppenheimer & Company. Please proceed.

[Brian Nagel:]

Hi. Good morning.

[Dennis R. Knowles:]

Hey, Brian.

[Brian Nagel:]

So, my question, I think, is a follow-up to some of the prior questions, but really on traffic. As I look at the results today and there's a lot of things you guys have been well here and clearly 2017 was a nice rebuilding year for you. But the one factor in my mind that remains still a bit soft and somewhat of a drag is traffic. So, as we look into 2018 and recognizing that traffic did improve sequentially through the year, but is there – I guess the question I have is, are there levers you can pull to drive traffic? You'd mentioned putting the traffic counters in your stores, some advertising. But is there a lever you could really pull and is the company now positioned to handle better traffic?

[Dennis R. Knowles:]

I would tell you, yes. We are in a much better position. Mark and the store teams have really focused on training and retention in the stores. And we really enjoyed a much better – probably, our best turnover ratio since I've been here at the store manager level in the latter half of the year. That, coupled with the fact that we're now fully deployed for installation, gives us the ability to market, like I said earlier, across all the categories, but to also drive services. And then, I really like – some of the work that we're doing with the Pro, I think, is really going to give us an opportunity to drive additional footprints in our store in a way that we never have. And we're working to build some capability to help accentuate that opportunity. But at the same time, last year for us was really – we stood up the Pro team, we started to kind of clean up our database and kind of work through our existing customers, and then learn how we could market to that customer. We do not do a lot of marketing to Pro customer. And so, our plan this year is to have that group of customers more inclusive in our total advertising plan. So, with installation in the Pro, in addition to what we're doing with our assortment, I think, gives us – as Marty mentioned, we will lean into advertising this year because we don't have any holes in our assortment. We feel like we've got the people in place in our stores to drive that into conversion. So, that's one of our biggest focuses this year.

[Brian Nagel:]

Great. So, I'm going to just follow-up on that. So, there's obviously a lot of talk about competition within the space. You have a new competitor coming in aggressively. You've got the larger format boxes, if you will, at least in this category, not pushing further. And as you look at this, I mean, you believe then that Lumber Liquidators could be more aggressive in driving traffic and that will work despite this what's likely a more competitive environment?

[Dennis R. Knowles:]

Absolutely. Absolutely. We see the response with our customers as it relates to our advertising and marketing spend. As Marty said, our Pro, while it's still at about 20% of our business, our comps are outpacing the company. And we believe that there's even more to gain there. And what really gives me that confidence is when we run, promote certain promotions and we see the growth in our new orders, we know that we're starting to fire on all cylinders as it relates to having the right product, having the right advertising cadence and then leveraging that against the experience in the store. It is clearly more work for us to do. We realize that 2018 is a year that we've really got to stay focused on both those metrics, both conversion and traffic. But we believe, even in the competitive environment, we have what we need to drive traffic, and they will respond.

[Brian Nagel:]

Got it. And one more I'm going to slip in, if I can. On Florida, you mentioned, I guess, it was in your prepared comments that you really haven't seen the – in any significant way, the hurricane recovery there. That's consistent with what we've heard from other companies. Is that business still on the come, or is it just not going to happen?

[Dennis R. Knowles:]

I think it is. Particularly, down in Southern Florida, down in the Keys, we've deployed a mobile showroom to kind of help. But I think it was a different kind of damage than what we saw in the Houston market. And I think it was either roof damage and wind damage or total devastation. And in Southern Florida, it seems that that was more total devastation. And so, it's going to play out over a longer period of time.

[Brian Nagel:]

Well, thank you very much. Appreciate all the color.

[Dennis R. Knowles:]

Thanks, Brian.

[Martin D. Agard:]

Thanks, Brian.

[Operator:]

Our next question is from Greg Melich with MoffettNathanson. Please proceed.

[Greg Melich:]

Hi. Great. I had a couple questions. One sort of a near-term one, then longer term. If comps are little slower in the first quarter, is that basically driven by all traffic or is ticket part of that? Then I had a follow-up.

[Martin D. Agard:]

Yeah. So far, the first quarter feels proportional. A little softer traffic, average ticket, I'd say, is probably close to what it's been at in terms of the year-over-year progress. So, I'd say proportional.

[Greg Melich:]

Okay. Great. And then, maybe to tie together the strategy with the cash flows, just to make sure I got these right, Marty. The inventories were down last year, but then you mentioned they should be coming up in the next quarter or two. Where is the right number for sort of inventory and working capital now and if you could sort of put your guidance in a framework of cash flow, that would be great, with CapEx numbers and D&A for this year?

[Martin D. Agard:]

Yeah. So a year ago, we were really overhauling the assortment and kept a position in both the sort of older products and the newer products. We were particularly conservative around the Chinese New Year potential disruptions and so forth. So, we really, I guess, took a conservative building inventory position that we didn't replicate this year, and that's part of the year-over-year big declines. We will always have this sort of seasonal build that goes on along about now where we are preparing for the spring season and, to some degree, we're bringing in new items while we still have the old onboard. So, I would say, the pattern I called out in terms of ending in this $270 million-$280 million range at the end of the first quarter feels about right. It tends to slide down in the second quarter and down further in the third quarter, hits a low point somewhere along there towards the end of our third quarter. And so, that's pretty comfortable. It's generated cash year-over-year. But certainly, we handle that type of seasonality and the inventory just fine. The AP cycle tends to lag it a little bit, so you'll see that fluctuating a bit. In terms of the rest of the CapEx kind of guidance, opening 20 to 25 stores, many of these will be where we invest in those openings, but again spread over the course of the year, that's handled in the $15 million to $20 million of capital. Some of those stores may be turnkey, where the landlord invests some and that lowers our capital requirement. We think we've got a mix of that and that the $15 million to $20 million of CapEx manages that. So, liquidity ends up being solid all the way through the year really and including the ability to sort of handle the MDL types of obligations that will come up. Certainly, the first $22 million is known that it'd likely be in the third quarter when inventory is at its lowest point. So, we don't expect any kind of pinch point there either. So, we're pretty comfortable with the balance sheet and liquidity.

[Greg Melich:]

That's great. And maybe the last question would be the transition there on the growth. And I guess you've put up just a handful of stores the last couple of years, less than 10, but now ramping up to 20 to 25. I know you're running some more retail areas as opposed to industrial. What other differences are you looking at as you put up those stores, either geography infill, retail versus industrial, that we should be watching for?

[Dennis R. Knowles:]

Greg, I would tell you, as we've mentioned before and you mentioned is, we are focusing more on A and B sites. And the performance of our new stores, over the course of the last year, have been really good. And we look forward to kind of seeing that – but I've also mentioned, we've also taken a different advertising approach to a new store as well. But we'll continue to focus on driving – we've got several markets. And I would tell you that we've got a balance of new and existing markets that we'll be going into that's pretty even. But our focus as it relates to how we open those stores will not change. We'll continue to conduct a grand opening when we open. And then as I mentioned earlier, we'll also focus on – we're going to look at a couple of new formats. But as it relates to where we'll put them, we'll continue to put those stores in A and B sites.

[Greg Melich:]

Perfect. Good luck, guys.

[Dennis R. Knowles:]

Thanks, Greg.

[Martin D. Agard:]

Thanks.

[Operator:]

Our next question is from Peter Keith with Piper Jaffray. Please proceed.

[Peter Jacob Keith:]

Hi. Thanks. Good morning, guys.

[Dennis R. Knowles:]

Good morning, Peter.

[Peter Jacob Keith:]

We have been in your stores in recent months and they do look a lot better and the service is great, so congratulations on the stability and turnaround. I was curious if you could provide us a quantification of the sales lift in the fourth quarter from Houston rebuild around the hurricanes.

[Martin D. Agard:]

I mean, it was a solid rebound. We don't want to break it out, per se, but it was supportive. It wasn't off the charts. But it was a strong comp in that mark. We only have 8 to 10 stores depending on where you draw the storm ring around that. So, it's a very small part of our business and just didn't have that strong contribution.

[Peter Jacob Keith:]

Okay. Fair enough. I guess, to pivot to the bigger picture question I want to ask is around that the comp guidance for the year. If we look at the last three quarters, we'll call it, Q3 to Q1, your comps have averaged, we'll call it, kind of 3% to 4%. So, the full-year comp guidance of mid-single digit does seem to imply some pretty healthy acceleration. The compares aren't necessarily easier. So, I guess, I'm getting some e-mail questions on this. Could you just help us get comfortable with the comp guide and maybe the overall drivers to the business as we look out towards the back half of the year?

[Dennis R. Knowles:]

Yeah. I would tell you that when you think about this year versus last year, as Marty mentioned, we completed the rollout of installation services last year in two of the biggest states, especially for us in terms of store count. So, you've got California and Florida. So, we're expecting lift, obviously, from those. And then we also see our penetration grow in our existing stores, as they become more comfortable with the installation and the process, and we continue to refine our install or provider base. So, both of those, we expect to draw – to provide some nice lift. And then the Pro customer, I don't want to not emphasize the expertise that we spent 2017 installing not only in our stores, but at the corporate headquarters. And we really think and expect that to start driving some of our comp growth beyond what it provided for us in 2017. So, we think both of those are big opportunities for us in terms of comp drivers.

[Peter Jacob Keith:]

Okay. Thanks, Dennis. Maybe just a question for Marty to narrow down the margin outlook. So, you've given the range in the press release of low to mid single. But I think but just in the Q&A here, you talked about gross margin SG&A, maybe getting 1 point, 1.5 point, which would imply, kind of in aggregate, 2 points to 3 points of margin expansion. So, is that maybe the fair way to think about it for the year where you're coming off of 1%, you're going to end up at around 3% to 4% for 2018?

[Martin D. Agard:]

Yeah. I think that's right. The reason we hedged it down just a little bit from that is just the risks around – well, we've talked a little bit about transportation costs. We've talked a little bit about the competitive environment. And so, we don't want to just count on being able to drive the top line at the full mid-single digits, while getting all of the best outcomes kind of on gross margin and SG&A. So, we ended up with that range of low- to mid-single digits. But your math is about right. We're just trying to identify that there are some risks out there.

[Peter Jacob Keith:]

Okay. Fair enough. The last question for me, more big picture around the brand. So, it sounds like you guys have been thinking strategically long term. How do you think about the overall Lumber Liquidators' brand going forward? And also just the tag line with Hardwood Floors For Less! given that so much of your new product focus is on non-hardwood product, is there a way that you think you might be able to tweak the brand or have you decided just going to stay steady going forward?

[Dennis R. Knowles:]

No, Peter, it's a great question, one we ask ourself every day. It is something that we feel like that we have the time now to really take a serious look at. We just had so many things last year I would tell you, and even in 2016, that were to me more important. And now is the time, I think, for us to really take a hard look at this. And so, we plan to do that over the course of the year, to kind of double down on our research to understand what the brand awareness is and what opportunities that we have, if any, for rebranding. But feel like now is the right time for us to do that.

[Peter Jacob Keith:]

Okay. Thanks for answering all my questions and good luck this year, guys.

[Dennis R. Knowles:]

You bet. Thank you.

[Martin D. Agard:]

Thank you much.

[Operator:]

Ladies and gentlemen, we have reached the end of the question-and-answer session. I would like to turn the call back over to Mr. Knowles for closing remarks.

[Dennis R. Knowles:]

Thank you, operator. Let me say thanks again to the Lumber Liquidators' team, our vendors, our customers and our shareholders for your continued support. We look forward to updating you next quarter.

[Operator:]

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