LL Flooring Holdings, Inc.
Q4 2018 Earnings Call Transcript

Published: 18 Mar 2019

[Operator:]

Good morning, ladies and gentlemen, and welcome to Lumber Liquidators' Fourth Quarter 2018 Earnings Conference Call. As a reminder, ladies and gentlemen, this conference is being recorded and may not be reproduced in full or in part without permission from the company. I would now like to turn the conference over to Danielle O'Brien [ph]. Please go ahead.

[Danielle O'Brien:]

Thank you, operator. Good morning, everyone, and thank you for joining us. Let me reference the Safe Harbor provisions of the U.S. securities laws for forward-looking statements. This conference call may contain forward-looking statements that are subject to significant risks and uncertainties, including the future operating and financial performance of Lumber Liquidators. Although Lumber Liquidators believes that the expectations reflected in its forward-looking statements are reasonable, it can give no assurance that such expectations or any of its forward-looking statements will prove to be correct. Important risk factors that could cause actual results to differ materially from those reflected in the forward-looking statements are included in Lumber Liquidators' filings with the SEC. The information contained in this call is accurate only as of the date discussed. Investors should not assume that 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 Knowles:]

Thank you, Danielle, and good morning, everyone. Today, I'm joined by Charles Tyson, our Chief Customer Experience Officer; Marty Agard, our Chief Financial Officer; Lee Reid, our Chief Legal Officer and Corporate Secretary; and Tim Mulvaney, our Chief Accounting Officer. Before we walk you through our financials and operating results, I wanted to discuss three pertinent topics; resolution of key legacy legal issues, our proactive approach to mitigating risks associated with trade tariffs and the announcement of Mary Agard's resignation. First, last week we reached resolution with the government regarding their investigations into the company's compliance with securities disclosure laws concerning the company's sourcing of Chinese laminate flooring. We entered into a deferred prosecution agreement with the U.S. Attorney's Office for the Eastern District of Virginia and the DOJ. We entered into a settlement of administrative proceedings with the Securities and Exchange Commission. The resolutions related to public disclosures made in March of 2015 and no findings were made about the safety or quality of the company's laminate flooring previously sourced from China, which we believe aligns with the decision by the CPSC in 2017 to close their investigation without issuing a product recall. Under the In-Home Testing Program we implemented and reported to the CPSC, we issued over 83,000 air quality test kits to our customers and they have not had a single tested floor produce a final emissions level that exceeded the World Health Organization's standards used in their program. We have cooperated with this investigation and are pleased to see the government recognized the changes in the company's leadership and our extensive investment in remediation. Notably, the DOJ charges are deferred and will be dismissed after three years provided we meet certain obligations, many of which we have already implemented. Separately, we announced this morning that we've reached a Memorandum of Understanding in the Gold matter that addresses customer concerns with certain Morning Star bamboo flooring that may not have met some of our customers' suitability expectations. Together, these actions represent an important milestone for our company as we can now look forward and focus on our commitment to providing quality products, services and experiences for our customers. Our new leadership team is excited to build on our progress and is dedicated to compliance, transparently, and accountability across our organization. These matters have been a financial constraint on the business and in addition to the legal expenses required a significant amount of the team's attention. We are pleased to resolve these matters, so that we can move forward with laser focus on operating and growing our business. I am also pleased to highlight that we have taken steps to enhance our liquidity position. Marty will provide details on the financial impact of these settlements and how we are managing liquidity in a moment. Second, we have been facing microeconomic challenges in the form of trade tariffs. While the impact of the current tariffs and a potential for a larger tariff has significant financial implications, it has given us the opportunity to reevaluate our entire sourcing and supply chain process. This we believe should unearth enormous long-term benefit. In the near term we were able to substantially mitigate the 10% tariff impact and expand gross margins during 2018. While the 25% of tariff has been indefinitely postponed, we know that our work to further mitigate the impact is still in front of us. To that end, we are not only improving our cost structure and supply chain, but also enhancing our capabilities under new leadership. We are actively renegotiating costs and moving product out of China where it makes sense. Our head of sourcing has already made immediate impacts by identifying significant areas to create efficiencies. In this challenging environment we recognize our pricing strategy is important to ensure that we are optimizing our revenue and costs. We are working tirelessly to improve profitability and remain committed to managing all that is under our control and expanding operating margins through a combination of initiatives and leveraging SG&A. Third, as seen in the earnings release, Marty Agard has announced his resignation and will be taking a new opportunity outside the company. He will remain our CFO until April 5, to ensure a smooth transition. I want to thank Marty for his contributions and hard work over his tenure. Marty has been instrumental in helping us rebuild our finance organization and deepen our team talent and has helped us overcome many legacy issues we have faced. We wish Marty well in his new role. I am pleased to announce that Tim Mulvaney will take over as our interim CFO while we complete our succession process. Tim has served as our Chief Accounting Officer since 2017 and has many years of public company experience. Tim has been a valued member of the leadership team and I along with the Board have the utmost confidence in his ability to serve as our interim CFO. Lastly, we have retained Herbert Mines Associates, a leading executive search firm, to assist us in completing a comprehensive search for a permanent successor and as always we'll keep you updated. Now to recap 2018, one year ago we discussed our plan to transform Lumber Liquidators through a number of strategic efforts including operational excellence through improved service, merchandising, assortment and value, enhanced value proposition and customer experience through digital and technology advancements, expanded business services including system-wide rollout of installation and enhanced value proposition for the Pro and improved profitability. While we recognize there is still work to be done, as I sit here today I am pleased with the hard work and dedication our team has shown to make progress in 2018 and that it was a year of investment, executing on our stated initiatives and laying the groundwork for the future. For the full year we delivered 2.6 comp growth driven largely by installation, pro sales and sales in our resilient flooring category. Gross margins increased 30 basis points year-over-year despite headwinds from tariffs and transportation costs which together had a negative impact of 100 basis points. Our ability to grow margins in a challenging environment highlights the success of our assortment initiatives and effort to become more cost effective. I would like to take a moment to highlight some of the progress we made against our key initiatives in 2018. First, we continue to execute on our plan to grow our installation of pro businesses. For the full year installed sales grew 12% and contributed roughly 13% on a comp store basis. Installation now comprises roughly 12% of our revenue and we expect this to continue to grow. We have officially completed the rollout of installations and had the first year under our belt. Additionally, our pro business continues to accelerate and now represents 29% of total revenue. We are pleased with the performances of both businesses and believe this progress underscores our commitment to service all customers and their needs which is a true differentiator for Lumber Liquidators. Second, one of our top priorities in 2018 was transforming customer engagement at every touch point. We've improved the way we interact our customers as well as our overall customer experience. Charles will discuss this in further detail, but I'd like to highlight two initiatives in particular; digital and marketing mix. On the digital front, we are evolving to an omnichannel approach that creates an integrated and cohesive customer experience, no matter how or where our customers engage. This begins with revamping our online presence. We are not only working to improve our website to provide a seamless shopping experience, but to develop expanded capabilities which we are especially excited about. More to come on that this year. Additionally we are reshaping our marketing mix to more temporary business driving elements. We have hired a new agency on both the media planning and creative side and have taken action to move ad dollars away from less effective channels such as print. There is still much work to do in this area; however, the initial read out on our work is encouraging and pushing us to expedite this transition. Lastly, we continue to expand our presence in key markets. In 2018 we opened 21 stores, bringing us to 413 total stores which furthers our goal of achieving 500 stores. Growing our presence in key markets is essential to expanding our market share. Coupled with our exciting customer experience initiatives, solid inventory management, tactical advertising and improved product mix, we see store expansion as an exciting opportunity. Notably, we debuted a new larger format store in Altamonte Springs, Florida and the Orlando market. This store design is a first of its kind for Lumber Liquidators equipped with more in-stock items, a pro desk and design center which sets a new standard for our customers' flooring experience. We have identified a number of locations in high traffic areas where opportunities exist to open stores similar to this format or alternatively transition current stores to this format. While the store is in its early months of operation, we are pleased with the initial results. We plan to continue refining and testing this format before making a decision on further rollout. These successes are encouraging milestones that we believe position us better competitively. However, we recognize that there are some areas where we need to further accelerate our transformational strategy. For the full year our merchandise and traffic were down 0.6% and 0.8% respectively. The launch and growth of installation business has resulted in some cannibalization in merchandise transactions. We believe the declining comp store traffic is also a result of our own new store cannibalization, the competitive environment and the modest softening of the industry we saw in the latter part of 2018. As we transform our marketing approach away from traditional direct mail to more digital, we have realized this transition could undoubtedly impact traffic in the interim, but are confident this should improve traffic in long run. Looking ahead to 2019 we see a clear opportunity to continue to execute our transformational strategy and make further progress against our initiatives. While we expect some moderation in the economic backdrop, particularly as it relates to new and existing home sales, the ongoing consumer shift from carpeting to hard surface flooring should ultimately sustain demand for our wide variety of wood and vinyl products. We are currently assuming the trade environment with 10% tariff, thought the potential of a 25% mark will have a substantial impact on both the cost side, as well as economic growth and consumer demand. With that said, we believe 2019 macro environment to be similar to what we experienced at the end of 2018 showing a slight deceleration. Turning to Lumber Liquidators priorities for the coming year, first we are focused on capturing additional market share and believe our differentiated customer experience will be a driving force behind that. We have a dedicated team of employees that focus solely on the hard surface flooring business and we are seeing our close rates improve, which we believe will continue moving forward. I am also proud to say our employee turnover is at its lowest level during my tenure. We are incredibly grateful to our associates around the country for the way they do to serve our customers and showcase our differentiated value proposition. Second, with these with the major legacy legal issues behind us, we have the opportunity to increase our advertising spend this year, enhancing our efforts to modernize our marketing plan. We will also look to continue optimizing regional product assortment, product mix, sourcing and executing on our store development plan. With our priorities in place, it is now a matter of strong execution. We are targeting to deliver a flat to low single digit comp growth in 2019 along with continued adjusted operating margin expansion. Lastly, in 2019 we anticipate that there could be consumer weakness due to the media reaction related to the settlement, coupled with weaker industry demand, more difficult comparisons against Hurricane Harvey and slowing installation tailwind. As a result, we expect comps to be down in the low single digits in the first quarter, but flat to up low single digits for the year. We expect flat to 50 basis points of adjusted operating margin improvement. The opening of 10 to 15 new stores depending a bit on the success of the new larger format prototype at Orlando and capital spending of $15 mi to $18 million. To conclude, our strategy remains focused on transforming our customer experience through a number of digital and in-store initiatives, enhancing our value proposition, improving business operations, and expanding business services. We are confident in our ability to provide a seamless foreign experience, improved profitability, and drive long-term shareholder value. We have a talented team committed to executing on these initiatives and we look forward to updating you on our progress in 2019. Now I will turn the call over to Charles.

[Charles Tyson:]

Thank you, Dennis. I'd like to focus my comments this morning on opportunities to improve our profitability, our merchandising initiative and our efforts around driving traffic including our digital program. When reviewing opportunities to improve our long-term profitability, our leading initiatives here include global sourcing, product mix enhancements, and product regionalization. Our global sourcing team continues to evaluate the best alternative country sourcing opportunities to drive improved product acquisition costs. The team was proactive in the quarter negotiating lower costs to substantially offset the 10% tariff environment and we expect to see further sourcing benefits delivered as we progress through 2019. In past calls we've talked about the need for our assortments to reflect the style and functional demand of local and regional [indiscernible]. We've recently completed a reset of our store planograms to more accurately reflect local versus national flooring trends. Our merchandising teams are actively working with our vendor partners to create unique assortment for specific markets. For example, this will allow us to differentiate our mix between coastal assortment styles in the west versus hardwood trends in the northeast. We will continue to develop these regional assortment choices through 2019, specifically in the engineered wood and laminate categories. On the merchandising side, the market continues to be dominated by the growth in vinyl. But we also saw encouraging share gains in both hardwood and laminate in the fourth quarter of 2018 driven by changes in both our assortments and promotional cadence. This quarter in laminates we have launched our new AquaSeal water-resistant products for both 24 hour and 72 hour performance that will complete in the growing water-resistant category. While we expect aggressive growth in the vinyl category to continue, we see that our unique differentiated, high touch service model is well positioned to deliver an exceptional customer experience in hardwood for both our DIY and infill customer segments. We've undertaken a number of assortments and marketing initiatives working with our vendors and field partners to deliver share gains in these segments and we expect to see these results accelerate as we progress through the year. Turning to our traffic driving initiatives, let's start with out digital strategy. You may have noticed we've completed a number of upgrades to our online shopping experience to improve site performance, speed and navigation. We've also completed the on-boarding of a number of new channel partners to optimize our digital marketing capabilities, especially in regard to search. We are focusing our efforts both on hyper local marketing as well as expanding new online capabilities to capture and convert increased traffic. Early next quarter we will be launching our new Floor Visualizer online. This tool will enable customers to take a photo of any room in their home and upload any one of the hundreds of floors that we carry to visualize what the finished product will look like in their home. We believe this provides a more tangible approach to online shopping as it overcomes any visualization hurdles in the digital buying process. We're also encouraged by the positive trend and early testing is resulting in higher conversions. We're seeing an increase in online user acquisitions as well as improved online engagements, conversion, and revenue growth. As we discussed last quarter, we see creating a compelling digital experience as a critical part of our strategy to capture customers at all stages of their flooring journey. Turning to our marketing plan, we've launched a new store opening marketing program that is delivering stronger results and driving higher awareness of our new Lumber Liquidators store in our customer's neighbourhood. We've completed on-boarding of both a new creative agency and new media planning agency which will bring greater focus to our brands positioning work. We expect to update you on this work later this year. We are focused on allocating our media mix to better align with how our customers consume media. We are testing a number of regional advertising approaches that will align content more closely to the mix of products being sold in specific geographical regions. As you know, we optimized our total spend in 2018 reducing allocations to unproductive spend mediums, we do not see further reductions from those spend levels in 2019 and based on specific media returns we see opportunity to increase spending as we progress through the year. Lastly, on the traffic front, we are aggressively reviewing our store prototype and the opportunity to create a more compelling customer experience. As Dennis mentioned, we're excited by the customer reactions to our new expanded store concept in Altamonte Springs, Florida. Roughly four times the size of an average store showroom this location features 8000 square feet with a design sensor that helps customers digitally envision and select their perfect floor from a larger in-stock assortment of flooring solutions. The stores features extra large display, same-day pickup or delivery, dedicated pro sales deck, and infants holding specials hours of operations designed to accommodate the pros busy schedule. Altamonte Springs offers a more in-depth stock [indiscernible] product than a typical Lumber Liquidators store and has a unique offering for all our client segments. As Dennis mentioned, we are in the process of identifying locations to open another prototype of a similar format, while we identify other potential remodel sites in our existing portfolio. I will now turn it to Marty to discuss our financial results.

[Martin Agard:]

Thank you Charles and good morning everyone. In the fourth quarter net sales were $268.9 million, an increase of 3.5% over last year with comparable stores net sales up 0.4%. This was driven by 31% increase in installation services sales slightly offset by 2.6% decline in merchandise sales. The overall 0.4% comp growth was affected by an increase in average transaction value of 2.2% and a decline in the number of transactions of 1.8%. We continue to see the attachment of installation sales and the increased Pro customer mix as the major contributors to the larger transaction sizes. I want to bring your attention to transaction size and count. We've made a slight change in our definition of transaction. The old definition aggregated multiple purchases into one transaction, which increasingly overstated average transaction size and correspondingly understated the number of transactions as our Pro customer business has grown. The new definition counts individual transactions over $100 independently unless added to a previous order. This change is detailed in the 10-K along with restated history by quarter for both 2018 and 2017. As a reminder, we finished the last of the geographic expansion of our installation services program in late Q4 2017, so fourth quarter 2018 cannot yet be viewed as entirely comparable. I will point out that our services business grew 13% in just those stores in which it's been offered for over a year which is the same rate we saw in the third quarter. Merchandise sales were negatively impacted in the Texas market and to a lesser extent Florida as well where we compared against the peak of the Harvey storm demand in the prior year period. If we exclude those markets, our merchandise comps were closer to flat. In terms of category performance, we continue to see strong growth in vinyl products with offsetting softness in bamboo and exotic solid subcategories. Gross margin for the fourth quarter was 35.7% and on an adjusted basis is detailed in the press release. It was 35.1% which was down 30 basis points from last year's 35.4% gross margin. The decline was driven by over 200 basis points of positive price and mix lift more than offset by roughly 150 basis points of tariff effect, approximately 50 basis points of higher transportation costs and 30 basis points of installation mix impact and other smaller elements. As we think about tariffs going forward, on a fully developed basis, a 10% tariff rate on the roughly 45% of our cost to goods sourced from China would result in approximately 270 basis points of gross margin headwind before any mitigation. The 150 basis points impact I referenced for Q4 reflects a partial effect due to lags as tariff affected purchases rolled through inventory. So if you see in our Q1 guidance, we will be see the tariff impact increase by approximately 100 basis points, but we should also start to see our cost out mitigation rolling through the inventory. These two dynamics should nearly offset each other and leave margins roughly flat or perhaps down slightly sequentially from Q4 2018 to Q1 2019 and then we plan for incremental improvement in margins through the rest of the year. Turning to SG&A expense for the fourth quarter, this was $151 million compared to $91.5 million in the fourth quarter last year. SG&A in the recent quarter included accruals for the two major settlements Dennis discussed along with incremental legal costs of $2.3 million, while last year's quarter included incremental legal fees of $3.4 million and disposal costs for the Chinese laminate inventory of $1.7 million. Both periods items are tabled out in the press release. When excluding these items from both periods, adjusted SG&A expense for the quarter was $87.6 million, an increase of $1.1 million from a year earlier driven by $1.2 million and higher occupancy costs related to the opening of 21 stores in 2018, $1 million attributable to the exit of our finishing operation in Toano and $1.6 million across the range of other areas. These were all offset by $2.7 million in lower advertising spend which reflects our efforts to reduce spend in areas we assess as less effective along with funding we redirected to develop our digital capabilities. For the quarter we recorded an operating loss of $55 million compared to an operating profit of $600,000 in Q4 2017. The large loss in the period reflects the accruals for the two settlements that together had a $61 million impact, and if we exclude those accruals and other unusual items as shown in our press release, we had an adjusted operating profit of $6.7 million in the quarter compared to last year's $5.7 million adjusted operating profit, an increase of 18%. Adjusted operating margin was 2.5% of sales compared to 2.1% last year, a gain of 40 basis points. I'd like to make a few notes on the full-year 2018. Our total sales were up 5.4% versus 2017 and our comp store sales grew 2.6%. Our adjusted gross margin came in at 35.6%, an increase of 10 basis points from 2017 despite approximately 40 basis points of tariff impact. Without that impact we would have expanded gross margins by 50 basis points. We also levered adjusted SG&A by 80 basis points. Adjusted operating margin finished at 1.9%, up 90 basis points and without tariffs would have been up 130 basis points year-over-year. Before moving on to 2019, let me address our liquidity and some forward-looking expectations given the two major settlements announced last week and today. As indicated in last week’s announcement of the DOJ and SEC settlements, $33 million will be paid in the next 30 days. On Gold, we will fund $1 million of the $14 million cash portion upon the court’s preliminary approval expected in the next few months. The funding of the remaining, $13 million depends on the court’s final approval. If that is granted in 2019, our funding would consist of two installments, $6 million funded upon final approval as early as September and the remaining $7 million in January 2020. If the final approval isn’t granted until 2020, our funding would happen in a single lump sum at that time. As of 12/31/2018 we had liquidity at $79 million consisting of availability under our credit facility at $67 million and cash of $12 million. This was down for the end of Q3 due to our funding of the MDL obligation of $21.5 million in November and elevated inventory levels related to the outsourcing transition, pre-tariff buying, and seasonality. In the coming weeks we will fund the full $33 million related to the DOJ-SEC settlement and by year end or early 2020 we expect to fund of $14 million cash portion of the Gold settlement. Deducting these from our year end liquidity position of $79 million, we would be left with $32 million. Over the next few quarters we expect to rebuild liquidity in two primary ways aside from normal operations. First, our inventory at year end and was $318 million and we expect this to be below $300 million by the end of Q2 generating approximately $15 million in net liquidity. Second, we have a commitment letter from our banks subject to customary closing conditions to expand our credit facility. Based on expected inventory levels we would add incremental borrowing capacity of roughly $35 million. So to recap our liquidity bridge, we start at year-end $79 million, deduct the full payment amounts for the DOJ and Gold settlements of $47 million, add back inventory reductions of $15 million and the expanded credit facility of $35 million, bringing us to an approximate range of $80 million to $85 million in liquidity before normal operating cash generation. Also, following these settlements our business will emerge with much less uncertainty and significantly reduce legal and related burdens going forward leading to improved cash generation. As an indication of the cash generating ability of the business, we can look at 2017 and 2018. Cash from operations in 2017 while impacted by nonrecurring items going in both directions was positive $39 million on a GAAP basis. In 2018 cash from operations with the use of cash of $43 million which included a use of cash of $55 million to build inventory net of payables that we do not expect to recur and $22 million for funding the MDL. If we set just those two items aside, we had positive cash from operations of $33 million in 2018. If we net against that level of operating cash flow, our capital spending of $12 million to $15 million per year, we get net cash before financing without major swings in inventory or payables or major legal payments of $20 million to $30 million per year. This is meant to highlight the cash flow potential of the business with these litigation issues behind us. Now going back to my earlier break of major liquidity events that left us at $80 million to $85 million before operating cash flow, we believe that level is sustainable and we would expect our liquidity to improve gradually from there. Turning to 2019 guidance, as you can imagine this is challenging given the uncertainties we face on the future of tariffs and the adverse customer reactions to the two settlements announced today and last week. That said, from a macro perspective, we anticipate a slowing of the flooring industry and expect low to mid single-digit growth, still a positive environment but decelerating 1 to 2 points from last year. And we anticipate 10% tariffs continuing, no removal and no escalation. So in 2019 for our comp store sales growth we will face the absence of the installation expansion contribution, tougher comparisons against the hurricane Harvey storm benefited markets last year and the forecasted slower industry growth. Additionally, and hard to factor in is the risk of consumer weakness due to the media reaction related to these latest settlements. As a result, we expect comps to be down low single digits in the first quarter and flat to up-low single-digits for the year. In terms of adjusted operating margins, for the year we are targeting flat to 50 basis points of expansion which on 2018’s actual adjusted operating margin of 1.9% would put us in the range of 1.9% to 2.4%. I will note that in the first quarter combining the softer sales residual tariff impacts on gross margin and modest year-over-year SG&A increases, we expect an adjusted operating loss of $3million to $5 million. On the investing side, we expect to open 10 to 15 new stores in 2019 depending a bit on the success of our new larger format prototype in Orlando and capital spending of $15 million to $18 million. On a personal note, I want to express my appreciation to Dennis, the Lumber Board, and all our associates for their partnership with me over these years. I want to assure our shareholders, the team is working hard every day to drive shareholder value and strengthen our brand. I’ve worked closely with Tim over the past two years and have complete confidence in him as the company’s interim CFO. Ultimately, this was a unique opportunity and a personal decision, it was not easy. I wish the Lumber organization all the best going forward. Thank you all for your time this morning and with that, I’ll hand it back over to the moderator for questions.

[Operator:]

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

[Unidentified Analyst:]

Hi guys it’s [indiscernible] for Simeon. We just had a question, excluding tariffs how should we kind of think about underlying gross margins, you know, installed mix should be less of a headwind, but maybe there’s some more transportation costs, I guess like how, should gross margins be up underlying?

[Martin Agard:]

Yes, this is Marty. You know there has been and we expect to continue a modestly favorable product mix improvement that starts with the vinyl product mix expanding, but we also bring products out that tend to have a little bit higher margins, higher price points, as we innovate, so that’s an underlying trend we’d expect to continue. Tariff and cost out work we’ve done to mitigation to be generally neutral and then transportation that has risen we are seeing at a pretty stable rate now and we kind of expect that to continue through the year. We don’t know quite when that cycle will reverse. We’d hope the next move is to have it reversed back in our favor, but we can’t really count on that and our guidance kind of reflects a flat transportation of level. So all in all, when you add all that up the guidance for 2019 I would say a little bit of improvement you know, something in that - a fair amount of that flat to 50 basis point operating margin improvement would come from the gross margin area.

[Unidentified Analyst:]

Okay, so the majority of the EBIT margin expansion is gross margin related, sounds like, so I guess SG&A may be it will average a little less because comps kind of slow down is that kind of the right away to think about it?

[Martin Agard:]

Yes, I think the SG&A leverage will be a little muted if any really, partly we want to put a little bit more money back into advertising as Charles gets that message really hone and we’re finding our analytics are getting better in terms of what’s really productive. And then the other thing is, we got a little bit of one-year transitional issues associated with headquarters move. There’s some overlapping ramp and some relocation and some retention efforts that we’re putting in place, so that also dampens the SG&A leverage, so we think of that as probably in line with sales growth.

[Unidentified Analyst:]

Okay, thanks guys.

[Martin Agard:]

Thank you.

[Operator:]

Thank you. Our next question comes from line of Budd Bugatch with Raymond James. Please proceed with your question.

[Budd Bugatch:]

Good morning. Marty good luck to you. Thank you for your help over the last couple of years. I guess I’d like to start on the balance sheet and I appreciate the leap through the liquidity bridge. I’m trying to understand those. I look at the balance sheet to try to understand what’s in the $97 million, how does that get relieved over the next couple of quarters that’s in the approved securities action, I know we’ve got a deposit, I guess off-setting that, but maybe you can help tell us what the detail is, I did not see it in the K?

[Martin Agard:]

Yes, so we at this point have all three of these major settlements accrued on the balance sheet as a liability. We still have the MDL on the books as a liability, the full $36 million because the $21.5 million that we refunded into the escrow, there were some technical GAAP requirements that doesn’t lead to - the liability stays on the books and the voucher side of the MDL settlement is still on the books. So that whole $36 million is in there. The $33 million from the DOJ settlement is in there and then all of the Gold is in there as well. So, there maybe a few other little things in there and addition but all three of those at their full values are on the books and then I think you understand how that will get relieved. The MDL part has been relieved and as soon as that appeal is settled that will meet the GAAP requirements and the deposit will come off the books and the liability will come of the books. We’ll issue vouchers and as those vouchers are redeemed over a couple year periods that will come off the books. The DOJ will pay cash in 30 days and that’ll come off the books. And then on the Gold, over the next, depending again on that final settlement of $14 million in cash will be settled let’s say by early 2020, that will come off the books and then those vouchers will get issued and again be redeemed over about a three-year period we expect, and so that’s how all those things unwind.

[Budd Bugatch:]

I got you, so basically we’re looking at something like about $30million of that $97 million is not cash. Rest of it is pretty cash?

[Martin Agard:]

That’s right, that’s right.

[Budd Bugatch:]

Okay and when I look at advertising, I think it’s down to 6.84 % reported for the year down, I think 60 basis points year-over-year. Historically, Lumber Liquidators has - advertising as high as high as 11% to 12% if I remember right going back a number of years, what the right level of advertising for this business now?

[Charles Tyson:]

So, this is Charles and I think there are a couple of things to know. One, as we’ve changed our mix over the last two quarters we are learning what’s more effective than different types of spend, and investment into digital which had been significant in Q4, we were significantly under-spent on so we’re learning our way through how fast and how far we can improve the productivity of that spend. So today we've said that we will not reduce our advertising spend below the 2018 level we may increase during the year as we find more effective and efficient spend. I’m not going to use a percent number, but we’ve got tests underway that are going to inform where we’re going to take our spend levels to?

[Dennis Knowles:]

This is Dennis, I would add a little color to that as well as that, as Charles has built out this digital team and our digital approach to marketing, we’ve had to make some investments in that team and pull back on advertising. So I don’t know that Q4 as a percent of sales would be a good quarter to look at. But you know, as he has built out you’ve seen, hopefully you’ve had a chance to get out on the site and seeing the improvements we’ve made to the site. We are seeing strong customer response and although it’s early, we like what we’re seeing in terms of, the reaction to the changes we’ve made on the site. The next piece for us has really been understanding where the consumer really reacts to us, whether that be radio, television, print. We still have a fair amount of customers that respond to our direct mail, but direct mail has become a less of a - less and less of a bigger portion of our marketing spend. It's expensive, it's slow. We cannot, it is put out there 90 days in advance and then we send it to print. So it does not give us the ability to be very nimble. And so, I would tell you that as we see the consumer reactive to the different expense, whether that be TV, we'll adjust that as needed to drive the appropriate amount of traffic in the stores, but as I said last call, and these last couple of quarters have been kind of the work in progress for us as we migrate from this direct mail to digital, but we're really pleased with the early customer response to our digital changes, but I think it’s too early for us to tell what that will look like on an annualized basis. But we are prepared this year with this significant amount of legal spend, you know that we were consuming on a monthly basis behind us to be able to react as we find the right mix of digital versus direct-mail.

[Budd Bugatch:]

And then, thank you Dennis, I’ll make it quick and my last question is, what adjustments are left to come through the income statement? Do we have, I think some Canadian litigation, maybe some employee litigation left, but we also have had the elevated legal costs. What's left and what's going to get adjusted out, the two you can see now in 2000 - and the first quarter in 2019?

[Dennis Knowles:]

It’s a great question. I would tell you that, this is the - this puts behind us the major product issues that we see and I'm afraid that you are right, the Canadian issue is still out there. We don't know. It's currently inactive and so we don't have a lot to offer as it relates to that. And we have some small litigation here, there are some, a couple of employment claims, but we are focused on having all this stuff behind us certainly. So hoping to see our legal spend to return to what most companies would call normal.

[Budd Bugatch:]

And is that the way the guidance has been impacted? I mean, how do we, what's in the guidance?

[Martin Agard:]

So Budd, the legal expenses to run down these employment matters and frankly the Gold matter to date and going forward have not been adjusted out. That's been left in our normal operations. The only things we've adjusted out have been for the DOJ, SEC and Goal, not gold, the MDL from last year. So we have a little bit of - we've got to finish the process. There's still court procedures going on and there's still an appeal on MDL, all of these things we fully expect to come to fruition as outlined. But over the next couple of quarters there will still be some of that unusual legal expense that we do adjust out. That's been running I'd say $2 million to $4 million a quarter. We hope that tails down in a way maybe by midyear and then you'll only be left watching for any big settlement type of thing which we don't see on the horizon for anything in the foreseeable future, so we don't have any of that in any guidance.

[Budd Bugatch:]

Well terrific. Good luck and I hope that's correct. Thank you.

[Dennis Knowles:]

Thanks.

[Operator:]

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

[Seth Basham:]

Thanks a lot and good morning. My first question is around insurance. You guys fully accrued for all of these legal matters, but do you have any potential insurance to mitigate some of the hit to you guys?

[Dennis Knowles:]

So we've been working pretty aggressively with the insurance carriers. I mean, there are the opportunities for the carriers to [indiscernible] in regards to past settlements that they stay attached to some exhausted towers, but at the same time as we've indicated, we're going after the opportunity to recover from the carriers and we have nothing that we're putting into financials at this point, but that is certainly something we're going to go out.

[Seth Basham:]

Alright, fair enough. And then following up on the traffic issue, can give us a little bit more color on how you're expecting transactions to trend in 2019? Do you expect positive comp transactions and if so, what's going to be the primary driver to get there?

[Dennis Knowles:]

Yes, I'll start Seth and then Marty or Charles wants to add any additional color. As we've said the installation is kind of cannibalized. We feel like in the past we've had probably three primary drivers of our decline, just our own competitive incursions, our own store conversions, the competitive environment has definitely cost us a little bit of traffic, but probably more so for us was our pro and our installation. Our pro business as Marty stated in his prepared remarks, we've kind of had recalculated how we thought about pro transactions and that's given us a better read on what we're actually seeing in terms of traffic. And then as it relates to the merchandise cannibalization from an installed sale, as we've talked about in the past, one of the things you see is a much higher average ticket for us on an installed sale. And the reason for that is, when we do an install for a customer, we really do a much better job estimating the needed product for the sale and encapsulating in that sale all the things we're going to need, the installation product, the finished product, as well as the flooring, in addition to the labor. And so, you know the DIY customer takes on the same project. They may make three trips to the store, once for the floor, once for the installation and finally the finished product. And so, as we move more of this business to installation, we've kind of seen that impact on our overall number of transactions. So when you think about cycling installation that should become less of a headwind for us, as well as to the way that we're starting to calculate so. And then our efforts in our marketing are to drive more traffic. And we'll have a headwind somewhat as we refine our digital space particularly as our website, we convert more customers online, we'll see less traffic in our stores, but we hope to see that be accretive to the transaction. So I would say that we are planning to see this continue to improve as we move through 2019.

[Seth Basham:]

Very good. Thanks a lot and good luck Marty. It has been nice working with you.

[Martin Agard:]

Yes, I appreciate that.

[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. You indicate on the product sales you're lumping all your kind of non-hardwood let me call it manufactured products. I assume vinyl is the fastest growth of those. Can you just talk about in Lumber Liquidators, how does that sale look to you? Is it a lower ticket sale than what you would see from hardwood? How does the margin compare to hardwood? Is the shift is pretty dramatic as you outlined in the K?

[Dennis Knowles:]

Yes. So as we've said and I think Marty said in a number of call, vinyl is always accretive to our overall margin performance. And as you've reflected and I said in my comments, vinyl continues to be an accelerator from a category perspective, but there has been AST improvements in the vinyl category itself as technology improves and technical spreads continue to improve. So we're excited about that growth in the vinyl business. And as I said on the call, we're beginning to do some interesting regional advertising to enhance our penetration on our wood program and so while the customer has absolutely gravitated from an industry perspective to vinyl, we see very solid customer interest in our solid programs, our exotic program, our domestic programs and we'll continue to invest there?

[Keith Hughes:]

Is the attach rate on that product on install, is it any different than what you see in your other product, or higher or lower?

[Dennis Knowles:]

I think for the industry we see good attach in our hardwood business and that's an important focus for all of our teams. In the install business there is a patch in vinyl and we're continuing to focus on training our teams to make sure that we're as equally focused on driving the attach through our vinyl installation as we are on the hardwood business.

[Keith Hughes:]

Okay. Thank you.

[Martin Agard:]

Yes, and Keith it's Marty, just a little bit on the economic profile. I mean the average pricing of our vinyl is approaching the line average at this point. We keep bringing out wider, thicker or more rigid vinyl products with pad and thinks it's a great product and with that the average price keeps climbing and it's pretty close to our average at this point. It is lower than a solid wood floor an exotic solid wood floor, but it's certainly a fine price level. And then from a margin standpoint this is a leader for us margin wise and that is part of that underlying product mix, the tailwind that I've mentioned a few times.

[Keith Hughes:]

Okay. Thank you.

[Operator:]

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

[Laura Champine:]

Good morning. Thanks for taking my question. I would like to dig in a little further into your full year same-store sales expectation for flat to low single digit growth because that would imply an acceleration from the trend you're seeing right now and the industry slowdown you call out in Q4. It also contrasts a little bit to the expectation for one to two points of macro related deceleration. Would it improve for any reason other than just easier comparisons as we move towards the end of the year, what's driving that improvement, the expectation for improvement in comp?

[Dennis Knowles:]

Yes, I'll start with a little bit and there's a couple of things going on in the first quarter that have it maybe a tougher compare that we expected improved from. The first is, this is really the peak of the storm benefits a year ago following the mostly Harvey, but to a lesser degree Irma storms as well. So our Houston market and some of our Florida markets really we're benefiting in the first quarter of last year at the peak and we've already seen that wane a little bit that compare challenge wane a little bit as we've gone through months and if we compare it to the first quarter, the fourth quarter and so forth. So that should actually fade away as we get in the back half of the year and so that's a part of the acceleration if you will quarter-by-quarter as we go through 2019. The other thing we're seeing a little bit of is our own cannibalization. We opened 21 stores last year which is the most in a while and some of those stores are in existing markets and they will take some share from existing stores, the existing stores are in our comp population and so they end up facing a little bit of a comparison issue on those existing stores. We include that in our economics. We're comfortable opening those stores where there is some cannibalization, but it does have this effect on the comps. And then Charles, this program is really come into the light that the digital capabilities we're seeing good results there. We expect that to improve as the year goes on. The marketing message of the new ad agency, all that really hitting its stride as we think of the back half of the year. So there's a couple of different things we think will create that that acceleration and go from the slightly low negative single digits in the first quarter to the positive low single digits on the year.

[Charles Tyson:]

Laura, I would highlight a couple of things as well as Marty said on the digital front. We really started in full force with our new agencies in March towards our first campaigns were around the very first part of March. So we're really excited about what we've seen. Just initially it's early on but we've also hired a new creative agency. We haven't really done any creative to speak of in several years and around both branding as well as the business. So think about it. The things that we've changed in the business since the last time we did any kind of creative media. We now offer installation while we tagline that in our ads, we've really built no messaging deep into our online ads or even our television ads. And then, as we've talked about over the last couple of years building this one of the points that we think is the differentiator for Lumber Liquidators is this high touch consultative sale and we really are looking forward to really highlighting that, as well as our ability to be competitive from a price perspective. So, all those things for us we feel are in front of us and are excited about the early read on what we've seen. So I would just add that as little more color to Marty's comments on the digital front. Q - Laura Champine Got it. Thank you.

[Operator:]

Thank you. [Operator Instructions] Our next question comes from the line of David MacGregor with Longbow Research. Please proceed with your question.

[Unidentified Analyst:]

Hi, [indiscernible] on for David this morning. I really wanted to ask about LVT [ph]. You talked about positive ASP trends, but I'm curious looking at the import data. There clearly was a glut of imports at the end of the year ahead of the possible January tariff inflection and I'm just curious what extent that poses risk to discounting if there's a glut of inventory in the channel?

[Dennis Knowles:]

Yes. I'd say where we've made you talk about LVT we've made major investments in EVP [ph] and now the SBC quo [ph]. Marty talked about ASPs going up and the customers are responding well to that. I feel very comfortable of where our inventory is sitting today on weeks of supply on LVT and don't see any necessity to take future discounts. We don't see any rational behavior in the marketplace today as it relates to pricing. Now of course as you mentioned that could change and we'll react accordingly. But I feel really good about where our inventory teams have positioned us going into our spring selling season.

[Unidentified Analyst:]

All right, thank you. And I guess just the guidance particularly 1Q the negative comps you're projecting, how much of those weather, just given the polar vortex you have rain on the west coast, how much is that? What's impacting the negative comps?

[Dennis Knowles:]

Undoubtedly it's had had an impact on us. We've had a few store closures but we don't feel it's been significant enough to really call out. It's not, weather is not something we like to talk about we feel like we had equal amount last year, so it's and we kind of see what the weather takes away it gives you back and we're kind of seeing that now here in the early part of March. So I feel like it's really not had a material impact on our core so far.

[Unidentified Analyst:]

All right thank you very much.

[Dennis Knowles:]

Thank you.

[Operator:]

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

[Peter Keith:]

Hey, good morning everyone. I want to just dig a bit into the global sourcing. So you stated last quarter that you had 45% of your sales were coming out of China its sounds like you may have gotten some concessions out of those suppliers, but maybe a two-part question. How should we think about that China mix going forward? Do you have a new lower goal of where you'd like that to be? And then, secondarily, I know you've got a longer term gross margins to be kind of in the higher 30s. Obviously that was pre tariff so maybe that's off, but could you give us some updated view on where do you think that the longer term margins settled out?

[Dennis Knowles:]

Yes, I'll start and take the sourcing I think Marty will chip in on the broader margin question. Look, we're evaluating not just Southeast Asia capabilities, but other geographies as well where we see benefits are sourced from. As you said, we have - the teams have done a nice job in helping mitigate our current costs coming out of China. And we are looking and at other countries sourcing that would potentially lower what we do out of China. I think all of us are looking at what happens with tariffs overall with keen interest and that in itself from a macro perspective. I think will have an impact from an industry point of view of what happens in China and to some degree what the China manufacturers themselves do. As you've seen in other industries, industries have moved out of China and gone to other countries of sourcing. We will be there if they are competitive and can sort of pull these levels and compliance levels that we expect. So we are actively looking at other places in the world to source from today and making determinations over the next few months based on some of the longer term targets that we see. I think Marty you want to talk about margins.

[Martin Agard:]

Yes. In terms of the longer term margin guides, the upper 30s that we've been guiding to as we think about running at around 36%. We're a little below that in 18. We hope to be a little above I thought that in 19. If you think about that with 250 basis point the tariffs in there. Now granted we are trying to mitigate that and generally have if we could just have that back you know we'd be in the definitely be in the upper 30s. Now we've got to work from here to drive hopefully some transportation improvements. We're not done working with our vendors. We're not done realizing the benefit of mix and innovative products that have wider margins so we're still kind of committed to that plan. It is going to be a little bit of a setback in terms of how quickly we can get there unless the tariffs go away, then I think we get some definite lift.

[Dennis Knowles:]

I would also add that - we've pointed out we brought in a new Head of Sourcing who is going to Head our merchandising and now managing our cost becomes part of the daily business as opposed to initiative driven. So the tariffs gave us the opportunity to jump in a meaningful way and kick that off. But this is something that we keep in front of us now every day is supposed to be important initiative driven. So we're excited to have the legacy issues behind us that allow us to focus on growing and running the business day-to-day.

[Peter Keith:]

Okay, and thank you. May be a separate follow up for you Dennis. If you're pivoting the model more towards the high touch consultation sale. Some of the history of Lumber Liquidators is to petition stores in we call maybe key locations, outside metropolitan areas and really as a form a destination based on little price. So ultimately what I'm getting at with the question is, do we need to think about a relocation strategy with some those older supers that maybe have been economics, but just aren't seeing the type of traffic that you think is beneficial long term?

[Dennis Knowles:]

We do. Oddly enough, some of our older, what I would call more inconvenient locations have solid traffic mainly because they've been around for a long period of time. So, the way we think about it is more rather that is two-fold. Chris, our Head of Real Estate he brings to us every month in our real estate community both existing locations that are up for renewal as well as in new locations. And we look at our existing locations always as an opportunity to upgrade to more what we would call an A to B location because we realize that conveniences are more and more a play in the consumer's mindset. So we realize that being off the beaten path is not always it's not just the consumer or the pro customer seeks a more convenient location as well. And so, we are always looking to upgrade our sites to a more convenient location when it makes sense and if they can pass our hurdle rates than we've shown that we will relocate these sites when it makes sense to us. And again, we're not putting any new sites in any of those locations.

[Peter Keith:]

Okay, very helpful. Thanks a lot and Marty it has been great working with you.

[Martin Agard:]

Yes, I appreciate it.

[Operator:]

Thank you, ladies and gentlemen. Our final question this morning will come from the line of Budd Bugatch with Raymond James. Please proceed with your question.

[Budd Bugatch:]

Yes, it's just a quick follow up. You have disclosed you have a merchandise sales and the cost of merchandise sales and services for the last couple of quarters, I don't know that I've been able to find the quarterly breakout for the first quarter and second quarter, is that have been posted somewhere, is that available or will you post it?

[Martin Agard:]

Hi, it wasn't required at the time of GAAP and I think you're probably only missing the first quarter of last year, so let me chat with Tim and see if we want to post. We'll kind of fill out the picture for you. It hasn't been required. That's the presentation that we triggered I think the third quarter of last year. So we can go back and consider filling in the background.

[Budd Bugatch:]

I couldn't find second quarter either, so that's so that's why I'm missing. If I could find one of the two we could get that and just go at it.

[Martin Agard:]

Yes, there go. All right, we'll give that some thought.

[Budd Bugatch:]

All right, thanks Marty.

[Dennis Knowles:]

Thank you, operator. Let me get say thanks again to the LL team, our vendors, our customers and our shareholders for your continued support. 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.