LL Flooring Holdings, Inc.
Q2 2016 Earnings Call Transcript

Published: 27 Jul 2016

[Operator:]

Good morning, ladies and gentlemen. Welcome to the Lumber Liquidators' Second Quarter 2016 Earnings Call. With us today from Lumber Liquidators is Mr. John Presley, CEO, and Mr. Greg Whirley, CFO. As a reminder ladies and gentlemen, this conference is being recorded and may not be reproduced in whole or in part, without permission from the company. I would now like to introduce Steve Calk of FTI Consulting. Thank you. You may begin.

[Steve Calk:]

Thank you, operator. Good morning, everyone and thank you for joining us. Let me take a moment to 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 future operating financial performance of Lumber Liquidators. Although Lumber Liquidators believes that the expectations reflected in its forward-looking statements are reasonable, it can give no assurance that such expectations or any of its forward-looking statements will prove to be correct. Important risk factors that could cause actual results to differ materially from those reflected in the forward-looking statements are included in Lumber Liquidators filings with the SEC. The information contained in this call is accurate only as of the date discussed. Investors should not assume that the statements will remain operative at a later time. Lastly, Lumber Liquidators undertakes no obligation to update any information discussed in this call. Now, I'm pleased to introduce Mr. John Presley, CEO of Lumber Liquidators. John?

[John M. Presley:]

Thank you, Steve and good morning, everyone. Thank you for joining us for our second quarter 2016 earnings call. I will start the call today by reviewing our second quarter performance and then providing you an update on the four strategic initiatives that we had laid out earlier this year. In the second quarter, we reported revenues of $238.1 million, a decrease of 4% compared to the prior year period. Net sales from a comparable stores declined 7.2% in the second quarter. We believe a number of factors contributed to our performance. First, let me step back and remind you the characteristics of our business in Q2 of last year. During that quarter, we were in the early months of managing the impact of significant negative media attention related to our Chinese laminates. We pulled that product from our shelf, creating a scarcity of laminate product and the need to discount alternative flooring options to satisfy our customers. At the same time, we were cleaning our – clearing our tools and tile inventory and actively reducing SKU accounts across all of our products. This inventory clearance and discounting was additive to sales in June of last year and attracted additional customer traffic. This June, we were simply in the business of selling wood at competitive prices. We believe this, in part, contributed to both the negative traffic comparison and positive margin comparison. Second, our pricing strategy which is now focused on margin dollars resulted in an increase in average sale in June versus the prior year period, but was more than offset by the decline in number of customers invoiced. Third, as we have discussed on prior calls, store associate turnover impacted one of our most important value propositions, our customer service at the store level. Dennis is making progress on this front, but we still have a lot of work to do. And fourth, given the disruptions in the supply chain last year, and the availability of certain product since that time, there are still opportunities to improve our assortment in light of customer demand. We are making these adjustments in real-time and believe that this will improve our competitive position in the marketplace. If there is a silver lining it is this. Despite all the noise related to legacy issues, we posted our best revenue quarter since Q2 of last year. Nevertheless, I am not satisfied with our performance. We can do better and we will do better. We have a solid core business model and we have the right team in place to execute our plan. As we move farther away from questions about our product quality, and as we rebuild our ranks in the field, I believe we can return the company to growth and profitability. On the legal and regulatory front, this quarter was very important to us. In April, we entered into a memorandum of understanding in the securities matter on terms that did not impact our cash flow position. In May, we entered into an MOU in the derivatives matter that will result in a cash outlay of $2.5 million. We now have signed settlement agreements in both matters, that are consistent with these MOUs, and the settled agreement in the securities matter has been preliminarily approved by the court. And in June, the California superior court reaffirmed a favorable ruling in the Proposition 65 case. In the late June, we announced our agreement with the CPSC regarding Chinese laminate products that we pulled from our shelves in May of 2015. We believe this was a positive development for the company, and that it did not recall any product, but encouraged customers who bought the product to participate in our testing program, which we voluntarily initiated in Q1 of 2015. Today, through third party certified laboratories, we have tested the air quality in more than 17,000 household and conducted formaldehyde emissions tests for about 1,300 of those customers' floors. None of those floors tested above the remediation guidelines. We believe this will be a positive message for our business in the quarters to come. With the closing of the CPSC inquiry, we have now put many of our legacy issues behind us. And we will be still working to resolve outstanding legal matters, including the multi-district litigation and remaining SEC Department of Justice investigation. Our team is gratified to have made so much progress in such a short time. Now let me take a few minutes to highlight the progress we are making against the four strategic priorities that we have discussed with you on previous calls. They are, focusing on store performance, strengthening our value power proposition, enhancing responsible compliant sourcing, and opportunistically expanding our business to better serve our customers. First, we are focused on improving store performance. On this front, we are continuing to work that we outlined in the beginning of 2016. Dennis continues his systematic review of the performance of each of our stores, as well as the strength of our overall network and is putting in place the processes that will enable us to drive both the top line and profitability. We have implemented significant personnel changes by upgrading the field leadership team at divisional, regional and store levels. And we have been very intentional about filling open positions with the right people at the store level. As a result, we have reduced open positions significantly. Dennis is also establishing product and sales training protocols, and standardizing store processes that will serve our customers and drive sales. For instance, we have significantly expanded our secret shopper program. And we have seen those scores increase 14% since the beginning of the year. We are confident that in time, this will enable us to improve the store performance of each store and serve as a best practice model for future store locations. We're also focusing on reducing customer order fulfillment to three days, executing a store promotional playbook and refining our pricing and marketing strategy, to increase store traffic and improve the bottom line. Finally, we are leveraging strategic communications, advertising and promotions that underscore our commitment to save quality products. We have launched a campaign focused on driving customers, who are seeking information about safety issues, through a special section on our site. We're also rolling out a TV and web video campaign around our value proposition, with a specific pillar, focused on quality and safety. We are confident that efforts like these will help reestablish our brand and enhance customer confidence in the company that they have come to trust for over 20 years. We're also continuing to make progress on our second focus area, strengthening our value proposition. A key part of this is, understanding the dynamics of the market, so that we can start the variety and quality of inventory needed to meet customer demand. Our good, better, best structure has simplified the shopping experience for customers. This is enabling us to drive sales in higher margin products such as vinyls and laminates, while also enhancing our ability to up sell into higher margin dollar products. As an example, store markdowns are often driven by lack of customer clarity on comparable – comparative flooring. Our good, better, best structure requires that invest in training on product knowledge and our selling process. This helps our associates and our customers understand the differences in products and prices, which reduces markdowns and enhances customer satisfaction. We look forward to seeing the results of these efforts in Q4, when we will have a full year of comparable data. We will then gain additional insights on how to improve our step-up strategy based on traffic and sales trends. On our third initiative, responsible compliance sourcing initiatives, Jill Witter has been instrumental in our process on legal and regulatory issues. She has also been hard at work in our compliance program, but independently in cooperation with regulators. We have enhanced our ability to source product, we have introduced Greenguard and FloorScore certification, which provide assurance to customers that our products meet comprehensive emission standards. And we were the first national retailer to commit to offer phyllite-free vinyl flooring. Not incidentally, we implemented rigorous testing protocols for that flooring and all of our suppliers have met those standards. We are confident in the modernized compliance system we have in place, and we will continue to make adjustments as appropriate to ensure superior quality and safety for our customers. Finally, we are making progress in the opportunistic expansion of our business. In particular, installation services should grow both sequentially and year-over-year, and we are thinking strategically about ways to invest in this offering to suit regional demand. As a reminder, we are not looking at these services to drive margin percentage expansion, we provide them to serve our customers and to attract new customers in the do-it-for-me category. If we succeed, installation services will help us drive top-line sales and overall market share, that is where the real opportunity is for Lumber Liquidators. We also continue to evaluate opportunities to grow the business in additional areas where we can leverage our competitive advantages. Now let me hand it over to Greg to walk you through the numbers in more detail.

[Gregory A. Whirley:]

Thank you, John and good morning, everyone. Today I'll provide details on our results for the second quarter of 2016. Note that unless otherwise specified, my references to percentage and basis point changes are in comparison to the prior year period. For the second quarter, net sales were $238.1 million, a decrease of 4%. Within our comparable stores, net sales for the quarter decreased 7.2% due to a 7.9% decrease in the number of customers invoiced, partially offset by a 0.7% increase in the average sale. Sales in our non-comparable store base increased by $8.1 million. Consistent with historical trends, our monthly net sales generally decrease during the quarter as we move through the spring months. Comparable store net sales however generally increase during the period. Comparable store net sales in April were below the quarter average, while May and June comparable store net sales were above and near the quarter average respectively. As John discussed, we attribute the quarterly decline in comparable store sales to a shift in pricing and sales strategy versus Q2 2015, during which higher sales of clearance inventory and discounted product drove an increase in the number of customers invoiced. Additionally, we believe that the demand for certain product categories decreased as our assortment of products did not match changes in customer trends. I'd now like to turn your attention to a number of items that have made the comparison of our results to prior periods more difficult. We've incurred incremental costs related to our resolution of significant legal and regulatory matters, cost related to an accrual as a result of the imposition of anti-dumping and countervailing duties against imports of multi-layered wood flooring, cost related to our indoor air quality testing program and other costs. To assist in clarifying how these charges impact our quarterly results in the current and prior year. We've included a supplemental schedule in today's press release that is also available on our website. Specifically, our gross margin was impacted by two items in the second quarter. First, we recorded an accrual associated with the third annual review of anti-dumping and countervailing duties against imports of multi-layered wood flooring. We have accrued $5.5 million in adjustments to cost of sales related to this item. Second, we recorded our best estimate of future cost to be incurred under our indoor air quality testing program as a result of our agreement with the CPSC. This along with other testing costs incurred resulted in a charge of approximately $3.3 million. Additionally our SG&A cost continued to be impacted by legal and regulatory settlement related costs. With that, let's turn to gross margin, which came in at 29.7% versus 25.1% in the prior year period, excluding cost related to the items I just mentioned, gross margin in Q2 would have been 33.3% versus 31.6% in the prior year period. This improvement over the prior year period was largely driven by a more favorable sales mix with higher margin vinyl and laminate products comprising a greater portion of our total sales as well the benefit of planned retail pricing strategy changes, implemented in 2015. Turning to SG&A. SG&A expense for Q2 was $89.9 million or 37.8% of sales compared to $90.5 million or 36.5% of sales in Q2 of 2015. SG&A expenses included incremental legal and professional fees and other cost of approximately $8.3 million, reflecting our ongoing efforts to resolve legacy, regulatory and legal issues. This compared to incremental legal and professional fees of approximately $9.7 million in the year ago quarter. Absent these items, SG&A expenses for the quarter were relatively flat but included slightly reduced advertising spend which was down 10.8% year-over-year to $18.5 million. We believe the reduction in advertising spend was the right choice for the quarter. As John mentioned; however, we are now refocusing our communications, advertising and promotions to rebuild our brand. Shifting to operating performance. In Q2 we posted an operating loss of $19.3 million compared to an operating loss of $28.3 million in the prior year period. Our net loss for the quarter was $12.2 million or $0.45 per diluted share compared to a net loss of $20.3 million or $0.75 per diluted share in Q2 of last year. Our effective tax rate was 37.1% for the quarter driven principally by an increase in a valuation allowance against certain of our deferred tax assets and our projections of pre-tax income for the remainder of 2016. We anticipate our long-term tax rate will be consistent with historic levels. Now let's look at our cash position and liquidity. We ended the quarter with $12.7 million in cash and cash equivalents. The decline in cash was primarily attributable to a build in inventory and changes in other liabilities. June net sales were softer than we anticipated, so that cash investment remains in inventory. It is important to note however, that in July we received a cash inflow of $22.1 million related to the carry back of our 2015 net operating losses to prior periods, where we generated taxable income. We remain confident that our liquidity is adequate to fund our business objectives. Available inventory per store was approximately $610,000 as of June 30, 2016, up from approximately $577,000 as of December 31, 2015, reflecting previously planned inventory increases ahead of the spring sale and changes in demand. The decline in inventory year-over-year reflects our efforts to simplify our assortment and improve our management of working capital. As John mentioned earlier, our store performance and store network remains central to returning the company to profitability. We are taking a prudent approach to managing our stores and selecting an assortment aligned to market demand while maintaining an in-stock position that enables timely delivery. During the quarter, we opened four new stores, all of which met our stringent standards regarding the use of cash. As we said last quarter, our strategy is to pursue new locations, where we are confident we can produce an attractive return on our investment. In summary, we remain focused on the levers of our business that are within our control. We are committed to profitable store operations and are taking the steps required to rebuild our brand over time. I am proud of our team and I am confident that we can rebuild and grow our business. I would now like to turn the call back over to John, for his closing remarks.

[John M. Presley:]

Thanks, Greg. As we close, I want to reiterate that our team is confident in the potential of Lumber Liquidators. We have the right business model, a talented team and a solid plan. And while we have successfully addressed some major challenges in the past year, we still have a long way to go. The short game is just as important as the long game and is just as challenging. But we are committed. We are committed to excellence, sound judgment and transparency. And we are committed to our employees, our customers and our shareholders. I would like to thank all of our associates, for their dedication and hard work, to bring our company back to the level of success that we have enjoyed in the past. With that operator, we are now ready for questions.

[Operator:]

Thank you. Ladies and gentleman, we will now be conducting our question-and-answer session. One moment, while we pull for questions. Our first question comes from the line of Simeon Gutman from Morgan Stanley. Please go ahead.

[Simeon Ari Gutman:]

Thanks. Good morning. I know, you don't provide guidance on the deposits, you don't provide that information. But can you talk about the lead time in the business, I am assuming that's still similar and what type of visibility you have, you mentioned that you're going to bring advertising back. Is the pipeline – has the pipeline been hurt, because of the lack of advertising or does it look pretty static to the way, the top line played out in the second quarter?

[John M. Presley:]

Simeon thanks for the question. This is John. Before I get started, I want to also let you know that Dennis Knowles is in the room with Greg and I today along with Jill Witter. So you will hear a couple of more voices in answering some of your questions. You're right, we don't give any guidance about what future sales are. We will tell you that we picked up the pace a little bit in regard to advertising in the month of July. So far we've seen some favorable results but the month is not over, so we're not going to comment on any specifics, but we have seen some pickup with the pickup in advertising so far in July. Dennis may add some more details on that.

[Dennis R. Knowles:]

Yeah. I would just agree with John's comments that we're pleased with the progress we're making in July. And also pleased with the progress we are making in future orders. So as we continue to focus on our in-store experience and continuing to enhance our assortment, we like the results we're seeing in short-term, so.

[Simeon Ari Gutman:]

And to clarify the purchase cycle, the purchase lead time for the customer into buying or to actually completing the transaction, that is not structurally changing, is that about the same as it was a couple of years ago?

[Dennis R. Knowles:]

I can tell you that it's changing only in that we're managing it differently on our side. We're working to improve our speed-to-market. Our cycle time was roughly 10 days to 12 days. We've worked hard with our supply chain to improve that to three days, but the customer purchase cycle still is similar to what we've seen in the past.

[Simeon Ari Gutman:]

Okay. And my follow-up question is on promotions. I think you mentioned, it was down year-over-year, it looked like sequentially, and then you may have said this, it looks like it may have – it's picked up, I'm just reading between the lines of some of the items in the release. I guess, if that's the right read, are you seeing, – what sort of not clicking, is it, you mentioned there was some change in trend, are you not attaching at the same rate some of the, I guess, related products? But can you talk about it because the gross profit dollars did improve given an easier comparison, but on a multi-year basis, it looked like it got a little bit worse from where we were in the first quarter?

[John M. Presley:]

This is John. I'll attempt to answer, and Greg and Dennis might want to jump in. I think the point we were trying to make in some of our comments were that in the second quarter of 2016, we were selling our core products, we were selling wood floors. Our comparison to 2015 is that we were liquidating a lot of SKUs, we were getting out of the tile business, getting out of the tool business, and driving a lot of traffic at some fairly low margin. So I think that was a point that we were trying to make in our comments is that, it was a little bit different business that you're comparing year-over-year.

[Gregory A. Whirley:]

This is Greg. I would just add to that, that as you think about comparisons Q1 versus Q2 and then year-over-year, I think when you look at our gross margin number, we are pleased and we think we can drive gross margin improvement in the business long-term. We think our strategic pricing approach is working and it's led to the pricing gains that you have seen. With that, again, we see opportunities over time. As we've highlighted in prior quarters, we are actively monitoring what's going on in the market place, and we are going to ensure that we are taking the most prudent approach to driving sales and profitability for the company.

[Simeon Ari Gutman:]

Okay. Thanks for the color. Good luck.

[John M. Presley:]

All right, Thank you.

[Operator:]

Thank you. Our next question comes from the line of Dan Binder from Jefferies. Please go ahead.

[Daniel Thomas Binder:]

Great. Thank you. You spoke to the challenges in the employee base in the turnover, felt like you've been busy trying to stabilize that. I was wondering if you can give us maybe a little bit of a sense, maybe in baseball terms what inning we are in on that effort. Are we getting pretty close to done on the organizational changes that you need to make to move forward?

[John M. Presley:]

Yeah. I'm going to let Dennis comment on that because he has been working very, very hard and it has been one of the focuses that he has had since he has been here starting in March – is getting the staffing levels back and where they need to be in the stores. So he has got some statics on that, that I think will shed some more light.

[Dennis R. Knowles:]

Yeah. Thanks, John. I'm pleased with the progress we are making in terms of reducing turnover. As I mentioned on the last quarterly update, when you start to put focus on improving your operations and put new accountabilities in place, you are going to pressure your ability to – you are going to have some turnover, some of it's turnover that you like, some of it's turnover that you don't, but we saw a little more pressure on that, as we started to kind of step up our game, if you will, in terms of our store accountability. We are making good progress. And for the first time in Q2, we saw our turnover stabilize and our fill rates on our open positions start to improve. And I'm pleased with what we're seeing, the turnover stabilize and we're seeing our tenure – average tenure start to rise as well. So we're pleased with the progress. We have scrutinized the performance at all levels, regional management, divisional management and store management. So we've made some great changes over the course of the last quarter and are pleased with the progress we're making both in turnover and around the stores and leadership. So it was a solid quarter in terms of progress.

[John M. Presley:]

And then, to answer your question, what inning we're in, I know we're not in the first inning, but we're also not in the ninth. And given the fact that, Dennis has been here four months or five months, I would put us probably in the third inning or fourth inning of getting to where we need to be.

[Daniel Thomas Binder:]

Okay. And then, on the product side, you mentioned not having the right products for trend, customer trend and interest. Maybe you could just shed a little bit of light on the challenges there, is it identified – is the challenge identifying the trend or getting the product in a timely fashion and what are the measures you're taking to address that? ` – [004P6C-E John Presley]>

[Gregory A. Whirley:]

Yeah. I would just think as John said last year, we faced various challenges and disruptions in almost all categories of our assortment. But at the same time we didn't simply rebuild it to what it was, we took the opportunity to improve it for the future and the disruptions and improvements were issues that we had to face. And there have been a lot of challenges as we revamp our global sourcing, but feel our assortment moving forward is now much better than it was a year ago. We – as John said, we also made changes in key growth areas like vinyl and that really didn't start to materialize in our store till the end of the second quarter. So, and we didn't simply replace Chinese laminate, we upgraded our colors and styles to meet the current trend. So, we feel really good about our position now, it's continuing to improve over the course of the third quarter and I feel like we're in a really good promotable condition in our stores.

[Daniel Thomas Binder:]

So when you think about that decision to increase advertising versus the ability to deliver on the product, maybe a little bit at odds with each other, but in terms increase the advertising you don't want to disappoint the customer, it sounds like there is a work in progress here to get the mix right. How long would you guess based on what you know today it would take to get you to the point we want to be on the mix and the product in stock?

[John M. Presley:]

I will address first the comments you made on advertising, and that's a challenge that we're dealing with every day. And it has got several prongs to it. One is, cash flow, we're managing cash flow as closely as we can. The other is, is we're measuring our effectiveness with our people out in the stores, and how good are we getting at conversion. And we fundamentally believe that we've got some ways to go in terms of getting our store to convert like we would like them to convert. And reducing advertising a little bit in the second quarter was a good test for us to see where we are in the stores from a conversion standpoint. We learned a lot. That's part of what we're doing as a management team is testing theories and testing ideas, and we learn from those and apply them going forward. So we learned a lot from the second quarter. We're applying those to the third quarter. Certainly, the assortment getting healthier will help us as we go forward and certainly help the effectiveness of the advertising.

[Gregory A. Whirley:]

I would also say that when John talked about focusing on rebuilding the brand, rebuilding the brand means focusing on everything we do to ensure that we have a compelling value proposition for our customers. We want to have the best answers and the highest level of service for our customers as well, and advertising is a component. And we'll always look to ensure that we have the best leverage on any investment. But since I've got here, I've also recognized the opportunity of improving the conversion of our traffic. Every satisfied customer is a step forward in healing our brand through a referral. So rebuilding our brand is more than advertising, it's becoming a compelling option for our consumers who are looking for value.

[Daniel Thomas Binder:]

Great. Thanks.

[Operator:]

Thank you. Our next question comes from the line of Brian Nagel from Oppenheimer & Company. Please go ahead.

[Brian Nagel:]

Hi. Good morning. Thank you for taking my questions.

[John M. Presley:]

Good morning.

[Brian Nagel:]

First question, and I apologize if I don't word this correctly. But you discussed in your press release and your prepared comments of some of the progress you made on the legal issues. I guess what's still outstanding from a legal issue for Lumber Liquidators?

[John M. Presley:]

This is John. I've got Jill here and she lives this every day. So she can answer this question as well as anybody. So, Jill?

[Jill Witter:]

Well, we're really very pleased that over the past year, we've been able to move past a lot of the major regulatory and legal issues that we have. And this is allowing us to focus more acutely on the core business. We do still have a number of non-operational issues to address which we've outlined in our public filings. We've talked about the multi-district litigation in prior calls and this is still in process on this case. We can't speculate on the outcome, but we do continue to focus on closing this issue and certainly we'll be transparent in providing information on this as it – as the developments unfold. The second item is, which is also reflected in our filings are the SEC and the DOJ negotiations. These primarily relate to disclosure, financial reporting and trading issues under the Securities Laws since 2011. We are continuing to cooperate fully with those investigations. We continue to produce documents as requested by the DOJ and the SEC and provide responses to other requests for information. Based upon what we know today, we believe we've got adequate resources to resolve these matters and to move the company forward.

[Brian Nagel:]

And timing still, we just don't have any idea at this point?

[Jill Witter:]

No, we don't.

[Brian Nagel:]

Okay, that's fair. Thank you. And then, my second question I have with respect to capital. So you ended the quarter with just roughly $12 million in cash and then you made the comment that you got another $22 million post quarter that came in. So, I assume you're running now in the mid-$30s million. You said you're comfortable with your liquidity position. So the question I have is, first off, where are we in a typical I guess capital need standpoint through the year. So, how did the cash flow cycle look through the year and is there a minimum level of cash you want to have on the books to run the business?

[Gregory A. Whirley:]

Well I think there are a couple of things. First, we believe we've got the right liquidity as you referenced to run the business and address the legal issues we've got outstanding. We are continuing to manage our investments and inventory and are spending smartly across the organization. As you saw, we borrowed an additional $7 million on our line. Our borrowings as of the end of the quarter were $32 million. And as I said I'll highlight for you that we had a $22 million receivable related to a tax refund come back to the company that's not reflected in our numbers at Q2; that was received in July. So, again I think we've got the right liquidity to help manage the business. As you think about where our cash position is and what we expect going forward, the short answer is this. Again, we think we've got what we need, we're being smart about where we spend with respect to opening stores, how and what we buy in inventory and where we spend cash to improve the company. With all those things we think we've got the right plan in place around cash to manage the business going forward.

[John M. Presley:]

The only thing I would add to that to Greg's comment was that, we did say in our – in Greg's comment that inventory per store did increase over the quarter from about $577,000 to $610,000 in part because of disappointing sales on our side. But that positions us pretty well from an inventory standpoint going into the third quarter, which should help cash – our cash balances as well.

[Brian Nagel:]

Thank you.

[Operator:]

Thank you. Our next question comes from the line of Seth Basham from Wedbush Securities. Please go ahead.

[Seth M. Basham:]

Thanks a lot, and good morning.

[John M. Presley:]

Good morning.

[Gregory A. Whirley:]

Good morning.

[Seth M. Basham:]

My first question is on gross margin. We saw an improvement year-over-year, but certainly a lot lower than Q1 on an adjusted basis. How should we think about gross margins here? Is it the new run rate or do you think we can get back closer to where we were a couple of years ago?

[Gregory A. Whirley:]

Again, this is Greg. I think we're pleased with where we are with gross margin, you're right on an adjusted basis, Q1 was a little bit higher. As a reminder, there are a number of things we're working through in Q2, not the least of which is – Q2 is a promotional period for the company, so we are. As we move to the spring months, making sure that we're driving sales in the right way. Long term, again, we think there's opportunities to continue to improve but we are going to be looking at what's going on in the market places, how our pricing should be managed over the coming quarters to drive top line revenue as well as manage to keep as much of that to the bottom line as we can.

[John M. Presley:]

Yeah. And I'll address your comment of going back to margins of a couple of years ago. I don't think you're going to see that out of the company. I think there are going to be a lot of levers going both ways with our margin. I think our installed business, as I mentioned in my comments is going to get better and better. That's going to come at the expense of a margin percentage, but at the benefit of margin dollars. As our mix settles and changes you will see that, that will affect the margin depending upon whether we're selling hardwoods – more hardwoods or more laminates. And as our sourcing gets better, which is starting to – we're seeing some real improvement in our sourcing capabilities that are due to Jill's hard work and compliance, the better we're able to source, the better we are going to be able to affect positive margin. So you are going to see some push and pull in the margin over the next several quarters based on all of those factors.

[Seth M. Basham:]

That's helpful. And just to isolate one of those factors, mix. You mentioned improved mix of sales with vinyls and laminates, which come at higher margins, can you help us understand how much of a benefit that was to gross margins?

[Gregory A. Whirley:]

I don't have that number off-hand. What I can share with you, our average selling price is down 3%. When you think about our ASP being down 3%, we have looked at it from a pure pricing standpoint, product compared to products, our ASP increased about 2% and that's really offset by changes in mix, down 5%. So really the kind of thought process that I would look at is even though our average selling price is down 3%, pricing is increased by about 2 percentage points period-over-period.

[Seth M. Basham:]

Got it. That's very helpful. And then, just one last follow-up question, it seems like in terms of the number of customers invoice, there are issues that you're facing on traffic and conversion basis. But if you think about conversion specifically, help us benchmark, where you are with conversion relative to a couple of years ago?

[John M. Presley:]

Yeah. I'll attempt that one first and then Dennis can provide some more color. What I'm learning about the business over the past nine months is that, couple of years ago, we were driving tremendous amounts of traffic into our stores. And what I believe is that, we didn't have to really be that great at conversion, because of the amount of traffic coming into our stores. Given, what's happened to us over the last couple of years, traffic certainly is down, but we still believe, and as we go out into the stores and we witnessed that ourselves, we have traffic counters in a lot of our stores now. We believe there is still traffic in our stores and certainly traffic to drive better sales, better than we are experiencing today. And that's why we are so focused and Dennis' team is so focused on getting the stores, up to speed and to be, as we call it around here, better fishermen going forward as opposed to shooting fish in a barrel that we feel like we build a little bit up in the past. So we're little focused on getting the right store teams out there and converting as we drive traffic and hopefully drive more traffic into the stores.

[Dennis R. Knowles:]

Yeah, this is Dennis. I'll just tag on to what John said in his comments. As I mentioned earlier, we've really been focused on stabilizing the teams in the stores. Our divisional managers and our regional managers have worked really hard to improve both, like I said the fill rate of our employees but also their capabilities, as it relates to providing a great experience for the customer. We've put an increased focus on our mystery shops. We basically have doubled the mystery shops and at the same time have been able to raise our mystery shop scores if you will. We've done that by really putting in intense training in the stores and continuing to develop training for product in our stores, especially new and emerging businesses such as the vinyl that we haven't had in the past. So, we're making good progress. Our conversion is improving, year-over-year, but as John says, we still have a long way to go to be where I'm comfortable with and feel like we're making the kind of progress that is acceptable to us. That conversion, we're measuring both in our installed business as well as our do it yourself business in the stores and we're making progress on both fronts. So – but as John said, it's still work in progress.

[Seth M. Basham:]

Very Good. Thanks a lot and good luck.

[John M. Presley:]

Thank you.

[Dennis R. Knowles:]

Thank you.

[Operator:]

Thank you. Our next question comes from the line of Matt Fassler from Goldman Sachs. Please go ahead.

[Matthew J. Fassler:]

Thanks so much and good morning. I want to follow up on the gross margin question. I guess, if you think about the levers in the business and what you were able to control, to the extent that we've been in the 33% to 34% gross margin range, I guess over the first half of the year, what do you see that you're able to improve upon that could help drive that number materially higher? Have you essentially stabilized at this point, and I'm not sure at this point, what role seasonality might have in margin rate. But it sounds like you've pulled back on promotions, the mix is a little bit more favorable to you. So are the natural drivers of gross margin rate higher from here?

[John M. Presley:]

Matt, I'll answer it the same way I answered before and we're not – we can't predict. At least I don't think I can predict right now where margin is headed. I do believe intuitively that it's headed higher. I believe for several reasons, I believe if you want to be able to source product better going forward, if you look at the last nine months and some of the products that we've had to source, we've been pretty much under the gun on how we've had to go and get product. We haven't done a lot of comparison shopping if you will to get product, so that's been hurtful for the margin and we expect as we get healthier and better and our compliance team continues to get us where we need to be that the cost of goods if you will, will continue to improve. So we think that's going to be positive. We do – we are focusing on a couple of other parts of our business that are inherently lower margins. We think, as I mentioned before, installation is picking up and that attachment is doing very well and Dennis can comment on that. Also our pro sales, we've put a lot of focus on in the last quarter on pro sales. That I think inherently comes in a lower margin than pure retail, so that will have a negative lever to it. But I think all-in-all, I would expect the business to slightly improve its margins over time, but there are a lot of factors that are going to push and pull on that – that depending upon our – our success will affect the margin percentage. But, again as I've said in this call, I guess now three times, this management team is far more focused on margin dollars and bringing those dollars to the bottom line than what the percentage is and that's going to continue to be our focus.

[Dennis R. Knowles:]

Yeah. I would agree with John. I think you'll see improvements in the margin going forward as it relates to the improvement of our overall mix, as we mentioned, we introduced vinyl into our assortment late in the second quarter and just the beginning stages of bringing that assortment in. So, we'll see that assortment broaden throughout the next quarter and that certainly will help us improve the mix. I think also from an execution standpoint, the disciplines that the divisional vice presidents and the regional managers have put in place to control unauthorized markdowns and ensure that we're managing our promotions correctly have really started pay our forces well and we'll only see that improve I think. Marco and the team have done a really nice job rolling out the good, better, best strategy. It kind of really clarifies it for the customer, helps our associates sell through the mix and up the continuum if you will.

[Matthew J. Fassler:]

Got it.

[Dennis R. Knowles:]

So while it's hard to predict where that will be, I think you'll continue to see improvement.

[Matthew J. Fassler:]

That's very helpful and then just by way of follow up. So there has been, I guess, a couple of times now, costs related to import duties and I've tried to take a crash course in trade law in your 10-Q; it's a bit complex for me to understand. And I guess the question is, is this in anyway kind of a recurring item, where you have visibility or is the charge that you've booked this quarter, essentially mark-to-market on your expectation of your total liability on the duties issue?

[Gregory A. Whirley:]

Matt, this is Greg, I can handle that. So we have a couple charges that we've taken in recent periods, $4.9 million roughly last year, $5.5 million this year, you can total those up, but somewhere in the neighborhood of $10 million to $11 million of charges related to these anti-dumping duties, that sits as an accrual on our balance sheet right now, we have not paid those. When you think about our approach, what we have historically done or how we've managed that is, when those rates are set and finalized with the Department of Commerce, we would at that point make an accrual. There is some outstanding periods that still remain. And we've given you an estimate of what we think those remaining costs will be in our 10-Q, I believe that number is in the $4 million to $5 million range of outstanding cost. So there is some to come. But the more important point is that, we understand where these costs are coming from, why they are there and have been actively managing to buy from suppliers and do things that limit our risks, the type of anti-dumping charge going forward. And it's important to know that these costs all relate generally to historic purchases, they aren't purchases that we're making today and forward, this – the most recent one that we accrued related to the period basically through 2014.

[Matthew J. Fassler:]

Got it. So, nothing in the way you're buying today would lead to – or it sounds like, little and kind of less each period will lead to additional liability for anti-dumping duties.

[Gregory A. Whirley:]

We can't make that statement and say nothing, but what we can say is that we are managing that to limit any surprising charges that don't show up directly on our gross margin.

[John M. Presley:]

And Matt, it will – it goes back to my comment of having multiple places to source and the dumping charges will factor into where we're sourcing product in the future.

[Matthew J. Fassler:]

Thank you so much guys.

[Gregory A. Whirley:]

Matt, before you go, you had asked as well the prior caller, about 110 basis point change related to sales mix and gross margin.

[Matthew J. Fassler:]

Got it. Thank you.

[Operator:]

Thank you. Our next question comes from the line of Budd Bugatch from Raymond James. Please go ahead.

[David Joseph Vargas:]

Good morning, everyone. This is David on for Budd. Thank you for my questions. And first, John, I hope your health is improving. I'll start it off with a point of clarification on anti-dumping and countervailing. Greg, the $10.4 million accrual that you have on the balance sheet that's the $4.9 million from December plus the $5.5 million from this quarter. Is that correct?

[Gregory A. Whirley:]

Yes.

[David Joseph Vargas:]

Okay. Thank you for that. And then, I want to focus on some of the legal issues, real quick. The insurance settlement mentioned in the 10-Q this morning, is that related to the multidistrict litigation case or is that the securities litigation – related to securities litigation?

[Jill Witter:]

No, that's related to the multidistrict litigation. So that, essentially that was an opportunity for us to resolve that matter, but it does mean that there is no insurance coverage relative to the MDL case.

[John M. Presley:]

And I'll also remind you that we believe we've got adequate liquidity to manage through those issues as it stands today.

[David Joseph Vargas:]

Okay. So, it's settled with the insurers, but it doesn't look like there would be any reimbursement from insurers when the final settlement from MDL comes out. Is that a correct statement or am I thinking about that correctly?

[Jill Witter:]

Yes, that is correct.

[David Joseph Vargas:]

Okay. All right. Thanks. And keeping on MDL, what is the latest on the docket? It looks like a couple of more cases were added to the overall litigation class action and it looks like there is ongoing discovery on those that were just added. Is that the latest; is there anything coming up that you can talk about?

[Jill Witter:]

Well there are always cases that are being swept into that MDL litigation. So we are continuing through the discovery processes and the cases are continuing on the docket.

[David Joseph Vargas:]

Okay. All right. Thank you. And the S-3 filed this morning for 750,000 shares, is that – that's related to the securities litigation settlement and the – what you've called out as 1 million shares you expect to issue related to that?

[Dennis R. Knowles:]

No. Unrelated. The S-8 that was filed more related to need for shares for – used for filling out new positions and that sort of thing to the company.

[Jill Witter:]

It's related to our equity that has been planned.

[Dennis R. Knowles:]

There you go.

[David Joseph Vargas:]

Okay. So, though you haven't registered for the 1 million shares yet for the securities, when do you think that may happen or when would we – when could we see that?

[Jill Witter:]

I don't have a date for you on that.

[David Joseph Vargas:]

Okay. All right. That's fine. And last question from me, Dennis, just kind of an open ended one for you, with respect to the core business, what's the biggest challenge you're facing right now, that if you overcame it, would have the biggest impact towards getting you back to where you want to be and what are you doing to overcome that hurdle?

[Dennis R. Knowles:]

Great question. So we're really focused on the fundamentals in the stores and that's making sure, number one, as I spoke earlier, making sure that we've got qualified quality associates in our stores that are trained to meet the needs of the customer and deliver what we call best-in-class experience and that's a lot of work to do. It sounds simple, but making sure that we've got the right focus in our stores and then they are trained, we're really working hard on that and pleased with the progress, but it has been a big hurdle. Secondly, is really establishing some standards and strategy for us as it relates to how we stock product in our store. We're focused on making sure that we've got the best sellers. I think for – just to be honest with you, I think in the past, we really didn't have a good understanding of what we needed to stock in the store versus what we could stock and ship from our distribution center. So, Carl, our Head of Supply Chain and his team have worked really hard on kind of understanding the dynamics of what's cash-and-carry and what businesses or what orders can be shipped from the distribution center, not needed to be stocked in the store and so making sure that we really understood that has been a big portion of the work in the second quarter. And the early read is making – it looks good and – but it's been a lot of work to really understand that, because in the past, we really didn't – two things we didn't do very well. We didn't assort our stores from a regional perspective and we certainly didn't look at store stocking matrix as a single unit. We've basically spread our strategy across every store in the chain. So, we've really had to step back, think about what inventory depth looks like in a store, what we want to see differently across the country. And so, that's been big work, but the pieces are falling into place and I like the progress we're making. And then secondly, now that we're starting to get healthy in terms of associates fill rate is starting to focus on the conversion. And as I mentioned earlier, we've really – not only have we doubled up our mystery shops, but we're really scrutinizing on the close. Additional focus on the actual customer experience, but we're also looking at when we don't close the sale, what's the reason. So, as we're focused on pricing product and the quality of the experience. So, those are the biggest challenges. From a merchandising perspective, it's just as John talked about, just making sure that we are continuing our work, filling out the assortment. And last year we had a lot of disruptions and we had to do some things in the business as it relates to clearing out old inventory and basically trying to make-up for sales in laminate and excuse the engineer by selling a whole lot of solids at reduced prices. So, also trying to help the stores understand what normal is and how we can focus on improving each segment of our assortment, both in terms of in-stock and our sales rate. So, those are the big challenges. I would say the conversion, the store experience and continuing to refine and improve our assortment.

[David Joseph Vargas:]

Great. Thanks for that and good luck going forward.

[Dennis R. Knowles:]

Thank you. I appreciate that.

[Gregory A. Whirley:]

Thank you.

[Operator:]

Thank you. Ladies and gentlemen, our final question for today comes from the line of Peter Keith from Piper Jaffray. Please go ahead.

[Peter Jacob Keith:]

Hi, thanks. Good morning, everyone. I appreciate you taking the questions.

[Gregory A. Whirley:]

Good morning.

[Peter Jacob Keith:]

Wanted to just ask about lapping last year's liquidation and promotion activity and how that might be disruptive to same-store sales. Is that isolated to June or seems like that, that could continue as a headwind here for the coming months, maybe give us an idea of how long that remains a headwind?

[John M. Presley:]

That was a great question, thank you for it. That promotional activity and liquidation started in June of last year, really ramped up through the third quarter of last year, I guess probably all the way through October of last year and really didn't start dissipating until late in the year, probably November and December. So, Tom did a great job of – of clearing that inventory, creating some cash for the company, but it will be a factor when you are looking at comparable sales year-over-year and not only in the second quarter, which we just finished but in the third quarter as well. So it will be a little choppy to really compare how we are doing this year in terms of just selling floors versus last year, but we will try to break that out for you in the third quarter.

[Peter Jacob Keith:]

Okay. That's helpful. And then, maybe just following up on that with all of the pieces in terms of getting through the formal activity, getting the products back in stock, you're ramping up the advertising, do you guys have a goal in mind of when you should start to see positive same-store sales?

[John M. Presley:]

We have a goal, most certainly. We are not ready to share that with you yet. It's a work in progress. This is a hard job we've got getting through this and I'm very pleased with the team, I'm very pleased with the efforts of all of our associates turning this around. And while we're disappointed as a management team with the second quarter, we're also encouraged by some of the results that we're seeing and we hope that those continue.

[Peter Jacob Keith:]

Okay. Very good. Last one from me. We do hear a lot of commentary in the marketplace about wood-look tile, it's something you guys do offer, but wasn't mentioned yet on the conference call? Is that something you feel like you're appropriately positioned in or maybe missing out on some of the share with the demand trend you sited?

[Dennis R. Knowles:]

This is Dennis. I'll take a stab at that. We like that business, it's something that we've really introduced over the course over the last year and it's doing – it's a category that does well for us. We do think we've got some opportunity to continue to refine not only just the assortment but the breadth if you will and are continuing to look at that as a regular part of our sourcing in an assortment strategy. So it is a good business for us and we feel like we've got more opportunity there.

[Peter Jacob Keith:]

Okay. Thanks for the commentary and good luck going forward.

[Dennis R. Knowles:]

Thank you.

[Peter Jacob Keith:]

Thank you.

[John M. Presley:]

I want to thank everybody for joining us today. We look forward to updating you on our progress next quarter and we will talk to you then. Thanks a lot.

[Operator:]

Thank you ladies and gentlemen. This does conclude our teleconference for today. You may now disconnect your lines at this time. Thank you for your participation and have a wonderful day.