Q3 2020 Lumber Liquidators Holdings Inc Earnings Call
Good morning, ladies and gentlemen, and welcome to the lumber Liquidators third quarter 2020 earnings Conference call. As a reminder, 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 Brian.
Please go ahead.
Good morning, everyone and thank you for joining us.
Today, I'm joined by our President and Chief Executive Officer and.
See Wallace, our Chief Financial Officer.
As we begin let me reference the harbor provisions of the U.S. Securities laws for forward looking statements due.
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.
Can you 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 FCC.
The information contained in this call is accurate only as of the date to Scott.
Mr should not assume that the statements will remain operative after today and lumber liquidators undertakes no obligation to update any information discussed in this call.
Now I'm pleased to introduce <unk>, President and CEO Chas Tyson Charles.
Thank you Daniel.
I'd like to begin by acknowledging a team for their continued dedication and focus that enabled us to deliver a very strong quarter.
Information is well under way and our associates demonstrated strong operational execution plan.
Plan by remaining agile and customer focus through the quarter.
Our entire team for myself Associates go ahead.
D season support centers up show, great commitment flexibility and perseverance throughout this entire year to deliver both outstanding results.
Terrific customer service to our foreign customers.
I'm very proud to be leading such a dedicated team working every day to execute our transformation strategy and are committed to delivering a high touch consultative experience for our hard surface flooring customers.
Turning to our positive results for the quarter.
We continue to make strides with our transformation plan, we saw evidence of progress on multiple fronts as comp sales increased by 10.9% gross margin expanded 320 basis points over Q3.
Adjusted EPS DNA was 4.5 million lower than last year, and we delivered 28.7 million in adjusted operating income for the quarter, a significant 25.3 million improvement in adjusted operating income versus last year.
We continue to navigate the COVID-19 environment, we remain focused on monitoring all factors influencing customer demand, including existing home sales and mortgage rates and consumer confidence.
During the quarter, we continued to execute against our strategic pillars of people and culture, improving the customer experience driving traffic and transactions in our stores and online and improving profitability.
Our first strategic pillar people and culture is a critical driving force behind our transformation strategy.
Our recently formed culture Committee is working to define a promise and mission as well as build out our company values developing the new Ll culture is critical to how we will execute our strategy and service our customers.
We're working to ensure that we have the right leaders in the right roles to effectively achieve our company's goals.
We continued to narrow spans of control in a field organizations by hiring more leaders at the regional level to bring greater concentration to executing a high touch service model for both D I y.
And pro customers.
Our field leadership has also focused on developing a more robust store a regional manager training program. The promotes both the books, an inclusive leadership as well as drive greater internal career advancement building up bench for future store leadership.
Weve enhanced our merchandising organization with new divisional merchandising positions, adding talent accountable for driving both trend right assortment and category portfolio management to grow sales and profits.
Turning to our second strategic pillar of driving traffic and transactions in stores and online.
We remain focused on enhancing our digital engagement with customers and continue to allocate our marketing is all that's where we believe they are most effective specifically increasing investment in social and search.
We were pleased to see that this work to increase allocation into digital marketing generated positive results by driving new customers to our brand. Despite a total marketing spend decreasing year over year.
On a product portfolio. Our goal is to consistently deliver a trend right assortment of wood and manufactured products. We're extremely pleased with the results that have been driven through the repositioning of our solid wood business to a more trend right quality assortment with a focus on improved finishes in due course.
This effort is centered around the expansion of our Bellawood teasing product portfolio.
Along with the continued strength and expansion of our vinyl offerings. These changes were a driver of that comp lift in the quarter.
Our field teams are focused on selling a complete solution to our customers.
Ensuring we meet that end to end needs.
In the quarter, we emphasize the attachment selling.
Training, our associates to sell older necessary high margin attachments, including moldings and accessories to complement any flooring purchase.
We want our customers to view us as a one stop shop for their entire flooring journey and we're pleased by the acceleration in sales we saw in our accessory categories in the quarter.
As it relates to transactions Ah installing pro customers, both improved significantly from Q2 to Q3.
Well I completed installs were slightly negative for the quarter. There was considerable improvement from Q2 to Q3, and we were pleased to see new installation assessments turning positive in the quarter.
This was driven by customers increasing willingness to allow contractors into their homes for home improvement and installation projects.
In pro we also saw sequential growth from Q2 to Q3 moving into positive territory.
We saw changes in segment mix with greatest strength from Remodels and installers and weakness in residential property management, we attribute to the impact of Cove at 19.
Our third pillar is improving the customer experience.
We remain committed to creating a uniquely consultative shopping experience across all our platforms and our goal is to meet our customers at any stage of that flooring project.
A significant portion of our customers are changing their preferences and shopping online for the flooring needs an organization is quickly adapting we.
We leveraged our investments in digital to improve our online experience with a unique tools like picture it and flow finder, gaining further traction.
Web sales grew approximately 140% over Q3 last year as our investments in digital drove our results.
We began piloting remote video selling would live associates to make it easy for customers, who want to shop from the home to do so.
We're pleased by the initial results and we anticipate expanding this capability over the coming quarters.
And fourth improving profitability.
Our merchant teams drove our business in the quarter by making changes to our promotional strategy that offer customers, new exciting promotion and yielded improved margin benefit.
The walk us sourcing a merchant teams have done over the last 18 months continues to deliver margin benefit or do we drive our alternative country sourcing strategy.
We remained extremely disciplined in managing our expenses to improve our bottom line.
Similar to last quarter, we optimized our marketing efforts and pivoted towards more efficient channels like digital.
We remain focused on executing our transformation plan and making progress against our strategic pillars to positioning us for long term success.
Now, let me update you on our initiatives against each of our full tell us.
First let's start with our people and culture.
As I spoke about last quarter, we introduced a fourth pillar to our previous strategic framework focused on people and culture that will be a key component of our strategy as a specialty retailer, providing a high touch service model with knowledgeable associates supplying flooring expertise.
A cornerstone to our People's agenda is our commitment to creating a diverse and inclusive workplace the values and leverages individual differences to accelerate the companys growth.
Especially proud about diversity inclusion task force that includes team members from across our organization they.
They are developing a set of initiatives, including building and supporting programs aimed at attracting developing and retaining diverse talent and promoting an inclusive workplace across our organization.
Additionally, each quarter, we continue to make investments in training to deliver a differentiated service experience for both pro and DIY customers and to give our teams greater confidence in building lasting relationships, particularly with our pro customers.
Finally, I'm also excited to introduce Alice Givens as our new General Counsel, a member of our senior leadership team.
Alice is strong retail background and public company experience is a perfect complement to our organization and she brings over 20 years of compliance legal and retail experience.
Turning to our objective of driving traffic and transactions, we believe revitalizing our brand will be a significant driver of this pillar we.
We are moving forward with our pilot of approximately 20 plus stores that have rebranded Ll flooring in Q4.
We are utilizing this pilot as an opportunity to learn and understand customer response to our updated branding.
As previously stated we do not expect any material capital or operating expenses related to the rebranding of these stores in 2020.
Our strategy to drive growth with the pro customers is a critical component of that transformation.
Field teams are focused on expanding trial scale and retention of our best pros and.
And as I, just mentioned with delivering consistent training to our associates around pro business development.
Additionally, we have created an enhanced reporting to allow for more effective understanding of pro behaviors at the local store level.
We are continuing to build out our pro value proposition I look forward to discussing this more fully as we roll out new programs in the first half of 2021.
Investments in a digital installed platform are enhancing the customer experience and driving install efficiency.
We see installation as a core element of our value proposition weeks.
We expect these new capabilities across our installed experience as well as testing remote in home selling will drive expanded adoption of our installation services.
Moving to improving the customer experience.
Digital capabilities reinventing the way, we do business, enabling us to interact with customers at a greater number of touch points and ensuring we can do business effectively in a world of social distancing.
Whatever a customer's preferences are and how they wish to engage with our brand we strive for a high touch approach unparalleled expertise and the trend right assortment with competitive pricing both in stores and online.
A end to end digital experience is exciting CIL to executing our transformation.
Our teams are laser focused on ensuring a differentiated experience for all our customers. Let me give you. One example, dylan spending a seasoned ll flooring store manager in New Jersey.
His customer came into the store to schedule an in home assessment.
After the assessment was completed the customer came back to the store multiple times to make revisions to his work order.
Team worked diligently to ensure the flooring and installation setup, where exactly meeting the customer's needs.
The customer himself a skilled crossman was so delighted with the floor and installation he posted a five star review and quoted the team trade at my House like it was their own and I will be using them to complete the rest of my house.
He returned to the store to buy floor care products and show the team pictures of his new home project. This great. So the story shows how our teams work alongside our customers over multiple weeks to ensure they have a great experience great work Dillon and team. Thank you very much.
No. This is just one of many stories highlighting the fantastic work our teams are doing.
Finally, we continue to work on improving profitability, focusing on best country sourcing to mitigate terrorists driving gross margins and reducing operating expenses.
As we communicated in August of Twentytwenty, the section three or one tariffs on certain vinyl products from China were again reinstated a 25%.
We have several approaches to mitigate the impact of the terrorists, including partnering with carb vendors to lower costs.
Alternative country sourcing and price adjustments now.
Nancy will provide more information regarding the reinstated tariffs in her remarks.
As a reminder, we saw a benefit of $11 million of operating income in the fourth quarter of 2019.
As a result of the retroactive exclusion of certain tariffs, which will not be repeated in 2020.
Leveraging best country sourcing for our entire suite of products across all of our operations is key to this mitigation strategy we've.
Weve significantly reduced the amount of goods, we purchase from China from approximately 46% for the full year 2019, with a goal of having a run rate of Chinese purchases to the mid Thirtys as of the end of 2020 and those efforts will continue in the coming year.
Looking to the future, we endeavor to partner with the best vendors to obtain premier quality products, regardless of location and we're always evaluating alternatives for best country sourcing.
Last quarter. We also communicated that we were conducting a comprehensive review of our real estate portfolio.
Following the conclusion of this review we made the decision to close our Canadian operations, including all eight stores in Canada, and six underperforming U.S. locations by the end of Twentytwenty.
We will continue to monitor the store performance on an ongoing basis.
We opened one store in the third quarter and as noted last quarter, our current plans, including opening two to three new stores in Q4.
This will enable us to expand our reach to serve new pros DIY customers and buy online pick up in store digital customers in key geographies.
I'm excited by the work ahead I'm pleased that our company's transformation is on track our teams remain agile and focused and our strategy is beginning to bear fruit as we evolve into a high touch specialty hard surface flooring retailer.
Before I hand, the call over to Nancy I once again want to thank our associates for their tireless efforts, we could not have this level of success without their hard work and dedication its through teamwork and collaboration both internally and externally with vendors landlords and supplies.
We were able to deliver strong financial performance and an exceptional experience for our customers.
I will now turn the call to Nancy to share the financial details of the quarter.
Nancy.
Thanks, Charles Good morning, everyone.
In the third quarter net sales for $295.8 million, an increase of $32 million or 12.1% versus last year due to a 13.9% increase in merchandise sales.
Service sales increased 2.3% and their installation sales decreased 3% year over year at consumers reacted jacoby.
This was more than offset by an increase in transportation revenue for sales to customers.
Comparable store sales increased 10.9% versus a year ago, primarily as a result of continued execution of our transformation plan and healthy consumer demand for home improvement project.
Additionally, as a reminder, the third quarter of 2019 was unfavorably affected by a network security incident in late August which the company believes negatively impacted total revenue by approximately $6 million to $8 million with an accompanying reduction in gross profit.
We experienced a 2.9% decrease in our average ticket due to lower installation sale and a 13.8% increase in transaction count compared to the same period in 2019.
The second quarter to the third quarter strengthening in our higher ticket installation sales as well as returning pro sales drove an increase in average ticket.
Gross profit increased 22% in the third quarter up 20 $20 million to $117 million from $96 million in the comparable period in 2019.
Gross margin increased 320 basis points to 39.4% in the third quarter of 2020 from 36.2% in the third quarter of 2019 due to lower year over year sections real one chair.
Supply chain efficiency, along with pricing initiatives and a larger mix of higher margin manufactured products. These.
These items were partially offset by higher customer delivery costs associated with promotion.
As a reminder, on tariffs beginning in September 2018 goods coming from China were subject to a 10% tariff under section 301, which was increased to 25% in June 2019.
On November seven 2019, the U.S. trade representative granted a retroactive exclusion on certain click vinyl and engineered products imported from China.
Subsequently on August six 2020, the U.S.T., our announced its intention not to extend the exclusion pertaining to those certain flooring products imported from China and the exclusion expired as of August seven 2020, which again subject. So its products to the 25% section three on one care.
At that time, approximately 43% of the company's merchandise receipts originated from China, approximately 10% of the company's merchandise receipts remains subject to the section three on terror, even during the exclusion period. The remaining 33% are once again subject to the section three a one terabyte.
The company has several approaches to mitigate the impact of tariffs, including altering its supply chain just sort of the same or similar products from other countries at lower costs and adjusting its pricing.
Company continues to monitor market pricing and promotional strategies to inform and guide its decision following the tariffs being reinstated in August 2020 cash flow was reduced as we began to pay for the tariffs on the product affected by sections real one tariff reinstatement at.
This product is sold beginning in the fourth quarter the increased cost of the tariffs will flow through the income statement.
SGN expense for the third quarter was $93.4 million or 31.6% of sales down.
Down 380 basis points compared to $93.5 million or 35.4% of sales in the third quarter last year.
SG name both quarters included certain costs related to investigations lawsuits and certain other legal matters.
Final Court approval was granted to the gold matter in October 2020, we recorded a final $2 million of expense for in store vouchers as we now believe the claims threshold in the settlement agreement will be met.
We originally recorded expense of $28 million in the fourth quarter of 2018 split evenly between cash and in store credit vouchers, we expect to fund the remaining $13 million in cash in the fourth quarter of 2020 and anticipate that the redemption of Divestures associated with gold will begin in the second quarter of 2021.
Additionally, SGN a in the third quarter of 2020 included costs related to Canadian and U.S. store closures we.
We expect to incur expense of between four and $5 million to close these stores in the second half of 2000 $22.6 million of which was recorded in the third quarter of 2020.
We expect all 14 stores to be closed by year end, although certain tranches of inventory and cleanup activities will not be fully completed until early in 2021.
Both periods items, our adjusted in the non-GAAP Reconciliations section of the press release.
When excluding these items for both periods adjusted <unk> expense for the quarter was $88.6 million or 29.9% of sales versus $93.1 million and 35.2% of sales in the last years third quarter.
$4.5 million lower year over year, and de leveraged 530 basis points on a percentage of sales basis.
In addition to the store closing impact the reduction in adjusted <unk> was primarily driven by the optimization of our marketing efforts as we pivoted toward more efficient channels like digital and $2.5 million from the settlement of the business interruption insurance claim related to the August 2019 network security incident.
Partially offset by an increase in credit card fees due to the year over year increase in revenue.
For the quarter, we recorded operating income of $23.2 million compared to operating income of $2.2 million in Q3 of 2019.
After adjusting for the unusual items previously noted operating income increased by $25.3 million to $28.7 million in the quarter when compared to adjusted operating income of $3.4 million last year.
The year over year increase was primarily driven by strong sales growth enhanced gross margin and strong expense management.
For the three months ended September 32020, we recognized income tax expense of $7 million, which represented an effective tax rate of 31%.
For the three months ending September 32019, we recognized income tax expense point $2 million, which represented an effective tax rate of 17.7%.
The variability of our third quarter tax rate reflects the timing of deductions as we calculated the discrete provision in 2020 because of COVID-19 uncertainty as compared to using an effective tax rate in 2019.
For the third quarter of 2020, net income increased by $14.5 million to $15.5 million compared to net income of $1 million for the third quarter of 2019.
Adjusted earnings a non-GAAP measure for the third quarter of 2020 with $19.6 million a year over year increase of $17.7 million compared to adjusted earnings of $1.9 million for the third quarter of 2019.
For the nine months ended September 32020, net income was $30.4 million, a $37.1 million increase versus net loss of $6.7 million in the first three quarters of 2019, and adjusted earnings were $35.4 million or $36.3 million increase versus.
An adjusted loss of $8.8 million in the comparable period of 2019.
Finally earnings per diluted share was 53 cents for the quarter versus earnings per share of four cents in the year ago quarter on an adjusted basis Q3 earnings per diluted share increased by 60 cents to 67 cents. This year compared to an adjusted earnings per diluted share a non-GAAP measure.
Her up seven cents last year.
Turning to the balance sheet.
Inventory at the end of third quarter was $237 million $69 million lower than Q3, 2019, and $11 million lower than Q2 2020.
22.6% reduction in inventory from Q3 last year was primarily driven by managing our inventory purchases as a direct result of COVID-19, and better than anticipated net sales growth, particularly in the third quarter of 2020.
As we stated last quarter, we are pleased with our ability to manage our inventory purchases and appropriately balance the goals of preserving our liquidity, while also supporting customer demand.
We ended the quarter with $101 million in outstanding debt under our credit agreement, which is unchanged since we announced our ABL Amendment in April.
Cash and cash equivalents balance increased by $194 million compared to Q3, 2019, and with $199 million at the end of third quarter.
Increasing cash came primarily from our focus on maximizing liquidity through expense and working capital management.
Despite our strong current physician uncertainty in the near to medium term environment require a continued focus on maximizing liquidity as a result, we have chosen to maintain high cash balance at this time to provide financial flexibility as we manage through the current uncertain environment.
Net cash provided by operating activities was $181 million for the year to date inclusive of $75 million in the third quarter, an increase of $198 million over the equivalent period of the prior year.
The increase in the quarter was driven by strong operating performance along with disciplined working capital management.
The working capital benefit included higher accounts payable a reduction in inventory due to strong sales collection of tariff receivables and further growth in customer deposits.
The company has a significant amount of inventory in transit as of September 32020, and expect inventory to build to $270 million to $290 million in the fourth quarter.
The accounts payable balance was higher at the end of the quarter due to the increased in transit inventory and extended payment terms with vendors and other service providers we.
We collected more than $11 million in Q3 related to tariff refunds and interest from the U.S. customs associated with the November 2019, retroactive tariff exclusion on click vinyl and engineered products imported from China.
That brings year to date total received to approximately $20 million of the $27 million refund anticipated, we expect to receive payments in the coming months.
As of September 32020, the company had $230 million in liquidity comprised of $199 million of cash and cash equivalents and $31 million of excess availability under the credit agreement distress.
This represented an increase in liquidity of $44 million from June 32020.
Our team remains dedicated to our transformation with the ultimate goal of improving profitability. We are pleased with our ability to reduce costs manage inventory and maintain a strong and flexible balance sheet. During these uncertain and challenging times.
Our focus on liquidity over the past several months has allowed us to build a strong liquidity position to navigate the current COVID-19 environments and our business is generating solid cash flow.
However, significant uncertainty surrounds the duration and extension to pandemic still remains making it uniquely challenging to accurately forecast our future financial performance.
As a result, we are not providing annual financial guidance.
As a reminder for modeling purposes, we had a benefit of $11 million of operating income in the fourth quarter of 2019 as a result of the retroactive exclusion of tariffs, which will not be repeated in 2020.
Additionally, as Charles mentioned, we are planning to open two to three new stores in the fourth quarter.
As Charlie stated our entire organization remains focused on continuing to execute our stated initiatives people.
People in culture, driving traffic and transactions improving customer experience and ultimately improving profitability.
Our near term strategy is maximizing financial and operational flexibility, while continuing to execute against our strategic initiatives.
I would like to reiterate Charles Thanks to our associates business partners and many other stakeholders, who are working collaboratively with us to navigate this environment.
We are all working to weather this pandemic and strengthen our organization.
Charles and I are excited about the opportunities ahead for our company and believe the future is bright.
Thank you all for your time this morning with that I'll ask the moderator to open the call for questions.
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Our first question comes from the line of Laura Champine with loop capital markets. Please proceed with your question.
Hi, Thanks for taking the question. It's it's on tariffs as we all kind of struggled to get a handle at least I do on the impact I know that you have some offsets you're working on but when did the offsets happen and at some point doesn't price just adjusted because isn't this an industry issue.
Yeah. Good good morning, Laura Yes, you're exactly right you know as the the merchant teams are working true strategy of working with our existing vendors on on potential additional cost out new product development. There's also an opportunity for us to leverage.
Pricing.
And we continue to work on our alternative country sourcing.
As a the tariff impact for the industry flows through over the top of the inventory and the inventory we.
We do expect there to be some pricing action and we will look.
Out over the landscape and look to be competitive.
But again we.
We have multiple strategies in place to work or the the entire Finpac that's come in and as we said you know we by no laminate from China today and.
And total purchases from China have come down pretty just that can significantly over the years. So I'm sorry, I didn't get the answer. Your question is yes pricing will play a component of offsetting tariffs over time.
Got it and then just quickly it looks like ticket was down a bit I. My guess is that that's because D. I Y is still gaining share from pro he is that accurate or <unk> or is there something else going on that line [noise].
No the decreased I'm sorry.
Good luck.
The decrease in our ticket during the quarter was due to the lower installation sales and that's a direct result of cold that our customers are still not entirely comfortable having other people in their homes.
Got it thank you.
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Thank you. Our next question comes from the line of David Macgregor with Longbow Research. Please proceed with your question.
Yeah, good morning, and congrats with the progress wanted to ask about the new store openings you got two to three opening here in the fourth quarter whats changing in terms of store design, if anything as you move forward and into 21 new stores [noise].
David You know we opened some prototype stores last year and yeah. We're just continuing to monitor those but we've taken some elements of those particularly a design center does now incorporate it into our current format, which stays the same at about 6000 total.
Square feet.
So you know I think as we look out over the next 12 months to really understand how.
Our customers are changing their behaviors, but clearly their interaction with digital and digital tools like the picture a tool.
We won't actually interact inside the store with those so we see bringing digital content into the store as part of the experience along with the tools to help customers fail to see exactly what the outflows will look like in the home. So Oh, we constantly look at a prototype, but that's where we sit today.
Okay, and then just brings up to date in terms of your experience with the rebranding you talked about are running pilots.
I'm just wondering what you're doing right now to protect traffic on those stores and to support that.
I guess the consumer perception.
Yeah. That's a good question. So I think we've been pretty transparent around.
Brand transformation and the revitalization of our brand we started with new creative.
Last year.
And that was the beginning of telling a different story of who Ll flooring is.
And the 20 stores with that you know the last few weeks and so it's too early to talk about those results, but certainly a initial feedback from our team members Derrick.
They're excited.
And we think that as we build it you know our end to end strategy of how we communicate to customers, whether its online or digital more digital marketing or lineal marketing that will be telling the story of two ll flooring is.
What you see in our advertising today, it says that the lumber liquidators now his fellow flooring and we've been telling that story now for about six months and so the dual branding story in our marketing it is creating the connection between the brand Thats retiring in the new the new the new name off the this moving.
Forward.
Is there any way you can sort of give us a sense of if this is successful which I presume it will be how we think about the rollout or through 2021 yeah.
Yeah to be honest everywhere evaluating that now right. The reason we're doing a pilot is going to really understand all the drivers we've got a pretty comprehensive set of KPN. So we're going to look out across our business, whether its D. I Y O pro or installation and in future quarters. So we'll give you that that give you an update on where.
Are we still.
Okay last question for me is just you mentioned building out your regional management at your merchandising Division managers, how quickly do we see a look how quickly should we expect to see leverage that.
So let's talk about the merchandising team we've added a number of new merchants over the last 12 months.
And we've really been focused on design and innovation.
The new roll out that we did at the end of last year on a wouldn't programs that I talked about but that has impacted our column. We believe the repositioning of Bellawood has created a premium what assortment in the marketplace that that would be that we're very pleased with the results. So merchandising is an all you can go.
During process cell line reviews happened consistently.
We have not slowed down through co bid on new product introductions and so this is just again building our bench strength into the future, but a lot of work has been done over the last 18 months to both incorporate design and accelerate new product development, both on the manufactured product and on the on the solid wood product.
I'll note that the regional managers, we actually flattened the top of our organization a little bit with less divisional Vice presidents and broaden the regional managers to oversee both a pro business an idea why business yesterday, we had a second to old National training day for the whole organization on the same day.
So the benefit of putting a more regional managers on the ground is the closest to our customers over saying no on average 15 to 20 stores and couldn't really helped develop leadership, particularly our store managers that just deliver such an outstanding customer experience and so we see that as part of that.
Culture change that will continue to be part of our transformation journey over the next 12 to 36 months.
Great. Thanks for the detail good luck David.
Thank you. Our next question comes from the line of Simeon Gutman with Morgan Stanley. Please proceed with your question.
Thanks, Good morning, Charles or Nancy can you just talk about the tariffs again a is there a.
The right way to look at it in terms of a basis point impact to gross margin and then how do you look at gross margin. What is the you know the underlying right way to think about gross margin at this point that it to 2021.
So in terms of tariff. The hierarchy is you know tariffs came on 18 19 last year. The tariffs came off so we've had almost a full year up no tariffs and now they've been reinstated again back to the 25% as Charles mentioned, we've done a great job of meeting or attempting to mitigate.
The tariffs using three strategies one is alternative country sourcing the second is partnering with vendors to reduce our costs and then pricing adjustments as we said in the prepared remarks, we have from the end of 19, where we were at 46% or product sourced from China by the end of this year, we expect to be in the mid Thirtys and we continue to work against that.
So we are seeing that the mitigation is working the great work that the team did starting a couple of years ago. When the terrorists first came on that they kind of hit all those results. Those were clearly evident this year until the terrace went back on again. So you know we've learned a lot from this is now the second time dealing with tariffs and we believe that we are going to be able to mitigate.
The tariffs are going forward and you know what we are expecting in terms of gross <unk> one is.
To continue to put all the effort into <unk>.
Improving that area, along with expense management to drive profitability.
And at some point will you be able to share you know a basis point impact I think because it feels like there could be a change in the absolute level into 21.
And then if so I don't know if there's a number that that that you know you guys can provide.
If if it's a profound change in the underlying run rate or is the gross margin that we're looking at today the right way to think about the business.
Yes.
So Simeon I would say that you know as we go into a into the spring well be able to update more on the assets that we have done a comprehensive in terms of working the overall profitability. If I remember you know inside a strategic pillars long term profitability improvement as part of our stock.
Got it you are and so as we think about whether it's new product innovation new product introductions.
All of those play into how we think about where we can position products.
The specialty retailer I'm I've been very happy with the results that are coming out of the premium end of that business that obviously affords us the opportunity.
To make more money on those premium products and again as I said before.
We have multiple levels. So we are going to be able to to work here and I think as we move into the spring season will be better informed to to to give you that basis point number that you're looking for.
Okay, and then just one follow up and she may per foot was was great during the quarter down a good amount.
Can you talk about you know, let's say, we roll into 21 demand for flooring continues to improve the pro gets better.
And the top line grows yesterday in a per foot how are you managing that and should it start to grow, especially as Charles you're building out you know regional management et cetera.
Nancy I think you're on mute.
Excuse me.
With the change from Q2 to Q3, and we really saw the temporary actions that we took as a result of Colgate and managing our liquidity a those have been reinstated so the things that we talked about during second quarter marketing, we have not returned to historical levels, yet and we're optimizing the marketing so the spend that is changing a little bit as we.
We moved toward more efficient channels like digital we had also offset in the variable costs that came into Q3 with the increase in sales from Q2, we had a couple of onetime events that hit in Q3 as well, but if you think about Q3 to Q2, you know a lot of the change you're seeing an increase in SGN a is a function of the temporary measures that we took.
During Q2, having said that you know we continue to very effectively manage our overall SGN, a and look to as as Charles mentioned, you know factor look at all the factors going into profitability. So while we managed gross margin were also continuing to manage very effectively though the s. gionee and would expect that both of those are gonna country.
<unk> sales grow to increasing profitability.
I mean, there is just one thing that I would oh, the I'd say the regional managers. So it's a really small impact on the on the total at best and I think what's more important for us as we think about productivity overall across our field organization and as we start to utilize some of these new tools for virtual selling or customer is able to.
Two video into a store.
And make an appointment to to actually have a light bulb appointment without us she visiting the store all of those are designed to help us be more productive in terms of how we think about planning our labor over the over the week.
And again I just want to make sure it's clear that the regional changes that we've made some really important culturally to us, but not a major impact to the to the piano. They're all the work that we're doing to think through productivity from a workforce management perspective.
Yeah. Thanks. Thanks.
Thanks, Jamie.
Thank you, ladies and gentlemen, as a reminder, if you'd like to join the question could you. Please press star one on your telephone keypad. Our next question comes from the line of Brian Nagel with Oppenheimer. Please proceed with your question.
Hi, good morning.
Very nice quarter congratulations.
Thanks Ryan.
Oh, sorry, I've I've a couple of questions that are maybe a little bit longer to predict you probably go first with regard to look at sales here in the quarter. We are not very nice acceleration quarter to quarter. As you look at the data is there a way to really parse out how what portion of that acceleration in your business reflects the internal initiatives versus just read back.
Drop or your space.
And then my second question just.
Just I guess types, it's actually Dave, but specifically with regard to Mark I mean, I think the answer you talked a lot about somebody initiates the Deridder group the marketing efficiency, how far are we into that could that effort or I guess, what everybody. So the question is how what what should we expect going forward and for further improvement or the market factors. Thank you.
Yeah. So let me let me take your first question too in terms of how do we think about sales growth from an industry perspective and transformation.
Clearly we have indicators of the places we've made an investment, particularly in digital where we can see what's happening to new users and traffic.
That are a direct result of both people investments Weve made systems investments we've made.
Content, and really wanting to position ourselves to be where the customers want to be obviously through this environment more and more customers have adapted online are there more and more comfortable with buying high ticket items online and that includes our installation services.
Which we're now able to conclude.
Selling from from in home. So there are definitely places that we see through the transformation work the.
The creative rebranding that Weve done online and the feedback that we're getting from customers around the recognition of where our brand is getting repositioned. Our product portfolio is is far superior to the merchant teams have really done an outstanding job and it's across both the manufactured and.
The hardware business.
And we're seeing that and our field teams.
I've done a lot of work in terms of looking at selling the complete set of solution that we're seeing attach rates go up so inside our business, we feel really good about all of the elements of the transformation well, we can see numbers the they're driving externally you know where I'm still very optimistic you know carpet is still seeding share.
To to hard surface flooring, you know from a macro perspective, you know obviously, none of US know workover, that's going to do in the in the short term as we go over the winter, but clearly low mortgage rates are a benefit to our industry you know.
Millennials will be the largest component of mortgage REIT as this year.
And and if you know that the outlook at least today for existing Homesales looks.
Looks very encouraging going forward. So I think we're encouraged by the macro events.
That's that are out there beyond even the impact of coded and people you know working from home schooling from home I'm wanting to figure out ways to vastly better utilize the homes and and and take on a home improvement projects. They take a little bit longer to plan, then stphane single well buying furniture.
And so I think you.
There are three real elements that we're encouraged by our transformation work, where we can see the data points that we're very encouraged by and we'll continue to grow into and then the macro environment as it relates to hard surface flooring. So hopefully that that takes care of question number. One question number two we started this marketing more formally at least 18 months ago.
And the if there isn't an easy answer to your question because we're really looking at how our consumers adapting that media consumption and we're continuing to learn ourselves around to the improvement in efficiency of how we've moved our media mix, particularly in into digital so.
Well, we'll continue to evaluate that that journey, we've made some pretty dramatic changes.
This year as as Nancy talked about but it will just be thought about hygiene in terms of looking at driving the best ROI, we can out of it.
Every dollar of marketing spend that we put into the into the marketplace. Okay [noise] like.
Thanks, John appreciate all the color.
I appreciate it thanks.
Thank you. Our next question comes from line of sight.
With Wedbush Securities. Please proceed with your question.
Thanks, a lot and good morning.
My first question is regarding cadence your primary competitor forgot influence sales cadence throughout the quarter ends October could you do the same.
No no says we've said a state of policies were only going to talk about.
Performance in the quarter and will be judged by that performance in the quarter.
All right fair enough.
Secondly, as it relates to the merchandise margins last time, when we had a secondary one theres going to affect Ah first up from zero to 10% I think it wasn't actually there's a very negative impact on your margins.
Why should we not think that's going to happen again in the next couple of quarters.
Well I think couple of things one we clearly stated that our reliance on products from China has decreased and the original or the original timing of the tariffs going into place and of course laminate for us It doesn't have any impact from us tire perspective, we've done a lot of.
Walk around product development, and we've continued to introduce a a number of new products. Both in Q2 in Q3 that that's helping with with up with our overall strategic agenda around profitability.
And we're continuing to look at logical pricing in the marketplace I think.
Foreign competitors, specifically called out well.
The expectation maybe fall for pricing in the marketplace and so.
Well evaluate all of our options around the the risk mitigation.
And you know we have a balanced product portfolio, a solid wood business that weve repositioned that isn't impacted so it's very minimally by by terrorists.
Is is really growing and we're very happy with that and again the premium end of that business around the bellawood TCM products affords us room for a full growing your profitability. So I think we've learned a lot in the last 18 months and our teams have got smarter and wiser on how to do the work.
And and you.
You know the tariffs will have some headwinds it seems will mitigate over the tone or the inventory but.
But I think we're much smarter than we were 18 months ago.
Got it so should we be thinking about merchandise margins increasing year over year still in the next couple of quarters.
Well, we're not we're not going to.
Margins are going to go into the future that is you have a solid agenda around long term improvement of profitability for our business along with top line growth and we've got multiple levels or were not going against the specifics of how those are going to sequence.
As the work is completed we will come back to you and report on our outcomes that we deliver.
Fair enough last question, if I may just regarding transportation cost, we've seen a market increase in domestic trucking cost as well as international container cost can you give us some insight into how that's affecting your PML now and how you expect it to impact your margins in the future.
Yes, so there's a couple of elements so right. So both on the domestic side and on the international side, we have contracts in place that are longer term contracts I think what is going to be interesting said, particularly on the international side will be what happens from a carrier perspective, when most of these calls.
Christ got renegotiated next year, and where they have to wait and see based on what is the demand environment look like clearly, there's a huge bubble of inventory coming back into the U.S. today that is driving a driving to bond and particularly increases on the on the spot market.
We've seen a little bit of a with increased salt on the international freight side on the spot market, where we've we've pulled in some extra containers. Because obviously you know we reported a log inventory number that we're catching back up on the domestic side I think it's going to be interesting I mean, I think dependent on co bid and the availability.
He of drivers what does that environment look like so there's a lot of external factors to really be able to accurately predict clearly.
When we negotiate a longer term contract for a reason, but does the unpredictability that I think cobot is bring into the marketplace that we're going to have to watch very carefully to understand what does that imply that look like coming out of 20 to 21 and 22.
Approximately how long are your contracts and when are they going to be renegotiated.
Yeah, we we don't we don't share that level of detail, but they all longer term contracts and they are they are renegotiated on annualized basis.
Annual thank you.
Thanks Seth.
Thank you. Our next question comes from the line of Peter Keith with Piper Sandler. Please proceed with your question.
Hi, Thanks, Good morning, Nice results guys.
I'm intrigued with the AD spending Brian running down a.
Year on year is that dynamic or were you just slowly building it back for Q2 or or do you think that the AD spend can continue to run down year on year for the foreseeable future.
So let.
Let me give some context figure I think if you went back traditionally to how ll manage their advertising.
It was heavily leveraged into a national television and very under developed from a digital perspective, and so for the last 18 months, we've been doing a lot of work on how we've looked at different channels. The.
The efficiency of those channels and our ability to optimize our marketing spend.
I'm with we're happy with the results that we've seen through that optimization.
And we believe that you know the the ability for us to drive our revenue.
Through our strategy is is heavily leveraged on as much as people as it is our advertising that's why we're spending so much time on training on making sure. We've got the right people in the right roles on adding new technology into a virtual selling for both install business, which allows customers to not have to come back in.
So the store, but it survive from home allows us to drive productivity and so we're not going to say whether were going to make any major changes to our marketing spend what we've said is we're comfortable with the moves we've made in terms of reducing our overall advertising spend over the last 18 months and we want to watch and see how it because.
Humans behaviors that I'm I'm very bullish on where the digital will continue to go and we think that that's an incredibly efficient and targeted method of bringing customers into our brand and if we find new places to put those dollars to work more efficiently than.
Other places in our business then we will look at that but I think our marketing teams have done a wonderful job both on the creative side and on the optimization side with new channels to deliver results for us.
Okay. That's helpful. Maybe I'll ask a follow up so historically L. L. A has run pretty high at about 8% of sales allocated advertising much higher than your competitors around 2% to 3% with the shift to the new model, that's more consultation a ish and more digital marketing.
Charles do you think you should be closer to industry peers as a as a percent of sales for ad spend.
Yes, I think if you if you were to do an analysis Tito of retailers that are either DLP and retail as I have some level of promotion you will see a slight discrepancy in the level of advertising spend between SDLP and non SDLP. As you know we had no need DLP house today from a from a return.
Oh perspective clearly.
Clearly, we saw an opportunity to leverage down or the other way way below the 8% I think the fact is that we are we've been consistent in this war for testing well looking at the results. If we like the results were continuing to further a draw.
Drive optimization into the digital channels and that's what we're going to continue to do over the next six months and we'll report out on where that spend level ultimately.
Ultimately Russ.
Okay. That's that's helpful. Thanks, I'll ask one more question Youve closed or announced several store closures. Here is this do you feel like the bulk of the closures that will be occurring work or do you feel like this will be ongoing work throughout 2021 and as a related question is there also.
So opportunity for you to reduce rents on stores that you're going to keep open.
So I'll take the first part of that question until Oh onto the second part. So we said we've done a pretty comprehensive piece of work from a real estate perspective, and not work. We've completed and then from that we've said that Unfortunately, we made the decision to exit Canada and a limited number of U.S. stores no.
We will always evaluate a store portfolio from an overall profitability you know with 420 stores you.
Yeah.
Economics can change, but we believe we've done the majority of the heavy lifting from a real estate evaluation perspective, and that's why we made the decision from an efficiency and profitability perspective to make the changes that we announced today.
From a from a an ongoing real estate perspective, maybe Nancy you want to.
Hi, I'm, a couple of thoughts on how you're thinking about that longer term more.
So you don't want to hear me, saying I'll stick to speaking for all of us.
You know as Charles mentioned, we did a comprehensive review of the entire portfolio and as we've mentioned previously it's a very small percentage of them that are not cash flow positive. So that has been a plus for us, but having said that as we.
Continue our expense management, we are targeting rent as well you know we've done a lot of analysis in this area and are looking at a number of different factors that impact the profitability of the stores and look to see if we can improve those but as Charles mentioned, we're going to continue keeping an eye on the profitability of the stores and make those decisions as they occur but at this.
This point in time after we finished a comprehensive review. This this quarter, we took those difficult actions of close in Canada, and a handful of stores that had been unprofitable for a period of time.
Peter.
Thank you. Thank you ladies and gentlemen. This concludes our question and answer session I'll turn the floor back to Mr. Tyson for any final comments.
Thanks, everyone for joining us today I want to reiterate that were excited about the strong sales growth and profit performance in the quarter there.
There remains a great deal of uncertainty in this operating environment, but we are confident.
In our strategy well wishing everyone good health and safety and we look forward to updating you on our performance next quarter have a great day. Thank you.
Thank you. This concludes today's conference you may disconnect. Your lines at this time. Thank you for your participation.