Q2 2019 Earnings Call
Good morning, ladies gentlemen, and welcome to lumber Liquidators second quarter 2019 earnings Conference call.
As a reminder, ladies and gentlemen, this conference is being recorded and may not be reproduced in full or in part without permission from the company I would now like to turn the conference over to Danielle Brian . Please go ahead.
Thank you operator, good morning, everyone and thank you for joining US let me reference the safe Harbor provisions of the U.S. Securities laws for forward looking statements.
This conference call may contain forward looking statements that are subject to significant risks and uncertainties, including the future operating and financial performance of lumber liquidators.
Although lumber liquidators believes that the expectations reflected in its forward looking statements are reasonable it can give no assurance that such expectations or any of its forward looking statements will prove to be correct.
Important risk factors that could cause actual results to differ materially from those reflected in the forward looking statements are included in lumber liquidators filing with the FCC.
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.
A lumber liquidators undertakes no obligation to update any information discussed in this call.
Now I'm pleased to introduce Mr., Dennis no CEO of lumber Liquidators Dennis.
Thank you Danielle and good morning, everyone today, I'm joined by Chas Tyson, our chief customer experience officer, and Tim mobility, our interim Chief Financial Officer.
We have been sharply focused on executing our stated transformation strategy throughout the first half of 2019.
With the goal of strengthening our foundation to position our company for future growth.
This quarter was our first full operating period without headwinds from legacy product related legal issues and in June we entered into a memorandum of understanding in the Kramer employment litigation case discussed in our SEC filings.
We're glad to have taken a meaningful step closer to full resolution of this matter and what these issues behind us we have been quickly moving to execute our transformation strategy as we work to build momentum and long term growth.
Our second quarter results were generally in line with our expectations and we delivered net sales of 289 million an increase of 1.8% over Q2 of 2018.
Comparable store sales were flat in Q2 and improved sequentially from Q1.
But we experienced softening traffic trends as the quarter progressed merchandise sales declined slightly but were offset by continued growth in installed sales.
Additionally, our average ticket grew approximately 2.5% for the quarter.
Similar to last quarter bamboo continues to face a secular shift in the consumer demand that has pressured sales.
Though to a lesser extent this quarter, we anticipate the impact of the shift away from Banbury will be significantly less of a drag in the back half of the year.
On an adjusted basis, our gross margin improved 20 basis points during the quarter as various cost out efforts and favorable mix towards higher margin vinyl products more than offset the current impact of tariffs.
We have worked diligently over the past three quarters to navigate the challenging and uncertain tariff environment.
As we relayed last quarter, we fully offset the approximate $22 million of annualized headwind created by the 10% Terror implemented last September through cost mitigation efforts and other inventory elements.
It has been far more challenging to address the incremental $34 million of annualized headwind created by the additional 15% tariff that went into effect in mid June but our teams have made great progress we have doubled down on our mitigation efforts and identified areas to further reduce cost within our existing initiatives.
These include continued negotiations with vendors the evaluation of our multi country sourcing and supply chain strategy as well as our decision to selectively increase retail prices late in the quarter.
We're also managing our cost structure and reducing asked in a while continuing to maintain a high level of customer service and improve the experiences in our stores during the quarter, we underway field structure reorganization reduced overtime in the stores and identified other cost saving initiatives.
This focus on efficiency will continue during the back half of the year with the expectations of near term benefits stemming from an ongoing deep dive into cost across the business as efficiency opportunities are realized.
As we look back at the first half of the year. We're proud of the progress to date, but recognize we have significant work ahead of us to bring lumber liquidators to the next level.
With legacy product related litigation issues behind us, we have been relentless and executing on the transformation strategy.
And this quarter alone, we launched new advertising that more effectively reaches consumers early in their flooring project journey.
Produced new creative content to be deployed across the national networks through the back half of 2019, we enhanced digital and technological capabilities expanded pro and installation services.
Leverage learnings from our new open concept format and continued our tariff mitigation efforts, all while delivering great value to our customers and maintaining a strong competitive position. We believe these initiatives will position us well to increase our market share and drive revenue growth.
Moving on to our plans for the remainder of the year, our strategic priorities remain unchanged as we focus on growing our topline providing the best possible unique customer experience and optimizing margins in this challenging tariff environment to this and we will be making some exciting progress in the second half we intend to activate new creative advertising content for national distribution drive traffic with our new four finder digital tool prioritize pro uninstalled sales growth through our new sales associate training to identify cross selling opportunities and highlighting pro needs and test new display tactics to identify where the customers respond most positively including alternative ways of displaying flooring samples.
First our new advertising agency as a full quarter under their belt with us and we have been able to activate some exciting new campaigns.
This includes optimize promotional materials, which drove our largest ever April sale.
Additionally, as we seek to constantly improve the customer experience. We remain focused on building, our omni channel approach and utilizing our digital capabilities to meet our customers needs at every touch point.
Our picture it for Visualizer tool continues to receive rave reviews, both in the stores and online and is allowing us to attract new customers to our brand.
Second what's driving store traffic as a priority for the second half of the year, we expect to enhance our digital presence deploy our four finder tool and build a more robust inventory of product descriptions to ensure our customers have all the pertinent information at their fingertips.
We are working to identify customers earlier at the beginning of their flooring journey during their ideation phase and the floor finder does just that.
Tool is personalized quiz based product that walks customers through several sets of questions to help narrow what flooring samples they may want to explore in the store.
Third both our pro and installed sales continue to drive growth for our business consistent with our focus over the past several quarters, we are developing capabilities to be more relevant both of these customer groups.
Both our pro and installed businesses delivered double digit sales growth in the quarter.
In the back half of the year, we will be conducting market research focused on these groups and we'll be launching a catalog for our pro customers early in the third quarter.
Finally, we remain on track to add 10 to 15, new stores. During this year and of that total expect four to five to be opened or retrofit into the open concept format. As we continue applying the learnings from our ultimate Springs location.
In light of these strategic initiatives, let me take a moment to provide some color on how we're thinking about the puts and takes that contribute to our outlook for the back half of the year.
First it is important to note that the new 10% tariff on list for products proposed last week do not apply to products, we sell and therefore will not have a direct impact on cost. However, we are conscious of how potential price increases on a broad set of consumer products could impact consumer sentiment and discretionary spending.
That said in the second half, we expect traction from new initiatives and from a relative perspective, we benefit from easing year over year comp sales performance as our second half 2018 comps were approximately 250 basis points lower than our first half 2018 cops.
We also benefit from the calendar as the second half of 2019 has one fewer Sunday, our lowest volume day versus 2018, which should result in approximately $2 million in year over year benefit.
Finally, as we stated previously we expect the drag from the underperformance of bamboo to continue to lessen throughout the back half of 2019.
Offsetting those expected tailwinds and as I mentioned earlier, we experienced slowing traffic as the second quarter progressed.
With weakness continuing into July and we believe the hard surface flooring industry is in a period of heightened uncertainty on many fronts.
We are mindful of the current moderating growth in many housing related metrics that we consider drivers of the home improvement spending.
Additionally, we see the potential for the uncertainty created by the tariffs influence consumer confidence, perhaps compounded by the potential 10% tariff on less for and ultimately rising retail prices across a variety of products that could impact.
Customer demand.
Finally, we remain very confident in our competitive position as well as the superior value that we deliver to our customers.
As a result of the uncertainty in this environment compounded by softness in the sales trends to start the third quarter, we are reducing our full year guidance.
We now are more comfortable with an outlook for low single digit total revenue growth down from mid single digits previously and approximately flat comp sales down from our previous expectation of flat to low single digits.
Our operating margin outlook is a range of 1.4% to 1.9% down 50 basis points from our previous outlook, which would equate to an operating margin of flat to down 50 basis points for the full year 2019.
Our transformational work will drive more transactions in our store and we are encouraged by the long term opportunities, we see as we execute our plans and our initiatives begin to deliver results.
While macro and industry uncertainty remains related the tariffs the strength of the consumer and the competitive landscape our ability to successfully navigate the expected and unexpected challenges of the first half of the year give us confidence in our ability to execute our strategic initiatives and continue our progress through the rest of the year.
I will now turn the call over to Charles.
Thanks Dennis.
Our teams have continued their work this quarter, improving the customer experience developing our marketing plan to improve traffic and driving brand awareness of lumber liquidators as a national specialty hard surface flooring provider.
With the current higher tariff environment, our teams continue to focus on impacting product costs.
The sourcing and merchandising teams have continued to execute strategies to develop alternative country sourcing for both manufactured and wood products to help mitigate the impact to margins and sales.
And we've already started moving some production out of China, but uncertainty regarding the future of terrorists has some supplies cautiously evaluating the commitment of capital required to build new manufacturing facilities.
As the tariff issues continue we see more of them seriously consider in building new facilities.
That could potentially accelerate sourcing from regions other than China.
But by the end of 2019, we expect to be in the mid 40% range of products purchase from China.
Down marginally from 2018.
Driving product development at an accelerated rate in this environment is critical exciting customers with new styles and trends is core to driving market share.
We have an aggressive new product introduction planned for the back half of 2019 building on the launch of Aquas sale brand in multiple categories as well as expanding a number of tests that are underway in our wood business.
This also provides our sourcing team increased leverage as we look to improve longer term margin performance in this environment.
As Dennis mentioned, we've adjusted prices to help offset the impact of tariffs pricing team is evaluating and executing on opportunities to optimize our promotional positioning by region and category across the country.
And we are confident in our current competitive position and continue to monitor the environment closely to ensure we remain competitive observing both independents and big box industry participants.
Turning to supply chain, we have accelerated initiatives to improve inventory productivity.
To offset the impact of rising inventory levels, driven by the 25% tariff.
We have worked with strategic vendors to reduce purchase order cycle times, which will enable a reduction in safety stock in the latter part of the year.
We have increased our focus on lifecycle management to improve inventory performance through product transitions.
In addition, we're working to increase the breadth of certain regionally specific in stock skews to drive take with sales.
We've seen the benefit of stocking these high velocity market specific skews, an ultimate spring store and this is one example of our teams applying learnings from this prototype to the chain.
To drive traffic, our marketing team has been developing new creative assets to highlight our value proposition that is driven by high quality products, coupled with a great in store and online subs experience.
During the second quarter, we launched a new commercial starring a picture it floor visualize a tool that began airing on HDTV at the beginning of July .
And was rolled out to other national networks later that same month.
We are continuously evaluating the best mix of advertising for our business and allocating our marketing spend wisely, which will remain a central pillar of our transformation strategy.
We plan to have a new creative content launching this quarter and are assessing new ways to promote store openings.
We will expand on this communication strategy in the back half of the year with new creative content and optimize deployment schedules.
Our teams have been focused on the preparation and development of our new E Commerce platform, which will be utilized by our install DIY and pro customers.
The goal of improving our online shopping experience has been central to the work of our digital team and will deliver enhanced performance benefits as we implement this new platform.
We expect to start implementation in the fourth quarter of this year.
Within this new platform there are opportunities to incorporate some of our digital advertising initiatives.
The marketing team focused on driving customer acquisition earlier in the purchase cycle is developing improved content and enhanced digital marketing programs that aim to capture customers effectively while they end the ideation purchase phases of their projects.
I will now turn the call over to Tim to share the financial details of the quarter Tim.
Thanks Charles.
Good morning, everyone.
In the second quarter net sales were $289 million, an increase of 1.8% over last year with comparable stores flat versus year ago.
The overall net sales increase was driven by 10% growth and installation sales supplemented by 8.7% uptick in merchandise sales. The overall flat comp was the result of a 2.5% increase in average transaction value offset by a similar decrease in transactions.
As Dennis stated, we continue to see strong growth in vinyl products with offsetting softness in exotic solids, most notably in bamboo.
Gross margin for the second quarter of 2019 was 35.5% compared to 35.7% in the equivalent quarter a year ago.
Both periods were favorably impacted by out of period Doody related adjustments.
Without these items adjusted gross margin grew to 35.2% from 35% in the prior year period.
A more favorable mix towards vital along with higher average selling prices drove the improvement over the second quarter a year ago.
Adjusted margin was up 20 basis points, despite product costs that were higher due to the tariffs.
The 35.2% was sequentially flat with the first quarter of 2019 as seasonally higher promotional activity, particularly during the April sale offset other margin gains.
As noted earlier the latest tariff increases were not part of our guidance last quarter.
As such our expectations for the remainder of 2019 have changed.
We now expect to see adjusted gross margin improve in Q3 due to higher average selling price and in Q4 be tempered by the flow through of inventory burdened with higher tariff costs.
This will cause some of the improvement to recede.
We expect to incur the full impact of the 25% tariff on Cogs late in Q4 as the tariff burden inventory flows through our supply chain, but our mitigation efforts will not fully offset the latest impact until Q1 of 2020.
SGN a expense for the second quarter was $104 million compared to $102 million in the second quarter last year.
SG in a in both quarters included incremental legal and other costs of about $6 million related to the lawsuits investigations and certain other legal matters.
Specifically, we booked a 4.75 million dollar expense in the second quarter of 2019 related to the Kramer employment case that Dennis mentioned.
Both periods items are tabled out in the press release.
When excluding these items from both periods adjusted SGN a expense for the quarter was $98 million or 34% of sales an increase of $1.9 million and flat on a percentage basis versus the same quarter a year earlier.
Higher payroll from new stores and advertising costs were offset by lower legal fees and professional fees.
For the quarter, we recorded an operating loss of $1.4 million compared to an operating loss of $2.9 million in Q2 of 2018.
After adjusting for the items noted above we had adjusted operating income of $3.6 million in the quarter compared to last year's 3 million adjusted operating income.
In 2018.
Improved adjusted gross margin was the single largest contributor.
Before moving on to our expectations for the remainder of 2019.
Let me address our liquidity, which remains strong as our core operations continue to generate positive cash flow.
We paid all amounts related to the DJ and FCC settlements early in the second quarter. As a reminder, we have also paid the cash portion of the MTL settlement from a year ago.
For the Kramer employment case, where we recently reached agreement, we expect to fund that $4.75 million in the second half of this year.
Our expectation related to gold settlement remains the same with payment expected later in 2019 or into 2020.
The mechanics of the payment remain unchanged and are outlined in our Form 10-Q .
As a reminder, we did add $50 million of borrowing capacity at the end of Q1 by amending the company's credit agreement. This also extended the maturity to 2024.
As of June Thirtyth, we had borrowings that consisted of a base term loan of $25 million and a revolving credit agreement with 64.5 million drawn.
We had liquidity of 117 million consisting of availability under our credit agreement of $104 million and cash of $13 million.
Inventory at the end of the second quarter was $304 million. However, with the expansion of tariffs on goods imported from China at a 25% we anticipate that inventory will expand in the back half of the year and we'll end the third and fourth quarters in the $305 million to $325 million range.
Turning to our outlook.
We are lowering our guidance for the year and our 2019 outlook now assumes a continuation of the 25% tariff on Chinese imports for at least the balance of 2019, which is a change from our previous guidance that only assumed a 10% tariff.
We have also experienced slower traffic trends than previously expected.
As a result, we now believe.
Total revenue will increase in the low single digits as compared to mid single digits from our previously issued guidance and comps will be approximately flat for the year as compared to flat to low single digits previously.
In terms of adjusted operating margins for the year. We are now anticipating this to be in the range of 1.4% to 1.9%.
The expansion of tariffs to 25% has added considerable uncertainty to the back half of the year.
The macroeconomic signals are mixed and how consumers will react remains to be seen.
In addition, as the industry fully digest the impact of higher tariff related costs, we will closely monitor competitive dynamics and hard surface floor pricing.
Our 2019 guidance reflects an assumption of moderating macro and consumer strength and an uncertain pricing environment in relation to rising costs. However, significant movement in any of these factors could meaningfully impact our outlook.
As a reminder, we have included $2.3 million of nonrecurring expenses in 2019 in the back half of the year related to relocation of our corporate headquarters, but we do expect our ongoing evaluation of costs across the business to deliver savings this year.
While also positioning us well for 2020 and beyond.
On the investing side, we plan to open 10 to 15 new stores in 2019.
We expect capital spending of $15 million to $18 million, we anticipate cash paid for taxes will remain nominal and that's a valuation allowance on our deferred tax assets will remain in place for the year.
We see cash paid for interest to be in the $3.5 million to $4 million range.
Thank you for your time this morning with that ill hand, it back to the moderator to open the call for questions.
Thank you.
At this time, we will be conducting a question and answer session.
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Our first question is from Budd Bugatch with Raymond James. Please proceed.
Yes. Good morning. Thank you for taking my questions I guess, the first place I'd like to go is kinda talk a little bit about the traffic and.
The concern you have of moderating traffic and whether you can pinpoint any of the causes for that door and talking to consumers. So what you've learned about that.
Moderating traffic.
But it's.
It's if you look at our traffic.
On a two year stack, obviously, we actually improved in Q2 over the prior year.
It's actually going against a stronger probably our strongest traffic comp from last year.
Just we've started to see things kind of slowed down a little bit.
Towards the end of the quarter in terms of traffic and I think you know there was a little bit of that was driven by we believe what's going on just in the macro environment. There is a lot of.
A lot of.
Noise in the news about interest rates and that always seems to.
At least my experiences, we always see a bit of a pause.
Waiting to see what's going to happen.
Seems to have some kind of impact on bigger ticket.
Obviously, especially if somebody's planning to finance that jobs, we saw a little bit of that.
No as we said we raised some retails towards the end of the quarter, but we don't believe the pricing was a factor.
We just saw things kind of slowed down a little bit.
Towards it was more towards in the core we had a great April sale and.
May was may was down a little bit and kind of more flattish in the month of June but.
It was.
It was just seemed like the slowdown kind of took place towards the towards the end of the quarter and a little bit into.
July now in July we had promotional calendar shifts so weve got some things that are moving that moved to the back of the quarter out of July .
Two events in particular that will take place they just they won't match up exactly with the.
So we think that probably was the primary driver of what we saw in July so.
Outside of just macro impacts.
Nothing material and what we did with the business.
We just we just kind of saw that slowdown we see our merged comps actually improved quarter over quarter, and we expect that to continue.
And I would say were probably are full probably through the biggest impact.
That we will see as it relates to the.
The installation as I've mentioned before you know we.
When we rolled out installation.
We procure that the entire transaction for the customer so.
They generally might make two or three trips and I think thats, just going to get lighter for us as a headwind as the as the year goes along and Tim has kind of unbundled the way that we did the pros in the past so that will be less of an issue for us as well, but I would say probably the primary driver that we saw just seemed like there was a bit of a slowdown or pause if you will.
Towards the middle and end of the quarter.
Was there any difference could you Tony difference in velocity of items on which you raised prices. It was there any noticeable change in the in the velocity of the consumer acceptance of those products are.
Which is not so we did it we did it in the women's we really did that towards the end of the quarter. So I think it's a little early for us to tell yet but.
Nothing noticeable at this point.
Okay, and Ultimate Springs, you open that you talked a little bit about it last quarter are good. It was we've got three more months under your under your belt, what so what's the early read or the more intermediate term read on Ultimate Springs, we really liked the results I mean, it's driving bigger ticket, it's driving product sales across.
More product sales across other categories that weve quite honestly have struggled in.
And Weve able as Charles said, there is a couple of things that we've been able to glean from that store early on that we can apply to our existing store base and then we are planning to open our second open format store in Colorado within the month. So we're still excited about the performance of it and just kind of.
Pulling the things that we're learning from that store that we can roll out to our existing store base as well as tweak, making tweaks to the well also retrofit a couple this year as well.
Okay and just for me just two more detailed questions of the $68 million of the accrual on the balance sheet for legal settlements how much of that chart shows the gold settlement in there I might take the Kramer settlements in there is there anything else in there are the deals in there too, but that's noncash right Tim.
That's correct to the remaining NGL that's in there.
Which is $14 million noncash the gold has 14 million of noncash as well.
So what's what's the cash portion of that 68 million then has to roll off well, there's still $21 million that we have as a liability 21, and a half million related to the MTL, but we have a corresponding asset on the asset side of the balance sheet. So it's still in the liability, but its there is a corresponding asset. So no further cash would go for it.
Got you and lastly from me I'm the inventory how much and how much is how much of the inventory is now Tara can you tell us can you quantify what.
304 million of inventory is is really tariff inside right.
I don't have a specific number but as you think about the impact on us the 10% tariff as of June 30 had largely run through that was approximately $22 million and we turn it a little over two times a year, so little bit less than half of that had been sitting on the balance sheet.
Okay, and so then we would have the of the additional 30 something million will.
I think about that the same way and kind of figure that maybe something like 15 million of that wind up on the balance sheet.
Yes somewhere between 12 to 15 million I think would be a good good estimate.
Thank you very much.
Thank you.
Our next question is from Simeon Gutman with Morgan Stanley . Please proceed.
Thanks. Good morning. My first question is on the merchandise the product comps just high level can you talk about why you think they havent turned yet it sounds like it's a combination of things, but want to hear your thoughts on it.
Yes, I would.
I would say that.
Bamboo is probably the single largest contributor.
Beyond.
Slide down for us its been our biggest headwind.
And is.
Tim mentioned on the call that that will become less of a headwind for us in the in the second half.
We'll we'll have fully cycled, what I believe will be norm more normalized trends.
In Q4.
But it's been it's been Simeon.
A significant headwind for the company.
Okay Fair enough my follow up is on the gross margin guidance.
Q3, you said up can you clarify is it up year over year or is that up quarter over quarter, and then related for the fourth quarter can you give us a sense of the magnitude of the compression that you're expecting.
Yes. This is Tim.
In terms of your first question it should be up to both.
In terms of.
We're expecting that expansion to both top and continue the.
The quarterly progression that we have started this year as well as top the prior year.
It will.
In the second half will be probably the way to think about the second half is.
Combined with the first half, we will probably get back to about the same level.
As we had for 2018 for the full year.
Which was a little north of 36%.
Got it okay. Thanks.
Thank you.
Our next question is from Oliver Wintermantel with Evercore ISI. Please proceed.
Yes, good morning, guys. Thanks for taking the question.
I had a question regarding the ASP drivers.
It looks like you were up about 2.5%.
What was the split was that.
How much of that was curious how much was the installation attachments and all of that if you could clarify that please.
I would say I don't really have the how much of the.
I would say I'd say most of it was probably Asap there was a large contribution from installation then.
Excuse me the installation mix.
Yes at 13% penetration and grew at double digits for the quarter. So thats a that was a pretty large driver of our ASP as well.
Okay. Thank you and.
From a if you could update us on the pro penetration and then maybe related to that.
If traffic was down about 2.5%.
What was that mostly due to have that is it was it mostly D. I Y O, which also a pro component to it.
I would say no is the pro continues to penetrate north of 30% and.
The pro traffic was was up.
Year over year as well I would say it was primarily the DIY traffic.
Okay got it thanks, very much and good luck.
Thank you.
Our next question is from John Baugh with Stifel. Please proceed.
Thank you good morning.
So I was wondering.
Dennis for Charles There was the final determination on engineered wood flooring out of China that raised rates significantly from many companies in China does that have any impact.
On you will prospectively.
Prospectively it shouldn't have much impact we've we've mitigated that.
For what had previously run through we have about.
About a 800000 dollar item that.
If it goes and fix because it probably will be appealed.
If it sticks, we would have an additional 800000.
Okay.
And then.
Fewer.
Six months moldings, and accessories is down a little bit more I think close to 6%.
Versus.
The year prior and I'm wondering is that is that the l. VP or what's driving moldings and accessories, which I think have higher margins.
Lower.
Two things are the driver that.
And primarily one item is the drivers the adhesives that we sell are used to sell with our solid bamboos is.
There's it's it's.
Right and the same comp performance as the solid bamboo.
Another driver that we'll see as an impact for the next year or so will be there is more of a there is a conversion from product without pad the product with pad attached both in the LPT and in the.
Laminate business, so that's a significant headwind for us.
But it's.
It's driving most of the attachment erosion.
Okay, and then lastly.
I don't expect you to discuss your pricing strategy going forward, but could you at least tell us.
Once you took pricing on late in the June quarter, and put the rough magnitude is and.
Yes, I assume Dennis we're kind of in a wait and see mode.
So many retailers have not yet seen the higher costs flow through Im just kind of.
Wondering if you will offer any about how you're thinking about pricing going forward as well as what you've taken so far thank you.
Yes, you bet. It's a great question as you think about that.
You know there was a fair amount of pre buying that where it could be bought.
Prior to the tariffs and I think different companies bought at different levels, and so that probably impacted.
No why you might see others move before others.
But we were very conscious of that as this as we solve these tariffs rolled through the quarter and really Charles in the pricing team had counted developed.
We would have done a lot of competitive intelligence both.
With the independents as well as the national chains to understand.
Kind of where everybody was if there was any movement. So we want to make sure that we were competitive and we applied those learnings to how we thought about as duston price increases now the difference between the 10% to 15 is you know as I said earlier, everybody had time to pre buy we're for the 15, there really wasn't any time I mean, the it was it was talked about in executed really within a short window and so with the with the order cycle. It's north of 100 days I doubt anybody buying anything out of China was able to to pre buy.
So.
We believe that there will be a lot quicker reaction to that the tariff increase and the subsequent price increases will probably I would say accelerate through the second half of the year. So we continue to monitor to monitor monitor monitor it on a daily basis.
On literally looking at where the competitors are we have seen.
Pretty significant uptick from the independents.
While the.
National chains have have been slower to move depending on you know just the mix of their product I think obviously you can imagine there are some products from China to have a shorter order cycle in there some that have a much longer.
The manufactured products in particular, primarily manufactured in China.
So I think we're going to hit everybody pretty quick again, we're fortunate enough. We don't we don't source laminate from China. So it's not something we've really had to had to focus on a great deal other than just making sure. We were competitive. So we'll continue to apply those learnings for the back half of the year and adjust our retails as needed.
We want to remain competitive and I remind you again, we're a high low retailer. So we will maintain our competitive posture in our in our our promotional events anyway, but.
Our day in day out pricing is where we'll really make sure that we're we're paying attention to the to the cost in the inbound costs from the tariff increase I mean is there they are hitting us today. So.
I appreciate your candor and good luck. Thank you.
Thank you.
As a reminder, this star one on your telephone keypad, if you would like to ask a question.
Our next question is from Laura Champine.
With loop capital markets. Please proceed.
Thanks for taking my question I, just want to make sure that I understand the full potential impact from terrorists. Your 10-Q calls out a 50 million dollar hit at the current tariff rates is that from what has is there any potential upside to that number if we go to list for all your products on lists three and does that include the impact of slightly reducing your exposure to China from the 45% to 50% range to the mid Fortys.
So.
As far as the latest list goes no. We are not on that list our products are already fully impacted there.
I think Dennis called that out in his notes.
As far as.
The mitigation for moving to alternate alternate country sourcing no that is that is a gross number before our mitigation efforts. So we're not expecting to see that 50 plus million dollars come through our our income statement because we've taken significant steps to mitigate it that is the gross.
Bill that that the tariffs have put onto the company.
Based on where we are buying.
Can you give us more of a split on mitigation versus price increases, meaning if 50 million is gross what do you think you can offset with them.
With mitigation efforts working with vendors and what do you think you need to pass through in pricing.
We haven't disclosed that but I think you know, it's a fair mix of everything we've talked about in the prior calls Laura there's there'll be a fair amount of it taking in.
Cost outs through our vendors.
There will be an additional portion, albeit smaller piece of it that we're moving or have already moved and then we will adjust the rest is with retails. We currently believe we have everything in place to mitigate that cost.
Got it.
Thank you.
Thank you.
Our next question is from Rick Nelson with Stephens. Please proceed.
Okay.
Good morning.
Do you have to independent source as much from China.
As.
Earlier today, and if you could comment on the big box Homes' financial so.
It's a great question high we believe.
We do our own competitive analysis and believe that.
Everybody is pretty much in the same boat is we are I mean, lv t. all the vinyl product I would say.
Probably and this is I guess is my guess, but I would say probably north of 80% of the production currently comes out of China.
So there is not much choice.
To move that product thanks.
In the short term.
And there is a fair amount of emerging production in the us.
But not enough to satisfy the demand. So I would say that probably everybody is sourcing that from China. The problem for I would say the challenge for an independent is that most of them don't buy direct they buy through either right.
Co-operative purchasing group or they buy from a distributor and we have seen.
We have seen that the distributors are passing that additional cost on to the to the.
To the independence and therefore, they have no opportunity to mitigate that that's what we suspect is happening and I think we've been heard that on another call. This week so.
Also I think I think the.
The big box stores by size.
Typically they seem to be challenged across more product lines than just flooring. So I suspect.
That they're they're bringing the same product in that we are the vinyl is primarily coming out of China.
Laminate Theres, a fair amount of US production now on laminate has been for the last couple of years, we buy laminate from Europe , and the United States and I think most of our competitors by.
I know one competitor by some significant amount of laminate out of out of China. So I'd say I'd say everybody is probably in the same boat.
As it relates to tile we don't.
Porcelain tile, we don't buy any tile out of China. So we're not we don't have to worry about that business. So.
And I know that.
We carry a small amount compared to everybody else. So that's not a problem for us I would say that.
It's probably pretty even with the distributors or the independents kind of being at the mercy of their distributor I suspect they buy some domestic solid wood and some engineered wood in the United States, but even that a lot of the components come from China.
Okay.
That's helpful.
Thanks, a lot and good luck guys. Thank you.
Our next question is from David Macgregor with Longbow Research. Please proceed.
Hi, This is Robert on for David This morning, I wanted to ask you about the alternative country sourcing you alluded to getting China down to a mid 40% level by the end of the year, but I was hoping you can maybe talk about moving past the end of this year, maybe where that number could get to maybe share what percent do you think can't be moved from China.
Yeah, So Rob it's Charles So as I said on my in my remarks, we're working with a lot of other vendors, who are looking at where they could potentially move production to China.
But I think this is going to be moving quarter by quarter in terms of the insights we are going to get.
Because many people are looking at a pretty significant capital investment, whether it's in Vietnam, and Cambodia or other plus the parts of Asia.
And it's a dance right if the tariffs come off than China's still will remain the lowest cost production. So even moving to Vietnam on a net basis may not be completely beneficial it tariffs come off.
So so we've got a good view of where we think our balance the sale is going to end by the end of the year, we are working with a number of suppliers.
One of which is already broken ground, which will cause us in 2020 to move more production out of China, but at this point, we're not prepared to give a number below where we're sitting at the end of the.
29 team because as you know production lead times are pretty long on some of these some of these manufacturers.
And we need to make sure that they get all the licenses that they're going to be compliant in the countries of which they are going to operate we spend a good amount of time doing our due diligence around compliance and quality and we need to be very careful when we make a move.
That move is two or two and new supply that is going to meet our compliance rig requirements. So we have a team thats been very diligent and has done good work in the last 18 months on both the cost out component with existing suppliers, which we continue to work with.
New product introductions, which gives us an opportunity to leverage across our supply base to further improve gross margin performance and then work strategically with vendors, where they intend to make commitments, whether it's here in the United States, where some are looking at additional capacity to build yet or if they continue to build in Asia.
Okay. Thank you for that and I was hoping to ask about mix just with the pricing you put in late into Q to what extent have you seen customers trading down as a result of that.
Yes, I mean, thats interesting I mean today.
We haven't seen any material change in mix between good better best assortment.
And so again incentive said this is early we just put those price changes in the at the end of June and.
We drive a significant portion of business on promotional mix. So it will be a number of months before I think we see.
The insights into that to decide our customers actually trading down when they looked at the total cost of acquisition I think the other thing thats important to bear in mind too on the cost side, we have a good growing installation business and when you think about installation cost is basically half the price of the project those costs are moving and so when you take the total project costs between material and installation in our installation business is less impactful because you're not getting cost increase across the whole transaction and again and cost increase on half the transaction. So again, it's not just looking at rural good better best in the product itself, it's looking at the mix.
Across both our installation business and our idea was.
Perfect. Thank you very much for taking my questions.
Thank you.
Our next question is from Brian Nagel with Oppenheimer. Please proceed.
Hi, Good morning, Thanks for taking my questions you bet good morning, Brian .
So my first question.
Good of a fall off in prior questions, but just to understand better.
The sales trajectory through the through the second quarter then into July .
Right. So two questions one any anything you'd call out geographically and then second I am just want to make sure I understood correctly before but I think I heard you say that at this juncture.
You do not think that weaker sales are weaker traffic has been a function of actions taken as a result, the tariffs is that correct.
Right that is correct.
You guys have trajectory was we had it we had a solid April and again, we that was the best April sale, we've ever had and I would attribute that to know we had a good we've got a good plan and we are agency was new and they did a really nice job for us. So may was may was down and then we started to rebound a little bit in June and then it tailed off more in July and so.
We didnt see anything from a geographic perspective. This made us feel like this was more of a macro impact than just just a pause if you will kind of it just seemed like.
Our our.
When we look at several factors, Brian we look at the number of measures that we do for installation. We look at the number of visits we have to the site.
We look at that.
Conversions are samples and none of that seemed to fall off dramatically. It just seemed like there was a purchase pause if you will and so I just we saw this a bit in the fourth quarter.
When the interest rates went up and there was it seemed like the pause before the action.
Seemed.
Seem to resonate with our consumer so.
But nothing nothing from any geographic perspective outside of the that the hurricane wrap you know, but we also had we have lift in the Panhandle of Florida, where hurricanes hit earlier this year. So.
I guess kind of our take on on how the quarter progressed and what we think were the impacts.
Got it.
And the second question I have I am looking at tariffs.
And assuming that in some cases.
You will try to put.
Push forward higher prices to mitigate the effects, but if you look at the product continue on to your stores is is there a way to generalize where the tear ups hit is it mostly both the lower priced product that if that is the case could you see a dynamic where this would actually push consumers may be two way.
What had been a higher priced higher quality product that could essentially be higher margin for you.
Potentially yes.
And that we're cognizant of that as we think about our pricing through our product price progression. So.
Something that was a big gap in the past might not be such a big leap for a customer to go from an engineered to a solid so to speak.
No there's no there's not much in our mix except for us the laminate that.
Enjoyed a lot of our engineered comes out of China.
We have a lot of solid domestics that don't have won't have the 10 per share now the 25% impact. So it's highly likely that we could see that and we have seen.
Hey, and improvement in our solid business. So just just at the 10%. So it's highly likely that that that product that might have been out of reach for somebody before just not in their consideration my my put it within reach so we definitely have thought about that and think about that as we as we price competitively.
And then just one final question shifting gears a bit to Charles.
You talked a lot of you've been talking about.
Some of the new initiatives on the digital side marketing side, how should we think about as we're looking at our bottles in the in the trajectory or expense trajectory for lumber over the next several quarters and so the extra investment needed to start to really fun to drive these initiatives forward.
Yes, I think there are two major pieces of work that we have underway. One is the enhancement of our digital platform.
Which does not have significant incremental expense, it's a replacement of an existing platform. We've been working on that for a year.
And that will have.
Material impact on both the customer experience.
Within the site and give us greater capability on driving greater efficiency on how we drive our current digital marketing spend.
We're in the middle of looking at a 2020 plans today in terms of how we will make.
Great or investments and in driving our brand.
Activation is a very important part of our strategy.
But we have to add a mix as we start to utilize our new creative.
You could see us applying more of a working media into that element of the funnel and so when we think about the purchase cycle for our customers six month lead time, we need to make sure that we are capturing them at the point of ideation, and we are putting greater investment, particularly in the digital side with social and the impact of social has as people are out looking at how they're going to make a decision on just what kind of flooring project are they going to do before they even get to think about the location the they.
That they end up planning.
And we're also looking at the efficiency of of.
Media and how to allocate reallocate out of which we continue to do this year self fund out of unproductive.
Mediums into more productive mediums.
To drive an overall improvement in in our advertising return on investment.
Right. Thank you very much appreciate the color.
Thanks, Brian .
We now have a follow up question from Budd Bugatch with Raymond James. Please proceed.
Yes, if I could just get a little bit into the weeds in the stores have seen.
Some new product that is on solid polymer core, though would veneer, which I see some of the major starting to introduce to that and I think it's under your equity she'll brand, but this is a different product and pretty exciting products. If you had any early read on the acceptance of that yes, but.
Glad you are in us dollars, saying single on new innovations that so thanks for doing that.
Look we're excited it allows us to really combine two platforms right, which is a a water resistant waterproof capability with a will real would affinia and the feedback I was in our stores last week and the feedback from our teams is that customers are excited about being able to now put those two together and allowing us to develop a new value proposition for customers for sure that SPC core that you saw.
It is a strong driver of waterproof and the vinyl category. We see is continuing to be a very strong category out through the balance of this year and into next year and this just adds incrementality of us being able to be more creative with our engineered business and bamboo business with adding that that water resistant capability on the SPC cool.
And now the product actually there's all Oh, because you're going to you are you going to be able to do that in some other engineers and the product looks like it's made in China.
As well so what's the capability of moving a out of China and B to other all to expand that to other products.
So as I've said before on the moving out of China, We're looking at that.
On a daily basis, and they're up supplies that are looking at SPC capacity.
That would allow them to do this kind of production.
And obviously, we will engage with them when they are ready.
From a from a changing choice of product, yes, we're looking at multiple types of the near that we could put onto this product to do different kinds of finishes.
Interesting well good luck on it thank you very much.
Thank you Brian .
We have reached the end of our question and answer session I would like to turn the call back over to Dennis for closing remarks.
Thank you operator, let me say, thanks again to the Isle team, our vendors our customers and our shareholders for your continued support weak traffic has led to a slow start to the third quarter, but in this period of significant uncertainty we remain focused on executing our transformation plan and proven initiatives to position the company for long term success. While also working on the drivers of near term financial results. We look forward to updating you next quarter as well as sharing the details on our longer term strategic plans and financial outlook at our analyst conference planned for the fourth quarter.
Thanks again for your interest in lumber liquidators and have a great day.
Thank you. This concludes today's conference you may disconnect your lines at this time and thank you for your participation.