Lumber Liquidators Holdings (LL) Q3 2018 Results - Earnings Call Transcript

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About: Lumber Liquidators Holdings, Inc. (LL)
by: SA Transcripts

Lumber Liquidators Holdings, Inc. (NYSE:LL) Q3 2018 Earnings Call October 30, 2018 8:00 AM ET

Executives

Steve Calk - Lumber Liquidators Holdings, Inc.

Dennis R. Knowles - Lumber Liquidators Holdings, Inc.

Charles E. Tyson - Lumber Liquidators Holdings, Inc.

Martin D. Agard - Lumber Liquidators Holdings, Inc.

Analysts

Seth M. Basham - Wedbush Securities, Inc.

Brian Nagel - Oppenheimer & Co., Inc.

Laura Champine - Loop Capital Markets LLC

Oliver Wintermantel - MoffettNathanson LLC

Geoff R. Small - Citigroup Global Markets, Inc. (Broker)

David S. MacGregor - Longbow Research LLC

Peter Jacob Keith - Piper Jaffray & Co.

John Allen Baugh - Stifel, Nicolaus & Co., Inc.

Rick Nelson - Stephens, Inc.

Operator

Good morning, ladies and gentlemen, and welcome to the Lumber Liquidators' Third Quarter 2018 Earnings Conference Call. As a reminder, ladies and gentlemen, this conference is being recorded and may not be reproduced in full or in part without permission from the company.

I would now like to turn the conference over to Steve Calk. Please go ahead, sir.

Steve Calk - Lumber Liquidators Holdings, Inc.

Thank you, operator. Good morning, everyone, and thank you for joining us. Let me reference the Safe Harbor provisions of the U.S. securities laws for forward-looking statements. This conference call may contain forward-looking statements that are subject to significant risks and uncertainties, including the future operating and financial performance of Lumber Liquidators. Although Lumber Liquidators believes that the expectations reflected in its forward-looking statements are reasonable, it can give no assurance that such expectations or any of its forward-looking statements will prove to be correct.

Important risk factors that could cause actual results to differ materially from those reflected in the forward-looking statements are included in Lumber Liquidators' filings with the SEC. The information contained in this call is accurate only as of the date discussed. Investors should not assume that these statements will remain operative at a later time, and Lumber Liquidators undertakes no obligation to update any information discussed in this call.

Now, I'm pleased to introduce Mr. Dennis Knowles, CEO of Lumber Liquidators. Dennis?

Dennis R. Knowles - Lumber Liquidators Holdings, Inc.

Thank you, Steve, and good morning, everyone. Today, I'm joined by Charles Tyson, our Chief Customer Experience Officer and Marty Agard, our Chief Financial Officer. At the beginning of 2018, we laid out a multiyear strategy to transform the business and drive growth through a number of operational initiatives that position us well for the long-term. Three quarters through the first year of the strategy, our goals remain unchanged and we remain confident in our ability to drive growth on both the top and bottom line.

Turning to our third quarter performance, we reported net sales of $270.5 million, an increase of 5.2% over Q3 of last year. Comparable store sales were up 2.1%. Adjusted gross margins improved to 36.2% compared to 36.0% in Q3 of last year.

We continue to leverage SG&A, and our adjusted operating margin improvement of more than 100 basis points reflects the hard work our field and corporate teams have been doing to optimize the business. Our pro and installation businesses continue to perform to our expectations, and we posted another record quarter in installed sales.

Speaking specifically to the comp result for the quarter, we had good momentum into July and comped in the mid-single digits that month. With that momentum and what we felt might be an easy September comp, we thought we had the flexibility to work on profitability. So, we tweaked advertising down slightly and tested some advertising initiatives we've been eager to try.

In addition, we widened promotions across more SKUs, but brought down the debt relative to last year. We also trimmed low-productivity mailers and slightly reigned in our field markdowns. The drag on topline was more pronounced than we anticipated and resulted in lighter traffic in August and September.

The arrival of Hurricane Florence did not provide a near-term lift to the business but it wasn't a significant negative event either. That said, we still see a lot of runway to drive sales. We are working tirelessly to improve our intelligence around advertising, pricing and promotion. Charles will provide more detail about some of our initiatives we're rolling out, but our goal remains to optimize the profitability and growth elements the way we go-to-market.

As I reflect on our strategic progress in the third quarter and year-to-date, a key driver of future growth is enhancing the way we engage the customer at all touch points. Historically, Lumber Liquidators relied heavily on national media and direct mail to drive traffic. It's clear to us that a digital strategy is the path forward, particularly given that so many customers begin their path to purchase with online research.

Charles has been hard at work identifying opportunities where we can enhance the customer experience through digital transformation. The first two areas of focus are our website and our digital marketing strategies. We're particularly excited about these transformations and as we begin to activate against a different media mix, we'll anticipate meaningful outcomes for our business.

While it's too early to quantify the results, it's clear we have identified multiple opportunities to unlock long-term value, including increased customer acquisition and retention. Charles will expand further on our marketing program shortly.

In addition to driving topline growth, we'll continue to improve profitability. We've gradually expanded gross margins even in the face of higher transportation costs, and remain committed to expanding operating margins consistently over the next few years through a combination of initiatives and from leveraging SG&A.

We acknowledge that we're faced with heightened macroeconomic conditions, namely increasing tariffs, which are impacting the cost side of our business. Roughly 45% of our merchandise comes from China and we're subject to the 10% tariffs as of September 24. We're aggressively and proactively exhausting all options to mitigate the cost increases.

Importantly, this environment has presented a unique opportunity to reengage with our vendors and we're seeing improvements in cost and terms. Additionally, we're constantly evaluating our pricing strategy and the sourcing elements we use for potential suppliers. A key part of this is also building our sourcing capabilities for the long-term and Charles will share more on this in a minute.

While the effects of our strategy will not be seen overnight and tariffs remain a challenge, we're considering any and all options to offset tariffs and improve our sourcing strategy.

As we look ahead, we have a number of strategic initiatives in place, the goal of being the customers' first choice of hard-surface flooring. Our breadth of product offered in a high-touch consultative environment will be anchored by omni-channel capabilities that engage and guide customers through their journey with effective floor selection, functionality, envisioning tools, and sales transaction and fulfillment capabilities.

Given our goal of 500 stores by 2022, implementing and advancing our technological capabilities will be key to improving visibility into areas such as inventory management, localized marketing, assortment and promotional activities. And with our nationwide installation program now fully rolled out, we can cover the customers' end-to-end journey.

To conclude, you can see from our results this quarter, we were in line with our margin goals, but behind where we want to be on the topline. As we project through the fourth quarter, we need to reset our full-year 2018 topline expectations, bringing down our range for comp store growth and operating margins slightly. Marty will cover this in more detail.

However, as I said earlier, our long-term goals remain unchanged, as does our confidence in achieving them. We continue to have a positive outlook on our business. In the near-term, installations will not be as large of a contributor to our comp growth given that the service is fully rolled out. But, we have a lot of opportunity to augment our excellent store experience with an equally outstanding experience, both assisted with much improved contemporary digital technologies.

Additionally, we're laser-focused on our bottom-line and believe we can drive margin expansion through careful cost management and strategic mitigation tariffs. We're actively managing our assortment to keep pace with customer trends and we continue to make investments to enhance our customer experience and deliver innovative ways to drive traffic. The team and I are looking forward to the coming year and we are committed to our mission to become the customers' first choice for hard-surface flooring.

This is an exciting time for our team. We have established a track record of identifying areas for improvement and are building a stronger, more-competitive Lumber Liquidators. As always, I want to thank our associates around the country for taking good care of our customers every day.

In particular, I want to thank those on the frontline in the Carolinas and Florida. Your dedication and resilience during the recent storms are a testament to the great people we have here at Lumber Liquidators. Great job, everybody.

And now, I'll hand it over to Charles to discuss our digital and customer experience initiatives. Charles?

Charles E. Tyson - Lumber Liquidators Holdings, Inc.

Thank you, Dennis. When I first joined Lumber Liquidators, I was very excited about the potential opportunities that laid ahead for the company. And after being here for the past five months, I'm even more excited now that I've gotten to learn the flooring business.

As I review our opportunities, I believe the greatest potential growth vehicle lies in the expansion of our digital capabilities, which is a critical part of driving both store traffic and omni-channel sales growth. We know that most customers in the market for new flooring start their ideation of a project online, something we've seen play out with as many as 80% of our customers.

Given that dynamic, it is crucial we make the ideation process easy for every customer and enable them to find the flooring solution that best suits their needs, either on our website or in our store regardless of their location.

We've launched two streams of work on the customer experience. First, enhancing web experience and site performance; and second, our digital marketing platforms and strategies. We've recently hired a senior digital leader to build out our e-commerce and digital marketing team, with plans for the team to be delivering benefits early in the first quarter of 2019.

Our focus on web experience will begin with the development of the technology needed to meet our customers' shopping needs. We enhanced our capabilities around shopper identification and data capture, allowing us to start and improve dialog with customers via e-mail, social media and display advertising, which are inherently at a lower cost point than direct mail.

We've been optimizing and enhancing our existing analytics and adding new capabilities to understand how users are leveraging our website. Ultimately, this will help us identify new opportunities with customers. This intelligence, coupled with a robust A/B testing strategy, helps us make quick measurable site experience improvements.

Another area of focus improvements we're making is to our store location, data quality and web presence. We believe the highly local demand differences around each individual stores means that building a local marketing plan will deliver more relevant content to customers.

Our second area of focus is to aggressively refine the digital marketing elements in our advertising mix and optimize spending to deliver higher quality traffic. As Dennis mentioned, Lumber Liquidators has predominantly relied on traditional direct mail as the primary form of marketing after traditional television.

Part of our strategy will lead to migrate part of this spend and some of the other less-effective advertising like newspaper and sports to a series of digital investments. This will take time as we must develop both the technology as well as the analytics.

However, we plan to continuously optimize the initiatives of driving digital traffic to help accelerate store traffic trends and put us on a solid growth trajectory for 2019.

We know consumers' media habits are rapidly changing, and we are actively reviewing our marketing spend mix to best attract new customers and increase our brand awareness. We have a number of marketing tests underway to help inform how to most effectively optimize our marketing and drive awareness for both our DIY and install customer segments. On our brand revitalization program, we are deep into this work and expect to discuss in more depth late in Q1.

Another very important piece that affects our customers is our product offering and sourcing behind it. We have hired a new Head of Global Sourcing who has significant experience in delivering value for large retail sourcing organizations. His work will be to expand our worldwide sourcing capabilities across Europe, South and Central America, and Asia.

As we've stated, our investments in quality and compliance give us the assurance we need to be able to flex our sourcing to meet the needs of our business. This is a step in the gross margin expansion targets Dennis and Marty referred to in past calls, and we've already gone to work on leveraging our costs as a means to mitigate tariffs.

We believe we have opportunities to expand supplier relationships to drive both our solid wood and manufactured categories, with new style-focused offerings, and refine our processes to drive greater speed to market.

Finally, we understand the critical importance of helping our sales team drive conversion in our stores. We are reviewing the design of the store experience with on-tread merchandise easily displayed. We'll have several tests underway around our network in the first quarter and believe these innovations will drive increased conversion and enhance the customer experience.

As I look forward to 2019, I'm excited for the work we're doing to build our analytics capabilities to help us improve both our promotional effectiveness planning, as well as digital and marketing effectiveness.

With that, I will turn the call over to Marty to discuss our financial performance. Marty?

Martin D. Agard - Lumber Liquidators Holdings, Inc.

Thanks, Charles, and good morning, everyone. I'll start with a few more specifics about the topline. Third quarter net sales were $270.5 million, an increase of 5.2% over last year, with comparable stores net sales up 2.1%. This consists of a 39% increase in installation sales, slightly offset by merchandise sales which were down 1.3%. The overall 2.1% comp growth was affected by an increase in average transaction value of 5.5% and a decline in the number of transactions of 3.4%. The higher transaction value in recent quarters and again in Q3 has been driven by the attachment of installations to the transaction, which can double its size and from the shift in mix to pro customers who tend to have larger jobs.

On the transaction number decline, a few things worked against us here. First our reduced promotional activity may have reduced our draw of value or opportunistic shoppers. And second, it could be a natural reflection of our focus on the pro and do-it-for-me customers that are a more involved sales process, but we feel better fit our value proposition. This plays out in our transaction definition that aggregates into a single transaction repeat purchases in the same month by the same customer to try to represent a project, not individual trips to a store or register rings. This has been consistent for all periods reported for several years.

Going back to the installation business, the growth in comp stores at 39% is heavily a function of the expansion of this business that was completed in late 2017, but we were also pleased to see this service grow 13% in just those stores it has been offered in for over a year.

On the merchandise side, we started the quarter strong in July, but as we made adjustments to our promotional tactics and store-level discounting in an effort to expand margins, sales were softer than expected in August and September.

In terms of category performance, our manufactured category, particularly vinyl products where we remain focused on innovation, continued to show strong growth and garner share from the wood and bamboo categories.

Our pro customer segment also continues to grow well above the chain average and represented almost 29% of our merchandise sales in the quarter. We opened three new stores in the quarter, bringing us to 16 year-to-date and we anticipate opening a total of 22 stores by year-end.

Moving onto gross margin, this came in at 37.2% for the quarter, an increase of 120 basis points from last year's 36% gross margin. Similar to the second quarter, we got a favorable final ruling on antidumping and countervailing duties rates from prior periods, resulting in a benefit of $2.8 million. If we adjust the quarter for this credit, as tabled out in the 10-Q, the adjusted gross margin in this quarter was 36.2%, an increase of 20 basis points from last year's 36%.

The margin expansion reflects both the reduced promotional activity and increased mix of manufactured products that carry above-average margins, offset by approximately 60 basis points in higher transportation costs and approximately 40 basis points in dilution from the increased mix of installation sales.

Comparing sequentially to the second quarter and again adjusting out the antidumping duty credits in both periods, gross margin was up 120 basis points, with about 30 basis points due to lower inventory adjustments, primarily the absence of the second quarter's obsolescence charge and the balance from the effective reduced promotional activity. Installation mix and transportation costs were generally consistent from Q2 to Q3 with only a minor negative impact.

SG&A expense for the third quarter was $94 million compared to $110 million in the third quarter last year. SG&A in the recent quarter included incremental legal costs of $3 million and the $1.8 million impairment of the Toano finishing line we discussed in last quarter's call, while the year ago quarter included an accrual related to the MDL settlement, incremental legal fees and an impairment related to our production assets. Both periods' items are tabled out in the press release and the 10-Q.

When excluding these items, adjusted SG&A expense for the quarter was $89.2 million, an increase of $1.6 million from a year ago. The increase in spend included $1 million in higher occupancy costs related to the opening of 22 stores since Q3 last year, $700,000 in higher promotional financing costs, and other smaller increases, offset by approximately $700,000 in lower advertising.

Total payroll was nearly flat with modest staffing increases, offset by a lower management incentive accrual than last year's quarter. The reduction in advertising was the net effect of our ongoing changes in marketing mix, in which we've been a little quicker to reduce spend in areas we assess as less effective like newspaper in some cases before we've funded newly identified elements.

Adjusted SG&A was 32.9% of sales versus 34.1% last year, and year-to-date is at 34.1% compared to 34.9% last year, driving 80 basis points of leverage compared to last year.

Moving down the P&L to operating profit. For the quarter, we recorded operating income of $6.7 million compared to an operating loss of $17.3 million in Q3 of 2017. If we exclude the unusual items that impacted these results as shown in our 10-Q and press release, we had an adjusted operating profit of $8.6 million in the quarter compared to last year's $5.1 million similarly adjusted operating profit. Adjusted operating margin was 3.3% of sales compared to 2.0% last year and year-to-date is 1.7% compared to 0.6% last year.

Looking at liquidity and cash flow. As of September 30, we had total liquidity of $114 million and we had borrowings under our revolving credit facility of $43 million, which compares to $35 million in borrowings at the beginning of the quarter. Our inventory ended the quarter at $305 million, up from $297 million at the beginning of the quarter, driven by the combined effect of new stores and increases in breadth of items stocked in our stores.

I'd like to make a few comments on the potential financial impacts of tariffs to our business. As Dennis indicated, approximately 45% of our merchandise costs are from China and we're subject to 10% tariffs for shipments received as of September 24.

These tariffs will roll through inventory and only partially affect the fourth quarter's gross margin, we estimate, by 150 basis points to 200 basis points. We're actively managing to mitigate these as we speak, by working diligently with our vendors across our entire supply chain and are already seeing success in lowering our costs.

Additionally, we're evaluating our own price adjustments where necessary and in several cases pursuing longer-term alternative sourcing options. For the fourth quarter, we believe we can mitigate roughly half of these tariffs, such as the net impact should result in sequential gross margin erosion from Q3 in the range of 50 basis points to 100 basis points on an adjusted basis.

With that in mind, I'd now like to walk through our updated guidance for the year. For comp store sales growth, we were at 3.3% through three quarters. Looking at Q4, we continue to work to find an optimal mix between price management and promotional activity and at the same time, assess the consumer reaction to ours and other's potential price changes.

As for the recent storms, Florence impacted 10 stores for about four days on average, and Michael eight stores about a day each with one of these having only just reopened. While we expect a slight tailwind from these later in the year, that will, at best, offset the headwind from comparing against the benefit of Harvey's post-storm lift in Houston in the fourth quarter last year. All that said, we think we can achieve low single-digit comps in Q4 and October looks to be in this range, and that would put the year in the 2.5% to 3.5% range.

We also revised our adjusted operating margin guidance. We are at 1.7% adjusted operating margin through Q3 and see Q4 in that range or slightly higher. So, we are now forecasting the full year in the 1.6% to 2.0% range, an increase of 60 basis points to 100 basis points from 2017, but a bit below our original target for the year.

The two real gaps from where we began the year have been the 60-basis point increased transportation costs that we continue to try and minimize and the reduced SG&A leverage caused by the lower comp store growth.

In terms of liquidity, we expect inventory decline to the $315 million to $325 million range through the year end and early 2019, generally related to tariff impacts and planning, and we will fund the $21.5 million remaining cash payment contemplated in the MDL settlement in November of this year.

Lastly on the legal front, we have no material update to the DOJ and SEC investigations. The MDL is consistent with past disclosures that is cash funding in Q4 and vouchers distributed to customers early next year. On the Gold bamboo case, we have continued some efforts around mediation, but also continue to prepare for trial in early 2019.

To wrap it up, we certainly have plenty of work to do, but also see the opportunities for the company and feel we have a strong plan in place to realize them. Thank you all for your time this morning.

And with that, I'll hand it back over to the moderator for questions.

Question-and-Answer Session

Operator

Thank you. At this time, we'll be conducting a question-and-answer session. Our first question is from Seth Basham with Wedbush Securities. Please proceed with your question.

Seth M. Basham - Wedbush Securities, Inc.

Thanks a lot and good morning.

Dennis R. Knowles - Lumber Liquidators Holdings, Inc.

Good morning, Seth.

Seth M. Basham - Wedbush Securities, Inc.

My first question is around traffic. It seems like traffic has been a challenge for you guys recently. You called out a number of issues why it might be, but as you think about tweaking the price and promotion and advertising strategies going forward, do you expect to have a meaningful impact in turning around the traffic declines in the near-term?

Dennis R. Knowles - Lumber Liquidators Holdings, Inc.

I would say, as kind of Marty mentioned in his remarks, we've looked at traffic really hard over the last, I guess, really over the course of the last three quarters. And we have seen as he mentioned some changing dynamics and that's impacted by how we promote. And if you we deep into price and not so wide in breadth, we typically can influence traffic, but we just haven't been happy with the margin. Typically, I would say, historically, we've had what I would call more deal-focused promotions as opposed to really kind of advertising across the category.

Two dynamics that are impacting our traffic that we're still – it's not as hard to quantify, but it does have an impact, and that's the pro and the install. The pro, as Marty has mentioned before, as we grow this business, if you think about a year ago, pro was just approaching 20% and now it's approaching 30%. We discount their traffic. If they make multiple trips, we pull those out. So those have some impact.

And then the installation business as it grows, as Marty mentioned, has two big impacts. Number one, there is less trips. If somebody's doing – our tickets are higher on an installed sale. We attach more; our actual merchandise sales are higher. So, we know that there is less trips. So, those two dynamics are playing against traffic.

But I think two things are going to help us in the long run, the sourcing initiatives that Charles mentioned and then we are working diligently on – we know that we have got to change the way that we go-to-market as it relates to our digital technology.

As we've mentioned, we've entered a traditional direct mail marketing play. So now, we've got to have – we know that we've got to reach customers in a better way. We've got to be able to target our customers more strategically, meaning that we just can't afford to blanket the market with mailers. We need to reach the customers directly that are interested in the hard-surface flooring.

So, that's kind of our work. Charles has hired an entirely new digital team that's focused on e-commerce as well as our marketing from a digital perspective whether that be digital television, e-mail marketing, or social. So, he might want to expand on that a little bit, but traffic definitely is something – we're not saying we're not concerned with. We're really trying to make sure that we're driving quality traffic into our stores that we can turn into a profitable sale.

Seth M. Basham - Wedbush Securities, Inc.

Fair enough. And my follow-up question is around the tariffs. You guys quantified what you think the impact would be in fourth quarter, but basically counting that tariffs stay at 10%, what might the impact be in 2019? And then, if tariff rate goes to 25%, how do we think about that impact?

Martin D. Agard - Lumber Liquidators Holdings, Inc.

Yes. Seth, Marty here. By the time we get to a full run rate on the tariffs coming through inventory, they stay at 10%, got 45%. That's kind of a current view of the level of Chinese-sourced product. So that will be a simple math of 4.5%.

We're working to mitigate on a long-term basis all of that sort of from a margin standpoint between the three different approaches we've talked about. They have slightly different ramp-up effects, cost out from our vendors and across our supply chain is something we're working on now and we're seeing some results there, and we think that's probably the quickest.

We have adjusted some pricing pretty modestly and we're watching that and seeing if that sticks or if more is necessary. That went in fairly quickly as well, but there are promotions that were already set, so that takes a little time and so we'll see as we get into 2019 how much from a price standpoint we can mitigate.

And then the longer term, when I say longer term that's over the course of next year, would be looking at alternative sourcing. At 10%, that's probably one degree of alternative sourcing. If tariffs go to 25%, it's slated, we'll probably more aggressive about that. But that alternative sourcing is something that would play out in the back half of next year and on from there into 2020.

So, I can sit here and say next year that even at 10%, we'll have no impact on our margin. We would certainly be working towards continuing the margin expansion goals that we've had and we certainly want to drive operating margin expansion we've had. But, it's a little unclear how we're going to get there depending on sort of consumer reaction to how strong the market remains and so forth.

Seth M. Basham - Wedbush Securities, Inc.

All right. Thank you very much.

Operator

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

Brian Nagel - Oppenheimer & Co., Inc.

Hi, good morning.

Dennis R. Knowles - Lumber Liquidators Holdings, Inc.

Good morning Brian.

Brian Nagel - Oppenheimer & Co., Inc.

So my – I'm probably going to follow-up on Seth's questions, but with regard to traffic, as we listen to – it seems like there's a lot going on at your company, you're doing a lot of the right things with respect to reconnecting with customers.

But, the big question I have is, do you see – is there some type of competition going out there? I mean to the extent that – so all that you're doing, the reason that near-term is just being offset by some other competitor, whether it be another specialty, whether it be bigger stores, whether it be some other factors that's just weighing significantly upon your ability to really connect with customers until these initiatives get in place?

Dennis R. Knowles - Lumber Liquidators Holdings, Inc.

Well, I haven't seen that. I mean, Brian, the independent flooring retailer still own almost half of the market share. So they are always a competitive threat. And I would say that I think everybody's gotten sharper in the hard surface flooring space. Particularly as the manufactured categories have continued to evolve, I think everybody's gotten pretty sharp in that space.

And I think for us, it's just finding kind of our balance of promotion and price. And again, we have a long history of going deep in price and promotion with – and mixing that product. But I think we're still trying to find that right balance of how deep on promotion we need to go with how broad across our categories and finding that right balance for customers.

To give you an example, what I was talking about with Seth is, if you look at our merchandise sales to our customers that do installation, their merchandise sales and ticket are up twice as much as our normal merch ticket is.

So we do know that that's impacting – that has a bit of an impact on our traffic. And – but I would say from a competitive standpoint, we're in a good spot with installation. Our pro business continues to grow. And where we've got to find the right balance for us is on that, what I would call, kind of that everyday traffic.

We're making good strides in pro and install customers, but our balance is to make sure that we've got the appropriate competitive position in the market as well as promotional depth as well. And I would tell you those are the two things that we're working on. As far as the competition goes, I think everybody's gotten good in the hard surface space.

Charles, I don't know if you have anything to add?

Charles E. Tyson - Lumber Liquidators Holdings, Inc.

Yes, Brian, I think there's couple of things. If you look back historically at how we've marketed, we've generally sent the same marketing communication to all customers. And what was done is segment customers from a strategic standpoint and looking at what the demand that that customer is actually driving.

So whether it's our solid wood customers in the Boston region or vinyl customer and waterproof customer in the Florida region, we need to start thinking about how do we customize those marketing messages, whether it is digitally, whether it's through digital television, whether it's through even direct mail and obviously through e-mail, so that we put more relevant messages in front of customers.

And we're testing some of that in Q4 and expect to make that part of our plan to drive the effectiveness of both our media and the appropriateness of the product that customers are actually buying in given local markets. And so, we feel that that will improve both our ad performance, productivity returns, as well as improve traffic.

The other one is we are running some tests in the fourth quarter around marketing through the high service seeker around our installation capability. That is something that we have not spent an amount focused on. We've been significantly focused on the DIY segment and we need to start driving both segments of our business from a marketing perspective. So hopefully Brian that gives you a little more color.

Brian Nagel - Oppenheimer & Co., Inc.

It does. I appreciate it. And the second follow-up question I have, I think every conference call I've been on, we talked about tariffs in some way, shape, or form. You guys are obviously talking about tariffs as well. Maybe the answer to the question is which you've laid out, but do you – as you look at your business and tariffs and obviously it's situation with regard to what tariffs will be enacted, but you just do not have pricing power. Not in the – maybe as a better, you just not want to try to exploit the pricing power you may have with consumers and some of these products to pass them along?

Dennis R. Knowles - Lumber Liquidators Holdings, Inc.

To make sure I understand the question, Brian, you mean raising retails, is that what you're saying?

Brian Nagel - Oppenheimer & Co., Inc.

That's correct, yes.

Dennis R. Knowles - Lumber Liquidators Holdings, Inc.

Well, I mean – we expect to do a fair amount of that. In fact, we think that, as we said in last call, we will mitigate this in three ways. We'll choose alternative sourcing, we'll raise retails, and we'll work to negotiate a better cost. And I expect it's going to take all of those and we have already moved in all three areas, and we're doing this as we speak.

We've got – we've had people on the ground. Charles has been in alternative sourcing countries for the last couple of weeks and we've got our sourcing team heading over next week. So, we'll manage this in all three lanes, pricing, cost out, and moving sourcing. So, – and we have a lot of opportunities.

And as Marty mentioned, one thing that we're happy with is this has given us an opportunity to accelerate our work. We've been talking about this for the last year, you know, that we have opportunity to go in and we think our margin expansion plan was – is to get cost out over the next year and a half, this kind of helps us accelerate that.

So, while we've got these impending tariff headwinds, this gives us an opportunity across all of our product categories, not just those affected by the tariffs. So, we'll lean into all three of those areas.

Charles E. Tyson - Lumber Liquidators Holdings, Inc.

I think the other thing Brian to remember is we – one of our major categories is in China. For obvious reasons, our laminates business is coming out of Europe; great quality product. Our suppliers are working aggressively with us to want to gain more market share in that category. So, there is actually a slightly less deleverage that we have than others in the marketplace that are producing the laminate category out of China.

Brian Nagel - Oppenheimer & Co., Inc.

Got it. Thank you.

Dennis R. Knowles - Lumber Liquidators Holdings, Inc.

Brian, I would – I'd just add one final point too. One of the big categories performance-wise has been the vinyl. And I would tell you the majority of the manufacturing capacity is in Asia. So, I think kind of everybody's kind of in that same boat.

Brian Nagel - Oppenheimer & Co., Inc.

Yes. Well, appreciate it.

Dennis R. Knowles - Lumber Liquidators Holdings, Inc.

You bet. Thank you.

Operator

Our next question is from Laura Champine with Loop Capital. Please proceed with your question.

Laura Champine - Loop Capital Markets LLC

Good morning. Thanks for taking my question. It's also on product that you're bringing in from China. I think when we talked earlier in the year, it looked like you might be bringing in more next year, not less. So, if you're sitting at 45% today, where would your goal be for this time, a year from now, and where would it have been ex-tariffs?

Charles E. Tyson - Lumber Liquidators Holdings, Inc.

Yes, I think – Laura, good morning. I think picking up on what Dennis said, if you look at EVP category, right, it's one of the fastest-growing categories in the industry. And from a mix perspective, it will continue – we expect it to continue to grow into next year.

I'm not going to share our natural penetration. But most of the EVP product today in North America is coming out of China. So we do expect that balance of sale to at least maintain. Obviously based on the previous calls, discussion around what's going to happen to industry pricing and what will the impact be on demand mix across categories, we're going to watch that as we begin in January depending on whether the tariffs move from 10% to 25%. So that's one driver, what's going to happen to mix.

The second one is we are actively looking at alternative country sourcing. And I believe that there will be potentially places for us to move product out of China and that will impact our mix, and that's a work-in-progress for us. That's why I'm not going to give you a number. As we start to look at where would we want to move products, whether it's in Asia, other parts of Asia, or whether it's in other parts of the world.

Laura Champine - Loop Capital Markets LLC

Understood, thank you.

Operator

Our next question is from Oliver Wintermantel with MoffettNathanson. Please proceed with your question.

Oliver Wintermantel - MoffettNathanson LLC

Yes, thanks. Good morning. I have a question regarding – you said that your comparisons in August and September slowed down versus July. Can you quantify that for us please, what the comps were in these months?

Martin D. Agard - Lumber Liquidators Holdings, Inc.

Yes, I guess a little bit anyway. In July, we certainly were in the mid-single digits and that led to some of the guidance that we had for the quarter or as part of the year. And then it dropped off to then I would say was sort of around low single digits and around zero in those next couple of months.

Oliver Wintermantel - MoffettNathanson LLC

Got it. Thanks. And then looking forward into the fourth quarter for your guidance for the full year, the 2.5% to 3.5%, what do you think is the driver of this, is it again more of the average sale, or do you think transactions can actually pick up in the back end of the year?

Martin D. Agard - Lumber Liquidators Holdings, Inc.

Well, certainly, the average ticket size that will continue its trend we believe for the same reasons we continue to have momentum with the pro and the install business.

What happens to traffic is a little bit of a wildcard. Particularly in December, you got a choppy month to begin with and then last year, we really hit a slow finish. We think it's generally weather-related, but it was a slow finish. Whereas this year, there is the wildcard around tariffs and some of the price adjustments we've made and how they hold up.

And if there is concerns about a pending 25% tariff to consumers move forward, does the whole thing slow down because of the uncertainty, I guess I'd say we feel less certain – there's more uncertainty around our fourth quarter comps in total and then the mix of them is also just a little bit more cloudy than usual. But we do believe that the transaction size trend will continue for the reasons its run and it's a matter of trying to get that traffic back up through some of the digital work and so forth as we go.

Oliver Wintermantel - MoffettNathanson LLC

Got it. Thanks very much. Good luck.

Dennis R. Knowles - Lumber Liquidators Holdings, Inc.

Thank you.

Operator

Our next question is from Geoff Small with Citigroup. Please proceed with your question.

Geoff R. Small - Citigroup Global Markets, Inc. (Broker)

Good morning, gentlemen. Thank you for taking my questions. You just mentioned the cadence of comparable sales through the third quarter. I'm curious if you can understand – help us understand how merchandise sales evolved through the quarter, and also just curious how overall comp sales have trended early into the fourth quarter?

Martin D. Agard - Lumber Liquidators Holdings, Inc.

Yes. The contribution of installs has been fairly steady through the third quarter. So, I would say that cadence that I comment on in total would generally apply to the merchandise pattern.

And as we think about the fourth quarter, I would tell you that we had a good – a solid October yard sale. We're in the low single-digits for the month of – think we're to-date and expect to be in the low single-digits for October. But again – and so that's part of that guidance and the range, but our visibility is only so-so as we think about November and December and certainly plenty of uncertainty as we go.

Geoff R. Small - Citigroup Global Markets, Inc. (Broker)

Understood. And your full year guidance for margin implies a fairly wide range in terms of fourth quarter outcomes. And I fully appreciate that there's a great deal of uncertainty regarding tariff, the associate cost and topline growth. I'm just curious if you can help us understand the additional puts and takes for the EBIT margin line item please?

Martin D. Agard - Lumber Liquidators Holdings, Inc.

Yes. I guess I'd say it's a little bit of both as – in terms of the gross margin, the question will be how well our prices hold up a little bit of our mix of merchandise versus install. And we have a decent visibility around there and I think the guide I gave should be okay.

And then the overall SG&A spend is somewhat manageable predictable. And when we add those together, we do have a reasonable range that gets in there. I don't know how else to characterize it, just a little bit of risk on both gross margin and SG&A leverage that come from the combination of sort of tariffs mix and just the topline in total that leads to the leverage question around SG&A. So, I don't know that I split out the risk items much more than that, so yes.

Geoff R. Small - Citigroup Global Markets, Inc. (Broker)

That's helpful. Thanks again and best of luck in the fourth quarter.

Dennis R. Knowles - Lumber Liquidators Holdings, Inc.

Thank you.

Operator

Our next question is from David MacGregor with Longbow Research. Please proceed with your question.

David S. MacGregor - Longbow Research LLC

Yes, good morning everyone. Couple of questions. First of all, just on the traffic, can you give any kind of geographic color, any regional color if there were disparities, or was it fairly uniform across the country?

Dennis R. Knowles - Lumber Liquidators Holdings, Inc.

It's fairly uniform across the country. We've talked in Q1 and Q2 about having some struggles in the North – or the North division lagging behind the rest of the company. That continued to improve over the third quarter and actually into October.

So, we've kind of seen the North kind of bounce back. But I would say that where we started to see some of the traffic decline that was maybe a bit exacerbated from the storms last year in Houston markets in Southern Florida, where we saw some benefit from hurricane, but other than that it's really pretty similar across the country.

David S. MacGregor - Longbow Research LLC

Okay. And just as a follow-up, I guess, as we head into the end of the year and over the next few weeks maybe the expectation of a step-up to a 25% tariff becomes more real, do you anticipate that to be a fairly substantial pre-buy I guess? Or I guess given the traffic lags of seaborne freight, maybe that's happening already?

Can you just talk about, to the extent to which you're maybe involved with that, are you seeing it across the industry? And I guess more importantly, what are the competitors' application to this as we go through the end of the year and into first quarter of 2019, if everybody's kind of loaded up on inventory?

Dennis R. Knowles - Lumber Liquidators Holdings, Inc.

Yes. I think there's a fair amount of that going on, not just in our industry but across all the industry as you can imagine. The tariff implications are enormous across other retailers, particularly multi-department retailers. They have a lot more product susceptible to the tariffs. And I suspect what we've seen in shipping lanes and traffic filling up, that's exactly what's happening. There is some pre-buying.

The 10% tariff is in place. And so, there are some – I suspect there are probably some out there that have made some pre-buys. We're doing – we are continuing to manage our business appropriately. And as I said, we're focused on all three areas, making sure that we're sourcing appropriately, pricing appropriately, and moving the business and making sure that we are focused on our retail.

So I think you are probably going to see some of that throughout the end of the fourth quarter. I think at this point, you kind of have to act like 25% tariffs going into place. And that impacts the aggressiveness of your sourcing changes as well as anything you might do to pre-buy.

So for us, there's a lot of moving parts for that. It's the lead times, the cost of goods coming into the company. So all those things have to be factored in. But I think you'll see – you probably are seeing a fair amount of that, at least it appears like that I think in everything from food to apparel.

David S. MacGregor - Longbow Research LLC

Is there any way you kind of quantify the extent to what you think people across the industry are pre-buying? Do you think they're picking up an extra month or an extra two months' worth of product?

Dennis R. Knowles - Lumber Liquidators Holdings, Inc.

I wouldn't have an idea, I really wouldn't.

David S. MacGregor - Longbow Research LLC

Right. Okay. Thank you very much.

Operator

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

Peter Jacob Keith - Piper Jaffray & Co.

Good morning, guys.

Dennis R. Knowles - Lumber Liquidators Holdings, Inc.

Good morning.

Peter Jacob Keith - Piper Jaffray & Co.

I know the tariff dynamic is quite fluid right now, but I want to think longer term around the gross margin. Certainly, there is disruption in the near-term. But I guess if you're assuming the 25% tariffs go in, you are forced to pivot to other countries. Presumably you had 45% of your mix in China because the pricing was the best there. So, does that upper 30%s gross margin target become less achievable with this full tariff exposure at 25%, just add over maybe one to two years?

Martin D. Agard - Lumber Liquidators Holdings, Inc.

Setting sort of tariffs aside, and that's a big set aside, but we don't think so. I mean, we do like the trend of the mix of products moving in our favor. We just really building into our sourcing capabilities and we're seeing that there is opportunity there. We have been facing headwinds of transportation and we can't sit here and say they're going to go away. But again, we continue to work at ways to bring to some of that back.

We've given up 60 basis points year-over-year. We're sitting around 36 today or will be on the year with some of those – we had some issues in the second quarter, obsolescence and some heavier promotion that we think was not effective.

We had transportation headwinds. So, we still think, go from where we are near around 36% today, up a point or two before the disruption of tariffs were to set in, is very realistic and we haven't lost sight of that whatsoever.

Peter Jacob Keith - Piper Jaffray & Co.

Okay. Thanks Marty. And I'm curious on your guys' perspective on the industry backdrop, it sounds like you had some company-specific call-outs around pulling back on promotions. But there's certainly debate here around remodel and flooring sales potentially slowing. Do you have any perspective on just the overall demand trends that you're seeing out there?

Dennis R. Knowles - Lumber Liquidators Holdings, Inc.

Peter, this is Dennis. It's interesting to see what's going on in the housing market. And I've seen this kind of play out in the home improvement business so many different ways. When new sales slowed down, remodel activity picks up, provided there's equity. But we watched kind of the things like cash out refis; they've slowed for almost a year.

But it is interesting for us, as particularly when we see how strong our pro growth is coming on in this installation business. And where we are seeing kind of that, I don't know, maybe the pull back if anything maybe in that lower tier, and just drives the need for what I said earlier, it was kind of a low deal.

But it's – I would tell you like – as Marty mentioned, our April sale – or our October sale was really successful. And we just – it seems like there's not necessarily been a pullback, but there does seem to be this drive towards more of this do-it-for-me. And I think we watch that really closely from remodel activity to new homes and tried to kind of mirror that up against what we see in our business.

And so far, it's really kind of – there's really been no correlation, but we do watch it intently and are kind of seeing how this plays out particularly with new homes and the remodel activity.

But they still continue to be strong in the forecast for remodeling activity still looks to be strong on the horizon. So, we keep an eye on it, but haven't really seen any connection between performance and what's been in the news as it relates to new home activity.

Martin D. Agard - Lumber Liquidators Holdings, Inc.

Peter, I would link this back to Brian's question around our pricing power and ability to just offset tariffs through price increases, and that is how does the consumer react to that and if there's a little bit of slowdown already, do rising prices just work against there as well, particularly in a 25% tariff scenario where those price increases could be more meaningful.

So, certainly affordability on housing, less churn of the housing stock, slowing down of remodel activity. While we potentially are needing to raise prices, because the tariffs is more of a downside case and causes us to be just hesitant about how much of that we do and have we protect the business.

Peter Jacob Keith - Piper Jaffray & Co.

Okay. Thank you very much, because I appreciate the feedback.

Dennis R. Knowles - Lumber Liquidators Holdings, Inc.

Yes.

Operator

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

John Allen Baugh - Stifel, Nicolaus & Co., Inc.

Good morning and thanks for taking my question. I was curious on the mix of what you're selling. I know you commented that LVP is up. And of course, that's sourced primarily from China. So I guess as an overall question, when you think about what you're seeing your business from a product mix standpoint, how the exposure overall is in terms of China sourcing versus everything else? In other words, is it going to be more of a headwind because you expect even more LVP or are there counter forces at work that would alleviate that?

Charles E. Tyson - Lumber Liquidators Holdings, Inc.

Yes, good morning, John. Yes, I think there are a couple of things, we believe there are opportunities to counterbalance some of the categories that are in China. And we have folks who are actively working those programs in country right now. We do believe that the consumer feels very strongly and the design and style benefits that are coming from EVP.

If the 25% tariff really does go into effect, our expectation is that, like in any cycle where manufacturing is moved from country-to-country whether it's out of Taiwan or out of Hong Kong into China, we expect others to move manufacturing bases that will open up opportunity.

Obviously, that is a longer term execution, but there is certainly some short-term risk mitigation that we believe is possible both from a cost negotiation standpoint and from a multi-country sourcing standpoint.

But we have a very large solid wood program. I've just recently, as Dennis said, come back from Brazil and we've got great suppliers down there with good capacity, the ability to be creative in their product design, and help us drive other categories other than just EVP.

As I mentioned, we're well positioned from a laminate perspective, from a sourcing perspective on the cost side and from a capacity side. And there may be mix opportunities there as the 25% goes into play. So, John, there's not one answer to this pretty complicated issue in terms of what does multi-country sourcing become to leverage both on the cost side and make sure that we're positioned with the right products for our customers. And we're working both of those angles very aggressively today.

Dennis R. Knowles - Lumber Liquidators Holdings, Inc.

Yes. John, I would say just a follow-up to Charles' comment, I guess if there is anything that surprised me as I learned this business was that you could get almost every category that we sell in China; solid engineered hardwood, laminates, as well as vinyl.

And so, as Charles mentioned, it's just we're just fortunate that we are less than half of it, but still sizable portion of it, but most of that we can source competitively if not better in other countries. So lot of opportunity for us there.

John Allen Baugh - Stifel, Nicolaus & Co., Inc.

And then maybe just as a follow-up, could you Marty maybe tell us the precise timing, so you mentioned the 10% end of September and you gave us some color on the gross margin, but that it's partially flowing through in the fourth quarter and not fully. Could you walk us through the timing of the 25%? And when that would start to flow into your inventory? And then when that would start flowing into your cost of goods? That would be helpful. Thanks.

Martin D. Agard - Lumber Liquidators Holdings, Inc.

Yes. And sort of the same answer gets into our inventory turns, but let's say that the 10% started October 1 and the 25% would start January 1. The tariffs will come in at an article level and turn through inventory based on the turn of that article. Vinyl products are generally faster turning and so that tariff would be fully realized somewhere in the three, four, five months depending again on how fast turning popular a given floor item is.

Engineered products slower, bamboo products slower, so some of those may take – they may be into the second quarter and still not fully reflective, could be – take six months really to get to going.

So, it's somewhere between, let's say, four months and six months before these tariffs are going to take real effect, and again, based on the speed of the turn. So, I think that's generally the question you're looking for.

Our price increases and cost – the cost outs from vendors go in the same way. They go in slowly but surely make their way to inventory and will turn at that kind of pace, depending again on the article, as fast as three months and as slow as six, seven months.

Our price increases can go in quicker, but sometimes we have promotional events coming up that we protect. And so there's sometimes a lag in the effect of our price increases as well, typically not as slow as the inventory effects on the tariffs or the cost outs.

John Allen Baugh - Stifel, Nicolaus & Co., Inc.

Great. Thank you and good luck.

Dennis R. Knowles - Lumber Liquidators Holdings, Inc.

Thanks, John.

Operator

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

Rick Nelson - Stephens, Inc.

Thanks. Good morning. I would like to follow up on the pro and the installation side of the business. You're seeing very big growth in both of those businesses, pro moving from 20% to 30%.

When – how big can that business become as a proportion of sales? When do you start to anniversary of some of these challenges with installation services as well the big growth, when do you anniversary that?

Martin D. Agard - Lumber Liquidators Holdings, Inc.

Yes. I'll start with – well, let's start with the pro, it is approaching 30% of our merchandising sales. And I don't know that we know – I don't think it slows down, it doesn't anniversary or anything. So, it can continue to edge higher for the foreseeable future to the extent millennials use pros and we can build our pro business and continue to have better offerings and service offerings and things for the pro, then that continue to edge higher and we expect it too.

On the install business, we got that fully expanded into the last states, Florida and California in late 2017. So, by the first quarter of 2019, we will be anniversarying a fully expanded install program from the first quarter of 2018.

So that's – and where it helped all the investors and the audience track that is that's part of why I indicate how much installs have grown in the stores where that program has been offered more than a year. That number for the third quarter was 13%. And that's been in that, I call it, the low teens range for a couple of different quarters, several quarters.

So as we get fully expanded and we're talking about the first quarter of next year being anniversarying a fully expanded offering, something like that for the installs part of the business feels reasonable and that installs business is sort of 12% – 11%, 12% of the sales, growing at 12%, 13%. That's 1.5 points of comp growth where it's contributing more like 3% to 3.5%.

So we will face that and we will be part way there in the fourth quarter of this year. So it will go from contributing something like 3% to 3.5% of the comp growth to maybe 2%-ish to something more like 1.5%-ish. So I think that's the best guidance I can give you around that.

Charles E. Tyson - Lumber Liquidators Holdings, Inc.

Yes, if I can just add, from an install perspective, as I said before, we have not spent a significant portion of our marketing spend leveraged against our installation customer segment.

And we see that as an opportunity. We are testing as I said in the four quarter an enhanced program against installation in certain markets and believe that that will attract a new traffic customer to our brand that doesn't understand today that we're even in the installation business. So, we think there is a lot of opportunity around brand awareness and installation at Lumber Liquidators.

Dennis R. Knowles - Lumber Liquidators Holdings, Inc.

Yes, and I would just, Rick, just add to that as well is that our pro business and our installation have been a very intentional build in terms of making sure that we have the right network, the infrastructure behind it, both on the pro and the installation.

Mike and Charles have worked tirelessly to make sure that we built this network in a way that when were ready to fully leverage it, we could. And I think that's where we're at and what Charles is talking about.

So, as Marty said, we'll see less benefit as we continue to cycle that. But in our markets where it is performing well, it has been in place for over a year. We're continuing to see that perform well and that's without any intentional push. So, we still have some work to do.

We want to continue to digitize that experience, both for the pro and for the do-it-for-me customer. But we see that as kind of our work to do for the remainder of 2018 and into 2019 to helps us fully leverage that. But as Charles mentioned, we will start to lean on that business a little bit in the fourth quarter and into 2019.

Rick Nelson - Stephens, Inc.

That's really helpful. Thanks a lot guys, and good luck.

Dennis R. Knowles - Lumber Liquidators Holdings, Inc.

Thanks, Rick.

Operator

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

Dennis R. Knowles - Lumber Liquidators Holdings, Inc.

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

Operator

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