LL Flooring Holdings, Inc.

Good morning, ladies and gentlemen, and welcome to the Lumber Liquidator's first quarter 2021 earnings conference call. As a reminder, this conference is being recorded and may not be reproduced in full or in part without permission from the company. I would now like to turn the conference over to Julie McMaden. Please go ahead.

Thank you, operator. Good morning, everyone. And thank you for joining us. Today, I am joined by Charles Tyson, our President and Chief Executive Officer. and Nancy Walsh, our Chief Financial Officer. As we begin, 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 LL Flooring. Although LL Flooring believes that the expectations reflected and 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 LL Florence's filings with the FTC. During today's conference call, management will be discussing results on an adjusted basis. a reconciliation of non-GAAP financial measures to the most directly comparable GAAP financial measures, and our explanation of why the non-GAAP financial measures may be useful are discussed in today's earnings release. The information contained in this call is accurate only as of the date discussed. Investors should not assume that the statements will remain operative after today, and LL Foreign undertakes no obligation to update any information discussed in this call. Now, I am pleased to introduce President and CEO, Charles Tyson. Charles?

Thank you, Julie. Good morning, everyone. On today's call, I will review our first quarter highlights and our progress towards realizing our vision to be the customer's first choice in hard surface flooring by providing the best experience from start to finish. First, I want to thank all of our associates for driving our growth and profitability strategies forward and providing a superior experience to our customers during the quarter. Turning to our positive results in the quarter, we delivered a 6.9% increase in comp sales, which was driven by continued execution on our transformation initiatives, strong demand from home improvement projects, and accelerating year-over-year growth in our installation business, as well as the impact from the onset of COVID-19 shutdowns in March of 2020. During the first quarter, a big winter sale event directly overlapped severe winter weather in February and compared unfavorably to a successful winter sale event in the first quarter of 2020. In addition, last year, we had one more day in the first quarter for leap year, during which we also benefited from a successful sales event. We feel good about the underlying demand in our business and the traction we are seeing in our initiatives, which we believe is not fully reflected in our first quarter comparable sales. Our teams delivered outstanding profitability improvement. We reported operating income of $13.1 million up from $8.8 million in the first quarter of 2020. On an adjusted basis, operating income increased $5 million to $14.4 million in the first quarter of 2021, or 5.1% of net sales versus 3.6% of net sales in the first quarter of 2020. The higher profitability reflects continued good work from our merchant and sourcing teams and disciplined expense management across our organization. Our cash flow and balance sheet are strong and position our company for long-term success. Our strong first quarter results reflect continued progress on our strategic pillars of people and culture, improving the customer experience, driving traffic and transactions, and improving profitability. Our first strategic pillar, people and culture, is a critical driving force behind our transformation strategy. During the first quarter, we communicated our new vision and purpose and rolled out a new set of six core values and commitments across our organization that directly shapes how we will interact with our associates and customers. We also reinforced our commitment to an inclusive, diverse team and a culture which understands, values, and adapts to the needs of our associates and customers. We remain steadfast in this commitment to demonstrate respect and tolerance to all groups through our words and actions to our associates and customers alike. To support this, our Diversity, Equity, and Inclusion Task Force has scheduled diversity workshops that will roll out through the organization over the coming months. And we are fostering an open dialogue with our associates, We completed the company's first culture survey, and we have already begun to respond to recommendations and feedback as we build a cohesive, inclusive, high-performing team. A second pillar is improving the customer experience. Our customers expect a seamless, omnichannel experience. One of the key benefits of our new digital platform is increased engagement on mobile. Across the industry, roughly 80% of customers start their flooring journey online, and mobile is increasingly their preferred way to shop. In February, we launched our new mobile app featuring our popular Picture-It and Floor Finder tools and making it easy to order installations. We are pleased with the customer engagement and conversion we are generating through mobile. Installation is a key service we provide that enhances the customer experience. First quarter installation sales increased year-over-year, and the rate of year-over-year growth accelerated sequentially from the fourth quarter of 2020, underscoring growing momentum in our installation business. New installation assessment trends indicate demand for installation services remains strong. Providing a seamless installation experience for our customers has been facilitated by the new in-store portal that we rolled out in December to enhance visibility to our customers' installation projects, increase efficiency for our store associates, and reduce turnaround time for our customers when quoting new jobs. In addition, in mid-March, we launched a new installation services section of our website that centers around the customer. ranging from easy to read content with useful tools and links to more detailed information for those interested in learning more. It also features before and after customer project testimonials. This educational content is helping drive stronger demand for installation assessments. Expanding our business with pro customers is foundational to our growth and transformation strategy. Building strong relationships with pros is our top priority, and we continue to reinforce that with our store associates through our trial, scale, and retention programs. We continue to build our pro value proposition, and as such, we are making it easier for pros to engage with us. For example, in early March, we launched new everyday pricing for pros, which our pros are telling us is highly valued and makes it easier for them to consistently quote jobs. And we continued to execute our outside pro account rep program. While our first quarter pro comp was flat versus last year, we saw higher sales and orders per pro that originated from our trial, scale, and retention program, reflecting the increasing quality and value we are generating by building strong relationships with pros. Turning to our third strategic pillar of driving traffic and transactions, for the first quarter, our web sales increased more than 70% versus last year. We're continually improving the features, tools, and online functionality on our llflooring.com digital platform to engage and delight shoppers and boost conversion. The quality and value of the flooring assortment we offer is reflected in our recently launched spring seasonal catalog, which presents beautiful on-trend and sophisticated floors as well as style insights. And we are publishing weekly blogs of home decor inspiration through our LL Style online content platform. Our trend right assortment makes us a leading destination for both retail and pro customers. With more than 400 varieties of hard surface floors, featuring a range of quality styles, we continue to offer customers quality choices. And our expert sales associates provide the high touch service and advice to help our customers achieve their flooring project needs. We are driving innovation and delivering on-trend flooring that resonates with how people want to experience their home environments today, whether that's simple luxury or bold patterns and designs. During the first quarter, vinyl plank and solid hardwood were again our top performers. We've expanded the number of wide-width SKUs in our vinyl category, and our best-in-class wood assortment remains a key competitor of Varnish. Our brand revitalization progressed during the first quarter, with our pilot stores trending ahead of comparable control stores in terms of new order dollars and pro new order dollars. We continued to evolve the presentation of our new brand in our advertising, with LL Flooring moving to the primary position versus Lumber Liquidators. This helped drive key gains in awareness, familiarity, and consideration for LL Flooring based on our national tracker, which are important milestones to ensuring a much more relevant brand in hard surface flooring. Fourth, improving profitability. Our adjusted gross profit of $109 million for the first quarter of 2021 improved $4 million from the first quarter of 2020. And despite the reinstatement of Section 301 tariffs, our adjusted gross margin of 38.5% was down only 80 basis points from the 39.3% in the first quarter of 2020. Our merchant and sourcing teams executed well to partially offset the impact of the Section 301 tariffs through pricing and promotion strategies and, to a lesser extent, alternative country sourcing efforts, reflecting continued progress on our strategy to diversify sourcing away from China. In addition, we improved adjusted SG&A spend to 33.4% of sales from 35.7% in the first quarter of 2020. We continue to focus on more efficient digital marketing spend versus other traditional channels, and we maintain disciplined expense management. Our first quarter adjusted operating profit was $14.4 million, up from $9.6 million in the first quarter of 2020. Our adjusted operating margin was 5.1% compared to 3.6% in the first quarter of 2020. Nancy will share more details on the quarter in her remarks. We remain focused on executing our transformation plan and making progress against our strategic pillars to position us for long-term success. I want to briefly update you on recent developments under each of our four pillars. First, let's start with our people and culture. We've selected a new learning management system to provide enhanced training content across the organization for all associates to maximize performance, improve the customer experience, and strengthen our associates' expertise. Moving to improving the customer experience, In April, we launched a new pro web experience that allows pros to see their exclusive everyday competitive pricing, allows them to extend that special pricing to their customers, and gives them visibility into our inventories and their job history. Making the shopping experience easier and more compelling to pros strengthens our value proposition and reinforces LL Flooring as their go-to partner. and we've received very positive feedback on this experience to date. Turning to our objective of driving traffic and transactions, we've strengthened our omnichannel capabilities with new tools to help drive traffic and transactions with customers. Customers have responded extremely well to our Picture It and Floor Finder tools, where they can find a floor they like on our website or app, take a picture of their room, and see how the floor will look in their space. And we're enhancing these tools with additional functionality such as improved catalog and navigation. We have just begun to take advantage of the power of our new digital platform and website that gives us more agility and speed to better showcase our flooring and service and drive traffic to our stores. We're excited about our product innovation pipeline for 2021. with a steady schedule of new product launches supported by digital campaigns, website, and in-store promotions. We are prioritizing digital marketing to tell the story of our new brand and expanding our efforts on search and social where our customers begin their inspiration journey. During the first quarter, we produced a new brand campaign to introduce the next chapter in the LL Flooring story, reinforcing our flooring expertise, high quality, trend right assortment, and building familiarity around the new brand. The campaign kicks off this week and will be reinforced online and through an enhanced presence on social media. We're looking forward to the broad scale rebranding of our stores that we anticipate will occur primarily in 2021. This will include a new mark on the outside of our stores, replacing lumber liquidators with LL flooring, and every store will have updated and redesigned interior signage that reflects our new brand. Finally, we continue to work on improving profitability. There are numerous factors in the MACRA environment making it hard to predict how consumer spending on home improvement will unfold in 2021. Given the uncertainty caused by these factors, we are not providing financial guidance for 2021 at this time. That said, we would like to share some color around our outlook and approach for the remainder of the year. First, on the positive side, we're seeing continued tailwinds to existing and new home sales, home valuation appreciation, and demand for homes exceeding available supply, all of which we believe are supportive of home improvement projects. In addition, U.S. consumers have healthy savings and increasing confidence based on recent stimulus measures and a strengthening job market. That said, we're navigating current international supply chain disruptions. Container availability continues to be highly constrained and we expect it to be volatile over the upcoming quarters. We're continuing to monitor this, including the potential impact of the recent Suez Canal disruption. Domestically, hardwood supply continues to be constrained. Similar to the fourth quarter of 2020, we believe we could have captured more sales in the first quarter of 2021 if our inventories had been higher. Our supply chain teams are working diligently to bring in new inventory and allocate it effectively across all our stores. In the second half of fiscal 2021, we will be up against more difficult sales comparisons with the third quarter and fourth quarter of 2020 comparable sales increases of 10.9% and 10.5% respectively. The impact of COVID-19 is mixed. On the positive side, more than 145 million in the U.S. have been vaccinated, which should underpin the sustained economic recovery in 2021 and beyond. However, we are monitoring the number of cases in the U.S. which could dampen consumers' willingness to have pros and installers enter their homes. And while there is still strong consumer demand for home improvement spending, we are watching how much consumers may expand their spending into other areas such as travel and leisure as 2021 unfolds. Amidst these positive factors and potential challenges, our team is focused on driving execution on our growth and profitability strategies. We have a robust pipeline of new innovative products. We are generating strong installation sales growth and building our value proposition for pros. Our new digital platform is driving traffic, and we're excited to expand the brand revitalization to more stores this year. Opening new stores is an important part of our growth strategy. During the first quarter, we opened three new stores as part of our plan to open 12 to 15 new stores this year. Turning to gross margin, as we demonstrated in the first quarter, our merchant teams are working hard to mitigate the impact of Section 301 tariffs. In addition to tariffs, we expect gross margin pressure from higher transportation and raw material costs as we move through 2021. To partially offset these headwinds, we will continue to execute our mitigation strategies, which primarily consist of pricing and promotion strategies and alternative country sourcing strategies. With respect to SG&A, we will maintain disciplined expense management. We plan to leverage our base SG&A expense year over year and reinvest expense savings in our growth initiatives, including new technology to improve the customer experience, investment in our teams, the opening of new stores, and investing in our pro customers. In summary, we are intently focused on executing our growth strategies to drive sales and profitability in 2021. With more than 400 varieties of hard surface floors featuring a range of quality styles and on-trend designs, we continue to offer customers quality choices while our supply chain teams work diligently to increase inventories. We will continue to pursue gross margin rate mitigation strategies and disciplined expense management to optimize profitability while investing in our strategies to position LL Flooring as the customer's first choice in hard surface flooring over the long term. I will now turn the call over to Nancy to share the financial details of the quarter. Nancy?

Thanks, Charles, and good morning, everyone. In the first quarter, net sales of $283.5 million increased 16.1 million, or 6%, versus the first quarter of 2020 due to a 4.7% increase in net merchandise sales and a 16.8% increase in net service sales, which reflected accelerating year-over-year installation sales growth. We saw a 4.4% increase in our average ticket due primarily to a higher merchandise average ticket and a 2.5% increase in transaction count compared to the same period in 2020. As Charles noted, first quarter 2021 comparable store sales increased 6.9% versus the first quarter of 2020. In addition to what Charles shared about the impact of COVID-19 and our 2021 winter sales event compared to the sales events during the first quarter of 2020, we also estimate that inventory constraints from supply chain disruptions represented a potential $8 million to $9 million in lost sales during the first quarter of 2021. This was a similar impact to what we experienced during the fourth quarter of 2020. Turning now to gross profit. Gross profit increased 10.1% in the first quarter of 2021 to $116 million from $105 million in the comparable period of 2020. gross margin of 40.8% in the first quarter of 2021 compared to 39.3% in the first quarter of 2020. During the first quarter of 2021, gross margin included a $6.6 million benefit from anti-dumping duty rate changes associated with applicable prior year shipments of engineered hardwood from China. The first quarter of 2020 did not contain a comparable item. When excluding this item from 2021, adjusted gross profit for the quarter was $109 million compared to $105 million in the prior year, and adjusted gross margin was 38.5% compared to 39.3% in the prior year. Despite the reinstatement of tariffs in August of last year on certain flooring products imported from China, the year-over-year decrease in adjusted gross margin was only 80 basis points, primarily due to solid execution on our mitigation strategies. SG&A expense for the first quarter was $102.5 million, or 36.2% of sales, up 20 basis points compared to $96.2 million, or 36% of sales in the first quarter of 2020. SG&A in both quarters included certain costs related to legal matters. In April 2021, we settled two employment litigation matters, and as a result, during the first quarter, we accrued a $7.7 million liability with SG&A for these litigation matters. When excluding these items from both periods, adjusted SG&A expense for the quarter was $94.7 million, $700,000 lower than the $95.4 million in the first quarter of 2020. As a percent of sales, adjusted SG&A improved 230 basis points to 33.4% of sales from 35.7% of sales in the first quarter of 2020. For the quarter, we delivered operating income of $13.1 million compared to $8.8 million in the first quarter of 2020. Adjusted operating income in the first quarter of 2021 was $14.4 million up $4.8 million from $9.6 million for the prior year period. An adjusted operating margin for the first quarter of 2021 was 5.1%, up 150 basis points from 3.6% in the first quarter of 2020. The higher operating income and margin reflect good progress on our profit improvement initiatives, with our merchant and sourcing teams implementing strategies to mitigate tariffs our marketing teams deploying more efficient and effective digital marketing spend, and our overall organization driving disciplined expense management. In the first quarter of 2021, we had other income of $800,000 compared to other expense of $900,000 for the three months ended March 31, 2020. Both years included interest on borrowings under our credit agreement. The interest expense on borrowings in 2021 was offset by a favorable adjustment of $1.8 million with reversal of interest expense associated with anti-dumping duty rate changes. This reversal was excluded from adjusted earnings. In the first quarter of 2021, we recognized income tax expense of $3.3 million or an effective tax rate of 23.4% compared to an income tax benefit of $4.4 million or an effective tax rate of negative 55.2% for the first quarter of 2020. The benefit in 2020 was driven by a $4.7 million benefit related to the provisions of the CARES Act. For the first quarter of 2021, net income decreased by $1.6 million to $10.6 million compared to net income of $12.2 million for the first quarter of 2020. Adjusted earnings for the first quarter of 2021 were $10.2 million compared to adjusted earnings of $12.8 million for the first quarter of 2020. reflecting the income tax benefit in 2020. Finally, earnings per diluted share was 36 cents for the quarter versus earnings per diluted share of 42 cents in the year-ago quarter. On an adjusted basis, first quarter earnings per diluted share of 34 cents compared to adjusted earnings of 44 cents for the first quarter of 2020, reflecting the income tax benefit in 2020. Turning to the balance sheet. Inventory at the end of the first quarter was $225 million compared to $244 million at the end of December and $270 million at the end of March 2020. The 16% year-over-year reduction in inventory was primarily driven by managing our inventory purchases as a direct result of COVID-19, followed by supply chain constraints on replenishment and strong sales that kept inventory below our targeted level. Our balance sheet and liquidity are strong. We ended the quarter with cash and cash equivalents of $209 million, up $186 million from a year ago, and up $39 million from December 2020. Net cash provided by operating activities was $45 million for the first quarter of 2021, compared to $36 million in the first quarter of 2020. The increase was driven by our disciplined working capital management program. and we have not yet been able to replenish inventory to optimal levels due to continued supply chain constraints, which also contributed to our above-average customer deposits and accounts payable during the first quarter of 2021. These working capital factors favorably impacted our cash flow from operations in the first quarter of 2021. As of March 31, 2021, we had $240 million in liquidity, comprised of $209 million of cash and cash equivalents, and $31 million of excess availability under the credit agreement. This represents an increase in liquidity of $109 million from March 31st, 2020. At quarter end, we had $101 million in outstanding debt under our credit agreement, and this amount is unchanged since we announced our ABL amendment in April 2020. On April 30th, we entered into a second amendment to our credit agreement. We were pleased to reduce our interest expense and fees extend our maturity date, and increase our financial flexibility. The total size of the credit agreement remained at $200 million as we converted $25 million in FILO to the revolving credit facility, and we still have an option to increase that to a maximum total amount of $250 million. The maturity date of the credit agreement was extended to April 30, 2026. We decreased the margin for LIBOR rate loans by 125 basis points over the applicable LIBOR rate, reduce the LIBOR floor from 1% to 0.25%, and decrease the unused commitment fee by 25 basis points per annum. Except to set forth in the Second Amendment, all other terms and conditions of the credit agreement remain in place. We are monitoring the current macroeconomic conditions and the impact of COVID-19, especially if vaccine administration continues, and we are considering the timing of repayment of some or all of our debt balance perhaps as soon as the end of the second quarter of 2021. Turning now to the remainder of 2021. Our team remains dedicated to our transformation, driving growth and improving profitability. I would like to expand on some of the details that Charles touched on at a high level. During the first quarter, we opened three new stores. In January, we opened our Fort Smith, Arkansas store, which is a new market for us. And in March, we opened a new store in Rochester, New York, and Franklin, Tennessee, representing expansion of existing markets. The new stores have the LL Flooring branding, and we are excited about the opportunities to drive additional sales and profitability growth through these new locations. We expect installation sales to return to a pre-COVID mix in 2021 as we execute our initiatives to attract more customers and as our customers are more comfortable having people enter their homes. This will benefit gross margin dollars but lower the gross margin rate. With respect to SG&A, we plan to continue our expense management efforts and to invest behind our growth initiatives, including new technology and store service levels to improve the customer experience, as well as opening new stores. With respect to cash flow, given continued supply chain disruptions, we do not have full visibility into how soon we can increase our inventories to optimal levels, which could also continue to keep our customer deposits above historical levels. In 2021, we still expect CapEx investments of approximately $24 million to $28 million, as our overall business results support the broad-scale rebranding of our store fleet, the opening of 12 to 15 new stores, and investments in digital. In summary, we delivered strong sales growth and profitability in the first quarter. Our entire organization remains focused on continuing to execute our transformation initiatives to drive growth and profitability in 2021 and beyond. and our strong balance sheet and liquidity provide us with the financial flexibility to fund our growth initiatives and position LL Flooring for long-term success. Thank you all for your time this morning. With that, I'll ask the moderator to open the call for questions.

And at this time, we'll be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. Confirmation tone will indicate your line is in the question queue. You may press star 2 if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Our first question is from Laura Champagne with Loop Capital Markets. Please proceed with your questions.

Thanks for taking my question. It's on the supply chain issues that impacted sales and inventory in the quarter. Do you expect or when do you expect to see a resolution there? What is the resolution and how are the sourcing issues impacting your approach to marketing?

Hey, Laura, good morning. Thanks for the question. Yeah, so I think you really got three different things in that question. First of all, understanding our supply chain constraints are really two issues. One is the well-known international constraint around container availability that's coming out of Asia specifically, and there likely will be some continued delays also that the new Suez issue has created. And we see, as others have reported, supply chain environment continuing to be volatile, and we expect that constraint to continue certainly through Q2. Our current view is an improvement through the back half of the year, but I do want to qualify. We're really looking at this week on week as we work with carriers on availability. The second constraint is North American-based, and that's just in lumber availability. We see sawmill output on hardwood lumber still running at about 80% of capacity from pre-COVID, and that certainly has curtailed the amount of availability through the domestic wood production. So two different issues that we're working on. I think you're asking how are we managing through that. In North America, we're working strategically with our vendors from obviously a planning perspective, and we've brought on a couple of new vendors to help, and we're actually pleased with our productivity on a solid wood domestic program that we produced in the quarter. So I think the lost sales that we think in first quarter was in the range of eight to nine million, We continue to see constraint in the second quarter, and that current view is improving through the back half of the year.

Got it. And then any impacts that has on your marketing spend?

Yes, so we've been optimizing our marketing spend over the last 12 months as we've moved more into the digital environment. Clearly, we're going through a rebranding with LL Flooring that we're really excited about and getting great feedback from our customers. So we think that we have our marketing spend optimized at the right levels going forward.

Thank you.

And our next question is from Ryan Nagel with Oppenheimer. Please proceed with your question.

Hi, good morning. So a couple questions, if I could. First off, and I know you discussed your results extensively in the prepared comments, but just help me understand better. If we look at the moderation in top-line expansion in Q1 versus what we saw in Q4, Q3 of last year, and on one-year basis or multi-year basis. What's really the key reasons behind that?

Yeah, good morning, Brian. Good to talk to you. So as we look at the sequential move from Q4 to Q1, you know, overall we're very positive on the outputs that we're seeing from the investments that we've put into our initiatives, particularly with installation, which you see, you know, our service numbers were very strong for the quarter, and those improved sequentially from Q4 into Q1. And we're also pleased with the underlying progress that we're making on our pro, particularly around our TSR program, and two very important new initiatives that we launched in the quarter, which is everyday pro pricing, which the feedback from pros, it makes it easier for us to do business with, as well as a pro portal that allows them to remotely work with us and allows them to be much more efficient. With that said, there were a couple events in the quarter. The leap year day was a big sales event for us a year ago and impacted the comparable comps. And then our largest sales event was planned in February right in the middle of when we had that major weather outlook. And it wasn't just in Texas. There were other parts of the country. uh that that had an impact and then obviously the inventory impacts uh flowing forward so there were a couple of events that were uh on anniversary from the year before that impacted the you know impacted the comps in the quarter i will say that we as you look at our strong customer deposits which continue to build in the quarter and the the strong assessment demand that we're seeing in install We believe on the demand side from the consumer that the home improvement appetite continues to be strong in the marketplace. And so, overall, we're positive on the quarter as we think about the longer-term work that we're doing on our transformation.

That's very helpful. The second question I have, with respect to tariffs, you talked about tariffs impacting gross margins. here in Q1 and disrupting the trend. We're going to recognize you're not giving official guidance to the balance sheet, but how should we think about just the impact of tariffs as we look through the balance of 2021?

yeah so a couple of things maybe i'll have nancy uh comment you know we anniversary those come the august time frame and we've really been working diligently on both our alternative country sourcing and a new pricing practice that really looks more strategically than the company's done historically how we price to market so i think the merchant teams have done a great job and the sourcing teams have done a great job And you can see some of that in our percent of revenue that we're shipping out of China. And so we will continue to work those issues as we work through the balance of this year. And I'm pleased with the work and the performance that the teams are delivering there. And you can see some of that in our first quarter margin performance. But I'll ask Nancy if she wants to just chime in.

So I will add just a few points. As we mentioned, our gross margin was only down 80 basis points. and we were partially offsetting the reinstatement of tariffs through pricing and promotion strategies primarily and to a lesser extent alternative country sourcing. We're expecting the gross margin pressure from higher transportation and some of the raw material costs that Charles just talked about, and we're planning to continue to leverage those through the same strategies as we have been doing currently. I will also point out that we showed in the queue that the percent of goods sourced from China was only 23%. in Q1, and that will fluctuate from quarter to quarter based on how we're balancing diversifying, moving away from China for our sourcing, and optimizing the flexibility to navigate the supply chain disruptions as well as watch the trade negotiations that are taking place in Washington.

Very helpful. I appreciate all the color. Thank you.

Thanks, Brian. Our next question is from Seth Basham with Wedwich Securities. Please proceed with your question.

Thanks a lot and good morning. My first question is whether you can assess what the underlying demand or comp trend is right now relative to, say, 2019 and how you expect that to progress going forward.

Hey, Seth, good morning. I'm not going to speak specifically to how we are going to project going forward. We don't do that. But as I said on the previous question, we see, at least today, good continued strength and appetite for consumers. on home improvement and the willingness to, even a constrained inventory environment, taking longer to fill their orders. Fortunately, we have good visibility through our supply chain, so we can tell customers when products are going to be available. And so we feel good about the strength of customer deposits. And with that being said, what we don't know is as the economy opens up, as customers start to do things like vacationing or going back into the workforce, buying clothing, is there an impact on an appetite to do home improvement projects? We think based on the housing market, interest rates, that this is going to continue through at least the back half of this year. But again, we're cautiously watching how the consumer is going to react as we move through higher vaccination levels and folks changing after being in their homes for over a year.

Got it. Okay. My second question is around gross margins. Lots of moving pieces here, but trying to think about how much pressure you guys might expected in the back half of the year from everything from the high transportation, material inflation, offset by pricing, et cetera, installation sales mix, pro sales mix, any product category sales mix. Can you help us put those things together and think about how gross margins might trend?

Again, I'm not going to speak so much to the trending other than to say we're continuing to expect you know, pressure on the gross margin from everything that you've been hearing in the marketplace, which is pretty much impacting all industries and all companies, both the higher transportation costs and the raw material costs. And we're planning to leverage those through the same pricing promotion strategies that we've been using. And as we continue the flexibility of sourcing our goods, you know, there really is a lot of volatility out there. So it's very hard to factor in when that is going to abate and, as Charles talked about, you know, what's going to happen with the demand afterwards. In terms of our services margin, you'll remember Q2 and Q3 of last year, we had talked about when COVID began that we had offered promotional pricing for delivery that made it easier for customers during the COVID crisis to be able to still shop with us. In January of this year, we increased delivery prices, but they still remain below pre-COVID levels. So you will see a slight difference in terms of the service margin as you're looking through the queue. I've forgotten what the rest of the questions are if Charles wanted to add anything else. But I think that gives you a little bit of picture. It's pretty much what we're considering more of a universal issue, and we'll see how things turn out.

So, Seth, I would say a couple of things. You know, with the strong demand in the marketplace for home improvement, Unlike the lumber business, I think when you look at a cost per square foot on the inflation side, which is your question, we see the opportunity from a pricing perspective to help augment that margin headwind. And I think on a cost per project basis, that elasticity is not – impacted that much by the amount of cost increases that consumers are going to face across all of the flooring categories with the inflation flowing through. And the same thing with transportation. We've been working on that for over six months in terms of offsetting that inflationary impact. On pro, we've been working on our pro pricing for over a year. Moving to everyday pro pricing is really a very strong critical component of our value proposition, and we've built that into our plans as we went into 2021. All right.

Really helpful, Collar. Just last follow-up to make sure we understand the dynamic here around pricing. Do you feel like your pricing is as competitive or more competitive in the marketplace than it was a year ago? And is there an opportunity, given this really strong demand environment, to take additional price to offset most of the gross margin headwind going forward?

Yes. So what I would say, Seth, is that we use new pricing tools to look competitively across the country, to look at how we believe we should be priced from a competitive standpoint. And we're very happy with our pricing. positioning as a market leader in the hot surface flooring space. So that I believe the teams are doing a good job of both on the inflationary side, as I just spoke to, but also making sure that we're very competitive, particularly in pro, where we're pleased to be working at TSR program, and we're getting good positive feedback both on the pro pricing and the web portal that we launched. So we're really excited about that work that the team are doing.

Thank you very much.

Thanks, Seth. And as a reminder, if anyone has any questions, you may press star 1 on your telephone keypad. Doing so will ensure your spot in the question and answer queue. Our next question is from Peter Keith with Piper Sandler. Please proceed with your question.

Hey, good morning. It's for Peter. Thanks for taking my questions. First, I want to ask around ProSales. So they're flat year-over-year for the second straight quarter. What do you think is holding back growth here? It certainly seems like pro-customer sales in the industry are very strong. It's not accelerating as consumers are letting pros back in their home. And as we look forward with improvements you're making around your pro-online experience and customer service, do you think you're now in a position to start taking more shares?

Thanks for the question. Good morning. We've said that our pro journey is a longer-term relationship play. Frankly, just because we show up, it doesn't mean the pros will automatically change their buying behaviors. We have to earn those behaviors. and change in behaviors. And this TSR program that our pro teams are working, we talked about the change in quality that we're seeing through that work. Now there's some headwind in public spaces and there's, you know, particularly in things like retail where those flooring projects are just not in the market. And we're even seeing in our small builder segment builders delaying because of the overall cost of projects and pushing those projects out. So there's some overall noise in the segments, but we're comfortable that the work the team are doing to create the relationships with those pros who value what it is we do between our expertise a high level of in-stock, a quality trend-ride assortment, and our teams changing culturally on how to build pro-relationships moving from more of a DIY-centric model. So the answer to your question is I'm comfortable with the work the team are doing. We're happy with the quality of the outcomes we're seeing on pro-relationships. And we only just launched this quarter two very important components of our pro-value proposition. As you know, pros want pricing every day to be firm so that they can effectively quote their jobs to their customers and not have to wait for us to decide to put something on sale to make it relevant to them. So we feel very positive about our pro future.

All right. Thanks, Charles. And just one more. To discuss some of the main trends you're seeing from a mixed standpoint, is there any evidence that With a strong housing backdrop and U.S. consumer debt, consumers are opting for higher ASP product now.

Yeah, so that's a great question. I would say, you know, from an overall mix perspective, when we think about labor in our business as well as product, we feel really good about our installation business and the demand that we're seeing for strong assessments. So customers are clearly open to letting people back in their home. I think as we've evolved and upgraded our assortments, our teams have done fantastic work in the solid domestic business, wood business and the engineered wood business. Yeah, the change in styles, absolutely. We're seeing a better and best products driving our demand. And again, we're highly competitive against many of the independent space. So extra wide boards, extra performance in the laminate category from a water resistant perspective and obviously vinyl. the trend right assortment that we have today and the breadth of that assortment playing into our premium segment is really helping us effectively drive the business. So I think customers absolutely are taking the time to look at what that finished product's gonna look like. And on a cost per square foot basis, we're so competitive in the premium segment, we're happy with the returns that we're seeing there.

All right, thanks a lot.

Thanks. And we have reached the end of the question and answer session, and I'll now turn the call over to Charles Tyson for closing remarks.

Thank you very much, operator. We'd just like to, first of all, again, thank all of our team members for all of their support and hard work in executing our transformation strategy in the quarter. We'd also like to thank the support from all our vendors, particularly in this supply chain constrained environment where they're really working hard every day to meet the expectations of our customer. We're very happy with our first quarter performance. And we look forward to talking to you all again at the end of second quarter. Thank you.

And this concludes today's conference and you may disconnect your lines at this time. Thank you for your attention.