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spk02: Hello and welcome to today's LL Flooring third quarter 2022 results call. My name is Elliot and I'll be coordinating your call today. If you would like to register a question during the presentation, you may do so by pressing star followed by one on your telephone keypad. I would now like to hand over to our host today, Julie McReady, Vice President of Investor Relations. The floor is yours. Please go ahead.
spk04: 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 Executive Vice President and 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 Florence. Although LL Flooring 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 LL Flooring's filings with the SEC. 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 Flooring undertakes no obligation to update any information discussed in this call. Now, I am pleased to introduce President and CEO, Charles Tyson. Charles?
spk00: Thank you, Julie. Good morning, everyone. During today's call, I will share the work we're doing to move the company forward to realize our vision and long-term growth potential as we continue to navigate near-term business headwinds. Our third quarter results were below our expectations. We reported comparable store sales down 7.3%. Our decline in comparable store sales was due to continued lower spending by consumers versus last year. We believe the lower consumer sales largely reflected continued pressures on consumer discretionary spending from inflation and higher interest rates. That said, our investments in serving pro customers continue to drive positive results During the third quarter, we posted just under double-digit growth in sales to pro customers, which represented our sixth consecutive quarter of pro sales momentum. We reported an adjusted operating loss of $4.3 million, or negative 1.6%, reflecting lower sales, continued supply chain cost pressures on gross margin, and the SG&A investments we're making to support our long-term growth. We continue to invest in our core growth strategies while actively working to reduce costs where possible. Notwithstanding the near-term challenging consumer spending environment, we believe there are opportunities to improve our performance and we're focused on increasing brand awareness and consumer traffic. We're encouraged by positive long-term leading indicators in our business that I will review during my remarks today. We're operating in a strong sector. The repair and remodel backdrop remains positive over the medium to long term, driven by secular tailwinds such as the aging housing stock in the U.S. The medium age is 39 years old, coupled with the new household formation by the large millennial cohort. the desire to age in place by large baby boomers cohort, and continued flexibility of remote work driving demand for single-family homes, among other factors. We remain confident in our long-term strategy and we're optimistic about our unique value proposition and positioning in the marketplace. We believe our ability to deliver the high touch service of an independent combined with the value and convenience of a national brand provides a long-term sustainable competitive advantage. We're well positioned to take advantage of the medium to long-term tailwinds for repair and remodel spending. I want to thank and recognize our valued associates for all of their efforts during a challenging business environment. Our entire organization is energized around delivering on our vision to become the leading destination for hard surface flooring by providing the best experience from start to finish. We're pleased to have a strong balance sheet and liquidity to weather the near-term business environment. Turning now to what we're focused on to improve our results. Continue to grow sales to pro customers. Continue building greater awareness of the LL flooring brand to drive more traffic and optimize traffic conversion by continuing to improve the omnichannel shopping experience for our customers. First, grow sales to pro customers. A strategy to increase sales to pro customers is working. We've seen strong growth in our sales to pro customers over the past two years, and we see a significant long-term growth opportunity ahead, supported by our long-term repair and remodel tailwinds. During the third quarter, we posted just under double-digit growth in sales to pros. We deliver value to pros through our people, products, and everyday low pricing, and we continue to build on this value proposition to attract and retain more pros. Our strategy is anchored by a pro-relationship program, which continues to drive greater pro-customer retention and higher sales pro-pro-customer. We're pleased with our investments in our pro team and the strong results they're delivering. We also offer the distinct competitive advantage for pros in our dedicated everyday pro pricing that both positions us highly competitively in the marketplace and makes it easier for pros to manage their projects. We're stocking more inventory at each local store to make it easier for pros to do business with us. We continue to see more pros transacting through our dedicated pro website, and we continue to invest in innovating this technology. A big thank you to the progress our pro team has made throughout the year. We're excited about the opportunity ahead. Second, build greater awareness of the LL flooring brand and drive more traffic. The physical rebranding of our stores has taken longer than we anticipated. We're pleased to report that as of today, we're largely complete with the store rebranding. New store openings also build awareness for the LL Flooring brand. In 2021, we opened a net 14 new stores, and to date in 2022, we've opened 15 new stores. We continue to see improvement in awareness of the LL Flooring brand, and we're excited about the potential to serve a larger audience of consumers and pros who want a high-touch, full-service offering at a great value. We're encouraged by our surveys from both pros and consumers who are familiar with our brand. These surveys show that the new LL Flooring brand scores significantly higher versus Lumber Liquidators on all attributes we measure, including product quality, a broad assortment of wood and wood-look flooring, and store associate expertise. And relative to the competition, LL Flooring is seen as a leader in flooring. It is rated highly on best wood and wood look flooring offerings and providing flooring expertise. On September 1st, we launched a new creative campaign that more sharply conveys the flooring needs met by LL, such as beautiful, high-quality flooring that stands up to the daily wear and tear from kids and pets and represents a great value. We're pleased to announce that 2023 will mark our 21st year of sponsoring the HGTV Dream Home. We're also broadening our network and connected TV presences across both linear and connected TV, and we're improving the effectiveness of our digital marketing spend and strategy. Third, we're focused on optimizing traffic conversion by continuing to improve the omni-channel shopping experience for our customers. Customer obsession is one of our core values. We are using Medallia, a leader in customer loyalty measurement, to inform us on a daily basis the voice of our customer. And this feedback allows us to identify opportunities to continuously improve the customer experience. We guide customers along their journey through a comprehensive omni-channel experience spanning our website, inside customer sales team, and our 439 stores located nationwide. This includes providing installation services through our network of professional, independent third-party contractors. Customers typically begin their journey on LLFlooring.com. Our website is designed to inspire customers and simplify a complex purchasing decision throughout our content, our picture and visualizer tool, and our free sample program. Through LLFlooring.com, many customers also engage with our inside sales team to help guide them through their decisions. The final step in the customer journey is one of our 439 stores located across the country. Associates represent the heart of a high-touch, high-service strategy. We continue to operate in one of the most competitive labor environments the U.S. has ever seen, And we're working hard to position LL Flooring as an employer of choice so we can attract, retain, and develop the best talent. To that end, we're investing in our associates in several ways. First, we offer extensive training programs to ensure a consistent high level of customer service, as well as programs that help our associates become managers and leaders within our company. Second, starting in 2021, we made wage adjustments to ensure our compensation is competitive in each market. Third, we've expanded promotion opportunities for our associates beyond the stores, including pro relationship, installation services, and inside sales positions. And fourth, We continue to leverage technology in our stores to help our associates inspire our customers in-store and manage processes such as installation. Our store associates are the front lines delivering our brand promise of providing an exceptional experience to customers every day. Taking a few minutes to speak to what we're seeing in the external environment. During the third quarter, we continued to battle sales headwinds from lower consumer spending, largely reflecting macroeconomic pressure such as inflation and increasing interest rates. We're seeing greater headwinds on spending at the more value-oriented price points. We expect external consumer pressures to persist throughout at least the end of 2022, and we will continue to monitor the macroeconomic environment. Taking a look at gross margin pressure, similar to the past few quarters, we were largely able to offset more than 800 basis points of inflationary pressures from higher material and transportation costs. We plan to continue to use pricing, promotion and our sourcing strategies to offset higher costs. but we will continue to monitor the impact of inflation on consumer spending and our ability to continue to pass on sufficient pricing to cover increased costs. With respect to sourcing, at the beginning of 2019, we made a concerted effort to better diversify our sourcing strategy to improve margins through vendor negotiations and alternative country sourcing that would lead to lower costs. Since then, our teams have made meaningful progress working collaboratively with our vendors to move sourcing to lower cost, lower tariff countries. As a result, we're pleased to report that we now import only 16% of goods from China, down from 48% in 2018 when the Section 301 tariffs were imposed. We view our diversified direct sourcing to be a competitive advantage versus independence. Another benefit of our direct diversified sourcing model is our ability to bring innovative trend-right products to market at a great value. A perfect example is Duravana, which is eco-friendly, waterproof, and scratch and dent resistant, delivering functionality for today's families in a range of beautiful designs. I want to congratulate our merchant and sourcing teams for executing our diversified product sourcing strategy. From a supply chain standpoint, we're pleased to have rebuilt our inventory levels after an extended period of supply chain constraints. Taking a look at current inventory levels compared to December 31, 2019, which represents a pre-COVID baseline for optimal inventory levels, the increase in our inventory reflects inflation and, to a lesser extent, higher units to support our growth strategies. We believe we've rebuilt a solid mix of quality flooring that is largely evergreen in nature. We're stocking more units of both flooring and accessories at our stores to support a concerted strategy to place inventory closer to our customers, particularly as we continue to further penetrate a pro-market opportunity. Inventory levels also reflect our expanded store count to 439 versus 419 at the end of 2019, and the introduction of new, innovative product lines that meet consumers' needs, such as waterproof, dent-proof, and scratch-proof flooring. We are pleased with what we're seeing in terms of international transportation costs decreasing from the peaks in 2021, assuming approximately two to 2.5 times per year turn of our inventory, we would expect these cost decreases to begin to benefit us towards the second half of 2023. With respect to SG&A, we continue to diligently manage our operating expenses and identify opportunities for further reductions in order to preserve profitability and liquidity while continuing to selectively invest in our long-term growth strategies. During the third quarter, we implemented cost savings measures, including a moderate reduction of headcount and a delayed cadence of hiring at our corporate office. We've also reduced the number of new store openings scheduled for 2022 to 18 from our original outlook of 20 to 25 stores. Our real estate team has built a pipeline of attractive potential new store locations and we will continue to monitor the macroeconomic environment to determine when to resume a more aggressive new store opening cadence. Despite our near-term caution on consumer spending, we feel good about the longer-term underlying strength in home remodel trends and the demand for hard surface flooring over the medium to long term. In addition, as our brand awareness increases, we're excited about our potential to serve a larger audience of consumers and pros who value a high-touch, full-service offering, including installation, at a great value. In summary, during the third quarter, while we were disappointed in our overall financial results, we delivered another strong quarter of sales to pros, and we believe we have a large opportunity ahead to grow our sales to pro customers. In the near term, our sales to consumers continue to be challenged, but we feel good about the long-term potential for growing sales to consumers as our awareness for the LL Flooring brand builds. We remain confident in our long-term strategy and unique value proposition, and everyone across our organization is laser-focused on executing our growth initiatives. We're navigating the near-term challenging business environment by managing our operating expenses diligently. And we have a strong balance sheet and liquidity to support our investments to position LL Flooring as the leading destination for hard surface flooring. I will now turn the call over to Nancy Walsh to share our financial details and outlook. Nancy?
spk05: Thanks, Charles. And good morning, everyone. Before I begin, I'd like to make sure everyone knows that I'll be discussing non-GAAP adjusted numbers today, which eliminates certain items that are not indicative of our core business results. Please refer to our third quarter results press release for more details. Turning to the third quarter results, I want to echo Charles' thank you to our associates for their tireless efforts to deliver an exceptional experience to our customers, even in the face of a challenging macro environment. Net sales of $268.8 million decreased to $13.4 million, or 4.8%, versus the third quarter of 2021. This was due to a 4.8% decrease in net merchandise sales and a 4.4% decrease in net service sales. We saw a 13.8% increase in our average ticket, primarily reflecting a higher merchandise average ticket. The average retail price per merchandise unit sold increased 13.4%. The higher average retail price was driven by pricing and promotion strategies, as well as favorable product mix, which primarily reflected the launch of our Duravana performance flooring brand. We saw a 21.1% decrease in transaction count compared to the same period in 2021, largely reflecting the decrease in sales to consumers. Third quarter 2022 comparable store sales decreased 7.3% versus the third quarter of 2021. Turning now to gross profit. Adjusted gross profit was $95.6 million in the third quarter of 2022 compared to $105.2 million in the third quarter of 2021. Adjusted gross margin was 35.6% for the third quarter of 2022 compared to 37.3% for the third quarter of 2021. The 170 basis point decrease primarily reflects significantly higher material and transportation costs, which were collectively up more than 800 basis points that we were able to partially mitigate through pricing, promotion, and alternative country and vendor sourcing strategies. Adjusted SG&A expense for the third quarter of 2022 was $99.8 million compared to $93.5 million in 2021. As a percent of net sales, adjusted SG&A for the third quarter of 2022 was 37.1%, an increase of 400 basis points from the third quarter of 2021. The increase primarily reflects increased investments in our growth strategies, such as new stores and investment in our customer facing and distribution center personnel, as well as deleverage on lower net sales. As Charles mentioned, even as we increase our investment and growth initiatives, we continue to maintain disciplined expense management and obtain savings that can be reinvested in growth. Adjusted operating loss in the third quarter of 2022 was $4.3 million, compared to adjusted operating income of $11.7 million for the prior year period. Adjusted operating margin for the third quarter of 2022 was negative 1.6%, a decrease of 570 basis points from the third quarter of 2021. The decrease in adjusted operating margin was due primarily to lower net sales, higher SG&A spend to support our growth initiatives, and increased gross margin headwinds. In the third quarter of 2022, we reported adjusted other expense of $646,000 compared to adjusted other expense of $18,000 for the three months ended September 30th, 2021. The increase in other expense was driven by interest expense on borrowings under our credit agreement in the third quarter of 2022, compared to no borrowings during the prior year period. In the third quarter of 2022, we recognized an income tax benefit of $1 million or an effective tax rate of 20.6%. This compared to income tax expense of $3.2 million or an effective tax rate of 27% for the third quarter of 2021. The lower effective tax rate in 2022 was due to the greater impact of permanent items on the pre-tax loss this year. We reported an adjusted net loss for the third quarter of 2022 of $3.9 million, which compared to adjusted net income of $8.5 million in the third quarter of 2021. Adjusted loss per diluted share of $0.14 compared to adjusted earnings per diluted share of $0.29 for the third quarter of 2021. Turning now to the balance sheet. We feel good about both the quality and the level of our inventory, which is largely evergreen in nature. Merchandise inventories at September 30, 2022 increased $111 million from December 31, 2021 to primarily due to increased purchases to replenish inventory, as well as, to a lesser extent, inflation. As Charles noted, compared to the pre-pandemic optimal levels in 2019, we are stocking more units of both flooring and accessories at our stores to support our concerted strategy to place inventory closer to our customers, particularly as we serve more pros. Our inventory levels also reflect our expanded store count of 439 versus 419 at the end of 2019 and the introduction of new innovative product lines that meet consumers' needs, such as waterproof, dent-proof, and scratch-proof flooring. Our balance sheet and liquidity remain strong. As of September 30, 2022, we had $134 million of liquidity comprised of $6 million of cash and cash equivalents, and $128 million of excess availability under the credit agreement. We ended the third quarter with $69 million outstanding on our credit agreement. The increase in debt versus the third quarter of last year reflects our use of cash for inventory purchases. For the first nine months of 2022, we used $124 million of cash flow for operating activities, primarily due to replenishing our inventory. Turning now to 2022. We continue to navigate uncertainty in the macroeconomic environment related to inflation, consumer spending, global supply chain disruptions, COVID-19, and a challenging labor market. As a result, we are not providing financial guidance today. We expect consumer spending headwinds to persist through the remainder of 2022. With respect to gross margin, we continue to expect the impact of higher transportation material costs over the turn of the inventory to be higher in 2022 versus 2021. The good news is that, as Charles mentioned, we expect the recent reduction in transportation costs to begin benefiting our gross margins toward the second half of 2023. In addition, our plan assumes we are able to continue to use pricing, promotion, and sourcing strategies to offset higher costs and there remains significant uncertainty around the impact of inflation on consumer spending and our ability to pass on sufficient pricing to cover increased costs. Turning to SG&A, we remain committed to making selective investments that are critical to driving long-term growth while reducing operating expenses where possible. As Charles mentioned, given the current macroeconomic environment, we have slowed our new store opening cadence. We expect to open 18 new stores this year, down from our original 20 to 25 stores. And we reduced headcount and slowed hiring in our corporate office while continuing to invest in pro and other customer-facing teams. Our 2022 SG&A investments and our long-term growth initiatives are primarily driven by opening 18 new stores, investing more in our customer-facing personnel, including our pro and omni-channel sales teams, and investing in technology and digital enhancements to improve the customer experience. The increase in spend to support these investments is more than offsetting our efforts to secure savings in our underlying business. As a result, we expect SG&A dollar spend and SG&A as a percent of net sales to increase in 2022 compared to 2021. From a capital allocation perspective, our balance sheet and liquidity are strong, supporting our plans for growth. We plan to invest CapEx in the range of $20 to $22 million in 2022 to support our growth initiatives, such as new store openings, and to complete our store rebranding, as well as to increase operational efficiency. In summary, our third quarter results reflected headwinds from the near-term consumer spending environment, which we expect will continue through 2022. We remain focused on investing in our strategies to support our long-term growth while maintaining disciplined expense management. And we have a strong balance sheet and liquidity to help us weather the current economic environment. Thank you all for your time this morning. With that, I'll ask the moderator to open the call to questions.
spk02: Thank you. If you would like to ask a question, please press star followed by one on your telephone keypad now. If you change your mind, please press star followed by two. When preparing to ask your question, please ensure your device is unmuted locally. Our first question comes from Laura Champagne from Loop Capital. Your line is open.
spk03: Thanks for taking my questions. I guess the first one is how urgent it seems to management to return to positive EPS, meaning this current quarter and future quarters, will you control SG&A expense so that you can be profitable in the P&L, or are you still considering growth investments the more important goal?
spk01: Yes, thanks, Laura. Good morning. First of all, I would say that we're looking at, you know, clearly the external environment and what is going to be the near-term health of the consumer. And as such, you know, we're taking a very hard look at all of the operating expenses in our business on the SG&A side, but just as importantly also on the gross margin side with obviously the inflation that's come through and now beginning to see relief on the transportation side that we expect to see margin impact flowing through the turn of the inventory through the back half of next year. So yes, we do have a sense of urgency and around all elements of our business, but we are going to stay focused on elements of our business that we believe fit with our strategy in terms of driving our business forward for the medium and long term. So whether we've made the investments in our pro business, and we're very pleased with the results we're seeing in the remix into pro, and new stores, and the portfolio of new stores that we can see opening in new and existing markets. So in the short term, very focused on EPS and our overall cost structure, but also balanced with where we believe the health of this brand can grow to being a unique value proposition in the marketplace.
spk03: Got it. In a related question, do you have a look on how many stores you think it makes sense to launch next year?
spk01: We're in the middle of reviewing a whole final plan for next year, so we're not prepared to outline that today. We will open more stores this year than we opened last year, and we're pleased with our overall new store portfolio.
spk03: Okay, but any sense on whether store openings will be up or down next year? Is it just too soon to announce?
spk01: It's too similar for us to give a number. Normally, we would indicate that in the first quarter. Got it. Thank you.
spk02: This concludes our Q&A. I'll now hand over to Charles Tyson, President and CEO, for final remarks.
spk01: Thanks, everyone, for joining us today. I want to thank our associates again for their hard work and dedication. While the near-term operating environment remains challenging, We're excited about our long-term growth opportunities. Wishing everyone good health and safety, and we look forward to updating you on our performance next quarter. Thank you.
spk02: Today's call has now concluded. We'd like to thank you for your participation. You may now disconnect your lines.
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