LL Flooring Holdings Inc
NYSE:LL
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LL Flooring Holdings Inc
Earnings Call Analysis
Summary
Q3-2023
In the third quarter, net sales decreased by 19.7%, driven by fewer transactions and reduced spending by professional and consumer customers. Gross profit dropped by 28.3% due to an unfavorable anti-dumping duty adjustment on imports from China, costing the company $10.7 million extra in duties and $5.5 million in interest. The company is also dealing with customs detentions under the Uyghur Forced Labor Prevention Act (UFLPA), which, including other related expenses, incurred $7 million in the first 9 months. SG&A expenses were down due to cost savings and lower variable costs, but as a percentage of net sales, they increased due to lower sales volume, which led to a significant operating loss of $29.6 million. Given the ongoing macroeconomic uncertainty, the company is not providing financial guidance at this time.
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Good morning or good afternoon, and welcome to the LL Flooring Q3 '23 Earnings Call. My name is Adam, and I'll be your operator for today. [Operator Instructions]
I will now hand the floor to Bruce Williams of ICR to begin. Bruce, please go ahead when you are ready.
Thank you, operator. Good morning, everyone, and thank you for joining us. Today, I'm joined by Charles Tyson, our President and Chief Executive Officer; Bob Madore, Chief Financial Officer; and Andrew Wadhams, Senior Vice President, Retail and Commercial Sales.
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 in its forward-looking statements are reasonable, it can give no assurance that such expectations of 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 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. The information contained in this call is accurate only as of the date discussed.
Now I would like to turn the call over to Charles. Charles?
Thank you, Bruce. Good morning, everyone. Joining me today are Bob Madore, our Executive Vice President and Chief Financial Officer, and Andrew Wadhams, our Senior Vice President of Retail and Commercial Sales. During today's call, we will review our third quarter results and discuss progress on our key strategic initiatives as we work to position ourselves for long-term sustainable growth.
Turning now to the quarter. We're disappointed in our third quarter results, which continued to be negatively impacted by the macroeconomic environment as well as internal challenges that we're focused on as we execute against our strategic initiatives. We've made progress on these initiatives, and we believe each initiative will improve sales productivity and profitability long term.
We reported comparable store sales down 20.5% year-over-year for the quarter. Our decline in comparable store sales was due to continued slow traffic as we believe consumers are pressured by elevated interest rates, inflation and weakened existing home sales. In addition, we saw less spending per flooring project by both consumers and pros as the average square footage project size continued to decline.
We're still working through our brand awareness challenges from our transition to LL Flooring, as well as inconsistent performance across our store portfolio. I'm really excited by the recent additions to our leadership team. We're targeting these areas, which we will discuss in more detail shortly. We've already begun to see improvement in our Net Promoter Score quarter-over-quarter, which Andrew will expand upon further.
For the quarter, we reported an adjusted operating loss of $17.1 million or 7.9%, primarily reflecting lower sales volumes, partially offset by efficiencies created by our new Dallas distribution center, and restructuring cost savings.
In August, the Board announced that they will be evaluating strategic alternatives to maximize shareholder value. The strategic review is underway and I will not be providing an update or taking questions on it today. My priority and our management team's priority remains focused on executing against our long-term strategic initiatives and providing a differentiated flooring experience to our customers to significantly improve our performance.
We remain committed to and continue to execute on our brand transformation and our 5 strategic initiatives, which are: focus investments on our top growth priorities; grow brand awareness; drive product innovation; and ensure a consistent customer experience; and improve operating efficiencies.
I believe that we're seeing promising signs that our strategic initiatives are starting to improve our capabilities. And this gives us confidence that we will return to growth as the economic environment improves, and, in the long term, regain share in what we believe will be a growing industry that's driven by long-term tailwinds from hard surface flooring, and remodels driven by aging housing stock, increased household formation and rising home values.
First, we're focusing investments on our top growth priorities to drive sales, including further harnessing the capabilities of our customer relationship management, CRM, system to generate more opportunities, expanding our carpet offering across our store portfolio and delivering exceptional service to the Pro customer. Our national rollout of CRM to all stores for Pro customers was successfully completed in the third quarter.
CRM is designed to create visibility to Pro buying preferences, enabling us to communicate messages that customers value and ultimately deepen our relationship with Pro partners and improve the ease of doing business with LL Flooring.
While early in its implementation, we've seen encouraging user-generated leads and conversion from those leads, indicating the right conversations taking place between the associates and Pros, and we can now track and drive conversion much more effectively. We remain on track to roll out CRM capabilities for our non-Pro customers by the end of the year. We expect that we'll gain greater visibility into the sales cycle, and we'll engage with our customers earlier in the buying process and more consistently to have a higher probability of converting those customers.
During the quarter, we extended our carpet pilot to 61 stores, and we expect to have carpet at 84 stores by the end of the year. We're pleased with the early results that we're seeing in these stores, as our goal to be a one-stop destination for complete flooring solutions is resonating with both Pros and consumers, with a strong percentage of carpet transactions, including both a hard and soft surface purchase.
We expect to improve our carpet trajectory as stores mature, as we learn more about how to optimize carpet sales and as we turn on the marketing of carpet, as carpet becomes more widely available in our system. Carpet is now fully supported on our website for those regions carrying it. We are not yet benefiting from the broad advertising of our carpet addition, and we're awaiting greater geographic coverage before doing so.
Through the growth of our carpet pilot, we're further expanding our addressable market, without requiring inventory investments, by having the product shipped directly from the manufacturer to the installer. We started our journey in the first half of the year in 3 major metro markets and are now in 7 major metro markets. As we expand the additional markets, we're generating learnings with each new market opening stronger than the initial markets. We intend to continue our carpet expansion throughout 2024, targeting 52 additional stores in Q1 of 2024.
While we saw a sequential deceleration in our Pro sales due to the market headwinds in renovation and remodel activity, we believe that implementation of our CRM system will equip our associates to drive our Pro business differently as market conditions normalize. CRM enables a structured pursuit of Pro business that focuses on proactive communication to our customers, driving more opportunities for our store and sales teams to serve. This new process allows us to offer a higher level of service to our Pros by better understanding their project lead times and requirements, and being able to work with them on a real-time basis to plan their future projects.
We recently launched CRM outreach campaigns to a targeted segment of high potential Pros and have seen encouraging results. We'll continue to deploy tactics connecting our store associates and marketing messages to our customers to drive higher retention. We believe the impact of CRM to build slowly each quarter as our associates learn how to maximize the use of it. We will also continue to expand our focus with national restoration accounts by launching several pilots in Q4, which we expect to drive new Pro business as we move into 2024.
Second, we're focusing on increasing brand awareness. We remain focused on enhancing our omnichannel brand campaign as we continue to focus on growing our brand awareness, led by a new Chief Marketing Officer, Laura Massaro. We are making targeted adjustments to our marketing allocations to ensure the most effective deployment of our resources to drive customer acquisition and conversion.
At the end of June, we launched a fully integrated campaign to break through the clutter of the category and drive traffic. We believe our marketing initiatives are creating a pipeline for potential future sales by driving high-value actions like free samples and installation assessments, which have a strong correlation with sales.
The marketing team has begun to generate opportunities from our investments in CRM and our customer data platform to improve media efficiency, personalization and focused targeting as we shift spend from traditional channels to cost-effective digital channels to drive better reach and engagement. CRM will allow us to deploy marketing at the right time and the right place, allowing us to promote products and services that customers may need at the ready.
Third, we're innovating new products. We believe brands that are innovating and creating new products will win in the long term, and we continuously build on the strengths of our merchandising and sourcing teams to enhance our product offerings. Duravana waterproof hybrid resilient flooring has been successful as a premium offering to our Pro and consumer customers with its waterproof, dent-resistant, scratch-resistant and eco-friendly PVC-free features. And we'll continue to invest in the brand and plan to further expand our product assortment through year-end.
We're also excited to expand our PVC-free vinyl products offerings through ReNature by Coreluxe in Q4. ReNature is designed with 25% recycled materials. Waterproof protection against everyday spills. Realistic looks with up to 30 unique plank patents. And a DIY-friendly click locking installation. This innovative flooring takes a step towards a brighter future, representing the pinnacle of style, performance and responsible manufacturing.
Fourth, to discuss how we're ensuring consistent customer experience across our omnichannel network, I'm joined by one of those key senior leadership additions, Andrew Wadhams, our Senior Vice President of Retail and Commercial Sales. Andrew brings 15 years of perspective and expertise to our team regarding defining our brand offering, aligning and streamlining practices, and deepening connections to customers. Andrew, can you describe why you joined LL Flooring, what you've discovered to date, and what you are most excited about?
Thanks, Charles. I was initially drawn to LL Flooring because I saw a strong value proposition focused on delivering high-touch service for both Pros and consumers. During my due diligence, I was excited by the positive feedback I heard from customers and the passion I felt around our high-quality portfolio of products. Now I'm excited to add my experience to inform and drive our high-touch oriented approach and create a superior customer journey that will further differentiate our brand and enable us to deliver on our vision to become the customers' first choice for hard and soft surface flooring.
During my first 120 days here, we've been focused on simplifying processes, developing our teams, and implementing and executing on our key initiatives. I want to thank the retail team for welcoming me, providing candid insights to accelerate my understanding, and their receptiveness to new ideas around transforming our sales processes and business trajectory.
During Q3, we saw consistent improvement in our NPS scores over Q2, validating that our work is resonating with our customers. While productivity and consistency across all stores continues to be below our expectations, we continue to refine our processes and invest in the activities our customers value most.
We're simplifying the customers' e-commerce experience by making it easier to engage with us earlier in the sales cycle. During Q3, we increased our in-home flooring assessment appointments by 25.6% over Q2. The customers need help with their online chats or checkout, our call center agents are here to help them making real-time updates to their order through shared cart functionality to deliver a seamless experience.
We've taken a leader-led approach to our key initiatives around CRM deployment. We elected to stagger our rollout across our stores to leverage key learnings, remove friction, and to enlist our pilot teams to cross-train their peer stores. While our teams are still learning to leverage this powerful tool, the rate of adoption and demonstrated competency in our CRM system is highly encouraging.
Through this first-person, leader-to-leader and peer-to-peer approach, we're driving the CRM pipeline behaviors that result in a higher value-added, customized approach to help us better serve and understand our customers. I expect the impact of CRM to build gradually as it becomes a natural part of our selling process and we learn to fully leverage CRM.
Finally, we continue to make investments to develop, train and retain our talent in support of our selling model. We're deeply focused on providing comprehensive flooring solutions to Pros and consumers all while delivering an exceptional customer experience. Further, we continue to reinvest in training to maintain a highly consultative and well-educated sales force across all our stores.
120 days in, I'm happy to confirm that my assessment of the opportunity with LL Flooring was correct.
Thank you, Andrew. Fifth, we're driving operational efficiencies through real estate optimization, supply chain improvements and a focus on working capital initiatives. Since we initiated a strategic review of our cost structure earlier this year, we identified $15 million of annualized savings and have achieved $7.3 million of realized savings year-to-date, with $3.7 million of those savings realized in the third quarter.
We're on track to open 3 stores for the year and with no current planned new store openings for 2024. We regularly review our store portfolio for profitability and cash flow. In the third quarter, we implemented a new, more disciplined approach through which we identified 8 underperforming stores which we will be closing in 2023 and early 2024. We have flexibility in the ability to make decisions within our real estate portfolio based on lease tenure, with approximately 49% of our store leases becoming available for renewal or expiring in the next 3 years.
Turning to our supply chain. I'd like to congratulate our supply chain teams in distribution, operations, transportation and logistics for successfully launching our new Dallas distribution center on time in the third quarter, which is now shipping effectively to 20% of our store network. We successfully negotiated all our carrier contracts to incorporate the Dallas distribution center with the initial benefits reflected in our gross margin improvement this quarter.
We're also excited to improve our service levels by providing product to customers in the middle of the country faster, while at the same time making our network more efficient and cost effective.
To mitigate disruptions from the impact of the Uyghur Forced Labor Prevention Act on vinyl flooring, we've diversified our supply chain through the addition of new vendor partners in different geographical locations, while at the same time launching new PVC-free product decors with expanded enhanced features and benefits.
While we have leveraged a much more balanced supply chain that will allow flexibility and create long-term benefits as we scale, the benefits will be moderately offset by gross margin headwinds going into 2024. We're pleased with the work we've done, and we will continue to strive to provide the best supply chain operations in the industry.
We remain focused on maintaining our strong inventory management practices to benefit our overall working capital, which Bob will discuss further. I will now turn the call over to Bob to share our financial details and outlook. Bob?
Thanks, Charles, and good morning, everyone. Today, I'll walk through key metrics pertaining to our third quarter results, and then I will discuss how we're approaching the final quarter of the year. I will be discussing certain non-GAAP adjusted numbers today, which eliminate certain items that are not indicative of our core business results. For full details regarding our financial results, please refer to our earnings press release on the Investor Relations section of our website.
For the third quarter, net sales of $215.8 million decreased 19.7% or $53 million versus the prior-year period, driven by a decline primarily in sales to consumers and, to a lesser extent, declines in our Pro segment. Comparable sales decreased 20.5% year-over-year, driven by 18.9% decline in transactions and a 1.6% decline in average ticket. Average retail price per merchandise units sold remained flat compared to the third quarter in the prior year.
During the quarter, we opened 1 new store, bringing our total store count to 443.
Gross profit of $68.5 million decreased 28.3% or $27.1 million compared to the third quarter of 2022. And gross margin of 31.7% decreased 390 basis points compared to the same period last year. The decrease in gross profit, and margin, was driven by an unfavorable $10.7 million 2012 to 2013 antidumping duty rate change and a $1.6 million in incremental cost of goods sold related to customs detentions on certain vinyl flooring products from Asia.
In September of 2023, the company received notice from the Department of Commerce that its imports of multilayered hardwood from China for the antidumping review period of December 1, 2012 to November 30, 2013 would be assessed at a 49.84% company-specific rate instead of the 3.92% weighted average rate published in the Federal Register. The change from the published weighted average rate to the company-specific antidumping duty rate was substantial, resulting in a $10.7 million adjustment to cost of sales and an additional $5.5 million in interest. The company tendered $15.7 million to U.S. Customs and Border patrol in the third quarter and accrued an additional liability of $500,000.
As indicated in our consolidated financial statements, we have seen both favorable and unfavorable rate adjustments for antidumping and countervailing assessments on multilayered hardwood shipments from China throughout the 2011 to 2020 reviews. Looking at our historical experience, this large of a rate change is highly unusual. Further, for the remaining open periods of antidumping and countervailing reviews, we believe there is minimal risk of a rate assessment at a material different rate from the finalized weighted average rates accrued.
[ In 2013 ] we incurred $1.8 million of incremental expenses related to the Uyghur Forced Labor Protection Act, which included demurrage, storage, transportation and legal expenses. For the 9 months ended September 30, 2023, incremental expenses related to the UFLPA were $7 million.
As Charles discussed, we are pleased with the work our supply chain team has done to mitigate the disruptions by leveraging our sourcing capabilities. We are rebuilding SKUs in the vinyl category, and we expect to have normal levels of inventory in that category by year-end.
Despite our robust compliance program and mitigation efforts, we continue to see a small number of shipments from additional vinyl vendors being impacted by UFLPA holds. We are unable to predict whether other vinyl foreign shipments will be impacted in the future and whether this issue could have further material impacts on sales and margins as we progress throughout the fourth quarter and into 2024.
Excluding the 2023 charges related to antidumping duties and vinyl delays, adjusted gross profit of $80.9 million decreased $14.7 million, and adjusted gross margin of 37.5% increased 190 basis points compared to the same period last year. The decrease in adjusted gross profit is driven by a decrease in transaction count, reflecting lower spending by Pros and consumers, while the increase in adjusted gross margin primarily reflects straight cost relief and the sourcing team's agility in finding alternative country vendor sourcing strategies.
As we continue to realize the benefits from the Dallas distribution center and leverage our balanced supply chain as we scale, we will continue to work to maximize customer delivered value through reinvestment of a portion of these cost savings into pricing, promotion and sourcing strategies, as well as product innovation.
SG&A expense of $98.1 million was 45.5% as a percentage of sales, compared to $99.7 million or 37.1% of net sales in the third quarter of 2022. The decrease in SG&A and adjusted SG&A expense was due to restructuring cost savings and lower variable costs due to lower sales volumes, partially offset by the investments we're making to generate long-term sales growth such as the Dallas distribution center and store closure costs. The increases in both SG&A and adjusted SG&A expense as a percentage of net sales were due primarily to expense deleverage from lower sales volumes.
Other expense of $6.4 million increased $5.7 million compared to the prior-year quarter, reflecting the $5.5 million interest charge related to the anti-dumping adjustment. Excluding the interest charge related to the anti-dumping duty rate change, adjusted other expense increased $0.2 million to $0.9 million for the quarter.
As a result, third quarter operating loss was $29.6 million, compared to an operating loss of $4.1 million in the prior year. Adjusted operating loss, a non-GAAP measure, was $17.1 million, compared to $4.3 million last year. And third quarter net loss per share was $1.25, compared to $0.13 last year. Adjusted loss per share, a non-GAAP measure, was $0.78, compared to $0.14 in the prior year period.
Now turning to our quarter-end balance sheet and cash flow. We continue to be focused on identifying further efficiencies and further improving our inventory management practices to yield continued improvements in our overall working capital.
In terms of liquidity, we believe that our balance sheet positions us to navigate the challenging macro environment. We ended the quarter with $120.2 million in liquidity, comprised of $10 million in cash and $110.2 million of availability under our revolving credit facility. The $110.2 million of availability under the credit agreement as of September 30, 2023, represents a decrease of $14.6 million from $124.8 million of availability as of December 31, 2022.
We are pleased with our working capital management and its contribution to operating cash flow. As of September 30, 2023, there was $77 million outstanding under the revolving credit facility, compared to $72 million as of December 31, 2022. Our net cash flow provided from operating activities for the first 9 months of the year was $8.4 million, driven by sell-throughs of higher-cost merchandise inventories and reduced inventory purchases. Merchandise inventories decreased approximately 14.9% or $49.7 million from December 31, 2022. CapEx was $14 million year-to-date, which primarily reflects our investment in our strategic initiatives, including our carpet expansion and the successful opening of the Dallas distribution center in Q3.
As we look to the remainder of the year, we expect to continue to navigate uncertainty in the macroeconomic environment due to low consumer confidence, inflation, an elevated interest in mortgage rate environment, and lower existing home sales. As a result, the company is not providing financial guidance at this time.
The company expects full year revenues to continue to be challenged due to macro uncertainty. Despite these cyclical factors, we remain focused on executing against our strategic initiatives, such as the expansion of CRM, carpet and service of the Pro customer, and believe our strategy to increase brand awareness and deliver a more consistent end-to-end customer experience across our omnichannel network will gain traction and drive profitability.
We are encouraged by the work we've done thus far to optimize our store portfolio, simplify our processes using CRM, and leverage supply chain flexibility through alternative sourcing strategies, and our new Dallas distribution center. We remain focused on identifying further efficiencies and further improving our inventory management practices to yield continued improvements in our overall working capital, and reinvest in activities our customers value most, including pricing and promotion strategies and product innovation.
Further, we continue to recognize savings from our strategic review of our cost structure, and we will prudently manage expenses and focus on aligning our cost structure with our current rate of sales to preserve profitability.
In terms of capital expenditures, we expect to spend approximately $20 million in 2023, primarily to support our strategic investments, including the Dallas distribution center, carpet rollout, and CRM.
With that, I'll turn the call back over to Charles.
Thanks, Bob. In conclusion, we continue to navigate uncertainty in the macroeconomic environment due to low consumer confidence, inflation and elevated interest and mortgage rate environment, and lower existing home sales. Despite external headwinds, we remain confident in our ability to deliver the high-touch service of an independent flooring retailer combined with the value, assortment and confidence of a national brand.
We're confident in our ability to execute on our strategic initiatives, focusing on continuing the implementation process of our CRM platform to drive both Pro and consumer sales, increasing our brand awareness, enhancing our product offerings by innovating products and executing on our corporate initiatives, while continuing to leverage our strategic sourcing efficiencies to deliver value to our customers.
We are continuously working to improve store performance through simplifying store operations execution, building great teams and driving our key sales initiatives. We believe our investments and our strategic initiatives will position us for long-term growth in an industry that benefits from both long-term tailwinds due to aging housing stock, increased household formation, and rising home values.
With that, I will now turn the call over to the operator for questions.
[Operator Instructions] And our first question comes from Laura Champine from Loop Capital.
I think you commented that the new Dallas DC is serving 20% of stores. Is that the plan or will there be more stores added to that network?
Laura, thanks for the question. Over time this is allowing us to realign our network. And so Dallas is significantly helping us improve service to particularly Texas, which is a high potential market. But it will allow us to add additional stores based on the capacity we have over time as we align on our longer-term supply chain strategy.
Got it. And then on the -- but for now, it sounds like 20% is correct and that will grow over time. Is that a fair characterization?
That's correct. That's correct.
The stores that are closing, the 8 stores that are closing, were those unprofitable stores? What were the hurdles that those stores did not cross?
Yes. Those -- the majority were unprofitable stores and the small number of the stores were stores that just were not fulfilling our strategic priorities, and kind of had -- outlived their usefulness, but the majority were unprofitable stores.
So Laura, on a previous call, we said we were doing a strategic review of our whole real estate portfolio. Since Bob has come in, he's been deep into that work. And that's part of the output of the work that we're doing.
I do think it's important, as Bob stated, we have certain stores that just don't meet brand standards. Some of them are just not the kind of locations that are appealing to the focus customers that we're targeting, both on the Pro and the consumer side. And so that's the reason that we accelerated the closing of these 8 stores.
We have no further questions. So I'll hand the call back to the management team for any concluding remarks.
Thank you, operator. Thanks, everyone, for joining us today. I want to thank all our associates again for their hard work and dedication executing on our strategic initiatives and navigating our business in a challenging macro environment. We'll continue to operate with discipline and believe that the execution of our initiatives will drive long-term sustainable growth as the cycle normalizes.
I wish everybody good health and a happy Thanksgiving. And we look forward to updating you on our performance next quarter. Thank you.
This concludes today's call. Thank you very much for your attendance. You may now disconnect your lines.