LL Flooring Holdings, Inc. (NYSE:LL) Q2 2023 Earnings Conference Call August 9, 2023 8:00 AM ET
Bruce Williams – ICR
Charles Tyson – President & Chief Executive Officer
Bob Madore – Chief Financial Officer
Andrew Wadhams – Senior Vice President Retail & Commercial Sales
Conference Call Participants
Laura Champine – Loop Capital
Hello, everyone, and welcome to the LL Flooring Second Quarter Earnings Conference Call. My name is Bruno, and I’ll be I’ll be operating your call today. [Operator Instructions]
I will now hand over to your host, Bruce Williams from ICR. Please go ahead.
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 US 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. Investors should not assume that those 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?
Thank you, Bruce, and good morning everyone. I want to welcome you to the LL Flooring’s second quarter earnings call. Joining me today, we have Bob Madore, our new CFO; and Andrew Wadhams, our new Head of Retail and Commercial Sales. During today’s call, I will begin by reviewing our second quarter results then Bob will take you through our financial results and then I will discuss progress on our key strategic pillars, including updates on our plans to improve sales productivity and profitability, which gives us confidence in achieving long-term sustainable growth.
Turning to our second quarter results. Our second quarter performance was below expectations and primarily reflected the continued impact of the difficult macro backdrop on home improvement spending. Weakness in discretionary categories driven by macroeconomic uncertainty, inflationary pressures and restrictive financial conditions have been headwinds for home improvement spending.
Looking ahead, there remains meaningful risk of slower spending trends due to these macro factors. In addition, we continue to experience pressure from our lower brand awareness as we continued on our transition to LL Flooring. This is combined with some operational opportunities which I will detail later. While our near-term results have been challenged we remain focused on executing against our long-term strategic pillars and providing a differentiated flooring experience to our customers.
To that end, I want to thank our field organization, supply chain and corporate team members, who are working hard to execute against our strategic initiatives. In addition, we recently announced several new critical hires within our senior leadership team, including Bob Madore, CFO who has over 30 years of retail, finance and executive experience focused on driving growth as well as optimizing costs and cash flow.
Laura Massaro, our Chief Marketing Officer who has built successful marketing campaigns to drive brand awareness at several leading global brands. And Andrew Wadhams, Senior Vice President of Retail and Commercial Sales who has extensive experience leading sales efforts and delivering extraordinary customer experience.
I believe that, these important hires in key strategic roles strengthen our team and provide us with leadership talent to successfully execute on our five strategic initiatives, which are; one focus investments on our top growth priorities; two, grow brand awareness; three, ensure a consistent customer experience; four, improve operating efficiencies; and five, drive product innovation. We continue to execute on these areas, which I’ll discuss shortly.
Turning to the quarter. Net sales declined 20.9% and comparable store sales were down 22.2%. These results were driven by a decrease in transaction count, reflecting lower spending by consumers versus last year combined with a decline in Pro sales.
As mentioned earlier, we believe the lower consumer sales largely reflected continued macro pressure, that’s been impacting bigger ticket discretionary spending. In addition, we saw less consumer spending on flooring projects as the average square foot project size declined sequentially.
In addition, while average selling prices increased during the quarter, we made strategic price investments in select categories in order to reemphasize our value equation that we’re well known for. I think it’s important to note that LL Flooring continues to score very high on value which is very important to consumers in this high inflationary environment.
In regard to our product segments, our best-selling category remains within our premium segments driven by the strength of our Duravana brand. For the quarter, operating loss was $20.5 million and adjusted operating loss was $17.6 million.
Now I will turn the call over to Bob, to review our second quarter financial results in more detail.
Thanks Charles and good morning everyone. By way of introduction, I have an extensive retail background and have over 30 years of public company management, finance and accounting experience, where I’ve led cross-functional teams focused on driving profitability and cash flow.
First I’d like to say that, I’m very excited to have joined the LL Flooring team. It’s been a very busy and productive month getting to know the business. While the Q2 results were again impacted by the challenging macro, the entire team is committed to driving improved performance.
Now turning to our results. Today, I’ll focus on the key highlights of our second quarter results and then I’ll discuss how we’re approaching the remainder 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 second quarter, net sales decreased 20.9% 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 22.2% year-over-year.
Drilling down on the second quarter sales drivers, average retail price per merchandise units sold increased 3.6%, compared to the second quarter of 2022 offset by 21.9% decline in transactions and a 0.3% decline in average ticket.
During the quarter, we closed one store bringing our total store count to 442. Gross profit of $84.5 million decreased $22.2 million, compared to the second quarter of 2022 and gross margin of 35.8% increased 10 basis points, compared to the same period last year.
Gross profit for the second quarter of 2023, included $2.4 million in incremental costs related to customs detentions on certain vinyl flooring products from Asia. Gross profit for the second quarter of 2022, was also impacted by the net of antidumping and countervailing duty rate changes of $1.2 million.
Excluding these 2023 and 2022 charges adjusted gross margin a non-GAAP measure of 36.7% increased 60 basis points, compared to the same period last year. The increase in adjusted gross margin primarily reflects the company’s ability to offset higher material and transportation costs through pricing, promotion and alternative country vendor sourcing strategies.
As we’ve said previously, we expect to see continued gross margin improvement as we realize the anticipated benefits from freight cost relief beginning in the second half of the year. SG&A expenses of $105 million increased $2.9 million, compared to the second quarter of 2022. Adjusted SG&A a non-GAAP measure was approximately $104.5 million or 44.2% of net sales, compared to $102.1 million or 34.1% of net sales in the prior period. The increase in rate was due primarily to expense deleverage from lower sales volumes.
In addition, operating expenses were higher due to investments we’re making to generate long-term sales growth, as well as investments in store labor as we focus on retaining talent. Q2 operating expenses were partially offset by restructuring cost savings and lower variable costs due to lower sales.
As Charles mentioned earlier, we’re focused on aligning our cost structure to our revenue run rate. During the second quarter, the company established a full valuation allowance of $23.2 million against its net deferred tax assets as it is presently deemed more likely than not that the benefit of such net tax assets will not be utilized. Due to recent cumulative losses, the company did not rely upon projections of future taxable income in assessing the recoverability of deferred tax assets. The valuation allowance was recorded as a non-cash adjustment in the second quarter of 2023.
As a result, second quarter operating loss was $20.5 million compared to operating income of $4.7 million in the prior year. Adjusted operating loss, a non-GAAP measure was $17.6 million compared to adjusted operating income of $5.9 million last year. And second quarter net loss per share was $1.35 compared to earnings per share of $0.09 last year. Adjusted loss per share, a non-GAAP measure was $1.28 compared to an adjusted earnings per share of $0.13 in the prior year period.
Turning to our quarter end balance sheet and cash flow. Inventory declined approximately 13.9% from December 31, 2022 and declined 20.3% year-over-year driven by sell-through of higher cost inventory. Our inventory balance as well as effective management of our accounts payable reflect our continued focus on managing working capital conservatively in this macro environment. We ended the quarter with $145.5 million in liquidity, comprised of $7.7 million in cash and $137.8 million of availability under our revolving credit facility.
Our net cash flow provided from operating activities for the first six months of the year was $39 million driven by lower inventory levels. We are pleased with our working capital management and its contribution to our operating cash flows. CapEx was $5.1 million for the quarter, which primarily reflects the investment in our Dallas distribution center that is scheduled to open in the third quarter.
Now, let me turn to my comments to the outlook for the remainder of 2023. Given the challenging macro backdrop and the customs disruptions on certain vinyl flooring products, we continue to expect sales visibility to remain limited for the balance of the year. Despite these factors, we remain focused on executing against our strategic initiatives and we believe our strategy to increase brand awareness and deliver a more consistent end-to-end customer experience will gain traction and drive store productivity.
Gross margins are expected to improve year-over-year with a stronger second half, driven primarily by a reduction in international shipping rates and sourcing costs as well as a greater mix of our premium Duravana brand, which carries higher margins. We will continue to be cognizant of the competitive pricing environment to form our pricing and promotion strategies.
SG&A dollar spend and SG&A spend as a percentage of sales are expected to increase year-over-year, primarily due to inflationary pressures on wages and benefits, investments in our customer relationship management platform, which we expect will support higher sales levels and make our operating structure more efficient over time and investments in our new distribution center.
In light of the challenging environment, we are prudently managing expenses and are looking for ways to align our cost structure with our current rate of sales to preserve profitability. To that end as we previously mentioned, we have engaged consultants to undergo a comprehensive strategic review of our cost structure.
In terms of capital expenditures, we continue to expect our 2023 spend to be in the $15 million to $20 million range primarily to support our third distribution center, productivity investments, maintenance CapEx and store openings.
As a reminder, we prudently moderated our store opening plans to only three stores for this year. In summary, our second quarter results were again impacted by the challenging macro environment. And while we expect these headwinds to persist, our team will be focused on driving profitable revenue, cost optimization, continued working capital improvement and optimizing our real estate portfolio.
As such, we are confident in our team’s ability to continue to navigate and mitigate the impact of the difficult backdrop.
With that, I’ll turn the call over to Charles to discuss our progress for our strategic initiatives as well as a few closing remarks.
Thanks, Bob. 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 convenience of a national brand. To that end, we continue to focus on our five strategic initiatives that we expect will improve sales productivity and profitability as well as deliver long-term sustainable growth.
I will now provide an update on our progress of each. First, focusing investments to drive sales. Our key investments to drive sales are led by increasing our Pro penetration as our Pro sales strategy remains a core long-term growth pillar for LL. We again saw a decline in the Pro category in Q2 and we believe this is largely reflective of the impact the difficult macro backdrop is having on consumer demand for Pro projects.
Nevertheless, we remain very confident in our build-out of a robust Pro value proposition. We’re developing capabilities aimed at driving increased retention and scale with existing Pros. And we’re pleased that our efforts paid off as we experienced a year-over-year increase in retention.
We’re working diligently to increase the number of new Pro customers to enter the brand. And to that end, we believe that implementing our new CRM platform will be an integral part in helping to achieve these goals.
Currently, our associates have to work in multiple systems to drive, manage and convert customer leads which are too complex and too manual for us to optimize our customer database. As an example, the number of customers that are sampling products which is a leading indicator of future sales have been relatively stable year-over-year. However, because we lack an end-to-end view of the customer, we have limited information on how and when to follow-up and do not know where that customer is on their purchase journey.
We believe that implementing our CRM platform will fundamentally change the way we’re working at LL and lead to potentially higher conversion. Our new CRM platform not only ensures a single repository of key customer information so we know how best to meet their needs and wants, but also triggers for future contact points during their shopping experience.
As such, we will now have deep visibility into the sales cycle and we’ll have a platform in place to monitor opportunities and measure conversion by store. This includes leveraging the right information at the right time with the right resource to ensure we offer our customers the personalized experience that exceeds their expectations.
So in that sampling example that I referenced earlier, a customer can order a sample online and wants in the store the store manager will now have visibility into that customer’s activity and can focus their attention on converting that customer into a sale.
We believe that having the customer insight data will significantly ease the store’s execution of how to track the customer’s journey and measure the effectiveness of converting that customer. We’ve made it our priority that our entire store teams focus on understanding each customer’s unique story and project objectives.
And our new CRM platform is helping streamline this process for both Pro and consumer. The CRM pilot is in 18 stores and is currently focused on our Pro business. The national CRM rollout to all stores for Pro is targeted during the middle of Q3 with the consumer rollout to be completed by early Q4.
Second increased brand awareness. We’ve seen that through the LL Flooring brand, we broaden our appeal as a national flooring destination offering a one-stop shop for consumers who are seeking exceptional expertise and curated selections at a price to match any budget. Our market research also continues to validate that our brand scores high on these key metrics. This combination of selection expertise, product assortment and value will allow us to drive differentiation and stand out in the market.
Our new tagline, Every Step Covered and fully integrated campaign has debuted helping us to break through the clutter of the category and drive awareness and consideration for our brand. By activating the investments, we’ve made in new technology including CRM, we continue to make progress on our personalization road map. This will allow us to invest in segments that are more closely aligned to our go-forward brand strategy with a significant near-term focus on our Pro marketing activation efforts.
As we said before, our unaided brand awareness remains low. However, we believe that these initiatives will allow us to gain traction by driving traffic and increasing conversion to improve our sales performance over the long-term. I’m excited about the hiring of Laura Massaro, our new Chief Marketing Officer and look forward to activating our marketing strategies to broaden and grow awareness of our brand.
Third, improving the customer experience through field operations and stores. Our primary focus has been on improving talent retention and training, as we continue to transition to a selling model that’s focused on providing comprehensive flooring solutions to Pros and consumers. To that end, we continue to reinvest in training to develop a highly consultative and well-educated sales force.
While we’re making progress, there is still more work to do on improving retention. However we’re encouraged that we’re seeing an improvement in the customer experience through improving NPS scores, as we continue to focus on associate training to provide value-added customer service. Second, we have a significant opportunity to improve the productivity of underperforming stores. Our focus is to drive consistent execution across these stores.
And Andrew will now provide an update of the strategies we intend to employ. Andrew?
Thanks, Charles. Just briefly on my background. I spent my career helping companies deliver on their brand promises by creating extraordinary customer experiences. The primary reason I’m excited to join the LL team is because the direction we’re pursuing is that same high-touch oriented approach that I’ve worked in for the last 15 years. And I’m confident that supporting this high customer-centric environment is not only right for LL, it’s what our customers’ value deeply.
That said getting there all require us to work differently. First, we need to simplify that all we do, enables us to direct time and energy toward the activities that our consumer and Pro clients value most. Second, we need to ensure the successful execution of critical sales initiatives like CRM, the launch of carpet and expanding our Pro business, which will drive the growth of our business.
Last and perhaps most importantly, we’ll focus on building teams and ensuring that we’re coaching them to be the most knowledgeable and responsive at the critical point of contact with all customers. The marketplace is more competitive than ever, but I’m confident if we focus maniacally on these areas, we’ll establish ourselves as the best partner for the DIY, DIFM and Pro customer. Charles?
Thank you, Andrew. Lastly, we’ve launched a major reset of our website to make navigation easier and to improve the omnichannel experience. In addition, the ability of our customers to connect between our website and a live call center representative, as opposed to a chatbot, has been beneficial to the overall customer experience. In fact, those when customers convert at a significantly higher average ticket than web alone.
Fourth, improving operating efficiencies. As we said previously, we are using consultants to help us gain more efficiencies, throughout the organization. Since the beginning of the year, we have implemented labor savings initiatives, resulting in annualized savings of $15 million and we’re working with consultants to identify further labor productivity through efficiencies at the store level. We’re also pursuing opportunities to reduce indirect spending and optimize costs throughout the organization and we’ll continue to update you on our progress in future quarters.
While we’re highly focused on reducing costs, it’s important to point out that we are reinvesting some of the cost savings back into our retention efforts which include, hiring training and developing talent; investing in competitive wages in our field organization.
Fifth, innovating new products. We believe that brands that are innovating and creating new products will win in the long-term. We continuously build on the strengths of our merchandising and sourcing teams to innovate on new products and it’s our competitive advantage.
Duravana has been successful as a premium offering to our Pro and consumer customers and we will continue to invest in the brand and plan to expand our product range with the goal of doubling the assortment by year-end. It continues to grow share in the waterproof laminate and vinyl categories, as it solves customers’ everyday needs at a great value. Duravana is our premium product in the category and generates above category ticket and margins. So we’re very pleased with this brand’s performance.
Next, I want to update you on our new carpet pilot. The addition of carpet to our product offering opens up $13 billion of market opportunity and we believe we have a significant opportunity to take market share in this highly fragmented segment. Our customer feedback from Pros and customers tells us that one the carpet offering increases LL value proposition as a one-stop shop for complete flooring solutions; and two, our rebranding effort gives us permission to participate in this segment.
During Q2 we extended our pilot to 20 stores and customer feedback has been promising. And as such we’re extending the pilot to 60 stores by the end of the year. We’ll be evaluating the level of store penetration as we move through the balance of the year and we’ll be updating you on our progress.
Finally, I just want to reiterate that our entry into carpet does not require any investment in our supply chain or in inventory as the product is directly shipped from the manufacturer to the installer.
Before turning to our outlook, as previously discussed, we are opening a third distribution center in Dallas in Q3, which will further optimize our supply chain network. This supplements our current East and West Coast distribution centers and opening a third DC will further improve our service levels and support our strategic growth priorities. It will also reduce transportation costs and optimize our supply chain efficiency over the long-term.
Now I’d like to take a few minutes to discuss our outlook for 2023. With regard to the vinyl flooring-related customs disruptions from Asia, as previously discussed, in February 2023, the company received detention notices from the US Customs related to certain vinyl flooring products that contain PVC, as a consequence of the Uyghur Forced Labor Prevention Act, UFLPA. Enforcement of the UFLPA is having a broad implications across the flooring vinyl products due to the customs disruptions.
During Q2, we incurred $2.9 million of incremental expenses related to the UFLPA, which included demurrage, storage, transportation and legal expenses. For the six months ended June of 30, 2023 incremental expenses related to the UFLPA were $5.3 million. We estimate that lost sales due to vinyl availability for Q2 were approximately $10 million. For the six months ended June 30, 2023, we estimate the lost sales due to vinyl availability were approximately $12.6 million. We’re continuing to work to mitigate the disruptions by featuring alternative products in our current assortment and leveraging our sourcing capabilities to look at alternative flooring categories and sourcing geographies.
During Q2, we determined that it would be most cost effective to return the majority of the product that have been detained by US Customs to the affected vendor. We expect the return to vendor to be completed in Q3. We do not expect that the remaining cost for the product to be returned will be material.
Despite our mitigation efforts, we continue to see a small number of other flooring vendors being impacted by UFLPA halt and continue to assess the impact through 2023. These interruptions may cause more significant impact to sales and margin through the year.
However, I think it’s important to point out that we are not sitting still. We are actively diversifying our supplier base looking at broader countries outside of Asia. As of the end of the quarter, we had reduced our imports from China to 15%. We continue to use our supply chain flexibility to look for and find the best suppliers for our network. In conclusion, we expect the macro backdrop to remain challenging. As economic indicators for home improvement spend remain lower limiting our sales visibility.
In terms of margins, we continue to expect that merchandise margins will improve as we realize the benefits from freight cost relief to gross margins beginning in the second half of 2023. However, as I mentioned earlier, we will continue reinvesting a portion of our cost savings into price, which will partially offset this gross margin improvement. We will continue to measure price elasticities to make our strategic price investments.
In addition, we continue to be focused on working capital improvements including identifying further efficiencies and further improving our inventory management practices to yield continued improvement in our overall working capital. In terms of liquidity the strength of our balance sheet positions us to navigate the challenging macro environment. We cannot predict the timing of a recovery.
However, we will continue to focus on the strategic priorities that we can control to position us for long-term growth when the cycle normalizes. We have fortified our executive leadership team with new leaders, who bring a wealth of financial retail brand building and consultative selling experiences and ideas to our team.
As such we are confident in our ability to execute on our strategic initiatives focusing on implementing our CRM platform to drive both our Pro sales and consumers improving store execution to remove friction and enhance the customer experience increasing our brand awareness and expanding on our product innovation as well as executing our carpet initiative, which provides a meaningful expansion of our addressable market and aligning our cost structures.
The work we’re doing combined with our new leadership team gives us confidence that we will return to growth in an industry that’s supported by long-term tailwinds for hard surface flooring and housing remodels. We believe that housing fundamentals including aging housing stock new household formation by millennials, the desire of baby boomers to age in place and pent-up demand for remodeling activity will continue to support our business over the medium and long-term.
Thank you. [Operator Instructions] Our first question comes from Laura Champine from Loop Capital. Laura, your line is now open. Please go ahead.
Thanks for taking my question. LL has managed to post positive free cash flow in each of the last three quarters. How long do you expect that to continue if sales don’t improve markedly from here?
Yeah. Good morning, Laura. Thanks for the question. We feel pretty confident through a combination of things. The team has really done a very good job managing working capital. Our inventory levels are down significantly from both year-end last year and Q1 of this year 14% and 20%, representative of those two periods.
And we’ve managed our accounts payable extremely well too. So we expect that to continue although, at a somewhat smaller rate than we experienced in Q2, for the remainder of the year and we feel pretty good about being able to deliver positive free cash flow through the entire full year period.
Having said that, we do have ebbs and flows on a quarterly basis and as I said we don’t expect the positive free cash flow in Q3, to the extent we experienced in Q2. But we do feel good about the remainder of the year. We really finished the quarter strong with availability of $145 million. And we feel like we’re well positioned for the remainder of the year and looking forward to the short-term.
Got it. Do you think that it makes sense to draw down debt, at least until your consultants have sort of put together a cost reduction plan for you?
We’re right in the thick of that cost reduction plan as we speak. And as a matter of fact with the activities we’ve already taken year-to-date, we’ve generated roughly $15 million of annualized labor savings. And we’ve already started a number of the other workflows as a result of that.
Drawing down is really just a function of cash flow needs on a monthly, quarterly basis. It’s nothing we consciously do, just because we’re waiting for the consultants to come up or help us formulate additional cost reduction opportunities. It’s really just a function of cash flow needs, inventory purchase cadence et cetera.
But as I said, we feel pretty good about being able to generate positive free cash flow for the year. We will possibly draw down slightly more than we ended this quarter as we look to Q3 and the remainder of the year, against the revolver but not a significant level and not to the magnitude that we ended last year. I believe we ended the year with about a $72 million drawdown. We don’t expect to be at that level at all by the end of this year.
Got it. Thank you.
Thank you, Laura.
We currently have no further questions. So I would like to hand over back to Charles Tyson, for closing remarks. Charles, please go ahead.
Thank you for joining our Q2 2023 earnings call. I’d like to thank again, all of our great associates and vendors for driving our strategic initiatives forward across the company to drive great customer flooring experience. And we look forward to joining you next quarter. Thank you.
Ladies and gentlemen, this concludes today’s call. Thank you for joining. You may now disconnect your lines. Thank you.