LL Flooring Holdings Inc (LL) 2015 Q1 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to Lumber Liquidators first-quarter earnings call. With us today from Lumber Liquidators is Mr. Rob Lynch, President and CEO; and Mr. Dan Terrell, CFO.

As a reminder, ladies and gentlemen, this conference is being recorded and may not be reproduced in hole or in part without the permission from the Company. I would now like to introduce Ms. Ashleigh McDermott, Director of Financial Reporting for the Company. Please, go ahead.

Thank you, operator. Good morning, everyone, and thank you for joining us today. Before we begin, let me take a moment to reference the Safe Harbor provisions of the United States security 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 financial performance of Lumber Liquidators. Although Lumber Liquidators believes that the expectations reflected in its forward-looking statements are reasonable, it can give no assurance that such expectations or any of its forward-looking statements will prove to be correct. Important risk factors that could cause actual results to differ materially from those reflected in the forward-looking statements are included in Lumber Liquidators filings with the SEC.

The information contained in the call is accurate only as of the date discussed. Investors should not assume that the statements will remain operative at a later time. Lastly, Lumber Liquidators undertakes no obligation to update any information discussed in this call.

Now, I am pleased to introduce Mr. Rob Lynch, President and CEO of Lumber Liquidators. Rob, please go ahead.

Thank you, Ashleigh. Good morning, everyone. I'm joined by Dan Terrell, our CFO, and we are pleased to share our first-quarter 2015 results with you. We also will talk about current trends and our progress on our 2015 priorities.

Let me start with a brief overview of the Q1 numbers. As we released a few weeks ago, our total net sales increased 5.6% versus the year-ago quarter to $260 million. In comparable stores, we saw a decrease in net sales of 1.8% during the first quarter. We did, however, see improvement in customer traffic for the first two months of the quarter, primarily as result of the impact of the changes in our marketing strategy.

Turning to margins, our gross margin decreased from 41.1% in the year-ago quarter to 35.2% in the first quarter of 2015. This was impacted by a number of factors, including the administration of air-quality testing for our customers, changes in our sales mix, changes to our marketing strategy and the transition to our East Coast distribution center. These factors, along with increased legal and professional fees and an accrual related to the DOJ's investigation of Lacey Act matters resulted in a net loss for the quarter of $7.8 million or $0.29 per diluted share.

Before I talk about operational details, I want to address some of the key headlines from the first quarter. First, we are appreciative of the confidence that many of our customers have shown in us, and we thank our employees for their exemplary effort, particularly over the course of the past few months.

Anyone who knows Lumber Liquidators and has done business with us knows that we deeply care about our customers. We believe our value proposition is unique, and we believe we deliver the best selection, value, and a quality product. Most of all, we are committed to serving our customers for the long haul.

Customer service has been a core component of our mission since our founding. Every product we offer and the service we provide is built on that fundamental value of the customer being first. In tough times, this commitment is even more important, so thank you sincerely to all of you who believe in us and stand by us.

Second, I want to add some additional detail on the air-quality testing we are currently providing to our customers. We know this topic is important to our customers as well as our employees and shareholders. In response to the allegations regarding our products, we developed a testing program in order to provide customers with information regarding the formaldehyde levels in their homes.

Lumber Liquidators established a multi-component screening program to assess the relative levels of formaldehyde that can be found in the air of homes were Lumber Liquidators laminate products were installed. The testing program is intended to serve as a screening to determine if levels are higher than expected and should be followed up with additional investigation.

Note that since this is an air-quality test, it would capture readings not only from laminate flooring, but also paint, furniture, other floor coverings and many other sources of formaldehyde. In this way, we are serving our customers by helping them identify if there are elevated formaldehyde levels in their home regardless of their source.

The analytical methods used by third-party labs are established methods for formaldehyde analysis published by the National Institute for Occupational Safety and Health. In addition, the Consumer Product Safety Commission has guidelines for consumer testing, which are published on their website under publications 725 from 2013.

Among other things, the CPSC guidance is for consumers to use a known; validated testing method, ours is; accredited labs, ours our; and a test that has a low detection limit, ours does. That is the protocol behind our testing.

Our plan is, now, for any homes where the testing program indicated formaldehyde levels in excess of guidelines identified by the World Health Organization, such customers will be contacted for purposes of additional investigations. As the CPSC underscores on the website, formaldehyde levels in the home can come from a variety of sources and can be affected by temperature, humidity and air flow.

Another impact on our business has been our ongoing talks with the Department of Justice. A special committee of independent directors was formed to address this matter and has been communicating with the DOJ. Based on the available information, including these communications, we accrued $10 million in the first quarter related to this matter.

Finally, we have enlisted the help of outside professionals to assist us. That assistance has been substantial and an important part of our response to this situation.

These three areas, customer testing, the regulatory accrual, and the legal and professional services fees combined to negatively impact operating income by over $15.5 million in the quarter. I believe these steps were necessary to help us maintain customer trust and to position us to be stronger, once we emerge from these matters.

Now, let's shift to operations. The marketing changes we implemented in Q4 of last year affected our promotional focus, advertising cadence and advertising retail price points. We believe these marketing activities are resonating with consumers, and we intend to continue to invest in them as the year progresses.

I'm also proud that we are fully operational in our East Coast distribution center and we have completed our consolidation of our prior four facilities. We anticipate that we will begin to reap the benefits of a modern, consolidated facility and more efficient delivery to our eastern locations.

I'm equally gratified that we were able to complete the build out of an extensive products testing facility as part of the new distribution center. Testing our products is not new to us, and we have been doing it for years. We will continue to focus on this area that is so important to our customers.

Finally, we have completed the installation of our new finishing line that we believe will significantly help our ability to meet demand and improve efficiency at the same time, as we continue to grow and move forward. I'm going to come back in a few minutes to talk about the rest of 2015, but first, I want to turn the call over to Dan for more complete analysis of the financial results. Dan?

Thank you, Rob, and good morning, everyone. I will provide details on our results for the first quarter of 2015. My references to percentages and basis point changes are in comparison to the first quarter of 2014 unless otherwise noted.

As we reported on April 2, our total net sales were $260 million, an increase of $13.7 million or 5.6% over the first quarter of 2014 and a compound annual growth rate of 6.2% over the first quarter of 2013. Non-comparable stores increased $18.2 million, and comparable stores decreased $4.5 million in comparison to the first quarter of 2014.

Net sales in the month of March were significantly different from the first two months of the year. Total net sales in the first two months of 2015 increased 18.7% over the same period in 2014, but in the month of March, decreased 12.8%, in comparison to March 2014.

As many of you know, we experienced significant volatility in 2014, and as a result, we are also disclosing compound annual growth rates from comparable periods in 2013. Through the first two months of 2015, total net sales had a compound annual growth rate of 12%, which turned to a negative 2.7% in the month of March. Our net sales in April, through Monday the 27th, our approximately $77.8 million.

As many of you know, April features our big sale, historically one of the largest promotions of the year. In the current year, the event ran from Thursday the 16th through Monday the 20th.

In 2014, due to a late Easter, the event ran from Thursday the 24th through Monday the 28th. If we compare the current year to a period from April 2 through the 28th, last year, a period including the entire big sale, total net sales are down 1.9%. If we compare the current year to the results through April 27, 2014, total net sales would have increased 2.3%, but lack the final day of the promotion.

Since the March 1 broadcast, we have disclosed information on our open orders to provide additional insight into customer demand. For disclosure purposes, we simplify our open-order roll forward as follows, are open order balance is increased each day by gross new orders and reduced by both invoiced sales and net adjustments including returns.

The open order balance at the end of the first quarter was $46.4 million, and through the operations of Monday, April 27, has grown to $52.6 million. Relative to the comparable prior-year periods, these open order balances were 13.5% higher than at the end of March, 2014 and 8.2% lower than our open order balance on April 28, 2014, the last day of our sale in 2014. In comparing April 27 of 2015 to April 27 of 2014, open orders increased 1%.

Net adjustments including returns, which had been approximately 10% of gross new orders through February, increased to 27% over the first 10 days of March, before moderating to 13% over the final two weeks of the month. Through April 27, net adjustments including returns have continued to stabilize and are 11.3% of gross new orders for April.

Before I move on to non-comparable and comparable stores, let me provide some color with regard to our sales mix of laminate flooring. Over the first two months of 2015, laminate flooring was 21.2% of our net sales and in the month of March fell to 16.4%.

That 480 basis point decrease in the sales mix of total laminate flooring was primarily driven by a decrease in the sales mix of laminate flooring sourced from China, which fell from 14.2% of net sales in the first two months of the year to 9.4% in the month of March. In the monthly operations through April 27, the sales mix of total laminate flooring was 16.7% and the sales mix of laminate flooring sourced from China was 10.4%.

Turning to our non-comparable stores. Net sales benefited from continuing store base expansion and the maturation of stores opened in 2014. We opened 4 new stores in the first quarter of the current year and 13 in the first quarter of the prior year.

We remain pleased with the results from stores operating in our expanded showroom format, and we have now opened 68 new locations in that format since the beginning of 2013 and remodeled 48 existing locations, including 9 in the first quarter of 2015. The 116 stores with the expanded showroom format represent approximately one-third of our store base at the end of March.

Turning, now, to comparable stores. Net sales in the first quarter decreased 1.8%, due to a 6.2% decrease in the average sale that was partially offset by a 4.4% increase in the number of customers invoiced. As with total net sales, trends were significantly different in March, as compared to January and February.

Through the first two months of the year, net sales at comparable stores increased 9.6%, but in March decreased 17.8%. The number of customers invoiced, our measure of traffic, was the primary driver of the change, having increased 15.7% in the first two months of the year, before decreasing 11.3% in the month of March. The average sale was down 6.1% in the first two months of the year and down 6.5% in March.

For the entire quarter, our average sale was approximately $1,560, a 6.2% decrease to the first quarter of 2014, primarily driven by a 6.8% decrease in the average retail price per unit sold of flooring, partially offset by an increase in the sales mix of moldings and accessories, which grew 80 basis points to 19.1% of our total net sales. The lower average retail price per unit sold, also referred to as average selling price or ASP, is due to two primary factors.

First, an expected decrease due to changes in the marketing of our value proposition, which we implemented in the fourth quarter of 2014. These changes lowered the average retail price offered on like-kind product, which was partially offset by significantly limiting ad hoc discounting at the point of sale. The impact of these planned changes can best be seen in the first two months of 2015, with ASP was down 7.4% in comparison to the first two months of 2014.

Second, in March, we further lowered the retail price offered on like-kind products across a number of merchandise categories in an effort to drive customer traffic. With an average selling price down only 6.2% in March, it appears to be an improvement from the 7.4% decrease in the prior two months.

That additional promotional pricing, however, is more than offset by shifts in our sales mix. As I mentioned earlier, laminate flooring lost share of our sales mix and it was generally picked up by solid and engineered hardwood, product categories with some of the highest retail price points but generally lower than our average gross margin.

Turning to gross margin, which was 35.2% in the first quarter and down 590 basis points from the first quarter of 2014, I will touch on each of the three categories in which we segregate drivers of gross margin. Within product, we believe the planned changes in the marketing our value proposition, represented approximately 250 of the 370 basis point decrease. We believe the additional promotional pricing in March to drive customer traffic and changes in the sales mix away from laminate flooring and towards hardwoods reduced gross margin by approximately 140 basis points.

We believe the cost of certain hardwoods, including our new Bellawood products, reduced gross margin by approximately 60 basis points. Finally, an increase in the attachment of installation services, which has an average gross margin less than our average merchandise transaction, reduced gross margin by approximately 20 basis points. Partially offsetting these gross margin pressures, was an increase in the sales mix of moldings and accessories, which we believe drove approximately 100 basis points of gross margin improvement.

Transportation costs, in total, adversely impacted gross margin by 80 basis points, but approximately 62 basis points were final costs to move product into our new East Coast distribution center. That facility is fully operational and we completed all transition and consolidated procedures by March 31.

All other costs adversely impacted gross margin by 140 basis points, driven primarily by two factors. First, we incurred approximately $2.3 million of costs, or 88 basis points, related to the implementation of air-quality testing program provided to our customers. The costs incurred for the air quality testing program through March 31 was $1.8 million, or 69 basis points, and we established a reserve of $0.5 million or 19 basis points for additional costs to service customers in the future.

Second, inventory reserves were up $1.7 million in the first quarter of 2015, as compared to an increase of $400,000 in the first quarter of 2014, and that $1.3 million difference reduced gross margin by approximately 50 basis points. The current-year increase included inventory reserves related to the Bellawood transition. The increase also, including consideration of higher returns in March of laminates previously sold, a greater number of order cancellations after product had been shipped to stores, and changes in our sales mix.

In April, gross margin continues to be pressured by lower average selling prices to drive customer traffic and shifts in the sales mix toward hardwood. As I mentioned earlier, April features our annual big sale and as a result, has historically had a lower gross margin than the gross margin for the entire second quarter.

In 2014, the April gross margin was 38.7%, 170 basis points lower than the 40.4% in the second quarter of 2014. In the current year, after considering our results to date and certain adjustments, we estimate April gross margin will be in the range of 31% to 32%.

SG&A expenses for the quarter increased approximately $18.6 million, or 23.6%, to $97.4 million, and as a percentage of net sales, increased to 37.5% from 32% in the prior year. As I mentioned earlier, we completed the consolidation and transition of the East Coast distribution center by March 31 and incurred approximately $1.1 million of incremental expenses in the quarter, primarily salaries and occupancy costs.

SG&A expenses also included an accrual of $10 million, which we define in our Form 10-Q filed this morning as the government investigation accrual. We believe there is a reasonable possibility that a loss greater than or less than the amount accrued may be incurred, but we are currently unable to estimate the amount.

The discussions with the DOJ are in the preliminary stage, and it is possible or resolution will not be reached. On our balance sheet, the accrual increased other current liabilities.

Salaries, commissions and benefits increased $1.7 million, but remained constant as a percentage of net sales at 12.5% as incremental costs related to store base growth and the full implementation of both the West Coast and East Coast distribution centers were fully offset by lower accruals related to our Management bonus plan. Advertising expenses increased $1.4 million or 8.7% of net sales, compared to 8.6% of net sales during the first quarter of 2014, as leverage of our national advertising campaigns over a larger store base was matched by increases in cost to strengthen our brand messaging and broaden our reach and frequency.

Occupancy expenses increased $1.2 million, and as a percentage of net sales increased 30 basis points to 4.6%, primarily related to store base expansion. Depreciation increased approximately 20 basis points as a percentage of net sales, due primarily to store base expansion and our infrastructure investments, including supply chain.

Our remaining SG&A expenses, including stock-based compensation, grew by approximately $3.6 million, and as a percentage of net sales, by approximately 110 basis points. Included in this increase were legal and professional fees of approximately $7.2 million, an increase of $3.3 million compared to the first quarter of 2014.

The year-over-year difference in the Company's effective tax rate resulted primarily from an increase in the first quarter of 2015 in the Company's liability for uncertain tax positions excluding interest and penalties. This liability related to the uncertainty around the deductibility of the government investigation accrual.

Additionally, the effective tax rate in the first quarter of 2015 was impacted by lower projected pretax income for 2015 as compared to 2014 actual. Our net loss was $7.8 million, or a loss of $0.29 per diluted share, based on approximately 27.1 million weighted average diluted shares outstanding.

Turning to our financial position, liquidity and capital resources, our cash and cash equivalents, were $43.9 million at the end of the first quarter, $20.3 million at the end of December, 2014 and $76.1 million at the end of March, 2014. We had $20 million outstanding on our revolving credit facility at the end of the current quarter.

On April 24, we entered into an amended and restated credit agreement with our bank, which provides $100 million asset-based revolving facility, primarily secured by merchandise inventory. We expect to use the facility to support working capital needs, fund capital expenditures and provide additional financial flexibility.

Merchandise inventory was $301.5 million at the end of the current quarter, down from $314.4 million at year end and up from $247.4 million at March 31, 2014. Available inventory per store was approximately $772,000 at the end of the first quarter, up from approximately $680,000 at March 31, 2014, primarily due to weaker than expected net sales, increases in solid and engineered hardwood and increases in moldings and accessories. Within available for sale inventory at March 31, 2015, total laminate flooring was approximately $40.3 million and laminate flooring sourced from China was approximately $22.7 million.

Capital expenditures were approximately $9 million in the first quarter and included store base expansion, the remodeling of existing stores and equipment for the distribution center and finishing operations. We are not able to provide an outlook for the remainder of 2015 at this time, due to our long purchase cycle and uncertainty regarding customer demand trends.

At this time, however, I can reiterated our plans to open 25 to 35 new stores in 2015 and remodel 10 to 20 existing stores either in place or through relocation within the primary trade area. In addition, we are continuing the rollout of installation services, where we expect to provide services to a total of 150 stores by year end. Finally, we continue to expect capital expenditures between $20 million and $30 million for the year 2015.

I'll now turn the call back over to Rob for his closing remarks.

Thank you, Dan. As you can see, there are a number of moving parts to the equation for this quarter. That said, our mission for the remainder of the year remains unchanged.

We intend to provide the best value to our customers. We intend to deliver to them a quality product and continue to build long-term relationships with them. We intend to continue to expand our assortment so that the customer has multiple options at multiple price points.

We have added flexibility and visibility as we consider the marketing of our value proposition. We intend to continue to make infrastructure investments combined with our fundamental principles, including enhanced merchandise allocation intelligence, expanded capacity in our supply chain, and continual investment in quality control and assurance. We also expect to continue to put resources towards our advertising message, expand our assortment of proprietary brands, and build a team of highly motivated flooring experts.

With respect to sourcing, we are expanding our assortment of laminate flooring to provide a complete assortment of styles, colors, construction and country of origin. This expansion will feature the addition of a number of new laminate products to our current assortment sourced from Europe and North America.

Additionally, in response to customer demand, we are currently not adding to our inventory of laminate flooring sourced from China at this time. We will continue to adjust our laminate sourcing as warranted, based in part on customer demand.

We expect to continue to make investments in store-based expansion and our expanded showroom format. By the end of 2015, we plan to be offering installation in about 150 stores, up from 85 at the end of 2014. We believe that by improving the customer experience and making it easier, we also improve our ability to win future business.

Let me also say a few words about the departure of our CFO and my friend, Dan Terrell. You have all seen the release, so there is not much to add, but I express my gratitude for your contributions over the past decade.

Dan, thank you for all your years of service and for agreeing to assist with the transition. I will miss you, as will the team you have built over the past 10 years.

We are launching a national search for Dan's replacement. In the meantime, we have hired Greg Whirley as our Senior Vice President of Finance, who will also serve as interim CFO beginning on June 1, 2015.

Greg comes from Ernst & Young and has experience in both public and private company financial reporting and accounting. I believe Greg will be an asset to the team and will provide additional insights and perspectives based on his experience with a wide range of companies.

In closing, I believe our core business model is strong. Our competitive position is resilient and our plan for 2015 is to execute and deliver on the significant potential of our 2014 infrastructure investments. In short, I remain optimistic about our future.

With that, operator, we are now ready for questions.

(Operator Instructions)

Seth Basham with Wedbush Securities.

My question revolves around your current sales and gross margin trends, in particularly thinking about gross margins. You talked about 31% to 32% for April, after a 31%-ish performance in March, and this is despite the fact that some of the things impacting you in March should be dissipating. How should we interpret the results in April gross margin and think about that going forward?

Seth, this is Dan. I will start and maybe let Rob finish. The gross margin number is going to be lower, due to merchandise margin. It doesn't include a lot of the one-offs that the March margin included.

We said there were two primary drivers in there, the competitive pricing analysis that we had done as part of our marketing of our value proposition, but then, beginning in March, significantly lower ASP to drive customer traffic. That's really the same two drivers you saw in April. I wanted to point out that the month of April includes the big sale and that is always one of the lower margin months of the year, so tried to give a perspective of our where April 14 was against the second quarter. Can't really promise that the second quarter of this year will improve. We're still have customer as job number one. Driving traffic is the main goal. That's going to hurt margin for a period of time until we are better able to establish customer demand trends.

This is Rob. Let me chime in, Seth, as well. What I would tell you is, relative to the impact that we saw in March, obviously, we are encouraged with where sales are, that they are recovering, March to April, and some of the metrics underneath, the demand metrics. As you recall, we have a very long purchase cycle. Dan talked about in his prepared comments, over 100 days from start to finish for our customers. So, obviously, the impact on what happened in March takes time to work out.

We continued with, as Dan said, the promotional pricing, which driving the margin changes that are allotted in the mix. There's a whole bunch of drivers there that Dan went through very carefully, but overall, what I would tell you is, we are encouraged. Feel good about, really, the customer is responding to our ads, responding to our incredible deals right now, and then also the efforts of our field and store associates selling out there. One of the metrics I look at every single day is our net adjustments in the returns, which we mentioned in the release. The fact that that's come back and has stabilized to pre March 1 levels, is also a good metric that we are looking at and encouraged about.

Great. That's helpful. Last follow-up question, open orders balance rose nicely sequentially from March to April. As you think about the implications of that for sales in May, would you expect to see year-over-year sales increases?

Seth, I would just say it gets us off to a good start in May. It's a good strong balance, as Rob said. It's been a slow recovery, but it has been a recovery. As you know, last year, May, June, and even into July were very difficult months for us with the inventory situation that we had. If you also remember, the mid-March to really mid-April and through April were actually fairly strong last year. It gets us off to a good start in May and 2014 is going to be an easier comparison for the next few months, also reason we are looking at a two-year compound annual growth rate to 2013.

Great. Thanks. I'll turn it over. Good luck, and we will miss you, Dan.

Thanks, Seth.

Dan Binder with Jefferies.

My question is really around what's happening in this your early cycle buyer traffic in the stores. If I look at calculation that you've provided for us, open orders equal gross new less invoice and adjusted returns, it would look like the gross new is still coming down, while it looks like it's up year over year, it's coming down sequentially. So, I'm just trying to figure out how we factor that into a comp store sales outlook? At this point, the simple question is, would you expect things to get worse before they get better on comps based on what you see in those numbers?

Dan, one thing to note is, it's really difficult, at this point at the end of April, and we struggle with this. We want to keep as much information out there as we can and be as transparent as we can, but last year's numbers are really difficult around the sale ending at a different time than it did this year. So, the open order balance and the order flow was a little bit different last year versus this year. Simply reiterate, keep an eye on the sequential trends. We view the number we did in April as a good, strong open order balance. The new order flow was good, as Rob said. The cancellation rates or the adjustments including returns began to normalize at 11.3%. I'm not sure we had it in our prepared comments, but we're seeing some stronger indicators of early demand through our samples numbers, as well. It's a long process, but I do think will gain back some share that we may have lost in early part of March.

Dan, what I would just add is, I think, instinctively to me, what's in there, what you are looking at is, again, the difference of how the ebb and flow of our events year over year and given that the April sale was a week earlier this year than last year, we ended the month -- ended the April sale into the end of the month. So, our stores -- the rate and velocity of shipping versus orders and how that ebbs and flows going into an event and out of an event based on the end of a period, can sometimes swing. Obviously, our stores are paid on commissions. Again, we tried an extra week or so this year post the big sale to be shipping.

If I could on a follow up, with regard to the things that affect your gross margin in the current quarter, you've already outlined April. It sounds like the promotional activity will continue. I was wondering if you could speak to the Bellawood transition? Where we are on that clearance activity, if we're through that at this point or if there will be an impact this quarter, as well?

Don't anticipate one in the second quarter, Dan. We are continuing to clear that through the April sale. The first quarter included some final adjustments to the reserves that we had, so you should not hear us mention that again.

Great. Thank you.

Bud Bugatch with Raymond James.

This is David Vargas on for Budd. I had a quick question about the $1.8 million in SG&A payments to customers for the air-quality tests. Where these payments because the customer came back with a test that had higher than expected or less than desired air-quality issues?

David, let me clarify a couple of things there real quick. It's actually in the cost of sales, so that impacted the gross margin. It was $2.3 million total, $1.8 million for the kits themselves. That was the cost of the kits and administrating the program, mailing them out, what not, so we are going to bear the cost on behalf of the customer, customers working with the lab. Then, there's an additional $500,000 that relates to potential steps that follow the air-quality testing procedure. So, $2.3 million in total, two components, $1.8 million and $500,000, both in the cost of sales.

Got it. Okay. The $500,000, that's just an accrual for estimated future costs, correct?

Correct.

Is that for additional test kits that have been shipped or you expect to ship?

It could be any number of things, David. Could be follow-up steps, just customer care, sending second tests in, additional procedures. I will let Rob pick up on that. It's for any number of costs that may follow these initial step.

As I mentioned in my remarks, this is the first step of a multiple step process for helping screen and put customers at ease. What I wanted to say is, as the result of these allegations and the sixth amendment story, a lot of customers, obviously, were very, very concerned. Our number one goal and focus was doing something quickly and effectively that would respond to our customers calling in that had concerns, get them a kit sent out that we could use to measure the formaldehyde in their home and then go through that process. What I would say is, it's a pretty big process because the number of tests we sent out and the number of customers requesting the significant -- really, probably unprecedented in this level of in-home air testing. So, we're working through that.

This incremental accrual is really around that customer service, making sure we've got the money in there advance point. On any readings that, for the home, that maybe an outlier and elevated, we are going to make sure we get in there and follow up and do follow-up testing to try to figure out exactly the source of any elevated formaldehyde in the house. Obviously, taking care of the customer along the way. We want to make sure the customer is first and that we take care of them and that they feel that we are responding to them and treating them like we always do.

Of course. Okay. Thanks. One final, one follow up on that. The last time you talked, you said 10,000 kits were sent out. At this point, what's the total number that have been sent?

We sent out close to about 27,000, I believe. That's approximately translates to about 13,000 households. It depends on size of home and size of the room where the flooring may be. That's about where we are right now. It's a pretty significant number to be processed and administrated, if you can imagine, getting customers sent to the lab, kits sent to the customer, the customers executing the kit in their home, following instructions and getting it back in and the lab processing and all that.

Okay. Thanks a lot for answering my questions.

Simeon Gutman with Morgan Stanley.

A follow up on open orders, can you help us interpret the open order number? Because you said April, the comps are running down 7.2%. I think the open order is running a little worse than that. There's a lot of math we could do to triangulate what that means and a lot of methods that's out there. Rob, you mentioned that there is a long lead time. And so, if you think about the 100-day lead time and that being impacted, maybe we aren't up to the peak sales impact, yet. Any additional help how to think how to interpret it?

Simeon, it is in the way that big sale fell, it's difficult. Let me give you a little bit of color. The number that we were at last year at this time, I think roughly about $57 million, would fall to about $50 million by the end of April. So, there would be about a $7 million decline in that open order balance in the last few days of the month. That kind of impact has already occurred this year. As Rob said, the sale shifted, so we've already had a chance to invoice out a lot of that open order balance. I would anticipate that our open order balance is going to wind up 3% to 5% higher than the prior year, once we get to the end of April.

As we said on our sales, that total sales were down about 2% in April. On a compound growth rate, they are up about 1.3 months to date. So, you're seeing some decent return in samples. The open order balance is still slightly higher than the invoiced sales, but you are seeing the invoiced sales slowly recover. I think they are all pointing in the right direction, but you're right. There's a lot of math and a lot of numbers to watch out for. That's one reason we are, one, trying to give you additional information to be more transparent, but there's always some factors to consider in those numbers.

If you have the data, can you share how the open order balance at the peak of the sale this year compared to the peak of the sale last year?

Simeon, I don't have that number.

Okay. My real follow up, then, is just regard to sourcing. You gave us the information on the March call. It didn't seem that costly, then, to source laminate elsewhere. If we read between the lines a little of what you just said, the question is how long is it going to take to completely move the laminate sourcing out of China and elsewhere?

This is Rob. Over the last three years, we've been diversifying our sourcing across all categories. In fact, even within the laminates, in the last three years we shifted -- if you look at the percentage of our laminates from China, we've reduced it, probably in the last three or four years, from about 80% down to less than 50%, actually, even before any of these issues came up. Again, that was just mainly around diversification of supply and sharing availability of our value proposition and having the best looks and colors out there.

What we are doing now, it's all about the customer. Where's demand? What do they want? What types of colors and styles do they want? Country of origin, as well. Obviously, there's a lot of concern right now about that. For now, what we mentioned is, we are not adding to our purchases of those products. We are going to continue to look and see, as time goes by, on what the customer wants. We're going to make sure that we give the customer the products that they want.

What we did say is we are expanding the mix. We are going to be shifting and expanding our existing mix that we're pulling from Europe, now, and the USA, within laminates.

Okay. Thank you.

Matthew Fassler with Goldman Sachs.

My first question is for Rob. It relates to the gross margin that you're generating in the business today, here in 2Q, and the level that that's pointing to and the level of profitability for the business that that implies. What kind of hit to the long-term profit model you are willing to take to drive volume? I understand there's been a lot coming at the Company, so it's maybe been a bit harder to plan to a margin level. But you seem to be willing to forgo historical, at least recent historical levels of profitability in order to drive volume recovery. I'm not sure if you have a game plan for walking that profitability backup to get closer to prior levels? As you think strategically about the consequences, I guess both of the pricing actions that you took prior to the 60 Minutes story and then the stance that you had, since then, how you think about where that goes over time and what the game plan is to drive it higher again?

Obviously, as you mentioned, value is such a key part of our value proposition. As we came into the year and got back in stock of some of our constrained products, it was important for us to really live up to that part of our value proposition and ensure that we lead the market from a price perspective. So, that's what a lot of what we're doing right now, obviously what we were doing before the event and we're continuing through with that.

I would tell you that, over time, we are contemplating how that impacts us and if and when we would want to start stepping that backup. Right now, it's really about taking care of the customer, ensuring our brand is relevant out there. That they see and we really live with our value proposition relative to value. We're doing it across all categories.

Right now, we have an event going on which is basically what the Company was founded on, is getting a real solid or engineered product for the price of lesser products at the competition. Even for laminate, you can get an engineered or solid at Lumber Liquidators. That's what the Company was built on. We are reinvesting in that. It's good for customers.

It's good for our associates. We want to keep them selling and keep them motivated and compensated effectively. The good thing is that our business model and our direct-sourcing model allows us to do that in times like this. I would say it's something we're going to stick to in the short term. As we move forward and things get past us, we definitely don't want to be giving away -- we're always going to be looking and being conscious of where the competition is and making sure that we're maximizing the returns, as well. There is room, obviously, there's going to be room to step that back up down the road, if and when we decide to.

I have a quick follow up on that. Thank you, and then one other. On that point, are the discounts being taken strategically and marketed? Or, are you getting -- do you have more flexibility today? Are you taking more discounts at the point of sale to close the deal, if you think about the mechanisms by which that gross is moving lower?

Actually, I got praise the field organization. As everybody knows, that was one of our gross margin drivers the last three or four years, where we're focusing on the ad hoc discounting and getting better operational execution in the field. I got to tell you, our level of performance against our reduction of ad hoc discounting and that metric is the best as it's been since I've been here, even in the midst of all of what's going on right now. We're absolutely -- the pricing is driven strategically, nationally, so that we're getting the full return on that perception across the entire marketplace that's to drive traffic into the stores and the stores are not ad hoc discounting. We pretty much locked it down completely across most categories. During the April sale we did loosen up a little bit. On a lot of odd lot and deleted inventory we wanted to cleanse out, but that's about it. We've got -- our disciplines in the field are better than they've ever been on ad hoc discounting. It's all being driven nationally.

That's helpful. Then just in closing, you touched on one question I was going ask, which relates to the quality of inventory based on both age and your exposure to some of the categories that you are moving away from. How much of the gross margin are there in the March quarter or in the month of April, reflected, accelerated clearance or desire to clean some of this stuff out? Was that a material part of what you saw happen in grosses?

I'll tell you operationally, we did -- back to my previous answer, we did have a goal with the folks in the field to, again, with the Bellawood transition, it would allow the obsolete transition categories that we have out there. We did open the spigot for the stores to sell through a lot of their -- we had obsolete identified by store and gave the stores a lot of flexibility to clear that out, and they did a very good job and, I think, relatively speaking, better than years past.

Any sense to how much of the gross margin hit that represented?

We raised the reserves by $1.7 million in total, the inventory reserves in the first quarter versus last year's $400,000, so that was $1.3 million. That included an analysis of all flow moving. Obviously, we had a lot of returns that came right after the broadcast in March, so we had to assess stranded inventory. Those reserves, we feel adequate at the end of the first quarter. Certainly, we've been running additional liquidation deals and whatnot during April. That's all included in the 31% to 32% for April. Reserves are that $1.3 million step up at the end of the first quarter.

Got it. Thank you so much for that, guys.

David McGregor with Longbow Research.

Thanks for the detail on the gross margins. Can you just talk a little bit about the strength of the dollar and how that might be helping you or what benefit you maybe realizing in your offshore purchases, benefit to the gross margin? Secondly, you talked about expanding the assortment in laminate. I'm just wondering if you can quantify the impact on the laminate product category gross margins going forward? It's always been a good category for you as you noted earlier. I'm just wondering what the impact might be in the future? Finally, what regional differences you are seeing in terms of traffic delta this year? Thank you.

Okay, let me try and answer all those. Relative to laminates and your question on the dollar, that's one of the things we've been looking at the last couple years. With the strengthening dollar versus the euro, it's helped us we -- prior to the current issue that hit us in March, we were transitioning some over there, and that was opening the doors for us with some really great factories in and across Europe. This is why we were doing it. It's also -- it continues to be a benefit. As we look to even transition more of it. That's a positive. It helps us from a margin perspective.

Part of the reason we're doing that, by the way, was to really to try to, from a constrained inventory perspective that we were hit with last year, is to make sure we have duplication of supply and we have multiple suppliers and they're spread out geographically, so that we mitigate risk of any constraint issues in a particular country. That's another reason why we had stepped up on the migration and the diversification of some of our top sellers, particularly laminates. Like I said, the dollar is helping us to ensure that that impact is not too dramatic.

Now, what's hurting us right now, significantly, is obviously the mix. I think as we do transition and broaden that assortment, particularly within some of the higher-margin 12-millimeter laminates and what have you and get more of them coming as well from Europe, that's going to help us overall with a mix, getting the back up to where it needs to be.

Dave, just real quick, the transition, I think, will take place throughout the summer, probably completed late August into September. You had a question about the margin on laminates, and it's still higher than the Company average, even with the discounted ASP that we've been running in March and April.

It sounds like what you're saying from a mix standpoint with more European 12 millimeter in there that the actual laminate category gross margins could actually improve. Did I hear that right?

It certainly got a potential to improve.

From here, obviously, yes. Also, because of the mix and the ASP, the advance point. If you did a SKU-by-SKU comparison, that may be difficult to actually get it exactly there. To your point, with this trend to the dollar and then some of the availability over there in some really efficient factories that we've identified, that's going to be up to us to try to maximize the margin.

Okay. The other question was just on the regional differences you are seeing around the United States, in terms of traffic deltas?

Nothing significant. The West and the Pacific Northwest, they'll perform really well. Texas is a little bit slower. Obviously, that's had some well-publicized issues related to the oil rigs shut down and whatnot. Nothing significant, obviously, we are loath to mention the weather word this year, but certainly, certain areas of the country had some difficulty. Nothing we see as long term.

Is there certain regions that are responding more to the 60 Minutes issue?

The Northeast, probably more than any. Other than that, really not a significant difference across the rest of the country.

It's been interesting. It's a very good question because instinctively, you would think that maybe the West Coast, California, would've been more impacted, but it was the opposite.

Interesting. Thanks very much, and good luck, Dan.

Thanks, Dave.

Peter Keith with Piper Jaffray.

I was going to ask two unrelated questions together. First off, I was hoping you could give us the monthly compares from April through maybe July from last year, just because there is a lot of noise? Secondly, for Rob, I know you are pretty close to the field. I was wondering if you could address some of the attitude in the field, if there's been an uptick in turnover, people quitting or anything like that given that what's transpired the last couple of weeks?

Peter, on the sequential, I don't have the numbers right in front of me, but April was the strongest month in the next three or four. We were progressively weaker in May, in June and July of 2014 versus the same period in 2013. I don't have them with me, but relatively speaking, April the strongest then each month was progressively weaker through July and then you started to see a turn in August and September.

Peter, I'll answer the question on the field. Field morale is really good, very high. I continue to get out there as much as I can, travel the stores. We've done -- I think what's going on, as we are really, I think, reaping some benefits of our focus on the stores and the culture the last four years, our annual LLU events. Again, our flattened organization and our culture putting the stores first. They are in a great place, relatively speaking, considering the issues we've all been faced with. Obviously, it's impacted them.

I will tell you, I'm so proud of the entire organization in terms of the corporate staff, our call center, our customer care department in terms of the amount of phone calls they've had to handle and deal with in terms of upset customers. Really, it's a testament to the culture of the Company in terms of doing the right thing and taking care of the customer.

To your point about the stores, the metric I had mentioned earlier, it is really is a good barometer of where the field is. Because given our long-purchase cycle, the fact that the customers have responded and the stores have also done an extremely good job of handling customers in the store, eyeball to eyeball, with their questions and their concerns that were raised. We did a very good job of training and having conference calls. We've had several all-store conference calls, where me and the senior team have been on with the stores talking with them, transparently, about what's going on and arming them with the right information so that they can help take care of the customers, and then they actually -- they have. Day in and day out, out there, the field has, with support from the corporate office, has done an incredible job. I'm so proud of them. They are in a great place, and they continue to take care of our customers and keep selling. That's what they're doing.

Okay. Thank you for that. I was also hoping to squeeze in one regulatory question, just regarding the CARB's standards and its deconstructive testing. You guys have disclosed in the last month that CARB did conduct deconstructive testing on some of your products on the came in above the limits. I was wondering, twofold, is this just a recent test, or have they been doing deconstructive testing since that protocol was established? Secondly, you had mentioned that in this the 10-Q today, that you believe they have tested others, Chinese products, but it wasn't clear if it was only your products that exceeded the limit or if others had exceeded it as well?

This is Rob. What I can say is that for the last several years, we've been working with CARB, cooperating with them. I've actually been out there to several of their workshops as they've been working on amendments to the regulation. We've been present with them, in communication with them, even before any of these issues popped up. We continue to do that.

To your question about what they're doing, what we believe and as much as we can tell from what they've told us or what they've communicated, they have been looking at deconstructive testing. They have been looking at our products and other folk's products out there across different industries, not just within flooring. They are doing work on that, and I don't have much specifics about that. All I can tell you is what we disclose, is that we're working with them; they are conducting tests. We had no further action from them since they've been doing this, at all. Again, the dialogue and the transparency and the working and cooperating continues.

Okay. Thanks for all the insight today. Dan, good luck. I very much enjoyed working with you.

Thank you, Peter. Appreciate it.

David Strasser with Janney Capital Markets.

I'm sorry to go back to gross margin. I know it's been talked about. We tried to take all the commentary, Dan, that you talked about and trying to put actual numbers behind it. I just -- in an attempt to try and understand from our perspective structural versus transitory gross margin issues. I just want to make sure we're correct that when had you talked going through the gross margin paragraph, are you talking about $2.3 million of test kits, about $500,000 relative to the East Coast distribution, which would be nonrecurring and promotions, 140 basis points, about $3.7 million, which would get -- and then you also talked about the inventory reserve of $1.3 million. That wasn't March, that was for the quarter. We get about 300 basis points of one-time gross margin for the first quarter, and, probably, about 600 are 700 basis points one time for March. Are we on the right path there, to the best of your knowledge?

You are, David. The one thing I would point out, is the $2.3 million included a $1.8 million for the kits and a $500,000 reserve and then there was another $1.6 million related to the transportation costs as we moved product from the old East Coast DCs. We had four buildings there and finished the consolidation into one facility by March 31. There was another $1.6 million and roughly 60 basis points, 62 basis points in there, as well.

Would that be for the quarter or for the month? Probably for the quarter?

For the quarter, right.

Okay.

As we look forward into April, the main difference between 2014 and 2015 is going to be in the retail price and in the sales mix to generate traffic. A lot of these one-off items that went through in the quarter, some of them in March, the quarterly margin was stronger than it would have been because prior to the March 1 broadcast, the margin was much stronger. Roughly about 700 basis points of impact as you look into April.

Okay. Just one other question. You talked a lot about the cost around the test results. You sent out, I guess you did 13,000 households, more than that in aggregate. What's been the return rate? Is there any data around how many come back elevated or something? First question is, what has been the return rate? Number two, has there been a substantial amount of elevation or however you want to put it?

Dave, this is Rob. What I would tell you is given the amount of tests and how unprecedented a study like this is, it's too early in the process for us for to provide information, but we are anticipating to be able to do that pretty soon. In general, what I can tell you is, based on the input from our third-party experts, from a number of sources, the test is administrating based on expectations. The return rates, the results are all basically in line in terms of what was expected and modeled going into it.

Okay. Going back, once again, to the promotional issue, you talked about at some point you hope you're able to bring that cadence down a little bit. What would drive that decision for you? What are you watching to make the determination of when and if you can try and drive a greater return towards the -- or less promotion, less than elevated promotions?

Really, it's about all the demand metrics. Overall, we're encouraged, given where we were, given the impact to our business, given that all we do is flooring. This is not 300 SKUs amongst 30,000 in a big box store. Given the relative impact on our business and how non-diversified we are across our product categories, I'm very encouraged with the Company's reaction to the issues, the response to the customers, across the corporate office, customer care and down into the stores and how we are responding. Each day since March 1, I've been pleased with how the field is responding, the customers are coming back, the net returns and adjustments, we feel really good. So, I anticipate to continue to feel that way as we go forward.

Back to Peter's questions about the morale, and morale is strong in the field. They're supported extremely well by the entire organization here, and they are doing their job. As we continue to get stabilized and be confident in that 100-day cycle, the demand metrics underneath, the open order build, I think it's really a matter of time as we get back to where levels of performance and expectations that we were performing at prior. I can't tell you when, but I think that the effort and that's a goal and that's our 100% focus is on our customers, on our stores, and getting the business back to where it needs to be.

Just lastly, just a quick question. You had said you would give monthly, will you give a monthly main number, publicly?

David, as we see customer demand trends develop and information that we think is going to be meaningful, definitely, we will give more frequent information. It's difficult for us, obviously, to look so far ahead. Until we can, until we get better visibility, we'll certainly give more frequent updates.

Okay. Thank you very much.

Ladies and gentlemen, thank you. We have come to the end of our time allowed for questions. I'll now turn the floor back to Management for any final closing remarks.

Thank you, everyone, for joining us on today's call. As we look forward, our team remains energized and dedicated to delivering strong results in growth that we believe is achievable, long term, for Lumber Liquidators. I want to thank our Lumber Liquidators team for their hard work over the last few quarters. What you do every day out in the field matters. Every time you help a customer, you reflect our core values and you make us better and stronger.

I also want to thank our customers for their support. We have been working with many of you for years and we plan to do so for years to come. We look forward to speaking with everyone again on the next earnings call to report on our continued progress and executing our strategic initiatives to achieve our long-term objectives. Thank you.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.