LL Flooring Holdings Inc (LL) 2015 Q3 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the Lumber Liquidators third-quarter earnings call. With us today from Lumber Liquidators is Mr. Tom Sullivan, CEO; Mr. Greg Whirley, CFO; and Mr. John Presley, Chairman of the Board. As a reminder ladies and gentlemen, this conference call is being recorded, and may not be reproduced in whole or in part without permission from the Company. I would now like to introduce Steve Calk of FTI Consulting. 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 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 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. Tom Sullivan, CEO of Lumber Liquidators. Tom, please go ahead.

Thank you Steve, and good morning, everyone. Thank you for joining us for the Lumber Liquidators third quarter 2015 earnings call. My name is Tom Sullivan. I founded Lumber Liquidators about 21 years ago. We grew from the back of a trucking warehouse outside of Boston to over 370 locations around the country. We did this by selling good wood at great prices with the best people in the business.

Over the past quarter we have made some progress getting back to our basic business. We have made progress on legal and regulatory fronts, and we have enhanced our compliance. But most importantly, we are beginning to re-build our trust with our customers.

Over the past quarter, we have been responsive to customers who have had concerns about our product quality, conducting in-home testing for all customers who requested it. That process continues, and we are encouraged by what we've seeing so far.

From a financial perspective, we are still feeling the impact of disruptions in the business. We are closing our tile stores, getting rid of tools that have clogged up our stores, and getting back in stock on the flooring we need.

Q3 revenues were down 14% versus Q3 of last year to $236 million. Part of this decline is certainly media related, and we have had some disruptions in our sourcing. The total sales were up 2% over the year-ago quarter, but because of revenue decline, gross margins remained at about 30%, which was similar to last quarter, absent certain one-time items. The 910-basis-point drop from a year-ago quarter continues to be driven by changes in our marketing strategy, our customer air quality, testing program, and changes in our sales mix.

In a few minutes, our CFO Greg Whirley, will go over the quarter in more detail. But first I would like to say a few words about the leadership transition we announced earlier today. On November 16, our Board member of eight years, John Presley, will become CEO of Lumber Liquidators. I will continue to serve as a member of the Board as Founder, and I will serve in a new role as special advisor to the CEO to provide guidance and ensure continued progress toward executing the Company's vision and long-term strategy.

John brings more than 30 years of leadership experience to Lumber Liquidators, with significant operational, financial, turn-around, and risk management expertise. In the most recent role as CEO of First Capital Bank, he played a critical role in leading the bank's turn-around. I look forward to working closely with John on our mission to get Lumber Liquidators back on track. With that, I will turn it over to John for an update on his work over the past quarter.

Thanks, Tom, and good to speak to all of you again. I would like to begin by saying it's truly an honor to be chosen to lead Lumber Liquidators at this critical juncture in the Company's history. Through my tenure on the Board and most recently as Chairman, I've gained unique insight into the business, strategy, and operations, and have seen first-hand what makes our culture and our value proposition unique. I am firmly committed to strengthening Lumber Liquidators across every area of the organization, and my top priority as CEO will be improving our core operations and improving our financial performance.

As we had told you last quarter, one of the key goals was to make sure the Management team could focus on the business without distraction. The Board, through the special committee, has been managing some of the non-operational issues. Let me give you an update on where we are.

We worked diligently with the Department of Justice to resolve issues relating to our compliance with the Lacey Act. On October 7, we announced a settlement with the DOJ, and on October 22 it was approved by the court. We are continuing to cooperate with all regulatory agencies, and we are focused on resolving all the legacy regulatory inquiries we have received as quickly as possible.

On the product front, the special committee has been conducting a comprehensive review of our sourcing compliance program and related policies. Compliance is extremely important to the Company, and with the addition of Jill Witter, our new Chief Compliance and Legal Officer, we have added some excellent talent in this area. Jill comes to us with a depth of experience, including with Rayonier and International Paper, and is systematically reviewing our compliance practices from top to bottom. She is committed to helping us overhaul where we need improvement, and strengthen where we are doing well.

Finally, over the last quarter the Company has made solid progress in getting back to basics, focusing on execution and serving our customers. We have put a number of the legacy issues behind us, but there is still work to do. I am confident that with our focused plan, solid execution, and talented employees, we can successfully drive Lumber Liquidators forward to enter the next phase of our growth and success. Together, we have the drive and the vision to execute a successful turn-around, and begin a new chapter for our Company.

I look forward to getting to know many of you over the coming weeks and months. With that, I will turn it over to Greg to discuss the results for the quarter. Greg?

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

Net sales were $236.1 million, a decrease of $30 million, or 11.3% over the third quarter of 2014. Non-comparable stores increased $8.9 million, and comparable stores decreased $38.9 million in comparison to the third quarter of 2014.

Within our comparable stores, net sales in the third quarter decreased 14.6%, due to a 1.6% decrease in average sale, and a 13% decrease in the number of customers invoiced. We believe net sales in the third quarter of 2015 continue to be negatively impacted by allegations surrounding the product quality of our laminate source from China. The allegations were part of a 60 Minutes episode that aired on March 1, 2015.

Additionally, we believe net sales in the third quarter of 2015 continue to be impacted by changes in our product assortment in certain merchandise categories. The suspension of the laminate source in China in the second quarter required us to replace a significant portion of our laminate product line with European and North American vendors.

We have worked diligently in recent months to stock an appropriate supply of laminate products, and we are where we expected to be at this point. We will continue to evaluate the performance of our laminate category as we move forward.

Additionally, related to our recently announced settlement, our supply of certain engineered hardwood products was disrupted as we replaced certain vendors. We also saw a stronger competitive environment in these two categories during the third quarter.

Within our non-comparable stores, net sales benefited from continuing store base expansion. We opened seven new stores in the third quarter, and are encouraged with the results of our new store openings. We believe their results show the strength of our store model.

We are also satisfied with the results from stores operating in our expanded showroom format, and we have now opened 82 new locations in that format since the beginning of 2013, and remodeled 50 existing locations, including one in the third quarter of 2015. The 132 stores with the expanded showroom format represent over 35% of our store base at the end of September.

I would now like to turn to gross margin, which was 30.1% in the third quarter, and will touch on each of the categories in which we have historically segregated drivers of gross margin -- product, transportation, and other. Product primarily represents the cost to acquire or produce our products, our retail sales price of those products, as well as the mix of products sold. Overall product margin was down 830 basis points.

Beginning in the second quarter of 2015, we focused on the reduction of our inventory levels, and began to rationalize our product assortment by eliminating approximately 140 varieties of flooring and related moldings. Our simplification of our product assortment, and focus on clearance inventory, adversely impacted our third-quarter 2015 gross margin, but we believe our efforts have resulted in a healthier mix of merchandise.

We believe consumers shifted away from laminates and bamboo flooring due to constrained levels of laminate, and consumer concerns over the quality of product sourced from China. Reductions in the sales mix of these products were primarily picked up by hardwoods, which generally have higher retail price points, but lower than average gross margins.

Finally, certain planned reductions in retail prices implemented in late 2014, and greater promotional pricing beginning in March 2015 to drive customer traffic and reduce inventory levels, has continued to adversely impact our gross margin. As we move forward, we will plan to be more strategic and selective in our promotional pricing, and adjustments of retail prices.

Partially offsetting these gross margin pressures was an increase in the sales mix of moldings and accessories, which we believe drove approximately 40 basis points of gross margin improvement. We have continued to analyze and review our merchandising and marketing strategy since the broadcast, and we believe we have the ability to be more strategic and selective in our promotional pricing, and adjustment of our retail prices going forward. We will continue to modify our marketing strategy based upon evaluation of its effectiveness.

With respect to transportation costs, lower international and domestic cost benefited gross margin as we reduced our inventory levels, both in our warehouses and stores. However, on a gross margin percentage basis, these benefits were more than offset by lower net sales compared to 2014. All other costs adversely impacted gross margin by 20 basis points.

There are two primary components impacting the comparison to the prior year. We incurred approximately $2.4 million of cost in the third quarter of 2015 related to our indoor air quality testing program, primarily reflecting the purchase of testing kits and professional fees. Meanwhile, we incurred approximately $2 million in additional expense during the third quarter of 2014, primarily related to our Bellawood re-launch, and higher inventory levels. That expense did not recur in 2015.

Turning to SG&A, SG&A expenses for the quarter increased approximately $10 million, or 12.7% to $88.3 million, and as a percent of net sales increased to 37.4%, from 29.5% in the prior year. Salaries, commissions, and benefits increased $2.4 million to 13.9% as a percentage of net sales, primarily due to retention incentives of $2.6 million.

Advertising expenses decreased approximately $3.2 million, and declined to 7.7% of net sales, compared to 8.0% of net sales during the third quarter of 2014, primarily due to an integrated marketing and merchandising strategy which combines promotional pricing and reduced advertising spend.

Occupancy costs were consistent with those in the comparable period of 2014 due to the benefits of the opening of our East Coast distribution center, which was fully offset by store-based expansion. Occupancy costs as a percentage of net sales increased approximately 50 basis points to 4.7%, due to lower net sales as compared to 2014.

Depreciation increased approximately 40 basis points as a percentage of net sales, due primarily to store-based expansion and our infrastructure investments, including supply chain. All remaining SG&A expenses grew by approximately $10.2 million as a percentage of net sales by approximately 480 basis points. Included in this increase were legal and professional fees of approximately $10.2 million, an increase of $8.7 million compared to the third quarter of 2014, and approximately $3 million in fixed asset impairment charges related to the termination of certain of our vertical integration initiatives.

With respect to SG&A expenses in the fourth quarter of 2015, we expect an increase in payroll expense of approximately $2.6 million due to employee retention initiatives, which are expected to increase SG&A expenses in 2016 by approximately $3.9 million. We expect legal and professional fees to remain elevated in the fourth quarter of 2015 and into 2016, while the various legal proceedings and regulatory investigations continue.

Finally, we are working to implement the environmental compliance plan that was agreed upon with the Department of Justice. We believe this plan will set a new compliance standard for the industry. Based on our expectations to date, we anticipate implementation and ongoing costs of our enhanced compliance programs to cost up to $3.5 million through 2016, of which approximately $0.5 million to $1 million is expected to be incurred in the fourth quarter of 2015.

The effective tax rate in the third quarter of 2015 was impacted primarily by a decrease in state taxes, reversal of uncertain tax position liabilities, and revised projected pre-tax income for the remainder of the year. Our net loss was $8.5 million, or a loss of $0.31 per diluted share, based on approximately 27.1 million weighted average diluted shares outstanding.

Turning to our financial position, liquidity, and capital resources, we believe we continue to be in solid shape. Our cash and cash equivalents were $53.8 million at the end of the third quarter, compared to $20.3 million at the end of December 2014, and $10.8 million at the end of September 2014. We had $20 million outstanding on our asset-based revolving credit facility at the end of the current quarter, and including potential limitations, we had $67.2 million available under this facility at such time.

Merchandise inventory was $243.4 million at the end of the current quarter, down from $314.4 million at year end, and $288.8 million at September 30, 2014. Available inventory per store was approximately $595,000 at the end of the third quarter, down from approximately $716,000 at September 30, 2014, primarily due to efforts to simplify our assortment during the quarter, and better manage our supply chain. This reduction was partially offset by weaker than expected sales.

Capital expenditures were approximately $19.5 million in the first nine months of 2015, and include a store-base expansion, the remodeling of existing stores, and equipment for the East Coast distribution center and finishing operations.

Looking at the fourth quarter of 2015, we plan to open five to six new stores, and relocate one existing store. We now expect capital expenditures between $22 million and $25 million for the year. We are still 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. But we believe the decisions made today will benefit the Company in the long term.

We have been busy working to assess and strengthen the business, and we've made some real progress. Although we think this will take some time, we believe there are opportunities ahead of us. I'll now turn the call back over to Tom and John for closing remarks.

Thanks, Greg. As I said last quarter, our plan is to get back to basics -- reviving the LL brand, re-building the relationships with our vendors, and continuing to make Lumber Liquidators run as efficient as possible. I look forward to working with John to make this happen as soon as possible. Let me turn the call back to John.

Thanks again, Tom. Over the coming months we have significant work to do, so there will be a lot going on at Lumber Liquidators. I believe in our core business model, and we will be working with Tom to continue his efforts to capitalize on that, while building customer and employee confidence.

I am also very accustomed to running a profitable business and taking care of the customer in a regulatory environment. I hope to leverage that experience at Lumber Liquidators. We've made some progress on the regulatory front in the last few months, and we will continue to improve our product and ensure compliance as part of our culture.

I also want to help improve our corporate culture in some specific areas. This means working with Greg to optimize financial analysis across the Company. It also means building a Management team where best practices are employed at all levels of the organization. It means building a team where we have a deep batch of talent.

Over the past few months, we have made significant adjustments to our go-to-market strategy as we've been driving traffic. Going forward, we feel we can make some refinements to that strategy and begin to rebuild some margin. For instance, our data suggests that we can be creative and surgical in the way we adjust promotional pricing. I believe we can create some additional value there.

The next area of focus is sourcing. We are optimizing our assortment so that the selling process is simplified. Tom talked about that last quarter. We must be smart on how we manage this process, and maintain strong relationships with our mills during this time. We are also conducting a systematic review of our mills. In the end, managing our supply chain more efficiently is critical to the future success. It will streamline and simplify our showrooms and logistics, and ultimately provide a better experience for the customer.

Finally, we want to be relentless about margins. While the special committee continues to work on non-operational issues, we are going line by line to control cost, maximize efficiency, leverage SG&A, and support our stores.

None of this works, however, without a commitment to operational excellence. As Tom has said last quarter, we are putting a lot of energy and resources into creating and maintaining best practices across the organization and in every store around the country. I believe we can make good progress in all of these areas if we stay focused and stay on mission.

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

Thank you.

(Operator Instructions)

Seth Basham, Wedbush Securities.

Thanks a lot, and good morning. My first question's around sourcing. You guys are making a number of changes with your sourcing. I'm trying to understand if you're going to be sourcing any engineered hardwood from China any more, and whether or not there's a cost associated with sourcing it from another location.

This is Greg. I'll take that. As you know, we're not sourcing right now from our products from China, laminate products from China.

He said engineered, so we are getting engineered.

But we are going to be continuing to source products out of China, including engineered. We will make sure that as we work through our compliance procedures, will make sure that we can source from anywhere. That's our goal.

Based on your sourcing plans at this point in time, what would you expect to be the gross margin implications from the places you're sourcing from going forward versus the places you were sourcing from in the past?

The best way to think about that -- again, we'll make sure that we have a compliance plan in place that allows us going forward to source from anywhere. In the near term, the biggest concern that we think about, we're not now sourcing laminate products from China.

Because we're now not sourcing those products from China, the costs associated with our laminate products are a little bit higher than what you would have seen historically, and that's going to have an impact on margin. I think we talked a little bit about that at the last quarter. We don't expect that -- that's still going to be accretive to our margins going forward, but maybe not to the levels we have seen historically.

Okay, thanks. I will turn it over.

Thank you.

Dan Binder, Jefferies.

Hi, this is [Dolph Worp] sitting in for Dan. I just want to clarify on the clearing out of the 140 SKUs. Is that all complete, or should we be expecting more of that activity going forward with the clearances that are related to that?

This is Greg. We've made substantial progress there, but that's something that we'll continue to do. I wouldn't tell you expect today that that process is finalized. We'll keep doing some of that, but again the Company is moving forward. We're expecting to improve the business in the fourth quarter by focusing on our promotional activity and how we adjust that going forward.

This is Tom. We will have products here and there ongoing that we will discontinue, as well.

Okay, thank you. If I could have one follow-up, with the employee retention incentives, are those across the board to all your employees? Are you seeing any increased turnover at the store level? Thank you.

Thank you, that's a good question. Yes, it is across the board. In fact, a significant portion of that, or a large portion of that is out in the stores. We've provided those incentives to both store employees, as well as to field. As you know, the store model that we have and our customers -- excuse me, our employees out in the stores are really the strength of the Company and drive our sales engine.

I think we have the right people in place. We're working hard now to make sure that they're executing on the sales strategy that we put forth. We're optimistic about the future on that front.

Thank you.

Sure.

Laura Champine, Cantor Fitzgerald.

Good morning, and welcome to your new role, John. I wanted to ask a question about how you got there. As the Chairman of the Board and the chair of the special committee, what in your own background made you feel that it made sense to essentially appoint yourself the new CEO?

Well, thank you for the question, and thank you for the congratulations. First, let's be clear. I did not appoint myself as CEO. It was a decision made after a long process conducted by the entire Board of Directors. We went on a national search, as we stated. We looked at a number of candidates. The closer I worked with the Company, the more it made sense to me to throw my name in the hat, if you will.

I'm very appreciative of Tom and the Board for entrusting this Company in me. I think that the familiarity that I have with the Company, the background that I have in working in regulatory environments, while providing working with profitable companies in those environments, working to serve customers in those environments, I think the Board -- and can't speak for them -- felt like it was the best choice at this time. Again, it wasn't a choice that I made individually. It was a collective choice made by our Board.

This is Tom. As well, and I think it's a good fit where I will still be involved in the stores and merchandise, and helping John with that. He has a lot of experience with, like he said, with the regulations and all of that stuff that we need to deal with at this point.

Let's hope that becomes less relevant sooner rather than later.

That's why he is here.

Yes, I understand. The second question would be on the sales front. I understand the desire to have more selective, more effective promotions, but do you think that pulling back on those promotional prices might create further pressure on the sales line the next couple of quarters?

This is Greg, Laura, and I appreciate that. The short answer here is maybe not that short. We're not happy with sales for the quarter. They're not where we would've liked them to be. But it's really not a surprise. Net sales were impacted by the allegations surrounding the Chinese laminate.

But we're going to focus on what we can control. On our last call, I think we indicated that our sales were being impacted by changes in supplies in certain categories, laminates being the biggest. That's an important category for us. As I mentioned, we are where we expected to be at this point.

We're going to look -- just to remind you -- we're going to look at that laminate supply and make sure going forward we are evaluating it to make sure we've got the right mix in laminates, the right style. It's something we'll continue to do.

Also mentioned on the call, and I will point out to you, that there were a few other things going on in the quarter that weren't just related to pricing. We believe there was an increase in competition in the marketplace during the quarter, particularly in the second half -- primarily in some of those categories that we talked about, laminates. We believe that increasing competition, combined with the timing of the retail calendar, made this somewhat of a difficult quarter for us.

But look, competition is a part of doing business. We understand that. We still believe in the value proposition and think that it's relevant today.

As we move forward, we're going to look at trying to continue to engage our customers, and highlight the value of our products. We will make sure that we have experts out in the field who are helping to serve our customers in the right way. We're going to make sure that we've got the right products available that will help us. I think if we focus on those three fronts, we'll be set up. It's not so much just the pricing promotional piece.

This is Tom. We will always have promotional pricing. We've always had that to get people in the door. Special buys are whatever we find in the market. It's not like we're going away from that.

Tom makes a good point. We're definitely going to be more surgical about how we go and do it. The idea is to say that look, we're still going to promote, and we'll still promote enough to drive traffic. We just believe we have the opportunity to do that in a way that saves some margin, and still drive traffic.

Got it. Thank you for taking my question.

Thank you, Laura.

Simeon Gutman, Morgan Stanley.

Thanks, good morning. I have two questions. First, on the legal, the regulatory side, you mentioned that there were some positive developments. I think you were referring to the Lacey settlement. Can you give us a lay of the land of the key outstanding issues?

I realize we don't have a lot of visibility. Just to set the table a little bit on what are the key pieces or allegations that we're still trying to get clarity on? Then I have one follow-up.

Okay, this is John. We're still working and cooperating with the Department of Justice over their investigation over statements that were made after the 60 minutes article. We're also working with and cooperating with the CPSC on their investigation in some of our Chinese laminate product, as well as working with the California Air Resources Board on the same Chinese laminate products. Those are the high-level items that we are working on today. We will continue to cooperate, and will continue to provide updates as we have them.

Right. Time frame, it's impossible I'm assuming to tell your recurring legal fees -- but it's just ongoing. Are you at the will or the mercy of their time frame, or is there anything on your side to do from a timing perspective?

We're doing everything we can do to cooperate to speed up the time frame. However, there's certain things we do not have control over. To some degree we are at the mercy of their investigation as it relates to time.

Okay, and then my follow-up just on the fundamentals, in thinking about bringing gross margin back up over time, are there any examples where -- are you starting to test in certain markets or geographies, looking at the trade-off between less promotion and higher sales? I don't know if that's something that's too early to be looking at, but curious how this process could evolve over time?

This is Greg. I think the answer to that question is yes, we are beginning to look at those things. As you would expect, as we move forward, the reason we're talking about being selective in the way we go about promoting is we feel like there are opportunities out there for us. We'll look to capitalize on those in the coming months and quarters.

What I would add to that is we don't see this as a one-month or one-quarter recovery. We feel like we've got a strong marketing plan that will invest in the right advertising mix to rebuild the customer confidence and our sales. The plan will roll out over time, and is based on successful response. It will also -- we'll link that very closely to promotions.

Okay, thanks.

Matthew Fassler, Goldman Sachs.

Thanks a lot, and good morning. My first question relates to associate and store manager turnover and retention. Can you give us a sense of what employee turnover trends have looked like over the past three to six months since the businesses has gotten a bit more turbulent?

It's a little more, but in general the attitudes in the store are very positive -- very focused on getting us back to what we need to be. The stores who have had the brunt of the issues there with dealing on the front lines, they've put up with a lot, but their attitudes are great overall. Some of the changes we've made, some they've made, but it's overall very good.

Thanks. Go ahead, sir.

I was just going to add, the employees that I've met out in the field so far are very enthusiastic, are very positive about the Company. The feedback I've gotten from the few I've met with so far are excited about the change we've made today, and excited that Tom is still involved. I would view the employee or the associate morale out there is very high at this point in time.

Thanks. Then my follow-up question relates to the real estate pipeline. You're opening another handful of stores in the fourth quarter. How many of those were you contractually obligated to open, given leases that you had already signed? Do you have signed leases for 2016 at this point?

As we talked on our last call, it was our intent to continue to open stores. I think we've continued along in that plan. We now have leases for all of those that we've now opened during the quarter. As we look toward 2016, we still intend to look at new store openings. We believe it's a good use of our capital. They are accretive to cash within a two-year period, and usually before that.

We've hit the right approach. Where we stand today we do not have leases signed for 2016, and we're going to make sure we are evaluating every lease and every capital spend over the next -- well, into perpetuity, but over the next few quarters, we'll make sure that we are very selective in how we approach signing new store leases.

Just to make sure, you said you do not have leases for 2016 signed at this point?

Not yet, no.

Okay. Thank you very much.

Brad Thomas, KeyBanc Capital Markets.

Thank you and good morning. I wanted to follow up on the topic of sales, particularly in light of the long purchase cycle. I was hoping that you would comment a little bit more on perhaps what you saw in terms of the cadence during the quarter, where the open orders stand, and any other metrics that you all are willing to share, like how many samples you've been giving out.

In terms of sales cadence during the quarter, we commented a little bit here. But the quarter -- the second half of the quarter was worse than the first half, and we believe that was, as I mentioned, in large part due to the retail calendar, as well as some of the competition we saw in the second half of the quarter.

Overall, you saw what the ending number would be; but again, I would tell you I think the second half was worse than the first. I apologize, I can't remember the second part of your question?

Any perhaps leading indicators of sales, like the open orders, the backlog, the samples -- things like that?

Open orders give us a look at a point in time, but they're really not reflective of what we're expecting for the quarter. We would prefer not to disclose that information at this point.

Okay. If I could follow up on the legal regulatory side. I was hoping you could just comment a little bit more about how things are progressing with the test kits that you've been sending out. I believe the 10-Q quantifies some costs associated with phase one and phase two, but it looks like you haven't gotten into any costs associated with phase three yet. How are things progressing with the test kits?

This is Greg. That's right. We've made good progress in the test kit program. The numbers, most of them, as you pointed out, are in the 10-Q and the table; but I will highlight that we've responded to the call from our customers by sending out at this point almost 48,000 test kits, and analyzing the results of 28,000, roughly. We do believe interest in the program is slowing. As you saw, roughly 6,000 test kits were issued during the third quarter -- much smaller than in the prior quarter.

We've stood by our plan to work with our customers, to help them evaluate the air levels in their homes, and understand whether our floors were causing an impact. We call that phase two of our testing. I tell you, based on the results today, which we believe actually provide a reasonable basis for our reserve, that we haven't seen a need to accrue for any cost to repair or replace floors at this point.

Great. Thank you so much, Greg.

Keith Hughes, SunTrust.

Thank you. Going back to the change or shift in promotional strategy. Do you expect to discount on less products, or change the level of discounting that you're going to be doing moving forward?

I would tell you we won't go into specific strategy on how we intend to do it. We'll look at all options. The idea here is that we're going to be more surgical in how we approach it. As we think about, we'll make sure we're discounting as needed to drive traffic, but not discounting more than needed to save margin and provide the value to our shareholders.

Also, right now a lot of the stuff that we're discounting is our own stuff. We would prefer to discount other people's stuff in special buys, where we're buying it at a much better price, and selling it at a good price and making money on it.

Okay, and on advertising, do we expect advertising spend to follow the changes in same-store sales, roughly?

We'll be smart about how we spend in advertising. As you saw, the gross dollars were down this quarter. However, again we're going to make sure that we are spending and talking to our customers as appropriate to continue to drive sales.

Then you had mentioned a CARB investigation. Clearly, that's about laminates. Is that included, or will it expand to include engineered wood from China, as well.

At this point in time, we're focused on Chinese laminates what we've been working and cooperating with CARB on, so we will leave it at that.

Final question, can you give us any sort of feel in the quarter in terms of the change in sales of our product. I'm assuming laminate was the worst, but ex-laminate, what the other product categories look like?

We haven't really gone into direct product categories, but as you would expect, laminates were the -- behind where we expected, or where they were in the prior year. As we get into the fourth quarter, we're really looking to evaluate all the new supply that we now have in stock with respect to our laminate assortment, and we're looking forward to getting back to the same mix that we had in the prior year. That's where we're looking towards.

Okay, thank you.

Peter Keith, Piper Jaffray.

Hi, thank you everyone. Just to follow-up on the last question from Keith. In the press release you noted there was a weakness in laminate and bamboo. I was wondering if with bamboo weakness showing up now, do you believe there might be a stigma on flooring products that are sourced from China that's impacting those categories?

It's very possible that is in fact the case. We don't see a direct reason as to why people wouldn't buy bamboo products. They're good products. We sell a strong assortment of those. But as we surmise, obviously with the stigma around Chinese products that we sell today that there could be some hangover there.

Okay. Then turning to the same-store sales trend, that was probably the biggest area of weakness relative to our expectations. I think we're all trying to figure out when you're trend might bottom out. 60 Minutes did re-run the segment in mid-August, which would be right at the mid-point of your quarter. Did that have a ripple effect that then caused another down-turn in the overall sales trend that you're now recovering from?

Yes, thanks for the question.

It didn't help.

That's right. It obviously isn't something that would be helpful. But again, we're looking right now to control the things that we can control, and that's the focus on how we talk to our customers, how we sell products.

I would tell you that although same-store sales are important, one of the things that we have seen is that the base business once by month has stayed somewhat steady. We've maintained a base level of sales throughout the period on a comp-store basis, as well. You're right, when you start to compare to prior year, we are struggling a little bit. But overall, it's not getting dramatically worse.

Okay, great. One last question for John, then. There's a number of things that are being shut down here from the prior Management team. You look at the talent initiative was short-lived, the vertical integration was short-lived. You're shutting down about 35% of your SKU count, and now ramping up the compliance efforts.

It seemed like things were being done by former Management that lacked maybe Board oversight, because of all of these quick sudden changes. Could you help us understand the disconnect on all of these initiatives that are now being shut down very quickly, versus where the Board was when these things were being approved?

First of all, I'll address where the Board was when these things were being approved. If you go back to 2012 and 2013, the Company's performance both in sales and net income was really good. There was a lot of confidence back then about what the Company was doing, and how the Company was performing. But as we get through some of these negative impacts that we've had with the negative publicity impacting our sales, it really has forced us to go back and really get back to basics.

Tom founded a Company 21 years ago that is really good at selling hardwood flooring. We need to get back to selling hardwood flooring. The other integrations, these expanding products, given the negative publicity that we had during 2014 and in 2015, is really important for us to get back to what we're really good at, and that's what we've done. That's what we will do for the foreseeable future. This has been a really good business for 21 years. We need to get back to that, and then grow from there.

Okay. Thank you very much, everyone.

Thank you.

Greg Melich, Evercore ISI.

Hi, thanks. I have two follow-ups. One was understanding the traffic trend during the quarter. I understand the second half was worse, but if you could break that down into maybe the traffic side of the equation? Then I had a follow-up on assortment and sourcing.

Again, I would tell you the traffic trend got worse in the second half compared to the first. As you start to look month by month, it's a little more difficult to pull out. Because of shifts in timing of weekends, you lose some of the meanings. We don't really want to go to that level of detail. But certainly we saw a strong start to the third quarter, and it ended on a less positive note because of the timing of the calendar, as well as some of the competition we saw in the second half of the quarter.

That's great. Second, I guess as a follow-up to several questions you had before about the 140 SKUs that you had taken out. How many of those have been replaced, or was that a gross or net number? I can't remember who it was -- I think John, you talked about getting back to where you were in the past as being a great hardwood floor specialist.

If we were to think about it, do we think we're ever going to go back to the same SKU counts in two or three years, or we only put half of them back. Give us a sense of what the store might look like in terms of mix, or how you want it to look a year or two from now?

This is John. I'll answer the question first, and then I'll let Tom jump in. But if you walk into one of our stores today that we have remodeled and re-configured for the future, you walk in and you see a lot more hardwood flooring that you've seen in the past. You've seen a lot less SKUs of tools. You see a lot less SKUs of other products like tile.

When you walk in the door, you see a wide assortment -- what even looks like a bigger assortment of hardwood floors, versus what you might've seen six months ago in one of our stores that would've been confusing, if you will, of looking at a lot of SKUs of tools and a lot of SKUs of tile, and a lot of SKUs of stuff that didn't make sense in our stores. I will tell you walking in today, when you walk into one of our stores you see a lot more hardwood flooring, and a lot more SKUs of flooring.

This is Tom. We had walls of tools and casters and stuff that wasn't selling. We just re-did the store in Richmond here. We had all the regional managers here last night to show it to them. We took out -- instead of a wall of casters, we put in a better display of butcher block, which we sell millions of dollars. We put in wood tile, wood-look tile that we have a better assortment of now. We put in pine that wasn't displayed properly, but we sell a lot of it.

We consolidated the tools that we're going to keep, and the cleaning products and the accessories on the other side by the register. It makes it much simpler for the customer to come in. We also reduced the duplicated SKUs. Birch and maple look very similar. We don't need to have both of those. So we got rid of that.

To the customer when they come in, they see more wood than anyone else in the industry, and it's a much easier shopping experience. They don't have to decide between four things that look exactly the same. There is one of those now.

The SKUs that we replaced or got rid are not necessarily for the business. This makes it much simpler, much easier for the customer. Much easier for the whole operation. We don't need to have a DC full of five similar things all the way down the line. We don't need to purchase all these things. We're getting back to what we need to sell. It's easier for us, easier for the consumer. It's a much better business.

Just a few changes in the store. We don't need storage for the tools up above, so the store can come down about 300 square feet. It's less cost to build it. It just becomes overall a much better efficient business.

The 140 varieties, that isn't just the laminate. That's basically editing tools in these other areas? Is that a gross number?

What do you mean, 140?

That's flooring SKUs. Again, I think Tom said it very well. We are reducing 140 flooring SKUs, but those SKUs were not our best-selling SKUs. We went through and systematically evaluated what products are selling, what's not selling.

We're trying to be more efficient in managing our splotching and our mix of inventory to make sure that we continue to buy the things that our customers want to sell. Those are the products that we're stocking, to make sure that it's easy to show them what we have available for them to buy. Now we're asking our stores to execute, which we think they can do better than anybody to get those sales.

That's great. Thanks a lot, good luck.

Thank you.

David MacGregor, Longbow Research.

Yes, good morning. As you go through this turn-around strategy, do you anticipate increasing your borrowings? If so, how much leverage do you think you're prepared to incur?

Right now, as we said on the call, we believe we have the right amount of liquidity. We've got $53 million in cash. We have $20 million outstanding. We did point out in the queue -- and you probably saw over the past few months a lot of our cash generation has been from reduction of inventory, and this aggressive approach that we've had of making sure that we have a healthier mix of inventory going forward.

But of course, you can't operate in that mode forever. As we look forward, the story here is really no different. We need to be working to generate sales and operating income. As we do that, we have what we need to operate the business.

Okay. Just as a follow-up, you mentioned the stronger competitive environment. I wondered if you could elaborate on what you're experiencing there. Is it the home centers that are coming in and applying more pressure and being more aggressive, or are you seeing substitution from other flooring products that are applying pressure to laminate?

I think there were a number of factors for us. We won't go into what specific competitors were doing. But during the quarter, as we mentioned, we were getting back into stock in some key categories for us, the primary one being our laminate products. As we looked out in the market, we saw that category was under some pricing pressure in the second half of the quarter, as well.

Last question. It seems as though there's still some certainty regarding the pace of new store openings and remodelings going forward. Can you talk about regional priorities? Do you favor the western markets, now that you've got established distribution out there?

I think at the end of the day, we believe our store model works in all regions of the country, and it works well. We are looking to continue to expand our footprint in markets, and we have a real estate team that will make sure that we're looking not only in the west but in the south and the east and the north.

I wouldn't tell you if any one particular market we're looking to go into at this point. We will make sure that we put those stores in the places where we make the best use of that capital in the next few months.

Thank you.

Sure.

Budd Bugatch, Raymond James Financial.

Good morning, this is David Vargas on for Budd. Thank you for taking my question. At the end of last quarter, you said you had about $20 million of inventory of laminate flooring sourced from China. I'm wondering if you can give us an update on what value this is being currently held on the books at, and if you anticipate having to adjust the value of that product and that inventory going forward?

That product is on our books at cost, again about $20 million. We believe it's appropriately valued as of today.

Got it, okay. Then on the promotional cadence from last quarter from Q2 to Q3, can you give us any color on whether you're more or less promotional and aggressive on pricing, and if there was any difference between the product and categories that you were more or less promotional on?

I think as we moved throughout the third quarter, again we were evaluating what we did in the second quarter, evaluating what we did early in the third quarter. We had a number of planned promotions that were in place. I'd comment to say as we move forward, we're expecting to be more selective in how we did that.

You can look at our average selling price and see some changes there. Overall again, we're looking forward right now and thinking we have opportunities as we move forward.

Okay, great. Thank you and good luck.

Thank you very much.

Again -- I'm sorry, go ahead operator.

I apologize. I would just like to turn the floor back over to Management for any additional concluding comments at this time.

This is John. Again, thank you for joining us on today's call. I want to thank our Lumber Liquidators team for your hard work. We couldn't do any of this without you. I also want to thank our customers for your continued support. You have stuck with us, and we appreciate it. We look forward to speaking to all of you again next quarter. Thank you.

Ladies and gentlemen, this does conclude today's teleconference. Again, we thank you for your participation, and you may disconnect your lines at this time.