LL Flooring Holdings Inc (LL) 2016 Q1 法說會逐字稿

Welcome to the Lumber Liquidators' first-quarter 2016 earnings call. With us today from Lumber Liquidators is Mr. John Presley, CEO and Mr. Greg Whirley, CFO. As 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. Thank you for joining us. Let me take a moment to reference the Safe Harbor Provisions of the US Securities laws for forward-looking statements. This conference call may contain forward-looking statements that are subject to significant risks and uncertainties including the future operating 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 this 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 on this call.

Now, I'm pleased to introduce Mr. John Presley, CEO of Lumber Liquidators. John?

Thank you, Steve. Good morning, everyone. Thank you for joining us for our first-quarter 2016 earnings call. This quarter, we reported revenues of $233.5 million, a decrease of 10.2% over the prior-year period, with net sales from comparable stores declining by 13.9%. Our January and February comparable store sales performance was up against particularly difficult comps, as we saw a substantial increase in customers invoice last year on the rollout of an aggressive pricing strategy.

In March of this year, we were impacted by continued negative customer sentiment, driven partially by a new round of negative publicity related to legacy regulatory issues, many of which were coming to a close during the first quarter. We were hopeful as we continued to resolve our remaining legal issues, that adverse media attention will subside. Importantly, we do not believe our financial performance in the first quarter reflects the progress we have made in repositioning Lumber Liquidators for success.

Since I became CEO in November, one of my main areas of focus has been to move our Company beyond these legacy issues, so that we can give our full attention to strengthening the core business and our competitive position in the market. I'm pleased to report that year-to-date, we have successfully overcome several of the regulatory hurdles that challenged our Company over the past year. While we still have some ground to cover, let me briefly walk you through the progress we have made on this front.

In March of this year, we reached a settlement with the California Air Resources Board, CARB, resolving from their inquiry with no formal finding of violation. CARBs inquiry was focused on a Chinese laminate product, which we have not carried in our stores for over a year. The financial portion of the settlement was $2.5 million of which $1 million was recorded in the quarter, as the remainder was accrued in 2015. We are also collaborating with CARB on the testing research and supplier audit programs designed to establish even stronger compliance protocol, which we believe will set a new standard for the industry.

Also in March, we received an updated report from the Centers for Disease Control. Despite the initial calculation error and the negative media attention that followed, the facts remain, the CDC's assessment was focused on one product only, laminate flooring imported from China, which I'll say again, we took off our shelves a year ago out of an abundance of caution. The CDC's report recommended commonsense steps, such as room ventilation, which we believe are reasonable and practical.

Then in April, we received a favorable ruling in the Proposition 65 lawsuit in California. The judge rejected claims made by plaintiff attorneys in Sunshine Park, a firm affiliated with product investment companies, who alleged that we had failed to properly label some of our products sold in that state. Finally, on April 27, we entered into an agreement in principle or a memorandum of understanding in our consolidated securities class-action.

Greg will walk you through the financial details, but the bottom line is that a settlement pursuant to these terms will have a minimal impact on cash, which allows us to continue to invest in the business. While we still have issues to address going forward, these developments represent major steps in the right direction for our Company. We are better positioned to focus on rebuilding our brand and ensuring we deliver on our promise of a high-quality, safe product and superior customer service.

A key component to moving the Company forward is having the right people in place. On March 1, we appointed Dennis Knowles to our leadership team as Chief Operating Officer. Dennis joins us from Lowe's and has more than 25 years of leadership experience. He is responsible for all functions supporting our store network and business operations. Although, he has only been on the job for two months, he is already putting tools in place for store management to better address the needs of our customers.

Additionally, during the course of the last year, our new Chief Compliant and Legal Officer, Jill Witter, has conducted a complete review of our compliance procedures and our suppliers including on-site audits of all of our suppliers in Asia-Asia and South America. She has also led the implementation of an environmental compliance plan.

Our improved compliance process enables us to track our goods from their harvest site to our showroom floor ensuring environmental and safety compliance throughout the process. These revamped procedures are designed to ensure that we only partner with suppliers fully committed to the highest quality and safety standards. I'll come back in a few minutes and review with you some of our most important operational initiatives. But first, Greg will walk you through the numbers.

Thank you, John. Good morning, everyone. Today, I'll provide details on our results for the first quarter of 2016. Note that unless otherwise specified, my references to percentage and basis point changes are in comparison to the prior-year period. For the first quarter, net sales were $233.5 million, a decrease of 10.2%. Within our comparable stores, net sales for the quarter decreased 13.9%, due to a 13.8% decrease in the number of customers invoiced and a slight 0.1% decrease in the average sale. Sales in our non-comparable-store base increased by $9.5 million.

The decline in our comparable-store sales this quarter was impacted by difficult comparisons in January and February driven by the rollout of a more aggressive pricing strategy in the prior-year period, which drove a 9.6% increase in comparable-store sales in the first two months of 2015. In March, we believe continued negative customer sentiment also impacted comparable-store sales. We believe this sentiment was in part a result of additional negative media coverage regarding legacy regulatory issues, many of which we recently put behind us and was related to products we no longer sell.

That said, we are seeing the continuation of some positive trends. With a full assortment of laminate products from suppliers in North America and Europe, laminates as a percentage of total sales continued to grow sequentially in Q1 to 17.9% of our sales mix, up from 16.2% in Q4 and 13.3% in Q3. Additionally, our focus on the do-it-for-me customer continued to drive growth in installation services revenue, which increased 65.9% over the prior-year period to $8.9 million in the first quarter. We believe there remains considerable opportunity for further expansion. This portion of our business will allow us to serve our customers more holistically throughout the entire purchasing cycle.

Now, let's turn to gross margin, which was 32.6% in the first quarter compared to 35.2% in the prior-year period. Excluding costs related to the consolidation of certain laminate products sourced in China and indoor air quality testing related costs, gross margin in Q1 was 34.5%. This represents an approximate 210 basis point sequential improvement compared to a similarly adjusted gross margin in the fourth quarter of 2015. This improvement is largely driven by our more strategic promotional strategy, favorable product mix, and reductions in product costs.

We remain encouraged by the progress we've made in our promotional efforts. We will continue to refine our promotional cadence going forward. Looking at the year-over-year comparison, despite the increases we've realized in our pricing sequentially, when compared to the first quarter of 2015, our price per unit sold was still lower by 3.3%, which continued to negatively impact our gross margin. Additionally, the year-over-year gross margin decline was impacted by the mix of products and accessories sold.

Turning to SG&A. SG&A expenses for Q1 were $117.2 million or 50.2% of sales compared to $97.7 million or 37.5% of sales in the prior-year period, an increase of 20%. SG&A expenses included incremental legal and professional fees and settlement expenses of approximately $29.5 million and $14.5 million in the quarters ended March 31, 2016 and 2015 respectively. Included in these costs were $16 million in net charges related to the securities class-action in the current year and $10 million in net charges related to the prior-year's settlement costs associated with the DOJ/Lacey matter. Within our SG&A, advertising expenses were flat year-over-year at $22.3 million and occupancy cost increased 1.5% to $12.1 million.

Moving forward, we remain committed to strong, disciplined cost control supported by increased levels of accountability. Q1 experienced an operating loss of $41.1 million compared to an operating loss of $6.1 million in the prior year. Our net loss for the quarter was $32.4 million or $1.20 per diluted share compared to a net loss of $7.8 million or $0.29 per diluted share in Q1 of last year.

Now, let's take a look at our cash position and liquidity. Cash at the end of Q1 was $22 million, a decrease of $4.7 million since December 2015. The decrease was primarily due to $8.2 million of net cash used in operating activities and $2.4 million used for capital expenditures, which were partially offset by $5 million of additional borrowings under our revolving credit facility. In total, we ended the quarter with $25 million outstanding under this facility, with the remaining availability of $61.6 million.

During the quarter, we made measurable progress in our efforts to resolve outstanding legal and regulatory issues facing the Company, including the resolution of an inquiry by the California Air Resources Board. Additionally, the Company received a favorable ruling in the Propositions 65 lawsuit, entered into an agreement in principle, a memorandum of understanding related to a potential settlement of its outstanding securities class-action litigation and also conducted a mediation related to outstanding derivative litigation.

Though the resolution of these matters is not final, it could change prior to ultimate resolution. The Company currently believes the net cash outlay to resolve these matters, exclusive of legal costs, will be approximately $2.5 million, in addition to the issuance of 1 million shares of our common stock. Merchandise inventory at the end of the first quarter was $240 million, down from $244.4 million as of December 31, 2015.

Available inventory per store was approximately $587,000 as of March 31, 2016, up from approximately $577,000 as of December 31, 2015 reflecting higher seasonal inventory as we prepare for the spring flooring season. Our inventory per store remains 24% below that of the March 31, 2015 reflecting the efforts initiated over the past year to better align our inventory with customer demand and simplify our assortment.

Let me now update you on our store network. Our top priority is to improve the performance of our existing stores. So we have and will continue to maintain our disciplined approach to opening new store locations. We opened one new store in Q1. We've signed five additional leases, which will fill in some of our most attractive markets. Again, we are only moving forward with new stores and locations where we are confident we will produce an attractive return on our investment.

In summary, we remain focused on improving the parts of our business that are within our control. We believe we have the right plan in place to execute this turnaround and bring Lumber Liquidators back to profitability. I would now like to turn the call back over to John for his closing remarks.

Thanks, Greg. Before we turn to your questions, let me remind you about the four components of the plan we laid out at the beginning of the year. First, we will improve our store performance. Dennis and I have talked at length about this. We agree there are many opportunities to help our store associates close sales and help customers get what they want. This begins with a strong training program. If our associates are not experts, we lose an important component of our competitive advantage. So our new training program is well underway across our stores, ensuring our associates offer customers the most knowledgeable and efficient store experience in the industry.

Our second area of focus will be strengthening our value proposition and ensuring we have the right product assortment to meet customer demand. Many of you are aware that we simplified our assortment at the back half of 2015, better aligning our in-store selling approach to a good--better-best framework, as well as ensuring consistent product availability. We believe our efforts on this front combined with our other initiatives, will lead to higher conversion over time.

Our third mandate is to continue responsible product sourcing and compliance. There are two fundamental reasons that this is important to us. First and foremost, we want our customers to have a quality, safe product in their homes. That's good business. That's how we will rebuild our brand. The second reason is that we want a system so reliable that it allows us to source from anywhere in the world with confidence. Earlier, I mentioned the great strides we've already made. Moving forward, Jill and her team will continue to improve upon the modern system they have built and can deliver not only results, but also adapt to a changing landscape.

Our fourth goal is the opportunistic expansion of our business. We told you last quarter that we are seeing additional opportunities to grow in complementary areas of our business including the expansion of installation services. We continue to be pleased with our results in this area and look forward to continued growth in the future.

Those are the four components of our 2016 plan. There's nothing elaborate or complicated here, but it is not necessarily easy. It takes a commitment to all parts to execute every component and run our business with the excellence in everything that we do. In closing, our management team is very confident in the potential of our business. We have a plan that will work. All we need to do now is execute. With that, operator, we are now ready for questions.

(Operator Instructions)

Simeon Gutman, Morgan Stanley.

Simeon Gutman. First, quick one, can you tell us or give us a sense of how much installation services are helping the comp? Or if you just breakout product versus services?

Yes. We can give you a short idea. At the end of the day, they've helped marginally or slightly, installation services on a large part of the business at this point. We don't want to give the specific numbers, but they've helped slightly over the course of the quarter.

Okay. My second question on the reputational issues, you can't control when they come out, but are you seeing less of a reaction to the business when they occur? Then is there anything that you could do offensively when these things happen, whether it's advertising dollars or brand -- reputational things to help offset some of these attacks?

This is John. I'll give a first shot at that answer and then Dennis Knowles is here with me today. He may have some to elaborate on. What I would say, it's what you can't measure is the thing that is bothering us the most, the people who do not come in. We've certainly had seen, when some of the negative activity comes out, we see increases in the volume of our customer care line. So, we had more explaining to do to the customers that come in the stores. So, we certainly believe that it has an impact on us. It's not an impact that we have been able to precisely measure. It's an impact that we see diminish over time as we stay out of the news.

The one thing I can tell you about the March negative news was that the customer needed less time to explain what had happened. It was presented in such a way that we got calls, not only about Chinese laminate, but about all of our products and about our competitors as well. So it was very confusing to the consumer what was actually trying to be conveyed to them. It was not just limited to one product or Lumber Liquidators but seemed to be almost to the whole flooring industry. Dennis deals with the stores every day on a granular basis, he may have more color for you.

Yes. I would say the challenge for us as news hit the public was making sure that we had 370 stores focused on the customer with the right answers. As John mentioned, you can imagine there's a lot of speculation in terms of what product was impacted, what our employees should talk about -- what they talk about when the customer comes in the store and asks them questions. We wanted to make sure that we armed our stores with that information for a couple of reasons.

Number one, we wanted a consistent message out there. Number two, we needed our employees to remain focused. Certainly, it's had a big impact if you look back on the trailing 12 months of just the focus of our employee base in the stores, but also their ability to deliver a great experience for the customer. So that was really important to us. It's something that we focused on a lot in the trailing part of the quarter and as we go into Q2, making sure that we're keeping our employees informed and arming them with talking points of how to answer questions as they come up.

Would you be willing to share what the bounce back has been post the reputational issues in Q1 and Q2?

We won't go in to Q2, but what we can tell you is that after each one of the incidents, there's typically a spike in interest about the Company and in some respects, negative interest. We will see an increase in the number of people that call our customer care department, as John mentioned. We have a test kit program out there to help customers understand information about their homes and the air quality of their homes. We see a spike in requests. Having our story essentially on the news continues that trend.

As we look and when we step back, where we are today, we're trying to put some of these issues behind us. We've got a ways to go, but this management team is really focused on what we can control today. I'll just highlight for you that we're not looking at this as a sprint. So while we do see things subsiding, it's not a sprint. We all know that the efforts and things that we're working on today are what's going to drive profitable sales and impact our brand positively in the long-term.

Thank you.

Thank you.

Rick Nelson, Stephens.

Please look beyond the class action, the CARB and Prop 65, what are the legal and regulatory matters that are still in front of the Company?

I've got, also in the room with us today is, Jill Witter, who we mentioned in our initial comments. Jill is greatly familiar with everything that we're working on, so she can give you an accurate synopsis of what's left.

If you look behind, beyond the securities matters and the items that we have already scheduled to date, the last item of that significance is the multi-district litigation. There are over 100 cases that have been consolidated. They are on a fast track in courts in Virginia, so those are the primary issues that we have. Like any other Company, we have day-to-day litigation that is normal for our industry. But what we refer to as the MDL or the multi-district litigation, is the big one that is still out there.

That Consumer Product Safety Commission, where does Lumber Liquidators stand as part of that goes?

Yes. The Consumer Product Safety Commission, as you know we've been negotiating with them. We continue to work with CPSC on their investigation and are hopeful that we will be able to come to a conclusion in the near future with them.

Okay, got you. Thanks. I guess, the strategies to get traffic back into the stores, that seems to be the big challenge. Is it advertising, marketing, what you're doing along those lines to shift the direction in the comps?

Well, I would tell you the main thing that we're doing is really focusing, as we talked about in our directives at the beginning of the year is, focusing on store operations and making sure the customer experience as they walk into our stores is immaculate. So that when the customer comes in they're getting the advice that they need. Time is healing a lot.

We also are stressing in some of our advertising, the safety of our product. But as I think Greg alluded to, getting your brand back, getting your reputation back, is not a sprint. It's going to be a marathon. So we've got to do the fundamentals right. We've got to do the blocking and tackling right. We cannot go out there and put up a sign that says, okay, now we're good. We've got to prove that we're good. So we realized that. That's what we think will, one, be effective, but, two, be actions that will last a heck of a lot longer than just talking about what we're doing.

Just to put a final point on that John. I would say that we believe today that enough customers are coming into the stores. We intend to execute better to earn the business of those customers.

Yes, you're right.

I would just tag on that with Greg, that we have customers coming in the store today. What we're focused on, as John mentioned, is the customer experience and the conversions from just someone in looking for flooring to someone that actually purchases flooring from us. We're working to have a holistic experience for them from beginning to end. By incorporating the installed sales piece, we continue to refine that model. We see that as a big opportunity for us to be the leader.

By doing that, by making sure we've got employees that are trained, Marco focusing on making sure that we've got an assortment that is attractive to the customer and then delivering on that experience. It's a big opportunity for us and something that John's talked about for several months now, about making sure that before we think about doing anything else, we've got to make sure that we can deliver on that in-store experience.

Thanks for the color, guys. Good luck as we move forward.

Thank you.

Seth Basham, Wedbush Securities.

My first question was just on your promotional strategy. Since, you've changed that strategy over the last few months, I would love an assessment from your perspective on how it's performed?

I think we believe it's done well. As you step back and look at what's going on, there's a lot going on in our comp numbers when you look at the period year-over-year. Given the disruptions in 2015, we've attempted to provide you with some visibility into the monthly breakout. I know you've only seen the quarter for a short period of time. But if you look at the first two months of the quarter, our comp was down about 17%. That was against tough comparisons and our, I guess, to the prior-year pricing strategies.

As you know, we've switched and changed our pricing strategy to be a little bit more strategic as we move forward. Comps for the month of March were actually down 7.6%. Remember prior-year sales in March were impacted by having a full queue of orders available to sell from a pre-60 Minutes scenario, that wasn't the case this year. This year's been fully impacted by it. Quite frankly, we don't expect to see those comparisons become easier until mid-Q2. I would say that in comparison in the current year, we believed that the 60 Minutes CDC report impacted our negative customer sentiment, impact to negative customers.

Marco's also here with us today. He may give you just a little bit more color on that.

Yes, John, thanks. We clearly are looking at our assortment as both Dennis -- everyone has said here, as the phases. It's not a sprint. So as we look at this assortment, we're looking at making changes to them. One of the things this year's been able to do is allow us to take that assortment and improve it. We've been doing that the last couple of months. We're seeing really good things around how that assortment is working.

Okay that's helpful. So no change to your promotional strategy going forward, given that it's working to your expectations at this point. Just making sure I understand the trends, since the negative publicity at the end of February. You saw a spike in requests for testing kits. Has that spike dissipated at this point in time? Would that imply that you should probably be seeing better conversion as a result?

It would imply that the spike is going down. Again, when we're not in the news is up to us to operate. Well, it's up to us to operate when we're in the news, quite frankly, and we're going to do that going forward.

I would question how much of that really has to do with conversion.

Right.

Conversion is more about our execution at the store level. If the customer gets into the store, a lot of things are obvious. They want to look at a floor. They're looking for some advice. That has nothing to do with the negative publicity or test kits.

Okay, great. Then my last question is just on your store plans. You had one net new store in the quarter. Did you close any stores? Do you plan on closing any stores going forward in 2016?

We did not close any stores in Q1. We have, as I mentioned and in my comments, signed five additional leases for the current year. With respect to closing stores, we're constantly looking at our store chain and our store network. This management team will make the tough decisions if there's a store that's not performing to our expectations, we won't hesitate to close that store. As we stand today, our store model and our store network is still very profitable. That's not our expectation at this point but we will make those decisions if necessary.

Great. Thanks a lot. Good luck

Thank you.

Peter Keith, Piper Jaffray.

I wanted to circle back on the topic of marketing, I understand the opportunity around conversion. But there does seem to be a general traffic problem to the stores. I'm curious if there's any regulatory decision perhaps with the CPSC that might give you more of an all clear to evolve that marketing and brand strategy to try to attract more traffic?

I don't know that we would -- we will tie our marketing strategy or brand strategy to any one particular issue. As we've mentioned a couple times and I hope you hear in the tone here that the management team wants to make sure that we are executing and doing the things regardless of what's going on in the market around us.

As a relates to our promotional strategy, I would expect as we put some things behind us that you'll see a change. We're going to always evolve to explain to our customers, why Lumber Liquidators, in the best way we can. So, we'll expect -- you should expect to see our promotional strategies evolve over time. But again, we think we're doing the right things today to help us drive sales in the near and long-term.

I'll just add, that everybody in this room are big believers in our store model and the resilience of our store model. Given what we've been through over the past 18 months, the fact that we've held up as well as we have, I think, is nothing but increased our belief in that store model. So we believe that as time goes, certainly will allow us to differentiate and make changes to our marketing strategy, learn from it.

It's also taught us a lot about our store operations and opportunities there. The better we get at execution in the stores, the less traffic we need in the stores to be successful. So as our conversion rate goes up, the less traffic we need. So we'll be looking at that marketing versus execution relationship going forward. So that's going to be the focus of Dennis and Marco working together over the near future.

Okay. That's helpful. Maybe as a follow-on to that, since Dennis is in the room. You do have a good store model as the base of the business. So curious with Dennis coming in -- maybe Dennis, you could share some insights or initiatives, areas of opportunity that you see to make some improvement on that conversion rate.

Yes. Absolutely. I think one of the impressive things for me coming into the Company was how good the customer experience can be in our stores. It's a one-to-one experience whereas in some of our competitors that's a tough -- that can be tough to deliver just because of competing demands. So the first opportunity was to strengthen and stabilize the staffing in the stores. As you can imagine, over the past 12 months, we experienced a lot of turnover.

So we had to stabilize the staffing. The four divisional Vice Presidents have been focused for the last 30 days on really making sure that we felt good about the experience the customer had when they came in the store. That included staffing, that included our ability to have an employee that stands in front of that customer and speaking confidently, meaning they're trained, they understand the selling model themselves. We're meeting the customers one-to-one. We're really scrutinizing our customer experience, meaning that we are conducting our own mystery shops.

We've doubled those up this year to make sure that every store gets shopped, so that we're really grading ourselves on a pretty tough curve to make sure that we're doing everything that we know we should do and can do to close that business. Then as John mentioned, there are some opportunities when you think about delivering an end to end experience for the customer, as it relates to install and sales. As someone's coming into the Company new, I was relatively surprised to know that we didn't install our product in all of our stores. But as you know, that's a complex transaction.

When you go into someone's home and the need for an informed associate that can speak intelligently to the process -- to explain to the customer, what to expect, how long it is going to take and the fact that we'll be there with them step-by-step. So, we've really redoubled our efforts in terms of training and developing our associates to be able to speak confidently to that process. Then I think there's some other customer segments that possibly we're not serving as good as we could be. That our model would lend itself to. We're exploring those opportunities, whether that be with our commercial services or continuing to expand our installed sales business.

Okay. Thank you very much for all the feedback.

Thank you.

Matthew Fassler, Goldman Sachs.

As you think about the gross margin numbers, you told us what some of the underlying numbers looked like. I guess in the Q, you broke out the air quality testing number and the cost associated with some of the sourcing changes. I guess the two-part question is, do you expect any more one-off line items like that, impacting gross margin? I guess the air testing could persist to some degree. Then if you think about the strategic changes or tactical changes that you've made on the pricing side, where are we in that continuum?

I think I'll take -- there's a couple things there, so I'll take them one at a time. We do remain focused on driving profitable sales for the Company. As we've mentioned, we're all focused on that promotional strategy. We think there's continued room for improvement. Having said that, we're going to look at market conditions throughout to make sure that we are -- continue to be priced competitively within the market net.

The product assortment category that we have a good-better-best model is continuing to work. We do think it's been positive for us today. In that format, I think, it's better, it's easier for our associates to explain the value of our products and better for our customers to understand why to buy a product from us and what product to buy, why they might want to. Those things have been very positive on the top line portion of our gross margin.

You separately mentioned, Matt, questions around the air quality testing program and whether there any other one-off items. I would tell you, we do expect at this point to continue the air quality testing kit program at this point. So we do expect some additional costs there.

Matt, I was just going to add some additional color to that. Matt, we've been operating for the last 18 months in a pretty hostile environment. One of the things that we're pleased that we've been able to do is reduce the discounting at the counter. So we have taken some very liberal actions at our stores, we're making our late last year. We've reduced that significantly, which has helped our margin.

In addition to that, somebody comes into our stores with the negative publicity that we've had, our negotiating power with the customer has not been very good. So that's going to improve as our reputation improves over time. The other thing that we've had to deal with is the scrutiny related around our sourcing. As Jill and our team and her team continues to make us better and better at sourcing, to the point that we're able to source product from, we think, all over the world, we think that's going to affect positively our pricing or our cost of product that we're bringing in.

So, the good-better-best pricing and allowing and training our employees out in the field to sell up. We think that will also help our margin. What will hurt our margin, we think, our margin percentage but would help our margin dollars, we'll be focusing on our hardwoods and our premium product. We think that there's some opportunity there to sell more of that high dollar product, which will bring in more margin dollars. But it may not bring in the same margin percentage. So, those are the things that we are working on day to day as it relates to margin. While we're not shooting for any particular margin percentage, we are all pretty excited about the possibilities to increase those margin comps.

Great. Then my very quick follow-up to Dennis or to anyone else, if you think about the store manager ranks and the degree to which you've retained your people, turned them over, want to turn them over. Where are we in terms of the continuity of management in the field at this point?

Great question. If you think back and you look at the history of the Company, Matt, we really haven't had a direct focus on the stores in, I'll tell you, several years. So first order of business was just to kind of align all four of our operating divisions into one direction. John spoke about the good-better-best strategy. It enabled us to kind of by pulling everybody together, we had one consistent message and one focus.

Really, the first thing for me was when we rolled out the good-better-best strategy was knowing that we had four divisions, 25 regions and 376 stores all focused on the same message. So that was the first thing, was kind of stabilizing the direction, starting to focus on execution and accountability. Because I'll be honest with you, we were kind of all over the board in the last 12 months, just with the distractions and the lack of focus. So the excitement of having that message is pretty clear when you walk in the stores I think much more so.

Like I said, we're starting to see that in our shop experience and starting to see that in just the overall focus in the stores as it relates to training and development. We're starting to see some stabilization in those numbers. We continue to look at this. We're looking at how we compensate our store managers. I'm still in review of the structure to make sure that we've got the right structure. But I think what we're seeing is just a more consistent message, better execution, and ultimately that delivers a much better customer experience as well.

Thank you so much.

Thank you.

Dan Binder, Jefferies.

My first question was just on, if you can comment even quantitatively on the trends quarter-to-date? Have you continued to see sequential improvement from the March levels? Or has that gotten tougher? I think you cited maybe mid-quarter things might get easier. But I just wanted to clarify if there has been continued sequential improvement?

Yes. As I mentioned, this is actually a tough part to think about when you look at all that's happening in the Company's business over the prior-year first quarter, the current-year first quarter. When you think about the prior year, in January and February, we were operating under a pricing strategy that was very different from our pricing strategy today. We were also unimpacted by any negative publicity around Chinese laminate products or 60 Minutes, that resulted in or partly resulted in comparisons to the prior-year period for this quarter of about a 17% decline over the January and February period, 2016 versus 2015.

When you think about what happened in March in the prior year, we had the 60 Minutes episode aired, but we also had a significant amount of orders already in the queue in the prior year. So when I spoke to and was trying to highlight that it would take some time for us to quote, see the bottom of what really happened, it's really mid-Q2 for the comparisons become easy. Because we have a longer purchase cycle, we had orders already in, people who were invested in the Company.

It didn't happen right away that on March 1, our sales levels changed, it took some time. That, again, proceeded into Q2. In March of 2015, we did fairly well. Not as well as we would've liked, but when you compare those results year-over-year, we are again, still going up against harder comparisons. But again, we're straddled with negative media related to a CDC report error. So those kind of things are out there that are impacting us. The comparisons that we're up against as you look in the first half of Q2 are more difficult than the second half of Q2.

We don't want to go into how we're doing to date and what those numbers look like right now. But certainly as we get through Q2 and into the second half of the year, the Comparisons become easier. I tell you though that I understand we have to look at it that way, we are managing the business day to day to say we want to make sure that we're driving profitable sales each day, each week, month, quarter, not comparisons to what it looks like in the prior year. So really that would help offer an explanation that important.

How did the sample requests look year-over-year? Is that still negative or has that started to turn positive?

We typically don't get into sample data or new order data. But again, as we look at the business, we're optimistic that the things that we're doing today are heading -- taking the Company in the right direction and will help us to drive profitable sales moving forward.

Just regarding your comments around assortment of changes and inventory. Just kind of reading between the lines, it sounds like your inventory's down, but maybe the content isn't quite what you want it to be? Is that what's driving the assortment changes? I'm just trying to understand a little more about what it is you're aiming to do on the assortments? Whether or not the inventory is right there, today?

What I would tell you is that we have a higher percentage of active inventory today than we have ever had. What we're trying to do with the good-better-best is to give the customer choices within categories. That if they want to be in a category, they can get into that category at different price points. So I would say it's more a function of giving the customer choices within a category, than trying to or then we're having problems sourcing inventory or we're short of inventory somewhere.

Okay, last item for you was just on the SG&A front. What should we expect on the incremental legal fees, either this quarter or if you have visibility beyond that, it be helpful as well.

Yes. I wish I could give you an exact number for all of those. We need to do the things today to help defend the Company going forward. I'll step back though, as you look at our SG&A spend and some of the things that we've provided to you in the Q, I'll highlight for you that we disclosed to you about $29.5 million of incremental legal and professional fees. We thought it would be helpful to describe not the typical run rate of what we spend on legal issues or professional items, but to give you some of what we considered to be the cost that hopefully as we move past we'd be able to resolve some of those things it includes $16 million in charges related to the Securities legation.

We've done that consistently giving you those numbers. I can't tell you how to think about or exactly what those numbers would be, but what I would tell you is that we do expect that those legal costs will remain and probably remain at elevated levels for the foreseeable future. I'd also highlight since we're speaking specifically about legal fees and professional fees, that with the agreement that we reached in principle on the Securities litigation, there is a likelihood that we will be required to pay additional legal fees because they won't be funded by insurance in the futures. Give you that and highlight as we talk about liquidity. Since, I've started that'll go ahead and tell you, that we do think that we've got the liquidity that we need to manage the business and also address those legal issues as we move forward.

Great. Thanks.

Budd Bugatch, Raymond James.

This is David Vargas on for Budd. With regard to the 100 multi-district litigation basis mentioned earlier on the call, are those -- are you referring to security litigation cases? Or is there something else in there.

This relates to the consumer products issue, so this is not -- what she was referring to was not the securities class-action. This is just the cases out there around product labeling related to CARB 2 compliance.

Okay, thanks for that. Then looking at the balance sheet, I'm trying to reconcile the $16 million charge called out for the securities class action and the $42 million increase in the accrued securities class-action liability on the balance sheet. What's in that $42 million?

Sure. So there are a couple pieces to that number, which if I don't describe it as well here, it's written in the Q. But the two pieces are as follows. We have tentatively agreed in this arrangement to use available insurance proceeds of about $26 million to fund a settlement in the securities class-action, plus the issuance of 1 million shares of our common stock. That common stock was valued, as of the date we made the agreement, the value was $16 million.

So you take the $26 million plus the $16 million, that gives you your $42 million number. The reason the net charge is described at $16 million is because we expect to receive insurance proceeds of $26 million, which would again fund a portion of that expense. It's really just a gross up in the balance sheet, if you look higher up in the financials, you'll see an insurance receivable that offsets a portion of that liability.

Okay. Perfect. Thank you. I was missing the common stock valuation there. It looks like for the air quality testing, there hasn't been a reserve for any Phase 3, where you actually have to go in and remediate the floor, pay the customer. Is that consistent with what you're seeing to date? Do you expect any -- having to pay any kind of Phase 3 costs with regard to your quality testing?

Based on what we've seen to date, we haven't felt there was a need to reserve anything for future costs related to Phase 3.

Okay. One last question, on the new store opened up this quarter and the lease that you entered into, what kind of locations are you looking at for the stores? Are they more traditional or are they more high-traffic retail centric locations?

I would tell you that we're being opportunistic about where we put those stores. Generally we've opened stores that followed the more recently follow the quote, Store of the Future format. Having said that, again, we're looking at locations that we can move into that are going to fill out some of our existing markets. Or if we're not in a market but believe it's going to be a strong ROI of course, we would go into that location as well. So, not a set location but that's the approach we're following.

Okay. Thank you very much.

Keith Hughes, SunTrust.

So on this call, we've heard about your really focusing on store level execution and really a lack of discounting as you've referred to taking some of the discount off and getting that practice away. When I look at your marketing message, on TV and email and online, it's all about price. So it seems like there's a disconnect. Is that's something that's going to continue? Or is it going to change? Or can you give us any sort of color on what you plan to do?

Well certainly the core of this Company and its past has been promotions. We have driven traffic and it's still proven today to drive traffic through promotional -- through promotions and promotional pricing. As we continue to get away from some of the negative impacts, we certainly hope that changes over time. But we are focused on and we're constantly looking at our marketing message. But in the past 18 months, given the pressure that has been put on our brand and our reputation, we've had to make sure that the customer has a reason to come into or look at our stores. It's been pricing. Certainly, we hope to get away from that. Marco's here. He's got -- he can give you just some brief color on how we're thinking about that.

Thanks, John. Yes. We are a destination. Certainly, through the year, it's been very important for us to continue to find a way to make a visit to Lumber Liquidators worth the trip. Now as part of that, one of the reasons we've been able to control the markdowns in the store is good-better-best allows us to really get a handle on what we're putting on sale, so that when the customer goes in, we can either sell them that or up-sell through the assortment.

So strategically that make sense. But we also view our value prop as much broader. It's not just about price. It's about assortment. It's about expertise. It's about availability. It's about all those things that we bring that we can bring someone and drive them into the store. We have phases that were working through. We have a brand strategy that we're working through. John is correct, all this stuff will come together. Again, for us we understand the time constraint. But this is a marathon of us taking our brand and evolving it.

So in terms of evolving the brand, now that we're past a lot of the litigation, do you think that will start sometime this year?

Yes, is the -- is a quick answer to that. But we're going to be methodical about it. You're not going to see us blitz the market with it. Again, it goes back to, we've got to earn that respect to go along with the words that were saying. So you're not going to see it change overnight. You're going to see it evolve.

Okay. The domestic manufactures have, which a lot of which you don't buy from, have announced pretty substantial price increases coming here in the second quarter. Will you be participating with that to look -- this is on hardwood floors, both engineered and solid. Would you be looking to raise your prices in conjunction with that?

With respect to, again as I mentioned before, with respect to our pricing, we are looking to ensure that we are priced competitively within the market. We won't just adjust our prices, we will adjust our prices based on what we see happening in the marketplace versus just consumer demand. By the way, we don't buy most of -- or all of our product from the US as well.

Okay. Two other questions, you'd referred to the comp in the prior year. The comps don't get easier until second quarter, but the March numbers in March of 2015, the same-store sales were down about 17.8%. So you talked about orders flowing through -- so I'm just sort of confused, it's pretty weak number. That's when the real first negatives hit. So is that what you're referring to? Or are you referring to another number?

No. Again, when you look at our comp year-over-year, the 60 Minutes episode was impacted March of the prior year. We believe it had an impact on our business, but we still had some overhang or some, not overhang, but some benefit from the fast-pace, the fast start that we got off to in January and February of that period. That's really driving, it would've been arguably a worse March is the point of the prior year.

Okay, final question. You had highlighted in SG&A two charges. Are both of those charges tax-deductible?

Remind me of which charges your referring to, just to be sure --

A total of $29.5 million. So, $16 million on the securities class action and $13.5 million on legal and professional fees.

Yes. So at the end of the day, we have highlighted those items as being tax-deductible.

They are tax-deductible. Okay, thank you.

(Operator Instructions)

John Baugh, Stifel.

I was curious -- I know you broke down on the gross margin some of the items that you'd add back, I think, air testing. There were other items, maybe you could restate those. What I'm curious about is assuming test kits ultimately go away, what will be a permanent, if you will, increased compliance cost versus what would completely go away if you assumed air testing and other things like that eventually go away?

Yes. We've provided for you a couple numbers that we did when we talked about in my remarks, excluding the cost of consolidation of certain laminate products, that was about $1.6 million. Then -- that's highlighted in the Q. Then the indoor air quality testing program was a little south of $3 million. I think roughly $2.9 million, in the quarter. Those are the numbers that we're referring to that we are adding back, if you will, to get to this -- the $34.5 million gross margin that I referenced in my remarks.

Great. (multiple speakers)

I was going to ask you, what the second part of your question? I apologize.

Well, there was just the two add backs. Obviously, those would ultimately go away. I was just curious, I know you've added staff and increased compliance to monitor sourcing. But you're not adding those back or are you, in that adjusted gross margin?

We have not added those back. We believe that our ability to source product from anywhere in the world will ultimately help the Company obtain a gross margin that we're looking for. So we expect to use that as a competitive advantage in being able to buy from where we want in the future.

Okay. Just a last quickie, the $26 million insurance proceeds. I know you've had a dispute with your insurance company, is this separate from that? There's high assurance that this money will come through?

They are unrelated. We are required to report that only when it's considered probable that we would receive those insurance proceeds. So it's unrelated to any of the other legal issues that are out there with the insurance carriers.

Thank you very much.

Thank you.

There are no further question at this time. I would like to turn the call back over to Mr. John Presley for any closing comments.

Yes. Thank you all for joining us. Thank all the Lumber Liquidators' team for your hard work. As an aside, in regards to my health, I'm feeling great. My treatment plan is on track. I remain actively involved in the business and remain confident in our ability of our management team to drive Lumber Liquidators back to growth and profitability. Thanks again for joining us this morning.

This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time.