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Edited Transcript of LL earnings conference call or presentation 30-Oct-18 12:00pm GMT

Q3 2018 Lumber Liquidators Holdings Inc Earnings Call

TOANO Nov 7, 2018 (Thomson StreetEvents) -- Edited Transcript of Lumber Liquidators Holdings Inc earnings conference call or presentation Tuesday, October 30, 2018 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Charles E. Tyson

Lumber Liquidators Holdings, Inc. - Chief Customer Experience Officer

* Dennis R. Knowles

Lumber Liquidators Holdings, Inc. - President, CEO & Director

* Martin D. Agard

Lumber Liquidators Holdings, Inc. - CFO

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Conference Call Participants

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* Brian William Nagel

Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst

* David Sutherland MacGregor

Longbow Research LLC - CEO and Senior Analyst

* Geoffrey R. Small

Citigroup Inc, Research Division - Senior Research Associate

* John Allen Baugh

Stifel, Nicolaus & Company, Incorporated, Research Division - MD

* Laura Allyson Champine

Loop Capital Markets LLC, Research Division - MD

* Nels Richard Nelson

Stephens Inc., Research Division - MD

* Oliver Wintermantel

MoffettNathanson LLC - Senior Research Analyst

* Peter Jacob Keith

Piper Jaffray Companies, Research Division - Principal and Senior Research Analyst

* Seth Mckain Basham

Wedbush Securities Inc., Research Division - SVP of Equity Research

* Stephen Calk

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen, and welcome to Lumber Liquidators Third Quarter 2018 Earnings Conference Call. As a reminder, ladies and gentlemen, this conference is being recorded and may not be reproduced in full or in part without permission from the company.

I would now like to turn the conference over to Steve Calk. Please go ahead, sir.

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Stephen Calk, [2]

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Thank you, operator. Good morning, everyone, and thank you for joining us.

Let me reference the safe harbor provisions of the U.S. securities laws for forward-looking statements.

This conference call may contain forward-looking statements that are subject to significant risks and uncertainties, including the future operating and financial performance of 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, and Lumber Liquidators undertakes no obligation to update any information discussed in this call.

Now I'm pleased to introduce Mr. Dennis Knowles, CEO of Lumber Liquidators. Dennis?

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Dennis R. Knowles, Lumber Liquidators Holdings, Inc. - President, CEO & Director [3]

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Thank you, Steve, and good morning, everyone. Today, I'm joined by Charles Tyson, our Chief Customer Experience Officer; and Marty Agard, our Chief Financial Officer.

At the beginning of 2018, we laid out a multiyear strategy to transform the business and drive growth through a number of operational initiatives that position us well for the long term.

Three quarters through the first year of this strategy, our goals remain unchanged, and we remain confident in our ability to drive growth on both the top and bottom line.

Turning to our third quarter performance. We reported net sales at $270.5 million, an increase of 5.2% over Q3 of last year. Comparable store sales were up 2.1%. Adjusted gross margins improved to 36.2% compared to 36.0% in Q3 of last year. We continue to leverage SG&A, and our adjusted operating margin improvement of more than 100 basis points reflects the hard work our field and corporate teams have been doing to optimize the business.

Our Pro and installation businesses continue to perform to our expectations, and we posted another record quarter in installed sales.

Speaking specifically to the comp result for the quarter, we had good momentum into July and comped in the mid-single digits that month. With that momentum and what we felt might be an easy September comp, we thought we had the flexibility to work on profitability. So we tweaked the advertising down slightly and tested some advertising initiatives we've been eager to try. In addition, we widened promotions across more SKUs but brought down the depth relative to last year. We also trimmed low productivity mailers and slightly rained in our field markdowns.

The drag on top line was more pronounced than we anticipated and resulted in lighter traffic in August and September. The arrival of Hurricane Florence did not provide a near-term lift to the business, but it wasn't a significant negative event either. That said, we still see a lot of runway to drive sales. We are working tirelessly to improve our intelligence around advertising, pricing and promotion. Charles will provide more detail about some of our initiatives we're rolling out, but our goal remains to optimize the profitability and growth elements of the way we go to market.

As I reflect on our strategic progress in the third quarter and year-to-date, a key driver of future growth is enhancing the way we engage the customer at all touch points. Historically, Lumber Liquidators relied heavily on national media and direct mail to drive traffic. It's clear to us that a digital strategy is the path forward, particularly given that so many customers begin their path to purchase with online research. Charles has been hard at work identifying opportunities where we can enhance the customer experience through digital transformation. The first 2 areas of focus are our website and our digital marketing strategies. We're particularly excited about these transformation, and as we begin to activate against a different media mix, we'll anticipate meaningful outcomes for our business.

While it's too early to quantify the results, it's clear we have identified multiple opportunities to unlock long-term value, including increased customer acquisition and retention. Charles will expand further on our marketing program shortly.

In addition to driving top line growth, we'll continue to improve profitability. We have gradually expanded gross margins even in the face of higher transportation costs and remain committed to expanding operating margins consistently over the next few years through a combination of initiatives and from leveraging SG&A. We acknowledge that we are faced with heightened macroeconomic conditions, namely increasing tariffs, which are impacting the comp side of our business. Roughly 45% of our merchandise comes from China, and we're subject to the 10% tariffs as of September 24. We are aggressively and proactively exhausting all options to mitigate the cost increases.

Importantly, this environment has presented a unique opportunity to reengage with our vendors, and we're seeing improvements in cost and terms. Additionally, we are constantly evaluating our pricing strategy in these sourcing elements we use for potential suppliers. A key part of this is also building our sourcing capabilities for the long term, and Charles will share more on this in a minute. While the effects of our strategy will not be seen overnight and tariffs remain to challenge, we are considering any and all options to offset tariffs and improve our sourcing strategy. As we look ahead, we have a number of strategic initiatives in place, the goal of being the customer's first choice of hard surface flooring.

Our breadth of product offered in a high-touch, consultative environment will be anchored by omnichannel capabilities that engage and guide customers through their journey with effective floor selection, functionality, envisioning tools and sales, transaction and fulfillment capabilities. Given our goal of 500 stores by 2022, implementing and advancing our technological capabilities will be key to improving visibility into areas such as inventory management, localized marketing, assortment and promotional activities. And with our nationwide installation program now fully rolled out, we can cover the customers in the end journey.

To conclude, you can see from our results this quarter, we were in line with our margin goals but behind where we want to be on the top line. As we project through the fourth quarter, we need to reset our full year 2018 top line expectations, bringing down our range for comp store growth and operating margins slightly. Marty will cover this in more detail.

However, as I said earlier, our long-term goals remain unchanged as does our confidence in achieving them. We continue to have a positive outlook on our business. In the near term, Installations will not be as large of a contributor to our comp growth, given that the service is fully rolled out. But we have a lot of opportunity to augment our excellent store experience with an equally outstanding experience, both assisted with much improved contemporary digital technologies.

Additionally, we are laser focused on our bottom line and believe we can drive margin expansion through careful cost management and strategic mitigation tariffs. We are actively managing our assortment to keep pace with customer trends, and we continue to make investments to enhance our customer experience and deliver innovative ways to drive traffic. The team and I are looking forward to the coming year, and we are committed to our mission to become the customers' first choice for hard surface flooring. This is an exciting time for our team. We have established a track record of identifying areas for improvement and are building a stronger, more competitive Lumber Liquidators.

As always, I want to thank our associates around the country for taking good care of our customers every day. In particular, I want to thank those on the front lines in the Carolinas and Florida. Your dedication and resilience during the recent storms are a testament to the great people we have here at Lumber Liquidators. Great job, everybody.

And now I'll hand it over to Charles to discuss our digital and customer experience initiatives. Charles?

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Charles E. Tyson, Lumber Liquidators Holdings, Inc. - Chief Customer Experience Officer [4]

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Thank you, Dennis. When I first joined Lumber Liquidators, I was very excited about the potential opportunities that laid ahead for the company. And after being here for the past five months, I'm even more excited now that I've gotten to learn the flooring business. As I review our opportunities, I believe the greatest potential growth vehicle lies in the expansion of our digital capabilities, which is a critical part of driving both store traffic and omnichannel sales growth. We know that most customers in the market for new flooring start their ideation of a project online, something we've seen play out with as many as 80% of our customers. Given that dynamic, it is crucial we make the ideation process easy for every customer and enable them to find the flooring solution that best suits their needs either on our website or in our store, regardless of their location.

We've launched 2 streams of work on the customer experience: first, enhancing web experience and site performance; and second, our digital marketing platforms and strategies. We recently hired a senior digital leader to build out our e-commerce and digital marketing team, with plans for the team to be delivering benefits early in the first quarter of 2019.

Our focus on web experience will begin with the development of the technology needed to meet our customer shopping needs. We enhanced our capabilities around shopper identification and data capture, allowing us to start and improve dialogue with customers via e-mail, social media and display advertising, which are inherently at a lower cost point than direct mail. We've been optimizing and enhancing our existing analytics and adding new capabilities to understand how users are leveraging our website. Ultimately, this will help us identify new opportunities with customers. This intelligence, coupled with a robust AB testing strategy, helps us make quick, measurable site experience improvements.

Another area of focus improvements we're making is to our store location, data quality and web presence. We believe the highly local demand differences around each individual stores means that building a local marketing plan will deliver more relevant content to customers. Our second area of focus is to aggressively refine the digital marketing elements in our advertising mix and optimize spending to deliver higher quality traffic.

As Dennis mentioned, Lumber Liquidators has predominantly relied on traditional direct mail as the primary form of marketing after traditional television. Part of our strategy will lead to migrate part of the spend and some of the other less effective advertising like newspaper and sports through a series of digital investments. This will take time as we must develop both the technology as well as the analytics. However, we plan to continuously optimize the initiatives by driving digital traffic to help accelerate store traffic trends and put us on a solid growth trajectory for 2019.

We know consumers' media habits are rapidly changing, and we're actively reviewing our marketing spend mix to best attract new customers and increase our brand awareness. We have a number of marketing tests underway to help inform how to most effectively optimize our marketing and drive awareness for both our DIY and install customer segments.

On our brand revitalization program, we are deep into this work and expect to discuss in more depth late in Q1. Another very important piece that affects our customers is our product offering and sourcing behind it. We have hired a new Head of Global Sourcing who has significant experience in delivering value for large retail sourcing organizations. His work will be to expand our worldwide sourcing capabilities across Europe, South and Central America and Asia. As we've stated, our investments in quality and compliance give us the assurance we need to be able to flex our sourcing to meet the needs of our business. This is a step in the gross margin expansion target Dennis and Marty referred to in past calls. And we've already gone to work on leveraging our costs as a means to mitigate tariffs.

We believe we have opportunities to expand supplier relationships to drive both our solid wood and manufactured categories with new style-focused offerings and refine our processes to drive greater speed to market.

Finally, we understand the critical importance of helping our sales team drive conversion in our stores. We are reviewing the design of the store experience with on-tread merchandise easily displayed. We'll have several tests underway around our network in the first quarter and believe these innovations will drive increased conversion and enhance the customer experience. As I look forward to 2019, I'm excited for the work we're doing to build our analytics capabilities to help us improve both our promotional effectiveness planning as well as digital and marketing effectiveness.

With that, I will turn the call over to Marty to discuss our financial performance. Marty?

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Martin D. Agard, Lumber Liquidators Holdings, Inc. - CFO [5]

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Thanks, Charles, and good morning, everyone. I'll start with a few more specifics about the top line. Third quarter net sales were $270.5 million, an increase of 5.2% over last year, with comparable stores net sales up 2.1%. This consist of a 39% increase in installation sales, slightly offset by merchandise sales, which were down 1.3%. The overall 2.1% comp growth was affected by an increase in average transaction value of 5.5% and a decline in the number of transactions of 3.4%. The higher transaction value in recent quarters and again in Q3 has been driven by the attachment of installations to the transaction, which can double its size and from the shift in mix to Pro customers who tend to have a larger jobs.

On the transaction number decline, a few things worked against this year. First, our reduced promotional activity may have reduced our draw of value or opportunistic shoppers. And second, it could be a natural reflection of our focus on the Pro and do-it-for-me customers that are our more involved sales process, but we feel better fit our value proposition. This plays out in our transaction definition that aggregates into a single transaction, repeat purchases in the same month by the same customer to try to represent a project, not individual trips to a store or registerings. This has been consistent for all periods reported for several years.

Going back to the installation business. The growth in comp stores at 39% is heavily a function of the expansion of this business that was completed in late 2017, but we were also pleased to see the service growth 13% in just those stores it's been offered in for over a year. On the merchandise side, we started the quarter strong in July, but as we made adjustments to our promotional tactics and store-level discounting in an effort to expand margins, sales were softer than expected in August and September.

In terms of category performance, our manufactured category, particularly vinyl products, where we remain focused on innovation, continue to show strong growth and garner share from the wood and bamboo categories. Our Pro customer segment also continues to grow well above the chain average and represented almost 29% of our merchandise sales in the quarter. We opened 3 new stores in the quarter, bringing us to 16 year-to-date, and we anticipate opening a total of 22 stores by year-end.

Moving on to gross margin. This came in at 37.2% for the quarter, an increase of 120 basis points from last year's 36% gross margin. Similar to the second quarter, we got a favorable final ruling on antidumping and countervailing duties rates from prior periods, resulting in a benefit of $2.8 million. If we adjust the quarter for this credit, as tabled out in the 10-Q, the adjusted gross margin in this quarter was 36.2%, an increase of 20 basis points from last year's 36%. The margin expansion reflects both the reduced promotional activity and increased mix of manufactured products that carry above-average margins, offset by approximately 60 basis points in higher transportation costs and approximately 40 basis points in dilution from the increased mix of installation sales. Comparing sequentially to the second quarter and again, adjusting out the antidumping duty credits in both periods, gross margin was up 120 basis points, with about 30 basis points due to lower inventory adjustments, primarily the absence of the second quarter's obsolescence charge and the balance from the effective reduced promotional activity. Installation mix and transportation costs were generally consistent from Q2 to Q3 with only a minor negative impact.

SG&A expense for the third quarter was $94 million compared to $110 million in the third quarter last year. SG&A in the recent quarter included incremental legal costs of $3 million and the $1.8 million impairment of the Toano finishing line we discussed in last quarter's call, while the year-ago quarter included an accrual related to the MDL settlement, incremental legal fees and an impairment related to our production assets. Both periods' items are tabled out in the press release and the 10-Q. When excluding these items, adjusted SG&A expense for the quarter was $89.2 million, an increase of $1.6 million from a year ago. The increase in spend included $1 million in higher occupancy costs related to the opening of 22 stores since Q3 last year, $700,000 in higher promotional, financing costs and other smaller increases, offset by approximately $700,000 in lower advertising.

Total payroll was nearly flat, with modest staffing increases offset by a lower management incentive accrual than last year's quarter. The reduction in advertising was the net effect of our ongoing changes in marketing mix in which we've been a little quicker to reduce spend in areas we assess is less effective, like newspaper, in some cases before we have funded newly identified elements. Adjusted SG&A was 32.9% of sales versus 34.1% last year, and year-to-date is at 34.1% compared to 34.9% last year, driving 80 basis points of leverage compared to last year.

Moving down to P&L to operating profit. For the quarter, we recorded operating income of $6.7 million compared to an operating loss of $17.3 million in Q3 of 2017. If we exclude the unusual items that impacted these results as shown in our 10-Q and press release, we had an adjusted operating profit of $8.6 million in the quarter compared to last year's $5.1 million similarly adjusted operating profit. Adjusted operating margin was 3.3% of sales compared to 2.0% last year, and year-to-date is 1.7% compared to 0.6% last year.

Looking at liquidity and cash flow. As of September 30, we had total liquidity of $114 million, and we had borrowings under our revolving credit facility of $43 million, which compares to $35 million in borrowings at the beginning of the quarter. Our inventory ended the quarter at $305 million, up from $297 million at the beginning of the quarter, driven by the combined effect of new stores and increases in breadth of items stocked in our stores.

I'd like to make a few comments on the potential financial impacts of tariffs to our business. As Dennis indicated, approximately 45% of our merchandise costs are from China, and we're subject to 10% tariffs per shipments received as of September 24. These tariffs will roll through inventory and only partially affect the fourth quarter's gross margin we estimate by 150 to 200 basis points. We are actively managing to mitigate these as we speak by working diligently with our vendors across our entire supply chain and are already seeing success in lowering our costs.

Additionally, we are evaluating our own price adjustments where necessary and in several cases, pursuing longer-term alternative sourcing options. For the fourth quarter, we believe we can mitigate roughly half these tariffs, such as the net impact should result in sequential gross margin erosion from Q3 in the range of 50 to 100 basis points on an adjusted basis.

With that in mind, I'd now like to walk through our updated guidance for the year. For comp store sales growth, we are at 3.3% through 3 quarters. Looking at Q4, we continue to work to find an optimal mix between price management and promotional activity and at the same time, assess the consumer reaction to ours and others' potential price changes. As for the recent storms, Florence impacted 10 stores for about 4 days on average and Michael, 8 stores for about a day each, with one of these having only just reopened. While we expect a slight tailwind from these later in the year, that will at best offset the headwind from comparing against the benefit of Harvey's post-storm lift in Houston in the fourth quarter last year. All that said, we think we can achieve low single-digit comps in Q4, and October looks to be in this range. And that would put the year in the 2.5% to 3.5% range.

We also revised our adjusted operating margin guidance. We're at 1.7% adjusted operating margin through Q3 and see Q4 in that range or slightly higher. So we are now forecasting the full year in the 1.6% to 2.0% range, an increase of 60 to 100 basis points from 2017 but a bit below our original target for the year. The 2 real gaps from where we began the year has been the 60 basis point increase of transportation costs that we continue to try and minimize and the reduced SG&A leverage caused by the lower comp store growth. In terms of liquidity, we expect inventory decline to the $315 million to $325 million range through the year-end and early 2019, generally related to tariff impacts and planning, and we will fund the $21.5 million remaining cash payment contemplated in the MDL settlement in November of this year.

Lastly, on the legal front, we have no material update to the DOJ and SEC investigations. The MDL is consistent with past disclosures, that is, cash funding in Q4 and vouchers distributed to customers early next year. On the Gold bamboo case, we have continued some efforts around mediation but also continue to prepare for trial in early 2019.

To wrap it up, we certainly have plenty of work to do but also see the opportunities for the company and feel we have a strong plan in place to realize them.

Thank you all for your time this morning. And with that, I'll hand it back over to the moderator for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is from Seth Basham with Wedbush Securities.

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Seth Mckain Basham, Wedbush Securities Inc., Research Division - SVP of Equity Research [2]

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My first question is around traffic. It seems like traffic has been a challenge for you guys recently. You called out a number of issues why it might be, but as you think about tweaking the price and promotion and advertising strategies going forward, do you expect to have a meaningful impact in turning around the traffic declines in the near term?

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Dennis R. Knowles, Lumber Liquidators Holdings, Inc. - President, CEO & Director [3]

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I would -- as kind of Marty mentioned in his remarks, we've looked at traffic really hard over the last, I guess, really over the course of the last 3 quarters. And we have seen, as he mentioned, some change in dynamics, and that's impacted by how we promote. And if we go deep into price and not so wide in breadth, we typically can influence traffic, but we just haven't been happy with the margin. Typically, I would say, historically, we've been -- we've had, what I would call, more deal-focused promotions as opposed to really kind of advertising across the category. Two dynamics that are impacting our traffic that we're still -- we -- it's not as hard to quantify, but it does have an impact, and that's the Pro and the install. The Pro, as Marty has mentioned before, as we grow this business, if you think about a year ago, Pro was just approaching 20%, now it's approaching 30%. We discount their traffic. If they make multiple trips, we pull those out. So those have some impact. And then the installation business, as it grows, as Marty mentioned, has 2 big impacts. On number one, there's less trips. If somebody is doing -- our tickets are higher on an install sale. We attach more. Our actual merchandise sales are higher. So we know that there's less trips. So those 2 dynamics are playing against traffic. But I think 2 things are going to help us in the long run, the sourcing initiatives that Charles mentioned and then we are working diligently on -- we know that we've got to change the way that we go to market as it relates to our digital technology. As we've mentioned, we've entered a traditional direct mail marketing play. So now as -- we got to have -- we know that we got to reach customers in a better way. We got to be able to target our customers more strategically, meaning that we just can't afford to blanket the market with mailers. We need to reach the customers directly that are interested in the hard surface flooring. So that's kind of our work. Charles has hired an entirely new digital team that's focused on e-commerce as well as our marketing from a digital perspective, whether that be digital television, e-mail marketing or social. So he might want to expand on that a little bit, but traffic definitely is something -- we're not saying we're not concerned with, we're really trying to make sure that we're driving quality traffic into our stores that we can turn into a profitable sale.

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Seth Mckain Basham, Wedbush Securities Inc., Research Division - SVP of Equity Research [4]

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Fair enough. And my -- all questions around the tariffs. You guys quantified what you think the impact would be in the fourth quarter, but basically, in counting, a tariff stay at 10%, what might the impact be in 2019? And then if tariff rate goes to 25%, how you think about that impact?

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Martin D. Agard, Lumber Liquidators Holdings, Inc. - CFO [5]

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Yes. Seth, Marty here. By the time we get to full run rate on the tariffs coming through inventory, they stay at 10%, got 45%. That's kind of a current view of the level of Chinese-sourced product. So that would be a simple math of 4.5%. We are working to mitigate, on a long-term basis, all of that sort of from a margin standpoint between the 3 different approaches we've talked about. They have slightly different ramp-up effects, cost out from our vendors and across our supply chains is something we're working on now, and we're seeing some results there. And we think that's probably the quickest. We have adjusted some pricing pretty modestly, and we're watching that and seeing if that sticks or if more is necessary. That went in fairly quickly as well, but there are promotions that were already set, so that takes a little time, and so we'll see as we get into 2019 how much from a price standpoint we can mitigate. And then the longer term, when I say longer-term, that's over the course of next year, would be looking at alternative sourcing. At 10%, that's probably one degree of alternative sourcing. If tariffs go to 25% as slated, we'd probably be more aggressive about that. But that alternative sourcing is something that would play out in the back half of next year and on from there into 2020. So I can't sit here and say next year that even at 10% will have no impact on our margin, we would certainly be working towards continuing the margin expansion goals that we've had, and we certainly want to drive operating margin expansion we've had. But it's a little unclear how we're going to get there depending on sort of consumer reaction, how strong the market remains and so forth so...

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Operator [6]

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Our next question is from Brian Nagel, Oppenheimer & Co.

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Brian William Nagel, Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst [7]

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So my -- I'm probably going to follow up on Seth's questions, but with regard to traffic, as we listen to -- we hear you -- it seems like there's a lot going on at your company. You're doing a lot of the right things with respect to reconnecting [with customers], but the big question I have is, do you see -- is there some type of [comparative going out there], due to the extent that -- so all that you're doing -- the reason that near term is just being offset by some other competitor, whether it be another specialty, whether it be the bigger stores, whether it be some other factors, it's just -- that's just weighing significantly upon your ability to really connect with customers until these initiatives get in place?

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Dennis R. Knowles, Lumber Liquidators Holdings, Inc. - President, CEO & Director [8]

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Well, I haven't seen that. I mean, like -- Brian, the independent flooring retailer still own almost half the market share. So they're always a competitive threat. And I would say that I think everybody's gotten sharper in the hard surface flooring space. I'm particularly -- as the manufacturing categories have continued to evolve, I think everybody's gotten pretty sharp in that space. And I think, for us, it's just finding kind of our balance of promotion and price. And again, we have a long history of going deep in price and promotion with -- and mixing that product. But I think we're still trying to find that right balance of how deep in promotion we need to go with how broad across our categories and finding that right balance for customers. To give you an example, what I was talking about with Seth is, if you look at our merchandise sales, to our customers that do installation, their merchandise sales and ticket are up twice as much as our normal merch ticket is. So we do know that, that's impacting -- that has a bit of an impact on our traffic. And -- but I would say from a competitive standpoint, we're in a good spot with installation. Our Pro business continues to grow. And where we've got to find the right balance for us is on that, what I would call, kind of that everyday traffic. We're making good [strides] for Pro and install customer, but our balance is to make sure that we've got the appropriate competitive position in the market as well as promotional depth as well. And I would tell you, those are the 2 things that we're working on. As far as the competition goes, I think everybody's gotten good in the hard surface space. Charles, I don't know if you have anything to add?

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Charles E. Tyson, Lumber Liquidators Holdings, Inc. - Chief Customer Experience Officer [9]

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Yes, Brian, I think there's couple of things. If you look back historically of how we've marketed, we generally sent the same marketing communication to all customers. And what was done -- need to do is segment our customers from a strategic standpoint and looking at what's the demand that, that customer is actually driving. So whether it's a solid wood customers in the Boston region or a vinyl customer and waterproof customer in the Florida region, we need to start thinking about how do we customize those marketing messages, whether it's digitally, whether it's through digital television, whether it's through -- even direct mail and, obviously, through e-mail. So that we put more relevant messages in front of customers. And we're testing some of that in Q4 and expect to make that part of our plan to drive the effectiveness of both our media and the appropriateness of the product that customers are actually buying in given local markets. And so we feel that, that will improve both our ad performance, productivity return as well as improve traffic. The other one is, we are running some tests in the fourth quarter around marketing to the high service seeker, around our installation capability. That is something that we have not spent an amount focused on. We've been significantly focused on the DIY segment, and we need to start driving both segments of our business from a marketing perspective. So hopefully, Brian, that gives you a little more color.

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Brian William Nagel, Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst [10]

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No, it does. I appreciate it. And the second follow-up question I have, I think every conference call I've been on, we talked about tariffs in some way, shape or form. You guys are obviously talking about tariffs as well. Maybe the answer to the question is which you've laid out, but do you -- as you look at your business and tariffs and obviously, it's very clear situation with regard to where tariffs would be enacted but you just not have pricing power? Not in the -- maybe as a better, you just not want to try to exploit the pricing power you may have with consumers and some of these products to pass them along?

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Dennis R. Knowles, Lumber Liquidators Holdings, Inc. - President, CEO & Director [11]

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Make sure I understand the question, Brian. You mean, raising retails, is that what you're saying?

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Brian William Nagel, Oppenheimer & Co. Inc., Research Division - MD & Senior Analyst [12]

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That's correct. Yes.

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Dennis R. Knowles, Lumber Liquidators Holdings, Inc. - President, CEO & Director [13]

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Well, I mean, we expect a bit -- do a fair amount of that. In fact, we think that, as we said in the last call, we will mitigate this 3 ways. We'll choose alternative sourcing, we'll raise retails, and we'll work to negotiate a better cost. And I expect it's going to take all of those. And we have already moved in all 3 areas. And we're doing this as we speak. We've got -- we've had people on the ground. Charles has been in alternative sourcing countries for the last couple of weeks. And we got our sourcing team heading over next week. So we'll manage this in all 3 lanes: pricing, cost out and moving sourcing. So -- and we have a lot of opportunity. As Marty mentioned, the one thing that we're happy with is this has given us an opportunity to accelerate our work. We've been talking about this for the last year. You know that we have opportunity to go in, and we think our margin expansion plan was -- is to get cost out over the next 1.5 years, which kind of helps us accelerate that. So while we've got these imprint tariff headwinds, this gives us an opportunity across all of our product categories, not just those affected by the tariffs. So we'll lean into all 3 of those areas.

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Martin D. Agard, Lumber Liquidators Holdings, Inc. - CFO [14]

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I think the other thing, Brian, to remember is, we -- one of our major categories is [now out of] China. For obvious reasons, our laminate business is coming out of Europe. Great quality product. Our suppliers are working aggressively with us to want to gain more market share in that category. So there is actually slightly less deleverage that we have than others in the marketplace that [are] producing a laminate category out of China.

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Dennis R. Knowles, Lumber Liquidators Holdings, Inc. - President, CEO & Director [15]

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Brian, I'd just add one final point, too. One of the big categories performance wise has been the vinyl. And I would tell you, the majority of the manufacturing capacity is in Asia. So I think kind of everybody's kind of in that same boat.

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Operator [16]

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Our next question is from Laura Champine with Loop Capital.

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Laura Allyson Champine, Loop Capital Markets LLC, Research Division - MD [17]

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It's also on product that you're bringing in from China. I think when we talked earlier in the year, it look like you might be bringing in more next year, not less. So if you're sitting at 45% today, where would your goal be for this time a year from now? And where would it have been ex tariffs?

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Martin D. Agard, Lumber Liquidators Holdings, Inc. - CFO [18]

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Yes, I think -- Laura, I think picking up on what Dennis said, if you look at the EDP category, right, it's one of the fastest-growing categories in the industry. And from a mix perspective, it will continue. We expect it to continue to grow into next year. I'm not going to share a natural percent penetration, but most of the EDP product today in North America is coming out of China. So we do expect that balance of sale to at least maintain. Obviously, based on the previous goals, discussion around what's going to happen to industry pricing and what will the impact be on demand mix across categories, we're going to watch that [as of the end of] January, depending on whether the tariffs move from 10% to 25%. So that's one driver, what's going to happen to mix. The second one is we are actively looking at alternative country sourcing. And I believe that there will be potential places for us to move product out of China, and that will impact our mix. And that's a work in progress for us. That's why I'm not going to give you a number. As we start to look at where would we want to move product, whether it's in Asia, other parts of Asia or whether it's in other parts of the world.

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Operator [19]

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Our next question is from Oliver Wintermantel with MoffettNathanson.

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Oliver Wintermantel, MoffettNathanson LLC - Senior Research Analyst [20]

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I had a question regarding -- you said that your comparisons in August and September slowed down versus July. Can you quantify that for us, please, what the comps are in these months?

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Charles E. Tyson, Lumber Liquidators Holdings, Inc. - Chief Customer Experience Officer [21]

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I guess a little bit, anyway. We -- In July, we certainly were in the mid-single digits, and that led to some of the guidance that we had for the quarter as part of the year. And then it dropped off to then -- I would say, was sort of around low single digits and around zero in those next couple of months.

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Oliver Wintermantel, MoffettNathanson LLC - Senior Research Analyst [22]

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Got it. Got it. And then looking forward into the fourth quarter for your guidance for the full year, the 2.5% to 3.5%, what do you think is the driver of this? Is it, again, more of the average sale? Or do you think transactions can actually pick up in the back end of the year?

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Charles E. Tyson, Lumber Liquidators Holdings, Inc. - Chief Customer Experience Officer [23]

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Well, certainly, the average ticket size, that -- it will continue its trend, we believe, the -- for the same reasons we continue to have momentum with the Pro and the install business. What happens to traffic is a little bit of a wildcard. Particularly, in December, you got a choppy month to begin with. And then last year, we really hit a slow finish. We think it's generally weather-related, but it was a slow finish. Whereas this year, there is the wildcards around tariffs, and some of the price adjustments we've made and how they hold up. And if there's concerns about a pending 25% tariff to consumers [either] move forward as the whole thing slow down because of the uncertainty. I guess I'd say we feel less certain. There's more uncertainty around our fourth quarter comps in total, and then the mix of them is also just a little bit more cloudy than usual. But we do believe the transaction size trend will continue for the reasons it's run, and it's a matter of trying to get that traffic back up through some of the digital work and so forth as we go.

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Operator [24]

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Our next question is from Geoff Small with Citigroup.

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Geoffrey R. Small, Citigroup Inc, Research Division - Senior Research Associate [25]

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You just mentioned the cadence of comparable sales through the third quarter. I am curious if you can understand -- help us understand how merchandise sales evolved through the quarter? And also just curious how overall comp sales have trended early into the fourth quarter?

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Charles E. Tyson, Lumber Liquidators Holdings, Inc. - Chief Customer Experience Officer [26]

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Yes. The contribution of installs has been fairly steady through the third quarter. So I would say that cadence that I commented on in total would also generally apply to the merchandise pattern. And as we think about the fourth quarter, I would tell you that we had a good, solid October yard sale. Have a -- we're in the low single digits for the month of -- or think we are to date and expect to be in the low single digits for October. But again -- and so that's part of that guidance in the range, but our visibility is only so-so as we think about November and December and certainly, plenty of uncertainty as we go.

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Geoffrey R. Small, Citigroup Inc, Research Division - Senior Research Associate [27]

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Understood. And your full year guidance for margin implies a fairly wide range in terms of fourth quarter outcomes. And I fully appreciate that there is a great deal of uncertainty regarding tariff, the associated cost and top line growth. I'm just curious if you can help us understand the additional puts and takes for the EBIT margin line item, please?

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Charles E. Tyson, Lumber Liquidators Holdings, Inc. - Chief Customer Experience Officer [28]

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Yes. I guess I'd say it's a little bit of both as it -- in terms of the gross margin, the question will be how well our -- our prices hold up a little bit of our mix of merchandise versus install. And we have a decent visibility around there. And I think the guide I gave should be okay. And then the overall SG&A spend is somewhat manageable, predictable. And when we add those together, we do have a reasonable range that gets in there. I don't know how else to characterize it, just a little bit of risk on both gross margin and SG&A leverage that come from the combination of sort of tariffs, mix and just the top line in total that leads to the leverage question around SG&A. So I don't know that I split out the risk items much more than that. So yes.

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Operator [29]

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Our next question is from David MacGregor with Longbow Research.

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David Sutherland MacGregor, Longbow Research LLC - CEO and Senior Analyst [30]

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Couple of questions. First of all, just on the traffic. Can you give any kind of geographic color or any regional color, if there was disparities, or was it fairly uniform across the country?

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Dennis R. Knowles, Lumber Liquidators Holdings, Inc. - President, CEO & Director [31]

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It's fairly uniform across the country. We've talked in Q1 and Q2 about having some struggles in the North or the North division lagging behind the rest of the company. That continue to improve over the third quarter and actually into October. So we've kind of seen the North kind of bounce back, but I would say that where we started to see some of the traffic decline, that was maybe a bit exacerbated from the storms last year in Houston markets and Southern Florida where we saw some benefit from the hurricane, but other than that, it was really pretty similar across the country.

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David Sutherland MacGregor, Longbow Research LLC - CEO and Senior Analyst [32]

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Okay. Just as a follow-up. I guess as we head into the end of the year over the next few weeks is -- maybe the expectation of a step up to a 25% tariff becomes more real. Do you anticipate it to be a fairly substantial prebuy, I guess? Or I guess, given the traffic lags of -- see more in freight, maybe that's happening already, can you just talk about to the extent to which you're maybe involved with that? Are you seeing it across the industry? And I guess, more importantly, what is the competitive implication to this as we go through the end of the year and into first quarter of 2019, if everybody is kind of loaded up on inventory?

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Dennis R. Knowles, Lumber Liquidators Holdings, Inc. - President, CEO & Director [33]

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Yes. I think there is a fair amount of that going on, not just in our industry but across all industries as we can imagine. The tariff implications are enormous across other retailers, particularly multi-department retailers. They have a lot more products susceptible to the tariffs. And I suspect what we've seen in shipping lanes and traffic filling up, that, that's exactly what's happening. There is some prebuying. The 10% tariff is in place. And so there are some -- I suspect there are probably some out there that have made some prebuys. We're doing -- we continue to manage our business appropriately. And as I said, we're focused on all 3 areas, making sure that we're sourcing appropriately, pricing appropriately and moving the business and making sure that we focus on our retails. So I think you're probably going to see some of that throughout the end of the fourth quarter. I think, at this point, you kind of have to act like 25% tariff's going into place. And that impacts the aggressiveness of your sourcing changes as well as anything you might do to prebuy. So for us, it's how -- there's a lot of moving parts for that. It's the lead times, the cost of goods coming into the company. So all those things have to be factored in. But I think you'll see -- you probably are seeing a fair amount of that, at least it appears like that, I think, in everything from food to apparel.

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David Sutherland MacGregor, Longbow Research LLC - CEO and Senior Analyst [34]

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Is there any way you're kind of quantifying the extent to which you think people across the industry are prebuying? Do you think they're picking up an extra month or extra 2 months worth of product?

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Dennis R. Knowles, Lumber Liquidators Holdings, Inc. - President, CEO & Director [35]

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I wouldn't have an idea. I really wouldn't.

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Operator [36]

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Our next question is from Peter Keith with Piper Jaffray.

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Peter Jacob Keith, Piper Jaffray Companies, Research Division - Principal and Senior Research Analyst [37]

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I know the tariff dynamic is quite fluid right now, but I wanted to think longer term around the gross margin. Certainly, there's disruption in the near term. But I guess if you're assuming the 25% tariffs go, and you're forced to pivot to other countries, presumably you had 45% in your mix in China because the pricing was the best there. So does that upper 30s gross margin target become less achievable with this full tariff exposure at 25%, looking just out over maybe 1 to 2 years?

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Martin D. Agard, Lumber Liquidators Holdings, Inc. - CFO [38]

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Setting sort of tariffs aside, and that's a big set aside, but we don't think so. I mean, we do like the trend of the mix of products moving in our favor. We just really building into our sourcing capabilities, and we're seeing that there's opportunity there. We have been facing headwinds of transportation, and we can't sit here and say, "They're going to go away," but again, we continue to work it at ways to bring some of that back. We've given up 60 basis points year-over-year. We're sitting around 36 today or will be on the year. With some of those, we had some issues in the second quarter, obsolescence and some heavier promotion that we think was not effective. We have transportation headwinds. So we still think go from where we are near around 36 today, up a point or 2 before the disruption of tariffs were to set in, is very realistic, and we haven't lost sight of that whatsoever.

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Peter Jacob Keith, Piper Jaffray Companies, Research Division - Principal and Senior Research Analyst [39]

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Okay. And I'm curious on your guys' perspective on the industry backdrop. It sounds like you had some company-specific call outs around pulling back on promotions but there certainly debate here around remodel and flooring sales potentially slowing. Do you have any perspective on just the overall demand trends that you're seeing out there?

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Dennis R. Knowles, Lumber Liquidators Holdings, Inc. - President, CEO & Director [40]

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Peter, this is Dennis. I -- It's interesting to see what's going on in the housing market. I've seen this kind of play out in the home improvement business so many different ways. When new sales slow down, remodel activity picks up, provided there's equity, but we watch kind of the things like cash out refis, they've been -- they've slowed for almost a year. But it is interesting for us. It's particularly when we see how strong our Pro growth is coming on and this installation business. And where we're seeing kind of that, I don't know, maybe the pullback, if anything, maybe in that lower tier and just drives the need for, what I said earlier, it was kind of a low deal, but it's -- I would tell you like, as Marty mentioned, our April sale -- or our October sale was really successful. And we just -- it seems like there's not necessarily been a pullback, but there does seem to be this drive towards more of this do-it-for-me. And I think we watch that really closely, from remodel activity to new homes and try that, kind of mirror that up against what we see in our business. And so far, it's really kind of -- there's really been no correlation, but we do watch it intently and are kind of seeing how this plays out with -- particularly with new homes and the remodel activity. But they still continue to be strong in the forecast for remodeling activity, still looks to be strong on the horizon. So we keep an eye on it but haven't really seen any connection between performance and what's been in the news as it relates to new home activity.

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Martin D. Agard, Lumber Liquidators Holdings, Inc. - CFO [41]

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Peter, I would link this back to Brian's question around our pricing power and ability to just offset tariffs through price increases and that is, how does the consumer react to that, and if there's a little bit of a slowdown already, do rising prices just (inaudible) against this there as well, particularly in a 25% tariff scenario where those price increases could be more meaningful. So certainly, affordability on housing, less churn of the housing stock, slowing down of remodel activity while we potentially are needing to raise prices because of tariffs is more of a downside case and causes us to be just hesitant about how much of that we do and how we protect the business.

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Operator [42]

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Our next question is from John Baugh with Stifel.

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John Allen Baugh, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [43]

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I was curious on the mix of what you're selling. I know you commented that LVT is up, and of course, that's sourced primarily from China. So I guess, as an overall question, when you think about what you're seeing in your business from a product mix standpoint. How the exposure overall is in terms of China sourcing versus everything else? In other words, is it going to be more of a headwind because you expect even more LVT or other counter forces at work that would alleviate that?

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Charles E. Tyson, Lumber Liquidators Holdings, Inc. - Chief Customer Experience Officer [44]

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Yes, John. Yes, I think there are couple of things. We believe there are opportunities to counterbalance some of the categories that are in China. And we have folks who are actively working those programs in country right now. We do believe that the consumer feels very strongly in the design and style benefits that are coming from EVP. If the 25% tariff really does go into effect, our expectation is that, like in any cycle where manufacturing is moved from country to country, whether it's out of Taiwan or out of Hong Kong into China, we expect others to move manufacturing bases that will open up opportunity. Obviously, that is a longer-term execution, but there is certainly some short-term risk mitigation that we believe is possible, both from a cost negotiation standpoint and from a multi-country sourcing standpoint. But we have a very large solid wood program. I've just recently, as Dennis said, come back from Brazil, and we have got great supplies down there with good capacity, the ability to be creative in the product design and help us drive other categories other than just EVP. As I mentioned, well positioned from a laminate perspective, from a sourcing perspective on the cost side and from a capacity side. And there may be mix opportunities there as the 25% goes into play. So John, there's no one answer to this. Pretty complicated issue in terms of what this multi-country sourcing become to leverage both on the cost side and make sure that we're positioned with the right product for our customers. And we're working both of those angles very aggressively today.

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Dennis R. Knowles, Lumber Liquidators Holdings, Inc. - President, CEO & Director [45]

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Yes, John, I would say, just a follow-up to Charles' comment, I guess if there's anything that surprised me as I learned this business was that you could get almost every category that we sell in China. Solid -- or solid engineered hardwood, laminates as well as vinyl. And so as Charles mentioned, just we're fortunate that we are less than half of it but still sizable portion of it, but most of that we can source competitively if not better in other countries. So a lot of opportunity for us there.

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John Allen Baugh, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [46]

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And then maybe just a follow-up. Could you, Marty, maybe tell us the precise timing, so you mentioned the 10% end of September, and you gave us some color on the gross margin but that it partially flowing through in the fourth quarter, not fully? Could you walk us through the timing of the 25%? And when that would start to flow into your inventory. And then when that would start flowing into your cost of goods. That would be helpful.

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Martin D. Agard, Lumber Liquidators Holdings, Inc. - CFO [47]

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Yes. And it's sort of the same answer gets into our inventory turns, but let's say that the 10% started October 1, and the 25% would start January 1, the tariffs will come in at a article level and turn to inventory based on the turn of that article. Vinyl products are generally faster turning and so that tariff would be fully realized somewhere in 3, 4, 5 months, depending again on the how fast-turning popular a given floor item is. Engineered products slower. Bamboo products slower. So some of those may take -- they may be into the second quarter and still not fully reflect. It could be -- take 6 months, really, to get to going. So it's somewhere between, let's say, 4 months and 6 months before these tariffs are going to take real effect and again, based on the speed of the turn. So I think that's generally the question you're looking for. Our price increases and cost -- the cost outs from vendors go in the same way. They go in and slowly but surely make their way through inventory and will turn at that kind of pace, depending again on the article, as fast as 3 months and as slow as 6, 7 months. Our price increases can go in quicker, but sometimes we have promotional events coming up that we protect. And so there's sometimes a lag in the effect of our price increases as well, typically not as slow as the inventory effects on the tariff to the cost outs.

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Operator [48]

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Our next question is from Rick Nelson with Stephens Incorporated.

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Nels Richard Nelson, Stephens Inc., Research Division - MD [49]

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I would like to follow up on the Pro and the installation side of the business. You've seen very big growth in both of those businesses from [moving from] 20% to 30%. When -- how big can that business become as a proportion of sales? When do you start to anniversary some of these challenges with installation services as well the big growth, when do you anniversary that?

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Martin D. Agard, Lumber Liquidators Holdings, Inc. - CFO [50]

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Yes. I'll start with the -- well, let's start with the Pro. It is approaching 30% of our merchandise sales. And I don't know that we know, I don't think it slows down, it doesn't anniversary anything. So we can continue to edge higher for the foreseeable future, to the extent, millennium -- millennials use Pros, and we can build our Pro business and continue to have better offerings and service offerings and things for the Pro, then that can continue to edge higher, and we expect it to. On the install business, we got that fully expanded into the last states, Florida and California, in late 2017. So by the first quarter of 2019, we will be anniversarying a fully expanded install program from the first quarter of '18. So that's -- and where it help all of the investors and the audience track, that is, that's part of why I indicate how much installs have grown in the stores where that program's been offered more than a year. That number for the third quarter was 13%. And that's been in that, I call it, the low teens range for a couple of different quarters, several quarters. So as we get fully expanded, and we're talking about the first quarter of next year being anniversarying a fully expanded offering, something like that for the installs part of the business feels reasonable, and that installs business is sort of 12% -- 11%, 12% of the sales growing at 12%, 13%, that's a 1.5% of comp growth where it's been -- it's contributing more like 3% to 3.5%. So we will face that, and we will be partway there in the fourth quarter of this year. So it will go from contributing something like 3% to 3.5% of the comp growth to maybe 2-ish% to something more like 1.5-ish%. So I think that's the best guidance I can give you around that.

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Charles E. Tyson, Lumber Liquidators Holdings, Inc. - Chief Customer Experience Officer [51]

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Yes, if I can just add, from an install perspective, as I said before, we have not spent a significant portion of our marketing spend leveraged against our installation customer segment. And we see that as an opportunity. We are testing, as I said in the fourth quarter, an enhanced program against installation in certain markets and believe that, that will attract a new traffic customer to our brand that doesn't understand today that we're even in the installation business. So we think there is a lot of opportunity around brand awareness and installation at Lumber Liquidators.

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Dennis R. Knowles, Lumber Liquidators Holdings, Inc. - President, CEO & Director [52]

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Yes, and I would just -- Rick, just add to that as well, is that our Pro business and our installation have been a very intentional build up in terms of making sure that we have the right network, the infrastructure behind it, the -- both on the Pro and the installation, Mike and Charles have worked tirelessly to make sure that we built this network in a way that when we were ready to fully leverage it, we could. And I think that's where we are at and what Charles is talking about. So as Marty said, we'll see less benefit as we continue to cycle that but in the markets where it is performing well. It's been in place for over a year. We're continuing to see that perform well, and that's without any intentional push. So we still have some work to do. We want to continue to digitize that experience, both for the Pro and for the do-it-for-me customer. But we see that as kind of our work to do for the remainder of 2018 and into 2019, to help us fully leverage that. But as Charles mentioned, we will start to lean on that business a little bit in the fourth quarter and into 2019.

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Operator [53]

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Ladies and gentlemen, we have reached the end of our question-and-answer session. I would like to turn the call back over to management for closing remarks.

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Dennis R. Knowles, Lumber Liquidators Holdings, Inc. - President, CEO & Director [54]

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Thank you, operator. Let me say thanks, again, to the LL team, our vendors, our customers and our shareholders for your continued support. We look forward to updating you next quarter. Thank you.

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Operator [55]

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