Ll Flooring Holdings Inc (NYSE:LL) Q4 2022 Earnings Call dated Mar. 01, 2023.
Corporate Participants:
Julie MacMedan — Vice President of Investor Relations
Charles Tyson — President and Chief Executive Officer
Analysts:
Laura Champine — Loop Capital — Analyst
Presentation:
Operator
Ladies and gentlemen, welcome to the LL Flooring Fourth Quarter 2022 Results Call. My name is Glen, I will be the moderator for today’s call. [Operator Instructions] I will now hand you over to your host, Julie MacMedan, VP, Investor Relations, to begin. Julie, please go ahead.
Julie MacMedan — Vice President of Investor Relations
Thank you, operator. Good morning, everyone, and thank you for joining us. Today, I am joined by Charles Tyson, our President and Chief Executive Officer. As we begin, 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 LL Flooring.
Although LL Flooring believes that the expectations reflected in its forward-looking statements are reasonable, it can give no assurance that such expectations 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 LL Flooring filings with the SEC. During today’s conference call, management will be discussing results on an adjusted basis.
A reconciliation of non-GAAP financial measures to the most directly comparable GAAP financial measures and our explanation of why the non-GAAP measures may be useful are discussed in today’s earnings release. The information contained in this call is accurate only as of the date discussed. Investors should not assume that the statements will remain operative after today, and LL Flooring undertakes no obligation to update any information discussed in this call. Now I am pleased to introduce President and CEO, Charles Tyson. Charles?
Charles Tyson — President and Chief Executive Officer
Thank you, Julie. Good morning, everyone. 2022 was a challenging year for LL Flooring. At the outset of 2022, we expect that the increased investments we made and our strategic growth pillars to begin to drive higher sales starting in the second half of the year. We did not deliver on that goal as continued weakness in sales to consumers more than offset the double-digit growth in sales to Pro customers that we achieved. We’re not satisfied with our results. We believe that the uncertain macro environment has partially contributed to weakness in our sales to consumers and continues to be a near-term headwind.
In addition, we have identified two primary opportunities to improve our sales performance: one, further broadening and growing our brand awareness amongst consumers to drive traffic, and two, ensuring a consistent customer experience across our omnichannel network to improve conversion. We will discuss how we’re planning to address both of these in a moment. Moreover, we know that our cost structure is not aligned to our current run rate of sales.
While we have made progress on our strategic initiatives, we have more work to do to get LL Flooring to the level of profitability that we are confident we are capable of achieving. On today’s call, I will review our fourth quarter and 2022 financial results and address how we plan to improve sales productivity and profitability. In addition, I will reaffirm the green shoots in our key operational strategies that give us confidence in achieving long-term sustainable growth. Now turning to a review of our fourth quarter results. Total comparable store sales were down 9.5%, and net sales were down 7.5% as lower spending by consumers versus last year more than offset growth in sales to Pros.
Average ticket increased 8.2% and average retail price per merchandise units sold increased 9.6% compared to the fourth quarter of 2021. The higher average retail price was driven by pricing and promotion strategies to offset higher costs. However, we saw a 17.7% decrease in transactions compared to the fourth quarter of 2021 due primarily to weakness in sales to DIY customers. Adjusted gross margin was 35.7% which declined 170 basis points from last year.
I want to recognize the continued good work of our merchant and supply chain teams as we’re able to largely offset more than 800 basis points of headwinds from higher material and transportation costs for our pricing, promotion and sourcing strategies. Adjusted SG&A as a percent of net sales was 38.8% up 510 basis points from last year due primarily to expense deleverage from lower sales volumes. In addition, operating expenses were higher due to the planned investments in our growth strategies, including costs associated with opening 18 new stores, higher marketing spend to build brand awareness, higher staffing to support our strength in Pro sales, and competitive wage increases for customer-facing associates.
During January of 2023, we implemented several cost savings measures, including reducing headcount and slowing new hires across the organization. With the related severance expenses reflected in our fourth quarter SG&A. We continue to look to improve operating efficiencies and are actively working to rightsize our cost structure and lower our fixed costs. During the fourth quarter, we reported a noncash goodwill impairment charge of $9.7 million which resulted from a decline in the company’s market capitalization, increases in the weighted average cost of capital as applied to our future cash flow models and comparable company market multiples.
Excluding that charge, on an adjusted basis, we reported an operating loss of $8.2 million compared to adjusted operating income of $10.8 million last year. We reported an income tax benefit of $3.2 million or an effective rate of 17.7%, which compared to an income tax expense of $0.5 million last year, or an effective rate of 4.4%. The effective income tax rate is inclusive of both federal and state taxes and was impacted by nondeductible and return to provision adjustments in 2022, and a benefit from state net operating loss adjustments in 2021. Fourth quarter adjusted net loss was $0.29 per share versus adjusted earnings per share of $0.35 last year.
Now I’ll briefly recap the full year 2022 results. Net sales of $1.1 billion decreased 3.6% and comparable store sales decreased 5.8% compared to last year, with lower sales to consumers more than offsetting double-digit growth in sales to Pros. We reported adjusted gross margins of 36.2%, which was down 140 basis points from last year. We were able to largely offset more than 1,000 basis points of headwind from higher material and transportation costs through our pricing, promotion, and sourcing strategies.
Adjusted SG&A as a percent of net sales was 36.3%, up 330 basis points from last year due primarily to investments in growth strategies, including higher marketing spend and deleverage of lower net sales. Full year adjusted operating loss was $1.8 million compared to adjusted operating income of $53.7 million. For 2022, we reported a $1.5 million income tax benefit or an effective rate of 10.8% compared to income tax expenses of $11.1 million or an effective rate of 21% in 2021.
The effective income tax rate is inclusive of both federal and state taxes and was impacted by nondeductible and return to provision adjustments in 2022 and a change in valuation loss carryforwards in 2021. Adjusted loss per diluted share of $0.17 in 2022 compared to adjusted earnings per diluted share of $1.39 in 2021. Overall, we were disappointed in our 2022 financial results, and our entire organization is focused on improving net sales growth and profitability in 2023. Now I will review our strategic priorities to drive traffic and increased conversion to improve our sales performance in 2023.
First, we will broaden awareness of the LL Flooring brand to increase traffic. We’re intensifying our efforts to build greater awareness of the LL Flooring brand in order to drive more traffic, particularly with consumers. Our brand surveys of both Pros and consumers consistently show that the new LL Flooring brand scores significantly higher versus lumber liquidators on the core attributes we measure, including product quality, assortment and store associate expertise. The LL Flooring brand also broadens our appeal as a national flooring destination, offering a one-stop shop for consumers who are seeking service and expertise from inspiration to installation.
As such, we believe that we are on the right track with our rebranding strategy. However, our unaided brand awareness remains low, and we’re focused on broadening brand awareness by investing in top of funnel marketing strategies that will focus on evolving our creative approach to increase relevancy, refining our media campaigns to increase efficiency and expand our reach to increase exposure. In terms of creative, we’ll be launching a new creative campaign this spring that will clearly articulate what the LL Flooring value proposition offers to consumers, leaning into selection expertise, assortment and value.
Regarding efficiency, we continue to improve the effectiveness of our digital marketing spend and strategy, which aims to increase conversion while lowering customers acquisition costs. To that end, we’re excited to announce the implementation of a new customer relationship management platform, or CRM. In 2023, that will both enhance marketing effectiveness as well as improved store and omnichannel conversion. We expect to begin to realize the benefits from the CRM implementation beginning in the second half of 2023. And finally, reach. We’re expanding our network presence within the discovery portfolio such as HCV and Magnolia Network and increasing spend on broader reaching news and weather channels.
In addition to broadening brand awareness to increase traffic, we’re working to drive increased conversion through improved execution across our store network. We offer a seamless omnichannel experience, driven by our foundation and flooring expertise. Most customers start with our digital platform, llflooring.com, and then complete their journey at one of our 442 stores located across the country. An important part of our brand transformation strategy includes elevating our brand positioning in the marketplace. Our associates are a key differentiator for LL Flooring.
We win when a customer walks into an LL Flooring store and is immediately greeted by knowledgeable associates who can help make buying flooring easy. In a small environment, our store teams are critical ensuring the success of delivering a great customer experience. To further improve our sales performance, we’re focused on improving conversion rates when customers request a free sample either online or in our stores and improving close rates on installation quotes by increasing the speed at which we turn the project quote to the customer once we’ve measured their space.
We continue to invest in field leadership and in 2023, we are further strengthening product expertise by increasing the number of hours per month devoted to product and sales training, and increasing investment in both our regional and store management training programs. In turn, our field leadership is held accountable to consistent execution of our operating plans and improving the customer experience that we’re driving through Medallia Voice of the Customer measurement program.
We continue to deploy technology in our stores to improve the customer experience and store associate productivity. Building on existing technology investments, such as our installation services portal, and iPads in every store. We’re excited to leverage our new CRM platform to help our associates more effectively capture customer interactions and engage with them. Our entire store teams are focused on understanding each customer’s unique story and project objectives regardless of which store or online associates managed the first interaction, and the new CRM software will streamline this process.
Given our high top service model, it’s critically important to hire the right people and retain them. In order to successfully attract and retain talent, in a competitive wage and hiring environment, we’ve strengthened the career opportunity of our associates by featuring a focus on promotion for within as well as certification programs that help our associates progress more quickly into roles that can earn incentive bonuses and expanding our investment in more competitive wages to attract and retain talent to further enhance the employee value proposition.
We believe our store associates are critical to delivering on our brand promise. We’re confident in our ability to improve performance and execution across the fleet as the investments in our associates and our field leadership accountability drive greater productivity. To that end, we’re significantly reducing our new unit openings in 2023 and shifting our focus to improving the productivity of our existing stores. While we plan to open only three new stores in 2023, we continue to believe that the market opportunity to grow LL Flooring locations remain strong.
It’s important to note that we have a strong pipeline of potential new store locations identified and will report our new store opening plans in future quarters. With respect to profitability, our cost structure has outpaced our growth as we’ve made significant investments in our strategic pillars that we expect will generate a strong ROI over the longer term. In the near term, we have a low variable cost structure, which has made it challenging to further reduce operating expenses in a difficult macro environment. That said, we continue to look to improve operating efficiencies and are actively working to rightsize our cost structure.
We look forward to reporting on our progress on future calls. In summary, as we look ahead, 2023 is about taking ownership of what we can control and delivering strong execution on our operating priorities. Now I would like to take a few minutes to give our thoughts about the external environment and discuss our outlook for 2023. In the near term, we continue to navigate an uncertain macroeconomic environment. We see customer spending on home improvement potentially challenged by consumer confidence, inflation, volatile mortgage rates impacting housing affordability and continued declines in existing home sales.
In addition to macroeconomic uncertainty during the first quarter, we began experiencing customs delays relating to certain shipments of vinyl flooring originating from Vietnam. In February 2023, U.S. customs added aluminum and polyvinyl chloride to a list of categories, including cotton, tomatoes, and polysilicon, for which customs has the ability to request additional documentation from importers. We began to receive notices requesting such additional documentation for some shipments.
We require our vendors to follow our strict guidelines on responsible sourcing, we obtain periodic certifications from them concerning compliance with these standards, and we perform audit procedures of their supply chain documentation. While we’re working with customers to provide requested additional documentation, we do not know how long their review of the documentation will take. Based on what we know today, the customs delay could have a material impact on 2023 full year operating income due to lost sales and higher inventory carrying costs. We’re working to partially mitigate the disruptions from the customs delays by featuring alternative products in our current assortment and leveraging our sourcing capabilities to look at alternative flooring categories and sourcing geographies.
In terms of our sales outlook for 2023, while we strongly believe that our strategy to increase brand awareness and deliver a more consistent customer experience will gain traction and drive store productivity throughout the year. Our visibility is limited as to when the macroeconomic environment will normalize or when the customs delays will be resolved. We expect adjusted gross margin to improve year-over-year with the strongest second half driven by reduced international container costs as we turn a higher cost inventory.
We will continue to monitor the competitive pricing environment to inform our pricing and promotion strategy. In addition, we expect our gross margin rate in 2023 to benefit from a greater mix of higher-margin products that deliver on customer needs for scratch proof or waterproof flooring. With respect to SG&A, our cost structure has increased primarily driven by investments in our strategic pillars in the face of lower-than-expected sales. While we expect these investments to drive sales growth over the longer term, we realize we have significant work to do to rightsize our SG&A levels.
We currently expect further pressure on our cost structure with adjusted SG&A expense increasing year-over-year due to inflationary pressures on wages and benefits, particularly as we continue to make important investments in our associates. As mentioned earlier, we will be investing in our CRM platform, which we will expect will support higher sales levels and make our operating structure more efficient over time. We’ll update you in future quarters on the work we’re doing to realign our SG&A.
With respect to capital allocation, we’ll continue to review our capital allocation priorities. We are pleased to have rebuilt inventory in 2022 and expect inventory to be a source of cash in 2023, as we sell through higher cost inventory and return to more historical purchase levels. We expect to invest capex in the range of $15 million to $20 million to support our strategic growth initiatives including opening three new stores and investments in productivity such as our CRM platform implementation and for maintenance capex.
We believe we have sufficient liquidity to support our operations and investments in growth. Turning to our longer-term outlook, we believe the long-term outlook for repair and remodel spending remains strong, supported by tailwinds such as the aging housing stock in the U.S., new household formation by millennials. We remain committed to deliver long-term growth driven by executing on our six strategic pillars, growing sales to Pro, building brand awareness, improving the customer experience, innovation in new products, developing our people and culture, and opening new stores.
Longer term, we believe the new LL Flooring brand will offer unique value proposition in the market for customers who want selection expertise, assortment, and value. We believe we are successfully gaining traction on several of our operating strategies, which gives us confidence in achieving long-term sustainable growth. In particular, we’re very excited about our Pro strategy and continued product innovation. First, we’ll continue to lean into our strategy of growing sales to Pro customers.
To that end, we’ve generated consistent growth in sales to Pro customers. The fourth quarter marked the eighth consecutive quarter of growth in Pro sales. I’d like to recognize our pro sales team for delivering double-digit sales to Pros in 2022 in spite of a difficult macro environment. We view our pro sales strategy as a core long-term growth pillar for LL. In 2023, we expect continued growth in our sales to Pro customers.
We believe we have a strong competitive advantage with Pros through our dedicated relationships, our trend right in-stock products and highly competitive everyday pro pricing. Our Pro relationship program starts with each of our store managers, developing their Pro business around every one of our 442 stores. And as the business scales, we assign a dedicated regional account rep to drive growth. In 2023, we plan to continue to build on the success of our Pro relationship programs driving increased retention and scale with existing Pros. We also plan to acquire new Pros, we’ve been excited by a number of wins with national customers, and we’re continuing to invest in that area to drive the business.
Finally, our new Pro customer acquisition strategy will be supported by a new CRM platform and expanded marketing programs to further personalize our communications with Pros. Second, product innovation. We believe we offer the best wood and wood-look flooring at a great value, and we continue to drive innovative new products that meet consumers’ flooring needs. Our direct sourcing model is a key competitive advantage that allows us to innovate beautiful flooring such as Duravana, which is PVC-free and is sourced in Europe that supports consumers everyday living needs at a great value.
We continue to build on the success of Duravana by expanding the assortment under the Duravana brand. During 2022, we rebuilt inventories in order to support our conservative strategy to place inventory closer to our customers. And we further reduced our dependency on imports from China, which is still tariffed at 25%. In short, we made good progress against our strategic pillars of growing sales to Pros and innovating product in 2022.
This, combined with our focus on execution against all six of our key strategic pillars gives us continued confidence in our ability to achieve long-term sustainable growth. As I conclude my formal remarks, I’d like to give a brief update on our CFO search to note that it is well underway. To close, we know we need to do more and we’re working to change the trajectory of our business by leaning into key elements of our strategies that are performing well, diligently working to increase brand awareness, and provide a more consistent customer experience, and improving profitability to rightsizing our cost structure.
Importantly, the long-term fundamentals of our business is strong. We have a unique positioning in the marketplace, we will deliver the high-touch service of an independent flooring retailer, combined with the value, assortment, and convenience of a national brand. With that, I will open up for questions. Operator?
Questions and Answers:
Operator
Thank you. [Operator Instructions] We have our first question comes from Laura Champine from Loop Capital. Laura, your line is now open.
Laura Champine — Loop Capital — Analyst
Thanks for taking my question. The first question is a little clarification on the gross margin outlook. I note that you mentioned that gross margin should improve year-over-year, but will that improvement likely begin in the first half or is that something we should wait for the second half to see?
Charles Tyson — President and Chief Executive Officer
Good morning Laura, thanks for the question. As I said on actually the last earnings call, as we see an improvement in our cost flow through on our inventory, primarily driven by the reduction in international transportation that margin benefit will start to flow through in the back half of the year as well as benefits we’re seeing through our sourcing strategies and reduction in some product costs. So most of that benefit will flow through in the Q3, Q4 period.
Laura Champine — Loop Capital — Analyst
Got it. And then secondly, on the sort of interim office of the CFO that you’re working with, my understanding is that you’re looking to outsource IR. Will that office change from a three-person office to a two-person office? And what are your plans for that on an interim basis?
Charles Tyson — President and Chief Executive Officer
Yes. We have partnered with a third party while we go through a transition, and we will continue to look for the replacement, obviously, of our CFO. And we’ve got a great team here back in Richmond, who is supporting whole finance initiative to make sure that we don’t drop the ball. And I feel really good about the team that are working it every day, both on the IR side and on our accounting side, treasury and tax.
Laura Champine — Loop Capital — Analyst
Got it, thank you.
Charles Tyson — President and Chief Executive Officer
Thanks Laura.
Operator
Thank you Laura. [Operator Instructions] We have no further questions on the line. I will now hand back to Charles Tyson to begin for closing remarks.
Charles Tyson — President and Chief Executive Officer
Thanks, operator. Thank you, everyone, for joining us today. While the near-term operating environment remains challenging, we remain focused on executing against our strategic priorities in 2023, and we’re excited about our long-term growth opportunities we see for our business. Wish everyone good health, and we look forward to updating you on our performance next quarter. Thanks.
Operator
[Operator Closing Remarks]