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Lumber Liquidators Holdings Inc (LL) Q4 2018 Earnings Conference Call Transcript

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Lumber Liquidators Holdings Inc (NYSE: LL)
Q4 2018 Earnings Conference Call
March 18, 2019 , 8:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, ladies and gentlemen, and welcome to Lumber Liquidators' Fourth 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 Danielle O'Brien. Please go ahead.

Danielle O'Brien -- Investor Relations

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

Let me reference the safe harbor provisions of the US securities laws for forward-looking statements. This conference call may contain forward-looking statements that are subject to significant risks and uncertainties, including the future operating 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?

Dennis R. Knowles -- Chief Executive Officer

Thank you, Danielle, and good morning, everyone. Today, I'm joined by Charles Tyson, our Chief Customer Experience Officer; Marty Agard, our Chief Financial Officer; Lee Reeves, our Chief Legal Officer and Corporate Secretary; and Tim Mulvaney, our Chief Accounting Officer.

Before we walk you through our financials and operating results, I wanted to discuss three pertinent topics: resolution of key legacy legal issues; our proactive approach to mitigating risks associated with trade tariffs; and the announcement of Marty Agard's resignation.

First, last week, we reached resolution with the government regarding their investigations into the Company's compliance with securities disclosure laws concerning the Company's sourcing of Chinese laminate flooring. We entered into a deferred prosecution agreement with the US Attorneys Office for the Eastern District of Virginia and the DOJ. We entered into a settlement of administrative proceedings with the Securities and Exchange Commission.

The resolutions related to public disclosures made in March of 2015 and no findings were made about the safety or quality of the Company's laminate flooring previously sourced from China, which we believe aligns with the decision by the CPSC in 2017 to close their investigation without issuing a product recall. Under the in-home testing program, we implemented and reported to the CPSC, we issued a 83,000 air quality test kits to our customers and not had a single tested floor produced a final emissions level that exceeded the World Health Organization standards used in their program. We have cooperated with this investigation and are pleased to see the government recognize the changes in the Company's leadership and our extensive investment in remediation.

Notably, the DOJ charges are deferred and will be dismissed after three years provided we meet certain obligations, many of which we've already implemented.

Separately, we announced this morning that we've reached a memorandum of understanding in the Gold matter that addresses customer concerns with certain Morning Star bamboo flooring that may not have met some of our customers' suitability expectations. Together, these actions represent an important milestone for our Company as we can now look forward and focus on our commitment to providing quality products, services and experiences for our customer. Our new leadership team is excited to build on our progress and is dedicated to compliance, transparency and accountability across our organization.

These matters have been a financial constrain on the business and in addition to the legal expenses, required a significant amount of the team's attention. We are pleased to resolve these matters, so that we can move forward with laser focus on operating and growing our business.

I'm also pleased to highlight that we have taken steps to enhance our liquidity position. Marty will provide details on the financial impact of these settlements and how we're managing liquidity in a moment.

Second, we have been facing macroeconomic challenges in the form of trade tariffs. While the impact of the current tariffs and a potential for a larger tariff have significant financial implications, it has given us the opportunity to reevaluate our entire sourcing and supply chain process. This we believe should unearth enormous long-term benefits. In the near term, we were able to substantially mitigate the 10% tariff impact and expand gross margins during 2018.

While the 25% of tariff has been indefinitely postponed, we know that our work to further mitigate the impact is still in front of us. To that end, we're not only improving our cost structure and supply chain, but also enhancing our capabilities under new leadership. We are actively renegotiating costs and moving product out of China, where it makes sense. Our Head of Sourcing has already made immediate impacts by identifying significant areas to create efficiencies.

In this challenging environment, we recognized our pricing strategy is important to ensure that we are optimizing our revenue and costs. We are working tirelessly to improve profitability and remain committed to managing all that is under our control and expanding operating margins through a combination of initiatives and leveraging SG&A.

Third, as seen in the earnings release, Marty Agard has announced his resignation and will be taking a new opportunity outside the Company. He will remain our CFO until April 5th, to ensure a smooth transition. I want to thank Marty for his contributions and hard work over his tenure. Marty has been instrumental in helping us rebuild our finance organization and deepen our team talent and has helped us overcome many legacy issues we have faced. We wish Marty well in his new role.

I'm pleased to announce that Tim Mulvaney will take over as our Interim CFO, while we complete our succession process. Tim has served as our Chief Accounting Officer since 2017, and has many years of public company experience. Tim has been a valued member of the leadership team and I along with the Board have the utmost confidence in his ability to serve as our Interim CFO.

Lastly, we have retained Herbert Mines Associates, the leading executive search firm, to assist us in completing a comprehensive search for a permanent successor and as always we'll keep you updated.

Now, to recap 2018, one year ago, we discussed our plan to transform Lumber Liquidators through a number of strategic efforts, including operational excellence through improved service, merchandising, assortment and value, enhanced value proposition and customer experience through digital and technology advancements, expanded business services including systemwide rollout of installation and enhanced value proposition for the pro and improved profitability.

While we recognize there's still work to be done, as I sit here today, I am pleased with the hard work and dedication our team has shown to make progress in 2018, and that it was a year of investment, executing our stated initiatives and laying the groundwork for the future. For the full year, we delivered 2.6 comp growth, driven largely by installation, pro sales and sales in our resilient flooring category. Gross margins increased 30 basis points year-over-year despite headwinds from tariffs and transportation costs, which together had a negative impact of 100 basis points.

Our ability to grow margins in a challenging environment highlights the success of our assortment initiatives and effort to become more cost effective. I would like to take a moment to highlight some of the progress we've made against our key initiatives in 2018.

First, we continue to execute on our plan to grow our installation of pro businesses. For the full year, installed sales grew 12% and contributed roughly 13% on a comp store basis. Installation now comprises roughly 12% of our revenue and we expect this to continue to grow. We have officially completed the rollout of installations and have the first year under our belt. Additionally, our pro business continues to accelerate and now represents 29% of total revenue.

We are pleased with the performances of both businesses and believe this progress underscores our commitment to service all customers's end-to-end needs, which is a true differentiator for Lumber Liquidators.

Second, one of our top priorities in 2018 was transforming customer engagement at every touch point. We've improved the way we interact with our customers, as well as our overall customer experience. Charles will discuss this in further detail, but I'd like to highlight two initiatives in particular, digital and marketing mix.

On the digital front, we are evolving to an omni-channel approach that creates an integrated and cohesive customer experience, no matter how or where our customers engage. This begins with revamping our online presence. We are not only working to improve our website to provide a seamless shopping experience, but to develop expanded capabilities which we are especially excited about. More to come on that this year.

Additionally, we are reshaping our marketing mix to more contemporary business-driving element. We have hired a new agency on both the media planning and creative side and have taken action to move ad dollars away from less effective channels such as print. There is still much work to do in this area, however, the initial read out on our work is encouraging and pushing us to expedite this transition.

Lastly, we continue to expand our presence in key markets. In 2018, we opened 21 stores, bringing us to 413 total stores, which furthers our goal of achieving 500 stores. Growing our presence in key markets is essential to expanding our market share. Coupled with our exciting customer experience initiatives, solid inventory management, tactical advertising and improved product mix, we see store expansion as an exciting opportunity.

Notably, we debut a new larger format store in Altamonte Springs, Florida, in the Orlando market. This store design is a first of its kind for Lumber Liquidators, equipped with more in-stock items, a pro desk and design center, which sets a new standard for our customers flooring experience. We have identified a number of locations in high traffic areas where opportunities exist to open stores similar to this format, or alternatively transition current stores to this format. While the store is in its early months of operation, we are pleased with the initial results. We plan to continue refining and testing this format before making a decision on further rollout.

These successes are encouraging milestones that we believe position us better competitively. However, we recognize that there are some areas where we need to further accelerate our transformational strategy. For the full year, our merchandise and traffic were down 0.6% and 0.8% respectively. The launch and growth of installation business has resulted in some cannibalization in merchandise transaction. We believe the decline in comp store traffic is also a result of our own new store cannibalization, the competitive environment and the modest softening of the industry we saw in the latter part of 2018.

As we transform our marketing approach away from traditional direct mail to more digital, we realize this transition could undoubtedly impact traffic in the interim, but are confident this should improve traffic in the long run.

Looking ahead to 2019, we see a clear opportunity to continue to execute our transformational strategy and make further progress against our initiatives. While we expect some moderation in the economic backdrop, particularly as it relates to new and existing home sales, the ongoing consumer shift from carpeting to hard surface flooring should ultimately sustain demand for our wide variety of wood and vinyl products.

We are currently assuming a trade environment with 10% tariff. So the potential of a 25% mark will have a substantial impact on both the cost side, as well as the economic growth in consumer demand. With that said, we believe 2019 macro environment will be similar to what we experienced at the end of 2018, showing a slight deceleration.

Turning to Lumber Liquidators priorities for the coming year: first, we are focused on capturing additional market share and believe our differentiated customer experience will be a driving force behind that. We have a dedicated team of employees that focus solely on the hard surface flooring business and we are seeing our floor (ph) rates improve, which we believe will continue moving forward.

I am also proud to say our employee turnover is at its lowest levels during in my tenure. We are incredibly grateful to our associates around the country for the work they do to serve our customers and showcase our differentiated value proposition.

Second, with these major legacy legal issues behind us, we have the opportunity to increase our advertising spend this year. Enhancing our efforts to modernize our marketing plans, we'll also look to continue optimizing regional product assortment, product mix, sourcing and executing on our store development plan. With our priorities in place, it's now a matter of strong execution. We are targeting to deliver a flat to low single digit comp growth in 2019, along with continued adjusted operating margin expansion.

Lastly, in 2019 we anticipate that there could be consumer weakness due to the media reaction related to the settlement, coupled with weaker industry demand, more difficult comparisons against Hurricane Harvey and flooring installation tailwind. As a result, we expect comps to be down in the low single digits in the first quarter, but flat to up low-single digits for the year. We expect flat to 50 basis points of adjusted operating margin improvement, the opening of 10 to 15 new stores depending a bit on the success of the new larger format prototype in Orlando, and capital spending of $15 million to $18 million.

To conclude, our strategy remains focused on transforming our customer experience through are a number of digital and in-store initiatives, enhancing our value proposition, improving business operations and expanding business services. We are confident in our ability to provide a seamless flooring experience, improve profitability and drive long-term shareholder value. We have a talented team committed to executing on these initiatives, and we look forward to updating you on our progress in 2019.

Now, I would turn the call over to Charles.

Charles E. Tyson -- Chief Customer Experience Officer

Thank you, Dennis. I'd like to focus my comments this morning on opportunities to improve our profitability and merchandising initiatives, and our efforts around driving traffic, including our digital program. When reviewing opportunities to improve our long-term profitability, our leading initiatives here include global sourcing, product mix enhancements and product regionalization.

Our global sourcing team continues to evaluate the best alternative country sourcing opportunities to drive improved product acquisition costs. The team was proactive in the quarter, negotiating lower costs to substantially offset the 10% tariff environment, and we expect to see further sourcing benefits delivered as we progress through 2019.

In past calls, we've talked about the need for our assortments to reflect the style and functional demand of local and regional taste. We've recently completed a reset of our store planograms to more accurately reflect local versus national flooring trends. Our merchandising teams are actively working with our vendor partners to create unique assortments for specific markets. For example, this will allow us to differentiate our mix between coastal assortment styles in the West versus hardwood trends in the Northeast. We will continue to develop these regional assortment choices through 2019, specifically, in the engineered wood and laminate category.

On the merchandising side, the market continues to be dominated by the growth in vinyl, but we also saw encouraging share gains in both hardwood and laminates in the fourth quarter of 2018, driven by changes in both our assortment and promotional cadence. This quarter, in laminates, we have launched our new AquaSeal water resistant products for both 24-hour and 72-hour performance, that will better compete in the growing water resistant category

While we expect aggressive growth in the vinyl category to continue, we see that our unique, differentiated, high touch service model is well positioned to deliver an exceptional customer experience in hardwood for both our DIY and install customer segment. We've undertaken a number of assortment and marketing initiatives working with our vendors and field partners to deliver share gains in this segment and we expect to see these results accelerate as we progress through the year.

Turning to our traffic driving initiatives, let's start with our digital strategy. You may have noticed, we've completed a number of upgrades to our online shopping experience to improve site performance, feed and navigation. We've also completed the onboarding of a number of new channel partners to optimize our digital marketing capabilities, especially in regards to search. We are focusing our efforts, both on hyper local marketing, as well as expanding new online capabilities to capture and convert increased traffic.

Early next quarter, we'll be launching our new floor visualizer online. This tool will enable customers to take a photo of any room in their home and upload any one of the hundreds of floors that we carry to visualize what the finished product will look like in their home. We believe this provides a more tangible approach to online shopping as it overcomes any visualization hurdles in the digital buying process.

We're also encouraged by the positive trend an early testing is resulting in higher conversion. We are seeing an increase in online user acquisition, as well as improved online engagement, conversion and revenue growth. As we discussed last quarter, we see creating a compelling digital experience as a critical part of our strategy to capture customers at all stages of their flooring journey.

Turning to our marketing plan, we've launched a new store opening marketing program that's delivering stronger results and driving higher awareness of a new Lumber Liquidators store in our customer's neighborhood. We've completed the onboarding of both the new creative agency and new media planning agency, which will bring greater focus to our brand positioning work. We expect to update you on this work later this year.

We are focused on allocating our media mix to better align with how our customers consume media. We are testing a number of regional advertising approaches that will align content more closely to the mix of products being sold in specific geographical region. As you know, we optimized our total spend in 2018, reducing allocations to unproductive spend medium. We do not see further reductions from those spend levels in 2019, and based on specific media returns, we see opportunity to increase spending as we progress through the year.

Lastly, on the traffic front, we are aggressively reviewing our store prototype and the opportunity to create a more compelling customer experience. As Denis mentioned, we're excited by the customer reaction to our new expanded store concept in Altamonte Springs, Florida. At roughly four times the size of our average store showroom, this location features 8,000 square feet, with a design center that helps customers digitally envision and select their perfect floor from a larger, in-stock assortment of flooring solution. The stores feature extra large displays, same day pick up or delivery, a dedicated pro sales set and an entrance holding special hours of operations designed to accommodate the pro's busy schedule.

Altamonte Springs offers a more in-depth stocks assortment and product than a typical Lumber Liquidators store and has a unique offering for all our client segments. As Dennis mentioned, we're in the process of identifying locations to open another prototype of a similar format while we identify other potential remodel sites in our existing portfolio.

I will now turn it to Marty to discuss our financial results.

Martin D. Agard -- Chief Financial Officer

Thank you, Charles, and good morning, everyone. In the fourth quarter, net sales were $268.9 million, an increase of 3.5% over last year, with comparable store's net sales up 0.4%. This was driven by a 31% increase in installation services sales, slightly offset by a 2.6% decline in merchandise sales.

The overall 0.4% comp growth was affected by an increase in average transaction value of 2.2%, and a decline in the number of transactions of 1.8%. We continue to see the attachment of installation sales and the increased pro customer mix as the major contributors to the larger transaction sizes.

I want to bring your attention to transaction size and count. We've made a slight change in our definition of transactions. The old definition aggregated multiple purchases into one transaction, which increasingly overstated average transaction size and correspondingly understated the number of transactions as our pro customer business has grown. The new definition counts individual transactions over $100 independently and less (ph) added to a previous order. This change is detailed in the 10-K along with the restated history by quarter for both 2018 and 2017.

As a reminder, we finished the last of the geographic expansion of our installation services program in late Q4 2017, so fourth quarter 2018 cannot yet be viewed as entirely comparable. I will point out that our services business grew 13% in just those stores in which it's been offered for over a year, which is the same rate we saw in the third quarter.

Merchandise sales were negatively impacted in the Texas market and to a lesser extent Florida as well, where we compared against the peak of the Harvey storm demand in the prior year period. If we exclude those markets, our merchandise comps were closer to flat. In terms of category performance, we continued to see strong growth in vinyl products, with offsetting softness in bamboo and exotic solid subcategories.

Gross margin for the fourth quarter was 35.7%, and on an adjusted basis, as detailed in the press release, it was 35.1%, which was down 30 basis points from last year's 35.4% gross margin. The decline was driven by over 200 basis points of positive price and mix lift, more than offset by roughly 150 basis points of tariff effect, approximately 50 basis points of higher transportation costs, and 30 basis points of installation mix impact and other smaller elements.

As we think about tariffs going forward, on a fully developed basis, a 10% tariff rate on the roughly 45% of our cost to goods sourced from China would result in approximately 270 basis points of gross margin headwind before any mitigation. The 150 basis point impact I referenced for Q4 reflects a partial effect due to lags as tariff affected purchases roll through inventory. So, as you see in our Q1 guidance, we will see the tariff impacting increase by approximately 100 basis points, but we should also start to see our cost out mitigation rolling through inventory. These two dynamics should nearly offset each other and leave margins roughly flat or perhaps down slightly sequentially from Q4 2018 to Q1 2019. And then we plan for incremental improvement in margins through the rest of the year.

Turning to SG&A expense, for the fourth quarter, this was $151 million compared to $91.5 million in the fourth quarter last year. SG&A in the recent quarter included accruals for the two major settlements Dennis discussed, along with incremental legal costs of $2.3 million, while last year's quarter included incremental legal fees of $3.4 million and disposal costs for the Chinese laminate inventory of $1.7 million. Both periods' items are tabled out in the press release.

When excluding these items from both periods, adjusted SG&A expense for the quarter was $87.6 million, an increase of $1.1 million from a year earlier, driven by $1.2 million in higher occupancy cost related to the opening of 21 stores in 2018, $1 million attributable to the exit of our finishing operations in Toano and $1.6 million across the range of other areas. These were all offset by $2.7 million in lower advertising spend, which reflects our effort to reduce spend in areas we assess as less effective, along with funding we redirected to develop our digital capabilities.

For the quarter, we recorded an operating loss of $55 million compared to an operating profit of $600,000 in Q4 of 2017. The large loss in the period reflects the accruals for the two settlements that together had a $61 million impact and if we exclude those accruals and other unusual items as shown in our press release, we had an adjusted operating profit of $6.7 million in the quarter compared to last year's $5.7 million adjusted operating profit, an increase of 18%. Adjusted operating margin was 2.5% of sales compared to 2.1% last year, a gain of 40 basis points.

I'd like to make a few notes on the full year 2018. Our total sales were up 5.4% versus 2017, and our comp store sales grew 2.6%. Our adjusted gross margin came in at 35.6%, an increase of 10 basis points from 2017 despite approximately 40 basis points of tariff impact. Without that impact, we would have expanded gross margins by 50 basis points.

We also levered adjusted SG&A by 80 basis point. Adjusted operating margin finished at 1.9%, up 90 basis points and without tariffs would have been up 130 basis points year-over-year.

Before moving on to 2019, let me address our liquidity and some forward-looking expectations given the two major settlements announced last week and today. As indicated in last week's announcement of the DOJ and SEC settlements, $33 million will be paid in the next 30 days. On Gold, we will fund $1 million of the $14 million cash portion upon the court's preliminary approval expected in the next few months. The funding of the remaining $13 million depends on the court's final approval. If that is granted in 2019, our funding would consist of two installments, $6 million funded upon final approval as early September, and the remaining $7 million in January of 2020. If the final approval isn't granted until 2020, our funding would happen in a single lump sum at that time.

As of 12/31/2018, we had liquidity of $79 million, consisting of availability under our credit facility of $67 million and cash of $12 million. This was down from the end of Q3 due to our funding of the MDL obligation of $21.5 million in November, an elevated inventory levels related to the outsourcing transition, pre-tariff buying and seasonality.

In the coming weeks, we will fund the full $33 million related to the DOJ and SEC settlements, and by year-end or early 2020, we expect to fund the $14 million cash portion of the Gold settlement. Deducting these from our year-end liquidity position of $79, we would be left with $32 million.

Over the next few quarters, we expect to rebuild liquidity in two primary ways aside from normal operations. First, our inventory at year-end was $318 million and we expect this to be below $300 million by the end of Q2, generating approximately $15 million in net liquidity. Second, we have a commitment letter from our banks subject to customary closing conditions to expand our credit facility. Based on expected inventory levels, we would add incremental borrowing capacity of roughly $35 million.

So to recap our liquidity bridge, we start at year-end $79 million, deduct the full payment amounts for the DOJ and Gold settlements of $47 million, add back inventory reductions of $15 million and the expanded credit facility of $35 million, bringing us to an approximate range of $80 million to $85 million in liquidity before normal operating cash generation.

Also following these settlements, our business will emerge with much less uncertainty and significantly reduce legal and related burdens going forward, leading to improved cash generation.

As an indication of the cash generating ability of the business, we can look at 2017 and 2018. Cash from operations in 2017, while impacted by non-recurring items going in both directions, was positive $39 million on a GAAP basis. In 2018, cash from operations was a use of cash of $43 million, which included a use of cash of $55 million to build inventory net of payables that we do not expect to recur and $22 million for funding the MDL.

If we set just those two items aside, we had positive cash from operations of $33 million in 2018. If we net against that level of operating cash flow our capital spending of $12 million to $15 million per year, we get net cash before financings, without major swings in inventory or payables or major legal payment, of $20 million to $30 million per year. This is meant to highlight the cash flow potential of the business, with these litigation issues behind us.

Now, going back to my earlier break of major liquidity events that left us at $80 million to $85 million before operating cash flow, we believe that level is sustainable and we would expect our liquidity to improve gradually from there.

Turning to 2019 guidance, as you can imagine, this is challenging given the uncertainties we face on the future of tariffs, any adverse customer reactions to the two settlements announced today and last week. That said, from a macro perspective, we anticipate a slowing of the flooring industry and expect low to mid single digit growth. Still a positive environment, but decelerating 1 to 2 points from last year. And we anticipate 10% tariff continuing, no removal and no escalation.

So, in 2019, for our comp store sales growth, we will face the absence of the installation expansion contribution, tougher comparisons against Hurricane Harvey storm benefited markets last year, and the forecasted slower industry growth. Additionally, and hard to factor in, is the risk of consumer weakness due to the media reaction related to these latest settlements. As a result, we expect comps to be down low-single digits in the first quarter and flat-to-up low-single digits for the year.

In terms of adjusted operating margins, for the year, we are targeting flat to 50 basis points of expansion, which on 2018's actual adjusted operating margin of 1.9% would put us in the range of 1.9% to 2.4%. I will note that, in the first quarter, combining the softer sales, residual tariff impacts on gross margin and modest year-over-year SG&A increases, we expect an adjusted operating loss of $3 million to $5 million.

On the investing side, we expect to open 10 to 15 new stores in 2019, depending a bit on the success of our new larger format prototype in Orlando, and capital spending of $15 million to $18 million.

On a personal note, I want to express my appreciation to Dennis, the Lumber Board and all our associates for their partnership with me over these years. I want to assure our shareholders the team is working hard every day to drive shareholder value and strengthen our brand. I've worked closely with Tim over the past two years and have complete confidence in him as the Company's Interim CFO. Ultimately, this was a unique opportunity and a personal decision that was not easy. I wish the Lumber organization all the best going forward.

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

Questions and Answers:

Operator

Thank you. (Operator Instructions) Our first question comes from the line of Simeon Gutman with Morgan Stanley. Please proceed with your question.

Xian Siew -- Morgan Stanley -- Analyst

Hi guys. It's Xian Siew on for Simeon. We just had a question, excluding tariffs, how should we think about underlying gross margin? Installed mix should be less of a headwind, but maybe there is some more transportation costs. I guess should gross margins be up underlying?

Martin D. Agard -- Chief Financial Officer

Yeah. This is Marty. There is a, has been, and we expect to continue a modestly favorable product mix improvement that starts with the vinyl product mix expanding, but we also bring products out that tend to have little bit higher margins, higher price point as we innovate. So that's an underlying trend we'd expect to continue. The tariff and cost out work we've done to mitigate should be generally neutral, and then, transportation that has risen, we are sitting at a pretty stable rate now and we kind of expect that to continue through the year. We don't know quite when that cycle will reverse. We'd hope the next move is to have it reversed back in our favor, but we can't really count on that and our guidance kind of reflects a flat transportation level. So all in all, when you add all that up, the guidance for 2019, I would say, a little bit of improvement, something in that -- a fair amount of that flat to 50 basis point operating margin improvement would come from the gross margin area.

Xian Siew -- Morgan Stanley -- Analyst

Okay. So the majority of the EBIT margin expansion is gross margin related sounds like. So I guess SG&A, maybe it levers a little less because comps kind of slow down, is that the right way to think about it?

Martin D. Agard -- Chief Financial Officer

Yeah. I think the SG&A leverage will be a little muted, if any really, partly we want to put a little bit more money back into advertising as Charles gets that message really honed and we're finding our analytics are getting better in terms of what's really productive. And then the other thing is, we've got a little bit of one-year transitional issues associated with the headquarters move. There is some overlapping rent and some relocation and some retention efforts that we're putting in place so that also dampens the SG&A leverage, so we think of that as probably in line with sales growth.

Xian Siew -- Morgan Stanley -- Analyst

Okay. Thanks, guys.

Dennis R. Knowles -- Chief Executive Officer

Thank you.

Operator

Thank you. Our next question comes from the line of Budd Bugatch with Raymond James. Please proceed with your question.

Budd Bugatch -- Raymond James -- Analyst

Good morning. Marty, good luck to you. And thank you for your help over the last couple of years. I'd like to start on the balance sheet and I appreciate the lead through the liquidity bridge. I'm trying to understand though, as I look at the balance sheet to try to understand what's in the $97 million and how does that get relieved over the next couple of quarters, that's in the accrued securities action. I know we've got a deposit, I guess, offsetting that, but maybe you can help tell us what the detail is, I didn't see it in K?

Martin D. Agard -- Chief Financial Officer

Yeah. So we, at this point, have all three of these major settlements accrued on the balance sheet as a liability. We still have the MDL on the books as a liability, the full $36 million, because the $21.5 million that we funded into the escrow, there are some technical GAAP requirements that that doesn't meet, so the liability stays on the books and the voucher side of the MDL settlement, it's still on the books. So that whole $36 million is in there. The $33 million from the DOJ settlement is in there, and then, all of the Gold is in there as well. So there may be a few other little things in there in addition, but there are all three of those, and their full values are on the books.

And then, I think you understand how they will get relieved. The MDL part has been relieved, and as soon as that appeal is settled, that will meet the GAAP requirements and the deposit will come off the books and the liability will come off the books, while the issue vouchers and as those vouchers are redeemed over a couple of year period that will come off the books. The DOJ will pay cash in 30 days and that'll come off the books. And then on the Gold, over the next -- depending again on that final settlement, the $14 million in cash will be settled, let's say, by early 2020, that'll come off the books. And then those vouchers will get issued and again be redeemed over about a three-year period we expect. And so that's how all those things unwind.

Budd Bugatch -- Raymond James -- Analyst

I got you. So basically we're looking at something like about $30 million of that $97 million is not cash, rest of it's pretty much cash? Is that --

Martin D. Agard -- Chief Financial Officer

That's right.

Budd Bugatch -- Raymond James -- Analyst

Okay. And when I look at the advertising, I think it's down to 6.84% as reported for the year, down I think 60 basis points year-over-year. Historically, Lumber Liquidators has had advertising as high as 11% to 12%, if I remember right going back a number of years. What's the right level of advertising for this business now?

Charles E. Tyson -- Chief Customer Experience Officer

So, this is, Charles. I think there are a couple of things to know. One, as we've changed our mix over the last two quarters, we're learning what a more effective and different types of spend. And our investment into digital, which has been significant in Q4, we were significantly under spent and so we're learning our way through how fast and how far we can improve the productivity of that spend. So today, we've said that we will not reduce our advertising spend below the 2018 level. We may increase during the year as we find more effective and efficient spend. I'm not going to use a percent number, but we've got tests under way that are going to help us inform what are we going to take our spend levels to.

Dennis R. Knowles -- Chief Executive Officer

This is Dennis. I would add a little color to that as well, is that, as Charles has build out his digital team and our digital approach to marketing, we had to make some investments in that team and pull back on advertising. So I don't know that Q4 as a percent of sales would be a good quarter to look at. But I have seen his build out, you've seen -- hopefully, you've had a chance to get down on the site, seen the improvements we've made to the site. We're seeing strong customer response and although it's early, we like what we're seeing in terms of the reaction to the changes we've made on the site.

The next piece for us has really been the understanding where the consumer really reacts to us, whether that be radio, television, print, We still have a fair amount of customers that respond to our direct mail, but direct mail is becoming less of a bigger portion of our marketing spend. It's expensive, it's slow. We can't -- it's put out there, 90 days in advance, we send it to print. So it's not -- it doesn't give us the ability to be very nimble. And so I would tell you that as we see the consumer react to the different spends, whether that be TV, we'll adjust that as needed to drive the appropriate amount of traffic into the stores.

But as I said last call, these last couple of quarters have been kind of a work in progress for us as we migrate from this direct mail to digital. But we're really pleased with the early customer response to our digital changes, but I think it's too early for us to tell what that'll look like on an annualized basis. But we are prepared this year with the significant amount of legal spend that we were consuming on a monthly basis behind us to be able to react as we find the right mix of digital versus direct mail.

Budd Bugatch -- Raymond James -- Analyst

And -- thank you Dennis. And that gets me to -- my last question is, what adjustments are left to come through the income statement? Do we have -- we have I think some Canadian litigation, maybe some employee litigation left, but we also have a -- we have had the elevated legal costs. What's left, what's going to get adjusted out that you can see now in first quarter in 2019?

Dennis R. Knowles -- Chief Executive Officer

It's a great question. I would tell you that this is -- this puts behind us the major product issues that we see. I am afraid that you are right, the Canadian issue is still out there, we don't know -- it's currently inactive and so we don't have a lot to offer as it relates to that. And we have some small litigation here, there are some couple of employment claims, but we are focused on having all this stuff behind us certainly. So, hoping to see our legal spend to return to what most companies would call normal.

Budd Bugatch -- Raymond James -- Analyst

And is that the way the guidance has been impacted? I mean, how do we -- what's in the guidance for the first quarter?

Martin D. Agard -- Chief Financial Officer

So, Budd, the legal expenses to run down these employment matters and frankly, the Gold matter to-date and going forward, have not been adjusted out, that's been left in our normal operations. The only things we've adjusted out has been for the DOJ, SEC and Gold -- not Gold, the MDL from last year. So we have a little bit of -- we got to finish the process. There's still court procedures going on and there is still an appeal on MDL. All of these things, we fully expect to come to fruition as outlined, but over the next couple of quarters, there will still be some of that unusual legal expense that we do adjust out. That's been running, I'd say, $2 million to $4 million a quarter. We hope that tails down in a way, maybe, by this year and then, you'll only be left watching for any big settlement type of thing, which we don't see on the horizon for anything in the foreseeable future, so we don't have any of that in any guidance.

Budd Bugatch -- Raymond James -- Analyst

Well, terrific. Good luck. And I hope that's correct.

Dennis R. Knowles -- Chief Executive Officer

Thank you.

Operator

Thank you. Our next question comes from the line of Seth Basham with Wedbush Securities. Please proceed with your question.

Seth Basham -- Wedbush Securities -- Analyst

Thanks a lot, and good morning. My first question is around insurance. You guys fully accrued for all these legal matters, but do you have any potential insurance to mitigate some of the hit to you guys?

Dennis R. Knowles -- Chief Executive Officer

So, we have been working pretty aggressively with the insurance carriers. I mean there are the opportunities for the carriers to build up defenses in regards to past settlements that they say cash used from exhausted (Technical Difficulty), but at the same as we've indicated, we are going after the opportunity to recover from the carriers and we have nothing that we're putting into financials at this point, but that is certainly something that we are intending to go after.

Seth Basham -- Wedbush Securities -- Analyst

All right. Fair enough. And then, following up on the traffic issue. Can you give us a little bit more color on how you're expecting transactions to trend in 2019, do you expect positive comp transactions, and if so, what's going to be the primary driver to get there?

Dennis R. Knowles -- Chief Executive Officer

Yeah. I will start Seth, and then, if Marty or Charles wants to add any additional color. As we've said, the installation has kind of cannibalized our -- we feel like in the past, we've had probably three primary drivers of our decline, just our own competitive incursions, our own incursions, the competitive environment has definitely cost us a little bit of traffic, but probably more so for us was our pro and our installation. Our pro business, as Marty stated in his prepared remarks, we've recalculated how we thought about pro transactions. And that's given us a better read on what we're actually seeing in terms of traffic.

And then as it relates to the merchandise cannibalization on an installed sale, as we've talked about in the past, one of the things you see is a much higher average ticket for us on an installed sale. And the reason for that is, when we do an install for a customer, we really do a much better job estimating the needed product for the sale and encapsulating in that sale all the things they are going to need, the installation product, the finished product as well as the flooring in addition to labor. And so, as the DIY customer takes on the same project, they may make three trips to the store: once for the floor, once for the installation and finally, for the finished product. And so as we move more of this business to installation, we've kind of seen that impact on our overall number of transactions.

So when you think about cycling installation, that should become less of a headwind for us, as well as the way we're starting to calculate. So -- and then, our efforts in our marketing are to drive more traffic and we'll have a headwind somewhat as we refine our digital space, particularly as our website -- we convert more customers online, we'll see less traffic in our stores, but we hope to see that to be accretive to the transaction. So I would say that, we are planning to see this continue to improve as we move through 2019.

Seth Basham -- Wedbush Securities -- Analyst

Very good. Thanks a lot. And good luck Marty. It's been nice working with you.

Martin D. Agard -- Chief Financial Officer

Yeah. I appreciate that.

Operator

Thank you. Our next question comes from the line of Keith Hughes with SunTrust Robinson Humphrey. Please proceed with your question.

Keith Hughes -- SunTrust Robinson Humphrey -- Analyst

Thank you. In the K on the product sales, you're lumping all your non-hardwood, let me call it, manufactured products. I assume vinyl is the fastest growth of those. Can you just talk about Lumber Liquidators, how does that sale look to you, is it a lower ticket sale than what you would see for hardwood, how is the margin compared to hardwood? Because the shift is pretty dramatic as you outlined in the K.

Charles E. Tyson -- Chief Customer Experience Officer

Yes. So as we've said, and I think Marty has said on number of calls, vinyl is always accretive to our overall margin performance. And as you've reflected and I said in my comments, vinyl continues to be an accelerator from a category perspective, but there has been ASP improvement in the vinyl category itself as technology improves and technical spend continues to improve. So we're excited about that growth in the vinyl business. And as I said on the call, we are beginning to do some interesting regional advertising to enhance our penetration on our wood program. And so, while the customer has absolutely gravitated from an industry perspective to vinyl, we see very solid customer interest in our solid programs, our exotic program, the domestic programs and we will continue to do investment.

Keith Hughes -- SunTrust Robinson Humphrey -- Analyst

Is the attach rate on that product on install, is that any different than what you see in your other products, higher or lower?

Charles E. Tyson -- Chief Customer Experience Officer

I think for the industry, we see good attach in our hardwood business. And that's an important focus for all of our teams. In the install business there is attach in vinyl and we're continuing to focus on training our teams to make sure that we're as equally focused on driving the attach through our vinyl installation as we are on the hardwood business.

Keith Hughes -- SunTrust Robinson Humphrey -- Analyst

Okay. Thank you.

Martin D. Agard -- Chief Financial Officer

Yeah. And Keith, it's Marty. Just a little bit on the economic profile. I mean the average pricing of our vinyl is approaching the line average at this point. We keep bringing out wider, thicker, more rigid vinyl products with pad and things. It's a great product. And with that the average price keeps climbing and it's pretty close to our average at this point. It is lower than a solid wood floor, or an exotic solid wood floor, but it's certainly a fine price level. And then, from a margin standpoint, this is a leader for us margin wise. And that is part of that underlying product mix, the tailwind that I've mentioned a few times. Okay.

Keith Hughes -- SunTrust Robinson Humphrey -- Analyst

Okay. Thank you.

Operator

Thank you. Our next question comes from the line of Laura Champine with Loop Capital Markets. Please proceed with your question.

Laura Champine -- Loop Capital Markets -- Analyst

Good morning. Thanks for taking my question. I would like to dig in a little further into your full-year same-store sales expectation for flat-to-low single-digit growth, because that would imply an acceleration from the trend you're seeing right now and the industry slowdown you call out in Q4. It also contrasts a little bit to the expectation for 1 to 2 points of macro related deceleration. Would it improve for any reason other than just easier comparisons as we move toward the end of the year? What's driving that improvement, the expectation for improvement in comp?

Martin D. Agard -- Chief Financial Officer

Yeah. I'll start with a little bit and there's a couple of things going on in the first quarter that have maybe a tougher compare that we expect to improved from. The first is, this is really the peak of the storm benefit a year ago following mostly Harvey, but to a lesser degree Irma storms, as well. So our Houston market and some of our Florida markets really were benefiting in the first quarter of last year at the peak and we've already seen that wane a little bit, that compare challenge wane a little bit as we've gone through months and if we compare the first quarter to the fourth quarter and so forth. So that should actually fade away as we get into the back half of the year and so that's a part of the acceleration, if you will, quarter-by-quarter as we go through 2019.

The other thing we're seeing a little bit of this is our own cannibalization. We opened 21 stores last year, which is the most in a while and some of those stores are in existing markets and they will take some share from existing stores. The existing stores are in our comp population and so they end up facing a little bit of a comparison issue on those existing stores. We include that in our economics. We are comfortable opening those stores where there is some cannibalization, but it does have this effect on the comps. And then, Charles' program is really come to the light. The digital capabilities, we're seeing good results there. We expect that to improve as the year goes on. The marketing message with the new ad agency, all that is really hitting its stride as we think of the back half for the year. So there is a couple of different things we think will create that acceleration and go from the slightly low negative single-digits in the first quarter to the positive low single-digits on the year.

Dennis R. Knowles -- Chief Executive Officer

Laura, I want to highlight a couple of things, as well. As Marty said, on the digital front, we've really started in full force with our new agencies in March, toward our first campaigns around the very first part of March. So we're really excited about what we've seen just initially. It's early on, but we've also hired a new creative agency. We haven't really done any creative to speak of in several years around both branding, as well as the business. So think about the things that we've changed in the business since last time we did any kind of creative media, we now offer installation. While we've tagged line that in our ads, we've really built no messaging deep into our online ads or even our television ads.

And then, as we've talked about over the last couple of years, building this -- one of the points that we think is the differentiator for Lumber Liquidators is this high touch consultative sale and we really are looking forward to really highlighting that, as well as out ability to be competitive from a price perspective. So all those things for us are -- we feel are right in front of us and are excited about the early read on what we've seen. So I would just add -- that is a little more color to Marty's comments on the digital front.

Laura Champine -- Loop Capital Markets -- Analyst

Got it. Thank you.

Operator

(Operator Instructions) Our next question comes from the line of David MacGregor with Longbow Research. Please proceed with your question.

Rob Aurand -- Longbow Research -- Analyst

Rob Aurand on for David this morning. I really wanted to ask about LVT, you talked about positive ASP trends, but I'm curious looking at the import data, there clearly was a glut of imports at the end of the year ahead of the possible January tariff inflection. And I'm just curious to what extent that poses risks to discounting if there is a glut of inventory in the channel?

Charles E. Tyson -- Chief Customer Experience Officer

Yeah. I'd say, well, we've made -- you talk about LVT, we've made major investments in EDP and now the SPC (ph). Marty talked about ASPs going up and the customers responding well to that. I feel very comfortable of where our inventory is sitting today, on weeks of supply on LVT and don't see any necessity to take future discounts. We don't see any irrational behavior in the marketplace today as it relates to pricing. Now, of course, as you mentioned, that could change and we'll react accordingly. But I feel really good about where our inventory teams have positioned us going into our spring selling season.

Rob Aurand -- Longbow Research -- Analyst

All right. Thank you. And I guess just guidance, particularly 1Q, the negative comps you're projecting. How much of that is weather just given the polar vortex, you have rain on the West Coast, how much is that, what's impacting the negative comps?

Dennis R. Knowles -- Chief Executive Officer

Undoubtedly, it's had an impact on us. We've had few store closures, but we don't feel it's been significant enough to really call out. Weather is not something we like to talk about. We feel like we had equal amount last year. So it's -- and we see, what the weather takes away, it gives you back and we're seeing that now here in the early part of March. So I feel like it's really not had a material impact on our quarter so far.

Rob Aurand -- Longbow Research -- Analyst

All right. Thank you very much.

Dennis R. Knowles -- Chief Executive Officer

Thank you.

Operator

Thank you. Our next question comes from the line of Peter Keith with Piper Jaffray. Please proceed with your question.

Peter Keith -- Piper Jaffray -- Analyst

Hey. Good morning everyone. I wanted to just dig a bit into the global sourcing. So you stated last quarter that you had 45% of your sales were coming out of China. Sounds like you may have gotten some concessions out of those suppliers, but maybe a two-part question. How should we think about that China mix going forward, do you have maybe a new lower goal of where you'd like that be?

And then, secondarily, I know you've guided longer term gross margins to be kind of in the higher 30s. Obviously, that was pre-tariffs, so maybe that's off, but could you give us some updated view on where do you think the longer-term margins settle out?

Dennis R. Knowles -- Chief Executive Officer

Yeah. I'll start to take the sourcing. I Think Marty will chip in on the broader margin question. Look, we are evaluating not just Southeast Asia capabilities, but other geographies as well, where we see benefits to source from. As you said, we have -- the teams have done a nice job in helping mitigate our current costs coming out of China. And we are looking at other country sourcing that would potentially lower what we do out of China. I think all of us are looking at what happens with tariffs overall with keen interest, and that in itself from a macro perspective, I think, will have an impact from an industry point of view of what happens in China and to some degree, what the China manufacturers themselves do.

As you've seen in other industries, industries have moved out of China and gone to other countries of sourcing. We will be there if they are competitive and can source at the quality levels and compliance levels that we expect. So we are actively looking at other places in the world to source from today and making determinations over the next few months based on some of the longer-term tariff inputs that we see. I think Marty, you want to talk about margin.

Martin D. Agard -- Chief Financial Officer

Yeah. In terms of the longer-term margin guidance, the upper 30s that we've been guiding to, as we think about running around 36%, we are a little below that in '18. We hope to be a little above in '19. As you think about that, with 250 basis points of tariffs in there, now granted, we are trying to mitigate that and generally have, if we could just have that back, we'd be it in the -- definitely be in the upper 30s. Now, we got to work from here to drive hopefully some transportation improvements. We're not done working with our vendors. We are not done realizing the benefits of mix and innovative products that have wider margins. So we are still committed to that plan. It is going to be a little bit of a setback in terms of how quickly we can get there, and as the tariffs go away, then I think we get some definite lift.

Dennis R. Knowles -- Chief Executive Officer

I would also add that, as we've pointed out, we've brought in a new head of source and have got a new head of merchandising. And now, managing our cost becomes part of the daily business as opposed to initiative driven. So the tariffs gave us the opportunity to jump in in a meaningful way and kick that off, but this is something that we keep in front of us now every day as opposed to be initiative driven. So we're excited to have the legacy issues behind us, that allow us to focus on growing and running the business day to day.

Peter Keith -- Piper Jaffray -- Analyst

Okay. Thank you. And maybe a separate follow-up for you Dennis. As you're pivoting the model more toward the high touch consultation sale, some of the history of Lumber Liquidators is to position stores in, we'll call it, maybe key locations, outside metropolitan areas and really as a more of a destination based on low price. So ultimately what I'm getting at with the question is, do we need to think about a relocation strategy with some of those older stores that maybe have good economics, but just aren't seeing the type of traffic that you think is beneficial long term?

Dennis R. Knowles -- Chief Executive Officer

We do. Oddly enough, some of our older, what I would call more in convenient locations, have solid traffic mainly because they've been around for a long period of time. So the way we think about it is, more -- well there is twofold. Chris, our Head of Real Estate Group brings to us every month in our real estate committee both existing locations that are up for renewal, as well as the new locations. And we look at our existing locations, always as an opportunity to upgrade to a more what we would call an A to B location, because we realize that convenience is more and more a play in the consumers' mindset. So we realize that being off-the-beaten-path is not always -- it's not just the consumer, the pro customer seeks a more convenient location as well. And so we are always looking to upgrade our sites to a more convenient location when it makes sense. And if they can pass our hurdle rates, then we have shown that we will relocate these sites when it makes sense to us. And again, we're not putting any new sites in any of those locations.

Peter Keith -- Piper Jaffray -- Analyst

Okay. Very helpful. Thanks a lot. And Marty, it's been great working with you.

Martin D. Agard -- Chief Financial Officer

Yeah. I appreciate.

Operator

Thank you, ladies and gentlemen, our final question this morning will come from the line of Budd Bugatch with Raymond James. Please proceed with your question.

Budd Bugatch -- Raymond James -- Analyst

Yeah. Just a quick follow-up. You have disclosed the merchandise sales, and the cost of merchandise sales and services for the last couple of quarters. I don't know that I've been able to find the quarterly breakout for the first quarter and second quarter, is that been posted somewhere? Is that available or will you post it?

Martin D. Agard -- Chief Financial Officer

It wasn't required at the time of GAAP, and I think you are probably only missing the first quarter of last year. So let me chat with Tim, see if we want to post -- we'll kind of fill out the picture for you. It hasn't been required. That's a presentation that we triggered I think the third quarter of last year. So we can go back and consider filling in the background.

Budd Bugatch -- Raymond James -- Analyst

I couldn't find second quarter either. So that's why I'm missing. If I could find one of the two, we could get that and just fill it in.

Martin D. Agard -- Chief Financial Officer

Yeah. There you go. All right. We will give that some thought.

Budd Bugatch -- Raymond James -- Analyst

All right. Thanks, Marty.

Operator

Thank you.

Dennis R. Knowles -- Chief Executive Officer

All right. 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 on our progress next quarter.

Operator

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

Duration: 64 minutes

Call participants:

Danielle O'Brien -- Investor Relations

Dennis R. Knowles -- Chief Executive Officer

Charles E. Tyson -- Chief Customer Experience Officer

Martin D. Agard -- Chief Financial Officer

Xian Siew -- Morgan Stanley -- Analyst

Budd Bugatch -- Raymond James -- Analyst

Seth Basham -- Wedbush Securities -- Analyst

Keith Hughes -- SunTrust Robinson Humphrey -- Analyst

Laura Champine -- Loop Capital Markets -- Analyst

Rob Aurand -- Longbow Research -- Analyst

Peter Keith -- Piper Jaffray -- Analyst

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