Toano, Va. -- Lumber Liquidators announced financial results for the third quarter and nine months ended September 30, 2019.
"We had a challenging quarter that included soft demand in July as well as a network security incident in August, but despite these headwinds, we made solid progress during the quarter implementing our strategic initiatives, including actions to mitigate the impact of tariffs," said Dennis Knowles, CEO. "We continue to work hard to evolve our business to better serve customers and build on our unique value proposition. During the quarter, we continued to leverage enhanced visual selling tools that we believe resonate with consumers as we guide them along their flooring project journey. This has been supported by a robust marketing strategy, including the launch of a new advertising campaign in mid-September 2019 that highlights our differentiated service and quality products while also emphasizing the great value we offer consumers."
"Looking ahead, we are lowering our full-year 2019 sales and operating margin guidance to reflect our weaker-than-expected third quarter results that included the impact of the network security incident," Knowles continued. "Encouragingly, we had positive comparable store sales in October as we completed a successful October Yard Sale, our premier fourth-quarter promotion, and we see a generally more supportive macro environment as housing turnover strengthens, home equity levels continue to rise, mortgage rates tick lower and employment remains strong, nevertheless we feel it is prudent to lower our annual guidance at this time. We remain focused on executing our transformation plan to better position us to serve both retail and professional flooring consumers and create long-term value for our shareholders."
Net sales for the third quarter of 2019 decreased $6.5 million, or 2.4%, to $264 million compared to the third quarter of 2018. Net sales in comparable stores decreased 3.6% compared to the third quarter of 2018, driven by soft sales at the beginning of the quarter and compounded by a network security incident in late August. However, comparable store sales showed significant improvement in the month of September, driven by growth in transaction count and higher average ticket. The company opened four new stores and relocated one store in the third quarter of 2019.
Gross profit decreased 5% in the third quarter of 2019 to $96 million as compared to $101 million in the comparable period in 2018. Gross margin decreased to 36.2% in the third quarter of 2019 from 37.2% in the third quarter of 2018. Both years were impacted by anti-dumping rate changes but in opposite directions. Excluding these items, adjusted gross profit (a non-GAAP measure) decreased by $1.4 million and adjusted gross margin (a non-GAAP measure) improved to 36.5% from 36.2% in the third quarter of 2018. The margin increase was driven by a larger mix of higher margin manufactured products, reduced discounting in the stores, merchandising cost-out efforts, including shifting production to lower-cost countries of supply, and retail price increases related to tariff mitigation. The improvement in adjusted gross margin was achieved despite higher tariff-related costs and with an increased mix of lower margin installation sales.
Selling, general and administrative (SG&A) expenses decreased 0.5% in the third quarter of 2019 to $93 million from $94 million in the comparable period in 2018 but included certain costs in both years related to investigations and lawsuits and a $1.8 million impairment of certain assets related to the company's decision to exit the hardwood flooring finishing business in the third quarter of 2018. Excluding these items, adjusted SG&A (a non-GAAP measure) increased $3.9 million primarily as a result of costs related to ten new stores compared to the third quarter a year ago, higher year-over-year incentive and equity accruals driven by a reduction in last year's third quarter to align with lower performance expectations, severance, and costs related to the corporate headquarters relocation occurring in this year's fourth quarter.
Operating income was $2.2 million and $6.7 million for the three months ended September 30, 2019 and 2018, respectively. Excluding the gross profit and SG&A items discussed above, adjusted operating income (a non-GAAP measure) was $3.4 million for the third quarter of 2019, down from $8.6 million for the third quarter of 2018. The most significant drivers of the decrease were higher adjusted SG&A in this year's third quarter in addition to the impact of the network security incident in August 2019 and soft sales in July 2019.
Net income for the three months ended September 30, 2019 was $1 million, or $0.04 per diluted share, compared to net income of $5.9 million, or $0.21 per diluted share, for the three months ended September 30, 2018. Adjusted net income and adjusted EPS (non-GAAP measures) for the three months ended September 30, 2019 were $2.2 million and $0.08 per diluted share, compared to $7.9 million and $0.27 per diluted share, for the three months ended September 30, 2018.
As of September 30, 2019, the company had $64.5 million outstanding under its revolver and $25 million outstanding under its FILO Term Loan, which collectively, is unchanged from the end of the second quarter. Considering these borrowings, at September 30, 2019, the company had $114 million in liquidity, comprised of $6 million of cash and cash equivalents and availability under the Credit Agreement of $108 million.
In August 2019, the company experienced a network security incident caused by malware that encrypted certain information technology systems and impacted the ability to electronically process transactions. Stores remained open during the event and executed the company's business continuity plan, which included utilization of manual processes to transact sales and serve customers. While it is challenging to know the precise impact, the company estimates the disruption caused by the event negatively impacted total revenue in the range of approximately $6 - 8 million. Since SG&A, net of insurance proceeds, was not materially impacted by the event, the company estimates the revenue impact flowed-through to operating income at approximately the company's gross margin rate. The company maintains cybersecurity and other insurance coverage and has been working collaboratively with its insurers throughout the incident and recovery process. Certain direct expenses related to the incident have been reimbursed and a receivable has been recorded in association with other reimbursable expenses. In addition, the company is pursuing a recovery of lost profit under the business interruption portion of its policies, although recovery is not guaranteed.
Commenting on the network security incident, Knowles stated "I was extremely appreciative of employees' cross functional effort to lessen the impact of the network event, and I would like to thank everyone for their tremendous efforts. I would also like to thank our customers for their patience and understanding as our teams worked diligently to effectively serve them during the event. Importantly, based on the results of the forensic IT analysis, there has been no evidence that any confidential customer, employee or company data was compromised or extracted."
The company's current 2019 full-year outlook assumes the continuation of the current 25% tariff applicable to products imported from China for the balance of 2019. The company expects the total revenue growth percentage to remain flat to slightly positive, revised from a growth in the low single digits. Company store sales has been revised to -2.0% to flat from approximately flat. Adjusted operating margin (a non-GAAP measure) outlook has been revised from 1.4% - 1.9% to 1.0 % 1.4%. New store openings has been adjusted to approximately 11 new openings as opposed to 10 - 15 new store openings, and capital spending has been adjusted to $15 - $17 million vs. the previous $15 - 18 million.
For more information, visit www.lumberliquidators.com.