Lumber Liquidators Holdings Inc. (NYSE:LL) reported first-quarter financial and operating results on May 1, and the market's reaction was swift and severe, sending shares down almost 18% by market close. That's the second post-earnings tumble for Lumber Liquidators' stock this year, following the nearly 10% decline back in late February following its 2017 full-year report. Add it up, and investors have seen the company's stock lose 36% of its value in 2018. 

And while its fourth-quarter results probably weren't as bad as the market's reaction would indicate, its just-reported first quarter wasn't as strong, especially with regard to customer traffic and sales growth for flooring itself. That's not to say it was all bad, but there are some things investors should pay close attention to in the company's release. Let's look at what went well, and what Lumber Liquidators' management needs to improve. 

Woman does yoga pose on hardwood flooring.

Lumber Liquidators is working to find the balance between DIY and "do it for me" customers. Image source: Getty Images.

Sales and margins increased, but customer traffic went backwards

The company reported that sales were up 5.4% in the first quarter to $261.8 million, with comps (sales at stores open more than 12 months) increasing 2.9%, and a gross margin of 36.3%, up from 34.9% year over year. After a relatively light year for new store openings in 2017, the company generated only $6.1 million in sales from stores not included in the comp base, so its 5.4% sales growth was well within expectations, and 2.9% comps growth was reasonable, if not as high as some would have liked to see. 

But when we cut into what generated sales growth, there is some reason to be concerned. Comps increased 2.9%, but the average sale increased 4.7%, while the company invoiced 1.8% fewer customers in the quarter. Merchandise sales did increase by 0.2% in the quarter, with an increase in services making up the vast majority of comps growth. 

The takeaway? Lumber Liquidators' efforts to increase installation sales and do more business with pro customers seem to be paying off, at least based on the increased installation sales and higher ticket prices for flooring that the company generated in the quarter. But a 1.8% decline in customer traffic should not be ignored. 

On the earnings call, CFO Marty Agard addressed this, saying that it was "particular softness in our North division, where comps were down mid-single-digits" versus mid-single-digit comps growth in the company's other divisions. The company's store base is heavily weighted to the northeastern U.S., so weak performance in this market is having an outsize impact on the company's results. Agard went on to say that management expects its comp result will improve as warmer weather emerges in the northeast. 

Operating results and balance sheet

Lumber Liquidators reported a net loss of $2 million, and an operating loss of $1.4 million in the first quarter, both of which were better than last year's first-quarter $26.4 million net loss and operating loss of $25.4 million. It's worth noting that last year's first quarter included a one-time charge related to resolving one of its biggest issues at the time: litigation related to Chinese-made laminate flooring. But even when adjusting for last year's expenses, this year's first quarter was a solid improvement both operationally and profit-wise. 

Operating expenses -- primarily sales, general, and administrative (SG&A) -- when adjusted for last year's one-time $18 million charge, increased $1.3 million year over year, primarily due to expenses related to new stores opened over the past year. As a portion of sales, SG&A (both GAAP and adjusted) declined in the quarter. 

The company ended the quarter with a higher amount of leverage on its balance sheet. Working capital increased by about $4 million primarily due to a $11 million increase in inventory, but cash declined by $7 million and total debt increased by $11 million. If the company is able to convert that increased inventory into more high-margin sales, it should help offset the cash decline and eventually lead to paying down debt. 

While it's not concerning at this stage since the company has about $129 million in combined liquidity between cash and available credit, investors should continue to monitor the company's balance sheet, especially if it weakens further in coming quarters. 

Looking ahead: Management remains optimistic

Even with the weak traffic result in its biggest market, Lumber Liquidators' management held firm on its full-year expectations. This includes mid- to upper-single-digit sales growth, mid-single-digit comps growth, and an adjusted operating profit in the 2% to 3% range. The company also expects to open 20 to 25 new stores this year, and has already opened nine through May 1. 

Needless to say, Lumber Liquidators is going to have to improve on its first quarter to reach those full-year goals. But based on the strength in its stores outside the northeast, if improved weather and better marketing can spark a recovery in that region, it would go a long way toward meeting the full-year targets. 

Jason Hall owns shares of Lumber Liquidators. The Motley Fool recommends Lumber Liquidators. The Motley Fool has a disclosure policy.