LL Flooring Holdings Inc (LL) 2010 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Lumber Liquidators second quarter 2010 earnings conference call. With us today is Mr. Jeff Griffiths, CEO of Lumber Liquidators; and Mr. Dan Terrell, CFO of Lumber Liquidators. As a reminder, ladies and gentlemen, this conference is being recorded. It may not be reproduced in whole or in part without permission from the Company.

I would now like to introduce Ms. Leigh Parrish of Financial Dynamics. Please go ahead.

Thank you. Good morning, everyone, and thank you for joining us today. Before we begin, let me take a moment to 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 financial performance of Lumber Liquidators. Although Lumber Liquidators believes that they expectations reflected as 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 the call today is accurate only as of the date discussed. Investors should not assume that the statements won't remain operative at a later time.

Lastly, Lumber Liquidators undertakes no obligation to update any information discussed in this call.

And now I'm pleased to turn the call over to Jeff Griffiths. Jeff?

Good morning, everyone. Thank you for joining us for our earnings call today. With me on the call is Dan Terrell, our CFO.

I'd like to begin today with a review of our second-quarter performance. Dan will then review our financial results for the quarter and discuss our outlook for the remainder of the year. I'll then return to update you on our current areas of focus before we open the call to questions.

We are very pleased with our performance at the midpoint of the year. We maintained our momentum through the second quarter, achieving the highest quarterly sales and net income in the Company's history. Further, we successfully leveraged our flexible and differentiated business model to generate continued expansion of our operating margin.

Consumers have continued to respond to respond to our value proposition, and across our organization, our team successfully executed against our long-term strategy.

Briefly touching on several highlights from the second quarter, we achieved a total net sales increase of 17.9%, a comparable store sales net increase of 5.5%, an increase of 7% in the number of customers invoiced at comparable stores, six new stores opened during the quarter and net income growth of 31%.

Our annual sale in April was a strong driver of our second quarter results. Our unique value proposition of price, selection, quality and availability continued to resonate strongly with consumers and drive increased traffic. We enhanced our value proposition and targeted promotional pricing of certain hardwoods and a broadened assortment of entry-level price points during our annual sale in April. As a result, we drew a very strong customer response with net sales up significantly over the record we set at (inaudible) last year.

Additionally, we experienced a strong increase in foot traffic, which contributed to our 5.5% increase in comparable store net sales. We believe this performance demonstrates the effectiveness of our marketing message, with consumers seeking quality and value.

As I just noted, we estimate the number of customers invoiced at comparable stores to have increased 7% in the second quarter of 2010, compared to the same period last year. New store openings also continued to contribute to our overall sales increase in the second quarter. We opened six new stores during the quarter and have opened another four stores to date in the third quarter.

We now have 2,007 locations-- I'm sorry-- 207 locations in 46 states and remain on track to achieve our expansion goals for the year, including our plans to enter Canada in the fourth quarter.

Expanding our footprint remains an important component of our long-term strategy to grow our sales and market share. As most of you know, our low-cost flexible store model enables us to quickly generate a strong return on capital when opening locations, whether in new or existing markets.

In line with trends we discussed on our last earnings call, there were several factors affecting our gross margin in the second quarter. First, our gross margin continues to benefit from sales of higher-margin products within our value-priced product lines as well as sales of moldings and accessories. And we saw this trend continue overall in the second quarter.

Offsetting this, the special promotional pricing we offered during our April sale, particularly discounts on selected hardwood products, generated sales of products carrying a lower margin. In addition, we continued to experience increased transportation costs as a result of the handling of higher inventory levels, transporting more units and higher fuel costs while our China supply chain initiative did not reach our product flow expectations until late in the quarter.

We continued to leverage advertising expense in the second quarter as we invest in our most effective channels, including direct sales generation programs, internet search and television.

We are confident that our marketing is resonating with the quality and value-seeking consumer. We expect advertising spend in the back half of the year to remain at the same level that we originally anticipated. And we should continue to see leverage in our advertising dollars as a percent of net sales.

Our record top and bottom-line results in the second quarter, as well as our ability to continue to deliver significant operating margin expansion demonstrate that our store model and value proposition continue to be adaptable and resilient across various locations and market conditions.

With the current strategic initiatives underway in 2010, we are well positioned to continue to enhance our value proposition, grow our store base, gain market share and drive top- and bottom-line growth.

I'd now like to turn the call over to Dan for a detailed review of our financial results and outlook, and then I'll return with closing remarks on our areas of focus for the back half of the year.

Thank you, Jeff, and good morning, everyone. As Jeff mentioned, I'm going to provide some additional details on our results for the second quarter and then discuss our outlook for the remainder of 2010. I'll start with our results for the second quarter.

Net sales for the three months ended June 30, 2010, grew to $168.7 million, an increase of $25.6 million or 17.9% over the second quarter of 2009. At comparable stores, net sales increased $7.9 million or 5.5%. And at non-comparable stores, net sales increased $17.7 million.

Overall, demand for our value proposition has continued to increase the number of customers invoiced at comparable stores, with an increase of 7% in the second quarter of 2010, on top of an increase of 13.6% in the second quarter of 2009.

This increase in customers invoiced was partially offset by a slight decline in our average sale as consumer demand has continued to shift our mix of products sold to certain product lines which generally have a lower average retail price point. We believe, however, that we have continued to grow our market share in these product lines.

We also believe we were able to drive incremental customer traffic through promotional pricing of selected products within our Bellawood enhanced-grade lines, as well as through a broadened assortment of hardwoods at the entry-level price point. These efforts were reflected in the overall success of our chain-wide sale in April, where demand was up substantially from the previous year.

Our average sale in the second quarter of 2010 was approximately $1,530. While down from 1.4% from the second quarter of 2009, it represented a 6.3% increase from our average sale of approximately $1,440 in the first quarter of 2010 in a reversal of the sequential quarterly decreases in our average sale that began in the second quarter of 2008.

In comparison to 2009, our average retail price per unit sold decreased approximately 3%, and our average volume per sale increased slightly.

At comparable stores, our net sales increase of 5.5% for the second quarter of 2010 compares to a decrease of 1.8% in the second quarter of 2009. We believe net sales continued to benefit from more consistent in-stock positions of certain key product lines, including moldings and accessories, which are featured in our never-out-of-stock program and was launched in the second half of 2009.

Our increase in non-comparable store net sales was a result of our continued store-base growth. We opened six new locations in the second quarter of 2010 and a total of 35 new locations since June 30, 2009. Of the six new locations opened in the second quarter of 2010, four were in new markets, and two were in existing markets.

Overall, we continue to be pleased with the performance of our new stores. Gross profit increased 15.7% to $58.5 million. Gross margin was 34.7%, down 50 basis points in comparison to the second quarter of 2009, primarily due to our sales mix, promotional pricing and increased product costs, including transportation.

Within our sales mix, a combination of offsetting factors resulted in a neutral impact on gross margin. Sales mix gains in certain premium products, including laminates, bamboo and engineered hardwoods benefited gross margins, as did gains in moldings and accessories. These benefits were offset by successful efforts to increase demand from Bellawood and certain hand-scraped products through promotional pricing in demand for our broadened assortment of hardwood products at the entry-level retail price point.

In comparison to the second quarter of 2009, we believe the promotional pricing offered during our April sale adversely impacted gross margin for the quarter by 20 to 25 basis points.

Product costs increased primarily due to transportation and finishing costs, adversely impacting gross margin by approximately 60 basis points compared to 2009. While the inbound transportation costs capitalized into the cost of units sold in the second quarter of 2010 were generally lower than comparable costs in the prior year, international container rates rose rapidly during the second quarter.

In addition, transportation costs to move our product domestically from the warehouse to the store and then to the final customer were greater than in the prior year as we drove more miles, delivering a greater number of units and per-mile costs increased primarily due to higher fuel costs.

Finally, 2010 per-unit finishing costs were generally higher than those in 2009, as we continue to expand and regionalize our assortment of Bellawood products, including greater demand for products, which are less efficient to finish.

While our shipments through our China consolidation center continue to increase sequentially from its launch in the second half of 2009, we were not able to reach a scale in the second quarter of 2010 where net benefits were commensurate with our transportation cost increases.

During the second quarter, however, we continued to strengthen our commitment to product allocation and logistics. And we believe these investments will result in significant increases in shipments, both through the consolidation center and direct from vendors to stores, offsetting increased transportation costs.

Selling, general and administrative expenses were $43.9 million or 26% of net sales for the second quarter of 2010, compared to $39.2 million or 27.4% of net sales for the second quarter of 2009. This improvement in SG&A expenses as a percentage of net sales was primarily a result of 135 basis point reduction in advertising and a slight reduction in legal, professional and certain other expenses, partially offset by an increase in labor costs.

Our advertising spend in the second quarter of 2010 was only half a percent greater than our spend in the second quarter of 2009. Within that slight increase, however, we significantly strengthened our commitment to the most effective channels and emphasize programs which highlight our value proposition.

Our labor costs increased due a combination of our store-based growth, greater unit flow through distribution and strengthened store support infrastructure.

The SG&A leverage more than offset the decrease in gross margin, resulting in operating margin expansion of 80 basis points in comparing the second quarter of 2010 to 2009, and followed an 80 basis point expansion in the first quarter of 2010.

Other income, which includes interest, was $135,000 for the second quarter of 2010, compared to $150,000 for the second quarter of 2009.

The effective tax rate was 38.6% in the second quarter of 2010, compared to 39.6% in the second quarter of 2009. The 2010 effective tax rate decreased primarily due to lower state income taxes.

Net income for the second quarter of 2010 increased 31% to $9.1 million or $0.32 per diluted share based on approximately 28.3 million weighted average diluted shares outstanding. Net income for the second quarter of 2009 was $6.9 million or $0.25 per diluted share based on approximately 27.5 million weighted average diluted shares outstanding.

Turning now to our balance sheet and cash flow, we ended the second quarter of 2010 with $42.2 million in total cash and cash equivalent, which compares to $35.7 million at December 31, 2009, and $43.3 million at June 30, 2009.

Our operating activities provided net cash of $12.6 million for the six months ended June 30, 2010, and $10.6 million for the six months ended June 30, 2009.

The total inventory balance at June 30, 2010 was $143.1 million and included $118.6 million for available-for-sale inventory, and $24.5 million in transit, primarily from international vendors. Inventory increased $9.8 million from December 31, 2009, primarily available-for-sale product and increased $36.4 million from June 30, 2009, with available-for-sale product of $23.8 million and in-transit inventory of $12.6 million.

Our available inventory for store was $584,000 at June 30, 2010, $588,000 at December 31, 2009, and $565,000 at June 30, 2009. This increase relative to June 30, 2009, is primarily due to our commitment to the top-selling products in our never-out-of-stock program.

Overall, we sold through our earlier seasonal build and then increased our safety stock prior to the implementation of our integrated business solution, impacting both in-transit inventory and available inventory. We expect to maintain generally higher in-store inventory levels in the second half of 2010, compared to 2009, but we expect available inventory per store to decline relative to June 30, 2010 at the close of both the third and fourth quarters of 2010.

Working capital was $137.7 million at June 30, 2010, compared to $107.5 million at June 30, 2009, with the current ratio at 3.3 times and 3.1 times respectively.

Capital expenditures totaled approximately $4.8 million for the second quarter of 2010, compared to $1.8 million for the second quarter of 2009. The second quarter of 2010 capital expenditures included $2.9 million related to our integrated information technology solution, and each period included fixtures, equipment, leasehold improvements for new stores, routine purchases of computer hardware and software, and leasehold improvements at the corporate headquarters.

Turning now to our outlook for 2010, we have generally maintained our guidance. We continue to expect net sales for the full year in the range of $630 million to $650 million, but now expect net sales at comparable stores to increase in the mid single digits.

We continue to expect new-store openings of 30, 36 to 40 locations for the full year, or 19 to 23 locations in the second half in an approximate equal mix of new and existing markets. We expect our first stores in Canada will open in the fourth quarter.

We expect 2010 earnings per diluted share in the range of $1.13 to $1.23. Our expected range is based on a diluted share count of approximately 28.4 million shares and an effective tax rate in the range of 38.5% to 38.8%. This range includes a loss of approximately $0.02 per diluted share related to our planned expansion into Canada, as previously disclosed.

Finally, we expect to be free cash flow positive in 2010 and remain free of long-term debt.

I'll now turn the call back over to Jeff for his closing remarks.

Thanks, Dan. As we look to the back half of 2010, we anticipate seeing gradual improvement in the macroeconomic trends which impact the wood flooring market. We remain pleased with the increased demand that we continue to see from customers, which is driving strong traffic and sales trends.

At the same time, we remain focused on further improving our operations and building a foundation for long-term success. As we discussed last quarter, we are continue to make progress with our never-out-of-stock inventory program. Our never-out-of-stock strategy has already positively impacted our business. And as we move forward, we see opportunities to refine this strategy to further enhance our performance.

Taking lessons we learn from the significant spring selling season, we recently added an additional management level in the field and implemented additional in-store training to help us better execute against this initiative.

Overall, as we've made this inventory commitment, we've added talented people to our team and planning (inaudible) to manage our never-out-of-stock program. We continue to view the increased investment in inventory as low risk to our business given the relative consistency of our product mix and low risk of inventory obsolescence. Our commitment to the in-stock positions and key products enhances our value proposition, and we believe will allow us to further distance ourselves from our competitors and capture additional market share.

Turning to our approach in advertising and promotional activity, we are seeing consumers come back into the market, but we expect they will continue to be price sensitive and value driven in their purchases. As you know, we believe it is our unique value proposition, which includes attractive pricing, which draws consumers to our stores.

Throughout the remainder of the year, we plan to implement advertising and promotional strategies that align with this consumer mindset. In addition, we've reinforced our focus on consistency and discipline in pricing. In particular, in relation to our never-out-of-stock strategy, we've recently initiated new processes in our stores that better support this program and the higher levels of key inventory we are now carrying in our stores on an ongoing basis.

In addition, we've increased our efforts to further enhance efficiency within our supply chain, and we continue to invest in our inventory planning and allocation expertise. We are continue to enhance our China supply chain initiative as we ramp up this program with our Asian vendors. And as a result, we've transitioned the oversight of this initiative to our planning and allocation team.

We began to see solid benefits of the China supply chain initiative in July. Entering the third quarter, we were on track with our planned increase in direct-to-store shipment levels, and we continue to believe that this initiative has important long-term benefits.

We will continue to add more stores and products to the mix over the course of the year to achieve our objective for over one-third of our store base to become part of this initiative by the end of 2010.

Looking ahead, we anticipate a strengthening in our operations, including continue to improve our in-stocks and merchandising presentation, increasing attachment rates for moldings and accessories, reinforcing focus on pricing discipline and consistency, continue ramp up of our China supply chain initiative and increasing direct-to-store deliveries will result in gross margin expansion in the second half of 2010, as compared to the first half of the year, as well as contribute to overall improvements in our performance.

We continue to make steady progress on the upgrade of our technology and systems. This will enable us to further increase the discipline and efficiency with which we manage operations and improve communication across our organization to support our growth plans, including those in Canada.

As we've previously discussed, this process will happen over time in a way that we believe minimizes risk. In the current quarter, we anticipate implementing the point-of-sale, warehouse management, merchandising, product allocation and related systems. Finally, we will continue leveraging our proven-store model to further expand our store base, including our entry into Canada.

We are excited about the opportunities in this market and believe that our value proposition will be well received as hardwood represents a greater percentage of flooring sales in Canada compared to the US.

We plan to begin our international expansion by focusing on the Greater Toronto area and are on track to open our first stores in the fourth quarter of this year.

We remain committed to further enhancing our value proposition, to improve our competitive advantage and expand our market share. We are already beginning to see the positive impact of the initiatives that we have implemented to date in 2010, and we remain on track to meet our strategic plans and financial targets for the year.

We continue to focus on increasing net sales and earnings by strengthening our position as a leading provider of hardwood flooring.

We remain as focused as ever on the key goals of our long-term strategy, which are to gain market share in the highly fragmented flooring market through the growth of our store base, to strengthen our unique value proposition through our commitment to in-stock positions of our top-selling products, to leverage our advertising and marketing activities across multiple sales channels to help educate potential new customers about hardwood flooring and drive repeat customer traffic, and to invest in our infrastructure to generate operating efficiencies in economies of scale to position the Company for sustainable growth and operating margin expansion.

We will now turn the call over to questions. Operator?

Thank you. We will now be conducting a question-and-answer session. (OPERATOR INSTRUCTIONS) Our first question comes from the line of Brad Thomas with KeyBanc Capital Markets. Please proceed with your question. Your mic is now live.

Thanks. Good morning, Jeff. Good morning, Dan. Wanted to just first ask about gross margin. You know, obviously you noted the container rates being up pretty significantly during the quarter, but it sounds like there are some nice benefits from your trying to direct the store program, that it's started to flow through. Can you just talk a little bit more about, you know, the pressure that you've seen in the first half and why you have confidence in driving gross margin expansion in the second half of the year?

Sure. You know, a number of things. The-- and to address the transportation costs first. You know, the China consolidation plan was, you know, certainly a key port-- point of our long-term strategy. And, you know, it's taken us longer to get that up and running efficiently than we had hoped to. There were some-- just getting to the point of more efficiently managing the product flow, a greater percentage of our product is now coming out of China.

So it just got a bit bigger in terms of what we were going to put through there. And, quite frankly, we didn't have enough resources to manage it properly, so we've added some more staffing resources to do that. And now for-- in-- and actually June was the first month where we hit our target with what we wanted to go through. So we certainly believe going forward we are going to see some significant freight savings benefits there.

We also had cut back on our direct-to-store deliveries as we were gearing up for that, you know, China strategy, and that added some additional time in transit method, some cost. And so we've corrected that as well. So we feel really confident that on the transportation side that we're going to see that being a lot better in the back half of the year and going forward.

You know, another piece of the gross margin is that we had very aggressive pricing for our April sale, and we had much higher inventory levels going into the sale than we ever had before. And so we sold through a lot more product than we expected to during the time period. And I think that had a-- you know, that was part of the result of the never-out-of-stock strategy, which was a good point of it, that the product was there.

It just-- I think we sold more of that product at promotional pricing in the quarter than we expected to. So, you know, we've changed some of the pricing strategies. It's not that we're backing off from promotional pricing, but we're going to spread it out a bit more, a little bit differently. And, you know, so we think that we'll get benefits back from that as well.

So we feel really confident that the mar-- we are going to see improvements in the gross margin.

Okay. And so as we think about some of those different drivers, the sourcing costs, the promotional levels, you know, especially given where inventory ended into the quarter versus some of the benefits you think you can drive, you know, can you just help us think about what may stay maybe consistent with where it's been for the last quarter or so versus what's going to change in the next quarter or two?

Well, Brad, this is-- we think transportation costs domestically will stay relatively consistent in the third quarter with what we saw in the second. We certainly believe international container rates, which went up quickly in the first half of the year, are going to remain higher relative to 2009 and even relative to our historic average in the second half of the year.

So we think those costs are going to be a challenge going forward, but we're pretty confident that with the investment we made and some additional expertise related to product allocation and logistics, that the increase flow direct from vendor to stores and through the China consolidation center, will offset those costs in the third and fourth quarters.

And as Jeff pointed out, we've invested in additional management structure within the stores to provide additional support to the never-out-of-stock program. That should increase some retail price discipline. So we actually believe a retail to cost of product equation will improve in the second half of the year as well.

Okay, thanks. And just wanted to follow up on advertising. Dan, I think you mentioned that it was only up a half a percent. I'm assuming that's in dollars year over year, and that-- I mean, that would obviously imply some very significant leverage. Can you just talk a little bit more about the basis point impact that you're seeing from ad leverage and how you're planning that going forward and how that sort of balances out, you know, maybe some of the more promotional activities that you ran last quarter?

Similar to the first quarter, we got about 135 basis points of leverage in the second quarter. We had intended for a greater spend in the second quarter, but what we found, by investing in those programs, which gave us the most effective results, we didn't spend all that we intended, and we drove the top line that we intended.

In the second half of the year, we believe that pattern's going to continue. On an annual basis, we look for 40 basis points of leverage for the year. We're not looking for 140 for the full year, but we're certainly going to continue the same trend such that we'll end 2010 with more than the 40 basis points of annual leverage that we normally look for.

Okay, great. Thanks so much, guys. And I'll turn it over to the next quarter.

Thank you. Our next question comes from the line of Rick Nelson with Stephens. Please proceed with your question. Your mic is now live.

Thank you and good morning.

Good morning.

I'd like to ask you, Dan or Jeff, about sales trends during the quarter and what you're seeing in the early going of the third quarter. It sounds like it may have been frontend loaded with the April promotion.

Yes, it was. And I think it was primarily driven by the strength of that promotion. We had some great price points, and we had very high levels of inventory to support those price points. So what happened was we sold through a lot of product, more than we expected to. We took orders for more of the product than we expected to. So a lot of the sales in May were actually products that customers had placed orders for during the sale period.

And I think that that strong strength coming out of the sale pushed some of the May and June business forward. So when you look at the overall quarter performance, it was right on target where we expected it to be. But, yes, more of it was during the April promotion or as a result of the April promotion. And so we-- you know, quite frankly, I think we thought May and June were going to be a little bit stronger based upon the performance of the April sale, but I think we just pushed all our business forward.

You know, July has been more of the same. You know, I think July was pretty much what we've expected it to be. So, yes, we're pleased with where we are so far with that.

Okay. And are you, in fact, seeing positive comps in July? And what is the big promotion event in the third quarter? Is that Labor Day?

The third quarter is treated a little bit differently from a promotional standpoint. We run a series of smaller promotions as opposed to one large promotion. So it's more spread out, and, quite frankly, we've had good experience with that in the past. We do tend to see increased traffic around Labor Day or post Labor Day, so we tend to get a little bit more promotionally oriented in early and mid-September.

Right. And Rick, not that we're a seasonal business, but our sales are strongest in March, April, May. As we get into the summer it tends to decline from April down through May, June, flat in July. It starts to build a little bit in August and September as we go towards one more peak in fall, October, November and then falls off for the holiday.

All months of the second quarter were positive on a comp basis, and July was positive on a comp basis.

The number of promotions you're planning for the third quarter, is that consistent with the prior year?

Yes. Yes, that's pretty consistent with what we did last year.

I'd like to ask you also about the store openings. You got six in the quarter. How does that compare to your expectations? And the cadence of store openings we should look for in the back half of third quarter and fourth quarter.

Yes. We were a little bit behind in our store opening plan in the second quarter, both from the number of stores and the timing of the opening. And that was just strictly related to, you know, going through the lease negotiation and the store build-outs. You know, so it put us a little bit behind, but that's a short-term issue. You know, I think we make that up in the fourth-- or, I'm sorry, in the third quarter. You know, we have the locations. We're making better progress with the lease negotiations and preparations.

So, but that's always the challenge you have going from one quarter to the next is the timing. You know, sometimes it's just a bit faster than you expect, and sometimes it's a bit slower. But it's not for a lack of finding viable locations or getting good lease rates. It's just that-- going through that process, you can never know exactly how long it's going to take.

Yes, and Rick, I mean, we opened four stores in July, which is a little bit ahead of our expectations too. So as Jeff said in his commentary, we had finished with, what, 207 I think for the current period.

Yes.

And the part in fourth quarter, should that be fairly even, do you think?

Yes, they should be.

Okay.

Yes.

If I could ask just one more. The China initiative, how many stores are you currently servicing with that strategy. I know you mentioned a third by yearend. But how does that ramp look?

We're getting fairly close to that number now.

And any indications as to the gross margin improvement that you're seeing in those stores?

I think it's real-- what we've been looking at more is the sales. We're seeing some nice sales increases in those stores because we're-- we've got a better in-stock position, and we've reduced the time in transit on that product.

Got you. So the benefits are more sales driven and margin--

It's-- no, there will be some margin benefits, but we've really been focused more on looking at the sales and how it's impact sales, and that's really what's initially driving, you know, how many stores we're putting into the program. I think the margin benefits will come though.

Got you. Thanks a lot. Good luck.

Thanks.

Thank you. Our next question comes from the line of Robert Higginbotham from Goldman Sachs. Please proceed with your question. Your mic is now live.

Good morning. Thanks for the questions. A question about credit or financing, have you seen or could you give us some color on how you've seen perhaps the penetration of financing change? Have you seen availability to credit change at all? And just kind of the general picture, how you want to talk to it, how have you seen that development.

In general, our penetration in our internal program, our Lumber Liquidator's card, has been lower in 2010 than 2009. More comparable, when we're offering the everyday six-month program, we've seen less of a response when we've opened the-- or when we've run the 12-month promotion. And we recently ran, for the first time, an 18-month promotion to see what consumer interest there would be this past weekend, and that was favorable.

But through the first six months of the year, the penetration rate overall has been lower in 2010 than 2009.

Got it. And have you seen your competitors doing anything differently? You know, recently Lowe's had kind of moved towards somewhat of a hybrid model, kind of in between what you guys do in terms of owning your own inventory versus special order. Have you seen anything change from the competitive landscape?

Yes, I think we've seen a gradual improvement in both Home Depot and Lowe's, and that's something that we've expected for a long time. You know, I think that actually since we've been a public company and we've had opportunity to share our business model and our growth, that it's a category that they're paying more attention to than they previously did.

Both chains have a relatively limited assortment of SKUs for most-- primarily entry-level items that they are now carrying inventory on in a more consistent basis. And I would say that their pricing is probably a bit sharper than it was before. But, you know, they still face the challenges, that it is a very limited assortment of SKUs. It tends to be the lower-priced products, none of the premium products.

I still think they face the challenges with having, you know, well-trained staff on the floor to help service the customer. This is a very complicated purchase. It usually requires several visits to the store to learn the product and get comfortable with it. We have the same people on staff in the store every day who can work with the customer on a regular basis and help them make better informed decisions.

You know, we have a much better commitment to moldings and accessories to help the customer complete the purchase. We have a great relationship with a third-party for install.

And so I just think that all of those are benefits that-- and this is nothing to take away from Home Depot and Lowe's. They're-- you know, they're both great retailers. But these are just challenges. These areas are challenges for them, and that's really what differentiates our model from theirs and why we think we've been able to grow and continue to grow our business during a period of time when hardwood flooring sales have declined double digits for, you know, the last four-plus years.

But, yes, you know, just I gave you a long answer to a short question.

No, that's very helpful. Thank you.

Thank you. Our next question comes from the line of Budd Bugatch from Raymond James. Please proceed with your question. Your mic is now live.

Thank you for taking my question as well. Just going back a little bit on gross profit, gross margin-- and I think you've said that you've expected to be sequentially up, but I don't know that I heard you comment on it's year to year and how it might end the year, year to year. So in the second half and the full year compared to last year.

Yes. Budd, we didn't comment on how it's going to compare to last year, but you're correct. We just believe that the second half of the year will be stronger in the first half.

And so no commentary about its year to year?

Well, there are a number of moving parts in there as far as transportation costs. Certainly last year was benefiting from much lower transportation costs and the initial launch of our China consolidation center, the initial launch of our never-out-of-stock program.

So, internally, we're comfortable that we can do a better job with gross margin and that it'll expand in the second half but aren't ready to talk about the comparison to last year.

And ultimately, going forward again, what's the-- remind me what the goal is that you think you can get gross margin to?

Well, we've talked about, over long periods of time, that we would see gradual gross margin expansion. Back in the terms of 10 to 20 basis points a year. 2009 was an exceptional year relative to 2008, but I think if you map out the last 24 to 36 months of our gross margin expansion, you'll see that we're on a progressive and beneficial trend line.

Okay. Talk-- I think for Rick, you talked a little bit about the sales progression being frontend loaded, but I don't know that I heard you talk about comp percentages for the last four quarters. What might have been the progression of that?

In the last four months or four--

Four months. Pardon me.

Yes. Comps were positive every month in the quarter, and it was kind of-- you know, it was a complete different from the previous year where, you know, comps were very weak in the early part of the second quarter and got a bit better. So the comparisons became, you know, a little bit more difficult as we went through the quarter. And just as we said, because the April sale was so strong that we probably pushed some business forward.

So I think it's a-- I don't think it should be viewed as a bad long-term trend. I think it's just that we-- because the sale was so strong, we pushed a lot of business into April.

So, Jeff, if we look at it as a two-year stack going for the last couple of months, how would that-- would that trend positively or was it flattening or compressing? How do we think about that?

It would be positive.

It would be-- and increasing or decreasing? That's kind of the-- sequentially. I'm sort of trying to make sure I understand. I don't want to overstate or understate the case.

I think it remains in the second quarter. We're certainly facing the challenges of demand, as everyone has, but we haven't seen any substantial falloff, might be a better way to understand it. We thought it-- we've understood this is going to be a difficult year. We're slowly improving metrics, and that's what we believe are happening out there.

It was a little uneven in March and April. But to give you an idea, I mean, of our 5.5% comp, there was no month higher or lower than 200 basis points from that number.

That's helpful. And lastly, if you just want to talk about customer deposits in relation to forward sales, it's about flat I think with last year, if I remember right, at the end of the second quarter. Is that a factor of the-- of your getting inventory more in the stores? What does that bode for what the backlog is of sales that would be delivered into the July end?

You know, we were a little stronger late June demand last year. We think our inventory levels helped satisfy some orders faster in the second quarter of this year.

That said, in July we actually saw a bit of a drop-off from June last year, and then this year we've seen a bit of a build. So we've kind of gone in the other direction. So a little bit stronger in 2010.

Okay. Thank you very much.

Thank you. (OPERATOR INSTRUCTIONS) Our next question comes from the line of Matt McGinley with ISI Group. Please proceed with your question. Your mic is now live.

Good morning. I have a question on your salary expense leverage. You've made a lot of investment in staff over the past year or so, and that's been a headwind as far as how you've delivered that as a percentage of SG&A. The gap has narrowed a little bit as you've progressed over the past year. Do you expect to actually leverage that this year, or do you think that will continue to be a headwind in the back half?

Matt, we're hoping it's going to-- we may start to see some leverage late in the year. That's right. It's-- we've de-levered the corporate office infrastructure spend over the past two years. It's going to take a little bit of time, but we think possibly late this year, early next year. So earliest that it will occur is late this year.

Okay, great. And then on the-- next question is on your traffic trends throughout the quarter, you know, you were around, I think, 20% traffic first quarter, around 7% this quarter. Has there been a change in the conversion rates that you've seen as people come in the store, or that's just a typical trend that you would expect given you were off such high levels previously in the year?

We're just running into the higher levels last year. Second quarter is where it really began a strong double-digit increase. We were pretty pleased with the 7% on top of 13.6%.

Okay. And then lastly, in your outlook, you very softly change your outlook, I think, on the macro (inaudible). You expect a steady improvement to a gradual improvement. Are you seeing changes in your customers from the first quarter, or is that just a commentary on general macro trends?

Well, on the general macro trends. We-- like a lot of retailers, we were excited by March and April, and the excitement didn't last. It's been steady. It's been progressive. There's certainly some challenges ahead of the consumer in the second half of this year as they are in this remodeling industry. But, you know, we believe it's going to gradually be over last year.

And we've taken that into consideration with our forecast.

Okay, great. Thanks a lot.

Thank you. Our next question comes from the line of Laura Champine with Cowen and Company. Please proceed with your question. Your mic is now live.

Good morning, guys. I'm looking for a little more detail on inventory. I know that there are a couple of drivers taking that higher, the always-in-stock program and then a build going into SAP implementation. Can you quantify the split there on the increase, on inventory, what's attributable to which program or plan?

Well, in general, we expected Q2 to be lower than Q1. It was slightly but not as much. We had kind of told folks we were thinking $430,000-- $530,000 to $570,000 on available per store. We came in at, what, $584,000? Earlier build of safety stock would be the difference between the number we came at and the top end of the range we had talked about.

And you're also going to see it in the in-transit number, which is a greater flow towards prior to the SAP implementation.

Is a-- and just as my one follow-up is on the-- an earlier build of the safety stock, does that reflect an earlier implementation of SAP, or did something change in the way that you'll be implementing the SAP?

No, we always said that the SAP would be a third quarter. So we've had-- you know, as a greater percentage of our product is coming from China, you know, the lead time for ordering for the total inventory is getting longer. So that's reflected in there.

Got it. Thank you.

Thank you. Our next question comes from the line of David Magee with Suntrust Robinson. Please proceed with your question. Your mic is now live.

Yes, hi. Good morning. Just a couple questions. One is that it's my understanding that you continue to be a little bit more promotional on Bellawood sort of away from the April sale. Is that correct?

Correct.

Yes.

How would you characterize the gross profit dollar as coming from that product?

Well, the gross profit dollars from sale of Bellawood, even if promotional price is greater than what we get from most of the other non-hardwood products. So there is certainly a-- you know, there's a top-line sales benefit and a gross margin dollar benefit, but it is at a slightly lower percentage.

Do you think the number of transactions are offsetting the margin [give up] on that product?

Not a bad assumption.

Thanks. And then, secondly, with regard to the always-in-stock program, any way you can sort of give us an indication or quantify the impact that that's having on the same-store sales number?

We haven't broken that out, but, you know, what we have said is that we feel it is-- it has and continues to have a positive impact on our comp store sales number. And it further differentiates us from our competition and strengthens our value proposition in that we can provide product for a consumer much faster than the mass majority of our competitors can.

And we think over a long run, this is the most difficult part of our value proposition for any of our competition to match. So we think it just long-term further strengthens our position in the marketplace.

Okay, great. Thank you, Jeff.

Thank you.

Mr. Griffiths and Mr. Terrell, there are no further questions at this time. I would like to turn the floor back over to you for any closing comments or remarks you may have.

Thank you for joining us on today's call, and we look forward to speaking with you again soon and keeping you updated on our progress. Thank you.

Ladies and gentlemen, this does conclude today's conference. You may disconnect your lines at this time, and we thank you all for your participation. Good day.