LL Flooring Holdings Inc (LL) 2010 Q3 法說會逐字稿

Good morning ladies and gentlemen. Welcome to the Lumber Liquidators third quarter earnings conference call. With us today is Jeff Griffiths, President and CEO of Lumber Liquidators and Mr. Dan Terrell, CFO of Lumber Liquidators. (Operator Instructions) I would now like to introduce Ms.Leigh Parrish from FTI Consulting.

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 United States 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 or financial performance of Lumber Liquidators. Although Lumber Liquidators, believes that the expectations reflected in its forward-looking statements are reasonable, they can give no assurance that such expectations or any of its forward-looking statement will prove to be correct. Important risk factors that could cause actual results to differ materially from those that are reflected in the forward-looking statements are included in Lumber Liquidators filings with the SEC. The information contained in the call is accurate only as of the date discussed. Investors should not assume that the statements will remain operative at a later time and lastly, Lumber Liquidators undertakes no obligation to update any information discussed in this call. And now with that out of the way I will turn the call over to Jeff Griffiths, President and CEO of Lumber Liquidators. Jeff?

Thank you. Good morning everyone. Thank you for joining us on short notice for our earnings call today. With me on the call is Daniel Terrell, our CFO. We announced our results for the third quarter earlier than scheduled, yesterday afternoon and acknowledged that they are not what anyone, including us, expected. Given the difference in our results versus what we had anticipated for the quarter, as well as the change to our outlook for the full year, we wanted to communicate with our shareholders and analysts now, rather than waiting until our previously scheduled earnings date.

As we outlined in our release, our under performance during the third quarter resulted from productivity issues we experienced due to our implementation of SAP. I want to spend some time talking about this. I will then turn the call over to Dan to review our financial results for the quarter, including additional details on the financial impact of our system implementation and discuss our outlook for the fourth quarter. I will then return to update you on our areas of focus for the remainder of the year before we open the call to questions.

As you are aware, in late August we began the implementation of the most significant phase of our integrated business solutions from SAP. Including our point-of-sale, warehouse management, inventory control, merchandising and product allocation. We converted all critical information existing in our previous information system and we have continued to operate our business without interruption since the conversion. However, we experienced significant declines in productivity, both at the store level and in our warehouses in the weeks following the system implementation. The system implementation had a pervasive negative impact on execution across our operations and the issues we experienced are reflected in our net sales, gross margin, and operating expenses as well as our inventory levels at the end of the quarter.

To provide more color on the productivity issues we experienced at our stores, we were not able to service customers or identify new sales opportunities at the level that has been typical for our business, historically. Overall, we were not as effective or efficient in identifying open orders or tracking and processing orders. We also encountered issues with visibility into what inventory was in stock to fulfill customer orders, which led to orders not being completed during the quarter as they should have been. All of this, combined with our associates acclimating to the new system, reduced the time that could be spent helping potential customers shopping at our stores and converting those shoppers into sales.

I think it is important to spend a few minutes discussing our customer deposits on open orders. Both in terms of the strong customer demand reflected in the level of deposits and how we viewed the build in deposits over the course of the quarter. We ended the third quarter with customer deposits at a level that is almost double the level we recorded at the end of the third quarter last year. During the quarter, as we evaluated the build in customer deposits, we believed that we would be able to convert them into completed orders at a rate that was in line with historical norms, and that would allow us to meet sales expectations. However, we were not able to make improvements in our operations quickly enough to fulfill existing customer orders as expected and did not maintain our focus on serving new customers at our stores.

Ultimately, as we look at historical trends in customer deposits and third-quarter results, prior to the implementation, we believe that we had approximately $12 million to $14 million in unrealized net sales in the third quarter as a result of our reduced productivity. On a more positive note, we believe our unique value proposition of price, selection, quality and availability continues to resonate with customers and that the level of customer deposits, demonstrates that there is solid demand by consumers for our products, despite the challenging economic environment. And looking at gross margin performance, we were impacted by disruptions in the flow of product at our warehouses and delays in shipping products necessary to fulfill orders that resulted in having to use more expedited modes of transportation, generally at higher costs. Prior to the system implementation, we significantly reduced product flow in preparation for a physical inventory count at a number of our distribution point servicing our stores including our central warehouse operation.

In the first few weeks following implementation, we were not able to reestablish the product flow to satisfy customer demand as quickly as expected. We returned to expected levels of product distribution by mid-September, however. The unit count shift during the third quarter of 2010 was significantly lower than planned. In addition, as a result of the reduction in warehousing and merchandising productivity, we experienced an impact to our finishing operations for a period of time following implementation which caused us to finish fewer units per hour in comparison to historical norms and expectations. We also experienced higher than expected operating expenses during the quarter as a result of the system implementation. Because of additional time required to perform activities associated with our associates normal day-to-day operations, we experienced higher payroll costs. Overall, we allocated a higher level of both internal and external resources to the system implementation than we had initially planned to help address the issues we were experiencing. Support operations and address specific productivity concerns. We also made a decision to invest additional dollars in strategic advertising and promotions to help drive sales and did not leverage advertising as planned.

Turning finally to our inventory levels. As we discussed last quarter, we significantly increased our inventory levels prior to the system implementation to ensure we had appropriate inventory in stock throughout the process. As a result of this significantly lower than expected sales volume, we ended the quarter with higher than planned inventory levels. In addition, we made strategic increases in inventory to drive demand. In total, we believe that our inventory levels at the end of the quarter were approximately $8 million higher than they would have been if we would had converted customer deposits on open orders into completed sales. The build in inventories primarily in our top-selling products and as you know, our inventory has a low risk of obsolescence.

Dan will discuss our inventory in more detail when he reviews the results for the quarter. We have continued to increase our productivity in each subsequent week following the systems implementation although at varying levels across the store base. We expect that we will continue to feel the effects of the system implementation in the fourth quarter and this is reflected in the updated full year guidance that we have provided.All of that being said, we have continued to make progress in addressing the issues associated with the implementation and believe that the most significant hurdles are behind us.

Before I turn the call over to Dan, I also believe it is important to provide everyone with a sense of the encouraging signs that we saw in our business during the quarter. Prior to the system implementation in mid-August, our net sales for the quarter were up over 18% compared to the same period last year. With July net sales up 15.5% and August net sales for the period prior to the implementation, up almost 23%. Within those numbers our comparable store net sales were up in the mid-single digits and we are experiencing positive customer traffic trends compared to the third quarter last year. We also continued to successfully open new stores during the quarter. We opened ten new stores during the quarter and have opened another two stores today, in the fourth quarter. We now have two hundred and fifteen locations in forty six states.

We remain on track to achieve our expansion goals for the year. Although given our focus on serving our domestic customers, the remainder of our openings this year, will be in the US and we now plan to enter Canada in the first quarter of 2011. Expanding our footprint remains an important component of our long-term strategy to grow our sales and market share. While I do not want to downplay the significance of the issues we experienced in the third quarter, or the impact we continue to anticipate our system implementation will have on our results for the remainder of the year, we are confident that these are temporary issues. Further, our upgraded system will significantly benefit the business, over the longer term, and provide the tools to make Lumber Liquidators, a stronger company. We will be able to further increase our discipline in efficiency in managing our operations as well as enhanced communications across the organization to support our long-term growth. Looking more broadly at our business and industry, our unique value proposition continues to resonate strongly with consumers and we have maintained our leading market position.

We believe that our comparable store net sales, being up by mid-single digits prior to the system implementation as well as the growth in customer deposits, demonstrates the continued strong demand for our products. We expect the macro environment will remain challenging for the remainder of the year and into 2011. However, Lumber Liquidators remains well-positioned to meet customer demand as consumers continue to look for value in their purchases. Overall, we remain focused on further improving our operations and building a foundation for long-term success. I would now like to turn the call over to Dan, for detailed review of our financial results and outlook and then I will return with closing remarks on our areas of focus for the final months of the year.

Thank you, Jeff. Good morning everyone. As Jeff mentioned, I'm going to provide some additional details on our results for the third quarter and then discuss our outlook for the fourth quarter of 2010. Before I begin, let me remind you that we expect to file our 10-Q with the SEC on Tuesday, November 9. Now for the third-quarter results. Net sales for the three months ending September 30, 2010 grew to $147.2 million an increase of $6.7 million or 4.7% over the third quarter of 2009. At comparable stores, net sales decreased $8 million or 5.7% and at non-comparable stores, net sales increased $14.7 million. As Jeff noted, our net sales were adversely impacted by reductions in operating productivity related to our system implementation on August 22. Based on the significant build in open demand, we believe our net sales were some $12 million to $14 million lower than they would have been if our conversion rates of open orders into net sales approximated our historic norm.

We arrived at that value by comparing changes in our open demand as evidenced by the actual customer deposits and store credits reported on our balance sheet to historic norms. As many of you know, when a customer places an order but does not take possession of the merchandise that same day, we generally require a 50% deposit. However, depending on the order specific circumstances, we may receive a greater deposit and historically, our customer deposits have represented between one half and two thirds of our open orders or open demand at any given point in time. We do not recognize revenue until a customer takes possession of the merchandise. Until that time, a customer deposit is a liability on our balance sheet.

For the first seven weeks of our third quarter, prior to implementation, net sales increased 18.5% over the same period in 2009 and at comparable stores, net sales were up 7.3%. From an open demand perspective, customer deposits on open orders were $13.4 million at August 21, 2010, down slightly from the $13.9 million at June 30, 2010. By September 30, 2010, customer deposits and store credits had risen to $21.3 million. Indicating to us that customer traffic was relatively consistent with pre-implementation trends. We believe that had we converted the approximate $12 million to $14 million of open orders into net sales, our quarter end customer deposit balance would have approximated our expected and historic norm.. Other net sales trends to note, include our average sale of $1,550 in the third quarter of 2010, which was down only a slight 0.6% from the third quarter of 2009 and on a sequential basis, was approximately 1.4% higher than the second quarter of 2010. And, within our sales mix, we saw continued strength in certain premium products, in laminates, in bamboo, and in our expanded assortment of engineered hardwoods.

In addition, we continued to increase the sales mix of our moldings and accessories to 14% in the third quarter of 2010, up from 13.1% in the third quarter of 2009. Our non-comparable store net sales benefited from our continued store base growth. We opened ten new locations in the third quarter of 2010 and a total of thirty six new locations since September 30, 2009. Of the ten new locations opened in the third quarter of 2010, three were in new markets and seven were in existing markets. Overall, we continue to be pleased with the performance of our new stores. Gross profit increased 1.1% to $51.8 million. Gross margin was 35.2%, down 120 basis points in comparison to the third quarter of 2009. We believe less efficient unit flow in the first weeks after our SAP implementation together with certain reserve adjustments adversely impacted our gross margin by approximately 30 basis points. Otherwise, product costs increased relative to the third quarter of 2009, primarily due to higher transportation costs and certain finishing costs.

International container costs capitalized into the unit cost of our products sold in the third quarter of 2010, were significantly higher in comparison to the third quarter of 2009. Our average container costs in the third quarter of 2010 remained significantly higher than the cost paid in the third quarter of 2009. It remained higher than our historic norm though we began to see moderation in those prices during the third quarter. Transportation costs to move our product domestically from warehouse to the store and from store to the final customer were greater in the current quarter than in the third quarter of the prior year. We drove more miles delivering a greater number of units and per mile costs increased primarily due to higher fuel costs. These increases in transportation costs were partially offset by increased direct shipments received by our stores either through our China consolidation center or direct from the mill to the store.

In the third quarter of 2010, 23.7% of our purchases were received directly at the store, up from 14.4% in the same period of 2009. Selling, general and administrative expenses were $44.9 million or 30.5% of net sales for the third quarter of 2010 compared to $38.7 million or 27.6% of net sales for the third quarter of 2009. We believe SG&A included approximately $500,000 of expenses incurred as we dedicated additional resources to restoring productivity subsequent to implementation. Otherwise, SG&A expenses included increased labor costs due to a combination of our store-based growth, greater total unit flow distribution and strengthened store support infrastructure. Increased advertising costs, particularly in our more effective media channels, increased occupancy costs, due primarily to store-based expansion and increases in certain other costs including bank card discount rates for extended term promotional financing.

Other income, which includes interest, was $143,000 for the third quarter of 2010 compared to $116,000 for the third quarter of 2009. The effective tax rate was 38.7% in the third quarter of 2010 compared to 38.3% in the third quarter of 2009. The 2010 effective tax rate increased primarily due to the absence of certain favorable one-time adjustments recorded in the prior year. Net income for the third quarter of 2010 decreased 44.8% to $4.3 million or $0.15 per diluted share based on approximately $28.2 million weighted average diluted shares outstanding. Net income for the third quarter of 2009 was $7.8 million or $0.28 per diluted share based on approximately $27.9 million weighted average diluted shares outstanding.

Turning now to our balance sheet and cash flow. We ended the third quarter of 2010 with $26.8 million in total cash and cash equivalent, which compares to $35.7 million at December 31, 2009, $56.8 million at September 30, 2009. Our operating activities provided net cash of $3 million for the nine months ended September 30, 2010 and $26.4 million for the nine months ended September 30, 2009. Inventory balance of September 30, 2010 was $157 million and included $142.7 million of available for sale inventory and $14.2 million in transit, primarily from international vendors. Inventory increased $23.6 million from December 31, 2009 and increased $52.9 million from September 30, 2009. Our available inventory per store was $670,000 at September 30, 2010 , $588,000 at December 31, 2009 and $494,000 at September 30, 2009.

We had anticipated ending the third quarter of 2010 with approximately $570,000 to $580,000 of available inventory per store. Increases in actual available inventory per store are a result of the following. The build in open demand resulting from reduced productivity subsequent to our SAP implementation. Increased inventory carrying levels by approximately $8 million. Expanded product assortment of certain engineered hardwoods across a range of retail price points introduced in the third quarter of 2010, particularly in our southern and western stores, increased inventory by approximately $3 million. Opportunistic liquidation deals and available domestic hardwood buys, which we believe will serve future demand, increased inventory by approximately $5 million. An increased commitment to moldings during the SAP implementation and the introduction of certain new accessories increased inventory by approximately $4 million.

Working capital was $137.3 million at September 30, 2010 compared to $118.1 million at September 30, 2009 with the current ratio at 3.3 times in both periods. Capital expenditures totaled approximately $5.7 million for the third quarter of 2010 compared to $5 million for the third quarter of 2009. We capitalized $3.6 million of costs related to our SAP solution in the third quarter of 2010 and $2.8 million in the third quarter 2009. Other capital expenditures each period included fixtures, equipment and lease hold improvements for new stores, routine purchases of computer hardware and software and lease hold improvements at the corporate headquarters. Turning now to our results to date in the fourth quarter. An updated outlook for the quarter and full year. In October 2010, net sales increased approximately 14.5% over the prior year and net sales at our comparable stores increased 2.9%. Customer deposits and store credits at October 31, 2010 were approximately $17 million, down from $21.3 million at September 30, 2010 and comparable to $12.2 million at October 31, 2009. Although our overall productivity improved in October, we have not returned to pre-implementation levels and our build and open demand remains higher than our historic norms. In addition, as we dedicate additional resources to normalize productivity, we expect to incur incremental costs that may impact operating income.

Finally, as we continue to face a challenging macro environment, we now expect total net sales for the fourth quarter of 2010, increasing 10% to 15% over the fourth quarter of 2009 for a range of $151 million to $157 million and at comparable stores, net sales increase in the low to mid single digits. Total net sales for the full year 2010 and the range of $618 million to $624 million and comparable net store sales increases in the low to mid single digits. Opening nine to eleven new locations domestically in the fourth quarter of 2010 for a total of thirty six to thirty eight new store locations domestically. Fourth quarter 2010 earnings per diluted share in the range of $0.21 to $0.27 and full-year 2010 earnings per diluted share in the range of $0.93 to $0.99 based on a diluted share count of approximately 28.2 million shares and an effective tax rate of 38.7% to 39%. I will now turn the call back over to Jeff for his closing

Thank you, Dan. As we look forward to the remainder of the year, we are pleased that we continue to make strides towards reaching normalized productivity levels in our stores and warehouses. Our associates are continuing to increase their comfort with the new functionality to serve customer demand. Further, we are enhancing our efficiency and the flow of product throughout our supply chain. In addition, working with our SAP partners, we are continuing to dedicate additional resources to improving our performance. We're making progress in converting open orders into completed sales and we have reduced open demand in October. However, we may continue to carry open orders higher than our historical norms through the end of the year.

We recognize that the productivity of our store operations must continue to improve, to allow for conversion of open orders that existed as we entered the fourth quarter into completed sales as well as to provide appropriate service to new customers. Throughout the remainder of 2010, we will continue to focus on enhancing the value of our new system, including improving visibility of product flow information at the store level, in our warehouses and restore support functions. We are continuing to improve our operational efficiency and effectiveness every day and have begun to see improved results. Overall, keeping in mind the issues we are continuing to address in the current quarter, we fell good about trends in the business and the direction in which we are headed.

I think it is important to speak for a moment about the benefits we will expect to achieve through our SAP system implementation. The system implementation places us on a current and supportable IT platform that uses standard PC hardware and Microsoft operating systems. As we move through 2011, we will have enhanced capabilities that will offer us the opportunity to gain sales momentum and market share. Our new system should enable us to further increase the discipline and efficiency with which we manage operations and improve communications across our organization to support our growth plans. For example, our upgraded system provides us with a platform that can grow and change as our supply chain network changes through additional warehouses and distribution centers. The new platform will also help facilitate our international expansion in Canada and other locations beyond North America as well as the electronic exchange of information with our business partners. Going forward, we will be able to leverage a vast network of compatible technology and application tools to support our future needs in areas such as transportation and labor management.

Ultimately, our upgraded system should provide improved inventory visibility, leading to more precise allocation of inventory versus demand. Better reporting for all segments of the business, automation of manual processes, and improved management visibility which we expected to positively impact net sales and margin dollars. And finally, SAP has a large and active client base which therefore leads to the functionality of the system being improved continuously. Turning to some of our other initiatives, we are continuing to refine our never out of stock inventory program in ways that will further enhance our performance in the future. As we discussed last quarter, we added an additional management level in the field and implemented additional in-store training to help us better execute against this initiative. While the system implementation masked some of the results, we are continuing to make progress with this initiative.

We recognize that we entered the fourth quarter with higher than planned inventory levels that we need to work through. However, we continue to view both the higher inventory level as well as our increased investment inventory as low risk to the business given the relative consistency of our product mix and low risk of inventory obsolescence. Our commitment to in stock positions in key products continues to enhance our value proposition and is allowing us to further distinguish ourselves from our competitors and capture additional market share. While we have seen good customer demand, customers continue to be price sensitive and value driven in their purchases. Throughout the remainder of the year, we plan to maintain advertising and promotional strategies that align with this consumer mindset. We are continuing to enhance our China supply chain initiative as we expand this program with our Asian vendors. We're on track with our planned increase in direct to store shipment levels and despite the SAP implementation issues, we are experiencing the expected benefits of the China supply chain initiative.

We maintained our commitment to adding more stores and products to the mix as we entered into the fourth quarter and we are on track to achieve our objective of approximately one third of our store base to become part of this initiative by the end of the year. We continue to believe that this initiative has important, long-term benefits. We are disappointed in our results for the third quarter and the fact that the issues we experienced with our new system implementation are expected to continue to impact our fourth-quarter results. With that said, these are short-term issues and we continue to be highly confident in Lumber Liquidators business model, our competitive position in the marketplace and our ability to expand the business to generate sales and earnings growth. I would also like to add that we are grateful for the hard work and dedication of our employees through this challenging time. They have put a tremendous amount of effort in the past few months, into changing to our new system as well as regaining momentum in our productivity levels.

We look forward, we remain committed to strengthening our position as a leading provider of hardwood flooring and we are as focused as ever on our long-term strategy. Specifically we continue to be focused on gaining market share in a highly fragmented flooring market through the growth of our store base, strengthening our unique value proposition through our commitment to in stock positions of top-selling products. leveraging advertising and marketing activities across multiple sales channels to help educate potential new customers about hardwood flooring and drive repeat customer traffic, and generating operating efficiencies and economies of scale to position the company for sustainable growth and operating margin expansion. We will now turn the call over to questions. Operator?

(Operator Instructions)

Our first question comes from Brad Thomas with KeyBanc Capital Markets. Please state your question.

Good morning, Jeff and Dan. This is actually [Priscilla Tsai] on behalf of Brad today. So thanks for providing more detail on how SAP impacted sales during the quarter. Could you just provide more commentary on what you saw in consumer spending trends in general, if you back out SAP, and what you are seeing going into 4Q?

First of all, if you talk about backing out SAP, when we refer to the $12 million to $14 million, what we identified as lost sales, that is quantifiable based on the level of deposits, and our historic norms. We firmly believe that because of the loss in efficiency, and the stores being so focused on learning the new system, that we lost sales beyond that amount. We just can't really quantify what they were. So based upon the trends that we saw early in the quarter, we felt pretty good about consumer traffic, and we felt pretty good about consumers responding to our value proposition. I still think that the macro environment is challenging. But -- and that consumers are definitely responding to promotions and lower prices. We are seeing that in the products that we are selling. The fact that our average ticket stabilized, I thought was a positive sign, but we think consumers are still driven to value. But we think we are in a good position to benefit from that.

Okay. Do you have any specific clarity on what the impact will be in 4Q and 1Q sales next year?

We really haven't quantified a specific impact. We are improving productivity through the fourth quarter. Our guidance reflects the impact that we expect to the SAP system to have, but it also does include macro environment concerns. We believe that we will get through the productivity issues by the time we have reached the end of the fourth quarter. It may residually go into the first quarter, but we don't really expect that to have a material impact on 2011.

Do you have a timeline of when you are going to return to the historically normal conversion rates that you talked about?

We believe we are going to exit the fourth quarter with a higher than normal customer deposit balance, which will indicate that we haven't gotten all stores there by the end of the fourth quarter. So there will still be some productivity impact. But at this point in time, we believe we will get there in the fourth -- in the first quarter of 2011.

Yes, and again, so what Dan said, we don't feel it will materially impact our 2011 results.

Okay. Thank you so much, Jeff and Dan, and good luck in the fourth quarter.

Thank you.

Our next question comes from Matthew Fassler with Goldman Sachs. Please state your question.

Thanks a lot, and good morning too. A couple of questions. It looks first of all, like even when you back out the $1 million of higher inventory, that you indicated was directly associated with the SAP issue, inventory is up 43%, which is more than double what sales would have been up, excluding the SAP issue. And I know that Dan walked through a couple of specific drivers, and the goods, opportunistic deals, etc. It seems like you're putting in an awful lot more working capital into the business, to drive expected sales. If you could talk about the strategy, why that is necessary, how much of the incremental sales you think are associated with the incremental working capital, it would be helpful. And also, in that regard, to the extent you are adding new goods, are they replacing something, or is it just net additives to the overall working base?

Sure, well again, the $8 million dollars is directly related to the identified $12 million to $14 million, that we missed based on the deposits and the historical performance of the deposits. We are certainly are convinced that we missed sales beyond that, but we just cannot quantify what they were. So there is some additional inventory being carried out, as a result of that unknown miss. But I think the whole inventory build really goes back to our strategy of having a significantly larger list of SKUs that were committed to never being out of stock in. And we think that was a strategic benefit for us in the long-term, that distances us from our competition, and makes it harder for them to match our value proposition. I think that as we have -- it was about a year ago that we first announced the initiative. It was I guess, the fourth quarter of last year, that we first started to see that in our higher inventory carrying. Quite frankly, we are not doing that as efficiently as I think we can, long-term.

I think definitely as we built to try the consolidation this year, we have had some higher levels than probably necessary. And then, as we started to prepare for the SAP implementation, we brought in several additional weeks of inventory in our top-selling product. So there were a lot of moving parts there, as we built that this year. In terms of the moldings, that is a category that we are learning, we need to carry a higher level of inventory at store levels, if we are going to continue to grow that business. It is an important part of our strategy, in that it is a category that carries gross margins well in excess of 50%. And again, something our competitors have not been able to match. So I think it is a strategy. It was built under our old system, where we didn't really have the best tools to manage it.

One of the benefits of SAP, is it is going to give us much better tools for managing our inventory. So I think one of the goals we are going to have for next year is to get more efficient at that, without sacrificing the long-term strategic goal of having a more available inventory assortment.

Yes, and, Matt, I will just add, the $570,000 to $580,000 available per store still remains our internal target. And I don't foresee that changing, going into 2011 into the first half. Once we start realizing some of the benefits of better information, we may be able to take that number down, but that is still our target as far as what capital we commit.

Another question I have if I could, just relates to connecting the dots between why the orders booked? I understand fulfillment was a challenge without visibility into your inventory, but why the orders booked, would have slowed down due to this process? If you could kind o connect the dots, between what was going on in front of store, as your people focused on new business generation?

You mean why the deposits increased?

Not why deposits increased, I understand you could not fulfill the orders, but it sounds like the underlying business written, if you will.

I understand. I think that directly related to two things. One is that we were so focused on trying to fulfill these older deposits, and older orders, and understand why that did not convert to sales, because there were some challenges earlier on, and some of those were sales that weren't recorded, but were still being shown as deposits, and we had to correct that. And the other thing, is the stores were so focused on learning the new system and clearing that, that we lost a lot of our efficiency in generating new business, and new orders, and new demand. So, when your sales associate in learning the new system, and you're trying to figure out how you get these old orders filled and completed, it definitely impacted our ability to generate new demand. And we think, as we are seeing our efficiencies improve with understanding the system, that that ability to aggressively generate new demand will return.

And one last very quick one. The other expense item, SG&A was up a chunk, how much of that was explicitly due to the SAP item that you identified, and what were other contributors to that increase? .

There was a good piece of a $500,000 in the SG&A that went through that. We also had our bankcard discount rate increase go through there. We tried some different promotional programs during the third quarter. One of the reasons we switched from our previous provider to GE, was to allow some flexibility in those financing programs. So we utilized some longer-term financing that had higher discount rates, and those discount rates are included in the other category.

Thank you.

Our next question comes from Mitch Kaiser with Piper Jaffray.

Thanks, guys. Good morning. Could you talk a little bit about what you think the incremental expense might be for the fourth quarter? And it sounds like you don't think that is going to ripple through 2011, but could you just help me confirm that is the case?

First of all, Mitch, if anything comes forward to 2011, we don't anticipate it being material. We haven't specifically broken out the impact in Q4. It probably will not be as severe as the numbers we disclosed for Q3, which will give you a guideline.

Okay, so that is $500,000, not as severe as that?

And 30 basis points in the gross margin. We had a couple of items that impacted the gross margin, and them some that impacted SG&A

Got you. And did you say that inventory at year-end would be 570 to 580, down from the 640? Is that the number that we should be thinking about?

That remains our target.

Okay. How do you think that plays into 2011?

Still believe that is going to be the target, going through the first half of 2011. And if we begin to reap some of the benefits from the better information out of SAP, we may be able to take that down. But we will probably enter the first half of 2011 with that as the target.

Okay. And then just thinking about replacing Andrew, what is kind of the timeline associated with that, do you think?

Yes, we're going to -- first of all, we have a very strong team in the merchandising area. So I am very confident in their ability to perform, and that is one area, that is one group of people that really has taken SAP, and recognized the benefits from it. The department is currently reporting to me. And we are going to make sure we find the right person. We have got significant growth plans, and I think that it is really important to have the right person in that position.

Okay. And I know you have not provided guidance for 2011 yet, but if you just think about the trajectory of the businesses, is there any reason to think that this is a just kind of a one quarter blip, or how should we think about 2011 at this point?

At this point, Mitch, I don't think we see anything material coming from what happened in the third quarter, and what may be some impact in the fourth quarter, going into 2011.

Okay. Thanks, guys. Good luck.

Thank you.

Our next question comes from David MacGregor with Longbow Research. Please state your question

Yes, good morning, everyone.

Morning.

Wonder if we could just talk a little bit about the current market environment, very promotional, you talked a little bit about going to longer-term financing with your promotions. I'm wondering, tying this back into last quarter, you indicated you were focusing on pricing policies, in terms of trying to develop a little more pricing discipline, around how you go to market. I was wondering if you could talk about the current promotional environment, and the extent to which you feel you made progress in a pricing standpoint?

We feel that the current market is very similar to what we saw earlier in the year. The consumer is definitely responding to value, and we are going to continue to drive our promotions with low-priced products and value. Yes, definitely, on the one hand, we think we are making good progress with some of the pricing disciplines at the store levels. But I think we took a step backwards from that probably over the past couple of months, as we have had to. We had to give some additional discounts and concessions to consumers to save orders, just because of our slowdown in deliveries. But going forward, we don't expect that to be material. We are going to continue to be very aggressive with our pricing promotions, because that is the environment we are in, and that is what consumers are responding. And we think that plays into our value proposition, and the strength of our value proposition, and our competitive advantage.

Can you just talk about competitive force, with respect to the specialty retailers versus the home centers? And I know the home centers have been really working this $39 whole house installation on carpet, and your thoughts with respect to the extent to which that may have pulled demand out of hard surfaces, and adversely impacted your business?

As best we can tell, we still feel that hardwood is gaining share from carpet. So we don't think that has had a material impact on our business. One of the trends that we have seen over the past couple of years, more customers, more of our customers are doing it themselves. We definitely, with the finished floors, the laminates and the bamboos, those product are a lot easier to install. We think that is not that big of an issue, and not impacting us.

Okay, great, and the last question. You just mentioned you were 23.7% direct, including China and mill direct. Can you carve out the mill direct, and just give us some sense of what China would look like in terms of percentage of merchandise traffic?

It really isn't something that we have broken out. This is the first time of that statistic out. And we think that will be helpful for people to follow. But you really need to think of the mill direct program, and the China consolidation program, almost hand-in-hand. We have emphasized the discussion on China consolidation, because it was a newer program. But we have always been able to receive a certain amount of the SKUs from Asia directly, at some of our higher velocity stores. The volume of stores, the concentration in the market, and the distribution network within that market, often dictate whether the product flow comes through China consolidation, or direct from the mill.

Great. Thanks very much guys.

Your next question comes from Budd Bugatch with Raymond James Associates. Please state your question.

Good morning, and thank you for taking my question. A couple of questions. When you look at the -- thanks for at the information on the compensation of inventory changes -- but when you look at your inventory at the end of the third quarter, can you give us an idea of what your planned inventory was total, for the Company, and how the actual compared to that?

Well, the $570,000 to $580,000 per store is generally going to be our internal target, It has been for the last quarter or two, and will be going forward. That said, Budd, we're always going to take advantage of opportunities, particularly in the deals area, if there is a product that might be under some kind of source pressure. Or if there is an opportunity during a product introduction, which is why we called out those products. But that comparison is basically the $570,000 to $580,000 of available per store.

I understand that. But the total inventory does include, that does not include the in-transit inventory, which is also got to be part of your plan, I would think.

The in transit plan to the group degree that it is part of the overall flow. But because it is a timing issue, of when a product gets loaded onto a boat overseas, it is not often something we point in time plan.

I got you. When you look at the issue on SAP now, the issue I think you face, is how much risk do you have to -- through the open order book, and what happened to cancellation rates during this time? And I realize, I heard, I think Jeff say that he was putting in more discounts, or giving discounts to save orders. But can you get us a feel of what happened to cancellations, and what risk there might be to the order book?

Yes, there were higher than normal cancellations, in I would say probably experienced some of that in September, maybe towards the latter part of September. But now that has come back to more historical norms. We've been able to really identify where we have had issues with older orders, and communicate closely with the customer. We have given some additional discounts to save orders. So in looking at what we have in open deposits and open orders now, we feel that there is relatively low risk that were going to get significant percentage of cancellations out of them.

Okay. And finally, can you talk a little bit about the increase in inventory, to a little bit to Matt's question.You increased inventory purposely to take advantage of some other categories. Can you give us a little bit of the thought of the GMROI or how you would think of that as a return on that inventory investment? What's the incremental GMROI to the incremental inventory overall? Do you think of it that way, is that a reasonable way to think about it?

No, quite frankly, we haven't thought of it that way. We really have been focused on this separating us from competition, because it;s the most difficult part of our value proposition for competitors to match. Historically this has been a business where retailers were not willing or able to make an investment in inventory til a customer place an order with them. We feel, long-term, it improves, it strengthens our position in the market. If we have that commitment that we are going to be able to get the inventory to the consumer faster than anyone else. And because there is relatively low inventory obsolescence in this category, we are comfortable, that this is good for our long-term strategy. Now, are there opportunities to get more efficient with it? Absolutely. And SAP is going to help us with those tools over time. So if you look at, when we introduced the strategy a year ago, and how we have executed it over the past year, our execution has not been great. But that does not mean that it is a bad strategy. There are a lot of moving parts, and a lot changes. We were doing it with a system, that did not give us the tools that we needed. And we have got an opportunity to get better with that. And we are totally committed that we are going to carry levels of inventory, that are going to enable us to service the customers, faster and strengthen our competitive position. And in the long term, we believe that this is absolutely a critical thing for us to do.

Okay. Well, good luck on getting through the conversion, and getting back to a normal productivity.

Thank you.

Our next question comes from Matt McGinley with the ISI Group. Please state your question.

Good morning. I have a question on the SAP implementation. As you phased that in August, and you flipped on that switch, what exactly was the issue that you had? Was it a systems issue, or a was it a training issue, that the people were ready to I guess, bring it online? And then as you look at, as you had the initial problem back in August, how far have you moved through the issues you had? Are you 75% done, are you 50% done with the issues that you had, back in August and September?

I think it was a combination of learning a new system. And it was a combination of some things being different. One of the features of our previous system, was it was very flexible, it easy to manipulate, it was easy to change. SAP is very structured, that you follow steps. But it is also much more stable as a result of that. So that was a change for us. And there were a few things that didn't work quite right, and a few things that were unique to our business, that we probably didn't see as well ahead of time. So definitely, and there was disruption in the flow of product. We shut down the warehouse to take physical inventories. And then the first couple of weeks, we certainly had a slower flow of product. Then as we got through into September and early October, it became obvious that there were differences in store performance. We had stores that took to the system very quickly, got to know it, understood it, and made their sales plan in September.

And as we got through October, we had more stores come online, and more stores get familiar with the system. But there is still -- there is some disparity, between the stores that are performing very well, and the stores that continue to need help. We have identified what those stores are, and we have put more resources into them. And we're confident that as we move through the fourth quarter, we will bring those stores up to speed. So the system is functioning, it is doing what it is supposed to do. Are we at? And we are probably at 85% or 90% productivity, and we get better every week.

Did that impact the way -- some of the stores that had issues, where you had to send additional resources to the stores, did that impact the bonus accruals that the people had in those stores. And that now you may have a bunch of store managers that are kind of angry at the fact that they had issues with implementations of this, because it impacted their pay?

Certainly, we are very commission-driven. And so if a store significantly missed their sales plan, that impacted their performance and their bonus. Our message to them, is that should be an incentive for them to get to know the system, so they can get back on track.

And then on gross margin, Dan, when we talked about the trends in the second quarter, you said that gross margins would be up from the rate that you saw in the first half, down on a year-over-year basis. As we look at this into the fourth quarter, given where you are at with the inventory, and given transport, and you have less efficient finishing, should we still expect gross margins, I guess up from the rate we saw in the first half, or I guess, how should look at that?

We were actually pretty pleased with the 35.5. When you strip out the 30 basis points of SG&A impacts, we would have been at about 35.5. I think we were at 35.0 for the first six months, and 34.7 in the second quarter. So we were pretty pleased that we got the flow of product, more increased, and the flow of product through mill direct, the China consolidation center, and we're able to control some of the discounting we had experienced in the second quarter. Still comfortable that the fourth quarter can be a solid number. We were going up against, undoubtedly the hardest number in the third quarter of 2009 at 36.4. I think it had dropped back to the low 35 range, so much more comparable in the fourth quarter this year. Still going to experience some of the issues with SAP. So if you strip out the SAP impacts, I think the statement we made, we are still comfortable with.

Okay, thank you.

Our next question comes from John Baugh with Stifel, Nicolaus. Please state your question.

Good morning. You're not the first Company to have a SAP issue. Having said that, you had the China direct come on a little slower. I'm just curious, when you look at your staff, and your commitment of dollars to this -- I don't know -- logistics system, whatever category you put under. Do you think you're going to need a higher allocation of expense towards this, since it is so critical to your business going forward?

Well I think we made the comment about committing more resources. I think that is more temporary resources, of helping, getting the system to where we need to be, and increased training. I'm confident that the team that we have in place, has the ability to help us achieve our objectives in this area. And I think one of the frustrations for them, and for us as a Company is that we did not have the tools. We have very ambitious plans to make our whole allocation and planning process more complex. And we have talented people to manage it. We just did not have the tools to do it. We said this before, we had a lot of manual processes, we were running a lot of things off of Excel spreadsheets. And for the first time, we're going to have real tools to manage the whole inventory managing and allocation process. We are confident, we are going to see significant improvements and benefits over the next year or so with this. Again, I am very confident in the team that we have in place to do that.

And then, on the tone of business which you touched on, what certainly strikes me, is most the building product companies have complained about the business since May or June has gotten much more difficult. And I assume you have seen the same thing. You're stepping up promotions and in advertising. And I guess seeing in your mix, a little bit of a shift. Is that true? I just want a little more clarity on direction of business the last three or four months, and what you have seen happen.

Sure. That goes back to what we talked about a second quarter. Where we saw some strengthening and some higher-level products in March and April. And that really encouraged us, that maybe that trend was going to continue. But then when we moved through June and July, and we talked about this on the second quarter call, that it kind of reverted to what we had seen last year, where it was lower price points and consumer responding more to values. So we kind of took our marketing emphasis, and our promotional emphasis, back to where it was last year, and early part of this year, and focusing on the lower price points. And again, we feel like we are well-positioned to take advantage of that, probably better positioned than a lot of our competitors. And so we'll continue to use that to drive traffic and drive our business.

Your comment, I don't think it was yours or Dan's, but you didn't leverage the advertising. Was that just a comment, that because of the SAP, and the sales shortfall, the ad spending that you spent per dollar of sale didn't leverage, or was there something else implied?

No, it was the topline impact on it.

Okay. Great. Thank you, good luck.

Thank you.

Your next question comes from Laura Champine with Cowen and Company

Good morning, guys. I appreciate your comments on how the implementation impacted your sales trend. And our concern would be how the failure to promptly fulfill orders might impact repeat business? Could you remind us what percentage of your customer base is a do-it-yourself homeowner that might not be back for a few years anyway, and what percentage is a contractor that might be coming back to you week after week?

Contractors are a very small percentage of our business. The vast majority of our business is a homeowner, do it yourself, is a very high to that. Our average ticket indicates that it is a person doing one room at a time. So that repeat business is very important to us, and that is why we were really focused on making sure that if we were late in getting in order to a customer, that we made sure that customer was satisfied. And we will continue to do that. We're going to continue to communicate with those customers, offer them additional values. We don't believe there was any long-term damage to our customer base. I think, that to the outside world, Lumber Liquidators is still a great place to buy a hardwood floor.

Thank you.

Our next question comes from Peter Keith with JMP Securities. Please state your question.

Good morning, Dan and Jeff. Thanks for taking the question. I had a question on the container cost. And I know you that addressed it on the Q2 call, and it was going to be a gross margin headwind in Q3. I was under the impression that some of the China consolidation effort, was going to offset much of that. So I was curious if the container costs are actually higher than you expected, or did you not get the benefit from China consolidation that you expected?

No. We're still getting the benefit. The cost of actually started to moderate now, but the cost that we capitalized into the actual unit cost that we recognized in gross margin, we sell it at substantially higher still. When we started the year, we knew we were going to losing part of that benefit from last year. And it would take some time throughout the year. But our container costs rose much more quickly this year than we expected. They reached a peak probably in June, and then started to moderate.That said, it was going to be difficult to mirror the gross margin from the third quarter of 2009, because that was probably the pinnacle of the benefit we got from the low cost. Again, 35.5 for the third quarter, stripping out the 30 basis points related to SAP, was pretty much on plan.

Okay. What about then for Q4? I know you had commented on it earlier in the call. So there is some impact from SAP in Q4, and some freight costs. But how should we think about that gross margin for Q4 over on a year-over-year basis?

No question, we're going to have some SAP impact that is still going to still be in the cost of merchandise and in the transportation. But I said earlier, I think we still got the potential to have a much more -- comparable number. The number in the fourth quarter of 2009, I think was the low 35 range. And given how we came through the third quarter, I think it is reasonable to think that is comparable to what we can do this year.

For Q4 specifically, somewhere close to that 35.3?

That is right. Outside of the impact of SAP.

Yes. Okay, great. One last question just on SAP, I know this was really phase one that you had just implemented. And you still have two more phases for next year. Do you have any concerns about those follow on implementations? I know there are little bit lighter than what you just went through, but how should we be thinking about the impact of those later implementations in 2011?

This was the big one. We had to do it this way. The architecture of our previous system did not allow us to implement in phases, so we really had to do all of the big pieces at the same time. Anything, whatever, the stuff we do in the future will not be as big or as impactful.

Okay. Thanks a lot, and good luck with the rest of the year.

Thank you.

Our next question comes from Rick Nelson of Stephens. Please state your question.

This is Nate in for Rick, and most of my questions have been answered. But could you remind us of the monthly comps for the third quarter of 2009, did they get progressively harder, as you went through the quarter?

They were inconsistent in 2009. I think the final number we ended up with was up 1.8, or something like that. They did not get progressively or dramatically difficult as the quarter went on, which is one reason why we were running 7.3% up against a decent seven-week number, prior to the implementation.

So they were just kind of steady in each month? They were consistent, I should say?

Yes, there is some seasonal shift in there, the dollars shift as we headed towards the September month, off of July. So generally, the dollars increase each month, but from a percentage standpoint it didn't get dramatically more difficult.

Okay. On the direct shipment the side of things, I think you said 23% of your shipments were direct this quarter. Where do you see that going, and if you could help us break out or help us understand by the end of 2011 for you expect that to be?

There is a -- that number has the potential to shift, based on the domestic transportation rates. Where we opened some of our new stores, helps determine whether product is going to flow through China consolidation, whether it is going to go direct from the mill, or whether it makes sense to deliver from (inaudible). Obviously stores closer to the west coast have the greater opportunity to the serviced directly from Asia. Stores towards the center of the country, depending on domestic transportation routes. We were pleased with the third quarter percentage. Is there opportunity to improve that percentage? Definitely, and that is one of the challenges and yet, opportunities that lies ahead for us in 2011

Thank you, and one follow-up or one other question. Looking at the fourth quarter guidance, and the commentary from the last question, that would imply that SG&A as a percentage is going to be up significantly over the prior year. Is that more of a function for delevering on a lower comp? Or something else that was going to be in there, and I apologize if I missed it, or is there something else that was going to be in, that is raising the expense ratio?

There is obviously there are payrolls that have been trending higher, occupancy with the store base. We are trying to be reasonable about our other expenses, whether they are SAP related, or whether they provide us opportunity to continue to work on our promotional programs with the discount rates.

And think that is a reflection of the productivity not being back at 100% yet. So it is taking more time to do everything, costing him a little bit more to do everything. So that trend should continue to improve, but we are not expecting it to be 100% until very late in the quarter early next year.

Okay, great. Thanks for that, and good luck.

Thank you.

Ladies and gentlemen, there are no further questions at this time and I will turn the conference back over to management for closing comments.

Thank you for joining us on today's call. Again, we appreciate you joining us on short notice this morning. We recognize the significance of the issues and we experienced in the third quarter, but we are confident our ability to bring productivity levels back to historical norms, and continuing to generate top and bottom line growth over time. We look forward to speaking with you again soon, and keeping you updated on our progress. Thank you.

Thank you. This concludes today's conference. All parties may disconnect now.