LL Flooring Holdings Inc (LL) 2010 Q4 法說會逐字稿

Good morning, ladies and gentlemen, welcome to Lumber Liquidators fourth quarter and full year earnings conference call. With us today from Lumber Liquidators is Jeff Griffiths, CEO; Mr. Dan Terrell, CFO; and Mr. Robert Lynch, President and COO. (Operator Instructions) 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 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 financial performance of Lumber Liquidators. Although Lumber Liquidators believes that the expectations reflected in its forward-looking statements are reasonable, it can give no assurance that such expectations or any of its forward-looking statements will prove to be correct. Important risk factors that could cause actual results to differ materially from those reflected in the forward-looking statements are included in Lumber Liquidators filings with the SEC. The information contained in the call is accurate only as of the date discussed. Investors should not assume that the statements will remain operative at a later time. Lastly, Lumber Liquidators undertakes no obligation to update any information discussed in this call. Now I'm pleased to introduce Mr. Jeff Griffiths, CEO of Lumber Liquidators. Jeff.

Good morning, everyone. Thank you for joining us for our earnings call today. With me on the call are Dan Terrell, our CFO, and Rob Lynch, our recently appointed President and COO. Before Dan and I get into a review of our fourth quarter and full year performance and discuss our outlook for 2011, I would like to welcome Rob for our organization. Rob has almost 20 years of experience in retail operations and management and it's a unique combination of strategic, functional and real world experience that we believe will prove to be very beneficial in his role at Lumber Liquidators. Rob has really hit the ground running and his energy is very motivating to our entire team. We are all very excited to have him on board and look forward to the new ideas, capabilities and other contributions he will bring to our organization.

As we look back at 2010, the year is a story of two halves. The SAP implementation we completed in August and the productivity issues we experienced due to this implementation in the back half of 2010 significantly impacted our full year performance. However, I don't want to focus only on the challenges we faced and lose sight of the strengths of our business model, value proposition and growth strategy. The fundamental strengths of Lumber Liquidators remain in place and we continue to have additional opportunities ahead of us.

We experienced solid momentum in our business through the mid-point of 2010, and achieved the highest quarterly sales and net income in the Company's history in the second quarter. Our unique value proposition of price, selection, quality and availability continued to resonate strongly with consumers and drive strong foot traffic throughout the year. We also maintained our commitment to key long-term growth initiatives during the year, even while focusing on improving our execution following the SAP implementation. We continued to focus on enhancing our value proposition with our expanded product assortment, made additional progress in our China supply chain initiative, successfully extended our footprint ,and gained further share in the wood flooring market.

Briefly touching on several highlights from the year, we achieved a 13.9% increase in total net sales. As I noted, consumers continued to respond very positively to our value proposition and expanded product assortment throughout the year, as we remained committed to increasing our in-stock inventory position. The SAP implementation significantly impacted third quarter sales and we continued to see residual productivity challenges in the fourth quarter. However, our team focused on converting open orders into completed sales and reducing open demand. As a result, we had reduced our customer deposits significantly by year end, close to historical levels. For the full year, we generated comparable store net sales growth of 2.1%, with a return to positive comparable store net sales in the fourth quarter. For the full year, net sales continued to benefit, as we increased the number of customers served at comparable stores. While the number of customers invoiced in the second half of the year declined, this metric returned to an increase in December. Additionally, we saw increases in our average ticket through each quarter of 2010, and in the fourth quarter, experienced our first year-over-year increase in average tickets since the first quarter of 2008.

New store openings continued to contribute to our top line growth for the year. We achieved our expansion goals for the year with the opening of 37 new stores, 10 of those in the fourth quarter. To date in 2011, we have opened an additional seven locations and we now have 230 locations in 46 states. This expansion is a key component of our long-term strategy to grow our sales and market share and we plan to further expand in the United States in 2011 as well as enter Canada, our first international market.

There were several factors that impacted our gross margin throughout the year. Most significantly were higher transportation costs as we shipped a greater number of units during the year, due to our continued growth, and saw increased container costs on a year-over-year basis. In the second half of the year, we also absorbed additional transportation costs as we worked to fulfill orders that had been delayed due to SAP related issues. In particular in the fourth quarter, we chose to prioritize customer satisfaction and service, offering free delivery for certain orders and moving product from one store to another, in order to expedite delivery to customers. Additionally, in certain instances, we made price concessions on delayed orders to improve the customer relationship. Overall, we believe that ensuring customer satisfaction, while impacting gross margin in the short-term, was the right long-term strategy for the business.

Somewhat offsetting this margin pressure, we continued to leverage our China supply chain initiative and have made further progress with our planned increase and direct-to-store shipment levels. We maintained our commitment to adding more stores and products to our China supply chain initiative during the year, with approximately 25% of our store base being part of this initiative as of year end. We expect to continue to add stores in 2011, and the benefits will further expand long-term. We are also committed to increasing direct-to-store shipments across our store base, which will result in reduced time in transit and additional transportation savings. While SG&A expense grew as a percentage of sales for the year, we leveraged advertising expenses. We focused on increasing the ROI of our advertising initiatives with success to date in our efforts as we raised our level of advertising through direct mail, television and Internet search.

Let's spend a moment on our overall market and go advertising strategy, we have also been increasingly investing marketing dollars in new arenas such as online and mobile platforms, including website enhancement and mobile phone applications that offer greater customer interaction than traditional advertising methods. At the same time we have been scaling back on initiatives that are not producing the returns that we now expect from our marketing dollars such as certain sports sponsorships as well as personality and radio endorsements.

One last thing I would like to review is our inventory position at year end. As you know, we completed a planned build in inventory ahead of the SAP system implementation and our levels at the end of the third quarter on the total basis and per store were higher than expected. During the fourth quarter, we focused on returning to normalized productivity levels, completing open orders and reducing customer deposits to be more in line with historical year end levels. As a result, we successfully reduced our inventory position in a controlled and deliberate manner and ended the year closer to our target per store level of 570,000 to 590,000.

As 2010 came to a close, we'd steadily regained traction and are pleased to have ended the year on a stronger note. While we encountered unexpected challenges during the year, our business model and growth strategy have proven to be resilient. We made progress in our key growth initiatives and gained additional market share in the wood flooring market. At the same time, we addressed the issues encountered during our new system implementation. Ultimately, I believe we are well positioned to continue to enhance our value proposition, expand our store base, gain market share and drive top and bottom line growth in the coming year, and over the long-term. I'd now like to turn the call over to Dan for a detailed review of our fourth quarter financial results and our 2011 outlook, and then I'll return with closing remarks on our performance to date in the first quarter and initiatives we are focused on for 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 fourth quarter and full year 2010 and then discuss our outlook for 2011. I'll start with our results for the fourth quarter. Net sales for the three months ended December 31, 2010, grew to $153.2 million, an increase of 11.8% over the fourth quarter of 2009. Net sales at noncomparable stores increased $14.5 million, and net sales at comparable stores increased 1.2%. This fourth quarter increase at comparable stores compares to an increase of 5.5% in the fourth quarter of 2009 and follows a 5.7% decrease in the third quarter of 2010. We believe our net sales in the fourth quarter of 2010 were adversely impacted by our reduction in productivity, following the SAP implementation. As many of you remember from our third quarter disclosures, the key challenges we identified for the fourth quarter were timely service of the significant billed and open orders and to increase in-store comfort with a new functionality to serve new demand. As Jeff indicated, fourth quarter net sales benefited from the satisfaction of a significant portion of the open customer orders that had built at the end of the third quarter. However, we believe this benefit was more than offset by inconsistent servicing of new customer interest interrupting the normal sales cycle, followed by customers either delaying or eliminating conversion of that interest into an open sale or an open order.

Throughout the SAP implementation, we experienced very little change in the earliest evidence of consumer interest in our products, including activity on our website due to reduced productivity subsequent to implementation however, many of our operating metrics gauging next steps in the sales cycle, such as the in store distribution of catalogs and boring samples, declined in comparison to the prior year from the August implementations through November, only turning positive in December. Though we recognized inconsistent servicing of demand would result in an adverse net sales impacts, our efforts were dedicated to converting the open orders built through the end of the third quarter into invoice sales and our fourth quarter sales did benefit from those efforts. 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 deposit. Historically, our customer deposits have represented between one-half and two-thirds of our open orders. We do not recognize revenue as an invoiced sale until a customer takes possession of the merchandise. Until that time, a customer deposit is a liability on our balance sheet. At December 31, 2010, these customer deposits on open orders were approximately $12 million, up 23% from $9.8 million at the end of 2009, but down $9.3 million from the total balance at September 30, 2010. In 2009, the year end decline from the third quarter was $2.4 million. We believe we've realized the substantial portion of the fourth quarter change through net sales and refunded a small portion of the deposit to customers.

Within the components of net sales, our average sale in the fourth quarter of 2010 was $1,560, an increase of 3.2% from $1,512 in the fourth quarter of 2009, and follows a decrease of 10.7% in comparing the fourth quarter of 2009 to 2008. We believe the increase in the average sale was a result of changes in our sales mix, including demand for our hardwood products. Applying our average sale to comparable store net sales, we believe the number of customers invoiced in our comparable stores decreased 1.9% in comparing the fourth quarter of 2010 to 2009, following an 18.1% increase in comparing the fourth quarter of 2009 to 2008. From January 2010 to August 2010, the number of customers invoiced in our comparable stores increased each month, in comparison to 2009. Subsequent to the SAP implementation, each month was negative until a slight increase in December. Gross profit increased 7.6%, to $52 million in the fourth quarter of 2010, but gross margin decreased to 34%, down from 35.3% in the fourth quarter of 2009. Of the 130 net basis point decrease in gross margin, we believe net transportation cost increases represented approximately 100 basis points. Certain nonrecurring costs related primarily to reduce productivity subsequent to SAP implementation represented approximately 20 basis points, and certain other costs represented approximately 10 basis points.

Changes in our sales mix, netted to no meaningful difference as the benefits of increases in certain higher gross margin categories, such as moldings and accessories, were offset by increases in certain hardwood and deal products. The increase in transportation costs was primarily a result of higher international container rates, which reached a peak in the summer of 2010, with an average cost increase of more than 50% over the average cost we paid in the summer of 2009. These costs become a part of the related product's unit costs. And given our current inventory turn of once every four months, the impact on the fourth quarter was most severe. By 2010 -- by December 2010, our average container cost was only 15% higher than December 2009. And in January, 2011, the increase was only 5% higher than January 2010, approximating our historic norm. Our cost of moving units from our warehouse to store in the fourth quarter of 2010 was consistent with 2009 as a percentage of net sales, given the build in inventory we experienced in the third quarter of 2010. However, we drove more miles delivering units between store locations in an effort to better service the build and open orders, and our cost per mile was higher due to increases in the cost of fuel. Partially offsetting these transportation cost increases were increased deliveries direct to our stores from either our consolidation center in China or from our vendor mill partners.

In the fourth quarter of 2010, 23.9% of our unit purchases were received directly at the store, up from 13.8% in the fourth quarter of 2009. We were disappointed our overall sales mix did not offset expected transportation cost increases. As we addressed our open order build and regained in store productivity, our retail price discipline was weaker than we expected. Selling, general and administrative expenses increased 16% to $42.7 million, or 27.9% of net sales for the fourth quarter of 2010, from $36.8 million, or 26.8% of net sales for the fourth quarter of 2009. We believe fourth quarter 2010 SG&A expenses included approximately $400,000 in nonrecurring incremental expenses related to the SAP implementation. Otherwise, the increase in SG&A expenses as a percentage of net sales for the fourth quarter of 2010 reflects increases in occupancy costs due primarily to our store base expansion, maintenance and support expenses subsequent to SAP implementation, depreciation expense, certain bank card discount rates due to the greater use of extended term finance, and certain nonstore operating expenses.

Leverage of our national advertising spend partially offset these increases in expenses as a percentage of net sales. Nonstore operating expenses included increases in certain state and local taxes, insurance, certain executive recruiting fees, and our investment in Canadian operations. Other income, which includes interest, was $208,000 for the fourth quarter of 2010, compared to $110,000 for the fourth quarter of 2009. The effective tax rate was 38% in the fourth quarter of 2010, compared to 38.9% in the fourth quarter of 2009. The 2010 effective tax rate decreased primarily due to certain reductions in state income taxes and excess tax benefits on stock option exercise. Net income for the fourth quarter of 2010 was $5.9 million or $0.21 per diluted share, based on approximately $28.3 million weighted average diluted shares outstanding. Net income for the fourth quarter of 2009 was $7.1 million or $0.25 per diluted share based on approximately $28.1 million weighted average diluted shares outstanding.

I would now like to discuss our results for the year. Net sales for the year ended December 31, 2010, grew to $620.3 million, a 13.9% increase from $544.6 million for 2009. Net sales at comparable stores increased 2.1%, and net sales of noncomparable stores increased $64.2 million. As Jeff mentioned, 2010 was a year of two halves. In our comparable stores, net sales increased 6.7%, in comparing the first six months of 2010 to 2009, and decreased 2.3% when comparing the second six month period. Gross margin for 2010 was 34.8%, a decrease of 95 basis points from 35.7% for 2009. Higher transportation costs, loss of productivity, following the SAP implementation, less efficient finishing and certain promotional pricing in the first half of the year were the primary reasons for the decrease in gross margin. We currently believe our gross margin in 2011 will return to levels closer to those in 2009 as transportation costs monitoring, logistics initiatives are implemented and promotional pricing is controlled.

SG&A expenses in 2010 increased 15% to $173.7 million, or 28% of net sales from $151.1 million, or 27.7% of net sales in 2009. We increased our investment in salaries, wages and benefits, occupancy costs and certain other operating expenses at a greater rate than the increase in net sales, partially offset by national advertising leverage. The effective tax rate for 2010 was 38.5%, down from 39% in 2009. Net income for 2010 was $26.3 million, or $0.93 per diluted share, based on approximately 28.2 million weighted average diluted shares outstanding. Net income for 2009 was $26.9 million, or $0.97 per diluted share, based on approximately 27.7 million weighted average shares outstanding.

Turning now to our balance sheet and cash flow, we ended the year with $34.8 million in total cash and cash equivalents, down from $35.7 million at December 31, 2009. Our operating activities provided net cash of $17 million for the year ended December 31, 2010, including $14 million in the fourth quarter. In 2009, operating activities provided net cash of $7.8 million, using $18.6 million in the fourth quarter. Changes in our inventory and related accounts payable timing had the most significant impact in comparing the cash flow in the fourth quarters. Total inventory balance at December 31, 2010, was $155.1 million, up from $133.3 million at December 31, 2009. Total inventory decreased $1.8 million during the fourth quarter of 2010, and increased $29.2 million during the fourth quarter of 2009. Our available inventory per store was $611,000 at December 31, 2010, up from $588,000 at December 31, 2009, but down significantly from $670,000 at September 30, 2010. As I mentioned earlier, productivity was strengthened during the fourth quarter and, as a result, we satisfied a significant portion of our open customer orders at September 30, 2010.

Our available inventory per store was above our target level as we continued to carry slightly higher levels of key products, including moldings and accessories, engineered hardwoods and certain deal products. Working capital was $146.1 million at December 31, 2010, up from $124.1 million at December 31, 2009. And the current ratio was 3.6 times and 3.2 times respectively. Capital expenditures totaled approximately $20.5 million for 2010 and $11.4 million for 2009. The primary increase was capitalized hardware and software costs related to our SAP system, totaling $11.3 million in 2010 and $3.9 million in 2009.

Before discussing our outlook for 2011, please note that our 10-K provides an update on the timing, as we understand it, with regard to the international trade commission and their consideration of a petition filed by certain domestic manufacturers of multi-layered wood flooring, commonly referred to as engineered hardwood. The department of commerce is currently conducting countervailing and anti dumping duty investigation with regard to certain engineered hardwoods imported from China, with preliminary duty determinations expected in March. At that time, importers of multi-layered wood flooring from China will pay any applicable duty on subsequent imports into escrow, pending a final determination by the ITC, expected later this year. Although the scope of the products which may be subject to additional duties has yet to be determined, approximately 7% to 9% of our 2010 sales mix was engineered hardwoods manufactured in China.

Turning now to our outlook for 2011, we are providing more details on the expected results throughout the year than typical, given our expectation of fairly significant variance, between results in the first and last six months of the year. Taking into account current expectations for sales cycle recovery, market trends and visibility, we expect the following results for 2011. We currently expect net sales for the full year in the range of $700 million to $730 million, which includes a comparable store net sales increase in the low to mid single digits in 40 to 50 new store locations, including our first locations in Canada. We expect total net sales increases in the first half of 2011 in the low to mid single digits, followed by increases in the high teens to low 20s in the back half of the year. We expect gross margin expansion in 2011 as transportation costs moderate and initiatives and logistics, product planning and allocation, and store operations are continued or implemented. Our SG&A structure post SAP implementation is heavier, with regard to system maintenance, and certain legal and professional fees are also expected to be higher in the first half of 2011. In addition, due to changes in the timing of certain marketing and branding programs, we expect advertising expenses in the first half of the year to be greater than those in the second half. Finally, we expect to open a greater number of stores in the first half of 2011 than in any prior six month period, and those include our first Canadian stores. These openings will initially increase SG&A as a percentage of net sales.

We expect 2011 earnings per diluted share in the range of $1.10 to $1.28, based on a diluted share count of approximately 28.5 million shares and an effective tax rate in the range of 38.5% to 39%. As noted on our release, we expect earnings per diluted share to be lower than 2010 in the first half of the year, with a significant year-over-year increase in earnings per diluted share in the back half of 2011. We expect capital expenditures in the range of $16 million to $18 million in 2011, which includes investments in new stores, equipment, including our finishing line, and software to enhance our technology solution and website. We expect to be free cash flow positive in 2011 and remain free of long-term debt. I'll now turn the call back over to Jeff for his closing remarks.

Thanks, Dan. We are looking forward to 2011 cautiously, but with great enthusiasm. Our team is reinvigorated by the prospect of being able to offer our value proposition to customers with our productivity challenges largely behind us. The sales and earnings we are expecting for 2011 translate to strong double digit top and bottom line growth. Our ability to achieve this growth is due to our proven and resilient business model and our strong value proposition, which continues to resonate with consumers. That said, I want to ensure understanding of how we expect our performance will trend throughout the year and note some of the current trends we are seeing in our business.

As Dan noted, we anticipate earnings will decline year-over-year in the first two quarters, while we expect significant earnings growth in the third and fourth quarters. Providing some additional color, we were up against very strong results for the first and second quarters last year. We expect the economic environment and consumer spending to remain somewhat challenging in 2011 and we've seen this to date in the first quarter. We have also experienced impact to our business from the severe winter weather in January. In addition, while our operating productivity has returned to pre-systems implementation levels in the first quarter, we entered 2011 with less of a forward-looking view on new sales generation. We've only begun to focus on identifying new sales opportunities at the level that is typical for our business, as the first quarter has progressed. Typically, we have an order generation process, that involves a request for floor samples, capture of contact and project information, and customer follow-up. Due to our team's strong focus during the fourth quarter on servicing the large number of orders we had open and reducing customer deposit to close to normal levels, our servicing of new customer interest was inconsistent and efforts on new order generation were not as great.

Dan mentioned this earlier in his review of our fourth quarter results, and you'll recall we discussed this on our third quarter conference call as we considered what residual effects the SAP implementation may have on our operations in 2011. Our associates are now very comfortable with the new system's functionality to serve customer demand and we have enhanced our efficiency as well as the flow of product through our supply chain. We have also now increased our efforts toward generating new demand and providing appropriate and consistent service to new customers. While we are seeing a combination of internal and external factors affecting our business trends in the first quarter and remain cautious in our near term outlook, we are pleased with the progress that we have made to date in 2011. We anticipate our performance will continue to improve as we further strengthen our execution and focus on new sales generation as well as approach the warmer, seasonally stronger months ahead. Ultimately, we believe that we will gain momentum as the year progresses and we are confident we can deliver solid growth in sales and earnings in 2011, weighted toward the back half of the year.

As we move through 2011, we expect to further enhance our capabilities and capitalize on opportunities to gain sales momentum and market share. Increasing our store openings comparable to prior years, we expect to open 40 to 50 locations in 2011. We see an opportunity to maintain this increased level of openings on an annual basis in the future. We anticipate that approximately 35 to 40 of our openings will be in the US this year, with the remainder in Canada. Our team is excited to be entering Canada, our first international market, later this quarter. Wood flooring is a greater percentage of overall flooring in Canada than in the US and we believe our value proposition will prove to be very popular in this new market. As most of you know, our low cost, flexible store model enables us to quickly generate a strong return on capital when opening new locations, whether in new or existing markets, and we believe that this will hold true for our international expansion as well.

As a result of the progress we made in reducing our inventory during the fourth quarter, we are in a much better inventory position. This inventory reduction has been a controlled decline and has had no negative impact on sales. We remain confident in our ability to effectively and efficiently manage inventory going forward. As a reminder, we will continue to focus on optimizing our in store inventory through our never-out-of-stock program, which has already positively impacted our business. We see additional opportunities to refine this strategy to further enhance our performance.

Turning to our approach to advertising and promotional activity, as you know, we believe it is our unique value proposition, which includes attractive pricing, which draws customers to our stores. Given our expectation that the economic environment will remain challenging in 2011, our value and pricing messages will remain a component of our advertising approach. As I mentioned earlier, we are taking a much more efficient approach to advertising in order to further increase the ROI of our marketing spend, while simultaneously increasing the effectiveness of our consumer outreach. With the new capabilities of our IT system and our leadership being strengthened with the additional of Rob Lynch to our team, we believe there are additional opportunities to further enhance our value proposition to our customers as well as increase the discipline and efficiencies across our organization.

Looking ahead, our focus has not changed. We anticipate strengthening our operations, including increasing our focus on pricing discipline and consistency, continuing to improve our in-stock and merchandise presentation and leveraging processes that better support our never-out-of-stock strategy, increasing attachment rates for moldings and accessories, continuing to ramp up our China supply chain initiative under the oversight of our planning and allocation team, and increasing direct-to-store deliveries. We expect these initiatives to contribute to overall improvement in our performance and result in gross margin expansion for the full year, compared to 2010.

We are confident that despite our recent growing pains, improvements to our business are putting Lumber Liquidators in a much stronger position for the next phase of its growth. Importantly, we remain committed to further enhancing our value proposition to improve our competitive advantage and expand our market share. Our debt free balance sheet and financial flexibility put us in a strong position to execute on the initiatives that I've mentioned today. We are 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 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 and economies in scale to position the Company for sustainable growth and operating margin expansion. Before we turn the call over for your questions, I would like to thank our associates for their ongoing efforts and I would like to allow Rob to make a few brief remarks. Rob.

Thanks, Jeff. Good morning, everyone. I'm excited to have recently have joined Lumber Liquidators and feel this is a great opportunity for me and for the Company. I appreciate Jeff's earlier comments and I'd like to also say that the team has welcomed me with open arms. The excitement and energy is contagious all the way around.

I've had a chance to spend time with our broader management team as well as with many of our employees in the field and in our DC's. While everyone has been working diligently in recent months to address challenges of the SAP implementation, it is crystal clear to me that our value proposition is more relevant than ever, that we have a strong and passionate organization, and that the Company has a solid foundation in place. I have been very impressed with what I've seen in my first few weeks in the Company and feel better than ever about my decision to join this wonderful team. I also want you to know that I'm a quick study. And it was ingrained in me early in my career at Walmart, through Sam Walton, that to be a successful retailer, you only have to focus on two things. Number one, know what in the culture and value proposition makes your Company special and protect and nurture it. Number two, no matter how good you are or how big you get, never, ever become complacent and ensure you relentlessly work on continuously improving your operations. That being said, going forward as we continue to grow and expand, I see many opportunities to further improve our operation's end results. I am looking forward to continuing to work with all of our vendor partners and the management team to help strengthen our merchandising and product allocation strategy, bolster our logistics capabilities, and enhance the customer experience throughout our growing store base. We'll now turn the call over for your questions. Operator.

(Operator Instructions) Thank you. Our first question comes from Brad Thomas with KeyBanc Markets. Please proceed with your question.

Thanks. Good morning, Jeff and Dan and Rob, welcome to the team.

Good morning.

First of all, I just want to talk a little bit more on current sales trends and the outlook for the first half. I was hoping that we could try and peel things apart a little bit. Obviously, there's a number of factors affecting your business between the weather, the customer deposits that you've been working through last quarter, the slower new order generation. Jeff, when you look a little bit more closely at what you think that hardwood flooring demand has looked like through the fourth quarter and into the first quarter here, could you just give us a little bit better sense of what you think the overall industry trends look like?

Sure. First of all, I think that the trends that we're seeing are pretty consistent with what we've seen really the last few years, in that the consumer is very cautious, they're spending a lot more time to make decisions, and they're being driven by price and promotion. They're looking for lower priced product, they're looking for more value product. And that's been really, really consistent with what we've been seeing for quite some time. And we think we continue to be in the best position to take advantage of that. The one thing -- excuse me -- that we realized was a struggle for us in the fourth quarter, just as we said, that as we were so focused on getting our productivity back and filling those older orders that we really lost sight, that we weren't serving the new customers who came into the store at the same level of consistency that we had in the past. And that has had an impact on current order generation and sales fulfillment. We don't feel like that this is a long-term issue. But we do feel like that we certainly -- as we were focusing on recovering, that we missed that and we underestimated the impact that it was going to have on near term business. But we feel like we're -- we've gotten all that past us now. We feel like the customer contact lists and all that is working very well, working as it should. And the stores are getting comfortable with the system. But going forward, it's still going to be all about a cautious consumer looking for value, looking for low prices, taking advantage of that. And, again, as I said, we feel like we're well positioned to continue to take advantage of that and gain share as a result of it. And, again, you look at all the disruptions that we have had to the business. We were still able to gain share in the back half of the year last year.

Right. Right. So if I -- if your -- if I understand your guidance for total sales for the first half correctly -- is my math right, in that it implies comps being down around mid single digits?

That's a potential, Brad. We think the total sales low to mid single digits increase, which was likely going to result in a negative comp store.

Okay. And as you start to focus more on that service aspect of the in-store experience and new order generation, what's the typical lead time? Could we start to see an improvement in the second quarter? Or does this tend to take a couple of quarters to flow through?

I think it began impacting us in even the third quarter. And we caught the full brunt in the fourth quarter. We're cautious about the first quarter. Probably a greater impact on the first quarter than the second. But there's certainly still some potential for it to impact us in the second quarter. The sales cycle varies based on the customer, the species, and the use of the floor. And then, at the importance of working with the store manager, is to get a fuller understanding of that. It could be anywhere from weeks or it could be up to months. But we feel like this will likely be contained in the first six months of the year.

Great. Then I appreciate the update on the anti dumping duties during the prepared remarks. Was just hoping to get perhaps a little bit more color on perhaps the options that you would have in the instant that those were put into place. And as we think about your guidance, what's assumed as far as the anti dumping policies?

Sure. Just remind everybody that the engineered flooring product that we get from China was somewhere between 7% and 9% of our business last year. It has not yet been determined whether all of those products will be included in this. Our assumption at this point would be somewhat -- the number skews would be somewhat less than that. We have been preparing for the possibility of that happening with a number of alternatives. One is that it if the duty is not that severe, we could continue to purchase from our existing suppliers and most likely still be below market in our pricing. We are looking at some possible domestic sources. We're also looking at some sources outside of China. So, we feel that we have a number of options and that we'll have the opportunity to prepare for it -- that it's not going to have a material impact on our business.

This is Rob. I'd like to chime in as well. We are also working very closely with our top vendors around this issue. They are aware of it. They're helping us on all of these alternatives as well as the whole merchandising organization is -- on top of it, to Jeff's point. The details and tactics underneath are being worked on and put together, to Jeff's point, to mitigate it and make sure it's non material.

Okay. So, at this point -- not expecting a material impact on the business?

No.

Great. Okay. Thanks so much, Rob. Thanks, Jeff.

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

Thanks a lot. And good morning. First of all, just a follow-up on the sales question. I guess the fact that the comps are going to be under pressure in the first quarter makes this backward looking question a little less relevant. But when you look at the comp and you look at the business that was -- the customer deposits that were cleared, it looks like the newly written business you fueled during the quarter was down, and I just wanted to make sure that was an accurate assessment.

That is a fair assumption, yes. That probably we benefited more from -- the comp performance in the fourth quarter benefited somewhat from the backfill of -- the backlog of orders from the third quarter.

Got it. The second question relates to your inventory posture. As I listened to your comments on the call today about where you expected to take inventory -- where you took inventory -- and where you expect to taken inventory by the end of 2011, you seem to be a bit more disciplined, if you will, or focused on inventory reduction than you have been a quarter ago. And there seemed to be more of a strategic focus on in-stock and having the product to confirm your competitive position and make sure the customers got quick fulfillment. Is that accurate? Was there a change of heart or change of thinking?

No, it's not a change of thinking. It is just managing more efficiently. The in-stock -- we believe that we can continue to improve the in-stock position on top products and reduce the average inventory per store. And I've said this a number of times last year, that the never-out-of-stock strategy is great strategy, poor execution. And we've reorganized the planning and allocation department. We've put more resources in there. We've made good progress in the fourth quarter and will continue to make good progress in managing that. So, I firmly believe that we can achieve both objectives as we move through this year.

The -- a quick follow-up as well. You talked about price discipline. Are you talking about price cuts at the point of sale? Essentially at the discretion of store managers? And, if so, is there an ability to implement procedures that essentially restrict those?

It's always been part of our culture to get the sale. And we don't want to completely change that because we think it's been part of our unique value proposition. But that we need to continue to give stores better support and guidance and training in there. And we really felt like we were making good progress with that in 2009, and the early part of '10. But we lost some visibility with it and, really, our driving goal in the back half of last year was make sure that our customers are satisfied. It's not -- it's our fault that the floors were late or that we didn't meet their expectations. And we've recognized that our -- one of our best customers is that repeat customer and we were going to do whatever we had to do to make sure we kept that customer loyalty. So, we did loosen up a bit on that and it takes awhile to bring those disciplines back. So, we feel like now that we're past the bulk of those issues, that we need to start to rebuild those disciplines. And certainly with the addition of Rob and having stronger field emphasis on that, that we feel confident that we can really improve it.

And just a very last follow-up. You all have a lot of balls in the air and it sounds like the tone of business is difficult. You're opening quite a few stores next year. And, given the uniqueness of the concept, it would seem like you have the leisure or the luxury, if you will, of the delaying some of those openings, if you chose to make sure the operations of the business are shored up. Is that something that you have considered at all?

Yes, we did consider that. And, quite frankly, we felt confident that this is all short-term, it's all imposed -- we imposed this on ourselves. And we fell down and we are getting back up. But we feel that it's a great opportunity to be expanding. And that, long-term, this is going to just be a real benefit for us. So, yes. But we did give that consideration but I think we made the right decision to continue to expand.

Thank you.

Jeff can I give you a little more color on a couple of Matt's questions?

Sure.

I want to back up on the issue around the pricing controls in the stores. And, again, to reiterate how strong the culture is, doing whatever it takes to take care of the customer, it's actually a positive for SAP. And with me here and my time to focus on the field and execution, we have an SAP generated report that tells us exactly how the stores are complying, relative to pricing, that we are managing very closely and I'm working with our field leadership on. And I'm actually very impressed with the execution and follow-up just between the last two weeks on that as we focused on backing on that now that the productivity issues are behind us. So, something that we can definitely control going forward. The other thing too, is if you're going to lay the SAP, Matt to your point, on the never-out-of-stock initiative -- very good program as I'm out in the field. And I think the opportunity that I'm seeing and, again, something that SAP will help with, we can actually take that down more to a local level and understand what products are selling by market and by region. And actually use SAP to help us understand which product should be in stock locally as well and manage that and keep those stores in stock and drive sales. And, again, drive the bad inventory out and the good inventory up in market by market.

Our next question comes from David McGregor with Longbow Research. Please proceed with your question.

Yes. Good morning, everyone.

Good morning.

How many stores are currently behind productivity plan?

At this point, I would say very few. By the end of the fourth quarter, and certainly into the first quarter here, we think we've gotten the stores -- the entire store base up to acceptable productivity --preimplementation levels.

Okay. I guess just to build on the prior point on the SAP and some of the benefits, I'd love to hear some elaboration on what you think you can do now that you've got SAP up and running, in terms of margin improvement. How does this manifest itself into margin improvement? I guess is the question. And how quickly?

There is a lot more visibility to -- as Rob said -- to individual sales performance by store. The stores have much better visibility to add-on products. So, for instance, you as a customer, you come into a store and you pick a certain product -- foreign product that you'd like to buy. When the store enters that product into the system, it immediately tells them all the moldings and accessory products that go with it. Historically, under our old system, we didn't have the ability to do that so the store had to know what the products were. So that's going to be a significant enhancement to helping drive moldings and accessory sales, which is one of our long-term strategic objectives. So -- and that's something that everybody is using today. So that is just one of many examples that we are at. It's just a lot more visibility to trends and opportunities.

I think we indicated, though, that it wouldn't -- we wouldn't begin to see any margin expansion related to SAP alone until possibly in the second half of 2011 and into the following year -- that we weren't really looking for any of the benefits in the first six months. Individual areas are finding themselves with some benefits, and as Rob mentioned, managing the inventory is going to be one of the key benefits on a by store and by region basis. But don't look for that to come across until much later in the year and the following year.

But, again, I think as we leverage that tool -- I'm excited about it, in that I'm really focused on merchandising right now. And as we bring in a new leader in that area, that he or she will have the tools to dig down and seize the opportunities in our assortments on a regional basis because there are regional issues -- I mean, differences in demand. And I think we're going to be able to get a hold of those with the system -- new system. And I'll tell you this -- I want to back up with Jeff said. Coming in as the new guy, in the 20 or so stores I've been in -- before I got here and since I've been here -- to every last person, the store managers feel very comfortable with the tool. You feel that it's not impacting their ability to do their job and take care of customers. And actually, are very excited about the enhancements that it has. And that's a very reassuring and confidence building to me. So that's what exciting. The stores are embracing it. They understand it. They've learned it. They use it. And now I think, hopefully, as we go forward over the next couple of quarters, we'll be talking about some of the benefits we can get out of it now that we've done the hard work and got it in and are getting this one time event past us.

Okay. Maybe just a second question to take the conversation slightly different direction here. Can you talk about your attempts to build the pro business and build a pro clientele? Is it a different value proposition and what is the expected impact on margins and revenues and how quickly?

We've always done some business with the contractors and it was all pretty much left up to individual stores and individual stores developing relationships. We've committed some resources outside of stores to look at opportunities to build the commercial business. It's modest, it is very -- at this point it's very modest expectations with it. But we do think it's an opportunity to target small builders who maybe have been overlooked by some of the competitors in the past. It certainly is a -- generally it's a lower margin business. But it certainly can create some significant revenue opportunities. But again, like we said, it's very small percentage of our total business.

Right. How much lower margin would that business typically be?

Yes, we haven't really identified where that's going to be yet. We just don't have enough experience with it to say.

And then, I know your residential business has been built largely as you've taken share from specialty mom-and-pop flooring retailers. As you would build that pro business, would it be from lumber yards or, I mean, can you talk a little bit about where that share take would occur?

I think it's -- we haven't really targeted where we think it would come from yet. Again, this is just something that we've recognized as perhaps an opportunity because, as I said, we realized that individual stores had some contractors buying from them. But, again, we haven't really targeted a strategic plan as to where we're going to get that yet.

Sounds like this still has a long way to go. Just a last question on the Canadian stores, how should we think about new productivity?

We've got a model not significantly different than our US stores.

Okay. Thanks very much.

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

Good morning,.

Good morning.

My question is on the engineered wood flooring issue. I'm not going to ask you to speculate on -- because we just don't know what's going to come down. But I'm curious. What has happened in the last two to three months in terms of the price of engineered flooring that you're getting, not just from China, but everywhere. What is the availability? Or do you have an inventory cushion of any sort? And how do you see that sort of with what's developed to date for getting what decision may come down in March?

I don't think we've seen any significant change in pricing or availability in the last few months. It is kind of more of a wait and see attitude.

Yes, John, we were a little heavier in engineered product coming off of the build and open orders. But if you remember from the third quarter, we were also launching some new product offerings in that area. So, we're still a little heavier in engineered product, really because of the introduction of some of those products. Not because of specifically the ITC matter.

And then what would be engineered flooring as a percentage of your whole business? You mentioned 7 to 9 roughly, as coming out of China. Where are you getting product? Are you currently getting any from the United States or foreign sources? And if so, roughly how much? Thank you.

I'll start. In the 10-K, we actually break out engineered hardwood from solid hardwood. So when you get a chance to look at that, you'll see we have broken that apart, where we've historically just grouped those two together. Total engineered hardwoods were 11% in 2010, and 7% to 9% source in Asia. The rest of it's North America, Canada and the US.

Okay. Great. And then did I hear you right that wood flooring sales improved as a percentage of the mix? Number one. And then, number two, I got on a little late. If you commented on accessories and what they did as a percentage of the mix in the fourth quarter and any outlook on both of those in 2011. Thank you.

I'll give you the historic piece and let Jeff and Rob comment going forward. Moldings and accessories together continued to gain sales mix, a trend that's continued for a number of years now -- that we're pleased with -- believe it's a strategic advantage. Hardwood sales did edge up in the mix. Contributed to the slight increase in ticket. We -- every quarter in 2010, the ticket actually increased from a low in the first quarter, so sequentially, each going up. Hardwood gained some share -- put a little bit of pressure on gross margin -- still not seeing hardwood at the much higher price points. It's more the entry level and moderate hardwood right now.

Yes. And we expect both of those trends to continue in 2011. The growth in hardwood's going to be at the lower price points and that moldings and accessories will -- growth will outpace the overall Company growth as we continue to drive improvements in our attachment rates.

Great. Thank you.

This is Rob. I'd like to chime in -- go back to the engineered comments. I'll tell you, one of the biggest opportunities I am seeing as I dig into the assortments, interestingly enough -- and it has nothing to do with the ITC specifically, but is more of a business opportunity and strategy -- is our balance of sales in domestic engineered. As you benchmark that and compare it across to our competitors, we have a significant opportunity to enhance that assortment as we go forward. And the teams are looking at that and working on that. I mean, I can't commit to anything right now, but it's coincidentally -- maybe it's luck, maybe it is coincidence -- but I see that as probably one of the bigger opportunities as I look at -- from a sales perspective -- driving comps in the existing comp stores from an assortment optimization perspective. So, I think that now will help us over the engineered business, anyway.

Yes. I agree with that.

Our next question comes from Rick Nelson with Stephens. Please proceed with your question.

Thank you and good morning.

Good morning.

I'd like to ask about draw down and customer deposits during the quarter. That obviously provided a comp lift. Can you give us an idea of what the comps did, ex, that backlog of deposits.

Rick, really hard to break apart that impact. The overall customer deposits decreased about $9 million, from $21 million to $12 million. $21 million at the end of the third quarter to $12 million. And that usually runs between 50% and two-thirds of the open orders. So, it gives you an idea of what the lift coming into the fourth quarter from the third was. Compare that to last year, where the draw down was about $2.4 million. That's the normal seasonal move. And that will give you a bit of an idea on the incremental change. But as far as being able to specifically quantify the impact on the comp sales, it's harder to do.

Okay. Back in the envelope -- using some rough math indicates comp being down about 6%, ex, the draw down of the backlog?

Well, if you draw a round number on the comp, left, we thought the impact of not servicing the sales cycle, completely offset that. And our comp increase was 1.2%. So that will give you some rounded thoughts to look at.

The invoice decline -- the number of invoices is down 1.9%, an indicated (inaudible) I think you mentioned that things improved in December. And I'm wondering what accounted for that? Was there some change in promotional cadence or other factors?

We began to see our metrics improve in December. We were -- as the productivity increased throughout the quarter in the store, we went back to servicing that new demand. So that we saw our metrics turn positive in December for that second step in the sales cycle. Once there is some initial interest and then servicing it with catalogs and in-store samples, follow-up with the store manager -- those are negative post implementation and then turned positive in December gives us an indication that we feel productivity has returned to near pre implementation levels. And it is the first time we saw those metrics positive since implementation.

Yes. I guess, given that backdrop, why would you be guiding to deterioration in those metrics in the first half?

We're guiding to a little bit of a deterioration in sales related to those metrics recovering during the quarter. Just not sure of how long that tail is on the order of process, not being serviced late in the third quarter and through the fourth quarter, until those metrics are reestablished. Because they were reestablished in December, it gave us some idea that they were going to be contained in the first six months, given the sales cycle. But they could have impact in both quarters.

Got you. And then, finally, on the gross margin pressures, I think you called out 100 basis points related to transport. Can you break that down between container costs and that the increased costs that you incurred to service customers, expediting delivery, et cetera?

Yes. The -- not to get it too detailed here. But the container costs -- you've got an adverse impact of the container costs itself being partially offset by the directs that came through China -- consolidation or direct to the store. Probably looking at about 75 to 100 basis points in those areas. Harder to get a handle on the specifics on a by-customer basis. We know we were giving free shipping to some customers to take care of specific issues. We were transferring items between stores to take care of open customer orders. And we haven't grouped all that together and said, this is an impact that's specifically identifiable to servicing that demand.

Just to expand on that, the -- we certainly knew that we were going to have pretty high transportation costs in the fourth quarter. But we felt that our sales performance would have recovered faster than it did. And that we would have been able to focus more on up selling to get some higher margin products into the customer's hand to have better add on sales attachments. But that didn't materialize the way we had hoped it would in the fourth quarter. So, the impact of the transportation cost increases were much more dramatic to our overall gross margin performance than we had hoped.

Thanks for the color and good luck.

Our next question comes from David McGee with SunTrust Robinson. Please proceed with your question.

Yes. Hi. Good morning, everybody.

Good morning, David.

Just a couple of questions. One is, as business seems to be sort of tough here in the first quarter, I'm curious on how your price points would be on a year-to-year basis. Are you -- have you lowered some price on a year-to-year basis or kind of -- what's happening there?

It's more of an opportunistic pricing on promotional products that really drives that more than specifically lowering prices on in-line products. So, no, I wouldn't say that we've actually lowered prices. But again, there's been some overhang of the stores making some additional concessions and getting away from that pricing discipline that we referred to earlier. That's probably had a bigger impact on where the average pricing ends up, as opposed to us specifically changing pricing.

Now with regard to the upcoming tariff, would you begin to nudge up certain prices to offset that?

We really have to wait and see what the impact of the tariff is. If it's minor, it might be something that we can go back and negotiate with the mill. Remember, most of the mills we buy from we're -- maybe all their business or the vast majority of their business, so we do have some opportunity there. We do have some alternative sourcing opportunities that we are looking at. But -- and we also feel like we're not the only ones who are going to be impacted by this. So, I think that ultimately, it could just be that average pricing in this category of product increases, but that our low cost model doesn't change our pricing advantage, vis-a-vis, our competition.

Thanks, Jeff. And just lastly, as you contemplate 2011, do you have a meaningful change in your mix in the assumptions with regard to maybe better demand for wood?

We are assuming that, again, maybe a modest increase in hardwood but basically still at the lower price points. Our mix changes -- we're going to continue to -- we think laminate will continue to grow faster than the overall mix. And that's both an economic opportunity and a marker share opportunity because our share in laminate, historically, has been lower than our share in hardwood. Our -- we're going to continue to drive the moldings and accessory attachment rates higher. And as Rob mentioned earlier, we do think that we have an opportunity in engineered flooring, in that our market share in engineered is significantly lower than our market share in solid hardwood. So, we feel like we have a number of areas for some nice opportunity to move the mix more towards categories that we think will give us some margin benefit.

Great. Thanks a lot.

Thank you.

Our next question comes from Mitch Kaiser with Piper Jaffray. Please proceed with your question.

Good morning. This is actually John on for Mitch. Just looking at your comp guidance for low single digit to mid single digit for next year, what are you kind of thinking in terms of traffic and ticket?

With a moderate increase in hardwood and moldings and accessories attachment, we should see the ticket continue to gradually increase. So we expect through the year -- for the comp increase for the year to be a combination -- a small increase in both ticket and traffic.

Okay, great. And secondly, where do you think you guys can be in next year as a percentage of store base as far as the China supply chain effort? I think you said you're at 25% as of the end of this quarter?

It'll move closer to 30%, maybe a little bit higher than that. Yes. It's still some opportunity there.

Okay. Thank you. Thank you, guys.

Thank you.

Our next question comes from Matt McGinley with ISI. Please proceed with your question.

Good morning. Dan, I have a follow-up question on what you gave for the gross margin guidance for 2011. You said that you would likely -- or you'd potentially could get back to the level you were at in 2009 based on transport costs falling. Yet, when we look at fuel pricing, lumber pricing, resin pricing, all of that has gone up pretty significantly. Does that assumption include pricing? Or are you assuming that your China consolidation and your plant utilization next year will be so good that it can get you back up to that level?

It's a combination of the transportation -- the international container rates as well as some retail pricing discipline that we put in place. And, as you said, some of the logistics initiatives as we continue to shift to a more efficient delivery routes. We do anticipate that domestic fuel costs will be higher 2011, which will take the costs per mile, which puts an emphasis on reducing the number of miles driven. But if we can use more inter-modal, better planning, more direct delivery, lower international container rates, and then combine that with less transportation between stores and better retail price discipline, we should be able to get the gross margin to return closer to the 2009.

What kind of assumptions do you make in terms of what lumber pricing and resin will do in 2011?

Some of the domestic costs may increase. Some of the currency exchanges maybe -- put pressure on pricing. But we believe the relationships we got with our mills will enable us to offset most of those pricing pressures.

Okay. And then second, do you think you'll leverage store occupancy expense in 2011? Or do you think that the new store opening costs will cause you to delever that into this year?

It will probably be flat-ish. It will delever at the beginning of the year. By the time we get to the latter part of the year, we may get some leverage. But certainly as we add a significant number of new stores early we're going to see some deleverage early and then based on the sales ramp thereafter.

Okay. Great thank you.

At this time I would like to turn the call back over to management for closing comments.

Thank you for joining us on today's call. Again, recognizing the challenging environment we are currently operating in, we're looking forward to 2011 with cautious optimism. Our team is focused on executing against our long-term strategy to deliver strong results and position us for continued growth. We look forward to speaking with you again soon and keeping you updated on our progress. Thank you.

This concludes today's teleconference.