LL Flooring Holdings Inc (LL) 2011 Q3 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the Lumber Liquidators third quarter earnings call. With us today from Lumber Liquidators is Mr. Jeff Griffiths, CEO; Mr. Rob Lynch, President and COO; and Mr. Dan Terrell, CFO.

As a reminder, ladies and gentlemen, this conference is being recorded and may not be reproduced in whole or in part without permission from the company.

I would like to introduce Ms. Ashleigh McDermott. 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 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 am pleased to introduce Mr. Jeff Griffiths, CEO of Lumber Liquidators. Jeff?

Good morning, everyone. Thank you for joining us for our earnings call today. Rob Lynch, our President and Chief Operating Officer; and Dan Terrell, our Chief Financial Officer, are also both on the call.

We're pleased with our results for the third quarter as we saw both top and bottomline improvement versus last year's third quarter despite the continuing weakness in the wood flooring market.

To briefly review our results, total net sales increased 16.8% to $172.0 million and came in ahead of our expectations. Comparable store net sales increased 3%. Net income increased 57.2% to $6.7 million, and we opened six new stores.

Rob and Dan will review our third quarter performance in more detail in just a moment, but first I'd like to recap trends that we've been seeing in our customer end market as well as steps we've taken to enhance our unique value proposition for the long term.

As most of you know, our customers tend to be homeowners. Given the ongoing difficult macroenvironment and the consumers' tightened wallet, we continue to see a consumer that is cautious, price-sensitive and promotionally-oriented, especially as they consider large ticket discretionary purchases such as hardwood flooring.

This is a trend that we began to see earlier this year and expect to see at least through the end of 2011. However, even though we operate in a highly fragmented market, we continue to believe that there is opportunity to gain market share among this value-conscious consumer. As such, we continue to tailor our marketing message to call this consumer into action and motivate our sales force to convert their interest into demand for our products.

At the same time, we've undertaken several strategic initiatives that will provide a long-term foundation for strengthening our operational execution and better position the company for growth going forward.

We made some key progress during the third quarter, including strengthening our international sourcing, aligning available inventory levels to demand, bolstering our logistics and distribution team and expanding our facilities and increasing the effectiveness of our advertising and marketing.

I'd like to now turn the call over to Rob for more color on our third quarter results.

Thanks, Jeff. While we currently operate in a challenging environment, we believe our long-term strategic initiatives will fuel our value proposition and drive our growth for years to come.

As Jeff mentioned, our customer is cautious, price-sensitive and promotionally-oriented. While the macroeconomic backdrop remains tough, we continue to move our strategic initiatives forward to gain further efficiencies and ensure that the company is positioned to succeed in this environment.

We continue to invest in our merchandising team, building an organization under our Chief Merchant with experience and vision. Our recent acquisition in China is one of these investments.

As you know, a key competitive differentiator for Lumber Liquidators is our direct relationships with our vendor mill partners. The merchandising team we now have in place allows us to directly manage our sourcing in Asia. And our acquisition provides a seasoned team and strong existing mill relationships on the ground in China.

By taking over direct management of approximately 90% of our purchases from Asia, previously managed by a trading company, we will immediately lower product cost and more importantly strengthen our relationships with the mills.

Our experience has shown that long-term forecasting and planning directly with the mills results in a broadened assortment, better quality and ultimately lower product cost.

On our last call, we discussed strategic line reviews as a component of our sourcing initiatives where we work with vendors mills to evaluate breadth of assortment, quality, logistics and product cost. Our ability to effectively conduct these line reviews with Asia vendor mills is greatly enhanced with an experienced representative office in Shanghai.

We're pleased to have completed initial line reviews of the laminate and engineered hardwood merchandise categories. We expect to see the benefits of these sourcing initiatives in our fourth quarter, and these will build into next year.

We also realized that our enhanced sourcing function must be supported by effective product allocation and efficient logistics and distribution. To that end, we have continued to invest in a seasoned product allocation team, supported by the information provided by our integrated information technology solution.

This allowed us to significantly adjust our available inventory per store going to third quarter without adversely impacting topline results. We expect this combination of experience and information will allow us to maintain and improve our inventory per store, drive sales and more quickly adjust to changes in overall demand.

We're very pleased to announce that Carl Daniels will be joining the company at the end of this month as Senior Vice President of Supply Chain. Carl will report directly to me and oversee our international and domestic logistics, warehousing and distribution operations.

Carl comes to us with over 30 years of supply chain experience, most recently as Senior Vice President of Supply Chain and Operations at Harbor Freight Tools. Carl will work closely with Bill Schlegel, our Chief Merchant, and the team in china to further develop efficient international solutions to our product allocation needs.

Domestically, we noted last quarter the expansion of our distribution resources through our new Hampton distribution center, now in coordination with our facility in Toano. Our expanded operation enables us to more efficiently fulfill customer orders and maintain in-stock needs as part of our never-out-of-stock initiative.

As most of you know, we anniversaried the implementation of our integrated information technology solution in the third quarter. Many of our strategic initiatives rely on the better information we now receive. And the stable platform will enable us to drive continuous improvement in our operations going forward.

In our stores, we continue to emphasize better pricing discipline from our associates at the point-of-sale, as we seek targeted key item promotions and liquidation deals to drive incremental consumer interest. Improved information on inventory availability, including moldings and accessories, assist the store associates with both conversion of interest and attachments rates.

As we have said, we face a challenging macroenvironment and a cautious consumer. Our advertising and marketing approach must coordinate with our merchandising efforts to offer values and excitement which call the customer to action.

As such, we continue to invest in our marketing and branding strategy, and better information allows us to increase the effectiveness per exposure and the efficiency of the delivery. We plan to expand our marketing reach and to promote aggressive price points in order to clearly communicate to consumers that we are the lowest cost provider of hardwood flooring.

Overall, many of the weak trends that we have seen in the market and with consumers in general continue. However, we believe that we will continue to have opportunities through our ongoing initiatives to invest a portion of the benefits strategically into our value proposition by lowering retail prices, making us even more competitive while enhancing gross margin into 2012 and beyond.

I'll now turn the call over to Dan for a detailed review of our third quarter financial results and our 2011 outlook.

Thank you, Rob. Good morning, everyone. I will provide additional details on our results for the third quarter and then discuss our outlook for the reminder of 2011.

As Jeff mentioned, net sales for the three months ended September 30 of 2011 totaled $172 million, an increase of $24.8 million or 16.8% over the third quarter of 2010. This increase was primarily due to our store-base growth, as net sales at non-comparable stores increased $20.3 million.

We have opened 43 new store locations since the end of the third quarter of 2010 with 33 new stores opened in 2011, including six in the third quarter of 2011. We now operate 256 stores, including five in Canada.

At comparable stores, our net sales in the third quarter of 2011 increased 3%, which compares to a 5.7% decrease in the third quarter of 2010. As many of you recall, we believe the implementation of our integrated implementation technology solution in August 2010 adversely impacted our net sales as productivity across our operations was reduced.

In comparing the third quarter of 2011 to 2010, our average sale increased 4.7% to $1,625. And we believe the number of customers served in comparable stores decreased 1.5%.

We believe our customer has remained cautious, price-sensitive and promotionally-oriented with regard to large ticket discretionary purchases. However, when our customer did purchase, a greater preference was shown for premium products across a range of merchandise categories, including laminates, bamboo and selected hardwoods.

As a result, the increase in our average sale was primarily due to a 3.8% increase in the average retail price per unit sold complemented by a slight increase in unit volume, which we generally measure in square feet.

Within our non-comparable stores at September 30, 2011, we have 26 stores operating in existing markets, up from 19 stores at September 30, 2010. In markets with both a non-comparable store and at least one comparable store, we often see a decrease in the net sales for the comparable store for approximately 12 months, but a significant increase in the total net sales of the market.

Excluding the total net sales in markets with both the comparable and a non-comparable store, we believe the net sales at the remaining comparable stores increased approximately 8.3% for the third quarter of 2011.

Overall, our 2011 new stores have generally met or exceeded our expectations whether operating in new or existing markets. Further, our non-comparable stores continue to be less mature on a month of operation basis in comparing the first nine months of 2011 to 2010, though the maturity gap closed significantly in comparing the third quarters. As a result, our new store productivity improved both sequentially and year-over-year.

Gross profit increased 18.3% to $61.2 million. And gross margin was 35.6%, up 40 basis points in comparison to the third quarter of 2010. Overall, gross margin benefited from the continued implementation of our sourcing initiatives, partially offset by net sales mix shifts and a slight increase in net transportation cost.

2011 gross margin continued to benefit from our sourcing initiatives, adding approximately 80 basis points to gross margin in the third quarter. These initiatives included primarily volume-based discounts, vender reimbursement of sample cost and participation in specific promotional programs.

We believe our net sales mix may have adversely impacted gross margin by approximately 30 basis points. Gross margin continued to benefit from increased sales of moldings and accessories as well as certain premium products within our laminate, bamboo, and handscraped engineered hardwood line. However, these benefits were more than offset by the mix of certain hardwood sales with lower than average gross margins, ranging from hardwoods offered at the entry-level price point to certain Bellawood species.

In addition, certain Bellawood product costs in 2011, including finishing, were higher than those in the third quarter of 2010 due to our increased investment in quality control procedures, particularly in our exotic species.

We believe transportation costs, inbound from the vendor mill and from our warehouse to the first sales floor, may have adversely impacted gross margin by a net 10 basis points. Though the impact of our international transportation costs in the third of 2011 was comparable to the prior year, our domestic costs were generally higher due to fuel.

Further, due to the build of the in-store inventory at the end of the second quarter and coordinated efforts to reduce total available inventory per store, we've reduced direct shipments received by our stores to 19.9% of our total unit receipts from 23.7% in the third quarter of 2010.

Finally, in the third quarter of 2010, we believed less efficient unit flow following our system implementation had reduced gross margin by approximately 30 basis points. In the third quarter of 2011, those adverse factors no longer existed.

Selling, general and administrative expenses were $50.3 million or 29.3% of net sales for the third quarter of 2011 compared to $44.9 million or 30.5% of net sales for the third quarter of 2010. Note that SG&A expenses in both the third quarter of 2011 and 2010 included approximately $500,000 in costs we would consider non-recurring.

As previously disclosed, we acquired certain quality control and assurance, product development and logistics operations in China, and SG&A expenses in the third quarter of 2011 include approximately $500,000 in acquisition-related expenses.

SG&A expenses in the third quarter of 2010 included approximately $500,000 in non-recurring costs related to our system implementation primarily for additional support resources. Exclusive of these non-recurring amounts, SG&A as a percentage of net sales decreased approximately 120 basis points to 29% in the third quarter of 2011 from 30.2% in 2010, primarily due to lower salaries, commissions and benefits due to - improved productivity in our operations, store-based growth and a reduction in accruals for certain bonuses, leverage of our national advertising spend and increased efficiency of our direct sales generation programs, sourcing initiatives, which reduced SG&A expenses by approximately 15 to 20 basis points, partially offset by increased occupancy costs and depreciation of our integrated information technology solution.

Our effective tax rate was 39.2% in the third quarter of 2011 compared to 38.7% in the third quarter of 2010, primarily due to increases in certain reserves, higher state income taxes and certain non-deductible acquisition expenses.

Net income for the third quarter of 2011 increased 57.2% to $6.7 million or $0.24 per diluted share based on approximately 28.3 million weighted average shares outstanding. Our third quarter net income includes a net loss of approximately $0.02 per diluted share related to our Canadian operations, in line with our expectations and primarily due to advertising and administration expenses.

Net income for the third quarter of 2010 was $4.3 million or $0.15 per diluted share based on approximately 28.2 million weighted average diluted shares outstanding.

Turning now to our balance sheet and cash flow, we ended the third quarter of 2011 with $37.8 million in total cash and cash equivalents compared to $34.8 million at December 31, 2010, and $26.8 million at September 30, 2010.

Total inventory balance at September 30, 2011, was $160.8 million, up from $155.1 million at December 31, 2010, and $157 million at September 30, 2010. However, our available inventory per store was $585,000 at September 30, 2011, down from $611,000 at December 31, 2010, and $670,000 at September 30, 2010.

Available inventory per store at September 30, 2011, is in line with our expectations and lower than previous 2011 quarters due primarily to our continued investment in product allocation and distribution supported by better data from our integrated information technology solution.

We believe available inventory per store at both December 31, 2010, and September 30, 2010, was elevated primarily due to reduced productivity as a result of our system implementation.

Our inbound in-transit inventory and accounts payable balances at September 30, 2011, are generally lower than previous periods due to the timing and terms of the Sequoia acquisition. And we expect both to return to more historic levels in future periods.

We entered into the acquisition agreement on September 28, 2011, and at that time all outstanding invoices due to Sequoia and included in accounts payable were paid and Lumber Liquidators assumed responsibility for managing all open purchase orders with the Chinese mills.

The acquisition also included $8.3 million of purchase consideration of which $4.7 million was paid in cash. As a result of the purchase accounting, fully disclosed in our 10-Q, goodwill was increased by approximately $8.5 million.

Working capital was $156.4 million at September 30, 2011, compared to $137.3 million at September 30, 2010, with current ratio at 3.9 times and 3.3 times respectively.

Capital expenditures totaled approximately $3.3 million for the third quarter of 2011 compared to $5.7 million for the third quarter of 2010, with the decrease primarily related to fewer expenditures for our integrated information technology solution.

Please note that our 10-Q filed this morning includes our updated understanding of the matter being considered by the Department of Commerce and the International Trade Commission with regard to certain engineered hardwoods. We continue to believe the matter will not have a material effect on our operations.

Turning now to our updated outlook for 2011, we now expect full-year 2011 net sales will range from $674 million to $681 million with fourth quarter net sales in the range of $167 million to $174 million. We expect net sales at comparable stores in the fourth quarter to range from flat to a decrease in the low-single digits.

We continue to expect seven to nine additional new store openings in the fourth quarter, bringing the full year total to 40 to 42.

As we have discussed previously, the significant benefit of both our line reviews and direct sourcing in China result in a reduction in the cost of product. Because our inventory method is average cost, our inventory turnover at the product level will dictate when these lower costs benefit our periodic cost of sales.

We continue to expect benefits in the fourth quarter of 2011, but we now believe a certain portion previously estimated for the fourth quarter will instead begin in 2012. As a result, we have reduced our expected earnings per diluted share in the fourth quarter of 2011 to a range of $0.33 to $0.39 and anticipate a full year earnings range of $0.96 to $1.02 per diluted share.

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

Thanks, Dan. As we look ahead, we remain confident in the strength of our unique value proposition, our profitable store model and our opportunities for operating margin expansion. Our financial position is solid and our operations are aligned to meet the needs of a value-conscious consumer and take share in a fragmented market.

We're past the productivity challenges of our system implementation and we are beginning to utilize the information it provides in support of those long-term strategic initiatives and the more efficient daily operations of our business. We expect the wood flooring market to remain weak. Even so, we are as committed as ever to the core components of our growth strategy which have not changed.

We anticipate further strengthening our performance through our consistent focus on the strength of our sourcing relationships and the supporting logistics, the quality and breadth of our product assortment, our in-stock position and product availability, growing attachment rates of moldings and accessories, a knowledgeable and motivated sales team and effective advertising that combines our national branding message with efficient and exciting calls to action.

We have a strong team in place with a focus on long-term growth to deliver value to our customers and shareholders. Again, we are well positioned to compete effectively in a highly fragmented market and excited about the future opportunities.

We believe that the additional improvements we've been making to our business will continue to contribute meaningfully to our results and put Lumber Liquidators in an even stronger position for growth going forward.

I will now the turn the call over for your questions. Operator?

Thank you, ladies and gentlemen. We will now be conducting a question-and-answer session. (Operator Instructions) Thank you. Our first question is coming from Budd Bugatch of Raymond James.

Good morning, Jeff, Rob, Dan and Ashleigh. This is actually TJ going in for Budd. Thanks for taking my question.

Hi. Good morning.

The question, Jeff, or maybe, Rob, on the change in the sales guidance since the last update. What is it that's happened in the last month? Maybe you can give us a trajectory of the comps over the third quarter and then what you're seeing more recently. What has -- that's changed. Has there been a reduction in traffic or is the increase in ticket moderating a bit that's caused you to take the fourth quarter down a little bit?

This is Jeff, I'll take that. You know, October has not been as strong as we expected it to be. And you know, to point it out, we think we had a very strong end in September, but we're just -- we're being very cautious. We do think that we're starting to see some better traffic over the last week or so. But we just felt it was prudent to be cautious at this point.

Okay, that's helpful. And then on the EPS, Dan, the only other issue is just the fact that you're not moving the inventory through as quickly as you previously expected. Are there any other cost items in there that are affecting that EPS?

Yes, it's primarily a matter of when, not if, at this point. We've got those benefits coming from the line reviews and some of the efforts that we put forth in sourcing including the acquisition. The lower sales turns is going to delay some of that impact.

And the last one from me is a question on the mix. Just to make sure that I understand it, the mix toward the lower-end hardwood products, those are customers that were already in the hardwood or there are some customers in there trading out of some of the premium laminates and such and back into the hardwood, which might actually be a better sign?

This is Rob. I'll take that. It's probably a little bit of both, but it's also -- we've been targeting some promotions in those areas as well. So we would -- some of that was intentional. We drove the mix that way to make sure that we're mixing up our promotions, we have diversity out there, and we're speaking to all of our customers on what they're looking for.

Okay. That does it for me, guys. Thanks for taking the questions and best of luck on the remainder of the year.

Thank you.

Thanks.

Thank you. Our next question is coming from David MacGregor of Longbow Research.

Yes, good morning, everyone. Just while we were on the topic of the line review and the impact, and I understand with the lower sales turn you're going to see some of the benefit pushed out now to early 2012. Over the last couple of quarters, you've given us a little bit of quantitative guidance on the impact of the line reviews. I think it was 50 bps in the second quarter and about 80 bps in the third quarter. What does your guidance for fourth quarter include in terms of contributions from line reviews?

Well, David, the total impact of our sourcing initiatives was 80 bps in the third quarter and 50 bps in the second quarter. And we had talked about it being lumpy. So that really doesn't include much of the line review yet. The line review that we completed in the spring was in laminates. And as Rob said, we completed a second one now. Those benefits can take up to six months or so to come through. It's going to be lumpy and cumulative. The fourth quarter has benefit that's a little bit greater than what you've seen in the other quarters here in 2011 as we begin to see the impact of the laminate line review come in, some of the benefit of the Asian sourcing on top of some of the benefits from what we were calling phase one, which are vendor allowances and specific programs.

Maybe I can take that up with you offline. Help me understand the negative 1.5% traffic comp. I guess you're up against a negative 5.2% traffic comp from a year ago, and obviously that was a disruptive situation a year ago. But could you just talk about traffic trends right now?

We're still struggling with traffic. We are seeing the customer move towards a more premium product, which has increased the average ticket. But for the year now, I think we're -- the traffic is down about 6.5% which is about what the increase was last year. So we are still struggling with traffic. Even though we had a very difficult third quarter last year, we weren't able to comp positive in the traffic.

There has been a lot written and said about home centers kind of dialing up the level of intensity in this category. Can you just talk about the extent to which you feel as though that may have been an influence in your traffic comp?

It might have had a small impact on it, but we don't think it's that significant. The product mix that they're offering is still very limited. We're starting to see signs with the in-stock positions aren't as consistent and as fresh as they were earlier in the year. So we think it's just more of the overall consumer high-ticket discretionary spend challenge than it is a competitive issue. And we feel that the margin benefits that we're going to get from the sourcing initiatives and the fact that we're going to use some of that money to leverage some of our opening price points in our promotions, we feel that we can effect -- compete very effectively against that.

You don't feel the assortment gives you the opportunity to compete against these guys effectively without having to take too much away from margins and take to the market.

We think that the margin impact is going to be relatively small, but it's really just being strategic with some key opening price points to help drive some of the traffic. We think with our well-trained sales force and their ability to really trade up customers to more premium products once we get them into the store, we really think that it's going to be more of a marketing traffic message than it's going to actually impact margin.

Last question. Just, Dan, you talked about new store productivity trends. You didn't quantify them. Can you help us understand quantified terms, just update on productivity trends for new stores?

Yes, in our calculation, we target the mid-50 range. In the third quarter, we were about 60. We expected to be better than the average in both the third and the fourth quarter as the stores -- the significant numbers of store we opened in the first half of the year began to mature.

And is it your intent for 2012 to kind of front-load the calendar as well with openings like you did this year?

We are still looking at 2012, but I think you can count on the first six months having a greater number of openings than the second and may not be as disproportion as 2011 was.

Right, thanks very much.

Thank you.

Thank you. Our next question is coming from Rick Nelson of Stephens.

Thank you and good morning. Can I ask you what you think is happening in the overall market for hardwood floor, laminates, moldings and accessories? As your comps year-to-date are down 3% -- you're up 3% in the current quarter, do you think you're capturing share within the overall industry?

Yes, absolutely we're capturing share. I mean if you look at our overall sales increase for the year, the most recent information we saw for hardwood is basically flat for the year and that laminates are actually down slightly. So we're confident that that overall our business is taking share.

So can I ask you about the line reviews now? You captured the laminates. You've got the new category coming on. What is the timeline for the remaining categories? I guess how much of sales are captured with the current line reviews and what sort of savings are you seeing?

We talked about our engineered hardwood throughout the entire ITC, the matter being -- representing about 11% of our sales mix that we've done the line review of our engineered hardwoods, and we've done laminates which you've seen are greater than 20% of our sales mix.

I think Rob and Jeff have indicated that the line reviews will be done over the other merchandise categories over the next 12 months or so.

Okay. And if you could update us on SAP and the benefits that you're starting to see from that system, that would be helpful.

Sure, this is Rob. As we mentioned, we anniversaried it in the third quarter. And I highlighted on in my comments really it's a foundational system now that's providing a lot of data and new information we need in terms of the focus areas that we are driving in our initiatives. So that's a good thing.

And also, another comment I made is that it gives us the foundation to where and now we can focus on continuous improvement with the operation without having to worry about stability and scale. So we feel good about it. We're past it. We've anniversaried it. And we continue to -- we are focused with the system and continue to fine tune it and drive efficiencies out of it, and we're going to leverage it as we drive on our other major initiatives.

Rick, one of the first tangible benefits that we noted on the call here today, although we've got some great people in product allocation now, the information that we're getting out of the system really helped us manage that available inventory per store back to our expected level.

Great. Thanks a lot and good luck.

Thank you.

Thank you. Our next question is coming from Brad Thomas of KeyBanc Capital Markets.

Hi, guys. This is actually Jason Campbell showing in for Brad today. As far as your Sequoia announcement, you had said that you expect it to be a slight benefit in 4Q. I was just wondering if this holds true in the most recent fourth quarter guidance and also what you kind of see that ramp-up of the benefit going forward into 2012.

We do see a slight accretive benefit in the fourth quarter and it will certainly be much greater in 2012. Again, it's impacting the unit cost on the broader spectrum of products. So it's not as targeted as the line review would be like with laminates or engineered hardwoods. We are going to see benefit in the fourth quarter related to those line reviews as well. It's just that some of the benefit we expected is going to move into '12.

And secondly, you'd mentioned kind of the conversion of your catalogs and samplings. I think earlier in the year, it wasn't as great as you have seen in the past. So I was wondering if you can comment on what you've seen in the last three to six months in terms of how many of those samples are actually turning into sales and are people still waiting just for promotions or are they buying some more at full price?

I think we're still seeing a very, very cautious consumer, similar to what we saw in the second quarter. We're still attracting interest through our advertising, whether it's call to action or branding. We're still seeing the customer interest there. But we're still having a difficult time pulling that customer off the sideline when we're not offering a promotion. So there is a lot of caution, lot of price sensitivity there.

Yes, this is Rob. I can answer that. This is what we're seeing. So we -- thus in my comments, we talked about being very strategic in coordinating across what we're doing relative to the items we're putting on ad, the deal product we're putting out there and how we're coordinating that in the advertising and marketing to convert the demand and to ship sales. So the customer is cautious, and they are being very selective out there. And we know that, but we're doing right now what we need to do to make sure we are the low-cost leader out there in our industry.

All right. That's all I have. Thanks.

Thank you.

Thank you. Our next question is coming from Matt McGinley of ISI Group.

Good morning. My first question is on the payables. You had a drop in payables because of the Sequoia acquisition. Will those payable dollars increase in the fourth quarter to offset that acquisition or will that be a use of cash on a full year basis?

We actually think the payables will go back to a more historic cadence. So it will be fairly comparable to last year's fourth quarter and then commensurate with the change in inventory level.

And my second question, it's kind of a two-part, one on the payrolls. I know you had decent payroll leverage this year or this quarter rather, probably the best you had since you started breaking this out. Granted, it was on a bit of an easy compare because of SAP. But generally, you have a tick-up in payrolls in the third quarter and you said that this was down due to a reduction in bonus accrual. What cost reduction in bonus accrual if you were actually comping positive within the quarter?

And the second part of that is on payrolls as well. When we look at transactions per store over the past couple of years, you had modest increases in traffic in 2009 and 2010 and even with the SAP mishap, you still only had modestly negative transactions per average store in 2010. But in the third quarter and even in the first half of this year, that continued to run down. So my question is kind of a theoretical one. If you continue to have a reduction in transactions per store, does that structurally inhibit your ability to leverage SG&A?

Let me take the first part with the bonus and the payroll, and then I'll let maybe Rob or Jeff comment on some of the traffic. The bonuses that we're referring to were more of the executive and full year bonuses. In store, the store managers are monthly, the regional managers have quarterly. And those are commensurate with prior years. We are disappointed with the numbers for the full year. We targeted the higher numbers of some of the management accruals are less than the prior year, but only about 10 to 12 basis points.

Okay.

This is Rob to your question about traffic in leveraging SG&A. I would say that we're focused on the traffic question, and part of our strategy going forward is just to make sure that we're appropriately reinvesting and driving the price point out there to drive footsteps into the stores. And in general, as we move forward, as we continue to investment in our team, we're full confidant that we'll be able to show leverage in SG&A over time.

Okay, thank you.

Thank you. Our next question is coming from Peter Keith of Piper Jaffray.

Hi, good morning, everyone. I want to dig in a little bit on the mix shift that was negative. And at least from what I can tell, that's the first time that's happened in probably about a year-and-a-half. And in fact, a little bit surprising too that the customers were shifting to more of the premium-priced product when you talk about a fairly cost-conscious customer. I guess should we think about that mix shift going forward continuing to be a slight negative, because I guess your promotions will be targeted on some of those higher-end products?

Well, when we talk about the premium products, we're referring to the premium product within the lower price categories. So it's really in the laminate engineered bamboo categories where we been able to continue to drive more of the business towards the higher-priced products within those categories, but the average ticket on these products is lower than the average ticket in the hardwood. So that's really what we're referring to when we talk about the move to the premium.

And we should -- it's going to be hard to handicap into 2012 with the consumer being as cautious as they are. When we do get them to move, we feel like we've got the greatest price advantage against our competition in the premium category. So we think we're doing a better job moving the customer into those premium categories.

But part of their preference if it continues to be hardwood and hardwood at the entry level price point or hardwood and some of the Bellawood categories where we have a narrower margin, then we may see a little pressure come from the sales mix going forward. I don't know if we would see more than a 50 basis point drag or driver going into 2012 though.

Also, I know historically you've talked about the solid hardwood carrying a lower gross margin rate, but higher gross profit dollars, and therefore your preference is to sell hardwood to your customers. As we think about some of the changes to the laminate category, you have the line reviews, now you're doing the direct sourcing, so you should be seeing pretty meaningful margin expansion in that laminate category. Are you more neutral now to the products you want to focus on from a gross profit dollar standpoint, comparing specifically I guess laminate to solid hardwood?

This is Rob. I would say not necessarily. I mean we want to sell what the customer wants. The way I would frame it is as we go forward in implementing these sourcing initiatives, we're gone to be reaping the benefits of the line reviews that have been done and also the value created by the acquisition. So as those benefits are coming through and as we move forward in the process of looking at every category -- we're investing in our merchandising organization. We're hiring in folks that are experts in these other categories. And we're actually starting -- and we're going to be shifting and looking into the other categories such as the higher premium exotics, the Bellawoods and also focusing on and developing our strategy and implementing it into South American and into those categories as well. So we see opportunity there. We're framing those ideas and initiatives right now and will be our Chief Merchant's focus as we implement in these other areas to the other opportunities that within our categories.

Okay, all right. Thanks, Rob. I had one last question probably more for Dan. It looked like with the SG&A that the expenses were nicely controlled for the quarter. As far as I could tell, it looked like it was advertising that was the main driver. Your advertising dollars were kind of flattish year-over-year and you highlighted you're getting some improved efficiency. Is that kind of a good runway we should think about going forward that advertising dollars could begin turn flattish on a year-over-year basis?

Well, we talked about the fourth quarter usually has the lowest spend. We have been talking about that the second half of this year would have a lower spend than the first half just due to timing of some of the programs. You've noted on the nine months comparison that we've got about 16 basis points of leverage for the year. We still expect 40 for the full year. So you can kind of gauge that for the fourth quarter.

We want to be careful looking forward into 2012. We still expect to get advertising leverage. We're not going to pull-off of the 40 basis points on an annual spend. But because of the cautious nature of the consumer and what's its taken to call them off the sideline, we're still considering whether that spend goes into branding or call-to-action.

Okay, great. Thank you very much and good luck for the rest of the year.

Thank you.

Thank you. Our next question is coming from John Baugh of Stifel Nicolaus.

Thank you and good morning. A couple of things. I think you mentioned Canada was a $0.02 drag in the quarter. Did I hear that right? Can you just give us some color on how Canada is going, how many stores you hope to have going into '012 and what the drag might be in '012 versus '011?

Canada is about where we expected it to be. Going into a new market, we expected the ramp for the stores to be slower than the ramp we've experienced in the US, and we expected some additional marketing spend than we would spend in the US as a percent of total sales. And we have a small number of stores that they're supporting an operation -- home office operation that will be able to leverage that as we continue open stores. But we're about where we expected it to be. We're pleased with the customer reaction to our product mix and our pricing strategy. And so that -- and the flow of product from here-there has worked very effectively. So all that's working well.

We currently have five stores. We expect to open maybe one or two more this year and continue a similar pace next year. So we're about where we expected to be with it.

And, John, I'd just say quantitatively looking into 2012, we would expect the stores to turn positive in 2012. It will no longer be a drag on EPS.

Okay, super. And then if I were to say -- think about the line review savings, and call that in index of 100, how much of that should we expect to fall to the EBIT line versus reductions in price to remain more competitive? And has that ratio -- because I assume it's going to be some of that in this promotional environment, has that ratio changed at all over the last three, six months?

Hi, this is Rob. I'd say we're not going to give you a specific number. I think what we said is our plan is for majority of it to flow through to margin. But the exciting thing is and what it does for us is it gives us flexibility to react out there to make sure that we're the lowest price in each of our categories. So we're going to be opportunistic about it and strategic about it as we go forward.

And just to be perfectly clear, the fourth quarter issue with margins maybe being slightly lower than where you thought previously relating to the line reviews, it's not due to reducing prices further than you thought as much as it is a lower sales forecast which causes the delay of product flowing through the P&L and hitting the lower cost. Is that right?

That's right. It's more a factor of the inventory turn.

And then, Dan, I recall transportation costs were sort of trending down. Could you help us think about transportation cost both maybe in the fourth quarter, year-over-year, and how that looks and then maybe for the first half, at least the next year?

Sure. We had had a drag on gross margin in the first six months of this year, primarily due to some much higher container rates. And March-April, we began having those rates return to a historic level. So about a push in Q3, and we actually should have a bit of a tailwind in Q4 related to the international container rates. Fuel -- domestic fuel dragged all year, offset it with greater direct store delivery, greater use of intermodal versus road. As we look forward into 2012, that's probably still going to be a challenge. It probably won't have the same year-over-year drag that '11 did compare to '10, but still expect that to be a challenge. So Q4 on a net basis, we may actually have a bit of a tailwind year-over-year as international rates offset what may be a challenge from domestic fuel.

Looking forward into 2012, I could envision the international container rates roughly approximating our historic norm, which will give us a bit of a tailwind early in the year and then it will start to level out as the year goes on. And as I said, domestic fuel will probably be a challenge throughout 2012.

Great, thank you.

Thank you. Our next question is coming from Matthew Fassler from Goldman Sachs.

Hi, good morning. This is actually Ryan Brinkman for Matt Fassler. Thanks for taking my call.

Sure.

Could you please elaborate a bit more on the trended inventory per store? It looks like this metric might have tracked I think the lowest level in a couple of years. And where do this trending -- can you remind of your goal? Are you still targeting, what is it, $570,000 to $590,000 range, I think, and over what timeframe do you see that as being achievable?

Yes, we're very pleased with the results that we have accomplished in the third quarter. Our goal still stands in the range of $570,000 to $590,000 per store. So we're happy where we are. We've invested in the teams there. We're going to have some benefits from the -- our new systems and the information we're pulling from there and then the coordination across the supply chain and the allocation teams and the stores. So we feel good about it and we expect to end the year within our range.

That's right.

Okay. And then with regards to gross margins, you have cited quality control procedure is related to with the import of South American exotic hardwoods has been a drag from second quarter in a row now. Can you quantify at all the impact of these higher expenses and margin rate? And what did these expenses relate to exactly? Is it more of a regulatory issue, a sustainability type of issue, or is it an actual product quality issue? If it is related to product quality, is the effect to increase actual product quality or is it simply costing more to ensure the same level of quality as before?

We had done a lot of our quality control when the product arrived in the US. And about a year ago now, we are starting to get close to anniversaring this initiative. We contracted for some feet on the ground that could do the inspection and quality control work at the mill in South America. There was an additional step-up in cost we expected to pay longer-term benefits through better product, lower performance issues. It works its way through unit cost, probably has somewhere in the 25 to 30 basis point drag on it.

Okay, thank you.

Thank you. Our next question is coming from David Strasser of Janney Capital Markets.

Thank you very much. I appreciate it. I have two questions kind of related. Looking through the Q this morning that came out as well, and you kind of went through the different classes and the strength and weaknesses of some of the different -- the 12 to 24 months stores, which seem to have a very big step-up in comp. And I was wondering if there is any particular reason for that other than just the general business?

And then I guess related to that, if you kind of back in a little bit into the mature stores, kind of based on some of the comments you made, it seems that cannibalization in the existing markets is maybe over 1,000 basis points when you're opening. I'm not sure -- first is my math relatively close there, and if that is, do you think that it's a higher or lower number than you were anticipating as you open some of the stores?

David, I'll kind of work backwards. The cannibalization is higher in the third quarter of this year than it probably has been in the first or second and it is on a year-over-year basis. We've got a greater number of stores now operating in existing markets this year than last year. And some of the markets that they are operating in have created additional cannibalization. And we called out this morning that if you pull those markets out of our comp store comparison, then instead of having a 3% increase, we would have about an 8.3% increase.

The performance of the newer comps, the 13-to-24 and 25-to-36, obviously we've got a lower bar to compare against in the third quarter of 2010. That said, their performance was a bit stronger, a bit closer to the model. We've had some nice openings now in 2010 that are going into the comp base. But I don't think there has been a significant change in the performance based on maturity.

Okay. I guess on the cannibalization, was that number sort of in line where you've kind of anticipated it knowing the increased openings and so on, was it better, worse?

We've always said that we expect somewhere in about 300 to 500 basis point range. So this would have been at the top of and even through that range a little bit higher than we anticipated.

Does it change any -- I mean -- further thinking about store growth over the future, does that have an impact on that decision? I know you've said there is lot of opportunities still in new markets as well as the existing markets. But does that have any impact one way or the other?

At this point in time, I would say no, it does not. We continually analyze that, review it, keep in mind that our lead time for opening new stores is very short. So we have a lot of flexibility there. Our new store investment is very low. So if we feel at some point in time we need to change that approach, we can. But our feeling is with our low market share and with such a fragmented market that long-term it still makes sense for us to continue to open stores. We're still getting a very strong return on investment in the new stores and the existing stores even with the negative comps, so that their contribution to our overall profit performance is still very solid. So we -- just looking at comp performance is just one of many measurements that we really need to take a look at when we're looking at our long-term growth strategy.

Thank you very much. I appreciate it.

Thank you. Our final question is coming from David Magee of SunTrust Robinson Humphrey.

Thank you. Good morning. Just a couple of questions, one on the near-term sales visibility. Could you remind us how the fourth quarter last year trended, do your comparisons get easier or harder as you get deeper into the quarter?

Last year's fourth quarter data was up 1.2% if I remember right. We're down 5.7% in Q3. Implementation really reduced our productivity. We're operating with reduced productivity in Q4, but we probably had some of Q3 sales still into it. So it's up 1.2%.

Okay. So -- it was a comparison -- it was comparison. Was that -- the performance throughout the quarter, that was flat, do you say, or were there a lot changes throughout the fourth quarter?

Monthly comp performance last year?

Yes.

It was up in October, slightly down in November and up in December. So I think to Dan's point, if you think back to the SAP implementation, some of the productivity issues may have pushed some sales out into December. So from that perspective, it could be a bit of a tougher comparison.

And then the second question on the line reviews, is there anything as you go through the process here that's surprised you about how that's going in your discussions? Is there any pushback that you're having to deal with that you think was unanticipated?

No, we're actually -- we are very pleased with how they are going in terms of the process, the preparation from the teams. I feel confident with the team that we have in place now with our Chief Merchant, the incumbents that were there and some of the new folks we've brought in. We have a dynamic merchandise organization that's implementing well. We're just going to be very thoughtful and as we go through the process across the rest of the business. So in general, based on my experience, we're very pleased with what we're seeing and there are no big surprises.

Thanks, Rob. And then just lastly and I'll apologize if you had mentioned this. But with regard to 2012, I know you're still thinking about -- you have approached the year, but is it fair to assume that you'll open 40 to 45 stores next year?

Dave, we haven't come to a final number yet. As Jeff said, it's a -- and as you know, it's a quick to open one from the time we plan. But we're taking a good hard look at 2012 in a difficult environment, cautious consumer. And I can't say right now that it would match 2011.

Okay, Great. Fair enough. Thank you, Dan.

All right. Thank you for joining us on today's call. All of us look forward to speaking with you again on our next quarterly earnings call to provide an update on our continued progress and executing our strategy and achieving our long-term objectives.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you all for your participation.