LL Flooring Holdings Inc (LL) 2012 Q4 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the Lumber Liquidators fourth quarter earnings call. With us today from Lumber Liquidators is Mr. Rob Lynch, President and CEO; 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 now like to introduce Ms. Ashleigh McDermott. Please go ahead.

Thank you, Operator. 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 Liquidator believe 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 Liquidator undertakes no obligation to update any information discussed in this call.

Now, I am pleased introduce Mr. Rob Lynch, President and CEO of Lumber Liquidators. Rob?

Thank you, Ashleigh, and good morning everyone. I'm here with Dan Terrell, our CFO, and we are pleased to be speaking with you about our 2012 results as well as our plans for 2013 and beyond.

Our team delivered record results for the fourth quarter, with better than anticipated performance in revenue, operating margin, and EPS, capping off what has truly been an outstanding year for Lumber Liquidators. I want to thank the team for their dedication to strengthening our value proposition of price, selection, quality, availability, and people; and most importantly, for their strong unified commitment to continuous improvement in all that we do.

A year ago, I spoke to you about how passionate I was about the Lumber Liquidators brand, the business, and the significant opportunities I felt we had in front of us. I laid out a strategy for strengthening our business and driving multi-year growth, zeroing in on five key strategic initiatives -- growing revenue, driving traffic through advertising reach and frequency, optimizing our supply chain, improving our sourcing, and developing the best people to serve our customers.

Our culture is to work together to meet or exceed our expectations and we certainly did so in the fourth quarter. Our entire team also shares a vision of our long-term potential and we understand that a portion of our success must be reinvested for the future, and that our competitive advantages must be strengthened to provide a solid foundation for growth. The entire team is excited by both Lumber Liquidators' current position in the market and the opportunity to continue gaining market share as we carry our momentum from the past year into 2013 and beyond.

Turning briefly to our financial highlights for the quarter and year. Net sales for the fourth quarter grew 20.8% and 19.3% for the year. Comparable store net sales increased 13.2% in the fourth quarter and 11.4% for the full year. Gross margin increased 360 basis points to 39.1% for the fourth quarter and 270 basis points to 38% for the full year. Operating margin expanded 390 basis points to 11.6% for the quarter and 340 basis points to 9.6% for the full year. Net income for the fourth quarter increased 63% to $13.8 million or $0.50 per diluted share, and for the year grew 79% to $47.1 million or $1.68 per diluted share.

In the fourth quarter we continued implementing our expanded advertising strategy, targeting both the core DIYer as well as a more casual consumer, which enabled us to drive demand. Our average sale continued to improve, reflecting our customers' preference for premium products and the expansion of our assortment toward our goal of providing the customer everything needed to complete a flooring project, including the tools to remove, install, repair, and maintain their investment and enhance it with complementary moldings and accessories. We believe these trends are a direct result of improvements in our sales training and our teams' ability to educate the customer. Our customers have responded positively to the introduction of more than 50 new floors and the expansion to a full assortment of flooring tools.

Our net sales growth also reflects our ongoing success in opening new stores. As I have discussed on previous calls, we slowed our store openings to 25 in 2012 from 40 in 2011, as we challenged our real estate strategy and improved the site selection process. We now look to optimize total share within a market as we utilize more quantitative metrics, demographic and financial, to analyze long-term return on invested capital. The real estate team is excited by our record new-store productivity in the fourth quarter and, combined with the success generated by our five key strategic initiatives, the significant increases we have achieved in four-wall profitability.

Our sourcing and supply chain optimization initiatives have continued to contribute significantly to our gross margin expansion. Ongoing line reviews and product assortment evaluations have remained critical in our ability to align with customer preferences in flooring trends, and these initiatives remain top priorities. We've been pleased with the reduction in product costs; but equally as important, our people have forged stronger relationships with our mills to deliver a broader assortment, enhanced availability, and stronger control over product quality.

We continue to invest in our team on the ground in China. In Brazil, new resources have enabled direct access to additional mills, both in Brazil and throughout South America.

Before I turn the call over to Dan, I want to discuss our longer-term strategy and communicate my excitement with regard to the opportunity we have in front of us. First, I will begin by reiterating what I have said often in 2012. We believe that we have significant opportunity to grow both net sales and earnings for years to come, as we capture additional share in the highly fragmented flooring market, both domestic and international. 2012 was a year of significant accomplishment, but our most important steps were toward cumulative multi-year growth of market share and operating margin.

As we enter 2013, our team is motivated and ready to develop and implement initiatives that will deliver benefits for years to come. We have assembled a team with the expertise and the innovation to build on our core strengths. Our philosophy and cultural DNA is the foundation behind our drive for continuous improvement in our existing operations, to fuel both enhancements in our value proposition and to enable future growth. Our focus will be determining how we best leverage the significant enhancements we have made to our competencies and competitive advantages the last two years.

One example of the key multi-year initiative is the development of our Store of the Future, which we are confident will enhance the shopping experience for our customers. Developing and testing our store of the future showroom design was a significant endeavor for our team in 2012, and we are pleased with the results and the opening of our first stores in this new format. The effort put forth by the team to develop and implement this significant initiative in 2012 was truly world class.

These efforts, combined with the success of our sourcing initiatives, supply chain optimization, and focus on continuous improvement also allowed us to challenge our domestic store target. We coordinated an analysis with third-party experts utilizing detailed market demographics and our own historical results to evaluate available market share and the key drivers to capturing it. As a result, we believe that the US market will support at least 600 store locations with four-wall financial metrics similar to our historical store model.

With the outstanding results our team achieved in the fourth quarter and full year, we believe we have a strong foundation upon which we can generate sustainable, additional growth as we enter 2013. Our overriding theme this year is to ensure we appropriately develop and resource our strategic initiatives to realize our long-term potential. I continue to have great confidence in the team, in our ability to continue our momentum and in the opportunities that lie ahead.

Dan?

Thank you, Rob. Good morning everyone.

I will begin with our results for the fourth quarter and full year 2012 and then discuss our outlook for 2013. My references to percentage and basis point changes are in comparison to the fourth quarter of 2011 unless otherwise noted.

On the top line, our fourth-quarter net sales grew 20.8% to $210.7 million, led by a 13.2% increase in comparable stores and bolstered by an extremely strong performance in our non-comparable stores. As Rob indicated, a focus on our key strategic initiatives continued to benefit net sales, as we aggressively pursued market share through our advertising, and achieved a higher average sale through assortment expansion, increased availability of product, and improved execution throughout our supply chain and store operations. In comparable stores, net sales were driven by a 9.1% increase in the number of customers invoiced and a 3.9% increase in our average sale. We believe the increase in the number of customers invoiced, our measure of traffic, was primarily a result of broadening the reach and frequency of our marketing and branding messages.

As Rob discussed, we believe our value proposition, which has been so well-received and understood by the passionate DIY customer, also resonates across a larger population of consumers considering a flooring project. In the fourth quarter, we continued testing and evaluating the effectiveness of various media channels for both our promotional and branding messages, building on successes with the ultimate goal of multi-year market share gain.

In addition, we believe the number of customers invoiced at comparable stores benefited from the maturation of our store base. First, we had fewer new stores operating in comparable markets. At the end of the most recent quarter, we were operating 18 non-comparable stores in markets with at least one comparable store, down from 24 stores at the end of December 2011. And second, we had a greater number of stores in operation for 13 to 36 months, the first two years as a comparable store when increases in net sales are generally higher than our average as customer awareness of our brand and value proposition builds in the market.

Our fourth quarter average sale, at $1,635, was the highest quarter of 2012 and increased the full year average to $1,600 for the first time in four years. In comparison to the fourth quarter of 2011, the average sale benefited from both an increase in the average retail price per unit sold and an increase in the square footage of each sale. We believe both price and quantity benefited from increasing customer preference for premium products and an increase in the sales mix of moldings and accessories.

Net sales in our newer, non-comparable stores exceeded our expectations in the fourth quarter of 2012 and represented the highest quarterly productivity since 2006. We opened four new stores in the fourth quarter; and for the year 2012, we opened 25 new stores, 17 of which were in existing US markets, six in new US markets, and two in Canada.

Turning now to our gross margin, which expanded 360 basis points to a record 39.1%. Lower cost of product, lower net transportation costs, and a reduction in fourth quarter inventory shrink all contributed to the increase. Let me begin with our products costs, which were, as a percentage of net sales, 220 basis points lower due to both shifts in our sales mix and the continuing benefit from sourcing initiatives. Sales mix shifts favorable to gross margin included an increase in customer preference for certain premium products and an increase in moldings and accessories, which represented 17.6% of our net sales in the fourth quarter of 2012, up from 15.2% in the prior year.

Sourcing initiatives favorable to gross margin included the net benefit of direct relationships with our vendor mills, competitive line reviews, and vendor cost-sharing, primarily through certain allowances. These initiatives, initially implemented in the first quarter of 2011 and continuing through the present, have cumulative multi-year benefits net of our reinvestment in programs to drive traffic and capture market share. Looking back over the two years since initial implementation, our cost of product for the full year 2012 is 200 basis points lower than the full year 2011, and 340 basis points lower than the full year 2010. We believe these sourcing initiatives have not only lowered product costs, they have facilitated the assortment expansion of premium products and enhanced product availability.

Turning to transportation cost, gross margin benefited by 20 basis points as certain supply chain efficiencies outweighed the impact of generally higher rates for international containers and domestic fuel costs. The net impact of all inbound freight costs reduced gross margin by approximately ten basis points. International containers cost capitalized into the unit cost of products sold were higher in 2012. In addition only 16.4% of the units received were direct to our stores in the fourth quarter, down from 20.2% last year. Direct receipts continue to be a strategic goal within our comprehensive supply chain optimization strategy, though 2012 was impacted by a transition in certain service providers. Domestic transportation costs were generally higher in the fourth quarter of 2012 than 2011, due to increases in both unit flow from our warehouses and cost per unit, resulting primarily from higher fuel costs. These higher costs were more than offset, however, by greater efficiencies in our supply chain, and as a result, gross margin benefited by a net 30 basis points.

Finally, all our other drivers of gross margin contributed 120 basis points to the fourth quarter expansion, led by lower inventory shrink recorded in the quarter. Throughout 2012 procedural discipline and enhanced coordination throughout the supply chain resulted in more accurate and more timely identification of shrink, thereby reducing the fourth quarter impact.

Selling, general and administrative expenses for the quarter increased approximately $9.4 million or 19.4%, to $57.8 million, due primarily to higher net sales and growth in our store base; but as a percentage of net sales fell to 27.4% from 27.7% in the prior year. Salaries, commissions and benefits increased approximately $3.7 million, but as a percentage of net sales were 11.9%, down from 12.2% in the prior-year quarter. Leverage of our corporate infrastructure and warehouse operations was partially offset by higher benefit costs and bonus accruals. Advertising expenses increased 25.7% or approximately $2.8 million, and as a percentage of net sales increased 20 basis points to 6.4%.

Again, we continue to reinvest in our value proposition by broadening our reach and frequency and we are continually challenging the allocation of our spend to the most effective media channels. All remaining SG&A expenses, including occupancy, depreciation, and stock-based compensation, increased approximately $2.9 million but as a percentage of net sales decreased 20 basis points to 9.2%.

Our effective tax rate rose to 43.7% due to our recording of a $1.3 million valuation allowance on net operating loss carryforwards in Canada, which had been recorded as a net deferred tax asset. During 2012, Canadian operations were profitable on an aggregate four-wall basis, but that profitability was more than offset by certain costs of management, infrastructure, and administrative support. The reserve, therefore, was necessary. Changes implemented in the latter half of 2012 and in 2013 are expected to result in profitable Canadian operations in 2013. Absent the valuation allowance, the effective tax rate in the fourth quarter of 2012 would have approximated 38.5%.

Net income increased by 63.2% to $13.8 million or $0.50 per diluted share based on approximately 27.8 million weighted average diluted shares outstanding.

I'd now like to discuss our results for the full year. Net sales for 2012 increased $131.7 million or 19.3%, to $813.3 million, with comparable stores increasing 11.4% and non-comparable stores contributing $54.5 million. In comparable stores, the number of customers invoiced increased 8.6% and our average sale increased 2.5%. Gross margin for 2012 was 38%, an increase of 270 basis points from 35.3% for 2011, with lower cost of product contributing 200 basis points, lower net transportation cost contributing 40 basis points, and all other costs including inventory shrink contributing 30 basis points.

SG&A expenses in 2012 increased 16.2% to $230.4 million, but decreased to 28.3% of net sales from 29.1% in 2011. Salaries, commissions, and benefits were 30 basis points higher in 2012 and included an increase of approximately 70 basis points due to higher bonus accruals, commission rates, and certain benefit costs. Advertising expenses were 7.2% of net sales, 50 basis points lower than 2011 due to national advertising leverage; and all other expenses were down 60 basis points. Operating margin increased 340 basis points to 9.6%. The effective tax rate for 2012 was 40%, up from 39% in 2011, adversely impacted by the fourth-quarter valuation allowance. Net income increased 79.2% to $47.1 million or $1.68 per diluted share, based on approximately 28 million weighted average diluted shares outstanding.

Turning to our financial position, liquidity and capital resources, our cash and cash equivalents increased to $64.2 million at the end of 2012, up from $61.7 million at the end of 2011. Merchandise inventories totaled $206.7 million at the end of 2012, up from $164.1 million at the end of 2011, as available inventory per store increased to $585,000, within our targeted range of $580,000 to $600,000. Inbound in-transit inventory increased $38.3 million. Capital expenditures were $13.4 million in 2012, down from $17 million in 2011, primarily due to fewer new store openings and lower expenditures for technology.

In November 2012, we were pleased to announce an increase in the authorization to repurchase our common stock, bringing the total to $100 million. Through the end of 2012, we had repurchased approximately 1.6 million shares on the open market at an average price of $29.74 using $49.1 million of cash.

Turning now to our outlook for 2013. We currently expect net sales for the full year in the range of $885 million to $920 million, with the comparable store net sales increase in the mid-single digits. We expect 2013 earnings per diluted share in the range of $1.90 to $2.15, based on a diluted share count of approximately 28 million shares exclusive of any impact of our stock repurchase program. We expect capital expenditures to range from $16 million to $19 million and include expenditures for 25 to 35 new stores, all in our Store of the Future format; the remodel or relocation of 20 to 25 existing stores to the Store of the Future format; and continued investment in technology, supply chain initiatives and the effectiveness of our marketing programs.

Allow me to provide some color in key areas of consideration. As Rob discussed, we were pleased with the launch of our Store of the Future design, including the expanded showroom, here in the first quarter. We will monitor results and implement adjustments where appropriate. As a result, we expect the number of new stores open in 2013 to be greater in the second half of the year. Therefore, we expect generally lower than average maturity in our non-comparable store base. In addition, we expect new locations to be weighted towards larger existing markets, potentially increasing cannibalization.

We expect gross margin expansion in 2013, though less than the previous two years, with expansion driven by lower product costs and our focus on continuous improvement, partially offset by higher net transportation costs. We currently expect SG&A expense increases proportionate to or possibly greater than increases in our net sales, as we aggressively pursue market share through our marketing and branding messages, incentivize and reward outstanding performance, and invest in new initiatives, both domestic and international. Finally, we expect an effective tax rate ranging from 38.3% to 38.8%.

As Rob discussed, our team is proud of our record 2012 results and we are motivated to achieve our long-term potential. We believe 2013 will be a year to resource initiatives with multi-year benefits.

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

Thanks, Dan.

Lumber Liquidators continues to be a great growth retailer with a strong and unique value proposition that resonates with our customers. As we look forward to 2013, we will remain focused on the same five key strategic initiatives. We believe we have a long runway of opportunities ahead of us and will continue to aggressively pursue market share, while at the same time remain committed to continuous improvement in all areas of our business every day.

The progress we have made in many areas of the business highlights the incredible efforts and work done by our world-class Lumber Liquidators team. I'm extremely proud of and honored to be a part of this team. The ongoing progress of our Best People initiative remained a priority in the fourth quarter, as it has throughout the year. We were pleased with the four Lumber Liquidators University programs held across the country during the year. They were attended by all store managers and focused on enhanced selling techniques, in-depth product training, and strategic discussions with senior executives. Our focus continues to be on a commitment to excellence and a one-team culture. Our next step is a national Lumber Liquidators University bringing everyone together for the first time to further reinforce our unified, long-term vision and set of objectives for the Company.

We also recently announced the appointment of our Vice President of International Sales, James Costa. James will oversee the development and operation of international sales efforts. Our initial plans for growth outside North America are focused on wholesale operations and licensing. We believe there is a strong opportunity for us to leverage our core competencies to establish a presence in new markets with our private label flooring brands without a significant capital investment.

Lastly, I was pleased that our Board of Directors increased our stock repurchase authorization to $100 million in November. We will remain focused on appropriate capital allocation to fund our operations, strategic initiatives, and ultimately future growth, while generating value for our shareholders.

Again, we are very excited by all of the opportunities that lie ahead in 2013 and beyond. As we move forward, we believe we are well-positioned to further expand our footprint and deliver multi-year expansion of our net sales and operating margin. With the best team in place, continued emphasis on our strategic initiatives, and the ongoing enhancement of our unique value proposition, we thoroughly believe Lumber Liquidators is poised to continue its strong growth for years to come.

Before we turn the call over for your questions, I would like to thank all of our associates in the US, Canada, and Shanghai for their dedication and ongoing efforts. I'm excited to lead this team into 2013. Operator, we are now ready for your questions.

Thank you. We will now be conducting our question-and-answer session.

Operator Instructions)

Gary Balter with Credit Suisse.

This is actually Dan filling in for Gary. Congratulations on a strong quarter. The first question, understandably very much in the early innings of the rollout of the new store format, but if you could provide any more color, initial comments on some of the differences you are seeing compared to the previous layout, that would be very helpful.

In terms of the store the future concept?

Yes, just in terms of-- understandably there's not a wealth of data I assume you guys have looked at yet, but just in terms of what you're seeing in terms of the differences between the new store format the previous layout?

Yes. It's still very early relative to the results and we will be following up with everyone with those, but overall I cannot tell you how pleased I am with it and if you get a chance I think the best way is to really get into one and see the difference for yourself. The initial feedback from customers is phenomenal. Our store associates are tickled. They are basically standing in line, begging for the next one to come to their store. So that feedback obviously is anecdotal but very, very positive.

I'm just-- what I would tell you is I'm just generally pleased with the teams' effort in terms of pulling this thing off last year, delivering the results they did while at the same time developing and implementing an initiative like this was really, truly world-class. The way we're looking at it, this is our new mousetrap. This is not-- as we test and measure this thing it's really going to be for us to calibrate and to understand where we-- how we maximize return on our invested capital in terms of the mix between the number of new stores, relocations and remodels as we optimize the market. We took the same continuous improvement mindset within this initiative as we have everything else we've done. We've directly sourced-- we've done line reviews on all of the costs and the CapEx going into our new stores which is one thing that significantly kept the cost of this initiative down as we planned to roll it forward. So really what we're doing now is resourcing the teams and putting the plans in place so that we effectively roll this thing out to all stores and obviously all new stores going forward will have the new format.

One quick follow-up on the gross margin, if it's all right, is it looks like given the chronology of the initial reviews, there would be maybe the potential for the product cost benefit to accelerate in the first half of next year, is that the right way to think about it or how would you guys think about the cadence of those reviews flowing through in 2013?

Dan, here-- obviously there are a number of drivers that are impacting gross margin all at once. They often occur in a lumpy format. The line reviews are just one piece of it. As we see supply chain efficiencies come through or as we might see vendor allowances or participation or contribution, it is always going to make the margins somewhat lumpy. The best we can say is we still see multi-year benefit ahead in 2013. We see gross margin improving even in the face of higher net transportation costs but we just don't think that improvement is going to be higher than we saw 2011 versus 2010.

This is Gary. Just a follow-up, sorry I've been dealing with a merger and then so I have been on and off your call, but you mentioned you're going to go to more stores and one of the questions that we get a lot is you've talked in the past about cannibalization and the potential impact of cannibalization. How do you think about that now?

Cannibalization has been a fact for us even as a young chain just because of the very large radius that an individual store draws from. Our strategy had initially been one store in every major market, one store in secondary markets. So as we came back to add the second store, there was ample opportunity to increase the market yield, but we were certainly going to impact the sales in that store. As we look to open stores of the future in 2013, we think that has the potential to have a greater impact on our overall cannibalization because our plan is going to be to look at tier one markets where we open these so they're going to be large, metro areas and areas that we have-- that we're already have some market penetration in but see additional opportunity. That's usually the case where we see more market cannibalization.

Congratulations on a very nice quarter.

Budd Bugatch, Raymond James.

It's actually TJ McConville filling in for Budd. Congratulations on the quarter and the year and thanks for taking the question. The main question we have is around the increase in the total addressable market size or the store footprint size, if you will. Can you talk a little bit, Rob or Dan, about some of the assumptions that you had? That's a 50% increase in the total number of stores. I see your 10.5% market share. What kind of market share goes into a number of 600 stores? How much of the change here is due to the entrance into the laminate market? Any points you can share there?

TJ, I will start a little bit and maybe Rob can follow me. You know our history has been when we first came out we were looking at 300 stores in roughly a five-year period that turned out to be pretty close to being true. We then upgraded that to 400 stores and that number had been out there for quite a period of time. When Rob got here, Jeff was looking at it as well, but as Rob got here we accelerated the quantitative analysis around our historic results to really begin to take a look at what that ultimate store count might be and preserve some of the four wall financial metrics that we have had historically. The number was older. We feel pretty comfortable that we've taken the approach that incorporates some of the benefits we're seeing from our strategic initiatives as well as what we think is going to happen in the housing market over the next three to five years as we begin to recover. I would tell you that initially we think our market share, this might take us to as much as the upper teens, to potentially low 20%s, depending on how the market goes. And we're also looking at 600 stores as a target right now, it doesn't mean that that's ultimately the top end of the target.

This is Rob. The only thing I would add is, Dan touched on it, the exciting thing is, what we're seeing is a complementary effect from all of our strategic initiatives and the Company's focus on continuous improvement. And as we've dug into the real estate strategy, all of the processes-- and we've improved our site selection processes, right, which drove the new store productivity number, which drove down cannibalization even though we actually put more stores in complementary markets this year than we have in the past, the cannibalization factor is down, okay? The marketing and advertising changes in there in terms of expanding our customer base has been another driver of our thought process here and this is before all the analytics that we did with-- in terms of the stuffiness, but what we saw is we were attracting other customer segments, more convenient locations were a driver in this, and then I think you also hit on this, the broadening of our assortments. Right? If you look back to the beginnings of the Company it was all hardwood.

But as we've gone into other categories, laminates, vinyl, bamboo, as we've brought in moldings, accessories, tools, all these things are again are making us more of a one-stop shop for our customers. And as I said, as we've opened up that radar in our advertising reach and frequently, we're seeing our traffic increasing significantly. We think all of this is working together and it's allowing us, in combination with the improvements in the operating metrics of the Company too, is opening more markets for us. And that's really the gist of it. We're confident about this. There was a lot of rigor that went into the assessing of this opportunity. We've been spending a lot of time in it over the last-- over a year really. We're excited about the opportunity.

And if I could sneak another one in here. Dan, you went through some of the puts and takes on the 2013 guidance. If we do some back of the envelope math it looks like the pretax contribution margin at the midpoint somewhere around 15%, that's obviously lower than you've experienced in the past. What do you think we ought to look for longer term when maybe we're not in an investment year? Maybe beyond 2013. What would you expect that sort of contribution margin to look like at that time?

That a good point. SG&A is going to be heavier in 2013 then we'd like to see it in future periods going forward as a percentage of sales. We've recognized that we're going to have to really resource some initiatives that have longer term pay backs. So where you have been used seeing us get some slight leverage off of our SG&A, payroll aside, generally advertising has led our SG&A leverage. We don't think that's going to be the case in 2013 but we think 2013 is the year of investment and we'll start to see that gradual leverage come back in 2014 and beyond.

Well thanks again for answering the question, very helpful. Best of luck on 2013 and beyond that.

Matt McGinley, ISI Group.

As you guys reflect upon the changes you made in your advertising strategy, namely, going to target that more casual customer versus the DIY customer that you may have targeted the past, how much do you attribute that change in the move that you had in traffic? That is, what percentage of the increase in traffic do you attribute to that change and how you're going after your customer?

I think it's a significant piece. But again in conjunction with the others, I made this point earlier, we're very fortunate that our initiatives are working in conjunction and feeding off of each other and contributing to the effects of each other. But to your point on the marketing advertising, the team has done a thoughtful job there. That has been working. We've been testing it and implementing it for over a year now, going on 1.5 years. So we're very pleased with that. And the results speak for themselves.

I think the other contributor, obviously are-- there's two other contributors, back to my point about these are all working together, the merchandising team, our sourcing initiatives, our leveraging of our buying offices are absolutely helping drive this in terms of the deals that we-- the pick and sell work that our merchants are doing in terms of driving and coordinating the advertising programs with the advertising department. Then again on top of that you cannot forget about our best people and our LLU-- our Lumber Liquidators Universities that we had last year. We developed-- we've enhanced our teams out there. We've enhanced our compensation structures with our folks, we are rewarding them better and differently, we're measuring them differently. Again, we're training them and sending them to really go after and take care of our customer and that's a big difference as well. So I think those three things working together in that order are what are driving those numbers.

And then on the occupancy expense leverage, you've had two pretty good quarters where you've had decent occupancy expense leverage where in the past you've de-levered that. You're still putting up stores at a pretty decent run rate. Has something changed about the rents of the locations? Are you extending the lease terms? Are you getting lower rents? What's driving it other than sales leverage and does the store of the future change the ability to get occupancy leverage in maybe the long run but also in 2013?

We don't think the store of the future concept is going to change it looking forward. We think we're going to have the same size box, just a different configuration, more efficient warehouse, which will allow a larger showroom. We have looked at where our stores are located and while we're not going to be a tier one retailer or a high-traffic in a tier one facility, we do want to make sure that our locations are retail centric. So we're evaluating what opportunities are out there as our stores come up for lease renewal and as you know, one of the values of our store model is that we have short leases. So every five years we generally get a chance take a look at a store whether it's in the right place and whether we would like to move it. Because of the macro environment, we've been able to relocate some of our stores into better retail centric areas and actually wind up with a lower occupancy cost. I would also tip the hat to the real estate team and to Rob's approach of line reviews. Our negotiations have been thorough and I think that's helped as well.

The other driver within occupancy costs is our supply chain and what we might need to service our future growth. We've had some costs to go through as we continue to look at additional floor space to move our product. We're in the process over the next year or two of evaluating what supply chain configuration works to support our growth for the next five years and that will have some impact on occupancy costs and we'll continue to call out. But keep in mind from a store perspective, we don't see the occupancy equation changing because of the store of the future.

Brad Thomas with KeyBanc Capital Markets.

Let me add my congratulations as well. Wanted to follow-up about the SG&A spend for 2013. When we look back to 2012, if memory serves me, I think the plan was to deleverage advertising. Fortunately it yielded very strong results. As we think about some of the spend for 2013, is it a case that you guys are trying to be conservative with the revenue benefit from some of these investments?

Right. When we went to 2012, we actually had planned for the advertising spend to be consistent as a percentage of sales with 2011. And we had better results than we originally anticipated. But think about we really started some of these tests about five quarters ago now. So we didn't have as clear a picture as we have now and we do believe that there is share to be had and there's a branding message out there that's going to have multi-year pay back but it may require significant spend in 2013 and I mean significant to the point that it de-levers against the top line. I don't know that it's necessarily being conservative, it's that we see an opportunity. What we've seen for the past five quarters has worked and we're going to try and take advantage of that opportunity.

As a housekeeping item on gross margin in the quarter, what was the benefit on shrink in the quarter? And maybe what would that have looked like if it'd been spread out over the course of the year rather than all coming just in the fourth quarter?

Brad, I think that category which we lump shrink into all other contributed to 120 basis points, a benefit for the quarter and about 30 I think for the full year. Shrink was definitely one of the primary pieces of that category. We just did a better job. The commitment to continuous improvement in working together we were able to identify where we were consuming product and where shrink might be taking place throughout the year which left us with a lower fourth quarter adjustment. So when you see those two numbers, the 120 basis points and the 30 basis points, know that shrink is one of the primary drivers of the change.

Lastly, if memory serves me, last year in the first quarter I don't think you had thought that there was much benefit from favorable weather, but being almost two months into the quarter, how are you guys feeling about things thus far having had a snowstorm already?

We generally feel that we're not seeing any impact from weather.

That's very straightforward. (laughter)

Matthew Fassler, Goldman Sachs.

I'd like to start off with a quick question about working capital. Clearly the inventory in the stores is in line with your recent averages. The increase in inventory per store is somewhat greater than the increase in sales productivity and we also saw a bit of a pop in customer deposits. I know that moves around a lot. How should we think about those two numbers as it relates to customer backlog and what that tells us about sales prospects for the next couple of quarters?

Matt, I'll start and I'll let Dan take some of the technical pieces of that. In general, if you remember last year this time coming into 2012 on the heels of a lot of the line reviews and the changing out and transitioning of categories, we made a conscious effort in Q4 2011 to really clean up and make the inventory a lot healthier. We-- that's one of the things that we did. So the year-over-year comparison I think is a little bit -- looks a little bit elevated because of that. In hindsight it was absolutely the right thing to do.

Number two what I would tell you is as we talk about the benefits and what we're doing as a Company, one of the most important things that we are focusing on, I feel is our responsibility, is understanding and investing in our value proposition. So, obviously, availability, I talk about on every call, availability of inventory and having that inventory accessible to the stores, accessible to the customers when they need it is very important. That's one of the things that we have done as we have been running the business and increasing some of the assortments, we've also been increasing selectively the inventory positions in terms of the best sellers by store because it's something that's so relevant to our customers and it's a competitive advantage for us. So that would be a thoughtful, intentional thing that we've done but again, overall, we're pleased with where we ended up. We really are, and the positive is that those investments in that portion of our value proposition have been paying off and is a contributor to some of the pickup in sales.

I'll follow up really quickly on the customer deposits. We did end the fourth quarter with higher customer deposits. We had a great incremental A promotion in October. We didn't see much of an undertow in November. And then we had an incremental spend on our December promotion which just-- we had a strong finish to December and built a nice customer deposit balance. We'll see what kind of undertow that has the first six weeks of the first quarter or not all that meaningful, but we'll evaluate that and then we'll start to get into the spring remodeling season this last week of February or so and then through March.

Quick follow-up. Just to clarify on your gross margin target, you talked about an increase at least as big as that of what you saw in the last two years. So I guess this year's gross margin increase was a lot bigger than the 2011 gross margin increase. How should we try to hone in on the implied guide in that comment?

Matt, I probably said it backwards but what it is is we don't think 2013 is going to be as great as either of the other two so that the lower one was 140 bps, 2011 over 2010. So we don't think it's going to be that high.

Finally, just on the strategic front, you talked about broadening out your target customers through advertising targeting the more casual customer. What are the characteristics, the economic characteristic of that customer as related to ticket and the kind of product that you think they're migrating to? Is it a higher-margin product, lower margin product, and how has their joining your family, if you will, impacted the economics of the business?

Matt, the interesting thing is those customers, what we're seeing is they are appealing to our value proposition even more so than our typical core customer, which is interesting. If you think about it, it's common sense. It makes sense because they're novice, may not be as experienced with big-ticket projects, with doing them on their own or even making the purchases. Our value prop is really resonating with them so as they're coming in, they tend to be a little bit less price sensitive, more looking for our expertise, our one-on-one service, our wide assortment. They are definitely interested in our premium products and the advice and service that our folks have to offer in the store. So it's a really good match if you want-- the kind of match made in heaven if you think about it, which is why the advertising is working so well. The advertising team is doing a great job of driving those new folks into the store and our sales-- our store associates are doing a fabulous job of transacting and closing the sale.

Congratulations on a very good year.

Peter Keith, Piper Jaffray.

Congratulations from me as well. With the stepped-up outlook on stores, just to clarify, you're talking 600 in the US. You'd still think about another 50 in Canada, so are we talking about 650 total at this point?

Probably 40 in Canada.

If we look at the guidance for your store growth this coming year, it looks like your-- maybe I'm backing it about it around 8% to 12% unit growth. That compares to 2012 where we saw 8% so as you've picked up that forecast on the future store potential, are you in turn accelerating the unit growth? Should we think about this new 8% to 12% as the new run rate?

It really wasn't the 600 stores that caused us to take a look at our opening schedule. We were at 40 in 2011 before we pulled back to 25 in 2012 and most of that was to make sure we had the right approach to real estate, the market optimization and the right quantitative metrics. So it's our desire to have the right quantitative metrics and market information that led to the reevaluation of the total store count. We're going to look at 25 to 35 stores in 2013 and that pace is going to be more on how we are able to get this store of the future rolled out, how that works, and then looking at a balance of the resources between new stores and remodeling and possibly relocating older stores. So we're comfortable with this pace. It certainly could change in 2014 or 2015, either faster or slower based on some of the results that we see.

This is Rob, Peter. I think to answer that well is that I think that range is exactly where we want to be. But to Dan's point we-- swinging within that range is going to be dictated relative to the results of what-- how the store of the future works and the difference of that-- those results between a new store, a remodel, a re-lo and then the existing market as we optimize the markets, right. So it's we really-- we're very thoughtfully going to be measuring the impact of the store of the future. When we do, we go in and we remodel the existing store and/or we relocate and remodel an existing store. Obviously as we get those results coming down, it will drive the mix between new, re-lo, remodel.

Just a quick follow-up on the store of the future re-lo, remodels, I think you said 20 to 25 for this year. Did those-- do all of those stores, whether it's a remodel or a re-lo, do those stay in the comp base?

They will if they-- if the relocation stays within a tighter primary trade area, we will keep that in the comp base. If the relocation takes it outside of what we classify the primary trade it might become a non-comp.

One last question on the ad spend, so up 25% in Q4. Clearly you guys have got some very positive results off of that. Is that a nice-- is that a run rate you're thinking about going forward for 2013 up 25% or so from 2012?

I wouldn't put a number around it. What I would tell you is-- I'm going to lump it in to our whole discussion around continuous improvement. Marco Pescara, our chief marketing officer, and his teams have done a fabulous job with that initiative. Obviously you can tell that we've got-- we cranked it up in the fourth quarter because we were so happy with the results, we wanted to see where the ceiling was there. What I would tell you is things are going out as planned. We're pleased with the results and we're going to continue to press on that. That's an initiative that we see has got legs to it, it's multi-year, and we're going to appropriately press on that and also be very thoughtful about measuring the ROI of the spend as well. We're going to keep our options open and be flexible as we go forward.

Laura Champine with Canaccord Genuity.

Congratulations on a great year. The question I have is really a follow-up on some of the questions you've already gotten about your square footage growth and the remodeling program. These projects seem to be pretty low cost and you've been experimenting with the store of the future for some time. I understand it's the pace of growth at which you're comfortable. Why not grow faster in terms of units and in particular the remodelings? That's less than 10% of the store base remodel this year.

Laura, that's a good question and I hinted to it. But what I want to tell you is this is a new initiative for us. The team did a fabulous job putting this together last year and the reason why you see the pace that we're guiding to is really because of us lining up the resources and making sure that it was something that the teams can handle. Like I said, we went in and we line reviewed and re-engineered all of the components of the capital components and actually layout, the design, the fixtures, everything in the stores. We've got new vendors, new fixtures, we've gone direct to factory on a bunch of this stuff to mitigate the cost increase. The positive is it's a fabulous change. We think it is going to work tremendously, our customers and associates are going to love it and so really what you're seeing is just us being moderate and moderate in the pace of-- as we go forward.

As we get everything lined up, you can see progressively picking up in the out years. But this year we wanted to make sure we balanced-- we're adding some resources to the real estate team, to our store planning, our store set teams. This is something we want to do-- that we want to make sure there's not distracting to the field, to our store associates and their selling. When you go in and remodel and tear up a store, it also can be distracting and impactful to the customer and the sales in that unit. So all of those factors have been weighed into the-- to what we are doing here in our plans and I think it's appropriate. Like I said, as-- if we can-- if things go well on-- we have the flexibility and want to pick up the pace during the year, but for now that's what we feel comfortable doing. And it has nothing to do with the optimism around the initiative itself.

David MacGregor, Longbow Research.

Let me add my congratulations on a great quarter, a great year. A couple questions. Early in the life of these line reviews you had talked about, and admittedly it was early in your arrival at Lumber Liquidators, Rob, but you had talked about the possibility of growing the gross margins but at some point you start taking some of that benefit back to market in the form of market share development and brand support and so on and so forth. I'm just wondering now, given the tremendous performance we're seeing in the upside we've seen since you've arrived in gross margins, just are we getting close to that point now? Dan in his guidance had talked about the fact that the growth in gross margins would be less than 2012 and 2011. How much upside do you envision in gross margins from this point forward versus getting to that point where you start taking it back to market?

Well, I would say first of all we've actually been taking some back to market along the way. So the margin enhancements you've seen are net of reinvestment back into the value proposition, into price point changes, into funding some of the market-- some of the advance in terms of the marketing and advertising that we've been doing. We've been doing some of that along the way, so this is net of that. I would tell you, overall, I am very excited about our future potential in terms of the things we're working on--the go forward and the existing initiatives and then some of the potential in some of the other things that we are-- the other initiatives that are in development in both sourcing, supply chain, operations.

The message I would give to everybody is margin enhancement in retail is not a silver bullet. There's probably 20 different-- I could reel off 20 different areas you can impact gross margin in a retail company, shrink being one of them obviously, sourcing of course, supply chain, store operations-- within the store is this component is there as well. We have been taking a comprehensive look at continuous improvement approach to our margin enhancement the last couple of years and we're going to continue to take that same approach going forward. I think we've got multiple years of enhancement. As Dan guided, we don't think it's-- we wouldn't expect it to be as much as it has been the last two years but we think that it will still be significant and that it will continue.

Joseph Edelstein, Stephens Inc.

Earlier you spoke about adding SKUs and obviously you started with the hardwoods and moved to laminates and more recently added the tools. I'm just curious what you think about how consumer preferences have changed for flooring in general? Do you see-- which of those categories do you see taking the most share and then even as an alternative, what do you think about tile taking share from hardwoods?

I'll start and maybe Rob can finish. We have seen an evolution within the assortment and I've always been a proponent that hard surface flooring is going to take share from carpet because most people view the hardwood or what looks like hardwood in the laminates as a more elegant flooring choice. We've seen constructions change, we've seen stains change, we've seen click mechanisms change, so we think the customer now has a broader assortment and a broader range of price points that can compete with carpet more effectively. Hardwood, three-quarter inch solid hardwood used to be a large aspirational price jump from carpet. Now there are all sorts of alternatives that are available to the customer at each price point in each level of quality that they are looking for.

I would tell you that our expectation and as we look forward, we think hard surface flooring will continue to take share from carpet. We think technology will continue to improve the various types of hard surface flooring, whether it's resilient, whether it's laminate or whether it's the finishes in the hardwoods. As far as tile versus hardwood we haven't done a whole lot of research on that. I think both of them are kind of junior players to carpet.

Also I just wanted to ask about your planned promotional schedule that you have this year and how that compares to the prior year.

We are going to be more aggressive in our approach to take share. That may or may not be greater discounting on-- as far as promotions but we're certainly, as we've said a number of times, broadening the reach and frequency of our promotions, our brand message as well, but certainly our promotion call to action as well. We haven't seen that take a deep bite into gross margin, but we're certainly prepared to drive traffic in 2013 and use everything at our disposal.

Thank you. We have reached the end of our question-and-answer session. At this time, I would like to turn the floor back over to management for any closing remarks.

Thank you for joining us on today's call. We look forward to speaking with you again on our first quarter earnings call to provide an update on our continued progress in executing our strategy and achieving our long-term objectives.

AKBA

Thank you, ladies and gentlemen. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation. Have a wonderful day.