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Lumber Liquidators, Inc (NYSE:LL)

Q3 20 Earnings Call

November 6, 3008 10:00 am ET

Executives

Jeffrey W. Griffiths - President and Chief Executive Officer

Daniel E. Terrell - Chief Financial Officer

Caren Villarreal - Financial Dynamics

Analysts

Robert Higginbotham - Goldman Sachs

Rick Nelson -Stephens Inc.

Operator

Good morning ladies and gentlemen and welcome to the Lumbar Liquidators Third Quarter Earnings Conference Call. With us today are Mr. Jeff Griffiths, CEO of Lumber Liquidators, and Mr. Dan Terrell, CFO from Lumbar Liquidators. (Operator Instructions) I would like to introduce Caren Villarreal of Financial Dynamics.

Caren Villarreal

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 Security 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 Lumbar Liquidators believes that the expectations reflected in its forward-looking statements are reasonable, it can give no assurance that such expectations or any of its forward-looking statements will prove to be correct.

Important risk factors that could cause actual results to differ materially from those reflected in the forward-looking statements are included in Lumbar Liquidators filings with the SEC. The information contained in this 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 obligations to update any information discussed in this call.

Now I am pleased to introduce Mr. Jeff Griffiths, President, and CEO.

Jeffrey Griffiths

Good morning everyone. Thank you for joining us for Lumber Liquidators Third Quarter 2008 Earnings Call. With me on the call today is Dan Terrell our CFO.

I would like to begin today with a brief review of our third quarter 2008 performance. Dan will then review our financial results in detail as well as our outlook for the remainder of 2008. I will return with a few comments on our growth strategy and our outlook for the remainder of the year before we open the call to questions.

We are pleased with our results for the third quarter as we continued to build on our positive momentum and achieve strong sales and earnings despite the more challenging macro economic environment.

Our solid performance is due primarily to the ongoing execution of our growth strategy, operational improvements we’ve made to our business that are allowing us to be a more effective retailer, and our appealing value proposition of price, selection, quality, and availability that continues to resonate with our customers.

In fact, we found that our value proposition has become even more relevant in this difficult economic environment in which many consumers have become value seekers and are more price conscious.

I would now like to mention a few highlights of our third quarter performance.

We achieved a 20.6% increase in year-over-year net sales; comparable store sales growth of 2% which includes positive comparable store sales growth among our mature store base and does reflect some impact from the more difficult economic environment. Solid expansion in gross margin of 150 basis points and an almost 50% increase in year-over-year net income.

We are encouraged by the strong results generated by both our new and mature stores. Our newly opened stores continue to contribute above plan and represented a large percentage of our total increase in sales for the quarter. Our new stores are ramping up more quickly than originally expected and are rapidly producing strong returns on the very low initial investment that they require.

In line with the first half of the year total sales reflect our enhanced merchandise selection comprised of higher quality premium products. Specifically we have continued to increase sales of moldings, trims, treads, and risers, as we successfully promoted them as essential add ons to new hardwood floors.

Our enhanced selection of products also includes an expanded assortment of hand scraped hardwoods, laminates, bamboos, and exotics, all of which have experienced increased demand and also helped to drive total sales.

The increased demand for higher margin products contributed to our 150 basis points gross margins expansion over the third quarter of the prior year. Also contributing to the margin expansion was our continued pricing discipline as well as our improvements in inventory allocation.

It is also worth mentioning that we had fewer special liquidation buys this quarter than we did during the first two quarters of the year and the sales of those buys had less impact on our third quarter gross margins.

Although our increase in SG&A for the quarter reflects some higher professional fees and stock compensation expense versus the third quarter of last year, we are pleased with the continued progress we are making in aligning our operating costs with growth in our store base.

With that said, we will continue to make certain additional investments in infrastructure to support the expansion of the business. For example, we recently strengthened our merchandising efforts, focused on the liquidation deal cycle from purchase to complete sell through. This included the addition of a senior buyer with significant industry and product experience.

Again, the investments in our infrastructure and improvements in our operations that we’ve made are enabling us to operate more efficiently and effectively while solidifying our foundation for long-term growth.

Given the difficult environment in which we are operating we are more focused than ever on maximizing revenue opportunities and leveraging operating costs. Our focus on store operations has continued to include showroom modifications, associate training and improved in stock positions that enhance both conversion and attachment.

In logistics we continue to improve the matching of inventory flow with consumer demand which allows for greater on time customer satisfaction at a lower cost. We are pleased with the success of all of our operational improvements, which we believe allow our customers to more fully benefit from our value proposition. Ultimately, we are improving customer satisfaction and strengthening our market position.

Before I turn the call over to Dan, I would like to briefly touch on another way in which we are improving the customer experience through our recently expanded business partnership with the Home Services store.

HSS manages fully insured and licensed providers of professional installation services that measure, deliver, and install flooring at competitive prices. As many of you know we have carefully controlled the roll out of this program and I am pleased to announce that we now offer HSS installation services in almost every store in our chain. This partnership not only strengthens the full range of services offered to the customer, but adds efficiency to our store operations as store managers spend less time on installation issues.

Importantly, the agreement with HSS allows us to market a full start to finish product and services package to our customers and provide a more attractive and competitive offering by combing our hardwood flooring with reliable installation services.

In particular for those customers who may not be interested in a do it yourself home improvement project we have now made it easier for them to shop with us. Further by partnering with a national firm, such as HSS, we can offer a consistent program and level of service at all of our stores.

It is also important to note that this is a true partnership. HSS represents its presence in our stores, usually on Saturdays, in tandem with Lumber Liquidators own sales staff which allows us to present customers with an integrated team that can assist them with all of their hardwood flooring needs.

I would now like to turn the call over to Dan and I will be back in a few moments to discuss our on going strategy and answer questions.

Daniel Terrell

As Jeff mentioned I am going to provide some additional details on our results for the third quarter 2008 and then discuss our outlook for the year.

Net sales for the three months ended September 30, 2008 grew to $123.1 million from $102.1 million in last years third quarter, an increase of 20.6%. Comparable store net sales increased 2% on top of an 8.4% increase in the third quarter of 2007. Our growth in comparable store net sales was primarily driven by increased volume, which we generally measure in square feet, partially offset by a decrease in the average retail price per square foot sold resulting from changes in our sales mix.

Consumer demand continues to be driven primarily by our expanded product assortment, particularly the premium products in each category, and our commitment to a more consistent in stock position including moldings and accessories.

Comparable store sales were impacted somewhat by the hurricanes in the gulf region and the related flooding in the Midwest. Although a number of stores were closed from a few days to a few weeks all locations were reopened by October and we did not have any damage to our inventory or stores.

We opened eight new stores during the third quarter of 2008 ending the quarter with 143 stores in 43 states. We opened 32 new stores in the 12 months from September 30, 2007 to September 30, 2008. Overall, our new stores are outperforming our expectations and continued to contribute significantly to our top line growth.

Gross margin increased 150 basis points to 35.3% from 33.8% in the prior year period. This gross margin expansion continued to be primarily a result of the effective execution of iniatives in the areas of store operations, merchandising, and logistics where we maintained retail-pricing discipline, broadened the selection of higher margin premium products, and controlled total transportation costs. In addition, the completion of our filings for a retroactive rebate of a certain bamboo tariff added 40 basis points to gross margin.

Special liquidation deals, which had contributed to gross margin expansion in the first half of the year, had less impact in the third quarter; however the strengthening of our merchandising efforts focused on liquidation product added approximately 15 basis points to the third quarter of 2008 gross margin in comparison to 2007.

Selling general and administrative expenses were $34.6 million or 28.1% of net sales for the third quarter of 2008 compared to $28.3 million or 27.75 of net sales for the third quarter of 2007 as total leverage of advertising, labor costs, and occupancy expenses were more than offset by increases in certain other expenses, including legal and professional fees and stock compensation expenses.

Advertising expenses as a percentage of net sales were 9.7% in the third quarter of 2008 down from 10.2% in the prior year third quarter primarily due to the leverage of national campaigns over a larger store base and partially offset by increased spending on direct sales generation programs in local advertising.

Labor costs at 10.1% of net sales for the third quarter of 2008 were slightly higher than the 10% for the 2007 third quarter primarily due to increases in certain bonus accrual and employee benefits, while occupancy costs at 3.1% of net sales, down from 3.1% in 2007, were leveraged over the greater sales of a maturing store base.

Certain other expenses increased $1.6 million or 70 basis points primarily due to increases in legal and professional fees of operating as a public company in 2008 and legal fees incurred with regard to the variable plan.

Net interest and other income for the third quarter of 2008 was $220,000.00 and was primarily tax-exempt interest income from invested cash. In the third quarter of 2007 net interest and other expense was $184,000.00 and was primarily interest expense on bank debt outstanding prior to our IPO.

Net income for the third quarter of 2008 increased 47.6% to $5.5 million or $0.20 per diluted share based on approximately $27.3 million weighted average diluted shares outstanding. In the third quarter of 2007 net income was $3.7 million or $0.16 per diluted share based on approximately $23.2 million weighted average diluted shares outstanding.

Turning now to our balance sheet and cash flow, we had $24.8 million in total cash and cash equivalents at September 30, 2008 up from $22.3 million at June 30, 2008 and we remained free of long-term debt.

Merchandise inventories totaled $96.5 million at the end of the third quarter down from $100 million at June 30, 2008 and up from $74.9 million at September 30, 2007. Available for sale inventory, which are products we have received and inspected at either our central distribution center or at a store location, totaled $86.4 million at September 30, 2008, $85.3 million at June 30, 2008, and $66.8 million at September 30, 2007.

Although our merchandising strategy in 2008 has included carrying a greater level of both liquidation deal merchandise and moldings and accessories, in comparison to 2007, our available inventory per store was basically equivalent in comparing September 30, 2008 and 2007. [Franklins] forecasting and planning by our merchants resulted in lower available inventory per store in comparison to June 30, 2008.

Working capital was $91.3 million at September 30, 2008 with a current ratio of 3.4 x up from $86.1 million and 2.95 x at June 30, 2008 and $76.8 million and 3.12 x at December 30, 2007.

Capital expenditures totaled approximately $2 million for the third quarter of 2008 and $6 million for the nine months then ended. Capital expenditures in the third quarter of 2008 were primarily for new store fixtures and lease hold improvements, but also included $800,000.00 for the acquisition of 1 800 hard wood for use in our marketing and branding campaigns.

Turning to our outlook for the full year 2008, we are narrowing our full year sales guidance to a range of $482 million to $486 million from our previously expected range of $480 million to $490 million. We now expect comparable store sales to increase in the low single digit range. We have now opened 34 new locations in 2008 reaching our goal for the year of 150 total stores in operation; however we anticipate possibly opening one or two additional locations in 2008.

Finally, we are narrowing our full year 2008 EPS range to $0.74 to $0.77 per diluted share from our previous range of $0.73 to $0.78 per diluted share.

I would not like to turn the call back over to Jeff for his closing remarks.

Jeffrey Griffiths

I would not like to take a few moments to update you on our store openings and outlook.

As we mentioned in today’s press release we have achieved our store-opening goal with 34 new stores in 2008. As Dan noted there is a possibility we may open one or two more stores this year. We are pleased to have achieved our store-opening goal as planned in our first year as a public company.

We have been very encouraged by the rapid ramp up of our new stores and their ability to quickly recover start up costs. More over, we are achieving success with our new stores across geographies which we believe is largely due to our strong brand recognition and effective nationwide advertising campaign.

We opened five stores in new markets and three stores in existing markets for a total of eight new stores opened in the third quarter.

As we have mentioned previously, our current store opening plan calls for about half of our stores to be opened in new markets and half to be opened in existing markets. When we open new stores in existing markets we tend to focus on large metropolitan areas that can support several stores and have found that our total returns in a specific market tend to be greater as we open more stores.

We believe that our store expansion strategy will enable us to take additional market share in the highly fragmented market in which we operate. As you may know, our current goal is to expand our still relatively small store base by 30 to 40 new locations in each of the next few years.

Our infrastructure investments and store model continue to allow for this growth as our stores become profitable quickly with a relatively low capital investment. However, we remain prudent in our approach to expansion in light of the current macro economic challenges.

We are encouraged by our performance through the first nine months of 2008; however as we look forward we are certainly aware of the challenges that we face given the turmoil in the financial and credit markets and its impact on consumers. We are mindful of weakened consumer trends and though we believe we offer the best value proposition to consumers we are not completely immune from the effects of the current headwinds.

With that said, we are cautiously optimistic that the positive traction we are experiencing within our business will continue through the fourth quarter. Further, as we noted in our release, we are confident our debt free balance sheet, cash positive and flexible store model, and strong infrastructure will enable us to navigate the current macro economic environment and continue to implement our growth strategy.

Long term we remain confident in our strong prospects for growth. As I had mentioned, our appealing value proposition of price, selection, quality, and availability continues to resonate with our customers and is even more important in this difficult economic environment in which many consumers have become value seekers and are more price conscious.

In addition, we continue to operate in a fragmented market with a significant number of independent retailers. We believe this, along with our still small store base, provides us with ample opportunity for continued growth. As we move forward we will remain focused on achieving sales growth and margin expansion, maintaining and broadening our effective brand marketing strategies, and continuing to add successful new stores to our chain. All of this will help us to extend our leadership position as the largest specialty retailer of hardwood flooring in the US.

We would now like to answer any questions that you may have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Robert Higginbotham with Goldman Sachs.

Robert Higginbotham - Goldman Sachs

Could you talk a little bit about the trajectory of sales performance you saw in the third quarter as trends may have changed from the beginning to the end, and what you think so far in the fourth quarter? It sounds as if, based on some of the comments you made pointing to your guidance, that maybe you actually haven’t seen a big fall off in sales, but are kind of bracing yourself for that. Maybe you could help us understand that.

Jeffrey Griffiths

Sales were pretty consistent the first two months of the quarter, they slowed down a bit in early September and then they were very strong the end of September. October was a challenging month, but certainly we had some strength there. I think the main thing is that we’re being cautiously optimistic given the more general environment.

Robert Higginbotham - Goldman Sachs

The weakness you have seen in terms of the challenge in October, is that coming in the form of mainly volume as you put it, or is that a price per foot in terms of people trading down, how has that been reflected in what you are saying?

Jeffrey Griffiths

I think customers certainly are being very value conscious and I think that certainly works to our strategy and our product mix.

Robert Higginbotham - Goldman Sachs

One more question on inventory. The available per sale inventory per store, as Dan alluded to, was kind of flattish. The in transit type inventory, I believe, accelerated a bit in terms of year-over-year growth from last quarter. Could you help us understand that and maybe, to put it in different terms, when should we expect to kind of see inventory growth come a little bit more in line with sales growth?

Daniel Terrell

We are pleased with the direction that we went in during the third quarter. We did lower the available inventory per store from June to September and that was the same trend that was in 2007. We are probably more pleased with the mix of inventory that is at the stores, because we are carrying a higher level of liquidation deal inventory and a higher level of moldings and accessories by plan.

That said, we believe that we are going to continue to make some improvements in our planning and forecasting in Q4 such that we will be able to drop that inventory per location; at least the available inventory per location.

The on the water inventory is always going to be a timing issue. It will certainly vary with the ebb and flow of the overall inventory, but that is still going to be subject to the timings around the end of the quarter.

Operator

Your last question comes from Rick Nelson from Stephens Inc.

Rick Nelson -Stephens Inc.

Can you talk about the economics of the installation business and also what your rollout plans are for that?

Jeffrey Griffiths

The main thing with the installation businesses, we want to make sure that the customer has as good a value from installation as they do from the flooring that they buy from us. So our focus there is to keep those prices as low as possible.

We started a test very early this year with Beckham and it was a very well managed rollout so if gave us the opportunity to work together in a small number of stores and get to understand what worked well. It also gave installers that we have had a long-term relationship with an opportunity to join and participate in the program; so it was actually something we have done over the last nine, ten months.

Rick Nelson -Stephens Inc.

And what about that rollout plan of that business?

Jeffrey Griffiths

It is in substantially all of the stores now and our expectation is that it should be in all new stores that we open going forward.

Rick Nelson -Stephens Inc.

Can you quantify the sales cannibalization that you experienced in the quarter where you opened new stores in existing markets, how that impacted the comps?

Daniel Terrell

It’s not a number that we usually disclose and it’s not a number we are going to get in the habit of disclosing. We certainly have cannibalization when we open in new markets, but it is not a number we are going to put out there.

Jeffrey Griffiths

I think the thing to keep in mind is that we under serve all major metropolitan areas. We just simply do not have enough stores to support the potential sales in these markets. Yes, it is unreasonable to expect customers to drive an hour plus from one end of the market to the other to visit the store, especially when they are usually making multiple visits before they finalize their purchase.

Because of our well known brand and the long-term marketing that we do, our name is very well known, our value proposition is well known, and so when we open a second or third store in these markets these stores just ramp very quickly and when we look at the total return that we get form the combined stores in the market it is significantly better than the return we were getting from the single store. But, it is going to have a cannibalization impact and we have known that all along and we think that is the best thing for the business long term.

Rick Nelson -Stephens Inc.

Could you also speak to regional areas of strength and weakness?

Jeffrey Griffiths

Again, we don’t really see any significant change from one region to the other, because our store base is so low in any given market. I don’t think that we are impacted as much as retailers that have a much larger number of stores.

Rick Nelson -Stephens Inc.

Would that be true in the housing affected areas such as Florida and California?

Jeffrey Griffiths

Our performance in those markets is pretty consistent with what we see in the rest of the chain. There is not that much of a difference.

Rick Nelson -Stephens Inc.

How about the availability of closeouts? Do you see more of that as the macro economic environment has grown more difficult?

Jeffrey Griffiths

There has been a pretty consistent high level of availability this year in special deals and closeout. We expect that to continue. We think we are in a great position to maximize our business with that and take full advantage of it, so we see that actually as a plus for our business.

Operator

There are no further questions.

Jeffrey Griffiths

We would like to thank you for joining us on today’s call and for your interest in Lumber Liquidators. We look forward to speaking with you again very soon.

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