Lumber Liquidators Holdings Management Discusses Q4 2012 Results - Earnings Call Transcript

 |  About: Lumber Liquidators Holdings, Inc. (LL)
by: SA Transcripts


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.

Ashleigh McDermott

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 Law for forward-looking statements.

This conference call may contain forward-looking statements that are subject to significant risks and uncertainties, including the future operating financial performance of Lumber Liquidators. Although Lumber Liquidators believes that the expectations reflected in its forward-looking statements are reasonable, it can give no assurance that such expectations or any of its forward-looking statements will prove to be correct.

Important risk factors that could cause actual results to differ materially from those reflected in the forward-looking statements are included in Lumber Liquidators' filings with the SEC.

The information contained in the call is accurate only as of the date discussed. Investors should not assume that the statements will remain operative at a later time. Lastly, Lumber Liquidators undertakes no obligation to update any information discussed in this call.

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

Robert M. Lynch

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 the dedication to strengthening our value proposition of price, selection, quality, availability and people, and most importantly, for their strong and 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, business and the significant opportunities I felt we had in front of us. I laid out a strategy for strengthening our business and driving multiyear growth, zeroing in on 5 key strategic initiatives: growing revenue; driving traffic through advertising recent 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 shared 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 DIY-er, as well as a more casual consumer, which enabled us to drive demand. Our average sales continued to improve, reflecting our customers' preference for premium products and the expansion of our assortment towards 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 team's 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 improve 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 5 key strategic initiatives, the significant increases we have achieved in 4 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 and flooring trends and these initiatives remain top priorities. We have been pleased with the reduction in product cost, 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 multiyear growth of market share and operating margin.

As we entered 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 2 years.

One example of a key multiyear 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 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 U.S. market will support at least 600 store locations, with 4 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?

Daniel E. Terrell

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 noncomparable stores.

As Rob indicated, our focus on our key strategic initiatives continued to benefit net sales as we aggressively pursued market share through our advertising and achieve 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 multiyear 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 noncomparable stores in markets with at least 1 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 2 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 4 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 noncomparable stores exceeded our expectations in the fourth quarter of 2012 and represented the highest quarterly productivity since 2006. We opened 4 new stores in the fourth quarter, and for the year 2012, we opened 25 new stores, 17 of which were in existing U.S. markets, 6 in new U.S. markets and 2 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 cost and a reduction in fourth quarter inventory shrank, 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 multiyear benefits net of our reinvestment in programs to drive traffic and capture market share.

Looking back over the 2 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 cost, they have facilitated the assortment expansion of premium products and enhanced product availability.

Turning to transportation costs. Gross margin benefited by 20 basis points as a certain supply chain efficiency outweighed the impact of generally higher rates for international containers and domestic fuel costs. The net impact of all inbound break cost reduced gross margin by approximately 10 basis points. International container costs 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 continued 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 carry forwards in Canada, which had been recorded as a net deferred tax asset.

During 2012, Canadian operations were profitable on an aggregate 4 wall basis, but that profitability was more than offset by certain cost 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 to 63.2% -- increased by 63.2% of $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 noncomparable 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 costs 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 and 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 increasing to 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 are 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 opened in 2013 to be greater in the second half of the year. Therefore, we expect generally lower than average maturity in our noncomparable store base. In addition, we expect new locations to be weighted towards larger existing markets, potentially increasing cannibalization. We expect gross margin in 2013 -- gross margin expansion in 2013 be less than the previous 2 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 multiyear benefits.

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

Robert M. Lynch

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 5 key strategic initiatives. We believe we have a long runway of opportunities ahead of us and we'll 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 had throughout the year. We were pleased with the 4 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, and 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's 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 allocations 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 multiyear 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 U.S., 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.

Question-and-Answer Session


[Operator Instructions] Our first question comes from the line of Gary Balter with Credit Suisse.

Daniel Engel-Hall - Crédit Suisse AG, Research Division

This is actually Dan, filling in for Gary. I guess just a first question. I mean, understandably, very much in sort of the early innings of the rollout of the new store format, but could you provide any more color, just kind of initial comments on some of the differences you're seeing compared to the previous layout? That would be very helpful.

Daniel E. Terrell

In terms of the store of the future concept?

Daniel Engel-Hall - Crédit Suisse AG, Research Division

Yes, just in terms of kind of -- I mean, understandably, there's not a lot of kind 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 and the previous layout.

Daniel E. Terrell

Yes, it's still very early relative to the results and we'll 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 was phenomenal. Our store associates are tickled. They're basically standing in line begging for the next one to come to their store. So that feedback, obviously, is anecdotal, but very positive. I'm just -- what I would tell you, I'm just generally pleased with the team's 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 and 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 of invested capital in terms of the mix between the number of new stores, relocations and remodels as we optimize our market. The team -- 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 cost and the CapEx going into our new stores, which is one thing that significantly kept the cost of goods initiatives down as we plan 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.

Daniel Engel-Hall - Crédit Suisse AG, Research Division

Great, that's very helpful. And one quick follow-up on just the gross margin, if it's all right is, it looks like -- kind of 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 kind of the right way to think about it? Or how would you guys think about the cadence of those reviews going through in 2013.

Daniel E. Terrell

Yes, Dan, 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's always going to make the margin so much -- somewhat lumpy. The best we can say is we still see multiyear benefit ahead in 2013. We see gross margin improving, even in the face of higher net transportation cost, but we just don't think that improvement is going to be higher than we saw 2011 versus 2010.

Gary Balter - Crédit Suisse AG, Research Division

Just -- this is Gary, just a follow-up, sorry, I've been dealing with the merger and then -- so I've been in 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?

Daniel E. Terrell

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 yields, 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 1 markets where we open these. So they're going to be large metro areas and areas that we have -- that we already have some market penetration in and would see additional opportunity. That's usually the case where we see more market cannibalization.


The next question comes from the line of Budd Bugatch with Raymond James.

Thomas J. McConville - Raymond James & Associates, Inc., Research Division

Rob, Dan, Ashleigh, it's actually TJ McConville, filling in for Budd. 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 went -- I mean, 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?

Daniel E. Terrell

TJ, I'll start a little bit, and maybe Robert can follow-up maybe. Our history has been, when we first came out, we were looking at 300 stores in roughly a 5-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. So 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. So 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 3 to 5 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-20s, depending on how the market goes and we're also looking at 600 stores as a target right now, doesn't mean that that's ultimately the top end of the target.

Robert M. Lynch

Yes, this is Rob, the only thing I would add is -- Dan touched on it. The exciting thing is what we're seeing is kind of a complementary effect from all of our strategic initiatives and the company's focus on continuous improvement. And as we dug into the real estate strategy, all of the processes, and we've improved our site selection processes, right, which is -- 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 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 assessing this, 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 at the beginnings of the company, it was all hardwood. But as we've gone into other categories, laminates, vinyl, bamboo, as we 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 frequency, we're seeing our traffic increasing definitely, so we think all of this is working together, and this is allowing us, in combination with the improvements in the operating metrics of the company, too, that is opening up more markets for us. And that's really the gist of it. So 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 on it over the last -- over a year, really. So we're excited about the opportunity.

Budd Bugatch - Raymond James & Associates, Inc., Research Division

That's really helpful, guys, I appreciate that. 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 that pre-tax 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?

Daniel E. Terrell

That's a good point. SG&A is going to be heavy in 2013 than we'd like to see it in future periods going forward as a percentage of sales. We recognize that we're going to have to really resource some initiatives that have longer-term payback. So where you have been used to 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.

Ashleigh McDermott

Okay. The next question comes from the line of Matt McGinley with the ISI Group.

Matthew McGinley - ISI Group Inc., Research Division

As you guys reflect upon the changes you've made in your advertising strategy, namely, going to target that more casual customer versus the DIY customer that you may have targeted in the past, how much do you attribute that change and 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 customer?

Robert M. Lynch

I think it's a significant piece. But again, in conjunction with the others, I've made this point earlier. We're very fortunate that our initiatives are kind of working in conjunction and speeding off of each other and contributing to the effects of these -- 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 still the contributors, back to my point about how these were 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 the work that our merchants were 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 University, that we had last year. We've 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 and then again, we're training them and sending them to really go after and take of our customer. And that's a big difference as well. So I think those 3 things working together, in that order, are our driver -- are driving those numbers.

Matthew McGinley - ISI Group Inc., Research Division

Great. And then on the occupancy expense leverage. You've had 2 pretty good quarters where you've had a 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 or the locations? Are you extending the lease terms? Are you getting lower rents? I guess what's driving that and the sales leverage, and does the store of the future change the ability to get occupancy leverage maybe in the long run, but also in 2013?

Robert M. Lynch

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 1 retailer or a high-traffic in a Tier 1 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 5 years, we generally get a chance to take a look at a store, whether it's in the right place and whether we like to move it. Because of the macro environment, we've been able to relocate some of our stores and do 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 2 in evaluating what supply chain configuration works to support our growth for the next 5 years, and that will have some impact on occupancy cost 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.


The next question comes from the line of Brad Thomas with KeyBanc Capital Markets.

Bradley B. Thomas - KeyBanc Capital Markets Inc., Research Division

I want to just 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 de-leverage advertising and fortunately, it yielded very strong results. And since we think about some of the spend for 2013, is it the case that you guys are just trying to be conservative with the revenue benefit from some of these investments?

Robert M. Lynch

You're right, when we went into 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 it, we really started some of these tests about 5 quarters ago now. So we didn't have a clearer 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 multiyear payback, but it may require significant spend in 2013, and I mean significant to the point that it de-levers against the top line. So I don't know that it's necessarily being conservative, it's that we see an opportunity. What we've seen for the past 5 quarters has worked and we're going to try and take advantage of that opportunity.

Bradley B. Thomas - KeyBanc Capital Markets Inc., Research Division

Okay, great. And then just 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 had been spread out over the course of the year rather than all coming just in the fourth quarter?

Daniel E. Terrell

Yes, Brad, I think that category, which we've lumped shrink into all other, contributed 120 basis points of 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. Their commitment to continuous improvement and 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 2 numbers, the 120 basis points and the 30 basis points, you know that shrink is one of the primary drivers of the change.

Bradley B. Thomas - KeyBanc Capital Markets Inc., Research Division

All right, great. And maybe, just 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 2 months into the quarter, how are you guys feeling about things thus far having had a snowstorm already?

Robert M. Lynch

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


The next question comes from the line of Matthew Fassler with Goldman Sachs.

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

I'd like to start off with a quick question about working capital. So 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 kind of a bit of a pop in customer deposits. I know that moves around a lot. How should we think about those 2 numbers as it relates to customer backlog and what that tells about sales prospects over the next couple of quarters?

Robert M. Lynch

Matt, I'll start, and I'll let Dan take some of the technical pieces of that. But in general, if you remember last year this time coming into 2012, we had -- on the heels of a lot of line reviews and the changing out and transitioning of categories, we made a conscious effort in Q4 2011 to really kind of cleanup and make the inventory a lot healthier. So 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. And in hindsight, it was absolutely the right thing to do. Number two, what I would tell you is, as we've talked 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 the inventory and having that inventory accessible to the stores, accessible to the customers when they need it, is very important. So that's one of 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 bestsellers by store because it's something that's so relevant to our customers as a competitive advantage for us. So that was a thoughtful, intentional thing that we've done. But again, overall, we're pleased with where we ended up. I mean, 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 pick up in sales.

Daniel E. Terrell

I'll follow up really quickly on the customer deposit. We did end the third quarter with a higher customer deposit. 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 6 weeks of the first quarter are 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.

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

Great. A quick follow-up. Just to qualify on your gross margin target, you talked about an increase, at least as big as that of what you saw in the last 2 years. So I guess this year's gross margin increase was a lot bigger than the '11 gross margin increase. So how should we try to kind of hone in on the implied guide on that comment?

Daniel E. Terrell

Matt, I've 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 2. So the lower one was 140 bps '11 over '10, so we don't think it's going to be that high.

David S. Strasser - Janney Montgomery Scott LLC, Research Division

Okay, that's helpful. And then finally, just on the strategic front, you talked about broadening out your target customers through advertising, kind of targeting a more casual customer. What are the characteristics -- the economic characteristics of that customer as it relates to ticket and the kind of product that you think they're migrating to, as the higher margin product or lower margin product. How has their joining your family, if you will, impacted the economics of the business?

Daniel E. Terrell

Yes, 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. And if you think about it as common sense, it makes sense. Because they are not as -- may not be as experienced with big ticket projects, with doing them on their own or even marketing -- making the purchases, so 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 kind of -- more looking for our expertise, our one-on-one service, our wide assortment. They definitely have -- they are definitely interested in our premium products and the advice and service that our folks have to offer in the stores. So it's a really good math, if you want -- I mean, kind of math 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 with driving those new folks into the store and our sales -- our store associates are doing a fabulous job of transacting and closing this up.


The next question comes from the line of Peter Keith with Piper Jaffray.

Peter J. Keith - Piper Jaffray Companies, Research Division

With the stepped up outlook on stores, just to clarify, because you're talking 600 in the U.S., you'd still pick about another 50 in Canada, so are we talking about 650 total at this point?

Robert M. Lynch

Probably 40 in Canada.

Peter J. Keith - Piper Jaffray Companies, Research Division

Great. Okay. And so if we look at the guidance for your store growth this coming year, it looks like you're kind of -- maybe kind of backing around 8% to 12% unit growth, that compares to 2012, we saw 8%. So as you picked up that forecast on the future store potential, are you kind of in turn, accelerating the unit growth? And I guess should we think about this new 8% to 12% as a new run rate?

Daniel E. Terrell

It really wasn't the 600 stores that caused us to take a look at our opening schedule. Where we're -- 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, to market optimization and the right quantitative metrics. So it's sort of our desire to have the right quantitative metrics and market information 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 the store of the future rolled out, how that works. And then looking at the 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.

Robert M. Lynch

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, 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 relo and an existing market as we optimize the markets, right? So we're very thoughtful in measuring the impact of the store of the future, when we do, we go in and we remodel an existing store and/or we relocate and remodel an existing store. So obviously, as we get those results kind of down, it'll drive the mix between new relo, remodel.

Peter J. Keith - Piper Jaffray Companies, Research Division

Okay, that's very helpful. Just a quick follow-up on the store of the future relo, 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 relo, do those stay in the comp base?

Robert M. Lynch

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

Peter J. Keith - Piper Jaffray Companies, Research Division

Okay, fair enough. Just one last question on the ads spend. So up 25% in Q4, clearly, you guys have got some very positive results off of that. Is that kind of a nice -- is that a run rate you're thinking about going forward for 2013, up 25% or so from 2012?

Daniel E. Terrell

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


The next question comes from the line of Laura Champine with Canaccord Genuity.

Laura A. Champine - Canaccord Genuity, Research Division

So 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 store of the future for some time. I understand that's the pace of growth at which you're comfortable. But why not grow faster in terms of units and in particular, the remodeling? That's less than 10% of the store base remodeled this year.

Robert M. Lynch

Yes, Laura, that's a good question then. I kind of hinted to it, but what I want to tell you is, this is a new initiative for us. The team did a fabulous job of putting this together last year. And the reason why you see the pace that we're guiding to is really because of us kind of lining up the resources and making sure that it's something that the teams can handle. Like I said, we went in, and we aligned our view and reengineered all of the components of the capital components and actually the layout, the design, the pictures, everything in these stores, right? So we've got new vendors, new fixtures, we've gone direct-to-factory on a bunch of the stuff to kind of mitigate the cost increase. The positive is, it's a fabulous change, we think it's 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 us potentially picking up in the out years, but this year, we wanted to make sure, we balanced -- we're adding some resources for the real estate team, to our store planning, our store set teams, this is something we want to do -- we want to make sure that's not distracting to the field to our store associates and their selling. And yes, when you go in and then 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 kind of weighed in to what we're doing in our plans, and I think it's appropriate. And like I said, if we can -- if the things go well and we have the flexibility, we want to pick up the pace during the year. But for now, that's kind of what we feel comfortable doing. And it has nothing to do with the optimism around the initiative itself. Is that all, Laura?


The next question comes from the line of David MacGregor with Longbow Research.

David S. MacGregor - Longbow Research LLC

I guess a couple of 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 started taking some of that benefit back to market in the form of your market share development and brand support and so on and so fourth. I guess I'm just wondering now, given the tremendous performance we're seeing and the upside we're seeing since you've arrived in gross margins, just, are we getting close to that point now? I mean, Dan, in his guidance, had talked about the fact that the growth in gross margins would be less in '12 than in '11. Just how much upside do you envision in gross margins from this point forward versus getting to that point we start taking it back to market?

Robert M. Lynch

Well, 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 and some price point changes, and funding some of the advance in terms of the marketing and advertising that we've been doing. So 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 and some of the other things that we're -- other initiatives that are in development in both sourcing, supply chain, operations. The message I would give to everybody is margin enhancement in the retail is not a silver bullet. I mean, there's probably 20 different -- I could reel off 20 different areas you can impact gross margins in a retail company, shrink being one of them, obviously, sourcing, of course, supply chain, store operations within the store, there's components there as well. So we have been taking a comprehensive look, the continuous improvement approach to our margin enhancement in the last couple of years and we're going 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 going -- we wouldn't expect it to be as much as it has been in the last 2 years, but we think that it'll still be significant and that it will continue.

David S. MacGregor - Longbow Research LLC

The next question comes from the line of Joseph Edelstein with Stephens Inc.

Joe Edelstein - Stephens Inc., Research Division

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 do you think about how consumer preferences have changed for flooring in general. Do you see -- I guess, 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?

Daniel E. Terrell

I'll start and maybe Rob can finish up. 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 and 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, 3/4 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're looking for. So 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.

Joe Edelstein - Stephens Inc., Research Division

That's very helpful. Also, I just wanted to ask about your planned promotional schedule that you have this year and how that compares to the prior year.

Daniel E. Terrell

We are going to be more aggressive in our approach to take share. That may or may not be greater discounting 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 messages 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.


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.

Robert M. Lynch

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.

Daniel E. Terrell

AKBA [ph].


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.

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