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Lumber Liquidators, Inc. (NYSE:LL)

Q4 2008 Earnings Call

March 11, 2009, 10:00 am ET

Executives

Leigh Parrish - FD

Jeff Griffiths - President and CEO

Dan Terrell - CFO

Analysts

Rick Nelson -Stephens, Inc

Gregory Mills

Peter Keith - Piper Jaffray

Joe Owen - Key Banc Capital Markets

Robert Higginbotham - Goldman Sachs

John Baugh - Stifel Nicolaus & Company, Inc.

Hardy Bowen

John Curti

Operator

Good morning ladies and gentlemen and welcome to today's Lumbar Liquidators Fourth Quarter and Full-Year Conference. With us today is Mr. Jeff Griffiths, CEO of Lumber Liquidators, and Dan Terrell, CFO of Lumbar Liquidators.

As a reminder ladies and gentlemen today's conference is being recorded, and may not be reproduced in whole or in part without permission from the company. At this time I would like to introduce Ms. Leigh Parrish of FD. Please go ahead.

Leigh Parrish

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 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.

And now I am pleased to turn the call over to Jeff Griffiths, President and CEO. Jeff?

Jeff Griffiths

Good morning everyone thank you for joining us for Lumber Liquidators fourth quarter and full year 2008 earnings call. With me on the call today is Dan Terrell our CFO. I would like to begin today with some highlights of this past year's performance, Dan will then review our financial results in detail as well as our outlook for 2009.

I will return with comments on our ongoing strategic directions and our plans for the remainder of the year, before we open the call to questions.

Overall we are very pleased with our performance for 2008 our first full year as a publicly traded company. We are particularly gratified with our results in light of the very difficult macro environment which as we all know began to deteriorate rapidly in the fourth quarter.

Despite these external challenges the company's performance met our expectations for the year, as we expanded our gross margin and leveraged our operating expenses. We successfully demonstrated that our business model is flexible and resilient and we ended the year solidly positioned to continue to grow and expand our market share as well as drive earnings growth in 2009.

Much of our success last year was due to our ability to grow our store base and expand our market share at a relatively low cost. In 2008 we added 34 new stores to our base which was in line with our expectations, and we ended the year with 150 stores across an expanded national footprint.

These new stores consistently performed above expectations and made significant contributions to our sales growth for the year.

Hoping to drive the solid performance and quick ramp up of our new stores was our well known brand and unique value proposition both which are supported by our strong national advertising program. This high brand recognition and acceptance of our offering, combined with our low startup cost enabled us to gain significant market share in 2008 and to take advantage of the expansion opportunities presented by the highly fragmented hardwood flooring industry in which we operate.

We intend to continue to grow our store base and capture additional market share in 2009. Even in light of challenging external factors, and we will continue to maximize the strategic opportunities for growth that we identified at the time of our initial public offering.

But before I touch on our growth strategy, I would like to discuss the other important drivers of our success in 2008. Our unique value proposition of price, quality, selection and availability has been and continues to be one of our key contributors to our strong performance.

In 2008, we saw greater acceptance for our value proposition as well as an expansion of our customer base as demand for our offering grew. As consumers became more price and value-conscious during the latter part of the year, we quickly adjusted our marketing strategies to address their shifts in attitude.

We moved from branding and to call to action messages, and specifically focused on our value proposition. Notably, we were able to ship a significant amount of marketing dollars to this call to action strategy in a relatively short time period allowing us to keep pace with the rapidly changing atmosphere and generate sales without negatively impacting margin.

Our gross margin continued to benefit over the course of the year from our expanded product selection and increase in stock position of premium products. Margin expansion was also driven by increased sales of high-margin items such as moldings, trims, treads, and risers.

In addition, during the year we continue to take advantage of opportunistic liquidation purchases. Our solid cash position puts us in a great position allowing us to act quickly when these opportunities arise. We believe that these liquidation opportunities will continue to occur during this difficult economic time.

Another important driver of our success throughout the year was our ability to improve operational efficiencies and strengthen our infrastructure. We made several advancements on these fronts by adding support at the store and regional management levels, upgrading our merchandising processes in the areas of inventory and product allocation and improving the quality of our in-store product presentations.

While improvements in product planning and forecasting enabled us to ship more deliveries to intermodal and more cost efficient carriers without reducing our frequency of deliveries to our stores. As a result, we were able to contain the increases related to fuel costs by reducing the amount of miles traveled.

The improvements and planning and forecasting also led to more consistent in-stock positions of our core flooring skews. One of the resulting benefits is that we are able to continue to reduce the number of days outstanding for open orders which we believe leads to greater customer satisfaction and continue to strengthen our competitive position. This is a good example of how our investments and infrastructure continue to yield benefits and enable us to further improve our execution.

In addition to all of these important advancements, we believe that there are more opportunities to create further operational efficiencies as we continue to position the company for a long-term growth and expansion. I will discuss these in greater detail later in the call.

Before I turn the call over to Dan, I would just like to say that we are very pleased with all of our achievements for the year and encouraged by our performance especially against the backdrop of a challenging economic environment. It's a testament to our entire team and our hard work over the past year as we have established a strong foundation and put the right pieces in place to support our long-term growth strategy.

We remain confident in the attractiveness of our unique value proposition and in our ability to execute our low cost store expansion strategy. As we leveraged these important aspects of our business model, we expect to continue our positive momentum, capture additional market share and build on our leadership position as the largest specialty retailer of hardwood flooring in the US.

I will now turn the call over to Dan for detailed review of our financial results and will be back in a few moments to discuss some of our strategy initiatives for 2009 as well as answer questions.

Dan Terrell

Thank you, Jeff. Good morning everyone. Let me provide some additional details on our results for the fourth quarter and full-year 2008 and then discuss our outlook for the year. I will start with our results for the fourth quarter.

Net sales for the three months ended December 31, 2008 grew to $116.5 million an increase of 10.4% from $105.5 million for the fourth quarter of 2007, due to the growth in our store base.

Comparable store net sales decreased 4.6% for the fourth quarter of 2008 compared to an increase of 8.6% in the fourth quarter of 2007. Comparable store net sales in the fourth quarter were impacted by the rapid deterioration in the general economy. There were monthly comparable store net sales improved as the quarter progressed largely due to the adjustment in our marketing strategy Jeff previously mentioned accommodating the increased price sensitivity of our customers.

We believe our retail prices present the greatest value relative to our competitors in the premium products of each product line. And throughout 2008 our expanded assortment of premium products captured a greater percentage of our sales mix. In the fourth quarter of 2008, we saw an acceleration of this trend particularly in our laminate, bamboo and cork proprietary brands. Even the premium products within these product lines carry a retail price point lower than our average and as such the average retail price per unit sold declined approximately 9% during the fourth quarter while our total sales volume which we primarily measure in square feet grew approximately 21%.

We opened 7 new stores during the fourth quarter and 34 stores in total for 2008 ending the year with 150 stores operating in 44 states. Overall, we were pleased with the fourth quarter performance of our new stores given the challenging environment and we expect expansion in the store base to continue to be the primary driver of sales growth in the near-term.

Gross margin increased 30 basis points to 34.2% from 33.9% in the prior period. This gross margin expansion was primarily due to the shift in sales mix towards premium products within certain product lines and strong sales of moldings and accessories partially offset by higher transportation costs in comparison to the fourth quarter of 2007.

Selling, general and administrative expenses in the fourth quarter of both 2008 and 2009 were significantly impacted by the stock-based compensation expense. SG&A in the fourth quarter of 2008 included a benefit of $3 million resulting from a reversal of a stock-based compensation expense accrual related to the Variable Plan originally accrued in the fourth quarter of 2007. We discussed this reversal in the details of the Variable Plan in our 10-K which we filed this morning.

In addition, SG&A expense in the fourth quarter of 2007 included $1.2 million related primarily to the accelerated investing of certain stock options in the recognition of certain restricted stock units triggered by the IPO.

Excluding all stock-based compensation expense from SG&A, expenses were 26.6% of net sales for the fourth quarter of 2008 compared to 27.3% of net sales for the fourth quarter of 2007. This improvement was primarily driven by decrease in professional fees in the leverage of national advertising over a larger store base.

We are pleased that our strengthened infrastructure enabled us to control certain SG&A expenses without adverse impact to sales or operations including the flexibility in advertising mentioned earlier.

Net interest and other income for the fourth quarter of 2008 was $215,000 versus $132,000 in the same period of 2007. The effective tax rate was 42.3% in the fourth quarter of 2008 up from 39.5% in the fourth quarter of 2007. This increase was primarily due to certain state income taxes and adjustments to certain full-year estimates.

Net income for the fourth quarter of 2008 was $6.5 million, or $0.24 per diluted share, based on approximately 27 million weighted average diluted shares outstanding. The fourth quarter reversal of the Variable Plan [accrual] increased diluted earnings per share by $0.07.

In the fourth quarter of 2007 net income was $3 million or $0.12 per diluted share based on approximately 25.3 million weighted average diluted shares.

I would now like to discuss our results for the full year which were inline with our guidance for net sales, comparable stores sales growth and diluted earnings per share.

Net sales for the year ended December 31, 2008 grew 19% to $482.2 million from $405.3 million for 2007.

Comparable store net sales for the year grew 1.6% on top of an 8.6% increase in 2007. Consumer demand for our expanded product assortment primarily certain premium products drove sales volume partially offset by a slight increase in the average retail per unit solid as a result of changes in our sales mix.

In addition, sales benefited throughout the year from our commitment to a more consistent in stock position including moldings and accessories and our merchandising investment in liquidation deals including certain special liquidation buys in the first half of 2008.

Gross margin for 2008 increased to 150 basis points to 34.8% from 33.3% for 2007. This expansion included approximately 35 to 45 basis points related to items we will regard as non-recurring or unique. Including the retroactive rebate of a portion of a bamboo tariff and the impact of certain special liquidation buys.

That said we were pleased with the success of store operations, merchandising, and logistics initiatives where we maintained retail pricing discipline, strength and controls related to our purchase cycle or under our product assortment in control transportation cost. We expect these benefits to continue in 2009 and result in gradual expansion of gross margin.

SG&A expenses for the full year 2008 were $130.7 million or 27.1% of sales compared to $116.3 million or 28.7% of sales in 2007.

As I mentioned earlier SG&A expenses in both 2008 and 2007 have been significantly impacted by our stock based compensation expense particularly related to the variable plan and our IPO.

We fully describe these impact in our 10-K, excluding all stock based compensation expense, SG&A expenses were 27.1% of net sales in 2008 compared to 27.2% of net sales in 2007.

This improvement primarily resulted from leveraging our national advertising partially offset by increases in legal and professional fees in our first full year as a public company and increase in certain labor cost primarily due to our infrastructure investment.

We had income of $807,000 related to interest in other items in 2008 compared to net expense of $309,000 in 2007. The effective tax rate for 2008 was 41.4% up from 38.8% for 2007 and included the impact of the non-deductible portion of the variable plans cumulative compensation costs.

Excluding this impact the effective tax rate was 39.7% for 2008 compared to 38.8% in 2007 largely due to increases in certain state income taxes.

Net income for 2008 was $22.1 million or $0.82 per diluted share based on approximately 27.1 million shares. Net income for 2007 was $11.3 million or $0.48 per diluted share based on approximately 23.6 million shares.

Again the 2008 earnings per share included the aforementioned impacts from the variable plan, a benefit of $0.07 per diluted share. Partially offset by $0.03 per diluted share of increased tax expense in the first quarter due to the non-deductible cumulative compensation cost of the variable point.

Turning now to our balance sheet and cash flow, we ended the year in a solid cash position with $35.1 million in total cash and cash equivalents up from $24.8 million at September 30, 2008 and $33.2 million at December 31, 2007.

We remained free of long term debt and we did not draw on our $25 million revolver during 2008. Merchandised inventories totaled $88.7 million at the end of the fourth quarter down from $96.5 million at September 30, 2008 and up from $72 million at December 31, 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 $75.5 million at December 31, 2008 and $86.4 million at September 30, 2008 and $60.3 million at December 31, 2007.

Our merchandising strategy throughout 2008 included greater carrying levels of liquidation deal merchandise as well as broadened and more consistent in stock position in moldings and accessories. We are pleased that our strengthening merchandising efforts throughout the purchase cycle we were able to achieve these goals and reduce available inventory per store to 503,000 at the end of 2008 from 520,000 per store at the end of 2007.

Working capital was $96.2 million at year end with the current ratio of 3.6 times this compares with working capital of $77.9 million at year end 2007 with the current ratio of 3.2 times.

Capital expenditures totaled approximately $7.4 million for 2008 including $800,000 related to the purchase of 1-800-HARDWOOD. This compared to $6 million for 2007.

Before I turn the call over to Jeff for discussion of our overall 2009 priorities I will provide our financial guidance for the year.

Overall, we expect the economic pressures on the wood flooring market to continue through 2009 and as a result our sales growth will be through the expansion of our store base.

Even in these challenging economic times, we believe the flexibility and profitability of our store model will allow us to continue to capture market share as well as expand our cash position and increase net income exclusive of the variable plan benefit we have recorded in 2008.

We expect to generate total sales of $515 million to $530 million in 2009 which reflects our plan to open 30 to 36 new store locations and our expectation of a comparable store sales decrease in the low to mid single digit range for the year with slightly easier comparisons in the later half of the year.

We expect 2009 full year earnings per diluted share in the range of $0.76 to $0.86 on approximately 27.5 million shares. Adjusted for the variable plan at pool reversal and tax expense for non-deductible cumulative compensation cost expense achieving the mid point of this range would result in year-over-year earnings growth of approximately 6%.

We expect capital expenditures in the range of $10 million to $13 million in 2009 as we continue to invest in new store openings, remodel existing stores and seek logistics in information technology solutions to optimize our product flow and enhance management control reporting and planning. We expect to be cash flow positive in 2009 and remained free of long-term debt.

I would now like to turn the call back over to Jeff for his closing remarks.

Jeff Griffiths

Thanks, Dan. I would now like to take a few moments to update you on some of our strategic growth initiatives for 2009, which will help us achieve our goal of expanding our market share and earnings during the year.

As we both said in 2009, we expect to continue with the expansion of our store base and capitalize on opportunities to leverage our proven store model with relatively minimal upfront expenditure. This is in keeping with our long-term goal of opening 30 to 40 stores per year.

While we are certain and cognoscente of the ongoing challenges presented by the downward shift in the economy, we are fortunate to have a flexible store opening model as well as significant financial flexibility, which enable us to sustain our expansion strategy.

In addition to our store expansion strategy, we are implementing several strategic initiatives that we expect will help us to drive additional growth this year and over the long-term.

First, as we outlined last quarter, we have developed an important business partnership with the Home Service Store, or HSS in which we now offer fully insured HSS installation services in every store in our chain.

Our addition of HSS installation services has proven to be a strong selling tool as it strengthens the full range of services that we offer, and raises the total level of customer satisfaction.

Second, as Dan mentioned, we will be making some additional investments in our software and systems so that we can increase the discipline and efficiency with, which we manage operations throughout our organization. In particular, the upgrade is intended to optimize our warehouse and distribution systems and assist us with managing our inventory.

While we have budgeted for some upfront cost associated with this advancement, we believe that the long-term benefits are better and more efficient operations outlay the additional incremental cost.

Third, we are piloting a program under which we will have product shift directly from China, while this direct-to-store delivery program is only in its early stages, long-term we believe this program enrolled out across all store overtime will allow us to make further significant improvements on reducing time and transit and improving inventory and stock positions while lowering transportation cost.

Lastly, related to our inventory management, we expect to strengthen our product allocation function by adding additional recourses and management expertise in this area. Our intention in doing so is to create systems that will further improve inventory management and reduce unnecessary interest to our transfers.

An important component of our enhanced inventory management will be to begin customizing our product assortments by region, so that our in-store assortments better reflect local customer preferences.

In summary, we look forward to a productive 2009, in which we plan to extend our market share and drive earnings growth. We will continue to take advantage of our ability to expand our store base with minimal upfront expenditure and expand our share on a highly fragmented market in which we operate.

We are confident that we will benefit from additional operational efficiencies and will be able to continue to expand our operating margin. Lastly, we look forward to beginning the implementation of the strategic initiatives that I just described to further advance our business and drive additional growth.

We look forward to providing with updates on our progress throughout the year. We would now like to answer any questions that you may have. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). We will go first to Rick Nelson Stephens, Inc.

Rick Nelson -Stephens, Inc

Thank you, good morning. Another great quarter.

Jeff Griffiths

Thank you

Rick Nelson -Stephens, Inc

Jeff, you mentioned that sales improved as the quarter progressed, can you provide more color as to the magnitude and any insight into January, February, say, first quarter would be helpful? Thank you

Jeff Griffiths

Yeah. As we said we made some adjustments in our marketing strategy, where we moved some dollars from some branding messages to some cost of action messages and we did see some improvement in sales as we got later in the quarter.

What we have seen this year so far is consistent with what we said, we expect negative comp store sales this year and we expect them to get a bit better as we get later in the year as we get up against easier comparisons.

Rick Nelson -Stephens, Inc

And I think you mentioned an average ticket was down 9%, was that on a same-store basis?

Jeff Griffiths

Yeah, the average ticket went down about 3% to 4%, the average retail price per unit sold was down 9%, and that was primarily due to the shift in the sales mix. Those are premium products in categories such as laminates, bamboo and our cork carry an average retail price that's lower than the company's average, and that took down the average retail price per unit sold.

Rick Nelson -Stephens, Inc

Thanks. And how about store traffic, a number of transactions, do you have that data?

Jeff Griffiths

We are not presenting that?

Rick Nelson -Stephens, Inc

Got you, how about regional strengths and weaknesses, particularly some of the housing effect in markets like Florida and California. If you could comment on sales there relative to the rest?

Jeff Griffiths

Our store base in any given market is still pretty small, so and we don't really, and because we are young business, and we feel like that a lot of the operational improvements that we are making probably clouds the performance in any given market between that in a small store base.

Rick Nelson -Stephens, Inc

All right, and then to store growth.

Operator

I am sorry. Mr. Nelson, pardon the interruption. We do ask that you please pick up the handset prior to posing your next question, if you are on a speaker phone?

Rick Nelson -Stephens, Inc

I am on a cell phone actually.

Operator

Okay. Please go ahead.

Rick Nelson -Stephens, Inc

Alright, thank you. Store growth, what's your planning for 2009. Can you break that down between the existing markets and new markets and what you are seeing in rents versus what you were paying previously and these are opportunities to renegotiate some of your existing rents.

Jeff Griffiths

We are sticking to our long-term strategy of roughly half of the stores, half the new stores being in new markets and half in existing markets. We do believe that we are starting to see some opportunities and some occupancy cost as we are looking at locations. We are balancing that versus maybe paying about the same cost but upgrading the location a little bit but that's pretty much a case-by-case basis. And I am sorry, what was the other part of your question?

Rick Nelson -Stephens, Inc

Existing markets versus new market?

Jeff Griffiths

As leases come up for renewal we are certainly using that opportunity to aggressively look for some concessions there.

Dan Terrell

Rick, I would just add that our occupancy costs are not a large percentage of our SG&A expense based on type of location we are in. So, even though we are aggressively pursuing cost benefit there, we are throughout the whole SG&A structure but occupancy as they come up for renewal and certainly on the new stores, but it just not going to have the same impact that you might see from other retailers who are going through the same strategy.

Rick Nelson -Stephens, Inc

And then the new stores are they going primarily into existing markets or these new markets what do you expect in term of cannibalization and what have you seen that rates?

Dan Terrell

As we said, we are sticking with the long-term strategy that about half will be new and half will be existing markets. Cannibalization is consistent with what we have seen previously.

Rick Nelson -Stephens, Inc

Alright. Thank you very much and good luck.

Dan Terrell

Thank you.

Jeff Griffiths

Thanks Rick.

Operator

We go next to [Gregory Mills].

Gregory Mills

Hi thanks guys, a couple of questions. In your guidance on the low single-digit to mid single-digit negative comps, what are you assuming will happen to that the ticket in average revenue per unit numbers you talked about and then I had a follow-up.

Jeff Griffiths

We feel that the trend we saw last year with that slight decline will probably continue or maybe start to stabilize a bit. We are still seeing a shift to more business in laminate, bamboo, cork which is lower sales per square foot, but we are offsetting that to some degree by selling more premium products in these categories. And those premium products carry higher gross margins than our average gross margin. So while we are seeing a slight decline in the average ticket, we are seeing improvement in margin. And we are also continuing to get more molding and accessory sales, which again helps offset that.

Gregory Mills

Did you quantify or could you quantify what currency did the gross margin just given the importing versus you are selling here. And what you think that is into '09?

Jeff Griffiths

Greg we don’t break that out separately as a component. Certainly it began to have a benefit in the fourth quarter as it worked its way through the inventory returns. And we expect it to have some benefit at least through the first half of '09 but we haven’t quantified it.

Gregory Mills

Okay, and you don't try to hedge any of that, it's just what it is.

Jeff Griffiths

Right everything we purchase is in dollars but we have no hedging programs.

Gregory Mills

Okay, great. And then, just last of the follow-up, I think, earlier there was a question on what trends you had seen as a quarter to-date in early '09, and I can't remember if you answered or I might have missed it. Was there any comment on what you are seeing so far in the last month or two?

Jeff Griffiths

Pretty similar to what we saw in the fourth quarter in terms of the product mix trending towards the lower price laminates, bamboos and corks which again helps the margin and reduces the average ticket.

Gregory Mills

Okay. So the improvement in comps in the quarter sounds like it didn’t continue to improve into this year but it didn’t go turnaround?

Jeff Griffiths

Fair assumption.

Gregory Mills

Okay. Thanks.

Jeff Griffiths

Thanks Greg.

Operator

Mitch Kaiser has our next question. Please go ahead sir.

Peter Keith - Piper Jaffray

Hi, good morning guys. It's actually Peter Keith calling in for Mitch. Just a couple of questions for you. I was wondering how we should think about gross margin at least for the first half of the year because, it seems to us that you will begin to get some benefit from your transportation from the lower fuel cost, but at the same time you are going to be going up against some of the nice margin drop you saw from the opportunistic buys in the first half of last year. Would we think that gross margins are going to be flat, or do you think you can still see some improvement in the first half of the year?

Jeff Griffiths

Our assumption is that we will see some improvement in margin with the product because of all the improvements we have seen in the product mix that we have already discussed. And we also, with the logistics initiatives that we are doing with the reduction in fuel cost, certainly they were benefited as well. We do think that the logistics benefits will be more dramatic in the later part of the year. As far as liquidation buys, there were some significant liquidation buys early part of the year last year, but we feel we will continue to be able to take advantage of those as we go through the year, so quite a bit of product available. We also had the one-off in the mid year last year with the bamboo rebate, but overall we think that the combination of the product shift we just takes initiatives we are going to continue to see margin growth.

Peter Keith - Piper Jaffray

Okay. That’s helpful. Turning to SG&A, Jeff I appreciate the strategy that you outlined for us, would we expect that those four initiatives will be margin dilutive in 2009 or will we begin to some benefit that might offset the ramp up in cost?

Jeff Griffiths

Overall, we think that the combination of all those, believe is that we will see some SG&A improvement in 2009, we still have the benefit of managing our marketing spend and there is some flexibility in there that should help that. A lot of the investment spending that we are doing is going to be spread out over a long period of time. So it's not going to be all impacted in 2009. And again that is going to be offset by a lot of the improvements in logistics which we will be seeing in gross margin improvement.

Peter Keith - Piper Jaffray

Okay. Thank you. And then one last question just thinking longer term about your business, I believe you stated operating margin goal of about 8% as a target. Assuming given those for the tough environment you still are beginning to approach that here at the end of 2008 understanding that economic and top line environments can remain challenging. But have you reestablished the new goal or do you have some new thinking around that?

Jeff Griffiths

We have not specifically said anything beyond that but our feeling is that long-term there is an opportunity to be better than that. Certainly as we went through the round of operational improvements in 2008 and we did see margin improvement. We are still not done, we still have more opportunities as part of what we outlined in this strategy for this year and I think that as we accomplish those improvements that we will be able to see more behind that.

Certainly the whole way we manage the inventory the allocation process, distribution process significant improvements, opportunities for improvement there over the next few years.

And I think that as we do that and we improve the in stock position and we improve the level of training in the stores and things like that there will be sales benefit on top of that which again will drive further margin improvement. So I think they will just build on each other. So, we have still got several years of improvement opportunities here.

Peter Keith - Piper Jaffray

Okay. Thanks for the color and good luck.

Jeff Griffiths

Thank you.

Dan Terrell

Thanks.

Operator

We will move on to Brad Thomas.

Joe Owen - Key Banc Capital Markets

Good morning. This is actually Joe Owen for Brad Thomas. I just had a couple of questions. I know you have mentioned something about, some of the following. But could you talk a little more about the timing of the store openings you have planned and from a more strategic standpoint? Could you also talk about how you are thinking about store openings in this difficult consumer environment, like for example if we continue to see the consumer weaken would that be a circumstance or we might see stores coming at lower end of the range or would that be a situation where you might be a little more opportunistic and accelerate store growth. I mean it's obvious that the economics on your new stores are very strong. So it be very helpful for us to understand how you all are thinking about the store opening?

Jeff Griffiths

Yeah, I think the store opening plan is fairly even throughout the year in terms of number of stores per month or per quarter. But the most important thing that come away here is that we have a pretty short lead time for opening. So we can make adjustments in this strategy very quickly if we feel that the situation is deteriorating. And so we are just constantly reviewing that. I will say that our new store performance continues to be very strong, new store productivity is exceptional and as long as those trends continue to be very positive, we feel that it's in our best long-term interest to continue to open stores because as the stores get established in their market and the economy does start to turn around. We should be in great position to really drive our growth much faster than we are driving it now. So it's something that we are constantly reviewing and can make adjustments very quickly if necessary.

Joe Owen - Key Banc Capital Markets

Okay, great. I also just had a follow-up question on the supply chain and distribution. I know you disclosed in your 10-K that you expect the facility to support planned growth over at least the new two years. But could you just give us an update on how close the full capacity maybe at right now and how much remaining capacity the facility could have and what sort of timing you might have in mind for additional investments?

Jeff Griffiths

We are making some improvements in this facility this year which is part of our capital expenditure. And we are going to triple the number of locations available for flooring as we get better at managing inventory we are carrying less square, our goal is to carry less square foot amount per skew, but have a higher in-stock level which [assesitates] more locations but does not necessarily require more square footage.

So, we feel that by making these investments we are going to be able to prolong the life of this facility which would preclude us from having to get another facility. But again that’s something that we are constantly revaluating as well. When we do get to the point and also to trying consolidation which is a leased operation will help prolong the life of this facility as well.

When we do get to the point where we think we need some more capacity it’s relatively low investment not a lot of technology that goes into warehousing wood. So it will be relatively low expense to bring on additional location. But again I do not see that necessary in the foreseeable future.

Joe Owen - Key Banc Capital Markets

Okay thanks for your time and good luck.

Jeff Griffiths

Thank you

Operator

Robert Higginbotham, please go ahead.

Robert Higginbotham - Goldman Sachs

Thanks good morning guys. A couple of questions around costs and the first on the ad expense line Jeff, just a minute ago you mentioned your ability to really flex your spending amount there and you certainly demonstrated that. This quarter as you look forward into 2009, how should we think about how you are going to manage that expense would it be a certain percent of sales, in other words, would you still be targeting the same 40 bit kind of range leverage that you had looked to achieve in a more favorable environment?

Jeff Griffiths

Yeah we are pretty much staying by the long term strategy at a target of 40 basis points per year, improvement in marketing spend. Some years it's going to be greater than others saying there were some benefits last year with some, particularly later in the year. Where cost to pay surge went down, there were some savings in some other areas that we were able to take advantage of. So we do not feel like we cut back on our average size. We think that we just got more efficient with it and took advantage of some cost savings opportunities. We have not built into our assumptions this year that we are going to continue to get those cost savings. But our feeling is that there is possibility that some of those will continue.

Robert Higginbotham - Goldman Sachs

And the second part of the question, when cost was on table which was essentially neutral of the percent of sales. The year-over-year and certainly much of that is commissions, which is going to automatically flex with sales. But could you talk a little bit about the level of service in your stores and how that might have changed and how much flexibility you might have to change that.

Jeff Griffiths

We feel that we have made a lot of improvements at the level of service in the stores, which we have, not that there has been a significant improvement in headcount. But there has been, in this environment opportunity to upgrade the quality of the staff, we made investment in training which certainly is paying some dividends there.

And the other piece of it is, continued investment in infrastructure here in the home office and just to give you an example of how that spend has helped. If you look at some of the significant improvements in gross margins that we had in 2008, a lot of it came from the fact that we invested in some additional staffing in our merchandising and product allocation departments.

And as result of that, we are able to better manage our buying, improve our in-stock positions, and that was an investment in payroll that gave us an improvement in gross margins.

So when we see opportunities like that that if we think we can make some additional investments in staffing, and we are going to get benefits either in cost savings in other areas, or improvements in gross margins, we are going to continue to make those investments.

Robert Higginbotham - Goldman Sachs

Sure. On the store levels, focus on that for the moment and granite, it's a pretty low labor-intensity kind of model, but did the number of man hours, if you will, and the stores change much in the quarter? And would you expect that to change going forward?

Jeff Griffiths

No. In RFT per store was pretty flat for the year.

Robert Higginbotham - Goldman Sachs

Okay, fair enough. Thank you.

Jeff Griffiths

Okay.

Operator

(Operator Instructions). We will hear next from John Baugh.

John Baugh - Stifel Nicolaus & Company, Inc.

Thanks. Good morning and congratulation Jeff, darn good quarter. Two questions, one on inventory. You made strategic push to beef that up, but the core sales [went up] being weaker than you thought. Where is that inventory number relative to where you want to be, is this right is it a little high, do you want to take it higher still for better service, little color there?

Jeff Griffiths

We certainly had a strategy in 2008 of increasing inventory to increase better service. And we feel that that paid off, and now we are looking for ways to be more efficient with that. So we expect to see improvement in the inventory levels this year. We did see reduction in inventory per store at the end of the year. We think that that trend will continue, and a lot of our strategic initiatives in '09 are centered around inventory management, so we should see that continue to decline on per store basis.

John Baugh - Stifel Nicolaus & Company, Inc.

And how big was the China program. How does that work a full container going to the store, or do take pieces of it, just some of the logistics on how that may work?

Jeff Griffiths

I guess first of all, let me say that historically product purchase from China would be put in a container and shipped to Ohio, Virginia. And then it would be broken down and shipped to stores. One product in a container and then we broke down, ship it to stores all over the country, so some of that flooring was making a long trip back and forth.

We have had a program for a number of years where we do some direct-to-store containers. But it was limited to products from one factory. So if a factory produced four different skews, we could do a container of four skews to a particular store.

What we are setting up now is a consolidation center, where every single skew that we purchase from China and almost 40% of our product came from China in 2008. Every single flooring skew will go to this consolidation center, so it will be much easier a lot more skews to put in a container.

So virtually every store can get a container of product on a fairly regular basis. And so we are starting the test in a few months, starting it slowly, small number of stores. But it will reduce transit time, particularly the stores in the western half of the country I don't remember the exact numbers, but let's say maybe 60 days down to 25, 30 days in our case. So a significant reduction in time and transit, which there will be huge benefits for that in the future.

John Baugh - Stifel Nicolaus & Company, Inc.

Okay, great. And then lastly, you keep talking about new store economics being strong, I don't have the figures in front of me, which you put out before, sort of the new store ramp.

Did you look at that for '08 versus the prior guidance you have given on new store economics? Any metrics you could share on that in terms of return on invested capital, time to breakeven revenues first year, first quarter, any metric would be helpful. Thank you.

Dan Terrell

John, we consistently look at the new store model. We are pleased with the performance in the fourth quarter and throughout 2008. Certainly, the fourth quarter, we had a bit of a downdraft in new store productivity, but it was still inline with our expectations.

The new store model that we have talked about in the past held throughout 2008. We are going to monitor it throughout 2009, but we expect those economies that we have achieved and that we published to remain conservative and we will be able to achieve them going forward.

John Baugh - Stifel Nicolaus & Company, Inc.

So, that's the word in your mouth for the year. You are more or less inline with the numbers you have given, albeit, probably stronger in the first part of the year than the later part given the macroeconomic backdrop, is it fair?

Jeff Griffiths

Fair, just remember the numbers that we have put out in the past were looking forward and had been somewhat historically conservative to the performance of the stores that we had opened previously. And therefore, yeah, we were comfortable with the performance in '08, a little bit weaker in the fourth quarter but not significant and therefore we kept our strategy going forward with new store openings in '09.

Dan Terrell

And just to add to that, the new stores continue to become profitable within three months beginning our operations and generally we are seeing a return on our initial cash investment within the first eight month. So it still an extremely strong model.

John Baugh - Stifel Nicolaus & Company, Inc.

Great, thank you very much. Good luck.

Dan Terrell

Thank you.

Operator

[Hardy Bowen] your line is open. Please go ahead with your question.

Hardy Bowen

Hello, Jeff and Dan. The cost of product from Brazil I am presuming is now lower and your prices at retail are considerably under other peoples prices for that product. Do you see any of it to lower your prices as the cost product comes down or you probably won't?

Jeff Griffiths

We review that on a case-by-case basis, we are firmly committed to being a low cost provider apart with flooring, and if we see a situation where we are getting some cost benefit, our first spot is to look at our retail pricing and make sure that we are super competitive with that. So, there are many instances where we have passed those savings on to the customer.

Hardy Bowen

As we come into the fourth quarter, do you see more competitors going out of business, is that picked up sometimes takes long time for competitors to go out of business?

Jeff Griffiths

We continue to see attrition in the marketplace and among independents and among some smaller chains, we think that will continue and we think that we will continue to benefit from that.

Hardy Bowen

As accelerated in the fourth quarter than the first quarter, do you think or not really?

Jeff Griffiths

Not that we have seen.

Dan Terrell

To clarify just a bit, I mean some of the unique purchases that we had in the first and second quarter were really high margin purchases, while there is still liquidation product out there and we have invested in the merchandising team to manage the whole purchase flow of that. We don’t anticipate, we haven't planned for that same kind of unique side out there. There seems to be an adjustment in inventory caring levels and mill production that doesn’t allow for that same kind of product to be available on the market.

Hardy Bowen

But broadly speaking you want to use this product to get people into the stores, some of which can be upgraded to the other product?

Jeff Griffiths

Yes, it's always been the strategy that it's commercial opportunity, I mean still great value for the consumer but it certainly provide a commercial opportunity.

Hardy Bowen

The consolidation a product in China if this works, and goes according to plan, well it take till the third quarter and the fourth quarter to roll it out to all the stores roughly?

Dan Terrell

We are starting a test which should happen in the second quarter. Right now our plans are very modest in the beginning. We want to make sure that it works and we want to make sure that doesn’t have some negative impacts on other areas of the business. Once we are comfortable with that we can accelerate it pretty quickly, but we have very-very low assumptions in our 2009 plan. If it's good there is some upside potential there definitely.

Hardy Bowen

Okay. It sounds good.

Jeff Griffiths

Thanks, Hardy.

Dan Terrell

Okay.

Operator

We move to next to [John Curti]. Please go ahead sir.

John Curti

Good morning, I have two questions. First off, what kind of amounts are you budgeting for stock compensation expense for 2009, stock base compensation?

Dan Terrell

Roughly, similar to 2008 without the impact of the variable plan if we break out the stock based compensation expense in a couple of charts in our 10-K and there is a continuing expense for options that have been granted in their RSV impact of the Variable Plan and the acceleration of vesting of certain options. So I just encourage you to look there and look that we have had a reasonable historic brand, 2008 would look to merit 2009.

John Curti

So while, exclude the impact of the Variable Plan?

Dan Terrell

That’s right and their acceleration from.

John Curti

Acceleration?

Dan Terrell

Right.

John Curti

And then with respect to advertising can you kind of give an indication at least in 2008 how much was of the advertising spend was devoted to the national advertising campaign and than how much was devoted to stuff like trade shows, direct mail, Internet searches et cetera and how, how you see that mix maybe shifting in '09?

Dan Terrell

We have not disclosed the breakout though, as a guideline you might keep in mind more of a 70-30 relationship between national and what we would consider direct sales generation or local and its been our intent it was through 2008 and will continue in '09 to shift that spin towards direct mail, local advertising and in other promotional events as we leverage national spend. National spend will continue to increase just not as a quick based sales.

John Curti

And are you seeing better buys on that national spend now?

Dan Terrell

Yes

John Curti

Thank you very much.

Dan Terrell

Thanks

Operator

And that concludes today’s question-and-answer session. I would like to turn the conference back over to management for closing remarks.

Jeff Griffiths

Thank you for joining us on today's call. We look forward to speaking with you again soon. Bye.

Operator

And that concludes today's conference and we thank you all for joining us.

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Source: Lumber Liquidators, Inc., Q4 2008 Earnings Call Transcript
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