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Executives

Ashleigh McDermott

Robert M. Lynch - Chief Executive Officer, President, Chief Executive Officer of Lumber Liquidators, Inc, President of Lumber Liquidators, Inc and Director

Daniel E. Terrell - Chief Financial Officer and Principal Accounting Officer

Analysts

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

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

John A. Baugh - Stifel, Nicolaus & Co., Inc., Research Division

N. Richard Nelson - Stephens Inc., Research Division

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

Laura A. Champine - Canaccord Genuity, Research Division

Peter J. Keith - Piper Jaffray Companies, Research Division

David G. Magee - SunTrust Robinson Humphrey, Inc., Research Division

Lumber Liquidators Holdings (LL) Q3 2012 Earnings Call October 24, 2012 10:00 AM ET

Operator

Good morning, ladies and gentlemen. Welcome to the Lumber Liquidators' Third 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. 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 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 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 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

Good morning, everyone. I'm here with Dan Terrell, our CFO, and we are pleased to be speaking with you about our third quarter 2012 results.

First, I would like to thank all of our teams across the company for delivering a terrific quarter with exceptional financial results. Highlights of our third quarter performance in comparison to the prior year include: a net sales increase of nearly 19%, comparable store net sales of 12%, a gross margin increase of 250 basis points to 38.1%, operating margin expansion of 380 basis points to 10.2%, net income growth of over 91% and we ended the quarter with a cash balance of $40 million.

Our ability to drive consistent strength in our top line, capture additional share in our fragmented market and deliver record operating margin and EPS, is a direct result of our team's commitment to our 5 key strategic initiatives. We continue to focus on growing revenue, improving our sourcing, optimizing our supply chain, driving traffic through advertising reach and frequency and developing the best people to serve our customers. Most importantly, we have maintained a strong and focused commitment through continuous improvement in all that we do and to strengthening our value proposition of price, selection, quality, availability and people. We firmly believe this value proposition distinguishes Lumber Liquidators in the marketplace.

Throughout the entire third quarter, we saw success with the expansion of our advertising reach to a more casual consumer, increasing recognition of our value proposition. Combined with the greater frequency of our call-to-action message, consumer demand remained consistently strong. Given our better than expected top line results, we again leveraged advertising even with our investment in broader campaigns. As we have discussed, we will continue to reinvest our national advertising leverage and programs to drive traffic, while also remaining focused on increasing the effectiveness of our total advertising spend.

Average ticket for the third quarter was the highest it has been since the fourth quarter of 2008. Primarily driven by increases in moldings and accessories and the expanded product assortment of premium products. Our merchandising team is relentlessly focused on providing the best selection and availability of all the products our customers need to be successful and satisfied with their flooring project.

As a result, we are striving to enhance the selection component of our value proposition across the board. For example, during the third quarter, we introduced a number of new floors in all categories and significantly expanded the flooring tools and accessory lines to better assist customers in completing their entire project from start to finish.

Our top line growth also reflects our continued success in opening new stores. As we have discussed, we have an enhanced -- we have enhanced our site selection processes this year, and continue to emphasize total market returns.

In the third quarter, we opened 7 stores, bringing our 2012 new store total to 21, and maintaining our pace to open 23 to 25 new store locations this year. Our approach has produced very profitable new locations, which have been performing better than we had anticipated. We continue to see increases in both total market penetration, as well as comparable store net sales in our cannibalized markets. Notably, our oldest stores produced high single-digit comparable store net sales in the third quarter.

At the same time, we have made considerable progress in our store of the future initiative. As we further develop this concept in the fourth quarter, we see significant opportunity for success and are even more excited about rolling this out to both new and existing stores in 2013.

Our sourcing initiatives and supply chain optimization, which are multiyear efforts, contributed to our gross margin expansion. Our line reviews are ongoing. And as I mentioned, we continue to evaluate product assortment expansion to align with customer preferences. We remain focused on sustaining close working relationships with our vendor partners worldwide. With specific focus on strengthening relationships in South America, which has enabled us to improve sourcing and quality control there. Progress on our key strategic initiatives is a reflection of the efforts of our world class Lumber Liquidators team. Focus on our best people initiative remained a priority in the third quarter, as we completed our 4 planned regional Lumber Liquidators university programs, reaching all store personnel with in-depth training and enhanced selling skills and providing direct access to members of the senior team. As we had hoped, this has enabled us to achieve an even more unified vision and set of values for the company.

We also remain focused on appropriate allocation of our capital. Our first priority is funding our operations, growth plans and strategic initiatives to expand our operating margin. Second, we will maintain our conservative, debt-free balance sheet. And third, with excess capital, return value to our long-term shareholders. We continue to view our share repurchase plan as an effective method to return value to our shareholders.

Going forward, we believe we are well-positioned to leverage our past capital investments and generate substantial free cash flow. Lumber Liquidators is successfully navigating through what remains an uncertain retail environment. We are a strong company, with a value proposition that resonates with our customers, and one that has substantial room to grow and improve.

I continue to have great confidence in our team's ability to build on our success and to further capitalize on the investments we have made to grow both net sales and earnings as we move forward. I am more excited than ever about the opportunities that lie ahead, as we execute against our long-term goals and strategic initiatives.

With that, I'd now like to turn the call over to Dan for a detailed review of our financial results and outlook. I'll then return with some closing remarks. Dan?

Daniel E. Terrell

Thank you, Rob. Good morning, everyone. I will provide additional details on our results for the third quarter and then update our outlook for the remainder of 2012. My references to percentage and basis point changes are in comparison to the third quarter of 2011, unless otherwise noted.

Our 2012 net sales growth remained consistently strong, with an increase of 18.8% in both the third quarter and 9-month comparisons. That growth was driven by strong comparable store net sales and the growth of our store base. In the third quarter, net sales of $204.3 million were up $32.3 million with a 12% increase in comparable stores, contributing $20.6 million and noncomparable stores adding $11.7 million.

The strength in comparable stores was consistent throughout the quarter, with a double-digit net sales increase in each month, and impressive across our maturity curve, with a 21.9% increase at stores operating for 13 to 36 months and a 9.3% increase at all stores older than 3 years. We were pleased that the increase in comparable store net sales was a combination of a very strong average sale, as Rob previously mentioned, and an 11.7% increase in the number of customers invoiced, or our definition of traffic.

We believe the increase in the number of customers invoiced was primarily a result of 3 factors. First, greater recognition of our value proposition, as we continue to broaden our advertising reach and frequency. Second, fewer noncomparable stores operating in existing markets. At the end of the most recent quarter, we were operating 19 noncomparable stores in markets with a least 1 comparable store, down from 27 stores at the end of September 2011. Third, a greater number of stores in operation for 13 to 36 months, when increases in net sales are generally higher than our average, as customer awareness of our brand and value proposition builds in the market. The performance of our newer noncomparable stores has continued to meet and exceed our estimates. We have opened 21 new store locations in 2012, including 7 in the third quarter and a total of 28 store locations over the trailing 12 months.

Turning to our gross margin. We had a 250 basis point improvement to a record 38.1%, as lower product cost benefited gross margin by 260 basis points. Net transportation costs were adverse by 30 basis points and all other items contributed 20 basis points of benefit.

Within the product cost, both shifts in our sales mix and sourcing initiatives contributed to the improvement in gross margin. Within our sales mix, customers continued to prefer our expanded assortment of premium products, particularly in merchandise categories with lower than average retail price points.

Further, as Rob touched on, we're striving to offer our customers a more complete solution to their flooring needs, and those efforts have driven increases in the sales mix of our moldings and accessories. Within our sourcing initiatives, gross margin continued to benefit from both the impact of line reviews, in the close direct relationships we have with our vendor mills. In 2012, we have strengthened our relationships in South America, and in September, we celebrated the anniversary of our acquisition in China.

Transportation costs were impacted by generally higher costs, partially offset by greater efficiency in controls implemented within our supply chain. Overall, international container cost capitalized into the unit cost of products sold in the third quarter were higher in 2012 than 2011. These costs were partially offset by an increase in the units received directly by stores to 26.4% in the third quarter, up from 20.6% in the prior year. The net impact of all inbound freight cost reduced gross margin by approximately 15 basis points. Domestic transportation costs were higher as we shipped more units from our warehouses to our stores. These increased cost were partially offset by greater efficiency in the manner of warehouse deliveries, including greater use of intermodal delivery. The net impact of these costs reduced gross margin by approximately 25 basis points. Finally, gross margin benefited by approximately 10 basis points due to a strengthening of the control over units transferred between stores and units delivered to our customers.

Selling, general and administrative expenses increased approximately $6.8 million or 13.5% to $57.1 million, due primarily to higher net sales and growth in our store base, but as a percentage of net sales, fell to 28% from 29.3% in the prior year. Salaries, commissions and benefits increased approximately $4.5 million to 11.8% of net sales, due primarily to significantly higher accruals for annual management bonuses, an increase in certain benefit costs and higher commission rates earned by our store management. Advertising expenses increased by approximately $1.8 million, but as a percentage of net sales, fell 30 basis points to 7.4%. As Rob discussed, we continue to reinvest in our value proposition by broadening our reach and frequency. And at the same time, we are challenging the allocation of our spend to utilize more effective media channels. All remaining SG&A expenses, including occupancy, depreciation, stock-based compensation and other expenses, increased approximately $500,000, and as a percentage of net sales, decreased 140 basis points to 8.8%.

Our effective tax rate fell to 38%, due to the timing of certain state tax credit expected to benefit only the most recently completed quarter in 2012.

Net income increased 91% to $12.9 million or $0.46 per diluted share, based on approximately 27.7 million weighted average diluted shares outstanding. Net income for the third quarter of 2011 was $6.7 million or $0.24 per diluted share, based on approximately 28.3 million weighted average diluted shares outstanding.

As we look at our financial position, liquidity and capital resources, our cash and cash equivalents increased to $40.1 million at the end of the third quarter, up from $31.5 million at the end of the second quarter, and up from $37.8 million at September 30, 2011. Merchandise inventories totaled $195 million at the end of the third quarter, down from $211.6 million at the end of the second quarter, and up from $160.8 million on September 30, 2011.

Available inventory per store was $622,000 at the end of the third quarter, down from $664,000 at the end of June, and up from $585,000 as of September 30, 2011. In comparison to the prior year, available inventory per store increased due to the expanded assortment of certain key merchandise categories with an increasing share of our sales mix, many carried as in stock at our store locations.

The final phase of certain supplier transitions following the line reviews, with these transitions now expected to be complete in early November. And preparation for certain incremental fourth quarter 2012 promotions, including our inaugural October yard sale.

Considering certain sales trends and the timing of promotions planned for the first quarter of 2013, we have raised our target range for available inventory per store to $580,000 to $600,000 at the end of the current year. Working capital was $174.4 million at September 30, 2012, compared to $156.4 million at September 30, 2011, with the current ratio at 3.3x and 3.9x, respectively. Capital expenditures totaled approximately $2.9 million for the quarter and now total $9.6 million for 2012. In 2011, capital expenditures were $3.3 million for the quarter and $11.6 million through the 9 months. The decreases in 2012 are primarily due to fewer new store openings and lower expenditures for technology. We now expect capital expenditures to total between $13 million and $15 million for the full year, down from $17 million in 2011.

As Rob noted, we prioritize our capital first to our operations, initiatives and growth. Second to maintaining a conservative balance sheet. And third, to returning excess capital to our long-term shareholders through our share repurchase plan. Through the end of the third quarter, we had purchased approximately -- purchase a total of approximately 1.5 million shares on the open market, at an average price of $27.14, using $40.1 million of our $50 million authorization.

Turning now to our updated outlook for 2012. We believe the economy faces a number of uncertainties in the fourth quarter, which may impact the demand for large ticket discretionary purchases. Those uncertainties may offset, to varying degrees, recent strengthening seen in metrics, traditionally associated with residential home improvement. That said, we are committed to our 5 key strategic initiatives, whereby we intend to continue to capture share in our fragmented market. We now expect net sales for the full year 2012 in the range of $791 million to $799 million, with comparable store net sales increasing in the mid-to high single digits, and a total of 23 to 25 new store locations.

As a result, we expect fourth quarter net sales in the range of $188 million to $196 million, with an increase in comparable store net sales ranging from the low to mid-single digits. We expect gross margin to continue its cumulative, multiyear expansion. But we expect that expansion in the fourth quarter to be less than the 250 basis points of expansion in the third quarter due to 3 factors: the timing of the benefit from certain sourcing initiatives, including line reviews; increases in certain transportation costs, including international container rates and domestic fuel surcharges; and the addition of certain fourth quarter promotions and special events to drive demand.

We expect the aggregate increase in fourth order SG&A expenses to be greater than the fourth quarter increase in net sales, due primarily to higher advertising expenses, bonus accruals and certain other fourth quarter 2012 expenses, including greater use of and longer-term, financing promotions offered under our Lumber Liquidators card. We expect our effective tax rate to return to a range of 38.7% to 38.9% in the fourth quarter. For the full year, we now expect 2012 earnings per diluted share in the range of $1.53 to $1.59, based on a diluted share count of approximately 28 million shares, exclusive of any future impact of our share repurchase program. And as a result, we expect fourth quarter earnings per diluted share in the range of $0.35 to $0.41.

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

Robert M. Lynch

Thanks, Dan. As we look forward to the fourth quarter and into 2013, our entire team remains unified in its vision and motivated to continue taking market share. We remain confident in the strength and positioning of our powerful value proposition and our uniquely profitable store model. We will emphasize continuous improvement in everything we do, and feel we are well-positioned to deliver value to our customers and shareholders. We expect to open our initial store of the future concept stores between late December and early February.

Overall, we believe the detailed planning and expansion of the showroom layout will strengthen our efforts to offer the customer the complete flooring solution. We expect the showroom layout to complement the expertise of our world-class store teams, and enhance the experience for the retail customer. Our team will continue challenging design and process for the remainder of 2012 with the stage rollout scheduled for 2013.

We are very excited by all of the opportunities we have. And with the best team in place, a continuous -- continued emphasis on driving traffic, growing our footprint, improving operations and expanding operating margin, we believe Lumber Liquidators has a future of consistent growth ahead.

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.

Operator, we are now ready for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is coming from the line of Brad Thomas with KeyBanc Capital Markets.

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

Hey, I wanted to talk about gross margin -- another very strong quarter here. You have a lot of initiatives driving that up. As we think about the fourth quarter and kind of the sequential outlook here for gross margins, it would seem like there's the potential for the fourth quarter to be another great quarter for gross margins here. I mean, how should we think about the magnitude, and maybe some of the things that you're doing in terms of pricing and other promotions that might limit the upside in the fourth quarter?

Daniel E. Terrell

Brad, I'll start with it and then maybe Rob will add to it. As we gave our guidance, we talked about the expansion in gross margin continuing. And certainly, we've talked in previous calls about cumulative multiyear benefits of our sourcing initiatives, including our line reviews. And where we're trying to implement additional controls within our supply chain, which will add benefit and offset some of the impact of rising transportation cost. And finally, we're making investments in our quality control procedures and strengthening our relationships with vendors, where we feel like we'll eventually get some gross margin benefit there as well. Based on the promotions that we're planning for the fourth quarter and based on the timing of the benefit of line reviews that we see coming, we expect to see expansion of our gross margin in the fourth quarter, but not in excess of those 250 basis points that we saw in the third quarter. We're still seeing some pressure from transportation costs. Certainly not a steep ramp, but a slowly rising cost in both international container costs and some uncertainty around domestic fuel costs. So all in, the timing of the benefit that we see of these cumulative multiyear initiatives, the transportation cost and some of the incremental promotions, all leave us with an expansion that's going to be somewhat less than what we saw in the third quarter.

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

And just to clarify on the transportation cost, I think, Dan, you said that, that was a 30 basis point headwind in the third quarter. Based on where the container rates have been, what would you expect that to be in the fourth quarter?

Daniel E. Terrell

Still a headwind. Part of it is going to be what happens with domestic fuel. The container rates are probably going to be higher than they were in the prior year -- continue to be, although I don't see it rising substantially. Domestic fuel is going to be the wild card. And how much the method of transportation and control we can exercise over the process will determine how that comes out, but still expected to be a headwind in the fourth quarter.

Operator

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

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

My first question, on the balance sheet customer deposits are up nicely year-on-year. There's a point in time when your supply chain wasn't quite as clear as it is right now, but that might not have been a good thing. But it seems like a pretty good leading indicator of your business. So how should we think about the big increase in customer deposits?

Daniel E. Terrell

Matt, I'll start. We had consistent strength throughout the quarters and that continued right into the end of September. We had a very strong end of period promotion. September, it's normally a month where we offer that promotion, but we had great customer reaction to our value propositions. So our customer deposits are strong and fresh. And as you said, post-SAP implementation, there were some issues with the supply chain in returning to full productivity, but we feel that's taken care of, and we're probably more productive than we've ever been. So that's why we're pretty comfortable with the balance and the freshness of the balance.

Robert M. Lynch

And Matt, this is Robert. What I would add to that too is you hear us talk a lot about continuous improvement, and one of the things I'm really pleased with is just how well the teams are working together cross functionally. We've made significant enhancements in how we're operating and executing within our supply chain, within our DCs, in terms of how we're servicing our stores, and the quality and accuracy of those deliveries to our stores. So all those, I think, are actually helping as well. As we've talked also about the advertising reach, being how we've been increasing advertising reach and frequency, we're really pleased with that. We've increased the advertising spend and we've been pleased with the results, and we're still leveraging advertising. So that's what we're trying to balance is -- the balance between how much of the improvements were driving that or are flowing through and how much are -- we're going to reinvest either in advertising and/or in promotions to drive traffic to take market share.

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

Got it. Rob, you actually anticipated my second question, which related to advertising. It's great to see Lumber Liquidators back to double-digit advertising growth, given that this has really been the life blood of the company over a long period of time. What is the right level of dollar growth to think about for advertising going forward?

Robert M. Lynch

Matt, I think, that's the holy grail, if I knew that question, I could retire, but really that's a good question. I will tell you this, that's why we talk about continuous improvement. We are learning every day. We're trying new things and we're staying on offense. And we're constantly looking for that balance in terms of optimizing the return on the investment in the advertising or in the markdown in the promotions. So as long as we see the results like we're seeing here, we're going to stay on offense and continue to reinvest in the advertising and in some of the margin enhancements back into price to take market share. So I'm pleased with the return we're getting on those strategies right now and I think, you'll see them continue.

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

And my final question, I know you're broadening up the mix in a number of ways, but if we focus on truly new categories, these had slowed -- not slowed at all, primarily tools, I guess. How big is that or -- and any others that you might be testing as a contributor to the same store sales increase versus the traditional flooring and accessory business?

Robert M. Lynch

Let me -- I'll talk high level about it and I'll let Dan maybe give you some of the specifics, but the thought process there, as I mentioned in my script, is we see significant opportunity for us to continue to grow our company grow our store base and take market share, given the relative small amount of market share we have today. And in doing that, we want to make sure we're taking care of our customers and giving them everything they need to be successful in their flooring project. I mean, these are big projects and we want to make sure we're giving them everything, and that's why we're rolling out some of these flooring tools. We expanded on that this quarter. We added another 50 or so flooring tool items and accessories to complement the purchase and the installation, if they need it. The other thing that we did too, as I mentioned, is we added some -- we're constantly looking, as we're going through our line reviews and working with our factories and with our vendor partners, the merchant teams are constantly assessing our assortments. So this last quarter, we actually came out with probably about a net new 40 to 45 new floors in our assortment across all the categories. So to your -- one of the -- some of the categories are newer like our Brazilian and Vinyl. But we also took a look at and either replaced, updated or added some new floors in almost every category we carry.

Operator

Our next question is coming from the line of John Baugh with Stifel, Nicolaus.

John A. Baugh - Stifel, Nicolaus & Co., Inc., Research Division

Could you talk about 2 things, one, the merchandise mix. You just mentioned, Vinyl is kind of a new category. You offered for years just wood and laminate, now are vinyl. Could you discuss -- are we creeping towards ceramic tile and other things? Or if you got the profile you want right now? And then you teased us with the store of the future. I was curious whether you could address that concept in any more clarity, both with merchandise mix, location, size, cost of capital to open a new store versus the old concept, et cetera.

Robert M. Lynch

Okay. Okay, John, this is Rob. I'll take a crack at those 2 questions. Relative to the categories I think, one thing we want to make sure we constantly do is listen to our customers, talk to our customers and understand who we are in the marketplace. You hear me talk about the value proposition all the time. So we want to make sure we know what our customers are looking for. And as new categories are coming out in the industry or if there's new technology or new items, we want to make sure we're first to market on those and we have them. Long-term, I think we're going to be sticking to our knitting. I wouldn't see us -- to your point on tile, seeing that coming out anytime soon. We have such an opportunity in our existing categories to continue our grow our market share and in some of these other categories that we've been expanding into. Now having said that, that's one of the really -- one of the drivers of the store of the future, on to your second question, which is the company over time has really matured and has done a fabulous job of meeting the growing needs of its customers. That's why the Laminate category has come into play and is such an extensive part of our assortment today. So that's why we're looking at the store of the future. We want to make sure that the showroom is optimal, in terms of how we're presenting, laying out and offering all of our products to our customers. And we want to make sure that in that purchase, in that -- this is a significant remodeling project of -- our average ticket is almost $1,600. We want to make sure we have everything they need, from the floor, to the tools to tear out their old floor, to install their new floor, to the materials -- I mean, to the accessories and items they need to clean, repair and maintain that floor. That's kind of what we're doing with the store of the future. It's an integrated strategy, that I think is coming out of the work we've been doing in real estate. As we're optimizing our real estate strategy, we're seeing that we have a need for this new type of a concept. And as I said, we're going to be getting a few of those stores out towards the end of the year and into early next year. And then we can -- and you guys can all see and we can take you to.

John A. Baugh - Stifel, Nicolaus & Co., Inc., Research Division

Rob, is it bigger? Is it better fixtured? Is it in a better location? Any thoughts on the capital deployed?

Robert M. Lynch

Yes, the -- what I would tell you is from a gross square-foot perspective, we're looking to be space neutral. So we're now looking for an overall prototype increase in terms of gross. However, the showroom, we're looking to expand significantly, so that we can appropriately merchandise and assort all of our existing categories and these new categories that we're bringing into the store. From a capital perspective, we are working very intently to manage that and I don't see any material or significant increase in the cost of capital at the unit level. So what I'm excited about, as you see, as we look at the things as we work with it and tweak it, is a showroom that is just really going to be exciting for our customers when they come in. All of our floors laid out, all of our accessories, all of our moldings, all of our stairs, our grills for our floors and all these others accessories and tools that you need to maintain your investment that you're making in your home.

John A. Baugh - Stifel, Nicolaus & Co., Inc., Research Division

Great. And I guess for Dan, I just wanted some clarity, there was some commentary around the comp influence of existing markets, could you go back over that again in terms of what you said?

Daniel E. Terrell

Sure, John, just that across the maturity curve, we just -- we had outstanding results. Our stores, older than 36 months, I think were up 9.3% and stores opened for 13 to 36 months, the newest comps, the first and second year comps were open -- were up about 22%, 21.9%.

John A. Baugh - Stifel, Nicolaus & Co., Inc., Research Division

But was there a commentary around of those older stores over their 36 months where a new store would come into that market and you still comp positively or did I hear that wrong?

Daniel E. Terrell

Commentary there was around traffic, John. We had a fewer stores operating in existing markets -- fewer non-comp stores operating in existing market. So we had less cannibalization, which certainly benefited the traffic and the comp number at those stores. So we have that chart in the 10-Q that shows our comp increase both before -- or with and without those markets.

Operator

Our next question is coming from the line of Rick Nelson with Stephens.

N. Richard Nelson - Stephens Inc., Research Division

Like to ask you about product price inflation in your categories and what you see as your ability to pass this on to the consumers? How your comp gains, you'd think, compare to the overall industry?

Daniel E. Terrell

Yes, Rick, I'll start with the product price. We've always been somewhat shielded from changes in the price of wood, if you will. The nature of working directly with the mills, long-term relationships, planning months in advance, all takes you out of the equation for short-term changes in wood pricing, whether there's spikes due to capacity or wet forest or what. So we haven't seen rising price of the product. Obviously, there's labor pressure in other countries. There's always going to be some impact of inflation. But again, working with -- working directly with the mill and working as far in advance that helps shield us from those cost increases, and that really hasn't been material for a call out.

N. Richard Nelson - Stephens Inc., Research Division

Also, like to follow up on the transport cost. 26% of your purchases came direct to store, that's up from 20% a year ago. I'm curious what the goal is there and what the efficiencies are to direct to store?

Daniel E. Terrell

We've always said we thought we could get about 1/3 of our product direct. It's always going to be dependent on changes in domestic fuel costs, obviously, where the product is sourced from and where it is -- where it needs to be in stock, whether it's west or east, north or south. So, there's always going to be some variability. But even with the 26%, we think over the longer term there's opportunity to increase that number.

N. Richard Nelson - Stephens Inc., Research Division

Okay, and finally if I could ask you about the impact you think that Sequoia acquisition had on your gross margin in the quarter, I think it was September a year ago that you made that acquisition?

Daniel E. Terrell

Yes, that's right we closed that in September 2011. So we've anniversary-ed that now, with the lag in the benefit because of our turn in inventory. We didn't really start to see benefit from that acquisition, as far as direct change in cost of goods, until the first quarter last year. So we really won't anniversary the benefit, even though we've anniversary-ed the acquisition until we get to the first quarter of 2013. We're certainly happy with the acquisition and we've been more pleased than we expected. The staff is fantastic. We've grown their level of responsibility. It has tightened our relationship with the mills. So while it's not a specific call out as far as basis points within gross margin we just couldn't be more pleased with what's happened and the direction we're headed in.

Operator

Our next question is coming from the line of Budd Bugatch with Raymond James.

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

Rob, you had I think changed and you talked about the real estate process a while ago. And I think to John's questions about the store of the future, I'm not sure you addressed the location aspect of that. Historically the company had said, it's stores would be inconveniently located to keep the cost of occupancy, I think, down to something down around 3%, if I remember correctly. What's the thinking now going forward as you look to new locations and how much it might impact the existing store portfolio?

Robert M. Lynch

Yes, very good question, we are -- we're looking comprehensively at our real estate, in terms of the work we're doing with the team in the real estate strategy. And we've mentioned before that we're taking an overall market optimization approach. So we absolutely are and have been, for the last probably 18 months or so. We've improved our site selection processes, the analytics that go into it and the team -- and the real estate team that drives that work and efforts. So that's part of what's driving the performance of the new stores and the new store productivity improvements you're seeing. We have absolutely enhanced and upgraded the quality of our sites that we've opened in the last 18 months, relative to your point to some of the older stores. But we've done that, again, with a philosophy of getting the best price, possible keeping occupancy extremely low and the commercial real estate market has cooperated very nicely for us there. But as we go forward, as we tweak the store of the future concept and get it out there, we, absolutely, will be integrating that into these other changes in the real estate in terms of optimizing end market. We'll be looking at either relocating and/or remodeling existing stores in a market, as we come in with a second store and/or a third store. And our goal is -- one of the things we're going to be experimenting with here is the store of the future, is potentially remodeling an existing store with the store of the future. And when we come in with a second store and they both have -- both of them having our -- this new prototype. So we're excited about that opportunity and we see benefits for our associates, for our customers and for our existing stores as we roll that out.

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

And the cost of occupancy, what do you -- is it higher? Is it about the same as it was when the company started to disclose those publicly?

Daniel E. Terrell

Yes, Budd, this is Dan. We really haven't seen a spike up in -- all in occupancy cost. Certainly, as Rob indicated, the commercial market has been beneficial for us. There's certainly been an available space as we looked at where the position stores within a market. But we haven't seen any significant increase on a unit basis. And the size of our stores are roughly the same, so all economics are pretty static.

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

And I've heard that maybe the showroom size would expand by just about double of where it is or?

Daniel E. Terrell

We've talked in terms of the showrooms being 800 to 1,000 square feet in the existing format. We say that because we have showrooms that are as small as 800 square feet and we have showrooms that are as large as 1,000 to 1,100 square feet. And what we're looking for are plan-o-grams that did take that larger -- we may go into the 1,400, 1,600-foot range. But as Rob said, box neutral, some planning -- and within the warehouse side will create some efficiency. Generally, we use temporary walls in the box, so basically taking some warehouse space and moving it to the showroom. But certainly a better shopping experience, but not a dramatic change to some locations and much larger in some that have currently have a very small showroom.

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

Okay. The line reviews, I think last quarter you told us you were 50% done, the line reviews with a 30% impact, and I'm not sure I heard those metrics on this call. Do you have the similar kind of metrics of where we are on the line review process and what's the impact so far?

Daniel E. Terrell

Not that specific, Budd. We're more than 50% and we've got more than 30%. [indiscernible]

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

That always gets an error in my -- whenever I put that kind of answer into my calculator. So, okay -- product mix, and I think Matt or somebody addressed that before, but are you seeing -- what are you seeing in hardwood and some of the premium products? How's Bellawood doing year-over-year? What kind of -- what are we seeing in the way that consumers thinking about their own pocketbook and their own ability to come back to hardwood, which has been a category that seemed to flatten out as we went into the housing bubble and -- the bursting of the housing bubble and the financial malaise?

Daniel E. Terrell

Right, still we're not seeing sales mix return to solid hardwood. We are seeing a demand strengthening in -- Hardwood Handscraped continues to do well. So where the look is right, where the surface is right for the use of the room, I think we're seeing this customer come back. But we're not seeing the strict solid hardwood buyer come off the sideline yet. So our sales mix is still dominated by the lower than average retail price points where we're seeing growth. But we expect as the macro strengthens that we may see that start to revert. And as we've said before that we don't ever see the same mix of hardwood being reestablished that we did before the economic fall.

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

Well, I sure hope you're wrong on that, but you probably have a better insight on that more than I do for sure. And my last question just goes to bonus accruals, given the great performance of this year, I would expect that you have been under accruing bonuses for the first, third -- second and third quarters. What's the level of increase that you need to do for the fourth quarter to catch up?

Daniel E. Terrell

Budd, we're very comfortable with where we are through the 9 months and we don't see any large change coming in the fourth quarter. Certainly the fourth quarter of '12 will be higher than the fourth quarter of '11, which based on the performance in 2011, we didn't need very much of an accrual. So it's going to be higher. It will still be a year-over-year comparison discussion point, but it's not more significant than we saw in the third quarter.

Operator

Our next question is coming from the line of Laura Champine with Canaccord.

Laura A. Champine - Canaccord Genuity, Research Division

You've been through assets and pieces but let me go with the merchandise margin expansion of 260 basis points in the quarter, can you break that out roughly between line reviews, the changes in the middleman, both in China and in South America and then the merchandise mix shift?

Daniel E. Terrell

Laura, it gets really tough to do that which is why in the Q we're trying to put that together. And I'll use an example, because we now had a stronger relationship in Asia, after our acquisition in September of '11, that opened up the market to additional vendors who may show up at a line review, it also strengthened the direct relationship that we have. So whether the benefit of a lower cost of product is strictly related to the line review or the acquisition of that office and the relationship of the vendor, it's hard to parse that out. Sales mix was a benefit. It certainly wasn't as strong as the sourcing initiatives, but it's been a strategic goal that continue to drive moldings and accessories forward and expand the assortment where it makes sense for the customer. And we're pleased that the customer continues to choose the premium products albeit it in the lower average retail price point line.

Laura A. Champine - Canaccord Genuity, Research Division

And then just as a follow on, how much of the savings from the line reviews are you actually passing on to your customers through more promotional pricing?

Robert M. Lynch

You know Laura, we haven't disclosed that specifically but I would tell you that a majority of the savings we're passing through and it's an appropriate amount we are sharing with the customer. So it -- and it's something that -- this is back to Matt's question which is -- that's something that changes within quarter, within month, within event, where depending on the event, if we're heading a new event or not. Depending on what categories are performing the best or not, we're tweaking that. And what I would tell you is, strategically we're continuing to push the envelope on finding that holy grail of where's the right mix. Where's the right balance of reinvestment of the margin savings in price and market share, and also in the advertising, okay? So there's a balance there and they actually work -- obviously, they work together. But what I would tell you is I would think that from a directional perspective, we probably did similar to what we did in Q2 in this last quarter.

Operator

Our next question is coming from the line of Peter Keith with Piper Jaffray.

Peter J. Keith - Piper Jaffray Companies, Research Division

Great results here. I want to actually ask about the cadence, Rob, of what you guys are seeing in the store. Clearly the double-digit comps through the quarter is quite impressive on the consistency front. We're hearing and seeing some actual evidence that the flooring industry is strengthening. I wonder if you just -- well, you could comment on maybe what you're seeing with regard to conversions and maybe even with regard to some of your leading indicators like web traffic and your total degeneration? And even has that changed more recently as we gotten closer to the election?

Robert M. Lynch

Yes, I would tell you, Peter, that it's difficult for us to see or to tie some of that change and that improvement in our web activity and/or improvement in our comps in traffic. So what's going on from a macro perspective or an industry perspective, we see it more coming from the things that we're doing. In terms of the increased marketing and advertising reach, the things that we're doing in the stores, the effectiveness of our store teams, the training that we did in our LLU road shows where we've engage everyone and we went out there retrained and all of our sales associates in advanced on techniques. What we're seeing is the things that we're doing, we're seeing the impact and the benefits of those mostly. And I would tell you it's -- that's where we're seeing it coming from and not so much from a macro perspective, either up or down. So I don't know if that helps.

Peter J. Keith - Piper Jaffray Companies, Research Division

Okay, that's fair enough. A second question for Dan, just on the transportation costs. Looks like you guys have some things working in your favor to be more efficient. In the past you've highlighted that you want to do a line review process with some of your carriers and take out some additional costs. How should we think about your ability to reduce those transportation costs with the addition of Carl Daniels? Are you guys kind of early in driving benefit? Or you feel like you kind of getting fully ramped up and driving better efficiency there?

Daniel E. Terrell

Peter, I think we're at the beginning, I mean certainly Carl coming on board -- he's a professional. He's built a professional team, so we couldn't be more pleased with what we've seen so far, as far as more efficient operations. And as we've said in the past, that supports store operations and helps the store team drive and close demand. The benefit -- the significant benefit towards gross margin though, is probably more 2013. As we take an approach, as we looking at the different carriers and the different lanes, that cost is generally going to have to be absorbed into the unit cost if it's inbound. So, I wouldn't look at that as a 2012 event. We may see the beginnings of that. We're certainly going to see more operating efficiency offset some of the headwind from higher cost, but we probably will see more of a 2013 supply chain store.

Operator

Our last question is coming from the line of David Magee with SunTrust Robinson Humphrey.

David G. Magee - SunTrust Robinson Humphrey, Inc., Research Division

I wanted to ask about the new products of the -- I think you've mentioned 40 new flooring products, did I hear that correctly?

Robert M. Lynch

Yes, approximately.

David G. Magee - SunTrust Robinson Humphrey, Inc., Research Division

And what would that be, in terms of like a percentage increase, in terms of your current assortment?

Robert M. Lynch

That's a transition of 10% to 15%.

David G. Magee - SunTrust Robinson Humphrey, Inc., Research Division

And is there any pruning going on at the same time?

Robert M. Lynch

Yes, absolutely. I mean, I think I mentioned earlier that the Bill Schlegel and the merchant team is constantly going through. And last quarter was a perfect example of it where you know there was a number of new items introduced in total and the number actually [ph] were up to 40 or so with net new. So, yes, there were absolutely some that were pruned. There were some that were updated or enhanced and then there obviously, were some new ones on top, and the net new was about 40.

David G. Magee - SunTrust Robinson Humphrey, Inc., Research Division

Do you see an opportunity, Rob, to add a similar amount over the next couple of quarters?

Robert M. Lynch

I would probably say that last quarter was probably the big quarter for the year. But like I said, it's something -- it's continuous improvement, it's something that's there all the time. And like I said, hats off to the merchant organization because they do a very good job of assessing every category on a regular basis, and looking at how they're performing against the events, and making sure that we got -- we're optimizing our assortments real-time.

David G. Magee - SunTrust Robinson Humphrey, Inc., Research Division

And my second question just has to do with the average ticket size of -- how close are we to the peak level right now? If you look back longer term, are we -- still have some distance there or are we getting close?

Robert M. Lynch

No. We -- absolutely there's still some upside left. You go back a number of years and it was as high as $1,750 to $1,800. And sort of referencing Budd's question, I don't think we're going to get all the way back there because we won't see the solid hardwood capture the same percentage of our sales mix, primarily because of the change in technology. So even if the housing market comes back, there's so many new products out there now from strand bamboos to resilient products to better laminate. There's been such a change and so many alternatives to carpet at so many different price points that I don't think we're going to see that mix return. That said, we're still going to drive moldings and accessories, look for this complete purchase for the customer, introduce premium products within each line. So there's still some upside in the average sale as we look over the longer period of time.

Daniel E. Terrell

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

Operator

This does conclude today's teleconference. You may disconnect your lines at this time, and we thank you for your participation.

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