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LL > SEC Filings for LL > Form 10-Q on 30-Jul-2014All Recent SEC Filings

Show all filings for LUMBER LIQUIDATORS HOLDINGS, INC.

Form 10-Q for LUMBER LIQUIDATORS HOLDINGS, INC.


30-Jul-2014

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Cautionary Note Regarding Forward-Looking Statements

This report includes statements of our expectations, intentions, plans and beliefs that constitute "forward-looking statements" within the meanings of the Private Securities Litigation Reform Act of 1995. These statements, which may be identified by words such as "may," "will," "should," "expects," "intends," "plans," "anticipates," "believes," "thinks," "estimates," "seeks," "predicts," "could," "projects," "potential" and other similar terms and phrases, are based on the beliefs of our management, as well as assumptions made by, and information currently available to, our management as of the date of such statements. These statements are subject to risks and uncertainties, all of which are difficult to predict and many of which are beyond our control. Forward-looking statements in this report may include, without limitation, statements regarding sales growth, comparable store net sales, impact of cannibalization, price changes, earnings performance, stock-based compensation expense, margins, return on invested capital, strategic direction, the demand for our products and store openings. Our actual results could differ materially from those projected in or contemplated by the forward-looking statements as a result of potential risks, uncertainties and other factors including, but not limited to, changes in general economic and financial conditions, such as the rate of unemployment, consumer access to credit, and interest rate; the volatility in mortgage rates; the legislative/regulatory climate; political unrest in the countries of our suppliers; the availability of sufficient suitable hardwood; the strength of our competitors and their ability to increase their market share; slower growth in personal income; changes in business and consumer spending; changes in transportation costs; the rate of growth of residential remodeling and new home construction; the impact weather may have on customer traffic and sales; and inventory levels. We specifically disclaim any obligation to update these statements, which speak only as of the dates on which such statements are made, except as may be required under the federal securities laws. Information regarding these additional risks and uncertainties is contained in our other reports filed with the Securities and Exchange Commission, including the Item 1A, "Risk Factors," section of the Form 10-K for the year ended December 31, 2013.

This management discussion should be read in conjunction with the financial statements and notes included in Part I, Item 1. "Financial Statements" of this quarterly report and the audited financial statements and notes and management discussion included in our annual report filed on Form 10-K for the year ended December 31, 2013.

Overview and Trends

Lumber Liquidators is the largest specialty retailer of hardwood flooring in North America. We believe we have achieved a reputation for offering great value, superior service and a broad selection of high-quality hardwood flooring products. We offer an extensive selection of premium hardwood flooring products under multiple proprietary brands at low prices designed to appeal to a diverse customer base. We believe our value proposition to the customer is the most complete and the strongest within a highly-fragmented hardwood flooring market. Sourcing directly from the mill provides the foundation for this value proposition, strengthened by our unique store model and the industry expertise of our people. At June 30, 2014, we sold our products through 344 Lumber Liquidators stores in 46 states in the United States ("U.S.") and in Canada, a call center, websites and catalogs.

Since 2011, we have focused on three strategic initiatives:

Expanding the base of customers recognizing our value proposition.

Expanding gross margin through sourcing initiatives, operational efficiencies and supply chain optimization.

Developing the best people to serve our customers and deliver continuous improvement in our operations.

In comparable stores, our net sales have been weaker in comparing 2014 to 2013 due primarily to a lower number of customers invoiced. We believe customer demand for our flooring has been weaker in 2014 than 2013, particularly in stores located in the Northeast and Midwest. Further, we have converted less customer demand to invoiced sales due to constrained inventory levels in certain key merchandise categories. These conditions of low customer count and constrained merchandise inventory have also adversely impacted gross margin, through shifts in our sales mix and greater ad-hoc discounting at the point of sale.

As we enter the fall flooring season in late August and constrained products are returned to full in-stock positions, we believe customer demand will strengthen and gross margin will improve relative to the second half of 2013. We continue to invest in the infrastructure supporting our long-term growth, and our investment in 2014 will be the largest in our history. These investments will bolster our supply chain and finishing capacity and continue to expand our store base. We will continue to aggressively pursue market share and elevate customer awareness of our value proposition through our advertising and branding. We now expect selling, general and administrative ("SG&A") expenses in the second half of 2014 to increase 8% to 12% over the second half of 2013, and second half operating margin to approximate or marginally expand in comparison to the second half of 2013.

Customer Demand

We believe customer demand in the second quarter and first six months of 2014 was weaker than the comparable periods in 2013 due to the continuing impact of an unusually severe winter across large sections of the Midwest and Northeast and a slowdown in the aggregate sales of single family homes, historically a driver of large-ticket, discretionary purchases. The tables below reflect a segregation of those stores we believe were impacted by weather or Hurricane Sandy from all other stores when comparing second quarter and first half of 2014 net sales and the percentage change to the second quarter and first half of 2013:

                                                                    Three Months Ended June 30, 2014
                                                                                  Stores Significantly        Hurricane Sandy
                                           All Stores      All Other Stores       Impacted by Weather1           Stores2
                                                                      (dollars in thousands)
Number of stores at June 30, 2014                  344                   206                        131                      7

Net sales                                 $    263,085     $         163,882     $               93,176     $            6,027
Percentage increase (decrease)                     2.3 %                 5.5 %                      0.4 %               (32.5) %
                                                                   percentage increase (decrease)
Comparable stores3:
Net sales                                        (7.1) %               (2.1) %                   (12.9) %               (32.5) %
Customers invoiced4                              (5.3) %               (1.9) %                    (9.6) %               (25.7) %
Average sale5                                    (1.8) %               (0.2) %                    (3.3) %                (6.8) %




                                                                     Six Months Ended June 30, 2014
                                                                                  Stores Significantly        Hurricane Sandy
                                           All Stores      All Other Stores       Impacted by Weather1           Stores2
                                                                      (dollars in thousands)
Number of stores at June 30, 2014                  344                   206                        131                      7

Net sales                                 $    509,376     $         316,545     $              181,181     $           11,650
Percentage increase (decrease)                     4.5 %                 9.7 %                      0.5 %               (37.7) %
                                                                   percentage increase (decrease)
Comparable stores3:
Net sales                                        (4.0) %                 2.8 %                   (11.4) %               (37.7) %
Customers invoiced4                              (4.3) %                 0.0 %                    (9.0) %               (29.0) %
Average sale5                                      0.3 %                 2.8 %                    (2.4) %                (8.7) %

1 Segregation of those stores we believe were significantly impacted by the unusually severe weather is consistent with that presented in the first quarter of 2014, except that those stores impacted by Hurricane Sandy are further segregated.

2 Includes store locations serving communities that were impacted by Hurricane Sandy and benefited net sales from the fourth quarter of 2012 through the third quarter of 2013.

3A store is generally considered comparable on the first day of the thirteenth full calendar month after opening.

4 Change in number of customers invoiced is calculated by applying our average sale to total net sales at comparable stores.

5Average sale, calculated on a total company basis, is defined as the average invoiced sale per customer, measured on a monthly basis and excluding transactions of less than $250 (which are generally sample orders, or add-ons or fill-ins to previous orders) and of more than $30,000 (which are usually contractor orders).

The winter weather experienced in the U.S. and Canada was unusual in severity, geographic scale and duration, in a number of areas lasting into the second quarter of 2014, which impacted our net sales in the first half of the year. In both the second quarter and first six months of 2014, net sales at the 131 stores we designated as significantly impacted by weather were considerably weaker than net sales at all other stores.

Our customers typically plan well in advance for the inconvenience of removing old flooring and installing new flooring. In larger, more complex projects, greater lead time and preparation is often required, and we believe the duration of the severe weather in some areas required a number of customers to reprioritize these multi-room projects. Historically, we experience the strongest demand for flooring in the spring, and again in the fall, often coinciding with the traditional period when children begin school. We now believe a portion of the reprioritized demand will return this fall, and a portion in the spring of 2015.

Though we believe we are early in a multi-year recovery in home improvement spending, we continue to expect periodic volatility in our customer demand. The wood flooring market in which we operate is highly fragmented, and dependent on home-related, large-ticket discretionary spending, which is influenced by a number of complex economic and demographic factors that may vary locally, regionally and nationally. Our reduced customer traffic coincided with certain weak macroeconomic trends related to residential remodeling, including existing home sales, which have generally been lower in 2014 than the corresponding periods in 2013.

Constrained Inventory

In certain key merchandise categories, primarily laminates, vinyl plank and engineered hardwoods, lower than planned, or constrained, inventory levels reduced our ability to convert customer demand into invoiced sales. Across all product categories with constrained inventory, we estimate an aggregate net sales shortfall in the second quarter of up to $18 million, as:

a portion of customer demand was converted to sales at a lower final retail price point as the longer customers wait for an order to be filled, the greater the likelihood and amount of point of sale discounting.

a portion of customer demand was converted to sales of a product substituted for a constrained product, often at a lower retail price point, and

a portion of customer demand was lost.

Constrained inventory resulted primarily from certain mills experiencing production delays in meeting our open orders as we continued to enhance our quality assurance requirements. Since we are committed to leading the industry in our quality and regulatory compliance standards, over the past several years, we have implemented significant enhancements to our quality controls throughout our supply chain. In the second quarter of 2014, certain international mills and their supply chains experienced delays in meeting revised requirements we considered primarily administrative. Though we understood the timing and substance of these requirements to be unique within our industry, we underestimated the aggregate impact on the mill base. As the mills have gained experience in complying with the additional controls, our supply chain has flowed more consistently and we expect full product availability during the third quarter, with no material impact to our product costs. As we improve our in-stock levels of these products, we will carry higher than historical inventory levels through the remainder of the year.

Store Base Expansion

In 2012, we began modifying our real estate strategy to consider total long-term share within a market over unit-based analysis, and we began targeting retail corridors within a market over more industrial locations. In January 2013, we implemented an expanded showroom format we designated as our "store of the future." All of our new stores opened in 2013 and 2014 feature the expanded showroom. Further, we continue to remodel our existing stores to feature this format, either in place or through relocation in the primary trade area. The results to date have generally met or exceeded our expectations. Store location activity to date in the expanded showroom format is as follows:

Number of stores featuring the expanded showroom:    2014        2013

Number of stores at January 1                            52           -
New stores opened during the period                      26          12
Existing stores remodeled during the period1              9           8
Number of stores at June 30                              87          20

1 A remodeled store remains a comparable store as long as it is relocated within the primary trade area.

In 2014, we expect to open a total of 33 to 37 new stores in the expanded showroom format, and remodel 15 to 20 existing stores.

Supply Chain Optimization

In 2014, we expect to strengthen our supply chain through the consolidation and expansion of our distribution facilities. On the East Coast, we are constructing a million square foot distribution center on 110 acres of land we own in Henrico County, Virginia with a targeted opening date late in the fourth quarter of 2014. This facility will consolidate and enhance existing East Coast operations, which currently utilize 750,000 leased square feet across four separate buildings. On the West Coast, we began operating a 500,000 square foot leased distribution center in Pomona, California in the first quarter of 2014. This facility is the primary distribution center for over 90 of our western stores.

We expect the East Coast investment in land, building and equipment to total approximately $55.0 million, with $29.7 million expended through June 30, 2014, including $15.8 million capitalized in the second quarter of 2014. Equipment for the West Coast distribution center totaled $3.3 million to date, with $0.3 million capitalized in the second quarter of 2014.

We expect incremental SG&A expenses related to our supply chain optimization initiatives, primarily occupancy and wages, of up to $1.7 million per quarter for the remainder of 2014, following the $1.6 million of incremental expenses in the second quarter. We do not expect any material SG&A expenses related to the East Coast facility until the fourth quarter of 2014, when construction is expected to be materially complete and the facility open for operation.

Non-Merchandise Services

Net sales in the second quarter included $8.8 million of delivery and installation services, up from $2.9 million in the second quarter of 2013. For the six months ended June 30, delivery and installation services totaled $15.2 million in 2014, up from $4.5 million in 2013.

Approximately one in 10 customers opt for fully-insured and licensed professional installation services which are available to measure and install flooring at competitive prices at each of our stores. In 285 of our stores, installation services are managed through a national arrangement with a third-party. Under this national arrangement, we receive certain reimbursements based on volume with which we offset other expenses. In the remaining 59 stores, we are testing structural alternatives to the national arrangement. In these stores, our own associates perform certain customer-facing, consultative services and coordinate the actual installation services provided by third-party professional installers. The installation transactions we arrange and coordinate are included in our operations, and in the second quarter of 2014, increased operating income but with gross margins generally less than our average merchandise transaction.

We engage third parties to deliver our products from the store to an address designated by the customer. The cost of the delivery varies based on weight and distance, and we pass our actual cost onto the customer with a small markup to cover administration. We believe the percentage of customers opting for non-merchandise services will grow as our value proposition resonates with a greater number of customers who do not consider themselves "do-it-yourself" or DIY consumers. Currently, approximately one in five customers opt for delivery services over in-store pickup.

Results of Operations



                                           Three Months Ended June 30,              Six Months Ended June 30,
Net Sales                                   2014                 2013                2014                2013
                                                                 (dollars in thousands)
Net sales                               $     263,085        $     257,111       $     509,376        $  487,530
Percentage increase                               2.3 %               22.2 %               4.5 %            22.4 %
Number of stores open at end of
period                                            344                  300                 344               300
Number of stores opened in period                  13                    7                  26                12
                                                              percentage increase (decrease)
Average sale1                                    (1.8 )%               5.4 %               0.3 %             6.3 %
Average retail price per unit sold2              (1.1 )%               5.6 %               0.3 %             5.9 %

Comparable Stores3:
Net sales                                        (7.1 )%              14.9 %              (4.0 )%           15.0 %
Customers invoiced4                              (5.3 )%               9.5 %              (4.3 )%            8.7 %
Net sales of stores operating for 13
to 36 months                                      2.1 %               17.3 %               3.0 %            18.1 %
Net sales of stores operating for
more than 36 months                              (8.1 )%              14.4 %              (4.8 )%           14.4 %

Net sales in markets with all stores
comparable (no cannibalization)                  (3.4 )%              16.9 %              (0.2 )%           17.3 %
Net sales in cannibalized markets5               15.2 %               45.5 %              17.0 %            43.6 %

1 Average sale, calculated on a total company basis, is defined as the average invoiced sale per customer, measured on a monthly basis and excluding transactions of less than $250 (which are generally sample orders, or add-ons or fill-ins to previous orders) and of more than $30,000 (which are usually contractor orders).

2 Average retail price per unit sold is calculated on a total company basis and excludes non-merchandise revenue.

3A store is generally considered comparable on the first day of the thirteenth full calendar month after opening.

4Approximated by applying our average sale to total net sales at comparable stores.

5A cannibalized market has at least one comparable store and one non-comparable store.

Net sales for the second quarter of 2014 increased $6.0 million, or 2.3%, over the second quarter of 2013 as an increase in net sales in non-comparable stores of $24.1 million was partially offset by a decrease in net sales in comparable stores of $18.1 million. Net sales for the six months ended June 30, 2014 increased $21.9 million, or 4.5%, over the same prior year period as an increase in net sales in non-comparable stores of $41.4 million was partially offset by a decrease in net sales in comparable stores of $19.5 million. In addition to the factors described in Overview and Trends, net sales were also impacted by the following factors:

Store base expansion drove the increase in non-comparable store net sales as we expanded our store base by 44 locations comparing the total at June 30, 2014 to June 30, 2013.

Store locations serving communities recovering from the effects of Hurricane Sandy reduced total comparable store net sales by 30 to 40 basis points in the second quarter of 2014 and by 65 to75 basis points in the first six months of 2014. Comparable store net sales benefited 65 to 75 basis points in the second quarter of 2013 and 100 to 120 basis points in the first six months of 2013 from these locations.

Gross Profit and Gross Margin



                    Three Months Ended June 30,           Six Months Ended June 30,
                     2014                 2013              2014               2013
                                        (dollars in thousands)
Net Sales       $      263,085       $      257,111     $     509,376       $  487,530
Cost of Sales          156,847              151,032           301,851          288,453
Gross Profit    $      106,238       $      106,079     $     207,525       $  199,077
Gross Margin              40.4 %               41.3 %            40.7 %           40.8 %

We believe that the significant drivers of gross margin contraction and their estimated impact compared to the prior year are as follows:

                                                           Three Months Ended            Six Months Ended
                                                                June 30,                     June 30,
    Driver                   Description                  2014            2013          2014           2013
                                                              expansion (contraction) in basis points
Product          Cost of acquiring the products we
                 sell from our suppliers, including
                 the impact of our sourcing
                 initiatives; Customs and duty
                 charges; Changes in the mix of
                 products sold; Changes in the
                 average retail price per unit sold;
                 Changes in the average retail price
                 and related cost of services,
                 including installation.                      (80 )           320          (20 )          330
Transportation   International and domestic
                 transportation costs, including the
                 impact of international container
                 rates; Fuel and fuel surcharges;
                 Impact of vendor shipments received
                 directly by our stores;
                 Transportation charges from our
                 distribution centers to our stores;
                 Transportation charges between
                 stores and the cost of delivery to
                 our customers.                               (30 )            60          (20 )           30
All Other        Investments in our quality control
                 procedures; Warranty costs; Changes
                 in finishing costs to produce a
                 unit of our proprietary brands;
                 Inventory shrink; Net costs of
                 producing samples.                            20              20           30            (10 )

Total Change in Gross Margin from the prior year (90 ) 400 (10 ) 350

Product: Gross margin was adversely impacted by net shifts in our sales mix, including those driven by constrained inventory, and an increase in the attachment of installation services. Gross margin benefitted from an increase in the sales mix of moldings-accessories, which increased to 19.0% and 18.7% of total net sales in the three and six months ended June 30, 2014, respectively, from 18.0% and 17.8% in the comparable prior year periods, respectively. In addition, greater discounting at the point of sale due to both lower customer traffic to our stores and constrained inventory adversely impacted gross margin.

Transportation: Gross margin benefited from generally lower international transportation rates which were fully offset by higher domestic transportation costs. Aggregate international container costs decreased as rates to our West Coast distribution center were significantly less than rates to the East Coast. The increase in domestic costs were primarily due to increased unit flow, including the number of customers choosing delivery services, which increased to 19% of all customers in the second quarter of 2014 from 11% in the second quarter of 2013.

All Other Costs: Gross margin benefitted from certain operating efficiencies, including a reduction in shrink, partially offset by lower net sales and our increased investment in quality control and assurance. In the first half of 2013, reserves for merchandise obsolescence were increased due primarily to supplier transition following certain line reviews. Those transitions were completed by the end of 2013.

Operating Income and Operating Margin



                       Three Months Ended June 30,           Six Months Ended June 30,
                        2014                 2013              2014               2013
                                           (dollars in thousands)
Gross Profit       $      106,238       $      106,079     $     207,525       $  199,077
SG&A Expenses              79,066               72,992           157,932          140,582
Operating Income   $       27,172       $       33,087     $      49,593       $   58,495
Operating Margin             10.3 %               12.9 %             9.7 %           12.0 %

The following table sets forth components of our SG&A expenses as a percentage of net sales, for the periods indicated.

                                            Three Months Ended June 30,             Six Months Ended June 30,
                                            2014                  2013              2014                  2013
Total SG&A Expenses                              30.1 %                28.4 %            31.0 %               28.8 %
Salaries, Commissions and Benefits               11.4 %                11.9 %            11.9 %               12.1 %
Advertising                                       8.7 %                 8.0 %             8.6 %                8.0 %
Occupancy                                         4.1 %                 3.3 %             4.2 %                3.4 %
. . .
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