LL Flooring Holdings, Inc.
Q2 2013 Earnings Call Transcript

Published: 24 Jul 2013

[Operator:]

Good morning, ladies and gentlemen. Welcome to the Lumber Liquidators Second Quarter Earnings Call. With us today from Lumber Liquidators is Mr. Rob Lynch, President and CEO; Mr. Dan Terrell, CFO; and Ms. Ashleigh McDermott, Director of Financial Reporting. As a reminder, ladies and gentlemen, this conference call is being recorded and may not be reproduced in any whole or in part without permission from the company. I would like to now introduce Ms. McDermott. Please go ahead, ma'am.

[Ashleigh McDermott:]

Thank you, operator. Good morning, everyone, and thank you for joining us today. Before we begin, let me take a moment to reference the Safe Harbor provisions of the United States 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 the call is accurate only as of the date discussed. Investors should not assume that the statements will remain operative at a later time. And lastly, Lumber Liquidators undertakes no obligation to update any information discussed in this call. Now, I'm pleased to introduce Mr. Rob Lynch, President and CEO of Lumber Liquidators. Rob?

[Robert M. Lynch:]

Thank you, Ashleigh, and good morning, everyone. I'm here with Dan Terrell, our CFO, and we're pleased to be speaking with you about our second quarter results. Our team once again delivered record-breaking results as we continue to see the implementation of our multiyear strategic initiatives drive cumulative benefits across our business. We continued to reinvest in each of the 5 components of our industry-leading value proposition to widen the advantage over our competition and broaden the potential customer base with which it resonates. We are improving our secret sauce, not with 1 ingredient but with many in combination. We are enhancing the customer experience while we broaden the store base, and we are continuously adding to our core assortment to provide a more complete flooring solution. The results we achieved in the second quarter and year-to-date are a reflection of improving yet sustainable strength across our operations, with each quarter including a reinvestment across our entire value proposition for future benefit. Second quarter highlights include

[Daniel E. Terrell:]

Thanks, Rob. Good morning, everyone. I will provide additional details on our results and then update our outlook for the remainder of 2013. As Rob noted, our operations are now benefiting from the implementation of a number of key initiatives, working individually and in unison to capture long-term share in a recovering residential home improvement market, in driving operating margin expansion. Though we believe these strategic initiatives will produce benefits which are sustainable for years, our continuing reinvestment in each component of our value proposition will provide even greater opportunity for share gains and operating margin expansion. Turning now to our results for the second quarter. Our references to percentage and basis point changes are in comparison to the second quarter of 2012, unless otherwise noted. Net sales increased 22.2% to $257.1 million, with a 14.9% increase at comparable stores and record new store productivity. Net sales were driven by a combination of increased traffic, which we measure as the number of customers invoiced, and an increase in our average sale. The 14.9% increase in net sales at comparable stores stacks on a 12.4% increase in the prior year and was driven by a 9.1% increase in the number of customers invoiced and a 5.4% increase in the average sale. As Rob noted, we believe our value proposition is appealing to a larger customer base through a greater reach and frequency of our advertising, and we also believe conversion to net sales is more effective due to our sourcing, supply chain and Best People initiatives. This is supported by strength across the maturity of our store base, including a 14.4% increase in stores operating for 3 years or more. Our second quarter average sale was $1,710, up from $1,625 in 2012 due to an increase in the average retail price per unit sold, which itself benefited from

[Robert M. Lynch:]

Thanks, Dan. We are very pleased with our team's performance in the first half of 2013, as we leveraged our value proposition in serving the flooring needs of nearly 300,000 customers. We speak often about the core strengths of our industry-leading value proposition with its unique combination of price, selection, quality, availability and the expertise of our people. We believe each component is recognized and appreciated by our large and growing customer base. We have spoken in past quarters about our key strategic initiatives enabling us to enhance our price advantage, broaden our offering and strengthen the availability of that entire assortment. We have also spoken more recently about our investment in training to ensure our customers receive expert assistance throughout the purchase cycle. I'd like to spend a few minutes today on quality, which is fundamentally important to the success of our premium brands and key to a loyal customer base. Sourcing directly from the mill provides the foundation for our entire value proposition. Due to our scale, we often purchase the majority of our mill partner's capacity, and as a result, we have insight and visibility throughout the sourcing process. This provides a significant competitive advantage compared to the distributor model of many of our competitors. Our product offering features our high-quality proprietary brands, which represent more than 95% of our net sales and include the premium brands Virginia Mill Works Handscraped Hardwoods, Morning Star Bamboo and our flagship, Bellawood lines. Our commitment to quality begins with well-designed product specifications, followed by strict adherence to a set of internal standards set well above regulatory requirements. Because of these standards, the products we sell nationally exceed the most stringent requirements of any state. We have developed quality control and assurance processes for our products that we believe lead our industry. Due to our international sourcing, we have more than 60 professionals around the world, including in the U.S., Canada, China and South America, who perform and monitor those processes that we believe are most effectively executed on the ground at the mill. We augment the on-site controls with additional testing in both our own labs and in independent certified facilities. The combination of our on-site controls and our additional testing is designed to ensure that our products exceed the highest regulatory requirements and meet our more stringent internal quality standards. As national standards are developed around product quality, construction and packaging, we will engage in and intend to lead our industry in the process. Before we turn the call over for questions, I'd also like to spend a few moments updating you on our new store of the future. As many of you know, our 2013 store base expansion has featured the store of the future and its expanded showroom. We are pleased with the results we have seen from the 20 expanded showrooms to date, and we plan to end the year with as many as 57, including up to 32 in new stores. The new format stores we have opened in 2013 are generally outperforming the net sales trends we have historically expected at new stores. And our new store productivity is at a record high in the second quarter. Further, the aggregate performance of our remodeled stores, whether in-place or relocated in the primary trade area, has generally exceeded our expectations. We recognize that the sample of expanded stores is small, and we have operated the locations during the spring remodeling season. That said, we are certainly encouraged by the results to date and look forward to additional openings in the second half of the year. Our real estate and store transition teams have done an excellent job implementing the new strategy and minimizing any disruption to existing operations, and we are confident we can ramp up our planned number of expanded showrooms in the second half of the year with continued success. In June, we reached a milestone with the opening of our 300th store. Our store base is now 250% of what it was at our IPO in November 2007, but only halfway to the 600 domestic stores we are currently targeting. Our improved real estate strategy, combined with our new store format, is proving to be highly successful. And as we experience greater market penetration with less cannibalization, we expect to challenge that target. As we look forward to the remainder of the year and beyond, we believe we have the right team, structure and strategy in place to continue gaining market share. We continue to be well positioned to deliver multiyear net sales and operating margin expansion. I would once again like to thank our entire team in the U.S., Canada and Shanghai for their unified commitment to continuous improvement and dedication to strengthening our value proposition. Operator, we are now ready for questions.

[Operator:]

[Operator Instructions] Our first question comes from Matthew Fassler with Goldman Sachs.

[Matthew J. Fassler:]

First question I want to ask relates to gross margin. Obviously, we're kind of in unchartered territory. If you think about the seasonality of your business, the second quarter has actually often been your lowest margin quarter from a gross margin perspective, I think due to the promotional cadence of the business, and the gross margin has typically picked up over the remainder of the year. Now some of that of late probably is just because of the continuous improvement that we've seen in the business that's overwhelmed seasonality, but if you look further back, that was the case. Would you expect that to continue to be the case as we move forward?

[Daniel E. Terrell:]

Matt, this is Dan. You're absolutely correct that the second quarter had usually been the lowest gross margin quarter of the year because of our promotional cadence, leading with the April Big Sale, but also the close of the remodel season. We were surprised by the strength we saw in the second quarter, most of it coming from the training and disciplines at the store increasing the average retail selling price, the better assortment and our ability to upsell to premium products, and then the transportation cost benefit is actually coming a little earlier than we expected. A little bit of it is rate, but probably most of it is the strength of our people through the supply chain and at the store to hold those costs down. I think those initiatives are going to wash through now so that the second quarter will not be the pronounced dip that it had been in prior periods. As we measure against the second half of the year, it was 38.6% [ph], I think, in the second half last year, up about 130 basis points from the first half. We now expect roughly that 200 to 230 basis points of expansion on top of that number.

[Matthew J. Fassler:]

That's 200 -- that second number you gave, the expansion expected this year, that's year-on-year expansion, correct, not sequential?

[Daniel E. Terrell:]

That's right.

[Matthew J. Fassler:]

All right. Second question, on the advertising. Clearly, you're putting money to work against the incremental gross profit that you're generating, and advertising was, in fact, precisely 8% of sales down to the hundredths in the first half of the year. Do you expect to manage it to that number as you move through the course of the year? Or are you simply saying that directionally, you're going to continue to advertise, to commit some of those excess gross profit dollars to marketing?

[Robert M. Lynch:]

Matt, this is Rob. What I would tell you is I think you should see us continue to maintain the pace of reinvestment of advertising to grow sales and take market share. I think we started talking about this about 2 years ago. And the exciting thing for us as a company is, when you look at the opportunity we have for growth, the market share within our core categories, as you peel that back and look at the total number of owner occupied homes in the U.S., we see about 75 million homes out there that we penetrated less than 1.5% a year. So we feel the growth potential for us is enormous. And that the things that we've been doing with the advertising and marketing, broadening that reach and frequency, and the teams that have been doing that have been doing a phenomenal job and it's paying off. So overall, yes, we are delevering. We think it's the right thing to do, it's investing in the value prop and it's delivering profitable sales growth. So look for it to continue.

[Operator:]

Our next question comes from Joseph Edelstein with Stephens Incorporated.

[Joe Edelstein:]

I'm curious how much more of the same-store sales of those remodeled stores outperform by the chain average?

[Daniel E. Terrell:]

Joe, they were improved and we've now seen it for enough months where we felt comfortable putting it in the prepared comments. But remember that it's still a pretty small sample. Even in the second quarter, I think all stores with remodeled showrooms was less than 4% of our sales. We operated during the remodeling season, always a strong time. So we've got a small sample operating for a short period of time, but we have seen it enough where we're comfortable saying, at least in this shorter term, they've outperformed our expectations in our historic model.

[Robert M. Lynch:]

This is Rob. I'll give a little more anecdotal color on that as well. What we're hearing from the field is what's most impressive to me, is that our store associates are loving the store, the customers are adapting to it very well. It's creating a great experience in the store for the customers, and it's creating an easier selling process for our store associates. And without getting into specific details at the store level, what I would tell you is we're pleased with it because it's working in the new stores, you can see that in the new store productivity; it's working in the relocated and remodeled stores where we're -- if we're moving a store to a better trade area -- to a better site as well as giving it the new mousetrap; and it's also working in our older stores where we're staying in place and remodeling that old box. We're seeing really good results there and we're pleased. So I would look for it to continue. And as we get -- as Dan says, as we get further into it, more data points, we'll share some numbers in the future.

[Joe Edelstein:]

Yes, that'd be great. Also curious about the cadence of the planned store growth and remodels, really for the rest of the year?

[Daniel E. Terrell:]

Yes. Well, we are going to finish the year, we think, with 28 to 32 new. We've got 12 now. And we still think 20 to 25 total remodel, either in place or relocation in the primary trade, and we've got 8 of those right now.

[Joe Edelstein:]

But the third quarter should probably have the heavier amount of stores?

[Robert M. Lynch:]

Yes, you're going to see that ramp up. One of the things, as we were just trying -- starting this year with the new store format with the store of the future, we start -- we slowed the pace down in the first half to help us get some of the kinks out and get -- still get the infrastructure and resources in place to ramp it up in the back half. So that's why you see it's implied in the numbers that yes, that, that pace is going to pick up but we're confident with the team and the infrastructure and the resources that we've put in place and the processes around it that we'll be able to deliver those numbers.

[Daniel E. Terrell:]

Yes, Joe, just don't look for it to be crazy disproportionate to the third quarter. I mean, the third quarter may be a little bit heavier than the fourth, but we're looking at a pace over these next 6 months.

[Joe Edelstein:]

Okay, that's very helpful. And if I can also ask a question on the per-store inventories, I appreciate the commentary that you gave. And I think even last quarter, you had mentioned that you were trying to get ahead with some pre-buys ahead of the Chinese New Year, some additional supplier transitions. Sounds like you're going to look for a peak in the third quarter this year. I'm curious to know, are you planning any additional sales perhaps in the fourth quarter to help you work down from those 3Q levels?

[Robert M. Lynch:]

This is Rob. We look at inventory very strategically. It's key to the value proposition in terms of availability. And really what we've been doing is, if you look back to the last couple of years, we feel that the quality of the inventory is probably better than it's been in a very long time. On top of that, probably what you're seeing in the sales benefit here is us reinvesting in front of some of the trends and new product launches that we've been seeing, the vendor transition as we -- and then also in terms of a recovering housing and flooring industry. So we've really invested in front of it. We feel that have very good control of the inventory that is high quality, that we have enough to meet the demand and the events and promotions coming up. But in general, if you think about the continuous improvement we've been driving across the operations from supply chain to merchandising to allocation to stores all working together, we actually have a much more efficient and streamlined operational efficiencies today than we have maybe in the past. So things are working together. We're doing more with less on the inventory. Again, I would see it to kind of continue the pace. And I see no problem with us falling in line to where we are projecting for the end of the year. And I think that means 2 things

[Joe Edelstein:]

Yes. That sounds great and clearly adding value for the customers. Just last question for me then it would be, could you just give us an early read on July trends?

[Daniel E. Terrell:]

Joe, in my commentary, I wanted to make sure people understood that there are a lot of things that can impact a discretionary purchase, particularly large ticket. But that so far in July, we hadn't seen any drop-off from the trends we saw, which were consistent across the second quarter.

[Operator:]

Our next question comes from Peter Keith with Piper Jaffray.

[Peter J. Keith:]

Rob, I was wondering if you could highlight some of the human capital additions that you made that maybe didn't require a press release. Because clearly, it sounds like some of the drivers, particularly on the gross margin line, are kicking in sooner than you thought. I'm wondering if that's from the addition of some new people that you might be able to outline for us?

[Robert M. Lynch:]

Yes, it's a really good question. We talked a lot about continuous improvement over the last couple of years. And we take that very seriously as a philosophy in how we're running the company. As you know, to your point at the senior level and my direct reports, we've made some changes and brought in some new folks. But we've also done that across the entire organization, all the way down into each of the functions. In merchandising, Bill Schlegel has brought in and added resources and built a world class team. As we acquired the China sourcing operations, we added -- we built that out and added resources there. We've done the same thing in almost each and every function in the company. And really importantly, too, and as we talk about the Best People initiative, all the way down into our stores. Our senior store leaders, our regional managers out there in the organization, we've had some involuntary and voluntary turnover there, that's been kind of continuous, and we've been raising the bar. Same thing down to the store manager ranks, the assistant manager ranks and then into the hourly ranks. So something we take seriously, something that we've been doing, absolutely. Haven't been -- we don't issue a press release each time we do it. But our people are extremely important to us. Every person down to the last can contribute. The exciting thing is that I think the morale in this company has never been higher. We are aligned around a common strategy, a powerful value proposition and a set of strategic initiatives and goals that are all working together to kind of create that secret sauce I talked about in my script. And that's what's exciting, and the team behind it is extremely important. And in my experience in my career in retail, I've never been at a company that it's more important when you understand the dynamics of our business, the high ticket, low transaction count type of the business that we do relative to other types of retailers. It's very, very important, and we will continue to invest in our people and drive our Best People initiatives. Which is why we brought -- we have Sandy Whitehouse now and our HR organization's going to help us with that going forward.

[Peter J. Keith:]

Okay, that's great feedback, I appreciate it. Then, I guess, turning to Dan. I've got a couple of investor questions on the SG&A, and obviously, it was a spectacular quarter. Maybe the SG&A line delevered a little bit more than what some people thought. It looked to be the advertising ticked up somewhere to Q1, but it was really that salaries and commissions line that didn't get any leverage compared to the last couple of quarters. Did something change in Q2 with the way maybe bonuses are accrued or something like that, that is specific to Q2 or may change things going forward?

[Daniel E. Terrell:]

There were some timing adjustments in there, Peter, and then there were some planned adjustments. We levered the corporate group, the warehouse and distribution team and then even some of the benefits, we got some leverage. But we did have higher accruals related to our annual management program. The success we've seen in the first half of the year, we pulled more of that accrual into the first half and the second half. We're always challenging the commission rates for the store teams. And obviously, the stores are just doing fabulous work out there as far as capturing demand and converting it to sales. So we're always challenging the commission rates. We also have some additional stock comp expense that's related to some equity grants that have run through. You've got a little bit of timing related to those accruals, and you've got some of the challenge that we want to keep the momentum going by challenging the rates that we pay, particularly the store teams.

[Peter J. Keith:]

Okay. Well, you can't argue against higher accruals for the store teams with what's going on. One last question. Just given the success of store of the future that you're seeing, you're doing 25 remodels/relos this year. Are you thinking about, kind of looking out to next year, how that might tick up given your, I guess, your early results that seem quite favorable?

[Robert M. Lynch:]

Yes, Peter, we are. It's 20 to 25 this year. We're still looking at a range, because obviously, a remodel in place has some difficulty to it that a relocation doesn't. So we're still looking at how effectively our team can transition that showroom while a store operates. And so far, they've just done great. But it's going to be a challenge looking forward. We believe there's the right location strategy and availability out there to do more relocations. But again, make sure we've got the right teams in place because obviously, the existing stores are doing well, 14.4% increase in all stores over 3 years. So we want to be very careful about how we accelerate that. But it is something we're looking at going into 2014.

[Operator:]

Our next question comes from David MacGregor with Longbow Research.

[David S. MacGregor:]

The gross margin, I wonder if we could just talk about that for a moment. Really kind of a great performance, particularly at a time when hardwood prices are inflating at a double-digit rate. So I wonder if you could sort of reconcile those trends for us? Are you just sourcing more offshore than domestically? And if there was some hardwood inflation impact on the gross margins that was just offset by progress on so many other things, could you help us understand the proportions there?

[Robert M. Lynch:]

Yes, this is Rob. We've talked in the past about a focus on gross margin and the expansion, and that it's a comprehensive initiative that really you can impact in almost every single function in the company, maybe outside of legal. And so it's something that we've been working on for a couple of years. I would tell you, just strategically, that I continue to see a very long runway in terms of our gross margin potential from here. In fact, as we speak, we're conducting a line review in China right now in our engineered products. And as I mentioned earlier, it's a combination of many different things working together. We've probably got 10 to 15 different separate initiatives, cross-functionally, working on and driving our gross margin; obviously, from the sourcing, the line reviews, the assortment mix is driving it. The marketing and advertising strategies are driving new customers into our stores that are -- have a different price sensitivity to the product pricing and what they're looking for in terms of the type of -- the quality of the product they're looking. They're looking for a higher quality product, they're looking for more help. They want all the attachments to complete the project. So marketing is actually driving that in terms of the traffic and the folks coming into the stores. And then the stores, like Dan said, our stores are exceeding all of our expectations in the way they are executing and delivering and meeting the demand that we are sending into the stores. And that's the Best People initiative, that's the field leadership, that's the motivation, that's the training that we conducted at Lumber Liquidators University in terms of everything they're focusing on from attachments to ASP, you name it. And I think Dan mentioned in his prepared remarks that moldings and accessories are really driving the margin. And there's 3 or 4 things underneath that, that's driving it from the mix of the accessories to the cost of the accessories post line reviews we've conducted, to the supply chain efficiencies, getting them into the stores and into the customer's hands more effectively and more efficiently and then the stores better attaching and selling them. All that stuff's working in combination to drive the margin. And like I said, we've got a number of things going on. Look for this to continue. We see a long runway here. And I think the important thing strategically for the company is, too, this gives us the flexibility to invest back into our value proposition, to drive the benefits in these initiatives, and to take some of that and reinvest back into advertising, to invest back into each point of the value profit; if it's availability, if it's quality, if it's people, you name it, we're going to be doing that very thoughtfully along the way.

[David S. MacGregor:]

Second question. You've been kind of putting up mid-single digit traffic or ticket comps here for the last couple of quarters. Is that how we should think about the second half of the year, kind of mid-single digit ticket comps?

[Daniel E. Terrell:]

Dave, it's got an opportunity to continue on this pace. We came into 2013 expecting traffic to be the primary driver of comps, ticket to not be a drag but not really to be a boost either. And what we've seen is, through the store performance of retail price discipline and attachment of moldings and accessories as the primary 2, we've seen ticket expansion. I think it's available to do for the second half of the year as well now that we've seen it in the first half.

[David S. MacGregor:]

So if you can continue to comp in the mid-single digit, you're guiding total store comps kind of mid- to high-single digit, help us understand kind of what looks like a fairly negative view on traffic for the second half.

[Daniel E. Terrell:]

Well, we think -- if you think about 10% being sort of a midpoint of the second half guidance, you may see 3% to 4% of it in ticket, 6% to 7% in traffic.

[Operator:]

Our next question comes from Matthew McGinley with ISI Group.

[Matthew McGinley:]

My first question is on the Big Sale. How much of the 15% increase in comp do you think was driven by the Big Sale versus the -- what you call the spring remodel season? And as it relates to the gross margin impact from that Big Sale, if it was more successful than last year and you're promoting product, why would that have had no impact on gross margins? What are you doing differently with promotion that it no longer has an impact on gross margin rates?

[Daniel E. Terrell:]

Matt, I'll start and let Rob fill in. The Big Sale's always a big driver in April. The last couple of years, we've changed the focus from invoice sales to orders, converting demand into orders that can be invoiced over a longer period of time. Think back a few years ago, we used to look at that sale as what could you invoice by Sunday afternoon, which meant the customer had to pick up the product. Now we've got a focus on just get the customer into the store, take care of them, sell them what they need, come back with the moldings and accessories, provide that full ticket. And that's not just for promotional product, that's across the entire spectrum of our assortment. So what we're seeing is that sale have an impact in the quarter; it doesn't drive as much of April but it drives both April and May. I will say again though that we saw -- even though that got us off to a good start, we saw really consistent demand across each month of the quarter, very consistent. So it got us off to a good start but we were able to maintain it. And well, the lessening of the impact on gross margin is because we're now featuring the whole assortment, booking the open order, coming back to follow up with moldings and accessories that may round out the ticket. So the last 2 years we've taken that approach, it had a far reduced impact on gross margin last year, and we can't -- we didn't see any adverse impact in the current year.

[Matthew McGinley:]

Okay. And then on the comment you made on the consistent trend through July, you had a pretty significant surge in customer deposits year-over-year. It was up around 32%. If those are actually converting, why wouldn't you experience acceleration in demand in July?

[Daniel E. Terrell:]

The customer deposit balance is sort of a reflection of open orders, which can -- which is maybe about 2 to 3 weeks of demand. It can vary based on where our inventory levels are aligned to sales, the sales mix that's within those open orders and the promotional cadence that we've got going on, which is why we tend to expect that to be an approximation of the sales increase but never a 1

[Operator:]

Our next question comes from Brad Thomas with KeyBanc Capital Markets.

[Bradley B. Thomas:]

Wanted to just follow up on some of the gross margin opportunities, specifically on the sourcing side. I was hoping, Rob, you could just kind of take a step back and, big picture, give us a sense for kind of what inning you feel like you're in on the sourcing side. And then maybe speak specifically to how much more opportunity is still in front of you in China, and how things are going with the line reviews that have been undertaken in Brazil?

[Robert M. Lynch:]

Yes, good question. I just want to reiterate what I said a few minutes ago, that we definitely see more runway in front of us here in terms of the exact inning we're in. The thing you have to understand is, I want to try to it pull up a level, we have a very strategic and comprehensive program around margin enhancement in terms of driving the margin and using that as fuel to drive sales, invest in the value prop, grow our market share and grow our earnings as well. So I would tell you that we feel very comfortable, we see a long runway. Specifically to the -- under sourcing, there's many things we're doing in sourcing. The line reviews are one thing we're doing in there. And the line reviews, we continue to conduct them, and they continue to add value. Based on the process and the procedure and the way we train our buyers and the way we conduct these line reviews, they continue to add value almost like, excuse the analogy, but the cow. As you feed and take care of the cow, you get more milk out of the cow, okay? So, I would look for those to continue. The thing that we are always surprised by is the fact that, in each of our line reviews we conduct, we're learning that there's so much capacity out there in the world. And as we've expanded our global presence and are reaching out to other countries and other potential mills out there, we see new players come into each line review. And it's a curious and nice, competitive process. And it gives us alternative source, diversifies our mill base and gives us also new and exciting products. We're looking at -- within Asia, we're looking and assessing mills in several other countries. Same thing in South America, same thing in Europe. So I would just say that, that's just -- it's really the sourcing team, the world-class team we have and the work that they're doing to kind of continue to drive it. And then as you know, early innings in the supply chain and what's going on there to drive margin enhancement, and early innings in the operations in terms of the stores and the patching and the mix. The management, the disciplines that the stores are doing are really exceptional in terms of their maintaining their pricing disciplines, their attachments, they're upselling when appropriate in terms of what the customer's looking for, all the way down to the execution on lowering our store-to-store deliveries and our store-to-store transfers. And also customer deliveries, the execution there. We're charging full amounts for our deliveries. We're not giving it away like sometimes we've done in the past for customer service issues. So there's many things working in unison that's going to drive the margin, that's doing it now and will continue to.

[Bradley B. Thomas:]

And if I could just add one more follow-up on the current pace of business and the outlook for the second half. Obviously, it sounds like things are still going very well at start of the third quarter. The comparison just on a 1-year rate are similar to what you were up against in the second quarter. They do get a little tougher on a 2-year stacked rate. Can you maybe help us think through some of the puts and takes in terms of the comparisons, anything that you're up against? And then on the flip side, any maybe new marketing initiatives or sale events or any new products that may help to accelerate sales in the back half? Just want to try and make sure we put everything into perspective here for the opportunity in the back half of the year.

[Daniel E. Terrell:]

Brad, I -- working backwards, I don't think we have anything that's a specific new item we'll introduce in the second half. It'll be more of the same. More of the new store expansion, a little bit greater pace than in the first half this year but not dramatically increased over the second half last year. We're always challenging the product assortment from what we sell as far as the premium products and the moldings and accessories and attachments. So no, nothing new coming there but more of the same that we've seen in the first half of the year. We're cautious because the second half of 2012 was stronger than the first half. The second half of 2011 was stronger than the first half. You recognize that it's a discretionary purchase. It can be delayed. There are a number of factors that influence it. So we're just trying to take a prudent look at what might come in the second half of this year and acknowledge that we're a purely discretionary large ticket purchase. So there's not anything embedded in the number. We're pleased with what we've seen in the first half. We're pleased with what we've seen to date in July. But there's still a second half to go.

[Operator:]

Our next question comes from Laura Champine with Canaccord.

[Laura A. Champine:]

The store is -- the new store format is so different and bigger. And I'm just wondering, of the -- most of the conversions you've done have been relocations, although I hesitate to characterize them as a group since it's 8 stores. But as you move forward, as you look at your entire existing store base, how many of those stores or what percentage of those stores do you think you'll need to relocate in order to get them into a good-looking store of the future?

[Robert M. Lynch:]

Laura, this is Rob. I would tell you if you look back historically at the real estate strategy, I mean, the success of the refined site selection strategy we've been implementing in the last couple of years, that I would look to a good 20%, 25% to 1/3 of the stores being relocated. And then obviously, we're going to remodel in place as well. And it's going to be -- there's a number of things that we're using to kind of filter and screen and decide on whether a store's relocated or not, and there's a lot of rigor and analytics behind that. But again, so far, so good. We have relocated several. We're pleased. Like I mentioned earlier, we've also remodeled in place a few of our higher volume stores, and we're pleased with what we're seeing there. So in general, we're just excited because the store of the future seems to be working in all 3 areas, either a relo, a remodel in place or in a new store location. And again, what it's doing for us in terms of a market optimization perspective, like the market you were in, in Las Vegas, we relocated the single store there to a store of the future before we opened up the new store. So that was exciting. And I think we're actually very pleased overall with the market and how that's performing.

[Laura A. Champine:]

And how much of the -- so there's a greatly expanded tool and accessory assortment in the new format. How much of that expanded tool and accessory assortment are you able to get into your older format stores?

[Robert M. Lynch:]

Good question. That's something that we're constantly looking at in terms of looking at the best sellers there and getting them out to the existing stores. And we're actually in the process of doing that right now. We've got another round of resets going out in terms of the tools and accessories going out to all the existing stores from the store of the future set.

[Daniel E. Terrell:]

And Laura, I would just add, you know that it's hard to pin a single metric down because our older showrooms can be as small as 700, 800 square feet, all the way up to, even in the older format, 1,100 square feet. So where the older store has got a little additional space to work with, we can look at some racking and put part of that assortment in. Where you're dealing with a 700-square-foot showroom, it's incredibly difficult.

[Robert M. Lynch:]

And I would just add to that. I mean, you shouldn't -- imagine the operational improvement and what it does for the store associates and also the customers, when you take a store, particularly an older higher volume store, and you take it from an 800-square-foot showroom to the new store of the future with the new set, with the expanded flooring assortment. It's just so much easier for them to sell the customers, it's an easier experience for them. It's even indirectly -- anecdotally and indirectly, helping we feel on the margin side, I think, because it's a more credible retail format. Customers are less likely to expect a discount or ask for a discount over and above what we're already promoting. So we're seeing a lot of really good benefits from it and we're very pleased.

[Operator:]

Our next question comes from Gary Balter with Credit Suisse.

[Gary Balter:]

Could you talk -- you obviously had a great quarter and you've been answering all the questions about how strong it was and the outlook. Could you talk about what you felt didn't work in the quarter, some of the initiatives, even if it's in the store of the future or in other areas where you're looking at it saying, "Hey, this is something we have to reexamine and think about the direction we have to move in."

[Robert M. Lynch:]

Gary, this is Rob. What I would tell you is, I think, fundamentally, we are very pleased with the overall operation and execution of the team, what the team's doing out there and with the major initiatives that we were talking about here in terms of the margin, the sourcing, the supply chain optimization projects, the marketing changes, things we're doing with Best People and what have you. Really -- what comes to my view, I mean, I think -- what I'll tell you, Gary, is there's always some other initiatives we're working on, other potential areas for improvement and growth that is probably where that type of focus is, where we're testing a new product in a market or testing a new type of selling procedure in a market. And that's kind of where we focus on our improvement opportunities.

[Daniel E. Terrell:]

Yes, I'd echo that. It's hard to introduce as many products as we have in the new store of the future and have all of them work with equal success. So that's the beauty of having a strong merchandising team is that they can put something out there and identify the sales trends around it, whether it's off to a slow start or whether it's just one of those things that's not going to perform as well and then we can reallocate that space. That's one of the initiatives. As Rob said, we're always -- we've got a lot of irons in the fire and not all of them are going to work. A lot of them revolve around product and how we can continue to augment the ticket and make it an overall purchase for the customer. And we've seen some success but not all of them will work.

[Robert M. Lynch:]

The biggest concern I will hear sometimes when I'm out in the stores is, when we've launched a new product that just completely takes off and maybe we didn't buy enough in, you definitely hear from the field and from the customers in terms of wanting that, that product becomes constrained because maybe we didn't buy enough going in. But our merchants have been very, very aggressive and obviously, that's a good problem to have.

[Gary Balter:]

What do you -- on the store of the future, what are you taking from that? What are you learning that you could apply back to stores that don't have that format?

[Robert M. Lynch:]

Yes. I think Laura hit on that a minute ago, Gary, relative to some of the expanded assortments. And particularly in tools and accessories, what we're learning is instead of waiting until we've converted a store, we're looking at some of the best sellers and the new assortments that can be identified and expanded into every store to an accessory assortment. Same thing with some of the new floors that we may be testing in the store of the future format. So that's one of the things that we are doing is we're using the store of the future as a lab, where we'll be -- we're going to -- if we're going to test a new item or new -- expand in a category, introduce a new item, we're going to do it there first and see how it works and then take it out to the other stores.

[Operator:]

Our next question comes from John Baugh with Stifel.

[John A. Baugh:]

Most of my questions have been answered. But just quickly, on the quality front, as you look forward, I don't know, 12 months, is there any level of expenditure that's meaningful that you think you'll have to spend to address the quality issue or we won't see anything?

[Robert M. Lynch:]

Good question. The point I would make there is that, as I've said in my prepared statements, quality is an equal part of our value proposition. We've been investing in it, just like we have in price, in selection, availability and service. Our product specifications are designed to exceed what's out there in terms of any regulatory requirements, John. We -- I would -- we're going to invest in quality just like we invest in any other part of the value prop. Nothing truly compelling right now, but I just -- I think look to us to continue to do what we're doing in terms of our mills comply with our product specs because we have personnel on the ground in the mills. We have Lumber Liquidators associates out. We've invested, we acquired our sourcing office in China, we added to that staff. We'll continue to kind of add to that staff as we grow and expand our sourcing base. And that gives us an advantage. We don't rely on a distributor to measure and control our quality. And then we do some things over -- above and beyond that we're doing now, and we'll continue to do that where we're ensuring that we are meeting our specifications and exceeding the industry standards. Okay? We do stringent testing of our products at multiple levels beyond what's required. Our products are tested by third-party experts, both at the mill and in offsite labs, as I said in my remarks. And we also go in and do random tests at the mill. And then I think the important thing is we're selling, nationally, products that exceed the most stringent requirements at any state. And that's something that we're going to continue to make sure that we're doing around -- on the forefront of any changes, any national standards that may be coming out and then we're going to lead the way if there are.

[Daniel E. Terrell:]

And my only other comment, John, would be it's an equal part of our value proposition. Just like we're looking to reinvest in the supply chain to enhance availability, into our people, to expand the assortment, the line reviews for price, quality's a part of the value proposition equal to the others. And we'll always look to reinvest in the advantage that we believe we already have and try to increase that advantage.

[John A. Baugh:]

Right. And then just on gross margin quickly. Is it right -- you've been very specific with guidance and that's very helpful. Is it right to think about that you'll see some level of wood inflation going forward but it will be way more than offset with all these other initiatives or you're really not seeing much wood inflation at all?

[Daniel E. Terrell:]

John, we're not seeing much. There's been some well-publicized domestic wood increases. But again, the nature of our relationships with the mills can mitigate that. And then what Rob has talked about a couple of times, there's just so many initiatives that are now combined and working in unison together that, even if there is some feeling of pressure, it's going to be well washed through by the other initiatives in gross margin.

[Operator:]

Our last question comes from David Magee with SunTrust.

[David G. Magee:]

I wanted to ask about the pricing in the store. I know you all invest in price and are very conscious of increasing share by having a pricing differential. It seems like some of your competitors might be raising price a bit because of vendor inflation. Is there an opportunity for you all to maybe tweak up a bit on sort of same item pricing and still keep that differential in the future?

[Daniel E. Terrell:]

David, I would tell you a couple of things there, that our ASP increase did not come from raising prices on like kind product. It generally comes from the mix of the product and the attachment of moldings and accessories. And I'll one last time tip the cap to the incredible merchandising team and the store team and the level of communication that we've got here. When Rob talked about the momentum and the enthusiasm, we have a very open line of communication from store floor to the merchandising team and through to the distribution and supply chain team. So we can react appropriately when we see whether a competitor has moved their prices and we need to move accordingly or we need to widen or keep our advantage. So there may be opportunity looking forward, but I think the thing to take away longer term is there are open lines of communication, and we're very dynamic and flexible and can react very quickly to what we see happening within retail prices.

[David G. Magee:]

Then, and secondly, with regard to the traffic increase in the quarter, which was very impressive, any way to sort of parse out how much of that was sort of sector driven versus the improvements you've made in marketing?

[Daniel E. Terrell:]

Really hard, as you might imagine or as you indicated. So we don't have a good metric to provide you. What we can say is we've got low market share. We are definitely seeing a firming in the housing market. I -- we still believe we're not seeing a full-scale recovery or tsunami of pent-up demand come yet. But we've got low share. We believe we can penetrate a customer base that we previously hadn't been looking at by broadening the reach and frequency of the advertising. So while we can't provide a specific metric on what's macro versus what's our own initiative, we're pretty excited with what we've seen come from broadening the reach and frequency. And perhaps the macro's added a little bit to that. But we believe we haven't fully maximized that and there's more to come.

[Operator:]

There are no further questions. I would like to turn the call back over to Mr. Lynch for closing comments.

[Robert M. Lynch:]

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

[Operator:]

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