LL Flooring Holdings, Inc.
Q3 2013 Earnings Call Transcript

Published: 23 Oct 2013

[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, Director of Financial Reporting for the company. Please go ahead.

[Ashleigh McDermott:]

Thank you, operator. Good morning, everyone, and thank you for joining us today. Before we begin, let me take a moment to reference the Safe Harbor Provisions of the United States 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. Lastly, Lumber Liquidators undertakes no obligation to update any information discussed in this call. Now, I'm pleased to introduce Mr. Rob Lynch, President and CEO of Lumber Liquidators. Rob?

[Robert M. Lynch:]

Thank you, Ashleigh, and good morning, everyone. I'm here with Dan Terrell, our CFO, and we are pleased to be speaking with you about our third quarter results. The work of our outstanding team, our ongoing commitment to continuous improvement in all that we do and the accumulative benefits we are seeing from the execution of our key strategic initiatives enabled us to again achieve record-breaking results in the third quarter. I spoke last quarter about our secret sauce and how we are improving it with not one ingredient but with many working together in combination. We firmly believe that our value proposition of price, selection, quality, availability and people distinguishes Lumber Liquidators in the marketplace. We continue to reinvest in each of these fine components, enabling us to broaden our potential customer base and widen our advantage over the competition. During the quarter, we continued to successfully expand our footprint and rolled out our store of the future format to additional locations for new store openings and remodels. We believe, that as a result of our expanded advertising strategy, our superior value proposition is resonating with a growing customer base, which contributed to consistently strong demand we experienced throughout the quarter. We continued to enhance our customer shopping experience through our sourcing supply chain and Best People initiatives. Through our delivery of a wide assortment of high-quality products and continuing to add to our core assortments, we are providing a more complete flooring solution to our customers. Once in the store, our world-class sales team is actively engaging with the customer, providing education and superior service from the moment they walk in the door, throughout the purchasing cycle. To briefly review third quarter highlights

[Daniel E. Terrell:]

Thank you, Rob. Good morning, everyone. I will provide additional details on our results, our supply chain optimization initiative and then update our outlook. Starting with our results for the third quarter, where my references to percentage and basis point changes are in comparison to the third quarter of 2012 unless otherwise noted. Net sales increased 24.5% to $254.3 million, with a 17.4% increase at comparable stores and record new store productivity. Net sales were driven by a good balance of increased traffic, which we measure as the number of customers invoiced and an increase in the average sale. At our comparable stores, the 17.4% increase in net sales stacks on a 12% increase in the prior year and was driven by a 9.8% increase in the number of customers invoiced and a 6.9% increase in the average sale. With our increase in the number of customers growing each quarter in 2013, we continue to believe our value proposition is appealing to a larger customer base, through greater reach and frequency of our advertising, though our market-based approach to real estate and through our focus on continuous operating improvement. We also believe the effectiveness of net sales conversion has strengthened due to our sourcing, supply chain and Best People initiatives. This is supported by strength across the majority of our store base, including a 16.3% increase in stores operating for 3 years or more. Our third quarter average sale was $1,745, up from $1,630 in 2012 due to an increase in average retail price per unit sold, which benefited from a net increase in the sales mix of premium flooring products, a 180 basis point increase in the sales mix of moldings and accessories and stronger retail price discipline at the point of sale. We believe the store locations serving communities recovering from the effects of Hurricane Sandy raised the increase in comparable store net sales by 50 to 60 basis points. Store base expansion continues to drive net sales. We were operating 307 stores at the end of September 2013, up 8.1% from 284 stores at the end of September 2012. As Rob mentioned, we were also excited by the continued expansion of our store of the future expanded showroom design. This format, combined with our market-based real estate strategy, broadened customer base and the targeting of larger metro market in a recovering housing environment, drove record new-store productivity during the quarter. During this quarter, we opened 7 new stores and remodeled 6 existing stores, bringing the 9-month total to 19 new stores and 14 remodeled existing stores. Though still early in our rollout, with only 12 stores in operation for 6 months or more in the expanded showroom format, we are pleased with the results to-date. In total, the 33 store of the future showrooms produced 9.3% of our net sales in the third quarter. By the end of the fourth quarter, we expect to operate approximately 50 of the new showrooms, representing over 15.7% of our total locations. In our remodeled comparable stores, exclusive of 4 cannibalized markets, net sales for these 10 stores were up 22.3% in the third quarter, versus an increase of 16.3% for all stores in operation for more than 36 months. In those 4 cannibalized markets, which generally have a new store in the expanded format and an existing store, total market net sales were up 81.5%, versus the total company average of 46.5%. Turning to our gross margin, which had a record 41.8%, represented an expansion of 370 basis points over the third quarter of 2012 and 620 basis points over the third quarter of 2011, which is when we completed the Sequoia acquisition. Our gross margin over the past 2 years has benefited from a portfolio of initiatives working individually and in combination to deliver cumulative multiyear benefit. Our entire team used gross margin expansion as a strategic focus and initiatives are implemented across the organization. Our merchandising efforts have strengthened the direct sourcing model. Advertising is broadening the customer base beyond the DIY customer, and that customer is frequently shopping in a more retail-centric location. Our store operations are better trained to understand and satisfy customer needs, leading to better attachment rates and then higher average ticket. Our supply chain continues to become more efficient as it prepares for a more effective long-term structure. While the implementation of these initiatives across the organization have and will continue to yield benefits, we see an array of opportunities for future gross margin expansion. We aggregate gross margin drivers in 3 primary categories, all of which contributed to third quarter expansion. The product margin drove 300 basis points due to shifts in our sales mix, including an increase in moldings and accessories, lower cost of product due to sourcing initiatives and higher like kind ASP, not due to retail price increases, but a result of greater retail price discipline at the point-of-sale. Transportation contributed 30 basis points due to lower rates, primarily international container cost and domestic delivery cost, generally lower fuel cost and continuous improvement in efficiency and control throughout the supply chain. All other costs decreased 40 basis points as a percentage of net sales due to supply chain initiatives to improve the accuracy and visibility of product movement, thereby lowering inventory shrink, partially offset by expanded quality control operations and greater demand for flooring samples. Selling, general and administrative expenses as a percentage of net sales for the quarter were 28.8% in the current year, up from 28% in 2012, primarily due to advertising and compensation. Advertising expenses maintained a consistent pace in 2013, as well as a consistent increase in basis points over 2012. In 2013, the 3 and 9 months were 7.9% and 8.0% of net sales, up 50 basis points from 7.4% and 7.5% for the corresponding periods in 2012. We continued to aggressively pursue market share, driven in part due to broadening of our advertising reach and frequency. Salaries, commissions and benefits were 12% of net sales in the third quarter, up 30 basis points from 11.7% in 2012. In general, store base growth, higher commission rates earned by our store management, larger accruals for management bonuses and greater benefit costs were only partially offset by leverage of our corporate infrastructure and supply chain operations. The effective tax rate was 38.8% in the third quarter of 2013, up from 38% in 2012. Net income increased 58.4% to $20.4 million or $0.73 per diluted share based on approximately 28 million weighted average diluted shares outstanding. Turning now to our balance sheet and cash flow drivers. Cash and cash equivalents increased to $84.2 million at the end of September 2013, up from $64.2 million at the end of 2012 and $40.1 million at the end of September 30, 2012. During the quarter, we used $9.8 million of cash to repurchase approximately 110,000 shares of our common stock on the open market and had $26.9 million remaining under our authorized limit. Merchandise inventories totaled $237.3 million at September 30, an increase of 14.8% over the year end level and 21.7% over the prior year's quarter end. Available inventory per store was $669,000 at September 30, 2013, up from $622,000 at the end of September 2012. The increase is generally due to the timing of our inventory build relative to certain fourth quarter promotions, vendor transitions resulting from certain line reviews, opportunistic purchases and in response to changes in our sales mix. We have increased our 2013 year end estimate of available inventory per store to a range of $660,000 to $680,000, as we build inventory earlier than in prior years around known events such as the South American rainy season, Chinese New Year, a build in safety stock in conjunction with our supply chain optimization and to adjust to updated sales projections for 2014. Capital expenditures now total $17.3 million for 2013, up $7.7 million from $9.6 million at the end of September 2012. Current year expenditures are primarily for the land for our East Coast distribution facility, store base expansion and remodeling and investment in and maintenance of our technology systems. In 2013, we were more than double the net sales we earned just 5 years ago and yet, we are more excited looking forward than back. With that growth in mind, we are pleased to announce the significant enhancements to the capacity and efficiency of our distribution operations through the opening of our first facility on the West Coast and the consolidation of our current East Coast operations under one roof. The 500,000 square-foot West Coast facility will be leased. We are targeting full implementation of the facility in the first quarter of 2014 and we are now receiving certain basic stock from vendors and transferring opening inventories from the East Coast. This Southern California facility will enable us to further strengthen the availability of our product assortment and allow customer shopping in our western stores even greater flexibility in the timing of their flooring projects. Once fully operational, we expect that our transportation cost will benefit from significantly lower international container rates and a reduction in the domestic miles driven for warehouse-to-store deliveries. Inventory planning and allocation will benefit from dramatically shorter transit times. Partially offsetting these benefits will be the incremental SG&A expenses for operating the facility, primarily occupancy and payroll. SG&A expenses in the third quarter of 2013 included approximately $300,000 of incremental expenses related to the startup of the West Coast facility. In the fourth quarter, we expect incremental transportation cost of $1.2 million to $1.4 million as we positioned opening inventory and incremental SG&A expenses in the range of $900,000 to $1.1 million, primarily occupancy and payroll. Capital expenditures for the facility in the form of leasehold improvements and equipment are expected to total $4 million, primarily capitalized in the fourth quarter of 2013. We consider an East Coast distribution facility a long-term core asset in any comprehensive supply chain structure. As a result, we purchased 110 acres of undeveloped land in Virginia to construct a 1 million square foot distribution center. Upon completion, targeted for the third quarter of 2014, we will consolidate and significantly enhance existing East Coast operations, which currently utilize 750,000 square feet across 4 separate buildings. We expect total capital expenditures for construction of the facility, including land, building and equipment, to range up to $53 million, with $5.3 million in the third quarter related to the land purchase and approximately $10 million to $12 million in the fourth quarter as construction of the building gets underway. We expect minimal SG&A expenses related to this facility in the fourth quarter. All of our capital expenditures are expected to be funded with available cash and operating cash flow. Moving now to our outlook for 2013. The combined strength of our key initiatives has exceeded our expectations in the current year. In addition, we continue to believe we are in the early stages of a multiyear recovery and home-related large ticket discretionary spending. Further, we have been pleased with the demand we have seen in October. We recognize, however, the potential for periodic volatility as consumer sentiment is tested, particularly large ticket customers in consideration of a discretionary purchase. We now expect sales for the full year in the range of $985 million to $995 million, up from our previous range of $940 million to $963 million. We expect the comparable store net sales increase of 14% to 15%, with fourth quarter ranging from 9% to 14%. We believe the store locations impacted by Hurricane Sandy will benefit the total increase in comparable net sales for the year by approximately 70 to 80 basis points. In the fourth quarter, we anticipate opening 10 to 12 new store locations and remodeling 5 to 7 existing stores. We believe certain incremental costs, including those related to our supply chain optimization, store base expansion and remodeling program, will produce fourth quarter gross and operating margins less than our third quarter actual. In comparison to the fourth quarter of 2012, however, we expect gross margin expansion between 170 and 240 basis points, partially offset by higher SG&A expenses as a percentage of net sales, again, led by advertising, compensation and certain other expenses. We now expect full year 2013 capital expenditures to total between $35 million and $40 million, including $19 million to $21 million related to our supply chain optimization. As a result, we now expect 2013 earnings per diluted share in the range of $2.65 to $2.74 based on a diluted share count of approximately 27.9 million shares, exclusive of any future impact of our stock repurchase program, up from our previous range of $2.45 to $2.60. I'll now turn the call back over to Rob for additional remarks.

[Robert M. Lynch:]

Thanks, Dan. As we look forward to the fourth quarter and into 2014, our team remains unified in its vision and motivated to continue taking market share through our powerful value proposition and uniquely profitable store model. We are extremely pleased with the team's strong execution of our strategy and achievements made to date this year that are being driven by our focus on continuous improvement in everything that we do. Our improved real estate strategy and new store format are generating the best new store productivity results we have seen since the start of the company. Generating strong lift in existing markets and strong sales growth overall, we will continue to extend the footprint of our store of the future format with an accelerated pace of openings and remodels as we enter the next year. Our broader advertising strategy is bringing our value proposition to more consumers, and we are continuing to deliver a superior shopping experience to meet strong customer demand. Our sourcing and supply chain initiatives are allowing us to deliver a wider selection of our products to our customers more efficiently than ever before. We are committed to maintaining our industry-best merchandise assortment and our position as a low price leader. Through our ongoing Best People initiatives, we are continuing to equip our sales teams with better techniques for service and selling, which is enabling our teams to educate and ultimately satisfy customer needs throughout the purchase cycle. As with other areas of our business, we are always improving our people processes, and we are excited about our plans for another company-wide Lumber Liquidators University early next year. As pleased as we are with our results year-to-date, we are truly more excited to look into the future. We will continue to reinvest a portion of our success in our people, store model and support structures to enhance our value proposition and to deliver cumulative multiyear benefits. We are confident in our ability to generate long-term operating margin expansion, driven by increased gross margin, joined by leverage of operating expenses in the future as we focus on delivering the best value proposition in flooring to our customers and rewarding our shareholders. 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 is coming from the line of Matthew Fassler with Goldman Sachs.

[Matthew J. Fassler:]

My first question relates to store of the future. If you could just refresh our memory, we could probably figure this math out. At what point does the store of the future become the entirety of the noncomp base? And if you could give us -- obviously, the new space productivity overall is terrific. If you could you give us a sense of the degree to which the store of the future prototypes you have in the mix that are outperforming. How much they're outperforming the legacy new store prototype?

[Daniel E. Terrell:]

Matt, just -- this is Dan. The -- from the new store perspective, all of the new stores in 2013 have been in the store of the future format. So in one more quarter, we'll basically have the entire noncomp base store of the future. The -- and as far as the store of the future's contributions' specific -- and segregated from the real estate strategy, the better assortment of product, the training in store, it's difficult to separate the components of those drivers. We're certainly pleased with the results right now, but we're not really ready to say what part of just the store of the future layout design is contributing to new store productivity.

[Matthew J. Fassler:]

I guess the reason I asked is that you've had now, I guess, 4 or so consecutive quarters of improvement and new space productivity measured as a percent of the base, and that has improved each quarter as the penetration of the store of the future has increased and approached, I guess, 80% of 90% right now. So would you look for -- and that number, as we calculated it, is kind of in the mid-80s. Would you look for that to be close to the run rate going forward given that store of the future now has just about filled the entire pipeline of noncomp stores?

[Daniel E. Terrell:]

Yes, Matt. We started with our real estate approach probably close to 2 years ago, when Rob reorganized the real estate committee and changed the approach, looking for those more retail-centered quarters. So you started to see new store productivity improved then, certainly accelerated by the store of the future format. I think the number you calculated, as new store productivity is dead on, and I think that's close to the top of where we're going to be.

[Matthew J. Fassler:]

Got it. My second question relates to the payroll commissions and benefits. So that line item was obviously up, sharply up about 27% in excess of -- when it was up last quarter and to a slightly greater degree than any acceleration of sales. If you could -- and obviously, your investments are yielding fruit in terms of gross profit dollars. But on a per square foot basis, it was up double digits, and that's been the case, something like 4 to 7 quarters, it was up 17%, I think, here in Q3. How much of that is essentially paper performance of the stores, how much of it would be discretionary compensation accrual? And I guess, the essence of the question is, what would you look for the relationship between sales per foot and compensation per foot to be kind of on a steady-state basis?

[Daniel E. Terrell:]

We probably reached the peak for 2013. We've turned a lot of dials related to pay per performance, and we've been pleased with the investment and the return we've gotten on that. We've adjusted how we accrue that management bonus, and you've probably seen the peak payroll as a percentage of sales in the third quarter should improve slightly in the fourth quarter. As far as the long-term run rate, I think you'll start to see some stability in the store commission rate and you'll start to see some gradual leverage over the management compensation plans.

[Matthew J. Fassler:]

Even with strong sales growth going forward, if that persists?

[Daniel E. Terrell:]

Yes.

[Operator:]

Our next question is coming from the line of Matt McGinley with ISI Group.

[Matthew McGinley:]

My first question is on the DCs and the inventory levels that you have at the end of this year. As you think about the DCs, when you did the math on this, how you should we think about that from an inventory efficiency standpoint or what kind of gross margin gains you can get from these facilities when they're complete? And then on the inventories, you're increasing the in-stock levels to meet sales or for potential disruptions of the supply chain. What do you think that optimal level of inventory would be once this process is complete? And do you expect that $6.60 to $6.80 per store to be the run rate through all of 2014?

[Daniel E. Terrell:]

I'll start from the end there, Matt. The $6.60 to $6.80s is going to be higher than what the run rate for 2014 would be, mainly as we build some safety stock related to conversion, and we'll certainly go toward conversion in 2014 as well on the East Coast as we launch that facility. But the normalized run rate should actually come down. The shorter transit times, the stronger availability portion of our value proposition by having a couple of warehouses available to support the stores, all of which should lead to generally lower available per store rates. So you're seeing a higher number at the end of 2013, will remain a little bit higher in 2014 and then, it should start to come down. As far as the contribution of the warehouses to gross margin, we haven't really quantified that, but look for that in 2014. What we feel is that the strengthening of the value proposition, combined with lower container rates, which will need to work their way through our inventory turn, and then it will lower domestic transportation costs, will ultimately yield operating margin benefit, but it's going to take some time into 2014 to realize those benefits.

[Matthew McGinley:]

Okay. The second question is on the mix benefit to ticket. You caught onto 2 things that were driving that. One was the better attachment rates on molding. Where is that at today and where do you think that can get to? And then, on the mix component, are you seeing mix shift back from lower-cost items to back to hardwoods? Are you seeing still -- just continuing to see that mix from the lower price point item within a given segment to better or best within that given product segment?

[Daniel E. Terrell:]

Yes, both strong drivers of ticket. I think we've picked up 180 basis points in moldings and accessories attachment for the quarter year-over-year, which was excellent. We still see upside to that. When we look over our store base, we still have opportunity to grow that within our sales mix. We're not really seeing a change -- we're still not seeing a change to more expensive products with -- but we are continuing to see the customers select the premium products in merchandise categories. So we're not seeing people leave laminates for hardwood or leave bamboo for hardwood necessarily, but we're seeing more premium laminates in their category, more premium bamboo products in their categories.

[Operator:]

Our next question is from the line of Brad Thomas, KeyBanc Capital Markets.

[Bradley B. Thomas:]

I wanted to just talk about the new distribution center, first of all, and sort of step back. And Rob and Dan, I was hoping you could just talk a little bit more about what the incremental capabilities are going to be for your 10 years as a public company. Obviously, you've leaned very hard on the Virginia facility. And so could you -- if you could just speak more broadly to the opportunities that the West Coast facility provides.

[Robert M. Lynch:]

Sure. This is Rob. You hear me talking about our value proposition all the time and of course, the availability of product is one of those key 5 points and drivers. And to your point, leaning on an East Coast only distribution model is not going to give us this structure that we need going forward with the growth potential opportunity we have in front of us. So it's actually -- it's an absolutely natural common sense, the next step for us. And given how important on-time delivery and availability of our assortments are to our value proposition and to our customer, we are very excited about this new West Coast distribution center and of course, with the expansion and then efficiency gains we'll get from consolidating on the East Coast. One just small tactical benefit I can tell you about is it's going to get that product closer to our customers out on the West Coast, but it's also going to allow our assortment, our merchandising and allocation teams to better regionally [ph] and tailor assortments as we move forward as a company to specific markets. So just, again, one of the many benefits we're going to see from these DCs. And I got to tell you, our West Coast stores that are going to be served by that new West Coast DC are ecstatic about getting this distribution center.

[Bradley B. Thomas:]

And Rob, I know that a couple of years ago, the company planned to place some more direct shipping where you did. You did [ph] believe a mixing center in Asia to avoid going to Solano for some of the West Coast stores. I presume this will expand how many stores you can ship to via the West Coast. But I mean, can you give us a sense of just how much more significant the savings will be if relative to the way you already have in place for the West Coast stores?

[Daniel E. Terrell:]

Brad, this is Dan. I'll take that one. We certainly benefited from a distribution center in Shanghai. But just because of having to pack on a by-store basis, it limited the amount of volume that can go through there. And you saw us reach -- I think it's high as 20%, 22%. And we always have thoughts about reaching into the upper 20s, low '30s. This West Coast facility will certainly reduce the amount of bulk that needs to be repackaged in Asia because it will just be shipped in bulk in this facility and then distributed to the stores. There's certainly no reason we can't see this West Coast facility handle as much as 1/3 of our product mix.

[Robert M. Lynch:]

It's also going to obviously -- the West Coast is one of the areas where -- as we look to our new store potential where we feel we are less saturated, so it's definitely going to be an investment in our future and our ability to open and service a bunch of new stores on the West Coast, up and down the West Coast.

[Daniel E. Terrell:]

Yes. And Brad, I'll tell you one more thing about it too. We really have leaned on these East Coast facilities for a long time, but what we've done is we've really accumulated a world-class supply chain team now from logistics to distribution and even product allocations. So we feel like we're prepared. We've made the operations as efficient as they can be and we've got the right structure from a personnel standpoint. Now it's time to put the facilities in action.

[Bradley B. Thomas:]

Okay. And if I could just ask one last point of clarification around the guidance for the fourth quarter. In the prepared -- in the press release, there's a $1.4 million to $1.8 million that's referenced, Dan, in your prepared remarks. I think you referenced some transportation impact of $1.2 million, $1.4 million and then an SG&A of $900,000 to $1.1 million. If you could just help reconcile all these numbers versus what you guys guided to at July, that will be helpful.

[Daniel E. Terrell:]

Absolutely. The $1.2 million to $1.4 million is the impact we see in our cost of sales, and that's going to relate to transportation costs as we position inventory. So I think $1.2 million to $1.4 million is the total number there. The total number in SG&A that we see is incremental is what you saw in the press release, which is the $1.4 million to $1.8 million, of which $900,000 to $1.1 million is the West Coast.

[Operator:]

Our next question is from the line of David MacGregor with Longbow Research.

[David S. MacGregor:]

Just wanted to ask the ticket comp question maybe a little bit of a different way. Last quarter, you expected the second half ticket comp to be up 3% to 4% percent. So I guess, a couple of questions. Where were you most surprised here? Was it the moldings and accessories attachment rates or maybe you can elaborate on that? And what are the implications for the fourth quarter ticket expectations?

[Daniel E. Terrell:]

I'll start and maybe turn it back over to Rob. The moldings and accessories are about where we expected it to be, a little bit better. The real strength, I think, is in the -- is in what our people are doing at the point of sale. The in-store training we've given them, the way the in-store teams are working with the customer and really selling the entire value proposition and selling the price. We call that retail price discipline, but that's where we're really seeing a surprise to the upside.

[Robert M. Lynch:]

Yes, and I would agree with that. We are pleased with both the ticket and traffic drivers in the comp, obviously, the extra investment in SG&A and the advertising. Our teams there are doing a fabulous job on getting a high ROI return on that investment. We're very pleased with the traffic that we're picking up. And then to Dan's point, our people are -- we've got better trained, better motivated, better incentived folks in the stores. They are to take care of that customer and detach everything when they come in that store. And you can't forget all these process improvements. We talked about continuous improvement all the time. But everything, all those support functions are doing behind the scenes like Dan talked about earlier and within supply chain. We're handing the ball off so much more efficiently and easily to the stores so that they can execute and take care of the customer. And that's freeing up their time and allowing them to really attach all of our wonderful products. And then again, you get there merchandising teams really enhancing our assortments over time, and that's all kind of working together.

[Daniel E. Terrell:]

Yes, you're working really well. How much inflation was in the comp?

[Daniel E. Terrell:]

We had no retail price increases on like kind products, so we really didn't see us raising the retail price drive the either ticket or the comp.

[David S. MacGregor:]

Okay. And then final question, just on the West Coast RDC, how many stores will that ultimately -- the 500,000 square feet, how many new stores will that ultimately support?

[Daniel E. Terrell:]

We're looking from between 75 and 100 stores, potentially more, and that being has capacity, by the way, to flex up to 750,000 square feet. We have options on the additional space if we needed.

[Operator:]

Our next question comes from the line of David Strasser of Janney Capital Markets.

[David S. Strasser:]

I have a question. I may have asked this in the past as well, but as you look at your business from the by-to-rent customer, the corporate customer, you've said in the past, it hasn't been much of your business. Is there any sort of strategy to go after that on the corporate side? How big of a potential could that be? I mean, as you start to read in some of these key markets where that's made up such a large portion of the housing turnover and it's -- and you guys aren't getting that at this point, how -- I mean, the opportunity would seem pretty significant at some point. And is there ways to do that, and how are you thinking about it?

[Robert M. Lynch:]

Yes, good question, David. We have a team fully dedicated to the -- well, we call it our commercial team. We've been growing that team each year, and the sales within that -- in that group are growing very significantly. They're not a large material effect right now, but we see a big opportunity there. We're going to continue to invest in it, and we have expectations of definitely high sales gains over time as we go and target and attack that customer. We've actually added resources to that team. We've added merchandising resources that are specializing in commercial products and those commercial customers working in tandem with the commercial sales force.

[David S. Strasser:]

Yes, I -- because I'm just -- in places like [indiscernible] and I don't know if this is correct, but somebody had said they did almost 2/3 of the existing home sales, has been sort of the corporate buyers. If that's the case and the strength that you're getting in, in a lot of these markets isn't even necessarily related to housing and would -- I almost argued that it's predominantly about existing upgrades or existing homeowners buying? I mean, is that a fair assessment as you sort of looked at sort of what you think is going to your -- from your customer.

[Daniel E. Terrell:]

David, the way I -- what I've seen and looked at doesn't really indicate that's it's that much related to what we would put in our commercial category. But certainly, we think a lot of our own initiatives have driven our comp sales increase and that the main part of the -- what may be a very strong multi-year recovery in residential housing is still in front of us.

[David S. Strasser:]

Our next question is from the line of Dan Binder with Jefferies.

[Daniel T. Binder:]

You commented that you're pleased with October volumes. I was wondering if you could just give a little color around what you saw with the government shutdown, if that was having any kind of impact at all and what happened since.

[Daniel E. Terrell:]

Dan, we want a October yard sale, which is a pretty strong event for us. And we we're very pleased with the way that went this year. As far as what the shutdown did, I don't want to say that it's not going to have any impact. That's why our guidance is a little bit wider, which is one quarter to go than it might have normally been. So even though we haven't seen it, it doesn't mean that it's not in front of us. But what I can say is we had a strong promotion in October, which is the second year we've had this very strong promotion in October.

[Robert M. Lynch:]

As we mentioned, through the third quarter, sales were consistently strong, demand was consistently strong. And to Dan's point, thus far, we have not seen any impact.

[Daniel T. Binder:]

That's great. My other question was regarding the store of the future. You obviously have more remodels under your belt at this point. Any learnings that you care to share with us from that process that allows you to get better at it or is it kind of cookie cutter at this point?

[Robert M. Lynch:]

Well, there absolutely are some learnings, which is why we've paid for ourselves this year and used 2013 as the kind of the test year to roll that out. I mentioned in my prepared remarks that we've been adding resources to the real estate and store transition teams. So that's one of the learnings that we saw as we were implementing the -- this new store of the future that it cost -- or it drove the need for us to standardize and systematize how we are opening our stores and make it more cookie cutter to your point, and we've been learning through that process this year and developing those teams and those processes and those vendor relationships to make sure it's seamless. And we feel really good about it. As we mentioned, this -- the fourth quarter is going to have our biggest number of new and remodeled stores ever, with close to potentially up to 19 of them. And we're confident in the team's ability to get them done and to get them to transition, and if it's a remodel, hand it over back to the store team seamlessly.

[Daniel T. Binder:]

So assuming that goes well, what do you think your capacity would be to do next year? In a given year, how many do you think you could pull off?

[Robert M. Lynch:]

Yes, we're assessing that right now, and we will give some clear definition around that when we give guidance for next year and we announce the fourth quarter. But as I mentioned in my remarks, we intend to absolutely pick up the pace compared to this year in both the remodels and the new stores.

[Operator:]

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

[Laura A. Champine:]

So in the 10-Q this morning, it looks like you're now sourcing most of your product out of Asia, South America's down to 7%. How do you like your mix of source regions, and how might that change over time?

[Daniel E. Terrell:]

Yes. Laura, we've -- we saw a pretty dramatic drop in the South American percentage really back in 2008 when we saw the financial collapse. So we -- that was also when laminates is beginning to play a more prominent role in our assortment bamboos did, some of the lower average retail priced products. Where we are right now has been about the same percentages between Asia, North America and South America we've been for the last few years, and we're pretty pleased with the way it is right now. We certainly look forward to a time where we might see some strength in the solid hardwoods come back, maybe see some volumes boost ticket and at that point, we may see some strength come back towards hardwood, whether it's North America or South America.

[Operator:]

Our next question is coming from the line of Joe Edelstein of Stephens.

[Joe Edelstein:]

Just wanted to follow-up on the comments on October again. Could you remind us what October represents as a percentage of the overall fourth quarter mix?

[Daniel E. Terrell:]

Yes, we've never given that. We usually don't break out what the individual months are in the quarter. But we can tell you that you've heard us talk for years about the April sale and how strong that is. And then that's not only as invoice sales, but it creates new order builds that also supports May. It's one of the reasons the second quarter is seasonally stronger than the other quarters. October is an event, an A event. This yard sale that we've put into place last year, we had some nice results from that and we saw a repeat of good strong results in 2013. So that's about as much as we want to say at this point. I don't really want to get into parts in the quarters out by month.

[Joe Edelstein:]

Sure. Would it be at least safe to say that the majority of the quarter is done by the holiday season?

[Daniel E. Terrell:]

Well, it used to be. We used to have a fall off as people started to shop for Christmas in earnest in mid-December, but we are actually running some promotions in December the last couple of years that are after Christmas events that have been quite strong, so...

[Robert M. Lynch:]

Yes, and I -- this is Rob. I would really back what Dan is saying, is that given our new approach to a broader consumer segment, investing in additional advertising, reaching frequency programs and additional events, we've -- you can definitely see a, I would say, a decreasing of seasonality across our entire calendar. And particularly in the fourth quarter, I would say, relative to a few years ago, it's pretty -- I would say it's pretty evenly distributed. And at Dan's point, we are finding that as we improve our marketing strategies and our advance and products. And as we've reached out to these new customers, these programs are resonating with them and they're shopping all year long, and that business is not falling off. We're actually creating that demand and bringing them in.

[Operator:]

Our next question is from the line of John Baugh of Stifel.

[John A. Baugh:]

Just a couple of things quickly. You talked of -- you've talked a lot about the sales productivity at the store level, and I guess there's 2 components to that, the mixing the customers up, as well as not giving in on price. I'm curious on the latter issue. If we use list price as the 100%, what percentage of the -- where are you already there to where you basically not going to allow discounting, or the discounting you're going to allow, is that a level where you're comfortable?

[Robert M. Lynch:]

John. This is Rob. I'll tell you, I'm going to talk about our team out there in the field and how aligned the field organization is with the functional teams up here in Virginia in terms of this -- our overall strategic initiatives. And I've never seen in my career a corporate organization and a field organization come together as one team that works so well together. So the stores are trusting in our products, in our supply chain services. And our promotional pricing and our marketing teams are driving customers into their stores. So they have so much confidence that they're going to have the products they need, that they're going to be able to take care of their customers. And then we're advertising and driving a whole bunch of customers in their stores and that they don't have to wheel and deal on the aisle. So we are very pleased with the contribution from the store's operational excellence to the margin, to the ASP, to the ticket. They're just doing such a great job out there. And we continue -- I expect and look forward to potentially several years of that as a driver in our -- that's why as we talk -- we still, even now with we've done with margin, we still seem very confident about it going forward on a multiyear basis because, as Dan mentioned, in his prepared remarks, it's a portfolio of initiatives. The foundations started a couple of years ago with sourcing and the acquisition of Sequoia and driving basic line review and negotiation processes into the company to get us competitively sourcing better. But we've added all these other equities to the portfolio, if we could say it that way. And I'm so pleased with them and they go across the operations to your point in the store, in the store pricing disciplines. We have opportunity there. There's markdowns out there, there's discounts out there that we're going to continue to lever down on over time and you'll see that driving margin on into the future.

[Daniel E. Terrell:]

Yes. John, just one other point I'd make there, you can hear, we're really excited about the team. We have a great regional management team, great store team, and we didn't turn off their ability to work with the customer on price. The advantages we're seeing are because they understand the -- selling the value. It's in the training, it's in working with a customer and the nature of the customer coming in, and then what Rob said about all the other support functions. So we didn't limit them from doing anything. This is their initiative which they own and control and are taking us forward on.

[John A. Baugh:]

Okay. And then -- and secondly, we've talked about advertising spend. And of course, you shifted fairly dramatically from it being a source of leverage to deleverage, and it's obviously having a huge positive return. I know you're not going to comment specifically on net spend for '14. But could you comment, in general, how you're thinking about it as a percentage of revenue going forward?

[Daniel E. Terrell:]

I would tell you, I learned this early on when I started in retail at Walmart. Sam Walton used to always say, "The stuff that works to keep doing it and the stuff that doesn't work don't do it." So I got to tell you, we got to be prudent, we got to absolutely ensure that the ROI is there. But our sense is, we're in the early innings of a housing recovery, what we're doing is working our teams. Our head of marketing and advertising is doing a fabulous job with his team executing on our strategies, and we're going to continue to be on offense and invest there as long as the payback is there.

[Operator:]

Our next question is on the line of Budd Bugatch of Raymond James.

[Budd Bugatch:]

Just on the West Coast distribution facility, you indicated the additional cost of goods and SG&A. And maybe I missed this, but does that persist -- does any of that persist into 2014 and if so, could you maybe give us a help of what that is?

[Daniel E. Terrell:]

It will, Budd. There's going to be a cost of operating the facility, so of the occupancy cost of the lease facility, the incremental people that will drive SG&A higher. And we think that once we get through the startup and we're into full implementation and operation that the benefit that we get from lower transportation cost will more than offset the incremental SG&A expenses. But certainly, the SG&A expenses will persist now that they're underway. Occupancy, obviously. In payroll, this is the initial start up. We've had teams. They are preparing the facility, organizing the inventory and the layout. And transportation is a little bit heavier right now as we're moving some inventory from our East Coast facilities to our West Coast facility. So you're looking at a bit of startup cost, but you're certainly going to see a higher SG&A cost as we operate the facility.

[Budd Bugatch:]

And just to make sure I understand, the cost of goods sold impact of additional transportation, that will be pretty much ended by the fourth quarter. The SG&A persists and at some point in time during 2014, you'll get the leverage return on that. And any guess as to when that comes in '14? Did I understand it right? Did I frame it properly?

[Daniel E. Terrell:]

You framed it correctly. And you should see those transportation benefits, we capitalized international rates into our unit costs, so as the inventory turns, you'll see that benefit begin to come through gross margin. We charge domestic transportation costs for where [ph] the store delivery when they're incurred. So with those shorter routes we'll pick up as soon as we're fully implemented in the first quarter. So you're going to see the higher SG&A cost in Q4 and probably Q1, and then you'll start to see transportation benefits late Q1 and then into Q2, Q3 as the lower international rates come through.

[Budd Bugatch:]

Okay. And finally, just any thoughts on where you want to frame the potential opportunity in gross margin? You've had great product performance from mix. And for the product line reviews, what's the additional opportunity there, and have you quantified that right now?

[Daniel E. Terrell:]

We haven't for 2014. But I mean, we're excited. We've said all year, cumulative multiyear benefit and now, we've been excited about all the different pieces that are -- I call them a portfolio of initiatives, and that's the way we think about it. We'll have to wait to talk about 2014 and further expansion, but we see cumulative multiyear benefit.

[Budd Bugatch:]

I was just thinking beyond 2014 or if that's kind of the long term, kind of high watermark. Any [indiscernible] you want to frame that?

[Daniel E. Terrell:]

Yes. Well, we've talked that we see our operating margins in the mid to upper teens over time. That's not necessarily '14 or '15, but we certainly see opportunities to continue to drive operating margin higher, and gross margin will lead that, although we will start to see SG&A participate.

[Operator:]

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

[Jonathan N. Berg:]

This is actually Jon Berg on for Peter here this morning. Just a couple of quick ones for you. As far as -- I know you guys mentioned you're going to be accelerating store growth and also your remodel effort next year. Any chance you can provide some -- maybe wrap some numbers around what that might look like going out to next year?

[Daniel E. Terrell:]

As soon as we get them figured out, we'll let you know. They're under development, and we're going to communicate those with the fourth quarter release and the 2014 guidance.

[Daniel E. Terrell:]

Yes. And Jon, we've talked about 8% to 12% unit growth on an annual basis over time and you've certainly seen us ramp up now in Q3 and Q4, the combination of location -- new locations and remodels, so that will give you an indication. We're feeling pretty strong, pretty -- and we think we're in good shape heading into 2014.

[Peter J. Keith:]

Okay, great. And then just a quick follow-up, as far your mix of moldings and accessories, I mean, you've had great gains there, you're up to 18.5% now. Is there any way you can tell us kind of the magnitude that the store of the future is turning ahead of the legacy store base in that regard?

[Daniel E. Terrell:]

I think we'll probably look for that in our 2014 guidance discussion. As you can imagine, with the entire assortment displayed in a more organized format, you're seeing better performance underlays, moldings, grills, butcher block, the tools, all of it is contributing to the success of the store of the future. But I think we're going to have to wait another quarter to really talk about those specifics.

[Robert M. Lynch:]

Thank you for joining us on today's call. We look forward to speaking with you again on our year end earnings call when we expect to provide our initial outlook for 2014, including outlining our store opening plans and reviewing continued progress and executing our strategic initiatives to achieve our long-term objectives.

[Daniel E. Terrell:]

AKBA. [ph]

[Operator:]

Thank you. Good morning, everyone, and thank you for joining us today.