LL Flooring Holdings, Inc.
Q4 2014 Earnings Call Transcript

Published: 26 Feb 2015

[Operator:]

Good morning, ladies and gentlemen. Welcome to the Lumber Liquidators Fourth Quarter and Full Year 2014 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 like to now introduce Ms. Ashleigh McDermott, Director of Financial Reporting for the company. Please go ahead.

[Ashleigh McDermott:]

Thank you. Good morning, everyone, and thank you for joining us today. Before we begin, let me take a moment to reference the Safe Harbor provisions of the United States security laws for forward-looking statements. This conference call may contain forward-looking statements that are subject to 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. 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 fourth quarter and full year 2014 results, our current trends, and our top priorities for 2015 and beyond. Let’s start with the summary of the fourth quarter numbers. Total net sales increased 5.2% to $272 million. At comparable stores net sales decreased 4.2% as our average sale weakens but our customer traffic on a year-over-year comparison turned positive for the first time in 2014. Our operating margin was 10.5% for the fourth quarter and net income was $17.3 million or $0.64 per diluted share. Let me provide some color with regard to a key initiative implemented in the fourth quarter. This initiative produced benefits late in the quarter that are not readily apparent when reviewing the aggregate results. As the availability of our entire assortment was materially restored we implemented a range of marketing changes to strengthen components of our value proposition and enhance customer recognition of its competitive advantages. These changes resulted from a comprehensive competitive assessment of our value propositions including customer perceptions. The marketing changes implemented during the quarter featured modifications to our promotional focus, advertising cadence, and outstanding advertise retail price points offset by limited point of sale discounting. Customer reaction was rapid and we saw improvement in the customer metrics we traditionally associated with interest in our products and the conversion of that interest into invoice sales. As a result of these changes and together with improved consumer sentiment, the number of customer invoiced our measure of traffic increased 8% in December and the month ended with open orders up $18 million or 69% above December 2013. Though we pressured our gross margin in the fourth quarter, we believe we captured market share and drove operating income. Year-to-date in 2015 I am pleased to say we have maintained that momentum. For those of you who have heard me speak over the years, you have heard my consistent enthusiasm for Lumber Liquidators and our tremendous potential to grow, both on the top line and at the operating level. Despite the challenges of 2014 that enthusiasm has not wavered one bit. We have a superior product, dedicated and energized employees, a growing presence in new markets, and improving infrastructure, and a value proposition to customers that is simply unmatched in the marketplace. That said 2014 was not the year we envisioned. We all know the circumstances around our sourcing, supply chain and weather impacted demand. So I am not going to revisit those topics. What I will say is this, I firmly believe that our competitive advantages are intact and we have a team focused on continuous improvement in all that we do but we have come a long way since 2011, we are not satisfied with where we stand. We have had significant success but also have a share of growing pains. The key investments we have made in our supply chain, merchandize allocation, visibility, and intelligence, product development, and training allow us greater flexibility in positioning our value proposition. We understand that comprehensive analysis and strong execution must be our focus to fully realize the potential benefits. I’ll also walk you through our strategic initiatives and our outlook for the business, but first I want to turn the call over to Dan for a detailed review of the financial results. Dan?

[Daniel E. Terrell:]

Thank you Rob and good morning everyone. Today I will provide details on our results for the fourth quarter and full year 2014, provide our outlook for 2015, and update the financial considerations with certain key initiatives. Please note that my references to percentage and basis points changes are in comparison to the fourth quarter of 2013 unless otherwise noted. I’ll begin with the fourth quarter results, where net sales increased 13.6 million or 5.2% to 272 million with an increase in non comparable stores of 24.5 million and a decrease in comparable stores of 10.9 million or 4.2%. Net sales were short of our expectations but we were pleased with the customer traffic trends in December and a substantial build in open orders up $18 million or 69% in closing the month and the year. A quick note on the 2014 finish, in the six day period between Christmas and year end where we have historically had a relatively small billed in open order balance, which means we take in more new customer orders than we invoices net sales. In the current year, instead of a small billed it was $7.5 million as new orders were driven by a surge in customer traffic. Contrast that to the last six days of 2013 when severe weather was already adversely impacting customer traffic. In that period, our team actually invoiced more sales when they took in as new orders and our open orders decreased. But we would have achieved our top line expectations in the fourth quarter of 2014 had we invoiced more of this bills, it is certainly one of the contributing factors to our strong start early in January 2015. Let me next provide some details around our average sale which in the fourth quarter was down 5.3% to approximately $1,660. The decrease comes primarily from a lower average selling price of flooring partially offset by a continued increase in the sales of moldings and accessories which grew 70 basis points to 20.1% of our merchandize mix. The lower average selling price is due to two primary factors, both of which we believe drove increases in a number of customers we invoiced during the quarter. First, the availability of our entire assortment was materially restored during the quarter which helped shift our sales mix to flooring categories such as laminates and vinyl that have lower than average retail price points. Second, as Rob mentioned, we implemented changes to the marketing of our value proposition which on a net basis in the fourth quarter lowered the average retail price offered on lifetime product relative to the fourth quarter of 2013. We partially offset a portion of the retail price impact as significantly limiting ad hoc discounting at the point of sale. We believe our conversion rates of customer interest into invoice sales benefitted from both restored availability and changes in our retail prices and as a result, the number of customers invoiced in our comparable stores increased 1.1% in the fourth quarter. Turning now to our non-comparable stores which included 34 new locations opened in 2014 with three opened in the fourth quarter. As many of you know, we have opened 64 stores with the expanded showroom format, basically all of our new locations in 2013 and 2014. Though 2014 presented challenges for all of our stores regardless of their maturity or showroom style, we believe these newer stores featuring the expanded showroom and located in more retail centric areas of a market continued to outperform our historical model on both the net sales and ROIC basis as comparable maturity. We are also two years into a multiyear plan to remodel existing stores and we have now remodeled 39 existing stores with 20 remodeled in place and 19 relocated within the primary trade area. Together with the new locations, 29% of our 352 stores featured the expanded showroom format at December 31, 2014. Moving on to gross margin which was consistent with the third quarter of 2014 at 39.2% and represented a decrease of 160 basis points in comparison to the fourth quarter of 2013. As most of you know, we segregate our gross margin drivers into those associated with our product including shifts in our sales mix and changes in our average selling price, those associated with transportation, and those associated with all other costs including inventory restraint and reserves for loss or obsolescence. I will begin with the product which decreased 160 basis points when comparing the fourth quarter of 2014 to 2013 and followed at 210 basis point increase in the fourth quarter of the prior year. I will briefly touch on each of the four primary categories impacting our sales mix and product gross margins. First, our non-merchandize services were the mix grew primarily due to the continued roll out of our own installation services. Though these services drive operating margin expansion and represent incremental revenue, the average installation transaction is at a much lower gross margin than our average merchandized transaction. In addition we pass our actual cost of store to customer delivery relative to customer with only a small markup to cover administration. In comparison to the fourth quarter of 2013 non-merchandized services pressured gross margin approximately 30 basis points. In 2015 we plan to double the number of stores utilizing our own installation services and we also expect the attachment of store to customer delivery to increase as we continue to broaden our appeal to a more casual customer. Second, we believe gross margin was adversely impacted by up to 70 basis points primarily due to the Bellawood transition and clearance of products not a part of our continuing assortment including certain domestic substitutes for products previously constrained. Third, we believe the merchandize mix of moldings and accessories which have a gross margin higher than the average transaction, benefited gross margin by approximately 20 basis points. And fourth, we believe the net impact of changes to the marketing of our value proposition reduced gross margin by approximately 80 basis points. So net impact of these changes generally resulted in lowering the average retail price offered and adverse impacted gross margin that was partially offset by significant reduction in ad hoc discounting at the point of sale and a greater up sell to premium products. In transportation, lower international transportation cost led to a net gross margin increase of 10 basis points. Aggregate international container cost decreased as rates to our West Coast distribution center were significantly less than to the East Coast with partially offsetting this benefit were higher domestic transportation cost due to increased unit flow including a fourth quarter 2014 build in available inventory per store. All other costs reduced total gross margin by a net 10 basis points due primarily to higher cost of shrink and an increase in our inventory reserves for loss and obsolescence including cost related to the Bellawood transition. Selling, general, and administrative expenses for the quarter increased $6.5 million, or 9.2%, to $77.8 million due primarily to higher occupancy, depreciation, advertising, and payroll expenses. And as a percentage of net sales SG&A expenses were 28.6% in the fourth quarter compared to 27.6% in 2013 fourth quarter. Salaries, commissions, and benefits increased $1.3 million or 4.4%, decreased 10 basis points as a percentage of net sales to 11.8% due primarily to lower costs related to our management bonus plans. Advertising expenses increased $1 million or 6.3%, and increased 10 basis points as a percentage of net sales to 6.4% as we continue to aggressively broaden our reach and frequency which was partially offset by leverage of our national spend. Occupancy expense has increased 1.9 million or 21%, and increased 60 basis points as a percentage of net sales to 4.2% due primarily to store based expansion by opening of our West Coast distribution center and approximately $200,000 of incremental transition expenses as we began the consolidation of our East Coast distribution facilities. Depreciation expense increased $700,000 or 22%, and increased 20 basis points as a percentage of net sales to 1.4%, due primarily to store based expansion, or program to remodel existing stores and investments in technology and the opening of our West Coast distribution center. Our remaining SG&A expenses increased approximately 1.6 million primarily due to higher bank card discount rates including those on extended financing terms. The timing of certain business taxes, increases in tender laws, and certain transition in consolidation expenses related to our East Coast distribution center. Operating margin was 10.5% in the fourth quarter of 2014 and 13.3% in the prior year. The effective tax rate was 39% and 39.3% in the fourth quarters of 2014 and 2013 respectively. Net income was 17.3 million or $0.64 per diluted share based on approximately 27.2 million weighted average shares outstanding. Now I would like to summarize our results for the full year. Net sales for 2014 increased 47.2 million or 4.7% to 1.047 billion with an increase of non comparable stores of 90.1 million and a decrease in comparable stores of 42.9 million or 4.3%. Gross margin was 39.9% for 2014 and 41.1% for 2013. SG&A expenses in 2014 increased 10.2% to 314.1 million and as a percentage of net sales were 30% in 2014 and 28.5% in 2013. The effective tax rate was 38.8% in both years. Net income in 2014 was 63.4 million or $2.31 per diluted share based on 27.5 million weighted average diluted shares outstanding. Turning to our financial position, liquidity and capital resources, cash and cash equivalents were 20.3 million at the end of 2014 as operations for the year produced 57 million. Capital expenditures used 71 million, and net investing activities including our share repurchase plan used 46 million. Available inventory per store was $756,000 at year end, up 5.5% from the beginning of the quarter and up 13% over the end of 2013. Increases during the quarter were primarily due to weaker than expected net sales, safety stock bills in our distribution centers, increases in merchandize categories previously constrained, and increases in moldings and accessories. Capital expenditures for 2014 are significantly higher than 2013, due to store based expansion, through remodeling of existing stores, operating equipment related to our new distribution centers of approximately $39 million in 2014, and expansion of our finishing vertical integration projects which incurred approximately $9.5 million in 2014. Turning now to our outlook for 2015, strong customer demand has continued in the first quarter particularly in comparison to the start of 2014 which was weakened by the severe winter weather. I know many listening today in parts of the Northeast and Midwest may question whether the current year isn’t just as difficult as the prior. And it may well be. But in our results the 2014 winter was unusual in combining severity, geographical scale, and duration. As we close -- as we disclosed in earnings release this morning, net sales through February 23rd were up 21.4% with comparable stores up 12.1% driven by a 16.8% increase in the number of customers invoiced and partially offset by our lower average sales. Further, open orders have increased 24.5% over the balance of February 23, 2014. With a significant spring flooring season ahead we expect these percentage increases to moderate and currently expect first quarter increases in comparable store net sales to range from the mid to high single-digits. I would also like to touch on the impact of our East Coast distribution center transition and consolidation which we expect to be completed by March 31st. We expect to incur $1.5 million of incremental transportation cost in the first quarter as merchandize is transferred to the new distribution center. In addition, we expect to incur $1.2 million of incremental SG&A expenses including payroll, occupancy, and other expenses in the first quarter. Overall, the marketing changes implemented to date have shifted our net sales mix and lowered average retail price we received from customers. As such, we currently expect first quarter 2015 gross margin in the range of 38% to 38.5%. Finally, we expect SG&A expenses to increase 9% to 12% over the first quarter of 2014. I would also like to provide an update on the preliminary anti-dumping duty rate issued by the Department of Commerce in January 2015 pertaining the multilayered wood flooring from China. I encourage you to read the complete disclosure included within our 10-K filed this morning. In the context of our outlook for 2015, understand that we have not considered any change to the duty rates applied to our engineered hardwood imported from China and if those preliminary rates become final, we would incur a loss of approximately $5.7 million on purchases through November 2013, the end of the period included in the second annual review. The final ruling on the second review is expected in May 2015, though certain appeal periods are expected thereafter. Our outlook for 2015 anticipates moderate improvement in the marketplace for residential wood flooring, marks up periods of volatility when our customer maybe cautious and price sensitive. Within the flooring market, we expect demand for wood flooring to continue to take share from profit. We expect net sales for the full year in the range of 1.14 billion to 1.21 billion with an increase in comparable store net sales of 3% to 9%. We expect to open 30 to 35 new store locations in 2015 and remodel 15 to 20 existing stores all in our expanded showroom format. We expect to increase the number of stores where we provide our installation services from 85 at the end of 2014 to 150 by the end of 2015. While this expansion is expected to drive increases in net sales and operating income, we expect 20 basis points of gross margin pressure in comparing 2015 to 2014. We expect increases in the number of customers invoiced as we continue to implement marketing changes to strengthen our value proposition partially offset by our lower average sales. We expect the net effect of our changes to lower the average retail price offered significantly reduce ad hoc discounting and facilitate more effective up sell to premium products in each merchandized category. We believe that adverse impact on gross margin may range from 60 to 100 basis points but expect to gain market share and drive operating income as a result. We expect the adverse impact of the Bellawood transition and clearance of certain products not a part of our continuing assortment to be 10 to 20 basis points in the first half of the year with no material impact in the second half. We expect moldings and accessories to increase as a percentage of our merchandize mix and drive 20 to 40 basis points of gross margin expansion. We expect our transportation and other cost to be gross margin neutral in 2015. We expect certain transportation benefits from our new East Coast distribution in the second quarter just as we anniversaried the benefit of the 2014 opening of our West Coast distribution center. Fuel costs are expected to benefit domestic transportation costs, but driver shortages may increase lane rates. We expect higher unit sales in 2015 partially offset by lower average inventory levels in the second half of the year. We expect to continue to invest in our quality control and assurance processes as we have done in each of the last four years. Finally, we expect greater cost of samples as demand strengthens and higher cost of shrink due to greater inventory levels and product transitions. As a result we expect full year 2015 gross margin to be in the range of 39% to 40% with the second half generally stronger than the first. We expect capital expenditures to return to historical levels between $20 million and $30 million. Net SG&A expenses are expected to increase 6% to 12% over 2014 due to store based expansion, transition in the full implementation of East Coast distribution operations, legal and professional fees which continue at elevated levels, higher incentive compensation, and greater depreciation including recent infrastructure investments. We expect advertising expenses to range as a percentage of net sales from 7.3% to 7.6% down from 7.9% in 2014. Once the East Coast distribution center is fully transitioned and consolidated, we expect a net $3 million shift out of occupancy expenses and into depreciation. We believe the new facility provides the potential for more efficient operations but we have not included those benefits in our current outlook for 2015. As a result we expect 2015 earnings per diluted share in the range of $2.50 to $3 based on a diluted share count of approximately 27.2 million shares exclusive of any future impact of our stock repurchase program or resolution of any legal or regulatory matters not accrued at December 31, 2014. I’ll now turn the call back over to Rob for his closing remarks.

[Robert M. Lynch:]

Thanks Dan, with the infrastructure for future growth in place we intend for 2015 to be a year where improved execution across our operations begins to level those significant investments. Our competitive strengths including our value proposition, direct sourcing from the mill, our uniquely profitable store model and our people are intact. Improved execution will only widen our competitive advantage. As I mentioned earlier and Dan expanded upon, we began implementing marketing changes to strengthen our value proposition in the fourth quarter and we have had strong customer traffic since. This will be a process we continue in 2015 and we’ll touch these components of our value proposition. We have new flexibility and visibility as we consider the marketing of our value proposition as 2014 infrastructure investments combined with our fundamental principles including enhanced merchandize allocation intelligence, expanded capacity in our supply chain, and continually increasing investment in quality control and assurance, a willingness to commit significant resources to increasing the reach of our advertising message, greater control over our assortment of proprietary brands, and a highly motivated team of flooring experts. We will continually assess and enhance customer perception of our value proposition. We believe the components of our value proposition are individually the best in the industry and we will focus on the combination of price, assortment, availability, and quality delivered by flooring experts in an effort to maximize our market share and operating profit. Our competitive advantages our clear, with the investments for future growth in place one of our key 2015 areas of focus is ensuring that operational execution enhances customer perception of those advantages. We continuously challenge the overall marketing of our value proposition that is not new for us. So it is particularly important to do during times of significant growth and the implementation of a range of strategic initiatives and infrastructure investments. One example of a marketing change has to do with our retail prices, what we offer versus what we realized as a final price to the customer. We will take advantage of the great values we offer by advertising those prices nationally and on the web. We set prices based on competitive analysis which includes robust discussion with our store management teams. This process eliminates the need for ad hoc discounting of the point of sale. One of the area where we want to continue to drive improvement is in our sourcing. Our sourcing model is a key component of our value proposition. We have direct relationships with more than 130 mills around the world. We believe those relationships enable us to offer the highest quality products in an assortment of the lowest prices. As we have strengthened those relationships over the years, we have also maintained our commitment to uncompromising integrity across all areas of our operations and we require the same of those we do business with. I want to also reiterate our position of product safety. We now believe the news program 60 Minutes will feature our company in an unfavorable light with regard to our sourcing and product quality, specifically related to laminates. We believe this story will be a derivative of Prop 65 matter and Balero [ph] matter disclosed in our 10-K. We have not factored any adverse impact on customer demand into our 2015 outlook but we will vigorously challenge any false allegations or factual incorrect presentations. Every media enquiry provides an opportunity for us to reiterate our firm commitment to the safety and quality of our products. Our processes are designed to ensure that our products meet or exceed required standards in every market in which we do business and undergo thorough independent third party testing. We also perform substantial in house testing in many locations around the world. We have recently opened our new advanced testing facility located at our East Coast distribution center to further enhance our compliance capabilities. This lab has a mission testing capabilities that mirror those set by the California Air Resource Board or CARB. We know no other foreign retailer that goes through this effort to ensure the quality of its products. Our vigorous quality control processes includes steps designed to ensure compliance with the low emission standards set by CARB, although CARB regulations are only applicable on California, we apply these stringent standards to subject products and we sell everywhere we do business. In addition, all of our suppliers of these products are either themselves certified under California regulations or source their core materials from certified manufacturers. We verify the status of these suppliers and manufacturers by using CARB's own resources. This provides us an extra level of vigilance as we seek to provide the highest level of quality to our customers. As a result of our continuous commitment to quality, the products you buy at Lumber Liquidators meet CARB standards and are absolutely safe. And finally we are transparent about our quality control and assurance processes. Our flooring meets the highest quality and environmental standards, that is why we sell it, that is why we use it in our own homes, and that is why we are a market leader. We don’t just follow the letter of the law, we are just a volume higher so that our customers enjoy the best the safest products in the world. Turning to the store based expansion and services we offer. We are pleased with our market based real estate strategy and the financial results of our expanded showroom format. We will continue both store based expansion and our remodeling program at a measured pace similar to 2014 but we may accelerate unit counts as opportunity exists. By the end of 2015 we plan to be offering installation in up to 150 stores up from 85 at the end of 2014. We believe that by improving the customer experience and making it easier, we also improve our opportunity to win future business. In addition we have substantially upgraded our distribution capabilities on Gulf Coast which we believe will not only result in margin improvements but also improve inventory management. Additionally using our merchandise planning and allocation system we implemented in 2014, we are able to forecast to a level of inventory to more accurately align each stores sales. We believe this improved visibility will lower overall inventory levels in 2015 and bolster our ability to aggregate and recognize situations which threaten the availability of inventory. Finally our people are the essential components to a successful value proposition and to the strong execution required to deliver on its potential. Hiring, training, and retaining the best people to serve our customers continues to be a top priority in 2015. We recently held our fourth annual Lumber Liquidators Anniversary that brought all of our stores and leadership teams together to further reinforce our unified long-term vision and to communicate our 2015 strategic priorities and goals for the company. This year we focused on our strategy to rededicate ourselves to our value proposition while leveraging all of our recent investments. Our entire team strongly embrace this message, exiting LLU our team dedication, sense of urgency and commitment to delivering results were stronger than ever. In closing our core business model is strong, our competitive position is robust and our plan for 2015 is to execute and deliver on a significant potential of our 2014 infrastructure investments. I could not be more optimistic about our growth potential, operating margin expansion, and value creation for our shareholders in the coming years. Operator, we are now ready for questions.

[Operator:]

[Operator Instructions]. Our first question comes from Simeon Gutman of Morgan Stanley. Please proceed with your question

[Simeon Gutman:]

Thanks and good morning. So Rob, I guess my big question is if the value proposition is intact which you mentioned why make I guess the adjustments, why lower prices and I realize it’s a little bit loaded because I think lowering them you are trying to avoid the mark downs, but your gross margin guidance 39-40 and that’s still was less mark down meaning it’s still lower than where this business was. So I guess are you lowering the margin rate of the business or do you think you are going to be able to bring it back up over time?

[Robert M. Lynch:]

Thanks Simeon, this is Rob, so as we got our product back in stock and we’re beginning 2015 going into it, we want to make sure that we specifically look closely at competitors and that we were priced right out there. And living our value proposition which is critical to us, and price being foremost in the value proposition. Last year with some of our constrained product issues, as we talked some competitors took advantage by then we were out of stock of took advantage of those products off with some of their prices in assortments to you know sort of customers that we can serve last year. So we want to make sure that we came out very strong this year reassess all the parts of the value pop and make sure we’re investing in the way we should. You know as we saw the year, we are excited about this year given what we are up against prior year and also giving all the investments and infrastructure that’s in place. We want to arm our people with the best prices and the confidence that they need now that we are back in stock to go out there and clearly lead in the price part of the value proposition. So to your point about can they come up, absolutely, I would say that this is the bottom you know what we do is we just want to make sure we completely level the playing field and show that we had the advantage on price out there and we always will and we will live up to that, and steps we are doing this is an investment an upfront investment into the value proposition you know I could say that you can trust that we will calibrate skew by skew and down the road its appropriate you know we don’t want to get away in margin we don’t have to but we’d also want to make sure that the gap is right on price.

[Simeon Gutman:]

Thanks.

[Operator:]

Our next question comes from Aram Rubinson with Wolfe Research.

[Aram Rubinson:]

Hey thanks, for taking the question. Wanted to talk about inventory, I think over 3 years the sales per store up 12%, the inventory per store is up 42%, the DSIs are up another 20 days here can you just help give us a sense as to what when you peel back the onion what is there, what would you kind of like not to have as you had you drudgers how much less inventory would you have and what’s the plan going forward to actually reduce without crossing any margins?

[Robert M. Lynch:]

Yes this is Rob. I’ll start and then pass over to Dan for some of the specific numbers. What I would tell you is that with some of the constraint issues we had last year, obviously we bought in substitute products. We had the Bellawood transition so the issue there relative to CARB running the old skews and the new skews and then also going into this year, the Chinese New Year and all some of the port issue on the West Coast we bought in very big. Again we want to make sure again back to the value prospect we had availability that we have the fuel on the tank. I would tell you one thing we are doing now have availability that we have fuel in the tank. I would tell you one thing we're doing now -- we are leveraging very carefully this new visibility into our allocation systems and intelligence and are delivering store specific top selling inventory that is needed by store. And as we are doing that and stores and regions we have been testing it in, we have had good results and I have been in some of these stores and I am seeing levels of inventory with very strong sales and productivity of that inventory. The best I have seen since I have been here. So that is why we are projecting that we think the leveraging of the system is going to potentially as we get through the year implement that across all stores is going to pull down inventory. And I will just add that it was hard to believe that I didn't have everything in my prepared remarks but in the K it has got that we are still going to look for the 640,000 to 690,000 per store by the end of this year and led by mid-year 2015 average inventory level to be less than 2014. So I have said we have two new tools. We obviously have a new distribution centre on the East Coast which I think is going to be significant and when we open the West Coast DC we put in a merchandise allocation system, the benefits of which were a little lost primarily because of what happened in our inventory assortment during 2014. But looking at those two together, the inventory intelligence we have and our focus on execution gives us an opportunity to lower inventory levels in 2015 certainly by the end of the year. And that maybe only one step. I want to be careful to protect the availability, the product as Rob said we learned valuable lesson about how key availability is. With good execution and these tools in place, better intelligence we can lower those inventory levels.

[Aram Rubinson:]

Okay, thank you Dan. I only got one question so I will save this for our conversation later.

[Daniel E. Terrell:]

Okay.

[Operator:]

Our next question comes from Matthew Fassler with Goldman Sachs.

[Matthew Fassler:]

Thanks a lot. I am going to ask a different question from what I originally intended because since you mentioned 60 Minutes your stock is down 10%. And I guess I am interested in what -- really you are not going to make their case for them, but just -- what is your affirmative assertion about some of the issues that seem to be out there that you cite in your K and -- I guess litigation about the safety of the product relative to some of these testing regimes?

[Robert M. Lynch:]

Hey Matt, what I want to clearly say is that we have been dealing some of these allegations for a couple of years now going back to 2012 and 2013. What I would tell you very confidently and clearly is that we are a leader in safety, we are proud to sell the products that we sell. They meet the highest quality in environmental standards in the nation. And they are safe, they are compliant. We specifically spoke to the regulations in California that are the most stringent in the U.S. and that we apply those nationally. And we are confident in the suppliers that we are buying from and the fact that they are certified and compliant relative to those regulations and standards and we check them and over and above also above what is required for our own testing their investment there. So, we know that our product is safe and is compliant.

[Matthew Fassler:]

And just as part of the same question, presumably given the episode is likely there?

[Robert M. Lynch:]

We don’t know exactly they haven’t sold this out, but we believe that it is potentially this weekend.

[Matthew Fassler:]

Okay. Thanks so much.

[Operator:]

Our next question comes from Greg Melich with Evercore ISI.

[Oliver Wintermantel:]

Hi, this is Oliver Wintermantel for Greg. Just wanted to ask a question about SG&A. You mentioned SG&A growth of about 6% to 12%, how would that change based on sales, for example if you come to -- with the SG&A how would that change?

[Robert M. Lynch:]

We believe we got the opportunity to adjust some of our advertising spend along with these marketing changes. How we go to market, how strong the overall value proposition is somewhat determinant to how our conversion rate will be to close sales. What we need to offer as far as the extended financing and advertising and that is why we believe there is an opportunity to see some leverage. Always one of our largest things next to payroll and we think that has at least 30 basis points of leverage in there, potentially more. In payroll we believe there is some opportunity to challenge our staffing major sees and as stores progress up their maturity curve to get some leverage that we haven’t had before so we believe there is an opportunity to lever some payroll cost. On the other side there are higher legal and professional fees are going to stay elevated. We do expect a change in occupancy and depreciation as we open the new warehouse facility and as I said in my prepared comments there is upside potential so we could go towards the lower end of that SG&A increase range or just not building a lot of it into the overall guidance.

[Oliver Wintermantel:]

Thanks very much.

[Operator:]

T Our next question comes from Peter Keith with Piper Jaffray.

[Peter Keith:]

Hey, thanks for taking the questions for all the details this morning. I want to talk about the impact of the pricing changes and this recent uplift in sales you’re seeing because you are lapping now pretty sure sell off in your comp trend, so can you help us maybe trying to break out the is it benefit from the pricing changes, or is it benefit from the macro, is it benefit from the compares, maybe more explicitly you are seeing a lift in non-weather impacted areas that gives you confidence that the pricing change is working?

[Daniel E. Terrell:]

Peter it’s hard to breakout the changes but we can’t say that we felt the inflection as soon as we made some of the marketing changes that was really the Black Friday weekend and we saw some strength coming there, continue to implement on them and saw a traffic increase substantially. No question some areas of the country had a really tough January and February last year, and really even a December. But we are seeing performance across all of our regions. So one reason we put in the press release this morning was the 17% or 16.8% CAGR was to look at what the compound annual growth rate was for that period over three years. I mean 2012 itself was a pretty strong first quarter, certainly 2013, 2014 was somewhat weak. So it helped putting it in perspective. But I would tell you no questions or comparisons are easier but the marketing changes drove the traffic and that’s where we are seeing across the country. We’ve been encouraged by what we have seen. We think that’s going to continue through the year and that’s why we believe traffic will carry our top number in 2015 partially offset by ticket.

[Robert M. Lynch:]

Peter, this is Rob just to add a little color. It’s something that we did as we were getting it to the end of the year, something we get regionally and then also in specific categories. So we saw the immediate impact category by category in the markets. So that was a clear sign to us as well, I just want to add that.

[Peter Keith:]

Okay, thanks for the color, appreciate it.

[Operator:]

Our next question comes from Budd Bugatch with Raymond James.

[Budd Bugatch:]

Well it always amuses me, how I get handled. Good morning and thank you for taking my question.

[Robert M. Lynch:]

That’s a new one.

[Budd Bugatch:]

Those are many new ones. I guess I am going to ask a different question then I originally intended to ask as well because it was another foot note in the K that it seemed to have new language regarding the Department of justice Investigation. Can you expand or talk anything about that the update on that investigation?

[Daniel E. Terrell:]

Sure Budd, we had that as in other consideration and we moved it all the way into a foot note and it’s also in legal matters. It had previously been, they had issued a subpoena, we have applied to the subpoena we were working on providing all the information that was requested of us. We are now having conversations with the Department of Justice. We believe they are at a point in their investigation where it’s time to sit down and start looking at next steps that have gone beyond just providing the information so because of that we’re looking at it as an item more as a contingent liability in trying to assess where to go its very early in the process it could take a quarter it could take two years but what we seen is now we are having conversations we are beginning or we are scheduling dialog with the government that wasn’t happening previously.

[Budd Bugatch:]

Thank you, but there was also a language it says contemplating criminal charges is there any further hope you can give us on that?

[Daniel E. Terrell:]

Well I think there was always that they were going to either come with a misdemeanor or a felony under the Lacey Act. So we believe that is what they are going to come to the table with and begin the discussions. I think the only other alternative is that they would have dropped the investigation. But really that is no change in what we have been looking at ever since we got the subpoena.

[Budd Bugatch:]

Alright, good luck on it. Thank you.

[Operator:]

And our next question comes from Brad Thomas with KeyBanc Capital Markets.

[Bradley Thomas:]

Thanks, good morning. To follow up on just a trend on comp, so I was hoping to ask what average ticket obviously in the quarter and number of items affecting it that maybe temporary in nature. I was wondering if you could call out how much might be unique to the fourth quarter and some of the Bellawood transitions and promotions. And as we look forward, what your outlook is for ticket given the strength that you are seeing and the quality of engineering and hardwood floor price point products, that opportunity you still have of course to trade people up to this new Bellawood lines? Hello.

[Operator:]

The speaker line is connected, gentleman. Gentlemen did you possibly mute your line.

[Bradley Thomas:]

Rob and Dan we can't hear you.

[Operator:]

One moment please. Your speaker line is still connected just one moment please. Ladies and gentlemen please just hold for one moment please. Ladies and gentlemen please continue to hold one moment please while we reconnect the speaker lines. Ladies and gentlemen thank you for your patience, please continue to hold the error connecting reliance once again please continue to hold while we are reconnecting the speaker lines. My apologies, the speaker line is now reconnected.

[Robert M. Lynch:]

Brad are you still there.

[Bradley Thomas:]

Do we have you back then.

[Robert M. Lynch:]

Yes, we do. Apologies for that.

[Bradley Thomas:]

Did you hear my question, I left you speechless.

[Daniel E. Terrell:]

We could hear you guys the whole time, somehow you couldn’t hear us. I heard about average sale and I started to explain a bit about 3 was what we were down in Q4. We were up 1.1 in traffic. We expect that down 5.3 to moderate as we go into 2015. You saw that it already had somewhat in Q1. We expect that to continue to moderate so that we still expect the average sale to be down but more like 3% to 4% throughout 2015, not as strong as that 5.3, not as significant as 5.3 was in Q4.

[Bradley Thomas:]

Alright great. And if I could just squeeze in a housekeeping item on the anti dumping matter. I think you all obviously quantified the historic impact if there is a ruling on that. As we look forward, if you did get an unfavorable ruling within the range of quantified in the K, what kind of a drag could that have on gross margins on a go forward basis if this ruling was applied?

[Daniel E. Terrell:]

Yeah, well Brad you saw applying it over about a two year period would have been about $12.5 million impact. We’re accruing now at about 6%, that ruling is at 18.3. We certainly think that’s up for a second look and then the appeal process it usually lags by about a year and year and half. But if we have start putting deposits down at 18.3 we are already looking at shifts in our assortment, how we are going to source product in 2015. We are diversifying the assortment over multiple countries, we are looking at different constructions. It will take some time I would tell you that 2015 even though it’s a more significant year sales wise would have a lesser impact than what we disclosed in the K simply because we are already in the process of transitioning some of that demand.

[Bradley Thomas:]

Got it and just to be clear, your current guidance does not include accruing it for this year?

[Daniel E. Terrell:]

It doesn’t and if for some reason that ruling becomes final we’ll certainly call that out and put special attention on it so that everybody can see it and be very clear on it. But we do not have anything anticipated in 2015.

[Bradley Thomas:]

Got you, thanks so much.

[Operator:]

Our next question comes from David MacGregor with Longbow Research.

[David MacGregor:]

Good morning. I guess question on the forward-look on comp growth and just what you’re expecting in terms of overall category growth to start with and then just secondly, on maturation, with all the changes going on, are you expecting any change in terms of kind of the first, second, third year productivity growth in your stores?

[Daniel E. Terrell:]

Dave, from the overall macro outlook we think it’s going to be a slight tailwind, low single-digit. Still feel like there is a lot of uncertainty out there but you do see improving employment, improving consumer sentiment. The housing numbers get a little sketchy but they are still positive on a year-over-year basis. Access to credit is going to be an interesting discussion throughout 2015. Definitely believe hard surface flooring takes share from carpet so that said, you might look at a small 2 to 3 percentage point lift out of the macro. Maturity curve is there, we opened 34 stores on top of 30. We’re actually seeing that maturity curve outperform our historic model and while that out performance may narrow as those stores mature, we still believe that’s going to be a benefit to our comp sales. Get back a little bit as far as cannibalization, 300 to 400 basis points that we seen historically there. With the big question then comes with how effective these marketing changes are driving and capturing shares. They’ve been very effective so far. If they continue it will be towards the higher end of that range. If it moderates we maybe towards the lower end.

[David MacGregor:]

Thanks for the detail Dan.

[Daniel E. Terrell:]

Sure.

[Operator:]

Our next question comes from Dan Binder with Jeffries.

[Unidentified Analyst:]

Hi, this is Ralph [ph] putting in for Dan. Just factor changes in the mix and the promotional changes, looking long term beyond this year, where do you think long-term gross margin get to, thank you?

[Robert M. Lynch:]

We’ve always looked at margins go into the low to mid 40s, still believe of our multi year period we can get to 42% to 43%. We really look at the business on can we drive operating margin, what can we do to get operating income high to drive operating and margin expansion. And we still believe there is an opportunity to get to the low to mid teens over the next few years. So this is a bit of a reset. We put a lot of infrastructure investments in place, it allows us a lot of flexibility on how we position that value proposition. Execution has come under question. We still need to show that we can execute with these tools and rebuild that. But we do believe the opportunity is there. We are going to address ad hoc discounting that had been an issue that we need to take care of and we need to take care of that with outstanding prices and working closely with the field and we will do that. There are a number of areas where the gross margin has continued to expand though from attachment of moldings and accessories to premium products up sell. So once again doing line reviews and what not that can lower your overall costs. We are investing in vertical integration and finishing capacity which we think longer-term has the opportunity to lower some product cost as well. In the SG&A, if we see this constant repositioning of the marketing traffic we will question about what SG&A structure is needed to support that and we think there is some opportunity to level a little faster in future periods than we had been considering. So, 2014 is a tough year, it has been a bit of a resale we are going in to 2015 quite conservatively but we still believe the long-term opportunities are there.

[Unidentified Analyst:]

Thank you, quick question. [Indiscernible] have normalized, have you seen any discernible changes in consumer taste starting out this year, thank you?

[Robert M. Lynch:]

Yes, not necessarily. I mean color and style is something that we absolutely always focus on. We recently conducted a very thorough consumer research study, about that. So we are always looking ahead, we are always using it to be out front drive our assortment again. Our selection, those colors and styles and being the leader out there is part of the value proposition. So we are always looking at it. Yes, I mean specifically we have seen some trends the last year or so in the area of more of the rustic and interestingly the great trend that has been out there I am sure they are aware of we are obviously aware of that nearest sorting through it taking advantage of it

[Unidentified Analyst:]

Thank you.

[Operator:]

Our next question comes from Seth Sigman with Credit Suisse.

[Seth Sigman:]

Okay, thanks for taking the question. Two quick follows-up here, first the decline in average sale that you are talking about average ticket, down three to four going forward. Can you break that down a little bit further, what are you seeing there, is the size of the project maybe different customer, little bit change in mix there, that would seeing that, how are you thinking about that?

[Robert M. Lynch:]

Two primary drivers are change in the average retail price, just on like on product as a result of these marketing initiatives. And we have seen a change in mix towards lower average retail price points. I haven't seen a whole lot of move in the project side or the units per ticket. Really what we have seen is people -- as we got back in stock we saw people gravitating towards the laminates, the vinyl, the bamboos. That has been a longer term trend as well. The marketing initiatives began in those product categories and we saw an even greater shift in the sales mix. We had kind of a combined impact of shift with these lower average retail price points and then they will lower on the offered price than they had been. And then partially offsetting that was the elimination of the ad hoc discounting around those products and then it was easier for our people to up sell to premium product. So by having a more logical pricing metrics, a little different advertising strategy people who are able to work the up sell within those merchandise categories to help offset some of the lost as well .

[Seth Sigman:]

Okay, that is helpful. And then in terms of there was a disclosure in the 10-K about your sourcing, looks like there was about 900 basis point swing to North America in 2014, away from Asia. Let me reflect some of the temporary challenges you had but is there a structural element there that could potentially change with the gross margin structure going forward, and how are you thinking about that?

[Daniel E. Terrell:]

No, that is just really part of our sourcing process. I think you hit on it, part of it was also just because of last year and some of the substitute product that we had to ship to other sources but this is part of our long-term strategy of diversifying and ensuring the availability of our product and making sure we’ve had enough resources out there. We are looking at where the highest quality and low best providers are around the world. So that’s more of natural jus the execution of long term sourcing strategy is for us. We’ve shifted some came back here, some went to Europe. It varies by category so we are constantly out there looking and assessing new opportunities for source.

[Robert M. Lynch:]

I would just add, we are always going to be opportunistic and we really kind of went back to 2012 levels. Obviously the strength of the U.S. dollar presents opportunities when you look at manufacturing in Europe and even from other countries. So we’re looking at all components that part of the relationship as it is about tender realization. We price RPOs in dollars as well as you can provide us with a quality and reliable source of a product.

[Seth Sigman:]

Okay, thanks very much.

[Operator:]

Our last question comes from Jessica Mace with Nomura.

[Jessica Mace:]

Hi, good morning. Thanks for the taking the question. My question is on the real estate strategy, I was wondering if you could tell us on the remodeled stores, any change in the performance you’ve seen post remodel or relocation versus before. Then any further metrics, you said that your new store opening have performed higher productivity but any more color you could give us around that?

[Robert M. Lynch:]

With the new we’re looking at those, we will have a chart that we will put out when we go to the Raymond James Conference next week. The new stores are outperforming the historic model by anywhere from 15% to 20% on the top line. In the early parts of that first year, it can be more significant than that and then it narrows with the maturity, and we expect that to continue to narrow somewhat but still to maintain the advantage. There is slightly greater investment in inventory and in fixturing than we had had in the past. But the overall our ROIC has improved. In the remodel and relocation, we’re still assessing which one is more powerful. There are times when we were leaning more towards relocation within the primary trade area but we are really moving from DF sites to DC sites looking for more retail centric areas of a marketplace. So depending on how different the spots you are coming from to where you are going to it may favor relocation over remodel. So we are not going to be able to offer any metrics because the samples there is quite large enough there yet. But from what we have seen looking at in its totality we are pleased with the performance that it had in the ROIC we’ve gotten out of them, whether its remodel in place or relocation.

[Jessica Mace:]

Great, thanks so much.

[Robert M. Lynch:]

Thank you operator. I want to thank everyone again for joining us. We are committed and determined team. We are excited about the year ahead and what we plan to accomplish. We look forward to speaking with you again in April to update you on our progress.

[Operator:]

Thank you, ladies and gentlemen this concludes today's conference. You may disconnect your lines at this time. Thank you all for your participation.