Overview and Trends
From 2011 through 2013, we continued to successfully implement our key strategic initiatives and strengthen our value proposition. These key strategic initiatives include:
· Broadening the reach and frequency of our advertising to increase recognition of our value proposition and ultimately the number of customers served. · Expanding gross margin through continued execution of our sourcing initiatives, optimization of our supply chain and operational efficiencies across the organization. · Focusing on continuous improvement in our operations, with a foundation of developing the best people to serve our customers.
We believe our value proposition is unique within our industry, with strength from a balance of price, selection, quality, availability and the expertise of our people. We believe we lead the industry in each of these five components and further investment will widen the advantage and drive market share gains.
We have experienced strong net sales trends, with 2013 up 23.0% following a 2012 increase of 19.3%, with net sales in comparable stores up 15.8% in 2013, following an increase of 11.4% in 2012. We believe our message is resonating with a broader customer base as our measure of traffic in comparable stores, the number of customers invoiced, increased 9.2% in 2013, following an 8.9% increase in 2012.
We have expanded gross margin through initiatives across our operations, working individually and in combination to deliver multi-year benefit. Gross margin has expanded 580 basis points in comparing 2013 to 2011, and 310 basis points in the past year.
Though we aggressively pursued market share through our advertising and marketing, continued to invest in our Best People initiative and reinvested benefits in new programs that will drive future growth, operating income increased 60.9% in 2013, following an 84.6% increase in 2012. Operating margin has expanded 640 basis points in comparing 2013 to 2011, and 300 basis points in the past year.
In 2014, we intend to continue to focus on these multi-year initiatives in an effort to continue to expand our operating income. Our planned infrastructure investment will be the largest in our history, as we open key facilities in our supply chain, expand our finishing capacity and continue our store of the future rollout. We expect our initiatives will result in gross margin expansion greater than operating margin expansion, as we continue to broaden the reach and frequency of our advertising to capture greater share from the casual consumer. In addition, we expect to incur incremental legal and professional fees for legal defenses and certain costs related to internal reviews between
We operate primarily in the highly fragmented wood flooring market for existing homeowners. This market is dependent on home-related, large-ticket discretionary spending, which is influenced by a number of complex economic and demographic factors that may vary locally, regionally and nationally. In 2013, we continued to see a number of these factors improve overall, varying by region as they have historically, though with greater volatility in the second half of the year. With most factors remaining below historical averages, we continue to expect strengthening over time, but marked by periodic volatility when our customer is likely to be cautious and price-sensitive.
Store of the Future
The store of the future retains our targeted location size of 6,000 to 7,000 square feet, but expands the average showroom to approximately 1,600 square feet from the 1,000 to 1,200 square feet previously targeted. The assortment of flooring options presented has expanded, grouped by product category, displayed within color palate and in a good-better-best format. The assortment of moldings and accessories displayed has expanded significantly. We believe the store of the future format has combined well with our advertising message resonating with a larger base of casual customers, our real estate strategy of locating stores in retail areas more familiar to the customer and increased in-store service levels through our Best People initiative. Capital expenditures in the 30 new stores averaged approximately
In 2014, we expect our 30 to 40 new store locations to be in the store of the future format, with openings weighted to the first half of the year. In addition to the new stores, we expect to remodel 25 to 35 existing stores in the store of the future format, either in their current location or relocated within the primary trade area.
Supply Chain Optimization
We expect capital expenditures for land, building and equipment to range up to
In 2013, incremental selling, general and administrative ("SG&A") expenses related to the
26 Share Repurchase
In 2012, our board of directors authorized the repurchase of up to
Results of Operations Net Sales Year Ended December 31, 2013 2012 2011 (dollars in thousands) Net sales
$ 1,000,240 $ 813,327 $ 681,587Percentage increase 23.0 % 19.3 % 9.9 % Number of stores open at end of period 318 288 263 Number of stores opened in period 30 25 40 percentage increase (decrease) Average sale1 6.6 % 2.5 % 2.8 % Average retail price per unit sold2 5.7 % 0.2 % 6.8 % Comparable stores3: Net sales 15.8 % 11.4 % (2.0) % Customers invoiced4 9.2 % 8.9 % (4.8) % Net sales of stores operating for 13 to 36 months 21.8 % 23.3 % 12.0 % Net sales of stores operating for more than 36 months 14.9 % 9.1 % (5.5) % Net sales in markets with all stores comparable (no cannibalization) 18.2 % 13.3 % 2.2 % Net sales in cannibalized markets5 45.2 % 33.3 % 18.6 %
1 Average sale, calculated on a total company basis, is defined as the average invoiced sale per customer, measured on a monthly basis and excluding transactions of less than
$250(which are generally sample orders, or add-ons or fill-ins to previous orders) and of more than $30,000(which are usually contractor orders) 2 Average retail price per unit sold is calculated on a total company basis and excludes non-merchandise revenue 3 A store is generally considered comparable on the first day of the thirteenth full calendar month after opening 4 Change in number of customers invoiced which is calculated by applying our average sale to total net sales at comparable stores 5 A cannibalized market has at least one comparable store and one non-comparable store
Net sales for 2013 increased
Net sales in comparable stores increased 15.8% comparing 2013 to 2012 with an increase of 9.2% attributable to the increase in the number of customers invoiced and an increase of 6.6% in the average sale. Net sales in comparable stores increased 11.4% comparing 2012 to 2011 with an increase of 8.9% attributable to the increase in the number of customers invoiced and an increase of 2.5% in the average sale. Net sales at comparable stores increased primarily due to the following factors:
· We believe the number of customers invoiced in comparable stores has benefited
from greater recognition of our value proposition due to our efforts to expand our advertising reach and frequency. 27
· We believe the average sale benefited from increases in the average retail
price per unit sold due primarily to changes in the sales mix of flooring products, stronger retail price discipline at the point of sale and increases in the sales mix of moldings and accessories. Moldings and accessories generally increase both the volume of units sold and the average retail price per unit sold.
· We believe net sales at comparable stores in 2013 were positively impacted by
40 to 50 basis points due to the seven store locations serving communities
recovering from the effects of Hurricane Sandy, and as a result, experiencing
increases in net sales greater than average.
We expanded our store base unit count by 10.4%, 9.5% and 17.9% in 2013, 2012 and 2011, respectively, with 25, 17 and 20 locations, respectively, opened in existing markets where brand awareness tends to increase first year net sales per unit relative to a new market.
Gross Profit and Gross Margin
Year Ended December 31, 2013 2012 2011 (dollars in thousands) Net Sales
$ 1,000,240 $ 813,327 $ 681,587Cost of Sales 589,257 504,542 440,912 Gross Profit $ 410,983 $ 308,785 $ 240,675Gross Margin 41.1 % 38.0 % 35.3 %
We believe that the significant drivers of gross margin expansion and their estimated impact compared to the prior year are as follows:
Year Ended December 31, Driver Description 2013 20121 20111 expansion (contraction) in basis points Product Cost of acquiring the products we sell from our suppliers, including the impact of our sourcing initiatives; Changes in the mix of products sold; Changes in the average retail price per unit sold; Changes in the average retail price and related cost of services, including installation. 300 230 140 Transportation International and domestic transportation costs, including the impact of international container rates; Customs and duty charges; Fuel and fuel surcharges; Impact of mill shipments received directly by our stores; Transportation charges from our distribution centers to our stores; Transportation charges between stores and the cost of delivery to our customers. 20 30 (60) All Other Investments in our quality control procedures; Warranty costs; Changes in finishing costs to produce a unit of our proprietary brands; Inventory shrink; Net costs of producing samples. (10) 10 (30) Total Change in Gross Margin from the prior year 310 270 50 ___________________
1 Certain amounts have been reclassified to conform to current year presentation
· Product: Gross margin benefited from net shifts in our sales mix, lower net costs from our suppliers, certain operational efficiencies and a higher average retail price per unit sold. o Moldings and accessories, which generally produce a gross margin higher than flooring, increased within our total sales mix to 18.1% in 2013 from 16.3% in 2012 and 14.6% in 2011. 28 o Greater customer preference for certain premium products, which generally produce a higher gross margin than the entry level or moderate products within a merchandise category. o Sourcing initiatives, including line reviews and the percentage of product we source direct from the mill, generally lowered net costs from our suppliers and increased vendor allowances. o Greater retail price discipline at the point of sale increased the average retail price per unit sold on like-kind product. o Gross margin was adversely impacted by an increase in customers choosing non-merchandise services including delivery and installation, which, in aggregate, produce a gross margin lower than merchandise net sales. · Transportation: Gross margin was impacted by changes in international and domestic transportation rates as well as certain operational efficiencies. o Negotiated international container rates for the importation of product from both
Chinaand South Americawere generally lower in 2013 than in 2012. o Average costs per domestic mile traveled between our distribution centers and stores were lower in 2013 primarily due to generally lower domestic fuel costs, partially offset by an increase in the total domestic miles traveled as we grew our store base and established initial inventory levels in our new West Coastdistribution center. o Initiatives launched in 2012 enhanced the efficiency of supply chain operations. Significant transportation contracts were subject to line reviews and reduced per unit rates. Enhanced reporting and control strengthened the accuracy of product movement and reduced inter-store transfers. · All Other Costs: In 2013 and 2012, gross margin benefitted from supply chain initiatives to improve the accuracy and visibility of product movement within the distribution centers and the stores, thereby lowering inventory shrink. Expanded quality control operations and a greater number of sample requests offset this benefit.
Operating Income and Operating Margin
Year Ended December 31, 2013 2012 2011 (dollars in thousands) Gross Profit
$ 410,983 $ 308,785 $ 240,675SG&A Expenses 284,960 230,439 198,237 Operating Income $ 126,023 $ 78,346 $ 42,438Operating Margin 12.6 % 9.6 % 6.2 %
The following table sets forth components of our SG&A expenses for the periods indicated, as a percentage of net sales. Individual line items include the impact of our finishing operations, with a credit for these expenses included in other SG&A expenses.
Year Ended December 31, 2013 2012 1 2011 1 Total SG&A Expenses 28.5 % 28.3 % 29.1 % Salaries, Commissions and Benefits 12.1 % 12.1 % 11.8 % Advertising 7.6 % 7.2 % 7.7 % Occupancy 3.5 % 3.7 % 3.9 % Depreciation and Amortization 1.1 % 1.2 % 1.2 % Stock-based Compensation 0.6 % 0.5 % 0.6 % Other SG&A Expenses 3.6 % 3.6 % 3.9 %
1 Certain amounts have been reclassified to conform to current year presentation
Operating income for 2013 increased
· Salaries, commissions and benefits increased in both 2013 and 2012 primarily
due to higher accruals for our management bonus plan, greater benefit costs and higher commission rates earned by our store management. Additionally, 2013 included incremental salaries and commissions related to our test of structural installation alternatives and our supply chain optimization, including the start-up of our
West Coastdistribution center. 29
· Advertising expenses in 2013 increased as a percentage of net sales as we
continued to broaden our reach and frequency. Partially offsetting this increase in 2013 and providing a net reduction in comparing 2012 to 2011, we levered our national advertising campaigns over a larger store base and reallocated advertising to more effective media channels.
· Occupancy costs increased due to store base expansion, expansion of our
distribution network and in 2013, our supply chain optimization, but in each year, decreased as a percentage of net sales.
· Stock-based compensation in 2013 included a special grant of restricted stock
to certain members of management in
March 2013which will fully vest in March 2014. In addition, our chief executive officer, who does not participate in our annual grant of equity, was awarded a grant of stock options and restricted stock in March 2013which resulted in approximately $0.6 millionof expense in 2013.
· Other SG&A expenses in 2013 included incremental legal and professional fees of
$1.5 million, approximately $0.5 millionof costs related to the start-up of our West Coastdistribution center and costs of certain programs under development, including international operations and our installation test. In 2012, other SG&A expenses decreased as a percentage of net sales primarily due to higher net sales and increased reimbursements from our primary installation partner, partially offset by higher bankcard discount rates related to certain extended-term promotional programs and approximately $0.5 millionrelated to the resolution of a 2012 legal matter. Provision for Income Taxes Year Ended December 31, 2013 2012 2011 (dollars in thousands) Provision for Income Taxes $ 49,070 $ 31,422 $ 16,769Effective Tax Rate 38.8 % 40.0 % 39.0 %
The effective tax rate may vary due to changes in state taxes and certain reserves. The increase in the 2012 effective tax rate was due to a
Net Income Year Ended December 31, 2013 2012 2011 (dollars in thousands) Net Income
$ 77,395 $ 47,064 $ 26,256As a percentage of net sales 7.7 % 5.8 % 3.9 %
Net income for the year ended
Liquidity and Capital Resources
Our principal liquidity and capital requirements are for capital expenditures to maintain and grow our business, working capital and general corporate purposes. We periodically use available funds to repurchase shares of our common stock under our stock repurchase program. Our principal sources of liquidity are
In 2014, we expect capital expenditures to total between
· open between 30 and 40 new store locations, using up to
· remodel or relocate 25 to 35 existing stores using, up to
· continue to invest in our supply chain, using up to
primarily related to the
· invest in our finishing line and other vertical integration initiatives, using
· continue to invest in integrated information technology systems; and
· continue to improve the effectiveness of our marketing programs.
Cash and Cash Equivalents
In 2013, cash and cash equivalents increased
In 2012, cash and cash equivalents increased
In 2011, cash and cash equivalents increased
Merchandise inventory is our most significant asset, and is considered either "available for sale" or "inbound in-transit," based on whether we have physically received and inspected the products at an individual store location, in our distribution centers or in another facility where we control and monitor inspection.
Merchandise inventories and available inventory per store in operation on
2013 2012 2011 (in thousands) Inventory - Available for Sale
$ 212,617 $ 168,409 $ 135,850Inventory - Inbound In-Transit 39,811 38,295 28,289 Total Merchandise Inventories $ 252,428 $ 206,704 $ 164,139Available Inventory Per Store $ 669 $ 585 $ 517
Available inventory per store at
Inbound in-transit inventory generally varies due to the timing of certain international shipments, but may also be influenced by seasonal factors, including international holidays, rainy seasons and specific merchandise category planning.
Operating Activities. Net cash provided by operating activities was
Investing Activities. Net cash used in investing activities was
Financing Activities. Net cash used by financing activities was
Revolving Credit Agreement
A revolving credit agreement (the "Revolver") providing for borrowings up to
Related Party Transactions
See the discussion of related party transactions in Note 5 and Note 10 to the consolidated financial statements included in Item 8 of this report and within Certain Relationships and Related Transactions, and Director Independence in Item 13 of this report.
Contractual Commitments and Contingencies
Our significant contractual obligations and commitments as of
Payments Due by Period Less Than 1 to 3 3 to 5 Total 1 Year Years Years 5+ Years (in thousands)
Contractual obligations Operating lease obligations(1)
35,873 35,873 - - -
Total contractual obligations
(1) Included in this table is the base period or current renewal period for our operating leases. The operating leases generally contain varying renewal provisions. (2) Purchase obligations represent capital expenditure commitments for the construction of the
East Coastdistribution center.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements or other financing activities with special-purpose entities.
Inflationary factors such as increases in the cost of our product and overhead costs may adversely affect our operating results. Although we do not believe that inflation has had a material impact on our financial position or results of operations to date, a high rate of inflation in the future may have an adverse effect on our ability to maintain current levels of gross profit and SG&A expenses as a percentage of net sales if the selling prices of our products do not increase with these increased costs.
Certain External Factors and Events Impacting Our Business
Antidumping and Countervailing Duties Investigation. In
A number of appeals have been filed by several parties challenging various aspects of the determinations made by both the ITC and DOC, including certain pending appeals that may impact the validity of the AD and CVD orders and the applicable rates. Additionally, the DOC is in the process of finalizing the first annual review of the AD and CVD rates. As part of that review process, such rates may be changed and applied retroactively to the DOC's preliminary determinations in the original investigation. The final results of the first annual review of the AD and CVD rates are expected in
A request for a second annual review of the AD and CVD rates has been submitted by the Petitioner. Any change in the applicable rates as a result of the second annual review would apply to imports occurring after the end of the first annual rate review period.
In 2013, approximately 15% of our flooring purchases were subject to AD and CVD. At this time, we are unable to determine the positive or negative impact, if any, that the various appeals and rate reviews may have on our business. See "Item 1A. Risk Factors- Risks Related to Our Suppliers, Products and Product Sourcing."
Execution of Search Warrants. On
Critical Accounting Policies and Estimates
Critical accounting policies are those that we believe are both significant and that require us to make difficult, subjective or complex judgments, often because we need to estimate the effect of inherently uncertain matters. We base our estimates and judgments on historical experiences and various other factors that we believe to be appropriate under the circumstances. Actual results may differ from these estimates, and we might obtain different estimates if we used different assumptions or conditions. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our financial statements:
Recognition of Net Sales
We recognize net sales for products purchased at the time the customer takes possession of the merchandise. We recognize service revenue, which consists primarily of installation revenue and freight charges for in-home delivery, when the service has been rendered. We report sales exclusive of sales taxes collected from customers and remitted to governmental taxing authorities. Net sales are reduced by an allowance for anticipated sales returns that we estimate based on historical and current sales trends and experience. We believe that our estimate for sales returns is an accurate reflection of future returns. Any reasonably likely changes that may occur in the assumptions underlying our allowance estimates would not be expected to have a material impact on our financial condition or operating performance. Actual sales returns did not vary materially from estimated amounts for 2013, 2012 or 2011.
In addition, customers who do not take immediate delivery of their purchases are generally required to pay a deposit, equal to approximately half of the retail sales value, with the balance payable when the customer takes possession of the merchandise. These customer deposits benefit our cash flow and return on investment capital, because we receive partial payment for our customers' purchases immediately. We record these deposits as a liability on our balance sheet in customer deposits and store credits until the customer takes possession of the merchandise.
We value our merchandise inventories at the lower of merchandise cost or market value. We determine merchandise cost using the average cost method. All of the hardwood flooring we purchase from suppliers is either prefinished or unfinished, and in immediate saleable form. To the extent that we finish and box unfinished products, we include those costs in the average unit cost of related merchandise inventory. In determining market value, we make judgments and estimates as to the market value of our products, based on factors such as historical results and current sales trends. Any reasonably likely changes that may occur in those assumptions in the future may require us to record charges for losses or obsolescence against these assets, but would not be expected to have a material impact on our financial condition or operating performance. Actual losses and obsolescence charges did not vary materially from estimated amounts for 2013, 2012 or 2011.
33 Stock-Based Compensation
We currently maintain a single equity incentive plan under which we may grant non-qualified stock options, restricted shares, stock appreciation rights and other equity awards to employees and non-employee directors. We recognize expense for our stock-based compensation based on the fair value of the awards that are granted. Compensation expense is recognized only for those awards expected to vest, with forfeitures estimated at the date of grant based on our historical experience and future expectations. Measured compensation cost is recognized ratably over the service period of the entire related stock-based compensation award.
The fair value of stock options was estimated at the date of grant using the Black-Scholes-Merton valuation model. In order to determine the related stock-based compensation expense, we used the following assumptions for stock options granted during 2013:
· Expected life of 6.0 years to 7.5 years; · Expected stock price volatility of 45%; · Risk-free interest rates from 1.3% to 2.0%; and · Dividends are not expected to be paid in any year.
The expected stock price volatility range is based on a combination of historical volatility of our stock price and the historical volatilities of companies included in a peer group that was selected by management whose shares or options are publicly available. The volatilities are estimated for a period of time equal to the expected term of the related option. The risk-free interest rate is based on the implied yield of U.S. Treasury zero-coupon issues with an equivalent remaining term. The expected term of the options represents the estimated period of time until exercise and is determined by considering the contractual terms, vesting schedule and expectations of future employee behavior. Had we arrived at different assumptions of stock price volatility or expected terms of our options, our stock-based compensation expense and results of operations could have been different.