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March 2, 2021, 6:07 a.m. EST

10-K: LUMBER LIQUIDATORS HOLDINGS, INC.

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(EDGAR Online via COMTEX) -- Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Overview

Lumber Liquidators ("LL Flooring" or "Company") is one of North America's leading specialty retailers of hard-surface flooring, with 410 stores as of December 31, 2020. We seek to offer the best customer experience online and in stores, with more than 400 varieties of hard-surface floors featuring a range of quality styles and on-trend designs. Our online tools also help empower customers to find the right solution for the space they've envisioned. Our extensive selection includes water-resistant vinyl plank, solid and engineered hardwood, laminate, bamboo, porcelain tile, and cork, with a wide range of flooring enhancements and accessories to complement. Our stores are staffed with flooring experts who provide advice, pro partnership services and installation options for all of LL Flooring's products, the majority of which is in stock and ready for delivery. We offer delivery and in-home installation services through third-party independent contractors for customers who purchase our floors.

Our vision is to be the customer's first choice in hard-surface flooring by providing the best experience, from start to finish. We offer a wide selection of high-quality, stocked products and the accessible flooring expertise and service of a local store, with the scale, omni-channel convenience and value of a national chain. We plan to leverage this advantage to differentiate ourselves in the highly fragmented flooring market. We launched our new digital platform, LLFlooring.com, in December 2020. This mobile-friendly site features inspirational content, highlights our digital tools like Picture It! and Floor Finder and promotes our services such as installation, free flooring samples and delivery.

To supplement the financial measures prepared in accordance with GAAP, we use the following non-GAAP financial measures: (i) Adjusted Gross Profit; (ii) Adjusted Gross Margin; (iii) Adjusted SG&A; (iv) Adjusted SG&A as a percentage of sales; (v) Adjusted Operating Income; (vi) Adjusted Operating Margin; (vii) Adjusted Earnings and (viii) Adjusted Earnings per Diluted Share. The non-GAAP financial measures should be viewed in addition to, and not in lieu of, financial measures calculated in accordance with GAAP. These supplemental measures may vary from, and may not be comparable to, similarly titled measures by other companies.

The non-GAAP financial measures are presented because management and analysts use these non-GAAP financial measures to evaluate our operating performance and management, in certain cases, uses them to determine incentive compensation and/or to address questions it receives. Therefore, we believe that the presentation of non-GAAP financial measures provides useful supplementary information to, and facilitates additional analysis by, investors. The presented non-GAAP financial measures exclude items that management does not believe reflect our core operating performance, which include regulatory and legal settlements and associated legal and operating costs, and changes in antidumping and countervailing duties from prior periods, as such items are outside of our control or due to their inherent unusual, non-operating, unpredictable, non-recurring, or non-cash nature.

Executive Summary

Fiscal 2020 was a dynamic and challenging year due to the uncertainties around the COVID-19 pandemic. Despite COVID-19, we were able to progress on our transformation plan to elevate the experience for all of our customers which positioned us to take advantage of a robust home improvement spending environment in the second half of the year. Our transformation plan includes the four strategic pillars of people and culture, improving the customer experience, driving traffic and transactions in our stores and online, and improving profitability.

Highlights for the year ended December 31, 2020 were as follows:

Net sales increased $5.1 million, or 0.5%, to $1,098 million in 2020 from $1,093 million in 2019, which includes a $10 million increase in non-comparable store net sales partially offset by a decrease of $5.3 million, or 0.5%, in comparable store net sales. Following a 20% decrease in net sales in the second ? quarter due to the impact of COVID-19, the Company recovered to deliver a strong second-half performance. For the full year, net merchandise sales increased 2% while net services sales (install and freight) decreased 10% over the prior year. The Company closed nine net stores in 2020, and as of December 31, 2020, operated 410 stores.

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Gross profit of $428 million in 2020 increased $24 million from 2019 and, as a percent of sales, gross margin in 2020 increased to 39.0% from 36.9% in 2019. Both 2020 and 2019 were impacted by the net of anti-dumping and countervailing duty rate changes. Additionally, 2020 included costs related to Canadian and US ? store closures. When excluding items in the table that follows in Results of Operations, Adjusted Gross Profit (a non-GAAP measure) of $426 million in 2020 increased $22 million versus 2019 and Adjusted Gross Margin (a non-GAAP measure) in 2020 increased to 38.8% from 37.0% in 2019. This 180-basis point improvement in adjusted gross margin was due primarily to merchandising sourcing and cost-out efforts, and selective retail price increases.

Selling, general and administrative ("SG&A") expenses of $371 million in 2020 decreased $16 million from 2019, and as a percentage of net sales, SG&A decreased to 33.8% in 2020, compared to 35.4% in 2019. When excluding items in the table that follows in Results of Operations, Adjusted SG&A (a non-GAAP measure) of $363 million in 2020 decreased $17 million from 2019 and, as a percentage of net sales (a non-GAAP measure), was 33.0% in 2020, a decrease of 170 basis points from 34.7% in 2019. The decrease in adjusted SG&A was ? primarily due to lower advertising expense as the Company reduced its promotional cadence in response to COVID-19 and then optimized its marketing efforts, pivoting towards more efficient digital channels, as well as $2.5 million from the final settlement in 2020 of the business interruption insurance claim related to the August 2019 network security incident and lower travel and entertainment expense. These savings were partially offset by higher bonus and commission reflecting the Company's strong financial performance, and higher benefits expense.

Operating income was $56 million in 2020, compared to operating income of $17 million in 2019. When excluding items in the table that follows in Results of Operations, Adjusted Operating Income (a non-GAAP measure) was $64 million and ? Adjusted Operating Margin (a non-GAAP measure) was 5.8% in 2020, compared to $25 million, or 2.3%, in 2019. The primary driver of the increase was the Company's execution on its profitability initiatives, which increased adjusted gross margin and reduced advertising expense.

The Company had other expense of $2.6 million and $3.8 million for the years ended December 31, 2020 and 2019, respectively. The expense in both years ? primarily reflected interest on borrowings on our Credit Agreement. The expense in 2020 was partially offset by a favorable adjustment of $1.1 million for the reversal of interest expense associated with anti-dumping and countervailing duty rate changes.

Income tax benefit was $7.8 million in 2020 compared to income tax expense of ? $3.3 million in 2019. 2020 included the partial release of $20 million of valuation allowance on deferred tax assets.

? Net income was $61 million, or $2.10 per diluted share, in 2020 compared to net income of $9.7 million, or $0.34 per diluted share, in 2019.

Earnings per diluted share was $2.10 for 2020 versus $0.34 in 2019. 2020 ? Adjusted Earnings Per Diluted Share (a non-GAAP measure) increased $1.74 to $2.28 compared to $0.54 for 2019.

Other Items

Impact of COVID-19 Pandemic

In March 2020, the World Health Organization announced that infections of COVID-19 had become a pandemic and the U.S. President announced a National Emergency relating to the COVID-19 pandemic. Starting as of the week of March 22, 2020 the Company closed as many as 56 stores for a period of time while all other stores operated under reduced hours and/or warehouse only conditions, offering curbside pickup and job site delivery for our Pro and DIY customers. During the third and fourth quarters of 2020 the Company's stores remained open except for temporary closures necessitated by local market conditions. Net sales for the first half of 2020 were substantially impacted in a negative way by COVID-19 due to the store closures and general uncertainty. The progress on the Company's

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transformation plan and a healthy consumer demand for home improvement projects during the second half of 2020 mostly offset the impact of COVID-19 on the first half of 2020.

Section 301 Tariffs

The Company's financial statements have been impacted by Section 301 tariffs on certain products imported from China in recent years. A subset of these imports for certain click vinyl and other engineered products (the "Subset Products") received an exemption that was made retroactive to the beginning of the Section 301 Tariffs for a period of time. The Company has deployed strategies to mitigate tariffs and improve gross margin, including alternative country sourcing, partnering with current vendors to lower costs and introduce new products, and adjusting its pricing. The following chart provides a timeline and tariff levels for the key events related to Section 301 Tariffs.







                                                      Section 301 tariff                   Corresponding approximate
                   Event                 Timing        level on imports  Tariff level on    percentage of Company's
                                                          from China     Subset Products merchandise subject to tariff
        Imposition of Tariffs        September 2018          10%          10% then 0%1                48%
        Increase in Tariffs             June 2019            25%          25% then 0%1                44%
        Retroactive Exemption on      November 2019          25%               0%                     10%
        Subset Products1
        Exemption Not Renewed and
        Tariffs Re-imposed on          August 2020           25%               25%                    32%
        Subset Products
                                    December 31, 2020        25%               25%                    34%
        


On November 7, 2019, the U.S. Trade Representative granted a retroactive 1 exclusion to September 2018 on Subset Products as defined in the Section 301 Tariffs section above bringing the rate to 0%.

The Company recorded a benefit of approximately $13 million of gross profit and $11 million of operating income in the fourth quarter of 2019 as a result of the retroactive exclusion of these tariffs, which did not repeat in the fourth quarter of 2020.

During the fourth quarter of 2020, the August reinstatement of tariffs began to flow through the income statement as these products were sold. This impact was partially offset by the Company's mitigation strategies.

The future impact of the reinstatement of tariffs is dependent on several factors including: 1) ongoing Company mitigation efforts for which the outcome is uncertain, 2) inventory turnover rates which were affected by COVID-19 in 2020, and 3) behavior of consumers and competitors as prices for products adjust based on supply/demand and as consumer preferences shift among product categories impacting both product sourcing and inventory turnover. It is still too early to predict the outcome of such measures adopted by the Company.

Canadian and US Store Closure Costs

During the third quarter of 2020, the Company conducted a comprehensive review of its real estate portfolio. Following the conclusion of this review, the Company made the decision to close its Canadian operations, including all eight stores in Canada, and six underperforming US locations by the end of 2020. The Company will continue to monitor store performance on an ongoing basis. The Company incurred expense of $3.8 million to close these stores in the second half of 2020. All 14 stores were closed by year end although certain clean-up activities will not be fully completed until early in 2021.

Network Security Incident

In August 2019, the Company experienced a network security incident caused by malware that prevented access to several of the Company's information technology systems and data. Stores remained open and operating throughout

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the incident, but the Company utilized manual back-up processes for approximately six days. The Company estimated the disruption caused by the event negatively impacted total revenue for the third quarter of 2019 in the range of approximately $6 million to $8 million with an attendant reduction in gross margin. The Company maintains cybersecurity and other insurance coverage and received an initial recovery from insurance in excess of $2 million in 2019. As of December 31, 2019, the Company recorded approximately $0.8 million as a receivable related to further anticipated insurance recovery. The receivable did not include any potential business interruption recovery or voluntary gains. It was recorded in "Other Current Assets" on the Consolidated Balance Sheet as of December 31, 2019 and was collected during 2020. In 2020 the Company recorded $2.5 million from the final settlement of the business interruption insurance claim in SG&A during the third quarter of 2020.

Working Capital and Liquidity

As of December 31, 2020, the Company had liquidity of $214 million, consisting of excess availability under its Credit Agreement of $44 million, and cash and cash equivalents of $170 million. This represents an increase in liquidity of $103 million from December 31, 2019. As of December 31, 2019, the Company had $111 million in liquidity, comprised of $9 million of cash and $102 million in availability under the Credit Agreement. In addition, the Company's debt balance as of December 31, 2020 was $101 million, unchanged since amending the Credit Agreement on April 17, 2020, and up $19 million from December 31, 2019. The increase in liquidity at December 31, 2020 from the year earlier was driven by improved operating performance along with disciplined working capital management. The working capital benefit included a 15% reduction in inventory due to strong sales and supply chain disruptions, collection of tariff receivables, growth in customer deposits, and higher accounts payable. The accounts payable balance was higher at the end of 2020 due to the increased in-transit inventory and extended payment terms with vendors and other service providers. In 2021, we expect inventory to return to the $270-$290 million range and other working capital accounts like customer deposits to return to more traditional levels. We also expect to maintain cash balances higher than we have historically carried until the uncertainty surrounding COVID-19 eases.

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Results of Operations

We believe the selected sales data, the percentage relationship between Net Sales and major categories in the Consolidated Statements of Operations and the percentage change in the dollar amounts of each of the items presented below are important in evaluating the performance of our business operations.







                                                                                           % Increase (Decrease)
                                                                  % of Net Sales             in Dollar Amounts
                                                             Year Ended December 31,            2020
                                                             2020            2019             vs. 2019
        Net Sales
        Net Merchandise Sales                                    88.8 %          87.5 %                 2.0 %
        Net Services Sales                                       11.2 %          12.5 %              (10.0) %
        Total Net Sales                                         100.0 %         100.0 %                 0.5 %
        Gross Profit                                             39.0 %          36.9 %                 6.0 %
        Selling, General, and Administrative Expenses            33.8 %          35.4 %               (4.0) %
        Operating Income                                          5.1 %           1.5 %               236.7 %
        Other Expense                                             0.2 %           0.3 %              (29.8) %
        Income Before Income Taxes                                4.9 %           1.2 %               314.1 %
        Income Tax Expense                                      (0.7) %           0.3 %                  NM
        Net Income                                                5.6 %           0.9 %               535.7 %
        SELECTED SALES DATA
        Average Sale1                                     $     1,343     $     1,379                 (2.6) %
        Average Retail Price per Unit Sold Increase 2             0.3 %           0.2 %
        Comparable Store Sales Decrease3                        (0.5) %         (1.0) %
        Customers Invoiced Increase (Decrease)4                   2.1 %         (2.8) %
        Number of Stores Open, end of period                      410             419
        Number of Stores Opened (Closed) in Period, net           (9)              11
        Number of Stores Relocated in Period5                       1               3
        


1 Average sale is defined as the average invoiced sales order, measured quarterly, excluding returns as well as transactions under $100 (which are generally sample orders or add-on/accessories to existing orders).

2 Average retail price per unit (square feet for flooring and other units of measures for moldings and accessories) 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 is calculated by applying the average sale to total net sales at comparable stores.

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

A detailed discussion of the 2020 year-over-year changes can be found below and should be read in conjunction with the Consolidated Financial Statements and the Notes to Consolidated Financial Statements presented in this report. A detailed discussion of the 2019 year-over-year changes can be found in "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Form 10-K filed on February 25, 2020.

Net Sales

Net sales increased $5.1 million, or 0.5%, to $1,098 million in 2020 from $1,093 million in 2019, which includes a $10.4 million increase in non-comparable store net sales partially offset by a decrease of $5.3 million, or 0.5%, in comparable store net sales. Following a 20% decrease in net sales in the second quarter due to the impact of COVID-19, the Company recovered to deliver a strong second-half performance. For the full year, comparable store

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sales slightly declined due to a decrease in average ticket of 2.6% driven by the lower attachment of installation mostly offset by a 2.1% increase in customers invoiced. Net merchandise sales increased 2%. By major category, manufactured products grew from 41% of sales in 2019 to 46% of sales in 2020, partially offset by a decline in solid and engineered hardwood products. The vinyl sub-category within manufactured products continues to drive growth due to its outstanding aesthetics, high resilience, and water-resistant characteristics. Net services sales (install and freight) decreased 10% over the prior year as the second quarter was impacted by customers' willingness to have contractors enter their home. The Company closed nine net stores in 2020, and as of December 31, 2020, operated 410 stores.

Gross Profit

Gross profit of $428 million in 2020 increased $24 million from 2019 and, as a percent of sales, gross margin in 2020 increased to 39.0% from 36.9% in 2019. Both years were impacted by the net of anti-dumping and countervailing duty rate changes, with a favorable adjustment of $2.2 million in 2020 and an unfavorable adjustment of $1.1 million in 2019. Additionally, 2020 included costs related to Canadian and US store closures and 2019 included favorable classification adjustments related to Harmonized Tariff Schedule ("HTS") duty categorization. When excluding those items in the table that follows, Adjusted Gross Profit (a non-GAAP measure) of $426 million in 2020 increased $22 million versus 2019 and Adjusted Gross Margin (a non-GAAP measure) in 2020 increased to 38.8% from 37.0% in 2019. This 180-basis point improvement in adjusted gross margin was due primarily to merchandising sourcing and cost-out efforts and, to a lesser extent, selective retail price increases. The growth of higher-margin manufactured products as a percent of sales from 2019 to 2020 also favorably impacted adjusted gross margin.

We believe that the following items set forth in the table below can distort the visibility of our ongoing

performance and that the evaluation of our financial performance can be enhanced by use of supplemental presentation of our results that exclude the impact of these items.







                                                                  Year Ended December 31,
                                                            2020                        2019
                                                      $         % of Sales        $         % of Sales
                                                                  (dollars in thousands) 1
        Gross Profit/Margin, as reported
        (GAAP)                                     $ 427,712          39.0 %  $  403,686          36.9 %
        Antidumping Adjustments 2                    (2,208)         (0.2) %       1,143           0.1 %
        HTS Classification Adjustments 3                   -             - %       (779)             - %
        Store Closure Costs 4                            822             - %           -             - %
        Sub-Total Items above                        (1,386)         (0.2) %         364           0.1 %
        Adjusted Gross Profit/Margin
        (non-GAAP measures)                        $ 426,326          38.8 %  $  404,050          37.0 %
        


1 Amounts may not sum due to rounding.

2 Represents countervailing and antidumping expense associated with applicable prior-year shipments of engineered hardwood from China.

3 Represents classification adjustments related to the HTS duty categorization in prior periods during the full year ended December 31, 2019.

4 Represents the inventory write-offs related to the Canadian and U.S. store closures described more fully in Item 8. Note 11 to the consolidated financial statements.

Selling, General and Administrative Expenses

SG&A expenses of $371 million in 2020 decreased $16 million from 2019, and as a percentage of net sales, SG&A decreased to 33.8% in 2020, compared to 35.4% in 2019. When excluding items in the table that follows, Adjusted SG&A (a non-GAAP measure) of $363 million in 2020 decreased $17 million from 2019 and, as a percentage of net sales (a non-GAAP measure), was 33.0% in 2020, a decrease of 170 basis points from 34.7% in 2019. The decrease in adjusted SG&A was primarily due to lower advertising expense of $13 million as the Company reduced its promotional cadence in response to COVID-19 and then optimized its marketing efforts, pivoting toward more efficient digital channels, as well as $2.5 million from the final settlement of the business interruption insurance claim related to the August 2019 network security incident and lower travel and entertainment expense. These savings were partially offset by higher bonus and commission reflecting the Company's strong financial performance, and higher benefits expense.

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We believe that the following items set forth in the table below can distort the visibility of our ongoing

performance and that the evaluation of our financial performance can be enhanced by use of supplemental presentation of our results that exclude the impact of these items.







                                                                Year Ended December 31,
                                                            2020                       2019
                                                      $         % of Sales       $         % of Sales
                                                                 (dollars in thousands) 5
        SG&A, as reported (GAAP)                   $ 371,430          33.8 %  $ 386,970          35.4 %
        Accrual for Legal Matters and
        Settlements 6                                  1,500           0.2 %      3,475           0.3 %
        Legal and Professional Fees 7                  4,220           0.4 %      4,169           0.4 %
        Store Closure Costs 8                          2,962           0.3 %          -             - %
        Sub-Total Items above                          8,682           0.9 %      7,644           0.7 %
        Adjusted SG&A (a non-GAAP measure)         $ 362,748          33.0 %  $ 379,326          34.7 %
        


5 Amounts may not sum due to rounding.

6 This amount represents expense of $2 million related to the Gold matter in the third quarter of 2020 partially offset by a $0.5 million insurance recovery in the second quarter of 2020 of legal fees related to certain significant legal action. 2019 reflects a $4.75 million expense for the Kramer employment case and $0.3 million for certain Related Laminate Matters partially offset by a $1.1 million insurance recovery of legal fees related to certain significant legal action. These matters are described more fully in Item 8. Note 10 to the consolidated financial statements.

7 Represents charges to earnings related to our defense of certain significant legal actions during the period. This does not include all legal costs incurred by the Company.

8 Represents the inventory write-offs related to Canadian and U.S. store closures described more fully in Item 8. Note 11 to the consolidated financial statements.

Operating Income and Operating Margin

Operating income was $56 million in 2020, compared to operating income of $17 million in 2019. When excluding items in the table that follows, Adjusted Operating Income (a non-GAAP measure) was $64 million and Adjusted Operating Margin (a non-GAAP measure) was 5.8% in 2020, compared to $25 million, or 2.3%, in 2019. The primary driver of the increase was the Company's execution on its transformation plan, which increased adjusted gross margin and reduced advertising expense.

We believe that the following items set forth in the table below can distort the visibility of our ongoing

performance and that the evaluation of our financial performance can be enhanced by use of supplemental presentation of our results that exclude the impact of these items.







                                                                Year Ended December 31,
                                                           2020                         2019
                                                     $         % of Sales       $         % of Sales
                                                                    (in thousands) 1
        Operating Income, as reported (GAAP)      $  56,282           5.1 %  $  16,716           1.5 %
        Gross Margin Items:
        Antidumping Adjustments 2                   (2,208)         (0.2) %      1,143           0.1 %
        HTS Classification Adjustments 3                  -             - %      (779)             - %
        Store Closure Costs 4                           822             - %          -             - %
        Gross Margin Subtotal                       (1,386)         (0.2) %        364           0.1 %
        SG&A Items:
        Accrual for Legal Matters and
        Settlements 6                                 1,500           0.2 %      3,475           0.3 %
        Legal and Professional Fees 7                 4,220           0.4 %      4,169           0.4 %
        . . .
        


Mar 02, 2021

COMTEX_381986510/2041/2021-03-02T06:06:44

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