LL Flooring Holdings, Inc. - Quarter Report: 2010 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

For the quarterly period ended September 30, 2010

or

For the transition period from            to            

Commission File Number: 001-33767

Lumber Liquidators Holdings, Inc.

(Exact name of registrant as specified in its charter)

(757) 259-4280

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 of 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    x  Yes    ¨  No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    ¨  Yes    ¨  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    ¨  Yes    x  No

As of November 8, 2010, there were 27,424,089 shares of the registrant’s common stock, par value of $0.001 per share, outstanding.

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LUMBER LIQUIDATORS HOLDINGS, INC.

Quarterly Report on Form 10-Q

For the quarter ended September 30, 2010

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PART I

FINANCIAL INFORMATION

Item 1. Financial Statements.

Lumber Liquidators Holdings, Inc.

Condensed Consolidated Balance Sheets

(in thousands, except share data)

See accompanying notes to condensed consolidated financial statements

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Lumber Liquidators Holdings, Inc.

Condensed Consolidated Statements of Income

(in thousands, except share data and per share amounts)

(unaudited)

See accompanying notes to condensed consolidated financial statements

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Lumber Liquidators Holdings, Inc.

Condensed Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

See accompanying notes to condensed consolidated financial statements

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Lumber Liquidators Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

(amounts in thousands, except share data and per share amounts)

(unaudited)

Nature and Organization of Business

Lumber Liquidators Holdings, Inc. and its subsidiaries (the “Company”) is a multi-channel specialty retailer of hardwood flooring, and hardwood flooring enhancements and accessories, operating as a single business segment. The Company offers an extensive assortment of exotic and domestic hardwood species, engineered hardwoods and laminates direct to the consumer. The Company also features the renewable flooring products, bamboo and cork, and provides a wide selection of flooring enhancements and accessories, including moldings, noise-reducing underlay and adhesives. These products are primarily sold under the Company’s private label brands, including the premium Bellawood brand floors. The Company sells primarily to homeowners or to contractors on behalf of homeowners through a network of 213 store locations in primary or secondary metropolitan areas in 46 states. In addition to the store locations, the Company’s products may be ordered, and customer questions/concerns addressed, through both the call center in Toano, Virginia, and the website, www.lumberliquidators.com. The Company finishes the majority of the Bellawood products on its finishing line in Toano, Virginia, which along with the call center, corporate offices, and distribution center, represent the “Corporate Headquarters.”

Basis of Financial Statement Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q for interim financial reporting pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). While these statements reflect all normal recurring adjustments which are, in the opinion of management, necessary for a fair presentation of the results of the interim period, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles (“U.S. GAAP”) for complete financial statements. Therefore, the interim condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes included in the Lumber Liquidators Holdings, Inc. annual report filed on Form 10-K for the year ended December 31, 2009.

The consolidated financial statements of the Company include the accounts of its wholly owned subsidiaries. All significant intercompany transactions have been eliminated in consolidation.

Results of operations for the three and nine months ended September 30, 2010 are not necessarily indicative of the results to be expected for the full year.

Fair Value of Financial Instruments

The carrying amounts of financial instruments such as cash and cash equivalents, notes receivable, accounts payable and other liabilities approximate fair value because of the short-term nature of these items. Of these financial instruments, the cash equivalents are classified as Level 1 as defined in the Financial Accounting Standards Board ASC 820 fair value hierarchy. The Company had cash equivalents of $11,045 at September 30, 2010 and $27,022 at December 31, 2009.

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The following table sets forth the computation of basic and diluted net income per common share:

The following have been excluded from the computation of Weighted Average Common Shares Outstanding—Diluted because the effect would be anti-dilutive:

As of September 30, 2010, the Company leased the Corporate Headquarters and 25 of its store locations from ANO LLC, a company that is wholly owned by the Company’s founder and current chairman of the Board (the “Founder”). The Company also leased one store location from Wood on Wood Road, Inc. and one store location from BMT Holdings, LLC. Wood on Wood Road, Inc. is wholly owned by the Founder, and 50% of the membership interest of BMT Holdings, LLC is owned by the Founder. Rental expense related to these companies for the three and nine months ended September 30, 2010 was $660 and $1,978, respectively. Rental expense related to these companies for the three and nine months ended September 30, 2009 was $630 and $1,902, respectively.

On September 3, 2009, a former store manager and a current assistant store manager at the time (together, the “Plaintiffs”) filed a putative class action suit against Lumber Liquidators, Inc. (“LLI”) in the Superior Court of California in and for the County of Alameda. The Plaintiffs allege that with regard to certain groups of current and former employees in LLI’s California stores, LLI violated California law by failing to calculate and pay overtime wages properly, provide meal breaks, compensate for unused vacation time, reimburse for certain expenses and maintain required employment records. The Plaintiffs also claim that LLI did not calculate and pay overtime wages properly for certain of LLI’s non-exempt employees, both in and out of California, in violation of federal law. In their suit, the Plaintiffs seek compensatory damages, certain statutory penalties, costs, attorney’s fees and injunctive relief. LLI removed the case to the United States District Court for the Northern District of California. No class has been certified with regard to any of the alleged causes of action. LLI is vigorously defending the claims in this suit including class certification. While there is a reasonable possibility that a material loss may be incurred, the Company cannot estimate the loss or range of loss, if any, to the Company at this time.

On or about September 7, 2010, a former store manager filed an action against LLI in the United States District Court for the Middle District of Florida. In the complaint, the former store manager alleges that LLI breached an alleged contract for the payment of a commission and violated the Fair Labor Standards Act (“FLSA”) by failing to pay him for overtime hours worked. In addition, he asserts a purported collective action on behalf of similarly situated LLI employees alleging that LLI denied them overtime wages in violation of the FLSA. No class has been certified with regard to the purported collective action. LLI intends to defend the claims in this suit vigorously including collective action certification. While there is a reasonable possibility that a material loss may be incurred, the Company cannot estimate the loss or range of loss, if any, to the Company at this time.

The Company also is, from time to time, subject to claims and disputes arising in the normal course of business. In the opinion of management, while the outcome of any such claims and disputes cannot be predicted with certainty, the ultimate liability of the Company in connection with these matters is not expected to have a material adverse effect on the Company’s results of operations, financial position or cash flows.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Cautionary Note Regarding Forward-Looking Statements

This report includes statements of our expectations, intentions, plans and beliefs that constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 and are intended to come within the safe harbor protection provided by those sections. These statements, which involve risks and uncertainties, relate to matters such as sales growth, comparable store net sales, impact of cannibalization, price changes, earnings performance, stock-based compensation expense, margins, return on invested capital, strategic direction, the demand for our products, and store openings. We have used words such as “may,” “will,” “should,” “expects,” “intends,” “plans,” “anticipates,” “believes,” “thinks,” “estimates,” “seeks,” “predicts,” “could,” “projects,” “potential” and other similar terms and phrases, including references to assumptions, in this report to identify forward-looking statements. These forward-looking statements are made based on expectations and beliefs concerning future events affecting us and are subject to uncertainties, risks and factors relating to our operations and business environments, all of which are difficult to predict and many of which are beyond our control, that could cause our actual results to differ materially from those matters expressed or implied by these forward-looking statements. These risks and other factors include those listed in this report and in our other reports filed with the SEC, including the Item 1A, “Risk Factors,” section of the Form 10-K for the year ended December 31, 2009.

When considering these forward-looking statements, you should keep in mind the cautionary statements in this report and the documents incorporated by reference. New risks and uncertainties arise from time to time, and we cannot predict those events or how they may affect us. There may also be other factors that we cannot anticipate or that are not described in this report that could cause results to differ materially from our expectations. Forward-looking statements speak only as of the date they are made and we assume no obligation to update them after the date of this report as a result of new information, future events or subsequent developments, except as required by the federal securities laws.

This management discussion should be read in conjunction with the financial statements and notes included in Part I, Item 1. “Financial Statements” of this quarterly report and the audited financial statements and notes and management discussion included in our annual report filed on Form 10-K for the year ended December 31, 2009.

Overview

Lumber Liquidators is the largest specialty retailer of hardwood flooring in the United States, based on industry sources and our experience. We believe we have achieved a reputation for offering great value, superior service and a broad selection of high-quality hardwood flooring products. We offer an extensive selection of premium hardwood flooring products under multiple proprietary brands at everyday low prices designed to appeal to a diverse customer base. We believe that our vertically integrated business model enables us to offer a broad assortment of high-quality products to our customers at a lower cost than our competitors. As of September 30, 2010, we sold our products through 213 Lumber Liquidators stores in 46 states, a call center, websites and catalogs.

2010 Highlights

SAP Implementation.

Overview. In June 2009, we signed a software license agreement with SAP Retail, Inc. (“SAP”) for a broad scope of SAP retail software products to implement an integrated business solution in multiple phases. On August 21, 2010, we implemented the first, and most significant, phase, which included:

These new management information solutions were fully integrated with our website, call center and customer service systems.

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All critical information was converted from our previous information system and we have continued to operate our business without interruption since the conversion. However, the implementation of this system had a pervasive impact across our operations, primarily resulting in reduced productivity in our store and warehouse operations, adversely impacting our results in the quarter ended September 30, 2010. This reduction in productivity included:

The reduction in productivity was greatest in the initial weeks following implementation. Although the Company did not reach pre-implementation productivity by the end of the third quarter, operational efficiency and effectiveness improved during September and improvement has continued in the fourth quarter of 2010. Additional resources were allocated to address specific areas of concern in September, and we will continue to dedicate appropriate resources through the remainder of 2010 to improve operating productivity. In addition, general operating familiarity improved with continued execution. In an effort to focus appropriate resources on serving our domestic customers, we have postponed the opening of our first stores in Canada until the first quarter of 2011.

We remain confident in the long-term benefits of the integrated solution, and we believe our operations will ultimately benefit from enhancements not available through our previous information system. We expect the SAP system to enable us to further increase the discipline and efficiency with which we manage operations, and improve communication across our organization to support our growth plans. Our new system provides us with a platform that can grow and evolve as our supply chain network changes through additional warehouses and distribution centers. The new platform will also help facilitate our international expansion into Canada and other locations beyond North America, as well as the electronic exchange of information with our business partners. Additionally, we believe that we will benefit from better inventory information that will enable more precise allocations, automation of manual processes and improved management visibility which ultimately should positively impact net sales and margin dollars. We expect to enter 2011 with enhanced system capabilities that will offer us the opportunity to gain sales momentum and market share.

Impact on Third Quarter Results. Reduced productivity related to our SAP implementation impacted both our results of operations for the quarter ended September 30, 2010 and our financial position at that date, including:

For the period of the third quarter prior to the implementation:

For the full month of August 2010, net sales increased only 1.8% in comparison to August 2009, and at our comparable stores, decreased 8.3%. In September 2010, net sales decreased 2.0% in comparison to September 2009 and comparable store net sales decreased 12.6%.

Customer demand, as evidenced by customer deposits on open orders, grew from $13.4 million at implementation to $16.1 million at the end of August 2010 and at September 30, 2010, our balance sheet reflects customer deposits and store credits of $21.3 million. In comparison, the balance was $12.2 million at September 30, 2009.

Customer deposits have historically represented one-half to two-thirds of our open orders at any given point in time. Our open orders are those where the customer has placed an order, but has not yet taken possession of the product. We generally require a 50% deposit on an open order, but depending on order-specific circumstances, we may receive a greater deposit. We recognize revenue when the customer takes possession of the merchandise, and until that time, a customer deposit is a liability on our balance sheet.

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We estimate this build in customer deposits over historic norms and over our expectations during the third quarter equated to approximately $12.0 million to $14.0 million in unrealized net sales during the third quarter.

Prior to implementation, we significantly reduced product flow in preparation for a physical inventory at points within our distribution network, including our central warehouse operation. In the first few weeks following implementation, we were not able to re-establish the product flow as quickly as expected. Though we returned to anticipated levels of product distribution in mid-September, the unit count shipped during the third quarter of 2010 was significantly lower than our expectations. In addition, delays in shipping products necessary to fulfill orders resulted in more expedited modes of transportation, generally at higher costs.

We have historically utilized cycle counts of physical inventory on a sample basis to adjust our inventory reserves during the year, and performed a full physical count of all locations simultaneously in conjunction with our year-end closing procedures. Our annual shrinkage has generally been immaterial, and our related reserve is combined with an analysis of obsolescence. Together, those reserves were $0.6 million and $0.5 million at December 31, 2009 and December 31, 2008, respectively. As a result of physical inventory procedures performed prior to implementation, our evaluation of productivity within the new inventory control systems, and our general quarterly review procedures related to inventory, we increased our inventory reserve for loss and obsolescence. This reserve was $1.7 million at September 30, 2010 and $1.0 million at September 30, 2009.

The reduction in warehousing and merchandising productivity also impacted our finishing operations for the first few weeks following implementation. We finished fewer units per hour in comparison to historic norms due to the physical inventory procedures and slower ramp up of operations after implementation.

Through September 30, 2010, we had capitalized approximately $13.9 million related to our new integrated system, including work allowing for international operations. We now expect an additional $1.5 million to $2.5 million in capitalized costs by the end of 2010. We had previously expected capitalized costs to reach a total of $13.0 million for the project by the end of 2010. Increases were primarily a result of scope expansion and the development of processes to enhance the visibility and the reporting required to stabilize the system after implementation and generally moderate the loss of productivity.

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Expectations and Risks for the Fourth Quarter. We continue to experience the impacts of reduced productivity in the fourth quarter of 2010, though operational efficiency and effectiveness are improving. We currently expect to regain much of the pre-implementation productivity during the fourth quarter, but we anticipate that achievement will continue to require resources greater than expected. Amongst our key challenges in the fourth quarter:

Outlook.

In addition to the productivity challenges described above, we believe that, relative to historical metrics, the wood flooring market is likely to remain in a weakened state through the remainder the fourth quarter of 2010. The wood flooring market for homeowners is highly fragmented and dependent on home-related discretionary spending, which is impacted by a number of complex economic and demographic factors that may vary locally, regionally and nationally. Many of the economic indicators associated with the wood flooring market and generally associated with consumer discretionary spending remain weak. While our results have been impacted by the implementation of our integrated business solution, we continue to believe we deliver a unique value proposition to our customers, which translates to gains in our share of the wood flooring market.

Based on our results to date and current trends, we expect the following for the fourth quarter and full year 2010:

Results of Operations

Net Sales

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Net sales for the third quarter of 2010 increased $6.7 million, or 4.7%, over the third quarter of 2009 as a result of an increase of $14.7 million in non-comparable store net sales which was partially offset by a decrease of $8.0 million in comparable store net sales. Net sales for the nine months ended September 30, 2010 increased $59.6 million, or 14.6%, over the same prior year period as a result of a $9.9 million increase in comparable store net sales and an increase of $49.7 million in non-comparable store net sales. In addition to effects from our system implementation, our net sales have been impacted by the following factors:

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Gross Profit and Gross Margin

Gross profit increased $0.6 million and $17.5 million, or 1.1% and 11.9%, for the three and nine month periods ended September 30, 2010, respectively, from the comparable prior year periods. The gross margin decline in comparing the three and nine months ended September 30, 2010, to those ended September 30, 2009, was primarily due to the following factors:

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Operating Income and Operating Margin

Operating income for the third quarter ended September 30, 2010 decreased $5.6 million over the third quarter of 2009 as the $0.6 million increase in gross profit discussed above was offset by a $6.2 million increase in SG&A expenses. SG&A expenses for the third quarter of 2010 included approximately $0.5 million in incremental expenses related to the SAP system implementation. Operating income for the nine months ended September 30, 2010 increased $0.8 million over the same period in 2009 as the $17.5 million increase in gross profit discussed above was primarily offset by a $16.7 million increase in SG&A expenses. The increases in SG&A expenses were principally due to the following factors:

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Provision for Income Taxes

The effective tax rate increased to 38.7% for the third quarter of 2010 from 38.3% in the third quarter of 2009 primarily due to the absence of certain favorable one-time adjustments recorded in the prior year. The effective tax rate for the nine month period ended September 30, 2010 decreased from the comparable 2009 period primarily due to lower state income taxes.

Net Income

Net income decreased 44.8% comparing the third quarter of 2010 to 2009, and increased 2.8% comparing the nine months ended September 30, 2010 to the nine months ended September 30, 2009.

Seasonality

Our net sales fluctuate slightly as a result of seasonal factors, and we adjust merchandise inventories in anticipation of those factors, causing variations in our build of merchandise inventories. We experience slightly higher net sales in spring and fall, when more home remodeling and home building activities are taking place, and slightly lower net sales in holiday periods and during the hottest summer months. These seasonal fluctuations, however, are minimized to some extent by our national presence, as markets experience different seasonal characteristics.

Liquidity and Capital Resources

Our principal liquidity requirements have been to meet our working capital and capital expenditure needs. Our principal sources of liquidity are $26.8 million of cash and cash equivalents at September 30, 2010, our cash flow from operations and our $25.0 million of availability under a revolving credit facility. We expect to use this liquidity for general corporate purposes, including providing additional long-term capital to support the growth of our business (primarily through opening new stores) and maintaining our existing stores. We believe that our cash flow from operations, together with our existing liquidity sources, will be sufficient to fund our operations and anticipated capital expenditures over at least the next 24 months.

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In 2010, we expect capital expenditures to total between $18 million and $21 million. In addition to general capital requirements, we have or intend to:

Cash and Cash Equivalents

During the first nine months of 2010, cash and cash equivalents decreased $8.9 million to $26.8 million. The decrease of cash and cash equivalents was primarily due to $3.0 million of net cash provided by operating activities and $1.3 million in proceeds from the exercise of stock options, offset by the use of $14.1 million to purchase property and equipment.

During the first nine months of 2009, cash and cash equivalents increased $21.6 million to $56.8 million. The increase of cash and cash equivalents was primarily due to $26.4 million of net cash provided by operating activities and $2.6 million in proceeds from the exercise of stock options, partially offset by the use of $8.1 million to purchase property and equipment.

Merchandise Inventories

Merchandise inventories at September 30, 2010 increased $23.6 million from December 31, 2009, as an increase in available for sale inventory of $33.4 million was offset by a decrease in inbound in-transit inventory of $9.8 million. We consider merchandise inventories either “available for sale” or “inbound in-transit,” based on whether we have physically received the products at our central distribution center in Toano, Virginia, at an individual store location, or in another facility where we control and monitor inspection, including the China consolidation center.

Merchandise inventories and available inventory per store in operation were as follows:

Available inventory per store at September 30, 2010 is higher than December 31, 2009 primarily due to reduced productivity as a result of the SAP implementation and strategic increases in available inventory for certain product lines. Available inventory per store at September 30, 2010 is higher than September 30, 2009 due to these same factors, as well as the implementation of our “never out of stock” program in the fourth quarter of 2009.

The build in open demand resulting from reduced productivity subsequent to our SAP implementation is estimated to have increased inventory carrying levels by approximately $8.0 million. In addition, available for sale inventory is substantially higher than our expectations due primarily to the following:

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We increased inventory carrying levels prior to our SAP implementation, and we continued to take advantage of opportunities to drive demand in the fourth quarter of 2010. However, we continue to expect our available inventory per store at December 31, 2010 to be lower than the level at December 31, 2009.

Cash Flows

Operating Activities. Net cash provided by operating activities was $3.0 million for the nine months ended September 30, 2010, and $26.4 million for the nine months ended September 30, 2009. Net cash provided by operating activities decreased due primarily to a build of merchandise inventories, as previously discussed, and the timing of inventory receipts which reduced accounts payable, partially offset by an increase in customer deposits and store credits.

Investing Activities. Net cash used in investing activities was $14.1 million for the nine months ended September 30, 2010 and $8.1 million for the nine months ended September 30, 2009. Net cash used in investing activities for the first nine months of 2010 included $8.2 million related to our integrated business solution, of which $3.6 million was spent in the third quarter of 2010. During both the three and nine months ended September 30, 2009, we had capitalized approximately $2.8 million in total expenditures related to this initiative. In addition, net cash used in investing activities during the first nine months of both 2010 and 2009 included capital purchases of store fixtures, equipment and leasehold improvements for the new stores opened in the first nine months, routine capital purchases of computer hardware and software, and certain leasehold improvements in our Corporate Headquarters.

Financing Activities. Net cash provided by financing activities was $2.3 million for the nine months ended September 30, 2010 and $3.3 million for the nine months ended September 30, 2009, primarily attributable to proceeds from the exercise of stock options.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements or other financing activities with special-purpose entities.

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 have had no significant changes in our critical accounting policies and estimates since our last annual report on Form 10-K for the year ended December 31, 2009.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Interest Rates.

We are exposed to interest rate risk through the investment of our cash and cash equivalents. We invest our cash in short-term investments with maturities of three months or less. Changes in interest rates affect the interest income we earn, and therefore impact our cash flows and results of operations. In addition, any future borrowings under our revolving credit agreement would be exposed to interest rate risk due to the variable rate of the facility.

We currently do not engage in any interest rate hedging activity and currently have no intention to do so in the foreseeable future. However, in the future, in an effort to mitigate losses associated with these risks, we may at times enter into derivative financial instruments, although we have not historically done so. We do not, and do not intend to, engage in the practice of trading derivative securities for profit.

Item 4. Controls and Procedures.

Evaluation of disclosure controls and procedures. Our management evaluated, with the participation of our Chief Executive Officer and our Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this quarterly report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.

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Changes in internal control over financial reporting. We have made significant changes to our internal control over financial reporting to address the implementation of the SAP system that occurred during the third quarter of 2010. Our third quarter 2010 implementation included point-of-sale, warehouse management, merchandising, product allocation, general ledger and related management reporting systems. Our internal controls impacting these processes and systems, including information technology general controls, significantly changed or were modified in the third quarter of 2010.

PART II

OTHER INFORMATION

Item 1. Legal Proceedings.

On September 3, 2009, a former store manager and a current assistant store manager at the time (together, the “Plaintiffs”) filed a putative class action suit against LLI in the Superior Court of California in and for the County of Alameda. The Plaintiffs allege that with regard to certain groups of current and former employees in LLI’s California stores, LLI violated California law by failing to calculate and pay overtime wages properly, provide meal breaks, compensate for unused vacation time, reimburse for certain expenses and maintain required employment records. The Plaintiffs also claim that LLI did not calculate and pay overtime wages properly for certain of LLI’s non-exempt employees, both in and out of California, in violation of federal law. In their suit, the Plaintiffs seek compensatory damages, certain statutory penalties, costs, attorney’s fees and injunctive relief. LLI removed the case to the United States District Court for the Northern District of California. No class has been certified with regard to any of the alleged causes of action. LLI is vigorously defending the claims in this suit including class certification. While there is a reasonable possibility that a material loss may be incurred, we cannot estimate the loss or range of loss, if any, to us at this time.

On or about September 7, 2010, a former store manager filed an action against LLI in the United States District Court for the Middle District of Florida. In the complaint, the former store manager alleges that LLI breached an alleged contract for the payment of a commission and violated the FLSA by failing to pay him for overtime hours worked. In addition, he asserts a purported collective action on behalf of similarly situated LLI employees alleging that LLI denied them overtime wages in violation of the FLSA. No class has been certified with regard to the purported collective action. LLI intends to defend the claims in this suit vigorously including collective action certification. While there is a reasonable possibility that a material loss may be incurred, we cannot estimate the loss or range of loss, if any, to us at this time.

We also are, from time to time, subject to claims and disputes arising in the normal course of business. In the opinion of management, while the outcome of any such claims and disputes cannot be predicted with certainty, our ultimate liability in connection with these matters is not expected to have a material adverse effect on our results of operations, financial position or cash flows.

Item 1A. Risk Factors.

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, Item 1A, “Risk Factors,” in our annual report on Form 10-K for the year ended December 31, 2009, which could materially affect our business, financial condition or future results. Other than the risk factor described below, there have been no material changes to those risk factors since we filed our fiscal 2009 annual report on Form 10-K. The risks described in our annual report on Form 10-K are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or results of operations.

If we are unable to regain productivity levels as quickly as anticipated in the aftermath of the SAP ® system implementation or if subsequent phases of the implementation are unsuccessful, our operations and anticipated results may be impacted.

On August 22, 2010, we implemented the most significant phase of our integrated business solution from SAP. The implementation had a pervasive impact on our information systems and across all of our operations, including store operations, merchandising, technology and finance. Although we believe that we will regain much of our pre-implementation productivity during the fourth quarter of 2010, it is possible that our operational efficiency and effectiveness will not recover as quickly as we anticipate. Further, as we continue to utilize the system, other issues may arise that could impact our operations and results. In such circumstances, there may be additional adverse effects on our capital resources, financial condition, results of operations and liquidity.

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Although the most significant phase of the SAP system was implemented in August 2010, we anticipate that there will be subsequent phases. Although such subsequent phases are significantly smaller in scope, difficulties relating to the implementation of these subsequent phases may negatively impact our operations and results.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

None.

Item 3. Defaults Upon Senior Securities.

None.

Item 4. (Removed and Reserved).

Item 5. Other Information.

None.

Item 6. Exhibits.

The exhibits listed in the exhibit index following the signature page are furnished as part of this report.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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EXHIBIT INDEX

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