Lumber Liquidators 2010 Annual Report Download - page 43

trends and experience. 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. In addition, customers
who do not take immediate delivery of their purchases are generally required to leave a deposit of up to 50% of the retail
sales amount with the balance payable when the products are delivered. These customer deposits benefit our cash flow and
return on investment capital, since we receive partial payment for our customers’ purchases immediately. We record these
deposits as a liability on our balance sheet under the line item “Customer Deposits and Store Credits” until the customer
takes possession of the merchandise.
Merchandise Inventories
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.
Stock-Based Compensation
We currently maintain a single equity incentive plan under which we may grant non-qualified stock options, incentive
stock options and restricted shares 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. Measured compensation cost is recognized ratably over
the service period of the 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 2010:
• Expected life of 3.5 to 7.5 years;
• Expected stock price volatility of 45%;
• Risk-free interest rates from 1.9% to 3.2%; and
• Dividends are not expected to be paid in any year.
The expected stock price volatility range is based on 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 life 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 lives of our options, our
stock-based compensation expense and result of operations could have been different.
Item 7A. 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.
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