Lumber Liquidators 2011 Annual Report Download - page 42

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, restricted shares 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. 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 2011:
• Expected life of 7.5 years;
• Expected stock price volatility of 45%;
• Risk-free interest rates from 1.7% to 3.0%; 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.
New Accounting Pronouncements
In September 2011, the FASB issued guidance that revises the requirements around how entities test goodwill for
impairment. The guidance allows companies to perform a qualitative assessment before calculating the fair value of the
reporting unit. If entities determine, on the basis of qualitative factors, that the fair value of the reporting unit is more likely
than not greater than the carrying amount, a quantitative calculation would not be needed. We will adopt this guidance for
our fiscal 2012 annual goodwill impairment test.
In June 2011, the FASB issued guidance that revises the manner in which entities present comprehensive income in
their financial statements. The guidance requires entities to report the components of comprehensive income in either a
single, continuous statement or two separate but consecutive statements. We early adopted this guidance for our fiscal 2011
financial statements, and have presented the components of comprehensive income in a separate but consecutive statement.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Interest Rate Risk.
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.
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