Customers are yet to start returning to Lumber Liquidators en masse. Image source: Lumber Liquidators.

Is it possible the worst is in the past for Lumber Liquidators Holdings Inc. (NYSE:LL)? After reporting its second-quarter financial results on July 27, there's a very real chance that's the case. Yes, sales fell versus the year-ago quarter, and the company reported a net loss, but sales were higher sequentially, comps declines slowed, and operating costs fell.

Don't get me wrong: This wasn't a good quarter. As long as comps continue to decline, the company won't have turned things around. But that doesn't mean there wasn't progress. Let's take a closer look.

The numbers

MetricQ2 2016Q2 2015Change
Revenue  $238.1  $247.9 (4%)
Net income ($12.2) ($20.3) (39.9%)
Earnings per share ($0.45) ($0.75) (40%)
Comps (7.2%) (13.9%)  670 basis points

Revenue and net income in millions. Data source: Lumber Liquidators.

A deeper look at the numbers

There's some good news in the results, but even the good must be taken with a grain of salt. To start, the results were down from last year, but they were a little better sequentially. In the first quarter, revenue was $233 million, the net loss came in at $32.4 million, and comp sales -- that is, sales at stores open at least one year -- fell 13.9%. In other words, the company looks to have gained at least a little traction, though it may be better to describe the result as slipping behind a little less. 

The company also reported sales, general, and administrative expenses of $89.9 million, down from last year and substantially lower than the $117.2 million in the first quarter. Lumber Liquidators also broke out some items that impacted SG&A in the quarter, such as $8.3 million in legal and professional fees, that should begin to decline once the company moves past ongoing litigation. 

But let's be frank about the comp result. 2015's second quarter was the first full quarter following the 60 Minutes special that made the allegations against the company widely known. Sales fell 6% and comps were down 10% last year, so the declines reported on July 27 were the first against a quarter already affected by the negative coverage of the company, and they were still well down. 

We're talking about a two-year comps decline of 17.2%. This isn't a recovery yet. 

At the same time, the balance sheet is in better shape than it seems. A quick look at working capital -- i.e. current assets minus current liabilities -- showed a working capital increase of $3 million in the second quarter. Debt increased by $7 million, so the company's liquidity situation really only worsened by $4 million in the quarter. This is significantly better than if we only look at the $9 million decrease in cash, and the $7 million increase in debt, and ignore the $15 million increase in inventory. 

And there's more good news. The company received a $22 million tax refund in July after quarter end, so that's an extra $22 million in capital not accounted for in the Q2 earnings filing. Add up the smaller than expected change in working capital, the cash infusion from the tax return, and the $53.7 million available on its revolving credit facility, and the company has a substantial amount of liquidity to work with. 

Major headway on its legal troubles

Lumber Liquidators also made significant progress with the numerous legal issues it has been facing since the start of the year, including:

  • California Air Resources Board investigation over allegations it was selling illegal laminate flooring resolved in Q1; found no wrongdoing. 
  • California Prop 65 lawsuit: Court entered judgement in favor of Lumber Liquidators. 
  • Consumer Products Safety Commission investigation: In mid-June, the company reached a favorable agreement with the CPSC, following completion of a study into the potential risks from Lumber Liquidators' Chinese-made laminate flooring. In short, CPSC found that the company's products weren't likely to cause any substantial risk for consumers. The CPSC will oversee the company's air quality testing program, but there were no punitive damages since CPSC didn't find any significant risk to consumers. 
  • Securities litigation matter: Parties have reached a settlement to be paid in Lumber Liquidators stock. While there will be dilution, this non-cash settlement is good for the company. Final settlement is scheduled for November. 
  • Derivative litigations: There are several ongoing cases, one which has reached a settlement that will cost the company $2.5 million, another that was settled at no cost to the company, and another that has no resolution yet. 
  • Chinese-made laminate class action suits: So far at least 10 class action cases have been consolidated into a single case. Lumber Liquidators continues to seek to have any additional federal cases filed consolidated together. There are also a number of state cases the company is facing. 
  • The company's suit with nine of its insurers has been settled, with the company and its insurers basically walking away. The good news is the company faces no damages, but the bad news is it will have no insurance coverage for the federal class action. 
  • Various other product suits: There are at least three other lawsuits at various ongoing stages dealing with other products the company sells. To date, the company is moving forward with these cases, which with one exception, cropped up following the 60 Minutes broadcast. 

Here's the good news: The positive CARB, Prop 65 lawsuit, and CPSC investigations should go a long way toward helping the company with the ongoing class action suits over laminate flooring. After all, two major government agencies have cleared the company and its products, while a California court found in the company's favor that it wasn't breaking any laws by selling the Chinese-made laminate. 

However, even if the company avoids significant damages from lawsuits, it's going to cost many millions of dollars simply to fight the cases. At some point the company must make a decision whether it will be best to settle and move on, or to continue fighting. Not only is there the legal cost, but there's also the public perception issue of this playing out in the headlines. So far, we've seen how well that's worked for the company. 

Looking ahead

Lumber Liquidators has started to make some progress, but there's still a tremendous amount of work to be done, both in dealing with the ongoing legal challenges and winning back customers. The company has made efforts to become more efficient, including getting back to basics with the products in its stores, as well as better, more consistent training for store employees in order to win more business, and also increase retention of the best employees. 

Given time, the company can recover from this. It's not the only retailer to face a major scandal. It's just far from clear how long it's going to take for that to happen. 

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.