Well, that was worse than expected.
Lumber Liquidators Holdings (NYSE:LL) just disappointed Mr. Market, and in a big way. The combination of declining sales and increased expenses related to a March 60 Minutes report ended up leading to a very surprising $7 million loss in the quarter. The main culprits:
- Gross profit dollars fell by $10 million, while Sales, General, & Administrative costs increased $18.6 million.
- $15.5 million in one-time charges in the quarter.
- 6.8% decrease in average selling price per product, versus unchanged average cost per product.
Factor in the confirmation that the Department of Justice will seek criminal charges related to a 2013 investigation into illegally sourced hardwood, and the surprise announcement that longtime CFO Dan Terrell will step down at the end of May, and the market is responding strongly. As of this writing near the market open, the stock is down around 20%.
While the results are certainly worse than expected, I don't know that anyone should be too surprised or disappointed. If you're a shareholder right now, you should know that the company has a tough row to hoe ahead of it. Besides, as is usually the case, once you get under the surface there are some positive trends in the sales results.
Preparing for the worst
While the company initially seemed slow to respond to the allegations that some of its products were potentially harmful to consumers, taking more than a week before presenting its case and rebutting the claims, it has taken a number of serious (and expensive) steps to both manage customer concerns and prepare for the financial impacts.
In conjunction with its earnings release, Lumber Liquidators announced that it was expanding its existing credit facility from $50 million to $100 million. On the surface this may seem troubling, but the reality is that liquidity is a hedge against uncertainty. By making this move today, the company is better positioned for any surprises that may come its way. Most importantly, this simply gives the company flexibility, especially if there are continued challenges to sales.
Beyond this step, the company spent around $5.5 million to deal with the allegations made in the 60 Minutes piece directly, including $2.3 million for air quality test kits and customer support related to concerns over formaldehyde emissions. The company also disclosed that it was accruing $10 million toward the pending criminal charges under the Lacey Act stemming from potentially illegally sourced hardwoods. This investigation started in 2013, and frankly it's good that the company will finally be able to move beyond it.
Lumber Liquidators still has a Consumer Products Safety Commission investigation that's just getting started, which will take several more months to produce results. The result of this investigation should either clear the company's name to some degree, or confirm claims that some of its products are potentially harmful to consumers. While there's a lot of evidence -- as I discussed in the earnings preview -- to indicate that the odds are relatively in Lumber Liquidators' favor, it's not a sure thing. So it's reasonable that the company is creating a margin of safety to deal with worst-case possibilities.
Sales are trending better so far in Q2
Though net sales were down about 2% as of April 28, management indicated that store traffic was up moderately in the first few weeks of the second quarter. And while a 2% decline in sales isn't good, considering that the company is operating almost 30 more stores than the year-ago period, it's definitely an improvement from the 12.8% drubbing in March.
Customer returns have also continued to stabilize. In the first two months of the year they were around 10% of orders, before spiking to above 27% in the 10 days following the 60 Minutes piece. In the last two weeks of the first quarter, customer returns fell to 13% of orders, and have fallen to around 11% of orders in April. Seeing this metric continue to fall back toward historical rates is a good sign that customers aren't having second thoughts about product safety after the fact.
Sales of laminate flooring -- specifically Chinese-made laminate, which is at the heart of the allegations against the company -- have slightly rebounded in April. All laminates were 21.2% of sales through February, but fell to 16.4% in March. Sales of Chinese-made laminate remain the lion's share of the laminate mix, but fell from 14.2% of total sales through February to 9.4% in March. Through April, laminate rebounded to 16.7% of sales, with 10.4% of sales being Chinese-made laminate. This points to customers being a little less resistant to these products than at the peak of the scare following the 60 Minutes story.
Sales and traffic are both beginning to rebound as well. Same-store sales -- or comps -- through the first two months of Q1 were up 9.7% before falling 17% in March. Through April, comps are down 7.2%. Down isn't good, but that's a major improvement from the battering following the 60 Minutes piece. After falling 11% in March, it looks like traffic (as measured by customers invoiced) is also rebounding, down about 5.9% thru April data.
Capital allocation moves
Lumber Liquidators management took several other steps to prepare the company for a possible cash crunch, suspending the share buyback program for the time being. As much as it would be nice to see it buy shares at these levels, the company is right to focus its capital efforts on navigating the uncertainty surrounding it right now.
With this in mind, the company also lowered the low end of its range for both new stores and remodels in 2015, from 30-35 new stores to 25-35 new stores, and from 15-20 remodels to 10-20. Its anticipated capital expenditures of $20 million to $30 million remained the same, but this could be adjusted down later if fewer stores are opened or remodeled.
Looking ahead: Time to be patient
Despite the fact that shares are getting hammered as of this writing, the sales trends have certainly improved since the end of the first quarter. Factor out the $15.5 million in one-time costs related to product allegations and another $1.6 million in transportation costs related to the consolidation to its East Coast distribution facility, and that would have swung the company back to a $9.3 million profit last quarter.
But one-time charges are indeed charges, and the uncertainty around the CPSC investigation -- and the risk of huge recall expenses -- is likely to continue weighing on the stock.
When it comes to investing in the company, it boils down to this: If you trust the company and think that the sales trends will continue improving, you'll still have to deal with what is sure to be a very volatile stock as this story plays out. Can you stomach the ups-and-downs to come? That's up to you to decide.