3 Key Takeaways From Lumber Liquidators Holdings Inc Earnings

Reversing weak traffic and managing costs are major concerns. Source: Lumber Liquidators.

Beleaguered wood-flooring retailer Lumber Liquidators Holdings Inc (LL) reported financial results on February 29, and it was more of the same painful numbers that the company has delivered since about this time last year, when allegations were made that the company was selling Chinese-made laminate flooring with potentially hazardous levels of formaldehyde. 

A year later, and a lot has changed, but ongoing investigations have continued to play out, keeping the story in the news cycle, and driving away customers. Here's a closer look at the company's results last quarter and for the full year, as well as key takeaways on what's happening, particularly what management is doing to turn things around. 

The numbers 
Full-year 2015:

Revenue, net income, and operating profit in millions. Source: Lumber Liquidators.

Takeaway 1. The Chinese laminate story won't die 
It's been a year since 60 Minutes ran its report that the company's Chinese-made laminate was potentially harmful due to high formaldehyde emissions. A recent report issued by the CDC in a joint effort with the Consumer Products Safety Commission initially indicated relatively low risk, before a revision indicated that the exposure levels could be higher. Apparently, someone at the CDC can't use a calculator or Excel.

Without belaboring the details, the key takeaway of the report and the CDC's recommendations -- which were that most homeowners would probably need to do nothing more than increase ventilation temporarily, and that it wasn't recommending replacing the flooring -- remained unchanged. But that didn't stop the national press from running with the story. 

As long as this remains in the news cycle, that's bad for Lumber Liquidators. This takes me to the second takeaway...

Takeaway 2. Store traffic fell again, and further 
Comparable sales, which are sales at stores open at least one year, fell 11.1% in 2015, with an 8.1% decline in the number of customers invoiced. In the fourth quarter, comps were down 17.2%, and the number of customers invoiced was down 15.6%. This compares to a 14.6% comps decline in the third quarter, and a 13% decline in the number of customers invoiced. 

Bottom line: The number of customers invoiced declined at a higher rate in the fourth quarter than in the third, so the negative sentiment may have not reversed. CEO John Presley is keenly aware of this, and thinks, in part, it's a matter of not doing enough to earn customers' business. He said the following on the earnings call:

It is clear to me, we are missing opportunities to close sales at the store level. ... We are executing a number of initiatives, one of which is sales learning, to help deliver improved services to customers. This isn't about pressure sales or to get the customer to do what you [we] want. This is about helping the customer get what they want.

Takeaway 3. Keeping an eye on working capital changes and non-recurring expenses
The company ended the year with $26.7 million in cash and equivalents, and $20 million in debt. The debt level remained constant sequentially, but cash fell sharply, from $53.8 million at the end of Q3. Furthermore, inventory remained at about $244 million. This is a sharp drop from $314 million worth of inventory one year ago, and no debt.

Management said that they used another $10 million on the revolver early in 2016 to fund inventory purchases, leaving the company with $57 million in available liquidity above and beyond its $26.7 million in cash. Add it all up, and the company ended the year with $54.4 million less working capital than it started with. 

CFO Greg Whirley said the following:

I'll highlight a couple of things for you. First, we are focusing on our existing stores which we talked about before, and less on new store expansion right now. We believe it's going to benefit us, and I said I won't commit to no new stores -- in fact that we referred to a couple that we'll open or opened in Q1. But any new stores that we open are going to have to pass a high level of scrutiny. The idea here is again in 2016 we are going to make sure that we're managing our expenses to keep the liquidity equation equal for the company, or at least on the positive side.

There were a number of expenses from 2015 that should not recur, including $9.4 million in air quality testing expenses, $37 million in legal and professional fees and settlement expenses, $16.2 million in asset impairment and employee retention charges, and $22.5 million in inventory writedown charges. 

Of these, $51.7 million were cash expenses, almost equal to the company's net loss, and just below the decrease in working capital over the year. The company also spent $22.5 million on capital expenditures in 2015, and plans to spend as little as $10 million this year.

In other words, if non-recurring expenses return to "normal" in 2016, and the company does reduce capital expenditures, that would make a huge impact on working capital even if it does take some time for sales to recover. 

Looking ahead: Bring back customers; keep tightening the belt
The reality is, as long as there are ongoing investigations, there will continue to be bad press, and that could continue to negatively impact customer traffic for the flooring retailer. So while efforts to turn the tide of customer sentiment are hugely important, the company is also making efforts to improve its operating structure. 

To wit, the company hired Dennis Knowles as Chief Operating Officer. Knowles comes to the company from Lowe's, where he was Chief Store Operations Officer. The plan is that his expertise will help continue driving down costs, while still providing strong support to stores. 

As things stand today, Lumber Liquidators is probably in better shape than Mister Market thinks. But until customer perception starts turning back in its favor, it's probably going to remain a bumpy ride for investors.