Answering Questions About Lumber Liquidators by Whitney Tilson, Seeking Alpha.

Summary

  • I have no connection to Sunshine Park, Larson/GCM or Drury.
  • Tom Sullivan is grasping at straws in trying to link me to Barry Minkow.
  • Regulators appear to be moving quickly, but it will still likely take months before any take action.
  • A response to Lumber Liquidators’ highly misleading and disingenuous statements on testing.
  • Regulatory action won’t drive the stock to zero immediately; if that happens, it will likely happen over time due to lawsuits.
  • How to analyze the tests 60 Minutes did.

I no longer read the message boards for the articles I publish because the attacks from anonymous trolls causes me too much agita, but I do want to hear thoughtful comments and questions so I invited my readers to communicate directly with me via Seeking Alpha messaging. Seven people took me up on this offer, so I posted my replies on the message board and wanted to share them more broadly here.

Question 1 (from Eric):

Dear Mr. Tilson,

I appreciate your effort of answering the questions that many of us have had. Would you consider provide further transparency and give us some information about your connection to GCM and its joint plaintiff Sunshine Park LLC? Lumber Liquidators had claimed that GCM and Sunshine Park LLC are motivated by short sellers, but Sunshine Park LLC had remained silent through the trial. Do you know anything about who is behind this entity?

Thank you for your time, and I look forward to your answer.

My reply:

Dear Eric,

Thank you for your question. It’s an easy one: contrary to the company’s claim that “These attacks are driven by a small group of short-selling investors who are working together…”, there’s no such conspiracy (at least to my knowledge). I have no idea who the hedge fund(s) are behind Sunshine Park LLC, nor have I met or had any communication with Denny Larson, the executive director of Global Community Monitor, or Richard Drury, the prominent environmental attorney, both of whom were featured in the 60 Minutes story.

I can only assume that the hedge fund(s) behind Sunshine Park figured out, as I did, that Lumber Liquidators was poisoning its customers, but chose a different route than I did to be an activist (by hiring Larson and Drury).

Question 2 (paraphrasing questions from multiple people):

Lumber Liquidators’ founder and Chairman, Tom Sullivan, accused you at the end of his CNBC interview of being linked to twice-convicted felon Barry Minkow. What is your response?

My reply:

Tom Sullivan’s attempt to smear me by association shows how desperate (and clueless) he is.

This is an old and not-very-interesting story, but here goes: After Minkow finished serving 7½ years in prison for the ZZZZ Best scam, he appeared to have turned over a new leaf, becoming a pastor and doing great work uncovering frauds. His original targets were penny stock companies and Ponzi schemes – and, as former fraudster himself, he was very good at identifying frauds/scams to the point where he became a guest on Your World with Neil Cavuto as a fraud expert, was profiled by The Wall Street Journal, Bloomberg News and 60 Minutes (how ironic, eh?), and received a letter of commendation from the FBI for bringing something like 18 scams to their attention so they could shut them down.

He ended up establishing the Fraud Discovery Institute, a for-profit investigative firm, and some of his early work was top-notch, pioneering research on the multi-level marketing industry. I thought the industry was (and still is!) really scummy and had a short position in Usana at the time, so I signed up for Minkow’s service, paid him $70k from May 2007 through April 2008, and he shared his research on the MLM industry with me. (I also liked the idea of a fraudster turned fraud-catcher and wanted to support him, as I believed – very wrongly, as later events showed – in his redemption story.)

Then his research slowed to a trickle, so I stopped paying him and we lost contact.

In 2009, unbeknownst to me, he began a reprehensible short-and-distort campaign against Lennar (NYSE:LEN), the homebuilder. Lennar sued him, showed what he was doing, and a judge sent him back to prison in 2011 to serve a richly-deserved five-year sentence. (See Wikipedia for the full story.)

I had nothing to do with any of this, but Sullivan is obviously insinuating that I’m doing to his company what Minkow tried to do to Lennar. This is, of course, absurd.

I am guilty of perhaps wasting my money and certainly being a bad judge of character in this particular instance – a master con man fooled me (and a lot of other folks) – but that’s all.

Question 3 (from Ray):

“I value what you do and it is not always easy to be facing off an evil doing company or entity.

What is puzzling to me is that why California CARB regulatory agency has not stepped forward to put an end to the mis-labeling practices of Lumber Liquidators or other companies doing the same?

Is there anything that we can do to help?”

My reply:

Dear Ray,

Thanks for your question. I’m not surprised that CARB hasn’t taken any action yet. My experience with most regulatory agencies is that they take forever to take action, even in the most obvious cases of wrongdoing. In fairness, it can take time to document everything, to ensure that whatever action they take will hold up in court when the company inevitably countersues/appeals.

I think there’s a lot of scrutiny/pressure on CARB (and other regulatory agencies like the Consumer Product Safety Commission), however, so I’d be surprised if there isn’t meaningful action in the next month or two.

Question 4 (from Clayton):

Whitney I was hoping you can comment on Lumber Liquidators’s quote on CARB, located on the third line on Page 4: app.quotemedia.com/data/downloadFiling?w…

“CARB has indicated to us that no one in the industry is required to conduct deconstructive testing for compliance purposes ”

Why is CARB apparently telling Lumber Liquidators one thing and you another?

My reply:

Dear Clayton,

Thank you for your question. This is a typical statement from Lumber Liquidators: true but highly misleading and disingenuous. CARB doesn’t require testing of finished laminate at all (only the initial medium-density fiberboard, before it’s made into laminate), but if testing of finished product is done, it specifies clearly that it must first be deconstructed.

If you’re interested in the details of exactly why Lumber Liquidators’ claim that 60 Minutes (and others’) testing is “improper” is wrong – it’s their testing that’s questionable and/or improper – I suggest reading a few of my articles:

Question 5 (from Ken):

I see the issue not as “this test vs. that test” but whether or not there was deliberate mis-labeling of product and if Lumber Liquidators had knowledge, should have had knowledge or was complicit.

Obviously, the factory workers statement is anecdotal evidence.

My question is simply:

What steps are or can be taken to investigate the veracity of their claims? …. and are they underway or likely to be pursued?

Is there any indication of what tests the mill used to certify the product … was it deconstructive?

Thank you.

My reply:

Dear Ken,

Thanks for your questions. To the first one, in addition to a half dozen or so regulatory agencies looking into Lumber Liquidators, there are nearly a dozen lawsuits against the company (here is a list). Most (if not all) of these entities will likely get all of Lumber Liquidators’s emails, have the board and management give depositions under oath, etc., so I have little doubt that the truth will come out.

I’ve talked to many knowledgeable people, observed the company’s behavior, and applied common sense – all of which has led me to the conclusion that I’ve published in a number of articles: that they knew they were buying (and selling to their customers) non-CARB-compliant laminate.

To your second question (“Is there any indication of what tests the mill used to certify the product … was it deconstructive?”), the initial tests the company relied on (the only required tests) were of the medium-density fiberboard (MDF) before it was processed into laminate by the Chinese factories. There’s obviously no issue of deconstruction here. Then, the company tested the finished product and, contrary to CARB’s clear guidance, didn’t deconstruct the laminate (i.e., sand off the outer layer). I discuss this at length in four prior articles:

Question 6 (from Igsman):

Now that the government has decided to do testing consistent with the companies view on how it should be tested, the game has changed. Failure of the test will almost certainly result in immediate chapter 11 for the company, as they would be ordered to replace all flooring at their expense. I do not know how a manager with a fiduciary obligation would be able to hold a position into and all or none scenario. they would be liable to for holding.

My reply:

Dear Igsman,

Thank you for your question. I disagree with your premise that “the government has decided to do testing consistent with the companies view on how it should be tested.” As I explained in my latest article (Why the U.S. Consumer Product Safety Commission Conference Call Portends a Double Whammy for Lumber Liquidators), there are two types of tests, one of which involves deconstruction and one of which doesn’t. Numerous tests of Lumber Liquidators’ Chinese-made laminate show that it will fail both tests in spectacular fashion.

I also disagree with your assertion that “Failure of the test will almost certainly result in immediate chapter 11 for the company, as they would be ordered to replace all flooring at their expense.” I don’t think anything will be immediate – if Lumber Liquidators does go to zero, it will happen over a long time I’d guess because it’s not clear what regulators will require LL to do to remedy the problem, nor that the correct solution for most (or even a small percentage) of homeowners is to rip out the existing flooring. If the flooring was installed a year or two earlier, most of the formaldehyde has likely “off-gassed” and thus don’t pose a danger. This doesn’t mean Lumber Liquidators is off the hook, however, as these homeowners, if they suffered coughing, bronchitis, etc., will still have a strong claim for damages. It’s long-tailed legal liabilities like these that would eventually bankrupt the company, not short-term regulatory action.

Lastly, I disagree with you here: “I do not know how a manager with a fiduciary obligation would be able to hold a position into and all or none scenario. they would be liable to for holding.” Lots of investment managers, myself included, invest in tainted businesses in the hopes that things turn out better than expected – and if they don’t, they don’t (nor should they) face liability.

Question 7 (from Christian):

I compared your data that you took from the 60 Minutes home model tests and compared it to the actual tests from the 60 Minutes website and couldn’t make them tie. Perhaps you might explain in a comment how your 3 sample numbers, 268, 93, 57 ppb [from my article, A Response To Lumber Liquidators], can be footed to the pdfs of the tests that 60 Minutes posted. Thanks in advance

My reply:

Dear Christian,

Thank you for your question. It’s a long answer, so bear with me.

First, download the tests 60 Minutes did, which they posted here.

You’re looking for two files:

1) In the folder named “CBS – HPVA Test Results,” open the pdf entitled “1350 Summary.CA 01350 VOC Test Report_CBS News_1-5-2015”. On page 2 of the pdf, in the middle of the page, in red, under “Estimated VOC Concentrations – Flooring (?g/m3)**”, you’ll see that the formaldehyde reading is 113.6. And on page 3, in the same space, you’ll see that the formaldehyde reading is 329.3.

2) In the folder named “CBS – Benchmark Test Results” (this is the other lab 60 Minutes used), open the folder named “Benchmark – CDPH,” and in there you’ll find an 8-page pdf named “CBS News CA 01350 Test Report 12WS.” On page 7, about halfway down the page, you’ll see that the formaldehyde reading is 69.96.

OK, so now we have the results from the three California Dept of Public Health (CDPH) real-world tests – the kind that the Consumer Product Safety Commission will be doing:

1) 329.3 micrograms per meter cubed

2) 113.6 micrograms per meter cubed

3) 69.96 micrograms per meter cubed

Now, we need to convert micrograms per meter cubed into parts per billion, which you do by dividing by 1.227 (or 1,227 for parts per million).

(This number comes from the volume of 1 mole of gas at 25C (24.47 L) and the molecular weight of formaldehyde (30.03 grams/mole). See e.g. ASTM D6007 equation (6); see the middle of page 2 of this white paper.)

So:

1) 329.3 micrograms per meter cubed = 268 ppb = .268 ppm

2) 113.6 micrograms per meter cubed = 93 ppb = .093 ppm

3) 69.96 micrograms per meter cubed = 57 ppb = .057 ppm

Even the lowest of these three numbers is massively higher than the limits regulators have set to protect everyone, including children. Here are three formaldehyde limits set by two regulators:

1) The California Office of Environmental Health Hazard Assessment sets formaldehyde limits of 55 micrograms per meter cubed for acute (short-term) exposure and 9 micrograms per meter cubed for 8-hour and chronic exposure. (9 micrograms per meter cubed = 7 ppb, which is the figure I used in my article, A Response To Lumber Liquidators, when I wrote: “Lumber Liquidators claims that ‘The emissions from our laminate floors will typically only add approximately 5 ppb to a home when first installed.’ If true, this would be good news since regulators have set 7 ppb as the limit to protect everyone, including children.”)

2) The California Office of Environmental Health Hazard Assessment, in another document (see page 5), sets formaldehyde limits of 40 micrograms per meter cubed for “No Significant Risk Levels (NSRLs) for Carcinogens.”

3) The Centers for Disease Control and Prevention’s National Institute for Occupational Safety and Health (NIOSH) Pocket Guide to Chemical Hazards sets formaldehyde limits of 0.016 ppm (16 ppb) for an 8-10 hour period.

Thanks for all of your questions and please send me more.

Lumber Liquidators