Lumber Liquidators (LL): Research, Not Hyperbole by “Max Vision” – Disclosure – the author of this piece has a long position in LL
“When the facts change, I change my mind, what do you do, sir?” Keynes
“The amount of energy necessary to refute bullshit is an order of magnitude bigger than to produce it.” Alberto Brandolini
I first heard about Lumber Liquidators two years ago when I read an article in Grant’s Interest Rate Observer. Technically, this was the “original short piece” (although I have since found one from 2010–that must have been a painful short). Grant’s short thesis was based solely on valuation. I followed the story closely when Xuhua Zhou’s article appeared regarding high levels of formaldehyde. That was a little more interesting. The side-show regarding Lacey Act violations never really raised my interest. Gibson Guitar had endured a similar issue and paid a miniscule fine; a blip on the radar. However, when I heard that 60 Minutes was going to air a piece, I was intrigued. After viewing that segment, my first thought was: It doesn’t matter what price the stock opens at on Monday morning, anything greater than zero is too high–and a good short.
However, I prefer to do my own diligence rather than rely on Mr. Cooper for investment advice, so I started digging.
What follows is the first entry into what may become a series of articles regarding my observations on the facts, the myths, and what we can, can’t and may never know regarding Lumber Liquidators. I hope what I write will clarify some of the much discussed, but little understood issues in this controversy and help you decide–whether you want to stick with your long or short position or switch sides….
As for my own position, I subscribe to the quote above from Keynes, “When the facts change, I change my mind….” I am happy and open to consider new facts as they become available.
Lumber Liquidators: 60 Minutes’ lab data
My first thought was to call the labs where the tests were performed. 60 Minutes released the lab data on their testing, so I picked up the phone and starting asking questions.
I spoke with HPVA Labortories, specifically the signatory on each of the test results provided by 60 Minutes. My first question revolved around comparing the results between Home Depot/Lowe’s and Lumber Liquidators. The response from HPVA was that 60 Minutes only asked HPVA to test Lumber Liquidators’s products. The other lab, Benchmark International, confirmed this same point, that their lab had only tested Lumber Liquidators’ products. I thought this was odd. From a consumer standpoint, which I thought was the thrust of 60 Minutes efforts, one would want to test a wide variety of stores’ products to confirm the products’ safety. This was my first nudge in the opposite direction, forcing me to rethink my initial conclusions.
In this entry, I will focus on CARB 2 compliance and the testing methods used by the enforcement division of the Air Resource Board. This may be long, but hopefully it will be worth it.
The CARB 2 standard that is now well-discussed stems from a law passed in 2008 called the Airborne Toxic Control Measure to Reduce Emission from Composite Wood Products (“ATCM”). Here is a link to the law.
The final statute is 60 pages long, but not very complicated. The ATCM has two points that are important to note in this discussion. First, the focus of the ATCM is the regulation of platform materials. These materials may end up in a variety of different finished goods: furniture, doors, windows, toilet seats (yes, this example was in the law’s legislative history), or, what we are all most concerned about–laminate flooring.
Second, the ATCM is heavily biased towards a “process-based” regulatory framework.
By this, I mean the ATCM requires of Lumber Liquidators the following five items (I am paraphrasing from the statute):
- Use a Third-Party Certified Facility
- Only use platform materials that comply with the applicable emissions standards.
- Take reasonable precautions to ensure that the platform materials are in compliance with the applicable emissions standard. And I quote here: “Reasonable prudent precautions include, at a minimum, instructing each supplier that the goods they supply to the fabricator must comply with the applicable emission standards, and obtaining written documentation from each supplier that this is so.”
- Maintain records for a minimum of two years.
- Certain product labeling requirements.
The formaldehyde levels that are applicable to this situation vary from .11ppb (parts per billion) to .13 ppb, depending on the size of the composite panels.
These specific emission standards are very exacting and are applicable to the platform materials that make up all different kinds of “finished goods.”
Lumber Liquidators: Third-party certified labs
What follows here is how it has been described to me by certain TPCs (third-party certified labs). The list of TPCs is available on the Air Resource Board’s website and I found many, if not all, of the labs very open to discussing these issues. They are enjoying their 15 minutes of fame.
Imagine a production process that starts with a specific piece of platform material at point 1. At point 1 in the process, this piece will be called Eric1. (This whole process reminded me of the children’s book, The Very Hungry Caterpillar by Eric Carle). Keep in mind, the ATCM and its associated CARB 2 emissions standards are applicable only to Eric1. However, in order to become a piece of laminate flooring (or toilet seat) that ends up on the shelves of a local Lumber Liquidators store, Eric1 must go through approximately 15 steps to arrive at its final step (the number of steps is irrelevant and made up for this example). These steps include many at the manufacturing site: heating, adding decorative and protective layers, stains, glues, and a variety of other steps. Additionally, the packaging materials, shipping time, time on shelves, all are additional steps along the way before the original piece of platform material will end up in its final resting place. Each of the steps along the way from 1 to 15 have an impact on Eric1, he becomes for a brief time Eric2, Eric3, Eric4, before ending at Eric15. Some of these changes are fairly significant.
Now, fast forward a little bit to something called the “Deconstructive Method.”
The Summary of Procedure on the deconstructive method can be found here:
The goal of the deconstructive method is to turn Eric15 back into Eric1 and then test the emissions levels to see if Eric1 complied with CARB 2 at step 1.
I will provide support for this statement below, but what some individuals, let’s call them the Gotcha Camp, have done here (I won’t judge their intentions) is to mistakenly think that the deconstructive process is meant to take Eric15 and turn him back into Eric1. This is incorrect. What the process does is create Eric1A, an entirely different “platform material.” This is purely a scientific-based mistake. The platform material in its original form, Eric1, after having gone through a variety of significant changes, to become Eric15, can never truly be returned to its original state as Eric1, instead after the deconstructive process it has become Eric1A. At this point, the emissions standards applicable to Eric1 serve