Did Lumber Liquidators Know It Was Selling Toxic Laminate? by Whitney Tilson, Seeking Alpha

Summary

  • This question defines the bull-bear debate on Lumber Liquidators.
  • I think senior managers knew, for six primary reasons: industry scuttlebutt; Ray Cotton; Lumber Liquidators’ behavior; knowledge of the industry, the product, and China; knowledge of the Chinese mills; and a lie-detection analysis.
  • If they knew and this information becomes public, then it would be devastating to the company (and the stock).

In many ways, the question of whether senior managers of Lumber Liquidators knew that they were buying toxic, formaldehyde-drenched, non-CARB-compliant laminate from their Chinese suppliers defines the bull-bear debate on this stock. If this proves to be the case, it would be devastating to the company in the courtroom, amongst regulators, and in the court of public opinion – so much so, in fact, that I believe the fate of the company (and the stock) will be largely determined by this issue.

The bulls, to the extent that they acknowledge any formaldehyde problem at all, tend to think that Lumber Liquidators’ Chinese suppliers deceived the company, claiming to be producing CARB-compliant laminate but in reality not doing so to inflate their profits, so at worst the senior managers of Lumber Liquidators are guilty of being sloppy, naïve and/or overly trusting.

Conversely, the bears (myself included) think they deliberately sourced toxic laminate – knowingly threatening the health and safety of their installers and customers, especially children – to save ~10% on their sourcing costs, and are now engineering a massive cover-up to hide their evil behavior.

Let me be very clear: I cannot prove my hypothesis. To date, no damning emails, documents or whistle-blowers have emerged, nor have any Chinese suppliers ratted them out. But I’m not surprised by this – these things take time, and it’s only been 38 days since the 60 Minutes story aired.

I’m confident that the truth will eventually be discovered by the many regulators, lawyers, reporters and short sellers who are carefully scrutinizing the company. When the truth does emerge, I think it’s 90% likely that we will learn that at least some senior managers at Lumber Liquidators knew exactly what was going on.

Why am I so sure? There are six primary reasons:

1) Industry scuttlebutt. I have spoken with numerous people in the industry and have yet to hear a single person tell me anything along the lines of “I was shocked by the 60 Minutes story because it’s not at all consistent with the company I know.” In fact, no one I’ve spoken with was the slightest bit surprised by it.

Without exception, they tell me that Lumber Liquidators is a notorious bad actor: cutting corners at every opportunity, selling very low-quality products, treating customers, installers and employees badly, and, most damningly, not being serious about compliance.

2) Ray Cotton. No company serious about compliance would hire (and twice promote) someone like Ray Cotton to be Senior Vice President, Chief Compliance and Sustainability Officer. As I document in the last section of this article, Lumber Liquidators’ Campaign Of Distraction And Deception, he’s totally unqualified for the job and is not a serious person (to see what I mean, take a look at his personal home page and Twitter feed before he took them down – see links below). In fact, he’s exactly the person I think a company would hire if it was knowingly sourcing tainted product and didn’t want the head of compliance to know about it. Here’s an excerpt about him from my article:

His LinkedIn profile reveals a college degree from an online, for-profit school followed by plenty of job hopping (10 jobs at seven employers from October 2000 to the present), yet little relevant experience related to his most important areas of responsibility at Lumber Liquidators: quality control, sourcing, managing suppliers in China, overseeing the testing program, etc. Rather, every prior job was related to either “security” or “loss prevention.”

Worse yet, Cotton doesn’t appear to be a serious person, as evidenced by his personal home page, which borders on comical and bizarre (he took it down a day or two ago, but not before I took screenshots of every page – click here), and the fact that less than two weeks ago, on February 24-26, he attended the Oscars and posted to his Twitter account (#raycotton) a dozen photos of himself standing behind the stars on the red carpet (again, he’s since removed them, but I have posted my screenshots here).

Why should anyone care if he took a few days off to attend the Oscars? Because at the very moment that he was posting some of these pictures (check the time stamps) – the morning of Wednesday, February 25th – the company was reporting: a) terrible earnings; b) that the Department of Justice might be bringing criminal charges against it for violations of the Lacey Act (for buying and importing hardwoods illegally harvested in Siberia); and c) that 60 Minutes was running a negative story a few days later – all of which crushed the stock 26% that day.

To repeat: on this crucial day, Lumber Liquidators’ Senior Vice President, Chief Compliance and Sustainability Officer was yukking it up at the Oscars. Talk about fiddling while Rome burns…

3) Lumber Liquidators’ behavior. Since the 60 Minutes story broke, the company has, in my opinion, acted exactly as I’d expect a guilty company, not an honest and reputable one, to act. Imagine if this story was about Home Depot. Immediately after it aired, Home Depot would:

a) Stop selling the product in question (even if it doubted the validity of the testing 60 Minutes did, why take any chances with customers’ health and the company’s reputation, not to mention future liabilities?);

b) Offer a full refund to any customers who wanted to return unopened product;

c) Set up a Special Committee of the board, made up of independent directors, to conduct a full investigation; and

d) Hire an independent firm to do a wide range of testing, not just of Chinese-made laminate, but all of the company’s products.

This isn’t rocket science – it’s Crisis Management 101. Yet Lumber Liquidators hasn’t done a single one of these things. The only possible explanation, in my mind, is that they have a lot to hide – and they know it – in which case, the deny-and-attack strategy they’ve adopted, which I analyzed in my article, Explaining Lumber Liquidators’ Reckless Strategy And Rebutting Its Claims About Deconstructive Testing, makes perfect sense.

4) The industry, the product and China. The idea that Lumber Liquidators was duped by nefarious Chinese mills is preposterous. As I wrote in my first article, Why Lumber Liquidators’ Wood Testing Doesn’t Comply With CARB:

Laminated wood is a low-end, global commodity product in which 1% or 2% differences in pricing are meaningful. For a savvy player like LL, which has been buying in China for roughly two decades, they would instantly know that if they were buying 10% below the standard price for a particular piece of laminated wood that something was wrong: perhaps it was stolen, used illegal or incorrect wood, was of exceptionally low quality, or was filled with toxic chemicals.

Maybe this example will

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