Whitney Tilson’s quick take on Lumber Liquidators’ earnings report, emails from a LL customer and former employee, Cantor cuts LL price target, What LL didn’t say that’s the worst part, even at $16 LL can keep falling and conference call transcript. Excerpted from an email Whitney Tilson sent to investors.
1) My quick take on LL:
- I was expecting bad Q2 numbers, but they were even worse than I (or anyone, based on the stock’s reaction) expected. Revenues were better than I expected, but gross margin of 25.1% and SG&A of 36.5% are awful (even excluding a litany of charges, GM was 31.2%, down from 40.4% year over year);
- A friend emailed me: “I think they padded Q2 revenues with future bookings. I can’t prove it, but it comports with what I’ve heard. Revenues were suspiciously high. I think the only way they got to $248 million was to ship material that was paid for but not really “shipped”;
- LL has been mostly out of the news for at least a month, so I thought there was some chance that July sales might have stabilized or even picked up (from a very low base), which the company would then trumpet in its earnings release and/or conference call in an attempt to put a silver lining on this very dark cloud. The fact that it didn’t report open orders or July numbers is therefore very significant, as it’s strong evidence that revenues and margins continue to be horrible;
- Note that LL has $19.8 million of Chinese-made laminate in inventory that it hasn’t written down for a variety of lame reasons outlined in the 10Q. I doubt LL will ever be able to sell this in the US and therefore will have to write off nearly all of this amount (knowing LL, they will sell it to someone who exports it to a country without strong formaldehyde standards, thereby poisoning foreigners rather than Americans…);
- From a capital allocation standpoint, the company is doing the right things: they drew down $20M from their line of credit in Q1 ($79M more is available), slashed inventory (which generated $34.2 million in cash in Q2 vs. expanding inventory consuming $25.4 million in cash in Q2 ’14), cut cap ex to the bone (only $5.3 million in Q2; the previous four quarters were: $13.9M, $27.9M, $14.9M and $9.0M), and suspended all share repurchases. Thus, free cash flow (operating cash flow minus cap ex) in Q2 was slightly positive ($6.1 - $5.3 = $0.8M). But the massive inventory liquidation in Q2 (accomplished in large part by slashing prices – hence the abysmal gross margin) isn’t sustainable, so the company will start burning a fair amount of cash in the near future unless the fundamentals turn around.
- All of this said, for the first time I can now at least understand (if not agree with) the argument that some investors might think that LL’s stock is cheap. At $13.44 (down nearly 90%), LL has a tiny $364 million market cap and $339M enterprise value. Who knows what normalized earnings or EBIDTA will be or when the company might get there (Cantor is out with a note today (summary below) saying it doesn’t see LL returning to full-year profitability until 2017), but with 365 stores and ~$1 billion in revenues, the stock is trading at ~$1M/store and 0.37x sales, which might appear cheap to some investors looking to bottom-fish a potential turnaround. Indeed, based strictly on the financials, I might be tempted to start covering my short position – except that regulators haven't acted (and they surely will) and all sorts of litigation and class action lawsuits loom as well.
- LL’s disclosures in this area consume eight pages of its latest 10Q, including new information about actions taken by:
o The SEC: “In addition, on May 19, 2015 and July 13, 2015, the Company received subpoenas from the New York Regional Office of the SEC in connection with an inquiry by the SEC staff. Based on the subpoenas, the Company believes the focus of both the U.S. Attorney investigation and SEC investigation primarily relate to compliance with disclosure, financial reporting and trading requirements under the securities laws since 2011.” and;
o CARB, which confirms the testing 60 Minutes, I and others did: “In May 2015, CARB notified the Company that additional samples of finished products were obtained in 2014, some of which, based on deconstructive testing, exceeded the CARB limits for raw composite wood cores. CARB has further informed the Company that it has performed additional deconstructive testing on certain finished products it obtained in March 2015, with certain of the samples of the Company’s products exceeding the CARB limits for raw composite wood cores.”
- While I’m sure that there will be plenty of rumors going forward about LL being acquired, I’m quite certain that nobody will buy this company at any price until there's more clarity on these potentially very large contingent liabilities.
- To summarize, based on all of the new information Lumber Liquidators released this morning, the situation for the company is more dire than I thought. However, the stock’s 26% collapse today strikes me as a reasonably accurate response to the new information, so I see no reason to do anything: I’m content to have it remain one of my largest short positions (albeit a 26% smaller one than it was yesterday), so I’m neither covering any of my short nor adding to it today.
2) To better understand LL’s potential liabilities from various lawsuits (and the serious harm that some people suffer from formaldehyde exposure), here are two emails I received in the past month, one from a LL customer and another from a former LL employee, both of which (if true) are very damning. First, here are excerpts from what the customer, who suffered a miscarriage, emailed me:
Thank you for all that you have done to bring awareness to the Lumber Liquidators issue. Our family purchased their laminate both for our former home in Virginia and our current home in Florida. We have had a medical nightmare and we now know it is because of the flooring.
We did not buy the flooring because it was cheap. They marketed to us. We had bought our nebulizer in Fredericksburg and must have been on a mailing list. They intentionally marketed it to us because they said it was great for families with kids with asthma. They said a doctor endorsed their Dream Home Laminate. They said it contained no glue and no chemicals. They even sponsored an asthma and allergy summit. We thought that it was just like when you get a special HVAC filter and you can get credit for that if your kids have asthma. We found that we couldn't get credit, but we thought that since it was backed by doctors, that it must be great.
We have been classified as having both chronic exposure as well as acute formaldehyde poisoning. Our family has suffered: Pneumonia, bronchitis, asthma way worse than before, lymphadenopathy, miscarriage, hysterectomy, nasal issues including sinusitis and rhinitis, acquired kidney cysts, and headaches.
Our miscarriage was listed as abnormal and seems to show that it had the mutation related to formaldehyde exposure. It was so upsetting to our boys as I started to miscarry in