Summary

  • Management has made many changes in an effort to professionalize operations at the company.
  • Most of these changes have been perceived negatively by employees and have handicapped growth.
  • A real turnaround will only occur if management returns to the simple, winning principles which made the company a success to begin with.

If It Ain’t Broke, Break It…

To a man with a hammer, everything looks like a nail.
Warren Buffett

The above adage perfectly describes the recent actions of senior management at Lumber Liquidators (LL). From the moment Dennis Knowles assumed the CEO position, with the goal of turning around the company, he started to “fix” things with his proverbial hammer. The problem is that many of those things were never broken to begin with and fixing them with a “hammer” only made matters worse.

Mr. Knowles has “professionalized” the company. Created checks and balances; systems and management teams to mitigate the factors which created the now famous scandals. It can be argued that these extra layers of bureaucracy were needed, to a degree, and had been lacking for too long.

If Mr. Knowles had been content to limit his tinkering to those main problems, the company could have returned relatively quickly to at least a semblance of growth that it once had. The problem is that management at Lumber Liquidators went much further. They changed the sales culture at the company. They tweaked selling techniques which had worked perfectly for two decades. High selling divisions were downsized. Focuses were shifted. The company lost many valuable employees who did not agree with the many changes. It seems like current management has systematically tried to change everything about the company, and in doing so, caused many more and greater problems. To exemplify the vast extent of the change, even the company headquarters is set to change city by the end of the year.

The Butterfly Effect

When Lumber Liquidators was growing rapidly (before 2015) the company’s sales team was heavily compensated on commissions. There was a strong sales focus and deep entrepreneurial spirit. Salespeople were motivated to sell as much flooring as possible, earn as high a commission as possible and work as long as was needed to make those sales. That system worked wonders for the company.

After the scandals, average store sales fell from $3.2 million in 2013, to only $2.5 million per year in 2016. The sales people at those stores saw their commissions drop heavily. Through no fault of their own, their commission compensation was being reduced, by about 20%. These associates were less incentivized to show up early or stay late. Many of these great salespeople simply left the company. Turnover was becoming an enormous issue

It is at this point when CEO, Dennis Knowles started making dramatic changes to the core selling culture of the company. Management decided to modify the employee compensation structure by paying the sales associates a higher fixed salary and placing less emphasis on commissions. This option was ultimately disastrous for the sales culture. Turnover was reduced due to higher salaries, but since the salespeople were not being highly compensated to make sales, comparables never bounced back. Due to financial constraints, the company also cut back on opening hours (opening at 9am vs 8am).

The simple acts of reducing the commission component of the sales associate compensation and reducing store hours handicapped the company’s ability to grow as rapidly as it had just years before. Sales associates were not as financially incentivized as they once had been to make sales and lost the entrepreneurial drive that they once had.

The only way to get the company growing again at a rate even remotely close to a competitor like Floor and Decor (FND) (23.5%, year over year net sales growth), is to bring back the old compensation strategy and reward the best salespeople with high commissions. This will naturally make it easier for the company to attract the best sales talent. The company needs these “sales closers” in order to drive revenue. A passive approach to selling has never worked, especially for a company like Lumber Liquidators. Under past management teams Lumber Liquidators was showing same store sales growth of 10% to 15% per year. Under current management, the company is forecasting “flat to up-low single-digits” growth. Clearly this new sales strategy is not working. The company must go back to what worked.

Mixed Signals

The reduction in store opening hours was another major factor which negatively influenced sales growth. For contractors and tradespeople, the workday usually starts very early. Floor and Decor capitalizes on these sales by opening all their stores at 7am during the week. Home Depot (HD) stores typically open at 6am, to be fully prepared for the morning Pro customer rush. Lumber Liquidators misses the mark completely by opening at 9am during the week. At this late time, Pro customers who are buying thousands of dollars of merchandise are forced to queue their pickup trucks at loading docks along with retail customs who are making smaller purchases. This disorganization is detrimental to both Pro and retail customers in the morning. While current management outwardly claims to be focused on driving Pro sales, their actions in opening stores so late seem to contradict this strategy

A similar story plays out for retail customers in the evening. Floor and Decor stores are open until 9pm during the week. Home Depot stores are usually open until 10pm during the week. With these hours, it is very convenient for retail customers to browse the stores after work and after dinner. Lumber Liquidators misses the mark completely, by closing stores at 7pm during the week, seemingly making it as difficult as possible for retail customers to visit their showrooms. Is it any wonder that store traffic has been down or stagnant for years?

The solution is to have stores open longer; earlier in the morning and later in the evening. This is almost guaranteed to increase sales. Of course, if salespeople have to be paid on salary to staff the stores, this initiative will inflate costs. But if stores are open longer hours and salespeople are remunerated based on commissions, then staffing costs will increase in line with sales, and the whole company will be better off.

Margins vs. Sales

Another major change in the corporate strategy relates to how the company views margins and sales. When Lumber Liquidators was growing rapidly, management was heavily focused on closing sales. With a customer in the store, willing to make a purchase, the salespeople were open to negotiating the price to a reasonable extent in order to close that sale. While this strategy hurt margins, it still drove higher profits and it reinforced to customers that they could always find a deal at LL.

Under the current management team, the focus has been much greater on maintaining and expanding margins. Salespeople have much less room to negotiate prices with customers. Lumber Liquidators loses many potential sales. Former Lumber Liquidators CFO, Marty Agard said on October 30, 2018, “in an effort to expand margins, sales were softer than expected in August and September.” In that quarter, sales came in approximately $11.5 million below expectations. If the company had focused less on margins, it could have potentially hit the sales targets, and made even more income. It’s a simple concept of selling at slightly lower margins, but making up the difference on much higher volume.

Clearly, in order to drive higher profits, Lumber Liquidators must change focus from simply maintaining higher margins, to selling a greater volume of flooring. The company cannot afford to turn away profitable sales simply to keep margins artificially high. The current strategy is causing store traffic to stagnate and customers who leave the store empty handed simply price shop at competitors.

Changes At The Top

Since CEO Dennis Knowles started implementing his sweeping changes at Lumber Liquidators, management has changed dramatically as well. Marco Pescara, the company’s Chief Merchandising and Marketing Officer, who had been at the company for over 12 years, departed. According to a statement from Lumber Liquidators “Mr. Pescara developed the brand and customer strategy to communicate and deliver the Company’s core value proposition through all areas of marketing.” Various sources have mentioned that Mr. Pescara was a marketing “genius” who was a protégé of company founder Tom Sullivan. He was replaced by Charles E. Tyson, who I do not doubt is very competent at marketing, and who has held various roles at Advance Auto Parts, Inc. but has no experience in the flooring industry. Lumber Liquidators new SVP of Global Sourcing, Kevin Dempsey, is also an Advance Auto Parts alumnus, and similarly, has no experience in flooring sourcing.

There are several other notable departures since Mr. Knowles became CEO of the company. Carl R. Daniels, the Chief Supply Chain Officer at the company with 7 years experience and with many recommendations to his name left the company in November 2018. Jill Witter, Chief Legal and Compliance Officer left in August 2017. Most notably, even company founder, Tom Sullivan, resigned as a director and left the company completely.

The above mentioned employees did not simply retire or change career. They all continue to work in the home improvement retail sector, and actually, they all still work together, at a company called Cabinets To Go. It would appear that these seasoned veterans left or were pushed out of their roles at Lumber Liquidators, perhaps because they did not like the new direction management was leading the company.

If Lumber Liquidators is to grow, it must stop losing the managers and executives who were so influential in leading the company’s growth over the last decades. That talent must be valued and retained. There is clearly a clash of cultures between the old LL and the new management team. A compromise must be met. It is infinitely harder to hire a new “all star” employee than to simply retain an existing one.

Summary

The new management team which has joined Lumber Liquidators since late 2016 has formalized and professionalized the company, but unfortunately they have also tampered with the winning formula of sales and growth. It is easy for many people to assume that the scandals that rocked the company years ago have left it unable to compete. But the story is much more complex. Many great companies have faced adversities. ChipotleJack in the Box and Volkswagen, just to name a few. Those companies were able to rebound because they remained true to their core principles. Management was able to identify exactly what made those companies special to begin with and to focus on those strength. Of course, each of these companies made changes and evolved, but customers returned despite those changes, not because of them.

The pendulum of change at Lumber Liquidators has swung too far towards compliance and bureaucracy. It is time to focus on rebuilding the selling culture of the company by incentivizing salespeople and chasing sales. It is time to hire executives who have knowledge and experience in the flooring and renovation fields and to retain the talent the company already has. It’s time for Lumber Liquidators to get back to selling as much flooring per year as possible. This strategy clearly worked during the company’s first 20 years of existence. It will work again.

The Lumber Liquidators Value Committee

Investors have taken notice of the many problems which the company faces by bidding LL shares down to a lowly $12. Despite the turmoil, current management has failed to release a detailed proposal on how they plan to increase flooring sales and has not given any indication that they know how to solve the growth problems at the company.

It is exactly for this reason that I have formed the Lumber Liquidators Value Committee, which is composed of shareholders with a significant equity stake in the company. We have a turnaround plan for Lumber Liquidators and our goal is to rapidly increase growth, profits and the share price. We want to change the management team and the board. Streamline operations. Reestablish the selling culture of the company. In short, we want to Rebuild LL into the prosperous company it once was.

Shareholder support for our proposed changes is growing by the day. If you are a shareholder of Lumber Liquidators, you can show your support for change by voting against the Lumber Liquidators proxy proposals to be tabled at the 2019 Lumber Liquidators Annual Meeting of Shareholders. These management proposals do not align with the best interests of shareholders. It is time to send a clear message to management that enough is enough. Selling flooring should not be so difficult. Let’s make the necessary changes. Let’s rebuild LL.