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Knowles Meets With Tilson – Shareholders Should be Enraged

Lumber Liquidators shareholders might be surprised to know that yesterday, Thursday, May 30, 2019, Whitney Tilson held a meeting with Lumber Liquidators CEO Dennis Knowles. Tilson is a short-seller whom you will all recall was responsible for the dubious scandals which hit the company in 2015 resulting in billions of dollars of losses to investors. A year later, he actually lost a lawsuit against the company and his group was forced to pay LL $100k.

Whitney Tilson, the man responsible for billions of dollars in shareholder losses at Lumber Liquidators, was actually invited into the company and met with CEO Dennis Knowles and others, for 2 hours.

Of course, the only person who comes even close to Tilson in terms of destruction of shareholder value at LL is Dennis Knowles. Perhaps it is fitting that these two meet. But undoubtedly, it is a slap in the face to all Lumber Liquidators shareholders that the CEO of the company and members of the management team actively engaged with this character.

You can get more info about this meeting here.

I call on all investors to contact Lumber Liquidators investor relations immediately to voice your anger with management and the board, not only for their unwavering degree of incompetence (stock has lost 70% of it’s value in the last 20 months), but for this latest act of egregious disrespect of shareholders.

Investor Relations:

Let’s Change Management at LL and Finally Turn This Company Around

Join Our Proxy Fight to ReBuild LL

By |2019-05-31T17:16:13-04:00May 31st, 2019|Uncategorized|3 Comments

Dennis Knowles – Slashing Advertising and Stalled Sales

After covering the mess Knowles and the management team has done with “mitigating” tariffs, I think it’s a good idea to look into the absolute disaster in the marketing department. For the home players, you should know that Knowles and Co. have mentioned their focus on Pro customer and their installation program non-stop for the past 2 years. But oddly enough, when you look at the company’s financials, same store sales are barely moving up at all, and last quarter, they were negative. And for the rest of 2019, we will be lucky to be positive at all. How could that be, if Pro and Install are doing so well? It’s because Lumber Liquidators’ DIY consumer sales, which has historically been the core market, and main growth driver, are dropping.

But why are DIY sales dropping?

There are 2 main reasons

  1. The advertising budget has been slashed.
  2. The advertising sucks.

For today, let’s just talk about problem #1

Slashed Advertising Budget

The following chart shows historic LL ad spends by year.

2010 – $49,797

2011 – $52,345

2012 – $58,548

2013 – $75,506

2014 – $82,604

2015 – $77,455 – Drop due to lower sales (scandals, etc…)

2016 – $80,079 – Rebound due to increasing sales after scandals.

2017 – $76,586 – Knowles becomes CEO….

2018 – $74,242 – Knowles cuts ad spending again!

2018 – Q3 – Sales miss estimates by a wide margin.

2018 – Q4 – Sales miss estimates again.

2019 – Q1 – SSS are negative…

Ad spending in 2018 was the lowest in 6 years. Of Course, Knowles said that cutting ad spending was a good thing, because he was going to spend those ad dollars more efficiently. But same store sales dropped in Q1 2019. And in Q3 2018, sales missed targets by a wide margin, coming in at only 2.1% while analysts were projecting 4.9%. And the stock collapsed on the news. Q4 2018 sales missed too. And Q1 2019 same store sales were actually negative.

Knowles vs Knowles

Excerpt from Q1 2018 Conference Call (source)

Seth M. Basham – Wedbush Securities, Inc.

You referenced some changes in your promotional programs. You’re expecting strong promotional programs going forward. Could you give us a little bit more color as to what you’re planning for the balance of the year?

Dennis R. Knowles – Lumber Liquidators Holdings, Inc.

Seth, I’m sure my competition would like to know that too.

Dennis, if you’re competitors want to know what your “secret sauce” is, it’s only because they want to avoid repeating your mistakes. The only thing that competitors would learn from your fiasco, is what not to do.

Seth M. Basham – Wedbush Securities, Inc.

Fair enough. So, as we look at the buckets of advertising spend and promotional dollars, do you expect both of those to be up for the year or how are you planning those going forward to drive the traffic that you’re looking for?

Martin D. Agard – Lumber Liquidators Holdings, Inc.

Yeah. I mean, up a little bit, I would say, yes.

Dennis R. Knowles – Lumber Liquidators Holdings, Inc.

I think you might see the dollars move around the buckets. You’ll see – my plan is to increase dollars, but not necessarily to increase a percent of – I mean, it’s got to work. And so, we don’t want to drive – we want to keep our ratio as flat as possible, but we will increase dollars. And we will test a fair amount this year as it relates to some of the digital capabilities, but we still expect to leverage total SG&A and we’ll just be leaning into our advertising spend.

Dennis clearly said in Q1 2018 that he would “increase dollars” spent on advertising. Yet, advertising dropped in 2018, and it led to a huge sales miss in 2018 and that sales miss is continuing in 2019, as the stock craters. Dennis blatantly lied.

In the Q2 Conference Call Dennis Knowles repeated: (source)

Dennis R. Knowles – Lumber Liquidators Holdings, Inc.

I did mention last quarter that we would likely be more assertive with our advertising dollars in 2018 now that our basic infrastructure is in place.

But in Q3, Dennis had this to say (Source)

Dennis R. Knowles – Lumber Liquidators Holdings, Inc.

So, we tweaked advertising down slightly and tested some advertising initiatives we’ve been eager to try.

We are working tirelessly to improve our intelligence around advertising.

Analysts were quick to pick up on the link between the drop in advertising and the drop in traffic.

Seth M. Basham – Wedbush Securities, Inc.

My first question is around traffic. It seems like traffic has been a challenge for you guys recently. You called out a number of issues why it might be, but as you think about tweaking the price and promotion and advertising strategies going forward, do you expect to have a meaningful impact in turning around the traffic declines in the near-term?

Dennis R. Knowles – Lumber Liquidators Holdings, Inc.

I would say, as kind of Marty mentioned in his remarks, we’ve looked at traffic really hard over the last, I guess, really over the course of the last three quarters. And we have seen as he mentioned some changing dynamics and that’s impacted by how we promote. And if you we deep into price and not so wide in breadth, we typically can influence traffic, but we just haven’t been happy with the margin. Typically, I would say, historically, we’ve had what I would call more deal-focused promotions as opposed to really kind of advertising across the category.

More Promises From Knowles and his Merry Men

In Q4 2018, Knowles assured shareholders that advertising would be up in 2019. I like the way they promise, then fail to deliver, and then extend a new promise.

Dennis R. Knowles – Lumber Liquidators Holdings, Inc. (source)

Second, with these with the major legacy legal issues behind us, we have the opportunity to increase our advertising spend this year

Of course, by now, with the stock price in the single digits, people have started to ask questions… One analyst seems surprised by the rapid drop in advertising:

Budd Bugatch

Okay and when I look at advertising, I think it’s down to 6.84 % reported for the year down, I think 60 basis points year-over-year. Historically, Lumber Liquidators has – advertising as high as high as 11% to 12% if I remember right going back a number of years, what the right level of advertising for this business now?

Dennis has reassuring words.

Dennis Knowles

This is Dennis, I would add a little color to that as well as that, as Charles has built out this digital team and our digital approach to marketing, we’ve had to make some investments in that team and pull back on advertising.

What Dennis effectively said is that he reduced advertise spending in order to increase payroll in the advertising department. Let that sink in. He is hiring employees in the digital advertising team, instead of simply advertising products. So payroll increases, advertising decreases and sales drop. That is the Knowles’ formula for success… leading to a single digit stock price. Note that Charles Tyson joined Lumber Liquidators in 2018 and is in charge of advertising. His compensation was $1.44 million. Maybe that money should have been simply spent on more advertising.

If the company was so desperate to expand the size of the “Digital Team,” why not just spend money to grow that team, and also spend money to increase advertising? Sure, that would increase costs at the company, but costs don’t actually seem to be a huge concern, as Adjusted SG&A has ballooned almost $20 million in the last 2 years anyway. And the advertising expense would have at least been offset by increased sales and net net profit dollars.

The issue here is poor planning and even worse execution by the CEO, Dennis Knowles. He has made decisions which have had direct, negative impacts on the business and his mismanagement is the leading cause of the company losing over 70% of its market value over the last 18 months, leading to huge losses for investors.

Let’s Change Management at LL and Finally Turn This Company Around

Join Our Proxy Fight to ReBuild LL

By |2019-06-10T21:02:55-04:00May 31st, 2019|Uncategorized|0 Comments

Dennis Knowles – The Tariff Blooper Reel

Lumber Liquidators imports approximately 45% of their products from China. Throughout 2018 there were rumblings about possible tariffs on these goods. Despite the huge impact that tariffs would have on the company and the clear risk that tariffs would be imposed, CEO Dennis Knowles did not mention the word tariffs a single time in Q1 or Q2 2018. This seems peculiar.

Martin Agard, the former CFO, had this to say about tariffs in Q2 2018.

Martin D. Agard – Lumber Liquidators Holdings, Inc. (Source)

“In my earlier comments about second half margins, assume no meaningful tariff adoption”

Here is an interaction with an analyst:

Gregory Scott Melich – MoffettNathanson LLC

Marty, I guess on the guidance, I heard that tariffs are not included and what’s your thinking for the back half? Could you remind us what percentage of your COGS are imported, anything that you have on what’s directly imported versus indirectly or China as a proportion of those?

Martin D. Agard – Lumber Liquidators Holdings, Inc.

Yeah. It’s in the 40% range that comes from China. But we have various appeals to those. And then a range of ways we would try to manage it. So, rather than speculate on what we’d include, what we wouldn’t, what would impact margin and so forth, we’re kind of sticking to the guide is kind of clean of that. And then we’ll sort of cross those bridges as we go.

The tag team of Knowles and Agard clearly didn’t think tariffs would be much of an issue.

But in Q3 2018, after tariffs were implemented (Sept 2018) Knowles faced a barrage of questions about tariffs. Mind you, this is also the time when the LL stock nose dived 50% in 3 months (July 15 to October 15 2018). Perhaps Knowles’ lack of planning and mismanagement of the tariffs issue had something to do with it?

What did Knowles have to say about tariffs then?

Dennis R. Knowles – Lumber Liquidators Holdings, Inc. (source)

We acknowledge that we’re faced with heightened macroeconomic conditions, namely increasing tariffs, which are impacting the cost side of our business. Roughly 45% of our merchandise comes from China and we’re subject to the 10% tariffs as of September 24. We’re aggressively and proactively exhausting all options to mitigate the cost increases.

While the effects of our strategy will not be seen overnight and tariffs remain a challenge, we’re considering any and all options to offset tariffs and improve our sourcing strategy.

Additionally, we’re laser-focused on our bottom-line and believe we can drive margin expansion through careful cost management and strategic mitigation of tariffs.

I think at this point, you kind of have to act like 25% tariffs going into place. And that impacts the aggressiveness of your sourcing changes as well as anything you might do to pre-buy.

So, all of a sudden, tariffs are being discussed, and they seem to be a major issue for the company. But Dennis Knowles assures everybody that he is being aggressive, proactive, strategic, exhaustive, and “laser-focused” (Dennis loves lasers) at mitigating these costs, by any means possible. He even says he is acting like 25% tariffs are going to happen.

Then what?

Five months later, in the Q4 2018 Conference Call, Martin Agard had this forecast to make on tariffs. (source)

Martin Agard

We anticipate 10% tariffs continuing, no removal and no escalation.

Martin Agard then resigned from the company.

Dennis Knowles, didn’t resign, but took the opportunity to reassert his resolve to mitigate tariffs:

Dennis Knowles

While the 25% of tariff has been indefinitely postponed, we know that our work to further mitigate the impact is still in front of us. To that end, we are not only improving our cost structure and supply chain, but also enhancing our capabilities under new leadership. We are actively renegotiating costs and moving product out of China where it makes sense.

Dennis also took a optimistic, yet cautious tone:

Dennis Knowles

We are currently assuming the trade environment with 10% tariff, though the potential of a 25% mark will have a substantial impact. 

Notice that this is a softer stance than his former remark “you kind of have to act like 25% tariffs going into place.”

In Q1 2019, tariffs remained a hot topic and Dennis Knowles gave us several insights on the company’s strategy and planning surrounding those major issues.

Dennis Knowles (source)

Our expectations for tariffs remain unchanged in the immediate turn and we remain focused on efforts to counter these impacts. As we mentioned last quarter, we expect incremental improvement in margins throughout the remainder of the year.

We have spoken about our core strategic priorities for 2019 that are focused on growing the business, enhancing the customer experience and, ultimately, driving margin expansion even in the face of tariffs.

Where does all this leave us?

As of May 10, 2019, tariffs on imported flooring products from China were increased from 10% to 25%. It caught the “management” team completely off guard. Knowles messed up again, and of course, it is at the shareholders expense. This virtually assures that margins at the company will fall in 2019. Unless something drastic changes, CEO Dennis Knowles will be proved completely wrong in his last quote.

I would also like to say that in my discussion with Lumber Liquidators IR, I can confirm that as of today, there has been no change in sourcing products from China. Despite everything that was said by Martin Agard, Dennis Knowles and even Charles Tyson, product sourcing from China has not changed. The new sourcing, away from China, will only start in Q3 2019 and it will only be a very small portion of the product mix. There will not be any significant sourcing change until 2020. Is it any wonder that the stock is now trading at under $10?

Sourcing Changes Take Time, But Management Changes are FAST! Let’s “source” a new Board and CEO.

Join Our Proxy Fight to ReBuild LL

By |2019-05-31T13:48:00-04:00May 30th, 2019|Uncategorized|5 Comments

Lumber Liquidators’ Branding Mess

Want to see a great example of sloppy branding? Look no further than Lumber Liquidators’ jumble of different sign designs.

No two Lumber Liquidators locations look alike.

Is this part of Management’s “strategy?” Is that a strategy to confuse consumers and devalue the brand? Because it seems to be having that exact effect.

LL shares are down to a lowly $9.70 today. Are you happy shareholders?

Sloppy Brand. Sloppy Management. Let’s Clean up this Sloppy Mess.

Join Our Proxy Fight to ReBuild LL

By |2019-05-31T09:45:12-04:00May 29th, 2019|Uncategorized|3 Comments

Performance vs Pay At LL – A Shareholder Heist!

I present the following information with very little commentary.

Performance Graph

The following graph compares the performance of our common stock during the period beginning December 31, 2013 through December 31, 2018, to that of the total return index for the NYSE Composite and a Custom Peer Group whose members are listed below assuming an investment of $100 on December 31, 2013.  In calculating total annual stockholder return, reinvestment of dividends, if any, is assumed.  The indices are included for comparative purpose only.  They do not necessarily reflect management’s opinion that such indices are an appropriate measure of the relative performance of our common stock. (Source:Lumber Liquidators Annual Report 10K)

(Source:Lumber Liquidators Annual Report 10K)

$100 invested in Lumber Liquidators in 2013 would now be worth…. $9.25. (And probably less today)

(Source:Lumber Liquidators Annual Report 10K)

Of note,

Cash is down, Total Assets are down,Stockholder Equity is down, Working capital is down.

Total Debt is up, Merchandise inventory is up, but the company added 60 new stores, so obviously it would be up. And the average sale is up, but below the rate of inflation.

Meanwhile…

🐷🐷🐷🐷🐷🐷🐷🐷🐷🐷🐷🐷🐷🐷🐷🐷🐷🐷🐷🐷🐷🐷🐷🐷🐷

Let’s Bring These Little Piggies to Market and Finally Turn This Company Around

Join Our Proxy Fight to ReBuild LL

By |2019-05-29T11:41:02-04:00May 29th, 2019|Uncategorized|0 Comments

LL Directors – Picked Up Some Free Shares!

With LL stock trading below $10 today, shareholders should all congratulate management and the directors for their stellar performance. After all, what better way to exemplify how great a job they are doing then by having the stock dive towards a yearly low.

The 52 week low is $8.81 per share. I’m sure as management continues to execute their “strategy” we should be seeing that price, and probably far lower in the near future.

But don’t worry. All is not lost. Because even though average shareholders are suffering, the board of directors have recently been able to pick up some delicious “free shares.”

Presenting The Winners of The 2019 Lumber Liquidators Stock Awards!

On May 24, 2019, each Director received 7,568 shares as part of their stock award for non-employee directors. A nice little windfall. All you home players should also note that last year, these same directors only received 2,863 because the LL stock price was higher. So, effectively, the lower the stock price goes, the more shares these guys get. Isn’t it just fabulous?

Note: Ms Nancy Taylor received 12,298 stock awards. She deserves more, since she’s leading this whole recovery.

Great work LL Directors!👏👏👏👏

And Directors,  just think about this, if you can get the stock to drop even more, then next year you can pick up even more shares!

Let’s Get These Clowns Out of Here and Finally Turn This Company Around

Join Our Proxy Fight to ReBuild LL

By |2019-05-28T16:05:26-04:00May 28th, 2019|Uncategorized|1 Comment

LL Sponsors the LPGA

Lumber Liquidators proudly proclaimed on their Facebook page that they were official sponsors for the LPGA Pure Silk Championship. They brought a trailer showroom down to the golf course to show off flooring styles. I question if this is worth the investment, but I will give them the benefit of the doubt.

The only problem is that the twits in charge of marketing wrote “mobile flooring share room” instead of “mobile flooring showroom” on the Facebook page. It stayed there all weekend.

They corrected the mistake on Sunday night…

You can see the edits in the post history.

How much money did it cost to sponsor this event? Probably a lot. Yet, the company shows zero attention to detail. Truth be told, the online team, especially the bozos in charge of Facebook, have been terribly incompetent for years. The Facebook page is notoriously a hotbed for defacement by unhappy customers and the marketing team usually takes days to delete the negative comments. I have mentioned this to the company many times, but nothing changes.

Don’t get me wrong. I think the Facebook page is a waste of time and likely drives negligible sales. But still, if the company is going to have a Facebook page and pay people to manage it, then they should at least try to do it properly.

Another example of incompetence at the company…

Let’s Change Management at LL and Finally Turn This Company Around

Join Our Proxy Fight to ReBuild LL

By |2019-05-28T14:53:01-04:00May 28th, 2019|Uncategorized|1 Comment

Proposal #4 Passes by Slim Margin

The Board of Directors’ Proposal #4, to dilute shareholders by over 6% in order to continue compensating Board members and the management team with free share options and restricted shares, was passed on May 22, 2019. The margin was very slim. If just 700k more shares (2.5%) had swung to our favor, we would have defeated the proposal.

As it stands, shareholders should realize that not only are LL shares trading at $10, having seen a massive loss of value over the last year, but shareholders can now look forward to also losing an automatic 6% more, through shareholder dilution, as management and the board continue to line their own pockets.

While we might have lost this effort, at LLVC, we are continuing to push aggressively for changes at the company. We have the help of many knowledgeable and experienced people and are working to implement our turnaround plan at Lumber Liquidators. There will be more votes in the future and they will be much more important and critical for the long term survival of this company.

Currently, we are proposing 2 new board candidates to be appointed directors of the company. We have already made the proposals to the company and will be making a public announcement shortly.

Mario Rizzi

Please sign up to the NEWSLETTER so that we can keep you informed. The next time we vote on a proposal, we will win.

NEWSLETTER – Shareholders UNITE

By |2019-05-24T13:30:04-04:00May 24th, 2019|Uncategorized|0 Comments

Lumber Liquidators Should Forget Margins And Focus On Comp Sales

Summary
  • Lumber Liquidators’ management has focused on increasing margins, but  failed to show results.
  • The company has been unable to leverage sales to offset costs, resulting in losses and poor sales guidance.
  • Same store sales are lagging competitors, resulting in lost market share.
  • The company blames macroeconomic issues, but competitors facing identical problems are growing faster and increasing gross margin.
  • The solution is not related to cost or gross margin, but growth. The only way forward is to increase same store sales.

Lumber Liquidators (LL) has faced its fair share of problems over the years, but its main failing is management’s inability to grow same store sales. Management has talked many times about the various levers they can pull and are pulling in order to return the company to profitability, but the only one which really matters and which they have been unable to pull, has been increasing same store sales. And this is why LL shares are trading at $11 per share. This is why shares have fallen 70% in the last 20 months. This is why investors are so angry that the Board has been obliged to hire a shareholder advisory firm to beg shareholders to ratify some unfriendly shareholder proposals. Frankly, if the company was showing same stores sales growth (SSS growth) in the 4% to 5% range, I wouldn’t be writing this article right now and the company would be in a very different position.

Everything But Sales

The following quote is directly from Lumber Liquidators’ 2018 Annual Report, on page 4:

The overall flooring industry has grown at a compound annual growth rate of 5.4% from 2012 through 2017. Over the same period, hardwood, laminate and vinyl flooring sales, including the cost of installation grew at a compound annual growth rate of 8.3%. [Source]

For 2017, Lumber Liquidators same store sales grew 5.4%, which was a respectable gain, after several tumultuous years of negative growth. But the healthy sales gains were temporary. In 2018, SSS only increased 2.6%. For 2019, management has guided for SSS to be” flat to up in the low-single digits.” So far in the first quarter of 2019, SSS actually dropped 0.8%. These numbers are all well below the industry average.

Management, so far, has been focused on growing overall sales, fundamentally by adding new stores, but this strategy is flawed because all new stores come with fixed costs and reduce the liquidity position of the company by necessitating the addition of inventory. Adding new stores also cannibalizes sales at older stores, which puts an additional anchor on SSS growth. Looking at the company’s income statement, we clearly see this, as the company says adjusted SG&A “increased $11.5 million in 2018, driven by a combination of higher payroll and occupancy costs, which are primarily related to the 21 new stores opened this year.” Of course, management tried to mitigate this cost increase, but again, they pulled the wrong lever. They reduced advertising by $2.3 million, or 3.1%. So not only did they invest money in new stores, but these new stores also considerably increased SG&A, cannibalized sales from old stores and increased inventory commitments and then to top it all off, management reduced overall advertising by 3.1%. Is it any wonder that SSS growth fell by more than 50% from the year before?

Current management at Lumber Liquidators has a strong bias towards increasing profitability by increasing gross margin and containing costs. On October 30, 2018, CEO Dennis Knowles said “we’re laser-focused on our bottom-line and believe we can drive margin expansion through careful cost management.”

It’s interesting to note that despite all this talk of margins, gross margins actually only increased by 30 bps in the last 2 years, rising from 35.9% in 2017, to 36.2% in 2018. More shocking, adjusted gross margins only increased 10 bps, from 35.5% to 35.6%

Gross margins lumber liquidatorsSource

Management is misguided in placing so much focus on one financial metric. The fact that management’s efforts have been almost completely ineffectual at moving that metric is an indication of incompetence. Using very simple arithmetic and assuming constant sales of $1.1 billion, an increase of 30bps would only increase profit by $3.3 million. That’s why the company has added 33 new stores in the last 2 years but adjusted operating income has only increased from 1% in 2017 to 1.9% in 2018.

What Should Management Be Doing?

The real driver of growth and profit at Lumber Liquidators has always been SSS growth. The logic and math behind this is very simple to understand and I will present it below. And I am not talking about setting astronomically high SSS growth targets. But a simple 4% to 5% SSS growth pace per year would be more than enough to solve every problem, both internally and externally originated at this company. There are three main ways in which SSS growth can turn around the company.

1) Operating Leverage

Very simple. In order to calculate profitability at LL, we subtract the SG&A percentage from Gross Margin percentage. The remaining percentage is the Operating Margin. This figure shows us the operating profitability of the company as a percentage of total sales. As shown above, playing with the gross margin number has produced negligible results. The only other lever we have in this equation is to reduce SG&A. In this article I am not going to rehash how the company can drastically reduce net SG&A expenses (i.e. reduce bloated salaries and management bureaucracy). There is a far simpler solution for the time being. Just grow same-store sales. Assuming that SG&A costs remain the same, if the company simply grows SSS, the SGA percentage will fall, fast and considerably.

Currently Adjusted Gross Margin is 35.6% and Adjusted SG&A is 33.7%. The chart below shows what happens if total SG&A in dollar terms stays the same, but the company simply grows SSS by 4.5% per year. SG&A as a percentage of sales would fall by almost 300 bps within 2 years, more than offsetting any gross margin erosion due to tariffs or lack of execution.

This is called operating leverage. It is a basic necessity in order to profitably grow a business, but for the last 2 years, there has been very little of it at Lumber Liquidators. The above estimates assume only same store sales growth, no new store additions and a constant SG&A, which is modest, because there is room for SG&A cuts.

2) Driving Profitable Incremental Sales Dollars

An even simpler way to see how sales growth would add profits is to ignore SG&A cost altogether. The company currently has adjusted gross margins of 35.6%, meaning it earns 35.6 cents on every dollar of sales, before overhead expenses. Most of the company expenses can be considered fixed, especially when considering marginal, extra sales happening at comparable stores. In 2018, the average LL store sold $2.67 million dollars of merchandise and services. If that same store could sell 4.5% more merchandise and services in 2019, it would not significantly increase the overall costs to operate that store. But the extra $120,000 of sales would generate an extra $42,700 of gross profit (35.6%). Most of that would flow directly to the company’s bottom line. Multiply that by 413 stores, and you have over $17 million of extra gross profit which would come at only a marginal cost increase. This is the power of SSS growth, presented on a very basic level. Negative SSS growth (Q1, 2019) produces the opposite effect, and results in a rapid erosion of profitability, as we have seen.

3) Market Share Gain

The flooring sales sector is very fragmented. The following pie charts, provided by Lumber Liquidators clearly show that the market is saturated with small players.

Lumber Liquidators market shareSource: LL Investor Presentations

In the past, LL was able to grow by taking market share away from these independent stores. But, in the last few years, large and fast growing competitors have entered the space. The “Big Box” (Home Improvement Stores) have gained share. Floor and Decor (FND) has entered the space and taken a large chunk of market shares. Contractors and Independent stores have lost market share. But Lumber Liquidators has not gained any market share. Clearly, it is no longer good enough for LL to be better than a mom and pop flooring retailer. They now have to beat players like Floor and Decor, Home Depot and Lowe’s, which, despite their size, have been posing far stronger net sales and same store sales growth.

It’s important to note that simply to maintain their market share, Lumber Liquidators has had to increase their store count from 356 at the beginning of 2015 to 393 at the end of 2017, while average store sales in that same period were actually down and are in fact still not back to average 2015 levels. That simple fact can explain almost all of the company’s current financial difficulty.

I came across an interesting study, published in the Harvard Business Review over 40 years ago, but still entirely relevant and very applicable to Lumber Liquidators current situation. Here is an excerpt of the findings.

The authors discuss why market share is profitable… Specifically, as market share increases, a business is likely to have a higher profit margin, a declining purchases-to-sales ratio, a decline in marketing costs as a percentage of sales, higher quality, and higher priced products. Data also indicate that the advantages of large market share are greatest for businesses selling products that are purchased infrequently by a fragmented customer group. [Source: Harvard Business Review]

Taking the concept of SSS Growth down to the lowest common denominator, we can ignore all financial terms. In a competitive industry like flooring, fundamentally, if you are not growing your SSS, then you are losing market share. The pie is growing, but realistically, it is only so big. Imagine a high stakes poker game with Lumber Liquidators playing against Home Depot, Floor and Decor and Lowe’s. If all those competitors are seeing their chip stacks grow, then logically, Lumber Liquidators’ percentage of the total winnings will be decreasing. Even if new money is entering the game, if the competitors are gaining it faster than LL, then eventually LL will be squeezed out. I bring up this poker analogy because in the Q2 2017 conference call, CEO Dennis Knowles made a relevant reference:

As far as I’m concerned, execution thus far has been for table stakes. The real work of uncovering and enhancing the value of Lumber Liquidators lies ahead of us, and I’m excited to work with our team to realize those opportunities.
—Lumber Liquidators CEO Dennis Knowles

In the almost 2 years which have followed, Dennis Knowles has unfortunately not even been able to win those table stake games. Losses have mounted and the balance sheet has deteriorated. Important people have left the company and new hires have not been able to show the same levels of performance. Most importantly, in this grand poker game, competitors have been winning big hands and the blinds are only increasing.

What About Tariffs? What About Storm Headwinds? Etc…

Skeptics will likely try to drill holes in my arguments due to tariffs, and their impacts on LL’s business and margins. This rebuttal is short sighted and not defensible. The 10% tariff rate which Lumber Liquidators has been forced to deal with since September 2018 and the new 25% rate which will shortly go into effect, will obviously impact the company. But it will impact all companies in the sector. In Q1 2019, Floor and Decor faced the same tariffs as Lumber Liquidators, but FND posted SSS growth of 3.1% while LL posted SSS growth of -0.8%. In that same environment, FND increased gross margin 120 bps, while LL saw gross margin fall 110 bps. Both companies are facing similar macroeconomic issues, but their financials are going in completely opposite directions.

I also find it interesting that FND blamed most of its slow SSS growth on headwinds from last year’s Hurricane Harvey. FND stated that if not for these tough comparables at stores located in the Houston market, SSS growth would have been 7.1%. Recall that in Q1 2018, FND posted a large “400 basis points comp benefit due to the demand from Hurricane Harvey.”

Meanwhile, Lumber Liquidators similarly decided to implicate hurricane headwinds for their poor sales guidance, blaming “tougher comparisons against the Hurricane Harvey storm benefited markets in 2018.” The only problem is that astute readers might recall that in the beginning of 2018, Lumber Liquidators management said that the company actually received very little benefit from Hurricane Harvey reconstruction.

February 27, 2018:

We only have 8 to 10 stores depending on where you draw the storm ring around that. So, it’s a very small part of our business and just didn’t have that strong contribution.”
—Former Lumber liquidators CFO Martin Agard

May 1, 2018:

We still see a bit of strength in the South from that in Texas. We never really saw much in Florida. Maybe there’ll be a slow steady tailwind there. The pickups we saw in the Texas, Houston market are diminishing. They’re not quite gone yet, but there were still a little tailwind from that one.
—Lumber Liquidators CEO Dennis Knowles

Put very simply, Lumber liquidators is claiming a same store sales growth headwind, when it actually never really benefited from a tailwind.

Again, the sluggish same store sales growth and poor same store sales guidance is not based on macroeconomic factors. It’s company specific. More accurately, it’s management-specific.

Summary

Management at Lumber Liquidators has been trying to increase the profitability of the company by focusing on increasing gross margins. During the last two years this “strategy” has had negligible results. It would have been far easier and more effective if those same efforts had been placed on simply growing same store sales. The company would have benefited from increased market share and sales leverage to reduce SG&A as a percentage of sales. Going forward, the company has blamed week guidance and poor performance on macroeconomic factors. But competitors such as Floor and Decor are facing these exact same factors and are seemingly having very little difficulty surmounting them.

The fault for this divergence of performance must fall on the shoulders of Lumber Liquidators’ management, specifically, the executive team’s failure to focus on relevant parts of the business needed to grow and drive profitable sales. I believe that in order to turn this company around, shareholders must unite and elect a new Board of Directors.

I have formed the Lumber Liquidators Value Committee, composed of a large and growing base of shareholders. Our goal is to gain board representation and drive positive change by strategically replacing members of the current management team. Interested shareholders can join this movement to Rebuild LL, and together we can return this company to profitability and growth, hopefully before it is too late.

By |2019-05-27T14:11:40-04:00May 20th, 2019|Uncategorized|0 Comments

Lumber Liquidators’ Board Proposals Will Dilute Shareholders

Summary
  • Facing a shareholder proxy fight, the Board has hired a proxy advisory firm to solicit votes in favor of company proposals.
  • The proposals are not shareholder friendly, as they would dilute the share count and lead to increased executive salaries.
  • A protracted proxy fight would be detrimental to the company, but may be required to achieve positive change.

The Board of Directors at Lumber Liquidators (LL) has recently hired a proxy advisory firm in an effort to contact and influence shareholders to approve proposals which will increase executive pay and dilute shareholder holdings. The Board is effectively using company money to help pass proposals which harm shareholders. From my perspective, it appears management and the board of directors may be more focused on self-enrichment and collecting stock options and equity incentive rewards than actually turning around the company to benefit all shareholders.

The Proxy Proposals

There are several normal proxy proposals which are to be tabled at the Lumber Liquidators Annual Shareholder Meeting to be held on May 22, 2019. They include the election of two directors, the approval of the company auditor and the advisory vote on executive compensation. As I have mentioned in another article, I am actively working with a group of large investors, as part of the Lumber Liquidators Value Committee, and we are urging all investors to vote against these proposals, as we believe they are not shareholder friendly.

Proposal 4

The most important proxy proposal to be voted on this year is Proposal 4. In this proposal the Board of Directors is asking shareholders for permission to increase the number of shares of common stock authorized for issuance by 1,750,000. This represents a dilution to current shares outstanding of over 6%. The company then plans to use these shares to grant higher equity-based compensation awards. The company contends that these equity grants are necessary to “attract, motivate and retain highly qualified talent,” but this is where I think shareholders should be very skeptical. From the Summary Compensation Table shown further below:

Directors at the company are collecting substantial stock awards as well, as shown in the following chart.

LL director stock awards

Money Won’t Buy Loyalty

The fact is that most of the best talent at the company has already left and the many thousands of dollars of equity based compensation which these executives had collected over the years didn’t seem to have factored in their decision to leave. Notable departures within the last 18 months include Marco Pescara, the company’s Chief Merchandising and Marketing Officer, who had been at the company for over 12 years, Carl R. Daniels, the Chief Supply Chain Officer at the company with 7 years experience and with many recommendations to his name and Jill Witter, Chief Legal and Compliance Officer. But this list goes on. Company founder, Tom Sullivan, resigned as a director, and just last month, the company CFO, Marty Agard decided to leave the company and forfeited almost $200,000 worth of unvested restricted stock awards and stock options.

Moreover, one must question the logic that granting more equity based compensation actual leads to better performance. Over the last 3 years, the top 5 executives at Lumber Liquidators have collected approximated $6 million in combined stock and option awards, yet growth and margins at the company are stalled and the share price recently hit an all time low.

Management equity compensation at Lumber Liquidators

Source: Lumber Liquidators DEF-14A Proxy Filing

Shareholders vs. Management

Considering the performance of the company and the high executive salaries and equity compensation, shareholders have little reason to be pleased. Asking shareholder to now dilute their holdings in order to pay management even higher compensation seems unfair and inappropriate. The Lumber Liquidators Value Committee is challenging these proposals and we have so far received very strong support from shareholder who are voting against all of the proxy proposals, and especially Proposal 4. Management at Lumber Liquidators has realized that the proposal is in jeopardy of being rejected by shareholders and they are now on the offensive. On April 23, 2019 the Board hired an independent proxy solicitation firm to “to provide strategic advisory services and to solicit proxies” in favor of the proposals. The cost of these services is “$25,000, plus costs and expenses.” The Board is effectively using company money to help pass proposals which harm shareholders.

Over the coming weeks the advisory firm will contact retail and institutional investors to solicit votes in favor of additional equity grants to management and a further dilution of the share count. As we have seen, not only are these proposals damaging to shareholders, but shareholders (via the company) will now actually be paying fees to an advisory firm to persuade them to approve them.

What Can Shareholders do?

We believe that in a battle between management and shareholders, there will be no winners, only losers. The turbulence of a proxy fight will be tumultuous for the share price. The resources wasted by management to fight off activism will inevitably cause distractions within the company. On the other hand, are shareholders expected to simply remain idle as they see a once great company like Lumber Liquidators stagnate amid fierce competition? Must we continue to watch silently as the share price falls, destroying our investment and savings?

The Lumber Liquidators Value Committee believes the best course of action is for management and the Board of Directors at the company to put their effort into turning around the core business and to only focus on proposals which are beneficial to shareholders. Until management is able to deliver results and drive a meaningful recovery in the business, we will not relent.

We continue to recommend that shareholders vote against all Board proposals to be tabled at the Lumber Liquidators Annual Shareholder Meeting in order to send a message to management and the Board of Directors that a change at the company is wanted and needed.

By |2019-05-27T14:11:37-04:00May 20th, 2019|Uncategorized|0 Comments