Investor Questions and Answers
In the short term, from a purely financial perspective, the re-branding is not critical. However, once the plan is implemented, customers will expect it. The financial goal of the plan is to generate profit, and the company should reinvest that profit into a capex initiative to improve the physical appearance of the stores and re-brand the company. Competitors like Floor And Decor and The Tile Shop have newer looking stores in high traffic retail locations. If we are to compete, we must at least match their offerings.
The scandals have tarnished the brand and eroded about 15% of revenue per store. That being said, currently Lumber Liquidators stores still generate a high amount of revenue. Going forward, the memory of the scandals will be an overhang on the brand. They have stunted growth on a long term basis. This is all the more reason for a re-branding of the company. So we can start fresh, drive new and old customers, and compete against the rising brands.
It doesn’t have to be. But Lumber Liquidators already owns the Builder’s Pride trademark and domain name. The name has been used as an LL flooring brand and already has some consumer awareness. It is short and implies construction and quality. It seems like a good fit.
Maybe it can be used for something else in the future, but for now, it should be retired. The company does not sell lumber, and it is not in the business of liquidating inventory. At this point, the name signifies cheapness and discounting, which may resonate with a subset of consumers, but is clearly missing the mark currently. With the various scandals over the years, the brand is tainted and should simply be changed. It would cost more, take more time and be more risky to rebuild the brand rather than just starting over.
It won’t be cheap. The company has over 400 stores. We have estimated it will cost about $20 000 per store for new indoor and outdoor signage plus uniforms, stationary, etc. That alone is over $8 million. A marketing push for the new brand is also needed. Total cost should be approximately $15 million.
Our goal is not to use any financing to pay for the re-branding initiative. The company must self generate the cash needed. This is why it is critical to use low cost methods to increase sales and gross margin. The easiest and cheapest way to increase sales is to increase store hours. Every competitor has longer stores hours than LL. Morning and evenings hours must be extended, even if there is just a skeleton crew of employees per store during those off peak hours. Then, to boost margin, prices must increase 1% across the board. The sales impact will be minimal, but the profit impact will been enormous. This will generate the money needed for a re-branding.
Flooring and installation is always priced per square foot. The average price of flooring sold at LL is about $2.00 per sq.ft. A 1% increase would result in the price of that flooring increasing to $2.02 per sq.ft. It’s really not a big difference. The average box of flooring contains about 20 sq.ft of product. That box would now cost about 40 cents more. So instead of costing $40, it would cost $40.40. Again, not a big difference.
The average customer purchase at LL is about $1300 as stated in the last annual report. A 1% price increase would add $13 to that price. Once a customer has found the perfect flooring for their project and is ready to spend $1300, would they really walk away from a purchase if it cost $13 more? Very unlikely.
Most customers will not. Flooring is an infrequent purchase. The average person might buy new floors every 10 years. Retail customers are very unlikely to take any note of the 1% price change.
So? For the last 4 years the company has been hemorrhaging money. It lost $60 million in 2018 alone. This is a corporation, not a charity. It cannot keep selling flooring at a loss. Simple as that.
LL has the lowest gross margin in the industry. Even if Pro customers shop around and are focused purely on price, LL would still be the cheapest option after the price increase.
In any case, if the flooring market was all about price, LL would be taking market share from everybody. And it is not. Because price is much less of a factor than it once was. By increasing Pro incentives and store opening hours, LL can drive those customers to the stores and they won’t care about a 1% price increase.
How much does a gallon of paint cost? You probably don’t have an exact price in mind. And there are many different types of paint, so there naturally cannot be 1 single price. But let’s say a gallon of paint costs about $20. If that paint not cost $20.20 would that impact your decision to buy that paint?
Imagine you decided to repaint your house and you created a perfect design concept and determined the ideal color for every room. You go to the hardware store to make your purchase and you have 2 options. You can get the exact color you want and it will cost you $20.00 per gallon. But, for $19.80 per gallon you can get the same paint, but the color is slightly different than the one you wanted. Will you choose to save 20 cents and go with the off color, or simply pay a few pennies more to get the color you want?
In both these cases, price is not a significant driver of your purchase. Even if price was important to you, the difference in price would not make it a relevant factor in your decision. That is why a 1% price increase at LL will boost profit without negatively impacting sales.
The other option is that we continue making no money. Does selling $1 billion of flooring per year and earning no money make you feel warm and fuzzy?
Re-branding is not easy. In the short term it creates customer confusion. (What happened to Lumber Liquidators??) The company will want to retain existing customers while also gaining new ones. The goal is to change the image of the company but still to keep the old clients. Inevitably, we will lose some clients in the process, and gain some others. Overall, it will be a positive, but only by about 1% in the first year. But as the new brand develops and customers gain awareness, it will have room to grow at a much faster pace than the current Lumber Liquidators.
Nothing is without risk. Management surely has considered raising prices. But, given the multitude of problems which the company has faced over the last years, it is likely that they did not think it was worth the risk. The responsibility for these actions lies squarely with management and if they implement a price increase and it does not go as expected, they will get the blame.
This proxy fight and our outside initiative to increase prices gives management a unique opportunity. They can implement the plan and avoid direct responsibility if it does not go as anticipated, while being able to take most of the credit if things go well. This is one major benefit of the proxy contest for management.
Customer reactions are hard to anticipate. Competitor reaction is even more difficult. This is why it is important approach the problem from different angles at the same time. Increasing Pro incentives and expanding store hours will both lead to increased sales. This will more than offset the loss of “bargain hunter” customers which will happen after the price increase. The goal is to maintain sales volume while expanding gross margin and profit. It will take a coordinated effort.
I am not.
Retail specialists cost about $300 per hour to hire for consulting gigs and the company has probably burned through dozens of them over the years, with very little to show for it. Fundamentally, a retail expert is not needed to fix the gross margin issue. A retail expert would never dare to propose such a simplistic solution as “raising prices” as that would be too common to justify their consulting fee. But it is the only solution.
How do I know it is the only solution?
Management has tried everything else and margins are still nowhere near where they need to be. This is the last remaining option. Let’s try it.
The warehouse stores… In the industrial parks. Yes, they are ugly. But they are profitable. The rent is low and they have an established customer base.
As the company was developing (years ago) it had the goal to expand as rapidly as possible. The warehouse stores allowed for rapid nationwide expansion on a shoestring budget. Just rent a warehouse, fill it with flooring and slap an LL sign in front. It used to work.
The “warehouse” stores are profitable. They drive strong revenue and have low operating cost. The problem is that they degrade the brand and they don’t grow. Sales at a warehouse stores remain stable for the most part. Existing customers who know about these stores will go to them, but new customers prefer to buy from newer, big box style stores, located on retail avenues.
The warehouse stores must simply be relocated to better retail streets. The objective is to retain existing customers while also driving new discovery and organic growth. The relocated “retail” stores should be located as close as possible to the warehouse stores, in strip malls, shopping plazas or roads with heavy traffic.
In all likelihood, competitors will see our price increases and increase their prices too. All the main competitors are publicly traded companies and although they have performed much better than LL in the past, their shareholder constantly demand more. And the easiest way for all these competitors to increase their own profits is to increase their prices in lock step with LL.
Very simple. Due to losses and lawsuit settlements, the company now has a debt load larger than ever before (but still manageable). In addition, over the last years the company has not invested enough money in their stores, so LL stores don’t look as good as competitors. Lastly, competitors are opening stores very rapidly and expanding into LL’s main markets.
The company needs as much money as possible, as soon as possible, to pay down debt, invest in stores and open new stores quickly. The company does not have years to do this. It must be done as soon as possible.
While LL has lost the overall top flooring retailer sales spot, it still has the largest nationwide network of flooring retail stores. Many of these stores are in smaller, under-serviced markets, where large scale competition is minor. Now is the last, best chance to increase prices and bank some profits. Once competitors enter these smaller markets and erode LL’s niche position, it will be harder to profitably raise prices.
The company must raise prices, rebuild the balance sheet so they can invest in stores and be in a stronger position to face the on-coming competition.
After the multiple scandals of 2015, the board of directors was hastily replaced. Current members have a lot of experience, but most of that experience is with companies which went bankrupt, or with companies that are irrelevant to the flooring or retail industry. We believe that these are not board members that will be effective at turning around this company or that even know how to turn around a company. They might be great people, but they are not a great fit for this business, and several members must be replaced.
Note that some members on the board have been serving for much longer and their tenure dates from before the scandals. While these members might be slightly more effective and have relevant experience, that does not change the fact that the company shares are currently at historic lows. If these members were actually “all stars” would they really have let the company fall as far as it has? The board needs new blood. A fresh, vibrant, and eager team of experienced members.
A list of the current board members can be seen here: http://investors.lumberliquidators.com/management-and-directors?cat=1
Members who must be replaced immediately:
Douglas T. Moore : Director at Lumber Liquidators since April 2006 (13 years). Currently President and Chief Executive Officer of Med-Air Homecare, a company with no functional website or phone number and almost no information to be found online. We contacted Lumber Liquidators Investor Relations with questions about “Med-Air Homecare” and were told that the company is in the process of “winding down.” IR seemed surprised and in fact thanked us for bringing the matter to their attention. From February 2012 through June 2012, Mr. Moore served as the Chief Merchandising and Marketing Officer at hhgregg, Inc (Bankrupt). Other experience: Senior VP at Sears (Bankrupt), Executive VP and Chief Merchandising Officer at Circuit City Stores (Bankrupt).
W. Stephen Cannon : Formerly senior vice president, general counsel and secretary of Circuit City Stores, Inc (Bankrupt)
David A. Levin : President and Chief Executive Officer of Destination XL Group, a struggling men’s apparel retailer which has not been profitable since 2013. Former director at Christopher & Banks Corporation, which is teetering on bankruptcy.
We are searching for candidates who bring freshness to the team while still having relevant knowledge in the home improvement and flooring industries. We are not just looking for warm bodies to fill vacant chairs. We are not simply looking for random directors to take a salary of $200k per year for showing up to a dozen board meetings. We don’t want candidates who come from mediocre or failed retailers. We want winners who know what they are doing and who will take an active interest in turning this company around. We can drive success from the top down.