Lumber Liquidators: Recovery Period Is Expected To Be Lengthy

| About: Lumber Liquidators (LL)

Summary

Lumber Liquidators reported Q2 earnings that were in-line with my expectations for a disappointing quarter. Sales were slightly better than I expected, but gross margin was slightly worse.

The report indicates that the recovery period is likely to be lengthy. Management is unable to give guidance for when it expects positive comps, or what gross margins will be.

Despite its challenges, Lumber Liquidators only effectively burnt $39 million during the past year though.

It will likely continuing burning cash for a while and may end up with a costly MDL settlement.

However, it isn't in serious financial trouble yet due to its limited amount of debt.

Lumber Liquidators (NYSE:LL) reported Q2 2016 earnings that I would consider in-line with my expectations. Given that my expectations were for a disappointing Q2, this isn't particularly good news for the company, but the quarter wasn't outright terrible. It appears that Lumber Liquidators is facing a lengthy recovery period as it is still unable to provide gross margin or sales guidance and is not able to say when it expects positive comps. However the level of cash burn at the company remains manageable and it retains a solid amount of liquidity.

Net Sales And Gross Margin

Lumber Liquidators recorded net sales of $238.1 million in Q2 2016. This was a 4% decrease from Q2 2015 and incorporated a 7.2% comparable store sales decline. This was slightly lower than analyst expectations for $240.6 million in revenue, but a bit higher than my $233 million estimate. Lumber Liquidators' Q2 2016 sales also falls within (albeit at the upper end) of my $221 million to $238.5 million range estimate based on March sales figures. That range estimate was based on the historical relationship of March sales to Q2 sales, and did prove to be significantly more accurate than doing a straight March times three estimate for Q2 sales.

My estimates were based on a 35% adjusted gross margin for Lumber Liquidators though, while Lumber Liquidators reported an adjusted gross margin of 33.3% for Q2 2016 after stripping out antidumping charges and air quality testing costs. This gross margin figure would need to be considered disappointing since it represents a slight decrease from Q1 2016's 34.5% adjusted gross margin. Gross profit with a 33.3% adjusted gross margin and $238.1 million in net sales is equivalent to gross profit with a 35% adjusted gross margin and $226.6 million in net sales. Therefore, Lumber Liquidators' gross profits ended up slightly below my expectations (by around $2 million). Lumber Liquidators appears to have reduced advertising by around $2 million versus last year though, so overall its numbers are fairly close to my expectations.

Lumber Liquidators did mention that Q2 2015 sales benefited from heavy promotions. However, the relatively low adjusted gross margins for Q2 2016 indicate that this quarter was still likely fairly promotional. Q2 gross margins have historically been close to full year gross margins (between 2010 and 2014 Q2 averaged around 0.3% lower gross margins than full year), so Lumber Liquidators still has work to do to get to the 35% to 36% gross margin level that I believe is achievable. Lumber Liquidators has not been able to indicate where it believes gross margins will end up, other than that it likely won't make it back to the 40% to 41% that it was at a couple years ago.

Liquidity And Cash Flow

Lumber Liquidators generally looks fine from a liquidity perspective still. It had $12.7 million in cash at the end of Q2 2016 and received a $22.1 million tax refund in July. It also had up to $53.7 million in availability under its revolving credit facility. One thing to note is that there appears to be a new line in the 10-Q filing which mentions that "we continue to address the outstanding legal matters, including MDL, which, if settled, could have a material adverse impact on our liquidity in future periods". I don't know if the addition of that line means that Lumber Liquidators is attempting to negotiate a settlement for the MDL. A settlement would likely be costly, but would remove a significant source of uncertainty for Lumber Liquidators as well as reduce future legal costs.

I also like to look at how Lumber Liquidators' working capital and debt situation has changed over the past year. I use working capital since it accounts for the various insurance and tax receivables and accrued settlement funds that Lumber Liquidators has on its balance sheet. Working capital has gone down around $32 million during the last year, while credit facility debt has gone up by $12 million and other long-term liabilities (including estimated antidumping duties that are owed if its appeal fails) has gone up by $10 million. The accrued securities class action line includes $15 million in stock payments, which I am backing out of these calculations since it isn't cash based.

In $ Thousands

Q2 2015

Q2 2016

Working Capital

$205,585

$173,228

Less: Credit Facility

$20,000

$32,000

Less: Other Long-Term Liabilities

$11,630

$21,847

Plus: Stock-based Component Of Accrued Securities Class Action

$0

$15,420

Total

$173,955

$134,801

Click to enlarge

The result is that Lumber Liquidators' financial situation has deteriorated by around $39 million during the past year. That isn't too bad given its high legal and professional costs and challenging business situation, and indicates that it should still be able to handle a prolonged and continuing business slump.

Conclusion

Lumber Liquidators reported disappointing Q2 2016 results, although this was generally in-line with my expectations. The results and management commentary indicate that Lumber Liquidators continues to have a challenging road ahead of it. It is unable to give guidance as to when it expects positive comps yet, indicating that negative comps could continue throughout 2016. As well, Lumber Liquidators is unable to give guidance as to where it expects gross margin will end up (other than not at 2013 or 2014 levels), and it appears to be making slow progress in getting its adjusted gross margins consistently above the 34% level. That being said, Lumber Liquidators still has a decent balance sheet and only effectively burned $39 million during the past year despite its challenging situation.

I have pared down my short position by around 50% as a result of the earnings aftermath and expect to close the rest of my position fairly soon.

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Disclosure: I am/we are short LL.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.