Lumber Liquidators: Black and White

There’s a reason I love stories like this Lumber Liquidators ($LL – no positions) saga.   First, a few disclaimers:  I have not traded $LL stock.  I have no positions, and no plans to initiate any positions.  I don’t know any of the short sellers who have been criticizing the company, and I don’t have any associations with the company.  I don’t have any of their products in my house – as far as I know.  I have no experience at all with California CARB regulations.  I have no dog in this fight.

So here are the cliff notes:   shorts have been critical of Lumber Liquidators for years for a variety of reasons.    Whitney Tilson presented the stock at the 2013 Robin Hood Conference, and updated his thesis in October of 2014.    Even before Tilson’s original short thesis presentation in November of 2013, others had written articles about potential problems with $LL products being contaminated with unacceptable levels of formaldehyde.

Last night 60 Minutes aired a 13 minute segment where they detailed the claims of an environmental attorney (Richard Drury) and a non-profit director (Denny Larson), who (at the behest of short sellers who backed them) bought and tested  a number of samples of Lumber Liquidators’ Chinese-made laminate flooring:

“Drury and Larson bought more than 150 boxes of laminate flooring at stores around California and sent them to three certified labs for a series of tests. The results? While laminate flooring from Home Depot and Lowes had acceptable levels of formaldehyde, as did Lumber Liquidators American-made laminates, every single sample of Chinese-made laminate flooring from Lumber Liquidators failed to meet California formaldehyde emissions standards. Many by a large margin.”

also from the piece:

“Drury and Larson only had wood tested that was being sold in California. But we wondered if the Chinese-made laminate flooring that Lumber Liquidators is selling nationwide also has high levels of formaldehyde. So we went to stores in Virginia, Florida, Texas, Illinois and New York, and bought 31 boxes of it.

We sent the samples for testing at two certified labs. It turns out of the 31 samples of Chinese-made laminate flooring, only one was compliant with formaldehyde emissions standards. Some were more than 13x over the California limit. Both labs told us they had never seen formaldehyde levels that high.

But when we took those test results to Lumber Liquidators’ founder and chairman Tom Sullivan, he refused to accept the methodology as valid and points out the company is not required by law to test their finished products like we did.”

Did you catch that?   60 Minutes bought wood from 5 other states, and then made a statement about how those samples compared to the California formaldehyde emissions standards.  That struck me as odd, as did this statement from 60 minutes:

“”It is legal for flooring to contain formaldehyde. The chemical is present in some of the cheap glues used in factories like this one in China. This footage was recorded by investigators hired by 60 Minutes.

Formaldehyde is in the glues used to bind wood particles together to make the core boards in laminate flooring. The laminated top, which covers the core board, keeps most of the formaldehyde emissions trapped inside. But formaldehyde does leak into the air.”

Is it possible that 60 Minutes’ tests weren’t in accordance with CARB methodology?  In other words, in my non-expert not-a-lawyer view: perhaps if you grind up these boards, you’re likely to get formaldehyde readings that may not conform to CARB regulations because CARB regulations are designed to mimic real world use of the products – where the laminated top contains the hazardous chemicals.   I think that this is basically the defense that $LL offered in their response:

“We believe that 60 Minutes used an improper test method in its reporting that is not included in CARB’s regulations and does not measure a product according to how it is actually used by consumers. Our laminate floors are completely safe to use as intended. In our attempt to be fair and transparent, we provided significant testing results to 60 Minutes, including the results of the random testing performed on products from each of our laminate suppliers. We also went to great lengths to document issues between the validated test method and that used by 60 Minutes. Our Chairman addressed the differences and our position on the test methodology but 60 Minutes chose not to include it.”

Now back to the first line of the post: this is what I love about this story:  it’s a He Said/She Said story, but it should all be easily verifiable, objective stuff!  It’s not a qualitative debate.   We’re not talking about subjective definitions, we’re not talking about forecasts of what will happen to customer demand in the future: we’re talking about regulations that exist, and whether or not the testing is in compliance with the regulations.

60 Minutes and Drury and Larson claim that they tested the product and found off the chart violations.  Lumber Liquidators claims that those test methods were inaccurate.   Who is correct? I have no idea – but it shouldn’t be life’s greatest mystery to remedy this “debate”!

Whitney Tilson was on CNBC this afternoon.   He explained that he has no affiliation with the short sellers mentioned in the 60 Minutes piece, and that he has done his own testing of LL’s product.   Directly to the point of my question, Tilson claimed that his tests and the tests done by 60 Minutes were done in accordance with CARB protocol, and that it was Lumber Liquidators who made up their own methodology.

Again, although I’m not equipped to judge who’s correct here (rule #1 – know what you don’t know!), I believe there should be an objective answer that’s easy to find, and that all parties can put the “debate” into a clearer light by publicly detailing their methodology.   This is something one would expect from 60 Minutes, for sure: release the testing methodology and show that it was in accordance with CARB protocol.

There’s also the issue in this case of the prototypical Evil Short Sellers attempting to bring down a company for profit.  Even Lumber Liquidators, in their response, plays that card, which is almost always a giant red flag for any company who uses this defense:

“As 60 Minutes noted, these attacks are driven by a small group of short-selling investors who are working together for the purpose of making money by lowering our stock price.  Their motives and methods are wrong and we will fight these false attacks on all fronts. “

There’s nothing wrong with shorting a stock and trying to expose wrongdoing.   I think the 60 Minutes piece was carefully researched, including independent testing done by 60 Minutes, and thus is clearly not in the realm of “short and distort” behavior that is indeed despicable and which many retail novices lump together with any short selling.   Those who tell lies in order to manipulate the price of a stock (either higher or lower!) are committing securities fraud, and I have seen nothing yet in this case to illustrate that this is an example of that.

A few more tidbits:

first, Lumber Liquidators has a page on their website explaining the detailed safety testing they do for all of their products, and their commitment to customer safety.  Again, in accordance with the arguments I put forth above: we have a conundrum, eh?  Someone is lying, and it shouldn’t take a team of monkeys working around the clock to find out who.

Is it possible that one can make a laminate flooring product that satisfies CARB regulations but, when tested by other methods tests positive for massive levels of formaldehyde that violate CARB limits?   That certainly seems possible to me.   Is it possible that 60 Minutes really built this segment around non-compliant testing methods designed to distort the results?   That would surprise me, but it’s not impossible.  This comes back to the quote above:

“But when we took those test results to Lumber Liquidators’ founder and chairman Tom Sullivan, he refused to accept the methodology as valid and points out the company is not required by law to test their finished products like we did.”

If only Anderson Cooper and 60 Minutes or $LL CEO Tom Sullivan could elaborate on exactly what that sentence means – what methodology DOES the company use and what was wrong with 60 Minutes’ methodology??

Finally, 60 Minute’s smoking gun was footage from hidden camera purporting to be from inside one of the factories where $LL’s product is manufactured.  They have footage of a guy in the factory saying that this product is not CARB2 compliant, but that they could make a CARB2 compliant product at a higher cost.    $LL’s response was again in direct conflict with 60 Minutes’ claims:

“After becoming aware of the nature and content of the 60 Minutes story, we immediately reached out to the Chinese suppliers included in the story. The suppliers have confirmed that all products provided to Lumber Liquidators have been and are CARB compliant. The suppliers could not verify the identity of the individuals appearing in the videos. One of the suppliers featured questioned whether the product shown was actually from its factory. We randomly test each of our six laminate suppliers in China using unannounced audits and all products tested are compliant and safe. Again, the results of the third-party testing are on our website.”

The bottom line is that Lumber Liquidators’ product either conforms to CARB2 regulations or it doesn’t.   It’s not something to debate: it’s a black and white issue.   Someone here is lying, and it shouldn’t be rocket science to figure out who.

related:

60 Minutes:  Lumber Liquidators Linked To Health and Safety Violations

Tilson: Why I’m Short $LL

California CARB Regulations

Xuaha Zhou: Illegal Products Could Spell Big Trouble at Lumber Liquidators

Lumber Liquidators SEC 8-k response to 60 Minutes piece

-KD