Import safety spotlight shines on Lumber Liquidators

Flooring retailer disputed charges it sold unsafe products from China, while investigation continues into whether it violated Lacey Act.    Lumber Liquidators is strongly denying charges it sold laminate flooring from China with high levels of the chemical formaldehyde. The case, combined with an ongoing government investigation into whether the company purchased illegal wood supplies from Russia in violation of the Lacey Act, raises questions about the company’s compliance with import safety and environmental rules, as well as its quality control measures for overseas suppliers.
   On Sunday, the CBS news magazine “60 Minutes” aired an investigation that claimed Lumber Liquidators is selling laminate flooring with dangerous levels of formaldehyde, a known carcinogen, in violation of California health standards for emissions in wood flooring. 
   Formaldehyde is used in the glues used to bind wood particles together in laminated products.
   Testing done by labs hired by a lawyer and community activist representing upset homeowners suing the company found that samples of wood flooring from stores in California contained six to seven times the state standard for formaldehyde and some were close to 20 times higher than the allowable level. The plaintiffs, who filed a class action suit in December, are backed by Wall Street investors who believe Lumber Liquidators’ stock is overvalued and are shorting it – borrowing and selling shares in hopes the price drops and they can repay the shares at the lower price. Fears that the company will be found liable for large damages could potentially hurt the value of the company’s stock.
   The fast-growing flooring retailer has more than 360 stores in 46 states and more than $1 billion in annual revenues. It expects to open 30 more stores this year. 
   “60 Minutes” bought boxes of laminate flooring in several states and had them tested. Only one of 31 boxes complied with the California emissions standard for formaldehyde. Some were more than 13 times above the limit set by the California Air Resources Board. 
   The CARB standards are set to become national this year under a new federal law.
   On Monday, Lumber Liquidators issued a statement defending itself and challenging “60 Minutes” testing methods.
   “We comply with applicable regulations set by CARB, which is currently the only regulator of composite core emissions. Although the CARB regulations only apply in California, we adhere to these standards everywhere we do business. Every manufacturer of fiberboard cores used in our products is certified in accordance with CARB regulations. We have documentation to support each step of our production process, including vendor agreements, vendor invoices, CARB certificates, and test results, to serve as further proof that our processes, practices and products are compliant across the board,” the company said, adding that it has also conducted independent third party tests.
   “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.’”
   The CBS News program said former Lumber Liquidator employees, suppliers and competitors also informed it that the company’s Chinese-made laminates are not being made to California standards. It used undercover investigators with hidden cameras to visit three of Lumber Liquidators’ contract manufacturers in Changzhou, where it said mill employees openly admitted they used core boards with higher levels of formaldehyde to save 10 to 15 percent on the price and that they falsely labeled the company’s flooring as CARB 2 compliant, meaning it meets California emissions standards and the new U.S. federal law.
   “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 Lumber Liquidators statement said. “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.
   “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,” the company added. “Their motives and methods are wrong and we will fight these false attacks on all fronts…We stand by every single plank of wood and laminate we sell all around the country and will continue to deliver the best product at the best price to our growing base of valued customers.”
   On Wednesday, company executives canceled an appearance at the Raymond James’ institutional investors conference.
   Two weeks ago, the flooring retailer announced the opening of an advanced testing facility within its new distribution center in Toano, Va., outside of Richmond. The lab includes two sophisticated temperature and humidity-controlled conditioning rooms, and two formaldehyde emissions chambers. The company said its network of labs in the United States and Asia perform full-scale product evaluations and testing using a nine-step process.
   Whitney Tilson, a Wall Street hedge fund manager who has shorted Lumber Liquidators’ stock but is not involved in any lawsuit against it, told “60 Minutes” that the company doubled profits in a short period of time, which pushed its stock price up from $13 a share in 2011 to $119 in 2013. 
   Lumber Liquidator’s stock, which was trading in the $50 to $68-range in recent months, has plunged in value by 50 percent since Feb. 17, closing Thursday at $33.83.
   Tilson, a managing partner at Kase Capital Management, said the cheaper formaldehyde-based flooring allowed Lumber Liquidators to rapidly make huge profits in a business with low profit margins.
    “In 16 years of professional money management, I’ve seen hundreds of companies do all sorts of bad things to get their stock prices up,” he said. “But this has got to be the worst.”
   In an earnings call with analysts last week, before the “60 Minutes” segment aired, Lumber Liquidators President and CEO Robert Lynch reiterated the company’s commitment to product safety. “In addition, all of our suppliers of these products are either themselves certified under California regulations or source their core materials from certified manufacturers,” said Lynch. “We verify the status of these suppliers and manufacturers by using CARB’s own resources. This provides us an extra level of vigilance as we seek to provide the highest level of quality to our customers.
   “We are confident in the suppliers that we are buying from and the fact that that they are certified and compliant with those standards, and we’ve checked them. And we go above what’s required with our own testing. So we know that our product is safe,” he said. “We don’t just follow the letter of the law, we set the bar even higher so that our customers enjoy the best and safest products in the world.” 
   In an interview Monday on CNBC, Tilson said, “Lumber Liquidators appears to have come up with its own testing protocol…so they’re the ones who are doing the bogus testing.”
   Lumber Liquidators fired back in a statement to CNBC, saying, “Short sellers like Mr. Tilson make a living on manufacturing doubt about publicly traded companies like Lumber Liquidators. In this case, Mr. Tilson has trumpeted the fact that he was the impetus behind ’60 Minutes’ running this story.
   “Mr. Tilson is executing a well-established and profitable playbook: publicly speculate about a company’s success and use a compliant media to execute on his strategy to drive down a company’s valuation for his own personal gain,” the statement continued. “These motives and methods are wrong, and we will fight these false attacks on all fronts.”
   Lumber Liquidators got more bad news this week, when a $5 million class-action suit was filed against it in Florida for selling unsafe products, according to Reuters. On Wednesday, Sen. Bill Nelson, D-Fla., asked the Consumer Product Safety Commission, the Centers for Disease Control and Prevention, and the Federal Trade Commission to independently test the company’s products and investigate whether the company made potentially false marketing claims about its product’s compliance with safety standards.
   Several trial lawyers are publicly shopping for individuals and stockholders who believe they have been harmed by the flooring retailer’s products and business practices to participate in other class action suits.
   Meanwhile, Lumber Liquidators is under federal investigation for allegedly buying illegally harvested timber from Russia in violation of the Lacey Act. The Department of Homeland Security’s Immigration and Customs Enforcement and the U.S. Fish and Wildlife Service raided the company’s Virginia headquarters in September 2013 and the company said in its Feb. 25 annual report that the Justice Department is considering filing criminal charges against it.
   The Lacey Act is intended to help preserve protected plants, trees and wildlife in other parts of the world by making their importation, or products made with such plants or animals, into the United States illegal. In 2008, Congress amended the law to cover plants and trees for the first time to reduce global demand for illegally obtained timber products. In addition, more stringent rules were adopted for importers to accurately describe the exact type of wood or plant product on their import declarations. 
   Lumber Liquidators net income decreased 18.1 percent last year to $63.4 million and Lynch, the company’s chief executive, acknowledged during the earning’s call that the company has had “growing pains” and that fourth-quarter sales were short of expectations. Officials said better supply chain processes and the company’s new distribution centers will improve margins and inventory management in the coming year.
   Last year, Lumber Liquidators relocated its East Coast distribution center from Hampton Roads, Va., to a 1 million-square-foot facility in Toano. In the third quarter of 2013, it opened a 500,000-square-foot DC in California, rather than ship imported goods across the country to its western stores.
   A new merchandising and allocation system enabled the company to better forecast store-level inventory aligned to each store’s sales and has already been effective in lowering inventory levels. “We believe this improved visibility will lower overall inventory levels in 2015 and bolster our ability to aggregate and recognize situations which threaten the availability of inventory,” Lynch said. 
   The company recently boosted orders to ensure adequate inventory ahead of the Chinese New Year and because of the West Coast port slowdown, he added.
   The transition to the East Coast DC is expected to be completed by March 31, Chief Financial Officer Daniel Terrell said. The company will incur about $1.5 million in incremental transportation costs in the first quarter as merchandise is transferred to the new facility, according to Terrell.
   Lumber Liquidators expects the new DC to help lower domestic transportation costs, although truck driver shortages may increase trucking costs in some lanes, he said. 
   American Shipper Magazine’s December feature story “Going With the Grain,” describes how Lumber Liquidators is transforming its supply chain to deal with the company’s rapid expansion.
   Lumber Liquidators also could take a financial hit this year if it has to pay extra duties on previous purchases of multilayered wood imports from China. In January, the International Trade Administration issued preliminary anti-dumping duty rates for purchases between December 2012 and November 2013 after an investigation determined that certain Chinese suppliers were selling the engineered hardwood products at below market value. A final ruling is expected in May, but as it stands companies that bought products from those Chinese suppliers would be subject to an 18.27 percent duty, compared to 5.9 percent under an initial rate review. The company said it would incur a loss of about $5.7 million this year on purchases for the period and that there could be an additional $6.3 million liability if the rates remain in effect for shipments subsequent to November 2013 through the end of 2014.
   Engineered hardwood accounts for about 11 percent of the company’s flooring purchases. 
  The retailer is beginning to set aside money to pay the extra duties and is already looking sourcing products from different suppliers this year and diversifying its supplier base over multiple countries, Teller said.