Lumber Liquidators Holdings Inc. Slammed By Likely Criminal Charges

Is that the best you got? That might be the question Lumber Liquidators investors are asking of those who have piled on the flooring specialist in the wake of the 60 Minutes investigation alleging its laminate flooring didn't meet federal and state safety requirements.

For all the negative publicity and pervasive coverage of the supposed risks associated with its flooring products, Lumber Liquidators said last week that same-store sales fell less than 2% in Q1. However, it reported a loss of $7.8 million, or $0.29 per share, compared with a profit of $13.7 million, or $0.49 per share, a year ago.

Lumber Liquidators sales were marred by allegations of impropriety in the production of its laminate flooring. Photo: Mike Mozart.

Of course, that doesn't tell the whole story -- March was brutal for the flooring specialist. Exceptionally strong January and February sales largely masked what occurred in the wake of the news report. Sales fell 13% in March and comps were down 18% that month. Lumber Liquidators' stock price was cut in half as a result of the allegations.

Getting dinged againWhile it seemed like things could have been much worse, that "worse" might have just happened. Buried in Lumber Liquidators' quarterly financial report was a notice that the Justice Department is pursuing criminal charges against the flooring retailer for violations of the Lacey Act, a law that prohibits the illegal importation of fish, wildlife, and plants. It was amended in 2008 to include wood and forest products.

In 2013, federal authorities raided Lumber Liquidators' headquarters, looking for proof that the company illegally imported wood products from Russian forests that are home to the Siberian tiger. The company estimates the federal action could ultimately cost it $10 million.

If you've heard of the Lacey Act, it probably stems from the law's use in a high-profile case in which the DOJ filed criminal charges against Gibson Guitar for allegedly illegally importing rosewood for use in making its iconic instruments. Gibson ultimately paid a $300,000 fine to settle the case.

Photo: Hans Westbeek.

There are risks other than monetary fines associated with the law, such as up to one year in jail for misdemeanor violations such as if executives should have known they were importing prohibited goods. Felonies are punishable by up to five years in prison and $500,000 in fines per violation.

Problems lead back to China againLumber Liquidators' troubles in this case seem to have originated with a conservation group called the Environmental Investigation Agency. The group accused Lumber Liquidators of importing millions of square feet of illegally sourced hardwood flooring from a Chinese supplier, Suifenhe Xingjia Group, which manufacturers its Virginia Mill Works brand of flooring.

Lumber Liquidators flooring alleged to be from protected forests. Image: Environmental Investigation Agency report "Liquidating the Forests," 2013.

Conservation group representatives posing as flooring buyers visited Xingjia's factories and videotaped conversations with executives who supposedly admitted to knowingly purchasing illegally harvested lumber, and said Lumber Liquidators knew that at least some of its products were illegally procured. The EIA turned its evidence over to federal authorities who presumably acted on the information.

Senior executives of the Russian timber company Beryozoviy, which supplied Xingjia with the wood, were convicted in Russian courts for illegal logging and for creating and participating in a criminal network. Two executives were sentenced to 15 years and 13 years, respectively, in a penal colony and were ordered to pay hundreds of thousands of rubles in fines. A third executive was sentenced to five years imprisonment.

A depressingly common refrainThe undercover work sounds very familiar to what occurred with the 60 Minutes report, in which the TV news magazine also sent people undercover and recorded Chinese suppliers admitting to knowingly violating U.S. air quality standards and alleging Lumber Liquidators was aware of the situation.

The flooring retailer has said it has policies and more than 60 people in place to help it monitor the sourcing of its flooring and comply with federal regulations.

The stock took another hit last week, dropping 20% on the day after the possible criminal complaints were revealed. Lumber Liquidators shares have lost 70% of their value over the past year.

There is little hope of their recovery in the near term, with the best chance for a bounce coming when the Consumer Product Safety Commission completes its investigation into the laminate flooring air quality allegations. Because of how the agency will conduct its testing, there's a good chance -- but no guarantee -- that it will validate Lumber Liquidators' position that its flooring is in compliance with federal law.

The criminal case is dicier. While it's hard to imagine any executive doing time for this, a hefty fine seems the probable outcome. A $10 million fine would equate to almost a whole quarter of profit -- well, a normal quarter anyway -- and that could offset any other positive developments at Lumber Liquidators. With the retailer facing multiple lawsuits, this stock remains a risky bet.

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