What to Make of Lumber Liquidators Holdings' "Good News, Bad News" Earnings

Beleaguered wood flooring retailerLumber Liquidators Holdings Inc. reported third-quarter financial results on Nov. 4, and, frankly, they were pretty bad. However, the company did report progress on a number of critical fronts -- the biggest of which was finding a permanent CEO -- and the market has responded quite positively, with shares of Lumber Liquidators climbing more than 15% in the two days following the earnings release.

However, some very real concerns remain, and the financial results have yet to bounce back since60 Minutesfirst aired its investigation into the company's Chinese-sourced laminates. Let's take a closer look at what happened this quarter.

The numbers

Revenue in millions.

The 11% decline in revenue and sharp drop in earnings only tell part of the story. For some context, let's take a look at the Q3 results posted byTile Shop Holdings in October:

Revenue of $72 million, up 25%
Earnings per share of $0.07, up 133%
Comparable-store sales increased 9.7%

While Lumber Liquidators and Tile Shop aren't direct competitors, they certainly compete for the same customer dollars and benefit (or suffer) from the same macroeconomic trends: housing and employment.

And overall, those two things are trending relatively well, unemployment rates are relatively low, jobless claims are at four-decade-low levels, and sales of existing homes are up strongly this year. Tile Shop is benefiting from that as well as efforts by its management team, led by first-year CEO Chris Homeister, to focus on strategic and profitable growth.

Lumber Liquidators, however, continues to struggle to bounce back from the allegations.

What happened in the quarter

Comps fell 14.6% in the quarter, but traffic (as measured by the number of invoices generated) declined slightly less, at 13%.
Seven new stores were opened, generating $8.9 million in incremental revenue.
The company continued refocusing on its core wood flooring business, significantly reducing the number of SKUs it carries to eliminate product overlap. This included the exit of the tile business and ending the company's vertical integration initiatives.
Reached a $10 million settlement with the Department of Justice on Lacey Act allegations from two years ago, putting one major issue behind it.
Gross margin fell significantly from 39.2% to 30.1%. Management said that product mix (particularly in laminates due to the discontinuation of Chinese-made product, as well as a drop-off in sales of bamboo), and the effects of lower retail pricing implemented in late 2014 were key drivers of this. The company also lost about 100 basis points of gross margin to pay for $2.4 million in home formaldehyde testing kits. This was less than half as much as in the second quarter.
Sales, general, and administrative expenses increased $10 million. The company paid out $8.7 million in legal fees and $3 million in fixed-asset impairment charges. These are expenses that shouldn't recur every quarter, but the legal fees are likely to continue until it moves past the allegations it sold harmful laminate products.
The company paid out $2.7 million in employee retention incentives, likely to make up the shortfall in commissions and bonuses due to sales declines. This may look like a one-off expense, but it probably just offsets commissions paid in a healthier environment.
Reduced marketing and advertising spending by about $3 million, saying it would be more "surgical" in its marketing efforts going forward.
The company remains under investigation from the DOJ, California Air Resources Board, and Consumer Product Safety Commission.

What management saidFounder and acting CEO Tom Sullivan, on the company's efforts to retain store and field-level employees:

Incoming CEO and current Chairman of the Board John Presley, on what makes him the right person to be the next CEO:

Presley on the company's progress with the ongoing investigations:

Looking aheadSales and margins weren't good last quarter, and it's unlikely they'll rebound in the next quarter. Chances are, sales aren't likely to start recovering until the multiple investigations are complete, and the company can truly begin to turn the page.

In the interim, there's a new CEO running things, and his experience in operating in the heavily regulated banking sector should help create the right culture and processes to prevent the company from being exposed to these risks and allegations ever again.

Furthermore, its balance sheet remains relatively strong, with $53 million in cash and $67 million available on the company's revolving credit. Yes, much of the increased cash position is a product of significantly reduced inventory spending -- which will only last so long -- but once the company's regulatory risk is put behind it, its legal expenses should drop significantly, moving it back toward profitability.

It's just unclear how long before that happens or how much it will cost to get there. That uncertainty is the biggest risk for investors for the foreseeable future.

The article What to Make of Lumber Liquidators Holdings' "Good News, Bad News" Earnings originally appeared on Fool.com.

Jason Hall owns shares of and options for Lumber Liquidators, and shares of Tile Shop Holdings. The Motley Fool owns shares of and recommends Lumber Liquidators and Tile Shop Holdings. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.