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Lumber Liquidators Earnings: The 3 Most Important Things to Know

Hardwood and laminate flooring retailer Lumber Liquidators Holdings Inc. (NYSE: LL) reported second-quarter earnings Tuesday morning that sent the stock soaring. The stock was up 33% around 2:30 p.m. While much of the market's reaction is based on the company's strong financial results, there are other things investors need to pay close attention to. Here are three important takeaways.

1. Profits well ahead of expectations

To start, Lumber Liquidators outperformed the financial expectations of Wall Street analysts by a significant margin. Total sales were $263.5 million, up 10.7% from last year, for the third-highest quarter of sales in the company's history. Additionally, the company generated a net profit of $4.5 million, good for $0.16 per share, while Wall Street analysts were expecting a loss of $0.07 per share on average. Needless to say, the result is far, far better than any of the financial crowd expected. It was also the company's first profitable quarter since 2015, when allegations first came out that it was selling Chinese-made laminate flooring that was potentially hazardous to people's health. Frankly, few analysts who cover the company were expecting it to return to profitability before 2018.

And with a huge 25% of shares outstanding sold short at last report, a lot of money was betting against the company doing well this quarter, so that's probably the biggest factor pushing the stock price up so much: short-sellers rushing to buy shares to cover their short positions.

Image source: Lumber Liquidators.

2. The "how" is as important as the "what"

The second thing investors need to note is not that Lumber Liquidators grew sales and returned to profitability, but how. CEO Dennis Knowles, who has a deep background as an operations expert, attributed it to sticking to the process and focusing on building a stronger, better Lumber Liquidators. This included rationalizing inventory and the product lineup, adding services customers want such as installation, and investing in strengthening and improving the quality of store employees.

It looks like this is paying off, as indicated by the huge gains in comps -- sales at stores open more than one year -- which were up a remarkable 8.8%. Knowles said that merchandise sales increased 6.1% on a comps basis, and that it invoiced 5.3% more customers than one year ago. It's hard to overstate how important this is: The company saw a big uptick in traffic, and sold more flooring to more people.

This is a big reason why gross profit increased 38% to $97.5 million, while gross margin was 37%, up 730 basis points. When adjusting out non-recurring charges in the current and prior quarter, the company said non-GAAP gross margin increased 220 basis points.

3. Two steps closer to putting the legal issues to bed

Thirdly, the company's strong financial and operating performance and surge in traffic indicate that, after a tough couple of years, customers are starting to return to Lumber Liquidators as time puts the allegations further out of the public consciousness. And with the company moving ever closer to resolving ongoing litigation, it may soon shut the door on this ugly chapter.

Case in point: The company and the Consumer Products Safety Commission have worked together for more than a year on an air-quality monitoring program to ensure that the Chinese-made laminate at the heart of the legal issues wasn't posing a threat to consumers. Last quarter, the CPSC agreed to discontinue the monitoring program, and closed the case.

Furthermore, the ongoing class-action litigation over this flooring is closing in on a potential settlement. Since the company announced in the first quarter that it was setting aside $18 million toward a settlement, there hasn't been any news or definitive action. However, the court overseeing the case has taken steps to move things forward, appointing a federal judge to mediate settlement talks, and appointing settlement counsel for both plaintiff classes.

Looking ahead

Following a tough couple of years, this past quarter's results offer very real evidence that things are starting to turn around. More traffic, higher per-ticket sales, and a big increase in comp merchandise revenue paint a picture of more customers coming in and buying flooring; that is driving higher margins, and generating operating leverage that's directly lifting the bottom line. Knowles put it thusly on the earnings call (emphasis mine):

Both the current and year-ago quarters had several unusual items that impacted those results, as scheduled in our 10-Q and press release. But it should be clear, both on a GAAP basis and when excluding the unique items we've tabled out for you: The business is making strides, in terms of profitability through both revenue growth and margin expansion.

In other words, the improved results aren't just a product of fewer and lower non-recurring expenses, but are due to management's focus on strengthening the business and adding products and services that attract more paying customers. Factor in another couple of steps forward in closing out the ongoing legal issues, and there are reasons to be very optimistic about the company's future.

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Jason Hall owns shares of Lumber Liquidators. The Motley Fool recommends Lumber Liquidators. The Motley Fool has a disclosure policy.