Notes to Condensed Consolidated Financial
Statements
(amounts in thousands, except share
data and per share amounts)
(unaudited)
|
Note 1.
|
Basis
of Presentation
|
Lumber Liquidators Holdings, Inc. and
its direct and indirect subsidiaries (collectively and, where applicable, individually, the “Company”) engage in business
as a multi-channel specialty retailer of hardwood flooring, and hardwood flooring enhancements and accessories, operating as a
single business segment. The Company offers an extensive assortment of domestic and exotic hardwood species, engineered hardwood,
laminate, resilient vinyl, engineered vinyl plank and wood-look ceramic tile flooring direct to the consumer. The Company also
features the renewable flooring products, bamboo, engineered bamboo and cork, and provides a wide selection of flooring enhancements
and accessories, including moldings, noise-reducing underlayment, adhesives and flooring tools. These products are primarily sold
under the Company’s private label brands, including the premium Bellawood brand. The Company also provides in-home delivery
and installation services. The Company sells primarily to homeowners or to contractors on behalf of homeowners through a network
of 385 store locations in primary or secondary metropolitan areas. The Company’s stores spanned 46 states in the United
States (“U.S.”) and included eight stores in Canada at March 31, 2017. In addition to the store locations, the Company’s
products may be ordered, and customer questions/concerns addressed, through both its call center in Toano, Virginia, and its website,
www.lumberliquidators.com
. The Company finishes the majority of the Bellawood products on its finishing lines in Toano,
Virginia, which along with the call center and corporate offices, represent the “Corporate Headquarters.”
The accompanying unaudited condensed
consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q for interim financial reporting
pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). In the opinion of management,
all adjustments (consisting of normal and recurring adjustments except those otherwise described herein) considered necessary
for a fair presentation have been included in the accompanying condensed consolidated financial statements. However, they do not
include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial
statements. Therefore, the interim condensed consolidated financial statements should be read in conjunction with the audited
consolidated financial statements and notes included in the Company’s annual report filed on Form 10-K for the year ended
December 31, 2016.
The condensed consolidated financial statements
of the Company include the accounts of its wholly owned subsidiaries. All intercompany transactions have been eliminated in consolidation.
The Company adopted Accounting Standards Update No. 2015-17 (“ASU 2015-17”) during the first quarter of 2017 and reclassified
approximately $6,090 of current deferred tax assets to long-term deferred tax liabilities on the prior year balance sheet which
now reflects a net deferred tax liability of $3,798, from the $9,888 previously disclosed.
Results of operations for the three months
ended March 31, 2017 are not necessarily indicative of the results to be expected for the full year.
|
Note 2.
|
Summary
of Significant Accounting Policies
|
Fair Value of Financial Instruments
The carrying amounts of financial instruments
such as cash and cash equivalents, accounts payable and other liabilities approximates fair value because of the short-term nature
of these items. The carrying amount of obligations under the revolving credit facility approximates fair value due to the variable
rate of interest. The fair values of these financial instruments are classified as Level 1 as defined in the Financial Accounting
Standards Board (“FASB”) ASC 820 fair value hierarchy.
Merchandise Inventories
The Company values merchandise inventories
at the lower of cost or market value. The Company periodically reviews the carrying value of items in inventory and records a
lower of cost or market adjustment when there is evidence that the utility of inventory will be less than its cost. In determining
market value, the Company makes judgments and estimates as to the market value of its products, based on factors such as historical
results and current sales trends. Although the Company believes its products are appropriately valued as of the balance sheet
date, there can be no assurance that future events or changes in key assumptions would not significantly impact their value.
Recognition of Net Sales
The Company recognizes net sales for products
purchased at the time the customer takes possession of the merchandise. Service revenue, primarily installation revenue and freight
charges for in-home delivery, is included in net sales and recognized when the service has been rendered. The Company reports
sales exclusive of sales taxes collected from customers and remitted to governmental taxing authorities, and net of an allowance
for anticipated sales returns based on historical and current sales trends and experience. The sales returns allowance and related
charges were not significant for the three month periods ended March 31, 2017 and 2016.
Cost of Sales
Cost of sales includes the cost of the
product sold, cost of installation services, transportation costs from vendor to the Company’s distribution centers or store
locations, any applicable finishing costs related to production of the Company’s proprietary brands, transportation costs
from distribution centers to store locations, transportation costs for the delivery of products from store locations to customers,
certain costs of quality control procedures, warranty and customer satisfaction costs, inventory adjustments including shrinkage,
and costs to produce samples, reduced by vendor allowances.
In early March 2015, the Company began
voluntarily offering free indoor air quality screening to certain of its flooring customers who purchased laminate flooring sourced
from China to address customer questions about the air quality in their homes. During the second quarter of 2016, the Company
agreed with the Office of Compliance and Field Operations of the Consumer Product Safety Commission (“CPSC”) to continue
its indoor air quality testing program for customers who purchased laminate flooring sourced from China during the period from
February 22, 2012 to February 27, 2015. The form of the testing program agreed to with the CPSC is substantially similar to the
program the Company has operated since March 2015. In connection with the continuation of the testing program, the Company recorded
a charge to cost of sales of approximately $3,000 in the second quarter of 2016 that represented our best estimate of the costs
to continue the program. No additional accruals were considered necessary during the first quarter of 2017.
Estimating the reserve for costs associated
with the Company’s indoor air quality program for certain of its customers who purchased laminate flooring sourced from
China requires management to estimate (1) the number of future requests for indoor air quality testing, (2) the results
of that testing and (3) the average cost to fulfill each request, all of which are subject to variables that are inherently uncertain.
The Company projects its best estimate of both the expected number of requests to be received and the percentage of requests that
will ultimately progress through various phases of its testing program using a range of assumptions derived from the Company’s
limited indoor air quality test program history and the identification of factors influencing the amount of requests, including
the declining trend in received requests due to the passage of time since customer purchase of the material and/or recent media
events. Actual liabilities could be higher or lower than those projected due to uncertainty in projecting the number of future
requests for tests, the potential for a media event driving an increase in test kit requests, future average costs per test and
other factors, which could materially affect the Company’s financial condition, results of operations or cash flows. If
the level of requests received or average cost per request differs materially from expectations, it could result in additional
increases to the reserve and reduced earnings and cash flows in future periods. At March 31, 2017, the Company’s best estimate
of its future indoor air quality testing program reserve is approximately $1,350.
A rollforward of the reserve for the Company’s
air quality testing program was as follows:
|
|
2017
|
|
|
2016
|
|
Balance at January 1
|
|
$
|
1,500
|
|
|
$
|
809
|
|
Provision
|
|
|
-
|
|
|
|
2,895
|
|
Reversal
|
|
|
-
|
|
|
|
-
|
|
Payments
|
|
|
(150
|
)
|
|
|
(2,925
|
)
|
Balance at March 31
|
|
$
|
1,350
|
|
|
$
|
779
|
|
Recent Accounting Pronouncements
In November 2015, the FASB issued ASU 2015-17,
which amends ASC Topic 740, Balance Sheet Classification of Deferred Taxes. In summary, the core principle of Topic 740 is that
an entity classifies both current and noncurrent deferred income tax assets and liabilities in the noncurrent section of the statement
of financial position. The amendments in ASU 2015-17 became effective for annual reporting periods beginning after December 15,
2016, and interim periods within those fiscal years. The Company adopted this new guidance during the first quarter of 2017 on
a retrospective basis, and accordingly reclassified approximately $6,090 of current deferred tax assets to long-term deferred
tax liabilities, such that the December 31, 2016 balance sheet reflects a noncurrent deferred tax liability of $3,798 and a current
deferred tax asset of zero. The adoption of this guidance had no impact on the Company’s results of operations or cash flows.
In March 2016, the FASB issued Accounting
Standards Update No. 2016-09, which amends ASC Topic 718, Compensation – Stock Compensation, which simplifies the accounting
for employee share-based payments. The new standard requires the immediate recognition of all excess tax benefits and deficiencies
in the income statement (rather than equity), which was adopted in the first quarter of 2017 on a prospective basis. The standard
also requires classification of excess tax benefits as an operating activity as opposed to a financing activity in the statements
of cash flows. The Company applied this amendment of the standard on a retrospective basis starting in the first quarter of 2017.
In the first quarter of 2016, there were no excess tax benefits recognized. The standard also clarifies that all cash payments
made to taxing authorities on the employees' behalf for shares withheld should be presented as financing activities on the statements
of cash flows, which is consistent with the Company’s current practice. Finally, the standard provides for a policy election
to either estimate the number of awards that are expected to vest or account for forfeitures as they occur. The Company will continue
to include the impact of estimated forfeitures when determining share-based compensation expense.
In May 2014, the FASB issued Accounting
Standards Update No. 2014-09 (“ASU 2014-09”), which creates ASC Topic 606, Revenue from Contracts with Customers,
and supersedes the revenue recognition requirements in Topic 605, Revenue Recognition, including most industry-specific revenue
recognition guidance throughout the Industry Topics of the Codification. In addition, ASU 2014-09 supersedes the cost guidance
in Subtopic 605-35, Revenue Recognition — Construction-Type and Production-Type Contracts, and creates new Subtopic 340-40,
Other Assets and Deferred Costs — Contracts with Customers. In summary, the core principle of Topic 606 is that an entity
recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration
to which the entity expects to be entitled in exchange for those goods or services. In August 2015, FASB issued ASU 2015-14, Revenue
from Contracts with Customers (Topic 606): Deferral of the Effective Date, which deferred the effective date of ASU 2014-09 to
reporting periods beginning after December 15, 2017. Early adoption is permitted for reporting periods beginning after December
15, 2016. The Company will adopt this ASU on January 1, 2018. Companies may use either a full retrospective or a modified retrospective
approach to adopt this ASU. The Company established a cross-functional team in 2016 to review its current accounting policies
and practices, assess the effect of the standard on its revenue contracts and identify potential differences. In addition, the
Company is in the process of evaluating changes to its business processes and controls to support recognition and disclosure under
the new standard. While the Company is continuing to assess all potential impacts of the standard, it currently believes the most
significant impacts will relate to its assessment of (i) determining when its merchandise and installation sales order arrangements
meet the definition of a contract when both arrangements are offered to its customers, (ii) determining the transaction price
as impacted by sales returns and promotional activities, including financing arrangements it offers to its customers; (iii) sales
commission costs it pays to its employees; and (iv) the potential impact on gross versus net presentation and classification relative
to the performance of its installation sales. However, the Company cannot currently estimate the impact of this change upon
adoption of this standard. The Company is also continuing to review the impact of this standard on potential disclosure
changes in its financial statements as well as which transition approach will be applied.
In February 2016, the FASB issued Accounting
Standards Update No. 2016-02 (“ASU 2016-02”), which creates ASC Topic 842, Leases, and supersedes the lease accounting
requirements in Topic 840, Leases. In summary, Topic 842 requires organizations that lease assets — referred to as “lessees”
— to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases. The
amendments in ASU 2016-02 are effective for fiscal years, and interim periods within those fiscal years, beginning after December
15, 2018. Therefore, the amendments in ASU 2016-02 will become effective for the Company at the beginning of its 2019 fiscal year.
The Company is currently assessing the impact of implementing the new guidance on its consolidated financial statements. When
implemented, the standard is expected to have a material impact as operating leases will be recognized on the Company’s
consolidated balance sheet.
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Note 3.
|
Stockholders’ Equity
|
Net Loss per Common Share
The following table sets forth the computation
of basic and diluted net loss per common share:
|
|
Three Months Ended
March 31,
|
|
|
|
2017
|
|
|
2016
|
|
Net Loss
|
|
$
|
(26,372
|
)
|
|
$
|
(32,402
|
)
|
Weighted Average Common Shares Outstanding—Basic
|
|
|
28,291,658
|
|
|
|
27,090,575
|
|
Effect of Dilutive Securities:
|
|
|
|
|
|
|
|
|
Common Stock Equivalents
|
|
|
—
|
|
|
|
—
|
|
Weighted Average Common Shares Outstanding—Diluted
|
|
|
28,291,658
|
|
|
|
27,090,575
|
|
Net Loss per Common Share—Basic
|
|
$
|
(0.93
|
)
|
|
$
|
(1.20
|
)
|
Net Loss per Common Share—Diluted
|
|
$
|
(0.93
|
)
|
|
$
|
(1.20
|
)
|
The following have been excluded from
the computation of Weighted Average Common Shares Outstanding—Diluted because the effect would be anti-dilutive:
|
|
Three Months Ended March 31,
|
|
|
|
2017
|
|
|
2016
|
|
Stock Options
|
|
|
769,456
|
|
|
|
795,480
|
|
Restricted Shares
|
|
|
469,076
|
|
|
|
449,869
|
|
Stock Repurchase Program
The Company’s board of directors
has authorized the repurchase of up to $150,000 of the Company’s common stock. At March 31, 2017, the Company had $14,728
remaining under this authorization. The Company did not repurchase any shares of its common stock under this program during the
three months ended March 31, 2017 and 2016, respectively.
|
Note 4.
|
Stock-Based Compensation
|
The following table summarizes share activity related to stock
options and restricted stock awards (“RSAs”):
|
|
Stock Options
|
|
|
Restricted Stock
Awards
|
|
Options Outstanding/Nonvested RSAs, December 31, 2016
|
|
|
835,614
|
|
|
|
586,187
|
|
Granted
|
|
|
61,350
|
|
|
|
159,401
|
|
Options Exercised/RSAs Released
|
|
|
(50,548
|
)
|
|
|
(104,194
|
)
|
Forfeited
|
|
|
(40,150
|
)
|
|
|
(36,707
|
)
|
Options Outstanding/Nonvested RSAs, March 31, 2017
|
|
|
806,266
|
|
|
|
604,687
|
|
|
Note 5.
|
Related Party Transactions
|
The Company leases stores, a warehouse,
and the corporate headquarters, which includes a store location, from entities controlled by the Company’s founder, who
was a stockholder and a member of the Company’s board of directors until December 31, 2016. Effective December 31, 2016,
upon the departure of the Company’s founder from the board of directors, these transactions no longer meet the criteria
of related party transactions. Rental expense related to these leases was $851 for the three months ended March 31, 2016.
The effective tax rate of (1.7)%
for the three months ended March 31, 2017 is less than the statutory rate of 35% due to the Company’s valuation allowance
recorded against its net deferred tax asset. Changes in the valuation allowance as well as the small tax expense incurred
in certain state and foreign jurisdictions with taxable income in the period are recorded as taxs expense and substantially reduce
the Company’s effective tax rate. The valuation allowance is recorded in deferred tax liability on the condensed consolidated
balance sheet. The effective tax rate of 21.5% for the three months ended March 31, 2016 was driven principally by the recognition
of a valuation allowance against certain of the Company’s deferred tax assets coupled with a limitation on the recognition
of tax benefits on an interim basis in which the quarterly tax benefit exceeds the estimated tax benefit for the full year.
The Company files income tax returns
with the U.S. federal government and various state and foreign jurisdictions. In the normal course of business, the Company is
subject to examination by taxing authorities. The Internal Revenue Service is conducting audits of the Company’s income
tax returns for the years 2013 through 2015.
|
Note 7.
|
Commitments and Contingencies
|
Governmental Investigations
In March 2015, the Company received a grand
jury subpoena issued in connection with a criminal investigation being conducted by the U.S. Attorney’s Office for the Eastern
District of Virginia (the “U.S. Attorney”). In addition, on May 19, 2015, July 13, 2015 and March 11, 2016, the Company
received subpoenas from the New York Regional Office of the SEC in connection with an inquiry by the SEC Staff. Based on the subpoenas,
the Company believes the focus of both the U.S. Attorney investigation and SEC investigation primarily relate to compliance with
disclosure, financial reporting and trading requirements under the federal securities laws since 2011. The Company is fully cooperating
with the investigations by the U.S. Attorney and SEC Staff and continues to produce documents responsive to the subpoenas and
pursuant to other requests received from the U.S. Attorney’s Office. Given that the investigation by the U.S. Attorney and
SEC Staff are still ongoing, the Company cannot estimate the reasonably possible loss or range of loss that may result from this
matter.
Litigation Relating to Chinese Laminates
Formaldehyde-Related Cases
Beginning on or about March 3, 2015, numerous
purported class action cases were filed in various U.S. federal district courts and state courts involving claims of excessive
formaldehyde emissions from the Company’s flooring products (collectively, the “Products Liability Cases”).
The plaintiffs in these various actions sought recovery under a variety of theories, which although not identical are generally
similar, including negligence, breach of warranty, state consumer protection act violations, state unfair competition act violations,
state deceptive trade practices act violations, false advertising, fraudulent concealment, negligent misrepresentation, failure
to warn, unjust enrichment and similar claims. The purported classes consisted either or both of all U.S. consumers or state consumers
that purchased the subject products in certain time periods. The plaintiffs also sought various forms of declaratory and injunctive
relief and various damages, including restitution, actual, compensatory, consequential, and, in certain cases, punitive damages,
and interest, costs, and attorneys’ fees incurred by the plaintiffs and other purported class members in connection with
the alleged claims, and orders certifying the actions as class actions. Plaintiffs did not quantify damages sought from the Company
in these class actions.
On June 12, 2015, the United States Judicial
Panel on Multi District Litigation (the “MDL Panel”) issued an order transferring and consolidating ten of the related
federal class actions to the United States District Court for the Eastern District of Virginia (the “Virginia Court”).
In a series of subsequent conditional transfer orders, the MDL Panel has transferred the other cases to the Virginia Court. The
Company continues to seek to have any newly filed cases transferred and consolidated in the Virginia Court and, ultimately, it
expects all federal class actions involving formaldehyde allegations, including any newly filed cases, to be transferred and consolidated
in the Virginia Court. The consolidated case in the Virginia Court is captioned
In re: Lumber
Liquidators Chinese-Manufactured
Flooring Products Marketing, Sales, Practices and Products Liability Litigation (the “MDL”)
.
Pursuant to a court order, plaintiffs filed
a Representative Class Action Complaint in the Virginia Court on September 11, 2015. The complaint challenged the Company’s
labeling of its flooring products and asserted claims under California, New York, Illinois, Florida and Texas law for fraudulent
concealment, violation of consumer protection statutes, negligent misrepresentation and declaratory relief, as well as a claim
for breach of implied warranty under California law. Thereafter, on September 18, 2015, plaintiffs filed the First Amended Representative
Class Action Complaint (“FARC”) in which they added implied warranty claims under New York, Illinois, Florida and
Texas law, as well as a federal warranty claim. The Company filed a motion to dismiss and answered the FARC. The Virginia Court
granted the motion as to claims for negligent misrepresentation filed on behalf of certain plaintiffs, deferred as to class action
allegations, and otherwise denied the motion. The Company also filed a motion to strike nationwide class allegations, on which
the Virginia Court has not yet ruled. The Company also filed a motion to strike all personal injury claims made in class action
complaints. Plaintiffs subsequently agreed and the Virginia Court has ordered that no Chinese formaldehyde class action pending
in this lawsuit will seek damages for personal injury on a class-wide basis. The order does not affect any claims for personal
injury brought solely on an individual basis. The Company’s motion for summary judgment on plaintiffs’ First Amended
Representative Complaint in the MDL was granted in part and denied in part, and its motion to exclude expert reports and testimony
by plaintiffs’ experts related to deconstructive testing was denied.
In addition, on or about April 1, 2015, Sarah Steele (“Steele”)
filed a purported class action lawsuit in the Ontario, Canada Superior Court of Justice against the Company. In the complaint,
Steele’s allegations include (i) strict liability, (ii) breach of implied warranty of fitness for a particular purpose,
(iii) breach of implied warranty of merchantability, (iv) fraud by concealment, (v) civil negligence, (vi) negligent misrepresentation,
and (vii) breach of implied covenant of good faith and fair dealing. Steele did not quantify any alleged damages in her complaint
but, in addition to attorneys’ fees and costs, Steele seeks (i) compensatory damages, (ii) punitive, exemplary and aggravated
damages, and (iii) statutory remedies related to the Company’s breach of various laws including the Sales of Goods Act,
the Consumer Protection Act, the Competition Act, the Consumer Packaging and Labelling Act and the Canada Consumer Product Safety
Act.
Abrasion-Related Cases
On May 20, 2015, a purported class action
titled
Abad v. Lumber Liquidators, Inc.
was filed in the United States District Court for the Central District of California
and two amended complaints were subsequently filed. In the Second Amended Complaint (“SAC”), the plaintiffs (collectively,
the “Abad Abrasion Plaintiffs”) sought to certify a national class composed of “All Persons in the United States
who purchased Defendant’s Dream Home brand laminate flooring products (the “Dream Home Product”) from Defendant
for personal use in their homes,” or, in the alternative, 32 statewide classes from California, North Carolina, Texas, New
Jersey, Florida, Nevada, Connecticut, Iowa, Minnesota, Nebraska, Georgia, Maryland, Massachusetts, New York, West Virginia, Kansas,
Kentucky, Mississippi, Pennsylvania, South Carolina, Tennessee, Virginia, Washington, Maine, Michigan, Missouri, Ohio, Oklahoma,
Wisconsin, Indiana, Illinois and Louisiana. The products that are the subject of these complaints are part of the same products
at issue in the MDL. The SAC alleges violations of each of these states’ consumer protections statutes and the federal Magnuson-Moss
Warranty Act, as well as breach of implied warranty and fraudulent concealment. The Abad Abrasion Plaintiffs did not quantify
any alleged damages in the SAC but, in addition to attorneys’ fees and costs, sought an order certifying the action as a
class action, an order adopting the Abad Abrasion Plaintiffs’ class definitions and finding that the Abad Abrasion Plaintiffs
are their proper representatives, an order appointing their counsel as class counsel, injunctive relief prohibiting the Company
from continuing to advertise and/or sell laminate flooring products with false abrasion class ratings, restitution of all monies
it received from the Abad Abrasion Plaintiffs and class members, damages (actual, compensatory, and consequential) and punitive
damages.
The Abad Abrasion Plaintiffs filed a Third
Amended Complaint and the Company moved to dismiss the Third Amended Complaint. The court decided that it would decide the motion
only as to the California plaintiffs (hereinafter referred to as the Abad Abrasion Plaintiffs) and ordered that all the non-California
plaintiffs (collectively, the “Non-California Abrasion Plaintiffs”) be dropped from the action with leave to re-file.
Many of the Non-California Abrasion Plaintiffs re-filed separate complaints in the Central District of California within the required
60-day period, which were then transferred to the district court located in the place of residence of each Non-California Abrasion
Plaintiff. These complaints included similar causes of action and sought similar relief as those of the Abad Abrasion Plaintiffs.
On October 3, 2016, the MDL Panel issued
an order transferring and consolidating sixteen of the federal abrasion class actions to the Virginia Court. In subsequent conditional
transfer orders, the MDL Panel transferred other cases to the Virginia Court. The Company will seek to have any additional related
cases transferred and consolidated in the Virginia Court. The consolidated case in the Virginia Court is captioned
In re: Lumber
Liquidators Chinese-Manufactured Laminate Flooring Durability Marketing and Sales Practices Litigation
(the “Abrasion
MDL”).
The Virginia Court issued an initial pretrial
order instructing all parties to undertake certain discovery and planning tasks and scheduled certain preliminary conferences.
Pursuant to a court order, on February 27, 2017, the plaintiffs filed a Representative Class Action Complaint in the Virginia
Court. The complaint challenged the durability of the Dream Home Product and asserted claims under Alabama, California, Nevada,
New York and Virginia law for breach of warranty, fraudulent concealment, violation of the Magnuson-Moss Warranty Act, and violation
of consumer protection statutes. The Company filed a motion to dismiss the representative complaint and a motion to strike irrelevant
and prejudicial allegations from the representative complaint. Both motions are currently pending.
Estimated Liability Associated with Formaldehyde
and Abrasion MDL’s
In April 2017, the Company initiated settlement discussions
to jointly settle the MDL and the Abrasion MDL. As a result of this and other developments, the Company has recognized an estimated
liability of approximately $18,000 in its results of operations (within selling, general and administrative expenses) for the
three months ended March 31, 2017, with a corresponding current liability on the accompanying condensed consolidated balance sheet
as the Company determined a loss was both probable and reasonably estimable. This is an estimate and significant uncertainty remains
regarding whether a reasonable settlement can be reached, and the timing, amount and form of any ultimate loss. The Company believes
that such a settlement may be funded by a combination of cash, shares of common stock, and coupons. The ultimate resolution of
the MDL and the Abrasion MDL matters, including the form of any settlement or any loss in the absence of a settlement, could have
a material impact on the Company’s results of operations, financial condition, and may have a material adverse impact on
the Company’s liquidity. The Company will monitor new information or developments in these contingencies in future reporting
periods and adjust its accruals, as necessary, in accordance with ASC 450-20-25. The Company is currently unable to reasonably
estimate the amount or range of possible loss in excess of the amounts accrued.
If the Company is unable to reach a reasonable
settlement, the Company will defend the matter vigorously and believes there are meritorious defenses and legal standards that
must be met for, among other things, class certification and success on the merits. The Company does not have insurance coverage
with respect to the MDL and Steele matters, and may have limited insurance coverage relative to the Abrasion MDL.
In addition to the MDL, the Steele
matters, and the Abrasion MDL, there are a number of individual claims and lawsuits alleging (i) damages due to excessive
formaldehyde emissions and (ii) damages similar to those in the Abrasion MDL. While the Company believes that a loss
associated with these additional matters and the Steele matter is reasonably possible, the Company is unable to reasonably
estimate the amount or range of possible loss.
Gold Matter
On or about December 8, 2014, Dana Gold
(“Gold”) filed a purported class action lawsuit in the United States District Court for the Northern District of California
alleging that the Morning Star bamboo flooring (the “Bamboo Product”) that the Company sells is defective. On February
13, 2015, Gold filed an amended complaint that added three additional plaintiffs (collectively with Gold, “Gold Plaintiffs”).
The Company moved to dismiss the amended complaint. The court dismissed most of Gold Plaintiffs’ claims but allowed certain
omission-based claims to proceed. Gold Plaintiffs filed a Second Amended Complaint on December 16, 2015, and then a Third Amended
Complaint on January 20, 2016. In the Third Amended Complaint, Gold Plaintiffs allege that the Company has engaged in unfair business
practices and unfair competition by falsely representing the quality and characteristics of the Bamboo Product and by concealing
the Bamboo Product’s defective nature. Gold Plaintiffs seek the certification of a class of individuals in the United States
who purchased the Bamboo Product, as well as seven state subclasses of individuals who are residents of California, New York,
Illinois, West Virginia, Minnesota, Pennsylvania, and Florida, respectively, and purchased the Bamboo Product for personal, family,
or household use. Gold Plaintiffs did not quantify any alleged damages in their complaint but, in addition to attorneys’
fees and costs, Gold Plaintiffs seek (i) a declaration that the Company’s actions violate the law and that it is financially
responsible for notifying all purported class members, (ii) injunctive relief requiring the Company to replace and/or repair all
of the Bamboo Product installed in structures owned by the purported class members, and (iii) a declaration that the Company must
disgorge, for the benefit of the purported classes, all or part of the profits received from the sale of the allegedly defective
Bamboo Product and/or to make full restitution to Gold Plaintiffs and the purported class members.
Fact discovery in the matter is now complete.
The Gold Plaintiffs filed a motion for class certification seeking to certify state-wide classes for purchases of the Bamboo Product
in California, Florida, Illinois, Minnesota, Pennsylvania, and West Virginia. The Company filed an opposition to class certification
and a motion to exclude the opinions of the Gold Plaintiffs’ experts. These motions are currently pending.
In addition, there are a number of other
claims and lawsuits alleging damages similar to those in the Gold matter. The Company disputes these and the Gold Plaintiffs’
claims and intends to defend such matters vigorously. Given the uncertainty of litigation, the preliminary stage of the case,
and the legal standards that must be met for, among other things, class certification and success on the merits, the Company is
unable to estimate the amount of loss, or range of possible loss, at this time that may result from this action.
Antidumping and Countervailing Duties
Investigation
In October 2010, a conglomeration of domestic
manufacturers of multilayered wood flooring filed a petition seeking the imposition of antidumping (“AD”) and countervailing
duties (“CVD”) with the United States Department of Commerce (“DOC”) and the United States International
Trade Commission (“ITC”) against imports of multilayered wood flooring from China. This ruling applies to companies
importing multilayered wood flooring from Chinese suppliers subject to the AD and CVD orders. The Company’s multilayered
wood flooring imports from China accounted for approximately 7%, 6% and 10% of its flooring purchases in 2016, 2015 and 2014,
respectively. The Company’s consistent view through the course of this matter has been, and remains, that its imports are
neither dumped nor subsidized.
As part of its processes in these proceedings,
the DOC conducts annual reviews of the CVD and AD rates. In such cases, the DOC will issue preliminary rates that are not binding
and are subject to comment by interested parties. After consideration of the comments received, the DOC will issue final rates
for the applicable period, which may lag by a year or more. As rates are adjusted through the administrative reviews, the Company
adjusts its payments prospectively based on the final rate. The Company will begin to pay the finalized rates on each applicable
future purchase when recognized by U.S. Customs and Border Protection.
The DOC made its initial determinations
regarding CVD and AD rates on April 6, 2011 and May 26, 2011, respectively. On December 8, 2011, orders were issued setting final
AD and CVD rates at a maximum of 3.3% and 1.5%, respectively. These rates became effective in the form of additional duty deposits,
which the Company has paid, and applied retroactively to the DOC initial determinations.
Following the issuance of the orders issued
on December 8, 2011, a number of appeals were filed by several parties, including the Company, with the Court of International
Trade (“CIT”) challenging, among other things, certain aspects that may impact the validity of the AD and CVD orders
and the applicable rates. The appeal of the CVD order was dismissed in June 2015. On January 23, 2015, the CIT issued a decision
rejecting the challenge of the AD rate for all but one Chinese exporter. This decision was finalized on July 6, 2015, and appealed
to the Court of Appeals for the Federal Circuit (“CAFC”) on July 31, 2015. On February 15, 2017, the CAFC vacated
the CIT’s prior decision with instructions to the DOC to recalculate its AD rate. The schedule for the DOC’s recalculation
has not yet been set. The Company is unable to determine the impact of the CAFC’s decision to vacate the initial determination
of AD rates; however, the DOC’s recalculation could materially impact the Company’s previously recorded loss related
to annual reviews of AD rates discussed below.
In the first DOC annual review in this matter,
AD rates for the period from May 26, 2011 through November 30, 2012 and CVD rates from April 6, 2011 through December 31, 2011
were modified to a maximum of 5.92% and a maximum of 0.83%, respectively, which resulted in an additional payment obligation for
the Company, based on best estimates and shipments during the applicable window, of $833. We recorded this as a long-term liability
on our accompanying consolidated balance sheet and in cost of sales in our second quarter 2015 financial statements. These rates
have been appealed to the CIT by several parties, including the Company. While the appeal is still pending, the CIT has issued
a remand to the DOC requesting reconsideration of certain AD rate calculations.
Pursuant to the second annual review, in
early July 2015, the DOC finalized the AD rate for the period from December 1, 2012 through November 30, 2013 at a maximum of
13.74% and the CVD rate for the period from January 1, 2012 through December 31, 2012 at a maximum of 0.99%. The Company believes
the best estimate of the probable loss was $4,089 for shipments during the applicable time periods, which was recorded as a long-term
liability on its accompanying consolidated balance sheet and included in cost of sales in its second quarter 2015 financial statements.
Beginning in July 2015, the Company began paying these rates on each applicable purchase. The rates relating to this second annual
review have been appealed to the CIT and that appeal is pending.
The third annual review of the AD and CVD
rates was initiated in February 2015. The third AD review covered shipments from December 1, 2013 through November 30, 2014. The
third CVD review covered shipments from January 1, 2013 through December 31, 2013. In May 2016, the DOC issued the final CVD rate
in the third review, which was a maximum of 1.38%. On July 13, 2016, the DOC set the final AD rate at a maximum of 17.37%. The
Company has appealed the AD rates to the CIT, and the appeal is currently pending. The Company believes its best estimate of the
probable loss associated with AD and CVD is approximately $5,500 for shipments during the applicable time periods. During the
quarter ended June 30, 2016, the Company recorded this amount in other long-term liabilities in its balance sheet and as a charge
to earnings in cost of sales on its statement of operations.
The total amount recorded in other long-term
liabilities through the third annual review in the accompanying balance sheets was $10,400 at March 31, 2017 and at December 31,
2016.
In February 2016, the DOC initiated the
fourth annual review of AD and CVD rates, which follows a similar schedule as the preceding review. The AD review covers shipments
from December 1, 2014 through November 30, 2015. The CVD review covers shipments from January 1, 2014 through December 31, 2014.
In December 2016 and January 2017, the DOC issued non-binding preliminary results in the fourth annual review for AD rates and
CVD rates, respectively. The preliminary AD rate was a maximum of 4.92% and the CVD preliminary rate was a maximum of 1.68%. The
final AD and CVD results in the fourth annual review are currently expected to be issued in May 2017. The Company paid AD and
CVD rates in excess of preliminary amounts for shipments during the periods impacted by the fourth annual review. The Company
has not recorded a gain contingency as a result of this preliminary review. If the final rate is determined to be above the rates
paid, the Company may incur additional expense or may receive a return of funds if the final rate is set below these rates.
The DOC initiated the fifth annual review
of AD and CVD rates in February 2017, which is expected to follow the same schedule as preceding reviews. The AD review covers
shipments from December 1, 2015 through November 30, 2016. The CVD review covers shipments from January 1, 2015 through December
31, 2015.
The 5-year Sunset Review of the antidumping
and countervailing duty orders on multilayered wood flooring (the “Sunset Review”) began in November 2016 at the ITC
to determine whether to terminate the orders. The Company filed a notice of appearance and documentation required at this phase
of the proceeding and intends to participate fully in the Sunset Review. The Sunset Review is expected to be completed in late
2017 or early 2018.
Other Matters
The Company is also, from time to time,
subject to claims and disputes arising in the normal course of business. In the opinion of management, while the outcome of any
such claims and disputes cannot be predicted with certainty, its ultimate liability in connection with these matters is not expected
to have a material adverse effect on the results of operations, financial position or cash flows.