Why Lumbers Liquidators Crashed

What happened? Lumber Liquidators (NYSE: LL) crashed by a breathtaking 21.5%

on Thursday after management reported disappointing sales for the second quarter of 2014 and reduced guidance for the full year.

The company had previously delivered weak numbers in the first quarter, which management attributed to a challenging industry environment.

However, recent performance seems to be signaling that Lumber Liquidators is going through serious difficulties, and this is a major red flag for investors in the company.

Weak salesSales during the second quarter of 2014 were $263.1

million, a 2.3% increase versus the same quarter in 2013, and materially below analysts' estimates of $303.2 million for the quarter.

The company opened 13 new stores during the quarter, bringing the total store base to 344 locations.

Comparable-store sales fell by a worrisome 7.1% during the quarter.

Disappointing earnings guidanceGross margin during the second quarter is

expected to decline due to “adverse net shifts in sales mix and greater discounting at the point of sale.”

Management expects earnings per share during the quarter to be in the range of $0.59-$0.61, considerably below analysts' forecasts of $0.90 per share on average.

Reduced guidance for 2014The company expects sales during the year to be in the

range of $1.05 billion-$1.1 billion, down from a prior range of $1.15 billion-$1.2 billion.

Comparable-store sales are forecast to change in the low single digits, either positive or negative, versus a previous guidance for a mid- to high-single-digits increase.

Earnings-per-share guidance for the year was cut to between $2.65 and $3 per share, versus a previous range of $3.25-$3.60.

“Customer traffic to our stores was significantly weaker than we expected, particularly in geographic areas severely impacted by the unusually harsh weather in the first quarter. The improvement in customer demand we experienced beginning in mid-March did not carry into May, and June weakened further. Our reduced customer traffic has coincided with certain weak macroeconomic trends related to residential remodeling, including existing home sales, which have generally been lower in 2014 than the corresponding periods in 2013. We now believe the prolonged purchase cycle associated with our customers' discretionary, large-ticket home improvement projects is likely to be delayed for some customers into the fall flooring season, and for others, into spring of 2015.”

--Robert M. Lynch, President and CEO

The explanation

Sales were also weak in stores not affected by the weather

Inventory problems

"In certain key merchandise categories, primarily laminates, vinyl plank and engineered hardwoods, lower than planned inventory levels reduced our ability to convert customer interest into invoiced sales. Certain mills experienced production delays in meeting our open orders as we continued to enhance our quality assurance requirements. We estimate an aggregate net sales shortfall in the second quarter of up to $18 million in those products impacted. We expect full product availability for our customers during the third quarter, with no material impact to our product costs.”

Robert M Lynch, President and CEO

What to watchIt will be important to monitor performance over the coming

quarters to evaluate if Lumber Liquidators is overcoming its inventory problems.

Regarding industry demand, big home improvement retailers such as Home Depot (NYSE: HD) and Lowe's (NYSE: LOW) can provide important information when it comes to evaluating demand strength for retailers exposed to the housing industry.

Both Home Depot and Lowe's are bigger and more diversified than Lumber Liquidators, and their wide geographical reach can make them more representative of industry conditions.

Home DepotHome Depot reported sales of $19.7 billion during the quarter

ended on May 4, a 2.9% increase versus the same period in the prior year.

Comparable-store sales increased 3.3% in the U.S. during the quarter.

Management is expecting accelerating sales growth during the rest of the year: "The first quarter was impacted by a slow start to the spring selling season. But we had solid results in non-weather impacted markets and expect our sales for the year to grow in line with the guidance we previously provided."

Lowe'sLowe's reported sales of $13.4 billion during the quarter

ended on May 2, a 2.4% increase versus the same period in the prior year.

Comparable-store sales increased 0.9% during the quarter.

Like Home Depot, Lowe's is forecasting improving growth rates during 2014: "Performance has improved in May, which, together with our strengthening execution, gives us the confidence to reaffirm our sales and operating profit outlook for the year."

Foolish takeawayLumber Liquidators is clearly facing considerable difficulties.

Although management is blaming its disappointing performance on industry conditions and temporary inventory problems, investors have valid reasons to be concerned.

It will be important to closely monitor the company in the medium term and evaluate whether Lumber Liquidators is overcoming its inventory problems.

In addition, investors may want to watch big retailers linked to the housing industry, such as Home Depot and Lowe's, in order to measure overall industry demand.

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