Lumber Liquidators Holdings Inc. (NYSE: LL) has been on a roller-coaster for the about past two months, whether it is being lambasted by “60 Minutes” or being picked up by activist investors. However, the story continues to develop as Lumber Liquidators is receiving results back from its testing program. With these results, brokerage firm Janney Capital was quick to comment as well.

Lumber Liquidators announced the initial results of the indoor air quality testing program for certain laminate flooring customers. The study was conducted by independent, accredited laboratories. The results indicated that over 97% of customers’ homes were within the protective guidelines established by the World Health Organization (WHO) for formaldehyde levels in indoor air.

Janney Capital noted three things it learned from Thursday’s announcement:

• A 3% failure rate for test kits translates to a $3 million to $4 million liability, far less than feared.
• The inventory write-down is likely below $20 million, and it could be lower when all is said and done.
• Impact to gross margin is likely about 30 to 70 basis points. The balance sheet can withstand these liabilities.

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Since March, Lumber Liquidators has sent around 26,000 test kits to roughly 15,000 customers. As of the end of April, the company had analyzed over 3,400 testing kits and found that 3% breached WHO standards. Assuming that is a statistically significant sample, out of the 26,000 kits, 3% equates to about 800 kits that require further testing. Assuming all those failed tests require new floors, at $4,000 per floor, that would be just over $3 million of liability. This is a far cry from the estimates suggesting over $1 billion after the “60 Minutes” viewing. Janney Capital anticipates that follow-up testing will bring the percentage down, which helps frame the liability.

At the end of the first quarter, Lumber Liquidators said that it had $22.7 million of Chinese Laminate inventory on the balance sheet. Janney Capital estimates that April sales were about $5 million for Chinese laminates, further reducing the inventory by about $2.5 million. The first week of May probably also worked through some inventory. Hence, the brokerage firm anticipates a number below $20 million for total Chinese laminate inventory on the balance sheet at the time it halted sales in the United States.

Janney Capital estimates Chinese laminate was about 10% of the business, or over $100 million, with merchandise margins about 50%. This translates to product cost of about $50 million, which will increase by about 10% or $5 million. This translates to about 50 basis points of gross margin.

The firm has a fair value estimate of $41, which implies upside of 41% from current prices.

Shares of Lumber Liquidator were up 6.5% Thursday, at $29.01 in a 52-week trading range of $25.81 to $86.45. The stock has a consensus analyst price target of $33.17.

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