UFP Industries, Inc. (UFPI) Q2 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Universal Forest Products Second Quarter 2012 Earnings Conference Call. My name is Derek, and I'll be your operator for today. [Operator Instructions] As a reminder this conference is being recorded for replay purposes. I would now like to turn the conference over to Ms. Lynn Afendoulis, Director of Corporate Communications. You may proceed.

Thank you. Welcome to the Universal Forest Products Second Quarter 2012 Conference Call. Hosting the call today are CEO, Matt Missad; and CFO Mike Cole. Matt and Mike will offer prepared remarks then we'll open up the call for questions. This conference call is available simultaneously and in its entirety to all interested investors and news media through a webcast on our website at www.ufpi.com. A replay will also be available at that website through August 17, 2012. Before I turn the call over to Matt Missad, let me remind you that today's press release and the presentations made by our executives include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. These statements are subject to risks and uncertainties that could cause actual results to differ materially from our expectations and projections. These risks and uncertainties include, but are not limited to, those factors identified in the press release and in our filings with the Securities and Exchange Commission. At this time, I would like to turn the call over to Matt Missad.

Good morning. Thank you, Lynn, and thank you all for taking the time to join us today. We really do appreciate your interest and we continue to work very hard to provide a good return for our shareholders. First of all, I want to let you know how proud I am of the team at Universal. As we look back over the last 12 months, the men and women of Universal family of companies have done an outstanding job. I'm honored and excited to be on their team. As Mike Cole will explain in more detail, our second quarter was the fourth consecutive quarter of improvement in profitability and sales growth. We have been focusing our profitable sales growth and are pleased to be seeing some results. Now as we analyze our sales mix last fall, we realized we had a number of sales that we were effectively doing for practice. Now we all have to maintain a delicate balance between being competitive in the marketplace, maximizing production and delivery efficiencies and above all, meeting the needs of our customers. However, we cannot afford to work for practice. To that end, our people have done a tremendous job of analyzing and reducing unprofitable sales, while at the same time, reducing costs and improving efficiencies in our operation. And the results show that we are headed in the right direction. We also know that some market conditions helped our performance during the first 6 months of the year. We spoke in April of the great weather and we'll talk today about the rising lumber market and how it helped to accelerate our sales dollar growth. Now as we run through the metrics that I like to focus on, let's start with sales. Our sales are up in each market except do-it-yourself retail where, as previously discussed, we made some pricing decisions designed to eliminate unprofitable sales. We also decided to focus on diversifying and growing sales to independent retail customers, which resulted in healthy sales gains with these customers. In the manufactured housing market, things are improving, due in part to sales in the oil exploration areas in the Great Plains states. Residential construction activity improved slightly but we traded market share for some better margin business. Now there remain some substantial excess capacity in this market, but we still believe there's an opportunity to provide great customer service and still be profitable. In our industrial and concrete-forming markets, we continue to grow aggressively and see further opportunities for growth. With our inventories, we are in very good shape today. Due to better-than-anticipated sales in some key products we did experience shortages during the second quarter, which had a slight dampening effect on earnings as we had to cover these products at higher prices. We are watching our inventories closely and trying not to get too far ahead because we are concerned about disappointing employment figures and lack of construction growth in the U.S. Our accounts receivable are still in very good shape, but we will maintain a cautious and watchful eye. And of course, we'll continue to be conservative on our business approach and watch the signs of the coming election carefully. Our forward outlook, a good question. It's overall positive, although we expect relatively slow growth domestically. Solid cloudy with a chance of rain, possible thunderstorms in late October or early November. We're just not getting a clear picture of what the economy is going to do. But despite the murky economic forecast, we are playing offense. We are aggressively seeking acquisition and partnership opportunities, both domestically and in our targeted foreign market. We also continue to pursue all avenues to improved sales and profits at our existing operations. Now I'd like to turn it over to Mike Cole for our review of the financial highlights.

Thanks, Matt. I'll start by reviewing our income statement. Overall, our sales for the quarter increased 9%, primarily due to an increase in lumber prices. Although we had significant changes within each market, our overall unit sales were flat with last year. By market, our sales for the retail market decreased 2% due to a 10% decrease in unit sales, offset by an 8% increase in prices due to the lumber market. Within this market, sales to our big-box customers decreased 14%, while our sales to other retailers increased 21%. Last quarter, we mention that we lost some lower margin business with one of our big-box customers this year, and one of our objectives has been to replace that business with sales to other retail customers. As you can see from the numbers, we've had some initial success accomplishing that objective. Our sales in the manufactured housing market increased 25% due to a 14% increase in unit sales and 11% increase in prices due to the lumber market. The unit increase is primarily due to industry production of HUD-Code homes, which increased 16% year-over-year. In addition, approximately 1/3 of our sales for this market are for modular homes, and the most recent data for modular housing sources indicates those shipments are up 19% year-over-year. Our sales to the residential construction market increased 6%, primarily due to an increase in pricing as our unit sales were flat year-over-year. By comparison, housing starts to experience the year-over-year increase of 26% between the months of March and May. Our decline in market share was anticipated and is due to our focus on profitability. This segment is still challenged with excess capacity so we continue to be selective in the business that we take in order to improve our performance. Collectively, our plants that primarily served this market have been profitable for 4 straight quarters and reported a year-over-year increase in operating profit of approximately $3.5 million this quarter. Finally, our sales to the industrial market increased 25%, comprised of a 7% increase in pricing and an 18% increase in unit sales. The story here is similar the past quarters. Our plants are doing a great job of adding new customers and increasing sales with the existing customers, taking advantage of the capital investments we've made in this business. One of the additional positives I see is that the increase in our industrial sales is spread out over several regions, which to me is a clear sign of uniform focus and success. Moving down the income statement. Our second quarter gross profit percentage as a percentage of sales increased by 170 basis points, primarily due to the favorable impact of selling into a rising lumber market in Q2, while we were selling into a falling market throughout 2011. In addition, we have a more favorable product mix in 2012 in that we're currently selling less low-margin commodity products. These improvements more than offset the effect of continued pricing pressure we face in each of our markets. In addition, I should point out that lumber prices have fallen each week since the end of May. While we've attempted to keep inventories lean and in line with current demand, if this trend continues, it may result in tougher year-over-year gross margin comparisons in the third quarter. SG&A expenses increased by almost $3.8 million or 8.3%. This increase was driven by a $4 million increase in accrued bonus and incentive compensation expense tied to profitability and a $1.7 million increase in bad debt expense as we experienced a bad debt recovery that is very significant in 2011. These increases were primarily offset by a $900,000 decrease in base compensation and related expenses and a $700,000 decrease in amortization expense. While we're always striving for improvement, overall, we're very proud of how our people continue to proactively manage these costs. Our operating profits were positively impacted by a net gain on the disposition of property, plant and equipment this quarter totaling $6.9 million, which resulted in pretax proceeds of over $12 million. Conversely, our early retirement and severance cost resulted in a $3.5 million charge to operating profits in 2011. As a result of sales, margin and cost improvements, our diluted EPS increased $0.88 per share in 2012. Excluding the net gain on the sale of property in 2012 and early retirement and severance cost in 2011, our diluted EPS was approximately $0.67 in 2012 compared to $0.33 last year. Moving on to our cash flow statement. Our cash flow used in operations was $20 million this year compared to $58 million last year. Our operating cash flow in 2012 is comprised of net earnings of $22 million and $9 million in noncash expenses, offset by a $51 million increase in working capital since December. Working capital increased since year end due to the normal seasonality of our business. Investing activities include capital expenditures of almost $16 million, which is comprised of about $7 million of expansionary capital expenditures for future growth and sale. With respect to our balance sheet, our total net debt was at $68 million compared to $85 million a year ago. We currently anticipate strong cash flows for the balance of the year, providing us with plenty of liquidity to support future growth. That's all I have in financials, Matt.

Thank you very much, Mike. And now, I'd like to open it up for any questions that you may have.

[Operator Instructions] And our first question is coming from the line of Trey Grooms from Stephens, Inc.

Just I guess, Matt, on your comments on kind of your outlook, I mean, obviously, you're mentioning that it's difficult to kind of read at this point. But mentioning kind of overall positive, but you sounded like you think that we could see kind of tougher times ahead this fall really just kind of wondering -- well, I'm trying to decipher what thunderstorms really means, but also just wondering what's kind of driving that concern for you as we kind of look out into the fall here?

Wow, Trey, that is a mouthful of one question there. I think I'm not trying to dodge the question, I think it's a great question. We don't have a lot of clarity. I think a lot hinges on the election, but we -- I want to make it clear, we're not sitting back and waiting for the results. We're not changing our course. I think that we will outperform our competition no matter what the economic situation is, and I think that's the message that I can leave you is the difficulty is that we try to forecast and look at what's going to happen in the economy. As you know, it's very difficult to predict. There's a lot of mixed signals out there.

Okay. Well, can you kind of talk about how business trended kind of through the quarter? How these trends kind of progressed through second quarter and kind of what you've been seeing thus far in July?

Yes, absolutely. I think we had a more typical year this second quarter. Sales were strong during the normal strong selling season. The business went very well. I think we had a typical slowdown around the Fourth of July holiday time. And in the near term, I would expect it to remain fairly typical, at least in most of our business segments. So going forward, much beyond the third quarter is where it gets really murky for my perspective.

And really, I was just also kind of looking at -- with the comments on the third quarter I guess later in the year, is it a concern of kind of pull forward from decent weather and that sort of thing, or is it just an overall kind of uncertainty?

Yes, I think it's pretty clear that we did see a little pull forward in the first quarter and that, over the last month or so, it become much more apparent that, that did happen. The degree to which it happened is still not totally clear, but there definitely was some of that. So as we go through the third quarter, we'll just keep that in mind.

Okay. And then my last question is on commercial. I mean, sales -- seems like sales are up pretty nicely there. I'm guessing this is mostly maybe pricing and market share gains, or you guys actually seeing some improvement in demand on the commercial front?

Yes, the commercial and concrete-forming, I think we have seen some sales growth. I think there are some bigger projects that we've been able to participate in, which certainly has helped. And I think our guys again are doing a tremendous job in growing that market. So there's a good combination of sales growth, market growth and market penetration.

Your next question is coming from the line of Steve Chercover from DAD.

A few questions. First of all, your initiative to broaden your retail base, I mean, that makes a lot of sense to grow and diversify it, but does it speak any changes in the retail market? Like are the big boxes losing share or are they the culprits when they ask you to do the work for practice instead of profit?

Steve, I will tell you that our big-box customers are among our best customers and we really enjoy working with them. We do see a need to diversify our sales mix and our guys have done a very good job doing that. We'd love to have more business with our big-box customers and we have to continue to figure out ways to be more efficient, to provide more value at a lower cost, and we're going to continue to work on that. So our goal is not necessarily to lose sales in the big box arena. It's really more to grow sales with all customers.

Got it. Okay. And the shortage that you alluded to, I don't think you mentioned what product. Is it something that you can pick up in Q3?

Yes, it was a relatively short-lived shortage. We're back in very good position on it. And part of the issue was in the first quarter, there was a lot more takeaway in the marketplace to this product than there have been in prior years, so the supply chain got short. We were able to cover with no problems to our customer, but that did impact us a little bit in second quarter.

Okay. But you still haven't told us what product it was.

It was basically a retail product. I don't want to get too specific on the item.

Okay, okay. No problem. And then lumber prices, as Mike mentioned, rose through the first half of Q2 and then they dipped in for 6 or 7 weeks into the long or the July 4 holiday. Was there any inventory gains or losses, whatsoever?

I think our guys have done a good job managing the inventory off throughout the time frame. I think there are obviously are going to be some gains and some losses, but there's nothing significant or major at this point. I think as long as we have a fairly good and manageable trend in inventory and in lumber market prices, we'll be able to deal with that issue. But we expect further declines over the next several months in the lumber market.

Which means lower top line but sometimes better margins for you, right?

Depending on the product mix, yes. It depends on how the products are sold, fixed price versus market-based pricing.

Okay, last one. I'm also trying to interpret your kind of cautious optimism on the outlook. So is it correct to say that you expect the continued year-over-year growth but we'll also see the typical seasonality? Because I mean you've had 4, 5 quarters of growth, but Q2 is almost always a peak at least for the last 8 years I've been covering it. Is that still accurate?

That is still accurate.

[Operator Instructions] Your next question is coming from the line of Robert Kelly from Sidoti.

A question on the retail building market. You walked away from some business so volumes were down. But in the business that -- your organic business I guess going forward, could you give us some help with what the baseline growth trend was there? Just trying to get an apples-to-apples of what you're seeing in retail, were there not -- if there were not products that you were walking away from?

Yes, I think overall, we had very, very good growth in the products that we maintain in the retail sector, so I think that was very good going forward. What we're hearing from our customers is they're seeing a little bit of a slowdown, but we still expect year-over-year gains.

We had a 21% increase in our sales at non-big-box customers, so if we're able to have that and if we had maintained flat market share overall with the big boxes, you're talking about strong double-digit increase.

Okay. Yes, that's helpful. So with the mix of revenue commodity versus value-add, where is that today having walked away from some of that lower-priced business, and where would you like to have that for the future?

It's about 60% value-add.

So it doesn't change from the historical?

Not a ton.

Okay, great. As far as the competitive pricing you're seeing out there, you said it was pretty broad-based across all your industries. Is the pressure greatest from your -- I mean, I don't know how you -- your struggling competitors trying to win back market share. Is it kind of predatory pricing or is it just consistent with what you've seen over the past couple of years?

Yes, I think there is probably a combination, Bob, and we see some competitors that are still struggling to hang on and they're just playing the cash flow game, so they can get cash coming in that will keep them fighting for another day. I think on the other hand, there are some larger competitors that we've seen over the past few months who have, I think, come to a similar conclusion as us. There still is excess capacity out there from a manufacturing standpoint, but they also realize that paying a customer to work for them is not a sustainable business model. So I think we're seeing some mixed signals there in terms of pricing gain [ph].

Okay, fair enough. When you discuss with your customers -- I'm not asking you to comment on whether housing is recovering or bottomed or what, but is the general sense is the optimism fairly broad-based in your retail and reconstruction customer base that we've hit bottom and we're in recovery? What's the sense you're getting from your customers?

I think a lot of folks, myself included, would like to believe that we've hit bottom and we're climbing. I think most of our customers feel that we have hit bottom, that it's still struggle. We might be bouncing along the bottom for a while before we do the hockey stick curve up. But I think, all in all, the multifamily segment of the housing market is much stronger than the single-family segment.

General sense is that the process of recovery has begun now?

Yes.

Okay. As far as the SG&A, up year-on-year despite the volume flat. That's kind of contrary to what we've seen out of you in the past couple of quarters. Should we still be thinking SG&A costs rise consistent with volume changes?

Well, the only reason SG&A was at bottom is because it was up $3.8 million. But if you pull out accrued bonus and incentive compensation, which is $4 million increase, pull out kind of the unusual increase in bad debt expense because our receivables is in really good shape. We just had a big recovery last year where we had a very low expense last year. Expenses were down for the quarter $2 million, even though units were up 1 point. So its been -- it's actually a bit of a head fake if you just look at the total numbers, if you go down the details, people did a great job of managing expenses down for the quarter.

Okay, great. So there's some one-timers that are propping up SG&A?

Yes.

That's great. And then just one final one. You talked about the end markets being what they were but UFPI being an offense. Could you talk about where M&A takes you? Is it new market? Product expansion? Where do you see most likely, if you were to do something on the M&A front, where it would take you?

It's going to be a combination. We're looking at -- and because of our decentralized model, we have a lot of different folks out there looking at opportunity. We are going to have some geographic expansion moving into areas where we currently aren't servicing and using our existing product mix and adding new product to that mix. We're also going to be looking at some consolidation opportunities where it makes sense for us. And in the foreign markets, we're looking to replicate with foreign partners, what we do here in the states and what they do in their native countries.

And as far as the candidates that you're looking at, multiple expectations, have they changed appreciably with the hope that housing is now back on the mend?

I think there's -- again, I don't know that we're you're putting a lot of stock in housing improving as a backdrop for us doing these acquisitions and partnerships. We're looking at it as though, if everything were to stay neutral, what should we be doing. And again, there's a lot of opportunities out there, we're excited about them and we're going to pursue them aggressively.

At this time, I'm showing no further questions in queue. I would like to turn the call back over to Mr. Matt Missad for any closing remarks.

Well, once again, I'd like to thank you for your time this morning and for your interest in UFP. I'm very proud of what we've been able to accomplish over the past 12 months, but I'm certainly not satisfied. And in fact, if you ask any of my colleagues, I'm rarely satisfied, which is why we continually look at better ways to do things. We are intent on growing our company, improving our performance and creating opportunities for our employees, all of which will lead to better returns for our shareholders. While we go back to strive -- we go back to work to strive for excellence and victory, we also want to wish our Olympic team best wishes for excellence and victory in London. Thanks again for joining us today. Have a great day.

Ladies and gentlemen, that concludes today's conference. We thank you for your participation. You may now disconnect. Have a great weekend.