UFP Industries, Inc. (UFPI) Q2 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the Universal Forest Products Second Quarter 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions]. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference Ms. Lynn Afendoulis, Director of Corporate Communications. Ma'am you may begin.

Welcome to the Universal Forest Products Incorporated second quarter 2017 conference call. Hosting the call today are CEO, Matt Missad; and CFO, Mike Cole. Matt and Mike will offer prepared remarks and 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 at www.ufpi.com. A replay will also be available at that website through August 18, 2017. Before I turn the call over to Matt Missad, let me remind you that yesterday's press release and today's presentation 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.

Thank you, Lynn, and good morning to all of you listening on the conference line and on the web. We appreciate your interest and your investment in UFPI. As you could seed from the press release, the UFP employees achieved record sales and profits for the second quarter. However, while we exceeded our sales target we fell considerably short of our earnings target. We don’t like falling short and we are working hard to make sure we hit our targets going forward. Of course sales growth is a vital catalyst to growing shareholder value. If you don’t have the sales, it’s impossible to increase margins on them. Therefore we are very encouraged by the 23% increase in Q2 sales to $1.07 billion versus 2016s Q2 total of $872.1 million. Year-to-date sales are $1.9 billion also up 23% from 2016. Now our goal is to continually improve the return on these sales. By market, sales growth was very good with retail sales up 13% construction up 17% and industrial up 47% over Q2 of 2016. Profit on the other hand should have been better. Our gross margins were down 130 basis points for the second quarter of 2017 versus 2016 due to several factors. The biggest single factor was the rapid increase in lumber market at the beginning of the quarter which was exacerbated by the concern over the softwood lumber duty with Canada. That was followed by a steady decline throughout the quarter as the duty issue was clarified and demand adjusted to the market. As we have stated the general level of the lumber market impacts, [Indiscernible] and percentage while a rapid increase or decrease in the market can affect margin dollars per unit. The swift fluctuations which occurred in the second quarter reflect the most challenging conditions to our business model. While the lumber market is unpredictable as evidenced by the recent fires in British Columbia and in South America, we are optimistic that the market will be more stable for the balance of the year. A second major factor impacting our profitability is the increased SG&A for our growth initiatives. While our second quarter SG&A expenses as a percent of sales were 10 basis points less than in 2016, we believe there are more opportunities to reduce this percentage as we grow. And we recognize that a significant portion of the cost increase related to new initiative designed to enhance our return on investment over the long term. These include increased spending on product development, design, testing and engineering additional training for all skill positions and enhanced off line learning programs, international growth for sales purchasing and new business ventures, e-commerce expansion for our customers and other ongoing organic growth and acquisition initiatives. We remain confident that these changes will improve our performance in the future and we are encouraged by the early results from these initiatives. Inspite of all these challenges, our team was still able to eek [ph] out a record profit, but we know we can and we’ll do better. As we look through our other key metrics, our inventory levels are up 300 basis points for our core businesses due to increased safety stock for potential product shortages, our inventory on fixture items is significantly higher as we built inventory for the upcoming peak sales season. Accounts receivable is at 92.5% current which is slightly below our target of 95%. We talked about some of the short term impacts of increased SG&A spending, so let’s look at some of the positive results so far. Our international group continues to grow sales and sourcing revenue by finding market opportunities in global markets. This gives you more options when market conditions such as we are in today create fiber challenges. New products sales year-to-date are $196.7 million, that’s up from $166.1 million in 2016 and ahead of our target for 2017. Our LX center is helping us speed the product development timeline and perform more design, engineering and testing at our own facility. Some examples of new product success are the UFP Edge product line, which includes interior decor items as well as our new Deckorators decking [ph] products such as our vault and Heritage lines, all of which are exceeding sales projections. Where necessary, we are converting additional manufacturing lines to increase capacity to meet this demand. Our increased training cost includes launching our new online learnings portal and consolidating our training initiatives under the UFP business school brand. We want to expand our new degree program to give our existing employees greater opportunities for promotions while offering highly specialised classes for individual training needs. We believe in order to continue to be a market leader; we need to continually invest in our people. Our target in education will help us better attract and retain employees in the future. The increased spending on e-commerce has enabled us to get more product skews on more customer sites and to improve the consumer shopping experience with more video and photos. We now have more than 1800 skews on our customer’s websites and continue to promote our ability to deliver products to our own distribution network. And in addition to these new initiatives we remain committed to spending for both organic growth and acquisitions. Our organic growth is strong as we have increased capital expenditures to add more automation and technology to our manufacturing process and have added additional geographic locations. And we continue to look at acquisition targets to increase penetration in our core markets and to add new products and services which complement our existing offerings. For operations added in the last year, we continue to find synergies and in the case of idX have accelerated implementation to lower operated cost. We are counting on all of these investments to provide excellent returns in the future. Now I’d like to turn it over to our very special birthday boy, Mike Cole to review the financial information with you.

Thanks, Matt. Before reviewing the financials, I should address the impact of the lumber market this quarter. Overall, year-over-year average lumber prices were up 18% and Southern Yellow Pine prices, which represent our highest volume of purchases, were up 7%. After a dramatic rise in lumber prices from the beginning of the year into April in which lumber prices increased 22%, prices fell steadily through the end of June finishing 9% [ph] down from the peak. While the diversity of our business generally helps to mitigate the impact of rising on lumber prices on our profitability the timing and the significance of these trends impacted our Q2 earnings. Moving on to the financials, I'll start with the highlights from our income statement. Our overall sales for the quarter increased 23%, resulting from a 16% increase in unit sales and a 7% increase in selling prices due to the lumber market. Our 16% unit sales increase was comprised of 12% growth from recently completed acquisitions and 4% organic growth. Breaking down by market, sales to the retail market increased 13% resulting from a unit increase of 8% and an increase in selling prices of 5%. Within this market of sales to big box customers grew over 13% with the small contribution from acquired operations, while our sales to other independent retailers grew 11% due to acquisitions. Our sales to the industrial market increased 47%, driven by a 40% increase in unit sales. Our unit sales growth was comprised of 32% growth from recent acquisitions and an 8% organic growth rate. Organic growth resulted from a combination of new customers as well as improved demand with existing customers continuing to gain a greater share of our existing customers business. Our overall sales to the construction market increased 17% due to a 9% increase in units sold and an 8% increase in prices. Within this category, our unit sales increased by 10% to residential construction customers and 9% to manufactured housing customers, and 5% commercial construction all of which represented primarily organic growth. Moving down the income statement, our second quarter gross profit increased by 4.7% both below our 16% increase in unit sales and gross margins declined from 15.1% last year to 13.8% this year. As I mentioned earlier, our profitability this quarter was affected by the volatility of lumber prices impacting each market of our core business. Excluding acquisitions the gross margins on our retail, construction and industrial sales were down 110, 90 and 260 basis points respectively as these acquisitions constituted almost $17 million to gross profits this quarter. Continuing to move down the income statement, SG&A expenses increased year-over-year for the quarter at $16.5 million or 21% as acquired businesses since June of last year comprised almost 14.5 million of this increase. Included in SG&A our accrued bonus for the quarter was $12 million and about $1.5 million less than the second quarter last year. Our SG&A excluding bonus expense and acquisitions was about $57.8 million compared to $64.3 million last year. The increase of $3.5 million was primarily due to salaries and wages to bad debt expense. In the income tax line you will note that our effective tax rate was 34% this quarter compared to 35.3% last year. This was due to a favorable new permanent tax difference related to our ability to evaluate certain stock grants at fair value for this year in an anticipated increase in our research and development tax credit. Finally, our net earnings from controlling interest were $33.6 million compared to earnings of $33.4 million last year. As we’ve mentioned before, we generally target earnings growth to equal or exceed our unit sales growth as we attempt to maintain or continue to improve our margins. Our short fall in earnings growth this quarter was primarily due to the impact of the lumber market and gross profits and lower than anticipated profit contribution from acquisitions so far for the year. Moving on to our cash flow statement for the year, our cash flow from operating activities was $50 million this quarter and was comprised of net earnings of $56 million, non-cash expenses of approximately $27 million, and an increase in net working capital since year-end of $68 million driven by seasonality and higher lumber prices. As I’ve mentioned on previous calls, we measure our cash cycle to assess our working capital management. Our cash cycle for the second quarter excluding acquisitions was 45 days compared to 43 days last year, including acquisitions our cash cycle increased to 50 days. Investing activities primarily consisted of $60 million centrally-acquired quality hardwoods, Robbins Manufacturing, Global Pallet [ph] and a small venture in Mexico, and capital expenditures of almost $35 million so far for this year, which includes expansionary CapEx of over $10 million. Financing activities included our semi annual dividend paid in June total to about $9 million or $0.45 a share and repurchases of 111,000 shares of our common stock for almost $10 million. As a reminder, our practice has been to buyback stock periodically when the price makes sense to offset these issues. Finally, with respect to our balance sheet, our net debt balance is about $205 million, which includes seasonal working capital of about $100 million which we expect to decline over the back half of the year. We expect our revolving facility at the end of June was $120 million and it’s already down to $78 million today. That's all I have in financials, Matt.

Thank you, Mike. Now I'd like to open it up for any questions you may have.

[Operator Instructions] Our first question comes from the line of Ketan Mamtora with BMO. Your line is open.

Good morning, Matt and Mike, and Mike, Happy Birthday.

Good morning, Ketan.

First question, Mike, I just want to go back to your comments that profits from some of the recent M&A has fallen short maybe of your expectations. Can you maybe at a high level highlight kind of two or three key challenges that you’ll are facing, which was perhaps unanticipated at the time of the acquisition. Or just any sort of high level comments will be helpful. And which businesses or ADRs you think more challenges?

Well, I think if you want to look, Ketan, at overall at the acquisitions, I think they are performing pretty much in line with expectations. I think the fixtures business, which we talked about before, the sales got pushback and we still feel confident that those sales are there and they’ll be coming or moving into the busy selling season for that operation. So, I would expect that to pick up considerably during the second half of the year. With respect to the other acquisitions our goal is to try to get at whatever synergies we identified initially and we’re moving to do that more quickly where we can. So, we feel really good about them overall. Yes, some more specific questions, details we would be happy to try to address those.

Okay. That’s helpful. And in your press release you’ve talked about lumber markets returning to kind of sort more normal levels in back half. What gives you that confidence? Because if I look at kind of how the duty shakeout, it’s kind of on and off. So I would imagine that there might be more volatility. Any thoughts on that?

I think major events that pointing to is the increase; kind of a very sudden increase of 30% addition back in earlier April, late March, and I think that was something that's unusual on the marketplace. There are certainly going to be some volatility and demand as different things happened. But I don't believe that there's going to be a huge and downswings. If it happens that will obviously impact, but we’re not forecasting that.

Got it. And then just on that it was obviously a pretty big move in Southern Yellow Pine pricing over the last eight to 10 weeks. Can you talk about how you’ll manage your inventories and when you see such large swings in prices? What I’m trying to get to is, do you run the risk of sitting on inventories which were purchased at a much higher price?

Yes. What we try to do is we try to manage the inventory overall and as we talk about before there are certain items that are sold on a fixed price basis. There are certain items that are sold on a variable price above lumber market level. So, what we’re trying to do in uncertain market situations is we try to buy if its need and we try to keep our inventories to match our demand. And that’s what we’re doing now. So, again there could be very short-term impacts from that price fluctuation, but we’re very balanced over the longer term.

Got it.

Yes, the base supply [Indiscernible] for at the end of the March, for example, is much much longer and it inspired [ph] them towards at the end of June, is much shorter. So there isn’t much risk associated with that inventory and variable price product.

Got it. That’s helpful. And just one last question and this is just more clarification. On some of the SG&A numbers that you mentioned Mike, I got a little confused, you said SG&A including bonus was $67 million?

Yes. 67 [ph].

So is it just sort of a second quarter event or is this kind of there every quarter. I'm just trying to get a sense?

Yes. So our practice has been to improve certain rates of operating profit each quarter. And so the high earnings quarters like Q2 and Q3 will add much greater bonus expense than Q1 and Q4 for example. So the part of the sequential when you see from Q1 to Q2 is just simply greater profits, higher bonus expense.

And this greater profit is on our gross profit dollar basis or just at a high-level? How is that determined?

Yes. It’s pretty bonus operating profits. So its gross profit, gross profit less SG&A cost.

Gross profit less SG&A. Okay, and then at this point or just for us for run rate basis how would you have us think about SG&A? Is it fairly…?

It’s a good question. So acquisitions have added quite a bit to our SG&A for the quarter. In fact acquisitions that we did in March increased our SG&A just sequentially to -- that’s about $1 million. So, I think at the end of March we showed core SG&A without bonus of about 79 million, and so recent acquisitions from March added about $1 million to that. Let’s say, our kind of core target would be $80 million. We finished at about $82 million with acquisition in it, and the reason for the increased from 80 to 82 this quarter is mostly because of bad debt. We had a tough quarter for write-offs and so we were up about a $1 million in this quarter and that added to bad debt expense.

And this does not include the bonus expense that -- or does this also include that bonus expense?

Our bonus expense is on top of that.

Got you. And that number will vary every quarter?

Correct.

Got it. Okay. That’s very helpful. I’ll turn it over. Thank you.

Sure. And to make sure that’s clear to you. So the 94 million in SG&A in total for the quarter is $12 million bonus expense within that, so the core SG&A is 82 [ph].

I got you. That’s very helpful. Thank you and good luck for the back half of the year.

Thank you.

Thanks Ketan.

Thank you. Our next question comes from the line of Steve Chercover with D.A. Davidson. Your line is open.

Thanks. Good morning and Happy Birthday. Have a beer at the end of the day.

Thank you, Steve.

Good morning, Steve.

So, yes, while Ketan touch on a bunch of different issues, but just to synthesize the lumber issue. Is it fair to say that you started the quarter with very very strong lumber prices and they kind of ease off throughout much Q2. And so if there’s a little bit of an inventory correction so to speak?

The great way to look at that Steve; it’s a very accurate. It’s still along that – so we sell lot of treated number of variable price products in Q2, so the sales mix is more heavily weighted towards variable price products in Q2, and we just selling into a following market that causes [Indiscernible].

Yes. That was my concern is basically the direction – you basically started the quarter with peak pricing and it eroded thereafter. So, okay, but we know you’re trying not to play inventory speculation, so that will moderate in due course. I did have a bunch of questions. Ketan talked a lot about the SG&A, so I think I’m good there. But I did want to talk about your recent acquisitions like Robbins and Quality Hardwoods. Did they contribute the way you anticipated?

Yes. Very much, so, I think they are operating and performing in accordance with our plans. So we’re very pleased with their progress thus far. And we still have opportunities for additional synergies and additional sales growth in all of those operations.

And how does that -- I’m sorry, go ahead.

Maybe it has some numbers to that as well, so acquisition that they contributed over a $100 million in sales for the quarter, EBITDA was about 4.5 million a quarter. It was like taken a little more there.

And that includes idX. I'm sure?

Correct.

Okay. And so I want to get to idX. It means, is that $25 million to $28 million EBITDA run rate still attainable or that still a target?

Can you repeat that again?

Well, I think last year when you bought idX it was generating in the vicinity of $25 million to $28 million in EBITDA, doesn't appear that that will be the contribution in 2017, but surely you still expected to be that and better over the course of the next two years?

That’s correct. Yes, 2017 definitely won’t be there, but 2018 beyond that that’s still the right target.

And without laying down your cards, can you tell us some of the steps that you're taking to address? I guess the shortfall at idX right now?

Yes. I think with respect to the first part of your statement there without laying down too many cards, I’ll just give you the broad strokes. Broad strokes are we’re driving much more consolidation in your costing, so we’re getting at the cost synergies first. That’s a right time to do that. So you'll see some things that that will come out here over the next six months or so. On the cost side that will be very beneficial. They had already been working on expanding their customer base and moving into additional markets. Those are showing good signs of success at this point. So, the two major areas of impacting that are to grow the customer base in the market -- the end market that they serve and to get at the synergies that we’ve identified early on quicker than we have plan to. So, those two things in combination will definitely help us to get where we need to be.

And culturally are they good fit for you guys?

They are great fit. They have incredible group of people. They fit in well with our company. They are very focused on getting a return. They are very focused on taking care of their customer and those are the reasons on the outset that we felt would be a very good fit and we still feel that way.

Okay. And then, you know I don't want to put words in your mouth, but idX clearly still needs some work and we're confident you'll address it. You bought back almost $10 million in stock. Does that show us the near-term, I mean A, it’s a statement of value on your stock, but is also a statement of your priorities perhaps for acquisitions in the next little while that right now you buy the company with being known the best which is UFPI. You address the biggest acquisition in your history? And you’re not so acquisitive or do you still acquisitive?

I think we’re definitely acquisitive and we will again continue to look for opportunities in our core space and in areas where we can provide new products that we can expand to all of our other operations. So, we’ll still look at. And as always you know us to be conservative and how we invest. We want to make sure that we get appropriate return on our investment and obviously we believe our stock provides a very good return on investment and that we can – if we can find companies that we could buy an acceptable return on investment we’ll do so.

Great. I had one more for you. The seven Greenfield facilities that you mentioned in Q1, how they’re doing? Are they now making contribution or they still a bit of a headwind as well?

I think they’re – and the aggregates are going according to plan and as we look at internally and now externally we assume approximately three-year run rate to breakeven for new operations built organically. And they are well on track for that.

Got it. Okay. Well, thank you all.

Thank you, Steve.

Thank you. And now our next question comes from the line of Dan Jacome with Sidoti & Company. Your line is open.

Hey, good morning, guys. Can you hear me?

Good morning, Dan.

Hi, Dan.

Great. Happy Birthday first as well, I’ll complete that. Just a couple questions here. I’ll just say on iDX because there was just talk about, I know that, that business had a lot of exposure to retail, just wondering how you guys feel about that, do you still feel there might be some room for portfolio repositioning or just kind of re-alignment of customers or do you want to keep the business as it came to you when you acquired it, that was my first question.

Yes, I think that’s a great question Dan and well in advance of our acquisition they had already recognized which trend and they had expanded their customer base and end markets as I mentioned they are continuing out with that process, so I suspect that what you will see is a lower percentage of their sales going to strictly retail. But we also believe that retail will continue to exist going forward, it’s not as if there won’t be any brick and mortar retail out there, it will be more driven by trends and I think it will be a good thing.

Right. I know they do hotels and banks, you have liberty to say how much of the business came from the sort of brick and mortar that we keep reading about and that seems to be spooking a lot of investors or should I just kind of [Indiscernible] that question.

Yes I think we can give you broad strokes and Mike has the numbers in terms of kind of overall percentage of sales.

Yes, I was just curious because it seems to be something we were thinking about everyday rights, so...

Yes, so five years ago it was 90%, right more like 50%. So they make it a ton of progress as one of the...

Okay, great. And then turning to Deckorators, so that product line seems to be doing quite well, if I heard you correctly your adding capacity is that correct, and if you are, are you going to be adding that from exactly where you are producing that product now or is this sort of a larger scale capital projects or how...

Yes at this point it’s basically converting existing manufacturing lines to the newer product.

Okay, so that should be pretty – yeah that should be pretty quick, right?

Correct, yes.

Okay, last one. And just for segment, it sounds like I think you said you are taking wallet share there, is that correct? You said you are taking market share.

Well I think we are – the acquisition and as well as additional pickups with customers, so that...

Yes, well just – maybe very high level what are those conversations looking like; just remind us again what they are going to universal for versus other manufacturers if you have the liberty to say that?

Yes, I think if I were to quote it again in the high level view we want to be the global packaging solutions provider to our customers, the fact that we have multiple locations, the fact that we can use multiple different materials and we can do our design engineering and testing in house, those things are all big selling points for us we believe.

Okay, great. And then my last one, I think I know the answer but you guys have always had a very solid return on invested capital which is very encouraging and then this quarter sounds like an outlier to me, do you guys still feel confident, do you still feel confident that is that you will be able to maintain a nice spread above your cost of capital going forward?

Yes, we do that’s why we are still in fitness here.

Okay, great. All right good luck with the rest of the current quarter. Thanks a lot for your time.

Right. Thank you Dan, appreciate it.

Thank you. And I’m showing no further questions at this time. I’d like to turn the call back to Mr. Missad for closing comments.

Once again thank you for your time today. We remain excited about our future and our strategy to grow and improve our company. And with the same incredible energy and passion, the residents of Michigan pursue their six weeks of summer to maximize their enjoyment. We plan to implement our strategies to maximize our returns. Thank you again and have a great day.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone have a wonderful day.