UFP Industries Inc (UFPI) 2017 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Universal Forest Products Second Quarter 2017 Earnings Conference Call. (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, Inc. 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 can see 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're 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. That's why we are very encouraged by the 23% increase in Q2 sales to $1.07 billion versus 2016 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 the 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 margin percentage, while a rapid increase or decrease in the market can affect margin dollars per unit. These 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 increase in 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 is related to new initiatives 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 online 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.

In spite of all these challenges, our team was still able to eke out a record profit, but we know we can and will do better.

As we look to 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 build inventory for the upcoming peak sales season, and accounts receivable is at 92.5% current, which is slightly below our target of 95%.

We talked about some of the short-term impact 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 a few more options when market conditions, such as we are in today, create fiber challenges.

New product 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 time line 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 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 costs include launching our new online learning 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-specialized 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 SKUs on more customer sites and to improve the consumer shopping experience with more video and photos. We now have more than 1,800 SKUs on our customers' websites and continue to promote our ability to deliver products through 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 operating costs.

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 some of the other (inaudible) prices, which represent our highest volume of purchases, were up 7%. After a dramatic rise in lumber prices from the beginning of the year in April, which lumber prices increased 22%, prices fell steadily through the end of June finishing 9% down from the peak. While the diversity of our business generally helps mitigate the impact of rising or falling lumber prices on our profitability, the timing and significance to these trends impacted our Q2 earnings.

Moving onto 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 in 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, our sales to big box customers grew over 13% from the small contribution from acquired operations, while our sales to other independent retailers grew 11% due to acquisitions.

Our sales in the industrial market increased 47% driven by a 40% increase in unit sales. Our unit sales growth is 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 and continuing to gain a greater share of our existing customers' business.

Our overall sales in 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% for residential construction customers, 9% for manufactured housing customers and 5% for commercial construction, all of which represented primarily organic growth.

Moving down the income statement. Our second quarter gross profits increased by 12.7%, 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, gross margins on our retail, construction and industrial sales were down 110, 90 and 260 basis points, respectively. And these 5 acquisitions contributed 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 expense 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 $67.8 million compared to $64.3 million last year. The increase of $3.5 million was primarily due to salaries and wages and bad debt expense.

The income tax line and other effective tax rate was 34% this quarter compared to 35.5% -- 35.3% last year. This was due to a favorable new permanent tax difference related to our ability to value certain stock ramps at fair value this year and an anticipated increase in our research and development tax credit.

Finally, our net earnings to controlling interest were $33.6 million compared to earnings of $33.4 million last year. As we have 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 shortfall in earnings growth this quarter was primarily due to the impact of 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 $15 million this quarter and was comprised of net earnings of $56 million, noncash 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 since we acquired Quality Hardwoods, Robbins Manufacturing, [global palette] and a small venture in Mexico. And capital expenditures of almost $35 million so far for the year, which includes expansionary CapEx of over $10 million.

Financing activities included our semiannual dividend paid in June totaling 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 buy back 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, as our revolving credit facility at the end of June was $120 million, and it's already down to $78 million today.

That's all I have in the 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.

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 2 or 3 key challenges that you all 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 areas you are seeing more challenges?

Well, I think if you want to look, Ketan, 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 pushed back. And we still feel confident that those sales are there, and they'll be coming. We're 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. So if you have more specific questions, details, I'll be happy to try to address those.

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

Yes, I think the major event at that point in queue was the increase -- kind of a very sudden increase and 30% addition back in early April, late March, and I think that was something that's unusual in the marketplace. There is certainly going to be some volatility, and demand is -- different things happen. But I don't believe that there's going to be the huge, unbalanced wins. If it happens, that will obviously impact us 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 in -- over the last 8 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 there -- as we've talked 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 try to do in uncertain market situations is we try to buy to 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.

Yes. The base supply of inventory at the end of March, for example, is much, much longer. And the base supply of inventory at the end of June is much shorter. So there isn't as 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 a clarification. On some of the SG&A numbers that you mentioned, Mike, I got confused. You said SG&A excluding bonus was $67 million?

Yes, $67.8 million.

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 a certain rate of operating profit each quarter. And so the high earnings quarters like Q2 and Q3 will have much greater bonus expense than Q1 and Q4, for example. So part of the sequential move that you see from Q1 to Q2 is just the greater profits, higher bonus expense.

And this greater profit is on a gross profit dollar basis? Or just on a high level, how does that determine...

Yes, it's pre-bonus operating profit. So it's gross profit less SG&A cost.

Gross profit less SG&A, okay. And then at this point of -- or just for us on a run-rate basis, how will you have us think about SG&A? Is it still...

That's a good question. So acquisitions, it added quite a bit to our SG&A for the quarter. In fact, acquisitions at the end of March increased our SG&A just sequentially to about -- it's about $1 million. So I think at the end of March, we showed core SG&A without bonus to be 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 acquisitions in it, and the reason for the increase from $80 million to $82 million this quarter was mostly because of bad debt expense. We had a tough quarter to write off. So we wrote off about $1 million in savings 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.

Right.

All right, got you. And that number will vary every quarter?

Correct.

Got it. Okay, that's very helpful.

Yes, sure. And to make sure that's clear to you, so the $94 million in SG&A in total for the quarter, there's $12 million bonus expense within that. So the core SG&A is $82 million.

Our next question comes from the line of Steve Chercover with D.A. Davidson.

So yes, well Ketan touched on a bunch of different issues. But just to synthesize the lumber issue, is it fair to say that you've started the quarter with very, very strong lumber prices, and they kind of eased off throughout much of Q2? And so there's a little bit of an inventory correction, so to speak?

A great way to look at that, Steve. That's very accurate.

All right. And going along with that, Steve, just -- so we saw a lot of treated number of variable price products in Q2 so the sales mix is more kind of weighted towards variable price products in Q2. And when you're selling into a falling market, that causes issues, obviously.

Yes, that was my concern. It's basically the direction -- you basically started the quarter with peak pricing and it eroded thereafter, so. Okay, well we know you try not to play inventory speculations, so that will moderate in due course. And 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 Hardwood. Did they contribute the way you anticipated?

Yes, very much so. I think they're 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 do you...

Maybe attach some numbers to that as well. So acquisitions, they contributed over $100 million in sales for the quarter. EBITDA was about $4.5 million for the quarter, and we'd like to see a little more there.

And that includes idX, I'm sure?

Correct.

Okay, and so I want to get to idX. I mean, is the $25 million to $28 million EBITDA run rate still attainable? Or that's still a target?

Can you repeat that again, Steve?

Last year when you bought idX, it was generating in the vicinity of $25 million to $28 million EBITDA. It doesn't appear that, that will be the contribution in 2017 but surely you still expect it to be that and better over the course of the next few years?

That's correct, yes. 2017 definitely won't be there but 2018 and beyond, 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 of costing, so we're getting at the cost synergies first. That's the right time to do that, so you'll see some things that will come out here over the next 6 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, and those are showing good signs of success at this point. So the 2 major areas of attacking that are to grow the customer base and the market -- the end markets that they serve, and to get after synergies that we identified early on and quicker than we have planned to. So those 2 things, in combination, will definitely help us get to where we need to be.

And culturally, are they a good fit for you guys?

They're a great fit. They have an incredible group of people. They fit in well with our company, they are very focused on getting a return. They're very focused on taking care of the 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, 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 that near term, I mean, a, it's a statement of value on your stock, but is it also a statement of your priorities perhaps for acquisitions in the next little while that right now, you'd 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 are 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 that and as always, you know us to be conservative in how we invest. We want to make sure that we get appropriate return on our investments and obviously, we believe our stock provides a very good return on investment. And if we can find companies that we could buy an acceptable return on investment, we'll do so.

Great. I have one more, forgive me. The 7 new greenfield facilities that you mentioned in Q1, how are they doing? Are they now making a contribution? Or are they still a bit of a headwind as well?

I think they're -- in aggregate, they're going according to plan. And as we look at it internally and now externally, we assume approximately a 3-year run rate to breakeven for new operations built organically. And they're all well on track for that.

And our next question comes from the line of Dan Jacome with Sidoti & Company.

I just have a couple of questions here. I will just stay on idX because it was just talked 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 that there might be some room for portfolio repositioning? Or just kind of realignment 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 they had, well in advance of our acquisition, they had already recognized the constraint, and they had expanded their customer base and end markets, as I mentioned. And they're continuing on with that process, so I suspect that what you'll 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 too. Are you at liberty to say how much of their 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 punt that question?

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

Yes. I was just curious because it seems to be something people are thinking about every day, right? So...

Yes. So 5 years ago, it was 90%. Okay?

It was more like 50%.

So maybe that's kind of farther up...

Yes. I'm sure that it's huge. Okay, great. And then turning to Deckorators. So that product line seems to be doing quite well. If I heard you correctly, you're adding capacity, is that correct? And if you are, are you going to be adding that where -- from exactly where you're producing that product now? Or is this a sort of larger scale capital project you have?

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

Okay, so that should be pretty -- yes, that should be pretty quick, right?

Correct, yes.

Got it, okay. Last one, industrial segment. Sounds like -- like you said, you're taking wallet share there, is that correct? You're taking market share?

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

Yes, well just -- yes, 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 liberty to say that?

Yes, I think, if I were to quote it again at a high-level view, we want to be the global back end 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'll be able to maintain a nice spread above your cost of capital going forward?

Yes, we do. That's why we're still in business here.

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 that the residents of Michigan pursue their 6 weeks of summer to maximize their enjoyment, we plan to implement our strategies to maximize our returns. Thanks 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.