Earnings Transcript for UFPI - Q2 Fiscal Year 2023

Operator: Good day, and welcome to the Q2 2023 UFP Industries Inc. Earnings Conference Call and Webcast. [Operator Instructions]. I would now like to hand the conference over to your speaker, Mr. Dick Gauthier, Vice President of Investor Relations. Sir, the floor is yours.

Dick Gauthier: Welcome to the second quarter 2023 conference call for UFP Industries. Hosting the call today are CEO, Matt Missad; and CFO, Mike Cole. Matt and Mike will offer prepared remarks, and then the call will be open for questions. This conference call is available simultaneously in its entirety to all interested investors and news media through our website at ufpi.com. A replay will also be available at that website. Before I turn the call over to Matt Missad, let me remind you that today's press release and 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 the company's expectations and projections. These risks and uncertainties include, but are not limited to, those factors identified in the press release and in the filings with the Securities and Exchange Commission. I will now turn the call over to Matt Missad.

Matt Missad: Thank you, Dick, and good afternoon, everyone. We appreciate you joining our second quarter 2023 earnings call. Q2 was like a steeplechase run with plenty of hurdles and other obstacles and some competitive pressures thrown in for good measure. Our team definitely gave it their all, and like Kenneth Rooks, they persevered and came out ahead at the end of the quarter. Our earnings of $2.36 per share exceeded estimates and EBITDA margins remained strong in spite of lower sales volumes. In addition to the financial metrics, this quarter helped demonstrate the strength of the strategies, business models and ability to react quickly to market changes. We set a high bar for ourselves and pour our energies into exceeding it. The value of the balanced business model proved itself in the results. Some business units face tough economic environments while others did not and performed better. But our diverse mix of end markets and customers helps fuel long-term success while providing strong returns. We continue to see the positive financial effects of our 2020 restructuring and increases in value-added product mix, which have driven more focus and better returns than in similar periods in the past. As a result of these improvements in our long-term optimism, we are pleased to report that our board has increased the cash dividend for September and increased the share repurchase authorization for the next 12 months. As evidenced in the first half of the year, 2023 will not be a smooth year. Some of the macro factors, which affect our strategies include

Michael Cole: Thank you, Matt. Our consolidated results this quarter include a 30% drop in sales to $2 billion, consisting of a 22% reduction in selling prices, primarily due to the decline in lumber prices we passed to customers, and an 8% decrease in units. A 32% drop in operating profits to $193 million, resulting in an overall decremental operating margin of 10.7%, which was more favorable than the 15% to 20% range we originally estimated for the year. And adjusted EBITDA margin that improved by 50 basis points to 11.5%, demonstrating the progress we've made since our management structure changed in 2020, which enhanced our ability to offer new products and value-added solutions to customers in each of our business units. An annualized year-to-date return on invested capital of 25.5%, which is 2.5x our weighted average cost of capital. A $231 million improvement in operating cash flow compared to last year as lower volumes and lumber prices reduced our seasonal increase in working capital. And a balance sheet that continues to gain strength with a net cash surplus of $425 million this year compared to net debt of $191 million last year. By segment, sales in our Retail segment dropped 18% to $920 million, consisting of an 18% decline in selling prices and flat unit sales. Given market conditions, our unit sales held up well this quarter, primarily driven by our Prowood and DecKorators business units. Our unit sales to big box customers were also up with an increase -- with an 8% increase for the quarter while our business with independent retailers, which we believe is more closely correlated with new housing starts dropped by 16%, which was in line with expectations. Our retail operating profits increased to over $60 million this year, a 145% increase from last year. Last year, our retail segment which has a sales mix heavily weighted toward variable priced treated lumber was adversely impacted by sequential trends in lumber prices that dropped from over $1,300 per thousand at the beginning of the quarter to less than $600 per thousand at the end of Q2. Fortunately, we haven't had the same challenge in 2023. At the beginning of this year, we indicated our Retail segment was well positioned to report an increase in operating profits for the year. Their strong performance in Q2 resulted in a $5 million increase in year-to-date operating profit and we believe this segment is well positioned to build on this momentum in the back half of the year. Moving on to Packaging. Sales in this segment dropped 28% to $488 million, consisting of a 21% decline in selling prices, a 9% organic unit decrease and acquisitions, which contributed 2% to unit volume. Customer demand is currently softer than we anticipated at the beginning of this year, which has also contributed to a competitive price pressure. As a result of these and other factors, operating profits in our Packaging segment dropped to $57 million, a 40% decrease from last year, resulting in a decremental operating margin of 19.8%, slightly better than the low end of the 20% to 25% range we estimated for the year. Also, since most of the products we sell in this segment are at a fixed price for a period of time, falling lumber prices contributed to higher profits per unit last year. Sequential comparisons of sales and operating profits from Q1 to Q2 of 2023 provides us with cautious optimism that demand and pricing pressure in this segment has stabilized. Turning to Construction. Sales in this segment dropped 44% to $550 million, consisting of a 26% decline in selling prices and an 18% decrease in units. As expected, the unit decline was due to our Site-Built and Factory-Built businesses whose units declined 14% and 20%, respectively. Lower volumes and more competitive pricing caused the operating profits in our Construction segment to drop to $62 million, a 53% decrease from last year, resulting in a decremental operating margin of 16.7%. This was again better than the 20% to 25% range we estimated for the year -- for the full year. Last year, in Q2 through Q4, the Construction segment benefited from the drop in lumber prices I mentioned earlier because its sales are more heavily weighted to products with selling prices that are fixed for a period of time. Peak demand and capacity constraints also allow the team to be more selective in the business we pursued last year. As we manage through this cycle, each segment continues to focus on executing our strategies to grow our portfolio of value-added products. And we're pleased to report an increase in our ratio of value-added sales to total sales to 67% this year from 62% last year. Similarly, our ratio of new product sales to total sales increased to 9% this year from 7% last year. We're confident these efforts will continue to help us achieve our minimum EBITDA margin target of at least 10% and help us continue to enhance our profitability and competitiveness over the long term. We're also mindful of our cost structure in this environment as we ensure the company is appropriately sized relative to demand while still providing the resources needed to execute long-term strategies that enhance our ability to offer value-added solutions and drive innovation. Our SG&A expenses came in under plan and declined nearly $10 million or 5% this quarter, primarily due to lower bonus and sales incentive expenses. Moving on to our cash flow statement. Our cash flow from operations was $321 million, a $231 million improvement over last year due to lower seasonal working capital requirements resulting from lower volumes and lumber prices. Our cash cycle for the quarter increased to 63 days this year from 58 days last year due to a 2-day increase in our receivable cycle and a 3-day increase in our inventory cycle. While we've experienced a slight delay in payments from certain customers, our overall receivables are in good shape with over 93% current. Our current -- our inventory cycle is above historical trend and is an area of focus as we reset our safety stock levels for the improvement in availability of supply and adjust for the impact of the lower demand environment. As we move into Q3 and Q4, we anticipate a more typical seasonal decline in our net working capital. Our investing activities included $85 million in capital expenditures. Our capital investments are primarily focused on 4 key areas

Matt Missad: Thank you, Mike. Now I'd like to open it up for questions. Thank you.

Operator: [Operator Instructions]. Our first question will come from the line of Kurt Yinger with D.A. Davidson.

Kurt Yinger: Just wanted to start off on retail. I mean it sounded like Prowood, Sunbelt and DecKorators all had pretty good quarters there, but volumes were flat. Can you just talk about kind of some of the offsetting unit -- business unit segments and anything of note there?

Matt Missad: Yes, I would say it's probably driven primarily by UFP Edge. Their volumes were down considerably.

Kurt Yinger: Got it. And is that any destocking or anything specific or just, I guess, the overall market environment?

Matt Missad: Yes. I think there's a couple of different factors there. One is, I think as we look at where UFP Edge is going, they're driving it more towards their higher-end products and less on some of the just pure finishing items. So that's going to help -- it's going to help in the future, but it's got a sales impact that's happened this year so far so...

Kurt Yinger: Got it. Okay. That makes sense. And then you had a nice bounce back in retail gross margins, but I think you referenced that those were still below target levels. And maybe -- you just talk about what you think will kind of help bridge maybe the Prowood and Sunbelt business units, specifically from where they are today to where you're kind of hoping to push to from a margin perspective?

Matt Missad: Yes. I think it's been a consistent struggle. We've talked about the value add that we believe is in our treated lumber products, both with our preservatives or fire retardant and some of the new treatments that we're developing within the Performance Formulation Solutions group. And I think that will certainly help. We saw through the pandemic that the end consumer is willing to pay a fair value for the product. And so from our standpoint, it's a matter of us making sure that we're delivering the value in selling the value, and that's a real big focus for us is to help drive that profile up through the customer base and ultimately for the consumer to give them better product, better value, better margin for us.

Kurt Yinger: Okay. And then just lastly, I think you referenced kind of being at capacity in terms of Site-Built. And I assume that's with kind of manufactured products and the like. Any plans to kind of add greenfield facilities or any targeted kind of capacity expansion investments there?

Matt Missad: Yes. I think as we talked a little bit about -- we talked about automation in one of our larger facilities. We talked about adding the Chicopee, Massachusetts facility. We're looking at adding capacity in other areas. So that's certainly part of it. I think we talked -- and I tried to differentiate a little bit between functional capacity and actual capacity. I think I know not all the facilities are running 2 shifts. So adding a second shift is still a possibility for some of them. But I think for us, it's been a pleasant surprise that there's that much demand. And so who knows how long it will stay that way, but -- we're very pleased with it so far and the outlook from our customers has been very strong as well.

Operator: And that will come from the line of Stanley Elliott with Stifel.

Stanley Elliott: On the Site-Built kind of going back to that, was that more multifamily that you're seeing a lot of the strength? And then I guess the other part would be, how easy is it for you to flip these or not flip, but switch over production at some of these facilities between single-family and multifamily in the event that multifamily starts to tail off?

Matt Missad: That's a good point. I would say that the strength of multifamily has certainly been a factor for us. I've predicted incorrectly probably 4 years ago that multifamily would slow, and it's still -- it's just stayed strong. The demand is there for rental housing. So it's still got a strong place. And again, the outlook there looks good. With respect to how easy is it to switch production over at the risk of like irritating most of our production facilities, I'm not going to say it's easy, but they do a really, really good job of managing that transition and changeover. The real challenge comes when customers need to delay starts or change starts and that's where it gets even more challenging at the production level because we have to move things around and shift schedules. But they've done a really, really good job at our facilities of managing those and layering them in. And so I give them a ton of credit for that.

Stanley Elliott: And could you speak maybe a little more to the competitive pressures you guys saw in the packaging? And then I guess there's another thing, it looks like the PMIs are going to start -- or in the bottoming process may be actually even improving by the end of the year. Do you think you'll end up seeing that -- will it be a lag before that starts to benefit some of the packaging businesses? Or should it be kind of more in line with how those PMIs track?

Matt Missad: Yes. There's a couple of different things going on there, Stanley, which make it more difficult to be precise. But I will tell you, I think your points get on, it will probably be a slight lag there. I think there's been a program that they've had in packaging for a while, which is basically trying to convert from sticks and panels to value-added products and maybe not take certain orders if they're not at certain levels. I know there's been more quoting activity at a number of areas, which is typical in this environment. And so I think we've been doing very well with respect to the results of those types of things, but that's created some of that competitive pressure I talked about. I think on the pallet side, typically, the presence of a lot of excess cores on the market certainly can dampen pricing for a while until those are absorbed. But I think the PMI index coming back, that certainly shows a good sign for the future. And I think the takeaway that I have for the packaging group is they've done a nice job of managing their overall margins and business mix in spite of the fact that the sales volumes are down.

Stanley Elliott: Yes. And then lastly, any thoughts on the cadence of the repurchase activity? Is it -- the additional $200 million is only for this year? How should we think about that?

Matt Missad: It's really for the next 12-month period and so we'll continue to do what we've tried to do in the past. We want to make sure that the valuations are right. We want to allocate capital to where the highest return is and certainly, there's times within the second quarter, you saw that where the value of our stock far exceeded anything else we could invest in. So to the extent those opportunities are there, we wanted to have the approval of the board to be able to go ahead and repurchase.

Operator: That will come from the line of Ketan Mamtora with BMO Capital Markets.

Ketan Mamtora: First question, I was just curious, Mike, you talked about your big box sales were up kind of high single digits. On the independent retailer side, it was kind of down mid-teens as I -- which is kind of more skewed to new resi, as you said, as I think about on a go-forward basis with what we are sharing on new resi getting better, are you seeing any signs that, that sort of trend or year-over-year comps are changing as you move through the back half, given that new resi is actually seems to be holding up better and there are some positive indicators.

Michael Cole: From a year-over-year standpoint, we're still looking at demand being strong within retail, which is what you're talking about. I think I would make sure to point out, though, that we do have a pretty significant seasonal change that occurs from Q2 to Q3 and Q4. So that I would expect to kind of revert back to more normal historical patterns, so with respect to seasonality. But year-over-year, we still feel like the demand is in good shape and speculate, some of that may be due to higher lumber prices over the last couple of years in people deferring projects. And so I think that and some other factors are contributing to repair/remodel activity that's been better than we expected.

Ketan Mamtora: Got you. Okay. And then as I think about capital allocation, obviously, balance sheet is in very strong shape. You talked about share repurchases. I'm curious, as you think about M&A, kind of where are you seeing kind of most interesting opportunities as kind of how is the seller expectations kind of moderated and -- as you think about the 3 segments as the relative attractiveness of one over the other kind of increased, whether cyclical factors or anything else?

Matt Missad: Yes. I guess what I would say, Ketan, is I think packaging has been the area where we've had the most focus and the most opportunities that's obviously a highly fragmented marketplace. So for us that would be a much easier combination they work through, and there's more opportunities in that space. In the other segments, I think we're very selective in what we're looking at, and they have to be able to drive synergies and scale in some form or fashion for us or create a new product idea, a new product innovation that we can scale across our network. So I think you're right on the capital, and we talked a little bit about the valuations. And I think right now, people are still not quite where they need to be in terms of what I think real values are going forward. That's -- they're waiting for somebody come in and pay them what they might have been worth 1.5 years ago or 2 years ago. So I think there's a little ways to go there, but we are very confident that there will be some opportunities in our wheelhouse and at values that fit our model.

Ketan Mamtora: Got you. And one final question. Mike, any rethink or update for us in terms of how you think about decremental margins in your segments based on kind of what you've seen so far?

Michael Cole: Yes. It's a good question. We have and -- we're taking a fresh look at that guidance that we provided and the forward outlook of our 10-K and 10-Q last quarter. And so that will be updated next week when we file, but I would tell you, it wouldn't surprise you that it will likely lower the construction decremental margin given the performance and how we see the back half of the year materializing. I'm going to guess that packaging is that range might change, but it's probably closer to that original range and probably expect to do a little better on the decremental margin, therefore, overall, retail is pretty much doing exactly what we thought we do. We're finally up compared to last year on profits, and I think we'll build on that in the back half of the year.

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

Matt Missad: Well, thank you again for spending time with us today. While there are many challenges and unknowns we face, our experienced team gives me confidence to paraphrase the words of OneRepublic. I'm not worried about it right now because we'll keep the dreams alive. Thank you for your investment in us and we'll keep working to ensure great long-term returns. Have a great day.

Operator: Thank you all for participating. This concludes today's program. You may disconnect.