Business context and reporting period
Universal Forest Products, Inc. (now UFP Industries, Inc.) filed this unaudited Form 10-Q for the quarter ended June 25, 2011, with comparisons to the quarter and six months ended June 26, 2010. The company manufactures and distributes wood and wood-alternative products serving retail, construction, industrial, manufactured-housing and other markets. Dollar amounts below are in millions unless noted.
Financial performance and liquidity
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net sales | $544.1 | $638.6 | $931.4 | $1,031.6 |
| Gross profit | $56.6 | $77.9 | $98.0 | $129.5 |
| Gross margin | 10.4% | 12.2% | 10.5% | 12.6% |
| Operating earnings | $7.8 | $23.6 | $2.7 | $26.6 |
| Net earnings attributable to controlling interest | $4.3 | $13.7 | $0.6 | $14.7 |
| Diluted EPS | $0.22 | $0.70 | $0.03 | $0.75 |
- Net sales declined 14.8% in Q2 and 9.7% year to date. Gross profit fell 27% in Q2 and 24% in the first half; operating margin was 1.4% and 0.3%, respectively, versus 3.7% and 2.6% in 2010.
- Six-month operating cash flow was negative $57.9 million, compared with negative $56.0 million. Investing cash outflow was $10.7 million; financing provided $16.6 million, including $20.9 million of net revolving-credit borrowings. Cash declined from $43.4 million at year-end to zero, with an $8.7 million cash overdraft shown as a current liability.
- At June 25, total debt and capital lease obligations were $76.0 million, including $23.8 million classified as current and $52.2 million long-term. The company reported $23.0 million drawn on its $300 million revolving facility, maturing February 2012, and $31.3 million of letters of credit. It was in compliance with lending covenants.
- Current assets were $434.2 million and current liabilities $164.3 million. Shareholders’ equity including noncontrolling interest was $580.9 million; total assets were $832.9 million.
Material changes and management commentary
- Management attributed lower sales principally to a 4% Q2 decrease in unit volume and an estimated 10% reduction in selling prices from lumber-market declines. For the first half, unit volume declined an estimated 3% and prices 6%.
- Q2 gross-margin pressure reflected a 230-basis-point decline in retail building-material margins, lower volumes and fixed-cost absorption in weaker markets, competitive pricing, higher freight costs from fuel, and a $2 million loss on a construction project. First-quarter inclement weather also hurt production efficiency.
- By market, Q2 gross sales fell 18.6% in retail building materials, 15.5% in residential construction and 22.0% in manufactured housing/RVs. Commercial construction and concrete forming rose 23.2%; industrial sales declined 2.0%. The value-added share of sales increased to 59.9% from 58.8%.
- SG&A declined 16.1% in Q2 and 10.4% for the first half, mainly from lower bonus, compensation and bad-debt expenses. Headcount and other cost reductions were expected to generate about $10 million in annual savings; approximately $8 million of actions were completed by quarter-end.
- The CEO resigned June 20, 2011. The company recorded $2.6 million for the present value of payments under a consulting and non-compete agreement.
- Atlantic division reported a first-half operating loss of $4.1 million, compared with operating profit of $3.1 million in 2010. Eastern and Western divisions’ combined operating profit declined to $7.2 million from $19.8 million.
Outlook, risks and contingencies
- Management expected strong operating cash flow in the remainder of 2011 as seasonal working-capital needs eased and inventory was reduced. The cash cycle lengthened to 53 days from 43 days, reflecting more inventory and a longer receivables cycle.
- Planned 2011 capital spending was up to $35 million, including $4.9 million of outstanding project commitments; management intended to fund remaining spending from operating cash flows.
- The company identified lumber-price volatility, economic and housing weakness, competition, regulation and weather as risks. Lumber-price trends can affect sales, working capital and margins, especially on inventory held before sale at prices indexed to the lumber market.
- Sixteen operations had operating losses and negative cash flow for the first half. Their long-lived assets had a $16.5 million net book value and they carried $1.3 million in future fixed lease payments; further impairment was possible.
- Environmental remediation reserves were approximately $3.3 million. Management said ordinary-course lawsuits and claims were not expected to materially affect the financial statements. Outstanding performance bonds were $26.8 million for projects in progress and $19.7 million for completed projects under warranty; maximum residual-value lease guarantees were approximately $0.6 million.
- Management reported effective disclosure controls and no material changes in internal control over financial reporting. Part II listed no legal proceedings or risk factors, but the MD&A discusses business and market risks.
Important facts for investors to verify
- Whether the anticipated second-half cash generation and inventory reduction occurred, given negative first-half operating cash flow and the cash overdraft.
- Progress against the $10 million annual cost-savings estimate and the effect of the $2.6 million CEO agreement charge.
- Performance and potential impairment exposure at the 16 loss-making operations, especially the Atlantic division.
- Trends in lumber prices, sales volumes, gross margins and housing-related end markets, as well as the company’s ability to pass through material-cost changes.
- Revolving-facility refinancing or renewal before its February 2012 maturity, covenant headroom, and planned capital spending versus available cash generation.