BlueLinx Holdings Inc. Q2 FY2021 Earnings Call

Greetings, and welcome to the BlueLinx Holdings Second Quarter 2021 Results Conference Call. As a reminder, this conference is being recorded. It is now my pleasure to introduce Alexandra Lucas of Investor Relations. Thank you. You may begin.

Thank you. Welcome to BlueLinx Holdings second quarter 2021 results conference call. Leading the call today are our President and CEO, Dwight Gibson; and Chief Financial Officer, Kelly Janzen. The presentation we are sharing today is available on our website in the Webcast & Presentations section, and we encourage you to follow along accordingly. Today's discussion contains forward-looking statements about future business and financial expectations. Actual results may differ significantly from those projected in today's forward-looking statements due to various risks and uncertainties, including the risks described in our periodic reports filed with the SEC. Except as required by law, we undertake no obligation to update our forward-looking statements. We are using non-GAAP financial measures in our presentation. The appropriate GAAP financial reconciliations are incorporated into our presentation where available, which is posted on our website. All percentages in today's discussion refer to year-over-year progress, except where noted. At the conclusion of our prepared remarks, we will open the line for questions. With that, I would like to turn the call over to Dwight Gibson for his prepared remarks.

Thank you, Alexandra, and good morning. Before we review our record second quarter results, which by all accounts are a historic achievement for more than 2,100 team members, I want to say how excited I am to be part of the BlueLinx team. This is a great business with great people doing great work each and every day. Since joining BlueLinx as CEO eight weeks ago, I've had the opportunity to visit with our employees at multiple sites across the country. I, along with members of my leadership team, have visited 18 branches across four of our five regions. These locations represent roughly 45% of our total sales. During these visits, I was impressed by our associates' competitive spirit, their technical expertise, their deep relationships with suppliers and customers, and their focus on building a best-in-class building products distribution business. BlueLinx is a national business that serves key national accounts in hundreds of local markets, each of which have their own unique challenges and opportunities. Our teams do an exceptional job understanding the local market dynamics while leveraging our size and scale to provide an integrated, on-demand product and solution suite. I've come across groups of people who show up every day and make it happen, people like Leroy, a material handler in Richmond, who has worked for the company for over 49 years. People like Diana, a territory manager who's new to BlueLinx and delivering great results, and people like Nancy, a 20-plus-year member of the handcrafted panel production team in Aitkin, Minnesota, who will only allow product out of our facilities that she would be proud to put in her own home. We have a committed group of teammates who I'm now honored to lead. Let me be clear that although our runway is long, there are areas that we must address to realize our full potential. Specifically, we must invest more in our distribution branches. There is a need to upgrade some of our facilities and our equipment to increase efficiency and improve our customer service. We must also invest in technology to make our ordering easier, to enable real-time status and shipments, and to improve our internal operations, particularly warehouse management. As one investor recently indicated, I've been given the keys to an organization that is making a transition from good to great. I agree. In fact, it echoes one of the primary reasons I decided to join BlueLinx. It's a well-run company with strong financials. The potential for the company is significant given the strong macro trends, a solid balance sheet, and a talented team. We have the capability and capacity to drive meaningful and sustained profitable growth. While it is premature for me to describe my long-term plans on this call, allow me to share some preliminary thoughts around where there are clearly some opportunities. First, let me say that in my experience, culture drives the business, but people drive the culture. I firmly believe in the power of a strong culture, one that values employees and their contributions. Our customer experience will never exceed our employee experience. So we must always ensure that we're enabling our people to be successful in their jobs each and every day. We must ensure that our material handlers can safely and efficiently pick and load products. We must make sure our territory managers have the information they need to best support our customers. We must make sure our drivers can safely and efficiently deliver the right products to the right customers at the right time with the highest quality. If we do these things, we will create raving fans of all our key stakeholders, and most importantly, our customers. We will be increasing our investments in these areas, as I mentioned earlier, to ensure we consistently deliver world-class customer service and satisfaction. I also believe that accountability, productivity, and operational excellence are cornerstones of a well-run organization. The business has performed well in a period of significant supply-demand imbalances. We have had to focus on the things that matter most: our people, strategic product categories, and critical customers. In addition to our focus on culture, we will focus on our position in the market. Structural products are a key component of the products we sell, and we will continue to ensure that we are a key partner to our vendors and customers in these categories. We will seek to sharpen our value proposition, however, and focus on driving growth in higher-value specialty product categories. I believe the best way to increase shareholder value will be to grow our top line, while shifting a larger portion of our revenue mix toward margin-enhancing value-added specialty products. These carry higher barriers to entry and are less exposed to volatile price links. We will do this while ensuring sufficient capacity and capability to satisfy all of our customers' product needs. Next, let's talk a bit about our intention to develop a capital allocation strategy that we believe will generate long-term value for our shareholders. The team has done an outstanding job of driving profitability and strengthening the balance sheet. Net leverage is now at an all-time low due to targeted debt reduction and growth in adjusted EBITDA, and we have more flexibility to allocate capital toward high-impact opportunities. As I mentioned earlier, this translates to evaluating acquisitions that generate value for the business, such as expanding our capabilities in strategic product categories, deepening our high-value customer exposure, and/or meaningfully growing our footprint in target geographies. Along with this, we will direct more capital toward organic growth investments, including spending on our fleet and facilities as well as investing in productivity projects. So that's where my initial focus will be: culture and developing a strategy that strengthens and deepens our market position, a strategy that also deploys capital that delivers value creation for our shareholders. Once again, I consider it a great privilege to lead this organization. Mitch and the team have done a tremendous job of getting us to this point. I'm confident we are in the early innings of a multi-year growth story, one that I'm honored to be a part of. Now I would like to spend a few minutes before turning it over to Kelly to discuss our second-quarter performance. During a period of elevated demand within the domestic residential construction and home renovation markets, we have continued to leverage our scale, deep customer and supplier relationships, competitive spirit, and technical expertise to drive profitable growth across our organization. Our focus on both national accounts as well as local markets, when combined with the attractive products and solutions offered by our national platform, continues to represent a durable value proposition in what remains a fragmented market. Our record second-quarter performance, which resulted in $1.3 billion in net sales, an overall gross margin of 19.2%, and $166 million in adjusted EBITDA was driven by product price escalations, volume growth within our specialty products business, and an improved specialty sales mix. Supply-demand imbalances continue to persist across almost all of our specialty categories during the second quarter, resulting in a continued succession of supplier price increases and supported an expanded specialty margin of 24.4% for the period. This is the highest specialty margin the company has ever experienced. In addition to this incredible specialty performance, we also recorded excellent structural products results, including net sales of $633 million and a gross margin of 13.6%. Our disciplined approach of keeping inventory levels lean while continuing to provide excellent customer service, along with maximizing levels of available supplier consigned inventory, is providing the company resiliency as we navigate the recent extreme deflation in the wood-based commodities market. As of last Friday, the random lengths framing lumber composite was 68% below its mid-May all-time peak, which is very close to its five-year historical average. The panel composite was 53% below its peak in late June. And while we can never predict what commodity prices will do, we believe there is potential for further deflation in panel prices in the coming weeks. There are signs that lumber prices may have achieved relative stabilization for now. Given these market dynamics, we will continue to maintain lean structural inventory levels, which may have a short-term impact on volume, as we believe keeping lower levels of structural inventory is the right approach to mitigate inflation risk. I'd also like to acknowledge the team for achieving our best safety results ever. We've reduced our total recordable incident rate from 3.5 in December of 2019 to 1.8 in June of this year. This is significantly below the building materials industry benchmark for total recordable incident rates, which is above 4. We will continue to emphasize the safety of all of our associates and look to lead in this area. With that, I'll hand the call over to Kelly for a more detailed discussion of our second-quarter financial results.

Thank you, Dwight. As Dwight mentioned, we reported another record quarter with net sales of $1.3 billion, an increase of $609 million when compared to the prior year period, reflecting broad-based sales growth across both our specialty and structural product lines. Gross margin increased by nearly 480 basis points on a year-over-year basis to 19.2%. This was a result of improved price realization overall and a more favorable specialty product sales mix. We reported net income of $113 million or $11.61 per diluted share versus $7 million or $0.71 per diluted share in the prior year period, and we reported adjusted EBITDA of $166 million in the second quarter, the most we've ever recorded in a quarterly period. This was an increase of $135 million versus the prior year period. We ended the quarter with cash on hand and excess availability under our ABL of approximately $276 million, an increase of $138 million over the prior year period. Earlier this week, we both amended and extended our $600 million ABL for another five years. We reduced our fees and interest costs in doing so, and we also obtained greater flexibility to acquire companies and make strategic investments. Within our specialty product line, total quarterly net sales increased by 50% on a year-over-year basis in the second quarter to $675 million, driven by continuing price escalations and an increase in volume, primarily attributable to growth in our engineered wood, industrial products, and siding categories. Specialty gross margin expanded 710 basis points year-over-year and 510 basis points sequentially to 24.4%, fueled by elevated demand and supply-driven price increases. Our third quarter-to-date margin is in the 23% to 24% range. Given current market dynamics, where demand continues to outpace supply in several specialty product categories, we expect that specialty margins will remain elevated throughout the quarter. If and when supply starts to become less constrained, we expect there will be some reversal of the recent specialty margin expansion. While the magnitude of that is hard to predict, we believe that any decline will not be nearly as swift as what we've recently experienced with structural commodities, given our strong pricing practices and increasing investment in pricing capability. Additionally, pricing within our specialty product categories is typically much stickier than our structural products. Total revenue in our structural product line increased by more than 150% on a year-over-year basis to $633 million due to higher wood-based commodity prices. The random lengths framing lumber composite index averaged more than $1,200 per board foot in the second quarter, up from around $400 in the second quarter of 2020. However, within recent weeks, we have seen the composite fall off materially, currently holding at $479 per board foot as mill production has continued to ramp higher. The random lengths panel composite index averaged more than $1,500 per thousand square feet in the second quarter, up from $400 in the second quarter of 2020. Panels, unlike lumber, maintained strong pricing through most of the quarter. However, there has been a decline in panel pricing since late June. While the panel composite index is currently at $795 per thousand square feet, history shows that the two composites, lumber and panels, will typically align in pricing over time. In June, as a result of the steep decline in framing lumber prices, we adjusted our lumber inventory to reflect market pricing. As of the end of the second quarter, approximately 25% of our total inventory on the balance sheet consists of structural products, which excludes consignment inventory. Of that, approximately 50% was lumber, 40% panels, and 10% rebar and remesh. For July to date, structural sales volumes were approximately 27% lower compared to the same period last year, primarily due to our lean inventory approach. Third quarter-to-date, we are now seeing structural margins in the high single digits. We expect structural margins could decline further during the rest of Q3, given that additional decreases in panel prices are probable. Total SG&A increased by $16 million on a year-over-year basis to $87 million due to higher commissions and short-term incentives, as well as a return to normal spending levels in areas such as warehouse, delivery, and general and administrative costs, much of which we paused this time last year due to the pandemic. In the second quarter, our tax rate was 23.5%. We anticipate a tax rate in the range of 23% to 27% in the third quarter, having exhausted our remaining federal NOLs in 2020. We continue to maintain a disciplined approach towards working capital. Days sales of inventory improved by more than 18 days versus the prior year period and four days versus the first quarter of 2021. June 2021's currency rate on receivables was 93%. Higher sales drove a 48% increase in working capital year-over-year. Although this growth is significant, the deflation that started toward the end of the second quarter is expected to result in significant cash flow generation in the second half of the year. We estimate that there was approximately $130 million in inflationary investment in our working capital at the end of June compared to Q2 2020 levels. As Dwight mentioned earlier, the excellent performance of the business has provided financial flexibility to allocate capital toward high-impact opportunities. To that end, we expect to invest another $9 million in fleet and facilities during the second half of the year, including a $6 million investment in curtain side trailers with advanced safety features. We will continue to invest in areas that support organic growth and improve efficiency. Our balance sheet transformation continued during the second quarter, as we reduced total debt outstanding by $40 million quarter-over-quarter, resulting in a net leverage ratio including lease obligations of 1.5 times, the lowest level in the history of our company. Bank debt improved by over $70 million compared to the second quarter of last year, and our borrowings under the ABL were $320 million at quarter-end compared to $359 million at the end of the first quarter. Interest expense for the period declined by $2.4 million on a year-over-year basis, given a lower average outstanding bank debt balance and improved effective interest rate. Liquidity improved from Q2 of 2020 by $138 million to $276 million in excess availability under our ABL. As I mentioned earlier, we amended and extended our ABL for another five years at a lower cost and with more favorable terms. We continue to appreciate our strong partnership with our bank group, most of whom have supported BlueLinx for well over a decade. In summary, our second-quarter financial performance was nothing short of exceptional, resulting in improvements across all key financial performance indicators. We continue to remain highly focused on managing our working capital as we navigate the current deflationary environment, as well as cost efficiency. Our balance sheet is strong and provides significant financial flexibility for the future. Now I would like to turn it back over to Dwight.

Thanks, Kelly. Our second-quarter performance is a testament to the outstanding efforts of our approximately 2,100 teammates and an illustration of the strong foundation of the business. We are focused on building a great culture that prioritizes our people and enables deep customer relationships, strengthening our market position in strategic product categories, and deploying capital in ways that create shareholder value. I'm excited. The team is excited, and we look forward to doing great things together. Thank you.

That concludes our prepared remarks. Operator, please open the line for questions.

Our first questions come from the line of Greg Palm with Craig-Hallum.

Dwight, pretty impressive quarter. First one out of the gate. So welcome aboard again, and congrats again on the quarter. So I guess, a lot to unpack. I wanted to start off talking about segment results a little bit. What was kind of most surprising in terms of the forward-looking July comments were that structural margins quarter-to-date are in the high single-digit range, even with what's happened in lumber and panel markets recently. So thinking back historically, I know the company has been impacted more. So what's changed recently? How have you been able to bypass some of the weakness that others are seeing in the market?

Sure, Greg. A couple of reasons how we're managing through this. One, we continue to reiterate that we have kept our inventory low. I mentioned in the deck that we had lower structural volume year-over-year as a result of that. But we believe that was definitely the right decision. When you have lower inventory, you have lower risk. That's the main reason we've been able to do it. We also went into the quarter with adjusting our lumber inventories a bit down to market pricing, and that helps as well. Finally, we're holding the line on price, making good decisions on our execution, and we are focused on maintaining margin over sacrificing volume at lower prices.

Yes. Makes sense. In terms of specialty, I'm curious how much of the growth was driven by volume versus price? On the volume side, do you feel like you're gaining some share versus the market? If that's the case, what do you attribute that to?

Yes. Well, most of it was price. I think we laid that out that the inflation we've seen, it's really price escalations on the specialty side. We’ve had more price increases per week in the last few weeks than we've had sometimes in previous years. We've passed those along and maintained price in a very supply-constrained environment. That being said, we did have some volume increase overall, but we had significant volume increases in key categories like engineered wood, siding, and industrial products. We're seeing some market share gains especially year-over-year, and hopefully, we will continue to see growth in those categories. Specialty is definitely an area of focus for us, and I'm very encouraged by that.

One thing I'll add is that on the engineered wood side, our team has done a really good job of investing in our design services capabilities, which supports growth and share gain. We're able to respond quickly to our customers' needs and provide more services to help them in applying and using the products. So things like that are really supportive of hopefully us driving share, particularly as supply constraints abate a bit.

Interesting. And Kelly, to be clear, did you say that even in recent weeks? Even quarter-to-date, you've taken a number of price increases further versus what you saw in Q2?

We are continuing to experience some price increases, and we actually expect to get a few more into the rest of the year.

You talked about this $130 million inflationary investment in working capital. Does that completely reverse in the second half? I mean, I know you mentioned significant free cash flow potential. Just wanted to get some sense around maybe the magnitude relative to the level of free cash flow you generated in Q2.

Yes. We will see some significant cash coming in, in the second half related to deflation, but that number relates to our total working capital. The deflation is primarily on the commodity side, so it's not going to be the full amount of what's there. However, when you couple that with strong business and good earnings, especially as we're seeing strength in our specialty business, the cash could be significant.

Thinking ahead, how do you think about normalized net leverage? Just updating us on capital allocation, given the expected free cash flow generation and the complete transformation of the balance sheet, should we assume that M&A becomes a bigger focus for you? Or is it too early to tell?

Yes. It's great to be in a position where we have some flexibility and choice. We're always going to ensure that we deploy capital smartly and thoughtfully in a way that creates value. It's still early days, so I'll defer on sharing my long-term capital allocation strategy. But as I mentioned before, there are ample opportunities for us to invest in this business organically to drive growth, particularly in delivering best-in-class customer service. We're going to deploy capital in those areas. We believe this is an environment conducive to the right kinds of M&A, but it has to be complementary and allow us to better service our customers.

To add on how that translates into a net leverage ratio, obviously, it’s very low right now, given the TTM numbers. We would aim to maintain a normalized environment around 3%. It could be a little higher for some period if we pursue particular deals or lower depending on the cycle.

Maybe a preface to my comments here. I missed most of Greg's questions, so if I'm repetitive, apologies in advance. Just to start on structural margin performance, can you go into more detail about what you're seeing there? What specific products are you selling? Is the supply-demand dynamic still favorable? Is it all engineered wood products or predominantly that? What scenario would lead this margin level to not be sustainable?

Yes. Specialty margins have been expanded beyond what we've seen historically due to supply constraints being the primary driver of price increases and continued demand. There are certain factors that might make it unsustainable, such as resin impacts on specialty product inputs and potentially reduced supply constraints over time. We believe specialty margins would be elevated over the next few months.

The value of the relationships we have with our customers in our local markets and our national accounts cannot be underestimated. We work hard to understand their needs and ensure we design and deliver solutions that create value for both parties. All of this, combined with our pricing strategy and discipline, contributes to this performance.

On the structural side, I think I saw the write-down in the Q. Can you talk about how that flows through to profits? Was the high single-digit gross margin you had in July for structural, did that include the impacts of that write down? How do we think about that as the quarter progresses?

Yes, that's right. We adjusted the lumber inventory at the end of June down to market. When you sell that through with our days sales of inventory being low, that comes back into the quarter as you sell through the inventory. So the high single digits include impacts from that market pricing adjustment.

Congrats on the strong results. Dwight, you've set a high bar out of the gates here, so good luck going forward.

I appreciate that. Thank you. The team deserves all the credit.

So my first question is how we should think about structural volumes and inventories looking into 2022. You guys have managed inventories at the expense of volumes at times to reduce wood commodity risk. But with lumber prices where they are now, do you have more flexibility to bring inventories closer to normalized levels and focus on volume growth?

That's a good question, Jeff. Our view right now is that we want to maintain the current inventory approach, especially for the next quarter or two, to see if lumber prices have truly stabilized. Yes, they're closer to historical averages, but it has been very volatile. We believe that the current approach is the right one. I expect to see volumes lower year-over-year in the same extent as the past quarter or two.

When we touch on structural margins, is that high single-digit rate you saw in July a good run rate for the back half of the year? Is there anything else we should consider?

Unless there’s a big change in pricing, we would expect to return to more normalized margins in the range of 8% to 9%. Timing of that return is a bit unknown, but our days sales of inventory are quick on the structural side.

Can you provide an update on how product shortages and project timing delays have progressed this summer? Has that improved at all?

Unfortunately, not too much. We're still seeing challenges on the supply side, particularly across the specialty portfolio. The same issues creating constraints are continuing, such as access to labor, transportation challenges, etc. We expect this will continue through the second half of the year. Hopefully, as things settle out and more capacity comes online, we will see some improvements in 2022.

On the recent acceleration of housing starts, any thoughts on how that could impact demand as we look forward through the year into 2022? What are your expectations for new housing moving forward?

New housing starts remain at a much higher level than we've seen over the past decade or so, around 1.2 million expected for 2021. I expect this level to stay roughly the same for the next year. There isn't enough new housing stock to meet demand, and the environment still supports new home construction. However, lumber, land, and labor still create tightness that we need to work through. We feel optimistic about new home construction in the near to medium term.

Lastly, on M&A, I know the focus will be on growing specialty. Any details on the focus, whether it be bolt-on, specific geographies you're looking at, and about valuation would be helpful.

It’s still early days, but we're examining opportunities that are complementary to our business. Strengthening our specialty side is essential, as well as getting closer to our core customers in areas where we don't have a strong footprint. We're being prudent in our capital use and will ensure that all decisions are well thought out. We are expanding our M&A team as well, so we're in the process of bringing talent in.

There are no further questions at this time. With that, we thank you for your participation. This does conclude today's teleconference. You may disconnect your lines at this time. Have a great day.