================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES - --- EXCHANGE ACT OF 1934 For the quarterly period ended September 27, 2003 ------------------ OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES - --- EXCHANGE ACT OF 1934 Commission File Number 0-22684 ------- UNIVERSAL FOREST PRODUCTS, INC. (Exact name of registrant as specified in its charter) Michigan 38-1465835 ------------------------------ ---------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 2801 East Beltline NE, Grand Rapids, Michigan 49525 --------------------------------------------- ------------ (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (616) 364-6161 -------------- NONE -------------------------------------------------------------- (Former name or former address, if changed since last report.) Indicate by checkmark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by checkmark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of the Exchange Act). Yes X No --- --- Indicate the number of shares of each of the issuer's classes of common stock, as of the latest practicable date: Class Outstanding as of September 27, 2003 -------------------------- ------------------------------------ Common stock, no par value 17,788,288 ================================================================================ Page 1 of 31 INDEX PAGE NO. -------- PART I. FINANCIAL INFORMATION. Item 1. Financial Statements. Consolidated Condensed Balance Sheets at September 27, 2003, December 28, 2002, and September 28, 2002. 3 Consolidated Condensed Statements of Earnings for the Three and Nine Months Ended September 27, 2003 and September 28, 2002. 4 Consolidated Condensed Statements of Cash Flows for the Nine Months Ended September 27, 2003 and September 28, 2002. 5 Notes to Consolidated Condensed Financial Statements. 6-13 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. 14-26 Item 3. Quantitative and Qualitative Disclosures About Market Risk. 27 Item 4. Controls and Procedures. 28 PART II. OTHER INFORMATION. Item 1. Legal Proceedings - NONE. Item 2. Changes in Securities and Use of Proceeds. 29 Item 3. Defaults Upon Senior Securities - NONE. Item 4. Submission of Matters to a Vote of Security Holders - NONE. Item 5. Other Information. 30 Item 6. Exhibits and Reports on Form 8-K. 30 2 UNIVERSAL FOREST PRODUCTS, INC. CONSOLIDATED CONDENSED BALANCE SHEETS (Unaudited) (in thousands, except share data) September 27, December 28, September 28, 2003 2002 2002 ------------- ------------ -------------- ASSETS CURRENT ASSETS: Cash and cash equivalents ........................................ $ 10,747 $ 13,454 $ 12,800 Restricted cash equivalents ...................................... 1,383 Accounts receivable (net of allowances of $3,291, $2,427 and $2,702) ................................................. 157,768 105,217 149,962 Inventories: Raw materials ............................................... 81,831 83,557 43,806 Finished goods .............................................. 79,124 82,449 85,035 --------- --------- --------- 160,955 166,006 128,841 Other current assets ............................................. 5,847 8,037 3,279 --------- --------- --------- TOTAL CURRENT ASSETS .................................... 335,317 294,097 294,882 OTHER ASSETS .......................................................... 5,679 6,738 6,311 GOODWILL .............................................................. 124,377 126,299 120,333 NON-COMPETE AND LICENSING AGREEMENTS (net of accumulated amortization of $3,627, $2,463 and $2,214) ........... 7,168 4,516 4,764 PROPERTY, PLANT AND EQUIPMENT: Property, plant and equipment .................................... 355,552 328,499 311,652 Accumulated depreciation and amortization ........................ (141,215) (125,355) (120,303) --------- --------- --------- PROPERTY, PLANT AND EQUIPMENT, NET ...................... 214,337 203,144 191,349 --------- --------- --------- TOTAL ASSETS .......................................................... $ 686,878 $ 634,794 $ 617,639 ========= ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Short-term debt .................................................. $ 645 $ 1,758 $ 1,494 Accounts payable ................................................. 96,481 57,515 76,303 Accrued liabilities: Compensation and benefits ................................... 41,700 36,610 38,092 Other ....................................................... 15,959 6,463 12,507 Current portion of long-term debt and capital lease obligations .. 6,263 6,495 18,645 --------- --------- --------- TOTAL CURRENT LIABILITIES ............................... 161,048 108,841 147,041 LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS, less current portion ............................................. 195,833 235,319 185,091 DEFERRED INCOME TAXES ................................................. 12,671 13,328 10,320 MINORITY INTEREST ..................................................... 8,211 7,040 7,558 OTHER LIABILITIES ..................................................... 10,241 5,832 6,214 --------- --------- --------- TOTAL LIABILITIES ....................................... 388,004 370,360 356,224 SHAREHOLDERS' EQUITY: Preferred stock, no par value; shares authorized 1,000,000; issued and outstanding, none Common stock, no par value; shares authorized 40,000,000; issued and outstanding, 17,788,288, 17,741,982 and 17,816,613 ......... 17,788 17,742 17,817 Additional paid-in capital ....................................... 84,748 82,139 81,970 Deferred stock compensation ...................................... 1,424 1,434 1,501 Retained earnings ................................................ 195,384 164,221 161,850 Accumulated other comprehensive earnings ......................... 1,514 299 (322) --------- --------- --------- 300,858 265,835 262,816 Employee stock notes receivable .................................. (1,984) (1,401) (1,401) --------- --------- --------- TOTAL SHAREHOLDERS' EQUITY .................................. 298,874 264,434 261,415 --------- --------- --------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ............................ $ 686,878 $ 634,794 $ 617,639 ========= ========= ========= See notes to consolidated condensed financial statements. 3 UNIVERSAL FOREST PRODUCTS, INC. CONSOLIDATED CONDENSED STATEMENTS OF EARNINGS (Unaudited) (in thousands, except per share data) Three Months Ended Nine Months Ended ------------------------- ------------------------- Sept. 27, Sept. 28, Sept. 27, Sept. 28, 2003 2002 2003 2002 --------- --------- --------- --------- NET SALES ............................................. $536,278 $452,959 $1,444,360 $1,299,559 COST OF GOODS SOLD .................................... 463,715 391,294 1,241,251 1,117,994 -------- -------- ---------- ---------- GROSS PROFIT .......................................... 72,563 61,665 203,109 181,565 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ......................................... 48,424 41,148 135,309 120,291 -------- -------- ---------- ---------- EARNINGS FROM OPERATIONS .............................. 24,139 20,517 67,800 61,274 OTHER EXPENSE (INCOME): Interest expense ................................. 3,526 2,542 11,271 8,497 Interest income .................................. (2) (31) (133) (196) Gain on sale of assets ........................... (1,082) -------- -------- ---------- ---------- 3,524 2,511 11,138 7,219 -------- -------- ---------- ---------- EARNINGS BEFORE INCOME TAXES AND MINORITY INTEREST ................................ 20,615 18,006 56,662 54,055 INCOME TAXES .......................................... 7,715 6,678 20,964 20,051 -------- -------- ---------- ---------- EARNINGS BEFORE MINORITY INTEREST ..................... 12,900 11,328 35,698 34,004 MINORITY INTEREST ..................................... 695 684 1,831 1,924 -------- -------- ---------- ---------- NET EARNINGS .......................................... $ 12,205 $ 10,644 $ 33,867 $ 32,080 ======== ======== ========== ========== EARNINGS PER SHARE - BASIC ............................ $ 0.69 $ 0.60 $ 1.91 $1.78 EARNINGS PER SHARE - DILUTED .......................... $ 0.66 $ 0.58 $ 1.85 $1.71 WEIGHTED AVERAGE SHARES OUTSTANDING ................... 17,765 17,845 17,745 17,980 WEIGHTED AVERAGE SHARES OUTSTANDING WITH COMMON STOCK EQUIVALENTS ....................... 18,425 18,427 18,290 18,719 See notes to consolidated condensed financial statements. 4 UNIVERSAL FOREST PRODUCTS, INC. CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (Unaudited) (in thousands) Nine Months Ended ----------------------------- September 27, September 28, 2003 2002 ------------- ------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net earnings .................................................................. $ 33,867 $ 32,080 Adjustments to reconcile net earnings to net cash from operating activities: Depreciation ............................................................. 18,702 17,235 Amortization of intangible assets ........................................ 1,519 851 Deferred income taxes .................................................... (1,301) (246) Loss (gain) on sale or impairment of property, plant, and equipment ...... 918 (152) Changes in: Accounts receivable .................................................... (78,688) (61,235) Proceeds from sale and servicing of accounts receivable ................ 25,143 Inventories ............................................................ 5,051 (6,020) Accounts payable ....................................................... 37,717 28,076 Accrued liabilities and other .......................................... 24,463 11,353 -------- -------- NET CASH FROM OPERATING ACTIVITIES ....................................... 67,391 21,942 CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property, plant and equipment ..................................... (33,349) (21,136) Purchase of licensing agreements .............................................. (150) (2,000) Acquisitions, net of cash received ............................................ (787) (2,519) Proceeds from sale of property, plant and equipment ........................... 6,104 3,310 Other ......................................................................... 3,059 430 -------- -------- NET CASH FROM INVESTING ACTIVITIES ....................................... (25,123) (21,915) CASH FLOWS FROM FINANCING ACTIVITIES: Net (repayments) borrowings of notes payable and revolving credit facilities .. (36,884) 37,004 Repayment of long-term debt ................................................... (6,150) (8,205) Proceeds from issuance of common stock ........................................ 1,719 769 Distributions to minority shareholder ......................................... (833) (660) Dividends paid to shareholders ................................................ (798) (806) Repurchase of common stock .................................................... (2,029) (38,216) -------- -------- NET CASH FROM FINANCING ACTIVITIES ....................................... (44,975) (10,114) -------- -------- NET CHANGE IN CASH AND CASH EQUIVALENTS ....................................... (2,707) (10,087) CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR .................................. 13,454 22,887 -------- -------- CASH AND CASH EQUIVALENTS, END OF PERIOD ...................................... $ 10,747 $ 12,800 ======== ======== SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION: Cash paid during the period for: Interest ................................................................. $ 8,585 $ 6,659 Income taxes ............................................................. 12,102 16,406 NON-CASH FINANCING ACTIVITIES: Property, plant and equipment acquired in exchange for capital lease .......... $ 2,110 NON-CASH INVESTING ACTIVITIES: Non-compete agreements in exchange for future payments ........................ $ 216 Non-compete agreements with Chairman of the Board in exchange for future payments .......................................................... $ 856 Stock exchanged for employee stock notes receivable ........................... 887 300 See notes to consolidated condensed financial statements. 5 UNIVERSAL FOREST PRODUCTS, INC. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS A. BASIS OF PRESENTATION The accompanying unaudited, interim, consolidated, condensed financial statements (the "Financial Statements") include our accounts and those of our wholly-owned and majority-owned subsidiaries and partnerships, and have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, the Financial Statements do not include all of the information and footnotes normally included in the annual consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States. All significant intercompany transactions and balances have been eliminated. In our opinion, the Financial Statements contain all material adjustments necessary to present fairly our consolidated financial position, results of operations and cash flows for the interim periods presented. All such adjustments are of a normal recurring nature. These Financial Statements should be read in conjunction with the annual consolidated financial statements, and footnotes thereto, included in our annual report to shareholders on Form 10-K for the fiscal year ended December 28, 2002. Certain reclassifications have been made to the Financial Statements for 2002 to conform to the classifications used in 2003. B. COMPREHENSIVE INCOME Comprehensive income consists of net income and foreign currency translation adjustments. Comprehensive income was approximately $12.1 million and $10.0 million for the quarter ended September 27, 2003 and September 28, 2002, respectively. During the nine months ended September 27, 2003 and September 28, 2002, comprehensive income was approximately $35.1 million and $31.2 million, respectively. c. EARNINGS PER COMMON SHARE A reconciliation of the changes in the numerator and the denominator from the calculation of basic EPS to the calculation of diluted EPS follows (in thousands, except per share data): 6 UNIVERSAL FOREST PRODUCTS, INC. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - CONTINUED Three Months Ended 09/27/03 Three Months Ended 09/28/02 ------------------------------------ --------------------------------- Per Per Income Shares Share Income Shares Share (Numerator) (Denominator) Amount (Numerator) (Denominator) Amount ----------- ------------- ------ ----------- ------------- ------ NET EARNINGS................... $12,205 $10,644 EPS - BASIC Income available to common stockholders.......... 12,205 17,765 $0.69 10,644 17,845 $0.60 ===== ===== EFFECT OF DILUTIVE SECURITIES Options........................ 660 582 ------ ------ EPS - DILUTED Income available to common stockholders and assumed options exercised.................... $12,205 18,425 $0.66 $10,644 18,427 $0.58 ======= ====== ===== ======= ====== ===== Nine Months Ended 09/27/03 Nine Months Ended 09/28/02 --------------------------------- ------------------------------------ Per Per Income Shares Share Income Shares Share (Numerator) (Denominator) Amount (Numerator) (Denominator) Amount ----------- ------------- ------ ----------- ------------- ------ NET EARNINGS................... $33,867 $32,080 EPS - BASIC Income available to common stockholders.......... 33,867 17,745 $1.91 32,080 17,980 $1.78 ===== ===== EFFECT OF DILUTIVE SECURITIES Options........................ 545 739 ------ ------ EPS - DILUTED Income available to common stockholders and assumed options exercised.................... $33,867 18,290 $1.85 $32,080 18,719 $1.71 ======= ====== ===== ======= ====== ===== Options to purchase 260,000 shares of common stock at exercise prices ranging from $24.46 to $36.01 were outstanding at September 27, 2003, but were not included in the computation of diluted EPS for the quarter. Options to purchase 720,943 shares of common stock at exercise prices ranging from $21.13 to $36.01 were outstanding at September 27, 2003, but 7 UNIVERSAL FOREST PRODUCTS, INC. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - CONTINUED were not included in the computation of diluted EPS for the nine months ended September 27, 2003. The options' exercise prices were greater than the average market price of the common stock during the period and, therefore, would be antidilutive. Options to purchase 950,481 shares of common stock at exercise prices ranging from $19.75 to $36.01 were outstanding at September 28, 2002, but were not included in the computation of diluted EPS for the quarter. Options to purchase 335,000 shares of common stock at exercise prices ranging from $22.88 to $36.01 were outstanding at September 28, 2002, but were not included in the computation of diluted EPS for the nine months ended September 28, 2002. The options' exercise prices were greater than the average market price of the common stock during the period and, therefore, would be antidilutive. D. SALE OF ACCOUNTS RECEIVABLE On September 25, 2003, we entered into an arrangement with a bank to sell specific accounts receivable totaling $27.2 million with an Agreed Base Value of approximately $25 million, which was received in cash. Approximately $2.0 million was recorded as a retained interest and approximately $168,000 was recognized as an expense. The maximum amount of receivables which may be sold and outstanding at any point in time under this arrangement is $33 million. The agreement with the bank has a one year term; the September 25, 2003 transaction terminates on December 31, 2003. We will service the sold receivables as part of the arrangement with the bank and will receive servicing fees in the amount of .50% per annum. Our retained interest is determined based on the fair market value of anticipated collections in excess of the Agreed Base Value of the receivables sold. The fair market value of anticipated collections is determined using management's best estimate based on historical collections experience. Appropriate valuation allowances are recorded against the retained interest. The retained interest is reduced for subsequent collections. E. GOODWILL AND OTHER INTANGIBLE ASSETS On September 27, 2003, non-compete assets totaled $7.9 million with accumulated amortization totaling $2.8 million, and licensing agreements totaled $2.9 million with accumulated amortization totaling $0.8 million. Estimated amortization expense for intangible assets as of September 27, 2003 for each of the five succeeding fiscal years is as follows (in thousands): 2003............................... $ 378 2004............................... 1,633 2005............................... 1,477 2006............................... 1,302 8 UNIVERSAL FOREST PRODUCTS, INC. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - CONTINUED 2007............................... 781 Thereafter......................... 1,597 The changes in the net carrying amount of goodwill for the nine months ended September 27, 2003 are as follows (in thousands): Balance as of December 28, 2002...................................... $126,299 Final purchase price allocation...................................... (2,810) Foreign currency translation effects and other, net.................. 888 -------- Balance as of September 27, 2003..................................... $124,377 ======== F. BUSINESS COMBINATIONS AND ASSET PURCHASES Acquisitions completed in 2002 and 2003 were not significant to the operating results individually nor in aggregate, and thus pro forma results are not presented. The purchase price allocations for the composite manufacturing plant of Quality Wood Treating Co., Inc. ("Quality") and J.S. Building Products, Inc., acquired in the third and fourth quarters of 2002, respectively, were completed during the second quarter in accordance with Statement of Financial Accounting Standards ("SFAS") No. 141, Business Combinations. The total purchase price for the real estate, equipment, inventory and intangible assets of the composite plant was approximately $14.7 million, allocating $10.1 million to net assets, $2.3 million to non-compete agreements, $0.5 million to a licensing agreement, and $1.8 million to goodwill. The total purchase price for J.S. Building Products, Inc. was $4.1 million, allocating $2.9 million to net assets and $1.2 million to goodwill. On August 28, 2003, one of our subsidiaries acquired 50% of the assets of D&L Framing LLC, a framing operation for multi-family construction located in Las Vegas, NV. The purchase price was approximately $0.6 million. The purchase price allocation is preliminary and will be revised as final estimates of intangible asset values are made in accordance with SFAS 141. On August 26, 2003, one of our subsidiaries entered into an agreement with Quality to cancel the treating services agreement completed on November 4, 2002 and purchase plants located in Lansing, MI and Janesville, WI and the equipment of a plant located in White Bear Lake, MN. The total purchase price for these assets was $5.1 million. In addition, another subsidiary entered into a capital lease for the real estate of the White Bear Lake, MN plant totaling $2.1 million. 9 UNIVERSAL FOREST PRODUCTS, INC. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - CONTINUED On June 4, 2003, one of our subsidiaries acquired 75% of the assets of Norpac Construction LLC, a concrete framer for multi-family construction located in Las Vegas, NV. The purchase price was approximately $0.2 million. G. EMPLOYEE STOCK NOTES RECEIVABLE Employee stock notes receivable represents notes issued to us by certain employees and officers to finance the purchase of our common stock. As of August 1, 2002, directors and executive officers (including equivalent positions) do not, and are not allowed to, participate in this program. H. STOCK-BASED COMPENSATION As permitted under SFAS No. 123, Accounting for Stock-Based Compensation, ("SFAS 123"), we continue to apply the provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees, which recognizes compensation expense under the intrinsic value method. Had compensation cost for the stock options granted and stock purchased under the Employee Stock Purchase Plan in the third quarter and first nine months of 2003 and 2002 been determined under the fair value based method defined in SFAS 123, our net earnings and earnings per share would have been reduced to the following pro forma amounts (in thousands, except per share data): Three Months Ended Nine Months Ended ------------------------ ----------------------- Sept. 27, Sept. 28, Sept. 27, Sept. 28, 2003 2002 2003 2002 --------- --------- --------- --------- Net Earnings: As reported................................... $ 12,205 $ 10,644 $ 33,867 $ 32,080 Deduct: compensation expense - fair value method........................ (387) (347) (1,145) (1,011) ---------- ---------- ---------- ---------- Pro Forma..................................... $ 11,818 $ 10,297 $ 32,722 $ 31,069 ========== ========== ========== ========== EPS - Basic: As reported................................... $ 0.69 $ 0.60 $ 1.91 $ 1.78 Pro forma..................................... $ 0.67 $ 0.58 $ 1.84 $ 1.73 EPS - Diluted: As reported................................... $ 0.66 $ 0.58 $ 1.85 $ 1.71 Pro Forma..................................... $ 0.65 $ 0.57 $ 1.83 $ 1.70 10 UNIVERSAL FOREST PRODUCTS, INC. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - CONTINUED I. COMMITMENTS, CONTINGENCIES, AND GUARANTEES We are self-insured for environmental impairment liability through a wholly owned subsidiary, UFP Insurance Ltd., a licensed captive insurance company. We own and operate a number of facilities throughout the United States that treat lumber products with chemical preservatives. In connection with the ownership and operation of these and other real properties, and the disposal or treatment of hazardous or toxic substances, we may, under various federal, state and local environmental laws, ordinances and regulations, be potentially liable for removal and remediation costs, as well as other potential costs, damages and expenses. Insurance reserves have been established to cover remediation activities at our Union City, GA; Stockertown, PA; Elizabeth City, NC; Schertz, TX; Janesville, WI wood preservation facilities; and a wood preservation facility in White Bear Lake, MN which is leased by a subsidiary. The subsidiary has agreed to purchase the real property upon successful completion of the remediation activities. In addition, a reserve has been recorded for the removal of lead and asbestos containing material from property we purchased in Thornton, CA. Including amounts recorded in our captive insurance company, we reserved amounts totaling approximately $2.8 million and $2.2 million on September 27, 2003 and September 28, 2002, respectively, representing the estimated costs to complete remediation efforts. As part of its re-registration process and in response to allegations by certain environmental groups that CCA poses health risks, the EPA has been conducting a scientific review of CCA, a wood preservative we use to extend the useful life of wood fiber. In April of 2003, the EPA announced the re-registration of CCA preservative for certain industrial and commercial uses. The manufacturers of CCA preservative agreed to voluntarily discontinue the registration of CCA for certain residential applications by December 31, 2003. All of our facilities are presently capable of using a new preservative to treat wood products. We expect that all of our treating facilities will be using this new preservative on or before January 1, 2004, except those facilities which may treat with CCA for allowed industrial and commercial applications. In addition to the EPA review, an environmental group petitioned the Consumer Products Safety Commission ("CPSC") to ban the use of CCA treated wood in playsets. On February 7, 2003, the CPSC issued a staff report on its study of the risks of children playing on treated playsets. The study does not recommend removal of product, and proposes the CPSC take no further action until the EPA concludes its assessment. The EPA has previously stated that CCA treated lumber does not pose an unreasonable risk to human health. On October 14, 2003, the CPSC issued its professional staff recommendation, which stated that the CPSC should deny the petition to ban CCA, essentially agreeing that the product does not pose an unreasonable risk to human health. We have been requested by a customer to defend it from purported class action lawsuits filed against it in Florida and Louisiana. The complaints allege that CCA treated lumber is 11 UNIVERSAL FOREST PRODUCTS, INC. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - CONTINUED defective. While our customer has charged us for certain expenses incurred in the defense of these claims, we have not formally accepted liability of these costs. In February 2003, the judge in the Florida case denied the plaintiff's motion for certification of the class. In June 2003, the judge allowed the plaintiffs to amend their complaint and again reiterated that he would not certify a class in this case. In September 2003, the appellate court upheld the trial judge`s denial of certification. During the third quarter, we were advised of a purported class action filed in Texas where a customer of ours is named as the sole defendant. To date, no class has been certified in any of the pending actions. In addition, various special interest environmental groups have petitioned certain states requesting restrictions on the use or disposal of CCA treated products. The State of Maine has prohibited the manufacture and sale of CCA products after October 15, 2003. The Company does not presently sell product in Maine. The wood preservation industry trade groups are working with the individual states and their regulatory agencies to provide an accurate, factual background which demonstrates that the present method of uses and disposal is scientifically supported. On September 27, 2003, we were parties either as plaintiff or a defendant to a number of lawsuits and claims arising through the normal course of our business. In the opinion of management, our consolidated financial statements will not be materially affected by the outcome of these legal proceedings. On September 27, 2003, we had outstanding purchase commitments on capital projects of approximately $6.6 million. We provide a variety of warranties for products we manufacture. Historically, warranty claims have not been material. In certain cases we jointly bid on contracts with framing companies to supply building materials to site-built construction projects. In some of these instances we are required to post payment and performance bonds to insure the owner that the products and installation services are completed in accordance with our contractual obligations. We have agreed to indemnify the surety for claims made against the bonds. Historically, we have not had any claims for indemnity from our sureties. As of September 27, 2003, we had approximately $25.9 million in outstanding performance bonds which expire during the next three to eighteen months. We have entered into operating leases for certain assets that include a guarantee of a portion of the residual value of the leased assets. If at the expiration of the initial lease term we do not exercise our option to purchase the leased assets and these assets are sold by the lessor for a price below a predetermined amount, we are required to reimburse the lessor for a certain portion of the shortfall. These operating leases will expire periodically over the next five years. the estimated maximum aggregate exposure of these guarantees is less than $450,000. 12 UNIVERSAL FOREST PRODUCTS, INC. NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - CONTINUED On September 27, 2003, we had outstanding letters of credit totaling $30.6 million, primarily related to certain insurance contracts and industrial development revenue bonds. In lieu of cash deposits, we provide irrevocable letters of credit in favor of our insurers to guarantee our performance under certain insurance contracts. We currently have irrevocable letters of credit outstanding totaling approximately $12.3 million for these types of insurance arrangements. We have reserves recorded on our balance sheet, in accrued liabilities, that reflect our expected future liabilities under these insurance arrangements. We are required to provide irrevocable letters of credit in favor of the bond trustees for all of the industrial development revenue bonds that we have issued. These letters of credit guarantee principal and interest payments to the bondholders. We currently have irrevocable letters of credit outstanding totaling approximately $18.3 million related to our outstanding industrial development revenue bonds. These letters of credit have varying terms but may be renewed at the option of the issuing banks. Our wholly owned domestic subsidiaries have guaranteed the indebtedness of Universal Forest Products, Inc. in certain debt agreements, including the 1994 Senior Notes, Series 1998-A Senior Notes, Series 2002-A Senior Notes and our revolving credit facility. The maximum exposure of these guarantees is limited to the indebtedness outstanding under these debt arrangements and this exposure will expire concurrent with the expiration of the debt agreements. We did not enter into any new guarantee arrangements during the third quarter of 2003 which would require us to recognize a liability on our balance sheet. 13 UNIVERSAL FOREST PRODUCTS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Included in this report are certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The forward-looking statements are based on the beliefs and assumptions of management, together with information available to us when the statements were made. Future results could differ materially from those included in such forward-looking statements as a result of, among other things, the factors set forth below and certain economic and business factors which may be beyond our control. Investors are cautioned that all forward-looking statements involve risks and uncertainty. RISK FACTORS WE ARE SUBJECT TO FLUCTUATIONS IN THE PRICE OF LUMBER. We experience significant fluctuations in the cost of commodity lumber products from primary producers (the "Lumber Market"). A variety of factors over which we have no control, including government regulations, environmental regulations, weather conditions, economic conditions and natural disasters, impact the cost of lumber products and our selling prices. While we attempt to minimize our risk from severe price fluctuations, substantial, prolonged trends in lumber prices can negatively affect our sales volume, our gross margins and our profitability. We anticipate that these fluctuations will continue in the future. OUR GROWTH MAY BE LIMITED BY THE MARKETS WE SERVE. Our sales growth is dependent, in part, upon the growth of the markets we serve. If our markets do not achieve anticipated growth, or if we fail to maintain our market share, financial results could be impaired. The manufactured housing industry is currently hampered by market conditions, including a high rate of repossessions and tightened credit policies. Significant lenders who previously provided financing to consumers of these products and industry participants have either restricted credit or exited the market. A continued shortage of financing to this industry could adversely affect our operating results. Our ability to achieve growth in sales and margins to the site-built construction market is somewhat dependent on housing starts. If housing starts decline significantly, our financial results could be negatively impacted. We are witnessing consolidation by our customers. These consolidations will result in a larger portion of our sales being made to some customers and may limit the customer base we are able to serve. 14 UNIVERSAL FOREST PRODUCTS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED A SIGNIFICANT PORTION OF OUR SALES ARE CONCENTRATED WITH ONE CUSTOMER. Our sales to The Home Depot comprised 32% of our total sales in the first nine months of 2003. OUR GROWTH MAY BE LIMITED BY OUR ABILITY TO MAKE SUCCESSFUL ACQUISITIONS. A key component of our growth strategy is to complete business combinations. Business combinations involve inherent risks, including assimilation and successfully managing growth. While we conduct extensive due diligence and have taken steps to ensure successful assimilation, factors beyond our control could influence the results of these acquisitions. WE MAY BE ADVERSELY AFFECTED BY THE IMPACT OF ENVIRONMENTAL AND SAFETY REGULATIONS. We are subject to the requirements of federal, state and local environmental and occupational health and safety laws and regulations. There can be no assurance that we are at all times in complete compliance with all of these requirements. We have made and will continue to make capital and other expenditures to comply with environmental regulations. If additional laws and regulations are enacted in the future, which restrict our ability to manufacture and market our products, including our treated lumber products, it could adversely affect our sales and profits. If existing laws are interpreted differently, it could also increase the financial cost to us. Several states have proposed legislation to limit the uses of CCA treated lumber. (See Notes to Consolidated Condensed Financial Statements, Footnote I "Commitments, Contingencies, and Guarantees.") SEASONALITY AND WEATHER CONDITIONS COULD ADVERSELY AFFECT US. Some aspects of our business are seasonal in nature and results of operations vary from quarter to quarter. Our treated lumber and outdoor specialty products, such as fencing, decking and lattice, experience the greatest seasonal effects. Sales of treated lumber, primarily consisting of Southern Yellow Pine ("SYP"), also experience the greatest Lumber Market risk (see "Historical Lumber Prices"). Treated lumber sales are generally at their highest levels between April and August. This sales peak, combined with capacity constraints in the wood treatment process, requires us to build our inventory of treated lumber throughout the winter and spring. This also has an impact on our receivables balances, which tend to be significantly higher at the end of the second and third quarters. Because sales prices of treated lumber products may be indexed to the Lumber Market at the time they are shipped, our profits can be negatively affected by prolonged declines in the Lumber Market during our primary selling season. To mitigate this risk, programs are maintained with certain vendors and customers that are intended to decrease our exposure. These programs include those materials which are most susceptible to adverse changes in the Lumber Market. Vendor programs also allow us to carry a lower investment in inventories. The majority of our products are used or installed in outdoor construction activities; therefore, short-term sales volume, our gross margins and our profits can be negatively affected by adverse weather conditions. In addition, adverse weather conditions can negatively impact our productivity and costs per unit. 15 UNIVERSAL FOREST PRODUCTS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED WE WILL BE CONVERTING TO A NEW PRESERVATIVE TO TREAT OUR PRODUCTS IN THE THIRD AND FOURTH QUARTERS OF 2003. In February 2002, the manufacturers of CCA preservative agreed with the EPA to voluntarily discontinue the registration of CCA for certain residential applications by December 31, 2003. As a result, 23 of our 24 wood preservation facilities will convert to an alternate preservative by December 31, 2003. The remaining facility will be converted the first week of 2004. As of September 27, 2003, 10 of the 24 facilities have been converted. The necessary capital investments for the conversions were made in 2002. We are coordinating with our chemical suppliers and customers to insure an orderly transition and minimize risks associated with chemical efficiencies, lost production time during the conversion process, and inventory levels of products treated with CCA preservative. In addition, we estimate the new preservative will increase the cost and sales price of our treated products by up to 20%. While we expect that this transition will not have a material impact on our operations, certain factors, such as consumer acceptance, may adversely affect our planned transition to this new preservative. When analyzing this report to assess our future performance, please recognize the potential impact of the various factors set forth above. HISTORICAL LUMBER PRICES The following table presents the Random Lengths framing lumber composite price for the nine months ended September 27, 2003 and September 28, 2002: Random Lengths Composite Average $/MBF ------------------------ 2003 2002 ---- ---- January ......................... $278 $297 February ........................ 295 317 March ........................... 277 339 April ........................... 283 323 May ............................. 278 312 June ............................ 303 302 July ............................ 302 306 August .......................... 336 291 September ....................... 375 279 Third quarter average ........... $338 $292 Year-to-date average ............ $303 $307 16 UNIVERSAL FOREST PRODUCTS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED Third quarter percentage increase from 2002................ 15.8% Year-to-date percentage decrease from 2002................ (1.3%) In addition, a SYP composite price, which we prepare and use, is presented below. Sales of products produced using this species comprise up to 50% of our sales volume. Random Lengths SYP Average $/MBF ------------------ 2003 2002 ---- ---- January............................ $387 $410 February........................... 394 434 March.............................. 392 464 April.............................. 410 457 May................................ 385 408 June............................... 384 383 July............................... 374 409 August............................. 398 375 September.......................... 437 361 Third quarter average.............. $403 $382 Year-to-date average............... $396 $411 Third quarter percentage increase from 2002................ 5.5% Year-to-date percentage decrease from 2002................ (3.7%) IMPACT OF THE LUMBER MARKET ON OUR OPERATING RESULTS We generally price our products to pass lumber costs through to our customers so that our profitability is based on the value-added manufacturing, distribution and services we provide. As a result, our sales levels (and working capital requirements) are impacted by the lumber costs of our products. Our gross margins are impacted by both (1) the relative level of the Lumber Market (i.e. whether prices are higher or lower from comparative periods), and (2) the trend in the market price of lumber 17 UNIVERSAL FOREST PRODUCTS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED (i.e. whether the price of lumber is increasing or decreasing within a period or from period to period). Moreover, as explained below, our products are priced differently. Some of our products have fixed selling prices, while the selling prices of other products are indexed to the reported Lumber Market with a fixed dollar adder to cover conversion costs and profits. Consequently, the level and trend of the Lumber Market impact our products differently. Below is a general description of the primary ways in which our products are priced. - - Products with fixed selling prices. These products include value-added products such as decking and fencing sold to do-it-yourself/retail ("DIY/retail") customers, as well as trusses, wall panels and other components sold to the site-built construction market. Prices for these products are generally fixed at the time of the sales quotation for a specified period of time or are based upon a specific quantity. In order to maintain margins and eliminate or reduce any exposure to adverse trends in the price of component lumber products, we attempt to lock in costs for these sales commitments with our suppliers. Also, the time periods and quantity limitations generally allow us to reprice our products for changes in lumber prices from our suppliers. - - Products with selling prices indexed to the reported Lumber Market with a fixed dollar "adder" to cover conversion costs and profits. These products include treated lumber, remanufactured lumber and trusses sold to the manufactured housing industry. For these products, we estimate the customers' needs and carry anticipated levels of inventory. Because lumber costs are incurred in advance of final sale prices, subsequent increases or decreases in the market price of lumber impact our gross margins. For these products, our margins are exposed to changes in the trend of lumber prices. Changes in the trend of lumber prices have their greatest impact on those products that have significant inventory levels with low turnover rates. This particularly impacts treated lumber, which comprises almost twenty-five percent of our total annual sales. In other words, the longer the period of time that products remain in inventory, the greater the exposure to changes in the price of lumber. This exposure is less significant with remanufactured lumber, trusses sold to the manufactured housing market and other similar products, due to the higher rate of inventory turnover. In addition to the impact of Lumber Market trends on gross margins, changes in the level of the market causes fluctuations in gross margins when comparing operating results from period to period. This is explained in the following example, which assumes the price of lumber has increased from period one to period two, with no changes in the trend within each period. 18 UNIVERSAL FOREST PRODUCTS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED Period 1 Period 2 -------- -------- Lumber cost.................................... $300 $400 Conversion cost................................ 50 50 = Product cost................................. 350 450 Adder.......................................... 50 50 = Sell price................................... 400 500 Gross margin................................... 12.5% 10.0% As is apparent from the preceding example, the level of lumber prices does not impact our overall profits, but does impact our margin percentages. Gross margins are negatively impacted during periods of high lumber prices; conversely, we experience margin improvement when lumber prices are relatively low. BUSINESS COMBINATIONS AND ASSET PURCHASES We completed the following business combinations and asset acquisitions in fiscal 2002 and fiscal 2003, which were accounted for using the purchase method. Seller`s Name Acquisition Date Business Description - ------------- ---------------- -------------------- D&L Framing LLC August 28, 2003 Framing operation for multi-family construction located in Las Vegas, NV. Norpac Construction LLC June 3, 2003 Concrete framer for multi-family construction located in Las Vegas, NV. Quality Wood Treating Co., Inc. November 4, 2002 One facility in Prairie du Chien, WI which ("Quality") August 26, 2003 produces EverX composite decking. We also entered into an exclusive treating services agreement with Quality. On August 26, 2003, we canceled the treating services agreement and purchased two treating facilities in Lansing, MI and Janesville, WI and agreed to lease the real estate of a third treating facility in White Bear Lake, MN. J.S. Building Products, Inc. September 9, 2002 One facility in Modesto, CA which manufactures engineered roof trusses for the site-built construction market. 19 UNIVERSAL FOREST PRODUCTS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED Inno-Tech Plastics, Inc. ("Inno-Tech") April 10, 2002 One facility in Springfield, IL which - - Entered into exclusive licensing manufactures "wood alternative" products. agreement and acquired certain assets. Pinelli-Universal S. de R.L. de C.V. January 15, 2002 One facility in Durango, Durango, Mexico which ("Pinelli") - Purchased additional 5% manufactures molding and millwork products. interest. RESULTS OF OPERATIONS The following table presents, for the periods indicated, the components of our Consolidated Condensed Statements of Earnings as a percentage of net sales. For the Three Months Ended For the Nine Months Ended -------------------------- ------------------------- Sept. 27, Sept. 28, Sept. 27, Sept. 28, 2003 2002 2003 2002 ----------- ----------- ----------- ----------- Net sales .............................. 100.0% 100.0% 100.0% 100.0% Cost of goods sold ..................... 86.5 86.4 85.9 86.0 ----- ----- ----- ----- Gross profit ........................... 13.5 13.6 14.1 14.0 Selling, general, and administrative expenses .............. 9.0 9.1 9.4 9.3 ----- ----- ----- ----- Earnings from operations ............... 4.5 4.5 4.7 4.7 Interest, net .......................... 0.7 0.5 0.8 0.6 Gain on sale of assets ................. (0.0) (0.0) (0.0) (0.1) ----- ----- ----- ----- 0.7 0.5 0.8 0.5 ----- ----- ----- ----- Earnings before income taxes and minority interest ................. 3.8 4.0 3.9 4.2 Income taxes ........................... 1.4 1.5 1.4 1.5 ----- ----- ----- ----- Earnings before minority interest ...... 2.4 2.5 2.5 2.7 Minority interest ...................... (0.1) (0.1) (0.2) (0.2) ----- ----- ----- ----- Net earnings ........................... 2.3% 2.4% 2.3% 2.5% ===== ===== ===== ===== 20 UNIVERSAL FOREST PRODUCTS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED NET SALES We engineer, manufacture, treat, distribute and install lumber, composite, plastic, and other building products for the DIY/retail, site-built construction, manufactured housing, industrial and other markets. Our strategic sales objectives include: - - Diversifying our end market sales mix by increasing sales of specialty wood packaging to industrial users and engineered wood products to the site-built construction market. Engineered wood products include roof trusses, wall panels and floor systems. - - Increasing sales of "value-added" products. Value-added product sales consist of fencing, decking, lattice and other specialty products sold to the DIY/retail market, specialty wood packaging, engineered wood products, and "wood alternative" products. Wood alternative products consist primarily of composite wood and plastics. Although we consider the treatment of dimensional lumber with certain chemical preservatives a value-added process, treated lumber is not presently included in the value-added sales totals. - - Maximizing profitable top-line sales growth while increasing DIY/retail market share. - - Maintaining manufactured housing market share. The following table presents, for the periods indicated, our net sales (in thousands) and percentage of total net sales by market classification. For the Three Months Ended For the Nine Months Ended --------------------------------------- -------------------------------------------- Sept. 27, Sept. 28, Sept. 27, Sept. 28, Market Classification 2003 % 2002 % 2003 % 2002 % - --------------------- -------- ------ -------- ------ ----------- ------ ---------- ------ DIY/Retail................... $262,025 48.5% $214,975 47.6% $ 721,659 49.9% $626,394 48.3% Site-Built Construction...... 111,541 20.9 88,731 19.6 289,686 20.1 245,717 18.9 Manufactured Housing......... 79,306 14.9 79,588 17.5 206,880 14.3 227,990 17.5 Industrial and Other......... 83,406 15.7 69,665 15.3 226,135 15.7 199,458 15.3 -------- ------ -------- ------ ---------- ------ ---------- ------ Total........................ $536,278 100.0% $452,959 100.0% $1,444,360 100.0% $1,299,559 100.0% ======== ====== ======== ====== ========== ====== ========== ====== Note: In the first quarter of 2003, we reviewed the classification of our customers and made certain reclassifications. Prior year information has been restated to reflect these classifications. Net sales in the third quarter of 2003 increased 18.4% compared to the third quarter of 2002 resulting from an increase in units shipped of approximately 13%. Overall selling prices increased as a result of the Lumber Market (see "Historical Lumber Prices"). We estimate that our unit sales increased by 9% as a result of business acquisitions and an exclusive treating services agreement completed 21 UNIVERSAL FOREST PRODUCTS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED after September 28, 2002. We estimate our unit sales out of existing facilities increased by 4% in the third quarter of 2003. Net sales in the first nine months of 2003 increased 11.1% compared to the first nine months of 2002 resulting from an increase in units shipped of approximately 12%. Overall selling prices decreased as a result of the Lumber Market (see "Historical Lumber Prices"). We estimate that our unit sales increased by 7% as a result of business acquisitions and an exclusive treating services agreement completed after September 28, 2002. We estimate our unit sales out of existing facilities increased by 5% in the first nine months of 2003. The following table presents, for the periods indicated, our percentage of value-added and commodity-based sales to total sales. Three Months Ended Nine Months Ended ------------------------------------- ------------------------------------ September 27, September 28, September 27, September 28, 2003 2002 2003 2002 ------------- ------------- ------------- ------------- Value-Added........................... 49.6% 49.6% 50.7% 49.8% Commodity-Based....................... 50.4% 50.4% 49.3% 50.2% Value-added sales increased 18.8% and 13.8%, respectively, in the third quarter and first nine months of 2003, primarily due to increased sales of EverX (composite decking), engineered wood products, industrial products and other specialty products supplied to the DIY/retail market. Commodity-based sales increased 19.2% and 9.4%, respectively, during the third quarter and first nine months of 2003 primarily due to the exclusive treating services agreement we completed in November 2002. DIY/Retail: Net sales to the DIY/retail market increased $47.1 million, or 21.9%, in the third quarter of 2003 compared to 2002, primarily due to acquiring a composite manufacturing plant and entering into an exclusive treating services agreement with Quality. In addition, the higher Lumber Market caused an increase in our sales prices this quarter, and our organic sales growth out of existing facilities was approximately 4%. Net sales to the DIY/retail market increased $95.3 million, or 15.2%, in the first nine months of 2003 compared to 2002, primarily due to the composite plant acquisition and treating services agreement mentioned above, combined with organic sales growth out of existing facilities totaling approximately 5%. 22 UNIVERSAL FOREST PRODUCTS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED Site-Built Construction: Net sales to the site-built construction market increased 25.7% and 17.9% in the third quarter and first nine months of 2003, respectively, compared to the same periods of 2002. These increases resulted from acquisitions completed after September 28, 2002, a new framing joint venture, and organic sales growth out of existing plants totaling approximately 15% for the quarter and 12% for the nine months ended September 27, 2003. In addition, we estimate the Lumber Market caused our selling prices to increase 8% this quarter. Manufactured Housing: Net sales to the manufactured housing market decreased 0.4% and 9.3% in the third quarter and first nine months of 2003, respectively, compared to the same periods of 2002. These decreases resulted primarily from a 21% and 25% decline in quarterly and year-to-date industry production, respectively. In addition, the higher Lumber Market caused an increase in our sales prices this quarter. Industrial and Other: Net sales to the industrial and other market increased 19.7% and 13.4% in the third quarter and first nine months of 2003, respectively, compared to the same period of 2002. These increases resulted from unit sales increases out of several existing facilities. In addition, we estimate the Lumber Market had the effect of increasing our selling prices by 8% for this quarter. COST OF GOODS SOLD AND GROSS PROFIT Gross profit as a percentage of net sales decreased slightly in the third quarter of 2003 compared to the same period of 2002. Generally, a higher Lumber Market results in a decrease in our gross margin. (See "Impact of the Lumber Market on our Operating Results.") We attempt to price certain products to earn a fixed profit per unit, so in a period of higher lumber prices, our gross margin will decline. Therefore, a more meaningful analysis of profitability is a comparison of the change in gross profit dollars compared to our change in units shipped. Our gross profit dollars increased by almost 18% this quarter, while units shipped increased by 13%. We believe this was due, in part, to the positive trend in the Lumber Market in the third quarter. In a period when the Lumber Market is on an increasing trend, our selling prices for products that are indexed to the Lumber Market also increase, which can result in higher gross profit dollars on each unit sold. Gross profit as a percentage of net sales increased slightly in the first nine months of 2003 compared to the same period of 2002. A favorable trend in the Lumber Market positively affected our gross 23 UNIVERSAL FOREST PRODUCTS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED profit in the third quarter, but this was substantially offset by the effects of adverse weather in the first quarter. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general and administrative expenses as a percentage of sales decreased to 9.0% in the third quarter of 2003 compared to 9.1% in the same period of 2002. This decrease was primarily due to the impact of the higher Lumber Market on our selling prices. The dollar increase in our selling, general, and administrative expenses was primarily due to acquisitions and new operations, combined with higher compensation costs resulting from greater headcount to support growth in our business and an increase in insurance and legal costs. Selling, general and administrative expenses as a percentage of sales increased to 9.4% in the first nine months of 2003 compared to 9.3% in the same period of 2002. This increase was primarily due to the impact of the lower Lumber Market on our selling prices. The dollar increase in our selling, general, and administrative expenses was primarily due to acquisitions and new operations, combined with higher compensation costs resulting from greater headcount to support growth in our business. INTEREST, NET Net interest costs increased in the third quarter and first nine months of 2003 compared to the same periods of 2002. These increases were due to a higher average debt balance combined with an increase in our average borrowing rates as a result of issuing $55 million of long-term unsecured notes payable in December 2002. The proceeds from the note issuance were used to reduce amounts outstanding under our revolving credit facility, which bears interest at a lower rate. GAIN ON SALE OF ASSETS During the second quarter of 2002, we sold our corporate airplane and recognized a gain of $1.1 million on the sale, and entered into an operating lease for a replacement airplane. INCOME TAXES Our effective tax rate was 37.4% in the third quarter of 2003 compared to 37.1% in the same period of 2002, and 37.0% in the first nine months of 2003 compared to 37.1% in the same period of 2002. Effective tax rates differ from statutory federal income tax rates, primarily due to provisions for state and local income taxes and permanent tax differences. 24 UNIVERSAL FOREST PRODUCTS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED OFF-BALANCE SHEET TRANSACTIONS We have no significant off-balance sheet transactions other than operating leases. LIQUIDITY AND CAPITAL RESOURCES Cash flows from operating activities increased in the first nine months of 2003 compared to the same period of 2002 by approximately $45 million for the following reasons: - - During the third quarter of 2003, we implemented a new program whereby we sold certain accounts receivable for cash. The proceeds from this sale were used to reduce borrowings on our revolving credit facility. Benefits of this program include a lower net cost than our revolving credit facility, an increase in our available debt capacity, and further diversification of our funding sources. (See Notes to Consolidated Condensed Financial Statements, Footnote D, "Sale of Accounts Receivable.") - - We sold the extra inventory we carried at the end of 2002 and throughout the first quarter resulting from opportunistic buying and poor weather. - - We extended our payables cycle and our accrued liabilities increased. Seasonality has a significant impact on our working capital from March to August which generally results in negative or modest cash flows from operations in our first and second quarters. We experience a substantial decrease in working capital from September to February which results in significant cash flow from operations in our third and fourth quarters. For comparative purposes, we have included the September 28, 2002 balances in the accompanying unaudited consolidated condensed balance sheets. Due to the seasonality of our business and the effects of the Lumber Market, we believe our cash cycle (days sales outstanding plus days supply of inventory less days payables outstanding) is a good indicator of our working capital management. Our cash cycle increased to 46 days in the first nine months of 2003 from 44 days in the first nine months of 2002, primarily due to an increase in our days supply of inventory. We have carried comparatively higher levels of inventory this year due to: - - "Opportunity buying" by our purchasing managers at the end of 2002 due to the low level of the Lumber Market; - - The effect of adverse weather on sales in the first and second quarters; - - Preparations to convert to a new preservative; and - - Slower inventory turnover of our composite manufacturing plant. 25 UNIVERSAL FOREST PRODUCTS, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED The increase in our days supply of inventory was partially offset by an increase in our payables cycle. Capital expenditures increased to $33.3 million in the first nine months of 2003 compared to $21.1 million in the same period of 2002 as a result of greater spending on expansionary projects. For example, we completed a project to expand the manufacturing capacity of the composite manufacturing plant we purchased in November 2002 and completed or commenced construction of several new plants. We expect to spend approximately $13 million on capital expenditures for the balance of 2003, which includes outstanding purchase commitments on capital projects totaling approximately $6.6 million on September 27, 2003. We intend to fund capital expenditures and purchase commitments through a combination of operating cash flow and availability under our revolving credit facility. We spent approximately $2.0 million to repurchase 123,234 shares of our common stock in the first nine months of 2003. We have authorization from the Board of Directors to purchase an additional 1.5 million shares. On September 27, 2003, we had $17.7 million outstanding on our $200 million revolving credit facility. The revolving credit facility supports letters of credit totaling approximately $28.2 million on September 27, 2003. Financial covenants on our revolving credit facilities and senior unsecured notes include a minimum net worth requirement, a minimum interest coverage test, a minimum fixed charge coverage test, and a maximum leverage ratio. The agreements also restrict the amount of additional indebtedness we may incur and the amount of assets which may be sold. We were within our requirements at September 27, 2003. ENVIRONMENTAL CONSIDERATIONS AND REGULATIONS See Notes to Consolidated Condensed Financial Statements, Footnote I, "Commitments, Contingencies, and Guarantees." CRITICAL ACCOUNTING POLICIES In preparing our consolidated financial statements, we follow accounting principles generally accepted in the United States. These principles require us to make certain estimates and apply judgments that affect our financial position and results of operations. We continually review our accounting policies and financial information disclosures. There have been no material changes in our policies or estimates since December 28, 2002. 26 UNIVERSAL FOREST PRODUCTS, INC. Item 3. Quantitative and Qualitative Disclosures about Market Risk. We are exposed to market risks related to fluctuations in interest rates on our variable rate debt, which consists of a revolving credit facility and industrial development revenue bonds. We do not currently use interest rate swaps, futures contracts or options on futures, or other types of derivative financial instruments to mitigate this risk. For fixed rate debt, changes in interest rates generally affect the fair market value, but not earnings or cash flows. Conversely, for variable rate debt, changes in interest rates generally do not influence fair market value, but do affect future earnings and cash flows. We do not have an obligation to prepay fixed rate debt prior to maturity, and as a result, interest rate risk and changes in fair market value should not have a significant impact on such debt until we would be required to refinance it. 27 UNIVERSAL FOREST PRODUCTS, INC. Item 4. Controls and Procedures. (a) Evaluation of Disclosure Controls and Procedures. With the participation of management, our chief executive officer and chief financial officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a - 15 and 15d - 15) as of September 27, 2003, have concluded that, as of such date, our disclosure controls and procedures were adequate and effective to ensure that material information relating to us and our consolidated subsidiaries would be made known to them by others within those entities in connection with our filing of this third quarter report on Form 10-Q for the quarterly period ended September 27, 2003. (b) Changes in Internal Controls. There were no significant changes in our internal controls over financial reporting (as such term is defined in Rules 13a - 15 and 15d - 15 under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. 28 UNIVERSAL FOREST PRODUCTS, INC. PART II. OTHER INFORMATION Item 2. Changes in Securities and Use of Proceeds. (a) None. (b) None. (c) Sales of equity securities in the third quarter not registered under the Securities Act. Date of Class of Number Consideration Sale Stock of Shares Purchasers Exchanged ----------- ---------- --------- ---------- --------- Stock Gift Program Various Common 653 Eligible persons None 29 UNIVERSAL FOREST PRODUCTS, INC. PART II. OTHER INFORMATION Item 5. Other Information. In the third quarter of 2003, the Audit Committee approved non-audit services to be provided by our independent auditors, Ernst & Young LLP, totaling $58,000 for 2003. Item 6. Exhibits and Reports on Form 8-K. (a) The following exhibits (listed by number corresponding to the Exhibit Table as Item 601 in Regulation S-K) are filed with this report: 10(i)(3) First Amendment dated September 18, 2003 relating to Series 2002-A, Revolving Credit Agreement dated November 25, 2002. 10(k)(1) Program for Accounts Receivable Transfer ("PARTS") Agreement dated September 22, 2003. 10(k)(2) Deposit Account Control Agreement dated September 22, 2003, completed pursuant to the PARTS Agreement. 31(a) Certificate of the Chief Executive Officer of Universal Forest Products, Inc., pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350). 31(b) Certificate of the Chief Financial Officer of Universal Forest Products, Inc., pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350). 32(a) Certificate of the Chief Executive Officer of Universal Forest Products, Inc., pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350). 32(b) Certificate of the Chief Financial Officer of Universal Forest Products, Inc., pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350). (b) During the third quarter, we filed a report on Form 8-K dated July 15, 2003, to report the issuance of a press release announcing our financial results for the second quarter ended June 28, 2003 under Item 9. 30 UNIVERSAL FOREST PRODUCTS, INC. SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. UNIVERSAL FOREST PRODUCTS, INC. Date: October 27, 2003 By: /s/ William G. Currie ---------------- ------------------------------------ William G. Currie Its: Vice Chairman of the Board and Chief Executive Officer Date: October 27, 2003 By: /s/ Michael R. Cole ----------------- ------------------------------------ Michael R. Cole Its: Chief Financial Officer 31 EXHIBIT INDEX Exhibit No. Description - ----------- ----------- 10(i)(3) First Amendment dated September 18, 2003 relating to Series 2002-A, Revolving Credit Agreement dated November 25, 2002. 10(k)(1) Program for Accounts Receivable Transfer ("PARTS") Agreement dated September 22, 2003. 10(k)(2) Deposit Account Control Agreement dated September 22, 2003, completed pursuant to the PARTS Agreement. 31(a) Certificate of the Chief Executive Officer of Universal Forest Products, Inc., pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350). 31(b) Certificate of the Chief Financial Officer of Universal Forest Products, Inc., pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350). 32(a) Certificate of the Chief Executive Officer of Universal Forest Products, Inc., pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350). 32(b) Certificate of the Chief Financial Officer of Universal Forest Products, Inc., pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).