Roller-coaster price swings in the lumber market played a big role in trimming seven-tenths of a point off of the gross margin that Builders FirstSource (BFS) posted in the third quarter, the company's chief executive officer said today. He also said general volatility in the housing market led to a rise in labor costs and a drop in the dealer's ability to promote efficient operations.

"We've seen volatility [in lumber prices] that we haven't seen occur to this extent before," Floyd Sherman told analysts in a conference call. "We've seen some unbelievable run-ups in price within a quarter. For example, our price for OSB over the quarter was about a 16% increase, but if you look at it from a few weeks after the start of the third quarter to Sept. 8, it was up 48%. Then it fell off about the time you did your pricing [guarantees to customers]. So whatever replenishment you're doing during the quarter has been at high prices. ... This is what has created problems for us and for the rest of the industry." (See transcript of earnings conference call.)

The day before the analysts' call, on Oct. 18, BFS reported its gross margin in the third quarter had fallen to 19.8% compared with 20.5% in the year-earlier period. That decline in profit was one reason why BFS' net loss for the period deepened to $13.6 million from an $11.6 million loss in 3Q11 even though sales rose 34.3% to $291.8 million.

Many of BFS' biggest customers require the Dallas-based dealer--the eighth-biggest on the ProSales 100--to guarantee its prices for 90 days. Floyd says those prices tend to be set right around the start of each quarter. And because the volatility in the market has made it difficult to predict needs, it relies on the spot lumber market to replenish some of its stock. Thus, when spot market prices shoot up right after a quarter has begun--which particularly was the case with oriented strand board around mid-July--BFS got stung.

The purchasing picture so far this quarter has improved, Sherman said. "We've got some attractive co-op positions and we got some pricing in that's an improvement [over past quarters]," he noted. "At this point we feel we'll be seeing an uptick in margins."

One analyst asked whether BFS had considered increasing the amount of lumber it keeps on hand to protect against such spikes. Chief financial officer Chad Crow replied that this strategy creates its own problems.

"One option has been to take a position based on 125% of forecast [needs]," he said. "That takes up a lot of liquidity ... and you've got to find a place to put it all. Then you've got the issue of weather." Instead, he said, BFS prefers to regard what's going on as an aberration.

"It's not one that I expect to see again--certainly, I don't want to see it again," Crow said. "If we can see prices stabilize and demand improve, we'll see those margins come back."

Demand is rising, but stability is not, the BFS executives suggested.

"September was really unusual for us," Sherman said. "It was our highest sales per day average--15% higher than any other month we've experienced this year. That was really suprising for us, and it's continuing in October." Crow said that with such numbers coming it, he wasn't surprised when the federal government announced earlier this week that housing starts in September had climbed 11.6% from the month before and, at an 894,000 annual rate, were at their highest level in four years.

One result of the fall runup was that BFS had to hire more temporary workers and shell out more money for overtime. The company's salaries and benefits costs jumped by 23.6% in the third quarter from the year before to total $35.6 million. At one point, Sherman said, a BFS facility in Houston that had had just a handful of temporary employees was using more than 40 temps. That number has since dropped to about 10 as the company began beefing up its fulltime staff.

"Hopefully we'll begin to see more stabilization and be better able to plan," Sherman said. But in the meantime, Crow added, "you still don't get a whole lot of visibility [to your personnel needs] on a day-to-day basis. You're struggling to adjust your work forces."