American Woodmark Corp (AMWD) 2006 Q2 法說會逐字稿

Good day and welcome to this American Woodmark Corporation conference call. Today's call is being recorded. The Company has asked to us read the following Safe Harbor statement under the Private Securities Litigation Reform Act of 1995. All forward-looking statements made by the Company involve material risks and uncertainties and are subject to change based factors that may be beyond the Company's control. Accordingly, the Company's future performance and financial results may differ materially from those expressed or implied in any such forward-looking statements.

Such factors include but are not limited to those described in the Company's filings with the Securities and Exchange Commission and the annual report to shareholders. The Company does not undertake to publicly update or revise its forward-looking statements even if experience or future changes make it clear that any projected results expressed or implied therein will be - - not be realized. At this time for opening remarks and introductions I would like to turn the call over to Vice President and Treasurer, Mr. Glenn Eanes. Please go sir.

Good morning, ladies and gentlemen. I'd like to welcome you to the American Woodmark conference call to review our second quarter results. I'd like to thank you for taking time out of your busy schedule to participate. Joining me on the call today will be Jake Gosa, the Chief Executive Officer and Chairman of the Board, Kent Guichard, Chief Operating Officer, and John Wolk, Chief Financial Officer. Jake will begin with some opening comments and then John will go through a review of the quarter's results. At this time I will turn the conference call over to Jake for some opening comments. Jake.

Thank you, Glenn. I'd like to take a couple of minutes to give you my perspective and brief overview as to where we are from an operating standpoint. What actions we've taken to address the near-term situation. As well as other decisions that have been made that would have an impact over the longer term. For the second fiscal quarter, sales were softer than anticipated. The softness can be attributed to the lingering effects of transportation issues experienced by the Company during the recent period. As well as the general slowdown in the overall activity level of the remodeling market. Higher interest rates, higher energy costs and uncertainty over jobs have contributed to a consumer that's not spending on big ticket items as robustly as last spring and summer.

Our gross margins were negatively affected by three things. Freight, lower productivity due to lower sales volume, combined with too much labor both entering and during the period, and lower sales volumes spread over a higher fixed costs. Actions taken near term include increasing prices where appropriate. This includes implementing the increases discussed in the last conference call. As well as additional actions that will be realized beginning with the new year. We have and are continuing to reduce both headcount and spending wherever necessary or appropriate.

Actions taken to affect the longer term are as follows. We've gone through an exhaustive evaluation of the overall business to identify unprofitable and nonstrategic categories. Appropriate action steps are underway to transition out of those businesses. These businesses generally fall into two categories. First, the builder business has rapidly consolidated over the past three years. This has caused some builders to evolve into configurations that are not consistent with our original plan. Where customers no longer fit our product or service platform we're redeploying those assets and capabilities toward strategic accounts that afford a better overall business fit.

Second, we've been involved in an in-stock business that has grown beyond our expectations. At lower volumes it proved to be a viable way to service the strategic account and load level our facilities. At current volumes, it has outgrown that mission and will be better served by a different product platform. We are working closely with Lowe's to assure a seamless transition to their new vendors. These activities will allow us to focus on our core strategic business in the remodel and new construction channels. And rebuild the margin structure.

Looking ahead, the transition underway in the Company will be characterized by continued growth in our core business but lower overall growth due to the exiting of these low profit businesses. These actions will have a positive effect on both margins and capital expenditures. To gauge the effect of these actions - - or to gauge the effect these actions will have on growth for the transition period, I would suggest the following guidelines. High end growth estimates for this period are likely to be in the 8% to 12% range, versus our historical 15% to 20% range, while we work through this period. These lower growth rates will afford the Company a much more manageable operating environment than we've realized for the past two to three years.

Finally, the fundamentals of the business remain very attractive. The opportunity to grow our core business is good. Cash flow is strong and the balance sheet is solid. And with those comments, I will turn the call over to John.

Thanks, Jake. Again, thanks everyone for taking time to hear about our performance and progress at American Woodmark. This morning we released the results of our second fiscal quarter that ended October 31, 2005. In case you have not had a chance to read our earnings release here are a few highlights. Net sales for the quarter were 214.5 million, up 8% over the prior year's second quarter. Net income for the quarter was 6.2 million, down 46% from the prior year net income of 11.4 million. Diluted earnings per share of $0.37 for the quarter compare with $0.67 last year.

Regarding our second quarter sales performance, our previous guidance anticipated sales growth of 8% to 12% for the just completed second quarter. This guidance was based on an expectation for strong seasonal demand in both the remodeling and new construction sectors. Our actual sales growth of 8% was at that time low end that range, as our sales order rate was less than we had expected. Market dynamics remain positive. Although, prevailing sentiment is less positive than it had been in recent months. The Company believes that reduced consumer confidence, driven by a combination of soaring gas prices and higher interest rates, as well as lingering impact from transportation issues the Company experienced earlier in the year; impacted our sales order rates.

For new construction, overall market activity has been tracking at or near historical highs. Residential housing starts continue to be robust. Total monthly housing starts for October as reported by the Department of Commerce continue to exceed 2 million units on an annualized basis. On the other hand, several indicators may be signaling a changing market. Mortgage rates, as reported by Freddie Mac, have been in the low to mid 6% range for the 30-year fixed mortgage. Low by historical standards but the highest they've been since the first half of 2004.

October housing starts number, although healthy, represented a 6% decline from the previous month. As several large builders have recently announced reduced growth expectations for 2006 housing starts. We continue to believe the new construction market is healthy. Based on the value of our Timberlake product line, our extensive service reach and our partnerships with many leading home builders; American Woodmark expects to maintain its market share in what looks to be a somewhat less robust new construction sector.

For the remodeling market, conditions again have been tracking positively. Existing home sales, the leading indicator for home improvement spending, set new records in the second and third calendar quarters for 2005. And the major big box retailers continue to demonstrate overall growth and positive comparative store sales performance.

On the other hand, the 3% decline in existing home sales during the month of October, the significant decline in the consumer confidence index experienced in September and then followed up by October's drop, plus the record high fuel costs as we approach the winter heating season, may be indicative of a consumer who is less willing to spend in the near term. We believe the remodeling market remains generally healthy. However, we believe that a less confident consumer caused our fall selling season to be less robust than we expected. And we now expect the next few months will see a continuation of this trend.

Moving on to gross profit. Gross profit for the second quarter was 15.7%, down from 21.4% of sales in the second quarter of last year and from 17.1% in the most recent quarter. Increased freight costs, combined with the impact of reduced sales growth versus our expectation, were the biggest contributors to our reduced gross margin. Freight costs increased significantly in the second quarter. Increased freight costs adversely impacted our gross margin rate by almost 2% as compared with one year ago. And of this amount nearly 1% was driven by fuel surcharges.

In addition to some added costs from switching carriers, factors such as new DOT regulations and driver availability continue to drive added rate pressures. Our staffing and overhead levels include the addition of two manufacturing plants, which we opened one year ago. However, sales levels were up only moderately. As a result, the Company experienced additional costs and lower productivity as compared with one year ago. Driving the majority of the remaining margin decline.

Needless to say, we are extremely dissatisfied with these results. While there are a number of reasons for our disappointing performance, the fact remains that our performance is not in line with our expectations or those of our shareholders. And therefore it is not acceptable. We are determined to significantly improve our performance. To this end, we have performed a detailed analysis of our margin structure and identified and are putting into place action items to drive improved performance. Some of these corrective actions are being implemented presently and will provide benefits during the present quarter and the remainder of this fiscal year.

These include; adjustments to our staffing and spending levels to place them in alignment with our expected sales levels. And pricing actions to recover incremental costs driven by inflationary pressures, such as freight and materials costs. The Company has organically grown its sales four-fold over the last ten years. During this time we have made nearly 300 million in capital expenditures and grown our employee base three fold. While growing the business this quickly, we took on some customers and some product initiatives that seemed right for us at the time but in hindsight did not fit our platform very well.

Some of these opportunities ultimately required a disproportionate level of investment in new manufacturing capacity in relation to the amount of profit they have contributed. We have identified these sales and undertaken efforts to rebuild margins for this business. As a result of these - - this activity, we have identified approximately 12% of our sales revenue for which margins could not be significantly improved.

To drive meaningful changes in our operating profit margins we have decided to exit these profit categories and customers. The Company has commenced these transitions during this third quarter of fiscal 2006. To ensure that our strategic customers are not adversely impacted, we anticipate some of these exits will occur over transition periods covering the next several quarters. The combination of these short-term and longer term actions as targeted to improve gross margins to back over 20% on a sustainable basis.

With regard to our capital growth plans. Total capital expenditures and promotional displays deployed aggregated 16.9 million for the first half of fiscal 2006, as compared with 47.1 million in the first half of fiscal 2005. Outlays for promotional displays were essentially flat. While outlays for capital projects declined from 39.5 million in the first half of 2005 to 9.6 million in 2006. The decline in capital expenditures reflects the completion of two manufacturing plants in fiscal 2005.

We expect capital expenditures for the second half of 2006 to be similar to those over the first half. And we expect that outlays will continue to include a variety of maintenance and cost savings projects and equipment deposits to expand capacity. The Company expects to continue to fund its capital spending plan from a combination of operating cash flow and existing cash on hand.

Regarding SG&A expense. Total SG&A expense was 11.1% of sales in the second quarter of 2006, down from 12.1% in the prior year. Selling and marketing expenses increased slightly to 8.4% of sales from 8.2% in the second quarter of the prior year. Primarily reflecting the lower than expected sales levels. General and administrative expense was down from 3.8% to 2.8% of sales. Due to ongoing cost management efforts as well as reduced costs associated with the Company's pay for performance incentive plans.

Regarding our balance sheet. The Company's financial position remains outstanding. Long-term debt to capital on a book value basis was 11.1% as of October 31, 2005. Cash on hand as of that date was 37.9 million. The Company repurchased $200,000 of its common stock during the quarter. Since 2001, the Company has repurchased 28.5 million of its stock. And has a total of 11.5 million authorized for additional repurchases.

In closing, overall we are both disappointed with our recent level of performance and resolve to take the necessary actions to restore our margins. We have decided to grow at a slower overall rate during the transition period in order to focus on margin recovery. We believe that margins will be adversely impacted in the near term and then improve as the manufacturing capacity is back-filled by more profitable core business.

This new direction will enable the Company to focus on enhancing our performance and our position as the key provider of stock cabinets to the home centers and to our new construction customers. We have explained our decisions to our strategic customers. They are fully supportive and working closely with us to ensure that both their needs and our needs are met. The combination of our market positioning, our improved operating performance, and a continuation of healthy market conditions should help the Company continue to generate incremental sales volume and an improved product mix. We continue to generate strong operating cash flows while maintaining our strong balance sheet.

In addition, the Company expects to generate enhanced levels of free cash flow as this new direction will reduce levels of investment and capacity. As we look forward to the third quarter of fiscal 2006, we see a healthy overall housing environment that should continue to support sales growth. However, given the fact that it's presently affecting consumers, we expect that sales order rates will continue to be less robust in the coming months. We believe the Company remains well positioned to maintain and grow its market share.

The remodel side of our business presents continuing opportunities for growth through the expansion of the home improvement market. Our partnerships with the existing big box retailers, each of whom continue to grow their store counts and market coverage, position the Company to capture a growing share of remodeling activity. And the new construction sector remains positive. And our partnerships with both national and retail builders position us well to maintain and grow our market share. For the third fiscal quarter of 2006, we expect sales to increase by 0% to 4% over prior year levels. Excluding the impact of the sales transitions, this growth would have been estimated at 4% to 8% over prior year levels.

During the third quarter, we are adjusting staffing and spending levels to align with the expected sales levels. While maintaining the necessary flexibility to meet the expected increase for the upcoming spring selling season. Considering these factors, especially the impact of underutilized manufacturing capacity, we expect our diluted EPS will be in a range from from $0.20 to $0.30 per share. We expect that our operational and pricing initiatives underway, as well as improved volumes from the upcoming spring selling season, will drive sequential improvement in the fourth quarter. This concludes our prepared remarks. We'd be happy to answer any questions you have at this time.

[OPERATOR INSTRUCTIONS] Our first question is from Sam Darkatsh with Raymond James.

This is actually John Tate filling in for Sam today. My first question, if American Woodmark is going to walk away from the lower end SKU's at Lowe's, does that mean that a new supplier will be added, one? And, two, do you think that ultimately threatens your competitive position at the home centers, particularly if and when that new entrant gets some volume?

Good question, John. It will require new supplier. However, it requires someone that has a low-end platform. And would manufacture off of a platform that would be oriented to producing low SKU count, a very simple product offering, at very low costs. If you want to compete with the core platform that we're on, you need to do all of the opposite things. It requires a great deal more investment. It's a much more complex operating platform. As such, we don't think that that's a threat to our core business. That was one of the things that we evaluated over the last several months, as to exactly what kind of business is this? And if we open that space up, who is going to occupy the space and would that, in fact, change the competitive game? The answer to all of the above, we feel, is no.

Okay. And I was wondering if you all could give some sort of inside view of how sales progressed in the quarter? And maybe at what point did sales levels and fuel costs and other negatives begin to surprise you all to the downside versus your original expectations?

Well, from the sales standpoint, as we went through the previous quarter, sales came in within the range. So we didn't really think that much of it. Throughout the summer, we saw a little bit less robustness, I would say, than we had been experiencing for the last couple of years. And I think we mentioned that in the conference call comments. As we got into the quarter, we started to see some weaker sales. And as you got to the mid - - excuse me, mid-September/October time frame, when the selling season typically rolls in very strong and very quickly, it was just a lot more tepid than a normal seasonal footprint would lead you to project. At that point in time, the quarter is I pretty much projected, it's there.

As for as fuel costs, I don't think, given this last period that we were in, when we made our last forecasts, fuel has since hit a high of, what, $3.30 or, so or the mid $3, and it's now selling at Winchester for under $2. So, I'm not sure how anybody's going to forecast that in the period ahead or what impact it's going to have. Or what happens actually to it as we get into the winter months and how severe the winter is and so on. It's just a very volatile situation. The sales side of it, though, it pretty much hit us - - it hits you in the last two weeks of September, first of October. And that's your kind of window as to seeing whether or not it's coming in strong. And it just never quite materialized the way we had planned for.

Okay. And one final question before I get off and let others ask. Of the 12% sales decline by moving away from some of these other businesses, can you give us an idea of how much of that goes to Lowe's and how much of that goes elsewhere?

We'd rather not break that out.

I don't want to break that out for you. Just suffice to the say that it's a sizable chunk of business. And - - but it varies. There are small customers involved, and obviously what we're doing t Lowe's is a significant program. We're working very closely Lowe's. It's a category that's important to them. We've been, by their assessment, a strong vendor in that category. As it's evolved to a place where it's no longer space that it makes sense for us to be in, we've contacted their management. We've agreed that we will work our way out of that in a way that's a seamless transition to them and to us.

That could be sped up or slowed down depending on how effective new vendors are brought in. We're going to be patient with that. It is underway and it's going well. And Lowe's has been and continues to be a really great partner through the whole process. They were actually pleased that we came to them well in advance of being in a real bind and said, "hi, this is not a good long-term fit for us, we need to do some other things." While we still had time to make an orderly transition. So, if things go well there, and any further breakdown on that I'd be reticent to make any further comment for obvious competitive reasons.

Thank you very much, gentlemen.

[OPERATOR INSTRUCTIONS] Our next question comes from Robert Kelly with Sidoti & Company.

Good morning, gentlemen.

Good morning, Bob.

How are you doing today?

Okay.

Had better days.

I can imagine. Could you just give me a little bit of color on the transition impact? You're forecasting fourth quarter sales - - I'm sorry, third quarter sales of 0% to 4%. Yet exclusive of the transition impact you're looking at 4% to 8%. Could you just - - I guess I'm just confused. Would you mind explaining in that more detail?

Yes, Bob. Had we not been commencing this transition, we expect that sales would have been up about 4% to 8% over the prior year's third quarter. But because we have commenced the transition, we believe that net of the transition we'll see a 0% to 4% sales increase.

I see. And then you made a comment about reduced investment and being able to grow the free cash flow. Are you all still on track for the acquisition that you had guided towards for the fiscal '06 of the land acquisition, I believe?

Yes, we had announced some months ago the intent to build a new dimension plant on that site. And that's still on the drawing board. It's just really a question of timing. Given this direction, there will be obviously some delay in the original timing that was intended. But that's still on the drawing boards.

Okay.

We own that land, by the way. We did acquire that land.

Okay. Thank you very much.

And our next question is from Peter Lisnic with Robert Baird.

Good morning, gentlemen. John, I just want to clarify that 12% number. That is, I guess essentially if we looked at last year's sales numbers of 777 million or something, we're basically taking out 12% of that number? That's what you're getting rid of?

Yes, that's roughly the way to look at it. That's right.

So, that's data point one. And now you're saying that third quarter sales are going to be down basically 400 basis points because you're exiting some businesses. That's like $7 million. So I'm not sure how to reconcile between the forecast that you're giving for the third quarter and the $70 or $80 million loss, for the lack of better term, in sales; that you're talking about when you talk about the 12%.

Well, sales - - we believe that the amount of transition that's going to impact us will be in that rough magnitude. Sort of that 3%, 4%, 5%ish sort of magnitude of the quarter's sales base. So you're talking there, just multiply it out, and you're talking, let's say, $8 million, just to pick a number, 4% of roughly 200 million. Overall, the 12% of our total sales, obviously equates out to a much bigger number than that. But on an annualized basis, when the transitions are all said and done, that's about the amount of sales that we believe will go away because of these initiatives.

But that's going to happen, Peter, over several quarters. And the pieces of business that are in transition today would have the impact that John just mentioned.

Okay.

But there may be less impact of that in the fourth quarter, let's say. And there may be another impact in the first quarter of next year. So the timing, you can't level load the timing of this over the next period. We're going to take it out in chunks.

I guess that's what I was doing by annualizing the 7 or 8 million for the third quarter and saying it's 30 million versus 70 or 80 million. Okay. If I could move on to another question then. You're basically taking out that chunk of sales, and this is post having added some plants. I'm just wondering if you can reconcile between the amount of capacity that you've added and whether or not - - essentially what has to happen here, is that you're going to have to go out and get share or grow or whatever the appropriate term is in these core markets or core businesses that you're keeping. So, can you just maybe talk about that and how you look at in terms of the capacity that you have right now and ability to fulfill that capacity?

Well, this is going to - - this is Jake, Peter. This is going to create capacity in the system. There's no doubt about it. And that's a good thing. Now, unit of capacity, depending on which product you run over that capacity, it changes. For instance, if you're selling solid insert doors versus veneer insert doors, capacity is not one for one, obviously. So it hits you different ways in a couple of different locations.

But on balance, this creates a significant amount of free capacity that all things being equal, as we pull this business out, this quarter, you don't need that capacity. We will need some of that capacity in the spring, and over the ensuing three or four quarters, we'll be utilizing that. And what you're doing effectively, is you're taking out low-take, low-margin business, replacing it with significantly higher take, higher margin business. So, the ability to take relatively fewer units, generate more dollars with those units, and spread your overheads over that is another advantage of what we're talking about.

So there's a couple of things going on here at one time. But we're not in a situation where we need to mothball something. We are going to hit a soft patch or two as we go through this where we say we really don't need all of that capacity. But we can operate these facilities. And if we get our labor content right, and as we push through some of these cost recovery measures in the way of price increases, you go a significant way toward getting your margin back to where it was a year ago and beyond.

So right now today, with the actions we're taking, yes, for the next couple of months we don't need that capacity. Will you need it in the spring in March and April? Probably you're going to need some of it. But we'll have some capacity to run with for the next several quarters. It will take some pressure off of the need for investment and managing those new investments. Which, as I mentioned in my comments, would have a positive effect on the environment we're going to be working in here at the Company.

Okay. So you'll have presumably better cash flow because you won't - - it doesn't sound like you're going to put up another plant any time soon.

Yes, what I would say to that as I mentioned earlier, one of the things we'd really like to do is replace as much of this business as possible, obviously, up the product spectrum. To the extent that you do that with solid wood doors, versus replacing veneer doors, you do need dimension capacity, for instance, quicker than you would, say, assembly capacity. So, there are some - - it's not a one for one put and take. But clearly we will not have to put in another tier of facilities any time soon. We may have to make some capacity - - release some capacity chokeholds, though, just depending on how we backfill this thing. But certainly it will take a lot of pressure off, yes.

Okay. And then just one last follow-up, if I could. The - - if you look at the historical profitability of the franchise and I think most people look at gross margins in the 20%, 22%, 23% kind of range. Has anything here impaired your ability to get back to that level? Or how do you look at kind of long run what you think you can do kind of gross margin-wise?

Yes, I think what we're doing here is we've really enhanced that probability. As we've - - I think the - - what we're really telling you all here is that this 12% of the volume that we've identified is volume that's not core to our strategy. It's not linked to future strategic relationships. And it has been a real drag on the margins of the Company because the way you load it in. It's just really a pretty ugly business from our standpoint. Some of it could be okay business for other people on other platforms, but it's not good for us. And if we don't think there's a strategic link or a strategic relationship involved, it makes no sense to be in it. Getting out of it is going to have a tremendous enhancement on our ability to generate better gross margins.

I have to ask the question. You'll probably say no, but can you tell us how ugly or how big the margin drag has been?

No. No, but it's significant, otherwise we wouldn't be doing something like this in announcing it. But it is significant.

Okay. I'll leave you alone. Thank you.

You bet.

[OPERATOR INSTRUCTIONS] Our next question comes from Brian McCauly with Accre Capital.

A couple of quick questions for you. How are your service levels now, particularly in the southwest, after the problems you had back midyear?

Brian, we had some transportation issues. And as you know, we at the last conference call, spent some time talking about the need to finalize the transition of our freight system. And we had it down to a few hot spots. I think we described it as a handful of hot spots, primarily concentrated in the west. There were a couple of other areas, but they were less significant. And those tended to be concentrated in the Pacific southwest as well as the northern California area.

Since that time, we've taken a number of actions. The actions that we had in place at the last conference call we thought were showing improvement. They didn't show enough. We've made some decisions to make some further changes in the carrier base out there. In the case where we have not changed carriers, we have either generated activities to significantly improve the existing carrier, or have continued to take business and look for other carriers. Most of that has been transitioned to a new network.

All of it is performing at much more acceptable levels. Some of it is performing very, very well. And we're seeing a bounce-back in that business. Part of what we talked about, part of this volume loss, or the lingering effects that both John and I referred to, are really centered in that part of the country. And that's really where most of the effort has been to rebuild our service. But the service that's going out there today is pretty much on standard or above standard.

Okay. And my understanding is that for your white business, or flat pack business, you have some specialized capacity and machinery. You mentioned that you don't think there's the need to mothball any of the facilities. But could you just give us some sense for how much of your equipment may no longer be needed, or things along those lines?

Yes, I'm not sure what - - we were in a flat-pack business but we got out of that in 1999, I think, or 2000, around that period. But - - so, that's ancient history. With the transition that we're talking about today, these actions would not incapacitate anything. So, we'll be using all of our facilities, all of our equipment. We might need more or less of some equipment, depending on how we backfill our volume going forward. But we wouldn't decommission anything. There are no assets that are going to be impaired.

Then just a final question for you, you spoke about inflation and transportation costs. Could you just give us an update on where are the raw material and input costs are now and what the prospects are going forward?

On the hardwood side, things have stabilized and actually improved a little bit sequentially in the last few months. So, that trend has been a little bit favorable. On the other hand, anything petroleum based has been going the opposite direction. So, our finishing materials and so forth has been a challenge for us. Particle board is a commodity that's starting to go back the other way, too. So, I'd say it's kind of a mixed bag on materials right now. As you know, from quarter to quarter the situation can change quite a bit. In terms of freight costs, in addition to fuel surcharges that we've been having to bear; we've been having quite a lot of rate pressure. As the supply and demand situation for the carriers really doesn't seem to be in balance yet. And a number of carriers have approached us for rate increases. Depending upon what's really driving that, sometimes operationally you can change some of the operational circumstances. And avoid those rate increases by operating differently or more smartly. But the fact remains that those inflationary pressures are out there.

Also, I would add to that, Brian, that the surcharge environment is very volatile, because in these quarters' numbers, a lot of the freight costs that John referred to in the surcharge premiums were driven by $3-plus diesel. And now it's significantly less than that. So, with the lag times and everything else, we're going to get the benefit of some lower surcharges here for a period of time. What they'll be as we get into the cold winter months, boy, I have no idea.

And versus your large national cabinet manufacturing competitors, are you disproportionately impacted by transportation expense, or is that something that the whole industry is incurring?

I think the whole industry is incurring this, and if you look at - - I know Massco's recent release, I think they alluded to a 200-plus-basis-point degrade in their gross margins, and Fortune mentioned it also. Both of them highlighted energy and fuel costs and freight costs as a major culprit.

Thank you.

Sure.

[OPERATOR INSTRUCTIONS] We'll go back to John at Raymond James.

It's actually Budd this time. Well, I'm just trying to make sure I understand how 4% ultimately gets to 12%? Or how 20 million - - how the $7, $8 million sales impact gets to something on a quarterly basis around 20 million? And when do you transition to that? What's the next quarter's impact and the quarter after that? You seemed to indicate, I thought, by one of your comments that you'll have no impact next quarter, or maybe some a quarter afterwards.

Well, it could turn out that way. But as we exit some of these businesses, Budd, picture, if you will, a builder business that you exit a contract, and you finish out subdivisions and then you move on. That's kind of a slow, fairly, evenly loaded progression, as you kind of trickle out of there. But if you think of like an in-stock business, where you would take chunks of regions, and transition them. Settle that down and then move on and then move on and find another chunk or a region, that's much more of an event-driven process.

So, you're going to do that region by region, or for Lowe's?

Yes, it's not something that you can do on kind of trickle in/trickle out basis. Because you've got ad markets and all kinds of other things that you have to consider the logistics platforms, et cetera. So, we'll be moving that business out in planned chunks or pieces as we go forward. It's going to take several weeks.

And when do you expect - - and when will you think the transition will be done?

We're saying up to two years. It could be faster than that. It will just depend - - a lot of it will depend on incoming vendors and their appetite and capacity to turn the business on more quickly.

Well, the builder transition should happen more rapidly. We're not on a two-year cycle there. But I can understand how you would want to keep Lowe's - -.

Yes, the builder's cycle will not last two years. But we are in contracts, which typically have a six to 12-month life to them. So there are some pieces of business there that will be around for awhile.

So the builder business could be a year, and the Lowe's side could be two years.

Yes.

Help me understand, just describe what you meant by an exhaustive analysis. You couldn't have been surprised at the margins. I wouldn't hope you'd be surprised at the margins of the stock product line were less. Although, the margins were certain builders were less because of their programs. Describe the process, how long it took of that exhaustive analysis.

Well, we've been looking that it strategy for some time. And the question in our mind was, well, there were a number of strategic issues in our mind. But one of the things that had to really drive this was what kind of a growth rate and how much of our space this business is going to occupy. I think everyone who is in a broad line product business, you're going to have low-end, low margin products. And you're going to sell high-end, high-margin products. It's kind of almost has given as you go through that product continuum.

The problem that we had here was that for the past couple of years, this business has been an enormous success for Lowe's. It's done extremely well. And it's done much better than we had forecast. So, we kept putting forecasts for this business in at one level. It kept kind of working around; how do we make this work with a strategic customer? And it would come in significantly higher than that. It's now occupying a big chunk of space on the platform. It's not a static kind of a world that we live in, obviously, and we've been evaluating this for long time.

It has gotten to the point to where we looked at our overall operations. And we've evaluated the returns we're getting, based on products and other kinds of criteria. And it was very clear that there were some readily identifiable groups of products and businesses that we could exit out of. And have no strategic - - long-term strategic impact on the Company. And have a lot of benefit in terms of our operating performance, which has been frustrating us for the past 18 months. So that's not been something that we figured out last quarter. That's - - this is been an option in our minds for quite sometime.

It seems to me as you would go through the negotiations with that strategic partner you might say something like, "Well, we have to exit this business. We can't make a decent return on our employed capital." And one of the come-backs would be; "Alright, we will certainly accede to that over time. But we want some sort of guarantee that we don't have any price increases or we minimize the price increases in the other lines during the same time." Did that factor into the negotiations? Is that kind of the quid pro quo?

Well, I wouldn't start calling out elements of the negotiation. But, no, that wouldn't make sense for them or for us to start connecting business. I think Lowe's is a great partner. And just suffice to the say, when we went to Lowe's management with this situation, they were; on the one hand feeling badly that they were going to have to replace a vendor that had done a good job of supplying them in this category. But on the other hand very happy that we were being upfront and giving a long lead time. So, that we didn't put either them or us in a difficult situation where you have the kind of negotiations that you're talking about. So, we've not gotten to those kinds of problems, don't think we will.

And the price increases, John, that you have implied - - installed, is that going to be to the effect of 200 basis points of transportation costs, or is it still beyond that?

The price increases are meant to always in the - - with the eye toward what the competitive landscape is. And we believe that with these price increases selectively implemented that we will be able to recoup the lion's share of the transportation increases, as well as keep our product line competitive.

Okay. Last question. Just another nit question. We see that inventories rose 23% year over, while sales only rose 8. Are we out of balance in inventory?

No, we're not. We opened the two new plants roughly a year ago at this time. And at that time they just had opened. At this point they're fully functioning. And so in order to have them fully functioning they have to have the right compliment of materials and so forth and product mix and breadth. So, that's the driver to the inventory increase.

And the major worry we would have as kind of uses of capital going forward is; if you are successful in these higher margin areas and they require more solids as opposed to veneers, you still could be bottlenecked in the dimension mill? Is that right, Jake?

Yes, could be. That's an easy one to solve, though. Because we can buy kiln-dried lumber and dimension it ourselves. Or we can actually buy dimensioned lumber, which is a little bit expensive. But that's not the end of the world, if you have to span a period of time to do that.

I thought the major dimension supplier in the country kind of reduced capacity a year or so ago. No?

Well, there's no big dimension supplier for our business, not at the scale we're talking about. So, what we would talk about really is going out and buying kiln-dried lumber, as opposed to dimensioned lumber.

Our next question is from Eric Bosshard with Midwest Research.

Good morning. You mentioned - - maybe John mentioned the competitive environment. Can you just speak a little bit about what you're seeing in the competitive environment, especially, as you start to see a little bit of a moderation in demand taking place?

Yes, I think I would just say that I haven't seen any huge changes yet. I think the people out there trying to be opportunistic. And then the market to date is still in many areas a little bit oversold. You go to California, you go to Arizona, you go to Florida, places like that, and you're on the new construction side of the equation. Even though you're seeing a slowdown on the front end of the housing dynamic, the stuff that's in the pipeline is still at very, very intense levels. So, the country is still producing a couple million housing starts. And frankly, many areas of the supply chain don't have the capacity to support that. So, you see a real mixed bag out there.

If you look at the remodeling business in general, we haven't seen enough of a slowdown yet to - - that would precipitate a reaction by a major competitor. And of course, there are really three of us that service this special order home center business. There aren't a lot of platforms out there that are equipped to do that. We have some capacity. I have to assume some others do as well. But I don't think anybody's out there doing crazy things to find business. I think most of the emphasis from the major cabinet suppliers has still been on trying to restore some profitability because of the inflationary pressure and other kinds of pressures from this overheated market that we're coming on.

Great. Secondly, you mentioned an effort, these efforts are targeted to return gross margins to the prior 20% or better rate. Do you have any sense of a time frame over which that might be accomplished? Is it over the two years to which you expect to complete this transition? Can it be faster than that?

Eric, certainly we expect by the end of this transition period to have achieved that goal and exceeded it. We're certainly targeting to do it sooner than that. Obviously, a lot of that will depend upon volume. How quickly we can backfill the exited capacity. And those are sort of primary variables that are really a little bit tough to pin down as we speak. But we're certainly shooting to achieve and exceed those goals much sooner than the completion of the transition period.

Okay. And then lastly, I'm sure before you put in the two new facilities to add that capacity, you probably looked through your existing book of business and this 12% I'm sure this is not the first time you've looked at in this closely. Is there something that changed in terms of the economics of this business that suggested today let's clear this 12% off of the books and open up that capacity relative to your thought process two years ago when you were then looking at adding those facilities?

I think the thing, Eric, that has changed is the amount of space that's occupied on our platform. If you go back two years and you looked at our projected growth rates of the in-stock category as well as the opening price point categories, our builders, they were at lower levels than what they've come in at.

And that's driven by two things. One, enormous success that Lowe's has created with the in stock program. And two, as I referred to earlier, as the builder market has really concentrated and consolidated over the last three years, that consolidation has been very intense. A lot of builders have laid out plans that were based on more regionalized kinds of histories. And as they evolved to more national platforms, they had to rotate their product lines down some, selling more opening price points, things of that nature. As you go through those evolutions with them, you start out planning on selling a certain mix at a certain level. You end up selling at significantly below that level of mix.

Everything changes. It's very hard to predict that's going to happen. That consolidation will continue, as it continues, we're being forced at any rate to pick and choose who the long-term strategic partners are. We have plenty of room to grow with those accounts that can provide us some growth opportunity. And not force us to have to rotate that down that product continuum where we don't want to be. But that's the big difference, is where we thought that space would be occupied and what amount of it actually ended up being occupied.

Okay. Then lastly, just to be clear, your comments on underlying demand momentum, you reported 8% this quarter. And excluding the transition business you're talk about 4 to 8 in the coming quarter. And so you're really talking about a slight moderation from the current quarter. It's a more meaningful moderation from the 15% type growth in prior quarters. Is your conclusion that you're seeing things a little bit more moderate on the new construction and on the remodel side, or not really? Help me understand a little better what you're seeing in terms of demand momentum.

I think it would be a little bit more moderate on the new construction side. To me, I think that's where there's a little more volatility. If you look at house price inflation over the last couple of years, in certain markets, if you look at the housing inventory that's starting to grow out there. Some of those fundamentals, interest rates, they're up almost 200 basis points, whatever the last 18 months for the 30-year fixed. And we still don't know that they won't go up more. So, I think that's where more of the volatility is. And I think that's punctuated by the fact that a lot of the major public builders who have announced in the last 30 days have come out and lowered their forecasts. I don't think it's going to be huge.

I think there's a lot of stuff in backlog. I think the NHAP forecast is probably a pretty good one. That's forecasting single-digit drop this year versus last year and another single-digit drop or so in '07. So, some slowdown is certainly underway. I think it will be a little bit more accentuated you waited on the new side. But we don't see a cratering of anything. We still see a fairly healthy new construction as well as remodeling market.

Great. Thank you very much.

You bet.

And our next question is from Joel Havard of BB&T Capital Markets.

I always seem to have trouble making our star-1's operate on our calls here. Let's see, this actually echoes the previous question. I thought in opening remarks you talked about the wholesale growth, the builder direct actually still having been stronger through Q2. Did I get that right? Or I should say relative to retail?

Well, yes, I think that - - I'm not sure which comment - - I think you might have been referring to something John said. He's looking it up. But if you look over the past year, certainly the new construction markets have been the ones that we've really had a hard time keeping up with the growth. The following markets have been very, very healthy. But the the new construction market has been really overheated.

Yes. And that's as it pertains to your business with them.

Yes.

Yes. Okay. Using that as a base, kind of getting to the second stage of this one elaborate question. But of the 12ish% of sales that y'all need to carve out over the next 12 to 24 months, our best guess of it is about half of that would be the in-stock line at Lowe's. And the other half would be underpriced business with various builder-direct customers. Is there any sort of pattern to geography? Is this all concentrated in Texas, for instance, or - -?

It's all over the country.

So it's isolated customers in all of your eight markets. Is that fair to say?

The new construction site is and the in-stock business is over the entire Lowe's platform.

Yes. And that's, I guess, what, 12 territories or something with Lowe's, I think?

I don't think they'd look at that it way but it's in all of their sales regions.

Yes, okay. That gets to the real heart of the question here. You're probably - - if remodel is a little slower over the next few quarters, even than it has been. And you're pulling back from some of these underperforming builders. Does this open up an opportunity for you guys to, a) either expand in your existing eight primary geographic markets with the builder program? Or to carry it to the ninth and tenth in some of these other market that we've talked about in the past?

Well, I think that what we would likely do is not open the ninth and tenth because those aren't nearly as attractive as expanding within the eight that we are in. But I think that to the extent that we have some running room, yes we would - - if we feel the need to go grab share, that's what we would do. We would aggressively expand within the eight. And there's room to do that.

Jake, is that - - this kind of backs up a step from what we were talking about previously. If this is various - - and I assume various size, not just the little guys, not just the big guys, but various sized builders around the country that you the you're having problems with. In the past you guys have talked about being partnered up with the kind of 12 or 15 of the top 20 builders. Do you find that the guys you're anticipating having to pull away from is going to position you with larger guys, with the smaller guys? Is there some pattern?

No, I think we'll look for a certain mix of national accounts, and we'll look for a certain mix of regional - - local and regional builders as well. We'll continue to serve as those builders that look like they fit strategically into our mix. But in honesty, you're getting pulled significantly one way or the other, Joel. There's a lot of them out there.

So, you do see the ability to better choose the profitability potential of your partners rather than just go with the biggest, for instance?

Absolutely. I don't see any value to being able to say that we sell to the biggest. I think the thing we want to be able to do is sell among those top 10 or 12 builders, the strategic partners who we think we can grow with, service, and they fit our platform. They're looking for a product offering along the lines of what we build and service. And we see plenty of opportunity in that channel for that strategy.

Okay. Shifting gears one last theme here, you've talked sort of around the freight issues. Could you remind us again - - I think in the past two or three conference calls you've talked about some vendor changes where you're - - some vendor consolidation. Could you tell us - - remind us again what you've done over the last couple of quarters? And what steps are still within your grasp to further try and get a handle on freight related costs?

Joel, this is Kent. The big thing we had to do, was really starting last year, our major carrier made a decision to get out of the revenue - - what they called the revenue generation business. And completely turned their freight system into in-house product. They had been servicing not only us but several other third parties in terms of their delivery network. And we went through a series of replacing them in a lot of areas of the country. Some of the transitions went well. Some of them went less well. And as Jake mentioned earlier, we're on the second round of some of those transitions to get a carrier that can, in fact, meet our specification of profile for service and performance.

In terms of can we do anything, I think also, John mentioned some things. There are some things that we can do on the cost side. Constantly looking at your lanes. Constantly looking at how you're moving product around. Seeing if there are carriers that we can find where we can take advantage of dead-head runs. Where they've run a truck someplace, they're running it back to their terminal empty. If we can mirror that up closely with the lane that we run, sometimes you can negotiate lower rates because they're - - it's basically dead costs for them. That's really kind of an ongoing effort that we do constantly as the environment changes and as trucking lanes change. We have a group that looks at that on a pretty regular basis.

Sure.

There are things that we can do in terms of our internal organization. Does it make more sense, for example, in the way we load the trucks? Can we add some additional costs internally into the way we load the trucks? So, that we're not asking our third-party carrier to do that work or similar work in their cross-dock facilities. Is there a different way to package it, put it on pallets, shrink-wrap it. The way we put it in terms of sequence order in the truck? Is it cheaper for us to do that for them. So there are all sorts of those types of things that we can do. I think going back to what John said though, is that there's really two things that we don't have really influence over. The first one is just the pure cost of fuel. And it has been extremely high. It has moderated somewhat. Don't get too carried away with what you pay at the pump, because diesel fuel has not come down as rapidly as what you put in your car.

Yes, sadly, I drive a diesel.

Well, then, I guess you're pretty much where we are. That is not seeing the same level of price drop here in the last four to eight weeks that we've seen in terms of regular gasoline. Diesel has stayed up there.

Yes.

There are some limitations in terms of diesel capacity. The other big one is, this whole supply demand thing. That the demand for large package delivery, driven by Internet and other factors, has really exploded in the last couple of years. And there's significantly more demand for that delivery capacity than there is currently supply. When you're out of balance like that, the inflationary pressure, the price pressure, as more people, too many people chase too little capacity. Is really not something that's a macro thing that we really can't impact. And both of those things are driving. And as far as we can tell, they will continue to drive the freight world for some period of time.

Kent, those are great answers but it it begs one more question, and that is more strategic in nature. I've asked you all in the past; if this is the kind of environment where you can start to add a fuel surcharge line item to your ticket? And then more strategically, does it make sense for you all to own a little bit of trucking yourself?

I'll deal with the first one. The first one is, and you know the answer that's coming, is that we price to market. And to the extent that the market reflects those costs, whether it be in base rate, base prices, or whether it be in fuel surcharges or whatever, we will - - we aggressively look at what's going on in the marketplace. That's the volume versus price game. We need to make sure that we're competitive, so we continue to get the orders. But we will also participate in market action that all of the industry takes to recover just pure cost increases. The industry needs to be able to pass those through. As Jake also mentioned, we believe that the whole industry has been on something of a lag in being able to pass those through and have those reflected in the marketplace.

I know we've talked about that for awhile. Then your thoughts on the second point?

we have taken pricing action obviously that we feel is supported in the marketplace. In terms of owning your own fleet, as you know, we did that many years ago.

I recall.

It was something that we run the numbers on on a kind of regular schedule. What I would tell you, when you put in the full cost of operation, associated with owning your own trucking in terms of general liability and all those other types of things, from an economic standpoint, we still don't think that makes sense.

Okay.

Now, we do do some things, depending on the frequency of the haul and the amount of material that moves between point A to point B, we do have dedicated fleets. Where we have a third party operator that has dedicated a fleet to us. And based on that, because of what happens to their costs and their profile is that we, in some cases, can bring our costs down if we have a dedicated fleet versus just running third party.

Okay. Guys, great answers. Thanks for your time today. Good luck.

And our next question is from Mark Herbeck with Midwest Research.

My questions have all been answered. Thank you.

Sure.

Then this does appear to conclude our question-and-answer session for today. I'd like to go ahead and turn the call back over to Glenn Eanes for any additional and closing remarks.

Well, since there are no additional questions I'd like to thank you again for taking time to participate in this conference call. And speaking on behalf of management of American Woodmark, we do appreciate your continuing support. This concludes our conference call. Thank you.

As was just stated, this does conclude our conference call for today. We thank you for your participation, and have a great day.