American Woodmark Corp (AMWD) 2007 Q1 法說會逐字稿

Good day and welcome to the American Woodmark's first-quarter earnings call. Today's call is being recorded. The Safe Harbor statement under the Private Securities Litigation Reform Act of 1995, all forward-looking statements may be made by the Company involve material risks and uncertainties and are subject to change based on 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 not be realized. At this time, I will turn the call over to Vice President and Treasurer, Mr. Glenn Eanes. Please go ahead, sir.

Good morning, ladies and gentlemen, and welcome to the American Woodmark conference call to review our first-quarter results. I would like to thank you for taking time out of your busy schedule to participate. Also participating on the call today will be Jake Gosa, Chairman and Chief Executive Officer, Kent Guichard, Chief Operating Officer, and Jon Wolk, Chief Financial Officer. Jon will begin with a review of the quarter and an outlook on the future. After Jon's comments, Jake, Jon, and Kent will be happy to answer any of your questions. Jon?

Thank you, Glenn. This morning we released the results of our first fiscal quarter that ended July 31, 2006. In case you have not had the chance to read our earnings release, here are a few highlights.

Net sales for the quarter were $222.8 million, up 3% over the prior year's first quarter. Net income for the quarter was $13.4 million, up 80% over the prior year's first quarter net income of $7.5 million. Diluted earnings per share of $0.82 for the quarter compare with $0.45 earned last year. We implemented FAS 123(R) during the first quarter. The after-tax impact included in these aforementioned results was $0.9 million, or $0.06 per share in the first quarter of 2007.

As we discussed in our recent calls, we have been transitioning out of certain low-margin products including the in-stock cabinet business at Lowe's. As in the last call, I will provide a separate breakout of our transition status and impact and continue to do so on future calls until the transition is complete.

Regarding our first quarter sales performance, our previous guidance anticipated sales growth before products of 3% to 7% over the prior year's first quarter. Our actual core product sales growth came in at the high end of that range at 7%, driven by double-digit remodeling sales growth offset by a slight decline in new construction sales. Sales of low-margin products declined in line with our expectations. There were no new retail stores transitioned during the first quarter, but the transition schedule was further developed and replacement vendors and timelines were identified for the remaining regions of the country to be transitioned.

Our previous guidance anticipated an overall sales increase over the prior year of 0% to 4% for the quarter, inclusive of our transition out of low-margin products. Our overall sales growth of 3% was within that range. For new construction, mixed indicators seemed to continue to support the soft landing consensus projections that call for housing starts in the 1.8 million unit range. Residential housing starts continue to be solid although momentum continues to slow. Monthly housing starts for July 2006, as reported by the Department of Commerce, were 1.75 million units on an annualized basis, the fifth consecutive month below 2 million units.

Inventory levels of unsold new homes have grown especially in active markets such as South Florida, Phoenix, Washington D.C. and Northern California. Thirty-year fixed mortgage rates, as reported by Freddie Mac, fell for the fourth consecutive week to 6.52%, and while higher than last year, still remain favorable in comparison to historical levels.

The backlogs of large builders to whom we sell are declining due to customer cancellations. Although the new construction market continues to cool, we continue to aggressively bid and win new business. 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 and grow its market share in what looks to be a somewhat less robust new construction sector.

For the remodeling market, conditions have also been mixed. Existing home sales, a leading indicator for home improvement spending, continued to hover in the mid 6 million range on an annualized basis, lower than the record 2005 levels but still within 10% of historic highs. The Consumer Confidence Index remains stable and near recent highs. The unemployment rate, as reported by the U.S. Department of Labor, remains well below 5%, and new job creation remains healthy. And the major big box retailers continue to demonstrate overall sales growth. We believe the remodeling market will sustain growth and support our sales forecast.

Moving on to gross profit, gross profit for the first quarter was 22.0%, significantly higher than 17.1% in the first quarter of last year and better than the 21.1% in our previous quarter. Efficiencies were gained in relation to nearly all of the cost components of gross margin. As we described in our last two conference calls, numerous operating initiatives that were launched nine months ago have improved margins during our most recent quarter and in the two quarters that preceded.

These initiatives included focusing on operational efficiencies and disciplines, implementing selected pricing actions and rationalizing spending and headcount levels. Our transition out of low-margin products commenced in the latter half of the prior year. The reduction of these volumes enabled an improved sales mix of more core products with higher margins, as well as an enhanced level of focus on realizing operational efficiencies.

We were successful in delaying the impact of some previously announced raw material price increases. In addition, the impact of previous pricing actions also helped to reduce material costs as a percentage of sales. The higher than expected growth in core product sales also helped margins to exceed expectations. The combined impact of these actions and market dynamics helped to improve productivity and improve margins during the first quarter.

Regarding SG&A expense, total SG&A expense was 12.5% of sales in the first quarter of 2007, up from 11.5% the prior year. Selling and marketing expenses declined to 8% of sales from 8.3% of sales in the first quarter prior year reflecting the timing of sales promotions, as well as ongoing cost management efforts. General and administrative expense increased to 4.5% from 3.2% of sales last year, reflecting both an increase in the Company's pay-for-performance incentive plans, as well as the majority of the share-based compensation cost relating to the implementation of FAS 123(R).

With regard to our capital growth plans, capital expenditures and promotional displays deployed during the first quarter of 2007 aggregated 5.7 million as compared with 9.2 million in the first quarter of fiscal 2006. Capital expenditures drove the decline as outlays for promotional displays deployed at customers increased by 1.3 million. The reduction in CapEx was driven primarily by timing. Outlays for the quarter included a variety of maintenance and cost saving projects. We expect CapEx and promotional displays deployed in fiscal 2007 will be approximately $10 million higher than in the fiscal 2006, comprising a variety of small to medium-size projects but no new plant construction activities. The Company expects to continue to fund its capital spending from a combination of operating cash flow and existing cash on hand.

Regarding the balance sheet, the Company's financial position remains outstanding. Long-term debt to capital on a book value basis was 10.0% as of July 31, 2006. Cash provided by operating activities improved by $25 million year-on-year, as compared with the first quarter of 2006 to over $37 million. Cash on hand improved to over $70 million. The Company repurchased $8.6 million of its common stock during the first quarter, representing 1.6% of the Company's outstanding stock. Since 2004 the Company has repurchased $41 million of its capital stock and the Company has $18.8 million remaining on the recent $20 million authorization from July of 2006.

In closing, overall we're pleased with the continued improvements we have made in our operational performance and gross margins during the first quarter. For the third consecutive quarter, we improved our margins at a rate that exceeded our expectations. As we have stated in the past, management believes the Company should generate sustainable gross margins in a range of from 21% to 23%. Accordingly, we believe that the Company's performance during the last two fiscal quarters is in line with these expectations.

As we look forward to the second quarter of fiscal 2007, we continue to see a mixed housing environment that should continue to support our sales forecast. 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 continued expansion of the home improvement market, our partnerships with 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.

Many of our new construction customers expect to continue to gain market share. Although the new construction sector appears to be slowing down, our partnerships with both national and regional builders position us well to maintain and grow our market share. We continue to focus on regaining market share that we temporarily lost last year, particularly in the West where we have substantially recovered.

During our first fiscal quarter that ended July 31, 2006 we experienced higher core sales growth than we expected, an improved sales mix, continued benefits from our operational initiatives and temporarily stable material costs, all of which combine to yield results that exceeded our expectations.

For the second fiscal quarter that ends October 31, 2006 we expect that mix, remodel and new construction markets will support core product sales growth of from 1% to 5% over prior year levels. Regarding our low-margin products transition, there was approximately $130 million of total business to be transitioned out when we started, broken down as approximately 70% of retail business and the remainder being new construction. The new construction business transition has been completed. We expect the low-margin retail product transition will continue for the next several quarters. Pursuant to that transition schedule, we will exit the central region of the country during our second quarter at which time we will have completed approximately 40% of the total retail volume to be transitioned. Taking the low-margin product transition into account, we expect overall sales levels will be lower than those of the prior year, declining in a range of from 1% to 5% below prior year levels.

We expect the Company's gross margin rate will continue to remain over 20%, driven by the favorable impact of operational improvements, pricing actions and transition-driven improvements in the sales mix. Although we were able to defer certain material cost increases in the first quarter, we continued to experience inflationary pressures in particleboard, linerboard, and petroleum-based finishing products, in addition to diesel fuel.

We expect that second-quarter gross margins will decline somewhat on a sequential basis due to lower seasonal volumes and expected increases in material and fuel costs. The Company implemented FAS 123(R) share-based compensation during the first quarter and realized an impact of $0.9 million, or $0.06 per share. The Company expects a similar impact in the second quarter. Inclusive of the Company's provision for stock-based compensation expense, we expect the Company's diluted EPS for the second quarter will be in a range of from $0.55 to $0.60 per share. This concludes our prepared remarks. We would be happy to answer any questions you have at this time.

(OPERATOR INSTRUCTIONS). Peter Lisnic, Robert W. Baird.

Jon or Jake, a question on materials cost; you said you were able to defer the effect of higher costs in the quarter. Just exactly what does that mean? It sounds like you are getting increased materials cost and, for whatever reason, you were able to, what, put through price in the first quarter to offset that and you won't be able to do that in the second quarter? Just trying to understand why it's going to hit in the second quarter and didn't really hit in this quarter.

Thanks for the question. We have been working closely with our vendors and they had announced price increases. We were just able to push back the timing of when the price increases hit. They are hitting -- they have already hit, but they hit after July 31 for some of those increases and that is why we were able to defer some of those.

Okay. And your assumption is that you will be able to get price in return and help offset some of that.

Yes. This is Jake. We continue to take in some cases broad base, in some cases more specific targeted pricing action in both anticipation of some of these costs as well as in response to some of these costs. But most of the costs coming through are within what we have been able to forecast for the last several months. So maybe some timing issues here and there, but we have and continue to take action to offset these costs.

Okay. And can you give us a sense as to what kind of headwind you're looking at because when I look at some of the underlying numbers, I don't see particleboard costs going up that significantly. The hardwood costs, I don't think are going up that significantly. So it sounds like maybe freight or fuel costs might be the biggest part of that. But I'm just trying to get a sense as to what is driving or what the biggest components are and how that relates to your cost structure.

I don't know what you are looking at. I don't know what reports you're looking at on particleboard, but, boy, it is up a ton over the last few months and the general particleboard market and the grade of particleboard we are buying is way up. Hardwoods, you are right, has been pretty tame. Linerboard however has been active and, of course, you know what is going on with anything related to petrochemicals or diesel fuel.

But if I look at liner and particleboard, those are I think much smaller components of the cost structure than hardwood is. Is that right?

True. Yes. But they are still significant.

Okay. And if you kind of look at it, is there a way to -- I mean is this going to cost you a point of gross margin in the upcoming quarter, two? Is there any way of getting your hands around that?

As you know from being a pure play in the cabinet space, we try not to talk too much specificity about the specific aspects of the cost structure. You know, as Jake said, the hardwood is far and away the largest material cost, and materials is certainly a significant portion of cost of sales. But the particle and linerboard cost increases will eat into margins in our expectation.

Okay. That's a good answer. I'll jump back in queue. Thank you.

Joel Havard, BB&T Capital Markets.

Jake, start with you. Could you give me a little education here on how it is that retail side of the business was up double-digit and I presume I heard right that that was the core, of course, ex the transition business at Lowe's when their same-store numbers were fairly tepid for the most recent quarter and the unit growth wasn't anything surprising, maybe a couple more stores than we were looking for, but sort of on track? How's that being driven? And is it you or is it the retailer themselves?

Well, I think you have got a couple of things going on. One is, we're talking of course kitchen comps which don't always mirror broad-base store comps. There are a lot of other things that can affect the full store comps being reported. And if you look at historically, and I can't give you an exact number, but it is not at all uncommon for kitchen comps to run well above or counter to overall store comps.

In addition to that, we think we are comfortable that we are gaining share at both of the major retailers. And I think Jon mentioned in his comments and we had indicated to you over the past two quarters that we felt like the recovery of that lost share on the West Coast would be pretty well vested by the end of the summer, and we are there. We have pretty well fully recovered and are continuing to go forward.

So our position in that business has improved, and I think that I wouldn't necessarily compare full store comps to kitchen comps.

Of course. I think maybe we're just underestimating previously the importance of that West Coast recovery.

That may be the case as well, yes.

Yes, sir. On the builder side, any thoughts yet -- I mean Jon referenced your opportunity in the field. Anything moving toward the forefront on expanding the markets served that you could talk about yet?

Well, yes, I mean we are doing that, but keep in mind that we have two pieces to our builder business. One is the distributor piece, which works in concert. It's all one channel. We view that as one-channel distribution. We have two organizations servicing it. And we have a group specialized in going after those tertiary markets.

If you look at the builder markets that we are in, I don't think this is a great time to go open a location in Las Vegas or Denver or something. I would rather pursue that through secondary channels. But we are doing reasonably well in those secondary markets, and for the most part I think separate of certain portions of the Midwest, those secondary markets are actually holding up a lot better than the major markets that Jon pointed out, the Northeast, South Florida, Arizona, and Northern California.

Now, in the case of those four big markets that we just referenced, in three of those four markets we have actually picked up and are realizing a significant amount of new activity that we have been awarded. Because we started -- we saw this coming last fall and really accelerated our bidding activity. In the fourth of those four markets, we are a little bit behind the pace of the other three, but we are also making progress.

So as you look forward to the -- and Kent may have something to contribute to this -- but if you look forward to the next couple of quarters in new construction, I think we would characterize it as really being pretty much in the range of this soft landing scenario. It may be right now on the low side of that, but what we are experiencing in the direct markets, the bigger direct markets, is not at all disastrous. We are moving ahead; we are doing work; we're being awarded work.

We're seeing some new projects emerge. We're seeing some builders really struggling; some builders are coping with it better. And it just depends a lot on the positioning and what have you in terms of price. But going ahead, looking ahead, I think that the fall quarter -- our second quarter is definitely in the uncertain category in terms of market demand, but it is not in a real dire situation or anything like that.

I would characterize it as saying that the new construction market is continuing to settle itself out. We are continuing to aggressively bid work. We expect it to obviously be -- continue to be down compared to last year. So, you know, it will take a couple of quarters to really get our comps back where we would like for them to be, but nothing disastrous but still down.

The remodeling side -- excuse me -- you know, we see that continuing to be up. If we look at the footprint we are seeing from the spring on into the summer and what we are anticipating in the fall, we anticipate a fall selling season with some upward movement in the footprint. Given the current climate, I think it would be silly to forecast it as being robust. And so in our forecast we've got the vitality of that fall selling season measured or planned at a much less robust rate than we've had in the last say three years where it has really been strong.

So that is how we are kind of looking at it. So if we are being a little conservative, maybe, I don't know. But we don't really feel bad about the market in terms of where we have been forecasting the market and where it is coming out. The (indiscernible) market is about where we thought. New construction is probably in the lower range of the soft landing scenario. Kent, I don't know if you have anything to add to that.

Okay.

That's pretty much -- we are in agreement here.

Is Kent in there with you?

Yes.

Kent, what is the status on -- is it Grantsville?

Garrett County?

When did that open? How far along is it, that sort of thing?

Are you talking about the new site up in Western Maryland?

I guess that's the one. I had Grantsville in my model here and I understand that is a hardwood mill, and that is kind of the most recent.

That is Garrett County. We have a piece of property. We have made some base improvements to the property, but we have not done anything beyond that. There is no building there. We haven't done anything in terms of starting up that facility.

Talking construction, okay.

Yes, we don't have any construction. What we have is we have the site and we have done the base work on the site for when we put a pad on it, but we have not moved beyond that. We just really don't need the capacity at this point.

Okay. So it sounds like the CapEx forecast you all talked about probably doesn't include that. And just to clarify, this is a -- would you call it a rough mill or a finished mill? It's hardwood components.

It is a dimension mill.

Dimension mill, okay, good. So it is kind of the first stage of --.

Processing on the hardwood side, yes. And it is not in the -- as Jon mentioned, there is no new facility in that CapEx forecast.

Well, I guess there probably needn't be for a while, with the 100 plus million you are taking out of low-margin businesses. It's like you got a new plant this year, anyway, right?

Well, you have got to be a little careful because the businesses we are getting out of have the tendency to be at the low end of the price spectrum and their board feet -- hardwood board feet per cabinet is much lower than it is if you get into the remodel business or the upgrade on the new construction lines. They'll have veneer panel inserts and those types of things, so it's not really a one for one.

And last question, Jon, if you have got it yet, the trends on pricing and units in Q1?

Yes. The units were down a bit. Pricing was up, but that is more driven by mix, Joel, because as we are exiting that low-end product category, we are exiting some units, and the upgrade and price per unit is driven by mix more than anything else as we backfill that with some core units.

Were the trends similar to what you had inferred in Q1 -- I'm sorry Q4, Q3?

Yes. I would characterize it that way; it was similar, mix-driven primarily.

We'll look for the actuals out of the Q then. Guys, thanks. Good luck.

Thank you.

Thank you.

Sam Darkatsh with Raymond James.

A couple of questions. First off, compared to what you had expected for the quarter, I know your guidance, you beat it by maybe $0.20 or so rounded which I guess equates to about $4 million or $5 million on the EBIT line.

It looks like -- and I'm summarizing here -- but it looks like your sales came in pretty much as expected if not a little bit on the high end of the expectations. But it looks to me as though the only real major surprise in terms of what happened versus your expectations was the delayed impact of the raw materials increase. Did that constitute the majority of the $4 million or $5 million variance between your expectations or your guidance and what actually happened or were there other things that surprised you favorably in the quarter?

Hi Sam, it's Jon. That was a chunk of it, but I think we have to keep emphasizing, as we have in this call, some of the things I have said in my opening section which were the continued positive impact on the operating initiatives that we started up about nine months ago, as well as this sales mix change-out. It's been pleasantly surprising us as well how quickly the margins have improved as we exit that former category and backfill some of those units. So I would say that all those aspects were helpful.

I wouldn't overweight it, though, on the deferral of that inflationary increase. That played a part, Sam -- this is Jake -- but I wouldn't say that was the major chunk or anything like that. It's just a part of it.

Got you. Second question, the cash balance at $70 million, Jon, how much safety stock -- I use safety stock in terms of cash, not obviously in terms of inventories -- but how much safety stock do you really think the Company needs in terms of a cash balance? I notice you repurchased shares, but it is really just basically looks like it is offsetting option dilution at this point. So does that get stepped up to the point where you begin decapitalizing the equity base or what should we expect from cash usage going forward?

Sam, that's a good question. Certainly $70 million is probably more than we absolutely have to have on the balance sheet as you're alluding to. During the quarter we repurchased over $8 million worth of stock. And if you look back to the July announcement where our Board authorized a $20 million additional slug that we have only just really touched the surface of at this point. The previous authorizations were for $10 million pops. This was a $20 million pop. So I think in that sense we're sending a signal that we are looking to step up this activity. In addition, we are going to meet with our Board soon and we're going to discuss other options to think about how we use that cash.

So you (multiple speakers) -- perhaps we will see some actual share count take-down in the out quarters beyond merely offsetting dilution? Is that how we should read into that?

Well, if you look back even a year, Sam, if you look back to July of '05, our weighted average diluted share count was over 16.7 million shares, and for the quarter that we just completed, it was less than 16.3 million shares. So in addition to offsetting the dilutive effect of any stock options we have issued, we have been repurchasing certainly well in advance of our stock option issuances. So I think that we have begun to do as you have suggested.

Got you. Next question, the additional cost relating to the pay-for-performance incentive plans that we've seen in Q1, is that a one-off instance from a seasonal or timing aspect, or is that an ongoing type of expense?

Think of it as ongoing. We've had these plans in place for many years and in periods like we just closed out this quarter, and we tend to accrue more in incentive compensation for our management team, as well as really for all employees because all employees of the Company are a part of a bonus pool. So think of that as an ongoing expense and, as we accrue those numbers, we are looking out to how we think we're going to do for the year and we step up or step down accordingly.

And as you look into your August sales and orders and your visibility in the quarter, is it within your guided range of core sales growth above the range? I'm just trying to get a sense of the wiggle room that you are allowing yourself with your guided range of up 1 to 5 on the internal sales growth.

Certainly, we're looking at the sales trends that we've experienced to date as we set that guidance.

Understood. Thank you very much.

Jamie Lester, Soundpost Partners.

I guess if I back into the implied SG&A from your earnings and revenue guidance, I know it is inexact because I need to make an assumption on gross margin, but it seems like it is going to be roughly flat on a dollar basis quarter-to-quarter. And I guess the question is what is the variable component of SG&A and if my assumption is correct, why can't you take some of that out as the sales levels come down a little bit?

Most of SG&A is predominantly fixed because it is headcount based, Jamie. The variable items tend to be promotional-driven, as well as incentive compensation-driven. So it moves a bit with sales volume and profit expectation and promotional activity.

And you would anticipate something that is largely fixed is not an unreasonable one, based on the guidance you have given, I guess?

It is mostly headcount-driven.

Okay. And then the second question, this is a bigger picture one, but I've seen some of these studies with existing home sales plotted against kind of home improvement expenditures. And it seems like it is a pretty good correlation with a 6 to 9-month lag on the existing home sales. Given today's very weak number on existing home sales, I guess, do you guys put any credence into that correlation? Do you think that you guys -- that specifically kitchen remodeling is not as tied to the existing home sales market, or how do you think about that from a kind of 10,000 foot perspective? Thanks.

We look at existing home sales as an indicator of remodeling activity, but I think to try and, Jamie, to forecast that and to draw a direct link to it would be a mistake. We also look at consumer confidence. We have had upward demand on kitchens at times when consumer confidence was sinking, for instance, after 9/11 so those things are indicators. They are overall indicators of a certain level of vitality. We have seen very, very strong existing home sales in the past 18 months but with a less robust remodeling market, albeit a healthy one. So I didn't see the great tie-in when we went from 6 million to over 7 million resales a year. We didn't see that click up and, in fact, if that was going to click up, you would be experiencing that right now on that kind of lag. So I don't know that there is a real one-for-one kind of correlation there that you would need to do fairly specific forecasting.

So we would look at that, among a couple of other things. We look at the inflation rate, we look at mortgage rates, we look at consumer confidence. Jobs, big, big indicator. And we look at resales. But I wouldn't pick that out and say that's a harbinger of let's say a type or a down remodeling market six months from now.

Okay. But to be clear, the current revenue forecast is based on kind of a flattish remodeling market; is that a fair statement?

It's in the single-digits. Seasonally adjusted it's in the single-digits. And that is assuming that the fall goes up and it's single-digits up from last fall. So, no, I wouldn't call it flat. I would say that it's -- the seasonality is anticipated to be up and we look for growth in the single-digits over prior year.

I'm sorry, that's for your specific business or for the market as a whole?

Our specific business.

And the market as a whole should be again roughly flat, or is that --?

I think we'll outperform the market by a couple of points. We think we're gaining some share, but the market as a whole would maybe be just a digit or two shy of that.

Eric Bosshard, Cleveland Research.

I have got a couple of things for you. First of all, I don't know if you can do it, but could you talk a bit about the assumption in I guess the next quarter, because that's the only guidance that you give, of the new construction side of your business will do year-over-year relative to the retail side of your business? And what I'm trying to figure out is what growth you are assuming within that 1% to 5% core increase from each side of the business.

Eric, it's Jon. We don't tend to quote that specifically, but as Jake was just alluding to, we are expecting retail sales to be up sort of in the mid single-digit range and new construction to be slightly down also, certainly low single-digits versus prior year.

And was that the experience in this current quarter, or how was that different than what you just experienced?

In the current quarter, retail sales were up double-digit and new construction was down a little bit more year-on-year, but we had a tougher comp last year. We had pretty high new construction first quarter.

Secondly, in terms of pricing and promotion, it sounds like you have got more material cost [at lands] in this coming quarter, but also I -- and also I think perhaps there was some deferred promotional spending, but you have some expectation of better, I guess, list price performance. Can you just talk about how you expect the list price and promotional spending to behave in the next couple of quarters, especially when considering the impact of what looks likely to be a softer housing environment?

Well, we -- over on the -- as far as the promotional calendar goes, this is the time of year where you incur heavy promotional activity because you're moving into the fall selling season. So typically the retailers time their promotional activities to peak with the -- the two peaks in the selling season is spring and fall, so that is a natural occurrence. And I expect that this fall you may see a little more aggressive activity out of them in anticipation of a tougher market. So they will need to do -- the idea is that they need to do more to hit their numbers.

As far as the cost side of the business and the list price side of the business, I think that the market has really made the transition over the last 18 months or so from a noninflationary to an inflationary environment. And while -- you know, you just can't be walking in to your customers with regular price increase announcements. They have to be justified and really well vetted; you can't get them.

And the market even on the new construction side where we have seen certainly the pressure from the builders' side of the community to keep the lid on cost, we have seen some pushback. And we have seen the vendor community able to continue to move up the [face] of that. The vendor community do not participate in the run-up of those big gross margins and prices that the builders enjoyed for the last couple of years, and they are not participating in any kind of heavy discounting.

On the contrary, we see it holding pretty firm. Also I would say that on the inflationary side of the business, we don't see the intensity of cost increases that we saw a couple of years ago when it was really introduced into the market in 2004 and early 2005. They come at you, but they come at you in much more digestible chunks. So we are not getting those huge increases across the board that we were getting back then.

So it is a more manageable situation and it is not really the sort of situation that we had a couple of years ago where the market hadn't had any increases in a couple of years and just trying to get everyone psychologically reconditioned was really tough. They are pretty much there now. I think people pretty much accept the fact that we have got a certain level of inflation back into the marketplace.

So you would say that your big home center customers and your big builders are more open to accepting price increases now, just they've sort of educated themselves about how this works?

I think so. I think that's fair to say.

Great. And then the last question I guess for you, Jon, the gross margin performance was very impressive over the last couple of quarters. And I guess I'd just love to understand a little bit better how you have made the productivity improvement and how that productivity improvement is expected to hold up if the revenue starts to grow perhaps a bit slower, as your guidance indicates?

Thanks, Eric. Yes, I mean the margin has been driven by really primarily the resolution of the operating difficulties that we experienced a year ago. And the operational changes that we put in place that our team has led to really drive the efficiencies back into the process.

So at the same time, the product mix change-out is having a very good impact on margins as well. And I think that our operations group, our manufacturing team has done a great job at managing hours, managing labor productivity, really tuning the business back into the kind of metrics that we need to achieve to succeed. And I expect that to continue.

I just would add to that, Eric, that I am really bullish about the next period of time. I think this market is going to settle down okay, and I think we're going to be in good shape in terms of having some demand to service. And I think that we will continue to take share and I feel terrific about the operational outlook that we have here, and that Kent and the ops team have done a great job of putting us on some new platforms. They are paying off very well, and so we are pretty bullish about that aspect of the business going forward.

(OPERATOR INSTRUCTIONS). Robert Kelly, Sidoti & Company.

Most my questions have been answered at this point. If you would just touch on the transition. Is that a head-on or behind schedule? Just give us some more color on that transition of the in-stock product.

Thanks, Bob. That's roughly on schedule at this point. You know we're working very closely with our customers and we feel good about where we're at. We understand mutual goals. I think we're in alignment and we're moving ahead.

And we're still looking at fiscal '07 as possibly completing it?

Yes, that is roughly what we're expecting at this point.

You know it's not 100%, Bob, certainly to the point that it is no longer material.

(OPERATOR INSTRUCTIONS). Brian Macauley, Akre Capital.

As the new construction market has slowed down some, presumably you know there is some excess capacity emerging in your competitors' plants. I'm curious what kind of price competition you have seen on new builder contracts from your competitors.

This is Jake, Brian. We're seeing the market hold up reasonably well. And I think that one of the things you have got to realize is that with new housing between the 1.7 and 1.8 range, that you are much closer to having an aggregate supply chain that is in balance than you are having one that's just got loads of excess capacity laying around looking for something to do.

And at 2 million, the industry was unsustainable and we had -- it was a train wreck in terms of overtime and you know late shipments, house closings and just doing all sorts of things to meet these inflated demands of that kind of a market. So I think the market is a lot happier at 1.7 million and 1.8 million from a supply standpoint than it was at 2 million.

Labor is more readily available. Meeting closing dates is more doable. We are not working Saturdays, trying to get things done. That never works very well. So you have got to get I think another level below where the market is at before you're going to start creating I think a level of free capacity in the -- certainly in our sector that would cause people maybe to start bidding down or to get more aggressive with contract pricing.

And then a question for perhaps you, Jon. Do you have the warranty expense for the quarter?

Yes. We don't typically disclose it in this forum, but certainly the costs have been moving down. They are down well below prior year levels, driven again by our operations group and the stability of operations at this point in the cycle versus what it was a year ago.

And that will be out in the Q?

Yes.

Patrick Stowe, Priority Capital.

Thanks for taking the call. Maybe a follow-up, the color you just gave on industry capacity is helpful. I wonder if -- I guess Masco is bringing on some capacity in the West Coast. Does that bring any concern to you guys, or can you just give us some color on how that will affect your business in that region?

Yes, I will give you what little we know. I don't want to speak for them, but there are two -- I understand that there are two facilities coming up, one in New Mexico and one in Utah -- or is it Nevada -- Utah. And the facility in Utah is a semicustom facility which would have limited, if any, impact on the new construction market. It would really be there to almost exclusively service the remodeling market; it's a semicustom plant.

On the other hand, the New Mexico facility is a Merillat facility. We do compete with them for new construction business. My understanding is that they did a partial startup already which -- so they are trying to utilize that or just supplement some capacity needs that they have had.

I don't know the timing of bringing the rest of that plant up but I expect that, you know, they'll, from this point on, simply respond in accordance with the marketplace.

But my understanding is that it was at least operating on a partial basis as early as last -- early in the summer, so we don't look for that to have a huge impact on the industry. Probably a much bigger impact on Merillat. Masco, I'm sure, needs that capacity from that standpoint, but the industry as a whole, I don't think it will have any big shaping impact on price or competition in the West or anything like that.

Thanks. That's very helpful. Maybe in thinking about the seasonality and the fall selling season, historically do you get the benefit of that in the current, I guess, your second quarter or is it kind of mixed between your second and your third quarter, typically?

You get that -- it starts kicking in in September and you realize it in October and November. And you generally generate some backlog that you'll also ship the early part of our third quarter as you get into December and January. The vitality of the market will determine how much backlog you have to ship in the third quarter.

So the main benefit of that or, I guess, momentum in the business is seen in the third quarter, in the numbers anyway?

Yes, but it is a big second quarter phenomenon, historically.

And then just one more if I could. I don't know if you guys discussed this or disclosed it, but I was trying to maybe better understand the profitability of the retail business versus your new home construction businesses. Is there a large differential in the profitability of those two channels or can you give me any help in kind of getting my hands around that?

The answer is we can't give you any help on that, but no, there is not a huge difference in the two. We like both businesses. We would consider both businesses strategic businesses. But keep in mind the components of those businesses are very different. Price-point, service, they're very different, and the mode of services are very different.

So the buckets of cost activity are very different, the revenue they generate is quite different. But at the end of the day they are both strategic businesses and we like both businesses when we are operating well.

Thanks for the time. Good luck to you.

(OPERATOR INSTRUCTIONS). [Peter Reynolds], [Bonafide Capital Management].

When you are done with your exit from your low margin business, what is your expected gross margin at that point?

Peter, thanks for the question. Our expectations are that we can continue to operate this business in the 21 to 23% range that we targeted as sort of the best operating conditions. So as we exit that business we will have a little bit more pressure on overhead costs in relation to sales, but we are getting uplift because this business was dilutive to our margins in the end. So our expectation is a continuation to operate in that band as I have described.

Right. Okay. And your guidance for the upcoming quarter, what does that assume for growth in your retail business and what does that assume for growth in your wholesale business, your homebuilders business, if you will?

As I said earlier, perhaps you might not have been on at that point, we expect sort of single-digit growth on the remodel side and slightly negative growth on the new construction side.

And you mentioned earlier that you are, I guess, taking share. Who are you taking share from? I mean how is that working? It would seem to me that the business is a fairly competitive one, but I guess there are maybe smaller cabinetmakers out there. Are you taking share from sort of the weaker players out there or are you doing it via sort of price? How is that happening?

Peter, this is Jake. If you look at the major players in these two major strategic channels that we are in which is the major builder, regional builder and the home centers, the major players are us, Masco Companies and Fortune Brands cabinet suppliers. And so that is where the share moves around, and that is where the majority of our share gains come from.

Right. But you mentioned that you are taking share. You know, why is a builder going to give you business over say Masco or Fortune?

Well, the builder business is a primarily -- it really hinges on service capabilities and our just-in-time model, our direct-to-the-job site model offers a more efficient, better service, more consistent service across the states, the lower states, the sunbelt states, where we operate these builder centers than our competitors. So I think having a better service model to execute from and having one that is just -- that basically does the same thing in Orlando as it does say in Phoenix or Sacramento is a big advantage to us.

Is your exposure pretty much spread out across the country, or do you have sort of excess exposure to some of the markets that some people would consider sort of mobile type markets?

Well, if you are a big player and a major builder, you are going to have exposure in some of those bubble markets because, by definition, you can't kind of get there without being in those markets. But as I mentioned earlier, the four markets that are really under great pressure which are the kind of Northern Virginia, Philadelphia, South Jersey area, South Florida, Phoenix, and Northern Cal, without getting specific into what is going on exactly where, we are actually holding our own reasonably well in three of those four markets. The fourth one is lagging a little bit, but it is still bringing in new activity. So we saw this coming last year. We upped our bidding activity in the fall and are realizing some benefit from that now.

And what level of capacity utilization are you running at right now?

What kind of utilization --?

Well, again we have to go -- this is Kent -- versus hard capacity versus crewing. We are pretty consistent. Right now we're basically crewed to the volumes that we are producing. In terms of footprints or hard asset capacity if you take crewing out, we're probably running in the low to mid-80s. So we have a lot of running room as we exit out of the low-margin business that Jon talked about without having to put new facilities or real hard assets on the ground. We would have to crew up for it. So we have got lots of running room on the hard assets side, but we're (technical difficulty) basically to our production volumes.

Okay. And your CapEx for the year is going to be somewhere around $23 million; is that right?

No, for last year it was about $26 million, including outlays for promotional displays, and this year we expect that to be about $10 million higher in the aggregate.

So it is going to be about $36 million in CapEx this year.

Roughly.

And D&A is about that or a little higher?

It's a little bit higher than that.

And these promotional displays, is there -- I guess the number of those promotional displays that you are putting out is increasing and that is because there has been sort of store growth or you are switching out the promotional displays from the low-margin business with the promotional displays for the sort of custom business? Is that why that is increasing?

This is Kent again. From our -- two. One is there is some store growth, but these things do have a life to them, either because they wear out or they get replaced by new products. So part of what we're seeing this year is we're just seeing the natural aging and replacement cycle of displays that are in existing stores.

There is no displays -- no significant display investment associated with that low-margin business, Peter.

I see. So I guess what I'm trying to get a sense for is what is sort of the maintenance level, CapEx? Is it $36 million? Is it something north of that or is it something south of that?

I think we have been operating in that maintenance sort of level last year and we will operate it again this year. It's somewhere in this range.

25 to 35.

25 to 35. And a little while ago somebody was sort of asking about the correlation between the remodel business and existing home sales. And I sort of heard that answer. What I'm trying to get a sense for is -- I realize it is probably a combination of factors, but in your view what is sort of the best leading indicator, if you will, for your business? I mean if it's not existing home sales, is it consumer confidence?

There is not one. There is no silver bullet. We have tried to track it that way for years and you just can't get any real high correlation. There are a handful of things that really affect the two businesses. Interest rates, jobs, consumer confidence are germane to both of them. Certainly, however, on the remodel side, we also look at the turnover of the existing home market which has a lot to do with it. But there are so many other factors; that is, the consumer, what kind of shape is their balance sheet in, and how much home equity they have and what have you.

One of the reasons we remain positive about remodeling growth over the next several quarters in the face of a declining turnover in the existing home market is existing homes can turn over at a slower rate, but there's a record level of equity on the balance sheets of the American consumer and that only represents I'm told about 27% of their total assets. So there is a lot of potential investment power there for kitchens. And so there are just many, many things that go into it. I wouldn't look for one silver bullet, though. We just haven't been able to draw that correlation.

And you mentioned also earlier that units were down, pricing was up. I am trying to get a sense for -- you sort of look at magazines these days and you see kitchens and, gosh, I tell you they look a lot bigger than they used to be. Do you have any intelligence on sort of the pricing per kitchen that your Lowe's consumer is sort of purchasing? I mean, has that been going up, so if somebody goes in to remodel, are they making a bigger kitchen? Are they putting more sort of gadgets in their cabinets and that is increasing the pricing?

We have our own intelligence and then there is a lot published on that. And if you look at the data for the last 30 years, the size of the house in America has been increasing substantially. The role and size of the kitchen has also increased. The kitchen is generally considered the most important room in the house.

So along with all of that income growth, house appreciation, home appreciation, the tendency to move up the price spectrum or the continuum has been pretty much in place now for, gosh, 30 years probably. And we have seen a lot of that in the last 15 years.

I don't see that necessarily abating. I think there will be continued emphasis on that. The kitchen is a little bit unique in that most of the real estate studies that have been done in the last 20 years have indicated that an investment in your kitchen is paid back when you turn your house over. So it is considered to be a growing investment when people put it in. And that is commonly understood by the way.

Well, that's it for me. Thanks, guys. By the way, it was a great quarter.

Thank you.

There are no further questions at this time. I'd like to turn the call back over to management for any additional or closing remarks.

Speaking on behalf of management of American Woodmark, we appreciate your continued support, and that ends our conference call for today. Thank you.

Thank you for your participation. You may disconnect at this time.