American Woodmark Corp (AMWD) 2014 Q2 法說會逐字稿

Good day and welcome to this American Woodmark Corporation conference call. Today's conference is being recorded.

The Company has asked us to 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 on factors that may 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.

Now at this time, I'd like to turn the call over to Glenn Eanes, Vice President and Treasurer. Please go ahead, sir.

Thank you. Good morning, ladies and gentlemen, and welcome to this American Woodmark conference call to review the financial results of our second fiscal quarter ending October 31, 2013. Thank you for taking time to participate. Participating on the call today with me will be Kent Guichard, Chairman and Chief Executive Officer. Kent will begin with a review of the quarter and will conclude with an outlook on the future, and after Kent's comments, we'll be happy to answer your questions. Kent?

Thank you, Glenn. This morning we released the results of our second quarter ended October 31, 2013. First, the financial headlines for the quarter. Net sales were $191 million, representing an increase of 19% over the same period last year; and reported net income was $5.3 million, or $0.34 per diluted share this year, versus $2 million, or $0.13 per diluted share last year. For the 6 months ended October, net sales were $368.6 million, representing an increase of 20% over the same period last year. Reported net income was $11.9 million, or $0.70 per diluted share this year, versus $2.5 million, or $0.17 per diluted share last year. For the first 6 months of the current fiscal year, the Company generated $15.8 million in cash from operating activities, compared to a use of $2.2 million for the first 6 months of last year.

Moving underneath the headlines, starting with sales performance on the new construction side. Housing starts from the US Census Bureau are not yet available for September and October, due to the reporting delays resulting from the federal government shutdown. Our expectation, based on reported August preliminary data and general media sources, is that overall housing starts and single-family starts, in particular, during the 3 months covered by our most recent fiscal quarter, were elevated over the same quarter in calendar 2012. The period covered by our second fiscal quarter was the last quarter was relatively low year-over-year comparisons.

Between July and October of 2012, single-family starts increased 16%, from 512,000 annualized seasonally adjusted starts in July to 595,000 in October. Single-family starts increased approximately another 5% during the first calendar quarter of 2013 before settling back to approximately 600,000 starts, where they have stayed since April. As a result, housing activity during our second fiscal quarter, while flat on a sequential basis, was up 15% to 20% on a comparative year basis. In this environment, our new construction-based revenue increased over 40% for the quarter. We believe our growth in excess of starts continues to be driven by our partnerships with national and regional builders that are gaining share of total starts and by our increased share with those builder partners.

Moving over to the remodel side of the business. The remodeling picture remains murky, with the most commonly referenced indicators painting a less than uniform outlook. Residential investment as a percent of GDP continues to improve, albeit slowly. Over the last six sequential calendar quarters, it's moved from 2.7% for the quarter ended June 2012 to 3.2% for the quarter ended September, 2013. Improved, but still well below the 4.5% historical average.

October existing home sales of $5.12 million were 6% above the same period last year, but retreated for the second consecutive month of the current year, falling 3% from September. While the fixed 30-year mortgage rate fell from September to October, mortgage rates remained elevated versus October of 2012. The 30-year average commitment rate for a 30-year conventional mortgage was 4.2% for the month ended October, versus 3.4% in the same month of 2012. Home prices continue to rise, with composites up in the low teens on a year-over-year basis in most markets. Positive implication of rising home prices is the restoring of homeowner equity.

The number of units with negative equity dropped by over 30% from December 2012 to July 2013. The negative implication of home prices continuing to rise is that the combination of those higher home prices and increased interest rates have reduced affordability, particularly for the first-time buyer. Pending home sales declined throughout our second fiscal quarter, with October marking the fifth consecutive month of sequential decline. The unemployment situation is on balance and, in our opinion, unfavorable. The economy did create some 200,000 jobs in October, but unemployment was steady, at 7.3%. More telling is the participation rate dropped to 62.8%, with the total number of non participants reaching an all-time high.

Finally, in relation to the remodel market, consumer confidence has been unable to gain any consistent traction, and in fact, recently took a significant drop on the heels of the partial federal government shutdown and the constant partisan wrangling in Washington. When absorbed in its totality, our view of the overall remodeling market is that demand is relatively flat in terms of activity, demonstrating little, if any, lift. Our valuation of the remodel side of the industry is that it is slightly down in terms of overall units, but up in the mid to high single-digits from a revenue perspective, due to improved product mix and some pricing.

The dealer channel within the remodel business is more than likely generating higher growth than the big-box channel, due to the more affluent nature of their customer base; but both are still in single-digit territory. In this environment, we reflected the low side of the market during the second fiscal quarter on the remodel side of our business. We have held share in the big-box environment and gained share in the dealer business. We under index to the market, however, in terms of dealer versus big box mix, with the result being we weighted average to the lower side of the growth band, or mid single-digit growth.

Moving on to gross profit, the Company's gross profit margin for the second quarter of fiscal year 2014 was 16.9% of net sales, versus 15.5% reported in the same quarter of last year. The Company generated year-over-year incremental gross margin of $7.5 million on incremental net sales of $30.8 million, resulting in an incremental gross margin rate of 24%. The improvement in gross margin versus the prior year was driven by improvement in labor, freight and overhead costs.

Regarding the labor improvement in gross margin, during the first and second quarters of last year, we experienced significant labor inefficiencies related to the closure of two plants during April and May of 2012, and the resulting relocation of that production to our remaining facilities. These inefficiencies were further exacerbated by an increase in overall production levels during the same period to meet growth in new construction demand. The inefficiencies began to moderate during the third quarter and were resolved by the fourth quarter of fiscal 2013. The improvement in labor component of gross margin for the second quarter of the current fiscal year reflects current productivity versus the inefficiencies of the prior year.

Regarding the freight impact in gross margin, our freight cost declined as a percentage of net sales this year versus last year, due to higher volume across our delivering network. This increased utilization of the platform resulted in leverage on our semi-fixed and fixed capacities. Regarding the overhead impact on gross margin, very similar to the freight impact, higher volume generated favorable leverage on fixed and semi-fixed cost.

The favorable impacts in gross margin from labor, freight and overhead were partially offset by rising material costs across a broad range of inputs: including hardwood lumber, particle board, plywood, liner board and finishing materials. Material inflation continues to be significant, with the impact on gross margin from second quarter of this year versus second quarter in the prior year of approximately 260 basis points.

On a sequential basis, gross margin during the second quarter of the current fiscal year declined approximately 200 basis points from the first quarter of the current fiscal year. There were three primary impacts first quarter to second quarter of the current fiscal year. Approximately one-third of the decline is due to continued raw material inflation. Another one-third is due to the continuing shift towards new construction, which generally contains a higher cost of goods sold component associated with both the product mix and the installed nature in that channel of distribution. And the final third is due to timing associated with various overhead expenditures.

Spreading the timing impact associated with overhead, gross profit margin for the first 6 months of the current fiscal year was 17.9% of net sales, versus 15.2% reported in the same period of last year. The Company generated year-over-year incremental gross margin of $19.2 million on incremental net sales of $60.6 million, resulting in an incremental gross margin rate of 32% for the first half of the fiscal year.

From a broader picture at the gross profit level, the primary challenge is recovering sustained material inflation from the marketplace. I mentioned in last quarter's call that we had, at that time, seen some early movement in marketplace pricing to recover some of these costs, but that it was too soon, in our judgment, to determine whether or not this movement would hold in the marketplace or whether or not they would be sufficient to recover current and anticipated cost increases.

As of today, it appears that some of the pricing movement will hold. It does not, however, look to be sufficient to recover the full impact of the material cost increases; but it will have a meaningful impact on offsetting these costs. I would expect the market to begin to reflect these pricing changes through our fiscal third-quarter of the current year, and be fully effective in our fourth quarter of the current fiscal year.

Regarding operating expenses. Total operating expenses were improved from 13.5% of net sales in the second quarter of the prior year to 12.3% this fiscal year. Through 6 months, SG&A improved from 13.6% of net sales to 12.5%. Breaking down operating expenses, selling and marketing expenses were 8.3% of net sales in the second quarter this year, down from 9.3% in the prior year. General and administrative expenses were 4% of net sales in the second quarter of the fiscal 2014, compared with 4.1% in the prior year. The improvement in our operating expense ratio is the result of leverage from higher volume, combined with controlled spending levels.

Briefly, on capital spending and cash flows. The Company generated operating cash flow of $15.8 million during the first 6 months of fiscal 2014, an improvement of $18 million over the same period in the prior year. The improvement in operating cash flow was driven by higher profitability and some timing associated with various accrued liabilities. Investing activities in capital spending and promotional displays were $5.8 million for the first 6 months of the current fiscal year. Investing activities, excluding the sale of assets for the same period last year, was $8 million.

The decline in year-over-year was due to project timing and is not reflective of the Company's project activity. Excluding any significant capacity expansion project, the Company expects capital spending to be consistent with the prior year. The Company increased cash by $21.5 million during the first 6 months of fiscal 2014, ending October with $118.5 million in cash and cash equivalents on hand.

The Board of Directors has approved a stock repurchase authorization of $10 million, replacing all prior programs that have been terminated. After reviewing the Company's previous program and in light of the Company's capital plans and forecasts, the Board decided that smaller authorizations would provide more timely information to our shareholders. Going forward, the Board will approve repurchases that are most likely to occur in the following 12 months. The Company did not repurchase any shares during the second quarter just completed, while the Board reviewed the repurchase program.

In closing our prepared remarks, we continue to be pleased with our overall progress as the industry recovers from the great housing recession. Through the first half of fiscal 2014, we've continue to increase revenue, with net sales up 20%. We've improved gross margin by 270 basis points, despite significant headwinds in our material costs. We reported net income almost fivefold from the same period last year and greater than the full year in fiscal 2013. We've strengthened the balance sheet, giving us access to unprecedented financial resources. And most importantly, we have positioned the Company for continued success, as the new construction and remodel markets recover.

The return to normalcy will not, however, be linear. And the second quarter is reflective of the obstacles we will undoubtedly face during the period ahead. As we look towards the second half of our current fiscal year, we're focused on two main challenges. First, dealing with the ongoing impact of the material cost inflation, offsetting increases internally to the extent possible, and supporting efforts by the industry to recover legitimate changes in the basic costs of raw materials. And second, balancing our cost structure with demand in an extremely fluid environment, made even more volatile by the continuing dysfunction in Washington and the negative impact successive rounds of partisanship behavior have on consumer confidence.

With that, I'd be happy to answer any questions you have at this time.

(Operator Instructions)

Scott Rednor, Zelman and Associates.

Kent, good morning. And thanks for the incremental detail on the gross margin. As you think about the back half of the year with what you're seeing in [raws] and the offset of pricing, do you think you could get back to that 30% incremental on the gross profit line?

Well, there's obviously a lot of moving parts there. From a -- there are a couple of things I would say on your question specifically, and then I'll add another element to the mix. The thing that I would add is that it appears that the marketplace, as I said in my prepared comments, is that the marketplace is supporting some pricing.

But we continue to live in a material inflationary environment. So you're kind of always a little bit behind the curve. So the return in gross margin, while I think that the pricing activity looks like it will hold as we get through our third and certainly into our fourth quarter, the question is, everything else doesn't stand still, and what happens to material costs between now and then? As we've talked about before several times on the call, there's a little bit of a lag between when we get hit by material costs and when we're able to, as an industry, pass them through to the marketplace.

So I think it depends a lot on -- in the back half of the year, specifically to that part of your question -- I think it depends a lot on what happens on material cost inflation going forward. If it continues to rise at kind of the same rate that we've seen over the last 12 to 18 months, then we're going be chasing that again. The industry will be chasing that for a while. If it takes a pause and levels out, then I think that you'll see -- and what the industry has been able to do in terms of passing some of that on through to the end consumer, I think you'll help that buoy margins back up.

The other element that comes into the mix, and I mentioned it briefly, although probably not specifically enough, is what happens to volume. And we've got two things going on. I did mention it when I talked about new construction. Really, October last year, we kind of hit the 600,000 single-family starts level, and it's been pretty much flat since then.

So, as we get into the back half of the year, our year-over-year comps in terms of the industry volume on the new construction side look to certainly not be as robust, in terms of the growth. We still think we'll outgrow the industry, based on our share improvements. But I think we're going to start to get some more volume challenges, in terms of growth rates on the new construction side.

On the remodel side, this 90-day successive rounds of having to deal with the federal budget and with the debt ceiling. If you look -- probably I'd point mostly at the consumer confidence numbers, that's probably a good thing to look at -- if you look at the toll that, that's taking on consumer confidence, which rolls through to discretionary big ticket items, as we talk about going through the third and into the fourth quarter, we're a little bit more concerned about industry volumes maintaining than we probably were three or six months ago, just because of the impact that these kind of successive rounds are having on the consumer.

So if I hear you right, if the new construction comp slows, do you think that this -- and holding raw materials constant, should this be the low point for incremental margin going forward, given that this is the lowest in four or five quarters, in terms of that 24% drop down?

Well, you're asking to give some guidance. And to me, what I would suggest, just work through those individual pieces. What I'll go with is that I don't think we're going to see as robust growth on the top line. And your forecasts are probably as good as mine, in terms of what happens on material inflation.

The real driver of what's happening on our gross margin side is material cost. So it all comes down to what is material cost and how quickly can the industry move to recover those, understanding that there's some -- that there's a bit of a lag associated with that.

Okay. Fair enough. And then, on the remodeling market, to your point, when you noticed that the difference between volume and price mix is somewhere order of magnitude of 10 points, are you guys participating in that mix up?

Do you feel confident that you guys are seeing that revenue acceleration, you're picking it up in your results? Or is there some part of it that's priced above your product offering that maybe the consumer's coming back into?

No, we think that -- we think it's more channel of distribution than it is actual products within those channels of distribution. Now, we continue to introduce new products, based on where the consumer is shopping, specifically to your point, from a price point perspective. So we don't think that we are losing out because of our price positioning -- our product and price positioning in the dealer market versus the other.

It's just that, versus the industry, our dealer business is still relatively small versus the total remodel. We still over index -- as I mentioned, we still over index by a good margin to big box versus the industry. And so that will weight us average down.

Our remodel -- our dealer business continues to grow. We continue to be very successful. We're a little over three years, in terms of since when we launched that product. We launched it, really, in the spring of 2010. So it continues to gain momentum. It continues to gain critical mass. But it's still, versus the industry, we under index. So, on a like-versus-like basis, we're fine. We just don't have the same presence in that channel of distribution as, let's say, the industry average.

Got it. Thanks for your time, Kent.

Sure.

Garik Shmois, Longbow Research.

Hello. Thank you. Thanks for taking my question today. First off, you mentioned that sequentially quarter to quarter, you had about a third of the margin degradation came from higher overhead costs, and those, I would anticipate, was coming from the performance-based compensation expense. Is that expected to continue again into the third quarter, a sequential increase?

There's a couple -- certainly there is some performance based in there. The other one is, there were just some timing associated with, I'll just call it the lumpiness of expenditures. So there are certain expenditures that you have -- for example, hiring and relocation costs -- that don't come in equal increments. And that is one of the big -- probably one of the big items that we had in our manufacturing and overhead line was we hired a couple of senior people and we had their hiring and relocation costs.

So I would say that, going forward, our expectation is the first quarter was probably a little abnormally low, the second quarter was probably a little abnormally high. So my expectation would be that those overhead costs would moderate as we got into the second half of the year.

Okay. And then, I guess switching to pricing. You're indicating that you're going to be lapping some tough comps on the new housing side, repair and remodel still pretty choppy. You are seeing raw material inflation, which normally would be supportive of pricing, and you're getting pricing in the market.

But is there any concern right now that some of the promotional activity that's abated over the last several quarters starts to come back, as the industry starts feeling a little bit uneasy about the rate of volume growth?

Well, yes, sure. We all have, from the six years we've been through, those scars, if you will, are pretty close to the surface. So there's always, I think, some concern that we might get a heightened level of promotional activity that might come back in.

My view is that, while that's possible, I don't think it's probable. I think the industry is running at capacity utilizations that are very different than they were three, four years ago when a lot of that really started. I think that people are a little bit more -- with that, are a little bit more concerned about concentrating on the business that they are doing or covering some reasonable margin structure.

So while I think that, that's possible, I think there have been some things, particularly the utilization capacity, utilization in the industry, that are different than they were three or four years ago. So my guess is, it's probably pretty stable. Now, of course, anything can happen, but my guess is it's probably pretty stable. I don't see the industry kicking off another round. But you never know.

Okay. Thanks. And just one follow-up question to the incremental margin question that was asked previously. With respect to what happened in the quarter and your view on raw material cost inflation moving forward, and again, some of the volume trends that are starting to emerge, is there any change in your view, long-term, to the 25% to 30% incremental margin outlook that's been provided previously? And should we be concerned at all that the long-term view, what the business could do, is at risk?

Well, the target that we put out there is we think, particularly as we go through this recovery phase to get back to some historical norms, in terms of marketplace volumes and those types of things, that band that we've given of 25% to 30% is still a band, as a target, that we're comfortable with. And even, we did get -- comps are starting to come up in the second quarter. We had some, like I said, some additional material inflation.

The growth in new construction, the continued growth of new construction out of balance with remodeling, because that does have a higher cost of goods sold content for us. And even with some of our overhead expenditures, we still were basically at the bottom of that 25% to 30% band. And through the six months, we were over that band. So that's still our target.

As you talk about longer term -- longer term, our target, particularly when you're in a recovery phase getting back to some level of normal volumes in the marketplace, which would be, call it 1.5 million starts and probably in the low 6.2 million to 6.4 million existing homes sold. As long as we're back on that kind of a journey back to those kind of normalized or historical averages, we would look to continue to do that 25% to 30% incremental.

Okay. Thank you.

Sure.

(Operator Instructions)

Nick Coppola, Thompson Research Group.

Good morning.

Good morning.

Going back to raw material costs, as you -- what did that really hit? Was that more of an October phenomenon or was it throughout the quarter?

It's not limited to a month. We started to get to see -- there had been some discussion about it, and some conversation in the building materials industry going back to last year. We really started to see it, in terms of spot market and other direct market activity, at the beginning of calendar 2013.

But based on our contractual relationships and the partnerships we have with vendors, we didn't really see it start to flow through our books until sometime after that. So it probably really started to hit us late first quarter; but certainly, we got quite a bit of it in the second quarter.

And now did the Chinese plywood tariff issue have an impact on you?

Well, when that -- when it was initially done last year, last December, when the initial ruling was that there was dumping, we saw the markets move in anticipation of that. The pricing in the market moved up significantly, high 15% to 20%. It moved pretty quickly and then leveled out. Of course, the initial decision by Commerce was not upheld by the ITC, it was overturned. And so that's been a relatively recent event. And so I'm not sure exactly -- we haven't really seen a lot happen one way or the other in the plywood market since then.

If you think the run up in January, February, March was due to the potential for the dumping to hold, then you might anticipate that the markets would settle back down, maybe not go all the way back to where they started, but would certainly settle back down. But we haven't really seen that yet. But that's only one of the material components.

Lumber has been on -- hardwood lumber has been on a pretty steady march up now for well over a year. And we're also seeing pressure in other things, like finishing materials and particle board and liner board and those types of things. So, we're in a general inflationary environment here. It's not just plywood.

Okay. That's helpful. And you may or may not be able to answer this one, but looking for a little bit more color on what growth CapEx could look like? I know last quarter we talked about what kind of runway you have left, and just wanted to see if you had any updated thinking on that?

I'm sorry. Something happened right there in the middle there, and there was kind of a skip. It was about revenue growth?

No, no, I'm sorry. CapEx, growth CapEx last quarter. There was some comments about 18 months of runway and you were evaluating alternatives.

Yes. We still are. We actually, in our discussions with the Board, we did present them some long-term capital forecasts. And that fed into the decision on the new share repurchase program. And we are still presenting alternatives to the Board.

When we get to the point where we -- if it involves a significant investment, a change in our CapEx outflow, we'll actually go ahead, at that point, when the Board approves that, which may or may not be before the next regularly scheduled meeting, that we would go ahead and do a release on that, so everybody knows what that is. But when you go through these -- we have presented some things to the Board. They've had some questions. The discussions are ongoing.

As we've talked about before, our current forecasts continue to suggest that we need some meaningful capacity in the spring of 2015. And if you back that up in terms of the lead time of a facility and equipment, our target date to make a decision is certainly early in calendar 2014. So certainly before the springtime, we would look to ask the Board to approve our capital plans, and then we would be able to communicate that.

Okay. Great. Thanks for taking my questions.

Sure.

Peter Lisnic, Robert W. Baird.

Good morning, gentlemen.

Good morning.

First question, I just want to make sure I understand the margins and pricing and everything. In the second quarter, did you realize any price to offset some of the raw material costs or did you realize any price in the quarter to help offset some of that impact?

It was de minimus.

Okay. Presumably you've put through a price increase, because I think the comment was in the back half, if materials stabilize, that you should largely cover the inflation, all else equal, correct?

What I actually said was -- and there was a little bit in there between both actual and anticipated costs. But in the pricing that we've seen in the marketplace, it doesn't quite cover everything we've experienced in terms of cost inflation so far, but it is significant.

Okay. All right. So can you give us a little bit of help as to what sort of incremental price, all else equal I guess, if commodities stay where they're at, what sort of price increase you might need to help cover what you've seen so far from an inflationary standpoint?

Well, what I said is, our material increase year-over-year is 260 basis points in the second quarter, so --

And materials is what percentage of sales, or COGS? (Laughter) I can try, right?

Historically, what we've talked about, just in real rough numbers, is our cost of goods sold is about one-third material, about one-third labor and associated costs, and it's about one-third overhead. With the inflation we've had, material inflation we've had over the last year or so, materials probably moved up from that a little bit. But that will get you in the ballpark.

Yes. Okay. That's helpful. And then just in terms of your end-market exposures, in terms of a potential incremental price increase, that's not something that you can do real time, correct? There's only certain points during the year where we can expect to see some sort of price increase?

Well, yes. Again, in a normal environment, that would be the case. There are -- and they're different based on your channel of distribution. If you get on the new construction side, the vast majority of our volume on the new construction side with the national and regional builders is contractual relationships. And those contracts have clauses in them that relate to passing through price increases.

Each contract is a little bit different in terms of the wording. Each contract has many different trigger points in different periods. So on the new construction side, it does take some time between when you decide to go to the marketplace that the market will support it, and when you can actually get that through your pricing.

On the remodel side, it's pretty similar. You have a couple of windows a year, usually, where you can go ahead and try to get a price increase through, not 100%, but that's about what it is. And that's why, in my comments, the guidance I gave or the comment I made was that we expect to see that pricing become effective through the third quarter.

Okay.

And be fully in effect for the fourth quarter. So we would expect it to be, even when we saw it really at the beginning of our second quarter, three months ago, and started to move that way. Again, that's kind of that six-month lag we've talked about for a long time.

Okay. All right. Got it. And then, just on the capital allocation, the press release with the share buyback, I was just wondering, in terms of, as you look forward, and the Board, any sort of discussion about reinstituting a dividend of any kind? I know we've talked about it in the past, but just wondering if that came up during the conversations?

Of course, all of our capital uses, including any returns of excess cash not needed to reinvest in the business to the shareholders, that's always a topic of discussion. And at the moment, for quite a lot of reasons, I don't know if you want to go into them all, but the Board is not of a mind to put a dividend back in.

Okay. All right. That is very helpful. Thanks for your time.

Thanks, Pete.

(Operator Instructions)

And we have no further questions in the queue, and I'd like to turn the call back over to our presenters for any additional or closing remarks.

Thank you. Since there are no additional questions, this will conclude our call. Again, thank you for taking time to participate. And speaking on behalf of management of American Woodmark, we appreciate your continuing support. Thank you, and have a good day.

That does conclude our conference for today. Thank you for your participation.