American Woodmark Corp (AMWD) 2014 Q3 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 us to read the following Safe Harbor statement under the Private Securities Litigation Reform Act of 1995. All forward-looking statements are 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 would like to turn the call over to Glenn Eanes, Vice President and Treasurer. Please go ahead.

Thank you. Good morning, ladies and gentlemen, and welcome to this American Woodmark conference call to review our fiscal results -- our financial results for our third fiscal quarter ending January 31, 2014. Thank you for taking time to participate. Participating on the call today from American Woodmark will be Kent Guichard, Chairman and Chief Executive Officer. And Kent will begin with a review of the quarter and conclude with an outlook on the future. After Kent's comments, we will be happy to answer your questions. Kent?

Thank you, Glenn. Good morning, everyone. As you know, we have released the results of our third fiscal quarter ended January 31, 2014. The quick financial headlines for the quarter -- net sales were $169 million, representing an increase of 12% over the same period last year. And reported net income was $2.9 million or $0.18 per diluted share in the current fiscal year versus $2.1 million or $0.14 per diluted share last year. Now, that brings us through nine months into January of the current fiscal year to year-to-date net sales of $538 million, which is an increase of 17% over the same period last year. Net income is $14.4 million or $0.95 per diluted share in the current fiscal year versus $4.6 million or $0.31 per diluted share last year. And for the first nine months of the current fiscal year, the Company generated $23.5 million in cash from operating activities compared to $2.6 million for the first nine months of last year.

Underneath the headlines, let's start with sales performance on the new construction side. Single-family housing starts impacting the Company's new construction business were effectively flat for the period covered by our third quarter. Single-family starts going back a little bit to 2012 -- single-family starts during May, June and July of calendar 2012 averaged approximately 520,000. Starts increased almost 15% in September and October of 2012, reaching 591,000 and 595,000, respectively.

Jumping ahead to 2013, September and October starts in calendar 2013 average 590,000. So if you apply a 60 to 90-day lag between housing start and the cabinet installation, the overall market activity in single-family homes was effectively flat for the period covered by our financial third quarter.

In this environment, our new construction-based revenue increased over 25% for the quarter, a reduction from the over 40% growth in recent quarters, due to a combination of the flattening of market activity on a comparative year basis, and our efforts over the last 12 to 18 months to exit nonstrategic low-margin pieces of our business mix. The planned exit of those pieces reduced total company growth in the quarter by an estimated 5%. Our growth in excess of starts continues to be driven -- on the new construction side, continues to be driven by our partnerships with national and regional builders that are gaining share of total starts, and by our increase in share penetration with those builder partners.

Moving on to the remodel side of the business, the picture turned last quarter -- actually, the last couple of quarters; we've talked about the remodel side having a mixed picture. In our latest quarter, the third quarter, the picture turned from mixed to negative. Residential investment as a percentage of GDP for the fourth calendar quarter of 2013 declined sequentially for the first time in well over a year, reversing a consistent trend of improvement. The index had increased one-tenth of a point from 2.7 for the quarter ended June 2012 to 3.2 for the quarter ended September 2013. For the quarter ended December 2013, the index declined to 3.0, just slightly above the 2.9 for the quarter ended December 2012 a year ago.

Existing home sales also retreated at the end of calendar 2013. Between January and August, existing home sales increased almost 10% from 4.9 million annualized units to 5.4 million units. By November, existing sales dropped over 10% to under 4.9 million units. And December 2013 was actually below December 2012. In addition, the percentage of homes purchased for cash reached an all-time high, signaling a significant increase in investor activity. This corresponds with the drop in residential improvement activity, as investors are less likely to upgrade significant features in recently-acquired properties.

42% of November purchases were all cash, with several key markets well in excess of that level. Florida, for example, reported 63% of existing home sales in November were cash transactions. Georgia and Nevada reported 51%; South Carolina 50%. Interest rates have also risen. They are up a full point since the beginning of calendar 2013, from 3.5% to 4.5% for a 30-year fixed rate mortgage. Combined with an over 10% rise in average home prices, the affordability index has declined, both disqualifying many first-time buyers and reducing discretionary funds available for major remodel activity on the part of the successful buyer.

Unemployment has improved marginally. The U3 unemployment rate dipped below 7% for the first time in six years. U6 also declined but remains problematic at 13%. When you look at all that, our overall evaluation of the remodel side of the industry is that we are experiencing something of a bifurcation in the consumer, with the upper part of the market sustaining a positive trend line, and the middle of the market demonstrating skittishness and reluctance to pull the trigger on big-ticket discretionary remodel projects.

We are seeing this tale of two consumers through the channels of distributions with dealers who tend to have more affluent customers with household incomes over $100,000 per year outperforming big-box and distributors with remodel operations, who tend to have more mid-level consumers with household incomes in the $50,000 to $60,000 range. Our Waypoint dealer business continues to gain momentum, but we still are overindexed versus the industry to big-box distribution. As a result in this environment, we lag the industry in overall growth on the remodel side, with a small decline in units more than offset by mix and pricing.

As a transition to discussing gross profit performance, from our perspective, it really comes down to a question of your interpretation of, and conclusion from, the decline in virtually all of the relevant market drivers at the end of 2013. Specifically, do you believe that lower demand in October, November and December was an aberration from the trend line, and hence we will return to the recovery; or a fundamental altering of the trend line, in which case the period ahead is on a different trajectory? Our view as we sit here today is that it is most likely the former, an aberration from the trend line.

In our opinion, the government impasse that led to the government shutdown in October had a deep impact on the consumer. Consumer sentiment rose from the low 70s in January of 2013 to the mid-80s in June, July and August. Even in September, as the political fight was beginning to unfold, sentiment remained in the low 80s. In October, it dropped to 77; in November, to 73. And consumer sentiment remained in that range at about 75 in December. At the time it was particularly impactful on our industry, as it coincided with both the traditional year-end push by builders and the fall remodel selling season. In support of our view that the last few months is an aberration, consumer sentiment has rebounded to the low 80s in both January and February.

The choice then that we faced, having built the crewing and other infrastructure to support the trend line, is what to do during the hole created in the aftermath of the shutdown. In our opinion, and from our perspective, the answer was quite clear. You simply can't take out the crewing and infrastructure only to put it back in 90 days later. As a result, we held onto the crewing and infrastructure during the third fiscal quarter with a negative impact on short-term gross margins.

The Company's gross profit margin for the third quarter of the fiscal year -- of fiscal year 2014 was 15.4% of net sales versus 15.5% reported in the same quarter of last year. On a year-to-date basis, gross profit margin is 17.1% compared to 15.3% for the same period in the prior year. Year-to-date, the Company has generated year-over-year incremental gross margin of $21.6 million on incremental net sales of $78.3 million, resulting in an incremental gross margin rate of 28%. For the latest quarter, gross margin versus the prior year, gross margin was negatively impacted by both material inflation and costs associated with the crewing and infrastructure to support higher levels of sales and installation activity.

We continue to experience inflationary pressure across a broad range of direct material inputs. That continued during the third quarter, particularly on all species of hardwood lumber. Our average unit material cost increased almost 10%. While the higher material cost was partially offset through customer management, product mix, and some pricing relief, gross margin was still adversely impacted by continuing increases in material cost. We anticipate that material inflation will continue in the periods ahead.

Based on the previous discussion, gross margin was also negatively impacted by our decision to retain the crewing and infrastructure necessary to support higher volumes, which we believe will accompany a return to the trend line in place prior to the government shutdown in October of last year. To the extent it may take longer than anticipated to return to the trend line, either due to economic shocks, which impact consumer confidence, or other factors such as the severe weather across much of the country in recent weeks, these higher costs may continue to negatively impact margins for the period ahead. Should we conclude that the industry will not return to the trend line, we will move to reduce these costs in line with the anticipated volume.

The negative impact from rising material costs and additional infrastructure was offset by lower labor costs, and leverage on fixed and semi-fixed overhead. Direct manufacturing and labor cost improved as a result of higher productivity and reduced benefit expenses, primarily from lower medical claims and changes to our retirement programs. In addition, the Company generated leverage on overhead. Overhead spending increased 4% on the 12% increase in sales.

Regarding our operating expenses, total operating expenses improved from 13.0% of net sales in the third quarter of the prior year to 12.4% this fiscal year. Through nine months, SG&A improved from 13.4% of net sales to 12.5%. Breaking that down between selling and marketing expenses and G&A, selling and marketing expenses were 8.5% of net sales in the third quarter this year compared with 8.6% in the prior year. Our selling and marketing costs generally flexed with activity. General and administrative expenses were 3.9% of net sales in the first quarter of fiscal 2014 -- excuse me, the third quarter, compared with 4.4% in the prior year. The improvement in our operating expense ratio is the result of leverage from higher volume and lower pay-per-performance employee costs.

Briefly on capital spending and cash flow, the Company generated operating cash flow of $23.5 million through the first nine months of fiscal 2014, an improvement of $21.3 million over the same period in the prior year. The improvement in operating cash flow was driven by higher profitability, more efficient inventory management, timing associated with the payment of various accrued liabilities, and lower pension contributions. Our net cash used by investing activities was $8.3 million during the first nine months of the current fiscal year compared with $4.2 million during the same period of the prior year.

The increase year-over-year was due primarily to proceeds from asset sales in the prior-year which did not reoccur in the current fiscal year. The Company has increased cash by $29.1 million during the first nine months of fiscal 2014 and ended the third fiscal quarter with $126.1 million in cash on-hand.

In closing, the third fiscal quarter presented some different challenges than we've faced over the last few years, most notably the adverse impact the government shutdown had on confidence, and the middle income consumers' appetite to purchase a new home or begin a big-ticket discretionary home improvement project. We made progress in stemming the tide of material inflation, cutting the year-over-year drag on gross margins in half from the previous quarter, and securing partial recovery from the market for increases absorbed in early 2013.

We also made progress in returning direct labor efficiency to higher levels, a significant improvement from both the same quarter of the prior-year and from the second quarter of the current year. And we generated favorable leverage on our semi-fixed and fixed overhead with additional volume. Our financial results for the quarter were, however, negatively impacted by crewing and other infrastructure we put into place during the late summer and early fall to support the trend line. When the industry fell short of that trend line, we made the decision to maintain the higher level of infrastructure and thereby cost, believing that the industry would return to the trend line this spring.

At the end of last quarter's call, I commented that the return to normalcy will not be linear, and that one of our two biggest challenges would be balancing our cost structure with demand in an extremely fluid environment, made even more volatile by the dysfunction in Washington and the negative impact successive rounds of partisanship behavior have had on consumer confidence. During the third fiscal quarter, we were out of balance. As we have shared with you over the years, we will always err on the side of making sure we can continue to provide superior service and support to our long-term partners. And this results, on occasion, with short-term excess costs.

As we get into the spring, we will see if our challenges of distribution return to the trend line as we suspect, or if the government shutdown and successive events has altered that trend line. If it has been altered, we will move to adjust our infrastructure in line with demand.

That concludes my prepared remarks. At this point, I would be happy to answer any questions you have.

(Operator Instructions) Scott Rednor, Zelman & Associates.

Hey, good morning, Kent. A quick question for you on the gross margin. I guess there's lots of puts and takes, and I could appreciate that you guys kept labor but yet also the offsets from exiting lower margin business. So when we see some of your peers out there who have similar or even weaker growth and are posting margin improvement, and your margins are pretty flattish year-over-year, can you help us explain the disconnect there?

Well, I won't speak to anybody else in the industry; they have different cost structures, they're in different channels, they make different choices. I'll just speak to our performance. And as I kind of mentioned on the call, our topline was 12%. If we hadn't taken the actions that we took over the last year, year-and-a-half, to get out of some of the business that wasn't sustainable at -- you know, when we have to carry full costs, and you're not running the business kind of on an incremental basis, as we were through the recession, that would have added about 5% to the gross. So it would have been about 17% as opposed to the 12%.

Longer-term, we still think that those are good decisions. But in the short-term, those things did have positive incremental contribution. They couldn't carry the full load of fixed cost, but they did make a contribution. So that -- exiting those businesses in the short-term had a little bit of an impact. But the real drivers of the two -- one we've talked about for quite some time now, which is material inflation. And the other is that, based on the trend line, we had put crewing and other infrastructure in place, particularly out in the field, to deal with installations and those types of things supporting a lot of our builder customers.

And the business just didn't come in. And again, it goes back to the -- you know, the real question is, is it temporary on the back half of the shutdown? Or is it something that's really changed the trajectory? But from that perspective, it's -- the material is basically what we have been struggling with for a while, although we did make some progress. The other one is our decision to keep those people in place, believing that it's an aberration to the trend line that we saw in the quarter, not a permanent change in the direction of the trend line.

So just based on those comments there, in your backlog, are you seeing that improvement of that demand starting to come through?

Well, we're seeing some seasonal improvement with the demand. We are kind of through the dark period. One of the old kind of adages in the industry is between December 15th and January 15th, you try not to make any decisions if you don't have to; because when it's dark, it's really dark. And that's just really the low point for the industry.

So we are starting to see, as we come out of January, halfway through February here, we are starting to see some of the seasonal change in terms of coming up. Now, it's a little bit difficult to gauge the extent of that change. Certainly, the weather, the successive rounds of weather that have rolled through the country, particularly that have hit the Midwest -- the Northeast has really been hit hard on successive waves -- it's difficult to actually quantify what impact that has.

We did see, if you look at November and December starts, they did jump up. We ran that kind of that 590,000 -- 600,000 for September and October. They jumped up to over 700,000 in November, and retreated a little bit to about -- a little under 670,00 in December. Wait 60 to 90 days, is when those investments start to come through our system in terms of the cabin installs. So I'm hopeful and encouraged that that start number went up, although that would not have really hit our backlog yet.

So, we are seeing a little bit of an increase, just based on it being February as opposed to December and January. But in terms of actually getting back on the trend line that we saw prior to the government shutdown, I think it's a little bit too early to call whether we're actually going to get back on that trend line for the spring selling season.

Okay. Thanks for that. And just last one for me, can you just talk about the balance between -- if you thought about it on a net basis -- between the raw materials and the incremental pricing? It seems like your past comments have stated that if there is sustained inflation, the industry will take price. And that certainly seems to be what's going on this calendar year. So, how should we think about the net impact in terms of going forward?

Yes. To go back to the last couple of calls, we've talked about the impact on gross margin, over 200 basis points, you know, 220 -- 240, in that range. And for the quarter, not all of it was pricing. Some of it was customer and product mix. But generally, on the materials side, if you look at it, we have about cut that decrement in half in the third quarter on a year-over-year basis. So we made some progress, but we are still behind at well over 100 basis points on a year-over-year basis in terms of the impact of material inflation.

Okay. Thanks, Kent.

Sure.

Peter Lisnic, Robert W. Baird.

This is John Shannon filling in for Pete. Kent, just going back to the previous comment about raw material inflation, I guess, is it the expectation to be able to offset some of the inflation by the fourth quarter? Or do you think that it might take a little bit longer than that?

Well, it's kind of like a -- if inflation had stopped and there was an end date to it, then I could probably give you a better idea about how long it would take us to recover. But inflation continues to kind of march along. And so, we have recovered a good chunk, as I said in my comments, of the inflation that we saw in early 2013. But since that time, since we put together those pricing structures and the market has gone out to recover that, we've had additional inflation. If you just go out and look at the hardwood market reports, you can see that hardwood continues to increase at a rather significant rate, pretty much all of the hardware that we use.

So we're kind of in a catch-up. And until it slow -- stops or even slows down significantly, we are always going to be a little bit of a catch-up. As I've said in the calls over the years -- I don't exactly remember which one we talked about it most recently -- but our industry is not an industry over time that has been able to get anticipatory price increases. They have been more, once the inflation is here, we go out and recover it. And so we're always going to be -- as long as inflation goes up, we're always going to be a little bit behind the curve in terms of recovering all of it. When we do have enough of it out there and the market goes out to get it, generally, as we've talked about before, that's a six to nine-month lag.

So that's kind of a long explanation. But as a way of setting up in the fourth quarter, I would anticipate we would continue to feel something of a drag. We would hope that it would be reduced, as it was in the third quarter versus what it was in the second quarter. But again, that just depends on what happens in the raw material markets.

Right. That makes sense. Okay. And if I shift over to your comment about the crewing being out of balance with the current volume, I guess, is there a way to ballpark sort of how much volume growth do you need to see before you're able to sort of absorb -- bring that back into balance, if you will?

Yes. I mean, if we -- if you go in and look at where we were on trend line through the third quarter, we had expected and kind of put in the infrastructure to deal with volume that was a good 10% to 15%, probably closer to 10% but 10% to 15% higher than we actually experienced. And so you kind of do that math. If we'd had 10% to 15% more in demand, we would have been able to cover those costs. So that's about what the number is.

Okay. And then last question. I think, previously, you had mentioned potentially needing some capacity expansions in calendar 2015. Have you made any decisions on that in terms of whether to go forward with those kind of projects?

Yes, we have not. We -- our forecast, our longer-term forecast, has suggested that we needed some capacity in the spring of 2015. Now, we have been able to pull that -- or move that out just a bit, because we have done some things such as getting out of some of the lower margin business, nonstrategic lower margin business. We have set up a few more outsourcing arrangements. So, we may have moved that out a little bit.

But, generally speaking, we still think that it's probably in that range. And we have to start maybe a year ahead of that. And so, in terms -- depending on the option that we choose, a greenfield would be a full year. If we decide to do an expansion of an existing site, you are probably more 9 to 10 months. So the decision point for us is really the spring.

We have all the work done in terms of what our options are, and the one that we would recommend to the Board that we pursue. But we're going to wait, as we get into the spring here, and again, see if we are back on that trend line or if there has been some longer-term change to the trajectory. If there has been a longer-term change to the downside, then, obviously, our need for capacity moves out. If we are back on the trend line, then we would look in the spring or early summer to go ahead and start that project -- present it to the Board and start that project. And at that time, we would communicate it.

Great. Thank you for your time.

Sure.

Garik Shmois, Longbow Research.

This first question is on mix. It didn't seem like there was as much of an impact on mix as there has been in prior orders, but just wondering if you could call out some of the puts and takes around mix in the quarter, where you saw potential headwinds or benefit?

Mix from what perspective?

Both from a customer standpoint and from a product standpoint.

Okay. Yes, our product mix has been pretty stable. On a year-over-year basis, it's improved but it's been pretty stable. Generally speaking, we do the big launches in the fall and they usually have an impact in the spring. So the product launches we did last fall wouldn't have really changed our mix a whole lot. So, generally, the mix, certainly sequentially. And even over the last year, I mean, sequentially, they have been pretty stable over last year; there's still a bit of an improvement.

If you look at it between channels, nothing significantly different. It's just that we kind of continue -- now we've had several orders of the new construction business growing significantly. Now we're off the 40% that we ran for a few quarters, but 25% on the new construction side, or over 25% is still -- that business is still growing and recovering faster than the remodel side is. So we kind of continue on the trend of weighting -- reweighting the business more towards the new construction side than the remodel side, just based on the growth trends in the end markets.

Okay. And you mentioned that by exiting some of the new construction business, it was about a 500 basis point impact to revenues in the quarter. Is the strategy to continue to exit some of the less profitable new construction customers, in that you may end up underperforming the prior trend? Or was this a one-time strategic change?

And then, I guess, secondly, if you could provide maybe a little bit more color with respect to the gross margin, I guess, net benefit from that move in the quarter, maybe what we should expect moving forward?

Yes. I mean, it's a process that, when the industry started recovering, everybody was looking at using up their capacity quickly. As I mentioned on a few calls ago, we kind of looked at that and said that we had taken on some business during the recession that made sense during the recession, because it added incremental dollars with the capacity that we had. When we started to look at having to add new capacity, with business having to carry full costs as opposed to just incremental contribution, there were certain business -- certain pieces of business that we took on during the recession that didn't make sense in an environment where you're at full capacity, and you're looking at adding -- you know, having to justify the addition of capacity.

It takes a while to exit out of those businesses and really fold the tent. We don't leave customers in the lurch. We work with them to transition them to another supplier. So that's been an ongoing process for 12 to 18 months. We've really kind of stopped that process at this point. Now, because it's been an ongoing process for a few quarters from now, we will continue to have that, if you will, reduction or drag on the growth rate. Because until we get out -- until the end of this calendar year, early into calendar 2015, you will still have some of that in the comp period. So it will continue, but it will kind of decline as we go forward from here, in terms of its impact on the growth rate.

In terms of its margin in the current quarter, in the current quarter, it would have hurt margins. I kind of alluded to that in one of the previous questions. It would have hurt margins. Because that business did contribute, and we didn't run at capacity. And so we gave up some incremental dollars during the third quarter because we had to exit out of those businesses.

We still think that that was a good decision. Because as this thing gets back on trend line at some point, and the industry continues its recovery -- now, remember, we are still well below the long-term average in requirement to build 1.4 million to 1.5 million houses per year, and there's -- the private residential investment as a percentage of [GP] still has to recover back into the mid -- low to mid-4's, where it's been historically. So, as we get -- as that comes back and we get back to capacity, we think the business that we have replaced that with will be at higher-margin. But in the third quarter, it actually hurt margins.

Okay, thanks. And then just last question with respect to inventories at home centers, as far as you can tell. Is there any risk that they are carrying higher levels of inventory relative to seasonality? And then if you come back and start to see the trend line improve, that the rate of volume recovery for you may take a while, as inventories getting balanced downstream? Or are you not seeing much of a impact with respect to inventory stocking right now in the customer base?

Well, all of our -- on the home center side, we don't -- there are no inventories. We're not a stocking distributor. We're -- entirely all of our business is special order, so we basically make to order and ship it. So everything we make has a customer name on it. So there's no pipeline expansion or contraction through the distribution channel.

We really don't carry any finished goods. What you see on every one of our balance sheets for finished goods is really in-transit material; is final passes upon delivery. So that's our in-transit material. But all of our finished goods has a customer name on it and, in essence, has been paid for or will be paid for. So there's no inventory. We don't have a pipeline, there's no inventory in the system. So we are pretty close to real demand.

Okay, thank you.

Sure.

(Operator Instructions) Sam Darkatsh, Raymond James.

This is Josh filling in for Sam. Thanks for taking my questions. First, I want to clarify and make sure I heard correctly. You said 100 basis points of year-over-year headwind to gross margin from raw materials. That was net of price and mix offsets, correct?

Yes. I mean, you've got several things in there. I mean, as I alluded to, you do have some changes in customer mix; you do have some change in product mix; and you do have some recovery of some of the inflation that we saw in early 2013. The last couple of calls, we've talked about the margin drag being well over 200 basis points. And effectively, in the third quarter, we cut that in half.

Okay. And assuming we return to trend line going forward, what should we be looking at for your incremental margin, given that you have already stepped up some of the crew capacity?

Well, again, we go through -- on an individual quarter, obviously, things can happen. Our target remains gross margin of 25% to 30% incremental on revenue growth. We were above that at the beginning of the fiscal year. We are obviously below that in the third quarter. But we are still kind of in that range, 28%, a little bit around there for the first nine months. So, over time, if you look at it over, call it, a rolling year or whatever it is, we would look to still deliver that 25% to 30%, with some quarters being above that and some quarters being below that.

And you talked about the dealer channel tending to perform stronger than big-box. Could you give us a sense of how big that business has become for you now, and what traction you are gaining in expanding that part of your business?

Yes, it continues to roll along. We started about three -- a little over three years ago. Last year, late last year, last fiscal year, it became 10% of our business. It's continuing to roll along. It's approaching the mid-teens of our total remodel business, so it continues to grow very rapidly. We continue to do well not only signing up new dealers, but penetrating share within those dealers. But versus the industry, we still overindexed the big-box. So, on the weighted average basis, we still have -- we'll still be behind the curve, if you will, just because of that mix. But we continue to do pretty well; we're pretty happy with that business.

Thank you.

And it appears there are no further questions. I will turn the conference back over to our presenters for any additional or closing remarks.

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

This concludes today's presentation. Thank you for your participation.