PGT Innovations Inc (PGTI) 2007 Q2 法說會逐字稿

Good day, ladies and gentlemen and welcome to the Second Quarter 2007 PGT, Incorporated Earnings Conference Call. My name is Jendy and I'll be your coordinator for today.

(OPERATOR INSTRUCTIONS)

Today on the call we have Jeff Jackson, CFO and Rod Hershberger, President. Please proceed, Jeff.

Thank you and good morning. Welcome to PGT's Second Quarter 2007 Conference Call. I'm Jeff Jackson, CFO of PGT and I'm joined today by Rod Hershberger, President and CEO. We will represent PGT on this morning's call.

Rod will provide an overview of the Company's performance for the second quarter and first half and I'll discuss our results in more detail.

We'll also discuss our continued efforts to advance our value enhancing strategy, our thoughts on the housing market and then we'll take questions.

Before we begin, let me remind everyone who's listening that today's conference call contains statements concerning the Company's future, prospects, business strategies, and industries trends.

Such statements are considered forward-looking statements under the Private Securities Litigation Reform Act of 1995. These statements are based on current expectations and are subject to risk and uncertainty.

Actual results may vary materially from those contained in the forward-looking statements because of certain risk factors.

Please refer to yesterday's press release and our Annual Report filed on Form 10-K with the SEC on March 21st, 2007 for further detail. We undertake no obligation to publicly update or revise any forward-looking statements.

A copy of the press release is posted on our Investor Relations section of our website at www.pgtinc.com. Included in the press release are the unconsolidated balance sheets, a summary of consolidated statement of operations prepared in accordance with GAAP and pro forma information which has been quantitatively reconciled to GAAP.

Our Company uses non-GAAP measures as key metrics for evaluating performance internally.

A detailed explanation of these non-GAAP measures can be found in our Form 8-K filed yesterday. These non-GAAP measures are not intended to replace presentation of financial statements in accordance with GAAP.

Rather we believe the presentation of earnings excluding certain items provides additional information to investors to facilitate past and present operations.

With that, let me turn the call over to Rod. Rod?

Thanks, Jeffery and good morning, everyone. We have a few items to share this morning and we'll do so in the following order.

First, I will highlight our results for the second quarter and first half of 2007 and then provide an update of our key strategic initiatives for the remainder of 2007. Jeff will follow-up with a detailed review of our financials for the second quarter and first half of 2007.

As I mentioned in our press release the building industry in which we operate continues to see significant deterioration in new construction starts as evidenced by a decline in new housing permits of 46% in the second quarter of 2007 versus the same period in 2006.

Our revenues decreased 26.7% in the same period driven by lower unit volumes particularly in our aluminum product line which was down 47%.

We were able to offset some of the decline in the industry by focusing on our repair and remodeling business or as we refer to it R&R.

Compared to the second quarter of 2006, sales of R&R were essentially flat this past quarter, but were up 31% over the first quarter of 2007.

It is also important to note that as a percentage of the total sales for the quarter, R&R sales accounted for 56%, compared to 44% for new construction. This is quite a switch from the second quarter last year when new construction represented 61% of total sales.

For the second quarter, a combination of decreased volume and the rising cost of aluminum partially offset by a favorable mix shift toward our WinGuard branded and Architectural Systems products lines and a decrease in SG&A spending resulted in an adjusted net income of $3.3 million versus adjusted net income of $13 million in the prior year's quarter.

We continue to invest in our marketing efforts. Our marketing expense was $2.2 million in the second quarter of 2007 versus $2.3 million in the same period a year ago.

Focus on spending in the second quarter was in our R&R markets with an increase in consumer promotions and advertising co-op allowance to our distributors. We believe it is important to invest in this area during periods of cyclical downturns in order for us to achieve our goal of increasing market share.

We remain disciplined in our spending with our sales, general, and administrative expenses which we have decreased by $2.1 million from the prior year quarter.

Net income per diluted share was $0.10 for the quarter compared to $0.55 for the second quarter of 2006. Adjusted net income per pro forma diluted share was $0.12 for the second quarter versus $0.47 for the same period in the prior year.

For the first half of 2007, new housing permits in our primary markets were down 49%, while our net sales were down 25.7%.

Adjusted net income for the first half of 2007 was $4.1 million or $0.14 per pro forma diluted share compared to $19.8 million or $0.71 for the first half of 2006.

We continue to manage our capital structure well. Optional debt repayments totaled $5 million in the second quarter of 2007 for a total of $25 million through the first six months.

As of June 30, 2007 our cash balance was $18.9 million and our net debt was approximately $121 million. We believe our plan for managing through the housing downturn as detailed in previous calls is still the right strategy given the market conditions.

As a reminder, this plan includes generating incremental sales, increasing market share and introducing new products while focusing on decreasing operating costs and conserving capital.

We have made some good progress in these areas specifically managing our cost structure as you will in the results for the quarter and first half that Jeff will now review in greater detail.

Thanks, Rod. Let me give you more detail on the quarter and the year-to-date numbers. We reported net sales of $79.7 million for the second quarter of 2007, a decrease of 26.7% versus the prior year quarter.

This decrease was driven by our new construction sales down 44% versus prior year, as we continue to weather the impact of the declining housing market down approximately 47% in our core areas.

This decline was somewhat mitigated by a stable R&R market. As Rod mentioned for the quarter, our sales in the R&R market represented 56% of sales.

We also experienced a favorable mix with our WinGuard branded product representing 69% of total sales for the quarter.

This shift in product mix is consistent with higher R&R sales as impact products are the product of choice in the R&R market. We believe this gives us an advantage in these challenging market conditions.

On a sequential quarter basis compared to the first quarter of 2007 our sales increased 9.6%. This increase is mainly driven by our WinGuard brand, up $6.8 million over the first quarter of 2007.

Results by product line show our WinGuard branded product had net sales of $54.9 million in the second quarter of 2007. This represents a decrease of $16.8 million or 23% from the second quarter of 2006.

Our Architectural Systems sales were $4.7 million in the second quarter of 2007 which was $1.4 million lower than net sales in the second quarter of 2006.

This decrease in our Architectural Systems was driven by a reduction in our 800 Series product line who's sales have also been affected by the declining housing market.

Sales in our aluminum product category were $15.1 million in the second quarter of 2007. This represents a decrease of $13.6 million or 47% compared to the second quarter of 2006 as our aluminum product line is more closely tied to the new construction market.

Net sales for the first half of 2007 were $152.4 million which is a decrease of 25.7% compared to the first half of 2006 net sales.

As Rod mentioned before the decrease in revenues is driven by the downturn in the new housing market with starts down 47% in the first half.

Offsetting this partially is our improvement in product mix towards a shifting towards our WinGuard product brand and stable R&R market performance.

Our WinGuard branded products had net sales of $103 million in the first half of 2007, a decrease of approximately 22% from the first half of 2006. WinGuard sales represented 68% of total sales for the first half compared to 64% for the first half of 2006.

Our gross margin for the quarter was 36.4% versus 43.3% in the same period of 2006.

The main drivers for this decrease included the impact of the declining leverage we experienced due to our lower sales volume estimated at 380 basis points and the impact of aluminum cost increases, impacting our margins by approximately 290 basis points.

When comparing our margins to the past two quarters, we've shown significant improvement. As a reminder, our Q4 2006 gross margin was 28.8%.

We improved that to a 34.1% during the first quarter of 2007 and again improved our margin to 36.4% in Q2.

These improvements have been driven by an improved product mix, a reduction in operating costs including labor efficiencies with our workforce being down approximately 17% from its high in September of '06. Improved material usage and an overall reduction and various overhead costs.

The first half of 2007's gross margin came in at 35.3% compared to last year's first half gross margin of 40.4%. Again, this reduction was driven by decreased operating leverage caused by lower sales and the increase in aluminum costs.

Our selling, general, and administrative expenses were $21.7 million, down $2.1 million compared to the prior year's second quarter.

The decrease in SG&A was driven by lower distribution costs related to lower sales volume as well as the absence of management fees which were charged in the second quarter of 2006.

Offsetting these decreases was an increase of $826,000 impairment charge for our Lexington facility, which is currently held for sale.

As a percent of sales our SG&A increased to 27.2% compared to the 21.9% in the second quarter of 2006 due mainly to the decreased leverage caused by lower sales volumes as we previously discussed.

We continue to invest in our brand awareness especially in the Carolina and Gulf Coast markets to help drive our volume growth. Total marketing investment of $2.2 million was roughly flat in the prior year despite our decrease in sales volume.

For the first half SG&A was 27.5% of net sales compared to 22.3% for the first half of 2006, again mainly driven by a decreased leverage related to lower sales volume.

Interest expense for the second quarter was $2.8 million compared to $7.3 million for the second quarter of 2006.

The difference mainly relates to non-recurring charges incurred in the second quarter of 2006 associated with our February 2006 debt refinancing, as well as higher outstanding debt in the second quarter of 2006 of $320 million versus our debt levels now at the end of the second quarter of 2007 of $140 million.

On an annualized basis we expect our interest expense to be approximately $11 million to $12 million on current debt levels.

In the second quarter of 2007 our tax rate was 36.8%. This is lower than the 38.8% in the second quarter of 2006 due mainly to increase -- an increase in our manufacturing deductions related to the Jobs Creation Act. We expect our tax rate to average approximately 37% for the year.

Net income for the second quarter was $2.8 million versus $10 million in the prior year comparable period. This resulted in a net income of $0.10 per diluted share compared to income of $0.55 per diluted share for the same period last year.

After adjusting both quarters for items such as the Lexington impairment, expenses associated with our 2006 IPO and debt repayment our adjusted net income for the second quarter was $3.3 million versus $13 million in the prior year's second quarter.

Our adjusted net income resulted in $0.12 per pro forma diluted share compared to $0.47 per pro forma diluted share in the second quarter of 2006.

Our first half 2007 adjusted net income was $0.14 per pro forma diluted share versus $0.71 in the first half of 2006.

I'll encourage everyone to review the reconciliation attached to the earnings release for further detail and also more explanations on the changes.

Our EBITDA for the second quarter of 2007 was $11.1 million compared to $27.4 million for the second quarter of 2006.

On an adjusted basis EBITDA was $11.9 million or 14.9% of sales. For the second quarter of 2007 versus $28.4 million or 26.1% of sales for the second quarter of 2006.

For the first half of 2007, adjusted EBITDA was $20.2 million compared to $47 million for the first half of 2006. A reconciliation of the adjusted pro forma diluted shares, adjusted net income and the adjusted EBITDA that I've just described has been included in our earnings release for your reference.

Now let me turn to the balance sheet.

We continue to manage our resources well during this challenging market condition. As of June 30th, 2007 our net working capital excluding cash was $39.4 million or 12.4% of trailing 12-month sales. This compares to $36.5 million or 9.8% for the year ended 2006.

Accounts receivable increase related to our growth in our sales volume from year end. Inventory increased from year end due to the holiday shutdown at -- during 2006 we actually had artificially lower inventory as year end.

The current inventory levels are more in line with our current volumes. DSO decreased from 46 days to 39 days.

Offsetting this impart was a decrease in our other current assets which was driven by the Lexington impairment and an increase in trade accounts payable and accrued expenses mostly associated with timing.

Our first half of 2007 capital additions were at $6.2 million. Depreciation and amortization totaled $7.8 million for the first half. Our debt outstanding as of June 30th, 2007 was approximately $140 million through the first six months.

We repaid $25 million against our long-term debt. Our cash on hand as of June 30th was approximately $19 million giving us net debt of $121 million at quarter end.

Also in July 2007 we repaid an additional $4.5 million on long term debt bringing our net debt down to approximately $117 million as of this call.

We will continue to prioritize our cash flow in evaluating its use for organic growth, acquisitions or to continue to pay down debt when appropriate.

With that, let me turn the call back over to Rodney.

Thanks, Jeff. We are still in difficult market conditions that negatively affect our business and will continue to impact our operating results in year-over-year comparisons through the near term primarily due to the record results we experienced in 2006.

As I'd previously outlined we instituted several measures to stimulate sales as well as to reduce operating costs to counteract the current market conditions.

While there's been a decline in the housing market we believe that the U.S. Impact Resistant market will continue to grow over the long term and we will expand our presence in this market.

We recently introduced several new products which will help drive our traditional organic growth. While in addition, we will opportunistically review acquisition candidates as they come up.

I believe we have the right strategy and the right people in place to not only effectively manage for the current market downturn but also to quickly take advantage of opportunities as market conditions improve.

With that, I'll conclude and Jeff and I will be happy to answer your questions. Operator, if you'd like to take the first question please.

(OPERATOR INSTRUCTIONS) One second. We're standing by for the first question. Your first question comes from the line of Michael Rehaut.

Hi, this is Jen Consoli on the line for Mike.

Hi, Jen.

Hi, Jen.

Hi. How are you? Just -- I wondered if you could give a little bit more color on the new product offerings.

I know on the last conference call you kind of went through and said that you thought that the new products could contribute roughly $10 million to $15 million of sales in fiscal year '07.

Are you still on track for that and if you can give us some additional color on what those new products are and how they're doing.

Yes. We had approximately a million dollars worth of new product sales to date through the first six months. I would say we're closer to the $10 million level at this time. The new products if you recall were a higher and/or.

We had a new AS product that came on the market and we also released a lower line in our aluminum product series. So all are out on the market now but definitely in terms of its impact for the year I would say it's closer to the $10 million range.

Jeff, if I can just add a little bit of color to that. We're still -- I think I'd categorize as very happy with the product offering and the response we've been getting in the field.

However, we're not as happy as we could be with the number of orders that are coming in and I think a lot of that is attributed to a lot of these product serves in new construction market and it's attributed to the slowdown in the market.

So we think from a response point of view it's very positive. From the actual dollars coming in it takes a lot of work.

Okay, great. And then a quick follow-up. I was hoping to hopefully get a little bit more color on your SG&A and the seamless sales kind of stay constant at current levels. Where do you think SG&A is going to end up for the second half of this year?

Again, without giving you the exact percentage because we want to give guidance --

Right.

-- to that regard I mean we feel that as the market continues to progress and if it stays at its current levels we will take additional steps within our SG&A expense to bring costs out but again that will all depend on the market and the volumes that come in over the next couple of quarters.

There's no silver bullets in there other than we are -- this year we are getting 404 compliant. It will cost us when alls in close to $1 million dollars. Between $900,000 and $1 million dollars to get 404 compliant so that is in the numbers that hopefully will obviously not be in there next year but other than that there is no other costs.

We will continue to monitor our SG&A and as I mentioned earlier we did invest. We are investing in marketing and promoting our brand to try to take market share to spite the decreases in volumes and I think we've done that strategically and in line with our growth strategies.

So -- but I assure you Rod and I both look at that daily so it's something that we do monitor. We've taken costs out of the system in total as evidenced by our margin improvements but overall we'll see about the back half on this SG&A.

Okay. So there's costs initiatives that are kind of growing. In other words, you're continuing to look at it and it's not just the initiatives that you announced during your fourth quarter call?

Yes that's definitely the case. The initiatives that we announced back in the fourth quarter call obviously we're getting those benefits now and even improving a sequential quarter we continue to get more benefit from it as we identify additional cost areas.

It's not like a one time we identified them and now we're just going to get them. We do keep going on that -- those initiatives and there will be targeted SG&A items we review in the back half.

Great. Thanks so much.

Your next question comes from the line of Keith Hughes of SunTrust Robinson.

Thank you. Just wanted to see. What kind of gross margin did WinGuard do in the quarter?

WinGuard had a fairly strong product mix within the product category itself. It came in right at 46% gross margin.

Okay. And that's pretty high based on what you've done the last several quarters. Was it [mixed] the biggest driver there?

Yes.

Okay.

It was.

And the impairment charge was that the old facility in North Carolina?

Yes. If you recall we had the Lexington facility we purchased in conjunction with an acquisition back several years ago and we initially wrote down that facility at the end of last year and listed it for sale.

We've had some activity go through there mainly through the local county economic development group but no firm offers and in talking to our broker and looking to hold and where we want to go with it in terms of the facility we thought it best to go ahead and write it down to a price we thought could move the facility, so we took an additional impairment this quarter.

And can you give us any kind of clue where you are now in terms of your revenue mix outside of Florida?

This quarter we closed at 91% of our sales were from the Florida market so roughly 9% outside the state.

All right. And final question in terms of the competition. Have you seen any competitors given what's happening in Florida and would exit the market pull back from the market. I don't need names but just in general.

We've seen people really cut their service levels through the state. I don't know that I could sit here and say confidently that they pulled out. I think the pull out becomes very gradual. You cut service enough and eventually you don't do business there anymore and we've seen a bit of that.

Okay, thank you.

Your next question is from the line of Sam Darkatsh from Raymond James.

Yes, this is actually Jeff calling in for Sam. Good morning, Rob. Good morning, Jeff.

Hi, Jeff.

Hi Jeff.

My first question is on the gross margin. Obviously the number looks pretty good especially sequentially.

I guess my question is going into the second half, is there anything structurally or I guess seasonally any reason to expect the lower gross margin if you were to assume sales growth [to be] flat sequentially.

Yes. I mean assuming sales growth that would be up to the individuals, obviously we don't give any kind of guidance on that end.

But basically two things are driving that margin -- aluminum which you all know is our largest input cost in terms of the raw materials and we monitor that daily and also volume. Overhead absorption within the plan itself.

So absent the changes in those two items that would dictate the margins. We've already really hammered home cost reduction in terms of labor efficiencies, in terms of scrap and utilization and rearranging lines to better utilize the plant.

We continue to do that but I don't look for a huge pickup from that end. At the same time the two big drivers that we monitor are volume and aluminum costs.

Okay. My next question -- obviously this quarter you were able to continue to outperform the housing market. You talked about that 20 to 30% out performance.

Is there any reason to think that as the housing market bottomed and turned around and got off of these big year-over-year declines is there any reason to think that number would change that 20% to 30% out performance? Do you think you could do that in (inaudible)?

Yes. I think if you look back at our history we've -- as you said we've outperformed the downturns in the market by that amount. In the up market I think it's a little harder to measure and it becomes a mix of R&R versus new construction.

I think I'd be very hesitant to sit here and say that in a tough market especially when it comes back I'm not going to even try to project how and when it's going to come back from this downturn other than -- we know it well. It's the business that we're and it always comes back.

I don't know that I would be confident sitting here saying that we will outperform that market by 25% or 30% because we're so diverse and we're -- one of the things we didn't talk about on this call is some of the initiatives that we've talked about previously in our North Carolina plant and outside the state of Florida and some of that growth opportunity that's out there.

So, yes. I think we can perform well. I don't know that I'd go out on a limb and say we're going to outperform and up market by 25% or 30%.

What I will -- I'll just add a little bit to that. We did obviously outperform the market by roughly 20% this quarter and that's against the quarter in 2007 that was a record quarter. I mean we had a -- you know almost 109 million in sales and we were up 39% or so last year.

So -- I mean we're comparing against a very tough comp there and we -- obviously the housing being down 46%, 47% we still did very well and I think we all feel we'll continue to try to execute and keep some kind of delta there whether it's 20%, like we saw this quarter or 25% we don't know but we feel with executing on our out of state strategy, with executing in the R&R market and its stability there and our branded product WinGuard in the impact markets we feel all those are great tools in differentiating ourselves from the market.

Okay. Thank you. You've answered all my questions.

Your next question comes from the line of Nishu Sood from Deutsche Bank.

Thanks. Good morning, Jeff. Good morning, Rod.

Good morning, Nishu.

I wanted to follow-up on the Keith's question talking about maybe some of the impact resistant players serving the new market in particular it might be seeing some difficulty.

Are those potential acquisition candidates for you or is that even part of the universe that you would screen and if you were to consider acquisitions like that would there be issues in terms of differences in your business model?

For example, you have higher levels of service, shorter turnaround times and probably different manufacturing layouts as well.

We talked about it a number of times when we look at acquisition candidates. There's a couple of things that we look at they're pretty important to us. One is geographical area. Serving an area that we intend to go to but maybe we aren't as strong as we should be right now.

Our product line and that product line may serve a geographic area or it may serve our existing geographic area and I think that's the struggle when we look at some of the players that might be pulling back from a service point of view or that might be smaller.

Especially the smaller players is what their product line looks like. We've said many times and we'll continue to say that our product line is so much broader than everybody else until you take the next four, five, six players in the market and put their product line together you kind of equal our product line.

So that doesn't' mean we have everything that needs to be there to serve the market but it does mean that it's a little tougher for someone to bring in a unique product that we do not have. So we continue to look at things like that.

The cultural fit I think is very critical. I've seen most acquisitions that don't work don't work because of culture and not necessarily because of product and those types of things.

So our service level is extremely high. It's something that we will focus on. We'll continue to focus on. It's something that we provide. It's a value added process that allows us to maintain some the margins that we see even in down markets.

So the hurdle rate for someone when we're considering acquisition is fairly high but it makes an acquisition then be pretty successful.

Okay, great. Thanks. That's helpful. And I also wanted to Jeff dig down into the SG&A question a little bit more.

You gave some great details $800,000 I think you said in impairments. There's probably a couple of hundred thousand of the compliance costs you were talking about as well.

But SG&A continues to rise sequentially. I think it was up $1.5 million this quarter so I was wondering if maybe you could give us a rough breakout bucket wise of what is it structurally that's driving your SG&A to kind of be flat or continuing up in this environment.

Well again, we have various what we would call I guess fixed costs within that SG&A bucket and some that we would like to think is also variable that maybe more semi-variable or not variable initially and variable over the long run.

We've looked at our commission structures. We've looked at our distribution costs to take costs out. Some of the drivers there that again that are in there are warranty expense, accruals.

We've actually increased the warranty expense accruals associated mainly with new product intros and also with past performance results of products. We've also looked at our bad debt accrual. We've actually had very good efforts in collections.

So there hasn't been really a need there but again that's the driver that is not necessarily volume driven but we'll continue to look at it. I think mostly around the marketing spend is where we'll target in the future in terms of its value.

In terms of gaining market share and also a headcount. There's a lot of overhead in our SG&A that we look at.

Okay, great. And final quick question. Is there -- do we still have to factor NatureScape or is that pretty much gone from a discontinue basis you know year-over-year?

It's gone. The last sale happened in I think late January, early February of last year so it's just not in these quarters number at all and I would also just comment on one more thing on the acquisitions comment.

You'd mentioned a couple of things Nishu, our shorter lead times et cetera. We view those as actually potential synergies what we bring to the table.

We think we have a very good vertically integrated operations here that we can in essence bring to the table to a manufacturer or obviously putting that volume into our plant and taking advantage of things like short lead times or our expertise in the industry which is a core competency that we have. We are the impact experts.

So whenever we look at an acquisition we always look at various mechanisms engaging whether or not to move forward.

Okay, great. Thanks a lot.

Next question comes from the line of [Corey Johnson] of [King Court Capital].

Hi guys. Thanks for taking my question. Bookkeeping -- what percentage of sales were in Florida last quarter?

91%.

Okay and that compares to the previous year of this time?

Yes.

What is the comparison of the previous quarter?

Q2 of '06 sales?

Yes.

Q2 2006 sales were $109 million.

I'm sorry. Percentage wise of sales to Florida, sorry --.

92%.

Okay great, 92%, thanks. And earlier somebody asked about -- these said they talked about the housing market bottoming and turning around. Are you seeing signs of a bottom and indeed are you seeing signs of a turnaround?

I don't know that we're capable of answering that question. We commented I think on the last quarter's call that we've seen dramatic slowdown and we don't anticipate it coming back quickly.

I kind of makes jokes about it sometimes but I don't want to do that on the phone here with a lot of people on.

Trying to pick the time it actually bottoms out and starts turning around I don't know that we're going to see an actual -- here we can pinpoint the time that it actually hits bottom and comes back because we see certain areas where the market is relatively strong.

We see other areas where the market is extremely week and then we see that bounce around. So I don't believe there's going to be an overall here's the day and everything started coming back.

I think we're going to see certain markets start getting a little bit stronger driven by different drivers or potentially different drivers and then once we get through this over inventory of houses I think then things start getting back to normal.

I guess my question though is -- I understand what you might see but are you seeing anything right now that would indicate that the worst is over.

Yes. I guess that's what we're trying to tell you. We don't necessarily want to comment if we think the worst is over.

What we've seen in our top line growth is sequential quarter improvement. You can look back to the fourth quarter, first quarter and now second quarter.

That does not necessarily correlate with an improving market. That's us executing in a down market. So I don't know--

Yes, I think what we said before Corey is that the market dropped dramatically and we don't see it getting dramatically worse or even significantly worse.

We also don't see it coming back strong. So from the bottoming out concept I'm not sure that -- it may go down a little bit. It may go up a little bit.

I'm not real sure when that bottom out is but we don't see it dramatically getting better. We don't see it dramatically getting worse.

Okay. That is helpful. Thank you very much.

You bet.

And your next question comes from the line of Jim Wilson of JMP Securities.

Thanks. Good morning, guys. I guess two or three questions. First I guess Jeff the margins -- the base for the margin on -- or the margin -- your gross margin on the rest of the product line so of low teens? Is that--

Yes. Well the vinyl was low teens. The aluminum was actually between 8% and 9%. That's where we experienced most of the margin decline.

From a unit basis we basically allocate a lot of those costs based on product units and obviously with WinGuard carrying sometimes three and four times higher price than an aluminum window that's how you get the margin allocated.

From an AS standpoint it's in the 40%, 42%, 43% arena and then vinyl as I mentioned is like low teens 12%, 13%.

Okay. And so I gather there is way to look at I don't know. Dollar quantifying the impact of higher aluminum or percentage either compared to Q1 or compared to a year ago?

The aluminum input costs?

Yes.

Yes. It was roughly $2.3 million for the quarter. Almost $5 million for the first half. I think it's like $4.8 million for the first half of 2007 compared to last year.

Okay, great. And then final question. With the repair and model any sense through a distribution channel how much the major home center guys, Depot and Lowes are of your end market business?

Of the -- I'm not sure I understand. Of the total end market of repair and remodeling or business or personal business?

Either way.

I don't know that we know. I mean other than -- other than. We get the same thing as you guys.

We listen to their calls and look at their volume and how they're up or down so we can kind of get a feel for that. I know that they're -- they've commented they're down quite a bit from repair remodeling.

We seem to be holding pretty steady on repair and remodeling and the -- as we look at the overall market, I think there is -- there has been some concern in the general market because housing prices have come down and folks are a little more hesitant to put a lot of money in their house when housing prices come down.

So we're pretty happy with our ability to continue to drive additional sales really on our side or at least to hold our sales steady on the R&R side. But I don't know if that give you a feeling or not of how we look at it.

Okay. No I know it's got a hired through a distributor channel to really know where it all ends up. But yes, okay that's fine. That's great. Thanks.

Your next question comes from the line of Evan Ratner of Credit Suisse.

Good morning, guys.

Good morning, Evan.

A couple of housekeeping items and some more strategic questions. I don't know if I missed this. You said new construction was up -- down 44% in the quarter and R&R was -- what was that percentage increase?

It was flat.

Oh flat. Okay, that's what I thought. Okay.

As a percentage of mix. It was 56--

56% versus 44%, okay.

That was an improvement but overall if we looked at the R&R section it was flat.

Got it. CapEx for the quarter and expectations for the year.

Expectations for the year. We actually revised our expectations last call obviously due to the decline in the market conditions.

We looked at our CapEx and took it down to the $10 million annual level. We're holding to that number $10 million to $12 million annually. For the quarter it was $4 million.

Okay. Okay. Okay. Regarding the Lexington facility you had a non-cash 826 impairment charge. Is there any savings to come once that sale happens and I don't know if you will tell us what you have it offered for?

Yes. Right now it's listed for roughly $1.8 million with a broker. Savings, you know -- I mean the cost of upkeep, maintenance -- to guard it security. That kind of--

Okay but nothing more material than that.

The property taxes. Nothing material. No.

Okay. Okay. On the pricing side. Can you maybe give us -- you were talking about some of the service levels declining. Can you maybe talk generally on pricing and other -- market -- maybe talk about market share as well?

Yes. On the pricing side I think Jeff had commented as he was talking through the financials that on the aluminum product line which is a product line that serves primarily new construction. Almost all new construction.

We see some pricing pressure on that and I think you saw that from the margin levels that he just talked about I think in the last question. So that product line has seen a little bit more pushback on pricing.

I think I can say pretty openly that the rest of our product lines really haven't received much pricing pressure. I think that's due a lot of the service levels that we provide. People see that as a value add, short lead times, everything on time and complete.

The WinGuard product line obviously had good margins. Our Architectural Systems had good margins. Vinyl, it's not a big part of our product line yet. We've got some pretty strong initiatives there so we're matching some of the market prices and the margins there are a little bit lower but we really haven't see a lot of pressure on that product line.

So I think from a pricing point of view aluminum will continue to see some pricing pressure.

Okay. And maybe -- I know we had previously talked about this but from a macro perspective the building codes in terms of how they're changing. Any update as worthy of note?

I don't think there's anything that's worthy of note. It's a -- commented a number of times a lot of the codes are in place or are being voted in place. It becomes then a matter of enforcement and enforcement takes various times in different states.

I think as we understand how storms act and how codes work the enforcement becomes a little bit faster than it was maybe five years ago, six years ago but it still takes some time to really train building officials and train builders on what the code means, how to inspect or how to build to it. That sort of thing.

So we continue to think there's pretty large opportunity in all the states that are in any type of zone that would be in a hurricane rest type area.

Okay. On the expansion side outside of Florida and I think many of us on the call want to see that -- that 9% number increase. Can you maybe just update us on exactly what you're doing now? What the game plan is again.

We know that its' slow and stuff and I know you said there were some -- I guess a similar spend on the revenue -- I guess on the marketing but I just wanted to just talk about the expansion in near term and then sort of go the next couple of years if anything's changed and give us an update.

Near term, we've talked in the past again and I'll just update everybody on the initiative in North Carolina with a complete new vinyl product line to serve the out of state market.

That is on track. Team is in place. There's a lot of design work, testing work, implementation, some of the capital spends that you see and the reason the capital isn't lower for 2007 is.

That's primarily driving a lot of those capital spends to put -- I say vinyl line. When you talk about a vinyl line that's actually about six or seven different products coming down that line so people can build a house and buy all the products from us.

That introduction is still scheduled for February of next year and there will probably be a little bit of marketing spend around that as we get toward the end of the year so that's why we're -- we've hedged a little bit on our SG&A spend as we get toward the end of the year to make that we have the proper money there to promote that but that is on track.

Along with that and the team that's in place brings the ability to capitalize on some of their relationships that they've had in the past and we're exploring those and we're really not ready to comment on those because we don't have the product out there yet.

Okay. And in Louisiana?

Louisiana we're seeing some action. We've actually -- just detail as we done a couple of pretty major school projects with impact resistant product there that are getting done this summer and have sold products through.

It's moving slowly but we think that that's not going to be -- or our feeling is that's not going to be rebuild like we saw from some of the hurricane damage in Florida where in the course of six to nine months almost everything got either replace or was under permit to get rebuilt.

We think it's going to take quite a few years but it is slowly but surely moving and we're seeing a little bit more activity there with a number of dealers and distributors there that are pushing some product.

Okay. Thanks very much guys.

You're welcome.

Thanks.

Your next question comes from the line of [Mafasla Habib] from [BA Capital].

Hi guys. Good morning.

Good morning.

Good morning.

A couple of housekeeping items. The first is you mentioned that net debt at the end of or as of the end of this call was $117 million. Did I hear that right?

Yes, $117 million.

Okay. What was cash flow from operations for the quarter?

For the quarter well -- free cash flow for the quarter was roughly $4.5 million. Cash flow from operations I don't have that number on me right this second.

Okay.

Something I can get to you.

Or we can wait unit later. That's fine. A lot of the questions I had have been answered but let me ask you a couple of follow-ups.

As we've been talking to some of these other companies that make doors and windows and siding and whatnot, they've mentioned that during the downturn they would look to get into Florida and impact resistance is sort of pretty good faith being.

Are you -- in terms of that are you seeing any new competition or guys who are existing window wise trying to get into this space in your geography?

No. What we've actually seen is almost the opposite of that.

We've seen -- in the good times last year we saw a lot of people try coming into Florida and looking at the new construction market and the amount of business that was there in the impact resistant market in coming in and then as slow down we've seen a lot of folks pushing to get into this market actually pull back on service levels and product offering and I can speculate.

I don't know that I can say accurately but speculation is there's just not a lot of new houses being built and that's the market that gets served the most down here. So we've actually seen a little bit of a pullback from a service level.

You hear a lot of noise in the industry about who's interested and who's not interested in the different markets it will serve but this year we have not seen a lot of pressure from competition coming into the state.

Got you. And in terms of some of these out of state initiatives that you mentioned Louisiana, school projects and your vinyl line of products for North Carolina.

Do you have a sense or goal for sort of in the outer years what kind of -- whether it's a revenue target that you have in mind or a percent of sales that you would like to achieve from outside Florida. Can you talk a little bit about that?

Actually, I can just talk briefly about it. We've been pretty adamant about not giving guidance and not giving specific numbers.

We have -- we have fairly aggressive goals for what those products are going to do from an architectural systems because there's still a pretty large commercial market in Florida and outside of Florida and vinyl outside the state of Florida primarily is the window framing material of choice.

So we think there's a huge market in that primarily east of the Mississippi and as you go further west also there but east of the Mississippi market so our -- we have a pretty aggressive growth and sales plan and I'm not going to comment on the actual numbers we have in place.

Thanks. That is helpful. In terms of the high rise impact resistant dynamic could you just take a minute to talk and maybe explain a little bit about what the differences are between the impact product for sort of closer to the ground [step] forces versus high rise stuff in terms of I guess both structure features and also to some extent the purpose?

Yes, I'm glad to. I can do it I think pretty quickly. The product that we manufacture or the type of glass that's installed in windows as you go to higher elevations we don't differentiate between high rise and close to the ground and I realize that there's depending on where you're at with code you can actually go to a lighter grade of window or lighter grade of glass as you go up because the missile impact is not quite as stringent. We choose not to do that, and we choose not to do that because we're in this market.

We serve this market and we've witnessed what happens when -- as recently as about two years ago when Wilma came through and really destroyed a lot of high rise buildings that were built to code, but did not have impact resistance in the upper floors because it wasn't required at that time and we believe strongly when you see the type of debris that gets blown around in a 120, 130 mile storm it's important to have this same type of debris protection on those upper floors that you have on the lower floors.

So from a glass type we don't really differentiate.

From a structural load point of view it's an engineering detail as you get to higher elevations the wind speed picks up and wind is measured at 30 feet off the ground.

As you go up it incrementally -- incrementally increases so it's quite a bit larger as you get to higher floors and the loads required become much higher. The framing material becomes much stronger. It's the primary reason that as you get into higher elevations you see really heavy aluminum or in some cases steel and things like that to support those window frames.

Got you. And is the high rise opportunities sort of in terms of magnitude is it sort of what you envision for out of state and also what kind of penetration level does impact resistance have in high rises today?

We actually see it for both in state and out of state. The largest market right now and I think everyone's read the stories -- the demise of the Miami market and the condos but there's still -- it looks like crane city in Miami.

There's still a lot of building going on. But the Florida market has traditionally been the strongest and the New York market and then after that you can kind of take pockets of any major metropolitan area, up the coastline, Chicago. You kind of pick the cities.

There's a lot of construction going on and it balances between residential high rise, the condo market and commercial which is the office buildings and when one gets week the other one generally gets a little bit stronger. So that product line will serve both Florida and out of Florida market and that's our anticipation as we go forward.

And currently do high rises have impact resistance?

I didn't answer that part. Apparently, in the state of Florida in Dade and Brower County high rises are required to have impact resistant product in place. In other states -- in some places it's required on the upper floors. In most places it's only required up to about 60 to 80 feet.

Is it fair to say I guess that high rise impact resistant dynamic today is sort of what regular impact resistance was maybe two years ago?

I think it's fair to say that only I wouldn't say two years ago. I would say it's more like the impact resistant market was probably six or seven years ago.

Oh. So there's a lot of opportunities.

Yes, I think there's a lot of opportunity there and that's going to be driven to by awareness of -- number of storms and awareness of storms and how a product performs.

Got you, and the last question is you spoke about acquisition opportunities and what would be good fit for you et cetera. If you were to do an acquisitions could you talk about how you would look to fund that or finance that?

Well it could be -- we can look at a number of ways depending on the size of the acquisition. Obviously we could do it with cash. We have roughly $20 million of cash on hand if it's a smaller player or we would look at debt -- potentially additional debt.

Right now I know our debt is trading above par so it's actually -- that's definitely an avenue there. So it would just depend on the circumstances.

In following up on your cash flow question it will be part obviously our 10-Q that we file. But cash flow from operations for the three months was $7.8 million --

Okay.

And for the six months it was $10.5 million.

Thank you so much guys.

You bet.

Thanks.

Your next question comes from Robert Kelley of Sidoti & Company.

Hey guys thanks for taking my question.

Hey, Robert.

Just a question on the sequential jump you saw in the R&R market. Anything other than maybe seasonality and contractors becoming available driving that?

I think you hit it pretty accurately. A little bit of seasonality. Not a dramatic amount. Second quarter is the start of hurricane season.

It's driven some by insurance and that doesn't' go away because insurance keeps evolving and changing and it's difficult to get and insurance companies for having impact resistant product in place so that really is somewhat beneficial but I think that's probably what drives it as much as anything.

Great. And then just quickly on the architectural group. $4.7 million for the quarter. Was that pretty much flat sequentially with Q1?

Yes.

But the gross profit was what for Q1?

For Q1 it was in the 40%. I don't if it was 43% like it was in Q2 or not. It was low 40s.

So there's a sequential mix improvement there and what's driving that?

Well it's roughly this -- it's roughly the same. You're talking about architectural systems?

Yes.

Yes. It was in the low 40s even last quarter so roughly the same amount of sales.

All right. That's all I had. Thanks.

That's great. Thanks.

Your next question comes from the line of John Sykes of Nomura.

Hi. Good morning.

Good morning, John.

Just a couple of quick questions. If you look at the cost structure right now what percentage of the total cost structure is variable relative to fixed?

That's a very tough question because there's a lot of semi-variable in that answer. Obviously within costs of good sold roughly 60% or so is -- 65% or so is going to be a majority of your material costs which are going to be all variable.

Right.

Direct labor we don't necessarily view as variable. We just manage it accordingly. So if volume falls off we're not going to let labor fall off with it. We're going to be smart about that and not do anything to damage the company long term so that's more semi-variable.

And then we've got some overhead that's got the fixed costs in it; depreciation, amortization those type costs. So it's just -- that's too tough of a question to give you an exact answer. Within SG&A it's probably I'd say 65%-35%.

Okay.

65% fixed, 35% variable. You do have distribution in there. You've got commissions in there all of which are variable. You have marketing in there. Advertising that can be variable but again it depends on what you choose as a company to do with it.

Well but I guess the point is that there is still room to convert some of the fixed costs to variable costs to make the cost structure more flexible if the environment doesn't improve but also if it continues to get worse I guess.

Yes. That's definitely the case as I was mentioning earlier on in a question. We're constantly looking at that. In the back half if things get worse for instance we will take further action in terms of our costs of infrastructure.

In talking about the high rise buildings is there also like an industrial application that you might have for WinGuard or high impact? In other words where you could move some of this business to a more commercial market relative to a residential market?

Yes. When we look at the high rise market we kind of capture all that in one statement and although the market that's been probably the hottest the last while has been the residential high rise market, the condo market. Even in most -- I won't say most.

Even in many of the condos that the product goes into the bottom say three to six floors will be commercial and will be stores or office buildings or that type of thing and what you see is you see in some of the cities the vacancies rates on commercial are going down considerably because there's been such an emphasis on the residential side of things. The product that serves those two markets it's identical but it's very close and very similar.

I guess -- I know you don't you know want to talk about guidance so I'm not going to kind of ask you that but I guess -- what I'm trying to get a sense of is that is there a way to move this business over a period of time whereas that sector.

I'm just going to call it the commercial sector becomes a significant percentage of the total business. Is that -- do you see that kind of market opportunity that would enable you to do that overtime?

Well I guess to answer that when we look at the high rise market or the architectural systems market we don't try to differentiate between residential and commercial. We've bid jobs whether they are R&R jobs or whether they're new construction jobs and some of those are commercial.

Some of those are residential and that's why I said the product -- the product that they're bidding is not significantly different.

I mean we're basically bidding our product line what the contractor or what the developer wants to see and an office building is generally more fixed.

In a residential it might be more operating windows but you're basically dealing with the same type of structural window.

Okay, I've got you. I guess the other question I have is on the financial covenance. Do you -- do you anticipate any issues covenant wise in the next couple of quarters

No we don't see any issues there. We obviously look at that every quarter and have various different covenants from CapEx to leverage ratios so we don't -- but based off our current results and where we think we're going to be we don't see any issues in our covenants.

Okay. And would you -- you know again I know you can't give guidance here, but just -- excuse me -- in terms of free cash flow can we just sort of expect that you'll be doing sort of the same type of cash flow generation throughout the remainder of the year?

Again, can we expect some additional debt repayment from here I guess?

I would say no comment.

Okay. All right. All right. All right. Well thank you very much. I appreciate it.

All right. Thanks.

Have a good day now.

Thanks.

Your final question comes from the line of James Yun from AIG.

Hi. Thank you. My one question is do you expect working capital to be a source or use going into second half?

I expect it to be a source going into the second half.

Any type of magnitude that you're willing to share?

It's not going to be -- it's not going to be material. I mean -- maybe $500,000 to $1 million dollars in terms of cash, free cash flow analysis in terms of the source.

Okay. Thank you.

I would now like to turn your call back over to your host Jeff Jackson.

Thank you for your time in joining us today. We look forward to speaking with you all again next quarter. If you have any further questions just please feel free to call me and good day.

Thank you for your participation in today's conference. This concludes our presentation and you may now disconnect and have a wonderful day.