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American Woodmark Corporation (NASDAQ:AMWD)

F2Q08 (Qtr End 10/31/07) Earnings Call

November 29, 2007 11:00 a.m. ET

Executives

Glenn Eanes - VP and Treasurer

Kent Guichard - President and CEO

Jon Wolk - CFO

Analysts

Mark Herbek - Cleveland Research

John Haushalter - Robert Baird

Robert Kelly - Sidoti

Keith Johnson - Morgan Keegan

Operator

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 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 at 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 Vice President and Treasurer, Mr. Glenn Eanes. Please go ahead, Sir.

Glenn Eanes

Good morning, ladies and gentlemen and welcome to this American Woodmark conference call to review our fiscal 2008 second quarter results. Thank you for taking time out of your busy schedule to participate.

Participating on the call today from American Woodmark Corporation will be Kent Guichard, our Chief Executive Officer and President and Jon Wolk, our Chief Financial Officer. Kent has some opening comments and then he will turn over the call to Jon to review the quarter and outlook on the future. At this time, I would like to turn the call over to Kent. Kent?

Kent Guichard

Thank you, Glenn, and good morning everybody, and again, I would like to add my welcome to all of you who have taken out to call into for our second fiscal quarter conference call. In a minute I will turn the call over to Jon for our normal review of the quarter, followed by a question-and-answer period. But this morning, as supposed to what we usually do before Jon runs through the details of the quarter, I would like to take a few minutes to, just an overall context to, the current state of affairs.

For those who have listened in on our last several calls, during the last few quarters we've shared with you our experience in the market and most notably, our experience to get to that depth the industry was bouncing along the bottom. We were not experiencing much of an up tick but we were also not experiencing a significant additional deterioration in activity from the level we saw really, in the spring and through the early and mid summer.

As events have continued to unfold during the last few months, it now appears that we were experiencing a false bottom. Every week seems to bring another revelation regarding the fallout from subprime and other credit issues. Many of the major builders have significantly curtailed or even ceased in some markets all building activity. We have seen a relatively rapid rise in existing home liftings on the market and a reduction in the turnover which is in some markets, the month’s supply of existing houses for resale is 14 to 16 months.

So, we are really seeing that go up significantly and that's resulted in potential buyers of new homes exercising the contingency, if they have one, to get out of their new home contract. And, if they don't, they even walk away from deposits because they can't get out their equity in their existing home, which has caused another increase in the cancellation rates reported by the major builders in the last few months.

And of course, oil is approaching $100 a barrel, we are pressing that. So, I could go on with that list for quite some time. But, I think the point is, is that the cumulative impact of both the real and perceived events has culminated in some rather dismal consumer confidence numbers over the last several weeks.

Some experts look at this data set and come to the conclusion that the entire economy is headed for a significant recession that would impact everybody well in the calendar 2009. Others have pointed to some of the positive signs, to more positive signs. Job growth, for example, and continued employment levels are consistent with the full employment economy; people who want to work have a job.

Incomes are rising, real incomes are rising. Consumer spending is holding that increased 3.25% to 3.5% on a year-over-year basis. The first numbers reported from the holiday season were relatively good they are up with traditional retailers and of course, internet sales were extremely, they were well in to the double-digits in terms of their growth on a year-over-year basis.

So consumer spending is holding core inflation as well. Long-term rates remained very affordable. The credit markets are still little bit tougher and it's taking longer even if you are qualified for credit to get through the process, but the rates remain very affordable. And some markets appear ready for growth. Las Vegas for example, forecast -- all the way is forecasted, I saw for Las Vegas. Vegas is expecting an influx of 70,000 new people and the creation of around 40,000 jobs in 2008. So it's very mixed out there.

Looking forward, the reality is that nobody knows the timing of the cycle. The recovery is not going to be this quarter, the quarter that we're currently in. But will we see some life in the spring, will it be next fall? Will it be sometime in 2009? The reality is that nobody knows.

In this environment from our perspective, we are not going to maintain product-to-profitability clearly we've seen over the last five years. We just can't cut that cost to get to $2 a share on EPS. You can spend yourself into trouble, but you can't save your way to prosperity. Somewhere between another $0.10 and another $1 a share and cost cuts in the short-term environments, somewhere out there, there is a switch over point where you just stop saving money and you start to inflict long-term damage on the value of the franchise.

In our opinion, that is clearly not in the best long-term interest of the shareholders. We clearly believe, firmly believe that it is when, not if, the market recovers. We are a nation of homeowners. Its core to, who we are as a people, fundamentally it's in our DNA. So we believe that the market is going to come back and nobody really knows the timing.

So, in the meantime, the core question is what are we doing? And when we get in there in a minute when I turn over to Jon, behind all the numbers he'll review is our approach over the next period of time. And our approach and the thing that Jon will talk about and refer to in the review of the quarter really gives the result of three choices that we've have made.

The first is to protect the core assets of the business. You can probably think of this as the franchise value. We are protecting the organization, we are protecting key employees, we are filing customer facing and critical skills positions. We are maintaining our training programs. We continue to invest in our HR programs to really perpetuate the vitality of the company.

We are also protecting our relationships with both customers and vendors. Of the long standing, these long standing relationships and the strength of these relationships are a core asset to the company. And we are protecting our fixed asset base. We are maintaining our facilities. We are staying current with technology.

So the first choice is we're going to protect our core assets. The second choice is to pursue volume. We need business, as everybody does right now. There aren't as many kitchens out there to be had as there were a year or two years ago. The ones that are, the new houses that are being built and the remodel jobs that are occurring, we want and quite frankly we want more than our share.

We are not going to do anything stupid, having said that. We have to be competitive in this environment. It's not just about price. It still includes quality and service, but we certainly have to be competitive on price.

On the other hand, the business we are pursuing must make sense within our strategy, within our offering to the markets and within our capabilities. For this next period of time, volume is going to come from market share gains and our focus continues to be on penetrating share.

Our third choice is to run the business given the context and make sure we are as efficient as we can. Given the first two choices, make sure all of our expenditures are appropriate, generate cash, protect our outstanding balance sheet and just all-around, be good stewards of the business.

Again, nobody knows what the market is going to do, nobody. The so-called experts can go on and on, but nobody knows. Ultimately, as we go through this next period, we are going to make decisions that we can live with either way. If the market does come back in the strength, we need to be in the position to support our customers. If the market stays or drops even further, we need to be in a position to continue to build the core franchise value of the company that will be recognized and realized on the other side of the cycle.

With those comments kind of still in the context, let me now turn it over to Jon, to run through the numbers for the quarter and the forward-looking statements and then our outlook. And then both Jon and I will be available for questions. Jon?

Jon Wolk

Thanks Kent. As you all know, this morning we released the results of our second quarter fiscal year 2008 that ended October 31, 2007. In case you've not had the chance to read the release, here are few highlights.

Net sales for the quarter were $160.3 million, down 24% below the prior year second quarter. Net income for the quarter was $1.2 million, down 87% below the prior year's second quarter net income of $9.2 million. Diluted earnings per share of $0.08 for the quarter were 86% lower than the $0.57 we earned in the prior year's second quarter.

For the six months ended October 31st, net sales were $326.3 million, down 25% versus the prior year's first six months. Net income was $6.3 million, down 72% versus the prior year's first six months and diluted earnings per share of $0.42 were 70% lower than the $1.40 we earned in the prior year's first six months.

As we've previously discussed, in February of this year, we completed the transition that had commenced in October of 2005, at a certain low margin products, including the in-stock cabinet business at Lowe's.

As in the recent calls, I will continue to provide a separate breakout of the transition impact, as our prior year comparative numbers will continue to include sales relating to these products for the next two quarters.

Regarding our second quarter sales performance, our previous sales guidance anticipated that our sales of core products for the fiscal year would be 8% to 12% below core sales levels achieved in the prior year, with sales declining more in the first half and less in the second half of the year. Our actual core product sales declined by 17% and 18% in the second quarter and first half of fiscal year 2008 respectively, a slightly greater decline than we had expected.

Total sales were 24% lower than in the second quarter of fiscal 2007, as the impact of the transition low margin products were eliminated as planned resulting in a $14 million reduction as compared with the prior year's second quarter.

In new construction, total residential housing starts on a year-to-date basis have drifted down to the $1.2 million annualized level, approximately 25% below 2006 levels. The short-term outlook for the new construction market seems obvious, as market sentiment has become decidedly negative. However, we believe the outlook for the industry is far from certain. We are enforcing the short-term outlook, most of our large builder customers continue to report limited to no visibility as to when an improvement in their sales order rates will occur and builder confidence according to the NAHB, Wells Fargo Housing Market Index is at its lowest level since the index commenced in 1985.

Yet, on the positive side, 30 year mortgage rates, as reported by Freddie Mac have drifted down to their lowest level of the year and remain low by historical standards. The underlying economy remains strong, as Kent indicated, as job growth continues above 100,000 per month. And the Federal Reserve has begun to take action to cushion the impact of the credit cost.

Our new construction sales were almost 25% lower than in the prior year second quarter. However, new construction sales managed a modest sequential improvement for the second consecutive quarter as the impact from our market share gains continued to exceed the impact of the declining market.

At the conclusion of the quarter, two of our new construction customers filed for Chapter 11 bankruptcy protection. After evaluating the likelihood of collection from these and some of our other new construction customers, we added $1.5 million to our allowance for doubtful accounts.

Although the new construction market continues to be slow, we continued to aggressively bid and win new business, focusing on companies that we believe have the staying power to outlast this downturn. Based on the value of our Timberlake product line, our extensive service reach and our partnerships with many leading homebuilders, we believe we are growing our market share and what looks to be a relatively weak new construction sector for the next several quarters.

For the remodeling market, economic fundamentals remained healthier than for new construction but momentum continues to be negative. Existing home sales are leading indicator for home improvement spending have declined from the mid $6 million level at the beginning of the calendar year to the present $5 million level on an annualized basis.

The consumer confidence index fell for the fourth consecutive month and now stands at a three year low. The median sales price of existing homes has been trending lower for the past year and our two primary remodeling customers continue to report declines in comparable store sales.

During our second quarter, our core remodeling sales were approximately 10% lower than in the prior year for the second consecutive quarter driven entirely by reduced market performance in our product category.

We continue to expect that the remodeling market will be flat to down until credit availability, housing prices and the associated headlines settle down.

As we remain bullish on the housing market's long-term viability, we continue to invest company resources to pursue additional share gain initiatives. We believe that our market share gains and our market position as the value provider of goods and services, positions us well during this down phase of the housing cycle.

Moving onto gross profits, gross profit for the second quarter was 17.3% of sales well below both the 20.3% we generated in the second quarter of last year and the 20.7% we generated in the previous quarter. The primary drivers to this disappointing performance were inefficiencies and labor and overhead costs that were caused by the impact of lower sales volumes, new product launches, higher medical cost and also, due to rising fuel cost.

We reduced production in response to lower order rates during the quarter and made a small corresponding reduction in head count at the same time. Through attrition and reductions in force, we've reduced the size of our direct labor force by over 27% in the past eighteen months. Subsequent to the reductions, some inefficiency has occurred as the remaining employees are reassigned to new areas of responsibility, which has in turn, contributed to the increased labor cost.

The gross margin rate was also reduced by change in the form of the company's sales promotion reimbursement with one of its resale customer. This change in form did not affect net income but shifted cost that have previously been selling and marketing expenses to a reduction of sales revenue. Excluding this change, the company's gross margin would have been 18.3%.

Somewhat offsetting the impact of these adverse factors was the continuing positive impact upon the company's sales mix from the completed low margin products transition. The low margin products had higher materials and freight costs in relation to their sales prices. By removing the impact of the low margin products, materials and freight costs has improved as the percentage of sales, and are expected to continue to show improvement through the balance of the fiscal year.

Regarding SG&A cost, total SG&A expense was 16.5% of sales in the second quarter of fiscal 2008 as compared to a 16.2% in the first quarter of fiscal 2008 and 13.5% in the second quarter of the prior year. SG&A expense was 16.4% of sales in the first half of the fiscal year as compared with 13.5% of sales from the first half of the prior fiscal year. Total SG&A expenses for the first half of fiscal 2008 were lower than in the comparable period of the prior year by $3.1 million or 6% on a 25% decline in sales.

Selling and marketing expenses were 11.6% of sales in the second quarter, up from 8.5% in the previous year driven by a 3% increase in cost and the reduced second quarter sales level. Selling and marketing expenses were 11.9% of sales in the first half of fiscal 2008, up from 8.3% in the first half of the prior year.

The increased level of sales and marketing costs was driven by the company's continued investments to gain market share. These investments included increased amounts of product displays deployed with new customers in the new construction channel as well as remaining costs relating to the company's December product launch.

General and administrative expenses were 4.9% of sales in the second quarter as compared with 5% in the prior year second quarter. General and administrative expenses were 4.5% of sales in the first half of fiscal 2008, down from 4.7% in the first half of the prior year.

A reduction from prior year reflected primarily lower cost relating to the company's pay-for-performance incentive plans. The higher level of costs in the second quarter of fiscal 2008 reflected the company's $1.5 million provision for doubtful accounts from new construction customers.

Regarding our capital spending, capital expenditures and promotional displays deployed in the first half of fiscal 2008 were $10.6 million, in line with the prior year's first half amount. As in the prior year, our investments and promotional displays and property, plant and equipment were roughly comparable in amount. Capital expenditures continue to comprise a variety of small to medium size projects and no new plants were constructed.

The company expects to continue to fund its capital spending from a combination of operating cash flow and existing cash on hand. Outlays for fiscal year 2008 are expected to be in line with those of fiscal year of 2007.

Regarding the balance sheet the company's financial position, as Kent explained, remains outstanding. Long-term debt-to-capital on a book value basis was 10.9% as of October 31, 2007. Cash provided by operating activities in the first half of fiscal 2008 was $19.3 million while free cash flow was $8.6 million.

The company repurchased $17.8 million of its common stock in the first half of fiscal 2008, encompassing 549,000 shares, including these repurchases the company's weighted average shares have been reduced by $1.5 million in the last 12 months or 9% of the previous share base.

Net of this utilization of free cash flow, the company's cash on hand was $46 million as of October 31, 2007. The company has approximately $102 million remaining on stock repurchase authorizations.

In closing, we believe the company's continued emphasis upon improving the quality and breadth of its products and services and investing to drive future growth is the right course of action during this -- to turn this market downturn. We continue to manage the business with the objective of creating long-term value for our shareholders. In so doing, we continue to maintain our staffing levels for our customer facing jobs and maintain adequate manufacturing and field installation capacity to ensure adherence to our stated service levels.

As we have previously stated, we believe the company should generate sustainable gross margins in a range from 21% to 23%. Our performance in the second quarter of fiscal 2008 was well below this expectation and we are not satisfied with these results.

As we look forward to the remainder of fiscal 2008, we continue to see a housing environment that is underpinned by macroeconomic and demographic fundamentals that remain sound but also overshadowed by inventory overhang, falling home prices and the recent credit crunch.

We believe that the impact of these factors and their associated media coverage have contributed to a negative buyer psychology and a reduced ability to obtain mortgage financing. We expect the outlook for the housing economy to remain uncertain until a credit crunch is resolved and housing prices have stabilized.

From a marketing perspective, for the remainder of our fiscal year, we expect the kitchen remodeling market will continue to experience weakness as compared with prior year comps. We further expect that housing starts will continue to trend 25% lower than prior year, to approximately the $1.1 million level on an annualized basis and roughly 20% less than had originally been forecasted for this year and approximately 50% below the market peak.

As mentioned earlier, we had two new construction customers filed for bankruptcy. We have several other customers on our credit watch list and it is possible that some of them could also follow the same route.

During the quarter, we continue to win a greater share of business from some of our existing National Home Builder customers that have solid creditworthiness. In addition, we continue to gain market share at the National Home Centers. Because of our strong competitive position and focus on continuing to enhance and differentiate our value from that of competition, we believe that the market share gains our company has achieved will continue for the foreseeable future.

Our partnerships with the big box retailers each of whom continue to grow their store counts and market coverage positions the company to capture a growing share of remodeling activity. Our market position, as a provider of superior products and services at competitive price points is extremely competitive in a more challenging retail sales environment. Most of our new construction customers expect to continue to gain market share. Our partnerships with these national and regional builders position us well to maintain and grow our market share.

We expect that our remodeling sales for the second half of fiscal 2008 will be flat with that of the prior year, resulting in a mid-single digit decline for the year. The continuing decline in the new construction market, which has contributed to an increasingly difficult credit situation for several of our new construction customers, has cost us to once again, update our sales expectations for that aspect of our business.

Our updated expectation is that our new construction sales for the second half of fiscal 2008 will be flat with the corresponding period of the prior fiscal year. Still evidencing our market share gains, but less optimistic than we had previously expected. For the entire fiscal year, we expect our new construction sales will decline in the high teens. Overall, we expect that our fiscal 2008 core sales will decline by 10% to 12% as compared with prior year.

During fiscal 2007, the company had approximately $35 million of low margin product sales that will not reoccur in fiscal year 2008. Inclusive of the impact of these transition products, the company now expects that total sales will decline 14% to 18% as compared with prior year levels.

The company's gross margins had held up pretty well until the just completed quarter when the combined impact of lower production volumes, costs associated with the company's recent product launch, rising fuel costs and the change in the form of the company's sales promotional reimbursements all took their toll on the quarter's margins.

The company has been working aggressively to improve the issues which impacted labor productivity and now expect labor cost will exceed previously expected levels, but show gradual improvement over the next few quarters. The company continues to monitor fuel costs and will consider pricing actions as market conditions persist.

Considering the company's sales outlook and these increased costs, the company has reduced its forecast of gross margin for the fiscal year to approximately 18.5%. This gross margin level reflects a reduction of approximately 50 basis points for the change in the form of the company's sales promotion reimbursements. Because the company's costs were higher than expected in its second quarter and because we expect market conditions to continue for the remainder of the fiscal year, we now expect that results for our seasonally weakest third quarter that ends January 31st, will approach breakeven and that we will earn modest net income in the fourth quarter.

Overall, we have reduced our earnings guidance for the fiscal year to $0.70 to $0.90 per diluted share, as compared with $2.04 per diluted share in the prior year.

This concludes our prepared remarks. We will be happy to answer any questions you have at this time.

Question-and-Answer Session

Operator

Thank you. The question-and-answer session will be conducted electronically. (Operator Instructions). And we will go first to Mark Herbek with Cleveland Research.

Mark Herbek - Cleveland Research

Good morning, guys.

Kent Guichard

Good morning.

Jon Wolk

Good morning, Mark.

Mark Herbek - Cleveland Research

You didn't revise or remodel expectations versus 90 days ago. There is something you are seeing and everything your end market that gives you confidence. Remodel is going to improve sequentially as we go forward or is this simply a function of easier comparisons?

Kent Guichard

The majority of it is going to be the easy comparisons. If you go back, the market for us really started to go January, February of last year and so, we are going to come up here after the holidays with much lower comps. And Jon mentioned, basically flat on the new construction side. It's the same thing over there, it's basically you got lower comps.

What we are seeing on the remodel side is that there is still activity over there. It's certainly not robust, there is activity. It is from our experience, a highly promotional dependent. So, when the retailers run promotional activity, advertising promotional activity, we get a reasonable amount of activity. But as soon as those promotional dollars stop, it drops pretty quickly.

Mark Herbek - Cleveland Research

Are you seeing anything different out of the home centers, in regards to 2008, when it comes to promotions or programs asking for additional support?

Kent Guichard

Well, I think there are two questions there. One, are we seeing anything different? New rule won't speak for them. I'll tell you that we are involved with them. I won't talk about how they are running their business. I'll talk about how we will run our business with them. And that is that, first and foremost, we are just going to continue with kind of a normal calendar year, always tweak around with and experiment with what is attractive to the consumer and what isn't unattractive to the consumer. But we continue to work with them to be able to do that. So, that activity will kind of continue, I would say. They maybe high or maybe more but it will continue pretty much along the same lines.

We are supporting them. Jon mentioned that part of our SG&A increase was more promotional dollars and we are certainly supporting our customer in doing that and trying to maintain levels of business and gain share. And some of the sales out there are little more expensive to drive through than they were, say, a year or two years ago. But we still think that it's supportable in terms of the margin structure, as everybody that's delivering the value to the end consumer.

The other thing I would say is that we continue to work with most of our large retail customers in terms of next generation programs. So, it will be on the quality side, the service side whether they would be the layout of the stores and the departments in terms of how it's presented to the end consumer. There is a lot of work going on right now and a lot of retailers, especially big box retailers, to how to get closer in some cases, in some markets to a dealer type environment where you can get a better connection with the end consumer and create more of a bond, level of trust, which is needed to closing sale. So, we continue also to work with them on those long-term initiatives.

Mark Herbek - Cleveland Research

And then, last question. Just in regards to momentum throughout the quarter, working capital would suggest maybe demand was a little bit softer in the quarter. Can you talk a little bit about how the quarter progressed? And then, maybe what you are seeing at this point in November?

Kent Guichard

Yeah, I'll talk in general terms. Normally, when we first started the quarter, we got into late summer and even the early fall, we saw a normal uptake in activity that you would expect with the footprint. Now, it would be from a lower base obviously but when we first started to get into the fall selling season, we would consider to be a relatively normal footprint. When we got into the fall selling season, it is not a peak like the traditional footprint would suggest, but nor did it last as long as the traditional footprint would suggest.

So, in general, I guess, I hope that answers your question as that started out pretty much on the right trajectory, didn't get as high and didn't last as long as we would expect it from the historical footprint, even considering that we started at a lower level.

Mark Herbek - Cleveland Research

Thanks guys.

Kent Guichard

Okay.

Operator

Thank you. Next we'll go to Peter Lisnic with Robert Baird

John Haushalter - Robert Baird

Good morning, it's actually John Haushalter turning on for Pete. The total kind of the balance sheet, if you look back, your average price on the shares was in the $26, $27 level for the quarter and you bought back about $6 million. In previous quarters you've been willing to spend a bit more at a higher share price, is there something we're reading into that or you need kind of cash to run the business given your outlook right now or --?

Kent Guichard

No.

John Haushalter - Robert Baird

Should we expect kind of activity to resume at a higher level perhaps?

Kent Guichard

Yeah, what our approach is on the repurchase is, just like we try to coach all you guys, market time it doesn't really work and so, what we have as we set internal targets in terms of cash balances. And when we have cash, that's an excess to that and we don't think there is anything really strange going on in the market. Then we are in the market as buyers and when our cash reserves hit or drop below our targets, we are out of the market until they recover. I wouldn't read anything into our activity, especially, on a short-term basis like the quarter. That's a signal of any change that's coming.

John Haushalter - Robert Baird

Okay. And then just turning over to the credits, I guess with the two customers, the $1.5 million that you guys reserved this quarter, is that fully those two customers or is that you guys kind of taking up proactive approach to the other ones on credit launch right now?

John Wolk

It's the ladder. It's actually both. It's certainly in a 100% write-off on the two customers that did file for bankruptcy. Although we hope there can be some collection there, we haven't assumed that will occur. In addition, we proactively review the rest of the portfolio and made some additional adjustments based upon that review.

John Haushalter - Robert Baird

Okay. And I guess --

Kent Guichard

One thing, this is Kent. Don't read into that as it's done. I mean, if we do, the situation remains fluid and when you go through market cycle like we are going through now, there are lot of builders out there that are distressed and what we did as we went through, like we do every quarter and did a complete evaluation of all of our exposure in light of the performance with these companies. If there is a builder out there that if we learned about tomorrow all of a sudden it goes from hanging in there to severe distress, will every quarter through that based on what we see our exposure is.

John Haushalter - Robert Baird

Okay. And in general, are you kind of tightening your AR days? With those customers, you are gradually taking every one down?

Jon Wolk

Well, that will be a very desirable outcome from our perspective, which is that the reality is that as Kent indicated, several of these companies are distressed and their ability to just reduce our DSO is not necessarily there right now given their own cash flow dynamics, but, having said that, we are working very closely with the number of these customers. There are in some cases, weekly or even daily conversations on cash flow, on housing starts and so forth, and on when cash is going to commence to get the accounts receivable balance managed down as much as possible.

Kent Guichard

I'd also add to that from an operational standpoint, our terms, we believe are well within reason. The thing can get you exposed, really get you exposed is if you can't do the punch list and get the house signed-off and get it into their system there starts a clock tick.

If you wait a week or two weeks or three weeks or however long it is to get that last piece of molding there or that last door or that last part to make that last service call, the clock isn't ticking yet. And so there is a real premium, particularly with customers that they are working at the margins, with making sure that our first time installs are complete and we get sign-off, so we get into the system.

Once we get into the system the process works pretty normally and we get paid in a timely fashion. The real thing that we can control is to make sure that our first time complete install is done and we get them. We get the superintendent to sign-off and get the same cleared into the system.

John Haushalter - Robert Baird

Okay. And then just turning over to the gross margin line, you attributed the decline to about four or five factors? If you were to weight those factors, is that really just the lower sales volume or the one I am kind of curious about is just the fuel prices, because that seen to spike up. This diesel prices seem to spike up in the quarter and just what's your outlook is there?

Jon Wolk

Yes, the impact of diesel prices is actually going to get worse, because after the conclusion of the quarter they shot up another $0.30 per gallon. So, that's going to become more and more of an impact, and as I said, we're evaluating taking pricing actions there with customers because of that dynamic.

But in terms of order of magnitude, I'd say that the biggest impact upon us at this point, is the lower sales volume and the labor inefficiencies that that causes. And, as I indicated in my comments, having reduced the direct labor force by 26%, 27% over the last 18 months, we've been pretty much on that. We tend trail it, we don't lead it. So there is some of that impact as well.

John Haushalter - Robert Baird

Okay. Thank you. I'll get back in queue.

Kent Guichard

Thank you.

Operator

Thank you. (Operator Instructions). And we'll go next to Robert Kelly with Sidoti.

Robert Kelly - Sidoti

Good morning. Thank you for taking my question.

Kent Guichard

Good morning.

Jon Wolk

Hey, Bob.

Robert Kelly - Sidoti

I have just a follow-up on the diesel-fuel expense. Is that kind of included in your guidance, some sort of flat level with the recent spike for the remainder of the year?

Jon Wolk

Yeah, it's not going to move the needle versus the guidance that we've just put out there.

Robert Kelly - Sidoti

You are not expecting any sort of relief there?

Jon Wolk

No. Not at this point.

Robert Kelly - Sidoti

Also a question, you guys have targeted the top builders for market share. Now, we've heard quite a bit about margin pressure up and down the supply chain throughout the year here. Is that something you are experiencing or is this just an opportunity for those guys to go after the lower price point that you guys are providing?

Kent Guichard

I am not sure, I understand your question.

Robert Kelly - Sidoti

We've heard from many guys in the supply chain, how the builders are looking to hammer the suppliers over the head. Is that something that you are experiencing or are they kind of trading down to your price point? It seems like you have done a pretty good job on the builder side. Could you just give us a little color there?

Kent Guichard

Yeah, I am not sure in our category there is especially between suppliers, that you really get a lot of trading down or price points between suppliers. You don’t go from one supplier to another for that. I mean, fundamentally, it's different that way than the remodel market, where you'll get a significant amount of business in custom, semi-custom and then in our stock category. The builder market has a tension and it would be mostly the stock manufacturers, primarily due to lead times. So, large production builders can't live with the lead times that come out of say a custom house.

So, a lot of the volume, at least all the volume from them, everybody pretty much has pretty similar price points and products. Now you have trade up strategy, but it is pretty similar. And, in terms what we have seen from the builder, it varies by builder. Builder's that are still trying to keep up their production rates are very aggressively trying to bring down the price of the house and we are certainly in active discussions about how to do that. Value engineering, you can value engineer you can go to a lower price point products there are all sorts of ways to do that.

We have had pretty good experience, in terms of working with our builders in partnership, to be able to make sure that the end result accomplishes something that all parties can live with. And I think more of what I'm starting to see out there in terms of an emerging trend from the builders is, we have hit a lot at this. They are starting to talk about hitting really an inelastic part of the demand curve. And that is by taking another 20,000 or 30,000 or 40,000 out of a house, you are still not going to sell the house.

And so, they have gone more in terms of trying to get the inventory out and at least resume some production as opposed to continuing to drive down the point of a house, because they are finding that, giving a few more bucks or extra plasma TV's in incentive of whatever, really isn’t moving inventory, because they are really in an inelastic section of the curve.

We have to be very competitive. As I mentioned in my opening comments, we certainly need to be competitive at the opening price points. But that's anything different, quite frankly, than it's always been, it has always been very competitive at the opening price point. So, we think that right now, we are seeing a situation where our customers are working with us and so far we think it's manageable.

Robert Kelly - Sidoti

That's great. And then finally, is there a level where your outlook drops or you have a chance to maybe go, consolidate some sort of your manufacturing capacity to maybe get the cost structure lower. Is that something that's even on the table at this point?

Jon Wolk

Well. The way I would answer that question is first of all, we are constantly reviewing our asset base. For us to make a decision on our asset base, it's a three to five year decision. What we would have to do is come to the conclusion that, three to five years from now, for whatever reason, we would have excess assets, whether it's a facility or whatever it might be.

And right now, our evaluation again, based on our view of the world, it's when not if those things going to get back to something normal. The real question is what, do you look like on the other side. And we still think in terms of our core facilities, that on the other side that all of those our good assets are in the right place that we will be going to earn an adequate return on.

In terms of the shorter term issue, one is, again that would be inconsistent with looking out, in managing the asset base longer term. But the other one is, say you think it's going to last a year, but if you close the major facility, over the first 12 months, you are probably going to lose money. You are going to have an initial hit, certainly a book hit, some cash hit, to close hit and get you out of that facility. It will be a large facility, you would be covered by the Warren Act, you have to go through all the notifications and everything else in the world.

But the other thing that John mentioned a little bit earlier, it's the similar impact in terms of when you reduce head count significantly. It's even after you go through those initial expenditures, you're going to have to rebalance your entire network. We are very freight intensive. For example, after the customer you're going to have to change all your freight range, you're going to have to redo your distribution network, you're going to have to change your internal flows. So, you're going to go through even after the initial expenditures, you're going to go through another period of time where you're going to generate a lot of this inefficiency, you rationalize your network.

So, it's not easy to close down our mainline facility in the integrated global goods manufacture. So, we wouldn't do that based on a quarter or two quarters. We would only do that if we looked out many years, three to five years, and decided that we just didn't have the platform. We didn't have the footprint that we think was appropriate for, out there in a normalized environment.

Robert Kelly - Sidoti

Okay, great. Thank you.

Jon Wolk

Good.

Operator

Thank you. (Operator Instructions). We'll go next to Keith Johnson with Morgan Keegan.

Keith Johnson - Morgan Keegan

Hi. Good morning.

Kent Guichard

Hey, good morning.

Keith Johnson - Morgan Keegan

I had a couple of quick questions. First is on the quarter, it looks like the tax rate came in a little bit lower and where you guys were in the first quarter of fiscal year. I didn't know if there was anything broader than that, if you could give us little guidance on tax rate for the remainder of 2008?

Kent Guichard

Yeah, Keith. It's been coming down as the year has been progressing, simply because our forecasted amount of net income has been going down and our permanent differences are roughly constant. So, the impact of the permanent difference is in relation to the pre-tax income has just been going up and that's been causing the effective rate to go down. I would say that for the remainder of the fiscal year, our expectation is that the effective tax rate is going to be in the vicinity of --

Keith Johnson - Morgan Keegan

Alright, so the --

Kent Guichard

So, I am getting those number right?

Keith Johnson - Morgan Keegan

Okay.

Kent Guichard

Roughly 34% give or take.

Keith Johnson - Morgan Keegan

Okay, for the year? Okay. And, a follow-up question on the doubtful account allowance.

Kent Guichard

Yeah.

Keith Johnson - Morgan Keegan

On the customers that we're starting to see the financial distress show out, can you give us an idea what size, either from maybe a number of homes per year or some type of run rate, give us an idea of the size of those customers?

John Wolk

There were numbers of large builder with a pretty large footprint and publicly traded. We're primarily focused on the eastern side of the United States. Another one was the West Coast privately held company that was really focused as I said, pretty much Midwest. In terms of some of the other ones that are showing some distress, it's sort of once a gallop.

Keith Johnson - Morgan Keegan

Okay, I appreciate the answers. Thanks.

John Wolk

Sure.

Operator

Thank you. And at this time there are no further questions. I would like to turn the program back over to Mr. Glenn Eanes for any additional or closing comments.

Glenn Eanes

It seems there are no additional questions, this concludes our call. And again, I would like to thank you for taking your time to participate. And speaking on behalf of the Manager of American Woodmark, we appreciate your continuing support. Thank you.

Operator

That does conclude today's conference. You may disconnect your lines at this time.

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Source: American Woodmark F2Q08 (Qtr End 10/31/07) Earnings Call Trasncript
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