Scott Culbreth - SVP and CFO Cary Dunston - CEO and President.

Nick Coppola - Thompson Research Group Garik Shmois - Longbow Research Josh Chan - Robert W. Baird Scott Rednor - Zelman & Associates.

Welcome to the American Woodmark Corporation Second Quarter 2017 Conference Call. Today's call is being recorded November 22nd, 2016. We will begin the call by reading the Company's 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 in any such forward-looking statements.

Such factors include, but are not limited to, those described in the Company's filings with the Securities and Exchange Commission and the annual report to shareholders.

The Company does not undertake to publicly update or revise its forward-looking statements even if experience or future changes make it clear that any projected results expressed or implied therein will not be realized. I would now like to turn the call over to Scott Culbreth, Senior Vice President and CFO. Please go ahead, sir..

Good morning, ladies and gentlemen. Welcome to American Woodmark's second fiscal quarter conference call. Thank you for taking time to participate. Joining me today is Cary Dunston, President and Chief Executive Officer. Cary will begin with a review of the quarter and I will add additional details regarding our financial performance.

After our comments we will be happy to answer your questions.

Cary?.

Thank you, Scott, and good morning to you all. Although our second quarter appears challenging, for the first six months we remain pleased with the performance and, more importantly, very confident and optimistic about our strategic work underway.

For the quarter, we grew sales 3% over prior year, with new construction remaining very strong while remodel lagged. For the six months, sales were up 7% over prior year.

As I talk about our revenue comps I want you to keep in mind my communications last quarter regarding the need for us to bring production down in our second quarter as a means to elevate our backlog to desired levels.

In addition, relative to comps, as you may recall, last year we had the completely opposite situation where we ran light the first quarter and had to run heavy in Q2 to bring our backlog down. Actual production and revenue levels cannot be tied directly to incoming demand levels for the given quarter.

Again, specifically at new construction revenue, we had another strong quarter, growing our Timberlake business 15% over prior year. With single-family starts up only 4% for the same period, we continue to gain share and excel with our direct to market service platform.

From an industry perspective, single-family starts were a bit sluggish in the quarter but picked up recently with the Southwest and Southeast regions remaining the strongest growth areas in the country.

We're continuing to hear more conversation around first-time homebuyers and we're beginning to see some new programs and subdivisions being developed. However, the actual mix impact has been minimal up to this point. We do feel that the entry-level activity will continue to ramp up but at a moderate rate in the new year.

From a remodel perspective, we were down 9% for the quarter, with home center the key driver. Within the dealer channel we were up 9% from prior year. We did see some moderation of growth with the more affluent consumer.

Personally I feel it was more tied to the uncertainty in the economy and the pending election, as consumer confidence did waiver a bit. As such, we remain optimistic on solid growth within dealer as we move forward. Our greatest challenge remains within home center business which was down 13% for the second quarter.

Four key factors influenced the negative comp. The first is that the overall home center business did not comp well during the quarter as it continues to lag the dealer business. Secondly, as I stated before, we did temper our production at a rate lower than our actual incoming levels as a means to elevate our backlog.

Thirdly, I mentioned last month that we were reluctantly going to begin responding at parity with our competition on promotional activity. We did indeed do this.

However, there is on average a 4 to 5 week delay or potentially greater, dependent on the actual timing of the promotions in the quarter, for when an order is placed and the revenue is earned. So it will take the third quarter before we see the full impact. We did, however, see a steady improvement trend in our order pattern throughout the quarter.

However, the overall impact for this increase in our promotional levels is going to be diluted somewhat due to the fourth factor.

Much to our amazement, as soon as we communicated that we were going to elevate our promotional spend to match what I considered to already be unhealthy levels, one of our key competitors immediately raised the bar even higher.

And although we have traditionally not allowed competitors to buy share, there is a point at which we simply will not follow. I strongly believe that the current levels are very unhealthy for the long term sustainability of the kitchen business within home centers.

In addition, with our current capacity utilization levels, it does not make financial sense for us to pursue such high levels of promotional activity. Our organic growth since the end of the recession has outpaced the industry and our competition and we simply have no reason to buy share.

Within the channels, where we directly compete with a long term competitive advantage of service, we're clearly winning. The positive is that we at American Woodmark do not have to focus our efforts on buying share.

Rather, we continue to invest in and further strengthen our true competitive advantage in all our markets, as this is the right long term winning strategy. From a gross margin perspective we ended the quarter at 21.3%.

Incremental gross margin proved to be a challenge for the quarter as we were facing tough comps from prior year, as well as the impact of lower home center sales, higher depreciation from our expansion completed roughly one year ago and a higher healthcare rate.

Finally, our operating margin for the quarter came in at 10.7% and we generated $17.6 million of net income. Relative to where we expect our performance to be in the second quarter, despite the challenges with lower revenue, we performed well on our operating margin.

And year-to-date we remain pleased with our incremental gross margin rate of 27% and our operating margin of 11.5%. From a backlog perspective we're sitting where we wanted to be as we head into our third quarter, with production properly balanced.

We remain confident in new construction activity and the dealer business going forward and we will be keeping a close eye on consumer spending and the promotional activity within remodel. From an overall Company perspective we're actively engaged in researching and vetting all opportunities to expand our positioning, as I communicated last quarter.

I'm extremely excited by our future and our ability to truly focus on our strategic platform. We have a winning competitive advantage and we can and will leverage our service platform to successfully expand our businesses well into the future. With that, I'll turn it back over to Scott for the financial details..

Thanks, Cary. The financial headlines for the quarter, net sales were $264.1 million, representing an increase of 3% over the same period last year. Reported net income was $17.6 million or $1.07 per diluted share in the current fiscal year, versus $18.2 million or $1.10 per diluted share last year.

For the six months ended October, year-to-date net sales are $522.2 million, representing an increase of 7% over the same period last year. Net income was $39.3 million or $2.39 per diluted share in the current fiscal year versus $33.3 million or $2.03 per diluted share last year.

For the current fiscal year the Company generated $40.1 million in cash from operating activities compared to $42 million for last year. The new construction market slowed during the quarter but continues to perform well.

Recognizing a 60 to 90 day lag between start and cabinet installation, the overall market activity in single-family homes was up only 4% for the financial second quarter. Single-family starts during June, July and August of the prior period averaged 726,000 units. Starts over that same time period from the current year average 752,000 units.

Our new construction based revenue increased 15% for the quarter. As we have stated on prior calls, we continue to over-index the market due to share penetration with our builder partners and the health of the markets where we concentrate our business. The remodel business continue to be challenging.

On the positive side, unemployment continues to improve. The October U3 unemployment rate dropped to 4.9% and U6 dropped to 9.5%. Both measures were lower than the October 2015 reported figures. Residential investment as a percent of GDP for the third calendar quarter of 2016 held steady at 3.5% versus 3.5% from the prior year.

The index remains well below the historical average of 4.6% from 1960 to 2000. Interest rates remained low in the quarter, with a 30-year fixed-rate mortgage at 3.47% in October, a decrease of approximately 33 basis points versus last year. All cash purchases in September were 21%, down from 24% last year. The share of first-time buyers improved.

The September reported rate was 34% better than the prior year rate of 29% and matched the highest share since July 2012. Keep in mind the share remains well below historical norm of 40%. On the negative side, existing home sales decreased during the third calendar quarter of 2016.

Between July and September 2015, existing home sales averaged 5.4 million units. That same period for 2016 averaged 5.38 million units, a decrease of 0.4%. The median existing home price rose 5.6% to $234,200 for September, impacting our consumers’ affordability index.

Consumer sentiment dropped to 87.2 in October versus the 92 recorded at the beginning of the calendar year and the 90 recorded in October 2015. Homeownership rates remain low versus historical averages. The percent of Americans who own their own home in the third calendar quarter was 63.5% or 0.2% below last year's rate.

Our combined home center and dealer remodel revenues were down 9% for the quarter, with home centers declining 13% and Waypoint growing 9%. Promotional activity remained higher than the prior year for the second quarter, as we responded to competitive positioning and market conditions.

We disclosed a change in our approach during last quarter's call and shared that we'd begun matching competitor promotions. Due to the lag in order placement and order shipment, we will not fully realize the impact associated with this change until our third fiscal quarter.

The Company's gross profit margin for the second quarter of fiscal year 2017 was 21.3% of net sales, versus 21.9% reported in the same quarter last year. The Company generated a year-over-year incremental gross margin of 1% for the second fiscal quarter.

Gross margin was negatively impacted in the quarter by higher labor benefit cost and appreciation costs. Year-to-date gross profit margin was 22.1%, compared to 21.8% for the same period in the prior year.

Gross margin for the first six months of the current fiscal year was favorably impacted by higher sales volume, lower labor benefit costs and improved operating efficiency. Year-to-date the Company generated a year-over-year incremental gross margin rate of 27%.

Total operating expenses decreased from 10.7% of net sales in the second quarter of the prior year to 10.5% this fiscal year. Through six months, SG&A improved from 11.1% of net sales to 10.6%. Selling and marketing expenses were 6.5% of net sales in the second quarter this year compared with 6.5% in the prior year.

Additional product launch costs in the quarter were offset by lower commissions. General and administrative expenses were 4% of net sales in the second quarter of fiscal year 2016 compared with 4.2% in the prior year.

The decrease in our operating expense ratio was a result of leverage from increased sales and lower pay-for-performance compensation costs. With respect to cash flows, the Company generated net cash from operating activities of $40.1 million in the first half of fiscal year 2017 compared with $42 million during the same period in the prior year.

The decrease in the Company's cash from operating activities was driven primarily by lower increases in accounts payable and accrued expenses. Which was partially offset by lower increases of customer receivables and higher operating profitability.

Net cash used by investing activities was $50.4 million during the first half of the current fiscal year compared with $25.8 million during the same period of the prior year, due to an increased investment of $36.5 million in certificates of deposit which was partially offset by decreased investment in property, plant and equipment.

Net cash used by financing activities of $8.5 million increased $7.8 million in the first half of the current fiscal year compared to the same period in the prior year, as the Company repurchased 139,800 shares of common stock at a cost of $10.4 million.

A $3.4 million increase from the prior year and proceeds from the exercise of stock options decreased $3.7 million. In closing, we were challenged this fiscal quarter with a tough retail environment and faced our strongest comps from the prior year.

In the past, I've shared that our performance has been on a positive trend since the recession which has mirrored the improving housing market. Some quarters will be above the trend line, like Q1 2017 and some will be below the trend line, like Q2 2017.

Looking forward, we maintain our expectation we shared in our last call that we will increase our operating margins for fiscal year 2017. As Cary mentioned, we remain excited about our future and our ability to leverage our service platform beyond our current business. This concludes our prepared remarks.

We would be happy to answer any questions you have at this time..

[Operator Instructions]. We will take our first question from Nick Coppola from Thompson Research Group..

So, wanted to really dig into the home center channel there.

Can you talk anymore about what you're seeing in terms of incoming orders versus that revenue performance that you cited down 13% year-over-year?.

All I can really say, it does get a little diluted because you go out with one variable and you change one key variable which is promotional rate, promotional spend and you want to watch that and see how that variable has impacted the market. And then another variable gets thrown in where competition immediately increase theirs.

So it does make it a little challenging to see the direct impact. But as I mentioned, about the only thing I can say is, taking the delay into consideration is, we're seeing a positive improvement in the trend throughout the quarter. So exactly where that trend is going I think is still to be determined, but it did improve throughout the quarter..

So, when you started -- it sounds like you are not going to promote as much as competitors, but you did step up.

Did you see any recovery in market share or any accelerated growth from your actions?.

That's what I'm referring to. So when we -- like I said, there's a four to five week delay and really longer dependent -- because the promotional activity, depend on the timing of it.

As soon we made the decision and communicated that we're going to step up, that doesn't necessarily associate that week with the fact that there's a promotional activity going on. So taking that into consideration, yes. We actually did see a response, a favorable response in the market, in our incoming levels.

That got diluted somewhat by a competitive response, but overall yes, it did trend favorably throughout the quarter. It's still kind of to be determined. I personally don't feel that the levels that we're seeing out there are sustainable, particularly by one competitor. So it may come back down and we may be back at parity given our increase.

That's really to be determined..

And then I just wanted to ask about product launch costs. I think we had talked about there being an impact in Q2 and Q3.

What did you see this quarter and expectations going forward there?.

Yes, that still holds. We did have some launch costs in Q2. We will have them again in Q3. They will be a tick higher in the Q3 period versus Q2; we've got more product coming out with that launch.

We didn't really see it read through the P&L and see a negative impact overall on our selling costs and the primary reason for that is we saw lower commissions. And you could directly correlate the lower commissions back to the conversation we were just having around our home center performance..

We will take our next question from Garik Shmois from Longbow Research..

I just have a follow-up question on the promotional activity in the home centers.

Is there a risk at all that the increased promotions bleed into some of the other channels, whether it's to the builders or into dealer? I guess another way to ask it, is pricing attractive enough and competitive enough that retail will start taking share from the other channels that have been holding up quite well?.

To answer your question directly, in the new construction market first, no. You really don't see it. You could see it somewhat on it the distribution side of the business with smaller builders.

That's obviously a low percentage of our business because we go direct and most of that business is all contractual and we negotiate pricing and everything on a contractual basis. And obviously they take a lot into consideration, particularly service levels which is what gets is our market share there.

We still price to the market but it's our service levels that get us the share. But yes, we're seeing an increase in promotional activity in the dealer business. The good thing there is that, if you think about home center, there's really two key competitors in that market.

So if one or both of them do a heavy promotional activity, it has a very direct and immediate impact on you. When you get out in the dealer world, number one, there's thousands and thousands of dealers. And number two, it gets a lot more spread out with regards to market share.

There's literally thousands of competitors and a large number of key competitors, particularly a significant number of regional players that hold some pretty heavy market share in the dealer side.

So even though you are seeing an increase and you're seeing one key competitor in particular do some pretty heavy promotions out there, it does not have the impact that you would typically see in the home center market..

Just switching to how you're thinking about strategic initiatives. Last quarter you indicated that you'd be taking a look at the possibility of either greenfield or acquisition expansion.

Can you provide an update on where you are at with your thought process there?.

Yes, we're continuing to aggressively work on that -- both those options, really. So we're working with our partner in Baird and we're doing a lot of vetting and looking at all opportunities that may exist in the market with regards to acquisitions, either below and/or above our current level.

In addition, we're doing parallel work in the event that we decide not to acquire, that we would enter those markets directly via our own greenfield/brownfield. So the work is definitely continuing. I know that a question everybody asks is when can you communicate something? Obviously if I knew that, that would be great.

I don't know exactly when I will be able to communicate, nor could I communicate to you if I did know exactly when I could communicate. Most of what I'm telling folks is in the next six months we certainly want to get this locked up. It's not with regards to the need to communicate, but just strategically.

We're in a place where we want to get ourselves in a position where we're starting to move forward with regards to financial investments, whether that be internal with a greenfield/brownfield project or we can announce a potential acquisition in the market that would drive that.

In the not-too-distant future we certainly hope to finish this work and communicate to the market. But I will say we're very pleased with the direction we're moving right now and I think there's a lot of opportunity for us..

[Operator Instructions]. We will take our next question from Josh Chan from Baird..

I wanted to follow up about the home center trajectory. You mentioned that the quarter improved through the quarter.

What does it mean for the kind of growth rate going forward? Do you expect to still have negative comps in the second part of the year? And then related to that, is there any change to the way you look at your revenue growth outlook for the year?.

Yes, why don't we focus on the second half of the question versus getting into all the various forecasts from a channel perspective. But last quarter and also what we said I believe two quarters ago, was our expectation on the year was we expected our growth to be low double-digit. And we still believe that's what we will deliver for fiscal year 2017.

So we're still holding to that low double-digit result on the top line. And from an operating margin perspective we're still holding that we will drive growth in that measure year on year..

And then switching over to some of the items on gross margin, you mentioned labor costs.

Was that anything unusual this quarter? And then also for the impact of the promotions that you did realize, was that significant in terms of impacting gross margin this quarter?.

The promotional piece was not a significant impact in the quarter, back to Cary's earlier comments that we did not see a significant amount of revenue shift in the period associated with that. So that's more of a Q3 type conversation.

But the way we had modeled that is we were anticipating incremental revenue there for leverage to help us mitigate some of the impacts associated with that. So no significant impact in Q2. Back to the other margin areas that you focused on, depreciation we still had that last bit of lapping for the South Branch expansion we had out in West Virginia.

We have now gotten past that now that we've closed out Q2. And on healthcare you will recall we had a lot of conversation in Q1 about a very favorable impact on the business which we articulated in our minds to be an anomaly. We felt they would recover back to a more traditional type of healthcare rate.

We did see that in the second quarter, so it was up versus our first quarter and it actually was up versus prior year as well..

We will take our next question from Scott Rednor from Zelman and Associates..

A question on the promotions.

Is there anything with your customers on that channel that should get reset in terms of the cadence as they go to their new calendar year or fiscal year?.

Not sure if I totally understand your question, but that's always something we work closely with them on. Their fiscal years are coming up, as you know. As they start to close out the year, it all depends on where they are at the end of their fiscal year relative to where they forecasted they would be.

And sometimes we can see an additional surge of promotional activity, sometimes they really back off. That is in their hands relative to where they typically end their fiscal year.

But as of right now, there's nothing that I would say, when I look into the future and say that -- at least it's not been communicated to us with regards to a change in the status or the posturing with regards to promotional activity. We all talk with it; I think they all agree that it's not at a healthy level.

The question is at what point in time can they make the decision to start to bring it down. I think that's just a challenge for them, given the fact that the pie is just not growing at a rate that would help to offset the loss from that revenue, given the reduction in promotion.

So it's a tough situation I know for them, because they have to get the comps. So as of right now, all I can say is I don't know what they're going to do towards the end of the year, but right now there's nothing that I have seen or heard that's going to change the promotional activity on their front, anyway.

At a competitive level that's to be determined..

And I guess within that, now that this has stepped up incrementally in terms of the promotional environment for -- I guess it's now three or four quarters in a row, does it change how you guys think, what the long term margin potential of your business is? I know before we were talking 8% to 10%; you guys blow through that in 1Q.

But how do you guys think about that now with what we're seeing?.

It doesn't really change our forecast, as Scott mentioned, for this fiscal year. Longer term, no. I think where we've talked -- we were at a Baird conference a couple weeks ago and got asked that question on the margin. We feel good with where we're right now.

The 10%, 11% to 12%, can we -- I think the first goal in our mind was to get -- not only achieve it, but to sustain it because it will be a first in the history of the Company to be able to achieve it and sustain these levels. And we're differently showing we can do that. And now it's our objective to take it to the next level.

What that level is, obviously I think is a piece of it and is tied to our current core business. I'm certainly not willing to accept that our home center business has to take a margin hit. I think it just might mean how we go to market. personally I don't feel the high promotional activity is sustainable long term.

If it is, yes, it will force us to make some decisions with regards to our market positioning. And I think it will be a balance between revenue and margin when it comes to that equation. But longer term, no.

We certainly plan to grow our margins and our EBITDA and the question is how do we do that and that really is tied to the strategic work that we have underway and we feel very encouraged by it..

And one last one, Scott.

Can you maybe talk about how we should think about tax rate, given a little bit of noise in the quarter? And then did the discretionary pension contribution, did that hit in 2Q?.

Yes. So on the tax rate itself, you're right, we had an unusually low Q1 because of the stock-based comp impacts and how you get to roll that through with the new edict. Second quarter had it go the other way related to domestic production which is tied to the pension contribution.

So going forward, what I would say is a 36% to high end 37% type rate is more appropriate. And I think you'll see more consistency in the back half of the year than we saw in the choppy first quarter and second quarter. With regard to the pension, we made $8 million of discretionary contributions to that plan in the quarter..

[Operator Instructions]. As I do not see that there is anyone else waiting to ask a question, I'd like to turn the call over to Mr. Culbreth for any closing comments. Please go ahead, sir..

Thank you. Since there are no additional questions, this concludes our call. Thank you for taking time to participate..

Again, that will conclude today's conference. We thank everyone for their participation..