Good day and welcome to the American Woodmark Corporation Second Fiscal Quarter 2021 Conference Call. Today’s call is being recorded, November 24, 2020.

During this call, the company may discuss certain non-GAAP financial measures included in our earnings release, such as adjusted net income, adjusted EBITDA, adjusted EBITDA margin, free cash flow, net leverage and adjusted EPS per diluted share.

The earnings release, which can be found on our website, americanwoodmark.com, includes definition of each of these non-GAAP financial measures, the company’s rationale for their usage and a reconciliation of these non-GAAP financial measures to the most comparable GAAP financial measures.

We also use our website to publish other information that maybe important to investors such as investor presentations..

Good morning, ladies and gentlemen. Welcome to American Woodmark’s second fiscal quarter conference call. Thank you for taking the time to participate. Joining me today is Scott Culbreth, President and CEO. Scott 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.

Scott?.

Thank you, Paul and thanks to everyone for joining us today for our second fiscal quarter earnings call. I hope that you and your loved ones continue to remain safe. Our teams did an exceptional job of delivering results in the quarter. Our second quarter sales were up 4.8%.

Within new construction, our business declined 7.4% versus prior year as we felt the impacts from COVID-related restrictions on prior period starts. Our Timberlake direct business comped positive low single-digits on units, while our frameless PCS business continued to comp negatively in Southern California.

Our national builders are optimistic for the remainder of our fiscal year due to strong order growth over the prior months. Capacity of the manufacturing trade base to keep up with demand rising prices and potential COVID-related restrictions could slow future build rates.

Lot supply and community count growth are also key indicators we are watching closely. Our incoming order rates for the Timberlake business increased throughout the quarter building backlog across our MTO platform. As a reminder, we level load our production on the MTO platform.

Our incoming order rates across both new construction and remodel businesses exceeded shipments for the quarter. Our teams have been increasing production levels, which will drive incremental sales in our next fiscal quarter and improved backlog levels..

Thank you, Scott. The financial headlines for the quarter, net sales were $449 million, representing an increase of 4.8% over the same period last year. Adjusted net income was $33.5 million or $1.97 per diluted share in the current fiscal year versus $31.2 million or $1.84 per diluted share last year.

Adjusted net income was positively impacted by higher sales leveraging of our fixed costs and benefits from our actions taken in the first quarter.

Additionally, we incurred restructuring charges related to the closure of our Humboldt manufacturing facility for $2.8 million that were partially offset by an unrealized gain on foreign exchange forward contracts of $0.6 million.

Adjusted EBITDA was $65 million or 14.5% of net sales compared to $63 million or 14.7% of net sales for the same quarter of the prior fiscal year. The combined home center and independent dealer and distributor channel net sales increased 14.1% for the quarter, with home centers increasing 18% and dealer distributor increasing 0.6%.

The remodel business is showing strong signs of recovery as people are more comfortable allowing access into their homes to install cabinets as well as the increased demand from the DIY and pro customers.

The new construction sales channel lagged market demand during the second quarter of fiscal year 2021 recognizing a 60 to 90-day lag between start and cabinet installation. The overall market activity in single-family homes was up 9.5% for the fiscal second quarter.

Looking at the start data that extends the lag time to 90 to 120 days, we saw a 2% increase in starts during that same period. Shifting focus to completions during our second fiscal quarter, we saw a 0.7% decline year-over-year, which further supports timing impacts. New construction net sales decreased 7.4% for the quarter.

Timberlake direct business comped positively in units, which was offset by a mix shift to lower priced products and negative comps in our frameless business. The company’s gross profit margin for the second quarter of fiscal year 2021 was 20% of net sales versus 20.3% reported in the same quarter of last year.

Gross margin in the second quarter of the current fiscal year was negatively impacted by higher material and logistic costs, investment made in our locations for PP&E and safety measures, combined with wage and retention programs.

These costs were offset by increased sales creating leverage of our fixed costs in our operating platforms and a one-time benefit received in the quarter related to an employee retention credit of $0.8 million. Keeping our employees safe during these unprecedented times remains a key focus for everyone at the company..

We will now begin the question-and-answer session. First question comes from Garik Shmois of Loop Capital. Please go ahead..

Thank you.

Just wondering, just given the lag between backlogs and delivery rates, it seems like you are expecting inflection sales growth in the third quarter, but how long do you think it’s still going to take to normalize and so that you will be able to catch up with respect to the delivery times versus the order rates?.

Yes, we think it will take us till the end of the calendar year to fully catch up so that we better match our demand with production. We have been making significant progress throughout the prior fiscal quarter.

By the time we get to January, we think we will be matched and caught up and get our lead times back to normalized rate as well as on the stock platform get our customer inventory levels to the rate they need to be at..

Okay.

And with respect to the sales opportunities in the third quarter, could you maybe walk through the different categories and how you see that and what’s driving the inflection relative to the nearly 5% growth that you saw in the second quarter?.

Sure. When you take a look at each of the respective channels, the trends are going to be fairly comparable to the discussion we just had around fiscal Q2. So new construction, certainly, has accelerated when you look at starts and look at the lag.

We still felt some of the impacts at the start of our quarter related to the COVID shutdowns back at the very beginning of summer. We’ve now lapped that, so now we are seeing a strong demand read through from the starts that were up significantly at the end of the summer. So we’ll see new construction growth as we push forward.

On the remodel side, both our home center and dealer distributor business both returned to positive growth inside Q2. We think that carries forward again as consumers are willing to invest in their home and they’re spending more time there.

And then finally, our stock business, which again is both kitchen and bath, pro and DIY demand there has been tremendous. We were up over 25% in Q2. We think the opportunity for continued growth there remains high. Part of that is getting our customers’ in-stock levels up to the appropriate level.

We think when we do that, it creates additional POS opportunity as well for those customers going forward..

Thanks. And just my last question just on the made-to-order within the home centers, it seems like it’s – I think after the last quarter, you indicated you’re expecting that to improve and it looks like you comped positive this time as well.

Do you think that you’re seeing just a step function change in improvement in made-to-order in home centers and how sustainable is the recent ?.

Yes, I do think there is a step change function there with consumer behavior. We’ve definitely seen millennials now back in the marketplace as it relates to new buying, either new homes or existing homes. As they’re doing that, we’re seeing millennials engage in projects like a remodel project of their kitchen.

There were questions over the last 2 to 3 years as to whether they would go – that population would go to home centers. We’re definitely seeing that. We’re seeing that in the retail data that millennials are going to Home Depot and Lowe’s to do those types of projects. They are also going to dealers, but definitely over indexing at home centers.

So we’re seeing that as an opportunity. The other thing that I would mention would just be around imports and as we’ve seen again the import data fall come out of China, net imports down out of Asia, that’s created an opportunity for domestic manufacturers and domestic retail outlets.

So you’re seeing, I believe, an increase at the home center, both in special order and stock as a result of that..

Great, thanks very much and happy holidays..

Yes. Thanks, you too..

Next question comes from Truman Patterson of Wells Fargo. Please go ahead..

Hey, good morning, guys. Thanks for taking my questions. First, I wanted to touch on a little bit more on the capacity issues or potential issues constraining your ability to service demand. And I’m asking this a little bit because I thought last quarter you all gave the impression that new residential would be pretty solid.

It was down, I think you said, 7.5%. So I’m hoping to understand some of the market share dynamics there whether or not any imports are starting to play in that at all. But also, single-family starts are now up 30% in October.

Do you all have the capacity to service that? Does the industry have the capacity to service that? Just trying to understand the moving parts there?.

Yes, so there’s a couple of questions in there, Truman. I’ll try to unpack the first. Let’s talk maybe more holistically about capacity, I think you were asking about our business. So specifically in our business and our platforms, there’s really two areas that drive the capacity question for us.

One is labor and we certainly talked at length about that in the prior quarter call. I’d say that’s continuing. We have made progress. The labor continues to be a challenge, both the attraction and retention of that.

Also just the component supply base, so it’s not just our ability to make but all the parts and pieces we’re buying, is our supply partners capable of doing that.

That’s been the work that’s been ongoing inside our fiscal second quarter and will continue till the end of this calendar year to get us in a better position to be able to match our production to overall demand. As you think about market share, that was the second question you had in there around new construction.

On our Timberlake side, no share losses there, in fact, I’d be more optimistic and say we’ve likely taken share over the summer timeframe. We have lost share in Southern California with our frameless business there, so if I kind of separate that out, that’s been a different topic, and we certainly talked about that as well over the last few quarters.

But on the direct platform, no share erosion loss issues there. Can the overall new construction industry absorb 30% comps for a long period of time? I think it’s going to create challenges for all involved. It’s not just a cabinet discussion, it’s appliances, it’s roofing, it’s all the categories as well as just the builders themselves.

We’re certainly scaling our operations to ensure that we can produce the product and then make sure that we’ve got the installed capacity in place.

We’ll have to see how the other comps were actually read through for the builders and how quickly does the – I guess the question here would be does the lag stay 60 to 90 or does it start to move out? And as Paul had simulated, we’re starting to see a shift there.

We’ll see how long the lag time carries into the first part of next year and that will tell you whether or not they’re able to absorb that type of increase..

Okay. Okay, thanks. And then just following up on the cabinet imports, I understand, year-to-date, outside of China, it’s still not necessarily healthy but we’ve seen total imports recently I think are up like 60% in August and September, if my numbers are correct.

Are you seeing import competition start to come into the market in the past, we will call it, 3 months or so? If so, which channels are you seeing it take place?.

Yes, I’ll take the second part of the question first. So we’re not seeing any incremental import challenges in any of the channels at this point in time, especially these last couple of months that you just highlighted.

Going back to the import data itself, sort of, through September, the data I saw was China’s still down almost 60%, definitely see the increases with Vietnam and Malaysia.

But still, in total, down about 60% through that 9-month period, which is about a $375 million shortfall, and that’s where we’ve intimated there’s been opportunity created domestically for dealers, distributors and the home centers to grab that share..

Okay, thanks, guys..

Yes. Thanks, Truman..

Next question comes from Steven Ramsey of Thompson Research Group. Please go ahead..

Good morning. Maybe just start with the Timberlake mix.

Can you share a bit more on the mix shift, how it impacted Q2 sales and margins and thoughts how that evolves in Q3 and if there is thoughts beyond that?.

Yes, no additional details really to provide around that, Steven, other than to just talk about the introduction of our value line, so Origins and that’s something we certainly highlighted coming out of the acquisition. It was one of the key synergy drivers. It’s a profit improver for the business, but it does come at a lower price point.

So as we rotate and move more consumers to that space or grab more share in that, it does have an impact in the mix equation. So that’s what you’re seeing inside of the quarter and I would expect that to be something that continues as we go forward..

Great. And then can you share more on regarding dealer and distribution growth, not as strong as home centers in the second quarter? Do you expect home centers to still outpace dealer and distribution going forward? And then, should there be economic shutdowns in the U.S.

in the coming months, do you think the dealer channel is more prepared to handle that during this timeframe? Is there enough business for them in backlog to even keep them going, should they have to shut down stores?.

Yes, so on the demand side of it, as – if you impact our dealer distributor business, the Waypoint brand, which is our principal brand we get a market at, in the dealer space, it was still up double-digits, which was more consistent with the special order business in the home centers.

So I think there is a line where we continue to see the weakness and challenges have been in the distributor space. So I still think that the dealer business, overall, should be able to perform pretty well, consistent with what we’re seeing in the special order home center categories.

As we look at shutdown impacts, overall, our dealers are better prepared for that. I would say they should be, based on living through that, but more importantly, our customer is prepared for that. Our customer is going to be willing to go spend time at dealers or they’re going to allow folks in their home.

We certainly saw that open up and it was – they were more willing to do that toward the back half of the summer and current time period. But does that mindset start to pivot away with some of the shutdowns? I don’t know yet.

We’re going to have to see how that shakes out, but I have to think that all parties are better prepared to go through a second round of shutdowns than they did the first time..

Got it. And last quick one from me on the launch costs impact that you called out for Q2.

Is this a cost headwind that fades – I’m sorry, you called out for Q3 is this a cost headwind that fades following Q3? If it does, are there other marketing expenses to take its place or is this a source of better margins in out quarters?.

Yes, Steven, just kind of reflecting back into our Q1 call, we announced that we do really product launches in two periods of time. One, we see it in our Q2 and then we’ll see it in our Q3. Our Q3 expected launch costs will be higher than they were in Q2 and that’s really kind of directionally the guidance we will give you there..

Great. Thank you..

Next question comes from Justin Speer of Zelman. Please go ahead..

Hi, good morning, guys. Appreciate it. I wanted to dig into that PCS frameless business in Southern California.

If you could give us a status update and maybe give us an idea of how big that business is and how much it fell in the quarter?.

Yes. So it was down pretty substantially inside of the quarter, Steven. We’ve talked about our frameless business – sorry, Justin, sorry, our frameless business, the last couple of quarters. And quite frankly, it’s not really met our expectation post acquisition.

This is an opportunity for us to think about expansion of that product category outside of SoCal. Where we’ve had some specific challenges in markets in SoCal is around just the product offering, price and logistics. We have been working through the product space and we actually do have a number of new colors that are launching in February.

So that’s inclusive of our frameless line, when we talk about product launches. So we are pushing that through. We are looking at the price and logistics and complexity of our product offering and what opportunities we have to take that outside of Southern California.

There are certainly opportunities in markets like Phoenix, Dallas, Houston, etcetera, so that’s what we continue to work on from a strategic standpoint..

I guess, what changed, because I know it has been – as you mentioned, it’s been an obstacle to performance, I guess, since before the pandemic? Maybe, like, what took place or what detail can you provide behind the scenes that have led to those headwinds?.

Yes, I would say there is a couple of things in that, specifically around our effort to grow that outside of Southern California. That’s been a capacity issue internally. We’ve talked about it and just haven’t prioritized it or put the resources on it. So that’s on us.

And we’ve done that over the last quarter where we dedicated an assigned team to work through that.

The other part of the question is around product and have we stayed relevant in the market? And we got behind on launching some products over the last couple of years that put us at a disadvantage from a goods standpoint, and lost us some share there in Southern California. So I’d say that was the biggest driver..

Perfect.

And then I guess on the – in terms of the – on the trends on the single-family versus multi-family side, can you, I guess, – is the Timberlake kind of a good idea of what the single-family look like? Is that a good kind of breakdown at low single-digit numbers or maybe more detail you can provide in those distinct trends between single-family and multi-family?.

Yes, so Timberlake, the proxy, there’s single-family, that’s the vast majority of the business that we do there. The real – the only significant multi-family business we do is that PCS line, the frameless offering in Southern California. So Timberlake direct will match up with single-family..

Okay. Okay.

And then lastly for me, in terms of the incremental margin pressures that everyone is seeing, I guess, if you were to snap the line and look ahead recognizing, there is a lot of moving pieces here with the PCS business as well, can you offset or maybe even more than offset as you think about price and volume in this environment? Can you offset these headwinds from pricing and productivity levers?.

Yes, so in Paul’s comments, he talked about our outlook as we thought about the third quarter and we certainly think we’ll expand margins off of prior year, just not as robustly perhaps as what we saw in Q2. So we do believe we have the opportunity for improvement, specifically around inflationary considerations.

We do watch that closely and if we see commodities move in a direction that allows us to go take pricing. In the past, we’ve been able to accomplish that. The answer is certainly different by channel and how quickly it takes you to go get it. But over time, we’ve been able to get commodity increases back via pricing..

Thank you..

Next question is from David MacGregor of Longbow Research. Please go ahead..

Yes, good morning, everyone. Just to follow-up, first of all, on that last question.

How much forward visibility do you have right now on things like your raw materials and components and logistics costs?.

Yes, David, what we’re seeing kind of in the marketplace out there is there is a little bit of pressure on our hardwood lumber supply, kind of refreshing memory is this, we do primarily source from the East Coast. With the fires around the West Coast, it did create a little bit of challenges and some pricing pressures that are out there.

That will continue until more supply comes back into the marketplace that is out there. If you remember, from last year, we had pressures around the particleboard charges and things of that nature. There is another mill that’s coming online later this year that we expect that will relieve some of those pressures out there.

So we’re not projecting those to be really significant headwinds for us. One of the concerns that we do have is around freight and logistics charges.

We are seeing concerns in international shipments and containers coming in as well as domestic freight carriers charging increases and just the availability of those freight carriers that are out there today..

Alright. Okay, thanks for that. Can you just – you were talking earlier about your stock cabinet business.

Can you just talk about kind of that home center cash-and-carry business and what you saw in terms of cadence through the quarter on that cash-and-carry business?.

Yes, so again that stock business was up over 25% for us for the – for both kitchen and bath. So we saw strong demand trends throughout the quarter..

It was consistent throughout the quarter at 25%..

I don’t know what the exact number was by individual month, but I’ll just say it was strong throughout the quarter..

Okay, okay. And then just how are you thinking about capital allocation heading into next year and I realize it might be just a little bit early to be talking about 2021 yet.

But I am interested in just kind of, at a very high level how you are thinking philosophically about use of cash and potentially M&A growth – inorganic growth?.

Yes. Speaking of our capital allocation they really have remain unchanged. Our primary focus is going to be really deleveraging our debt position. That’s going to be our first and foremost priority that’s out there today. We will look back at giving investments back into the business through digital investments.

We started our finance and procurement journey now to the cloud-based solution out there to really kind of joining ourselves as one operating company and gain other efficiencies through that channel. But really our overall capital allocation will still stay at roughly the 2% to 2.5% guidance that’s out there..

And with regards to M&A?.

In M&A, if there is a strategic fit that would outpace our kind of our debt pay-down in our internal investments, we would consider it, but as of right now, our priority is focusing internally right now. We’re focusing on our core..

Right. And you mentioned deleveraging is your priority.

What is your updated thinking around the target on leverage?.

Yes, so Paul and I were having this conversation earlier this week. So when we announced the transaction 3 years ago when we acquired RSI, we intimated that we could get down close to 1.5x by the end of, I think, calendar ‘19. So, it’s taken us a little bit longer to get under 2.

Primary reason for that is we did opportunistically do some stock repurchase, I think, when you see post acquisition, and then obviously COVID pushed us out from a timing perspective. So we’re now under 2x. I think as we push ahead, we’ll probably get closer to that 1.5x.

And as we start to approach that, if we don’t have incremental organic investments or M&A investments, certainly share repurchase would come back up into the conversation..

Great. Thanks very much and good luck. Have a great holiday..

Thanks..

Next question is from Tim Wojs of Baird. Please go ahead..

Hey, guys. Good morning..

Hey, good morning, Tim..

I have a couple of follow-ups and then just one bigger picture question. So the follow-up just on the margin sequentially kind of not being quite at the Q2 level in Q3, but that’s really due to just normal seasonality, right? There is nothing to kind of think about in terms of moving parts there..

Two things to think about, Tim, there, one, you got the seasonality down, so Q3 is always our typical weakest period, but also back in Paul’s remarks, he talked about the ERC and then legal one-time events. That was a tailwind of about 30 basis points inside of the quarter. It’s one-time in nature..

Okay. Okay, that’s fair.

And then just the closure of Humboldt, could you talk about when you start to see the benefits of that hitting the P&L?.

Yes, we’re seeing that currently, Tim. We closed the operation, so we are realizing that now as we speak..

Okay. And then the bigger picture question, just – you’ve started to see home sizes or the average size of a home increase.

Do you think cabinets and Woodmark should benefit from more square footage in a home or do you think it’s the kitchens are staying the same, but we are adding a bedroom or something like that? I mean, is that a content opportunity for you as you kind of look out 12 to 24 months?.

Yes, I think it is an opportunity, Tim. I haven’t seen data yet that support that’s occurring, but historically, when there has been larger homes, it’s created larger spaces for cabinetry product, whether that be motor rooms, laundry spaces or certainly the kitchen spaces.

So, if we see that rotate back up and I think we are on, where are we at, year 3 or 4 of a downward trend of size of home as we see that start to move back up, it certainly should create content opportunity for our business..

Okay. Okay, great. Good luck on the rest of the year, guys and have a good holiday..

Alright. Thanks, Tim. You too..

Next question comes from Julio Romero of Sidoti. Please go ahead..

Hey, good morning. Just staying on the topic of your margin outlook, you said you expected margins up year-over-year, but lower than 2Q, but that’s a pretty wide range, so I don’t know if you could give us a sense of incrementals year-over-year. The way I am thinking about it is last year your margins contracted despite higher sales.

So, that kind of leads me to believe that your incrementals this quarter on a year-over-year basis might be on the stronger side?.

We certainly had some one-time hits last year looking back and inside the Q3 time period, there was a bit of the particleboard disruption and we were also moving that facility that we had now out in California. So that creates an opportunity to drive stronger incrementals. I think we still got some unknown challenges in front of us, right.

It’s just the beginning of the quarter. We don’t know exactly where COVID and restrictions are going to push us as we go forward so that creates a little hesitation on giving you an exact number. You are right it is a bit of a range, but I think that’s also a function of the volume. We have given you a pretty wide range on the volume there as well.

It could be mid to upper single digits. So we are just trying to give you some boundaries to be able to operate within..

Yes, that’s fair. And I guess on your technology investments, I guess you gave us a little bit more behind the veil on what you are thinking about ERP cloud solution.

Can you maybe dive a little more into expected expenses, timeframe and maybe the opportunity there?.

Nothing beyond prior color that we have provided on that, we have started the project. We are hopeful to turn on our finance and procurement functions about a year from now. That’s our targeted go-live date. So, the activity between now and then will begin up and running.

And then on the backside of that is when you would expect to see some of the efficiencies..

Okay, got it. And then just last one from me is on your Vision 2025 plan, one thing you guys talk about often is prepping for a shift in consumer behavior and that’s always evolving.

But I guess, given where we are today, it’s been a wild year, we are in late November can you maybe speak to anything notable you are seeing in regards to consumer behavior over these fall months?.

Yes. Certainly, the use of digital technology tools to assist in the buying process. We saw that really early on whether you talk about the builders and their use of tools when folks couldn’t go to the actual showrooms or go to the jobsite to look at homes. So, we saw it there.

We see it as well on the visualization tools that we offer on the front end to many of our customers’ websites from a purchasing standpoint. So, we saw – we have seen an uptick in activity there.

What we are exploring and continue to work on is how you make that ultimately turn into a transaction, so how do you get card-to-card capability and link that directly into your retailer.

So if you are at home and you go through that process of designing a kitchen or a layout, how do you make that a seamless experience so that when you go to whatever outlet you go to, it’s easily transitioned into an order and you get a price and a bill off of that.

So, I think that’s accelerated and that’s something we are continuing to spend time and energy on..

Great. Thanks for taking the questions..

As I do not see that there is anyone else waiting to ask a question, I would now like to turn the line back over to Mr. Joachimcyzk for any closing remarks. Please go ahead, sir..

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

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect..