American Woodmark Corporation (NASDAQ:AMWD) Q3 2023 Earnings Conference Call February 28, 2023 11:00 AM ET

Company Participants

Paul Joachimczyk - Senior Vice President and Chief Financial Officer

Scott Culbreth - President and Chief Executive Officer

Conference Call Participants

Adam Baumgarten - Zelman

Garik Shmois - Loop Capital

Steven Ramsey - Thompson Research Group

Tim Wojs - Baird

Collin Verron - Jefferies

Operator

Good day, and welcome to the American Woodmark Corporation Third Fiscal Quarter 2023 Conference Call. Today's call is being recorded, February 28, 2023.

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 definitions 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 may be important to investors, such as investor presentations.

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 Paul Joachimczyk, Senior Vice President and CFO. Please go ahead, sir.

Paul Joachimczyk

Good morning, ladies and gentlemen, and welcome to American Woodmark's third fiscal quarter conference call. Thank you for taking the time today to participate.

Joining me is Scott Culbreth, President and CEO. Scott will begin with a review of the quarter, and I'll add additional details regarding our financial performance. After our comments, we'll be happy to answer your questions. Scott?

Scott Culbreth

Thank you, Paul, and thanks to everyone for joining us today for our third fiscal quarter earnings call.

Our teams delivered net sales of $481 million or growth of 4.6%. Our made-to-order frame backlog normalized as planned at the end of the calendar year. In addition, demand trends softened throughout the quarter within remodel, and as a result, we took several unscheduled production down days around the holidays. Recent trends, however, have improved, and we remain confident in delivering our full year forecast shared last quarter.

Within new construction, our business grew 19.7% versus prior year. Order growth has slowed due to the decline in single-family housing starts that began last summer and fall. Builders are optimistic going forward as January sales have improved. We continue to monitor recent trends with interest rates, home prices, household formations and consumer confidence.

The long-term fundamentals of the market remain strong. There continues to be a deficit in the number of homes built falling short of household formations, but we acknowledge the slowdown will occur in calendar year '23. Opportunities remain to grow our share with new and existing customers.

Looking at remodel, which includes our home center and independent dealer and distributor businesses, revenue declined 4.9% versus the prior year. Within this, our home center business was down 9.8% versus the prior year. Our stock in made-to-order kitchen business was down single digits with stock bath down double digits versus the prior year. Our stock bath business was impacted by a promo loss versus the prior year at a retailer, along with inventory destocking efforts at our customers. With regards to our dealer/distributor business, we were up 14.4% versus the prior year.

Our adjusted EBITDA increased 66.8% to $51 million, or 10.6%, for the quarter. Reported EPS was $0.88, and adjusted EPS was $1.46. The improvement in performance is due to pricing better matching inflationary impacts, mix and improved efficiencies in the manufacturing platforms.

Our cash balance was $45.8 million at the end of the third fiscal quarter, and the company has access to an additional $277.6 million under its revolving credit facility. Leverage was reduced to 1.81 times adjusted EBITDA as the company paid down $46.1 million in debt during the quarter.

As I shared in the prior two quarterly earnings calls, we committed to restore profitability and are delivering on that commitment. A slowdown in demand will present a near-term headwind, but we were prepared to navigate short-term demand reductions, and our product portfolio is positioned to win and attract customers in a more difficult economic environment.

Our full year outlook remains unchanged from the prior quarter as we continue to reflect a low double-digit growth rate in net sales with mid-single-digit negative sales comps expected in fiscal Q4. Despite this revenue headwind, we are maintaining the expectation of low double-digit adjusted EBITDA margins for the fiscal year.

We released an updated Investor Relations deck in January that shared our view on financial performance over the next five years. Despite a near-term slowdown in demand, we believe the 4% to 5% CAGR in net sales is appropriate, and then we will grow adjusted EBITDA little over $350 million. The key driver of margin expansion is tied to our platform design work that I will cover in a moment.

Our team continues to execute against our strategy that has three main pillars: growth, digital transformation and platform design.

Growth will benefit from our upcoming summer launch at two new finishes in several new door styles.

Digital transformation efforts over the last fiscal quarter include the planning efforts for the next implementation area of ERP and our manufacturing operations, including global design and Monterrey location planning. We also completed the first two sprints in the build phase of our CRM project, which goes live this summer.

Platform design work is accelerating as ground break in dense occurred within the quarter for our expansion in Monterrey, Mexico and Hamlet, North Carolina, that will deliver additional capacity in our stock kitchen and bath cabinetry product lines. Automation efforts continue, and we have committed over $75 million in automation investments over the next five years.

In closing, I am proud of what this team accomplished in the third fiscal quarter and look forward to their contributions during the fourth fiscal quarter of fiscal year '23.

I will now turn the call back over to Paul for additional details on the financial results for the quarter. Paul?

Paul Joachimczyk

Thank you, Scott.

Financial headlines for the quarter and year-to-date. Net sales for the third quarter of fiscal year 2023 were $481 million, representing an increase of 4.6% over the same period last year. And year-to-date, our sales were $1.6 billion, representing an increase of $229.6 million or 16.9%.

Adjusted net income was $24.4 million or $1.46 per diluted share in the third quarter of fiscal year 2023 versus $9.9 million or $0.60 per diluted share last year. Adjusted net income for the third quarter of fiscal year 2023 increased $14.5 million due to higher sales, largely driven by price increases and improvements in our operations. Year-to-date, our adjusted net income was $90 million compared to $32 million in prior year, representing a $58 million increase.

Adjusted EBITDA for the third quarter of fiscal year 2023 was $51 million or 10.6% of net sales compared to $30.6 million or 6.6% of net sales for the same quarter in the prior fiscal year, representing a 400-basis point improvement year-over-year. Adjusted EBITDA year-to-date is $175.1 million compared to $93.5 million in the prior year, representing an $81.6 million increase.

Looking at our sales for the quarter. The combined home center and independent dealer and distributor net sales decreased 4.9% in the third fiscal quarter with home centers decreasing 9.8% and dealer/distributors increasing 14.4%.

New construction net sales increased 19.7% in the third fiscal quarter compared to the prior year. New construction sales outpaced market demand during the third quarter of fiscal year 2023, recognizing a 60- to 90-day lag between start and cabinet installation. The overall market starts in single-family homes were down 24.6% for the fiscal third quarter. Looking at completions during our third fiscal quarter, we saw an 8.1% increase year-over-year. Given the decline in starts and a large separation between starts and completions, our backlog returned to normal levels within the first part of this quarter.

The company's gross profit margin for the third quarter of fiscal year 2023 was 15.7% of net sales versus 11.3% reported in the same quarter of last year, representing a 440-basis point improvement. Year-to-date, our gross margin was 16.5% compared to 11.6% of net sales in the prior year. Gross margin in the third quarter of the current fiscal year and year-to-date was positively impacted by the pricing actions and operational improvements, offset by increases in labor and domestic logistic costs.

Total operating expenses were 10.4% of net sales in the third quarter of fiscal year 2023 compared with 10.2% of net sales for the same period in fiscal year 2022.

Selling and marketing expenses were 4.4% of net sales in the third quarter of fiscal year 2023 compared with 5.1% of net sales for the same period in fiscal year 2022. The ratio to net sales decreased 70 basis points resulting from decreased spending and lower commission plan expenses, combined with leverage created from higher sales in the third quarter of fiscal year 2023.

General and administrative expenses were 6% of net sales in the third quarter of fiscal year 2023 compared with 5.1% of net sales for the same period in fiscal year 2022. The increase in the ratio was primarily driven by increases in incentives and profit sharing, partially offset by leverage created from higher sales.

Free cash flow totaled a positive $91.5 million for the current fiscal year compared to a negative $48.8 million in the prior year. The $140.3 million increase in free cash flow was primarily due to changes in our operating cash flows, specifically higher net income, lower accounts receivable balances and lower capital spending.

Net leverage was 1.81 times adjusted EBITDA at the end of the third fiscal quarter, representing a 1.72 times improvement from the 3.53 times at the end of the fiscal year 2022.

As of January 31, 2023, the company had $45.8 million of cash and cash equivalents on hand, plus access to $277.6 million of additional availability under the revolving facility. The company paid down $67.3 million of debt during the first nine months of the current fiscal year.

Shifting our focus to the remainder of 2023. Our full year outlook remains unchanged, and we expect low double-digit growth rate in our net sales versus fiscal year 2022. To achieve this, our fourth quarter sales are expected to be mid-single-digit decline. The growth rate is highly dependent upon overall industry, economic growth trends, material constraints, labor impact, interest rates and consumer behaviors. Our EBITDA margin for the fiscal year 2023 remains low double-digit EBITDA percentages.

It is great to see the commitment, hard work and efforts our employees invest in the company to achieve our results, and react to the changing dynamics in the macroeconomic environment. I'm grateful for what the team has accomplished and thank all of our team members at American Woodmark for their continued efforts. They are the ones who make it happen daily.

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

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. [Operator Instructions] And the first question will be from Adam Baumgarten from Zelman. Please go ahead.

Adam Baumgarten

Hey, everyone. Good morning.

Scott Culbreth

Hey, good morning, Adam.

Adam Baumgarten

Just on the quarter, can you break down the revenue growth by volume and price overall?

Paul Joachimczyk

We don't break it down to that level of degree, Adam, but I can tell you that clearly units were down in the quarter. And then, I think maybe more importantly is that there's been no activity to roll back pricing.

Adam Baumgarten

Okay. Got it. That's helpful. And then, just on the input cost basket as we think about heading into fiscal '24, maybe how you're seeing trends today and how that may play out as we move forward?

Paul Joachimczyk

To make sure I heard that question correctly, were you asking about input costs?

Adam Baumgarten

Yes. So, what you're seeing today and how you think that flows through into next year?

Paul Joachimczyk

Yes. What we're seeing right now is hardwood lumber prices have started to come down for several species, not all. But we are still seeing other commodity purchases that continue to show elevated purchase prices, things like particleboard, plywood, paint. And then, certainly, I don't think there'll be a slowdown in pressure on labor cost and likely not a slowdown on domestic transportation as I think forward into the remainder of calendar year '23.

Adam Baumgarten

Okay. Got it. And then just last one for me, just on CapEx. It seems like it's trending pretty well below the 3% to 3.5% range that you talked to for the year. Is that range still intact? Or is that pushed out a bit, and should we think about that range as a good level for next year?

Paul Joachimczyk

Yes, Adam, definitely the range is pushed out and we kind of -- for this year, we'll turn back to normal historical levels, primarily due to, I'll call it, constraints on our suppliers for equipment and manufacturing, but capital is suppressed. And say, going forward, we'll give you that full year FY '24 outlook when we do our annual call.

And, Adam, it's not a lack of great projects. Our team has a whole host of fantastic projects to either improve capacity or safety or overall cost positions. It's just the market is tight and the ability to get the suppliers to meet the initial timelines has proved difficult. So, a lot of those projects continue to push.

Adam Baumgarten

Got it. Makes sense. Best of luck.

Paul Joachimczyk

Thank you, Adam.

Scott Culbreth

Thanks.

Operator

And the next question is from Garik Shmois from Loop Capital. Please go ahead.

Garik Shmois

Hi. Thanks for taking my question here today. I'm just wondering if you could quantify the downtime that you had taken the quarter, how much did that impact EBITDA? And is production back to more normalized levels right now?

Paul Joachimczyk

Yes. I don't necessarily have a value that I want to attribute to that, Garik. I'd just tell you that we didn't expect to have the number of down days going into the quarter when we gave our perspective in the last quarter earnings call. So that was a change due to the softening demand. We chose to do initially with to take days out of the schedule. Then as we get through the holidays into the January timeframe, we let attrition adjust our staffing levels. Unfortunately, that didn't fully accomplish it, and then we wound up having to take some targeted reductions in force at the end of January. So, at this stage, we now have rightsized our labor force with the overall demand and production plans that we have in front of us.

Garik Shmois

Okay. Great. I wanted to ask my follow-up question with respect to a comment you made in the prepared remarks. You said that recent trends have improved. Is that related to just some of the commentary coming out of the builder channel? Or are you seeing an improvement in your orders as well?

Scott Culbreth

It would be both. So, certainly, we see the same commentary that you see from the marketplace. So, we're seeing that. But then we also are obviously monitoring our incoming order trends on a daily, weekly, monthly basis, and we've seen those trends improve from where they were mid prior quarter.

Garik Shmois

Great. Thanks for that. And I'll pass it on.

Operator

And the next question is from Steven Ramsey from Thompson Research Group. Please go ahead.

Steven Ramsey

Hi, good morning. Maybe I wanted to learn a little bit more on the retail decline. Can you talk about kind of the cadence of that decline through the quarter, maybe the sell-in, sell-out impact? And if there's any color to add on how that's unfolded year-to-date?

Scott Culbreth

I would just say the trends were most unfavorable in November, December. And then as we got back into the January timeframe is where we saw things start to improve overall.

Steven Ramsey

Great. And then, on company inventories, which had been increasing since the fourth quarter of 2020, but declined sequentially this quarter. Is that expected to continue? And can you talk about how much of that was less purchasing? Or how much of that was finished goods being delivered, whatever other factors were involved there?

Scott Culbreth

Yes. Steven, so really kind of [indiscernible] on inventories is during COVID, there was that stock up of that just-in-case inventories, and we are refocusing all of our efforts to be more back end just in time. We are seeing our suppliers' lead times and everything start to normalize and stabilize throughout the period. So that is something you'd say is we're going to be hyper-focused on our inventory levels just around the working capital plays that are out there, and making sure that, that trend will continue for us and stabilize our balances internally as well.

And to your question about where it's coming from, our teams are focused on raw, WIP and finished goods. So, we're looking at all areas to find opportunities to improve cash flow.

Steven Ramsey

Okay. Helpful. And then, one other quick one on the dealer/distributor channel, kind of one near term, one long term. Can you talk about what's driving the growth in that segment in such an outsized way? And then, thinking long term on this segment, your lowest market share segment, can you talk about success year-to-date and gaining share, and what you see for gaining share in a potentially slowing environment over the next 12 months?

Scott Culbreth

Yes, maybe start with the latter part of that particular question. So, as you noted, that's where we're the most underrepresented from a share position standpoint. So again, we didn't even have a product line to sell into the dealer space 10 years ago until we launched the Waypoint brand. We believe we can continue to drive share gains in both the dealer and distributor channel. We expect that to over-index the company average, if you will, as we go forward. So, we want to continue to gain share in that space.

Why do we think we can do that? And why have we done that? We think we bring a really good offering in the marketplace. It's a value price play, with the quality that many dealers and distributors are excited about to serve either their remodel or their new construction customers. We've been able to bring some new product to that space as well. So, we talked about [simple trends] (ph) a couple of quarters ago that we launched in the Northeast. We've done that. We're starting to look at expansion of that to other markets. And then other opportunities in categories such as bath that perhaps we can bring into the space.

Steven Ramsey

Okay. Excellent. Thank you.

Operator

And the next question is from Tim Wojs from Baird. Please go ahead.

Tim Wojs

Hey, guys. Good morning.

Scott Culbreth

Hey, good morning, Tim.

Tim Wojs

Maybe just -- maybe more of a theoretical question, Scott or Paul. If you do see sales declines kind of start in the April quarter and then maybe continue into fiscal '24, like what types of like volume decrementals would you normally expect to see on the sales decline kind of from a theoretical perspective? And then, I guess, what levers do you think are available to you internally to maybe offset some of that volume-based decremental?

Scott Culbreth

Sure. We've historically talked, and I know you've followed this for quite some time with a decremental gross margin of approximately 25%. And we've certainly had periods where we performed better than that and then also periods where we've performed worse than that. As we start our planning cycle, and just as a reminder, we're just now doing that now to get our full budget and plan set for fiscal year '24. As we start to do that work, we do think there'll be pressure on the top side. As we think about our gross margin and EBITDA margin performance, we believe will perform better than the historical norm. I don't have an exact number to deliver to you today, Tim, but that's what we're working through as we start to build out our budget plans, but we'll be better than the 25% as we go into next year.

So, why, which is the other part of your question, what are the things that we have as levers? Well, we have a lot of great projects that we put in place this year, OpEx savings that will carry forward. And then we've got a robust deck of projects that we'll continue to execute on as we shift into fiscal year '24 that will drive savings. We've got the platform work that we mentioned as well. That will start to help us more towards the end of '24, but set us up really nicely into '25 as well.

Tim Wojs

Okay. Good. That's good to hear. And then, I guess from your discussions with any of your builder customers or other channel partners, I mean, it doesn't sound like there's been any real push on price. But I mean, has there been any change to how they kind of think about mix as they think about future communities or kind of future shelf space?

Scott Culbreth

Nothing substantial around mix other than opportunities that we bring to the table where we can maybe put in Origins versus the core Timberlake offering. So that is our typical mix management offering that we'll bring to a builder. And we certainly want to continue to drive Origin's growth in the space. It's a benefit for the builder as well as the enterprise. So, we've done mixed management by driving more and more Origins. We've not rolled back pricing, but there's certainly a lot of price chatter in the marketplace to your point.

Tim Wojs

Okay. Good. And then, just the last piece on the facility expansions. I mean is there any sort of start-up costs or any sort of expenses that kind of run through the P&L over the next 12 to 18 months that would you just be aware of?

Scott Culbreth

There'll definitely be some startup expenses that will have inside fiscal year '24 as we get the operations ready. Again, we're just finalizing again the -- starting to actually work. I shouldn't use finalize for Paul, but we're starting to work on our budget process right now. And as we do start to finalize that, we'll have a better line of sight. As to those start-up costs, don't expect any of those really to impact the current fiscal year. But certainly, we'll have some expense and exposure in the next fiscal year.

Tim Wojs

Okay. Good. Well, good luck on the rest of the year, guys. Thanks for the color.

Scott Culbreth

All right. Thanks.

Paul Joachimczyk

Thanks, Tim.

Operator

[Operator Instructions] Your next question is from Collin Verron from Jefferies. Please go ahead.

Collin Verron

Good morning. Thank you for taking my questions. In the prepared remarks, I believe you mentioned some destocking headwinds in the retail channel in the quarter. Can you help quantify the destocking that you're seeing in the retail channel? And at this point, do you think your retail customers' inventory levels are in a good spot? Or do you think you could see some additional sales headwinds for American Woodmark in the retail channel going forward from this dynamic?

Scott Culbreth

Yes. In the prepared remarks, that was pretty specific to the stock bath category, and really, again, two points inside the current quarter. We had a promo loss that we had realized the year prior. So that gave us a headwind as we looked at the overall quarter. And then, we saw efforts to reduce inventory levels by the key retailers. We have not yet seen substantial movement back in building back those particular inventory levels, but the feedback we're getting is that is likely in the next 30 to 45 days. So, we believe, and data shows us that we're below optimal levels in that category at the retailers, and we would look to continue to drive inventory back in the stores to drive POS.

Collin Verron

Great. That's helpful color. And then, you guys saw some really strong incremental growth in EBITDA margin in the quarter. Can you help walk us through sort of what the price costs look like and then how much of the margin improvement was from those increased efficiencies that you guys called out?

Scott Culbreth

I'll just go back to the prepared remarks. Price, obviously, is a key contributor and has been the last couple of quarters as we took the actions to offset the inflation, but also operating efficiencies have been really important. And we spent the better part of two years dealing with labor challenges, inflation challenges, volume challenges, and our teams have done a much more effective job of stabilizing the operating footprint. And when we do that, we're able to drive efficiency throughout the entire process. So that's been a key contributor for us in the quarter as well.

Collin Verron

Okay. Thank you. Good luck on the next quarter.

Scott Culbreth

Thanks, Collin.

Operator

[Operator Instructions] The next question is from Julio Romero from Sidoti. Please go ahead.

Unidentified Analyst

Good morning. This is [indiscernible] on for Julio Romero. Thank you for your time.

Scott Culbreth

Good morning.

Unidentified Analyst

Good morning. My first question is, given the current macro environment, have you been approached on price from builders?

Scott Culbreth

Yes. We've been asked about pricing, but we've taken no action.

Unidentified Analyst

Thank you. And what was the exit rate in January by channel?

Scott Culbreth

I'm sorry, could you restate the question?

Unidentified Analyst

What was the exit rate in January by channel?

Scott Culbreth

I believe you're asking me the exit rate. I'm not quite sure I understand the question.

Unidentified Analyst

Right. I guess the way I'm asking is like, let's say, if you -- let's say something goes up this month if you lose GBP10. The next month, you go like you lose GBP15. So that's what I'm asking like what was an exit rate. So, is it trending upward or downward, I guess, I don't know?

Scott Culbreth

Yes. I think the terminology we typically use when we talk about the demand, Stefan, is incoming order rates. So back to the earlier questions in that space, we definitely saw a decreasing incoming order rate throughout the quarter. We saw January then start to rebound, and we've seen that sustain. So, we've seen an improving incoming order rate recently.

Unidentified Analyst

All right. Thank you. And the last one for me. Can you talk about your operating efficiency initiatives?

Scott Culbreth

Sure. I mean what we're going to be focused on is making sure we've rightsized our operations to the demand. So again, we had some attrition activities and reduction in force efforts inside the quarter. Our teams are focused on taking cost out of the process regardless of where it is. So that could be materials driven. It could be logistics transportation related. It could be manufacturing related. We continue to make investments in equipment such as automation. And we want to target that to be able to reduce the demand for labor, which drives the benefit to the enterprise, but also makes the work easier for our employees. If we're able to do that, we're able to track and retain the labor force more effectively. And just having less turnover inside the quarter has been a huge benefit for the enterprise as well.

Unidentified Analyst

Thank you so much for taking my questions.

Scott Culbreth

Yes, thank you.

Operator

Ladies and gentlemen, at this time, I see there is nobody else waiting to ask the questions. So, I'd like to turn the call back over to Mr. Joachimczyk for any closing comments. Please go ahead, sir.

Paul Joachimczyk

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

Operator

Thank you, sir. And the conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.