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Edited Transcript of AMWD earnings conference call or presentation 29-Nov-18 4:00pm GMT

Q2 2019 American Woodmark Corp Earnings Call

Winchester Dec 5, 2018 (Thomson StreetEvents) -- Edited Transcript of American Woodmark Corp earnings conference call or presentation Thursday, November 29, 2018 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* M. Scott Culbreth

American Woodmark Corporation - CFO, Senior VP & Corporate Secretary

* S. Cary Dunston

American Woodmark Corporation - Chairman, CEO & President

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Conference Call Participants

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* Jeffrey Stevenson

* Justin A. Speer

Zelman & Associates LLC - MD of Research

* Steven Ramsey

Thompson Research Group, LLC - Associate Research Analyst

* Timothy Ronald Wojs

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Truman Andrew Patterson

Wells Fargo Securities, LLC, Research Division - Associate Analyst

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Presentation

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Operator [1]

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Good day, and welcome to the American Woodmark Corporation's Second Quarter 2019 Conference Call. Today's conference is being recorded November 29, 2018.

During this call, the company may discuss certain non-GAAP financial measures, including our earnings release such as adjusted EBITDA, adjusted EBITDA margin, free cash flow and adjusted EPS per diluted share. The earnings release, which can be found on our website, www.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 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 conference over to Mr. Scott Culbreth, Senior Vice President and CFO. Please go ahead, sir.

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M. Scott Culbreth, American Woodmark Corporation - CFO, Senior VP & Corporate Secretary [2]

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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, Chairman and CEO. Cary 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. Cary?

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S. Cary Dunston, American Woodmark Corporation - Chairman, CEO & President [3]

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Thank you, Scott, and good morning. Our second quarter created mixed results with some significant positives as well as some challenges. We experienced growth in every channel. However, we faced some cost headwinds that impacted our margin performance. Net sales were up 55% for our second quarter, driven by the inclusion of RSI. Excluding the acquisition, our core growth was 8%, continuing to over-index the market and our competition.

Looking at our revenue by channel. Within new construction, we grew our business 16% over prior year with our core growth at 4%. On our frameless PCS direct-to-builder business, which primarily serves the Southern California market we continued very strong growth, up 25% over prior year.

Counter to our growth, as being reported in the industry, we are experiencing a slowing trend in single-family new construction. On the macroeconomic side, the combined impact of overall inflation, the uncertainty of incremental tariffs and the volatility in the stock market has impacted consumers' willingness to spend on high ticket items. More significantly on the microeconomic side, the housing industry continues to face growing headwinds.

Builders continued to be impacted by material inflation, rising land cost and labor availability. Up until recently, rising home prices have helped to offset this inflation for builders. However, when combined with rising interest rates, affordability, particularly for entry-level homes, has become a real challenge. The most talked about question is, how significant the slowdown and new starts will be. From our perspective, it is very important to keep in mind that the fundamental and underpinning drivers to the growth in new construction remain strong. Single-family starts at near 865,000 homes per year. It is very difficult to imagine a scenario over time, where starts now return to historical averages of closer to 1.1 million to 1.3 million. When considering the pent-up demand coming out of the recession, combined with the underlying demographics of rising millennials, housing must grow.

Our economy remains strong backed by the highest consumer confidence since the year 2000 and continued strong employment rates. However, when it comes to discussing actual demand within our industry, we feel it's important to separate notional demand from effective demand. We believe that opening price point consumers have a high notional demand for homes, implying that they have a strong desire to purchase a home, if not heavily burdened by the cost. The result is a much lower effective demands driven by affordability. We simply need to solve the equation of providing affordable opening price point homes to first-time homebuyers within both existing homes and new construction.

Although not an easy solution, historically our market has proven it is very efficient at filling demand. Builders, suppliers and the financing community ultimately find a way.

The current reality in the industry is that we are all working hard to understand the duration and magnitude of the current slowdown. However, we firmly believe it is just that, a slowdown. Through our direct-to-builder network, we will utilize our frontline position to stay very close to the current situation and we'll adjust our platform accordingly.

Longer term, we continue to believe that new construction in the industry, our outlook remains strong with real growth remaining. Looking at our remodel business, which includes our dealer distributor and home center businesses, revenue increased 97% or 12%, excluding the impact of the acquisition. With regards to our dealer distributor channel, excluding the acquisition, we grew our business 7%. Our dealer distributor teams are aggressively leveraging our expanded product offering in this channel, particularly with a proconsumer.

Within home center, we grew our core special order business by a very healthy 14% for the quarter. With promotional levels near parity, we have successfully regained some of the prior share loss. However, the cost to support promotional parity remains a concern as does periodic elevated promotional activity by our competition. As such, looking forward, our demand remains very contingent on promotional levels and actions of both our competitors and the home centers themselves.

Within our home center kitchen and bath stock category, we continued to have mixed results. And our largest category of in-stock kitchens, we are very pleased with our performance once again experiencing low double-digit growth with our home center partner. Within that, we continue to be impacted by low sales with 1 specific vendor. As in-store inventory, displays and new set execution continued to improve, we expect our performance to follow.

It is also important to understand that we still have time remaining before we fully lap some of the products that were discontinued within our home center channel. We have spoken in the past about lapping the market losses, which are all behind us. However, we continue to have some very discrete product discontinuances that remain. These business decisions remain prior to the acquisition, who have a longer duration to fully implement.

From a timing perspective, the majority of the discontinued products will be lapped within our third quarter. Overall, as we look forward on remodel sales, despite the slowdown in new construction, we remain positive. However, the great recession was an exception. Historically, remodel demand often showed some resilience and countercyclicality to new construction volatility.

When a consumer makes a decision, they're going to remain in the current home rather than repurchase, they often times elect to remodel. This impact is very dependent upon the overall housing cycle.

Longer term, we remain very optimistic on remodel. As I had mentioned a number of times on this past -- on past calls, I believe that kitchen remodel market is far from experiencing a full recovery. Kitchen cabinetry has lagged the other major R&R categories following the recovery. I continue to believe this is driven by the discretionary nature of our business and more importantly the lack of the younger first-time homebuyer entering the housing market. They moved down by baby boomers and they move up and move in by younger buyers with an existing homes will absolutely happen. And when it does, given the average age of existing homes and kitchens, we believe that we'll have a significant impact on remodel in our industry.

The key question is timing, as we all know. Strategically, American Woodmark will remain well positioned to leverage our national platform and low-cost product to capitalize on this future growth.

Moving on to gross margin. We had a number of cost challenges, finishing the quarter at 20.4% versus 20.9% prior year. We had 3 key drivers that contributed to this gross margin performance. The first was higher variable cost to the staffing for a higher level of demand than actually incurred in our operations. Although we experienced growth in all channels, it was a lower -- at a lower level than we forecasted and labor absorption was a challenge. We continued to monitor demand very closely. However, forecast accuracy is difficult given the current volatility of the industry.

Our plans are actively reducing headcounts in line with updated production levels. However, we always approach this with a level of conservatism to ensure we do not negatively impact our customer experience.

The next key driver is associated with inflation across material, logistics and labor. Regarding material inflation, although it has slowed, we continue to see increases in key inputs, including hardwood, plywood and paint. Many industries are seeing a downturn in lumber. However, these are more reflective of softwoods and oak rather than our key hardwood purchase of high-grade maple.

Regarding logistics costs, it is a significant macroeconomic factor impacting all of America. We continued to focus on load efficiency and utilization, while working on future state changes to our value stream to improve our overall logistics cost. Labor cost is driven not only by the cost to increase turnover in our factories, but we are beginning to see a rise in wage rates as well.

Once again our teams are very focused on actions to improve turnover, while improving productivity and reducing overall cost. On a positive, we have already seen a noticeable improvement in turnover in the past few months. Longer term, we are strategically committed to move for a domination in higher skilled labor.

The last driver was associated with the 10% tariff that went into effect on September 24. Although much less of an impact from the majority of our competitors, we have roughly $56 million of spin from China that are subject to the tariff. Our teams have been working diligently to minimize the impact associated with this 10% increase. Through short-term resourcing alone, we expect to offset 50% of the potential impact. When combined with incremental pricing action we expect to offset the majority of the 10% tariff.

Moving on to our adjusted EBITDA margins, we finished the quarter at 14.3%. The aforementioned cost within gross margin flowed through to adjusted EBITDA. To offset previously incurred material and logistics inflation, we passed along price increases through all channels that were effective in early November. However, the impact will not be fully realized until midway through our third quarter given the lag between order and ship within our system.

Looking forward to inflation, although there has been some talk by the administration to try to reach agreement with prior to the 25% tariff, at this time, we are assuming it will be effective January 1. As such, as I mentioned previously, we are very focused on offsetting the majority of the tariff impact. However, we are also sensitive to the overall demand elasticity curve and thus, our initial incremental focus is on resourcing including fully leveraging our low-cost Mexican operations. We will keep additional pricing action as an open option as needed. On adjusted net income, we generated $28.1 million in the quarter, up from $19.8 million in prior year. Lastly, we continued to generate strong free cash flow, which has not only allowed us to bring our pro forma net leverage to just under 2.65, but we also resumed repurchasing shares.

In summary, certainly a more challenging quarter than we anticipated. As stated in our last quarter's call that there was tremendous uncertainty within our industry. We were challenged in the quarter by various headwinds on the gross margin side of our business. However, numerous actions are under way to right size our business for the current market and to resource purchase products to counter the impact of the tariff. Pricing action has been implemented, and although we have some lag remaining, it will have a positive impact on our EBITDA margin. Although there are great many distractions to say the least, what we will not allow is any interference on our longer-term strategy. We remain focused on fully integrating RSI and capitalizing on our cost and revenue synergies.

Our teams are working diligently on all synergies with new revenue gains already being reflected in our ability to continue to over-index the market. Our new Origins product is accelerating in the market as our teams are actively bidding on and winning opening and lower price point projects that we had previously avoided. And although it can be challenging to fully understand the revenue side of the acquisition due to the remaining product discontinuances, with the exception of the discrete issue within bath at one of our vendors, we are growing in all channels. We are not losing share within our stock product, and in fact, we remain committed to regain share by restoring our business within the select markets that were lost within our [site] prior to the acquisition.

Multifamily also remains a tremendous opportunity as we finalize our long strategy. Starts may have softened. However, this will not dampen our ability to gain market share within this channel.

We are committed to leveraging our investment in our national direct builder service platform to offer differentiated service levels within the multifamily channel. Lastly, although most have been focused on the short-term cost impact of the tariffs, we do expect a net positive impact as we become more competitive against the Chinese imports. Our teams are monitoring competitive pricing actions closely, and we will capitalize on market gain opportunities as presented within all channels. The housing industry may slow for a period of time, but the economy remains extremely strong and robust. When evaluating our service platform versus competition throughout our industry, we will continue to win and gain share. We are focused on our gross margin and remain confident in our ability to begin to deliver on our cost synergies from the acquisition as well.

With that, I will turn it back over to Scott for the detailed financials. Thank you.

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M. Scott Culbreth, American Woodmark Corporation - CFO, Senior VP & Corporate Secretary [4]

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Thanks, Cary. The financial headlines for the quarter. Net sales were $425 million, representing, an increase of 55% over the same period last year. Excluding the impact of the RSI acquisition, net sales for the second fiscal quarter increased 8% to $298 million. Adjusted net income was $28.1 million or $1.60 per diluted share in the current fiscal year versus $19.8 million or $1.21 per diluted share last year.

Net income was positively impacted by additional sales volumes and mix, that was partially offset by a gross margin decline in the core business and an unrealized loss on FX forward contracts of $0.7 million. Adjusted EBITDA was $60.8 million or 14.3% of net sales compared to $37 million or 13.5% of net sales for the same quarter of the prior fiscal year. The increase during the second fiscal quarter was primarily due to additional sales growth in the quarter and the inclusion of 3 months of results for RSI.

For the 6 months ended October, year-to-date net sales were $854 million, representing an increase of 55% over the same period last year. Excluding the impact of the RSI acquisition, net sales increased 8% to $597 million. Adjusted net income was $64.1 million or $3.64 per diluted share in the current fiscal year versus $42 million or $2.58 per diluted share last year. Adjusted EBITDA was $128.9 million or 15.1% of net sales compared to $74.4 million or 13.5% of net sales for the same period of the prior fiscal year. The new construction market continues to grow, but at a slower rate. Recognizing a 60- to 90-day lag between start and cabinet installation, the overall market activity in single-family homes was up 1% for the financial second quarter. Single-family starts during June, July and August of the prior period averaged 859,000 units. Starts over that same time period from the current year averaged 867,000 units. Completions over that same time period grew 9%.

Our direct new construction base revenue increased 16% for the quarter and core growth was 4%.

The remodel business continues to be challenging. On the positive side, unemployment continues to improve. The October U3 unemployment rate was 3.7%, U6 was 7.4%. Both measures were lower than the October 2017 reported figures. This year first-time buyers increased. The September reported rate was 32% versus 29% in the prior year. Keep in mind, the share remains well below the historical norm of 40%. On a negative side, consumer sentiment decreased to 98.6 in October versus the 100.7 recorded October 2017. Existing home sales decreased slightly during the third calendar quarter of 2018. Between July and September of 2017, existing home sales averaged 5.4 million units. That same period for 2018 averaged 5.27 million units, a decrease of 2.4%. The median existing home price rose 4.2% to $258,100 for September, impacting our consumers' affordability index.

Interest rates increased in the quarter with a 30-year fixed-rate mortgage at 4.83% in October, an increase of approximately 93 basis points versus last year. All-cash purchases from September were 21%, up from 20% last year.

Residential investment, as a percentage of GDP for the third calendar quarter of 2018 remained flat at 3.3% versus the prior year. Home ownership rates remained low versus historical averages. The percent of Americans, who own their home in the third calendar quarter was 64.4%, which increased slightly from last year's rate of 63.9%. Our combined home center and dealer distributor channel revenues were up 97% for the quarter with home centers increasing 138% and dealer distributor growing 20%. Core growth within home center and dealer distributor was 12% for the quarter. The company's gross profit margin for the second quarter of fiscal year 2019 was 20.4% of net sales versus 20.9% recorded in the same quarter of last year.

Gross margin in the second quarter was favorably impacted by higher sales volumes, mix and overhead cost leverage due to higher volumes. These favorable impacts were more than offset by higher transportation cost, tariffs, raw material inflation and operating inefficiencies. With respect to the 301 tariffs, the company has almost $56 million in annual purchases impacted. If the 301 tariffs rise to 25% levels with no mitigation, we would experience approximately $14 million in inflation or roughly 1% of our annual cost of goods sold. We believe we can mitigate approximately 50% through sourcing changes by the end of fiscal 2019 with an opportunity to pass along price increases for the remaining impact.

Year-to-date, gross profit margin was 21.4% compared to 21% for the same period in the prior year. Gross margin for the first 6 months of the current fiscal year was favorably impacted by higher sales volumes, mix and overhead cost leverage due to higher volumes. These favorable impacts were partially offset by higher transportation cost, tariffs and raw material inflation.

Total operating expenses increased from 9.7% of net sales in the second quarter of the prior year to 12.2% this fiscal year. Through 6 months, operating expenses increased from 9.9% of net sales to 12.2%. Selling and marketing expenses were 5.4% of net sales in the second quarter of fiscal 2019 compared with 6.6% of net sales for the same period in fiscal 2018. The decrease in ratio is a result of leverage from higher sales and lower advertising costs.

General and administrative expenses were 6.8% of net sales in the second quarter of fiscal 2019 compared with 3.1% of net sales for the same period of fiscal 2018. The increase in the ratio was driven by $12.2 million of intangible amortization or approximately 288 basis points, acquisition-related expenses and higher incentive compensation cost.

Free cash flow totaled $89.5 million for the current fiscal year compared to $20.2 million in the prior year. Pro forma net leverage was just under 2.65x adjusted EBITDA at the end of the second fiscal quarter, and the company paid down $30 million of this term loan facility during the second fiscal quarter.

The company also repurchased 189,633 shares of common stock at a cost of $13.2 million. The Board authorized an additional $14 million for repurchases on November 28, 2018. In closing, the quarter was more challenging than projected. Strong sales growth in the core business and our in-stock kitchen business were partially offset by disappointing bath sales. Gross margin declines impacted our EBITDA margins, but we have taken recent pricing actions and projects are underway to improve our operating efficiencies.

The company expects that we'll grow core sales at a mid-single-digit rate in fiscal 2019, with total sales growth of approximately 32% to 33%. This growth rate is very dependent upon overall industry and economic growth. Margins will be challenged with increases in labor cost, raw materials, tariffs, fuel and transportation rates. The company expects adjusted EBITDA margins for fiscal 2019 of 14.75% to 15.25% depending upon synergy timing, execution and the significance of inflation or rate increases. Free cash flow generation should exceed to $115 million for the fiscal year.

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) And we'll take our first question from Kathryn Thompson with Thompson Research Group.

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Steven Ramsey, Thompson Research Group, LLC - Associate Research Analyst [2]

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This is Steven Ramsey on for Kathryn. The first topic I wanted to hit on, if you could just discuss regional demand trends? And also, if there is anything regionally that you would call out that any region that is more or less impacted by rising logistics costs?

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S. Cary Dunston, American Woodmark Corporation - Chairman, CEO & President [3]

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Steven, this is Cary. With regard to regional demand, yes, we are starting to see some variance by regional. That really depends on obviously, if we look at new construction, it does depend on the price point. The -- we'll start with the Northeast, Northeast actually remains fairly positive as of right now. As we look forward, that's always dependent upon what our winter weather looks like, but right now, we're not seeing as much of an impact in the Northeast as we've seen in some other areas of the country. Jumping down to our other really strong market, which is Florida. Believe it or not, Florida has actually remained quite strong, stronger than even we anticipated it would. So obviously at this time of the year, it gets somewhat difficult to decide, really decide that's demand -- real demand or if builders are trying to rapidly close out home because they get close to the end of their calendar or fiscal years. But right now, we're seeing strong growth in Florida. As you move into Texas and then further out west, yes, we're starting to see more softening. It's a little more evident in those markets. Obviously, you can read, particularly, in Southern California, there is a lot of talk of slowdown in that market. I think just given our platform out there with our low-cost approach with our PCS business, we had very, very strong growth. So we're definitely over-indexing the market. There is something we're paying attention to, but I think if you jump up into Northern California, that's where you probably start to see more evidence of a slowdown. And I think, they have grown so rapidly in the past couple of years, that inflation really got out ahead of them. And I think that affordability issue is becoming much more prevalent in Northern California. Texas is a -- it's one where there's a lot of price point sensitivity in the Texas market. So something we're paying close attention to, but at the same time, our teams are out now aggressively bidding projects with our new Origins product lines. So we'll have to see how it progresses over time. But right now, Florida is strong. We're starting to see some slowdown in Carolinas. There's a little impact of the hurricane in there, but obviously given the locales that, that hurricane went through, it wasn't really that prevalent. And the Northeast is slowing, but still remains a little bit higher than the rest of the country, but again in Texas and out west is where you're seeing more prevalent slowdown.

From a logistics perspective, that's very, very dependent upon -- we can answer that question much more differently than our competitors and then others within the industry. We do have the added benefit of having manufacturing so many plants all over the country, including out west, on the made-to-order size, special order size, we're the only ones that really have a major platform out west in Kingman, Arizona. So I think, we're all being impacted that significantly just given the fact that once you assemble a cabinet, we have that [final] delivery really and particularly you're basically shipping a lot of inefficient air. So that's something where the greater your distribution is of assembly plants, the better you are, but it's something that we're all seeing out there just because of availability and the overall cost of it. I mentioned before, I think, logistics is going to be and I'll say it is already a strategic driver in our industry and the one obviously we're more proactively addressing with regards to our future state platform.

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Steven Ramsey, Thompson Research Group, LLC - Associate Research Analyst [4]

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Great. And then, final question. You mentioned your push into the multifamily market, is there more of a target towards the repair remodel side or multifamily new construction? Is there a time line for kind of just starting and then where maturity margins get to?

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S. Cary Dunston, American Woodmark Corporation - Chairman, CEO & President [5]

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That's a good question, Steven. The first part of your question on new construction remodel, particularly when we talk about multifamily in the context on the call, I'm referring to new starts, new construction. So we do very -- we do a little bit of that business. From the total market perspective, we do some of that in Southern California with our PCS business. But for the most part, we don't participate in new starts on the multifamily side. So that's a tremendous opportunity for us to get into. When you think about the remodel side, though, that's something that we're talking a lot about. We don't really hear a lot of others speaking about it from a national level because it's really a big unknown is, you think about the past 30 years, how many multifamily units have been built in America? We really see that as a tremendous opportunity on the remodel side. I think the big question that we're all trying to figure out is how are they're going to go to market. Certainly, some of that business is been served today through the dealer channel and sometimes served through the pro channel, when you get into home centers and so forth as well as for distribution. But I -- personally I feel that business is just now starting to take off. I think, there's a lot of opportunity when you get in the multifamily remodel, but there's also a lot of market knowledge to be gained, that we really need to understand before we can go out and really make some assumptions or forecast what the impact of that business will be. From the ramp-up on the new construction multifamily side, obviously, it's -- the first stage is where we're doing on -- and say, pretty nearing in our market analysis, and we're in the hiring mode, so we're actually out hiring specific people to go out and actively start bidding projects in that market. We build -- we got -- we had bid on some. But over the next 2 quarters, we really expect to start to get more actively engaged in that market and the big question there obviously is timing. Obviously, is -- it is a longer cycle time. You go out and you win big projects. Some of those projects may take 1.5 years to materialize. So we're not far enough along for me to give you a discreet answer on the impact to our financials, but I would suspect in the next 1 quarter or 2, we'll be able to give to you a little bit more discreet information on the timing and impact.

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Operator [6]

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And our next question is from Truman Patterson with Wells Fargo.

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Truman Andrew Patterson, Wells Fargo Securities, LLC, Research Division - Associate Analyst [7]

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Just wanted to touch on some of the gross margin pressures. You guys mentioned several of them. I was just hoping you guys could rank order for us between the staffing and headcount, the transportation, tariffs, labor, some of the hardwood cost? And then, really just rank order those in the quarter for us? And then, how we should think about some of these moving parts going forward? I believe you guys said, you guys are starting to address the staffing issue. And then also, how we should think about transportation and some of the hardwood cost that appear to be at least leveling off here?

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S. Cary Dunston, American Woodmark Corporation - Chairman, CEO & President [8]

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Yes. I think, we won't get into details on, I'll say since this is -- cabinets are what we do, I don't want to get into detail and provide a rank order on -- on the cost just for competitive nature. But I think, we can tell you, in the past material inflation obviously was a key driver. And that's really, I know on the last call, we talked about -- we were preparing to take pricing action and obviously we did that. The challenge, of course, is there is lag when you go out and you start working on pricing, we have to go through the negotiation process with our -- because our -- we obviously are very heavy into the top 20 builders and very heavy with our 2 home center partners, so there is a negotiation process we go through, when you take pricing to the market. So we completed those, and we've implemented the pricing and now there's just a lag on getting the flow through. But historically, in the past 6 months, material was certainly a fairly significant impact and then logistics obviously. And when I say logistics that includes fuel and it includes the overall logistics, I will say negotiated rates with our logistics carriers. So we're really starting to see heavy -- more heavy inflation in that area, and I think -- I would say, that's the one that's probably going to start ramping up even more. I agree with you, the material is starting to level out a little bit. We still continue to see some on the lumber side or on the plywood and obviously some things are petroleum-based, resin-based, our paint is up right now just depending upon the petroleum market so that could start to soften. But logistics is the one that really, really probably concerns most of America, I'll say not just in our industry, but all the industries. Labor is another one that -- it's had an impact, but it's not as prominent as the other 2, but it's starting to have a greater impact just because of labor availability and overall wage rates. Obviously, we're all monitoring team in wage rates and so forth. But the bigger issue really is just availability. It's the turnover impact that manufacturers are having. So I think we're all getting very creative on our approach to managing that labor availability. And our culture certainly helps a lot with that. And we're also getting more creative with regards to our benefits and so forth. But I would say, the first 2 -- 2 highest priorities would be -- or, material and logistics are the 2 key drivers. As we jump into 25% tariff, obviously, it's going to have an impact. Scott provided the details on that already. So it's something we'll keep a close eye on, though.

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Truman Andrew Patterson, Wells Fargo Securities, LLC, Research Division - Associate Analyst [9]

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Okay. And I didn't quite catch your comments on the promotional environment on the home centers, could you guys just give us a little bit more color on that, especially in kind of the semi-customers' stock plus channel? And are you guys seeing any of the promotional behaviors start to creep into some of the lower price points of the stock product?

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S. Cary Dunston, American Woodmark Corporation - Chairman, CEO & President [10]

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To answer the second part of your question, no, we typically don't really get into heavy promotions on the stock side of the business. There is obviously some seasonal things we do with our vendors, but nothing that's our normal cadence. When we talk about heavy promotions, we're talking about it within the special order side of the business. And it is, I call it, a parity club. We're all, I think, constantly monitoring promotional activity. It is -- it does remain at a much higher level. That was really what my key comment was, key takeaway. So we've obviously comped very well on our special order business the past 2 quarters, because we regained much of that share that we had lost, because we were not promoting at the levels our competitors were previously. So we've taken our promotional levels up about 6 to 9 months ago. We're back near to what I call that parity level, but it is at a much elevated level. So it's something we're all monitoring very closely and obviously it can fluctuate. There's still volatility there. We certainly have no intentions of spending any more on that promotional level, but what we can't predict is how our competitors are going to respond and how -- if the market starts to slow, there is more pressure from the vendors to ramp up promotional activity, taking a higher level. Those are questions I really can't answer. But I just know right now, we're in a position -- I think we're -- the way we kind of communicated is we kind of called. We're not raising. So we're there. We're going to maintain that. We've restored our share, but we really don't know what's going to happen coming in the future.

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Truman Andrew Patterson, Wells Fargo Securities, LLC, Research Division - Associate Analyst [11]

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Okay. And if you guys don't mind, I'm going try and sneak one more in on, you guys pushing through the RSI product through the direct-to-builder network, especially at the entry level. Have you guys achieved any synergies yet? How were the discussions with some of the largest entry-level builders going and especially I'm trying to see how you guys are set up for the spring selling season?

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S. Cary Dunston, American Woodmark Corporation - Chairman, CEO & President [12]

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Yes. Actually, the Origins product is going well. Obviously, when -- if you go back a year ago, we obviously anticipated that first-time starts -- first-time homebuyers and the opening price point starts were going to be at a higher level by now. So that's obviously a little headroom we're facing is that, we need to get that first homebuyer in the market. But on the positive, the product is out there, our teams are out there. Obviously, there is a good number of homes that are still being built out there at the opening price point or entry-level home. Even at this price point, where it's not quite what we'd call opening price point, it's -- some of the 55-plus communities that you see growing out there, which tend to have a little bit nicer amenities, but still at a lower price point. This product fits that category very, very nicely. So we've got some nice wins almost -- really every week, we're having nice wins. We've had key customers actually visiting both of our central locations in Lincolnton and Anaheim, California. Lincolnton in North Carolina and Anaheim in California. I think that not only I'm impressed, but probably that we're amazed at the size and scope of our operations, the efficiency of the operation. It has a nice dimension. When you have a builder walk in and really understand the -- how sophisticated of an operation we have, and out there with supplying this Origins product and then -- that obviously then flows through our direct-to-builder network, which they are very used to. So it's been a big win for us, and it's just going to ramp up right now. And yes, we are very well positioned to go out. And as that market grows, we're being very aggressive in bidding on opening price point projects and any projects that fit that value-based proposition that we now offer.

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Operator [13]

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(Operator Instructions) And we'll take our next question from Tim Wojs with Baird.

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Timothy Ronald Wojs, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [14]

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Just maybe on the guidance, just a couple clarifications. Does the margin guidance, does that include the 25% tariff? I wasn't totally clear on that.

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M. Scott Culbreth, American Woodmark Corporation - CFO, Senior VP & Corporate Secretary [15]

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That's inclusive of what we think the impact could be, including the fact that we believe we'll be able to mitigate roughly half of that [probably into] the fiscal year. So we do have that built-in.

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Timothy Ronald Wojs, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [16]

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Okay. And then, when we think of just kind of the cadence in the back half for margins, is it reasonable to think that Q3 still sees some pressure, just as pricing doesn't fully offset and you kind of get the incremental, I guess, quarter of tariffs? And then, you see more pricing kind of cost lining up in the fourth quarter, is that the way that we should think about it?

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M. Scott Culbreth, American Woodmark Corporation - CFO, Senior VP & Corporate Secretary [17]

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Yes. Tim, I think, you hit that to the T is, if you look out historically in our industry, Q3s, what our fiscal Q3, but this time of the year for our industry always goes through a little bit of a slowdown, just because of the holidays and so forth. So large intensity, challenge a little bit more and then you see it come back up in Q4. And then, to your point, as we look at the impact of our pricing and so forth, it's basically exactly how you stated it.

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Timothy Ronald Wojs, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [18]

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Okay. And then just on construction, I guess, just with a little maybe softer outlook there from some of your customers over the next 6 months, what adjustments, I guess, have you made? And what adjustments could you make if new construction does slow down a little more than you think?

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S. Cary Dunston, American Woodmark Corporation - Chairman, CEO & President [19]

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Yes, it really all depends on the level. Short-term, our initial variable cost leverage would be within our manufacturing platform. Obviously -- there's obviously some cons associated with a turnover, but one of the positives is with the turnover is we can bring our headcount -- variable headcount down fairly quickly to match the demand platform. And so it really comes down to our forecasting ability as everybody out there right now, just as you are, we are trying to figure out what's going to happen with new construction over the next 6 to 9 months and obviously we're predicting -- really an important number for us is probably 2 months out, because we start to put plans in place from a production standpoint. But we are bringing down our manufacturing variable cost, so that's -- that occurs fairly quickly just given the turnover numbers. As we monitor it, obviously, it's -- there are actions we can take. We do have variable cost out in the builder centers and so forth, that we can start to address as well. Not there yet. We're not -- obviously, we always go into a little bit of a cost control mode. So we watch spending and then discretionary type decisions. But the other aspect of the builder centers, it really depends on the significance of when we really get the regionality, so if we start to see specific regions like Texas or Phoenix or out in California start to be more impacted in other regions then we would actually come back and address some of the variable cost in those plants. And it really does come down to labor, would be our option.

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Timothy Ronald Wojs, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [20]

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Okay. And then, just -- sorry the last one. Was the free cash flow guidance $115 million or $150 million? I didn't clearly hear that.

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M. Scott Culbreth, American Woodmark Corporation - CFO, Senior VP & Corporate Secretary [21]

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$150 million, Tim, so $150 million.

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Timothy Ronald Wojs, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [22]

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$150 million, so you up free cash flow guidance by $30 million?

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M. Scott Culbreth, American Woodmark Corporation - CFO, Senior VP & Corporate Secretary [23]

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Correct. If you look at with our first half, performance has been -- our first half was stronger than we had modeled. So we've carried that forward to a full-year revision.

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Timothy Ronald Wojs, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [24]

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And was that -- is that just working capital? Or is that just you were conservative initially just with bringing RSI on?

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M. Scott Culbreth, American Woodmark Corporation - CFO, Senior VP & Corporate Secretary [25]

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Working capital conservative with RSI coming on as well as CapEx being a little lower than remodel.

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Operator [26]

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And our next question is with Justin Speer with Zelman & Associates.

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Justin A. Speer, Zelman & Associates LLC - MD of Research [27]

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Just a few questions. I don't know if you can do it. I don't know if -- and I'm in a conference so hopefully it's not bothering you, because it's pretty loud over here. But if you guys could help us understand the underlying margins of the legacy business, maybe split that out and tell us how much [margin degradation] you face in that piece of the business. I think that would be helpful. In addition, the cost that you just mentioned, just teasing that out so we can kind of put this puzzle together?

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S. Cary Dunston, American Woodmark Corporation - Chairman, CEO & President [28]

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Yes. Justin, it's -- obviously, we're not going to get in that much detail with regard to start breaking margin out by legacy or RSI or by product. What I will say is, when we obviously communicated the acquisition and it was a very accretive to the business. It remains very accretive. Margins, if you look at any margin degradation within our company when I speak about the headwinds, those are headwinds as I called, so there's nothing discrete that we're facing and our RSI side, there's been no surprise on the RSI side. So I think any assumptions out there that we're losing share, there's been margin degradation on the RSI side that we were not aware of or surprised us, really does not exist. So it remains very accretive. We still have a lot of opportunity to grow that business. And obviously, through the synergies, we're very committed to the $40 million of synergies that we committed when we acquired RSI, we remain very committed to.

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Justin A. Speer, Zelman & Associates LLC - MD of Research [29]

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So I guess that logically follows the next question on the RSI, both the revenue and cost synergy, you guys had an intermediate-term road map, where are you, if you can articulate, I guess, the inning that you're in or the amount or magnitude of synergies that you've been able to enjoy thus far? And how do you think that lands in the coming quarters?

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S. Cary Dunston, American Woodmark Corporation - Chairman, CEO & President [30]

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Yes. Scott and I were actually discussing that. We will over time start to provide more detail related to kind of where we sit, obviously. Many of the synergies that most -- obviously, you find somebody to acquire somebody, it will takes time to ramp up the synergies. Obviously, the SG&A synergies, we see fairly quickly in the process. We completed those 3 or 4 months ago for the most part. The cost synergies that we committed we'll actually start to see those ramp up in Q3 and Q4 as we start to leverage our low-cost operations in Mexico with some of our core products. And then, on the synergy side, with revenue obviously, we talked about Origins, we'll provide more detail on that as it becomes more significant. Obviously, all this is a ramp-up. We are ramping that up. And as we get into Q3, but probably more likely Q4, we'll start to give you a little more color on where we are specifically on the revenue synergies. I will say we feel very comfortable with our commitment. Obviously, that $40 million we committed, we said about 70% of it would be through revenue. We continue to feel very comfortable with that, obviously, a part of that's dependent upon the market as a whole. If the pie starts to shrink, we still commit to our market share gains, but the net -- our revenue gain could be impacted by the market. We feel very comfortable with our ability to go out and get the market share gains that were behind our assumptions.

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Justin A. Speer, Zelman & Associates LLC - MD of Research [31]

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Sure. And the last question from me on the tariff side. That $56 million figure you quoted, that's a good number, but in terms of the annualized impact, thinking about that, you have the price in hand now to offset that? Or is that going have to be a perspective thing as the tariffs are layered in, particularly the January 25% of the tariff equation?

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S. Cary Dunston, American Woodmark Corporation - Chairman, CEO & President [32]

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We really have not taken pricing action on the -- anything related to the tariff yet. Like I mentioned, that remains an option for us. But I think, it's one of those, where we're going to really, depending upon on several variables and a lot of folks just keep saying, they're going to pass pricing on, pass pricing on. Obviously, this market does have last (inaudible) to it. So given our position with our low-cost product and the margins that we feel we can achieve with that product, we're going to be monitoring the market very closely. Part of that decision is based on obviously where our margins end up, but our ability also to offset some overhead cost by getting market share gain by going after -- closing some of this gap that we have with our competition on the Chinese side. There is definitely going to be some market share to be gained. So it's just a business decision, that we'll continue to evaluate, monitor over the next 6 to 9 months. And I'm sure we'll be passing some price increase on, but I'm not going to sit here and say that we're going to pass all of it to our customers, because at the end of the day we feel we can get some market share gain out of this as well.

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Justin A. Speer, Zelman & Associates LLC - MD of Research [33]

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There's -- ultimately, your net advantaged, it just so happened to your net advantage with your cost structure, well, the most of domestic peers and the import competition, that remains the positive for you?

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S. Cary Dunston, American Woodmark Corporation - Chairman, CEO & President [34]

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Yes. And that certainly is our goal, as the net benefit will be positive. So the big decision we make would be a net positive for the business. And so we've commented in the past that, we're less impacted than others. Relative to our total spend, it is much of a less of an impact, but it still doesn't have an impact on our EBITDA margin. So our purchasing teams are working very, very aggressively. And the nice thing for us versus some of our competition is we do have a low-cost manufacturing platform in place in Mexico already. There is no capital cost associated with moving that material to our Mexican operations, it's just a matter of relocating it. So we're [starting to see it.] So we're in the process of doing that. We're also looking at obviously other countries for potential sourcing options, and we're also obviously monitoring the tariff situation very closely. So we have a lot of options, which is a good thing. But at the end of the day, we feel this is a net positive for the company because it's going to make us much more competitive versus Chinese imports and they make up a lot more, whether it's 20%, 25% or somewhere in between, they make up a decent percentage of the current sales in America that is going to be challenged by 25% tariffs.

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Operator [35]

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(Operator Instructions) And we'll take our next question from Jeff Stevenson with Longbow Research.

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Jeffrey Stevenson, [36]

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I know you mentioned that you recently had price negotiations with home centers and builders, but I'm just wondering with the future potential pricing actions, how receptive do you think customers will be especially in a potentially slower near-term environment?

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S. Cary Dunston, American Woodmark Corporation - Chairman, CEO & President [37]

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Yes, obviously, I think that's the advantage that we have, that's kind of the significant question that's out there that I -- no, once again, I can't say I like the current situation, but I feel American Woodmark is much better positioned, because we have the ability to make a choice. Obviously, the tariff impact is less of an impact on us and that is impacting us. We have the ability to respond much more quickly than our competition, because we can not only leverage potentially other low-cost countries, but we have the ability to quickly source material from our Mexico operations.

So we don't necessarily have to go straight to market and pass all this through to the consumer, just to try to stay at parity on the margin perspective. We're going to be evaluating it and see if we can take -- perhaps not pass that price increase on and go out and really leverage our position within the market and pick up additional market share. So it really comes down to your business decision. The home centers have been very vocal about their position. They do expect more price increases to come from vendors, you can even read it in their releases. So it's not going to be a surprise to our, what we consider our customers, obviously, the home centers and the big builders and so forth, so if we come forth with price increases, but I don't necessarily assume that's the right decision at this point in time. And once again, it's -- going to the builder, it's 2 different things when we talk about price increases versus going to them and saying, hey, I know obviously they're all working towards finding a low-cost solution to the opening price point home. We have that solution. That solution exists with our Origins product. It's a great product. It's very focused on -- obviously, it's a reduced few comp, but it's -- offers what sells in the industry and it's a very reduced price point. So it's a great opportunity for us to go out there and work very aggressively with builders and come onto the product that we feel will win them the market. So it's going to be a strategic decision for us and how much and if we pass price increases through versus certain markets and certain channels that we go after market share instead.

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Jeffrey Stevenson, [38]

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Got it. That's helpful. And then you talked about the mix of businesses you're gaining share. And I'm just wondering, has that had any impact at all on margins from a mix perspective?

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S. Cary Dunston, American Woodmark Corporation - Chairman, CEO & President [39]

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That's a pretty complex formula to be honest with you. So in some cases, yes, and, in some cases, no. So obviously, if we go after and continue to grow our -- we talked about our stock kitchen business. We feel we have an opportunity to continue to grow that business and we are very focused on restoring the markets that we lost. Obviously, that's a very margin accretive business for us. So definitely opportunities there. Again, the home center side or special order side, I should say, it gets very challenging there. Obviously, promotions are having an impact on margins, but otherwise there's nothing that really stands out on the discreet side that I would say is impacting margins from a mix perspective.

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S. Cary Dunston, American Woodmark Corporation - Chairman, CEO & President [40]

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Anything to add?

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M. Scott Culbreth, American Woodmark Corporation - CFO, Senior VP & Corporate Secretary [41]

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Yes, I was just going to add that our new construction business, historically, if you looked at the margin profile of our core platform, typically, we'd have seen margins that were below fleet and you would've have seen our remodel business to be above fleet. But we've been nearing that gap and delta over the last few years as we've become more productive and more efficient on the new construction front. So from our vantage point, we try not to let the different in-channels drive what the overall margin results are going to be. Granted, there are nuances inside each of those, as Cary was already highlighting that you have to address, but we believe in the end that the synergy opportunities that we're tackling as an organization will be accretive overall. And that's why we communicated a positive synergy result for the combined enterprise.

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Operator [42]

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(Operator Instructions) As I do not see that there is anyone else waiting to ask a question, I would like to turn the line over to Mr. Culbreth for any closing remarks.

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M. Scott Culbreth, American Woodmark Corporation - CFO, Senior VP & Corporate Secretary [43]

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

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Operator [44]

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And this concludes today's call. Thank you for your participation. You may now disconnect.