The Cutting Edge™ April 2005

Business Briefing

What's Happening in the Secondary Wood Products Industry?
By Art Raymond, A.G. Raymond, A.G. Raymond & Company, Inc.,
araymond@raymondnet.com

This month, Business Briefing expands its usual sector situation report to headline status. Our purpose is to recap recent history and forecast the near future for the important secondary wood products sectors that comprise your largest customer base.

Hardwood Sawmills
Sawmilling is truly a business where supply and demand set prices. In 2004 mills produced 11.35 billion board feet of lumber, about 1 billion more than in 2003. Prices by year end were, voila, off their highs set earlier in the year. Driven by the continuing housing boom, mill customers in the cabinet and flooring sectors increased lumber purchases.

Hardwood Consumption

Buoyant markets for low-grade lumber from the center of the log are critical to mill profitability:

Pallets - Cutting over 3 billion board feet, the pallet industry is the biggest hardwood user. The industry is operating at 90% of capacity. With the economy continuing to grow, pallet mills are set to grow at a near 4% rate in 2005.

Furniture Frames - Upholstery frames built from U.S. hardwoods are in decline. The transition to plywood frames and the impact of imports are the primary culprits.

Railroad Ties - At 880 million board feet, 2004 saw the highest hardwood consumption since 1998. With railroads adding and upgrading track, tie demand will remain strong this year.

Specie winners included Hard Maple, which reached record price levels, as well as Cherry. The big loser was Red Oak as demand from flooring mills and cabinet plants dropped severely. Oak, our most prevalent hardwood, is no longer the consumers' favorite.

Exports were up 10% with the focus on Asia rather than Europe. The fastest growing market was Vietnam, and China retained second place in the destinations ranking. The Asian markets will continue strong in 2005. Lower demand will come from Germany, the UK, France, and the Benelux countries as Eastern European lumber enters these markets.

Hardwood imports rose by nearly 16% last year with Canada the largest supplier. In total 86 countries shipped hardwood lumber to the U.S. With abundant supplies available from U.S. mills, import penetration may flatten in 2005.

In the end, experts are predicting a solid 2005 for hardwoods with growth of about 3%.

Kitchen Cabinets
With continued strong demand from new home starts and remodeling, cabinet sales in the U.S. reached nearly $14 billion in 2004. Last year's growth of 16.8% extends the trend of double-digit sales increases to three years. In fact, since 2000 cabinet volume has expanded by an amazing 61%.

With this performance the cabinet industry has replaced wood furniture as a major consumer of lumber, panelboard, coatings, and machinery. Cabinetmakers purchased about 780 million board feet of North American hardwood lumber directly. Another 600 million board feet was purchased in the form of components like doors, drawer fronts, and mouldings.

This sector's preference for light-colored woods like Hard Maple and Cherry has pushed prices of those species to record highs. Red Oak, long a staple of the cabinet industry, has fallen out of favor with cabinet buyers.

Other noteworthy cabinet statistics include:

• About 91 million kitchen cabinets plus nearly 9 million bathroom vanities will be installed in 2005.
  

• Remodeling accounts for 75% of all kitchen installation - Rapid appreciation of home values has turned residential real estate into the investment of choice for most of America.
  

• Spending on kitchen remodeling has increased by nearly 100% in the past five years.

To date cabinetmakers have avoided the import tidal wave that continues to hammer the U.S. furniture industry. Imported cabinets accounted for less than 5% of domestic consumption. Of that amount Canadian producers supplied about 75%. Many major cabinet companies have, however, extended their sourcing programs for materials and components like drawer sides and doors to China and elsewhere. Imports of wood furniture parts, the statistical category that includes cabinet components, have expanded by nearly 19% since 2002.

Managing that lengthy supply chain has proved challenging. Some cabinetmakers are retreating to domestic suppliers as quality and delivery issues prove difficult to overcome.

Experts are predicting another banner year in 2005 with cabinet volume up by 12-15%.
Cabinet sales rose 12.8% in February vs. the same month in 2004 according to the KCMA's Trend of Business Survey. For the first two months of 2005 sales were also up 12.8%.

With the U.S. economy averaging 4.5% growth since 2000, can the industry sustain their recent double-digit advances? Many players in our industry have a vested interest in their success. Stay tuned.

Down at the company level...

Masco reported a 12% increase in cabinet sales in their 4Q2004. Operating profit was 18.2%, up from 16.6% in the same period last year. Installation services also showed strong growth with an 11.8% rise in sales.

KraftMaid, one of the Masco cabinet companies, is planning a $106 million, 700,000 ft2 plant in West Jordan, Utah, near Salt Lake City. At full capacity the plant will employ 1,300 workers and produce 6,000 cabinets per day.

Yorktowne Cabinetry, an Elkay Company, is expanding its operations through a $19 million, 356,000 ft2 assembly and finishing plant in Danville, VA.

American Woodmark reported disappointing 3Q2005 earnings in spite of a 12.4% increase in sales. Gross margin fell to 18.8% from 20.8% in the same quarter last year due to manufacturing inefficiencies. The company is developing a new assembly plant in Allegany County, Maryland.

Home Furniture
Our readers are all too aware of the cataclysm that has befallen the wood home furniture industry in the U.S. American consumers continue to buy furniture. Last year retail furniture spending rose 8%. But the sources of these products are foreign, not domestic.

As a result, 2004 saw 60 more furniture plants close or suffer mass layoffs. More than 14,000 workers were laid off. The list of companies affected included Thomasville, Pennsylvania House (a La-Z-Boy company), Ethan Allen, Bassett, and Hooker.

On the bright side, the remaining plants produced 4.2% more wood furniture in the first three quarters. If that pace continued through year-end, 2004 would be the first positive year of domestic production since 2000.

As shown in the Hardwood Consumption table above, a declining furniture industry also adversely impacts its supply chain. The usage of hardwoods as well as panelboard, veneer, coatings, and corrugated containers also fell. The Hardwood Review forecasts hardwood usage by furniture makers to fall another 2.9% in 2005.

With the tariff issue behind us, some experts are predicting a new wave of closures as plants that were saved by the prospect of a high tariff are finally shuttered. Recent shutdowns and layoffs include:

Broyhill Furniture is closing its Conover, NC, assembly and finishing plant that employed 106 people.

Bernhardt is shifting all wood casegoods production offshore with the closure of its 350,000 ft2 Plant 2 in Lenoir, NC. The plant will be converted into a warehouse. About 200 employees will lose their jobs.

Lexington Furniture is eliminating dimension production at its Plant 4 with a loss of 25 jobs and a downsizing at its Plant 5 affecting 70 workers.

Canadian producer Shermag announced the closing of its bedroom plant in Cotsdown, Quebec, with 84 jobs.

Other companies, particularly in upholstery, are fighting the closure trend. Mitchell Gold has purchased the former Bassett Furniture plant in Hiddenite, NC, to support continued sales growth. The company sells to specialist retailers like Pottery Barn, Crate & Barrel, and Storehouse. BenchCraft has expanded its production capacity by relocating warehousing operations to a leased 105,000 ft2 facility in Ripley, MS.

Private investors acquired WoodMarc, a subsidiary of Berkshire Hathaway's Nebraska Furniture Mart. The 260,000 ft2 plant, located in Winterset, IA, augments its domestic production with imported products to provide a broad range of entertainment and bedroom furniture.

Financial results at the company level...

Bassett Furniture reported a 5% increase in 1Q2005 sales fueled by a 22% gain in shipments to their BFD retail stores. Management stated that BFD growth is now outpacing attrition in sales to other, independent distribution channels. The BFD operation now includes 120 stores with another 20-25 planned for 2005.

La-Z-Boy announced a 5.3% increase in 3Q2005 sales with revenues through nine months growing by 4.4%. Increases in raw material costs caused operating profits to fall to 3.9% from 5.3% a year earlier.

Analysts report sales at Furniture Brands International "spotty" for its 1Q2005 citing weak demand across its middle- and upper-priced product lines. Like Bassett the company is focusing its distribution on single-branded stores that exclusively feature FBI products. FBI has gone from 137 such stores in 2000 to a planned 407 by year end.

Casegoods producer Stanley Furniture reported 4Q2004 sales of $83.3 million, up 12.4% over the same period last year. Gross margin also rose to 24.9% resulting in an operating margin of 11.3%.

Chromcraft announced a 27.7% jump in profits in its 4Q2004. Full-year results showed a sales decline of 6.4% with a 15.5% gain in operating income.

Office Furniture
BIFMA reported that January orders increased by 8% year over year marking the sixth month in a row of year-over-year growth. Shipments grew too, up 17%, the second consecutive month of double-digit increases.

This report is good news for an industry sector that suffered a breathtaking decline in sales three years ago following the boom times of the 1990's. From a rate of over $13 billion in late 2001, shipments fell to nearly $8.5 billion in mid-2003. Shipments are just now exceeding the rate first achieved in early 1995. Since 1999 the big three office furniture makers - Steelcase, Haworth, and Herman Miller - have shuttered 16 plants. Industry-wide layoffs totaled 13,000 workers.

Analysts are cautiously projecting the industry's return to more normal times when shipments grew in step with U.S. gross domestic product.

Company results are, however, mixed...

Steelcase announced a major restructuring plan to remove excess production capacity. Headcount is being reduced by 600, and 2.6 million ft2 of manufacturing space is being eliminated.

Herman Miller's 3Q2005 revenues advanced 16% to $382 million fueled by strong international sales. Gross margin rose to 32.1% despite higher material costs. SG&A expenses decreased to 24.5% leaving a solid 7.6% operating margin.

Overall, BIFMA, the industry trade association, is predicting 9.2% growth in 2005.

Wood Flooring
January 2005 shipments of strip flooring declined 4% over the same month in 2004.

This performance followed significant weakness in pricing and a leveling in sales over the last seven months of 2004. And while experts believe total U.S. hardwood flooring sales grew in 2004, much of that growth was in domestically produced engineered products as well as imported flooring.

Indeed Hardwood Review calls the significant growth of flooring imports the biggest hardwood industry story in 2004. Government data show that imports of solid strip and engineered flooring rose by 37% last year. But misclassification of trade data may under represent that number. Suffice it to say that imports of wood flooring are quickly gaining speed, and foreign producers are pushing for U.S. market share.

Strong consumer demand will not absorb the volume of flooring made available by importers and domestic producers who expanded their own capacities. Larger supply often means lower prices. Falling Red Oak prices, down 75% over the last 14 months, have enabled domestic producers to improve margins. However, experts predict lower prices will not bring increased sales of domestic Oak flooring. More exotic offerings like Brazilian Cherry and Mahogany are catching the consumers' eye. The import tidal wave of flooring, like that in wood furniture, will continue...

Moulding & Millwork
Cabinets were not the only wood product benefiting from record-setting home construction in 2004. Moulding and millwork producers, especially those selling into high-end residential markets, experienced good business.

While housing starts were up 7.5% and remodeling expenditures grew by 7.8%, non-residential construction lagged with only 0.6% growth in 2004.

Inevitably, as with most other wood products, imports have taken market share. For example, from 2000 to 2004 hardwood moulding imports rose 30.3%. About two-thirds came from Southeast Asia with China shipping about 43.5% of all moulding imports. Chile is now the second largest source of hardwood mouldings.

As a result, hardwood usage by domestic producers in this sector has declined about 19% since 2000. Like the cabinet industry, Maple has taken share from the Oaks in moulding and millwork products. In addition MDF and finger-jointed mouldings for paint grade and veneer-wrapped MDF have increased in acceptance and popularity.

Experts are predicting stronger non-residential construction in 2005. While homebuilding may decline slightly, demand for this sector's products should improve. In the end the story here will be the same - competition from every country that has a tree will put pressure on prices. To survive domestic producers must find niche markets, offer more customized products, and mind their costs.

Economic Factoid
Newsflash!! The U.S. household savings rate is growing, not falling. For years many economists have read disaster in a savings rate barely above zero. The savings statistic, it seems, simply subtracts consumption from disposable personal income and calls the difference 'savings'. By this logic 'savings' in 2004 were 1.1% of disposable personal income. What about appreciation in assets like stocks and real estate? And what about spending on purchases with long lives like education that is really a capital investment? Neither appreciation nor capital investment is counted as a positive. In fact the current measuring logic turns a reduction in education spending into an increase in savings! If appreciation in homes and equities was counted in 2004, the true savings rate jumps to 46% of disposable income. Those pessimists calling for the consumer to run out of cash might have a long wait.

Public Policy

Domestic Manufacturers
By John Satagaj, WMMA Legislative Counsel
email@jsatlaw.com

WMMA has worked actively with the National Association of Manufacturers (NAM) to identify a game plan to help domestic manufacturers survive and prosper. An important early step in that process was to identify why domestic manufacturers are having difficulty competing in the world marketplace. The NAM produced a study that demonstrated that external, non-production costs add approximately 22 percent to unit labor costs of U.S. manufacturers (nearly $5 per hour worked) relative to their major foreign competitors, and are the primary competitive challenge facing manufacturers and their workers. The report, "How Structural Costs Imposed on U.S. Manufacturers Harm Workers and Threaten Competitiveness," comprehensively documented these extra costs--corporate tax rates, employee benefits, tort litigation, regulatory compliance and energy--and estimated them at approximately 22 percent of the price of production for U.S. firms relative to our nine most important trade competitors. The external costs are twice the size of the average direct labor costs of U.S. manufacturers, and are a major factor in our loss of trade and jobs.

The next stage in the process was the publication of report by the Department of Commerce that made 63 recommendations for helping U.S. manufacturers. Among the recommendations was the creation of a manufacturing policy "czar." Al Frink, the Assistant Secretary for Manufacturing and Services, has met with WMMA.

Congress, at our behest, passed legislation at the end of last year that provides relief specifically targeted at domestic manufacturing. The more you produce in the U.S., the more tax relief you get. That was a big win for us.

The Administration has now taken another step to bring down that 22 percent differential. The Office of Management and Budget (OMB) has announced that Federal agencies will be taking practical steps to reduce the cost burden on manufacturing firms operating in the United States by acting on 76 public nominations to reform Federal regulations.

" Manufacturers incur a larger share of regulatory costs than other sectors of the economy, and these reforms can be undertaken while retaining the benefits of regulation to consumers, workers and the environment. By reducing the costs of operating businesses in the United States, these reforms help make businesses more productive while protecting American jobs," said Office of Information and Regulatory Affairs (OIRA) Administrator John D. Graham

In February 2004, OMB requested public nominations of rules and guidance documents that could be reformed to reduce the regulatory burden on the manufacturing sector. In December 2004, OMB released for agency review the 189 reform nominations that were submitted by 41 industry and non-profit groups. Of the 189 nominations, 76 were selected by OMB for priority consideration and action by the Bush Administration. The Federal agencies involved are the Departments of Treasury, Agriculture, Commerce, Labor, Health and Human Services, Transportation, and Homeland Security, as well as the Environmental Protection Agency and the Federal Communications Commission. Future actions on these reform nominations range from performing a priority investigation and reporting to OMB in order to determine appropriate next steps, to issuing modernized regulations. The report gives us, in the manufacturing sector, a way to monitor and measure progress.

Among the recommendations is reform of the rules of the Family and Medical Leave Act (FMLA). As more and more employees attempt to take advantage of the law, it has turned into an administrative nightmare. The OMB report recommends reform of almost every aspect of FMLA. Recommendations included: requiring employees to take intermittent leave in one-hour increments; allowing employers to disqualify employees for perfect attendance awards because of FMLA leave; allowing employers 5 days to designate a request as FMLA leave; modifying the definition of "serious health condition"; harmonizing HIPAA, FMLA, and the Americans with Disabilities Act privacy requirements; allowing employers to directly contact health care providers for FMLA determinations; clarifying that employers may substitute paid leave for FMLA leave; modifying penalty provisions specified in the FMLA regulations; and allowing employers to substitute "light duty" for FMLA leave.

Another proposal is to make improvements to the Hazard Communication/Material Safety Data Sheets (MSDS) program. Material Safety Data Sheets should be prepared in a consistent format by chemical suppliers throughout the U.S. A consistent format would allow the regulated community to find information on MSDSs more quickly and therefore save time and money. Additionally, quality of the information provided should be improved to reduce the risk of unintended employee exposure. The plan is for proposed guidance for preparation of MSDSs and an enforcement initiative will be posted on OSHA's website in 2005 and final guidance to be issued in February 2006.

Several of the recommendations are included in the project as the direct result of efforts by some of our customers in the furniture manufacturing industry.

It is amazing how there has been such a "sea of change" in Washington's attitude towards manufacturing. Now if we can convince Congress to give us some relief in the courtroom, we will really be on our way.

The Cutting Edge^™ April 2005

International Business Development

International Buyer Program: Reminder: 1st Deadline is April 19!

" Mikron is definitely in a better position because of this program"
Lynn Arbuthnot, Mikron Woodworking

2005 International Trade Opportunities

Manufacturing Strategies

Reminder: Registration Deadline is April 20
For the following Continuous Improvement Workshops
Sponsored by WMMA's Manufacturing Strategies Committee

Two workshops geared to members of the woodworking industry
Attend either one or attend both at a discount

Cost: WMMA has negotiated a group workshop rate and is passing on the savings to all WMMA members and their guests. The cost to members is only $200.00 for one workshop or $300.00 for the two. All workshops include lunch and a continental breakfast.

WMMA members: Bring a client and he/she participates at the WMMA rate.

Lean manufacturing is helping manufacturers survive. However, their continued survival may depend on their ability to extend their newfound competitiveness to the way they take their products to market, through the supply chain and ultimately to the customer. Often, this means an extension of CI initiatives. CI is now more than an initiative - it's a way of doing business. Bring your customers and seek means to not only survive but thrive in 2005!

ACCOMMODATIONS:

WMMA has negotiated a room rate of $99.00 at:
Greensboro Marriott Downtown
304 North Greene Street
Greensboro, NC 27401

The hotel, also the site of the Introduction to Continuous Improvement Workshop, is located 10 miles from JLT Clamps and 11 miles from the Greensboro Airport. We will provide directions for those registering.

HOW TO REGISTER FOR THE WORKSHOP(S): CLICK HERE for the Workshop/Hotel Registration form; complete and return it with payment to:

Ms. Karen Boyle
WMMA, Administrative Director
100 N. 20th Street, 4th Floor
Philadelphia, PA 19103
Fax: 215 963 9785
Email: kboyle@fernley.com

NOTE: Registration is on a first-come, first-served basis, up to 20 people, with a cut-off date of Wednesday April 20, so you must act quickly. Payment will not be processed until we have a minimum of 8 persons registered. If we do not meet our minimum of 8 registrants 21 days prior to the first workshop (April 20) registration fees will be refunded in full. WMMA reserves the right to cancel the workshops without recourse up to 21 days prior to the event.

HOW TO MAKE YOUR HOTEL RESERVATION: If you wish to stay at the Greensboro Marriott Downtown, complete the attached Workshop/Hotel Reservation Form and return it no later than April 20 to:

Ms. Karen Boyle
WMMA, Administrative Director
100 N. 20th St.
Philadelphia, PA 19103
Fax: 215 963 9785
Email: kboyle@fernley.com

For further information on the workshop series contact:

Harold Zassenhaus
Manufacturing Strategies Committee Coordinator
Wood Machinery Manufacturers of America
100 North 20th Street, 4th Floor
Philadelphia, PA 19103
Tel: 215 564 3484
Fax: 215 963 9785
Email: hzassenhaus@fernley.com