Cutting Edge August 2006

capital

While predicting short-term change is a fool's game, understanding the key longer range trends that may affect the global business landscape is a primary responsibility of senior executives. Companies that astutely plan for the future and adapt their operations accordingly have the best odds of dealing with uncertainty and risk.

In listing the top ten global trends that will shape the business world in the coming years, consultants McKinsey & Company included the demand for natural resources and the resulting strain on the environment. Indeed, global warming, the depletion of tropical forests, plus the ensuing regulations over the use of scarce materials and treatment of the atmosphere are grabbing ever larger headlines and the increasing attention of politicians. Our challenge is to create innovative technology and laws that balance economic growth and environmental sustainability.

The environment is nothing new for the wood products industry. Foresters clearly understand the need for sustainability. For years, forest products companies both large and small have patiently invested in their resource base often with 50+ year horizons. Much capital has been invested in maximizing the transformation of wood fiber previously considered waste into useful products. More billions have been spent to clean up the effluent streams of their manufacturing processes. Undeniably, our forests are our only renewable natural resource, and without it, the wood products industry will disappear. Our industry knows that well.

Recent wood industry headlines generate interesting questions and highlight potentially profitable opportunities to those in our business...

Energy Prices Impact Sawmillers
Prices of many wood products often do not reflect the costs of production inputs like labor and energy. When costs of these inputs rise, profit margins fall. According to Timber Processing, sawmill energy costs have increased by more than 40 percent in the last year.

Energy issues affect virtually every element of lumber production:

Transport - Sawmillers are paying 15 percent more for freight of logs and finished products than in 2005.
Mill Fuel - Mills that fire kilns and boilers with natural gas are suffering. The economics of wood waste-fired boilers and cogeneration have improved thus creating opportunities for companies supplying technology in waste-to-energy conversion.
Power - Electricity costs per thousand board feet have increased by more than 10 percent. Solutions like soft starters on large motors, computerized maintenance management programs, and energy measurement systems are finding increased application.

Mills are ripe markets for those companies that offer energy saving technology.

Demand for Green Furniture Grows
A survey by trade magazine InFurniture has found an increasing preference for eco-friendly furniture among U.S. consumers...

74 percent of consumers are interested in protecting the environment (58 percent somewhat interested, more than 16 percent very interested).
54 percent are more likely to purchase furniture from wood certified as originating in sustainably managed forests.

Unfortunately, only 36 percent indicate a willingness to pay a higher price for furniture built from certified wood. In Europe, timber certification is essentially mandated and thus part of the consumer culture. In the U.S., demand for such products is presently a niche market.

Through the efforts of enlightened retailers like Crate & Barrel, awareness of 'green' furniture is growing among consumers. In the contract sector, architects and developers who follow the voluntary environmental standard, Leadership in Energy and Environmental Design (LEDD), are sourcing eco-friendly furniture and other wood building products. Furniture and millwork manufacturers are increasing supplies of these items.

Interested residential furniture makers have formed the Sustainable Furniture Council to promote the benefits of 'green' furniture. The group is promoting responsible material sourcing and certification through the Rainforest Alliance's Smartwood program.

The 'green' movement in the U.S. may finally be gaining traction.

Forest Ownership Changes
Large and small forest products companies have invested in timberland since Frederick Weyerhaeuser purchased 900,000 acres in Washington State in 1900. With wood and paper demand remaining relatively strong across the decades, these timber investments were a good hedge against rising fiber costs.

Recently, these tree-owing companies have sold their forests. The buyers are Timberland Investment Management Organizations (TIMOs) and Real Estate Investment Trusts (REITs). In April, two TIMOs purchased International Paper's 5.1 million acres of U.S. timberland for $6.1 billion. One REIT, Plum Creek, owns more than 8 million acres of forest land. Weyerhaeuser (with 6.5 million acres) and Temple-Inland (with 2 million acres) are the only two large publicly traded companies with significant holdings of trees on the stump.

How will these new owners manage their forest holdings? Will quick profits from residential/resort development or the slower cash flow from sustainable management of these resources for wood fiber hold sway?

California Proposes Tougher Emission Regs
The California Air Resources Board (CARB) is seeking tighter restrictions on formaldehyde emissions from plywood, particleboard and medium-density fiberboard. Formaldehyde, a recognized human carcinogen, is used in the adhesives or binders employed in the manufacture of these products. These standards will apply to panelboard and products using panelboard made and sold in California.

Drafts of the Phase I regulations call for a maximum of 0.3 parts per million (ppm) in particleboard, 0.9 ppm in plywood, and 0.19 ppm in MDF by July 2008. Phase II limits formaldehyde emission to 0.05 ppm in plywood and 0.03 ppm in plywood after July 2010. MDF producers are allowed an additional two years to achieve 0.05 ppm for Phase II.

The key elements of this debate are:

This draft regulation reduces formaldehyde emissions to levels below what is found in nature. Companies like composite panel Sierra Pine who support the broad goal of the regulation wonder if the Phase II amounts can be measured accurately. How then will the new limits be enforced?
Some industry experts report that adhesives with ultra low formaldehyde levels suffer from poor physical properties and much higher cost. CARB claims that readily available, alternative resins are cost competitive and are "technologically suitable". Columbia Forest Products is now offering cost-neutral, formaldehyde-free hardwood plywood. Their adhesive provides superior water resistance and equal shear strength plus an end product that is compliant with LEDD standards. Formaldehyde-free MDF, however, costs more and has lower water resistance and strength properties.
The new regulations will require board manufacturers to certify their products and downstream users to provide chain of custody documentation. The enforcement mechanics for compliance with these regulations is unspecified. How will CARB police certification and chain of custody in foreign-made products? Will these rules lead to additional plant closures and job loss in the U.S.?

Ironically, composite panels like particleboard, MDF and plywood are environmentally friendly. Their manufacture employs millions of tons of wood fiber that have no other use except as fuel. The use of this fiber enables the recovery of more than 95% of harvested trees into valuable products. The use of panelboards as substrates for valuable veneers reduces the harvest of less abundant species.

CARB has presently scheduled a vote on these regulations no later than January 2007.

Bottom Line: Without question, environmental consciousness is growing, and this awareness will eventually bring change to your business. Don't despair. Rather, get informed and act proactively. Change brings opportunity for profit to those who are prepared.

Sector Report

Kitchen Cabinets
Cabinet sales rose 8.9% in June versus the same month in 2005, according to the KCMA's Trend of Business Survey. For the year to date, sales were up 11.8%. April saw custom sales fall by 3.9% while semi-custom rose by 13% and stock by 7.2%.

Cabinet sales continue to show strong growth in spite of declining housing starts.

At the producers...

Masco reported cabinet sales of $863 million in its 2Q2006, up 3 percent from the same period last year. Operating margin fell to 14.3 percent, down 8.2 percent from last year. Sales of assembled cabinets reportedly grew by double digits, but total revenues were negatively impacted by weakness in ready-to-assemble cabinets. The latter products suffered from higher transport and material costs. Higher interest rates also reduced sales of these cabinets to lower-end consumers.
American Woodmark 4Q2006 sales rose 4.5 percent to $216.4 million. Operating profit increased to 10 percent, a 76.6 jump from the same period last year. Analysts attributed much of this improvement to higher labor productivity and the exit from lower-margin cabinets.

Closets
A survey by trade magazine Closets confirmed the emergence of the home organization industry as an important secondary wood products sector. The products of this sector include closet, garage, and other storage systems. Experts indicate that the total ex-factory value of this sector exceeds $2 billion and grew 30% in 2005. Firms in this sector are small with mean sales of $1.6 million and an average of 17 employees. Solid wood and veneer doors/drawer fronts now account for 20 percent of sales. Drawers are the most popular upgrade. Melamine panels are the material of choice for the casework.

One industry participant forecasts a trend to larger, more sophisticated producers and resellers as the product category evolves.

Home Furniture

News among U.S. furniture producers remains mixed as more plants are shuttered and imports grow...

Furniture Brands International reported 2Q2006 sales of $601 million, up 1.3 percent from the same period the year earlier. Gross margin was essentially flat, while operating margin rose from 2.8 percent to 5 percent. Inventories grew by 11 percent to $489 million as purchases of imported products outpaced shipments to its resellers. Imports account for about 44 percent of FBI's sales. With the resignation of the Broyhill division's CEO, FBI now has three divisions without permanent senior leadership. Broyhill also announced the closure of its 522,000 square foot Pacemaker casegoods plant in Lenoir, NC, that employed 692 workers.
La-Z-Boy continued to under perform with 4Q2006 sales declining 10.1 percent to $508 million. Upholstery sales fell by 12.5 percent, while casegoods dropped by 8.2 percent. Gross margin rose to 25.1 percent from 24.1 percent last year. Operating margin declined to 4.3 percent from 5.3 percent in the same quarter last year. The company also announced the sale of its American of Martinsville contract furniture division to Hancock Park Associates, a private equity firm. The division's annual sales are about $96 million.
Bassett reported a 5.5 percent rise in 2Q2006 sales and tripling of net income. For the first six months of FY2006, sales grew by 6.3 percent to $174.1 million. The company now distributes through 136 Bassett Furniture Direct stores, which accounted for about two-thirds of total wholesale shipments.
Hooker reported net sales of $90.7 million in its 2Q2006, a 2.3% increase over the same period last year. The higher volume contributed to a 20% growth in net income. For the first six months of FY2006, sales totaled $176 million, up 4 percent from last year. For the year sales, of imported products rose by 25 percent while shipments of domestically-produced goods fell by 36.2 percent. As a result, management announced the closure of its 265,000 square foot Roanoke, VA, plant that employed 275 workers. Its production will be shifted to the company's remaining plant in Martinsville, VA.
Ethan Allen reported a 12.3% increase in its 4Q2006 revenues with sales totaling $272 million. Gross margin rose to 51.4 percent while operating margin improved to 13.6 percent. For FY2006, total sales topped $1 billion for the first time in company history.
Stanley Furniture announced 2Q2006 revenues of $77.5 million, a decline of 7.7% year on year. Decreased production levels and higher raw materials costs contributed to an 8 percent decline in gross margin. Operating margin fell to 8.1 percent from 11.2 percent last year.

Meanwhile, more plant closures were announced by other U.S. producers...

RTA furniture maker O'Sullivan Industries, which recently emerged from Chapter 11 bankruptcy, is closing its South Boston, VA, plant and idling 200 employees. The company now operates a single plant - its 1.1 million square foot facility in Lamar, MO.
Upholstery maker Berkline/Benchcraft is closing its Baldwyn, MS, factory putting 400 workers out of work.
Upholstery maker Stanton International is shuttering its Phoenix, AZ, plant and consolidating production to its Stockton, CA, operation. The closure will affect 40 workers.

Office Furniture

BIFMA reported that June orders grew by 2 percent, the lowest year-on-year increase since July 2004. Orders have grown by double digits in nine of the preceding 12 months. Shipments rose by 8 percent and have grown by 9 percent or better in nine of the previous 11 months. On a trailing twelve-month basis, orders grew 10.5 percent. Likewise, shipments rose by 9.7 percent reaching $10.49 billion. That level had not been reached since January 2002.

In spite of weak April and June performances, industry analysts indicate that the drivers of demand - corporate profits, service employment, and non-residential construction - remain strong.

NeoCon, the primary industry trade show held annually in June, was deemed a tremendous success by industry observers and participants.

At the company level...

Herman Miller announced 4Q2006 sales of $444 million, up 9 percent. Operating margin declined to $37.7 million, a decrease of 16.6%.
Steelcase reported 1Q2007 sales of $727.3 million, a 7.6 percent increase year-on-year. Operating margin improved to 4.4 percent from 3.8 percent. The company has experienced difficulties in consolidating its wood product operations from three plants to one. This consolidation is part of a strategy aimed at reducing overall square footage from 14 million to 5 million.
Knoll, Inc. reported a 25 percent gain in its 2Q2006 sales to $247.5 million. Its gross margin, historically among the highest in the office furniture sector, was 31.9 percent, down from 34.5 percent for the same period last year. Cost of sales was impacted by higher material and energy costs. Operating margin fell to 11.8 percent from 12.2 percent.
HNI, headquartered in Muscatine, IA, saw its 2Q2006 office furniture sales rise by 13 percent to $514.3 million. This product segment accounted for 77 percent of total company sales. Operating profit was $38.3 million, a decline of 17.5 percent over last year.

Wood Flooring

June 2006 shipments of strip flooring totaled 42.856 million square feet, down 5 percent compared with the same month in 2005. Year to date the industry has shipped 260.302 million square feet, only 2 percent more flooring than in the first six months of 2005.

Non-Residential Construction

Lodging construction increased at a 95 percent annual pace through April. This building boom is being driven by a 9 percent annual growth in room sales, triple the long-term expansion rate. At this point, building new hotel rooms is cheaper than buying existing rooms.

Factory construction jumped by 8 percent in April from the previous month, a 28 percent gain over the same period last year. Most of this gain is attributed to durable goods producers who are expanding to meet orders from both domestic and foreign buyers.

Warehouse construction is about 10.6 percent above last year. Thus far, demand for warehouse space has not matched growth in the overall economy. Experts attribute this situation to improved import product flow and direct container deliveries to final destinations.

Public Policy

I am not willing to take bets on the outcome of this November's congressional elections. Therefore, this may be our "last call" to secure passage of a statute of repose bill. The good news is that thanks to some hard work by friends and colleagues, the House Judiciary Committee has approved this year's version of the bill, H.R. 3509. We hope the bill will be brought to the House floor in September. If it is approved by the House, we have to convince the Senate to approve the bill before adjourning in October for the fall campaign season. At best, this is a long shot. However, I am optimistic. Even though we do not have a companion bill in the Senate, experience would suggest that the Senate is quite capable of taking up a House bill, in the last minute flurry of activity before adjournment, and passing it. In any event, we cannot worry about that step until we complete the first one - securing House passage.

In many respects, I am glad you did not see the House Judiciary Committee mark up of the bill. I think many of you would get quite upset. The opponents trotted out the same arguments they have used over and over again, the most prominent being the "innocent victim" protection arguments. Now, I have heard these arguments more times than I can count, but it still works me up when I hear them again. Basically, it breaks down to two lines of reasoning; one I characterize as "practical," the other as purely "hypothetical."

The practical argument suggests that manufacturers often make design changes in later models of a product, but fail to tell customers that they found out the original version has a safety issue. I want to jump up and yell, "That's the whole point of a statute of repose; do you know how hard it is to track a piece of machinery, 20, 30, or 40 years after the original sale? And who knows what customer/user modifications have been made in that time." I know most of you go through extraordinary efforts to try to track your machinery.

The second argument is the "business people are bad" theory. The opponents argue that some manufacturers would intentionally design machinery so it would fail AFTER the statute of repose period has tolled. Now, I am not so naive as to believe there are no "bad apples" out there, but it does make my blood boil to have us all painted with such a broad brush. All this aside, we need to focus on the job ahead. We need you to contact your Representative before September. The message is a simple one: "As a member of the Wood Machinery Manufacturers of America (WMMA) and a job creator in your district, I urge you to vote in favor of H.R. 3509, the Workplace Goods, Job Growth, and Competitiveness Act, when it is considered by the House. The bill would establish a uniform statute of repose for capital goods."

Because mail no longer gets through to congressional offices in a timely fashion, you need to call your Representative to get his or her fax number. To reach your Representative by phone, call the central congressional switchboard at 202-225-3121 and ask to be transferred to your Representative's office. Explain that you are a constituent and ask to speak to a staff person responsibility for business issues. Ask for a commitment to vote to approve the bill when it is considered by the House. Also ask the office to keep you informed. If you do not talk with someone with policy responsibility, at a minimum, explain you are a constituent and that you would like their fax number.

No matter what the nature of the conversation, follow up the phone call with written communication by fax or e-mail. Please send a copy of any correspondence to WMMA and drop us a quick email with a report on the results of your efforts. It is extremely helpful for us to be able to report to our friends and colleagues on what we are doing to help.

Small Business Legislative Council (SBLC) has brought back its' public policy briefing telephone conference. It is an improved product and it is free! This is an opportunity for SBLC member association staff and member association members (e.g. board, public policy committee) to participate in a briefing by SBLC President John Satagaj on the hot small business topics of the day.

International Business Development

Companies that sell U.S. manufactured capital goods and services overseas are often asked by their buyers to provide financing in order to close sales. This is especially true in emerging markets where interest rates are high and/or access to capital is limited. SunTrust Bank can provide this type of financing using programs of the Export-Import Bank of the United States ("Ex-Im Bank"). This independent agency of the federal government offers political and commercial risk coverage for short, medium and long-term financing of U.S. produced goods and services.

Coverage
Ex-Im Bank's guarantee or insurance covers the lending institution's repayment risks on the foreign buyer's debt obligations. This ensures that, in the event of default, Ex-Im Bank will repay the principal and interest on the loan. The loan is made directly to the foreign buyer and generally there is no recourse to the U.S. exporter. The Ex-Im Bank support covers up to 85% of the contract amount. The foreign buyer is required to make at least a 15 percent cash down payment.

Eligibility
The borrower must be a creditworthy entity in a country eligible for Ex-Im Bank assistance. Depending on the borrower's creditworthiness, a bank guarantee may be required or a Ministry of Finance guarantee for government sponsored projects. The borrower must provide detailed financial information for the application process. (See attached list of required financial information and criteria). The goods or services that are being exported must be U.S. manufactured or value-added.

Repayment Terms
Repayment terms on such transactions supported by Ex-Im Bank normally range from one (1) to five (5) years, depending on the contract value, the country, and the terms offered by officially supported competitors. Payments of principal and interest are usually made in semiannual installments, beginning six months after final delivery, the midpoint of deliveries, or completion of the project, whichever is appropriate.

Interest Rates / Fees
Because the Ex-Im Bank support carries the full faith and credit of the U.S. government, the interest rates on these types of loans are Libor-based floating rate and are usually very competitive. Ex-Im Bank charges the borrower an insurance premium or exposure fee that is based on the country risk and the financial strength of the borrower. This fee can be financed over the life of the loan.

SunTrust's Expression of Interest
SunTrust will be pleased to provide an expression of interest letter for proposed transactions that fit the Ex-Im Bank profile. The letter will include indicative pricing and structure for the loan.

Association News

October 18-19, 2006 - Woodmark Hotel, Kirkland, WA
November 14-15, 2006 - Le Merigot Beach Hotel, Santa Monica, CA

Senior managers and employees whose jobs require them to make decisions that can get manufacturers into product liability trouble should attend the 2006 Product Liability Workshop presented by Perkins Coie. The seminar will cover principles of liability, warnings and instructions, privileged documents and product liability abroad, among others. The workshop, based on a case study, will trace product problems from their beginnings and requires the workshop participants to decide, as the facts and events develop, what steps the company should take to protect itself from liability.

WMMA President Jim Laster and WMMA Treasurer Ed Fiantaca have both attended this workshop and found it to be very beneficial. To hear about the benefits of the product liability workshop to a WMMA member, contact WMMA Headquarters at mpappas@fernley.com. To learn more about the workshop agenda and/or to register, log on to www.perkinscoie.com/seminars or call Linda Gordon at (800) 475-6161.

The following article was written by Joy Bolin, an undergraduate M.E. student at Tennessee Tech. Joy is a recipient of a WMMA scholarship and recently completed a summer internship with WMMA member company AccuRouter. Several other WMMA members have benefited from the scholarship program by hosting interns this summer. If you are interested in participating this unique program, contact Molly Pappas at mpappas@fernley.com.

In the beginning of my internship at Accu-Router, I was introduced to my resources. I was shown where I could find information, who could answer which questions and what goals the company wanted me to achieve.

I went to work with the spindle technicians. The technicians taught me the value of experience. They knew how to work through any problems and were determined that things should leave in perfect condition. Years of working with spindles had instilled in them the importance of accurate and precise detail for every part of their machine, as well as the assembled spindle. Working with them showed me the significance of communication with other areas of the company. If the spindle technicians got frustrated, someone might walk through and give them some advice or a fresh idea. This communication was also essential between Accu-Router and other companies. Working with suppliers and maintenance teams that deal with similar situations commonly gave insight to factors that might have been overlooked. One day, we visited a company that handles some of our parts to show them personally how we had come to our conclusions and find out if they agreed with our analysis. The teamwork everyone showed, from within the company to between companies, and everyone's willingness to help with frustrating and complicated issues was impressive.

I have always been told that school and real life situations vary greatly, and while I never doubted it, this internship has shown me many of the differences. For instance, I was assigned a minor project to toss ideas at while I learned the ropes of spindle building. After the first week, I had come up with three ways to solve the issues presented for a particular part. This was the beginning of my grasp on real world problem solving. One solution was already being applied on a routine basis by the spindle technicians. The second solution was dismissed because my theoretical grasp on the capabilities of this particular part was insufficient. The third solution was valid, possible and new. I talked to some people about implementing this solution and they seemed to think it was practical also. However, while I had been working on this problem, the rest of the company was adjusting and improving their products (as they are always doing) and my entire project became obsolete.

While I was working on a major project, communication became absolutely essential. Working with the technicians and the draftsman, I discovered more views and alternatives than I knew what to do with. I focused on asking the right questions, taking notes and figuring out which people could give me the answers I needed. I found all the ideas I was confronted with in the beginning were fantastic, and without so many points of view, I would not have discovered such a simple, and most likely dependable, route to take. Besides having to work with different experts in the company, I had to deal largely with our suppliers and consultants. Even when they could not help me, they could often point me in the right direction and were often willing to give me valuable advice for my endeavors.

Experience is the most important thing I will be taking with me from this internship. I have seen the technical side of things where people know how things should work and they deal with the same things over and over. In this way, they have great insight into the dilemmas and directions to take. Alternately, I have seen the engineering side where people figure out why something works the way it does and they know the logic behind each decision for new ideas. I learned the importance in figuring out how something already works before trying to adjust it or fix it. Also, it is essential to know everything that the change is going to affect, from the weight of a part to the pressure in a system. There are many people that might know something, and by asking everyone, I could figure out which route to take.

I got some valuable presentation experience while I was at AccuRouter as well. The only presentation I have given since I've been in college was about my daughter, so the public speaking practice was helpful. I was able to follow a sales presentation and learn what technical language is acceptable, as well as what to expect from the salesman's perspective. Keeping the audience thinking and involved was very important to keeping their attention. Outlines and a slideshow helped greatly with a presentation I gave with a co-worker. It is essential to know everything about your slideshow, because that is probably where you get the most questions (at least this was my experience).

This summer has had a great impact on my grasp of the working force. I feel confident that I can go into a situation and know what to expect, as well as adjust my expectations as necessary to accommodate what inevitably will change.

Association Benefits

What if you could stay current with what is really happening in the US economy by listening to a CD? Even better, what about multi-tasking, listening while driving to and from work?

The Institute for Trend Research (ITR), publishers of WMMA's Quarterly Economic Outlook Report, has launched a new report format - EcoChat. EcoChats is produced quarterly in CD format. Subscribers to EcoChat can listen in on an informal meeting of the ITR economists as they talk about important issues relating to the economy and business. This new format allows ITR to respond to many questions that arise from what is reported in the news.

These forty-five minute conversations cover a wide range of timely economic topics on issues that directly impact your business. Each edition provided an overview of the US economy and a view of what is coming over the next 3-4 quarters. In addition there are specific discussion about topics such as energy costs, the impact of China's growing economy on the US, the truth about the housing 'bubble', what industries have potential in the future and what does the rest of this decade look like for US businesses? An audio sample of EcoChats is available on the WMMA website for your convenience.

These quarterly CD's are available in the months of March, June, September and December.

Sign up today!
Call ITR at 603-226-9331 and identify yourself as a WMMA Member to receive a special, discounted rate.

Contents

Cutting Edge Newsletter™ August 2006

Business Briefing

Public Policy

International Business Development

Association News

Association Benefits