I suppose it could have been worse for cabinetmaker American Woodmark (NASDAQ:AMWD) -- and it was.

A few months ago, the company informed investors that its sales would decline no more than 10% during the second half of its fiscal year, and stay flat among its "core" higher-margin products. A few hours ago, the company reported that sales in Q3 declined 16% overall, and 7% at the core. Ugh. Profits were down, too -- but more than half the apparent net profits "decline" came from the expensing of stock options, which Woodmark did not expense last year.

How did things go so wrong? It's not as if Woodmark tried to inflate expectations with last quarter's guidance. To the contrary, the firm warned that it expected double-digit declines in sales into the new construction market -- and so it came to pass. But Woodmark erred in expecting that double-digit growth in sales to home remodelers would largely offset those declines. In fact, sales into the remodeling market showed just "mid-single-digit growth."

On the one hand, that tallies with the weak results that Home Depot (NYSE:HD) blamed in part on an also-weak housing market yesterday afternoon, and it portends ill for Lowe's (NYSE:LOW) results, due Friday. On the other hand, Woodmark's smaller-than-expected gains in remodeling sales suggest that its plan to grab market share is off to a slow start.

Worse news
In further disappointments, the fear I expressed in last quarter's Foolish Forecast has manifested: Profit margins are slipping. Though it's up versus fiscal Q3 2006, the 18% that Woodmark grossed in Q3 represents a significant decline from the 20.4% it's posted year to date. Worse, the weak Q3 number forced Woodmark to recant its earlier prediction of 21% gross margins for the year -- and to talk down its profits expectations as well:

Targeted Gross Margin for FY2007

Net Profit Guidance

Last Quarter's Guess

21%

$2.40 to $2.50

This Quarter's

20.5%

$2.10 to $2.20



Good news (and more bad news)
Searching for something positive to say about Woodmark, I noticed the firm's boast of impressive year-to-date free cash flow. It's true: Woodmark's $45.8 million in cash generated over the first three quarters of 2007 dwarfs last year's $30 million. But Woodmark failed to say that last quarter it claimed to have generated $42 million in free cash flow -- meaning that cash profits generated in Q3 amounted to less than $4 million.

Sorry to end on a down note, but facts are facts.

We've been watching American Woodmark's turnaround for some months now. Follow along in:

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Fool contributor Rich Smith does not own shares of any company named above. The Motley Fool has a full disclosure policy.