This conference call transcript was computer generated and almost certianly contains errors. This transcript is provided for information purposes only.EarningsCall, LLC makes no representation about the accuracy of the aforementioned transcript, and you are cautioned not to place undue reliance on the information provided by the transcript.
spk00: Welcome to Mason 8's third quarter 2020 earnings conference call. During the presentation, all participants will be in a listen-only mode. After management's prepared remarks, investors are invited to participate in a question and answer session. Please note this conference call is being recorded. I would now like to turn the call over to Joanne Freiberger, Vice President and Treasurer.
spk01: Thank you, Melissa, and good morning, everyone. We appreciate you joining us today. With me on the call today are Howard Heckes, Masonite's President and Chief Executive Officer, Russ Tejima, Masonite's Executive Vice President and Chief Financial Officer, and Tony Hare, President of Global Residential, is joining us for our Q&A session. We issued a press release and WebEx presentation after market closed yesterday, sharing our third quarter 2020 results. These documents are available on our website at masonite.com. Before we begin, let me remind you that this call will include forward-looking statements. Each forward-looking statement contained in this call is subject to risks and uncertainties that could cause actual results to differ materially from those projected in such statements. Additional information regarding these factors appears in the section entitled Forward-Looking Statements in the press release we issued yesterday. Additional information about risks can be found under the heading Risk Factors in Masonite's most recently filed annual report on Form 10-K and our subsequent Form 10-Qs, which are available at sec.gov and at masonite.com. The forward-looking statements in this call speak only as of today, and we undertake no obligation to update or revise any of these statements. Our earnings release and today's discussion include certain non-GAAP financial measures. The definition of adjusted EBITDA was updated this quarter to exclude other items, as these charges are not part of our underlying business performance. Other items include legal reserves related to the previously disclosed settlement of U.S. class action litigation. please refer to the reconciliations which are in the press release and in the appendix of the WebEx presentation. Our agenda for today's call includes a business overview from Howard, a review of the third quarter results from Russ, and our view on the financial drivers for the balance of the year, followed by closing remarks from Howard and a question and answer session. And with that, let me turn the call over to Howard.
spk12: Thanks, Joanne. Good morning and welcome, everyone. As Joanne mentioned, late yesterday we released our third quarter 2020 financial results. I'm pleased to report that we saw meaningful net sales and adjusted EBITDA growth in the quarter. Improving conditions in our largest end markets, along with continued growth in average unit price, or AUP, across all three of our segments, allowed us to grow net sales by 6% in the third quarter as compared to the prior year. We saw areas of strength that exceeded our original expectations, resulting in better than anticipated performance in our North American residential and Europe segments. Growth in AUP, primarily driven by our previously implemented North American pricing strategy, plus strong operational performance, allowed us to see continued year-on-year adjusted EBITDA margin expansion in the quarter. Despite operating under the overhang of COVID-19, the direct financial impact was much lower than what we experienced in the second quarter and concentrated primarily in our architectural segment. The year-to-date impact on that business, due to a decline in non-residential construction activity, along with a weaker outlook for commercial and markets, led us to record a goodwill impairment charge of $52 million in the architectural segment during the third quarter. While challenged in the present environment, we remain confident there is opportunity to meaningfully improve the performance of this business. I'll speak about that in more detail shortly. If you recall, we resumed investments in key areas of the business last quarter with the goal of regaining top-line momentum. We accelerated spending this quarter with a continued focus on service, quality, and innovation. While these investments were primarily in our North American residential segment, we remain committed to delivering service and quality excellence across the company. Moving to the right of the slide, I'll cover business and operational highlights in the quarter. It's worth noting, and I cannot stress this enough, that our performance this quarter is due to the exceptional effort and dedication of our roughly 10,000 Masonite employees globally. The organization's commitment allowed us to stabilize operations and remain focused on servicing our customers. This hasn't been without challenges. Our teams around the globe have been forced to contend with new operating protocols, pockets of higher absenteeism, and isolated plant disruptions due to COVID. While operations are running well overall, these impacts have continued to limit our production capacity. Despite this challenging environment, the organization continued to leverage the mVantage operating system. Both Kaizen events and training certifications were up year on year in the third quarter. And while we have generally discussed Kaizen events in relation to productivity, it's important to note that we also use them to drive safety improvements across our organization. For example, going into the third quarter, one of our architectural facilities had demonstrated inconsistent safety performance and had an unusually high number of incidents in the first half of the year. We made the decision to temporarily take that facility offline to address these safety issues head-on. With the support of our continuous improvement organization, the team at that facility has held numerous Kaizen events targeting safety. This endeavor was a headwind to financial performance in the quarter, but it was absolutely the right decision for our employees' health and well-being. I'm pleased to say that since operations resumed, we have experienced only one recordable safety event at that facility. And while one is still too many, it is a significant improvement over the first half of the year. During the quarter, we announced that we entered into settlement agreements on previously disclosed U.S. class action litigation. The company continues to maintain the claims are without merit and denied any liability for them and entered into these agreements to avoid the incurrence of further costs and the uncertainties and risks inherent in treble damage antitrust litigation. Finally, we named Alex Legall, Senior Vice President and Business Leader of the Architectural Segment. If we move to slide five, I'll provide more details on Alex's background and some thoughts on the non-residential market as it stands. Alex has over 25 years of global experience in sales, marketing, and expanded P&L management roles. He came to us from Owens Corning, where he most recently served as vice president and general manager of the North American technical insulation business. In this role, most of his focus was on non-residential business, so he is accustomed to building relationships with both commercial distributors and down-channel influencers. We feel his unique background is a perfect fit as we seek to better understand the commercial decision-making process and create value propositions for our distributor partners, building developers, architects, and end users to drive long-term growth in the architectural segment. While we continue to believe in the potential of this business, the near-term outlook remains soft. The two non-residential leading indicators we most closely monitor are the Architecture Billing Index, or ABI, and the Dodge Momentum Index. While both indicators have stabilized, they have remained at contractionary levels, which suggest continued end-market weakness going forward. As I mentioned earlier, this led us to record a goodwill impairment charge in the quarter. Alex and the team are aggressively working on a thorough plan to reconfigure the business with a goal of improved service and quality and ultimately growth. Concurrently, the team is looking to optimize the segment's current and future cost structure. If you recall, throughout the last year, we made several other key leadership changes in the architectural segment across multiple functions, operations, human resources, and finance. We are delighted to have Alex as part of the Masonite team and plan to have him on future calls to provide you with updates. With that, I'll turn the call over to Russ to provide more details on our financials. Russ? Thanks, Howard, and good morning, everyone.
spk02: Let's turn to slide seven for a summary of our third quarter financial results. We reported net sales of $588 million, up 6% as compared to the third quarter of 2019. The growth was primarily due to a 9% increase in AUP, which was up year on year across all three segments, but largely driven by our previously implemented North American pricing strategy. These gains were partially offset by a 3% decrease in base volumes compared to the prior year, although we did see improved conditions for our residential business in both the U.S. and the U.K., our largest end markets. A further decline in volume from the net impact of a divestiture and acquisition in our Europe segment last year was offset by higher sales of components and other products and slightly favorable foreign exchange. Gross profit increased 28% to $160 million, driven by higher AUP, along with the benefit of cost savings from our previous restructuring actions. This was partially offset by the impact of lower volume and increased investments in the business. Gross profit margin expanded 460 basis points versus the third quarter of 2019 to 27.3%. SG&A, inclusive of the $38 million of charges related to settlement of U.S. class action litigation, was $118 million, up 53% compared to the same period last year. Absent these charges, our SG&A would have been 13.7% of net sales, a 30 basis point decrease compared to the prior year. We recorded a net loss of $22 million in the quarter as compared to $15 million of net income in the prior year. The decline was due to the combined impact of the settlement charges I just discussed and the goodwill impairment in the architectural segment. In total, these two items represent approximately $90 million of discrete pre-tax charges in the quarter. Diluted earnings per share fell to a loss of 89 cents as compared to earnings of 59 cents in the third quarter of last year. Excluding the after-tax effect of the charges related to goodwill impairment, legal settlement, and restructuring incurred in the third quarter of 2020, adjusted earnings per share increased to $2.16 compared to $1.08 in the third quarter of 2019, which excluded charges related to debt extinguishment and restructuring. Adjusted EBITDA increased by approximately 44% to $109 million, while adjusted EBITDA margin expanded 480 basis points to 18.5%. This marks the seventh consecutive quarter of year-on-year adjusted EBITDA margin expansion. Moving to the right-hand side of the slide, we have more detail under adjusted EBITDA performance, which was largely driven by strong year-on-year gains in price, which, along with improved mix, more than offset the impact of lower volumes in the quarter. Material costs were $4 million higher compared to the prior year, primarily due to inventory losses in our North American residential segment as a result of damages from Hurricane Laura to our facility in Lake Charles, Louisiana, and a straw fire in the outside storage of our Wapiton, North Dakota facility. We continue to see inflation in commodity prices in line with our original expectations, but our global sourcing team continue to deliver on savings initiatives to offset those cost headwinds. Factory costs were slightly higher in the third quarter due to increased investment spending, primarily associated with our North American investment plan, and lost absorption and higher spending in the architectural segment. While we continue to see higher costs related to wage and benefit inflation, these were offset by labor productivity and savings from our previously implemented restructuring initiatives. Distribution costs were $3 million higher due to our continued need to shift production across our plants in North America in response to COVID-related capacity constraints, resulting in longer or less cost efficient freight lengths. Lastly, SG&A was $3 million higher due to increased personnel costs, primarily due to incentive compensation and resources to support growth initiatives. Overall, another strong quarter from an adjusted EBITDA standpoint. Turning to slide eight and our North American residential segment. Net sales increased 12% from the prior year to $421 million due to a 12% increase in AUP. Base volume was flat year on year as our end markets remained resilient and our capacity stabilized. As mentioned earlier, market conditions continue to improve in the U.S., particularly in the wholesale channel, as housing completions remain positive despite a sharp decline in housing starts early in the second quarter. Coupled with continued strength in our retail channel, this resulted in better-than-expected net sales in this segment. While we stabilized capacity overall, we did have one plant idle briefly during the quarter and production constraints in specific areas of other plants due to higher absenteeism related to COVID. Looking forward, we remain cautiously optimistic about our ability to operate, but would anticipate that higher absenteeism could continue to impact our capacity. Adjusted EBITDA in the North American residential segment was $98 million in the third quarter, a 58% increase over the same period last year. Adjusted EBITDA margin expanded 670 basis points to 23.2% on a higher price and stronger operational performance. Given the continued strength in the business, we accelerated our North American investment plan in the third quarter of 2020. To date, these investments have focused on improved quality of components, service and delivery initiatives, and technical resources to support manufacturing and product development. We anticipate spending at an increased rate in the fourth quarter, which I'll speak about in more detail when I discuss our view on the balance of the year. Turning to slide nine and our Europe segment. Net sales decreased by 2% year-on-year to $74 million, primarily due to the 6% decline in net sales from a divestiture in the fourth quarter of 2019. Lower base volumes contributed another 2% to the net sales decline in the quarter, although this was better than anticipated as we continued to see very strong demand in the repair and remodel business, which drove strong exterior door volumes through our direct-to-contractor channel. Unfortunately, this was more than offset by continued weakness in our builder and merchant channels, which are more focused on interior doors for new home construction. Partially offsetting the net sales decline was a 4% increase from the favorable impact of board exchange, a 1% increase in AUP, and a 1% increase in the sale of components and other products. Adjusted EBITDA in the Europe segment was $15 million in the third quarter, a 41% increase over the same period last year. Adjusted EBITDA margin expanded 620 basis points to 20.2% on the strength of higher margin exterior doors, COVID-related cost savings, and the previously noted divestiture of a margin-diluted business. We would expect this performance to moderate as these tailwinds begin to diminish in the fourth quarter. For example, as the new build channel recovers, we would expect to see more normalized volumes of interior versus exterior doors. Moving to slide 10 in the architectural segment. Net sales decreased by 10% year-on-year to $87 million due to a 14% decline in base volume as we experienced continued COVID-related weakness in our end markets. in our longer cycle business we saw slower progress on commercial job sites as a result of safety protocols our short cycle business remained weak due to reduced tenant improvement activity as businesses held off on investments given the uncertain environment in some cases we've seen previously funded tenant improvement projects moving ahead but these projects are the exception rather than the norm growth of four percent from aup partially offset the decline in base volume In addition to higher price on quoted projects, MIX also contributed to year-on-year AUP growth as our volume declines were more skewed toward our stock business, which is generally comprised of lower-priced products. Adjusting EBITDA margin contracted 160 basis points to 12.8% due to lower volumes and higher factory costs. As Howard mentioned, we took one of our architectural facilities offline for a short period to focus on safety initiatives, leading to lower overhead absorption. Combined with incremental maintenance and personnel expenses in the facility, this resulted in a headwind of over $2 million in the quarter. We view this as an important investment to improve the safety environment for our employees. I'll address the non-residential construction market outlook in a moment when I discuss financial drivers for the balance of the year. Slide 11 summarizes our liquidity and cash flow performance for the quarter. While the initial concerns we had surrounding the impact of COVID on end market demand appear to have subsided, at least for the residential markets we serve, we think it's prudent to maintain elevated liquidity given continued uncertainty in the broader economy. Our exceptionally strong balance sheet in the third quarter reflects that, with total available liquidity of $522 million, inclusive of unrestricted cash and accounts receivable purchase agreement and our ABL facility, which remains undrawn. Net debt was $491 million, and we ended the third quarter with a net debt to adjusted EBITDA leverage ratio of 1.4 times. Share repurchase continues to be one of the tools in our disciplined capital allocation strategy, and we plan to continue to deploy it opportunistically to help maximize shareholder returns through the cycle. While we did not repurchase shares in the quarter, we restored our share repurchase program, which was temporarily suspended in March, as previously disclosed. We currently have $109 million of share repurchase authorization remaining, and And since we initiated our share repurchase strategy in 2016, we have purchased approximately 26% of the shares then outstanding at an average price of $61.56 per share. Year-to-date cash flow from operations was $219 million at the end of the third quarter, up from $138 million compared to last year. Through the end of the third quarter, capital expenditures were approximately $46 million and free cash flow conversion was 142%. Now let's turn to slide 12. Similar to last quarter, we'd like to provide our thoughts on the balance of the year. As we enter the fourth quarter, we see two areas impacting our financial performance, end market conditions and margin drivers. Market conditions have shifted rapidly this year, and we continue to monitor leading indicators and communicate regularly with our channel partners to gauge future demand. Conditions improved in our residential end markets in the third quarter, and we believe this strength will likely continue through the balance of the year. US housing starts were up 11% in the third quarter, with residential repair and remodel markets in North America appearing robust, given consistent point-of-sale strength and tight inventories in our retail channel. In the U.K., while our new build channel has lagged the remodeling channel, we are starting to see signs of a nascent recovery, including stronger order rates as we exited the third quarter. Partially offsetting solid demand in residential markets is a difficult outlook for non-residential construction, where demand shocks from COVID have been felt most. The net sales decline we experienced in our architectural segment in the third quarter weakened further in October, and we expect this pressure to remain throughout the fourth quarter and into 2021, given that the ABI, while improved in September, remains in contractionary territory. Taken together, these divergent trends across the segments lead us to expect continued year-on-year revenue growth in the fourth quarter, largely on strength in North American residential. While production impacts from COVID resurgence remain a risk, barring any meaningful manufacturing or supply chain disruptions, we would expect consolidated net sales in the fourth quarter to be up mid to high single digits versus 2019. With this resilient overall demand environment in mind, we believe it is prudent to keep investing in the business with an eye towards growth. These investments coupled with other items will be a headwind to margin expansion. For example, as I noted earlier, we expect spending for our North American investment plan to accelerate further in the fourth quarter. Additionally, we are making purposeful investments in many of our manufacturing sites to improve employee facilities. As Howard acknowledged earlier, our performance in the third quarter would not have been possible without the dedication and incredibly hard work of our employees. We felt it was important to show appreciation for their commitment by leveraging our strong financial results to improve the overall workplace environment. This includes things like refurbishing break rooms and bathrooms, upgrading training areas, improving air circulation, new signage, and more. We've already received positive feedback from employees at these facilities, which is great to hear. These folks have been coming to work wherever possible throughout the COVID crisis and giving their all, and these improvements are another way of saying thank you for their dedication. Beyond our investments in the company, we will face some external margin headwinds as well. First, weak demand in the architectural business is expected to yield reduced manufacturing productivity in that segment in the fourth quarter. In the U.K., further recovery in the new housing market is expected to have a positive impact on net sales, but will likely be margin dilutive as the new-build channel is heavily indexed to interior doors versus the higher-margin exterior door systems we sell predominantly into the remodeling channels. And perhaps most significantly, we expect a meaningful increase in material costs in the fourth quarter, principally due to recently implemented new U.S. tariffs on certain wood components from China in response to an anti-dumping petition filed earlier this year. While we are working on sourcing strategies to mitigate this for possible longer term, in the fourth quarter we anticipate that gross material inflation, inclusive of tariffs, will increase to at least mid-single digits. Despite these margin headwinds that we anticipate in the fourth quarter specifically, we're very pleased with our overall financial performance thus far in 2020, and our outlook for the full year is that consolidated adjusted EBITDA margins are expected to expand by at least 300 basis points as compared to 2019. With that, I'll turn it back to Howard for closing remarks.
spk12: Thanks, Russ. To summarize, we are pleased with our performance in the third quarter. Net sales grew year-on-year as we saw areas of strength that exceeded our expectations in both North America and Europe. We reported our seventh consecutive quarter of year-on-year adjusted EBITDA margin expansion and expect to see our eighth in the fourth quarter of the year. Although COVID had a lesser impact in the quarter, the impact was concentrated primarily in our architectural segment. With a new leader in the business and the talent upgrades we've made to the management team over the last year, we believe this business will navigate near-term challenges and be well positioned for the future. We continue to leverage mVantage operating system throughout the organization, increasing both Kaizen events and training certifications year-on-year in the third quarter. Kaizen events doubled from the prior year, so great work across the organization to utilize those tools. We accelerated investment spending with a continued focus on service, quality, and innovation, and plan to further accelerate spending this year. Given our expectations for the balance of the year, we anticipate mid to high single-digit year-on-year net sales growth with continued adjusted EBITDA margin expansion in the fourth quarter. While the future is uncertain, we feel positive about the longer-term trends impacting our business. We've shared our view before that the pandemic is shaping consumer preferences, which may ultimately play to our favor. What started as anecdotes about changing home trends is now being reported in survey data, and we are focused on capitalizing on these opportunities. As the world continues to grapple with the new normal, we believe the need for sanctuary spaces has increased and the home will remain a winner in this crisis going forward. And with that, I'd like to open the call to questions. Operator,
spk00: Thank you. If you would like to ask a question, register a question, it is star 1. If you are using a speakerphone, please lift your handset before entering your request. We ask that you limit yourself to one question and one follow-up question. Our first question is from Tim Woj with Baird. Please proceed.
spk03: Hey, everybody. Good morning, and nice job on the results here. Maybe just my first question, if you could maybe just talk a little bit and kind of expand the discussion about what you're seeing around North American volumes. Just maybe if you could compare and contrast what you saw in retail versus wholesale during the quarter, and then specifically if you've seen any improvement on the special order side of things.
spk13: Yeah, same with Tony. Good question. You know, we were pleased at the business in both wholesale and retail. You know, in the second quarter, we talked about concerns. Was there going to be a spot out there in the future with the slow starts in Q2 that would leave a hole for us? We did not see that happen in our wholesale business, which is primarily serving new construction businesses. We saw that business continue to grow and do very well. And so pleased with that. On the retail side, we continue to see very favorable unit POS out of our retail partner stores. And so, you know, we continue to try to work hard to serve that. So we saw nice sales growth across both of those channels in the quarter.
spk03: Okay. Okay, that's great. And then maybe, Russ, just on – the mid-single-digit growth in kind of raw material inflation in the fourth quarter. Is there a way to kind of unpack that a little bit in terms of, you know, tariffs, you know, employee costs, and maybe just other raw materials?
spk02: Yeah, sure, Tim. Well, the principal driver is higher tariffs that we anticipate. And first of all, I'll rewind and just remind everyone that we came into the year expecting that we'd see gross commodity inflation inclusive of tariffs in that 1% to 2% corridor. And we've largely run within that range, pushing more to the top end of it, but within that range throughout the year. And then we did mention a couple of quarters ago, or a quarter ago, I believe, that we were monitoring an anti-dumping petition that had been filed on certain wood components out of both China and Brazil. And it turns out that there were some new tariffs recently enacted by the U.S. on certain of those components coming out of China specifically. And a lot of those components are going into our exterior door systems. And so that's where the cost headwind is coming from. So if you look at the difference between, you know, call it that 1% to 2% commodity inflation that we would have anticipated to at least mid-single digits, that's why we called that out is because in the interim period, while our sourcing team tries to work through some mitigation strategies longer term, it is going to be a meaningful cost headwind to us. You know, you put that, call it four percentage point differential against our quarterly material buy, and you can see that that's easily an $8 to $10 million headwind.
spk03: Okay. And is there capacity kind of globally to make those shifts, or is that something that will take a couple years to kind of rebuild?
spk12: Tim, this is Howard. I think that the big issue there is, as Russ said, our sourcing team is working hard to mitigate with alternative supply and have been after 301 tariffs in China. I don't think capacity is an issue, but we take the quality of the product we make very seriously. And so, to qualify new suppliers for some of these component parts takes a significant amount of testing and trial. And so, while we're able to offset in some cases, we have to be very careful about how we do that. So the other thing is, as demand continues to climb, its uptick in demand has sort of necessitated the fact that we go back to some of the original suppliers and secure, you know, more components to satisfy demand.
spk03: Okay. Okay. Well, I appreciate the time, and good luck on the rest of your guys. Thanks, Tim.
spk00: Our next question is from Michael Renaud with J.P. Morgan. Please proceed.
spk06: Hi. Good morning, everyone, and congrats on the results. Hope everyone's safe and healthy out there. Great question. Just wanted to delve into a little bit of the sales trends going on, as you saw in 3Q and into 4Q. You know, the guidance for up mid to high single digits, I guess, coming off of 3Q being up 6%, I'm assuming that kind of points to maybe a point or two of acceleration. And I just want to understand if you feel that that's a correct assessment and where that might be coming from. And just to delve in a little bit deeper, in North America, with the volume flat in the third quarter, I guess you pointed to some strength in retail and wholesale. Just wanted to get a sense of where that was offset by and, you know, how did you see North America sales growth cadence from a volume perspective progress during the third quarter and your thoughts into the fourth quarter?
spk02: Yeah, Mike, it's Russ. Maybe I'll start out, and then I'll let Tony fill in any incremental color on North America. So the dynamics are different in each of our markets, and that's been consistent with what we've seen this year. Our expectation for the fourth quarter is that the business is going to continue to be pretty resilient in North American residential. And so a little bit of acceleration there to your question is what we would anticipate. Now, if you just take a look at how the business performed in October, our consolidated net sales were up circa 10%. That reflects, you know, high teens, call it, in North American residential. Europe business roughly flat. And the architectural business following net sales down about 10% in the third quarter, weakening a couple points more. And that, again, is in line with our expectations given how weak we're seeing the commercial construction end markets right now. So that's what is premised on our viewpoint for the balance of the quarter. Now, obviously, that's contingent upon growth. our ability to fully run and service demand. We are seeing increased chatter right now about the resurgence potentially of COVID as we get deeper into the year in the traditional cold and flu season. And as we commented on the call, we are anticipating that slightly higher rates of absenteeism are probably gonna be with us for the foreseeable future. Now, whether that accelerates and impacts any of our manufacturing operations, that's not our viewpoint right now, but it's something that we've gotta carefully navigate. Tony, anything to add on specifics on North America?
spk13: Yeah, I think just relative to North America, we feel really good about the demand profile, what's going on both retail and wholesale, so in new construction and in RRR. You know, for us, it is going to be how do we manage through the environment with absenteeism and the result capacity kind of constraints that will be put on us to be able to meet that demand. I think that's the balance we're going to walk. So we think appreciably the market's going to be going to be excellent. And, you know, our ability to take advantage of it is what we're going to be monitoring.
spk06: Great. Thanks, guys. I guess, secondly, just wanted to hit on, you know, price-cost, I guess, into 4Q. And obviously, you kind of outlined, you know, the anti-dumping tariffs and the impact. I guess that's essentially seems like the primary driver on 4Q right now. But as you look into 21, and I know it's always tough to talk about, you know, pricing before it happens, but I'm sure you've gotten a bunch of questions, obviously, in the last month, month and a half around, you know, Geldwin and their approach to pricing into 21. And, you know, it appears that they've implemented or announced another pretty large price increase for next year, double digits in interior doors, specifically mid to high single digits in exterior doors. How should we think, perhaps just from a top-down level, obviously understanding you're not most likely going to announce it on this call, but Just from a holistic point of view, how should we think about your approach to price costs in 21? Should we, you know, if, you know, typically you have another step up in input costs, should we be expecting that price would at minimum offset that? Just any thoughts around, you know, how we should think about pricing for next year would be helpful.
spk02: All right. Thanks, Mike. Well, with the proviso that we won't talk much about pricing prospectively until actions are in place in the market, let me provide a little bit of color on how we're thinking about price-cost. Clearly, our objective has been to stay ahead on the price-cost equation, and the pricing actions that we have taken thus far have done that. If you look at Our average unit price gains over the course of the year, they've been able to stay well ahead of inflation. And even in the fourth quarter, given the pricing actions that have been put in place, particularly in North America, and despite the much higher tariff load that we expect in the fourth quarter, the math would suggest that we should stay ahead on a price-cost basis. And, again, I'm going to be hesitant to talk much prospectively, but it's going to be our approach going into 2021 to ensure that we continue on that path and manage price costs effectively and more than offset any of the inflationary headwinds that we've got coming at us. Tony, anything you want to add specifically on North America pricing?
spk13: I think you hit it, Russ, that we want to stay ahead of that. The other piece of staying ahead is the North American investment plan that we put together. And so, you know, we still have many things that we want to do to drive value for our customers around service and quality improvements, around driving innovative new products. and around marketing that drives preference for Masonite brand and the products that we provide. So we have to stay ahead in that price-cost relationship to continue to invest, and we're doing that.
spk06: Great. Thanks so much.
spk13: Thanks, Mike.
spk00: Our next question is from Michael Dahl with RBC Capital Markets. Please proceed.
spk11: Hi. Thanks for taking my questions. Russ, sorry to beat a dead horse on this, but a couple ones on the price cost or specifics on fourth quarter. So just with your comment about mid-single-digit inflation, is that specific to North American resi, or is that across your entire business you'll average that mid-single-digit inflation?
spk02: So the tariff load that we are feeling is specifically for certain wood components that we import from China for production in the U.S.
spk11: So, yes, it would be applicable to the North American residential business. Right. I guess what I meant is, does that mean that if we're modeling out N.A. resi, that the cost inflation in N.A. resi is actually much higher than N.A. higher you know high single digits in any yeah okay thanks for clarifying and yes um when i'm citing the overall commodity inflation that we expect that isn't to consolidate the company level got it okay and then i i guess that'll kind of get at my next question which is you know your your margin guidance for the year is is for you know 16 plus and you're running a 17.2 year to date So that bridge you're giving, I guess, makes sense. But just to put a finer point on it, is it fair then to think that we should be looking at more like a 13% to 14% margin at a consolidated level for the fourth quarter based on what you're saying?
spk02: Well, as you know, we're hesitant to get into specific guidance for any particular quarter, but at this point in the year, it is just kind of math. So, you know, your math is directionally correct. I think if you step back and unpack the drivers, we've talked about the largest one being the tariff headwind that we see here in the near term. There's also the matter of the additional investments that we're making into the business. We talked a little bit about that during the prepared remarks, the fact that we are going to be accelerating investments our spending further on the North American investment plan as we get into the fourth quarter. That's in part recognition to the fact that in the early days of COVID, we put some pretty tight guardrails on our spending in the company, and we slowed down on certain initiatives until we had better visibility to what end market demand would be. And now having seen the resiliency in those end markets, we're accelerating to get back to a more normal pace of spend on that investment plan. And then the other factor we also mentioned is the fact that we are making some investments in our plant, specifically in the fourth quarter. And that's going to be circa $3 million worth of additional OPEX that we think will bear just in some of the cleanup and fix-up costs that we're incurring in our plant. So those three aspects together are going to be the reinvestment or cost headwinds that we anticipate that are specific to Q4.
spk11: Okay. That's helpful. Thanks for the detail.
spk02: Yep.
spk00: Our next question is from Jay McCandless with Wedbush Securities. Please proceed.
spk10: Hey, good morning. Thanks for taking my questions. The first one I had, good morning. So North American volume flat roughly in 3Q. Would have expected a little bit of growth there just given the easy comp and what we've been hearing from the builders. Can you talk about how volume is looking going into the fourth quarter? And then also, what are you hearing from your builder customers domestically about cycle times and when they can get those interior doors into the house?
spk13: Yeah, Jay, good question. So, you know, I think as we said in the early prepared remarks you saw in there, we had a plus one. price or a plus one volume mix for North America for Q3. And we have seen strong demand across both wholesale and retail. It's really been our ability to try to produce products in a new format with, you know, all of the COVID protection measures that we have and the absenteeism that we're seeing that's that has kind of limited us there. As we look at the response, certainly the builders are very optimistic. I think we're at two and a half months of housing supply for sale in the United States, and the builders have been very bullish about firing up building for spec and opening new communities to do that. So they're very much asking for more product and pushing to build more. And again, we're trying to do what we can in this operating environment to make sure that we can meet that need. But again, they're very positive.
spk12: I think, Jay, this is Howard. I think... As Tony said, really capacity has been the governor at this point in Q3. Russ mentioned some spot outages, you know, one plant closed for a short period of time in the quarter and some additional absenteeism. So that's really been what we've been managing. Demand has been very solid, but capacity has been the governor. I think looking forward we would expect, and we've seen some sequential improvement in in our output, if you will. We always have sort of, we're looking carefully at the potential hotspots, if you will, and it continues to be a changing sort of daily item. But we've been fortunate. We've been able to generally continue to run, and we're seeing sequential improvements. So I think in the fourth quarter, we'd expect to see some volume growth in North American residential as our capacity continues to increase.
spk10: Great. Thank you for all that color. And then just the second question I had is, if the higher cost on the lumber is only affecting exterior doors in North America, could you break out what percentage of North American sales those exterior doors are typically?
spk13: Let me clarify quickly, Jeff. If you look across what we provide, we were speaking, I think Russ was speaking specifically to the anti-dumping duties, countervailing duties. Those hit disproportionately our exterior door product categories. The existing 301 tariffs, the wood inflation, that impacts all of the products that we provide because of the components that we utilize. So just want to be specific. It's that ADD, CBD work that's hitting primarily exterior.
spk02: Yeah. And just to your broader question about mix of revenue on a sales dollar basis, Jay, it's roughly 65% would be interior doors and the balance exterior doors in North American residential.
spk10: Got it. Thank you for taking my questions.
spk02: Thank you.
spk00: Our next question is from Trey Grooms with Stevens. Please proceed.
spk04: Hi. Good morning. This is actually Noah Murkowsko on for Trey. We're Noah. So first question, following up on that capacity, you know, we've heard of some in the distribution or wholesale channel having trouble getting doors. Um, and there's been extending lead times and, you know, you guys just talked about how you're, you're running into maybe some short-term issues with capacity, but, you know, if you think over the last year or so you've, you've sort of maybe right-sized the business a little bit and taken out some capacity. So, you know, I guess, you know, how are you thinking about this? Do you, you feel like you have enough capacity as we look into 21 and further to serve the strong residential demand or, or maybe do you think we start seeing, you know, some capacity, uh, expansion?
spk13: Yeah, Noah, good question. In the near term, as Howard mentioned, certainly we've seen stronger demand than any of us anticipated when we walked into Q2 and started to enter this whole new world. We've been trying to respond to that and have been limited by absenteeism, availability of people, the ability to run on our normal shift structures, etc., We have seen sequential improvement in our output. We still are on allocation for interior doors with our customers. And so we have been for the last few months. We anticipate that probably will continue to the end of the year, but we are excited about the sequential improvement. When you talk about the footprint changes that we have made, certainly we have consolidated production into some of our major locations. We announced last time that we had opened a new facility in Tijuana, Mexico. We're ramping that up. We continue to ramp that up. We were slowed down because of COVID. We had some equipment that we couldn't cross the border and get placed in Tijuana. We couldn't get outside resources there to do the installs. So we're working through all that right now. I feel really good about the footprint and the capacity model that we'll have when we get that facility back up to full speed. And frankly, our CI team and the work that they've done on plant transformations in our existing facilities to be able to hit the output we're hitting with the limitations we have with absenteeism and differentiated shift structure has been very impressive. So as we come into whatever the new norm looks like and the ability to get T01 up and running, I feel really comfortable and confident we're going to be able to continue to support this growth with the footprint that we have.
spk04: All right, that's helpful. And then my second question, I was hoping to give a little bit more detail on your North American investment plan. Obviously, you've talked about accelerating that after maybe that was slowed down a little bit, but can you maybe give some examples of the sort of product innovation or improvements in service that you're rolling out and And as you're spending this money, how quickly do your customers start to see these benefits? Is this something that they see immediately, or is this maybe more of an impact in the 21st?
spk12: Yeah, so thanks, Noah. This is Howard. If you recall, we announced our intention to spend $100 million over five years, and we suggested that that would probably be close to linear. Well, obviously, COVID had an impact on that. We cut all discretionary spending, essentially, in the second quarter when this started, and so... we were a little behind that run rate, and we will be behind the run rate in the full year 2020. However, we, after four or five weeks, and we realized that demand was going to be much more resilient than we expected, we reinstituted the spending plan. Now, we said it was going to be against three separate sort of pillars, one, service and quality, two, innovation, and then three, down-channel marketing to drive demand for that innovation. And we said that sequentially, you know, would start heavier in service and quality and a little bit of innovation, and then we would lead up to more spending on marketing once we had innovation to speak to. So the investments thus far have been in certain component materials that we think the customers should see the benefit of in the near term. We have been spending on people, manufacturing engineers, quality engineers in our factories to drive improved systems, and we've been spending on innovation in our innovation center in West Chicago as we think about new products. And so, obviously, we're going to talk more about those when they're ready to be commercialized, and those things take just a bit of time. And as I said, that spending we intend over the years to ramp up in innovation and in marketing those new products. So we are excited about this investment plan. We think it's going to have a great – it's going to help not only us grow, but our customers grow in our channels. And so we're fully committed to it.
spk13: Tony, do you want to add anything? Yeah, just one piece of color. You know, some straightforward things in terms of product quality, you know, changes in construction of our product to deal with certain environmental impacts that are on the edge we've already made, and so our customers are already seeing that, things like packaging improvements. So, you know, we are starting to demonstrate some of those to our folks, to our customers out there, and you'll continue to see that as we invest.
spk04: Great. That's helpful, guys. I'll leave it there. Thanks, Noah.
spk00: Our next question is from Kevin Josevar with North Coast Research. Please proceed.
spk09: Hey, good morning, everybody. Hi, Kevin. On the inflation side, so I guess I wanted to obviously touch down the anti-dumping duties and the impacts there. Curious, you know, Holistically, if we look at the whole basket, it looks like steel has moved up, resins have moved up, freight's moving up. So I'm kind of curious how we should think about these other aspects of inflation. And do you think that you'll see that mid-single-digit type inflation for the next couple of quarters, or maybe as you start mitigating some of the anti-dumping duties, that starts to come down? Just trying to think of You know, obviously it sounds like fourth quarter you're expecting that mid-single-digit inflation, but just trying to think of, you know, how should we think of this, you know, going forward.
spk02: Yeah, Kevin, it's Russ. Here's how I would think about it. Barring this change in the anti-dumping tariffs that have been levied, we were still experiencing and would expect to continue experiencing through the end of the year that 1% to 2% gross inflation level. And so this really is, you know, a bit of a unique event with a particular tariff that has been, you know, launched that's driving some higher costs. That's how I would think about it. Now, longer term, again, the sourcing team is working very hard to figure out what strategies they can take relative to our supply base. But to Howard's comments earlier, there is a certain period of time and investment you've got to make in time to qualify and ensure that you've got sufficient quality if you're going to make a change in component, a change in vendor. And so I wouldn't want to call the ball sitting here today on how long exactly that will take. We're going to put the quality of our product as our foremost objective, but it's something that we're actively working to mitigate.
spk09: Okay. And then taking a step back, you know, in North America it seems difficult You know, this year has been a step change in margins. It seems like you've successfully reset that higher here where you've been running at mid-teens margins for the past five or so years. Here it looks like you're going to be in, you know, the low 20s or something. So curious where margins trend. From here, I mean, do you think that there's, you know, we've kind of reset the bar and we kind of stabilize here? Do you think that there's room to move up to the mid 20s or something? Just kind of curious to, you know, how much more room to go you think that the margins have and particularly the North American residential business?
spk02: Yeah, well, Kevin, it's Russ. Let me take a shot at that because, again, with a proviso that we're not sitting here today preparing to provide an updated long-range growth framework for the company, you know, what we have acknowledged is that while we're really pleased with the step-level change we've driven in our margin trajectory this year in particular and in North America in particular on the heels of our pricing strategy, it's not as if we're going to be satisfied with that level going forward. There's still plenty that can be done to improve the margin profile across the company. Now, there's probably greater opportunity in certain areas. For example, the architectural business, where we've got new leadership working on reconfiguring and resetting that business. But in the North American business, there's still plenty that we can do from an operational efficiency perspective. And as I commented earlier, from a price-cost point of view, to keep us ahead of inflation and continue to build margins there. So more to come as we, you know, finalize what our viewpoints are on the longer-term trajectory for the company. We'll probably talk about that early next year.
spk12: And just one other thing to add, Kevin, is Howard, you know, this investment in innovation is really important, too, as we think about margin accretion in future periods. So, you know, the intent there as we introduce new products is that they would be accretive to our margin profile. And so that's a really key part of the strategy going forward.
spk09: Okay, great. Thank you.
spk00: Our next question is from Ruben Gardner with the Benchmark Company. Please proceed. Thank you.
spk07: Good morning, everybody. Good morning, everybody. Apologies. We've got a couple of calls going on simultaneously here. So if this was already asked, sorry about that. But the pre-buy or potential for pre-buy or your outlook for the fourth quarter, have you embedded any in there do you have the capacity if if your customers did want to get ahead of the the price increase i assume with the success that you had um this year that that there might be uh some want uh from your customers to maybe build inventory ahead if possible are you able to do so and have you embedded it in your kind of growth framework for the fourth quarter
spk13: Ruben, this is Tony. I would say that given the dynamic that we're in now with the demand that we've seen and some of the governor that the capacity is put in place and the fact we're on allocation, there's probably going to be very little opportunity for customer pre-buy before the implementation of the price increase first of next year.
spk07: Okay. I guess anecdotally you're hearing a lot more about the size of homes maybe reversing a trend from the last few years. I assume that that potentially could lead to more, you know, a reversal of the trend in the number of doors per home and, you know, things like home offices and things like that. maybe closing off more rooms that need doors as well. How do you guys think about over the next couple of years? Do you think there's enough there to be a secular kind of reversal in what's gone on for the last four or five years that maybe we could start moving in the other direction in terms of number of doors per home?
spk12: Yeah, Ruben, this is Howard. We absolutely believe that the home is going to be a winner at the end of this crisis. And some of it is anecdotal, as you said, bigger homes and whatnot. We're beginning to see actual evidence. There was a survey out by the American Institute of Architects in July where they questioned 425 individual architects or firms. And it was interesting because 68% of respondents cited increasing client requests for home offices. And none reported a decrease in client requests for home offices. So that's a survey, you know, pretty substantial number of architects that are beginning to see interest in home offices. And it makes perfect sense, right? We've all been spending a lot of time at home and trying to find Quiet space. We call them sanctuary spaces where you can get away and have a Zoom call and not have to listen to your dog bark at the Amazon delivery or your kids ask for help on schoolwork. So we see that as a positive trend. We've seen great POS of barn doors in one of our retail partners. And I think that's a great DIY application of being able to close off a space. We hear anecdotes about larger houses, and we've done studies in the past that suggest for every 180 square feet, it's an additional door. And so as footprints get bigger because people want more space as they're spending more time at home, we see that as potential tailwinds going forward, as you said, reversing kind of some headwinds in that area over the last number of years.
spk07: Great. Thank you, guys. Congrats on the quarter, and good luck with the rest of the year.
spk00: Our next question is from Steven Ramsey with Thompson Research Group. Please proceed.
spk08: Good morning. One quick one on the anti-dumping tariff cost. Has your sourcing strategy in the past couple of years anticipated something like this? Has this worked its way through the DOJ and whatnot, or is your response now in sourcing just kind of purely responsive to the verdict?
spk12: You know, this one happened pretty quick, Stephen. The petition was filed in January of this year. And, in fact, it was filed for certain wood molding products from both Brazil and China. You never know how these things are going to turn out. As it happens, some tariffs went into effect at the end of Q2 and mid-Q3 for China. But in Brazil, the Department of Commerce deemed that no additional duties were assessed, and there wasn't dumping. So, you never know how these things are going to turn out. Now, as it happens, our sourcing team is always looking for dual sources of supply, you know, for obvious reasons. When COVID first hit in China, you know, we were worried about our ability to get a secure supply. And with Section 301 tariffs and, you know, it's just things are sort of continually changing and fluid so our sourcing team is always looking for dual sources of supply so that's been going on but this particular one hasn't been brewing for years it was you know pretty quick from the time the petition was filed until the time the duties were levied in this case gotcha and then uh switching to architectural um can you maybe talk to to how uh margins
spk08: could trend in Q4, maybe even into Q1 as you bring in costs for safety and quality kind of in line with, I know it's still a pressured sales environment there. So maybe how margins could look sequentially year over year in any color to add.
spk02: Yeah, Steven, it's Russ. I would just say that we would anticipate that business to be under pressure broadly, both top line and from a margin point of view in the fourth quarter. You know, the safety-related expenses that we bore in the third quarter, we remarked during the call it was in excess of $2 million. Those were probably costs that were more confined to the third quarter. It wasn't as if there was a permanent step-up in expense for that business. But part of that was... lost productivity and overhead absorption just because we're running at lower volumes and And that's going to be a headwind that we will face in the architectural business As we continue to see weaker and market demand and weaker production volumes for us So it's a business that will be under some pressure at least for the near term Great thank you.
spk00: Thank you At this time there are no more questions
spk12: Thank you, Melissa, and thank you for joining us today. Just a reminder, I don't think you probably need one, but it is Election Day, so please exercise your right to vote. We certainly appreciate your interest and continued support during these challenging times. Please stay safe and well, and this concludes our call. Operator, will you please provide replay instructions?
spk00: Yes, thank you. Thank you for joining Masson 8's third quarter 2020 earnings conference call. This conference has been recorded. The replay can be accessed until November 18. To access the replay, please dial 877-660-6853, and that's from in the U.S., or 201-612-7415 from outside the U.S. Enter conference ID number 1371407. Thank you. Have a pleasant day.
Disclaimer