Masonite International Corporation

Greetings, everyone, and welcome to Masonite's second quarter 2021 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 that this conference call is being recorded. I would now like to turn the call over to Rich Leland, Vice President, Finance, and Treasurer. Thank you and good morning, everyone.

We appreciate you joining us today. With me on the call today are Howard Heckes, President and Chief Executive Officer, and Russ Tijima, Executive Vice President and Chief Financial Officer. Tony Hare, President of Global Residential, will also be joining us for the Q&A session. We issued a press release and earnings presentation yesterday after the market closed, reporting our second quarter 2021 financial 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. More 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 released in today's discussion include certain non-GAAP financial measures. Please refer to the reconciliations, which are in the press release and the appendix of the earnings presentation. Our agenda for today's call includes a business overview from Howard, a review of the second quarter from Russ, along with our thoughts on the second half of the year and our updated 2021 financial outlook. Lastly, Howard will provide some closing remarks and will host a question and answer session. And with that, let me turn the call over to Howard. Thanks, Rich. Good morning and welcome everyone. Before we review our second quarter results, I want to take a minute and thank our more than 10,000 employees who are working tirelessly in a very difficult operating environment to service our customers to the best of their ability. Whether you're an HR generalist working to hire key talent, a supply chain leader seeking high quality best component options, or a production worker in one of our many factories around the world, I know it's been a crazy year and a half. I'm proud of the work that you are doing and the progress we are making as we transform our company to consistently grow through providing reliable supply, winning at the point of sale, and driving specified demand for doors that do more. It's a great time to be at Masonite, and I couldn't be prouder of our team. Let's move to slide four for a second quarter overview. We delivered record levels of net sales and adjusted EBITDA since becoming an NYSE listed company in 2013. Net sales increased 33% year-on-year and adjusted EBITDA was up 20% year-on-year to $111 million. This strong performance was primarily driven by higher base volumes in our residential businesses as we lapped the initial impacts of COVID-19 last year, along with higher average unit price, or AUP, across all three segments. Adjusted EBITDA margin contracted 170 basis points year-on-year due to the rapid rise in input costs ahead of price realization, along with a tougher count from 2020 due to cost actions taken in the second quarter last year in response to COVID-19. We continue to see rapidly evolving inflation across raw materials and logistics, along with higher wages and benefits as the labor market remained tight, despite the diminishing impact of COVID-related absenteeism. Russ will provide an update on these trends for the second half of the year, along with our updated 2021 outlook. Given the inflationary environment and our expectations for the remainder of the year, we have taken further actions in an effort to maintain a favorable price-cost relationship. Since our last earnings call, we've taken two additional rounds of price increases within our North American residential segment. One was effective late June, and a second just became effective for orders received after August 9th. We believe these price increases will drive a favorable price-cost relationship and return to adjusted EBITDA margin growth later this year, allowing us to still achieve full-year 2021 adjusted EBITDA margin expansion. In July, we completed a $375 million bond issuance at historically low rates to refinance our 2026 notes. This refinancing will result in more than $30 million of interest savings over the next five years and provide us with additional capital and financial flexibility as we invest to support our 2025 Centennial Plan. With respect to business and operational highlights for the quarter, we continue to see strong demand across our residential end markets in both North America and Europe, with early signs of recovery in our commercial end markets as well. This continued strength, coupled with material and labor constraints across our business, has challenged our ability to fully meet customer demand. Our supply chain team continues to identify alternative suppliers as well as material substitutions where possible. To address tight labor markets, we're using initiatives such as referral, sign-on, retention, and perfect attendance bonus programs, in addition to wage and benefit adjustments, to remain competitive in our local markets. In June, we published our 2020 Environmental, Social, and Governance Report, highlighting our ESG achievements and priorities. It also included our first comprehensive third-party verified carbon footprint assessment. I encourage you to visit our website to access the report and learn more about our ongoing efforts to extend a positive influence on the environment, as well as our employees and the communities in which we operate. While the organization remains keenly focused on near-term commitments to service our customers, we continue to look for the future and make investments that support our growth opportunities. Accordingly, I am extremely pleased that we are moving forward with new facilities in both our North American residential and Europe segments. We believe these two facilities will provide the additional capacity needed to better service our customers in the future and to do so more efficiently. Now let me provide you with some more details on these new facilities. In late June, we announced our plan to invest in a new door manufacturing facility in Fort Mill, South Carolina. This facility will assemble interior doors for our North American residential segment and is anticipated to be operational in the second quarter of next year. Given the continued strength and demand, we believe this new capacity is ideally situated from a logistics standpoint to efficiently service high-growth markets in the Mid-Atlantic and Southeast. Being a greenfield facility, we also have the benefit of designing the site utilizing mVantage tools along with targeted automation from the start, positioning this operation to be a highly efficient addition to our manufacturing network. In our Europe segment, work is underway on a new facility in Stoke-on-Trent, England. This facility will increase capacity for our high growth and margin accretive exterior door business. Mason and I entered this business in 2014 with the acquisition of DoorStop International, which sells fully finished exterior door systems direct to contractors. In early 2018, we acquired DW3, which includes additional direct-to-contractor entry system offerings, including the widely recognized Solidor brand. Our entry door business has grown in excess of 20% annually as a result of these investments, and the Solidor business in particular will soon become capacity constrained. As that business grew, expansion took place across multiple facilities, This new build to suit facility will afford us the opportunity to consolidate six buildings into one efficient location capable of supporting continued growth. We anticipate production will start in the first quarter of 2022. Both of these locations are great examples of our commitment to invest in the business for growth. This new capacity will help us execute on the first pillar of our doors that do more strategy, provide consistent and reliable supply. It's foundational for all we do, and these investments are designed to accomplish this goal and to help us achieve our 2025 centennial plan. With that, I'll turn the call over to Russ to provide more details on our financials. Russ? Thanks, Howard, and good morning, everyone. Turning to slide seven, I'll provide an overview of our second quarter financial results. we reported net sales of $662 million, up 33% as compared to the second quarter of 2020. The growth was primarily due to a 19% increase in base volumes as we laughed the impact of COVID in the second quarter of last year and benefited from previously announced new retail business in North American Residential. AUP improved 7% year on year with increases across all three segments due to pricing actions. We also benefited 5% from foreign exchange and 2% from higher component sales. Gross profit increased 21% to $164 million on higher volumes and AUP, which were partially offset by the impact of rapidly increasing inflation along with tariffs on raw materials, rising logistics costs, higher manufacturing wages and benefits, and increased investment in the business. As a result, gross margin contracted 250 basis points year-on-year to 24.8%. Selling general and administration expenses were 12.5% of net sales, favorable 220 basis points year-on-year, but up 12% in absolute terms to $83 million. This reflects the absence of cost actions taken in the second quarter last year in response to COVID-19, as well as the impact of wage and benefit inflation and renewed investments in resources necessary to support growth initiatives. Net income was $35 million in the quarter, an increase of 3% from the prior year. Diluted earnings per share were $1.41, up from $1.38 in the second quarter of last year. Adjusted earnings per share increased 49% to $2.23, which excludes charges related to our previously announced restructuring plans, the loss on disposal of our check business, and the impact of a corporate tax rate change in the U.K. This compares to $1.50 per share in the second quarter last year, which also excluded charges related to restructuring and the loss on disposal of our India subsidiary. Adjusted EBITDA increased 20% to $111 million, which, as Howard noted earlier, was a record quarterly adjusted EBITDA for Masonite. As expected, and per our comments on our first quarter earnings call, the timing of inflation in relation to our mitigation actions, as well as the return of expenses absent last year, put a governor on our adjusted EBITDA growth in the second quarter. While price actions more than offset material increases, adjusted EBITDA margin was 16.7%, down 170 basis points from a strong margin level in the prior year quarter. Moving to the adjusted EBITDA bridge on the right side of this page, you can see the significant year-on-year contribution from our strong top-line growth. with the benefits shown here for volume, mix, and price being delivered by roughly equivalent contributions from volume and AUP. We also realized year-on-year favorability of $6 million due to foreign exchange as both the Canadian dollar and British pounds strengthened against the U.S. dollar. Countering these tailwinds was the negative impact of a quickly changing inflationary environment on our cost of goods sold. Material costs dramatically increased and were $31 million unfavorable year on year. Strong demand and sporadic supply chain disruptions also required us to source more material subject to higher tariffs and duties. Coupled with higher logistics expenses to bring raw material into our facilities and move components within our supply chain internally, we experienced material inflation of almost 13%, equivalent to mid-single digits as a percentage of net sales. compared to the second quarter last year. We also incurred $8 million of higher factory-related costs in the quarter due to higher wages and benefits and production inefficiencies in the architectural segment. Distribution costs were also elevated $10 million year on year as a result of freight lane mix as we rebalanced production across our network to best meet customer demand, as well as inflation in logistics and packaging materials. Let's turn to slide eight for our North American residential segment results. Net sales increased 29% from the prior year to $493 million, primarily driven by a 19% increase in base volume. This increase includes the benefit of lapping COVID-related impacts in the second quarter of 2020, as well as continued strength in our retail business, which includes our previously announced new business with Lowe's. AUP contributed an additional 7% to growth in the quarter, driven by favorable price, which was partially offset by a mixed headwind as our exterior door production was constrained due to upstream supply chain disruptions. These disruptions also drove outside inflation in our chemicals basket. As Howard mentioned earlier, we have taken additional pricing actions to help mitigate the inflationary environment. I'll speak about the timing of those actions and their anticipated benefits when I discuss our outlook. Adjusted EBITDA in the North American residential segment was $100 billion in the second quarter, a 10% increase over the same period last year. This too was a record marking the highest quarterly adjusted EBITDA reported for the North American residential segment. Adjusted EBITDA margin was 20.3%, down 360 basis points as material inflation and higher logistics costs in the quarter outpaced mitigation actions. Adjusted EBITDA margin was also impacted by a tougher COP from 2020 due to the absence of COVID-related cost actions and investments in the business for growth, specifically our North American investment plan and capacity expansion. Turning to slide nine in our Europe segment. Net sales increased significantly year-on-year to $88 million, driven by higher base volume as we lapped COVID-related restrictions that resulted in the idling of our UK and Ireland operations for approximately half the prior year quarter. Underlying residential and market demand remained healthy, with increased new housing builds and sustained robust demand in the remodeling market supporting strong growth in both our interior and exterior door businesses. We achieved this strong top line performance despite material and labor availability impacting our Europe segment. AUP also contributed to year-on-year growth due to previously implemented price increases. In response to the current inflationary environment, we have recently taken further pricing actions in Europe as well. To further optimize our portfolio in this segment, we completed the sale of our check business near the end of the second quarter. This business did not have the scale necessary to serve as a platform for growth in Europe, with net sales of approximately $20 million annually and generating only mid-single-digit adjusted EBITDA margins. Adjusted EBITDA was $17 million in the second quarter, up significantly year-on-year as we lapped COVID-related closures from the prior year. Adjusted EBITDA margin was consistent with the first quarter at 18.9%, despite mixed headwinds from the relative strengthening of our interior business. Overall, a strong quarter for our Europe segment. Moving to slide 10 and the architectural segment. Net sales decreased by 11% year-on-year to $76 million. as a 16% decline in base volume was partially offset by a 4% improvement in AUP, driven by price actions. Volumes were impacted by lingering weakness in some of the commercial end markets we serve, while manufacturing constraints, including material and labor availability issues, also impacted output in certain plants. Adjusted EBITDA margin contracted to less than 1%, primarily due to the impacts of lower volumes. Favorable contributions from price were more than offset by inflation in the quarter. Adjusted EBITDA margin was also negatively impacted by a large capital project to upgrade essential equipment at one of our factories. The project was successfully completed, but resulted in extended downtime, and it was a headwind to second quarter financial performance. As discussed last quarter, we have a three-phase optimization plan and are executing against it. We completed two facility closures as part of Phases 1 and 2, and we expect to see the associated cost savings in the second half of 2021. We continue to make progress on Phase 3 and are currently evaluating our flush door capabilities. Our belief is that once this plan is complete, we will be able to take advantage of a commercial and market recovery, which we believe will be early 2022. Slide 11 summarizes our liquidity and cash flow performance for the quarter. Inclusive of unrestricted cash and accounts receivable purchase agreement and our ABL facility, which remains undrawn, our total available liquidity ending the quarter was $591 million. Net debt was $463 million, resulting in a net debt to adjusted EBITDA leverage ratio of 1.1 times. Cash flow from operations was $33 million through the end of the second quarter, down from $103 million in the first six months of 2020. These lower cash flow levels were expected, given our historically low net working capital at the end of 2020, coupled with the natural increases in working capital from rising sales volumes, along with anticipated higher cash taxes and the cash payment of $31 million in June related to the settlement of U.S. class action litigation. Capital expenditures were approximately $29 million in the first six months of 2021. We continue to execute our share repurchase program in the second quarter, purchasing nearly 284,000 shares for approximately $32 million at an average price of $114.28. Our board of directors and management continue to view Masonite shares as an attractive investment opportunity. Accordingly, the board recently approved a new share repurchase program, allowing the company to repurchase up to $250 million of its outstanding common shares. inclusive of approximately $40 million remaining available under the existing share repurchase authorization approved in May 2018. This repurchase program remains an important means for us to return value to shareholders. As Howard mentioned earlier, subsequent to quarter end, we successfully completed a $375 million bond issuance in July. Acting on historically low rates, we entered the market with the objective of fully refinancing $300 million of notes due in 2026. In addition to extending the maturity date to 2030, the coupon rate was significantly reduced from 5.75% to 3.5%. We will record debt extinguishment costs in the third quarter, but this refinancing will result in more than $30 million of interest savings over the next five years and provide an excellent foundational layer in our capital structure. I was pleased with the team's ability to execute on this deal quickly, taking advantage of favorable market conditions. Let's turn to slide 12 to discuss some of the key dynamics we expect to shape Masonite's operational and financial performance in the second half of 2021. Overall, we see three factors driving strong top-line performance for Masonite in the back half of the year. First, we anticipate continued favorable conditions in our residential end markets, both in North America and the UK. U.S. new housing starts remain up significantly year on year, which, when coupled with an existing backlog in the North American residential business and a steadily recovering new housing market in the U.K., should result in healthy demand for our residential products across the balance of the year. Second, we have worked hard to enhance our capacity to support this customer demand. Actions we've taken in the first half of 2021, such as adding shifts and new equipment in certain door assembly and fabrication facilities, are intended to provide incremental capacity for some of our most constrained product offerings. As a result, we expect volumes in our residential businesses will continue to be up year on year in the second half of the year. While select commercial end markets have shown initial signs of improvement, we still anticipate soft volume in the architectural segment through the balance of 2021. Third, as discussed earlier, we have implemented additional pricing actions across our segment to help mitigate inflationary pressures. In our North American residential segment, we expect to benefit from two additional price increases since our first order earnings call. Due to the timing of these price increases, late June and mid-August, coupled with the existing backlog I just mentioned, we would not expect to realize a significant benefit in the third quarter, but should see the full benefit of both increases during the fourth quarter. These price increases, along with pricing actions taken in our Europe and architectural segments, should drive acceleration in AUP growth as we progress through the second half. From a cost perspective, we expect the environment to remain challenging for the rest of this year. We have seen inflation continue to exceed our expectations. As of our last call, we expected material inflation could reach 7% for the full year. Given the further increases we experienced through the second quarter, coupled with our outlook that this headwind will strengthen in the third quarter before moderating, We now expect material inflation will be in the low teens for the full year, inclusive of tariffs and inbound freight. Due to the tight labor market, we are seeing higher year-on-year wage and benefit inflation. In North America, we have seen wage and benefit increases averaging over 5% this year across our hourly employees. The employment incentives Howard noted earlier present an additional cost headwind, but are expected to improve our ability to hire and retain qualified employees. yet we anticipate that labor availability will remain a constraint. Distribution costs also remain elevated as the logistics inflation we see to ship material between our plants also impacts our outbound shipping costs to customers. We also expect that our mix of freight lanes could remain somewhat sub-optimized as we continue to flex production across our manufacturing network to provide the best service levels possible in the current supply chain environment. Our manufacturing and supply chain teams are working incredibly hard and doing an outstanding job under the circumstances to manage through this difficult supply chain environment. Further, we remain confident that the incremental price actions we have taken will allow us to fully offset material and logistics cost headwinds for the full year. With these factors as a backdrop, on slide 13, we provide our updated outlook for the consolidated full year 2021. Based on the continued strength of residential demand and incremental pricing actions, we now expect year-on-year consolidated net sales growth of 17% to 20%, compared to our prior outlook of 12% to 15%. This updated outlook reflects a slight increase in the benefit from foreign exchange, from 2% to 2.5%, due primarily to further strengthening of the Canadian dollar and British pound. Given the challenging cost environment I just outlined, coupled with when we anticipate fully realizing the benefits of our additional price actions, we expect adjusted EBITDA to remain in the range of $435 million to $455 million, unchanged from our prior outlook. With the full benefit of pricing not expected until the fourth quarter, we anticipate additional adjusted EBITDA margin compression until that time. However, we do expect a return to adjusted EBITDA margin expansion in the fourth quarter and for the full year. Our adjusted earnings per share and cash tax expectations remain unchanged as well. We expect adjusted earnings per share in 2021 will be in the range of $8 to $8.60, and cash taxes will be $45 million to $55 million. We believe capital expenditures will now be in the range of $85 million to $100 million for the full year 2021 on increased investments to support growth. We now expect full-year free cash flow of $130 million to $160 million, reduced from our prior outlook to reflect the impact of higher net sales and material costs on our working capital balances and the slightly higher capital expenditures. Now I'll turn the call back to Howard for some closing comments. Thanks, Russ. We are very pleased with the results this quarter, given the challenging operating environment, as we reported record net sales of adjusted EBITDA, both the highest since becoming an NYSE listed company in 2013. While adjusted EBITDA margins were impacted by inflationary headwinds in the quarter, we've taken further pricing actions to help mitigate these impacts. It should provide incremental benefits as we progress through the second half of the year. We are encouraged by the continued strength in the residential end markets and initial signs of recovery in the commercial end markets. This strong demand gives us confidence to continue investing in the business, including larger capital projects to add new capacity. We are proud of the progress made on our ESG journey. We invite you to visit our website's dedicated ESG page to view this report. Lastly, we've updated our 2021 outlook to reflect a strong demand as well as recent pricing actions taken that should allow us to maintain a favorable price-cost relationship for the full year and drive year-on-year adjusted EBITDA margin expansion for 2021. And with that, I'd like to open the call to questions. Operator?

Thank you. Our first question comes from Josh Chan with Baird. You may proceed with your questions.