Q3 2020 Masonite International Corp Earnings Call
[music].
Welcome to <unk> third quarter 2020, <unk> 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.
Thanks, Melissa and good.
Turning everyone. We appreciate you joining us today.
Me on the call today are Howard made.
Make nice revenue.
Chief Executive Officer, Rob teach me.
Hi, Executive Vice President and Chief Financial Officer, and Tony here.
Global residential is joining us for acuity.
We issued a press release and why that presentation after market close yesterday sharing our third quarter 2020 result.
These documents are available on our website at <unk> Dot com.
Before we begin let me remind you that this call will include forward looking statements each.
Each forward looking statement contained on this call is subject to risks and uncertainties that could cause actual results to differ materially from those projected in such statements.
No 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 and me Tonight. Most recently filed annual report on form 10-K, and subsequent form 10, Qs, which are available at <unk> Dot Gov and meet Tonight Dotcom.
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 up you did this quarter two excluding other items. 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 reconciliation, 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 Russia, 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.
Thanks, Joanne good morning, and welcome everyone.
That's true in mentioned late yesterday, we released our third quarter 2020 financial results.
We used to report that we saw a 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 a U P 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 strikes that exceeded our original expectations, resulting in better than anticipated performance in our north American residential and Europe segments.
Growth in a p., 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 end markets, let us to record a goodwill impairment charge of $52 million in the architectural segments during the third quarter well challenged in the present in Bahrain.
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 topline momentum.
We accelerated spending this quarter with a continued focus on service quality and innovation well.
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 10000 makes knight 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 coal but well.
Well operations are running well overall these impacts have continued to limit our production capacity.
Despite this challenging environment the organization continued to leverage the advantage operating system.
Both kaizen events and training certifications were up year on year in the third quarter.
Well, we have generally discuss 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 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 what.
The support of our continuous improvement organization. The team at that facility has held numerous kaizen events targeting safety. This.
This endeavor was a headwind to financial performance in the quarter, but it was absolutely the right decision for our employees health and wellbeing.
I'm pleased to say that sense operations resumed we have had only 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 cost and the uncertainties and risks inherent in trouble damage Anti Trust litigation.
Finally, we named our goal 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 nonresidential market as it stands.
Alex has over 25 years of global experience in sales marketing and expanded PNM 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 is accustomed to building relationships with both commercial distributors and down channel Influencers.
We feel is 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.
Well, we continue to believe in the potential of this business the near term outlook remains soft.
To nonresidential, leading indicators, we most closely monitor our the architecture billing index or EBITDA and the Dodge momentum index.
Well 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.
Currently 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 and the architectural segment across multiple functions operations human resources and finance.
We are delighted to have Alex as part of the Mason like team and plan to have him on future calls to provide you with updates.
With that I'll turn the call over to Ross to provide more details on our financials Rob.
Thanks, Howard and good morning, everyone.
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 ATP, which was up year on year across all three segments 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 us and the UK our largest end markets.
A further decline in volume for the net impact of the 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 one $160 million driven by higher ATP, along with the benefit of cost savings from our previous restructuring actions. This.
This was partially offset by the impact of lower volume and increased investments in the business.
Gross profit margins expanded 460 basis points versus the third quarter of 2019% to 27.3%.
As today 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 sq they 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.
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 to 16 cents compared to one dollar an eight cents 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 on our adjusted EBITDA performance, which was largely driven by strong year on year gains in price a lot, 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 strong player in the upside storage of our Wap into 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.
Patrick costs were slightly higher in the third quarter due to increased investment spending primarily associated with our North American investment plan.
Loss 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 $3.3 million higher due to our continued need to shift production across our plants in North America in response to cobot related capacity constraints.
Resulting in longer or less cost efficient freight lanes.
Lastly, SGT was $3 million higher due to increased personnel costs, primarily due to incentive compensation and the 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 ATP.
Based volume was flat year on year as our end markets remained resilient and our capacity stabilize.
As mentioned earlier market conditions continue to improve in the us, particularly in the wholesale channel as housing completions remain positive. Despite a sharp decline in housing starts early in the second quarter couple.
Coupled with continued strength in our retail channel. This resulted in better than expected net sales in the 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 cobot.
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 of the business, we accelerated our North American investment plan in the third quarter 2020.
To date. These investments are 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.
I merely 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.
Just 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 foreign exchange.
A 1% increase in ATP and a 1% increase in the sales 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 Colvin related cost savings and the previously noted divestiture of a margin dilutive 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 cobot related weakness in our end markets.
In our longer cycle business, we saw a slower progress on commercial job sites as a result of safety protocols.
Our short cycle business remained weak due to reduced tentative proven activity.
This business has held up on investments given the uncertain environment.
In some cases, we've seen previously funded tenant improvement projects moving ahead with these projects are the exception rather than the norm.
Growth of 4% from ATP, partially offset the decline in base volume.
In addition to higher price on quarter project mix also contributed to year on year growth as our volume declines were more skewed toward our Soc business, which is generally comprised of lower price products.
Adjusted 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 nonresidential 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 Covance 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, 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.
We currently have $109 million of share repurchase authorization remaining and since we initiated our share repurchase strategy. In 2016, we have purchased approximately 26% of the shares that are 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 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 and the 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 the 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 sales strength and tight inventories in our retail channel.
In the UK, 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 the residential market is a difficult outlook for non residential construction, where demand shocks from cobot had been felt most.
The net sales decline we experienced in our architectural segment in the third quarter. We can further in October we expect this pressure to remain throughout the fourth quarter and into 2021, given that the guy 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 Covance 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.
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.
This includes things like refurbishing break rooms, and bathrooms upgrading training areas improving air circulation new signage at 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 cobot crisis and giving their all in 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 we demanded the architectural business is expected to yield reduced manufacturing productivity in that segment in the fourth quarter.
In the UK 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 index to interior doors versus the higher margin exterior door systems, we sell predominantly into the remodeling channel.
And perhaps most significantly we expect a meaningful increase in material costs in the fourth quarter, principally due to recently implemented new us tariffs on certain would components from China in response to an anti dumping petition filed earlier this year.
While we are working on sourcing strategies to mitigate this were possible longer term in the fourth quarter. We anticipate the gross material inflation inclusive of terrorists 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 will turn it back to Howard for closing remarks.
Thanks Ross.
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 eight in the fourth quarter of the year.
Although cobalt had a lesser impact in the quarter. The impact was concentrated primarily in architectural segment.
With a new leader in the business and the talent upgrades Weve 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 continued to leverage and vantage 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 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.
Well 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.
With that I'd like to open the call to questions operator.
Thank you as we would like to ask a question. Thank you for your question. It is star one.
We are using a speaker phone please lift your handset before entering your request please.
That you limit yourself to one question and one follow up question. Our first question is from Tim well.
With Baird. Please proceed.
Hey, everybody good morning, and nice job on the results there.
Thanks, Tim.
Maybe just on my first question. If you can maybe just talk a little bit and kind of expand the discussion about what you're seeing around north American volumes.
So maybe if you could compare and contrast, what you saw in retail versus wholesale during the quarter and that specifically if you've seen any improvement on special order side. Thanks.
Yes, Tony good question.
We were we were pleased at the.
Business in both wholesale and retail.
And the second quarter, we talked about concerns with what they are going to be a.
Spot out there in the future with 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.
We saw that business continue to grow in and do very well.
And so pleased with that on the retail side, we continue to see very favorable unit.
Yes out of our retail partner stores and so we've continued to try to work hard to serve that so we saw nice.
Sales growth across both of those channels in the quarter.
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 way to kind of unpack that a little bit in terms of tariffs employee costs and maybe just other raw materials.
Yes, sure Tim well the principal driver is higher tariffs that we anticipate and.
First of all rewind to just remind everyone that we came into the year expecting that we'd see gross.
A modest inflation inclusive of tariffs in that 1% to 2% corridor and we'd like 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 quarter go I believe.
Thats right.
We were monitoring that.
That anti dumping petition that had been filed on certain would components out of both China, and Brazil and it turns out that there were some new tariffs recently enacted by the us on certain of those components coming out of China specifically.
And in a lot of those components are going into our exterior door systems, and so thats, where the cost headwind is coming from.
So if you look at the difference between 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 put that.
Call. It four percentage point differential against our quarterly material by and you can see that thats easily and eight to 10 million dollar headwind.
Okay and is there capacity kind of globally to make those ships or.
Is that something that that will take a couple of years to kind of rebuild.
Yes, Tim This is Howard I think that the big issue. There is as Russ said, our sourcing team is working hard to mitigate.
Alternative suppliers have been after three or one 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 as.
How we do that so the other thing is as demand continues to climb.
It's uptick in demand the sort of necessitated the fact that we go back to some of the original suppliers and secure.
More components for to satisfy demand.
Okay. Okay.
I appreciate the time and good luck on the rest of your guys.
Thanks, Tim.
Our next question is from Michael Marino.
My again please proceed.
Hi, good morning, everyone and congrats on the results, everyone safe and healthy out there.
Right.
Great question, just wanted to delve into a little bit of the sales trends going on as you saw in Threeq and into Fourq you.
Yes, the guidance for mid to high single digits I guess.
Coming off of you being up 6%.
Hi.
Assuming that that kind of points to maybe a point or two of acceleration.
And I just want to understand if you feel that that's correct assessment in that.
Where that might be coming from.
And just to delve into a little bit deeper.
In North America.
The volumes 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 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, yes.
Yes, 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 and if you just take a look at how the business performed in October.
Consolidated net sales were up circa 10% that reflects.
A 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. We can take a couple of 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.
So thats what is premised on our viewpoint for the balance of the quarter.
Obviously, that's contingent upon our ability to fully run and service demand.
We are seeing increased chatter right now about the resurgence potentially of coping as we get deeper into the year and the traditional cold and flu season.
And as we commented on the call we are anticipating that.
Likely higher rates of absenteeism are probably going to be with us for the foreseeable future now whether that accelerates and impacts any of our manufacturing operations thats not our viewpoint right now, but it's something that we've got to carefully navigate.
Don't have anything to add on specifics on North America, I think just relative to North America, we feel really good about the demand profile, what's going on in both retail and wholesale so in new construction and the Triple R.
For us it is going to be how do we manage through the environment absenteeism and the result capacity kind of constraints that will be put on us to be able to meet that demand I think thats. The thats the balance middle office. So we think appreciably the market's going to be going to be excellent and.
Our ability to take advantage that is what we're going to be monitored.
Great. Thanks, guys.
I guess secondly.
Just wanted to hit on price.
Price cost I guess into Fourq, you and obviously you kind of outlined.
The.
The answer.
Anti dumping tariffs.
And the impact I guess, that's essentially it seems like the primary driver on Fourq you right now.
But as you look into 21 and I know, it's always tough to talk about.
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.
Jelled win.
And their approach to pricing into 21, and it appears that Dave.
Implemented or now announced rather 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.
Just from a holistic point of view, how should we think about.
Your approach to price cost and 21.
Should we.
If it did.
Typically you have.
Another step up in input costs.
Should we be expecting that price would at minimum offset that it's any thoughts around.
How we should think about price.
Pricing for next year would be helpful.
Thanks, Mike.
Well with the proviso that we wont 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've 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.
Even in the fourth quarter.
Given the pricing actions that have been put in place, particularly in North America and despite the much higher tariffs 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 cost.
Actively and more than offset any of the inflationary headwinds that we've got coming at us.
Tony anything you want to add specifically North America pricing I think you hit it right that we want to stay ahead of that the other piece of staying ahead as the North American investment plan that we put together and so.
We still have many things that we want to do to drive value for our customers around service quality improvements are 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 of that and that price cost relationship to continue to invest and we're doing that.
Great. Thanks, so much.
Thanks, Mike.
Our next question is from Michael Dahl with RBC capital markets. Please proceed.
Hi, Thanks for taking my questions.
Russ sorry.
Sorry to beat a dead horse on this but a couple ones on the price cost.
Or specifics on on fourth quarter. So just what's your comment about mid single digit inflation is that specific to north American resi or is that across your entire business, Joe average that mid single digit inflation.
The tariff load that that we are feeling is specifically for certain what components that we import from China for production in the U.S. So.
So yes, it would be applicable to the north American residential business right I guess I guess, what I meant is does that mean that if were modeling and a resi that those the cost inflation and a red is actually much higher than.
Or higher high single digits.
John.
Yes, okay. Thanks for clarifying and yes, when I am, citing the overall commodity inflation that we expect that as a consolidated company level.
Got it Okay, and then I guess that will kind of get my next question, which is you know your margin guidance for the year is is for 16% plus.
Boston, you're running a 17.2 year to date.
So that that bridge, you're giving I guess makes sense, but just to put a finer point on it does that its a.
[music].
Is it fair then to think that we should be looking at more like a 13% to 14% margin at a consolidated level for for the fourth quarter based on what you're saying.
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.
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 is also the matter of the additional investments that were making into the business, we talked a little bit about that during the prepared remarks. The fact that we are going to be accelerating our spending for.
Further on the North American investment plan as we get into the fourth quarter. That's in part recognition of the fact that in the in the early days of coal that we put some pretty TARP tight guardrails on our spending in the company and we slowed down on certain initiatives until we have better visibility to what end market demand would be and now having seen the resiliency in those end markets were.
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 plants 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 fixed 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.
Okay. That's helpful. Thanks for the detail.
Our next question is from Jay Mccanless with Wedbush Securities. Please proceed.
Hey, good morning, Thanks for taking my questions for Jay the first one I had good morning.
So north American volume flat roughly in Threeq, you 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.
Yes, it's a good.
Good question so.
I think as we said in the early prepared remarks, you saw in there we had.
Plus one.
Yes, our 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 all of the Kobin protection measures that we have and the absenteeism never say that.
That has kind of limited there.
As we look at the response certainly the builders are very optimistic I think were 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 are 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 I.
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 one plant closed.
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 our output if you will.
We always have sort of we're looking carefully at the potential hot spots, if you will and and.
Continues to be a changing sort of daily item.
But weve been fortunate weve been able to generally continue to run and we're seeing sequential improvement. So I think in the fourth quarter would expect to see some volume growth in North American residential as our capacity continues to increase.
Great. Thank you for all the color.
And then just the second question I had is.
The the higher costs on the lumber is.
There's only affecting exterior doors in North America could you breakout what percentage of of North American sales those exterior doors are typically.
Let me, let me clarify quickly if you look across what we provide we were speaking I think for us the speaking specifically to the anti dumping duties countervailing duties.
Those hit disproportionately our exterior door product categories.
The 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 is that 80, CVD, where thats hitting the primarily exterior yeah and just to your broader question about mix of revenue on a on a sales dollar basis, Jay it's roughly 65% would be interior doors and the balance exterior doors in north of.
Eric in residential.
Got it thank you for taking my questions.
Thank you next year.
Our next question is from Trey Grooms with Stephens. Please proceed.
Hi, Good morning. This is actually know AMR cosco on for Trey.
No.
So first question following up on that capacity, we've heard of some in the distribution or wholesale channel, having trouble getting doors.
Theres been extending lead times and you guys just talked about how you're running into maybe some short term issues with capacity.
You think over the last year or so you sort of maybe right size the business, a little bit and taken out some capacity so.
I guess how are you thinking about this do you feel like you have enough capacity as we look into 21 in further to serve the strong residential demand or or maybe do you think we start seeing some capacity.
Expansion.
Yes.
Good question in the 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 et cetera, we have seen sequential sequential improvement and our output. We still are on allocation for interior doors with our customers and so we.
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've made.
Certainly we have consolidated production into some of our major locations.
We announced last time and we hit open.
The new facility in Tijuana, Mexico.
Ramping that up we continue to ramp that up we were slow down because the cobot, we had some equipment that we could across the border and get placed since you Wanna, we couldn't get outside resource there to do the install so we're working through all that right now I feel really good about the footprint and the capacity model that will have when we get that facility back.
Got to full speed.
And frankly, our sales 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 of absenteeism and differentiated shift structure has been very impressive so as we come into all whatever the new norm looks like and the ability to get a tier one 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.
All right that's helpful and then.
And then my second question.
I was hoping you 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 that you're rolling out and.
And as you're spending this money how how quickly do your customers start to see these benefits is it something that they see immediately or is this maybe more of an impact in the 21.
So thanks Noah This is Howard if your recall, we announced our intention to spend $100 million over five years, and we suggested that that would probably be close to linear will obviously cobot had an impact on that we spent we cut all discretionary spending essentially in 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 realize that the demand is 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 to innovation and then three down channel marketing to drive demand for that innovation, and we said that sequentially would start heavier in service and quality and little bit of innovation and then we would lead up to.
More spending on.
Marketing once we had innovation 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 have been spending on.
Innovation in our innovation center in West Chicago, as we think about new.
New products and so obviously, we're going to talk more about those when they are 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 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 by our customers grow in our channels and so we're fully committed sales.
Turning to want to add anything just one piece of color.
Some straightforward things in terms of product quality, you know changes in construction of our product too.
To deal with certain environmental impact that are on the edge Weve already made and so our customers are already seeing that things like packaging improvements.
So we are we are starting to demonstrate some of those to our folks.
As to our customers out there and you'll continue to see that as we invest.
Great. That's helpful guys I'll leave it there.
Thanks.
Our next question is from.
Kevin.
Buyer with Northcoast research. Please proceed.
Hey, good morning, everybody.
Hi, Kevin.
On the inflation side, so I guess I wanted to.
Obviously touched on the anti dumping duties and the impacts there curious.
Holistically, we look the whole basket it looks like steel have moved up resins have moved up rates.
Moving up so kind of curious how we should think about these other aspects of inflation and do you think that you will 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.
No I would just sounds like fourth quarter, you're expecting that mid single digit inflation, but just trying to think of how should we think of this.
Going forward.
Yes, Kevin it's Rob 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% growth inflation level and so this really is.
A bit of a unique event with a particular tariff that has been.
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 tend to relative to our to 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 and you're going to make a choice.
Engine component the 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.
But it's something that we're actively working to mitigate.
Okay, and then taking a step back.
In North America it seems.
This year has been a step change in margins.
It seems that you've successfully reset that higher here, where youve been running at mid teens margins for the past five or so years here it looks like you're going to be in the low twentys 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 or do you think that there's room to move up to the mid twentys or something just kind of curious to know how much more room to go you think that the margins have been particularly the north American residential business.
Yes, Kevin It's Ross, let let let me take a shot at that because again with the proviso that we're not sitting here today prepared to provide an updated long range growth framework for the company.
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 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 theres, probably greater opportunity in certain areas. For example, the architectural business, where we've got new leadership working on Reconfiguring resetting that business, but in the North American business Theres 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 continued.
To to build margins there so more to come as we finalize what our viewpoints on the longer term trajectory for the company will we'll probably talk about that early next year and just one other thing to add Kevin It's Howard this.
This investment and innovation is really important to as we think about margin accretion in future periods. So.
The intent there as we introduce new products is that they would be accretive to our margin profile and so that's that's really key part of the strategy going forward.
Okay, great. Thank you.
Our next question is from Rubin Gardiner with benchmark company. Please proceed.
Okay.
Thank you good morning, everybody.
I noted earlier.
Hi, apologies I got Weve got a couple of calls going on simultaneously or so if this was already asked but.
Sorry about that but the pre buy.
Our potential for pre buy or your outlook for the fourth quarter have you embedded any.
In there do you have the capacity if your customers did want to get ahead of the price increase I assume with the success that you had.
This year that that might be.
Some want.
From your customers to maybe build inventory ahead, if possible are you able to do so and have you embedded in your kind of growth frameworks in fourth quarter.
Remember this is Tony I would say that.
Given the dynamic that we are in now with the demand that we've seen in some of the governor that the capacity is put in place. In fact were on allocation is probably going to be very little opportunity for customer pre buy.
For the implementation of the price increase first of next year.
Okay and.
I guess anecdotally you're hearing a lot more about the size of homes, maybe reversing the 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.
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 theres enough there to be a secular kind of reversal and what's gone on for the last four or five years that maybe we could start moving the other direction in terms of number of doors per home.
Yes, Robin this is Howard.
We absolutely believe that the home is going to be a winter at the end of this this crisis and some of it is anecdotal as you said bigger homes and one that we're beginning to see actual evidence.
There was a survey out by the American Institute of Architects in July where they question 425 individual architecture firms and it was interesting because 68% of respondents cited increasing client requests for home offices.
And none reported a decrease in client request for home offices. So that's a survey.
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 quite spent we call him sanctuary spaces, where you can get away and I assume call and not have to listen to your dog bark at the Amazon delivery or your kids asked for help on schoolwork. So we see that.
As a positive trend we've seen great Pos of borrowers and one of our retail partners and I think thats a great deal why application of being able to close office space, We hear anecdotes about larger houses and we've done studies in the past that suggest for every hundred 80 square feet, it's an additional door and so.
As footprints get bigger because people want more space as they are spending more time at all and 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.
Great. Thank you guys congrats on the quarter and good luck with the rest of the year.
Thanks, Thanks revenue.
Our next question is from Steven Ramsey Thompson Research Group. Please proceed.
Good morning, one quick one on the antidumping.
Kara cost as your sourcing strategy in the past couple of years anticipated something like this is this worked its way.
Through the community, Okay, Ed and whatnot or.
Your response now in sourcing just kind of purely in response to the deferred.
This will happen pretty quick Steven the petition was filed in January of this year and in fact, it was filed for certain wood molding moulding products from both Brazil, and China you never know how these things are going to turn out as it happens some.
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.
For obvious reasons when the cobot first it in China.
We were worried about our ability to get a secure supply and with section three one tariffs and it's just the things are sort of continually changing and fluids. So our sourcing team is always looking for dual sources of supply. So that's been going on but this particular, what hasn't been growing for years that was.
Pretty quick from the time the petition was filed until the time the duties were levied.
In this case.
Got you and then switching to architectural.
Can you maybe talk to how margins.
And in Q4, maybe even into Q1 as you bring in costs for safety and quality kind of in line with.
No it's still a pressured sales environment there so to maybe.
How margins could look sequentially year over year and any color to add.
Yes, Stephen it's Russ I would just say that we would anticipate that business to be under pressure broadly both topline and from a margin point of view in the fourth quarter.
The safety related expenses that we bore in the third quarter, we remarks 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 that's going to be a headwind that we will face in the architectural business.
As we continue to see weaker end 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.
Thank you.
At this time there are no my question.
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 yes.
Yes. Thank you. Thank you for joining Masonites 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 65, sorry.
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