Q2 2022 Masonite International Corp Earnings Call
Welcome to <unk> second quarter 2022 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 conference over to Richard Leland, Vice President Finance and Treasurer. Thank you you may begin.
Thank you and good morning, everyone. We appreciate you joining us for today's call with me here. This morning are <unk>, President and Chief Executive Officer, and Ross T. J Maxx Executive Vice President and Chief Financial Officer also joining us today for Q&A as Chris Hall, our president of global residential.
We issued a press release and earnings presentation yesterday reporting our second quarter 2022 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 his section entitled forward looking statements in the press release, we issued yesterday.
More information about risks can be found under the heading risk factors and masonite. Most recently filed annual report on Form 10-K, and our subsequent form 10, Qs, which are available at SEC Gov and at Masonite Dot com.
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. Please refer to the reconciliations which are in the press release and the appendix of the earnings presentation.
Agenda for today's call includes a business overview from Howard followed by a review of second quarter results and then.
To provide some closing remarks, we will begin our question and answer session and with that let me turn the call over to Howard.
Thanks, Rich good morning, and welcome everyone.
I am pleased to report that Masonite continued to deliver significant year over year growth in the second quarter as expected and as noted on slide four.
Net sales for the quarter were up 15%, while adjusted EBITDA increased 7% adjusted earnings per share for the period grew 16% driven by both positive earnings and a reduction in shares outstanding.
The accelerated share repurchase program, we announced in March of this year was completed in the second quarter, resulting in retirement of roughly 320000 shares on top of the approximately 848000 shares that had been retired as part of the program in Q1.
In total this program reduced shares outstanding by approximately 5%.
A key part of our operating philosophy is to maintain price cost favorability. Once again this quarter, we took appropriate actions given material and logistics inflation that continues to run higher than anticipated this year.
With respect to business operations, our North American residential segment. Once again delivered excellent results by servicing steady demand and realized a 3% year over year volume growth in the quarter.
In Europe , economic and geopolitical issues continue to weigh on consumer confidence and negatively impacted market demand in this difficult environment. Our team has done a good job of navigating the challenges and continues to take actions to manage costs.
Lastly, the architectural segments delivered sequential improvement in profitability as expected despite experiencing lingering material constraints on our critical components.
Overall it was another very solid quarter for the company driven by the focused execution and alignment on our doors that do more strategy by our dedicated teams around the world.
I'm very pleased with the continued progress we made in the second quarter on strategic initiatives, which further strengthen our competitive position, specifically I'm talking about new plants, new products and new marketing initiatives.
Let's turn to slide five.
For those that are new to our story, we developed the doors that do more strategy in 2020 as a way to accelerate the growth of the company.
The objective of this strategy is to drive outperformance in any macro environment by being the most reliable supplier to our customers launching differentiated products and becoming the most preferred door brand in our markets we.
We believe that by executing this strategy, we can achieve our ambitious 2025 centennial plan goals of $4 billion in net sales, 20% adjusted EBITDA margins and sector, leading return on invested capital.
Our strategy has three core pillars deliver consistent and reliable supply our focus on operational excellence.
Drive specified demand our focus on product leadership and when at the point of sale our focus on building the most respected brand in the category.
In Q2, we made further progress in all three of these areas.
Let's turn to slide six.
Last year, we announced plans to open two new Greenfield door plants, one in Fort Mill, South Carolina, and one in Stoke on trends, England today I'm happy to report that both plants are online and have started producing and shipping quality doors.
The plant in Fort Mill specializes in the assembly of interior doors and is an important to upgrade to the production network for our North American residential business.
The manufacturing footprint has been designed using our M vantage principles and the practical use of automation to drive a safer more efficient and reliable operation.
The plant has been strategically located to take advantage of a deep and talented local labor pool as well as major transportation routes that enhance our access to key markets.
We plan to continue adding equipment and expanding operations in the Port mill plant throughout the second half of this year and into 2023 with the objective of making it our most efficient door assembly plant in the U S.
Over in England, our team fully completed transition of production to the new Stoke-on-trent site in the second quarter as.
As you may recall from our previous comments. This plant combines the exterior door assembly operations from five buildings into one new facility with a highly optimized production layout.
Moreover, the old buildings were located in an area, where local ordinances limited our hours of operation.
Our new site is in an area with no sex restrictions, which gives us headroom for future growth.
I am proud of what these two plants represent in terms of the first pillar of our strategy consistent and reliable supply.
We're making our production networks more resilient and flexible while giving us opportunities to achieve production efficiencies that were not possible in our older facilities with less ideal layouts.
I'd like to thank and congratulate the many masonite employees involved in these two successful projects and give special recognition to the UK team that transition production into the new location without any interruption in service to our customers.
Let's turn to slide seven and talk about driving specify demand.
Fiberglass entry doors have been gaining popularity for over a decade because of the energy efficiency low maintenance durability and style they offer.
<unk> sells a wide range of fiberglass doors from opening price point up to our empower smart door and this June we were excited to add the masonite performance door system backed by a 10 year limited full replacement 42, our fiberglass product portfolio.
This store system features a four point performance seal, including an enduro self adjusting Phil adaptive weather stripping square edges and enhanced corner pads.
It has undergone certified third party testing and has proven to be 64% better at keeping air and water out then the leading competitor.
The system is offered with all masonite exterior fiberglass doors, including three new Shaker style designs.
These new exterior designs also released in Q2, representing an important addition to one of our most popular product portfolios.
Builders and homeowners can now buy exterior doors that match, our popular interior Shaker style doors in a complete home package.
The masonite performance door system, and the new fiberglass exterior door designs demonstrate our continued commitment to product leadership and will help us drive positive mix in both homebuilders in homeowners that are looking for an upgrade and performance and style.
For more information on these new products I invite you to visit our product pages at Masonite Dot com.
Turning to slide eight winning.
Winning at the point of sale is about building strong brand loyalty through creative down channel marketing and creating a seamless purchasing experience.
Although we have prioritized enhancements and consistent and reliable supply and product innovation in the early phases of our strategic plan journey. Our team has been working hard on a number of initiatives related to winning at the point of sale as well.
These have included digital marketing campaigns to drive awareness and preference for.
Refreshing in store displays to aid in product selection.
Increasing the assortment of products for sale online to meet consumers, where they want to buy.
Developing channel specific programs to improve product mix and.
And adding the masonite name to hinges on the millions of pre hung doors, we sell into the market each year to expand visibility of the masonite brand.
Two case studies that demonstrate the importance of this strategic pillar are the programs, we put together to drive barn door and solid core volume growth.
In both cases, we began with market research that gave us insights into consumer products references.
Where consumers go for inspiration how they learn about their options and the key factors in their decision to make a purchase.
To engage these consumers our marketing team created digital content targeted at both builders and homeowners.
Simultaneously, we placed physical displays and retail stores, so people could touch and feel the difference between products.
Finally, we expanded our online selection to give both pros and DIY is more ways to buy at their convenience.
As a result of these initiatives, we are seeing tangible mix shift towards these higher value products.
<unk> sales volumes have shown a compound annual growth rate of over 20% since pre pandemic days and the growth rate of solid core door volumes has been nearly three times the growth rate of interior doors overall since launching our sound decision marketing campaign.
As you can see implementation of our doors that do more strategy is happening across the organization.
Many of the projects that required months to bring to life. So I'm thrilled to see us hitting big milestones with these new plants products and marketing initiatives in the second quarter of this year.
I am confident that these investments are driving product mix operational efficiencies and overall competitive advantage that will make valuable contributions to our performance in 2023 and beyond.
The execution of our strategy is foundational to our ambitious centennial plan goals.
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 10, I'll start with an overview of our second quarter financial results.
We reported net sales of $762 million up 15% as compared to the second quarter of 2021.
The growth was primarily due to a 19% increase in A&P, which was up year over year on price implemented to offset inflation as well as positive product mix.
This increase was partially offset by a 2% decrease due to unfavorable foreign exchange, 1% decrease due to a prior year divestiture and a 1% decline in volume.
The year over year volume change was driven by declines in Europe , and architectural segments offset by an increase in the North American residential segment.
Gross profit increased 9% in the quarter to $179 million, while gross margin decreased 120 basis points year over year to 23, 6% due primarily to the effects of inflation and the volume deleveraging impact on factory and distribution cost in Europe and architectural segments.
Selling general and administration expenses were $90 million up 10% compared to the same period last year, while SG&A as a percentage of sales improved 60 basis points to 11, 9%.
Net income was $59 million in the quarter, an increase of $23 million in the prior year, driven primarily by higher gross profit as well as the absence of restructuring charges asset impairments and a loss on the disposal of our Czech business in the second quarter of 2021.
Partially offset by an increase in SG&A and income tax expense.
Diluted earnings per share were $2 58.
Up 83% versus the $1 41 realized in the second quarter of last year.
Adjusted earnings per share were also $2 58.
Up 16% compared to the $2 20, <unk> realized in the second quarter of 2021, which excluded $18 million in charges related to the restructuring and disposal impacts I just noted.
Adjusted EBITDA increased nearly 7% to $118 million for the quarter. Despite the volume deleveraging in our Europe and architectural segments.
As noted on our first quarter call, we have seen inflation continue to accelerate.
In response, we implemented incremental price actions late in the second quarter.
Adjusted EBITDA margin in the second quarter declined year on year as expected down 120 basis points to 15, 5%.
On the right hand side of the slide is further detail on our adjusted EBITDA performance, which continues to benefit from year over year A&P growth.
The impact of material inflation, including Ocean container and other inbound freight costs reached $68 million in the quarter.
Factory and distribution costs were up approximately $35 million draw.
Driven primarily by inflation on labor outbound freight rates and packaging materials with additional impact coming from volume deleveraging startup costs for new plants and increased health care costs.
SG&A was up $8 billion in the quarter with over half of the increase due to a year on year variance and accruals for incentive compensation and the remainder coming from investments in people and strategic initiatives.
Let's turn to slide 11 for our North American residential segment results.
Net sales increased 23% to $608 million attributable to A&P growth of 21% and volume growth of 3%.
Foreign exchange was a modest offset of negative 1%.
While pricing drove much of the A&P increase sales of higher value doors, including solid floor also delivered favorable mix.
The volume increase reflected a continuation of steady demand in the second quarter and our operational teams ability to service that demand.
Adjusted EBITDA in the North American residential segment was $125 million in the second quarter up 25% from the same period last year with.
With an adjusted EBITDA margin of 26% up 30 basis points on solid execution.
The North American residential team has built great momentum in the first half of the year, both operationally and in executing on strategic growth initiatives.
Our focus now turns to balancing appropriate actions to respond to uncertain market conditions with thoughtful investments to support topline growth and continued margin expansion in the future.
Turning to slide 12, and our Europe segment.
Net sales of $74 million were down 16% year on year. However, net sales were roughly flat excluding the impact of unfavorable foreign exchange and the divestiture of our business in the Czech Republic completed in June of last year.
Strong OUP growth of 16% was offset by 16% lower volume due primarily to declines in our exterior business servicing the renovation market, which has been impacted by continued weakness in consumer confidence.
Adjusted EBITDA was $9 million in the second quarter down 48% year over year adjusted.
Adjusted EBITDA margin was 11, 6% down 730 basis points due largely to volume deleveraging and factory relocation costs.
Despite the current macro headwinds impacting the U K, our view remains constructive for that market given the combination of an aged housing stock and the shortage of new housing construction.
Our Europe team has executed initiatives to deliver both improved productivity and create a more robust platform to support long term growth.
The seamless transition to our new exterior door plant installed contract is a great example.
Looking ahead the team's full attention is on managing cost in line with current demand levels.
Moving to slide 13, and the architectural segment.
Net sales of $75 million were roughly flat in the quarter as a 13% increase in A&P was offset by a 13% decline in volume.
Adjusted EBITDA improved sequentially by $3 million from the first quarter.
Our architectural team was able to build on the progress made in Q1 in the areas of staffing and training on new equipment and systems to deliver the sequential improvement, but our efforts to grow volume were hampered by material constraints that proved more acute than expected.
As with other manufacturers that produced wood veneer doors for nonresidential markets, we use a fiber board product called cross band is back into the door facings.
Availability of this component has been limited this year and the sizes and configurations, we use crossing our team to expand our sourcing footprint.
This requires a rigorous and time consuming qualification process, particularly where fire testing is required to achieve appropriate certifications.
Our sourcing and R&D teams have recently qualifying new suppliers and we anticipate that availability will improve as we exited the third quarter.
Turning to slide 14, we will cover liquidity and cash flow performance.
Our balance sheet remains very strong.
At quarter end, our total availability available liquidity was $482 million.
Inclusive of unrestricted cash and our Undrawn ABL facility and an accounts receivable sales program.
Net debt was $635 million, resulting in a trailing 12 month net debt to adjusted EBITDA leverage ratio of one four times.
Cash flow from operations was $34 million through the end of the second quarter as compared to $33 million through the second quarter of 2021.
Capital expenditures were approximately $40 million in the first six months of 2022 up from $30 million in the prior year.
As Howard mentioned during the second quarter Masonite completed the accelerated share repurchase agreement announced in Q1 and.
In total the $100 million ASR transaction resulted in the retirement of nearly $1 2 million common shares at a volume weighted average price of $85 63 per share.
Year to date share repurchases totaled $140 million or approximately $1 6 million shares through the end of the second quarter.
Based on our share repurchase activity to date, we expect an average diluted share count of approximately $23 million for the full year.
Turning to slide 15.
Based on our strong year to date performance and further price cost actions that were implemented in the second quarter, we remain confident in our ability to meet or exceed our net sales and adjusted EBITDA outlook for 2022.
As we discussed on last quarter's earnings call a number of macro cross currents are influencing our end markets and cloud visibility into demand in the second half of the year.
This backdrop of uncertainty remains unchanged on.
On one hand, we continue to drive favorable mix with marketing initiatives that target consumers seeking higher value door products.
Increased levels of home equity also provide support for continued renovation activity and we have seen this play out in the form of stable point of sale rates in our U S retail channel in the second quarter.
Counterbalancing these tailwind higher mortgage rates and persistent inflation present affordability headwinds in new housing.
While the need for additional housing units in our primary end markets suggest long term growth prospects remain intact.
We anticipate that U S housing starts will continue to soften through year end.
Accounting for these factors and considering the potential for channel Destocking. In response, we expect volumes will be down in the second half both in North American residential and on a consolidated basis.
Foreign exchange headwinds have also increased particularly for our Europe segment and continued strengthening of the U S. Dollar.
Inflation in the second half is now expected to be higher than our prior assumptions, particularly in the third quarter and due in part to the timing of higher cost material and logistics flowing through inventory.
However, price cost actions, we have taken will enable us to fully cover this inflation.
Due to our current view on the anticipated geographic mix of income in 2022, we now expect a higher full year tax rate of approximately 24% with cash taxes in the range of $75 million to $85 million.
Reflecting the impact of higher cash taxes, and incremental inflation on our working capital balances. We now anticipate full year free cash flow between 120 and $150 million.
And finally accounting for our higher tax rate and lower share count. We now expect our full year adjusted earnings per share to be in the range of $9 60, and $10 60.
In closing and consistent with our view last quarter, we believe our ability to exceed this outlook will largely be a function of industry volume in our north American residential segment.
Our operations team stands ready to service demand and our disciplined approach to price cost positions us to deliver year over year margin growth for the full year 2022.
With that I'll turn the call back to Howard for closing comments.
Thanks, Ross and.
In Q2, our team delivered another quarter of year over year net sales and adjusted EBITDA growth.
We also achieved key strategic milestones, including the opening of two new plans to modernize our production network and the launch of several new products featuring enhanced performance and style.
I believe this quarter provides a great example of the results we can achieve with tight organizational alignment around a clear strategy and strong execution of that strategy.
As Russ noted we remain confident in our ability to meet or exceed our outlook for full year 2022, net sales and adjusted EBITDA based on our performance year to date and factoring in a conservative view of the second half.
As always our intention is to continue to exploit the opportunities and mitigate the risks in order to realize the full upside potential in this outlook.
Our Centennial plan remains our true north and I am confident that our team will continue to successfully navigate through macroeconomic challenges to outperform in any environment and to achieve our long term objectives of sustained top line growth and margin expansion.
We are confident we have the right people the right strategy and the right assets in place to successfully execute our plans and we are grateful to all of our employees customers partners and investors that continue to support us now.
Now I'd like to open the call to your questions operator.
Thank you Mr <unk>.
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Our first question is from Mike Rehaut with Jpmorgan. Please proceed.
Thanks, Good morning, everyone. Thanks for taking my question, it's Mike Rehaut.
I appreciate all the color and congrats on the quarter.
Wanted to just.
Be clear I guess I'll make sure I understand with regard to your price cost.
Performance, so far and how you're thinking about the back half.
It sounds like you've covered price cost or are you covered cost inflation through price in the second quarter.
And you expect to continue to do so if I heard right in <unk> and <unk> I just wanted to make sure that was both on a dollar basis and on a margin basis or just on a dollar basis. How are you thinking about that.
Mike It's Russ Thanks for the question, Yes, we are expecting to cover both on a dollar and a margin basis.
Price cost.
Great Great and then also you gave some glenn granularity around back half.
Volumes I believe expected to be down.
Just wanted to also kind of unpack that a little bit.
Given how your price mix is.
It kind of trended in the first half of the year.
Yes, it would seem like unless there is a significant drop off.
In in your year over year price gains.
Particularly for North America in the back half.
Yeah.
What kind of modeling in and I know you don't want to get that granular, but it.
Just obviously with what you did in the first half around 18% contribution on average.
18, 19% actually.
Continuing in the.
Mid teens at least I know the fourth quarter is a tougher comp.
It would suggest that volumes might have to be down mid single digits or greater.
It didn't sound like that necessarily what you're expecting with the volume growth just so any any more granularity about how youre thinking about.
Volumes and price in North America in the back half.
Yes, Mike It's Russ, let me unpack that a little bit for you and first of all I appreciate that.
Regarding our first half performance I don't think we can understate how pleased we are with the team's ability to deliver both strong.
And volume growth in the North American residential business in the first half all right. So then what does that mean for the second half. If you look at our guidance range and you walk between say the mid and the high end of that of that guide it would imply that our second half net sales would be up call. It mid single digits.
And as we did remark during the prepared remarks, we are expecting volume to be down second half, but we are expecting strong AEP performance to continue through the year based on the price cost actions that we've implemented both the price increases taken in January and the secondary actions that we have.
In late June .
What that all means is that our guide allows for volumes to be down double digits now.
Now that would be <unk>.
Volume declines would largely be in the residential markets. So we think that there could be the opportunity that market demand itself could be down mid single digits and then as I noted during my prepared remarks around the outlook. There is also a chance that we will see some destocking.
In the wholesale channel.
In response to housing starts starting to soften so again put that altogether.
It would suggest that the guidance can absorb a double digit volume decline.
Don't necessarily expect that that could play out, but frankly, just given the turbulent backdrop that we're managing into we thought it was proved to be conservative and Thats, how we think about the moving pieces in the second half.
Yes, Glenn this is Howard I think thats the.
The important part what Russ said there at the end is that's not necessarily what we expect to see but our strong first half start allowed us to be conservative with our.
Continued outlook, where we really believe we can meet or exceed exceed that there are a number of.
Issues, obviously happening in the market and the guide allows demand to fall pretty significantly and for us to still be comfortably within it.
Just to clarify on that and I apologize for kind of my second follow up here, but I think it's really important.
There are other building products companies. This past earnings season that have.
You highlighted that <unk> already begun to see Destocking.
<unk> market softness at the point of sale.
Through July .
Is.
Your comment so kind of.
Point more to <unk>.
Caution based around what you've heard.
Not necessarily and this is what I'm trying to clarify what you've seen so in other words.
Have you begun to see any signs of destocking and or market softness that is driving that.
Volume outlook or is this just more.
Or just a little bit or is it.
Predominantly just based off of you know macro concerns and what you've heard but not necessarily what you're seeing yet.
I would say that July Mike was a little bit softer than the second quarter. So we saw maybe some signs of destocking, but not anywhere near to the level that the guide allows.
The back half.
Yes.
Okay perfect. Thanks, so much.
Thanks, Mike.
Our next question is from Mike Dahl with RBC capital markets. Please proceed.
Hi, Thanks for taking my questions.
Helpful color in response to.
Mike.
As a couple of follow ups just in terms of the inflationary dynamics can you.
Can you help us better understand what <unk>.
Impacted the second quarter, so the rate of inflation that impacted the second quarter, what your new expectations are.
For the full year and then you said.
Yes second half in particular areas is up towards <unk>.
Brian .
So again, maybe just quantify what that what that means in terms of percentage inflation would be it would be great. Yes.
Hey, Mike, It's Russ I'll take that one.
We've seen inflationary pressures really persist across the board.
Now we've done a lot on the productivity side to help get in front of some of the labor cost inflation, but material inflation continues to be a headwind for us material and logistics in particular and they built a little bit even beyond our expectations when we laid out.
Our guidance for material last quarter, we're seeing headwinds would materials ocean freight as I've mentioned now we are seeing early signs that the material inflation has plateaued and we see the opportunity for material that we're placing orders as we get later into Q3 Q4 may be.
And to moderate a little bit, but frankly, we don't expect that to really provide any P&L impact or benefit to any degree until we get very late into this year or even next year and thats just due to the fact that we're typically consuming material and production in the current environment. Several months. After we purchased elongated supply chains are creating some of that.
That's why I made the comment during my prepared remark about hydro cost material flowing through inventory and into the P&L, we're now consuming it or produce products.
Now all of that said what that means is that our inflation.
Outlook is pushed a little bit out to the right. We see some continued inflation, peaking up into Q3 before it stabilizes and drops off in Q4 that leaves our full year outlook right now or is it on the last quarter call. We said in the range of 20% for the year is probably now in the low to mid <unk> for full year 2022.
That's great very helpful and then.
And as a follow up.
Citing in terms of.
The two new plants, getting operational and ramping up presumably there as well the transition seem to have gone smoothly theres some sort of ramp costs associated with these maybe you can help us understand kind of.
Where these plants are at today in terms of profitability or what those headwinds have represented relative to the total company and then the.
The past their timeline for getting your uptick.
Up to company average margin and presumably based on what you've said about these this would eventually be even more profitable. So maybe maybe any color you have on.
And even longer term goal for those plants in terms of profitability.
Yes sure. Mike. This is Howard we are proud of the efforts to get those plants online in this environment. It wasn't easy certainly and if you look at both of them.
The stove plant.
They're absolutely worst will startup expenses that impacted the P&L for the UK business of European segment in the quarter in fact, the normalized sort of those costs as well as some of the spike in energy that business would have been more of the 13 range, which we're pretty proud of.
Pretty difficult environments on the European segment. So that's the efficiency of that plant is going to be significant for us because as we've mentioned a number of times and in fact, as we said in the prepared remarks, we took five different.
Facilities buildings on one campus and combine them into one so we absolutely theres learning curves as you said some startup expenses, but we would expect to see some.
Benefit to the P&L due to efficiency with Stoke Fort Mill is interesting for us because this will be we believe our most efficient door assembly plant because we're really using.
Targeted automation in areas, where we've had people in the past and jobs that maybe werent highly desirable.
Placed with Sim.
Simple practical innovation.
That is and I visited the plant recently after it start making.
<unk> and <unk>.
It's terrific as I said, it's not that it doesn't blow your mind with automation, but it's practical and it's going to create a very safe reliable and efficient operation. We believe the most efficient in the network. So both will be favorable to the P&L there are startup costs and efficiencies and learning curves that we go through it.
When I was in Fort Mill recently, so all kinds of Ci engineers and the automation engineers running around the factory. So it's certainly not our most efficient plant today, but it will be soon and we're excited for that.
Mike It's Russ I might just add one other quick point.
More specific to Fort mill.
Some of that plant was pretty thoughtful geographically because we wanted to be in a position to most position to most efficiently serve some of our highest growth markets in the southeast and the mid Atlantic and the placement of that plan outside the Charlotte Metro in addition to the labor pool benefits.
Howard mentioned.
That also positions us very well to move to more cost efficiently service those markets with more efficient freight lanes. So there are probably some distribution savings that we see going forward. It's a matter of really bringing that plant up to full ramp and continued to invest in some of the automation that makes it even more productive when it's running at full rate.
Okay. That's great. Thanks, Thanks, Ross Thanks Howard.
Thanks, Mike.
Our next question is from Josh Chan with Baird. Please proceed.
Hi, good morning, Thanks for taking my questions.
Hi, good morning.
My first question I guess.
On price versus cost I know you guys said that you expect to be positive all year, but based on your comments.
And the timing of pricing.
Q2 sort of the narrowest positive gap between the two or would that be would that be Q3.
Yes.
And I think.
Sure.
Likely to be Q3, now as Russ said, Josh it's interesting because.
And what we're using today, we bought in some cases several months ago, we order and that gets on a boat that arrives and so we continue to see inflation actually growing on our income statements because of the timing of when we ordered the product and that has to sort of work through the network. So.
Q3.
I think we're going to continue to see escalation and by the way our philosophy to remain.
Price cost favorable is alive and well and it's why we took.
Another action in June because inflation as we said is is now we think in the low to mid twenties, where going into the year. We thought it was going to be in the low to mid teens and so it's our obligation to address that with other actions, which we did so I think Q3 will probably be a little tighter and then it should open up in Q4.
Okay. That's great that's helpful.
Then I guess longer term on margins I know you have a margin expansion target out there.
I know you can't comment on 'twenty, three too much quantitatively, but could you just talk about sort of the pluses and minuses in terms of margins looking into into 'twenty, three and how you're kind of qualitatively thinking about the trajectory there.
Yeah. So we won't rewrite we're not going to talk much about 23 of this fall we'll get to that.
In October but.
We talk a lot about mix and thats going to continue to be important that we continue to drive favorable mix. So a big important part of our doors that do more strategy is.
Making life, a living better by designing and producing doors that address these basic human needs of comfort and security and style of convenience.
And that means higher higher prices and higher value. So mix is going to be important this price cost favorability philosophy, which.
We've proven over the last several years of a pretty disciplined approach there will continue to drive incremental mix of course, we've I'm.
Im sorry incremental margin of course, we have some problems in the architectural segment over the last 12 to 18 months and Thats been a.
Pretty significant drag on consolidated margins and so that's going to help.
Still really believes that these 20% adjusted EBITDA margins by 2025 are realistic are the ambitious shirt or the aggressive absolutely, but it's our target it's really our true north as we said in the script and that's what we're that's what we're shooting for Josh.
Great. Thanks for the color Howard and good luck for the rest of the year.
Appreciate it.
Our next question is from Trey Grooms with Stephens. Please proceed.
Good morning. This is actually known Murkowski go on for Trey.
I know hi, so first I wanted to dig in a little bit more on the destocking. It sounds like youre not seeing it much anymore, but if I heard correctly. The guide allows for volumes to be down double digits in that mid single digits for us.
End market demand and I'm guessing that implies the rest would be the potential and destocking. So if you could clarify that.
That'd be helpful and if that were to occur do you think.
Necessary destocking that will occur in the channel would be completely flushed out by the end of the year or could that be a headwind heading into 'twenty three.
Yes. This is Christian let me take that especially from a North America perspective. So if you hear the discussion around this wholesale destocking and we really see retailers being a bit more stable that is occurring as Howard said in July , but if you step back and look at what's driving it there is a destocking phenomenon in the order rates that are coming in but we also have.
Had really strong operational performance if you look at what happened in the first quarter and how we highlighted that progress. We now see that volume growth that we've seen in the second quarter. We really see that is also one of these key drivers as we're moving forward throughout the quarter. So I'd really say that both of those factors are really what are driving the overall order book and also how we.
And making sure that we're getting the right service levels and delivering back on the doors that do more strategy around delivering reliable supply in the market.
Alright Thats helpful. Thank you.
And then for my follow up I wanted to talk a little bit more about the mixed benefit you're seeing.
Just given the strategy of doors that do more I don't know if you can.
Quantify how much that helped AEP in the quarter.
But with this weakening macro backdrop.
Maybe you could talk about how your tactics might be changing there as we look forward.
And if you expect that to continue to accelerate as Youre, making these investments.
Investments in doors that do more.
Hey, it's Ron So let me take the first part and then Im sure want to comment on the second part of your question.
If you look at our A&P performance in the quarter. It was driven principally by price, but we did see a mixed tailwind as we noted during our prepared remarks.
Really across the residential businesses, we saw circa a couple of points worth of favorable mix.
In the North American residential business, a little bit of unfavorable mix and architectural just because they've seen a greater mix of stock doors versus some of the higher AEP project work, but in the residential parts of the business product mix has been a favorable tailwind for us worth a couple of points in the second quarter.
Yes.
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The architectural bit that Russ just talked about we've talked about that cross band and the fire ratings and that's an important part of that mix that crossband.
Obviously hurt us from a volume perspective, and from a mix perspective, because some of the higher value doors are difficult to make as far as how we change our tactics. This mix is important we continue to have consumers tell us that they expect their doors to do more everything around the homes evolved endorsed it evolves too and so our marketing are highlighted in the prepared.
Remarks, a number of things we're doing from a marketing perspective, and what I love about it is none of this is Terry.
Terribly expensive, it's very efficient so when you think about digital marketing campaigns that are very targeted at certain consumer segments pretty reasonable to get after that when we think about in store displays. There is some capital involved in in store displays, but again, it's pretty important for people to be able to touch and feel and aid in their products.
Selection online, adding products online through our partners that have online sites again, a very inexpensive, but meeting consumers where they want to buy.
And then simple thing like adding the masonite named our hinge as people look at that and say well it really but what we learned was people love their doors and we want them to know their masonite doors and so these things are all I would call a scrappy marketing.
Programs that are pretty inexpensive and we are seeing now as Russ said favorable mix.
You talked about solid core doors, three X the growth rate of solid core to our interior door rates that has a meaningful impact on our P&L and so when we can have two or a few points of mix growth and this is increasing quarter to quarter due to some of these campaigns were talking about.
I think it's a very successful strategy.
Yes.
It sounds like you're having some early wins there.
I appreciate the answers and I'll leave it there.
Thanks, Greg.
Our next question is from Steven Ramsey with Thompson Research Group. Please proceed.
Hi, Good morning, I was hoping you could add some more color around retail stocking being more stable you talked about solid Pos there I believe in the second quarter can you maybe compare go into a little more detail on retail.
For Q2, and the second half and how it compares to the wholesale activities.
Yes, Stephen this is Chris again, so if you really look at our overall business I mean, we have both the new construction portion of the business as well as the repair remodel and it's about 50 50 between the two businesses. So as you look at the overall environment right. Now there has been a slowdown from a new construction start standpoint, and I talked a little bit about that wholesale <unk>.
On the retail side, it's a bit more much more focused on the remodel side, that's more steady in the outlook that you see in the marketplace has a more healthy at least in the near term so kind of between the two of them were seeing that play out.
As we exited Q2 and as we've gotten into Q3.
And really when you look at both of those trends and that's really what reflects the overall outlook and also what we can allow here as we predicted in the back half from a unit growth as well as from a A&P growth.
Okay helpful. And then on North America residential the more uncertain outlook and the balancing act that you said for operating the business in this type of environment can you talk more about what that means and if you've taken any actions already to start lowering costs or <unk>.
The belt.
Preparation for slowly.
Hey, Stephen as Russ, let me take that one.
In the current environment.
We've not been forced to react with any kind of cost management actions aggressively in the North American residential business now that doesn't mean, we're not prepared to do that though.
Several years ago, we developed a pretty comprehensive playbooks for each of our segments on how we would respond to changes in volume that would become more durable in nature, including downsides.
The business segments update those playbooks on an annual basis as they rework their plans for the year ahead that work is underway right now but.
But there are a number of levers that we have from a cost management perspective to the extent they're needed.
I guess I'd first start though by reminding everyone that we've got a pretty highly variable cost structure.
Our cost of goods sold in particular over 50% of our Cogs is material. Another circa 30% is direct labor and distribution, which you can typically manage.
Pretty closely with demand and then it's just the balance of overhead that would need to be managed more carefully. If we were to see a significant downturn in volume that we think is going to be more durable in nature, but at the end of the day. We've got several levers that we can pull and managing costs. We're really excited about what some of the new investor.
We have made in our manufacturing network allow us to do with not only the <unk>.
Past the additions we've made over the last couple of years in Mexico, but not in the new plant in Fort Mill, South Carolina, because it gives us a naturally more efficient and optimized footprint to leverage to the extent that we need to re rack our capacity in the event that we saw more durable and long term downturn.
Okay.
Great. Thank you.
Okay.
Our next question is from Jay Mccanless with Wedbush Securities. Please proceed.
Hey, good morning, Thanks for taking my questions.
First one I had I think you guys have already answered this but if you look at the backlog of whats heading out.
There is still that favorable mix in terms of.
Getting higher prices in the back half of the year.
You saw in the second quarter.
We would expect so JF.
Okay.
And then just on Europe for a minute.
I'm, assuming that you talked about UK consumer confidence being weaker.
Have you seen any improvement in that July and August or is it still.
Pretty rough on that some of the pond.
Yes, now pretty it's been pretty consistent Jay.
In July certainly, we do think that the.
Long term macros are still really good their housing is under built and we certainly see long term upside in that market, but we're expecting some choppiness through.
Through the balance of 'twenty, two consumer confidence there is weak.
Volumes have been soft, but the team is taking appropriate actions.
They're doing what they need to do on the price cost basis, and again, we feel really good about that business.
Low teens margins in this environment, we think is pretty good I'm proud of our team over there for what they've delivered.
Got it okay. Thanks for taking the questions.
Thanks Jay.
This concludes our question and answer session I would like to turn the conference back over to Howard for closing comments.
Thank you Sherry and thank you all for joining US today. We appreciate your interest and continued support and this concludes our call.
Sherry please provide the replay instructions thanks.
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