Q2 2019 Earnings Call
Welcome to <unk> second quarter 2019 earnings conference call. During the presentation, all participants will be on 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.
Thank you Devin and good morning, everyone. We appreciate you joining us today with me on the call. Today are Howard has made nice new President and Chief Executive Officer breast teach them, a nice nice executive Vice President and Chief Financial Officer, and we also have Tony here present, as well residential and granted they are senior Vice President business leader architectural both joining us for acuity.
We issued a press release and whether perhaps webex presentation yesterday afternoon, but our second quarter 2019 result.
These documents are available on our website at me my Dot com.
But before we get begin I'd like to remind you that this call will include forward looking statements.
Each forward looking statement contained in this call is subject to risks and uncertainties that could cause actual results to differ materially from those projected in such statements.
Additional information regarding these factors appears in the section entitled forward looking statements in the press release, we issued yesterday more information about risks can be found under the heading risk factors and make nice most recently filed annual report on Form 10-K , and our Form 10-Q anticipated to be filed with the FCC later today.
Our SEC filings are available at the Si Dot Gov, and our web site at me like Dot Com.
The forward looking statements in this call speak only as of today and we undertake no obligation to update or revise any of these statements.
Our earnings release and today's discussion include certain non-GAAP financial measures.
Please refer to the reconciliation, which are in the press release and the appendix of the web presentation.
Our agenda for today's call include a business overview from power followed by a review of the second quarter financial results from Roth, along with our updated 2019 annual outlook and closing remark from Howard with a question and answer session and with that let me turn the call over to Howard.
Thanks, Joanne good morning, and welcome.
Before I get into the business overview I want to start with some opening remarks related to my first two months here It makes knight.
Since starting on June 3rd I've had the opportunity to meet a wide range of masonite employees and customers and several things have stood out to me.
First made my employees are committed to operational excellence and delivering results. The organization's focus on lean manufacturing through the M. vantage operating system has taken hold and is driving continuous improvement and related savings and I believe there is still a lot of opportunity in this area from my early career background and industrial engineering to running global businesses, including Valspar as global paint and industrial coatings businesses. I spent a good portion of my professional life and environment is focused on manufacturing and operational excellence I'm excited to see that Mace night employee share. This passion and I look forward to leading this organization to greater heights of operational excellence.
Second I've had the opportunity to meet with some of our largest customers I'm encouraged by the depth of these relationships and feel confident that we can continue to strengthen them as we seek to be the best provider of building products in their eyes. We plan to continue to do this through our focus on service and delivery as well as providing a broad portfolio of innovative products. While the recent improvements in our vitality index, specifically north American residential are good we have room to grow that someone that's driven organic growth in a variety of businesses I look forward to working with the Mace Knight team and our customers to continue to enhance our services and further improve the mix of the products we offer.
Now, let's move on to this quarter's results.
As Jordan mentioned late yesterday, we released our second quarter 2019 financial results. Despite softer than anticipated end market demand, we delivered both adjusted EBITDA and adjusted EBITDA margin expansion for the second consecutive quarter. The expansion was primarily driven by higher average unit price or a U P and productivity initiatives, partially offset by the impact of lower volume in fact, we achieved the highest quarterly gross margin and adjusted EBITDA margin in the last decade.
Net sales decreased approximately 1% in the second quarter as compared to the prior year.
Well, we had strong ATP across all segments and growth from acquisitions. These gains were more than offset by soft end markets and foreign exchange headwinds, excluding the impact of FX second quarter net sales increased almost 1% year on year from the second quarter 2018.
Key end markets remained relatively weak in the second quarter and the first quarter earnings call. We mentioned, we saw softness in the North American residential business during April and Unfortunately that continued through the second quarter. We also saw softness in the UK, which we believe is partially due to customers working through inventory builds from the first quarter ahead of the original Brexit dates.
The last bullet on the left addresses our recent bond issue in July we successfully completed a $500 million bond issuance to refinance existing notes that were due in 2023.
I'll, let Russ discuss this later in a little more detail, but we saw that as an opportunity to further extend our debt maturities at a reduced coupon rate with no impact to our overall leverage.
Moving to the right hand side of the slide the organization continues to drive the M. vantage operating system and we are seeing the benefits in our operational and financial performance.
I've spent time with Randy why our head of operations and his team and have already visited nine of our plants. They are doing a great job of continuing to engage employees and kaizen events training and lean certifications in the second quarter. We've increased the number of kaizen events, 77% compared to the same period last year as you know these kaizen events drive incremental improvements in our operations and we believe the more we can complete the better our results will be.
The number of employees, receiving belt training and lean certifications is up year on year by 140% and 41% respectively.
We laid out a restructuring plan on our fourth quarter and full year 2018 earnings call in light of the market uncertainty and prior to that we had discussed multiple initiatives aimed at controlling costs and improving margins. We are progressing as planned with these previously announced actions such as footprint optimization.
Since the last quarter call, we have announced the closure of an interior door Assembly plant located in Stockton, California note that this is an addition to the previously announced closure of the nearby stocked and cut stock facility, whose operations have been relocated to burdine, Nevada I'll speak more about the M. vantage operating system utilization and restructuring and a couple of slides.
We have also announced the opening of a new interior door plant in northwest Mexico. The new facility in Tijuana is scheduled to open later this year along with the existing facility in Monterrey, Mexico. This facility is designed to support the North American residential market.
We did incur discrete operational costs in the quarter related to plant damages and new factory startups as mentioned on the first quarter earnings call. There was severe damage at our Stockton, California cuts dock facility in late April due to a fire that started on an adjacent non masonite property and as Weve mentioned publicly and post earnings conferences. We also experienced a partial roof collapse at our Marshfield, Wisconsin plant due to unusually heavy snow throughout the Midwest.
These events, coupled with accelerated startup costs in burdine, Nevada, and our startup costs related to tier one in Mexico plant resulted in discrete costs of approximately $4 million in the quarter. Despite this adjusted EBITDA margin exceeded 14%.
On slide six we summarize the latest residential housing market data for our major geographies I won't spend a lot of time on the slide other than to say the markets remain very mixed and are generally softer than we had anticipated.
While some homebuilders in the US have cited increased order intake recently, we have yet to see that reflected in the market data. Accordingly, we remain cautious about the business conditions and will continue to focus on our margin improvement initiatives that we've discussed over the last few quarters.
On slide seven I'd like to provide you with a brief update on these margin improvement initiatives as mentioned earlier, we continue to drive the M. vantage operating system across the organization. The three key pillars of them vantage, our training and standards, which provide the tool set for our employees to drive continuous improvement programs.
Cruise, which our performance improvement teams routinely deployed throughout our operations to drive rapid improvement projects in specific areas and finally plant transformations, which our broader improvement events utilizing multiple teams across a single site to evaluate and improve entire value streams.
Last quarter, we mentioned we were nearing completion of two plant transformations and we are seeing the benefits for example, the M. vantage operating system, along with capital investments have driven an 85% increase in average weekly production that Monterrey, Mexico from 18 months ago.
It is capacity increases like this that are enabling our footprint optimization and reducing the cost of our manufacturing in North America.
During the third quarter, we began additional plant transformations at two more facilities and would expect future throughput capacity increases at those sites as well.
As I mentioned earlier kaizen events overall were up 77% year on year in the second quarter.
In addition to increasing the number of events the number of employees participating in events has more than doubled we've had over 1500, new participants involved and kaizen events. This year.
This higher level of participation is important as it improves the engagement of our manufacturing employees and drives a productivity mindset, which in turn enables us to better manage costs and help offset the impact of inflation.
We continue to progress on our footprint optimization initiatives as well the burdine, Nevada plant startup was accelerated in response to the Stockton, California Cutback plant fire between the acceleration of the startup bringing in incremental volume from our cut stock facility in Chile, and third party purchases, we were able to source enough material to avoid production issues and continue to service our customers.
As mentioned earlier, we announced the closure of our Stockton, California Interior door Assembly plant, which is part of the North American residential segment the ability to close this plant, which is one of our higher cost facilities results from work, we've done to invest and productivity improvements in capacity elsewhere in our network. We are beginning to ramp down production with an expectation of ceasing operations in December 2019, along with the previously announced closures of our residential plants in Denmark, South Carolina in Tampa, Florida, and an architectural plan and Largo, Florida. This brings the total announced closures in North America to four.
During the second quarter, we continued to reduce north American head count in ESG and overhead, resulting in a year to date reduction of 4% excluding the temporary head count we carry to assist in the transition from Stockton, California to Burdine, Nevada, We would have achieved a 5% reduction target set in February .
And finally with respect to portfolio optimization recall that in the first quarter of 2019, we announced the divestiture of two non core UK businesses, a floor joists business that was acquired as part of the National Hickman acquisition, and our Pts business. The divestiture of these noncore operations has streamlined our portfolio of offerings reduced the number of manufacturing sites and associated infrastructure costs and is having a positive impact on the Europe segment margins, which Russ will talk about in more detail during the second quarter. We continued to make progress on divesting a third non core UK business, which we are still targeting to complete in the second half of 2019.
While divesting non core businesses is improving the margin profile of our portfolio. We're also focusing on managing the product portfolio to drive higher ATP, we remain in that 11% product vitality for North American residential and plan to continue to focus on increasing the mix of new.
A P products in our portfolio.
At the same time, we continue to work with customers in all regions to streamline our product offering and rationalize low volume and low margin Skus last quarter. We mentioned, we've realigned our business in Mexico and put more focus on specialty products and in the process we have increased.
And shed some margin dilutive business, we're seeing more impact from this realignment in the second quarter with lower volumes in Mexico. However, we believe the capacity previously dedicated to the low margin skews, we exited in Mexico will be better utilized the service higher fee business elsewhere in the North American residential segment.
I have particularly pleased to see the organization solid execution on these key strategic initiatives, we believe that delivering on these initiatives has been a key enabler of our margin expansion in the face of weaker than expected and uncertain end market conditions.
Optimizing our manufacturing footprint is an important element of driving operational excellence and I'm pleased to say that we remain on track to achieve our goal of reducing the number of sites by over 10%, which we now expect to complete by the end of 2019.
With that I will turn the call over to Russ to provide more details on our second quarter financial performance Russ. Thanks, Howard Good morning, everyone.
On slide nine we summarize our consolidated financial results for the quarter.
We had net sales of $563 million down 1% versus the second quarter of 2018.
Strong a upi across all segments contributed growth of 6%.
While acquisitions contributed 2% growth in the quarter.
These gains were more than offset by a 7% decline in base volume due primarily to softer end markets and the foreign exchange headwind of over 1%.
Gross profit and gross margin both expanded due to higher ATP and met labor productivity, partially offset by the $4 million of discrete expenses Howard mentioned earlier.
Raw material inflation and negative volume leverage.
Gross profit was up by over 4% in the second quarter with gross margin expanding 110 basis points versus the prior year to 22.9%.
As DNA spending was $6 million higher in the second quarter, primarily driven by higher personnel costs, including incentive compensation and additional estimated cost associated with acquisitions.
We continued the margin trend from our first quarter results delivering year on year expansion in adjusted EBITDA and adjusted EBITDA margin in the face of weaker volumes.
Adjusted EBITDA increased by approximately 2% to $79.7 million, while adjusted EBITDA margin expanded 40 basis points to 14.2%.
The adjusted EBITDA Bridge on this slide illustrates the benefit of you in the quarter.
Similar to the first quarter. This once again was more than sufficient to offset the impact of lower volumes on our factory operations and material inflation.
Commodity inflation was approximately 2% in the quarter less than previously anticipated driven in large part by the excellent performance of our global sourcing team in delivering savings projects to offset gross inflationary pressures, particularly in the North America residential and Europe segments.
Relative to factory costs, the unfavorable year on year variance is primarily the result of the discrete costs related to the plant fire and the partial roof collapse and startup cost at the new bird eye and northwest Mexico plants.
These startup costs were in line with expectations and will not be ongoing following full ramp up of the facilities.
The remaining variance is related to lower overhead absorption due to minimal volume leverage consistent with headwinds we highlighted during a public investor conference presentation back in June .
Meanwhile, labor productivity continued to improve offsetting wage and benefit inflation.
Distribution costs were slightly up in the quarter, primarily due to some changes in shipping lanes to serving service existing retail customers on the west coast.
Finally, net income for the second quarter was approximately $24 million and diluted earnings per share was 96 cents.
Diluted EPS was down 28 cents per share from $1.24 per share in the second quarter of 2018, due to depreciation and tax expense and restructuring costs related to plant closures of approximately $3 million after tax.
Excluding the impact of those restructuring items, our adjusted diluted EPS was one dollar nine cents in the second quarter of 2019 compared to $1.24 cents in the comparable period of 2018.
Turning to slide 10, let's cover further details about our North American residential segment, where net sales were flat in the second quarter, but adjusted EBITDA increased by 8%.
Net sales increased 7% due to higher average unit prices.
While volume from our PWI acquisition for which the integration is progressing as planned contributed 3%.
These gains were equally offset by declines at base volume of 9%, primarily due to the soft end markets in our wholesale business and a 1% decrease due to foreign exchange.
As Howard mentioned, we stated on the first quarter call and subsequent public investor events that we continued to see softness in our North American residential business through April .
This trend continued through quarter end.
On weak housing market conditions in both the us and Canada.
Our business in Mexico also declined but this was in line with expectations given actions, we took to optimize our product portfolio in the market earlier this year in order to focus on specialty products and exit low volume or low margin skews.
We also saw some weakness in retail in the second quarter as we witnessed some destocking in the channel.
Despite these volume headwinds, we continued to deliver higher adjusted EBITDA and adjusted EBITDA margins in the North American residential segment.
Adjusted EBITDA margins increased 110 basis points in the quarter.
Noteworthy given that plant startup costs and fire related costs for the Stockton cuts stock plant impacted this segment.
Strong average unit price gains of over 7% in the quarter more than offset these costs as well as the impact of lower volumes material inflation and tariffs, which began to have a larger impact towards the end of the quarter as list three tariffs were fully implemented at a 25% rate.
Stepping back in light of all these factors were very pleased with the margin performance of this business in the quarter.
Turning to slide 11, and our Europe segment.
Net sales decreased by almost 20% year on year in the second quarter with 11% of the decline. The result of the noncore businesses, we divested in the first quarter and 5% due to foreign exchange.
Both the British pound and the euro our largest currency exposures in the segment, we can by over 5% versus the us dollar as compared to the second quarter last year.
Excluding the impact of FX and divestitures. The Europe segment was down approximately 3% as a healthy gain of 5% was more than offset by a 7% decline in base volumes and a 1% decline from lower component sales to third parties in Europe .
The Europe segment delivered strong adjusted EBITDA margin growth in the second quarter of 310 basis points to 16.6%.
Margin growth was the result of both the divestiture of non core businesses in the UK in the first quarter as well as solid growth in our entry door businesses supporting the repair and remodel market.
We believe that Brexit uncertainty continues to play a role in the volatility we see in the UK market and our performance there.
In the first quarter, we saw evidence of some customers building up higher than normal inventory levels in anticipation of the original March 30, Onest Brexit deadline.
With that deadline extended we believe some inventory burn occurred in the second quarter.
We've also experienced some business loss in the builder channel where orders can shift more quickly depending on service and delivery.
Now that the integration of our interior door distribution is fully complete and service levels have returned to targeted levels. We believe we are positioned to recover business with our key builder customers.
Moving to slide 12, and the architectural segment.
Net sales increased by 19% in the second quarter, primarily driven by 13% growth from our Graham and Maven acquisition, along with simultaneous increases in base volume and average unit price of 2% and 5% respectively.
This is the second consecutive quarter of year on year basis volume growth for the architectural segment.
We continued to see strong performance in the architectural quick ship business, which caters to custom, finishing and machining for commercial customers who value speed of delivery.
And we are investing in people processes and systems to support ongoing growth in this margin accretive business.
This investment in the business along with some discrete operational and material costs pressured margins in this segment again in the second quarter.
Adjusted EBITDA margin of 13.1% was down a 160 basis points year on year.
As Howard mentioned, we incurred cost related to a partial roof collapse at our Marshfield, Wisconsin plant due to the heavy snow in that region during the first quarter.
We also experienced higher market pricing for mineral core used in certain of our fire rated doors.
We are actively developing alternative sources for supply to address this cost structure going forward.
On slide 13, we provide an update of our liquidity and cash flow performance in the quarter.
Total available liquidity, including unrestricted cash and accounts receivable purchase agreement and our Undrawn ABL facility was $321 million or approximately 15% of our trailing 12 months net sales as of June Thirtyth 2019.
At the end of the second quarter total debt and net debt to trailing 12 months adjusted EBITDA.
Were 2.9 times and 2.5 times respectively.
Cash flow from operations was $69 million in the quarter capital expenditures were $18 million in the quarter.
As Howard mentioned the organization is executing well on our key strategic initiatives, which include capital spending on strategic projects to support new product development and transform our plants to improve productivity and margins further.
We continue to tightly manage working capital, which declined as a percent of sales both sequentially and versus the second quarter last year.
Year to date, our free cash flow conversion is in excess of 100% and slightly favorable versus the first six months of 2018.
We continue to execute our share repurchase program in the second quarter purchasing approximately 308000 shares at an average price of $50.34 per share totaling approximately $16 million in the quarter.
Subsequent to quarter end, we successfully completed a $500 million bond issuance to refinance existing debt.
In late June we saw high yield spreads narrow meaningfully as the market, presumably began pricing in future fed fund rate cuts, prompting us to quickly respond and enter the market with the objective of fully refinancing $500 million of notes due in 2023.
In addition to extending maturities and reducing our coupon rate from five and five eight to five and three eights. These notes have less restrictive covenants and baskets.
We will record some financing and debt extinguishment cost in the third quarter, but we will benefit from lower interest expense in future periods.
We also now have no debt maturities scheduled for the next five years.
I was pleased with the team's ability to execute on this deal quickly when the conditions were right.
Given we're halfway through the year and continue to see end market conditions that are softer than anticipated. When we provided our original 2019 outlook in February .
We're now updating our full year outlook accordingly.
We now expect full year net sales growth to be roughly flat to up 2% inclusive of foreign exchange compared to our original outlook of 3% to 5%.
While our original outlook expected.
Expected minimal contributions from end market growth, we now expect base volumes to decline mid single digits because of continued weakness in the U.S wholesale business along with continued uncertainty in the UK.
We still expect topline growth to be supported by higher average unit prices as well as a small net benefit from acquisitions and divestitures.
With foreign exchange, while foreign exchange headwinds are slightly higher than originally anticipated primarily due to further weakening of the British pound at a consolidated level, we still expect FX to reduce sales by slightly more than 1%.
Accordingly, we now expect net sales growth of approximately 1% to 3% excluding FX.
Given this reduced outlook for net sales growth. We're also tightening our original adjusted EBITDA outlook by reducing the top end of the range.
We now expect full year adjusted EBITDA to be in the range of $275 billion to $295 million.
The team continues to execute well operationally as indicated by the fact that the full year adjusted EBITDA margin implied at the midpoint of our updated outlook is slightly higher than that was implied in our original outlook.
Average unit price performance has been excellent and our sourcing teams have effectively develop savings projects to partially offset raw material inflation.
Yielding net commodity inflation that is lower than originally anticipated.
Our full year outlook for net material inflation, excluding tariffs is now approximately 2% versus 3% assumed in our original outlook.
That said moving into the second half of the year, we do face headwinds from higher tariffs as we assume the full 25% level on list three goods from China remains in place.
And we have a more difficult comp in ESG in a given meaningful reductions to incentive compensation accruals taken in the second half last year.
Also while we now expect to achieve a 10% reduction in manufacturing locations by the end of 2019, we will incur operating cost associated with transitioning production throughout the balance of the year. So consistent with our original outlook operational savings associated with our restructuring plans are not expected to incur until 2020.
We now expect full year 2019, adjusted earnings per share will be in the range of $3.30 to $3.90.
The midpoint of the range represents a 40% decrease from our original adjusted EPS outlook.
In addition to the tightened adjusted EBITDA outlook. This reduction reflects higher depreciation and amortization expense due to the trend of higher capital investments, including certain assets, having shorter depreciable lives such as IP systems.
And a slightly higher tax rate projection, which is now expected to be near the top end of the original outlook of 21% to 24%.
Relative to key cash flow drivers, we are updating the outlook for our cash tax range to $14 million to $60 million for the full year.
Our full year outlook for capital expenditures and free cash flow remained unchanged versus our original outlook and with that I will turn the call back to Howard for some closing comments.
Thanks Ross.
In summary, we're pleased with the year on year, adjusted EBITDA growth and adjusted EBITDA margin expansion for the second consecutive quarter.
Well weve updated our full year outlook in light of the continued softer than expected end market conditions, we still expect to deliver year on year adjusted EBITDA margin expansion for the full year 2019.
We are driving the M. vantage operating system across the organization and seen the benefits we've had a 123% increase in kaizen events year to date and doubled the number of participants involved in events. This higher participation is engaging employees and driving a productivity mindset at our facilities globally.
The M. vantage operating system will remain an area of focus given its critical to our margin improvement initiatives.
Our restructuring and footprint optimization are progressing as planned Stockton, California interior door Assembly plant marks the fourth North American facility closure announced this year Accordingly, we still expect to achieve a 10% reduction in the total number of manufacturing locations by the end of 2019.
Lastly, we improved our debt maturity profile by refinancing our 2023 bonds with newly issued 2028 notes. In addition to extending the maturity. These notes have more favorable terms and a lower coupon rate.
I am delighted to have joined the masonite team of nearly 10000 employees. There is a clear commitment to operational excellence product innovation and delivering results I look forward to building upon the initiatives that are now driving results and providing you with updates on future earnings calls as we focused on delivering outstanding products and superior service to our customers and ultimately enhancing shareholder value for you all.
With that I'd like to open the call to questions.
Operator.
Thank you.
If you would like to register a question. Please press star one.
The speaker phone, please lift up lift up the handset before entering your request, ladies and gentlemen, as a reminder, please.
Chris Star one on your telephone to ask a question.
Our first question comes from the line of Mike.
Eisen with RBC capital markets. Please proceed with your question.
Good morning, Thanks for taking the question.
Just wanted to start off on.
On the updated guidance raising the the margin target is encouraging and show some of the progress that you guys have had started to generate and Thats ahead of the restructuring actions. So can you help us talk about and think through.
How much is dependent on keeping this mid single digit pricing environment going to hit the midpoint, our higher end and then thinking out to next year and as the benefit of restructuring starts to come into play how we should think about the pace of margin expansion moving forward.
Yes, good morning, Mike, It's Russ I'll take that.
First of all with respect to price I guess I would point out that we had two price increases that went into effect in 2018, one would have been in July and the other one would have been at the very end and so you're not really seeing the benefit of those previously implemented price increases taking effect in the marketplace.
We've consistently talked about our objective to maintain and favorable price cost relationship and our viewpoint that we're not yet being paid full value for the products that we sell in the market. So we're going to continue to focus on.
Our average unit price accretion as a key part of our strategy now that said in addition to the price increases that we've already taken into the market. There is also going to continue to be this focus on investing in higher EVP product and mixing the portfolio up.
With respect to the second part of your question on operational improvements.
Not prepared to sit here today and provide any guidance out into 2020.
But I would highlight that the performance that you're seeing in the plans relative to labor productivity is allowing us to fully offset the wage and benefit inflation that we're seeing in the plants. We are underway with several plant transformations and restructuring actions that really will start to benefit margins further as we get into 2020, no discernible impact in 2019. Those are the factors I would think about as you look at the margin trajectory through the balance of this year and into next.
Got it very helpful and then transitioning to to volumes you made the comment that the weakness in the wholesale channel will continue to pressure volumes slightly down mid single digits for the year can you talk about what you're seeing in some of your other.
End markets and when at what point, there will be an inflection if you start to see better order trends from the builders and some of the backlog that you've talked about in the architectural business.
Yes, Mike This is Howard I'll take that to start and then I'll pass it on to the business guys, but I think that in general there was softness in the wholesale channel and if you look at that residential business about a third of the weakness was due to us wholesale which we think is market related a third is due to our Mexico, and Canada business, Canada, being a weaker market than anticipated, particularly in the east and Mexico being sort of on purpose as we exited some lower margin skews to utilize that capacity for higher margin products and then a third was in our retail business and generally.
Slightly softer Pos trends, although trending sequentially better throughout the quarter, but.
A reasonable amount of destocking in that channel sort of is what drove the the volume Miss now obviously architectural volumes have been up two quarters in a row, where we're proud of that we know we still have work to do on the service side of that business, but.
That kind of breaks down.
Volumes.
Tony or Graham you want to add anything to that.
I would just say on the residential business Thats exactly right in that we believe that wholesale softness was certainly end market demand some weather impacts we saw in Texas and the Midwest than.
While we are enthused about nine of the 10 top builders talking about order new order rates being up we're going to play a wait and see and make sure. We focus on advantage and the planned transformation pieces to support our cost structure.
And then the architectural space that we see our customers are reporting strong backlog further remainder of the year. So we see the market staying fairly strong and we are working on continuous improvement activities to really be able to support the service levels that we aspire to going forward.
Awesome appreciate all the information and good luck.
Thank you.
Thank you. Our next question comes from the line of Michael Rehaut with Jpmorgan. Please proceed with your question.
Hi, this is relied on for Mike.
I want to follow up on the margin guidance, how should we think about the updated margin guidance within each segment.
You had much stronger margin North America, and Europe this quarter.
But architectural margins remain under pressure.
How should we think about the margin trends for this segment as we get into Threeq and Fourq Q, both in North America, and Europe , and then also for one architectural could turn the corner.
Yes, a lot it's Russ I'll provide some high level commentary, obviously acknowledging that we're not going to provide specific quarterly guide or specific margin outlook for any of our segments individually, but when you step back and think about the drivers of margin in the quarter. You did have a majority of the discrete items landing in two areas the North American residential segment and the architectural segment more so even in North America residential.
Now as you get into the back half of the year. We've got these plant startups that are underway you will still see some costs into the next quarter as we bring the Verde plant up to full production rates and probably through the balance of the year as you see the tier one in Mexico plant ready for launch by the end of the year.
So some potential.
What we would consider more discrete costs on the factory side will continue.
But a lot of that.
At least as regards costs incurred from the plant fire and the roof collapse, a lot of that should now be be behind us.
So I would just think about those factors as you look forward in the business and on the UK side. We're real pleased with the fact that we've been able to drive a significant amount of margin improvement just from portfolio actions. If you look at that.
300 basis points plus worth of margin improvement about two thirds of that was associated with the portfolio actions that we've taken to divest.
Non core business that was overall margin dilutive to the business and the balances on the exterior door side, which is very margin accretive and continues to see good growth I wouldn't anticipate that trend to change necessarily and Alternatively, you should see some additional benefit as we get toward the end of the year around divesting. This additional non core business that we've discussed.
Thank you guys very helpful.
Thank you. Our next question comes from the line of Josh Chan with Baird. Please proceed with your question.
Hi, Good morning, everyone and welcome to the first earnings call Howard.
Thanks, Josh.
Hi, I wanted to ask about the the guidance I I guess, the updating of a guidance either intra year, it's a little different than the prior practice, so I'm I'm not sure if there is a.
Change in thinking there or just can you kind of go through the idea of updating guidance in the middle of the year I think that improves visibility for investors.
Sure.
I think may site has a history of providing annual guidance during our year end call or generally February 4th quarter and year end call and our plan would be to either affirm or to modify that annual guidance as appropriate or quarterly.
Alright, Yeah Thats good.
Yep Yep Yep, Thank you and and then for Howard I guess.
Just in terms of.
Two two months or so into into the role here.
Could you just kind of talk about.
Some some observations that you've had versus what do you expect that from the outside perhaps any surprises and then also you mentioned in the prepared remarks, some some opportunities for operational excellence I Wonder if you can kind of bucket those opportunities in terms of how you how you see them overtime to that'd be great. Thanks.
Sure Josh Thanks.
Not a lot of surprises actually I haven't had a lot of opportunity leading up to starting to spend time with our board of directors, who pretty clearly stated the opportunity we had it makes knight and obviously do some due diligence.
And what I've seen really since starting is pretty much as expected, which is a team that is focused on operational excellence and delivering results.
There is a a passion for winning in this business, which is great as I mentioned in my comments I've been to nine of our facilities and have several more planned in the coming weeks and its really consistent the employee engagement in these kaizen events and the incremental improvement is is terrific and I really think its reading through in our results.
We do have an emphasis on product development and product mix as as Russ mentioned and I think we can amplify that as we go forward and continue to focus on on mix and ATP and new product development, but sort of in summary, I think we have a great group of people in this company that.
I understand that so it's a good business. We're in a great category, we have an excellent brand and we're excited with.
All right Great and my last question is on on the guidance.
I think it implies continue margin expansion in the second half.
But I think Russ you made some comments about.
Sort of a ramping impact from tariff. So is there any cadence that color that you can give in terms of.
More margin expansion in Q4, or do you expect margin expansion to be fairly even across the second half.
Well I would just let our updated outlook for the year or kind of stand as it is.
You do see Lumpiness.
Potentially quarter to quarter is some of the discrete costs such as we incurred in Q2 around factory costs come in and out of the business.
But aside from that there is nothing that anteros theres nothing that would be.
Dramatically different.
In the.
Second half versus the first half at least with respect to gross margins I would caution people as I mentioned I think during my prepared remarks, we do have a difficult comp in the back half of the year given that we did take some pretty significant reductions to our incentive comp accruals in the second half of 2018.
With respect to terrorists since you brought it up.
On the topic of a lot of conversation of late.
We went into the tariff outlook early in the year estimating that it could be $20 million to $25 million at full run rate.
And by the time, we got into.
End of the first quarter, we thought that we probably gotten that down to the $10 million to $15 million range, assuming that the list.
For the section three a one tariffs I should say in China were implemented in March obviously that pushed out a little bit into June . So we're at the low end of that range now for tariffs, but that is comprehended in our outlook for the balance of the year.
As well as the expectation that in the conversations we've had with our customers, which is any tariff related impacts will need to look at pricing to recover appropriately.
All right. Thanks for the color I'll hop back in queue.
Thank you.
Thank you. Our next question comes from the line of John Paul with Stifel. Please proceed with your question.
Thank you and good morning, Congrats on the margin percentages for the volumes off so much I was wondering Ross if I could follow up.
On that last comment on the terrace, so if we sort of looked at an annualized.
Given that was delayed.
Wood going forward to 25%.
$20 million kind of gross impact annually, but you'd hope to get the pricing to offset that.
Yes, that's about the right way to think about it John Okay, Great and then on the price mix, which is.
Very strong.
You mentioned the two price increases.
And then you mentioned vitality index of so it's some of both I'm just curious.
If you can give us a rough idea of how much is one versus the other.
But I'm more interested in either the sustainability of that.
Moving forward, obviously, you've moved out of some products in Mexico low margin you cited that so im just trying to get a sense when we model next year.
Any help in thinking about price mix.
Sure John .
Well I think about it this way.
Price versus mix in the quarter or a U P. Together clearly was strong price was the significant contributor to it. Although we did have favorable mix in the quarter and that was despite the fact that we had lapped.
The loss of the.
Higher Asap business, if the Lowe's business. So we're kind of through that comp right now that had been a mix headwind to us for the last four quarters circa one point.
We're now through that and so you did see strong mix return and it was a contributor although price was the majority in the ATP that you saw us Brent for the quarter.
As we look ahead as I mentioned earlier, we're going to continue focusing on investing in higher average unit price.
Entries to our product portfolio you saw that back in February the builder show when we launch the new Livingston transitional interior molded wood door design, it's been received very very well from our customers. As just an example of how we're going to continue to focus on this cadence of product development.
And drive higher average unit prices across the portfolio wherever possible that's going to be strategy that will remain unchanged into next year and beyond.
Okay. Thanks, and then my last question quickly it was on the retail comment and I think some de stocking of inventory.
Could you give some color around that was that a result of.
Them changing out product lines or was that a result of them seeing slow sales.
At some period in the first half of this year, but then you mentioned the POS has picked up any any color on what precisely is going on with big retailers thinking.
Yes, John this is Tony I would say that.
There's there's always fluctuation in their inventory levels as they try to manage for different outcomes and I would say.
We did see that destocking through the quarter. We are encouraged by seeing sequential Pos improvement and we we would anticipate they will catch up with that.
But sometimes those things are just a little bit disconnected for periods of time.
I don't think there is specific initiative that we were aware of that was driving that the destocking.
Okay and what it was.
I know you don't comment monthly, but Youve commented the things improved through the quarter I was just curious if that sustains itself to any degree in July . Thank you.
Yeah, I'd say we.
We've continued to see reasonable Pos into July and we'll see how that transitions once the comp.
Thank you very much.
Yes.
Thank you. Our next question comes from the line of Michael Legg with Nomura. Please proceed with your question.
Hi, good morning.
First can you just comment on in terms of all the Destocking that you mentioned in the U.S. wholesale European in retail whether or not any of that abated. I know you commented on the point of sale, but did you see that the destocking and.
Yes, Mike it's Russ the Destocking that we saw was specific to the retail channel, we didn't see any meaningful inventory shifts and Tony can comment on this further but no discernible change in inventory strategy inventory in the wholesale channel I think we would say remains pretty well balanced with market conditions, Yes, Toni inventory has not been an issue in the wholesale channel.
On the Destocking with limited to retail and you mentioned Europe , and we said that certainly in light of the original Brexit plan of a March 31.
We did see a customers build inventories and start to bleed down through Q2.
Got it Okay and are you able to quantify any of the.
Nics benefits on a p. from the things like lower Canadian and Mexican mix, if that had any any material impact on that at U.P.
I wouldn't say that it was material to the overall in North America residential HCP print just because the Mexico business is a relatively small part of our overall footprint in North America, but at the margin it clearly was beneficial.
It has allowed us to dedicate more of our capacity to servicing hire eight you see higher margins use.
Including for the US market. So at the margin it would be a benefit but I wouldnt classify it are characterized as a material one.
Okay. Just finally I wanted to ask at a high level with the the UK business and then the divestitures that are underway is are we seeing a reversal of the trend there in terms of the consolidation of that market I mean is that a.
Is that something that you're you're watching are concerned about I know that you know part of the acquisition strategy of Pds and some of these other names were to just further consolidate that's what looked more like the U.S. residential business.
Yes, I would actually argue the opposite Mike and so far that the divestitures that you've seen from us predominantly been what we would consider product lines that are non core to our business.
Including the business that is anticipated for divestiture later this year I think about that as windows focused business that was picked up with one of our prior acquisitions. The acquisition strategy that we've implemented the UK has largely been around building out our product portfolio and our routes to market and sitting here today, we're pretty glad that we pursued the strategy that we did specifically around the entry door business because with the acquisitions of Dxi in early 2014, and with DW, three which includes the solid or brand in early 2018, it's given us a really strong position for the repair and remodel market for.
RP or fiberglass entry doors and that business continues to demonstrate really strong growth. We saw high single digit sales volume growth in the exterior door portion portion of our business in the UK in the second quarter.
So that breadth of product line via the acquisition strategy is now benefiting us.
Great. Thanks, so much.
Thank you.
Thank you. Our next question comes from the line of Jay Mccanless with Wedbush. Please proceed with your question.
Hi, good morning, Thanks for taking my questions.
America paid.
North American new residential.
Is that is that just purely a decline in demand or are we starting to see the effect of the shift that many of the builders are making for the smaller houses with less stores and less.
HM.
Lets fit and finish than what we've been used to seeing the production builders put out there.
Yes, Jay this is Tony I think Thats, an excellent question and it's a combination of the two certainly with.
With slower starts we would expect to see that volume come down we did see in communication from the big builders and you know we're tracking this now on a regular basis.
More of a swing to entry level homes and as we highlighted in the last quarterly update we know those entry level homes will have fewer interior doors in them for the most part. So we are watching that we're tracking that we're also trying to work with the builders who have indicated that while they are building smaller entry level homes. They want them to be well featured so we're trying to drive mix with them introducing them to things like the new Livingston interior doors. So certainly an initiative for us to keep the U.P. up in the light of perhaps fewer interior doors going into those newbuilds.
And then the second question.
On the on the retail Destocking was that was that across the board for the big retailers are focused on retailers.
Now as we look at it in aggregate. So when we were talking about Destocking for us it was up across the breadth of retail.
And then just the last one I think discipline asked several ways, but.
And with volumes coming down.
How how confident are you guys that youre going to be able to hold the pricing that youve put out there last year.
And this may be false hope, but is there any chance of being able to raise some prices beyond just what the tariff impact might be.
Okay I'll jump in 11, let Ross add color to you know we have consistently said, we don't speak about pricing before it's been implemented in the market. So I'm not going to comment about anything that might be future relative to pricing.
Certainly with the what we call the builder pause in Q4 of last year and through slower volumes and slower in markets in North America through the first half of this year.
We've been focused that.
Trying to drive margin improvement and maintain that margin improvement both through price through mix and through operational efficiencies.
We have every confidence we're going to continue to drive that and that will be our focus through the back half as well.
If I can just add one thing Jay at this mix is an important part Russ mentioned that price was the primary driver price mix, but as we continue to look at the product portfolio optimization, and new products and mix that will continue to be an important part of our.
Margin improvement efforts.
Okay. Thanks again.
Thanks Jay.
Thank you. Our next question comes from the line of proven Gardiner with Seaport Global. Please proceed with your question.
Thank you good morning, everybody.
So ruben.
On the.
Price volume in North America, just trying to understand do you guys. I mean do you feel like obviously the price realization was was very strong in the quarter do you feel like you had to walk away from any business to realize that level of price or do you feel that your your volume growth was was in line with the broader.
Door market.
Yeah Ruben that's a good question. This is Tony I would say that we don't believe there has been any significant fluctuation and.
You know share or ownership of the crop the market there.
There are always areas where.
You face increased competitive pressure.
We deal with those as a one off but we don't think theres been any significant.
Changes in customer alignment or or mix there.
Okay, great, Thanks, and Ross maybe for you the.
The S. DNA outlook I think you made a comment about the back half a incentive accruals a year ago can you just I mean looking at the first half of this year versus last year. It looks like you were up in dollars year over year and I know there were some acquisitions in there and some other items how do we think about the dollars a in the back half versus a year ago.
Yeah.
If you look at the SGN a that we recorded in the second quarter is roughly equivalent to what we saw in the first quarter and it's probably representative of the quarterly amount that we'll see throughout the balance of the year.
Relative to a year on year, I again, I'd remind folks that we had some pretty significant reductions in incentive comp in the second half of last year and in fact over the course of the second half it equated to almost $8 million reduction that would hopefully not repeat.
Okay, and Russ just to clarify I think that would imply a kind of a a meaningful ramp or acceleration in your gross margin expansion in the back half if a if I'm thinking about it the right way in your guidance is that am I missing anything or is there any other items to think about.
Well I'd just point back to our commentary earlier on the solid execution that we're seeing from the operations team and the fact that we're able to.
Effectively offset or wage and benefit inflation, we are taking actions to get fixed overhead out of the business as we take plants offline, obviously, that's going to occur over the balance of the year. So we'll see the benefit primarily in 2020 as we exit this year, but there's a lot of focus on continuing to improve our factory cost position and continue to work on these savings projects that offset the gross inflation that we're seeing in commodities. So those are the drivers yeah I wouldn't want to predict specific gross margin trends forward quarter by quarter, but those are the drivers that you should consider.
Great. Thank you guys.
Thank you.
Thank you. Our next question comes from the line of Alex Regal with.
B. Riley. Please proceed with your question.
Thank you.
Hi, I was little confused with the comment that stated that.
Some of the demand trends in June didnt seem to improve from the April trends could you clarify that and now that we're in August are you seeing any improvement in demand trends.
Well, maybe I'll start and then Alex It's Russ and then Tony can add any color commentary. If you look at our wholesale business in the U.S specifically the progression over the quarter was a little lumpy, but overall it was weak.
We were down slightly in April improved a little bit in may, but still soft and then down further in June and so thats really what set us up for the results that you saw for the quarter and.
We generally saw that softness continue into July so to Tony's comment earlier, while we're hearing plenty of constructive commentary from the builders about the potential for a forward order growth as we get later in the year.
We're taking a very cautious approach on how we manage the business and focusing on very tight cost control.
And within the manufacturing operations, specifically until we actually see some of that additional volume materialize.
Tony anything to add on I think the sequential trend I think thats exactly what we saw in what we're trying to do about it.
Okay very helpful and then as it relates to transportation costs any thoughts on how are your transportation costs are going to trend in the future from portfolio optimization.
Yes, Ross I'll take that.
What you saw in the second quarter was a slight tick up a lot of that was just driven by payload and mix, we had a different mix of freight lanes as we service our customers in the western part of the U.S. differently, including shifting some of our production to the Monterrey, Mexico plant.
So what you're going to see there in the future is probably a slight headwind on the distribution side as we incur slightly longer freight lanes, but its more than offset by the manufacturing cost and labor cost arbitrage that we realized by shifting.
An increasing amount of production to the Mexican plants.
So that would be the dam dynamic to expect going forward.
Thank you.
Thank you.
Thank you. Our next question comes from the line of Steven Ramsey with Thompson Research. Please proceed with your question.
Good morning.
I wanted to ask again on mix is there a focus across the product spectrum as you try to move up to a higher mix and thinking about.
The trend in single family construction.
Is it more of a challenge to improve mix, there as build or shift to lower price homes or in that segment of the market.
Is it more about getting operations aligned to get those product margins to satisfactory levels.
Hey, Stephen It's Ross, maybe I'll set the stage and Tony can jump in with any color on the residential side, specifically in the entry level trend.
As you've heard us talk about publicly a pretty consistent basis.
Our emphasis on mixing up the product portfolio is really across the board.
And it's really across all segments.
In the residential side is continuing to rollout new molded interior wood door designs.
As well as additional fiber glass designs using the Vista Grande product platform that we've successfully launched the last couple of years.
On the architectural side, we commented on our desire to be even more competitive in sound rated or STC rated doors. So that'll continue to be an area of focus for us going forward.
As well as in the UK.
Our portfolio shift to really emphasize our capabilities in the higher a upi higher margin.
Entry door business, specifically for repair in my model. So that that objective is really across the business and we've also talked about the fact that in the wholesale channel.
Which largely in North America, which largely services to domestic us housing market.
We've seen a pretty steady progression of mix upward in that portfolio.
Standard six panel doors have dropped to well under 30% of our mix in the wholesale channel from over 70% three to four years ago. So we've effectively driven that mix into the channel and as of yet we have not seen any meaningful decay in that mix. Despite the shift to entry level homes. It's been more of a volume impact as opposed to a mix impact to date anything to add yes, Stephen I would just reiterate what Russ said I think it's been more of a unit number impact than we've seen as a mix impact his discussion about the Vista Grande.
Flush glazed fiberglass door is a great example of we see that used on.
Entry level up the custom homes because it just provides more light more windows space, It's a lot better door design much cleaner and more contemporary so we expect to see that mix continue to drive and it will be a unit volume question as we move to more entry level housing.
This is Howard last point your point on operational excellence and cost is always going to be important in a focus for us we're going to continue to try to drive.
Operational excellence and improve margin through through cost.
Helpful. Thank you and then on on Europe .
As you try to build back.
Back up the business from the distribution integration being complete how do you expect this to impact volumes in the second half of the year and into next year and I guess seeking on the experience from the architectural segment a couple of years ago, where you gave up revenue to adjust the cost structure.
Is this a more challenging task then that in building up volumes or easier.
Yes, Stephen it's Tony.
You know our.
Our distribution transition that we went through in the European business was is serving us well from a cost structure standpoint, we did some a little bit at the end of last year. The beginning of this year in our service.
To the customers and so they moved to other in some cases moved to other modes of supply for that business now, it's just a matter of consistently improving our capabilities and that service level.
And we expect that we've got a plan working against the top house builders in the UK market to try to earn back their different regions in those regions of the different builders all operate almost independently. So it's a little bit of us going region by region proving our capabilities in winning that business back. We expect we will do that all the way through the course of the back half of this year and into next year, but I feel confident based on our.
Our new distribution model and the capabilities that team has put in place that we will get that back.
Great. Thank you.
Thank you.
Thank you. Our next question comes from the line of Kevin Hocevar with Northcoast Research. Please proceed with your question.
Hey, good morning, everybody.
Wondering.
I think you guys had talked on prior earnings calls about 3% type inflation.
For the year plus <unk> percent for the.
The tariffs.
Russ I think you mentioned earlier that the terrorists would be at the low end of your expectations and I think that 1% assumed they went in effect.
Earlier in the year, so could you give.
Any updated thoughts there on inflation 'cause it seems like it's been tracking nicely below that so some kind of curious any thoughts on the updated thoughts there on inflation.
Yes, what youre seeing is really an even better level performance than we expected earlier in the year.
Of our sourcing teams ability to identify savings projects whether that's.
Value engineering on products or shifting.
Our supplier footprint negotiating with our supply base.
On pricing they've done a really nice job of unlocking additional savings projects.
And so when we talk about inflation, we talk about it in terms of net inflation, so gross less our savings initiatives and the team's done an even better job than we would have anticipated and thats really whats driven.
Our inflation outlook to be closer to 2% as opposed to 3% when we entered the year.
Okay got you and then in terms of the tariff impact that.
$10 million.
Is the expectation here that that your pricing actions would be able to offset that.
And do you expect any timing gap here, where it might be a near term headwind as you try to push that pricing or.
You think you'd be able to push it through pretty pretty quickly.
Well, we've consistently talked to our customers about the fact that as tariffs are implemented.
We would look to recover those costs wherever possible.
In some cases there are lags.
You actually saw that in the fourth quarter of last year. When in addition to tariffs.
Being implemented we saw an increase in commodity inflation generally across the quarter and we didnt have pricing fully implemented until the end of the year that hurt our margins in Q4 of last year. It put us in very good stead with respect to price cost in the first quarter. This year and we're seeing that trend continue.
So theres always the potential for Lumpiness, and some timing gap between cost increase and pricing effectiveness.
But it is our strategy and our expectation that will continue to price to recover.
Any tariff related headwinds as they materialize.
Okay got you. Thank you very much.
Thank you.
Thank you there are no further questions at this time I'd like to turn the floor over to Howard for closing comments.
Thank you operator, and thank you all for joining US today. We appreciate your interest and your continued support and this concludes our call. Operator will you. Please provide replay instructions.
Thank you for joining Mason <unk> second quarter 2019 earnings Conference call. This conference call has been recorded the replay may be accessed accessed until August 20th to access. The replay. Please dial 87766 0685 straight in the U.S. or 20161 to 7415 outside the U.S. enter conference I'd 1369 to four Oh sorry.
Thank you and have a wonderful day.