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Edited Transcript of DOOR earnings conference call or presentation 6-Aug-19 1:00pm GMT

Q2 2019 Masonite International Corp Earnings Call

TAMPA Aug 11, 2019 (Thomson StreetEvents) -- Edited Transcript of Masonite International Corp earnings conference call or presentation Tuesday, August 6, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Andrew G. Thayer

Masonite International Corporation - Business Leader of Architectural & Senior VP

* Howard Carl Heckes

Masonite International Corporation - President, CEO & Director

* James A. Hair

Masonite International Corporation - President of Global Residential Business

* Joanne Freiberger

Masonite International Corporation - VP & Treasurer

* Russell T. Tiejema

Masonite International Corporation - Executive VP & CFO

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Conference Call Participants

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* Alexander John Rygiel

B. Riley FBR, Inc., Research Division - Analyst

* Elad Elie Hillman

JP Morgan Chase & Co, Research Division - Analyst

* James C McCanless

Wedbush Securities Inc., Research Division - SVP of Equity Research

* John Allen Baugh

Stifel, Nicolaus & Company, Incorporated, Research Division - MD

* Kai Shun Chan

Robert W. Baird & Co. Incorporated, Research Division - Junior Analyst

* Kevin William Hocevar

Northcoast Research Partners, LLC - VP & Equity Research Analyst

* Michael Benjamin Eisen

RBC Capital Markets, LLC, Research Division - Senior Associate

* Michael Robert Wood

Nomura Securities Co. Ltd., Research Division - Research Analyst

* Reuben Garner

Seaport Global Securities LLC, Research Division - Associate Analyst

* Steven Ramsey

Thompson Research Group, LLC - Senior Equity research Analyst

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Presentation

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Operator [1]

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Welcome to Masonite's Second Quarter 2019 Earnings Conference Call. (Operator Instructions) Please note, this conference call is being recorded.

I would now like to turn the call over to Joanne Freiberger, Vice President and Treasurer.

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Joanne Freiberger, Masonite International Corporation - VP & Treasurer [2]

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Thank you, Devin, and good morning, everyone. We appreciate you joining us today. With me on the call today are Howard Heckes, Masonite's new President and Chief Executive Officer; Russ Tiejema, Masonite's Executive Vice President and Chief Financial Officer; and we also have Tony Hair, President of Global Residential; and Graham Thayer, Senior Vice President, Business Leader of Architectural, both joining us for our Q&A session.

We issued a press release and Webex presentation yesterday afternoon with our second quarter 2019 results. These documents are available on our website at masonite.com.

But before we 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 in Masonite's most recently filed annual report on Form 10-K and our Form 10-Q anticipated to be filed with the SEC later today. Our SEC filings are available at sec.gov and our website at masonite.com.

The forward-looking statements in this call speak only as of today, and we undertake no obligation to update or revise any of these statements. Our earnings release and today's discussion include certain non-GAAP financial measures. Please refer to the reconciliations, which are in the press release and the appendix of the Webex presentation.

Our agenda for today's call includes a business overview from Howard, followed by a review of the second quarter financial results from Russ, along with our updated 2019 annual outlook and closing remarks from Howard with a question-and-answer session.

And with that, let me turn the call over to Howard.

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Howard Carl Heckes, Masonite International Corporation - President, CEO & Director [3]

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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 2 months here at Masonite. Since starting on June 3, I've had the opportunity to meet a wide range of Masonite employees and customers and several things have stood out to me. First, Masonite employees are committed to operational excellence and delivering results. The organization's focus on lean manufacturing through the MVantage Operating System has taken hold and is driving continuous improvement in related savings. And I believe there's still a lot of opportunity in this area.

From my early curve background in industrial engineering to running global businesses, including Valspar's Global Paint and Industrial Coatings businesses, I've spent a good portion of my professional life in environments focused on manufacturing and operational excellence. I'm excited to see that Masonite employees 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. As someone that's driven organic growth in a variety of businesses, I look forward to working with the Masonite 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 Joanne 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 AUP, 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. While we had strong AUP 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. On 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 U.K., which we believe is partially due to customers working through inventory builds from the first quarter ahead of the original Brexit date.

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 this 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 MVantage operating system, and we are seeing the benefits in our operational and financial performance. I've spent time with Randy White, our Head of Operations and his team and have already visited 9 of our plants. They are doing a great job of continuing to engage employees in 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've announced the closure of an interior door assembly plant located in Stockton, California. Note that this is in addition to the previously announced closure of the nearby Stockton cut-stock facility, whose operations have been relocated to Verdi, Nevada. I'll speak more about the MVantage operating system utilization and restructuring in 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 start-ups. As mentioned on the first quarter earnings call, there was severe damage at our Stockton, California cut-stock facility in late April due to a fire that started on an adjacent non-Masonite property. And as we have mentioned publicly in 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 start-up costs in Verdi, Nevada and our start-up costs related to Tijuana, Mexico plant resulted in discrete costs of approximately $4 million in the quarter. Despite this, adjusted EBITDA margin exceeded 14%.

On Slide 6, we summarized the latest residential housing market data for our major geographies. I won't spend a lot of time on this slide other than to say, the markets remain very mixed and are generally softer than we had anticipated. While some homebuilders in the U.S. have signed an increased order intake recently, we have yet to see that reflected in the market data. Accordingly, we remain cautious about the business conditions, and we'll continue to focus on our margin improvement initiatives that we've discussed over the last few quarters.

On Slide 7, I'd like to provide you with a brief update on these margin improvement initiatives. As mentioned earlier, we continue to drive the MVantage operating system across the organization. The 3 key pillars of MVantage are: training and standards, which provide the tool set for our employees to drive continuous improvement programs; pit crews, which are performance improvement teams routinely deployed throughout our operations to drive rapid improvement projects in specific areas; and finally, plant transformations, which are 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 2 plant transformations, and we are seeing the benefits. For example, the MVantage operating system along with capital investments have driven an 85% increase in average weekly production at 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 2 more facilities and would expect future throughput and 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 increase in the number of events, the number of employees participating in events has more than doubled. We've had over 1,500 new participants involved in 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 Verdi, Nevada plant start-up was accelerated in response to the Stockton, California cut-stock plant fire. Between the acceleration of the start-up, bringing an 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 in productivity improvements and 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 and Tampa, Florida and an architectural plant in Largo, Florida. This brings the total announced closures in North America to 4.

During the second quarter, we continued to reduce North American headcount in SG&A and overhead, resulting in a year-to-date reduction of 4%. Excluding the temporary headcount we carried to assist in the transition from Stockton, California to Verdi, Nevada, we would have achieved the 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 2 noncore U.K. businesses, a floor joist business that was acquired as part of the National Hickman acquisition and our PDS 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 1/3 noncore U.K. business, which we are still targeting to complete in the second half of 2019.

While divesting noncore businesses is improving the margin profile of our portfolio, we are also focusing on managing the product portfolio to drive higher AUP. We remain at an 11% product vitality for North American Residential and plan to continue to focus on increasing the mix of new, higher AUP 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 AUP 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 SKUs we exited in Mexico will be better utilized to service higher AUP business elsewhere in the North American Residential segment.

I'm particularly pleased to see the organization's 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'll turn the call over to Russ to provide more details on our second quarter financial performance. Russ?

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Russell T. Tiejema, Masonite International Corporation - Executive VP & CFO [4]

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Thanks, Howard. Good morning, everyone. On Slide 9, 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 AUP 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 a foreign exchange headwind of over 1%.

Gross profit and gross margin both expanded due to higher AUP and net 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%.

SG&A spending was $6 million higher in the second quarter, primarily driven by higher personnel costs, including incentive compensation and additional SG&A costs 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 AUP 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 start-up costs at the new Verdi and Northwest Mexico plants. These start-up costs were in line with expectations and will not be ongoing following the 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 $0.96. Diluted EPS was down $0.28 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 $1.09 in the second quarter of 2019 compared to $1.24 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 BWI acquisition, for which the integration is progressing as planned, contributed 3%. These gains were equally offset by declines in 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 continue 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 U.S. 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 that market earlier this year in order to focus on specialty products and exit low-volume or low-margin SKUs.

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 start-up costs and fire-related costs for the Stockton cut-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 3 tariffs were fully implemented at a 25% rate. Stepping back in light of all these factors, we're 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, weakened by over 5% versus the U.S. 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 AUP 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, up 310 basis points to 16.6%. Margin growth was the result of both the divestiture of noncore businesses in the U.K. 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 U.K. 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 31 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 ship 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 Maiman 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 base volume growth for the Architectural segment.

We continue 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 160 basis points year-on-year. As Howard mentioned, we incurred costs 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 pressure 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-month net sales as of June 30, 2019. At the end of the second quarter, total debt and net debt to trailing 12 months adjusted EBITDA were 2.9x and 2.5x, 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 6 months of 2018.

We continued to execute our share repurchase program in the second quarter, purchasing approximately 308,000 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 5 5/8 to 5 3/8, these notes have less restrictive covenants and baskets. We will record some financing and debt extinguishment costs in the third quarter, but will benefit from lower interest expense in the future periods. We also now have no debt maturity scheduled for the next 5 years. I was pleased with the team's ability to execute on this deal quickly when the conditions were right.

Given we are 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 are 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 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 U.K. We still expect top line 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 are 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 million 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 developed 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 3 goods from China remains in place. And we have a more difficult comp in SG&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 costs 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 $0.40 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 IT 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 $16 million for the full year. Our full year outlook for capital expenditures and free cash flow remain unchanged versus our original outlook.

And with that, I'll turn the call back to Howard for some closing comments.

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Howard Carl Heckes, Masonite International Corporation - President, CEO & Director [5]

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Thanks, Russ. In summary, we're pleased with the year-on-year adjusted EBITDA growth and adjusted EBITDA margin expansion for the second consecutive quarter. While we've 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 MVantage operating system across the organization and seeing 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 MVantage operating system will remain an area of focus, given it's 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'm delighted to have joined the Masonite team of nearly 10,000 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 focus 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?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Mike Eisen with RBC Capital Markets.

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Michael Benjamin Eisen, RBC Capital Markets, LLC, Research Division - Senior Associate [2]

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Just wanted to start off on the updated guidance, raising the margin target is encouraging and show some of the progress that you guys have started to generate, and that's 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 or 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?

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Russell T. Tiejema, Masonite International Corporation - Executive VP & CFO [3]

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Yes. Mike, it's Russ. I'll take that. First of all, with respect to price. I guess, I'd point out that we had 2 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 now really seeing the benefit of those previously implemented price increases taking effect in the marketplace. We have consistently talked about our objective to maintain a 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's also going to continue to be this focus on investing in higher AUP 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 plants 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.

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Michael Benjamin Eisen, RBC Capital Markets, LLC, Research Division - Senior Associate [4]

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Got it. Very helpful. And then transitioning to volumes. You made a comment that the weakness in the wholesale channel will continue to pressure volumes likely 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 backlogs that you've talked about in the architectural business?

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Howard Carl Heckes, Masonite International Corporation - President, CEO & Director [5]

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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 1/3 of the weakness was due to U.S. wholesale, which we think is market related. A 1/3 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 SKUs to utilize that capacity for higher-margin products. And then a 1/3 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 volume miss. Now obviously, architectural volumes have been up 2 quarters in a row. 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, do you want to add anything to that?

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James A. Hair, Masonite International Corporation - President of Global Residential Business [6]

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I would just say on the residential business. That's exactly right. And that -- we believe that wholesale softness was certainly end-market demand, some weather impacts we saw in Texas and the Midwest. And while we're enthused about 9 of the 10 top builders talking about new order rates being up. We're going to play a wait and see and make sure we focus on MVantage and the plant transformation pieces to support our cost structure.

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Andrew G. Thayer, Masonite International Corporation - Business Leader of Architectural & Senior VP [7]

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And in the architectural space that our customers are reporting strong backlogs for the remainder of the year. So we see the market staying fairly strong. And we are working on continuous improvement activities to be able to support the service levels that we aspire to going forward.

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Operator [8]

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Our next question comes from the line of Michael Rehaut with JPMorgan.

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Elad Elie Hillman, JP Morgan Chase & Co, Research Division - Analyst [9]

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This is Elad 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 in North America and Europe this quarter, but architectural margins remain under pressure. How should we think about the margin trends for the segment as we get into 3Q and 4Q, both in North America and Europe? And then also for 1 architectural to turn the corner.

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Russell T. Tiejema, Masonite International Corporation - Executive VP & CFO [10]

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Yes, Elad, it's Russ. I'll provide some high level of commentary. Obviously, acknowledging that we're not going to provide a specific quarterly guide or a 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 2 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'll still see some cost into the next quarter as we bring the Verdi plant up to full production rates. And probably through the balance of the year, as you see the Tijuana, 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 behind us.

So I would just think about those factors as you look forward in the business. And on the U.K. side, we're real pleased with the fact that we've been able to drive significant amount of margin improvement just from portfolio actions. If you look at that 300 basis points plus worth of margin improvement, about 2/3 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 balance is 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 noncore business that we've discussed.

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Operator [11]

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Our next question comes from the line of Josh Chan with Baird.

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Kai Shun Chan, Robert W. Baird & Co. Incorporated, Research Division - Junior Analyst [12]

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Welcome to the first earnings call, Howard.

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Howard Carl Heckes, Masonite International Corporation - President, CEO & Director [13]

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Thanks, Josh.

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Kai Shun Chan, Robert W. Baird & Co. Incorporated, Research Division - Junior Analyst [14]

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All right. I wanted to ask about the guidance. I guess, the updating of a guidance intrayear is -- it's a little different than the prior practice. So I'm not sure if there's 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.

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Russell T. Tiejema, Masonite International Corporation - Executive VP & CFO [15]

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Sure. I think Masonite has a history of providing annual guidance during our year-end call or generally in February, fourth quarter and year-end call. And our plan would be to either affirm or to modify that annual guidance as appropriate or quarterly. Does that answer your question?

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Kai Shun Chan, Robert W. Baird & Co. Incorporated, Research Division - Junior Analyst [16]

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All right. Yes. And then for Howard, I guess, just in terms of, 2 months or so into the role here. Could you just kind of talk about some observations that you've had versus what you expect to some of the outside perhaps. Any surprises? And then also, you mentioned in the prepared remarks, some opportunities for operational excellence. I wonder if you can kind of bucket those opportunities in terms of how you see them over time, that would be great.

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Howard Carl Heckes, Masonite International Corporation - President, CEO & Director [17]

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Sure, Josh. Thanks. Not a lot of surprises, actually. I 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 at Masonite and obviously, do some due diligence. And what I've seen really since starting is pretty much as expected, which is a team that's focused on operational excellence and delivering results. There is a passion for winning in this business, which is great. As I mentioned in my comments, I've been to 9 of our facilities and have several more planned in the coming weeks. And it's really consistent. The employee engagement in these Kaizen events and the incremental improvement is terrific. And I really think it's reading through in our results.

We do have an emphasis on product development and product mix, as Russ mentioned, and I think we can amplify that as we go forward and continue to focus on mix and AUP and new product development. But sort of in summary, I think we have a great group of people in this company that understand that it's a good business. We're in a great category. We have an excellent brand, and we're excited to win.

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Kai Shun Chan, Robert W. Baird & Co. Incorporated, Research Division - Junior Analyst [18]

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All right. Great. And my last question is on the guidance. I think it implies kind of continued margin expansion in the second half. But I think, Russ, you made some comments about sort of a ramping impact from tariffs. 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?

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Russell T. Tiejema, Masonite International Corporation - Executive VP & CFO [19]

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Well, I would just let our updated outlook for the year kind of stand as it is. You do see lumpiness potentially quarter-to-quarter as some of the discrete costs such as we incurred in Q2 around factory costs coming in and out of the business. But aside from that, there's nothing that can tear us. There's nothing that would be dramatically different in the second half versus the first half, at least as with respect to gross margins. I would caution people, as I mentioned, I think during my prepared remarks, we do have a difficult SG&A 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 tariffs, since you brought it up, 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'd probably gotten that down to the $10 million to $15 million range, assuming that the list or the Section 301 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 -- and the conversations we've had with our customers, which is any tariff-related impacts, we'll need to look at pricing to recover appropriately.

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Operator [20]

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Our next question comes from the line of John Baugh with Stifel.

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John Allen Baugh, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [21]

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Congrats on the margin percentages where the volumes off so much. I was wondering, Russ, if we could follow-up on that last comment on the tariff. So if we sort of looked at an annualized given it was delayed, would -- going forward at 25%, what? $20 million kind of growth impact annually, but you'd hope to get the pricing to offset that?

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Russell T. Tiejema, Masonite International Corporation - Executive VP & CFO [22]

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Yes, that's about the right way to think about it, John.

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John Allen Baugh, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [23]

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Okay. Great. And then on the price mix, which is very strong. And you mentioned the 2 price increases. And then you mentioned Vitality Index. So it's some of both. I'm just curious if you can give us sort of 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, a little low margin, you cited that. So I'm just trying to get a sense when we model next year, any help in thinking about price mix?

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Russell T. Tiejema, Masonite International Corporation - Executive VP & CFO [24]

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Sure, John. Well, I think about it this way. Price versus mix in the quarter or AUP 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 to the loss of the higher AUP business at the lowest business. So we're kind of through that comp right now. That has been a mix headwind to us for the last 4 quarters, circa 1 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 AUP that you saw us print 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 at the Builders' show, when we launched the new Livingston, transitional interior molded wood door design. It's been received very, very well from our customers. That's 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 a strategy that will remain unchanged into next year and beyond.

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John Allen Baugh, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [25]

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Good. And then my last question quickly was on the retail comment. And I think some destocking of inventory. Could you give some color around that? Was that a result of them changing product lines? Or was that a result of them seeing slow sales in some period in the first half of this year, but then you mentioned that POS had picked up. Any color on what precise is going on with big retailers?

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James A. Hair, Masonite International Corporation - President of Global Residential Business [26]

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Yes, John, this is Tony. I would say that 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 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 that there's a specific initiative that we were aware of that was driving the destocking.

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John Allen Baugh, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [27]

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Okay. And what was -- I know you don't comment monthly, but you've commented that things improve through the quarter. I was just curious if that's sustained itself than ingrained in July.

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James A. Hair, Masonite International Corporation - President of Global Residential Business [28]

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Yes, I'd say we've continued to see a reasonable POS into July, and we'll see how that transitions in the months to come.

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Operator [29]

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Our next question comes from the line of Michael Wood with Nomura.

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Michael Robert Wood, Nomura Securities Co. Ltd., Research Division - Research Analyst [30]

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First, can you just comment in terms of all the destocking that you mentioned in the U.S. wholesale, European and retail, whether or not any of that abated? I know you've commented on the point of sale but did you see the destocking end?

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Russell T. Tiejema, Masonite International Corporation - Executive VP & CFO [31]

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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. Do you want to add any, Tony?

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James A. Hair, Masonite International Corporation - President of Global Residential Business [32]

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Yes. Industry has not been an issue in the wholesale channel. The destocking was limited to retail. And you mentioned Europe, and we said that, certainly, in light of the original Brexit plan of March 31, we did see customers build inventories and start to bleed those down through Q2.

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Michael Robert Wood, Nomura Securities Co. Ltd., Research Division - Research Analyst [33]

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Got it. Okay. And are you able to quantify any of the mix benefits on AUP from the things like lower Canadian and Mexican mix, if that had any material impact on that AUP?

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Russell T. Tiejema, Masonite International Corporation - Executive VP & CFO [34]

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I wouldn't say that it was material to the overall North America residential AUP 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 had allowed us to dedicate more of our capacity to servicing higher AUP, higher-margin SKUs including for the U.S. market. So it's a margin, it would be a benefit, but I wouldn't classify or characterize it as a material one.

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Michael Robert Wood, Nomura Securities Co. Ltd., Research Division - Research Analyst [35]

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Okay. Just finally, I wanted to ask at a high level with the U.K. business and 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 something that you're watching or concerned about. I know that part of the acquisition strategy of PDS and some of these other names were to just further consolidate that. So it look more like the U.S. residential business.

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Russell T. Tiejema, Masonite International Corporation - Executive VP & CFO [36]

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Yes, I would actually argue the opposite, Mike. In so far, that the divestitures that you've seen from us predominantly been what we would consider product lines that are noncore to our business, including the business that is anticipated for divestiture later this year. Think about that as windows focused business that was picked up with one of our prior acquisitions. The acquisition strategy that we've implemented in the U.K. 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 DSI in early 2014 and with DW3, which includes the Solidor brand in early 2018, it's given us a really strong position for the repair and remodel market for GRP 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 of our business in the U.K. in the second quarter. So that breadth of product line, the acquisition strategy is now benefiting us.

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Operator [37]

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Our next question comes from the line of Jay McCanless with Wedbush.

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James C McCanless, Wedbush Securities Inc., Research Division - SVP of Equity Research [38]

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North America. North American new residential, is that just purely a decline in demand? Or are we starting to see the effect of this shift that many of the builders are making to the smaller houses with less stores and less -- less fit and finished than what we've been used to see in the production builders put out there?

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James A. Hair, Masonite International Corporation - President of Global Residential Business [39]

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Yes, Jay. This is Tony. I think that's an excellent question, and it's a combination of the 2. Certainly, with slower starts, we would expect to see that volume come down. We did see in communication from the big builders, and 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 that 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're 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 AUP up in the light of perhaps fewer interior doors going into those new builds.

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James C McCanless, Wedbush Securities Inc., Research Division - SVP of Equity Research [40]

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And then the second question on the retail destocking, was that across the board for the big retailers? Or was it focused at one retailer?

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James A. Hair, Masonite International Corporation - President of Global Residential Business [41]

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Yes. It was -- we look at it in aggregate. So when we were talking about destocking, for us, it was across the breadth of retail.

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James C McCanless, Wedbush Securities Inc., Research Division - SVP of Equity Research [42]

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And then just the last one, I think this has been asked several ways. But I mean, with volumes coming down, how confident are you guys that you're going to be able to hold the pricing that you've 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?

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James A. Hair, Masonite International Corporation - President of Global Residential Business [43]

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Hey, Jay, I'll jump in and I'll let Russ add color, too. We've 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 end markets in North America through the first half of this year, we have been focused at 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.

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Howard Carl Heckes, Masonite International Corporation - President, CEO & Director [44]

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If I could just add one thing, Jay. This mix is an important part. Russ mentioned that price was the primary driver of 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.

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Operator [45]

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Our next question comes from the line of Reuben Garner with Seaport Global.

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Reuben Garner, Seaport Global Securities LLC, Research Division - Associate Analyst [46]

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So 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 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 volume growth was in line with the broader door market.

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James A. Hair, Masonite International Corporation - President of Global Residential Business [47]

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Yes, Reuben, that's a good question. This is Tony. I would say that we don't believe there's been any significant fluctuation in share or ownership of across 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 there's been any significant changes in customer alignment or mix there.

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Reuben Garner, Seaport Global Securities LLC, Research Division - Associate Analyst [48]

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Okay, great. Thanks. And Russ, maybe for you, the SG&A outlook, I think you made a comment about the back half 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 in the back half versus a year ago?

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Russell T. Tiejema, Masonite International Corporation - Executive VP & CFO [49]

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Yes. If you look at the SG&A that we recorded in the second quarter, it was 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 year-on-year, 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.

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Reuben Garner, Seaport Global Securities LLC, Research Division - Associate Analyst [50]

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Okay. And Russ, just to clarify, I think that would imply kind of a meaningful ramp or acceleration in your gross margin expansion in the back half. 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?

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Russell T. Tiejema, Masonite International Corporation - Executive VP & CFO [51]

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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 our wage and benefit inflation. We are taking actions to get fixed overhead out of the business as we take plants off-line. 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 that I wouldn't want to predict specific gross margin trends forward quarter-by-quarter, but those are the drivers that you should consider.

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Operator [52]

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Our next question comes from the line of Alex Rygiel with B. Riley.

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Alexander John Rygiel, B. Riley FBR, Inc., Research Division - Analyst [53]

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I was a little confused with the comment that stated that some of the demand trends in June didn't 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?

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Russell T. Tiejema, Masonite International Corporation - Executive VP & CFO [54]

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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 that's 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 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 operation specifically until we actually see some of that additional volume materialize. Tony, anything to add on the sequential trend?

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James A. Hair, Masonite International Corporation - President of Global Residential Business [55]

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Nope, I think that's exactly what we saw and what we're trying to do about it.

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Alexander John Rygiel, B. Riley FBR, Inc., Research Division - Analyst [56]

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Very helpful. And then as it relates to transportation costs. Any thoughts on how your transportation costs are going to trend in the future from portfolio optimization?

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Russell T. Tiejema, Masonite International Corporation - Executive VP & CFO [57]

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Yes, it's Russ. I'll take that. What you saw in the second quarter was a slight pickup. 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 it's 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. That would be the dynamic to expect going forward.

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Operator [58]

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Our next question comes from the line of Steven Ramsey with Thompson Research.

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Steven Ramsey, Thompson Research Group, LLC - Senior Equity research Analyst [59]

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I wanted to ask again on mix. Is there a focus across the product spectrum as you try to move up to higher mix? And thinking about the trend in single-family construction, is it more of a challenge to improve mix there as builders ship to lower-priced homes? Or in that segment of the market, is it more about getting operations aligned to get those product margins to satisfactory levels.

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Russell T. Tiejema, Masonite International Corporation - Executive VP & CFO [60]

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Steven, it's Russ. Maybe I'll set the stage and Tony can jump in with respect to any color on the residential side, specifically in the entry-level trend. As you've heard us talk about publicly on 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, it's continuing to roll out new molded interior wood door designs, as well as, additional fiberglass designs using the Vista Grand 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 will continue to be an area of focus for us going forward. As well as in the U.K., our portfolio shift to really emphasize our capabilities in the higher AUP, higher-margin entry door business, specifically for repair and remodel.

So 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 the domestic U.S. housing market. We've seen a pretty steady progression of mix upward in that portfolio. Standard 6 panel doors have dropped to well under 30% of our mix in the wholesale channel from over 70%, 3 to 4 years ago. So we've effectively driven that mix into the channel. And as of yet, we've 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 there, Tony?

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James A. Hair, Masonite International Corporation - President of Global Residential Business [61]

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Yes, Russ. Steven, I would just reaffirm what Russ said. I think it's been more of a unit number impact, than we've seen as the mix impact. The discussion about the VistaGrande flush-glazed fiberglass doors is a great example. We see that used on entry-level of the custom homes because it just provides more light, more window 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 unifying question as we move to more entry-level housing.

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Howard Carl Heckes, Masonite International Corporation - President, CEO & Director [62]

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This is Howard. Last point, your point on operational excellence and cost is always going to be important and a focus for us. We're going to continue to try to drive operational excellence and improve margin through cost.

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Steven Ramsey, Thompson Research Group, LLC - Senior Equity research Analyst [63]

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Helpful. And then 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, speaking 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 than that in building up volumes or easier?

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James A. Hair, Masonite International Corporation - President of Global Residential Business [64]

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Yes, Steven, this is Tony. Our distribution transition that we went through in the European business was, it's serving us well from a cost structure standpoint, we did stumble 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 proving our capabilities in that service level. And we expect, and we've got a plan working against the top house builders in the U.K. market, to try to earn back their different regions and 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 and winning that business back. We expect we'll 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 new distribution model and the capabilities that team has put in place, that we will get that back.

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Operator [65]

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Our next question comes from the line of Kevin Hocevar with Northcoast Research.

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Kevin William Hocevar, Northcoast Research Partners, LLC - VP & Equity Research Analyst [66]

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I'm wondering -- I think you guys had talked on last -- or prior earnings calls about 3% type inflation for the year, plus 1% for the tariffs. Russ, I think you mentioned earlier that the tariffs should 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? Because it seems like it's been tracking nicely below that. So kind of curious, any thoughts on updated thoughts there on inflation.

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Russell T. Tiejema, Masonite International Corporation - Executive VP & CFO [67]

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Yes. What you're seeing is really an even better level of performance than we expected earlier in the year of our sourcing team's 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 has done an even better job than we would have anticipated. And that's really what's driven our inflation outlook to be closer to 2% as opposed to 3% when we entered the year.

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Kevin William Hocevar, Northcoast Research Partners, LLC - VP & Equity Research Analyst [68]

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Okay, got you. And then in terms of the tariff impact, that $10 million, is the expectation here 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 do you think you'd be able to push it through pretty quickly?

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Russell T. Tiejema, Masonite International Corporation - Executive VP & CFO [69]

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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 them 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 didn't 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 costs in the first quarter of this year, and we're seeing that trend continue.

So there's always a potential for lumpiness and some timing gap between cost increase and pricing effectiveness, but it is our strategy and our expectation that we'll continue to price to recover any tariff-related headwinds as they materialize.

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Operator [70]

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There are no further questions at this time. I'd like to turn the floor over to Howard for closing comments.

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Howard Carl Heckes, Masonite International Corporation - President, CEO & Director [71]

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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?

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Operator [72]

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Thank you for joining Masonite's Second Quarter 2019 Earnings Conference Call. This conference call has been recorded. The replay may be accessed until August 20. To access the replay, please dial (877) 660-6853 in the U.S. or (201) 612-7415 outside the U.S., enter conference ID 13692403.

Thank you and have a wonderful day.