Masonite International Corp (DOOR) 2007 Q2 法說會逐字稿

Welcome to the Masonite International second quarter 2007 earnings call for investors. During the presentation all participants will be in a listen only mode. After management's prepared remarks you are invited to participate in a question-and-answer session. This conference call is being recorded. The replay may be accessed until September 9, 2007 by dialing toll-free 1-800-231-7809, pass code 1809. I will now introduce Fred Arnold, Executive Vice President, Finance, of Masonite International. Sir, you may go ahead.

Thank you, Catherine. And good morning, everyone. Before we begin, let me remind you that this call contains forward-looking statements that are based on the beliefs of the management team regarding the operations and the results of the operations of the company. As well as general economic conditions. These beliefs and the related forward-looking statements are subject to substantial risks and uncertainties which are described in greater detail in the press release issued earlier today. Actual results may vary materially from those described in these forward-looking statements.

This morning we will review Masonite's results for the second quarter and first half of 2007. We released summary results for the quarter earlier this morning, and this information is also available on our website through IntraLinks and other media. Complete unaudited quarterly financial statements will be filed with the SEC in the near future.

Finally, please note we will not be providing specific future guidance or projections on expected revenues, earnings or cash flow for the remainder of the year. Without further preliminaries, allow me to introduce Fred Lynch, President and Chief Executive Officer of Masonite International.

Thank you, Fred, and good morning, everyone. Before we begin I want to take a minute to thank Ken Freeman who stepped into the role of CEO at Masonite a few months after joining KKR. And over his 20 months of tenure established a clear direction and strategy to take Masonite from a good company today to a great company tomorrow. Much of the progress we have made to date is a direct result of Ken's focus on building capabilities and developing talent. It has been a pleasure and an honor working with Ken, and we all look forward to his continued guidance in his role of Chairman of our Board.

On our last two calls we have discussed how Masonite has been weathering the storm in the North American housing market. In the midst of these difficult conditions I am very pleased with Masonite's performance in the second quarter. During the second quarter we began and largely completed the transition of a significant portion of our business with The Home Depot to another supplier. This was a complex operational task, and we were unwavering in our commitment to The Home Depot to maintain the highest standards of quality and customer service throughout this transition, and we did that.

As such, I am particularly delighted that the hard work of everyone at Masonite contributed to our ability to expand our profit margin in the quarter despite significantly reduced sales volumes and the added transition costs. Without question, Masonite finds itself today in a challenging market environment. North American housing market, our largest market, is not getting any better, and the turmoil in the subprime lending sector has only added fuel to the fire. I am not telling you anything that you already don't know.

Most recent US Census Bureau housing statistics continued to track significantly below last year. New housing starts came in at an adjusted annual rate of 1,467,000, 19.4% below the revised June 2006 rate of 1,819,000 starts. The rate of new housing permits issued, which is an indicator of the future housing starts and the early predictor of Masonite volumes six to nine months from now were also very weak in June at 1,406,000 according to the Census Bureau, and that is more than 25% below the issuance rate in June of 2006.

Then there is the National Association of Home Builders forecast for housing starts over the next 18 months. Their most recent estimate of housing starts in 2007 is 1,425,000, more than 21% below 2006 housing starts and more than 31% below the peak in 2005. This equates to a second half adjusted rate of only 1.39 million starts. And the forecast provided continued to weaken each month really making it difficult to predict where the bottom will be.

Back in January the NAHB predicted starts would rebound to 1.7 million in 2008. Their most recent estimate is only 1,445,000 starts in 2008; so basically the same level we are seeing today. At this point the US housing market continues to be weak, and there is no clear indication of when it will begin to recover.

Activity in our markets in Western Europe is also beginning to ebb somewhat. As you recall, the markets in the UK and France provide an important strength to Masonite in the first quarter, and they still do. The second quarter they begin to soften, though from the particularly strong performance they experienced in the first quarter. And although we do not expect a major downturn in Europe like we're experiencing in North America, these markets could be materially less robust in the second half of 2007.

Consequently, we continue to assess additional actions to ensure appropriate balance and manufacturing capacity needed to support the anticipated customer demand around the world. We have permanently closed five facilities dedicated to The Home Depot and have also closed an interior door manufacturing plant in eastern Canada as part of our plan to match capacity with demand and to minimize the impact on earnings caused by this topline weakness we face.

At the same time, we are aggressively striving to improve our levels of customer service and increase our business with existing customers and to win new customers in the North American market, while simultaneously increasing our focus on growing our business outside of the US. I will return to these initiatives after Fred Arnold overviews the second quarter financial results.

Thank you, Fred. As Fred mentioned, North American weakness and our loss of business with The Home Depot were the two biggest challenges Masonite faced in the second quarter. Revenues of $589 million were 10.4% below the $658 million achieved in the second quarter of 2006. And 12.3% below prior year period on a constant currency basis. In our North American segment where we felt only a partial quarter impact of the Home Depot loss, revenues fell 18% on a constant currency basis.

Now it may sound somewhat odd to speak of constant currency in North America but in fact the Canadian dollar strengthened rather dramatically during the quarter. This benefited our results noticeably, and there can be no assurance that this trend will continue in future periods. The strength in Europe, Europe has become an increasing portion of our business as North America weakened, as our businesses in Europe gain traction and as the US dollar has weakened. Our Europe and Other segment now constitutes approximately 28% of our sales, up from 21% in 2005 and slightly over 21.5% in the second quarter of 2006.

In the quarter just ended sales in our European and Other segment of $164.2 million were $22.6 million greater than sales achieved in the second quarter of 2006 of $141.6 million. This is an increase of 16% over the prior year period, and 8.7% on a constant currency basis. Said another way of the $22.6 million of sales growth quarter-over-quarter in the Europe and Other segments, $12.3 million of those dollars was due to organic growth, and $10.3 million was due to currency.

In light of the topline weakness in North America we are pleased to have achieved adjusted EBITDA of $91.9 million. That is only $3.1 million shy of the second quarter of 2006, which many of you on this call will remember was a particularly busy quarter in the door business. The housing downturn has not yet impacted our business, and the industry was in fact suffering from a door facing this shortage. Adjusted EBITDA margin in the second quarter improved to 15.6% compared to 14.4% adjusted EBITDA margin in the second quarter of 2006. By far the main drivers of profitability of Masonite have been the aggressive actions we have taken in rightsizing our business, both in terms of people and plants, reducing controllable costs such as labor, overhead and distribution in our manufacturing facilities and more appropriately pricing our products.

Fred has mentioned on prior calls that we are taking tens of millions of dollars of costs out of the business in 2007 through manufacturing benchmarking and more efficient work processes facilitated by the deployment of Lean Sigma. Finally, the US dollar's weakness against the Canadian dollar in particular positively impacted margins in the quarter just ended. That all being said, this is a solid 120 basis point increase, second quarter over second quarter, but it is short of the 220 basis point increase we achieved in the first quarter versus first quarter of 2006. So clearly persistent volume weakness.

Where did we drop off?

Approximately four minutes ago, sir.

Well, Chris, why don't you start off and talk about the quarter in some more detail? And if there are any other questions that come out if any of mine was missed I'm sure guys won't be bashful in asking questions.

Thank you, Fred. This has been a more complex quarter with respect to accounting, that is typical of Masonite given the transition of the facilities impacted by the loss of business with The Home Depot. As the press release mentioned, we have substantially closed five door fabrication facilities that were dedicated to The Home Depot, and we also closed an interior door manufacturing facility in the Toronto area that, while not dedicated to any particular customer, was impacted by both The Home Depot situation and the general weakness in wholesale business in eastern Canada and the US Northeast.

In this second quarter we took a total charge of $8.9 million in respect of these closures and restructuring. $6.8 million of which is related to severance, $2.1 million related to other items such as lease termination. Charges are recorded on the Other expense line in the summary income statement provided with the press release. Net other expense is added back to net income in calculating both operating and adjusted EBITDA with no impact on these metrics as a result of these charges. Recorded a very small similar charge in the first quarter of $450,000 so our year-to-date restructuring charge with respect to the loss of business with The Home Depot is $9.4 million.

Fred Arnold mentioned second quarter cash flow was negatively impacted by these events. In all, we paid out approximately $5 million of cash related to the $9.4 million of charges. We expect to out most of the rest or $4.4 million over the balance of the year depending in particular on how and when certain lease negotiations conclude. Also recorded are non-cash asset impairment charge of $2.6 million in the quarter. It also made clear that we anticipate further charges in connection with The Home Depot situation. Accounting rules prohibit us from taking these charges until certain events have transpired even though we may see them coming. These charges relate primarily to $4.5 million of leases, as well as other facility closure expenses and in total should be in the range of approximately an additional $7 to $8.5 million.

We've initiated a process to sell the recently closed interior door plant in Toronto and expect to conclude a sale by year-end or shortly thereafter. This transaction would help to partially offset the actual and anticipated cash outflows related to the Home Depot. So to summarize, the other expense line for the second quarter of 2007 includes $13.3 million of charges, the bulk of which are restructuring and asset impairment charges relating to the Home Depot situation. This is offset by about $3 million of non-cash foreign currency gains that also have no impact on either operating or adjusted EBITDA. That should help address most of the questions with respect to the charges.

Turning for a moment to EBITDA, operating EBITDA in the quarter increased 11% to $88.6 million from $79.9 million in the prior year period. Let me remind you that in the second quarter of 2006 recorded a $9 million non-cash inventory write-down that impacted operating EBITDA, but is added back in calculating adjusted EBITDA. This explains much of the difference between the operating and adjusted EBITDA comparables for the quarter.

Finally, a comment on the debt level shown on the balance sheet. We are required pursuant to standards recently adopted by the Canadian Institute of Chartered Accountants to reduce the debt balance shown on our balance sheet by any related unamortized deferred financing costs. Our June balance sheet has $66.2 million of such costs. Our debt is shown $66.2 million below what is actually the face amount of the debt; $66.2 million below what we owe our lenders and $66.2 million below the amount on which we calculate interest owed and our covenant measures. This is disclosed in detail in the notes to the financials which should be filed publicly in the next few weeks.

With that let me turn it back to Fred Lynch.

Thanks, Chris. We had another strong quarter considering the market environment. However, the severe headwinds continue. Now more than ever it is important that we stay focused on our strategic objectives and deliver on the goals outlined in our 2007 blueprint. We speak about this blueprint for success on every call. Because it is critical. It is a roadmap we follow each and every day to expect change despite improvements in Masonite. We reviewed the blueprint in detail with you over the past few calls, and today I will just provide a brief update on our quarter two status. Our first strategic goal involves building capabilities and developing talent. Second quarter of 2007 we continued to bring in new talent where it makes sense as we add new capabilities to strengthen the organization.

We made a number of significant hires in the quarter including several critical new roles; director of sales and inventory and operations planning or SAOP; director of Lean Sigma, the Vice President of product management. In addition, we hired a new general counsel and added operations and financial talent in critical jobs throughout the Company. In the past these talented executives hailed from companies like GE, BASF and Kohler and have exceptional track records.

Finally, we rolled out training initiatives, including a new global performance management system, and we are further accelerating our Lean Sigma program and expect to add even more resources in the second half of the year as we become more self-sufficient in Lean Sigma.

Second strategic goal is creating customer excitement. Make no mistake about it. The Masonite leadership team understands that in the current business environment there is no margin for error. No second chance for companies that provide their customers with anything less than consistently excellent quality of service. We continue to drive improvements in metrics such as fill rates, leadtimes and cost of quality. And while we are not perfect, this razor sharp focus is only becoming more intense every passing month.

We're also introducing new and innovative service initiatives. Let me share an example. Working together with one of our larger companies in Europe, we've introduced a process that allows us to directly manage their inventory, so VMI, and provide just in time delivery to their many locations, creating greater flexibility for our customer and allows them to focus on what they do best, that is selling our doors. Likewise, we continue to focus our efforts on new product, implementing new processes and adding additional product management resources to accelerate the introduction of new products. Our recent launch of our [Bozark] door line in France, our DPL laminate doors in Israel and our composite style fiberglass doors in the Florida market have met with strong customer interest.

Our third strategic goal is driving exceptional improvement in manufacturing. We always start with safety. Our performance measured by total incident rate in the first half of 2007 was 40% better than our average performance in 2006. Very significant results, both in terms of our people's health and welfare and in terms of money. We also continued to increase productivity, reduce waste and to improve our overall competitiveness. It so important when volumes are weak and cost inflation is very much still to be reckoned with. While we do not disclose these metrics publicly, we are on track to achieve the sort of year-over-year savings in tens of millions of dollars that we have mentioned in earlier calls.

To sum up, we are very pleased with the second quarter. Sales are down $68.6 million, but adjusted EBITDA is only down $3.1 million and margins are up 120 basis points. We have solid cash flows and net debt continues to decline. The hard work of our people around the world is paying off in solid financial results at Masonite. However, we are under no illusion. We understand we have even more work in front of us. The full impact of the loss of the Home Depot business has not yet been felt. North American markets show absolutely no near-term signs of improvement. And as Fred mentioned, quarter-over-quarter comparisons are becoming increasingly difficult.

We live each day with a heightened sense of urgency to drive continuous improvements throughout Masonite using every lever because we know this is how we will create value for our stakeholders, employees, our debt holders, our shareholders and our customers. We are not counting on a quick return of North American new construction or North American retail markets for that matter to prior year level. September of last year we have aggressively matched capacity with the reduced demand. Always striving to stay ahead of the curve.

Whether North American markets remain depressed or should they return to more robust levels, we believe that these efforts will produce a far stronger, more resilient, more efficient, innovative and more profitable Masonite. Operator, we are ready for your questions.

(OPERATOR INSTRUCTIONS) Philip with Goldman Sachs.

Thank you very much, and good job in a difficult quarter. I just want to touch on Europe a little bit. You mentioned that the European market is starting to slow a little bit. I just wanted to get a sense are you expecting European volumes to be down, or you just expecting them to be less positive?

That's a good question. We expect the second half of the year at this point to be less positive, so it is really a country by country issue. As you may be aware, the UK has had five interest rates, the bank rates have increased five times since August 2005 from 4.5% to 5.75% so we think that is going to have some impact. Ireland is slow. Spain is slow. France is an unknown at this point because it all depends on what we're going to see with the mortgage deductibility. And most of Eastern Europe still shows strong growth rates. So it is really a hodgepodge of results and right now we expect it to just be less strong than it was in the first quarter but we don't expect at this point for it to be down.

Thanks for the clarification. In terms of the Home Depot transition which was completed during the quarter, do you have a sense of what the cash costs were that probably flowed through cost of goods sold and SG&A to achieve that transition?

I think Chris had said that our cost, our restructuring charge todate I think is around $9.4 million, and I would for your analysis; I would assume that we've seen about half of those costs paid out already in terms of cash, with the remainder probably most of it during the remainder of this year.

So there is nothing additional in people being used inefficiently or things like that that are in COGS or SG&A?

There probably will be a modest amount of transitional costs. You see that in these sorts of situations.

In terms of working capital for the second half of the year historically you have generated cash. Any sense on how much you expect to generate? Will it be more or less than previously?

That's a great question. It's a different world out there right now, and while the usual seasonal affects and the seasonal slow down toward the end of the year which typically does produce some cash in this company, there will be the seasonal affect, but with markets being at lower volumes you would expect that kind of positive cash flow, seasonal cash flow to be moderated.

Okay, so are you willing to put a number on that, Fred?

We are not really giving projections, but have a look back at last year where things started to slow in the fourth quarter. We started to get some early shrinkage last year.

Okay, and in terms of pricing in North America obviously with the market being weaker, are you starting to feel pressure from your customers in terms of bringing down pricing?

There continues to be a lot of pressure in the marketplace, obviously. We are seeing it from both sides. We are seeing inflationary pressure still on the cost side although that might be unexpected, but that is the actual case. Our focus is making sure that we continue to pay the fair price of our product, and we trying, we try to take price out of the equation by really driving what is important to the customers around quality, service, delivery, the breadth of our productline, our new products that we are bringing to market, the fact that we have an all product strategy and our customers do value that. So yes there is pressure, but we're trying to remain steadfast in making sure they look at the total cost of ownership when they are dealing with Masonite.

Two last questions. Number one on the cost savings any surprises there in being able to realize what your plan was? And are you willing to give us a number of what you expect to save there?

From the perspective of any surprises I think our teams have done an exceptional job in being able to drive out costs as we had planned, both on material side. While we are seeing inflationary pressures our supply chain team, which is essentially a brand-new organization for Masonite and our logistics team have done a good job of working with our suppliers to try to moderate the effect of inflation. And in our plants as we bring new talent and new capabilities in we are getting after the costs, both in shutting down facilities and in making existing facilities more efficient through better operations. As we said, we are not prepared to give a number. But it is in the tens of millions of dollars.

Last question, you have a covenant that is starting to tighten down as you get closer to the end of the year and historically, or in the past you have mentioned confidence in achieving that covenant level. Are you still confident you'll be in compliance with your covenant at the end of the year?

Yes.

Great. Thank you, guys.

Nitin Dahiya, Lehman Brothers.

Good morning. Fred, so when we couldn't hear you, there wasn't a chance that you gave a detailed guidance for the back half of the year, was there?

Excellent start. No.

What does the EBITDA performance, Fred, by region was it consistent with how sales did?

EBITDA performance by region was not exactly the same as sales. Our sales decline -- we saw a sales decline in North America, sales increase in Europe and Other segments. But on a margin basis we actually had some margin improvement in the US and some margin drop as you saw the prior quarter in Europe and Other. And as we mentioned on our last call, that has a lot to do with supply chain movements within our company.

So I suppose you will file that so we can have a look?

You will have the details in the filing in the next week or two.

Fair enough. Fred, just on the margin improvement obviously your gross margin improvement was pretty healthy. How much of that benefit would you say was and world markets fine was some year-over-year pricing that you took last year?

That's a good question. It is really hard to pull out, as Fred mentioned, the wonderful work that has been going on in the plants in terms of efficiencies and pricing movements. Prices -- we did have a price increase last year. It went into effect over a range of weeks starting in June. So you will have seen length of the year-over-year price comparison in this quarter-over-quarter than you've had in the past.

But no ballpark like 2%, 3% -- like, I don't know, 3%, 4% benefit or whatever ballpark?

No, there are a lot of moving pieces and we haven't really quantified that. It varies very much by product. It varies very much by customer. It is done on a very careful analytic basis.

It is fair to say that the substantial improvement year-over-year has resulted from the cost improvement in our operation even with lower volumes.

Fair enough. Definitely I mean the margin improvement is pretty impressive by itself. So on the last call, Fred, we talked a little about the savings expected from the announced plant closures, and I don't think you gave a number last time. Now that you've kind of firmed up your plans a little more and you've increased the number of plants you are closing, I wondered if you could kind of back out the savings expectations from the plant closures a little better.

Yes, that's a very fair question. Again, I'm not sure where we all dropped off that call for which we apologized. But the total restructuring charges that we will be taking -- we anticipate taking with regard to the Home Depot situation is the $9.4 million we've already taken. Plus maybe another $7 million or $8 million or so going forward. So you will have about $15 million, $16 million in all restructuring charges. And our anticipation is that let's say the payback, if you please, will be slightly over a year. So maybe 10%, 15% annualized savings less than the charge amount.

That's great. I think that's -- and lastly, on the competitive environment, you talked about the pressures and how you are trying to offset it. But is there EBIT volumes coming down? Are you seeing anyone kind of being extremely promotional around price than you would have normally seen, or is it it's always tough and it is tough still, if you like?

I would say it is continuously a very competitive environment. Every company takes its own approach on how they sell their value. And we try to focus on how we sell our value, and we've been able to maintain our customer base, and they recognize the value that we offer. So we don't like to comment on how other companies do it. We prefer that you ask them. But our approach is straightforward. We provide a total value for our customers and price is a piece of that, but only one small piece of that.

Thank you very much.

[Robert Manovich, RBS]

Good morning. This is [Michael Kim] on for Rob. First question has to do with the Home Depot business. Just curious as to when you stopped taking deliveries. Was it in the April/May timeframe and also was there increase in shipments or termination of the agreement?

Michael, I don't think we can answer the question whether there was an increase in shipments directly. We play a large role and have played a large role for the Home Depot and for other customers as the inventory source for them. So there is only so much inventory they can actually hold. But the timeframe really began in May, and concluded by the end of June,

End of June. Okay, great. And just to clarify a comment during the prepared remarks, the sale of the interior door business is expected to offset the loss of the Home Depot business. Was that correct?

The proceeds from the sale of the closed interior door manufacturing facility, the cash proceeds it substantially mitigates the cash cost of closing the five facilities through the balance of this year.

Okay, great. And my third question, I guess could you briefly talk about commodity pricing during the quarter? Was it favorable or negative, and what are the expectations due the second half of the year?

Net net our commodity prices for our raw materials, if you look at wood, steel or chemicals that goes to our foam and our paints, we had inflationary levels of between 1 to 3%. Before programs, so before actions by our supply chains. Those are the types of levels that we are seeing. And as we predicted they are going to be in that same range for the second half of the year it is really hard to say right now.

And also, is there any way you can provide some color on the business through July and August? Are the trends pretty much consistent with the second quarter?

No. We pretty much like to stick -- our comments, we like to stick to the quarter that we are reporting on.

Okay, great. Thank you very much, and good luck.

[Neal Doschu], Credit Suisse.

Just a couple details on with respect to the debt balance. Could you guys tell us as of June 30 what was outstanding? What was the fund to balance in the revolver and if any LCs were issued and also was the outstanding balance on the term loan?

The outstanding balance on the term loan was $1,148.6 million. It was $54 million drawn on the revolver, about $11 million of LCs outstanding which leaves about 285 I think outstanding as far as availability on the $350 million revolver.

With respect to the Home Depot business for the half of the business that you still retain is that something you guys are comfortable that will continue to be there? Have there been any updated discussions with Home Depot with respect to that?

No obviously I think every customer that we deal with we have to earn their business each and every day. We are doing that with the Home Depot. I think a large portion of our focus in making sure this transition went well was to make sure that they understood our commitment to them and the fact that we are a professional organization that meets our commitment to our customers. And I believe they saw that. We believe we are the right supplier for a large portion of Home Depot's business, and we expect to continue to hold onto that business. But we're going to have to earn it each and every day.

Okay. Thank you.

Seth Harvey, UBS.

Good morning. Just had a quick question going back to the Home Depot. If you could kind of carve out that business could you give us any type of details on what type of decline in the North American market was important? (technical difficulty) was related to the weakness in the market as opposed to what you lost from (technical difficulty)

Seth?

Yes.

You must have the same phone supplier we have. Maybe you could pick up if you are not the handset; could you try that one more time?

I am just trying to figure out if the kind of carved out what happened with the Home Depot business in the North American market can you give us a sense of what is kind of the organic decline in the business?

A lot of moving parts in the quarter, as you said, you've got a decline in the wholesale segment in North America. You've got weakness in the retail business that we retain. And you have the beginning and termination of the transition of Home Depot business. I am not sure we can carve that out precisely, but you will be seeing in our disclosures when we do disclose our business with the Home Depot; of course it is about down, in the quarter it is about $30 million. And that will have a combination of factors in it, of course.

Okay, so the $30 million figure is not what you -- is the decline in the business as a result of what you are losing in that Midwest Northeast conference?

That is second quarter '07 versus the second quarter '06 with he Home Depot. That will have partially due to both the transition of business, the loss and partially due to weakness in the retail sector.

That makes sense. And then you had previously said your business mix is 25, new construction 75, repair (inaudible). Where does that stand now in the sense of the context of market conditions?

That is not by just to say that is not a breakdown that this management team has ever spoken to that precisely. That comes from other sources. But I would say that now as we look at our business and as you know this is not precise. There is some new construction sales that leave the retail channel; there is some innovation business that leaves the wholesale channel. There is nothing scientific about that. But we believe that our business is still greater than half, triple R. And we continue to believe that as a mix. It is less than 75; it is greater than 50.

Great. Thank you.

Philip Volpicelli, Goldman Sachs.

I just wanted to clarify the sale of the interior door facility will mitigate the cash costs that are yet to be paid out for the $4.4 million or the $9.4 million of cash? I just wanted to clarify that.

Do you want to do that, Chris?

We expect to take negative charge of 9.4, about half of which we paid. We expect to take another 7 to 8.5, and it should cover that additional 7 to 8.5.

Perfect. Thank you very much.

At this time there are no other questions.

All right then, I guess we can wrap up.

Thank you for joining the Masonite International update call for investors. This conference call has been recorded. The replay may be accessed until September 9, 2007 by calling 1-800-231-7809 for domestic. For international it is 1402 220-9686 with a pass code of 1809. Thank you.