Masonite International Corp (DOOR) 2018 Q4 法說會逐字稿

Welcome to Masonite's Fourth Quarter and Full Year 2018 Earnings Conference Call. (Operator Instructions)

Please note that this conference call is being recorded.

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

Thank you, Melissa, and good morning, everyone. We appreciate you joining us today. With me on the call today are Fred Lynch, Masonite's President and Chief Executive Officer; Russ Tiejema, Masonite's Executive Vice President and Chief Financial Officer. We also have Tony Hair, President of Global Residential, joining us for the Q&A session, since we're all at -- here at the International Builders' Show out in Las Vegas.

We issued a press release late yesterday afternoon with our fourth quarter and full year 2018 results. The release is available on our website at masonite.com.

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 and uncertainties can be found under the heading Risk Factors in Masonite's most recently filed annual report on Form 10-K and our subsequent Form 10-Q. Our SEC filings are available at www.sec.gov and on 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 in today's discussions includes certain non-GAAP financial measures. Please refer to the reconciliations, which are included in the press release and the appendix of the WebEx presentation.

On our agenda for today's call, we have a business overview from Fred, followed by a review of the fourth quarter and full year financial results from Russ, along with our updated financial outlook, followed by closing remarks from Fred and a question-and-answer period.

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

Thank you, Joanne. Good morning, and welcome, everyone. As Joanne mentioned, late yesterday, we released our fourth quarter and full year 2018 financial results. Net sales increased 4% in the fourth quarter as compared to the prior year due to 8% growth from acquisitions, which was offset by soft end-markets, particularly in the month of December.

As mentioned on our preliminary call earlier this month, we experienced lighter-than-expected sales volumes across the businesses in the quarter, primarily in our North American Residential segment. Additionally, we had anticipated some prebuy activity in December due to our price increases that took effect near the end of the month, but that did not occur.

The fourth quarter benefited from a 3% growth -- from 3% growth related to AUP driven by price increases that were implemented earlier in the year.

Adjusted EBITDA declined 10% year-on-year, primarily due to lower volume and higher material inflation, resulting in significant pressure on margins in the quarter. Both the cost actions that were taken to address lower volumes and the price increases aimed at offsetting higher material costs occurred towards the end of the quarter and did not meaningfully contribute to our results. We do believe these actions will deliver positive momentum as we enter 2019.

In early February, we announced the expansion of our asset-based credit facility from $150 million to $250 million. And while our capital deployment strategy remains unchanged, we're pleased with the increased liquidity to support the company.

Moving to the right hand of the slide, we continued to leverage the MVantage lean operating system to drive productivity across the organization. The expanded continuous improvement team drove numerous process-improvement initiatives throughout our manufacturing footprint in 2018, which we will share during this call. We continue to be pleased with the efforts from our MVantage system and believe the initiatives implemented throughout 2018 will improve efficiencies and increase throughput, particularly for certain new products, which had been constrained, provides an improved operating platform as we enter 2019.

The unit operation throughput improvements have allowed us to eliminate third shift at a number of sites, decrease overtime and reduce total headcount across the organization.

From the end of the quarter to the -- end of the third quarter to the end of the fourth quarter, we reduced company-wide headcount, excluding the impact of the BWI acquisition by roughly 3%, while also cutting U.S. overtime hours by over 20%. We further reduced U.S. headcount by 2% in January. We believe the combination of our MVantage system and our restructuring plans will enable us to more effectively manage our operations in an uncertain demand environment and help address the impacts of wage and benefits inflation.

Likewise, material inflation remained a challenge in Q4, rising 5% in the quarter, inclusive of tariff impacts. I shared previously, we implemented needed price increases to overcome these inflationary pressures, albeit they were too late in the quarter to impact results.

Moving to Slide 6. This is a look at the Residential housing market data across our major geographies. Please note that the U.S. housing data has not been published for December because of the government shutdown. So the fourth quarter data represents the year-on-year comparison for October and November with the same 2 months in 2017. As you're all well aware, in the first 2 months of the fourth quarter, U.S. housing started to decline for the first time this year, down 5.5% on a door equivalent basis.

Additionally, housing completions hit their lowest level in 15 months. While we still believe there are healthy fundamentals in the U.S. housing market, it's hard to predict how long these slower market conditions will persist. And we expect clarity will be limited prior to the spring selling season.

Similarly, Canadian single-family starts remained negative in the quarter, down 7% year-on-year, and this is the second quarter in a row, where starts were lower in both single and multi-family housing in Canada.

On a more positive note, the new housing in the U.K. strengthened following a year-on-year decline of 9% through the first half of the year, with starts up 2% in the third quarter and 15% in the fourth quarter. While that double-digit growth is encouraging, it is worth noting that December of 2017 was a particularly weak comparable. Excluding December, starts would be up a more modest 4%. While encouraging, we're planning for a soft end-market in the U.K. for the time being, given the uncertainty related to prolonged negotiations surrounding Brexit.

While fourth quarter demand reflected this lower construction data, we saw some signs of improvement in January, again, as noted on our preliminary call. Early underlying February demand appears similar, although the impact of the severe weather has resulted in a number of site closures both at Masonite and our customers.

While encouraged by what appears to be a rebound from an unusually slow December, we anticipate operating in a relatively flat environment for 2019, therefore, driving operating efficiency in the business and focusing on material margin expansion remains top priorities, which we'll speak to next.

On the third quarter call, we highlighted a series of cost and margin initiatives that we have been executing throughout the company, and we would like to update you on those as well as additional actions underway.

Our MVantage operating system is the foundation of our continuous improvement efforts and is focused on improving quality, delivery and productivity and, importantly, driving increased employee engagement. The 3 key pillars of MVantage are training and standards, which provide the tool set for our improvement programs; pit crews, which are the performance improvement teams deployed through the company to drive rapid improvement projects; and finally, plant transformations, which are 13-week long focused improvement events with multiple teams across a single site addressing entire value streams.

Our teams completed 7 plant transformations in 2018 aimed at driving out waste, reducing variation and improving material flow. These events both reduce costs and added much-needed capacity for our successful new Heritage and VistaGrande products that have been capacity-constrained previously. We're adding additional engineers through this effort to increase the number of transformation events in 2019.

We increased Kaizen events by 86% in 2018 compared to the prior year. These Kaizen events are conducted with our plant employees working on lean projects supported by our pit crews, which fosters broader employee engagement. Many of these employees are also pursuing lean and Six Sigma belt certifications, and in 2018, we had the highest number of individuals receiving belts at Masonite since 2013.

MVantage projects and Kaizen events also help identify additional opportunities for capital investments and improve efficiency through automation. In the last half of 2018 alone, we deployed over $30 million of capital through strategic investments, focused largely on manufacturing to improve efficiency, cost and quality as well as expand capacity where required.

If we look to the middle column, we previously mentioned the relocation of our Stockton, California cutstock components plant to Verdi, Nevada. We expect this new and much more automated plant to deliver 40% more capacity, with almost 20% less headcount, allowing us to lower our costs on internally supplied material and reduce higher-priced third-party purchases. I was visiting the plant yesterday, and this plant should be up and running by the end of the quarter -- second quarter.

We've also mentioned that we've made investments to increase throughput at our plant in Monterrey, Mexico, that have more than double that site's capacity, allowing us to more cost effectively service demand across North America.

We're also leveraging our global supplier footprint. Throughout the second half of 2018, our supply chain team has looked to qualify alternative suppliers throughout Southeast Asia and elsewhere to mitigate some of the impacts of tariffs on Chinese imports. To the extent practical, we plan to shift our supplier footprint to always maintain the lowest-landed cost.

Our actions to consolidate and streamline our U.K. shipping and warehousing operations were initiated in the fourth quarter, and we expect them to be completed by the end of the first quarter of this year. Once completed, we should be better positioned to serve customers with reduced lead times and also lower our distribution costs.

In January, we divested a noncore floor joist business in the U.K. that was acquired as part of the National Hickman acquisition in 2015. We're also working on divesting 2 additional small noncore businesses in that region later this year.

Between the plant consolidation of certain North American facilities and the initiatives already underway in the U.K., we expect a greater than 10% reduction in the total number of manufacturing locations.

Meanwhile, we've also worked to streamline our product portfolio, reducing complexity for our channel partners and end customers to help aid in their buying decisions. These actions provide the added benefit of simplifying our manufacturing operations and improving material flow in our plant, thereby reducing cost to serve. Importantly, we continued to invest in product innovation and are once again introducing some great new higher-valued products in 2019. For those of you attending the International Builders' Show this week here in Las Vegas, you can see some of these new products, including the new Livingston door.

The Livingston is a truly transitional design that, we believe, will appeal to homeowners across all styles and regions. Through our initial customer surveys, we've received over 70% preference ratings from professionals and consumers alike. Later this year, we're scheduled to launch the new Masonite exterior wood door with AquaSeal technology. We believe this will be the only factory-sealed exterior wood door on the market. We see this as a real differentiator in the marketplace and another example of a product that can command higher average unit prices and better margins.

As you can see, we continue to take a multilever approach to driving margin expansion across Masonite.

Let's spend some time on the restructuring actions on Slide 8. In the top actions section, you'll recognize actions we first discussed during our Q3 call, the U.K. site consolidation, the U.K. transition to a Global Business Services model and the relocation of the cutstock facilities from Stockton, California to Verdi, Nevada that I just mentioned. We expect these previously announced restructurings to be largely completed in the first half of 2019.

Moving to the bottom of the slide, we outlined the additional restructuring actions, for which we plan to take a charge in Q1. Investments we made in 2018 to improve throughput in some of our lower-cost plants, the Monterrey, Mexico plant, in particular, have enabled us to rationalize higher-cost operations to consolidate 1 of our 7 U.S. Residential Interior door plants. We've also decided to close an Architectural Stile & Rail plant and consolidate that production into a facility we acquired in the Graham and Maiman transaction in 2018. We communicated the closure of both of these facilities last week to employees. Both plants will begin reducing production immediately and will fully cease operations in the second half of 2019. As has been our practice, we are providing all affected employees with retention and severance benefits as we work through these transitions.

We've also begun to reduce North American headcount related to SG&A and overhead. As we mentioned on the preliminary call, after a detailed review of salaried staffing levels as part of our 2019 budgeting process and given the uncertain market environment, we expect to reduce these functions by roughly 5% in the first half of 2019 through a combination of attrition and focused restructuring.

The decision to close these 2 facilities and further reduce headcount elsewhere in the company was a difficult one, taken after a careful deliberation. Unfortunately, we're faced with an uncertain market and a rising cost environment. We know that our people are key to our success at Masonite, and we will, as always, treat impacted employees with dignity and respect as we go through these restructuring activities. I also want to thank all affected employees for their many efforts through the years on behalf of our customers.

With that, I'll turn the call over to Russ to discuss our financial performance and outlook.

Thanks, Fred. Good morning, everyone. On Slide 10, we summarize our consolidated financial results for the quarter. We had net sales of $528.4 million, a 4% increase over the fourth quarter 2017. Acquisitions and average unit price contributed approximately 8% and 3%, respectively, to this increase. This was partially offset by a 6% decline in base volume, part of which is attributable to the prior year retail line loss and, to a lesser extent, a 1% headwind from foreign currency.

Gross margin and adjusted EBITDA declines were largely driven by the same 2 issues: the continued impact of higher material costs and the abrupt slowing of orders in the fourth quarter, particularly, the month of December.

Gross profit was down by 4.7% in the fourth quarter, with gross margin declining 170 basis points versus the prior year to 18%.

Adjusted EBITDA decreased 10.4% to $57.5 million, while adjusted EBITDA margin contracted 170 basis points to 10.9%.

Looking to our adjusted EBITDA bridge on the right side of the slide, you can see the gap between volume, price and mix and material cost in the quarter. As discussed on the third quarter call, we anticipated additional pressure on margins due to continued material inflation in the quarter and additional pricing not being implemented until late December.

As Fred mentioned earlier, material inflation exceeded 5% in the fourth quarter, inclusive of the impact of tariffs. The primary drivers of inflation, again, were steel, as our contract [tollers] reset higher in the quarter and were more in line with the overall higher market prices, and chemicals, as higher oil prices earlier in the year flowed through resin costs realized in the quarter.

Moving to factory costs. We see the sizable impact that lower volumes had on our productivity in the quarter, a headwind of approximately $7 million. As Fred noted earlier, we took steps throughout the fourth quarter to reduce our manufacturing costs, but the timing of those reductions is largely at the end of the quarter. As such, we experienced higher year-on-year factory costs as a percentage of sales, particularly in overhead, as we lost absorption due to lower production volumes.

Distribution and SG&A remained relatively flat in the quarter. Our logistics team continued to effectively manage the higher carrier rates and fuel inflation we've seen across the industry. The slight increase in SG&A spending in the quarter is more than explained by cost at acquired businesses, partially offset by lower share-based compensation.

Net income for the fourth quarter was approximately $12 million and diluted EPS was $0.46. Diluted EPS was down $2.02 per share from $2.48 per share in the fourth quarter of 2017, primarily due to prior year tax benefits of $1.77 per share in 2017.

Our adjusted diluted EPS was $0.68 in the fourth quarter of 2018 compared to $0.70 in the comparable period of 2017.

Now let's look at our reportable segments. Turning to Slide 11, we'll start with our North American Residential business, where net sales decreased 3% in the fourth quarter and adjusted EBITDA decreased 21%. As discussed on the preliminary call, we experienced much-lighter-than-expected sales volumes during the fourth quarter.

On our third quarter call, we noted that October sales volume growth was noticeably down. This trend continued in November, and then we actually experienced year-on-year declines in wholesale sales volumes in December. The absence of prebuy activity, which is typically expected before a planned price increase, was a contributor to sales volumes that missed our expectations.

The retail portion of the business performed largely as anticipated, with a high single-digit decline in sales volume year-on-year virtually all due to the impact of the previously announced line review loss. This loss will anniversary at the beginning of the second quarter of 2019.

Adjusted EBITDA margins decreased 270 basis points in the quarter due to the price-cost dynamics and factory inefficiencies discussed earlier. Now that price increases are in place, the business enters 2019 with a favorable price-cost relationship. Similarly, the actions taken to reduce -- further reduce headcount subsequent to year-end are expected to improve our factory cost structure in the North American Residential business.

Lastly, it's worth noting that while we're in the very early stages of integrating the BWI acquisition, that work is progressing as planned.

Turning to Slide 12 and our Europe segment. Net sales increased by 23% compared to the fourth quarter of last year due to growth from our DW3 acquisition of 28%. Foreign exchange was a 3% headwind, and average unit price increased 1%. Base volumes were flat in the quarter, which is somewhat encouraging given uncertainty across the U.K. economy related to the impending Brexit decline -- deadline, excuse me. However, we experienced reduced component sales due to lower volumes at our recently divested floor joist business in the U.K. and lower sales of components in Western Europe.

Adjusted EBITDA grew in the fourth quarter by 22% over the comparable period of 2017. Adjusted EBITDA margin of 11.9% was done very slightly year-on-year, 10 basis points, as continued strong margin performance from DW3 was offset by cost and efficiencies related to the consolidation of distribution and warehousing operations announced last quarter. We maintained higher factory and distribution labor as we progressed through that process and experienced elevated costs related to picking and shipping as we worked through the resulting backlog.

As of January, the operations were back on track and performing as intended. Going forward, we believe the consolidated shipping and warehousing operations will both reduce cost and improve service levels.

Moving to Slide 13. In the Architectural segment, net sales increased by 19% in the fourth quarter, primarily driven by 17% growth from our Graham & Maiman acquisition and 4% higher average unit price. These increases were partially offset by a 3% decline in base volumes attributed largely to post ERP implementation recovery at our Northumberland, Pennsylvania plant. During that ERP implementation, our backlog increased, and efforts to work through that order book by year-end were only partially successful, preventing us from shipping as much as expected in the quarter. Post-ERP implementation issues also drove adjusted EBITDA and adjusted EBITDA margin declines in the fourth quarter. Adjusted EBITDA was down 20% from the same period in 2017, while adjusted EBITDA margin decreased 410 basis points to 8.3%.

In an effort to work through the customer backlog, production schedules were revised, causing inefficiencies. Distribution costs were also elevated in the quarter as payload efficiency was sacrificed or LTL freight was utilized to ensure customer delivery commitments were met.

We largely worked through the backlog and started 2019 at normal levels. We saw improving demand trends across 2018 and a continued recovery in early 2019 in our Architectural business. The fourth quarter marks the second consecutive quarter of year-on-year increases in quoting activity, and we saw solid year-on-year growth in sales volumes for January. While we are expecting some impact from the unusually cold weather earlier this month in the Midwest, where several of our architectural plants are located, we remain encouraged by this improved trend in demand.

Turning to Slide 14, we summarize our full year financial results. Full year 2018 net sales increased by 7% compared to 2017, which is driven by growth of 6% from acquisitions, a 3% increase in average unit price and a 1% positive impact from foreign exchange. This growth was offset by a 3% decline in our base volume.

Adjusted EBITDA increased 5.3% to $267.9 million for the full year, while adjusted EBITDA margin contracted 20 basis points to 12.3%. I'd again point your attention to the adjusted EBITDA bridge on the right-hand side of the slide. You can see that higher volume mix and price of $48 million was able to keep us slightly ahead of material and distribution inflation as well as higher factory costs driven in part by labor inflation, which altogether totaled $46 million for the full year. Material inflation, excluding tariffs, was 3.5% for the full year, the top end of our originally expected range of 3% to 3.5% and in line with the levels anticipated as we reached mid-year.

SG&A increased 7% for the full year 2018 as compared to 2017 to $266.2 million. As a percentage of sales, SG&A increased 10 basis points to 12.3% for the full year. The increase was largely due to additional costs from acquisitions, including related professional fees and personnel-related costs.

Net income for the full year was approximately $93 million, and diluted EPS was $3.33. Diluted EPS was down $1.76 per share from $5.09 per share in 2018. This decline was due to prior year tax benefits of $1.76 per share in 2017. Our adjusted diluted EPS was $3.68 in 2018 compared to $3.34 in 2017.

I'll briefly recap our current liquidity profile on Slide 15 before moving to our 2019 outlook. Total available liquidity, including unrestricted cash and accounts receivable purchase agreement and our undrawn ABL facility, was $265 million or approximately 12% of our trailing 12 months net sales as of December 30, 2018. At the end of the fourth quarter, total debt and net debt to trailing 12 months adjusted EBITDA were 3x and 2.5x, respectively. Fred already mentioned the expansion of the ABL, but I would add that in addition to increasing the size from $150 million to $250 million, we extended the maturity of the facility from April 9, 2020, to January 31, 2024, and we added assets from our U.K. businesses to the collateral base.

While we foresee no immediate needs for this incremental borrowing capacity, we're pleased to have strengthened our liquidity even further. We had our largest quarter and year of our stock buybacks, purchasing approximately 1.3 million shares in Q4 at an average of $55.40 per share, totaling approximately $72 million in the quarter. We purchased approximately 2.8 million shares during all of 2018 at an average price of $60.22 per share or a total of $167 million. Subsequent to year-end, we purchased an additional $18.6 million of shares at an average price of $51.34, bringing our cumulative share repurchases to almost 22% of the shares that were outstanding when we began the program in 2016.

Before we leave this slide, I'd like to point out our strong cash flow performance in 2018. We achieved free cash flow conversion of 118% for the full year as the business delivered strong operating cash flow of $203 million, an increase of approximately $30 million as compared to 2017, as we focused intensely on working capital management. Capital expenditures were slightly higher than our annual outlook of $75 million to $80 million, as we finished the year strong in our execution of key strategic capital projects in our plants.

Now let's move from 2018 to our 2019 outlook. On Slide 16, we framed up our view points on various external factors, that, we believe, could impact our business in 2019 and initiatives we have put in place in response. The largest headwind we see in 2019 is the continued uncertainty around the housing market in both North America and the U.K. As a result, we are planning for a minimal growth in end-markets overall. Given the current North American macroeconomic data and what we are hearing from our customers, we are planning for flat new residential construction spending in 2019 and low single-digit growth in RRR.

We are also planning for low single-digit growth in the U.K. housing market due to the continued uncertainty surrounding Brexit and low single-digit market growth in nonresidential construction markets served by our Architectural business.

We continue to see tight U.S. labor markets. We experienced elevated wage and benefit cost again in 2018 and expect to continue seeing low single digit to mid-single digit wage and benefit inflation again in 2019 as we compete for talent and deal with the impact of a very low unemployment rate.

Continued macroeconomic and political uncertainty is adding complexity to managing the business. U.S. tariffs on Chinese imports impacted material cost in 2018, and we are currently planning for additional impacts in 2019. At the full 25% tariff rate, Section 301 tariffs would be expected to yield approximately $20 million to $25 million of tariff-related material cost increases annually. While our global sourcing team has negotiated with suppliers and shifted some of our sourcing footprint, we are still expecting to see $10 million to $15 million of net tariff impact in 2019 when the full rate is enacted on March 1. This would represent over 1 percentage point increase to our overall material cost, in addition to normal material inflation, which we project to be approximately 3% in 2019.

Moving to the right-hand side of the slide, the summary of the mitigating actions Fred and I have already covered earlier on the call.

With this backdrop in mind, on Slide 17, we present our outlook for 2019. We're expecting net sales growth of 3% to 5% year-on-year, including approximately 1 point of unfavorable foreign exchange, given current weakness of the Canadian dollar and pound sterling versus the U.S. dollar. We anticipate top line growth to be driven primarily by higher average unit price. We also expect to benefit from about 1 point of net acquisition growth, reflecting the full year impact of 2018 acquisitions, offset partially by the anticipated impact of planned divestitures of noncore businesses in the U.K.

After accounting for one more quarter of year-on-year loss on previously announced retail business, the remaining contribution from end-market demand growth is expected to be less than 2%.

Taking into account this net sales outlook, we expect adjusted EBITDA to be in the range of $275 million to $305 million. It is important to point out that while we have a number of restructuring actions slated to help optimize our manufacturing footprint, the benefit of those actions is expected to largely occur post 2019, given the timing of facility consolidations and operating costs we expect to incur to facilitate the transition of production.

We expect that adjusted EPS in 2019 will be in the range of $3.60 to $4.40. This range incorporates an assumed tax rate of 21% to 24% and is based on our quarter-end 2018 share count. At the midpoint of the range for adjusted EBITDA and adjusted EPS compared to full year adjusted EPS for 2018, we expect to benefit about $0.80 from higher EBITDA and about $0.20 from a lower share count, with offsets from higher interest costs associated with incremental debt issued in our bond offering last September and higher tax and share-based compensation expense.

Relative to key cash flow drivers, we expect cash taxes to increase slightly from $11 million in 2018 to a range of $12 million to $16 million in 2019. We continue to expect capital expenditures in the range of $75 million to $80 million, and we also continue to anticipate free cash flow conversion in excess of 100%.

Our updated 3-year growth framework for net sales and adjusted EBITDA margin are shown on Slide 18. Market conditions have evolved since we provided the last version of this framework at our Investor Day in early March last year. At that time, we believed we could grow our net sales at a 5% to 7% compound annual growth rate through 2020, considering market growth that was expected at that time and our strategies to drive higher average unit prices, including investments in new products and value-added services.

While our AUP strategies and progress remain intact, we now expect to see lower end-market growth, which, we believe, equates to roughly a 200 basis point reduction in our 3-year revenue growth CAGR. This framework does not consider any incremental acquisition-related net sales growth. While we did complete 3 acquisitions over the course of 2018, after taking into account the expected divestitures of noncore businesses in the U.K. this year, the net impact to net sales would be minimal over the 3-year horizon. Thus, the 3-year revenue CAGR included in the framework has declined to approximately 4%, which would result in 2021 net sales of roughly $2.4 billion.

Moving to the bottom of the slide, we detail how our revised outlook for market growth and combination with increased inflationary pressures would translate to margin growth over the next 3 years. Our prior long-term growth framework showed adjusted EBITDA margins of 16% to 17% by 2020, driven by a combination of operating leverage from increased volume, higher average unit prices and net productivity in our manufacturing and distribution operations. Similar to our net sales growth assumption, our AUP assumptions remain intact. And we have been even more assertive where necessary on pricing actions to stay abreast of commodities' inflation and tariffs, albeit with some lumpy timing and price cost coverage, such as we saw in Q4 last year.

However, given soft end-markets, our framework reflects minimal impact from volume leverage. Further, general labor and distribution inflation have been more pronounced than we anticipated a year ago. While our operations and supply chain teams have done a great job offsetting these where possible, this remains a headwind that must be managed. This further underscores why we are laser-focused on executing multiple actions to optimize our manufacturing footprint, as Fred outlined earlier. Considering these factors and taking into account the lower baseline in 2018 that we stepped from, our updated long-term growth framework reflects an adjusted EBITDA margin of approximately 15% by 2021.

And with that, I'll now turn the call back to Fred to summarize today's discussion.

Thanks, Russ. So to summarize, we delivered higher net sales and adjusted EBITDA in 2018 despite the increasing market uncertainty and a challenging cost environment. While we achieved higher average unit price in Q4, it was not enough to cover our increasing costs. With the previously communicated pricing actions that took effect in the North American wholesale and retail channels later in the fourth quarter, we believe we are positioned to resume adjusted EBITDA margin expansion in 2019.

Coupled with pricing, we're executing on initiatives to improve margins in each of our 3 business segments. Our MVantage lean operating system continues to make positive impact on our operations, improving quality, delivery, productivity and employee engagement. While we won't see much immediate impact, our previously announced and additionally planned restructuring actions will help drive margin expansion in future periods.

Lastly, I want to, again, thank the 10,000 employees across Masonite who work tirelessly to help people walk through walls and deliver an extraordinary customer experience each and every day.

And with that, we'd like to open the call to questions. Operator?

(Operator Instructions) Our first question comes from the line of Michael Rehaut with JPMorgan.

This is Elad on for Mike. First, I was just wondering how we should think about the cadence of the EBITDA margin expansion in the full year. Should we be thinking about it more as a second half-weighted event or are you starting in 1Q? I think on the last call, you mentioned starting to see some margin growth already in January. And just further, should we be thinking about that in like the 20 to 30 basis points range or more in like the 50 basis point range, given that the price increase is already implemented and the benefits of the cost structuring are really more post 2019? Any help would be helpful just in terms of setting proper expectations for 1Q.

I just speak -- this is Fred. I speak at a high level. While we did see improved volume as we came into the first quarter, it's coming off of a low base that we saw in the fourth quarter. I think from a new construction perspective, the markets are still a little uncertain. And as we shared in the call, the information that will start to flow in through the spring selling season will, I think, give us a better sense of where things are heading. If you look at what the builders have said, most of them have said, this is going to be more of an H2 story in 2019. And since that's the market that we ultimately serve, you should expect that our story will be a second half story as well on the revenue side.

Okay. And then on the long-term targets, are you able to help quantify what you're assuming in terms of incremental material inflation and price realization over the next 3 years? And more specifically, can you break out some of the drivers within the 150 to 200 basis points benefit that you're expecting from stronger price and mix? How much is that from incremental pricing versus better mix?

Yes, Elad, it's Russ. The way I would answer that is, first, on the material cost side, as I mentioned during our prepared remarks, we're expecting about a 3% increase in commodity inflation in 2019. And we would expect some inflationary pressures to continue through the balance of that long-term growth framework horizon. Now we are seeing material cost begin to moderate a little bit versus 2018, and it would likely moderate a little bit as we get into 2021, but I wouldn't view that as a meaningful tailwind in the framework of our assumptions. And then related to price and mix, you've seen strong performance from the company in improving our AUP over the last couple of years. Unfortunately, that inflationary environment that we've been talking about has been eating up a lot of that. You're going to see the same strategies going forward over the next 3 years as we've executed the last several years, which are going to be around investing in new product programs and value-added services, with an eye to bringing new products to market, Fred mentioned one during his remarks, the new Livingston interior door, that can command higher average unit prices and margins. So as it has been previously, it will continue to be over a multi-year period a balance of mix and price.

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

This is Mason Marion on for Mike. So you announced $10 million to $15 million of restructuring charges you expect to take in 2019, laid out the additional actions now underway in your presentation. If we step back, though, what inning do you think you're in regarding your investments in your manufacturing footprint? And should we expect it will last beyond 2019? How many facilities have you invested in to date versus how many ultimately you need to invest in or will invest in?

So it is hard to hear your questions on the phone line. But I think that at a high level, the impacts of the restructuring activities that we spoke about in -- over the last 2 calls, with regard to the U.K. activities and restructurings and the Verdi, Nevada restructuring, the shutdown of Stockton, we will have completed those by the middle of 2019. The remainder of the restructuring will really start to impact results in 2020 and beyond. When it comes to -- I think the important thing is we are in a business of continuous improvement, so these are just actions again that we have been working through the years, and we'll continue to work those actions as we bring new products to market, improving our manufacturing processes to support those, using automation to help offset some of the wage and labor inflation that we're seeing, more recently moving more of our production to low-cost regions is going to be an ongoing and has been an ongoing part of the Masonite operating strategy.

Okay. And then how are you thinking about share repo versus investments in the business, as you guys have continued to repurchase significant amount of stock over the last 2 years and continued to do so in the fourth quarter?

Yes, this is Russ. Our capital deployment strategy really is unchanged. We are going to continue to prioritize investments in the business, first and foremost. You'll see that primarily in the form of capital projects. We've been able to execute a lot of improvement projects in our plants within that $75 million to $80 million guidance range that we typically provide each year and that we've affirmed again for the year ahead. And then once you get past the internal investments within the business, then it's a decision as to whether or not there are appropriate accretive M&A acquisitions available at reasonable valuations. And if not, we're going to pivot to deploy our cash against distribution to shareholders in the form of repurchase. And as I commented earlier on the call, the business continues to generate very strong cash flow, 118% free cash flow conversion last year and operating cash flows that were much stronger year-on-year. That puts us in a position to continue to evaluate those 2 alternatives. And in the current environment, we really like the valuation of our shares, vis-à-vis the acquisition opportunities we see.

And one thing I'd like to just add to that, kudos to Joanne and the treasury team and Russ for having the foresight back in the third quarter to go out and extend and bifurcate our high-yield debt. That allowed us to bring additional capital to bear. And that was very fortunate, given the opportunity for us to have the highest year ever from a share repurchase perspective and accelerate those as the markets decline.

Our next question comes from the line of Michael Eisen with RBC Capital Markets.

Just wanted to start off on the inflationary environment. Much higher levels than we expected at the beginning of the year. And just thinking out to '19, what level of inflation are you guys forecasting in that guidance range? And in so, is the 25% tariff all inclusive in the guide, that if it were to go away, does that represent upside or does that more get you to the higher end of the range?

Yes. Just to clarify, as I commented -- this is Russ, by the way. As I commented during our prepared remarks, we are anticipating 3% inflation plus tariffs on the Section 301 tariffs implemented in China. And we are anticipating that those are going to be in effect as of March 1st. That's the current policy the administration's articulated. So if you -- and I think I mentioned specifically that against our China source buy, that incremental tariff would equate to over 1% of inflation alone on our total material buy. So 3% base commodity inflation plus 1 point plus of tariff would equate to at least 4% all-in inflation in 2019 inclusive of tariffs.

Okay. Just to clarify, if the 25% tariffs do not go into effect, that would be upside to the current guide?

Well, I think the way you have to look at that is when we think about those tariff costs, we've included the impact of the tariffs in our outlook for 2019. Our expectation would be that if those tariffs do come to bear, we've already had discussions with our customer base that a significant portion of those need to be passed on. So it really comes out to a net zero either way.

Understood. And then as a follow-up, thinking about the 2021 metrics and kind of the overall profitability lower than 15%, can you help us think about if that step-down is evenly spread across all 3 segments or if 1 segment has kind of brought more of that than the rest from what prior expectations were?

I would think about the improvements that we're implementing, particularly on the restructuring side. Those are really broad-based across the company. Case in point, you saw us announce production consolidations in all 3 reportable segments, the North American Residential business, the U.K. business, including actions we actually announced in prior quarter and now also some consolidation of production in the Architectural business. So the focus is going to be on driving net margin improvement across all 3 segments.

Again, with that said, and since we're in Vegas, Graham is not here with us and Randy White is not here with us, I think both of them would tell you that they have expectations to be able to drive a larger level of margin improvement in the Architectural business just because we're starting from a lower base point, and we still have opportunity to benefit from some of the integration activities that we're looking at over the next couple of years. So the expectation of that team would be is they're going to contribute more over that 3-year horizon.

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

As it relates to the $20 million of annual savings, I'm assuming that January 1, 2020, you expect to be at that full run rate of savings, is that correct?

We'll see very little in 2019. It will ramp through 2020. You probably don't really see full savings impact until you're exiting 2020, Alex.

And then as it relates to your long-term framework, the market growth forecast is low single digits, but yet you're projecting minimal volume leverage. So if you can help me to understand that dynamic.

Well, we think about it as simply as there is much less production that we're going to be putting through our plants in light of that market outlook. We had been viewing the markets as being in the mid-single digit range when we last talked about our long-term growth framework, and that's now down into the very low single-digit range. And so depending on how we manage our manufacturing footprint, bottom line, we're going to plan for what is now a minimal volume leverage environment, and we're going to rely instead on the transformation activities that we have underway in our plants, the restructuring projects that Fred talked about and the continued efforts to drive AUP by pricing and mix via product investment.

And I do think it's important, though, that as we work on our productivity activities and transformations in the plant, we are very clear with our operating teams that this is a combination of improving cost and efficiencies without sacrificing instantaneous capacity, so that should the markets respond better than we anticipate, we'll be well positioned to take care of that.

And on the assumption of low single-digit market growth, is that purely volume or is that volume and price?

That would reflect just volume. We've separated out our AUP and mix initiatives separately, as you'll see on the slide that we presented in our deck.

Sure. I wasn't sure if the AUP was associated with the mix or if it was just pure AUP across the entire business.

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

This is Brian Biros on for Steven. I wanted to ask about the 2019 outlook and just how that kind of played out throughout Q4. I assume it's an ongoing process, the outlook. I'm kind of wondering how the outlook may have adjusted as Q4 played out.

So just to make sure that we understand the question, you're speaking specifically about 2019 and how that was shaped by what we saw in the fourth quarter, is that correct?

Yes, that's probably a better way of phrasing it.

Okay. Well, hey, we're not going to form an annual outlook on any one given quarter. We do see lumpy results quarter-to-quarter. And even within the quarter, as we commented earlier the downdraft that we saw in Q4 was principally a function of an abrupt slowing of orders in December alone. But be that as it may, we've got to be realistic and step back and acknowledge that the external environment has changed from where we were a year ago. We are expecting much lower end-market growth across virtually all the markets that we serve. And in light of that, then it forms a view that we're going to see lower revenue growth, and that's going to impact the amount of EBITDA and margin improvement that we drive. And that's really what sat behind our viewpoint on 2019, as looking ahead for the full year, how does that impact of the market generally translate and read through into our results.

Got it. Again, on the 2019 outlook, specifically, on the margin expansion there, I guess, how much of that is dependent on top line and the volume expectations. And I guess, how would you frame the other pieces that are there that might be able to help deliver those margin expectations? Is the top line and volume kind of underperform what you're thinking?

Yes. Well, I mean, without getting into a detailed modeling conversation here, the way I think about it is we already commented that we thought most of the revenue growth would be coming from average unit price and that the contribution from the overall market would be relatively nominal. And then you've got puts and takes on volume related to acquisitions, the loss of retail business and a little bit of nominal volume growth. If you take -- if you pull out FX, which we're saying is about 1 point impact on the top line, we typically see a read-through of 10% to 15% on the EBITDA line from FX. That's a couple $3 million headwind to EBITDA. On the AUP side, again, we've said most of that growth, call it, 3% or so on AUP, that's largely going to fall to the bottom line as price. And then the net of all other volume, if you assume, that's about $50 million in revenue or so, that would typically drop through at 20% to 25%. But you can see pretty clearly the read-through of revenue to the bottom line. And then you'll just have to take into account the other factors we cited: the material cost inflation of 3%; $10 million to $15 million worth of incremental tariffs we believe at this point; and a low to mid-single digit inflation for labor cost, which, as we talked about before, we've got a total payroll to company of about $500 million. So pretty soon that math all steps forward to take you to the range that we've shown here for adjusted EBITDA.

(Operator Instructions) Our next question comes from the line of Jay McCanless with Wedbush Securities.

So my question is, if input costs are moderating and you're thinking flat demand -- flat to softer demand for most of your end-markets, how confident are you guys that you're going to be able to hold these price increases because it doesn't sound like the backdrop for maintaining price increases is going to be very good in 2019?

Jay, this is Tony. I just give you the perspective that, I think, everybody has recognized the inflationary factors. Everybody has felt it across the industry. And so we've taken that in communication and, obviously, we support all the price increases with the data that we provide, and you can see it on the output -- or the documents that we've reviewed today. So we're going very fact-based in those discussions, and as I said, I think the customers that we deal with have seen those. We'll always have those areas where we have challenges, and we work through those, historically, very well with our customers as we push to get more value for the products, and we want them to get more value for the products as well. So we'll continue in that tension, and we feel pretty good where we are today with the pricing.

Then the second question I had, and I apologize if you've touched on this already, but the $10 million to $15 million in restructuring charges, how is that going to play out through the year?

Well, we're still working through the specifics. That's why we provided a range. That charge won't be taken until the first quarter. So we're finalizing estimates for all the costs associated with severance facility, exit costs, et cetera. And then there would likely be impairments on equipment for certain plants that are being exited. So we'll provide more details on that when we get to the Q1 call. But if the question really is around when we're going to see the impact of those closures or the timing of those closures, a lot of that's going to incur in the second half of the year, as Fred mentioned on the restructuring slide of the deck.

Yes, I think it's important to recognize, though, that we have announced the majority of these to the employees. We've already begun to take down production at the sites that we plan to exit and consolidate to other sites. The majority of the employees that will be affected on the SG&A and overhead reductions will be affected by the end of the first quarter. So it's -- we'll have the opportunity to go into more detail of the actual details of this in -- or the specifics of this, I should say, at the end of Q1. But I want to be clear that the activity has been, actually, underway for several months, and much of it is being driven now. There are expenses associated with some of these moves that are not restructuring charges that actually hit EBITDA to the negative end. We'll offset those through some of the savings in '19. But as Russ said, start to see it ramp -- the savings really ramp up in 2020 and beyond.

And if I could sneak one more in. You guys highlighted the weather in February as an issue. I mean, are we talking meaningful amount of days lost for your different plants and for your customers? Or is it just more of a hassle at this point?

Yes, when we got to that polar vortex, definitely, for our plants in places like Wisconsin and in the upper Midwest, some of our plants were shut down for 2 or 3 days. In cases, natural gas was rationed by the local -- by the state and by the local regulatory agencies and the gas company. So businesses weren't allowed to get gas to make sure that we can keep the population warm. So again, the hope is we'll be able to make a lot of that up as we move through the first quarter. Some of that we'll likely do by running some additional weekend shifts to manage through that. But it was very unusual cold weather, and it really did impact probably more so the Architectural business than our Residential business given that the footprint of those plants tends to be more northern, whereas we're more broad-based on the Residential side.

Ladies and gentlemen, this does conclude our question-and-answer session. I'll turn the floor back to Mr. Lynch for any final comments.

Great. Thank you, operator, and again, we want to thank all of you for joining us on the call today. For those of you who are here in Las Vegas or have other members of your firms in Las Vegas, please stop by our booth to see our great new products, and we'd be happy to show you around. Operator, could you please give a replay of the -- replay instructions for this call?

Thank you. Thank you for joining the Masonite International Fourth Quarter and Full Year 2018 Conference Call. This conference call has been recorded. The replay may be accessed until March 5. To access the replay, please dial (877) 660-6853 in the U.S. or (201) 612-7415 outside the U.S. Enter the conference ID number, 13687239. This does conclude today's conference. Thank you for your participation.