Masonite International Corp (DOOR) 2021 Q1 法說會逐字稿

Welcome to Masonite's First Quarter 2021 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, and good morning, everyone. We appreciate you joining us today. With me on the call today are Howard Heckes, President and Chief Executive Officer; and Russ Tiejema, Executive Vice President and Chief Financial Officer; Tony Hair, President of Global Residential is also joining us for our Q&A session.

We issued a press release and WebEx presentation after market closed yesterday, sharing our first quarter 2021 results. These documents are available on our website at masonite.com.

Before we begin, let me remind you that this call will include forward-looking statements. Each forward-looking statement contained in this call is subject to risks and uncertainties that could cause actual results to differ materially from those projected in such statements. Additional information regarding these factors appears in 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 subsequent Form 10-Qs, which are available at sec.gov and 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, a review of the first quarter from Russ, along with our updated '21 financial outlook. Howard will provide closing remarks and we will post a question-and-answer session.

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

Thanks, Joanne. Good morning, and welcome, everyone. I'm happy to be speaking with you all today and look forward to discussing Masonite's great first quarter results. But before I get to that, I'd like to thank those of you who were able to join us for our 2021 Virtual Investor Day. We've received a lot of positive feedback. So for those of you that couldn't join us, I'd like to revisit a few of the key highlights from the event. These are important as we believe this is how we will create value for shareholders going forward.

One area I'm particularly proud of is our strong leadership team. A key goal of our Investor Day was to provide you with access to a broader set of the management team. Since I joined Masonite, we've established 2 new roles to help our company focus on growth, and we gave investors an opportunity to meet our Chief Marketing Officer, Jennifer Renaud; and our Chief Innovation Officer, Cory Sorice, and hear a little more about their backgrounds and how their teams are helping drive our Doors That Do More strategy. We also caught up with our business leaders to hear how they're aligned with this strategy and discuss operational plans to support growth.

Moving to the center of the slide, we spoke about the 3 pillars of our Doors That Do More strategy, deliver consistent and reliable products, drive specified demand, and win at the last point of sale. We've spoken at some length this past year about how our North American investment plan has been focused on quality assurance, including improved raw materials and packaging and investments in strategic inventory to improve our lead times and service metrics. This is the first pillar and foundational for all that we do.

Second, we plan to increase specified demand for our products through Doors That Do More. Through our research, many consumers have told us that they want more from their doors. Yet today, most demand is unspecified, indicating that they do not receive any particular manufacturers focused on meeting their needs. Our goal is to drive demand to Masonite by developing and offering more innovative products. Examples include our new exterior smart door system and our interior SWITCHiT product, both of which Cory showcased at our Investor Day. We believe we can create a strong and sustainable preference for Masonite by offering products that deliver distinct benefits to consumers when and where they need it.

Third, our goal is to win at the point of sale. Our research shows that substitution is very common, and 94% of homeowners will purchase what is convenient and available at the time they are in market. We believe that the work Jennifer and her team are doing in conjunction with our channel partners to focus on down channel marketing and demand creation can change this behavior. With consistent and reliable supply, driving specified demand and winning at the point of sale, we believe we can drive incremental growth by capturing meaningfully higher prices for innovative new products, allowing Masonite to grow in excess of what the market would naturally provide.

These strategies underline the ambitious 2025 Centennial Plan we introduced at the event. This plan aspires to nearly double the top line of our company, achieving approximately $4 billion in consolidated net sales by the end of 2025. Given the improvements in our base business AUP, along with incremental product that should be margin accretive, we believe this will allow us to deliver adjusted EBITDA margins in excess of 20% by 2025. And this higher-margin rate, coupled with our disciplined capital deployment, should allow us to attain sector-leading return on invested capital.

We realize this is an ambitious plan, but we believe we have the right people and strategy in place to make it a reality. For those of you that haven't watched our Investor Day, I encourage you to take some time to visit the event link on our Investor Relations web page, where you can view the event in its entirety.

Now let's move to Slide 5 for an overview of our first quarter. Net sales increased 17% year-on-year on higher average unit price, or AUP, and continued growth in our residential businesses, both in North America and Europe. AUP was up year-on-year across all 3 segments as we continue to benefit from pricing. We saw our ninth consecutive quarter of year-on-year margin expansion, with adjusted EBITDA margins up 100 basis points. This was due to continued growth in AUP, primarily driven by our previously implemented North American pricing strategy despite some cost headwinds, largely in the form of inflation. Russ will provide an update on inflation trends when he discusses our improved outlook.

We continue to invest in the quarter with the North American investment plan on schedule and in line with our expectations. Following the quarter end, in April, Moody's upgraded our corporate credit rating from Ba2 to Ba1, reflecting their view that Masonite will benefit from residential end market tailwinds and achieve strong credit metrics. This upgrade places us just 1 notch from investment grade, aligned with our existing rating from S&P. It's nice to see our commitment to maintain a strong balance sheet being reflected in our credit ratings.

Shifting to the right of the slide, I'll touch on business and operational highlights for the quarter. Against a challenging backdrop, our operations team continued to deliver exceptionally well. At the core of our manufacturing operations is MVantage, our lean operating system, which is helping to drive continued safety improvements. While 1 accident is 1 accident too many, we are pleased to report that LTIR did improve 15% compared to the first quarter of 2020. Additionally, MVantage has continued to help drive sequential improvements in capacity.

We are making progress on our ESG initiatives. I'm pleased to say that we recently completed our first global carbon footprint assessment. This assessment has been third-party verified and will act as the baseline for our road map as we work towards science based targets. In addition to completing this assessment, we've also hired a dedicated ESG manager to focus on our sustainability journey.

Lastly, we continue to develop our Architectural optimization plan, which has been organized around 3 distinct phases. Phase 1 is focused on components. If you recall, we mentioned on our last earnings call, we had announced the closure of one of our veneer plants and will absorb its production into an existing facility. Phase II was focused on specialty doors. As part of this, we've announced -- recently announced the closure of our Springfield, Missouri style and rail door plant. Similar to our components action, we will absorb most of the production from this plant into other existing facilities.

Phase III is focused on optimizing costs in our flush door assembly plants, and we have already begun to take some actions there. Russ will quantify some of the costs related to these actions later, along with the anticipated savings. Overall, we remain encouraged by the long-term prospects of the Architectural business. We believe the actions we are taking will improve the segment's cost structure and service levels so we can support growth as commercial end market demand recovers.

With that, I'll turn the call over to Russ to provide more details on our financials. Russ?

Thanks, Howard, and Good morning, everyone. Turning to Slide 7. I'll start with a summary of our first quarter financial results. We reported net sales of $646 million, up 17% as compared to the first quarter of 2020. The growth was primarily due to a 14% increase in AUP, which was up year-on-year across all 3 segments due to price increases. We also benefited 2% from foreign exchange and 1% from higher component sales.

Base volume growth in the North American Residential and Europe segments was offset by volume declines in the Architectural segment. Gross profit increased 18% to $159 million, driven by AUP, which was partially offset by higher inflation and tariffs on raw materials, rising logistics costs, higher manufacturing wages and benefits and investments in the business.

Since outlining our 2021 outlook earlier this year, the inflationary environment has worsened. We saw higher inflation on our wood purchases than contemplated in our original outlook and experienced rapidly increasing inflation in resin due to the impact of February's severe winter weather, which extended all the way to the Gulf Coast. Wood and resin represent our 2 largest baskets of material spend. So this was a meaningful headwind in the quarter.

We also saw significantly higher inbound freight costs, particularly in the area of ocean freight. As a result, material costs increased in excess of 5% for the first quarter. Higher freight costs also impacted our distribution expense. Despite these headwinds, we expanded gross margin by 10 basis points year-on-year to 24.5%.

Selling, general and administration expenses were $84 million, up 4% compared to the same period last year, primarily driven by higher personnel costs, which includes resources to support growth and incentive compensation. However, SG&A as a percentage of sales was down 170 basis points to 12.9%.

Net income was $47 million in the quarter, an increase of $17 million from the prior year, driven primarily by higher operating profit. Diluted earnings per share were $1.89, up 59% from $1.19 in the first quarter of last year. Adjusted earnings per share increased to $1.93, which excludes charges related to our previously announced restructuring plans incurred in the first quarter. This compares to $1.24 in the comparable period last year, which also excluded charges related to restructuring actions.

Adjusted EBITDA increased 25% to $102 million, while adjusted EBITDA margin expanded 100 basis points to 15.8%. This represents the highest first quarter of adjusted EBITDA since becoming an NYSE listed company in 2013.

On the right-hand side of the slide, our adjusted EBITDA loss illustrates the significant year-on-year contribution from volume mix and price. This was primarily driven by price in the first quarter as the volume growth from our residential businesses was offset by continued weakness in our Architectural segment. We saw additional year-on-year favorability of $3 million due to foreign exchange as both the Canadian dollar and British pound strengthened against the U.S. dollar.

Next, we see the negative impact of the rising inflationary pressures I just discussed in both materials and distribution costs. We also experienced $17 million of higher factory related cost in the quarter due to higher wages and benefits, negative volume leverage in our Architectural business and weather related impacts, primarily in several of our North American residential plants.

Turning to Slide 8 then, and our North American Residential segment results. Net sales increased 24% for the prior year to $477 million, with the largest driver being a 17% increase in AUP, the result of an overlapping benefit of price. If you recall, our price increases last year were for orders placed in February, effectively yielding us only 1 month benefit, while this year's increases went into effect at the beginning of the year. This provided an outsized benefit to AUP in the first quarter.

Base volumes contributed an additional 5% to growth in the quarter. While our wholesale business was negatively affected by winter weather, which impacted both demand and our capacity in mid-quarter, our retail business continues to perform exceptionally well, supported by our previously announced new business win flows, strong POS and our ability to slightly rebuild channel inventory.

Adjusted EBITDA in the North American Residential segment was $95 million in the first quarter, a 32% increase over the same period last year. Adjusted EBITDA margin expanded 110 basis points to 19.8% despite inflation in continued business investments.

As I mentioned earlier, we saw an increasing inflation in a number of our material baskets. The rapid increases in resin prices due to weather impacts on the Gulf Coast, coupled with already rebounding oil prices, pushed material costs higher than our original expectations for the North American Residential segment.

Freight was also negatively impacted in both material and distribution costs in the quarter as we saw both inbound and outbound rates increase. I would remind you that our goal is to always maintain a favorable price cost relationship and steps we are taking that are intended to mitigate increased inflation are contemplated in our updated outlook.

Finally, our North American investment plan spending was on track for the quarter. Overall, another excellent quarter for our North American Residential team.

Turning to Slide 9 and our Europe segment. Net sales increased by 25% year-on-year to $89 million. Excluding FX, net sales grew 16% compared to the first quarter of last year. This growth was driven by base volume increases of roughly 7% as we saw continued strength in our exterior door business, up double digits year-on-year. AUP contributed another 7% to growth as we successfully realized price increases across all products and channels in the U.K., our primary European market.

Adjusted EBITDA in the Europe segment was $17 million in the first quarter, a 73% increase over the same period last year. Adjusted EBITDA margin expanded 520 basis points to 18.9% despite inflationary pressures. Margins continue to expand on the strength in our exterior business, while we experienced some capacity constraints on the interior side of the business.

Moving to Slide 10 and the Architectural segment. Net sales decreased by 18% year-on-year to $75 million due to a 22% decline in base volume as commercial end markets remained weak in the first quarter. These base volume declines were partially offset by growth of 5% from AUP as we continued to benefit from favorable price. Adjusted EBITDA margin contracted 890 basis points to 2.7%, with lower volume being the primary driver of this performance. Roughly 3/4 of our year-on-year adjusted EBITDA decline is due to lost volume and the impact of negative volume leverage with the remainder of the decline largely due to inflation.

The 3 phase plan our team is working on is designed to reset our footprint to improve our cost structure and better reflect the current demand environment, while also improving the flexibility of our network. As Howard mentioned, we have executed on Phase 1 and Phase II and have already taken some early actions for Phase III in the form of overhead reductions. The announced actions to date are expected to deliver annualized savings of approximately $5 million. We incurred some negligible restructuring charges in the first quarter, but you will see the majority of the restructuring charge, it's roughly $10 million, occurring in the second quarter.

We believe this business has the ability to earn attractive margins and support our Doors That Do More strategy in nonresidential end markets. Given the softness in those markets, it is time to aggressively reset the business. We are just beginning to see improvements in the Architecture Billings Index, suggesting that the market may have bottomed and could see eventual recovery as we enter 2022.

Slide 11 summarizes our liquidity and cash flow performance for the quarter, inclusive of unrestricted cash and accounts receivable purchase agreement and our ABL facility, which remains undrawn, our total available liquidity ending the quarter was $574 million. Net debt was $468 million, and we ended the first quarter with a net debt to adjusted EBITDA leverage ratio of 1.2x.

As Howard mentioned earlier, we're pleased to see that our focus on maintaining a strong balance sheet has been acknowledged, most recently with the credit rating upgrade by Moody's. We purchased approximately 85,000 shares in the quarter for approximately $10 million at an average price of $112.98. Cash flow used by operations was $14 million at the end of the first quarter, down from $6 million provided by operations in the first quarter of 2020. The first quarter is typically a minimal cash flow quarter given the working capital seasonality of our business. And this use of cash was not unexpected given our historically low net working capital at the end of 2020 and the higher cash taxes anticipated this year. Capital expenditures were approximately $14 million.

Now let's turn to Slide 12. On Slide 12, we provide our updated outlook for the consolidated full year 2021. Given the continued strength in residential demand, coupled with the anticipated benefit of foreign exchange tailwinds throughout the year, we now expect year-on-year consolidated net sales growth of 12% to 15% compared to our original outlook of 7% to 10%. With inflation running higher for the year than our original expectations, we would like to reiterate that our strategy is to maintain a favorable price cost relationship, and this updated outlook reflects actions designed to achieve that. This updated outlook also includes a 2% benefit from foreign exchange. On the assumption that the tailwind we realized in the first quarter due primarily to strengthening of the Canadian dollar and British pound will continue throughout the year.

With regards to our Architectural segment, our net sales expectations remained largely unchanged. On this updated net sales outlook, we now expect adjusted EBITDA to be in the range of $435 million to $455 million. While we expect to realize higher net sales, the incremental impact to adjusted EBITDA is likely to be offset largely by material inflation, which we now believe could be as much as 7% for the full year.

The timing of inflation in relation to our mitigation actions as well as the return of expenses absent last year could limit our ability to grow adjusted EBITDA margin year-on-year in the second quarter. We believe this will be temporary and anticipate meaningful full-year margin expansion again in 2021.

Moving to EPS. We now expect adjusted earnings per share in 2021 will be in the range of $8.00 to $8.60 compared to $7.40 to $8.30 in our original outlook. There is no change in our assumption for cash taxes or capital expenditures from our initial 2021 outlook. Given the increased adjusted EBITDA outlook, we would expect free cash flow of approximately $160 million to $180 million for the full year.

Now I'll turn the call back to Howard for closing comments.

Thanks, Russ. In summary, we were very pleased to have delivered a net sales increase of 17% for the first quarter as we continue to benefit from higher AUP across all segments and volume growth in our residential end markets. Strong price and mix drove adjusted EBITDA in the quarter, more than offsetting increasing inflation and resulting in our ninth consecutive quarter of year-on-year adjusted EBITDA margin expansion.

We leveraged the MVantage operating system to drive safety improvements and sequential increases in capacity. While capacity has improved, we remain focused on ensuring that we are a consistent and reliable supplier for our channel partners.

We continue to invest in the business to drive future growth as all our segments focus on strategies that support our goal of delivering differentiated products and Doors That Do More. We've increased our 2021 outlook based on favorable results in the first quarter and our expectations for the remainder of the year.

Lastly, before we start Q&A, I have an announcement to make regarding our Investor Relations department. After 13 years with Masonite, Joanne Freiberger has made the decision to leave the company for another opportunity. I want to thank her for her hard work and leadership in the organization. I've personally enjoyed my time working with her, and we all wish her well in her future endeavors. She'll be with us through the Annual Shareholder Meeting but you can always reach out to Farand Pawlak, Director of Investor Relations for any assistance.

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

(Operator Instructions) Our first question is with Josh Chan with Baird.

Just given your comments about February, at least in the North American residential channel. I was wondering if you could give sort of an update on sort of the cadence in March and into April, particularly in wholesale, how that trended exiting the strong impact of February? If you can talk about that, that would be great.

Yes, Josh, it's Tony. A couple of highlights. We did with the weather impact, we did see some slowness in both demand and our capacity with the limitations we saw, we have a pretty strong business in the south and south central part of the U.S., particularly in wholesale. So we did see a bit of a dip there. We also saw some impact as we looked at completions in the multifamily sector. So customers who are focused on multifamily felt a little dip in February as well. I would say that we got sequentially better in that demand and in our ability to supply in March as we started to recover from the weather impacts, and we continue to see very strong growth.

Through it all, we saw very strong demand and point-of-sale positivity in the retail business. And so that stayed relatively consistent and has done so. And I don't know, Russ, if you want to add some color. Across the rest of the business?

Well, I think, Tony, encapsulated it really well is that most of those impacts that we did feel from the February weather impacts were in the North American residential business and particularly in the wholesale business, given that a number of the plants servicing the interior door business were impacted by that. But the door fabrication plants, they have a natural amount of buffer inventory that they can continue operating to support the retail channel. And you did see a little bit of that mix shift as we continued to run our retail operations to keep up with point-of-sale that we're seeing in that channel.

And then my follow-up is on inflation. If you look at the bridge, Russ that you gave in terms of materials, factory and distribution, is it fair to think of those headwinds in Q1 basically continuing into Q2 in roughly the same magnitude just because it sounds like most of those factors haven't gone away, maybe with the exception of sort of the weather impact. So is that the right way to think about inflation looking into the second quarter?

Yes. Generally, that's true, Josh. If you step back and look at our updated outlook, we're comprehending material inflation now in the 7% range as opposed to the 4% range that we talked about earlier in the year. So 3 points alone up from material inflation. Now there are a couple of other factors that impact material spending we did see impacts from both of those in the first quarter, and a lot of that could very well continue. One factor is the fact that we do have just naturally higher inbound freight within our vertically integrated network. We're moving, for example, components, store facings, et cetera, from our facing plants to our door assembly plants, and we're moving door slabs from our assembly plants, in some cases, to our door fabrication plants to support the retail channel. So we're seeing some higher cost of freight logistics that accrue to our material cost just from that movement within our vertically integrated supply chain.

You also have some sourcing mix in there. Demand has been extremely robust, fortunately, but that is impacting our ability to supply components from our lowest cost plants. In some cases, they're maxed out. And so you're seeing us draw on a higher degree of components from some of our higher cost plants within the network, including actually bringing in some additional facings from our Ireland plant now to support certain operations in North America residential.

So those are some headwinds on the material side that we have comprehended at the outlook and to some degree, with the exception of any that will abate because of the weather impacts that we're trying to manage around the middle of the quarter, some of those headwinds will continue, however.

Our next question is with Michael Rehaut with JPMorgan.

This is Elad Hillman on for Mike. So first, on the raised sales guide, which was raised by 5%. I was curious if you could just provide a little more detail on how that breaks out by segment. I think you pointed to some stronger North America residential demand, Architectural not changed. But maybe where you're really seeing some upside and also regarding Europe.

Yes, it's Russ. I'll take that. If you look at it on a segment-by-segment basis, I guess I'd characterize it as Architectural kind of in line with our original plans. No real change there. We continue to expect pretty weak end markets throughout the year in the commercial end markets that the Architectural segment serves. Now I believe, as Howard noted, we are seeing some encouraging trends with the Architecture Billings Index. I noted that as well during the prepared remarks. That likely puts us in a position to see demand recovery in that business as we get to the end of this year and into 2022. But our outlook for Architectural currently is kind of as it was previously. The areas of strength that we're seeing across the residential business. Obviously, the bulk of that is in North American residential, but the U.K. business is continuing to recover at a little bit quicker pace than we would have expected. And we're also seeing FX tailwinds that earlier in the year, we were a little uncertain as to whether or not they would stick. If you look at the forward curves now, it would appear that they're likely to remain in place throughout the year. So if you step back and you look at that 5-point improvement in our net sales guide, midpoint to midpoint, I'd characterize 2 points of that as our best, and the other 3 points as being the combination of market strength and AUP as we get deeper into the year.

And then my second question is, looking at North America residential in 1Q. I was curious how much of the new Lowe's business win represented in terms of sales? And then also, you talked about kind of strong North America retail POS continuing. And you also talked about some rebuilding of inventory there. So I was just curious if that rebuild of inventory was indicative of some kind of slowing of market demand there or increased production on your side? And if there's still further opportunity for the rebuild?

Yes, I'll answer your last question first and just talk about the inventory situation. I would say, sequentially, our output improved through the application of all the MVantage efforts and trying to improve our capacity. So that was 1 key part of our ability to drive sequential improvements and inventory position. I would say that we just talked about a little bit of a lull in demand, particularly in multifamily and across wholesale, primarily due to weather. We saw that come back. And so we did deliver some sequential improvement in wholesale as a result of that because we were able to drive some output. We still see and we still have certainly some inventory makeup to do across all the channels, but primarily in retail. So we're going to continue to see that play out. As we see improved capacity and as we drive more output, we'll try to -- we'll be making up that inventory position on the retail side.

Yes, Elad, I think your other question was just with respect to the amount of pick up that we were having from the new business win with Lowe's in the retail channel. I think you estimated roughly 3%. I think that's in the right range. If you take a look at our annual guide for how much new business that represented, and that is fully now in place. And so that's about what we would have yielded in the increase in the first quarter.

Important to note too, this is Howard, that the POS remains strong. So it's a combination of business wins and POS, about equally split.

Our next question is with Mike Dahl with RBC Capital Markets.

So first question is kind of a 2 part around inflation and margins. I was wondering if you could put a finer point on maybe regionally when you think of the 7% full year. I mean, obviously, we're seeing worldwide issues. But presumably, the North American side is running a little hotter than some other regions given the multitude of issues there. So maybe a finer point on those inflation percentages by segment, if possible. But then the second part is your continuing comment about favorability on price cost. Your adjusted EBITDA margin guide is up 125 basis points year-on-year at the midpoint. And any sense of kind of order of magnitude we should be thinking about as far as how much of that's coming from gross margin versus SG&A leverage?

Yes, Mike, it's Russ. Let me take a shot at that, and then maybe Howard will want to add some color. Specific to your question around inflation, a significant majority of what you saw is the EBITDA impacting material cost in the quarter was indeed in the North American residential business. And that's driven by the fact that we're seeing pretty significant wood inflation in North America. Wood inflation is a global phenomenon, but it is primarily hitting North America because we are still incurring higher tariffs on wood imports. And so that's driven. In fact, if you look at just our commodity inflation by basket in the first quarter, we saw wood up low double digits. But the other category is low to mid-single digits, call it, but in all cases, effectively ahead of what our original outlook had been very early in the year. So that impact is clearly going to hit North America residential as well as some of the other dynamics, I think I mentioned on one of the earlier questions about just the higher logistics cost and moving our own components around our network to facilitate our vertical integration.

With respect to your question on the guide and margin progression, we're putting actions in place to mitigate the inflationary effects that we are seeing. But it's fair to assume that there's going to be a little bit of lag with some of those actions. And so that's why I commented during the call that in Q2, it's unlikely for -- we will fix the difficulty certainly in meaningfully growing margins on a year-on-year basis. But some of those actions that we're taking and planning would certainly give us a tailwind as we enter the third quarter. And so that is all comprehended in the outlook that I gave, and those actions should benefit us as well in gross margin.

Yes. If I can just add, Mike. Yes, I'm glad you recognized our margin increase year-over-year with our guide. I mean, we're really proud of the progress we're making on margins. We raised our margins 310 basis points last year. And the midpoint of our guide this year is in the 110, 120 basis range, on top of, as I said, a really strong year last year. So despite significantly more inflation than we had contemplated in the outlook, we're still planning very healthy margin growth to the low 17s, which I am proud of the team for.

My follow-up question is on Architectural. And so the -- it's helpful laying out details on the 3 phases. When I take a step back, that $5 million of annualized savings, and not to diminish it, but it's a little under 2% of sales, where even if you realize that, it doesn't really get you back to the levels of profitability that you were at just a couple of years ago and where I think certainly some of the long-term goals would be. So I'm wondering, is this kind of 3 phases of what could still end up being a 4, 5, 6 Phase plan? Are there kind of contingency plans in place? And any color around where that could potentially flex up in terms of the actions there?

Yes, Mike, obviously, that Architectural business had a disappointing quarter. That said, the volumes were actually a little better than we had expected. Volumes down 22% in that segment, well documented that, that commercial business is struggling right now. Now there are some encouraging suns. The ABI was north of 50. And of course, when it's greater than 50, it indicates an increase from the prior month. For the first time since February '20, it was north of 50 in February of '21. So it took a year. So we're in, what we would consider expansionary territory. Now in February, there were still some weak spots regionally and whatnot. In March, it increased to 55.6 and every measure trended positive. So we do believe -- now, there's obviously a lag because with doors, it may be 9 to 12 months later that they are putting doors on projects, but the markets are recovering. So when you look at this quarter, we had a volume and an inflation problem. We didn't have the flexibility in the network to be able to adjust for the dramatic reductions in volume, and that's what we're trying to address with our 3 phase plan. We also had some inefficiencies in the factory due to that volume leverage. And then we had quite a bit more inflation than we had planned. So between those 3 things, we had obviously troubled margins. But as we can take actions to moderate inflation, as Russ described, as we can lower the cost structure of our network through this plan, close to the [Newell] plant last quarter, we announced the closure of the style and rail plant recently, and we have to address our flush door capacity next, and we're doing some things with overhead there. Our cost structure is going to change. And then we do expect that volume is going to begin to recover. So we still like this business. We believe this business can be near at or slightly more than our margins. That's our goal with this business. We want it to be consistent with our other businesses, and we got some work to do to get there. We're committed to doing it.

Yes. And I might just add, Mike, you've talked about, is there a Phase 4, 5, 6. I wouldn't want you to think from our commentary that this means that Phase 3 is largely done. Phase 3 has just started, right? So while Phase I around components to Howard's point and Phase II around the specialty door, we've announced actions there. We're just very early in the phases of starting what we think can be additional cost optimization within our flush door footprint. So more to come on that, but I wouldn’t want you to think that the numbers that we have cited represent a fully completed plan. There's still plenty of work that the team is executing right now.

Our next question is with Noah Merkousko with Stephens.

So I wanted to go into a little bit more detail on some of the actions you're taking to impact -- to mitigate the impact of higher cost inflation outside of price? And maybe if you could talk specifically to the North American residential business?

Yes. Noah, this is Howard. Our sourcing team has been working hard on sourcing strategies to mitigate inflation, whether that's finding alternative suppliers regionally, part of the inflation is due to tariffs and antidumping duties and things like that. So that's something that's been going on for quite some time, and the team has done a terrific job actually at trying to mitigate some of the significant increases in tariffs and duties, and it's the same with inflation. So that's certainly a strategy that we use often.

You talk about the pricing as another arrow in the quiver. Surcharges. We've talked about surcharges to offset freight, for example, and they may be temporary in nature. But there's a lot of ways that we're working to try to mitigate the impacts of inflation. Russ also talked a little bit about moving components around the network in order -- when we had some of these capacity challenges, and we've been able to successfully increase our capacity sequentially, when you have capacity challenges, you're moving freight around the network more than you might normally. And so as freight, if there's inflation in freight, it hits us at a higher rate if we're moving product more frequently. So minimizing that by increasing capacity is another strategy to minimize the impacts of inflation.

And then for a follow up, you're talking about in 2Q, just given the timing of where you're seeing inflation, adjusted EBITDA margin expansion might be challenged on a year-over-year basis. Is that to say there's a possibility to see some compression that margin is lower or that it just won't be as high as we saw in the 1Q?

Well, Noah, it's Russ. I guess, Howard answered that. As you know, we don't like to provide a guide for any specific quarter. But what I can tell you is that if you look at the second quarter and some of the challenges that we're seeing around inflation, which is an industry-wide issue, clearly, and some of the actions that we're taking to mitigate that and the fact that there is anticipated to be aligned with some of those actions. That's really what informs our view that any kind of margin growth in the second quarter would be challenging to deliver. And it really becomes the ability to leverage those actions as we get into the second half, which we're pretty confident in. And that's why we've laid out the outlook for updated full-year results that we did.

Yes. The other thing to think about second quarter is, last year's second quarter, we essentially cut all discretionary spending because we had no idea what to expect relative to COVID. And so, our expense load in the second quarter relative to our comp is less than it is today on a run rate basis.

Our next question is with Jay McCanless with Wedbush.

I just wanted to ask first on the tariff and antidumping duties. Has there been any progress on that? Any signal from the administration that they may do away with those tariffs?

I don't think so, Jay. I wish we could make the call, but I don't think that's our call. So I don't think so at this point.

And then the second question I had, just talking about making up for the cost in North America residential. Have you gone to market with another price increase? Or is it going to be more trying to make it up through some of the freight surcharges you were talking about?

Yes, Jay, this is Tony. As a matter of fact it's we don't speak prospectively about price. I will say, and Russ alluded to it, certainly with the inflation that we've seen. And our mandate to remain favorable in price cost. We're going to do everything and used all those arrows in our quiver to be able to address the costs that come up. And we talked about certainly some potential challenges for Q2 margin relative to year-over-year performance. But for the full year, we expect to be favorable in that price cost relationship.

Our next question is with Steven Ramsey with Thompson Research Group.

Maybe to start with the mix factor in Europe. Can you maybe talk about how you expect mix to trend through the rest of the year? And thinking longer term, are there proactive measures you're taking to drive higher exterior mix even beyond 2021?

Yes. Thanks for the question, Steven. Exterior mix has been fantastic for our business for some time, and it continued in the first quarter. We were up sort of strong double digits in the exterior space. Our lead times are sort of back at pre COVID levels. We've aggressively increased our stock, both on hand and on the water so that we can minimize any potential disruptions due to stock outs. And so we're really proud of that exterior business. And we do aggressively and proactively generate leads and try to create demand in that business, and it's been working quite well for us.

The interior side of the business in the first quarter was softer. I would say that we had some internal challenges with capacity in our largest interior door plant driven by COVID. We had some pretty significant absenteeism in the quarter, and we actually left some business on the dock, if you will, because you couldn't get it made (inaudible) time. And absent that, we would have been essentially flat, maybe up a little bit on the interior side of the business. But we do expect the mix to continue to be strong for our exterior business or do whatever we can to drive that. And we do expect the interior business to begin to recover as well in subsequent quarters.

Yes, Steven, it's Russ. I might just add to that. You hear the management team here talk a lot about our MVantage operating system. I wouldn't want folks to think that, that's largely combined to our North American business. I mean MVantage is a global initiative for us. And so we have teams that are continually looking at continuous improvement changes and improvements that can be made in all of our plants, including our door plants over in the U.K. And so we'll continue to look at where we can from a capacity standpoint, also support what's been really, really good growth in the RRR market for entry doors specifically. And to Howard's point, it's been a really nice tailwind for our business in the Europe segment.

And then 1 more kind of adding on to that. But is there any way to quantify or even ballpark the sales that were lost in Q1 from the absenteeism? And then I guess sales or delayed sales into Q2? And then kind of thinking forward, is the labor situation involved evolving positively in the U.K.?

Yes. I'd say it was millions, not tens of millions. So not material to the total business, but probably borderline material for the European segment as far as those orders. And yes, I think it is improving. The situation is improving with labor in the U.K.

Our next question is with Reuben Garner from The Benchmark Company.

Most of my questions have been answered. I just have 1 quick follow-up on the U.K. What are -- there's been a lot of moving parts over the last year with shutdowns and stimulus or things to boost the housing economy over there. What's kind of the longer term outlook? I think most folks are pretty familiar with the U.S. dynamics. What are your thoughts on the new and R&R markets for the U.K. as we move through this year and into next year? Any high-level color would be great.

Yes, Reuben, it is an aged housing stock in the U.K. So we expect that the RRR market, particularly as it relates to our exterior door business has continued to be -- is going to continue to be strong. And we think housing in the U.K., just like the U.S., is a good bet long term. There -- the macro trends look good there. And housing stock is under built, it's aging. And so, we like it. In the U.K., like the U.S., people spend a lot of time in their homes over the last year, and they've realized that opportunities to make upgrades. And we think that, that's going to be a positive macro there, just like it is here in the U.S.

Yes, Reuben, it's Russ. I might just add that for those of you that have followed the company for several years, you know that we've been talking about some of the legislative moves even or policy moves that regulators in the U.K. have been talking about several years ago to actually promote more property being made available for development and more building by smaller builders in the U.K. and that was in recognition of the fact that the new housing stock, the new housing market in the U.K. has fundamentally been under built for several years. And there were strategies at one point in time to try to understand annual housing starts of certainly 250,000 units, whereas we had been seeing an annual run rate well below 200,000 units. Now Brexit got it the way and then COVID got in the way, but it doesn't change the fact that the tone that we feel from the regulators in the U.K. is that they recognize the housing stock is under built and where from a policy standpoint, they can continue to encourage that longer term, and they will. And that's what, in part, informs our view that it's going to be a constructive market for several years to come.

(Operator Instructions) Our next question is with Kevin Hocevar with Northcoast Research.

On the inflationary front, just revisiting that. So Russ, I think you mentioned upwards of 7% inflation for the year. And you gave all the dollar values of the inflation in the first quarter. But what was the percentage for the quarter? And it sounded like you expect relatively similar in 2Q based on an earlier question. So I'm just trying to figure out, for the full year, if you expect some mitigation, if it's going to be similar to the whole year or if maybe there's some mitigation in the back half of the year from maybe find -- mitigate the antidumping duties by finding alternative sources or whatever. But I'm trying to just get a sense for what -- what's the percent inflation in the first quarter and kind of how do you expect it to trend the full year?

Yes. If you look at the total inflation that we incurred, Kevin, in the first quarter, it was in excess of 6%. We were able to mitigate circa 1 point of that through some of the sourcing savings projects that we have in place. But yes, gross inflation was in excess of 6%. So as you can see, by our commentary on the outlook, our expectation is that certainly will continue or, in certain cases, even strengthen a little bit further.

And then on the Architectural front, you mentioned encouraging signs that -- obviously, those are leading indicators that take some time to develop. But curious, in your business, if some of the comps start getting easier in 2Q and beyond. So I'm just kind of curious if maybe 1Q is the low watermark, and we can start seeing some sequential improvements in sales and earnings. I know there is some a little bit of seasonality to the business. But I'm curious if that's kind of how you see it going to maybe 1Q is the low watermark. And we continue to see improvement from here? Or if we maybe take a step back before we take a step forward? Curious to your thoughts.

Yes. Kevin, we certainly had a difficult first quarter, as I said, on 3 fronts. Volume was way down, which hurt; inflation was up, which hurt. And then we had some factory inefficiencies due to leverage, due to that volume being down. So longer term, we certainly see some light at the end of the tunnel. Now we're taking some specific actions, as we said, through the 3 Phase plan, close the plant last quarter, announced the closure of the plant this quarter, addressing some capacity in our flush door plants. That will help our cost structure. So all these things that we're doing, I think, are going to improve this business. But the first quarter was difficult because we had a triple whammy.

Kevin, it's Russ. The one thing I might add also is just to remind everyone, this is a pretty long-cycle business, right? 80% of our revenues in the Architectural segment are related to project quotes. And those are for projects that won't go into effect or actually yield an order for, in some cases, 3, 6, 9 months out. And so we look at things like the Architecture Billings Index is more of an indication as opposed to just year-on-year comps in any other quarter. And so what we saw is that the ABI fell dramatically last year and it has stayed well. And given that, that is an indicator of market demand, 9 to 12 months in the future, the fact that it is starting to recover is encouraging, but it really doesn't indicate, in our view, any significant firming in commercial end markets until at least the end of this year.

Ladies and gentlemen, we have reached the end of the question-and-answer session, and I would like to turn the call back over to Mr. Howard Heckes for closing remarks.

Thank you, Maria, and thank you all for joining us today. We appreciate your interest and continued support. And finally, I'd like to thank Joanne, and wish her all the best. This concludes our call.

Thank you for joining Masonite's First Quarter 2021 Earnings Conference Call. This conference call has been recorded. The replay may be accessed until May 19. To access the replay, please dial (877) 660-6853 in the U.S. or (201) 612-7415 outside the U.S. and our conference ID number 13718196. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.