Masonite International Corporation
Q1 2017 Earnings Call Transcript

Published: 9 May 2017

[Operator:]

Welcome to Masonite's First Quarter 2017 Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. After management's prepared remarks, investors are invited to participate in a question-and-answer session. 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.

[Joanne M. Freiberger:]

Thank you, Audrey, and good morning, everyone. I'm joined in our Tampa office today by Fred Lynch, our President and Chief Executive Officer; Russ Tiejema, our Executive Vice President and Chief Financial Officer. The information for the webcast presentation that will accompany today's call is available on our website at www.masonite.com. During this call, we will be making forward-looking statements that are subject to risks and uncertainties, which are described in greater detail in the earnings presentation and press release that we will have made available in connection with this call and in our 2016 Annual Report on Form 10-K, all of which are available on our website. Actual results may differ materially from those expected or implied. Forward-looking statements are as of the date they're made. And we undertake no obligation to update any forward-looking information beyond what is required by applicable securities law. In addition, our discussion of operating performance will include non-GAAP financial measures within the meaning of SEC Regulation G. A reconciliation of these measures with the most directly comparable GAAP measures is included in the press release and in the appendix of today's presentation. On today's call, Fred will begin with a company overview. Russ will discuss financial performance. And then Fred will summarize before opening the call up to a question-and-answer session. And, with that, let me turn the call over to Fred.

[Frederick J. Lynch:]

Thank you, Joanne. Good morning and welcome, everyone. We had a challenging beginning to the year as reflected in our first quarter financial results. Sales volume was down year-over-year, primarily due to the very strong comparable quarter in 2016. Currency also was a headwind, as expected, given the impact that last June's Brexit vote has had on the pound sterling. These two factors combined drove a $5 million decline in adjusted EBITDA as compared to last year. More disappointing, however, was the fact that the benefit of solid average unit price increases across all three business segments was offset by poor cost and operational performance in our North American Residential segment. And in a few minutes, Russ will walk you through the impact of those inefficiencies and the steps that have been and continue to be taken to address them. Despite the disappointing operational performance in the first quarter, we continued to deliver on our strategic initiatives. We started the year by launching our newly-transformed brand and website, representing a bold step in our push to make the door category more relevant in home construction and home improvement projects. Late in the first quarter, we began the initial stocking of interior and exterior doors in the Florida market with the Home Depot. The investments we're making in digital also progressed throughout the quarter. Our Digital Innovation Center and new Tampa manufacturing facility are core to the test program we plan to launch in Central Florida late in Q2 based on our experience with Door-Stop International deployed in the UK. We believe this new business model will dramatically improve the customer experience through the use of digital tools, easy door configuration and fast installation, unleashing latent demand that will expand the entire door market. And, lastly, we also purchased $11 million of our shares in the first quarter continuing our strategy to return cash to shareholders. So let's turn to slide 6. Again, while we're disappointed with our operational performance in the first quarter, we do remain encouraged by the fundamentals in the housing market and the growth prospects for the company. During the quarter, we staffed and trained operators in our Florida and Georgia operations as we began preparing for the transition of Home Depot stores in Florida to Masonite branded interior and exterior doors. As part of the efforts to improve the customer experience, we've had made improvement in aisle with new display kiosk that incorporate our new branding and packaging. This is a staged rollout that began in late March and continues today. So we expect the net sales benefit to start showing up in the second quarter and then be fully reflected in our numbers by the third quarter. We're also excited by the continued momentum in new products. Earlier this year, we introduced the Heritage Series of exterior fiberglass doors, which aligns very well with the current trending of craftsman style design and is a perfect complement to our successful interior Heritage shaker style door. The new Heritage exterior doors are available both in opaque and glazed designs with new glass lite frame designs and also have the option of our new fir-grain textures, which looks like real wood. The Heritage Series has been one of our most successful new products. And we're really pleased to be able to expand that offering to exterior doors. Combined with the success of VistaGrande offering, we saw low double-digit sales volume growth in fiberglass doors in the first quarter, helping our entry door growth rate maxed out of our interior doors. Turning to slide 7, as part of our brand launch, which we discussed on last quarter's call, we embarked on a new, multi-faceted marketing initiative. This advertising and promotion effort represents an investment in the success of our customers by driving new leads in consumers to our channel partners to drive higher consideration of doors in the homebuilding and renovation process. Our recently redesigned website helps to address the overly complex process of searching for door and educate both the trade and consumers on how to more easily select and configure a door, a door that is a perfect fit for their home. We believe reducing complexity and confusion will reduce purchase abandonment that occurs all too readily in our space. The early returns on this marketing initiative have been encouraging. We've had over 13 million media impressions and our paid media has driven over 28,000 page views on our website. One very encouraging sign is that over 50% of new website visitors were identified as pros. Meaning, we're reaching a key influencer in driving door demand. We're encouraged by the early results from this important investment in our future. Now, turning to slide 8, over the past couple of years, we have spent time sharing our progress on our investment in digital initiatives and our desire to use these tools to improve the customer experience for people looking to buy a door. To that end, we recently shared with our channel partners and customers our plan to launch a test program in Central Florida in Q2 under the ADVISAR brand. ADVISAR is an online direct order platform for select offering of prefinished and prehung premium door systems, complete with hardware, delivered to the jobsite in as little as five days. This test program is a natural extension of our investments in the Tampa area with our new manufacturing facility and our Digital Innovation Center. It also leverages our learnings from the Door-Stop International business that we acquired in the UK in 2014. We believe this is an exciting opportunity to leverage those investments and test this new model in the Central Florida market. We believe that by making doors more relevant to the consumers and making it significantly easier for consumers to shop for, select, purchase and have contractors install their doors, we can unleash latent demand and grow the entire door category. So, with that, I'll turn the call over to Russ to discuss our first quarter financial performance. Russ?

[Russell E. Tiejema:]

Thanks, Fred. Good morning, everyone. Let's turn to slide 10 to summarize our consolidated financial results for the first quarter of 2017 versus the first quarter of 2016. Net sales were essentially flat at $487 million. Excluding foreign exchange, net sales would have increased 1%. Gross profit decreased to approximately $96 million or 19.6% of net sales, a decline of 50 basis points versus a year ago. Gross margin contraction was due largely to production and distribution inefficiencies in the North American Residential business, as Fred mentioned earlier. These impacts were felt in the direct labor, overhead and distribution areas of our cost of goods sold. SG&A was essentially flat when compared to the first quarter of 2016, despite approximately $3 million of incremental spend related to our new brand launch in the first quarter of 2017. The first quarter represented a period of greatest planned spend this year for the brand launch. Adjusted EBITDA decreased 9% to $53 million and adjusted EBITDA margin decreased 100 basis points to 10.9%. Net income was approximately $24 million and adjusted earnings per share were $0.77. The increase in adjusted earnings per share was largely due to tax income in the first quarter as we recognized $5 million of tax benefit due to the exercise and delivery of share-based awards. Recall that because of new accounting standards adopted late last year related to share-based compensation, our effective tax rate can be volatile depending on exercise timing and share prices at that time. We continue to believe our effective tax rate will be in the range of 19% to 23% provided earlier this year, although it's more likely to be at the low-end of that range. Let's turn to a review of each of our reportable segments, beginning with North American Residential. Net sales increased 3% in the first quarter and adjusted EBITDA decreased 13%. Volume was down 1% when compared to the first quarter 2016, primarily as the result of a very strong prior year quarter that benefited from inventory adjustments at a large retail customer and unusually warm weather throughout the quarter, which likely benefited housing completions. The first quarter of 2017 was likely impacted somewhat by a pull ahead of sales into the fourth quarter of 2016 as well, given our announcement last October of price increases beginning in January this year. After a slow start early in the quarter, we did see sequential improvement in net sales growth each month in the quarter. We believe the first quarter of 2017 was more representative of normal first quarter order patterns. Average unit price increased approximately 4% with solid AUP improvement in both wholesale and retail, the result of both like-for-like price increases and improved product mix. Unfortunately, the benefit from improving AUP was offset by operational efficiencies in both manufacturing and distribution. In certain cases, these inefficiencies resulted from purposeful actions to support longer-term growth. For example, as Fred mentioned, we added new hires in our Florida and Georgia plants to begin servicing the new Home Depot Florida business ahead of orders that did not begin to accelerate until the second quarter. That aside, in general, we were staffed for higher levels of ordering and sales overall that didn't begin to materialize until late in the quarter. Both direct labor and overhead performance were negatively impacted by head count that was not properly flexed for the lower volume. We also were not as efficient in planning shipments and balancing production between our plants, leading to higher cost in distribution that were not mitigated by higher shipping volume leverage. We have since taken steps designed to address these inefficiencies. We've leveraged normal attrition to reduce full-time head count in our manufacturing operations from the beginning of the year to today. In a few plants, we've eliminated weekend shifts where we found them to be significantly less productive than weekday shifts. It should be noted that our plans underway to invest in updated manufacturing assets and increased automation is intended to negate the need for most weekend shifts even as demand increases further. Now let's turn to slide 12 and our Europe segment. Net sales in the first quarter were down 13% when compared to the first quarter of 2016, due primarily to the decline in value of the pound sterling. Excluding foreign exchange headwinds, net sales were down 1%. Adjusted EBITDA decreased approximately $2.5 million with weakness in the pound sterling the primary driver of the decline. Average unit prices increased almost 4% through a combination of growth from our Door-Stop business and like-for-like price increases implemented in Q1 to mitigate transactional currency impacts. Importantly, we remain optimistic about this market as demographic trends and recent macroeconomic data suggest the UK housing market can continue to grow over the long-term, supported by policies the UK government is pursuing to increase new residential construction activity. Turning to slide 13, net sales in our Architectural business were down 2% in the first quarter compared to the first quarter of 2016. Adjusted EBITDA increased 18% and margin expanded 130 basis points compared to the first quarter of last year. Volume declined approximately 11% in the first quarter as compared to a very strong first quarter of 2016, especially in our lower-priced stock door business. Average unit prices increased approximately 8% in the first quarter through continued strong demand in our higher-end verticals as well as price increases that were implemented in 2016. Because of the lag time between quotes, orders and shipments, 2016 price increases are beginning to more fully benefit 2017 net sales. The execution of our Architectural transformation is progressing as expected. Door production at our Algoma, Wisconsin plant ceased the end of last week. And we expect the plant to be fully closed by the end of the third quarter. Turning to slide 14, our balance sheet remains strong, providing us with flexibility to pursue our strategic initiatives. Total available liquidity at April 2, 2017, including unrestricted cash and undrawn ABL and an accounts receivable purchase agreement totaled $187.5 million or approximately 10% of Masonite's trailing 12-month net sales. Total debt and net debt to trailing 12-month adjusted EBITDA stood at 1.9 times and 1. 8 times, respectively, compared to 2.1 times and 1.9 times a year ago. Looking at slide 15, we continue to operate our business with focus on our long-term strategies. We believe that the growth initiatives we're investing in, combined with a continued housing market recovery, should support a compound annual growth rate of 7% to 9% for net sales through 2019. We expect that the benefit of this growth in combination with our initiatives to increase price and mix and improve our operational performance will translate to adjusted EBITDA margins between 16% and 17% by that time. While our operating performance in the first quarter was subpar and quarter-to-quarter demand has continued to be lumpy, our viewpoint on the underlying housing industry indicators and our long-term growth and profit drivers remains unchanged. With that, I'll turn the call back to Fred to summarize today's discussion.

[Frederick J. Lynch:]

Thank you, Russ. So, in summary, again, we were disappointed with the first quarter operational performance. And we believe we're taking the necessary actions to address that shortfall. This miss offsets the benefits of average unit price increases in all three reportable segments in the quarter, which is a combination of both like-for-like price increases, as well as improved mix. Importantly, during each month of the first quarter, we experienced sequential improvement in both our net sales growth and adjusted EBITDA margins. We continue to see improvement in Architectural business. And while we still have significant work ahead to fully integrate those operations and improve margins, we're pleased with the transformation projects that are underway in the business. In our Europe segment, the decline in both sales and EBITDA was primarily driven by foreign exchange. And, again, we remain optimistic about the underlying growth potential in that market. We continue to deliver on key strategic initiatives that we've outlined, including the transformation of the Masonite brand; the launch of our direct to jobsite ADVISAR test program in Florida, which we believe can dramatically improve the customer experience; and digital and marketing tools designed to change the conversation around doors, making them more relevant to consumers, designers, contractors and homebuilders. And, with that, I'd like to open the call to questions. Operator?

[Operator:]

Thank you, Mr. Lynch. Our first question comes from the line of Alex Rygiel with FBR. Please state your question.

[Alex J. Rygiel:]

Thank you. Good morning, Fred and Russ.

[Frederick J. Lynch:]

Good morning, Alex.

[Russell E. Tiejema:]

Good morning, Alex.

[Alex J. Rygiel:]

Fred, I know you don't like to give sort of current quarter, current year guidance, per se, and I do appreciate your reaffirmation of your long-term goals here. But could you give us a little bit more color looking into the second quarter? I know you mentioned that the sales volumes improved month-to-month through the first quarter. Did you see that continue in the month of April? And then as it relates to some of the operational inefficiencies in the first quarter, how should we think about those inefficiencies in the second quarter given that you'll have a seasonal positive bump in volume?

[Frederick J. Lynch:]

Yes. So I'd say the – and, again, I appreciate you respecting our approach to look at the long-term. This is a lumpy business and our viewpoint is that the underlying housing industry indicators and the long-term growth prospects of the profit drivers remains unchanged. So that's how we want to think about the business. I would say that if you look at April, April was a lot like March. It's probably the best way to describe it. And while Russ has said we've made significant impact already in the operational performance because, quite frankly, we were just overstaffed and had some high cost in a number of areas, likely anticipating higher volumes in the first quarter. We've adjusted to that. We still have more work to do. So we're in the process of adjusting to that in the second quarter as well.

[Alex J. Rygiel:]

And then, secondly, congratulations on launching the ADVISAR business in Florida. It sounds super exciting. I suspect the geographic launch is probably too small to think about financial targets for 2017 and 2018. Any color around that would be helpful. And then, earlier this morning, you had a competitor that talked a little bit about less favorable price in the second half of the year. Is there anything relative to your business that we should think about as it relates to price in the second half of the year?

[Frederick J. Lynch:]

Yes. So, I'll start with the last comment and I'm not going to comment on what our competitor says because you have to speak to them about that. With respect to the ADVISAR program, you're right. This is not something – this is a test program. It is something that we are doing in conjunction with our channel partners. So we've been very open with our existing channel partners. We believe that our ultimate business model in the U.S. will be done in conjunction with many of our existing channel partners and an opportunity for them to grow their businesses as well. So, too early to say. That's why we called it a test and trial program. But we do believe that the need to change the customer experience is critical. And we have made it too hard as an industry to be able to shop for, select, purchase and install a door in a timeframe that make sense, that would have people follow through in that program. We have seen the benefits of this in the UK by having a process that enables that. And we believe in the UK strongly that that has just added to the demand in the marketplace for us to (21

[Alex J. Rygiel:]

Very helpful. Thank you.

[Frederick J. Lynch:]

Thank you.

[Operator:]

Thank you. Our next question comes from the line of Jason Marcus with JPMorgan. Please state your question.

[Jason A. Marcus:]

Good morning.

[Frederick J. Lynch:]

Good morning.

[Russell E. Tiejema:]

Good morning, Jason.

[Jason A. Marcus:]

First question is on the Europe margin. I wanted to see if you could drill down and give us a little bit more color on some of the drivers of the margin decline in Europe. Obviously, the volumes were a bit lower. But I wanted to see if there's anything specific to call out from either a product or channel standpoint that drove that?

[Russell E. Tiejema:]

There wasn't anything – Marcus, it's Russ, by the way. There wasn't anything specific across that business that drove a big part of that, aside from foreign exchange. We did see a pretty significant FX impact on both the top and bottom lines of that business and that is largely a result of the pound sterling being down about 13.5%, I think, from Q1 of 2016. And that again is all tied back to the late June Brexit vote. So that was a pretty material driver for the business. Volume in the base business over there was actually up slightly. We saw a little bit of reduced demand in some of our components sales outside of our own UK operations. So that's really the only other thing that I would point to as a driver of the margin aside from foreign exchange.

[Jason A. Marcus:]

Okay. Great. And then just moving on to SG&A, I think, it was roughly in line with where you were last year and I think that was kind of similar to how you had talked about it. And I think you had talked about the back half of the year really as being when you would really start to see some leverage this year. I just wanted to see if you're still comfortable with that and that's how we should think about it.

[Russell E. Tiejema:]

Yeah. I would say our viewpoint on SG&A is really unchanged. We're pleased with the fact that despite the incremental costs that we had related to the brand launch that we talked about earlier that we were able to control cost elsewhere in the business, particularly within our corporate function to largely offset that in the quarter. And then, as we've commented in the past, we expected that our revenue growth story would largely be post Q1 anyhow given the very strong comp we had in Q1 of 2016. So, hopefully, we see some volume growth and continue to focus on cost control in the business. To that point we would expect the leverage to be largely back half.

[Jason A. Marcus:]

Great. Thanks.

[Russell E. Tiejema:]

Thank you.

[Frederick J. Lynch:]

Thank you.

[Operator:]

Thank you. Our next question comes from the line of Bob Wetenhall with RBC Capital Markets. Please state your question.

[Robert Wetenhall:]

Hey. Good morning. Thanks for all the color on the quarter. Fred, maybe you could frame the first quarter North America, just to help me out. Was this kind of transitory misfire from an operational perspective? And coming out of this, maybe you could tell us how we should think about the cadence of margin performance in the back half of the year, if you're able to address North American profitability issues. And it also looks like you have some easing FX headwinds in the second half of the year in Europe as well.

[Frederick J. Lynch:]

Okay. So we'll go backwards on that one, Bob. And I think we would hope that we'd have some easing FX comparisons through the second half of the year, but we're not going to count on that at this point in time. Hence, the part of our reasons for driving additional price in the European markets. When it comes to the operational piece, clearly, it was a misfire on our part. No excuses. We did not have our ducks in a row when it came into the quarter. That is atypical of Masonite with our Masonite operating system and using our Lean approach to managing our manufacturing assets. Again, we have interceded on that and are making the necessary changes, I believe, to get that back in control. We like the progress we saw as we came out of the first quarter, but we have more to do and our teams know that and our teams are going to be held accountable to making that happen. From a demand side, I'd say, we had, as I said, anticipated maybe a little bit stronger first quarter in 2017 when we compare to 2016, which was a very strong first quarter. We came into the quarter, I think we shared that in the last call saying don't expect a lot out of the first quarter. But, ultimately, I think, the fundamentals in the market are positive, right. We think about what's happening with respect to the fact that single family home supply is by all accounts probably 25% to 30% below normal. We look at the millennials coming out as unemployment improves, the opportunity for seeing that. You're hearing it from the builders, the higher level of traffic, unemployment with great reports out recently. Wages are continuing to increase. That's a good thing and a bad thing for us. And the good thing is it makes more customers – puts more customers in a position to be able to buy homes. We're definitely seeing it on the labor side as we continue to have to increase our cost of production. We are seeing wage inflation. But net, net, we'll take that because we want to see ultimately greater demand. And I think then, to a certain extent, given the current administration, we are beginning to see some mortgage availability improvements occurring. And I think that will lead to again higher household – along with higher household formation will lead to a higher demand for single family homes. So we are very positive about where things are heading longer-term. Sure I'd like to see it happen faster.

[Robert Wetenhall:]

That's a great answer. Thank you and thanks for taking ownership for the quarter as a management team. That's understandable in a business like this, especially off a tough comp. I wanted to see if you could talk a little bit about the Architectural segment. It's the lowest margin business, with the most upside in the portfolio. And it sounds like you might be walking away from some lower margin sales and you're also operationally involved with plant consolidation. So when we think about the earnings power of this business and kind of how you're reshaping it operationally, what's like the two year to three year view for this business? How do you get it to deliver profitability consistent with the other two businesses?

[Frederick J. Lynch:]

Yeah. I mean our expectation, we said this before, is that by the end of this longer-term growth cycle or growth framework that we put in place that that business will be operating at the same level as our other segments. And we believe we're taking the steps to make that happen. Russ mentioned that we made the decision last year to close one of our sites in Wisconsin. That project is essentially complete. We stopped door manufacturing there. We're just finishing up the final closure of the site. We then, therefore, expanded capability in our other plants to be able to consume that demand. We're being very thoughtful with respect to what business we want to take on in our facilities and focusing on those higher value job or higher value projects and making sure we're focusing on high-end architectural doors and a little bit less on the lower end stock product, not that we're not having that available, but we want to make sure that we're selling value and up-selling our customers. Again, with this entire focus on making this category more relevant, not just in the residential arena, but also in the commercial and architectural region. We're doing a lot of work with regards to harmonizing the product line, harmonizing the brand across multiple brands we put in place, doing what we're calling chassis optimization to make sure that the manufacturing processes, which were different at the different acquisitions that we purchased, are now going to be much more alike moving forward, which provides us the flexibility to be able to make different products at all of the different plants. We're harmonizing under – and combining the brands as well. So, again, this is a multi-year effort. Our goal is by the time we get to the end of our financial framework that we put in place that that business will be operating as well as the best businesses in the company.

[Robert Wetenhall:]

Got it. And if I can just sneak one more in. Hey, Russ, you noted that AUP is up in all three reportable segments in the business, which is a lot of momentum. Do you see price outpacing cost inflation that Fred mentioned both for raw materials like wood and lumber and labor? Thanks and good luck.

[Russell E. Tiejema:]

Yeah. Thanks for the question, Bob. I'll tie it also back to one of the questions we had earlier about the cadence of price across the year – across 2017. As you know, in October last year, we announced our wholesale price increases and we put those in place in Q1. There's really nothing that suggests that the pricing dynamic changes over the course of the year. We obviously will monitor things in certain markets outside the U.S. And if we have significant FX headwinds, we always reserve the right to relook at pricing to mitigate some of those actions or some of those aspects better said. From the standpoint of inflation, we certainly incurred inflation in Q1. It was largely on the labor and distribution sides. We had some fuel cost inflation specifically. There wasn't a significant impact of material inflation in the first quarter. We do expect that 1% to 2% guide that we had provided previously for material inflation – that probably starts to roll in Q2 and forward. From a price-cost standpoint, we think that we have more than mitigated that. We're going to continue to work projects within our sourcing team to try and also mitigate fewer cost inflation. To some degree, there is a little bit of uncertainty right now just given how the price of oil has moved around. And, as you know, we've commented in the past some of our petroleum-based resins and binders are where we see the greatest volatility in our material cost inflation. So we're going to monitor that closely and see how that plays out as we go into the back half of the year.

[Operator:]

Thank you. Our next question comes from the line of Trey Grooms with Stephens. Please state your question.

[Trey H. Grooms:]

Hey. Good morning. So just to make sure I understand your last comment, Russ, on the pricing that you have in place today that's already in the market as of the beginning of the year. That you feel that the 1% or 2% guide for material inflation that starts to flow through in 2Q that that's enough that we should see margin expansion as we look into the back half of the year or was – so more than offset the raw material inflation? Or is that something that's going to be as the year progresses we'll get back to that point and we should still expect a little bit of headwind here in the near-term?

[Russell E. Tiejema:]

I think you see headwind on material cost for the balance of the year. If you just look at the price increases that were implemented – again, announced Q4 of last year, implemented in Q1 of this year that should more than mitigate that.

[Trey H. Grooms:]

Okay. Got it.

[Frederick J. Lynch:]

Again, assuming that we don't see unforeseen inflationary pressures...

[Russell E. Tiejema:]

That's correct.

[Frederick J. Lynch:]

That we'll have to react to that, so.

[Trey H. Grooms:]

Okay. Was this – Fred, on that is so far, as you're seeing – talking to your suppliers and seeing how things are coming through the pipe, is that looking like similar to what you had thought it would look like as we started through the first quarter or is it a little bit more delayed or how has that looked from just related to your expectations so far?

[Russell E. Tiejema:]

I think it's – yeah, Trey, it's Russ. I think it's generally running in line with our expectations. Again, some uncertainty ahead just given volatility in oil prices, we'll have to monitor that but so far largely as we expected.

[Trey H. Grooms:]

Okay. And then mix just briefly, just so we can kind of get our hands around how to think about modeling that going forward if we can. Mix moves around, obviously, but exterior doors performed in line with interior in the quarter. I think last year it seemed like interior outpaced some and obviously that can impact AUP. How are we thinking about mix as we look through the year? Are you seeing anything that we should be aware of from a mix perspective as we try to start thinking about 2Q and beyond?

[Frederick J. Lynch:]

I would say that our focus continues to be on trying to drive that mix upgrade, right. Everything we're doing from a branding perspective, everything we're doing from a new products offering perspective, the focus on even this new ADVISAR model, it's all about how do we drive and capture more of the value chain and how do we drive the AUP up in the business. So that has been a very consistent strategy and we're going to continue to focus on that as we move forward. But it does show that investment is needed, right. We need to invest in things like the new Heritage exterior doors and the VistaGrande, which have been projects that have been in the works for some period of time, because those are the things that will bring us that higher levels of growth as well as higher levels of margin in each of the door categories.

[Trey H. Grooms:]

Okay. And then last one for me and this is just to really be clear and if you talk about – I know you talked on it a little bit earlier, but just a little bit more color to be sure we all understand because the market's, it's ditching (36

[Frederick J. Lynch:]

Yeah. I think we've said we're making good progress on that through the quarter. We still have more work to do and had worked on it through the month of April. So we are not satisfied with where we are today. We were clearly not satisfied with our performance in the first quarter – intend to be satisfied with our performance in the second half.

[Trey H. Grooms:]

Got it. Okay. Thanks for the clarity on that. I appreciate it.

[Frederick J. Lynch:]

Thank you.

[Operator:]

Thank you. Our next question comes from the line of Kevin Hocevar with Northcoast Research. Please state your question.

[Kevin Hocevar:]

Hey. Good morning, everybody.

[Frederick J. Lynch:]

Good morning, Kevin.

[Kevin Hocevar:]

Back to the ADVISAR program, is there something that you think at some point if successful you would be able to rollout nationwide? Or is there something special about Central Florida that's – in terms of the infrastructure you have in place there that that's an ideal market for? And also when will you have a sense of the level of success from that program? Is it a year? Is it two years? And when would you look then to – and if successful when would you look to rollout to other markets?

[Frederick J. Lynch:]

So I would say that the model does require a much higher capability from a manufacturing perspective. So the requirements for inventory accuracy, station tracking within the operation to be able to get the speed to market is considerably more demanding than what a typical – one of our typical manufacturing operations can do today. So to the extent that we were to expand it outside the Florida market it would require additional investment in our manufacturing sites elsewhere. But we feel that that's achievable and doable, all based on how the market reacts to it ultimately.

[Kevin Hocevar:]

Got you. Okay. And then you mentioned the Home Depot business win. You started to ship a little in March and then it'll start to ramp in the second and really hit the full run rate in the third. What about the – I think last quarter you mentioned you had some other business wins in the distribution channel. So, just wondering if those are showing up in the results yet. How big that is as well and how that should ramp throughout the year as well?

[Frederick J. Lynch:]

Yeah. I think with regards to – we did had some, I would say, probably more minimal business wins in the wholesale channel that came through last year. Those will typically track what's happening with respect to market completion. So we talked about the fact that both Builders FirstSource and BMC did rather large line reviews across their business last year. You can see how they performed in the first quarter with regard to their window and door categories. They are very important strategic customers. We have lots of connections in place to make sure that we're servicing them well in the marketplace. They do have very demanding customers. And likewise they put that demand back on us. So we feel good about those relationships and the opportunity there. I think it's important to note the – on the retail side, we did have a strong quarter in 2016, a very strong quarter based on some restocking. So we think we'll see more normalized approach to retail as we go through the rest of the year.

[Kevin Hocevar:]

Okay. Got you. And last question, just to clarify, you said that the AUP improvement in North America Architectural was – or, sorry, North America Residential was offset by the operational inefficiencies. So the AUP improvement in North America was $12 million. So is that about the size of the – is that what you're saying that the operational inefficiencies were about, $12 million EBITDA headwind in that segment?

[Russell E. Tiejema:]

Kevin, it's Russ. The number you're quoting was the impact on revenue from AUP. Obviously, the impact on EBITDA would be considerably less than that. As we've guided before, pure price related changes in AUP will typically drop the bottom line at, call it, 90% or so. Mix impacts to a much lesser degree than that. So I think about it from that perspective, not from the revenue perspective.

[Kevin Hocevar:]

Okay. Got it. Perfect. Thank you very much.

[Operator:]

Thank you. Our next question comes from the line of Michael Wood with Nomura Instinet. Please state your question.

[Michael Wood:]

Hi. Good morning. Thanks for taking my questions.

[Frederick J. Lynch:]

Good morning.

[Michael Wood:]

Just the commentary on the sales performance in 1Q. Is there a particular area or region or end market that didn't live up to your expectation? You talked about tough comps but also there was some...

[Frederick J. Lynch:]

So, I'll give you one example of what we saw in North America Residential in particular. So if you look at our sales to our retail channel, in the first quarter 2017, they were more than 5% down from our retail sales in the first quarter of 2016. Now we have the same store count. The POS from those stores are positive. But if you recall, if you go all the way back to 2015, one of our larger retailers did a major destocking program and then used the opportunity in early 2016 to restock it. So we spent most of the first quarter 2016 restocking that. And so in spite of the fact that the POS data out in the marketplace is in line with what the – with the market conditions, we actually saw sales from us to our retailer down on a year-over-year basis by more than 5%. And we didn't have a – we haven't lost any share in that space. So that's probably one of the indicators we can share with you understanding what happened in Q1.

[Michael Wood:]

That's helpful. But how are you going to deal with the ebb and flow, I guess? It sounds like that may be very temporary as demand snaps back. Do you have to add back the weekend shifts additional labor? How do you prevent the continued inefficiencies?

[Frederick J. Lynch:]

Yes. Obviously, that's always one of the challenges in our business and one of the reasons why we continue to focus on our Masonite Operating System approach. I will say that we were again very open that our anticipation of production in the first quarter was off. And, therefore, we were overstaffed. So we think we have a good plan in place to be able to manage that. We've been able to manage that very effectively in the past. We just had a miss in Q1.

[Michael Wood:]

Great. And just one last question, just overall manufacturing longer-term. Just curious, when you fill up the Laurel, Mississippi plant, where does production go next? What's the impact? Is that a positive or a negative for you when demand growth kind of fills out that domestic production?

[Frederick J. Lynch:]

Yes. That's an interesting question. So when you think about our utilization of our door facing operations, we have five door facing operations around the world. If you look at our utilization on a rolling 12-month average, in the first quarter of 2017, we're running the plants as we said before at around 80% on a global basis. If you look at the number in just the plants that supply North America, we're higher than that. We're in excess of 85%. Our biggest relief valve is in the – in our capability is our Ireland facility. And we're running that facility today at probably around 50% utilization. And so if you think back during the last peak, we brought all of that – we brought half the capacity of Ireland into the U.S. So, that's our large relief valve that we have available when and if needed.

[Michael Wood:]

Great. Thank you.

[Operator:]

Thank you. Our next question comes from Jim Barrett with C.L. King. Please state your question.

[Jim Barrett:]

Good morning, everyone.

[Russell E. Tiejema:]

Good morning.

[Frederick J. Lynch:]

Good morning, Jim.

[Jim Barrett:]

Fred, that ADVISAR test looks very promising. Assuming you're unable to share the required investment spend to go national with that, can you give us a general sense as to how many years it would take assuming you did run a successful test? And then a related question, given the fact your cost increase to deliver this service, is it reasonable to expect that customers would pay a premium for receiving five-day delivery?

[Frederick J. Lynch:]

Yes. So we model the – and I'll go backwards again. We model this based on what we have seen in the UK with our DSI model, which is a much, much higher average unit price and a much – as we've shared in the past, it is one of the, if not the highest margin business that we have in the system. And so the difference here is remember – and what we're selling today in a typical application in Florida could be a door slab that ends up eventually becoming a door. And we're only capturing the component portion of that value chain through the – of the value chain. If you think about this model, it's everything, including the hardware, finishing, glass, et cetera, that goes all the way through the system. So this would be a much higher revenue and margin product or I'd say business model than we would have versus our existing business. With regard to where this goes, again, this is a test and a trial. We have invested heavily to be ready for this test and trial. We're not sharing the specifics around that, including making sure that this Tampa manufacturing facility is capable of that. But when you think about where this can go, when you look at customers like large retailers and the new in-home services type work that they do or where they're actually selling products with our PSI or PSE, this is an opportunity for us to give them that model that today they are not selling doors through those models and this – and partially because of the speed of execution. This gives us the opportunity to provide that speed of execution. So that's why we believe it does have a national opportunity for us not just a regional one. But we want to test it, make sure we're making the right decisions and we want to refine it because it has to be a truly unique and differentiated customer experience and we want to make sure we get that right.

[Jim Barrett:]

And is it safe to assume that a one-year test would be sufficient?

[Frederick J. Lynch:]

I don't want to go there at this point in time on how long it's going to take. But, again, ultimately, I think that our belief is that there is significant Lean demand in this marketplace if we can change the customer experience by providing an experience that is quick, easy and simple for the consumers. And we absolutely know from empirical data that they are willing to pay for it.

[Jim Barrett:]

Sounds promising and thank you very much.

[Frederick J. Lynch:]

Thank you.

[Operator:]

Thank you. Our last question comes from the line of John Baugh with Stifel. Please state your question.

[John Baugh:]

Thank you. Good morning. Most of my questions have been answered, but maybe on the volume or demand perspective you talked. I appreciate about the example with the retail year-over-year. I'm curious, though, as you look at March and April and you mentioned obviously sequential improvement. I believe the weather a year ago was very warm in January, February so that might be part of the tough compare. But, essentially, the question is this. Is there any – as we look at say March and April relevant to whatever your expectations were for volume for the year, is there enough improvement sequentially from the start in January to where you feel good about volumes and, therefore, it's all the execution, margin issues and maybe some raw material inflation that's the issue? Or are we still looking at a somewhat disappointing volume picture relative to your expectations for the year at this juncture? Thank you.

[Frederick J. Lynch:]

And I think the way I would answer that question it's not so much the concern around the volumes. It's concern around the timing of the volume that – and when because we do believe in the ultimate demographics that are driving the new construction market. We're listening to our customers and our customers' customers from homebuilders and retailers and seeing the demand that's coming that way. So we feel confident that demand will happen. But ultimately at the end of the day, it's about timing and when that happens. And one thing that has been proven in this business is that it's lumpy and we've been – and it has to come to that in the past. So, again, very confident about the long-term framework, very confident that we can deliver on the improvements in the manufacturing. And I think, ultimately, we're confident that the market is going to provide the demand that we anticipated. It's just a matter of when.

[John Baugh:]

Okay. Thanks for answering that, Fred, and good luck.

[Frederick J. Lynch:]

Thank you.

[Frederick J. Lynch:]

Okay. And we want to thank everyone for participating in the call today. We look forward to speaking to you at the end of next quarter.

[Operator:]

Ladies and gentlemen, thank you for joining the Masonite International first quarter earnings call. This conference call has been recorded. The replay may be accessed until May 23. To access the replay, please dial 877-660-6853 in the U.S. or 201-612-7415 outside the U.S. Enter conference ID number 13659577. Thank you for your participation. You may disconnect your lines at this time.