JELD-WEN Holding, Inc. (JELD) Q3 2018 Earnings Report, Transcript and Summary

Greetings, and welcome to the JELD-WEN Holding’s Third Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I'd now like to turn the conference over to Chris Teachout with Investor Relations. Please go ahead, Chris.

Thank you. Good morning, everyone. We issued our press release this morning and posted a slide presentation to the Investor Relations portion of our website, which we will be referencing during this call. I am joined today by Gary Michel, our CEO; and John Linker, our incoming CFO. Before we begin, I would like to remind everyone that during this call, we may make certain statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are subject to a variety of risks and uncertainties, including those set forth in our earnings release and provided in our Forms 10-K and 10-Q filed with the SEC. JELD-WEN does not undertake any duty to update forward-looking statements, including the guidance we are providing with respect to certain expectations for future results or statements regarding the expected outcome of pending litigation. Additionally, during today’s call, we will discuss non-GAAP measures, which we believe can be useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with GAAP. A reconciliation of these non-GAAP measures to their most directly comparable financial measure calculated under GAAP can be found in our earnings release and in the appendix to this presentation. I would now like to turn the call over to Gary Michel.

Thank you, Chris. Good morning, everyone. And thank you for joining us today. It’s been approximately five months since I assumed the role of CEO, and my impressions of JELD-WEN are as true today as they were per our last conference call. We have a fantastic set of assets, including a portfolio of well-known brands and an unparalleled global operating platform that allows us to manufacture and market quality products that provide beauty and security for our customers. And we have the strategy, operating model and team of associates to transform the company into a lean, world-class manufacturing processes as defined in our business operating system call the JELD-WEN Excellence Model. For these reasons, I am fully confident that we will achieve our long-term margin target of 15% adjusted EBITDA. This is an exciting time for JELD-WEN, and I firmly believe that the potential of this organization has never been greater. With that said, as highlighted on Page 4, our business is not without its challenges, and our execution during the third quarter did not meet my expectations. Core revenue growth was challenged by the lingering impact of prior service issues in our North American and European businesses. These issues resulted in reduced sales volumes, skewed revenue mix towards lower-margin business and led to negative productivity in labor and freight. While we did realize sequential price improvements in North America, materials and freight inflation continue to be a challenge. Our service levels have been normal for several quarters, and we are executing on plans to regain share with existing customers and expanding our efforts to win business with new distribution partners. We are optimistic that these initiatives will result in improved core revenue growth in 2019 and beyond. Additionally, we are focused on implementing improved process discipline to drive pricing and productivity and return the business to core margin improvement in 2019. We continue to integrate our recent acquisitions, and I'm pleased to report that the integrations and financial results are on plan. Now on Page 5, I’ll provide a brief summary of our third quarter financial results. Net revenues for the quarter increased by 14.7%, driven primarily by a 17% contribution from acquisitions. Core revenue was unchanged compared to the same quarter a year ago as positive pricing actions taken in North America and Europe were offset by unfavorable volume and mix across each of our three geographic regions. Our net income during the quarter decreased by $22.4 million year-over-year, to $28.9 million due in large part to increased SG&A related to a contingency expense associated with our ongoing Steves litigation, partially offset by discrete tax benefits. Adjusted EBITDA during the quarter was $132.9 million, within the range provided on October 15, 2018, but below our August guidance of $143 million to $153 million as core margins declined 132 basis points. Our core margins were affected by weakness in volumes, which drove an unfavorable mix variance and continued headwinds from freight and material inflation. During the third quarter, we repurchased 1.4 million shares of our common stock for $36.6 million. Year-to-date, we've returned $38.6 million to share holders. Net leverage remains at approximately three times which is at the upper end of our targeted range. However, our balance sheet and liquidity remains strong. Our leverage position should improve in the fourth quarter due to seasonal changes in working capital. Lastly, I'd like to take this opportunity to thank Brooks Mallard for his service and congratulate John Linker on his promotion to CFO. Brooks has been an integral member of the executive team for the past four years, having made numerous contributions to our finance function and preparing JELD-WEN to become a public company. The board and I have the utmost confidence that John will help to drive the organizational change that JELD-WEN needs. And with that, I'll turn it over to John to provide a detail review of our financial results for the quarter.

Thanks Gary. Starting on Slide 7, for the third quarter, net revenues increased 14.7% to $1.1 billion, the increase was driven primarily by the contribution of recent acquisitions, partially offset by a small headwind from foreign exchange. We reported net income of $28.9 million for the third quarter, a decrease of $22.4 million. The decrease in net income was primarily due to higher SG&A from the litigation contingency booked in the quarter, partially offset by discrete tax benefits related to the revaluation of our previous estimates for the impact of U.S. tax reform. For the quarter, diluted earnings per share was $0.27 and adjusted diluted earnings per share was $0.40. Adjusted EBITDA increased 3.7% to $132.9 million. Adjusted EBITDA margins decreased to 120 basis points in the quarter to 11.7%, as margins were unfavorably impacted by recent acquisitions and reduced profitability in our core business. Core business profitability was impacted by lower volumes in our U.S. windows and Canadian businesses and related labor and freight inefficiencies as well as unfavorable mix in our U.S. and Northern Europe businesses. Our core business adjusted EBITDA margins decreased approximately 130 basis points, which I'll describe more in a moment as we get into the segment detail. Relative to our outlook provided in August for the third quarter, approximately two thirds of the shortfall was due to North America and the other third due to Europe. Australasia’s results were in line with our expectations for the quarter. Additionally, I'll note that SG&A expenses increased by $91.1 million due to the $76.5 million litigation contingency and the impact of recent acquisitions. Excluding these factors, SG&A in the core business did not change materially compared to last year. We recognized the tax benefit and the quarter of $31.6 million, compared to tax expense of $13.0 million in the same period last year. In the third quarter, we recognize the $59.8 million discrete tax benefit primarily due to adjustments to our provisional estimates of U.S. tax reform. Excluding this discrete benefit, we expect a 2018 effective book tax rate of 32% to 36%, which includes the impact of the GILTI provision of tax reform. Our current accounting policy on GILTI is to treat the additional tax as a current period expense, which we expect will continue to have an impact on our book tax rate of approximately 800 basis points until our U.S. deferred tax assets are fully utilized. We continue to await additional guidance on GILTI from the U.S. Treasury in order to evaluate our options for accounting for the GILTI tax. Slide 8 provides a buildup of our revenue drivers. Here you can see that our core revenue in the quarter was unchanged as a 2% benefit from pricing was offset by a 2% decrease in volume mix. Pricing was favorable in both North America and Europe and flat in Australasia. Next, I'll move to the segment detail beginning with North America on Slide 9. Net revenues in North America for the third quarter increased 16.8%. The increase in net revenues was primarily due to a 17% contribution from the acquisitions of ABS and MMI Door. Core revenue was unchanged as improved pricing was offset by lower volumes and in U.S. windows and Canadian businesses. A 3% benefit from North America pricing in the quarter represented a sequential improvement from the 2% benefit we realized in the second quarter. Adjusted EBITDA in North America increased 2.0% to $84.1 million. Adjusted EBITDA margins decreased by 180 basis points. The decrease in margins was primarily due to 100 basis point decline in core EBITDA margins and the dilutive impact of our recent acquisitions. Core business profitability was impacted by productivity inefficiencies from lower-than-anticipated volumes as well as unfavorable channel mix, which impacted price realization needed needed to offset inflation, and materials and freight. On Slide 10, net revenues in Europe for the third quarter increased 10.5%. The increase in net revenues was primarily due to a 13% contribution from the acquisition of Domoferm, offset by a 2% unfavorable impact of foreign exchange. Core revenues were unchanged as a 1% benefit from improved pricing was offset by a 1% reduction in volume mix, driven primarily by performance in our northern Europe business. Adjusted EBITDA in Europe, decreased 15.7% $28.1 million. Adjusted EBITDA margins decreased 300 basis points. Margins were impacted by the dilution from recent acquisitions, as well as 250 basis points of margin compression in the core business. Core business margins were negatively impacted by productivity and efficiencies from lower volumes, as well as unfavorable mix and material inflation. On Slide 11, net revenues in Australasia for the third quarter increased 14.0%. The increase in net revenues was primarily due to a to 23% increase from recent acquisitions, partially offset by a 7% unfavorable impact of foreign exchange and a core revenue decrease of 1%. Volumes in Australasia segment where sequentially weaker in the quarter, as we now see the impact of a softening of the Australia residential new construction housing market. Adjusted EBITDA in Australasia increased 14.7% to $26.3 million. Adjusted EBITDA margins expanded by 10 basis points to 14.9% as a result of an improvement in core margins of 50 basis points, partially offset by the impact of acquisitions and foreign exchange. On Slide 12, I'll provide a brief update on our cash flow and balance sheet. Compared to last year, year-to-date cash flow from operations decreased $86.3 million and free cash flow decreased to $134.1 million. The decrease in cash flow from operations was primarily due to timing differences versus prior year terms changes with a few key customers and higher seasonal inventory. We expect these year-over-year working capital comparisons to improve in the fourth quarter due to seasonal cash inflows and the reversal of timing differences from 2017. Additionally, capital expenditures were higher by $47.8 million as we resume normal levels of spending after slower rate of spend in 2017. On the balance sheet, net debt increased by $327.5 million since the beginning of the year due to the three acquisitions we closed in the first quarter and our recent share repurchase activity. As of the third quarter, our net leverage was 3.0 times, compared to 2.4 four times as of the beginning of the year. Our balance sheet and liquidity remains strong to fund our strategic initiatives. Now I'll turn it back over to Gary to go through our updated 2018 outlook and our long-term margin improvement plan.

Thank you, John. Beginning with our financial outlook on Page 14, we are affirming the updated guidance provided in our pre announcement on October 15 for the fourth quarter and full year 2018. For the fourth quarter, we expect adjusted EBITDA of $99 million to $140 million, compared to $103.1 million in the fourth quarter of 2017. Fourth quarter adjusted EBITDA will benefit from the contribution of recent acquisitions and pricing actions taken earlier in the year, offset by ongoing core margin compression from volume related inefficiencies and inflation. For the full year, we now estimate net revenue growth of 15% to 17%, compared to our previous outlook of 16% to 18%. At the midpoint, our outlook assumes 1% core growth, 14% contribution from acquisitions, and 1% favorable benefit from foreign exchange. Our assumption for core growth has decreased due to the volume weakness experienced in Q3 and expected in Q4. Our outlook for adjusted EBITDA for full year 2018 is now $455 million to $470 million compared to our outlook provided in August of $500 million to $520 million and $437.6 million for 2017. The midpoint of our guidance assumes that core adjusted EBITDA margins will decline by approximately 70 basis points due to the issues I previously discussed on the third and fourth quarters. We expect capital expenditures of $100 million to $110 million for 2018, a reduction of $5 million at the midpoint from our previous guidance of $100 million to $120 million when compared to $63 million in 2017. The modest reduction at the midpoint compared to our prior guidance is due to the timing of certain projects moving from 2018 into 2019. I would like to discuss with you the details of our long-term plan to improve margins through productivity initiatives, and footprint rationalization and why we remain committed to our 15% EBITDA margin target. Beginning on Page 15, you will see how JELD-WEN compares to a group of our peers on several key metrics. Based on revenue size, we're approximately 55% larger than our peer group median and in the top 30% of the group, providing significant scale, yet our cost structure and labor productivity put us in the bottom quartile of our peer group based on profitability as evidenced by the variances and adjusted EBITDA margins and earnings per employee. There is no fundamental basis or competitive rationale for why this performance disparity exists. For this reason, we believe there is significant opportunity to improve margins and close the gap versus our peers through manufacturing overhead reduction and productivity improvements across the business. Turning to Slide 16, you can see the roadmap of how we will drive margins on today's volumes from 10.6% towards our 15% plus EBITDA margin target through equal parts of global footprint consolidation and cost productivity through JEM. We expect each leg of the strategy to drive annual cost savings in excess of $100 million and contribute approximately 450 basis points of cumulative margin improvement by 2022. The impact of these initiatives will be to increase total throughput and reduce costs and complexity, while improving quality safety and service levels to our customers. Page 17 provides the strategic overview of our footprint consolidation plan. By leveraging idle square footage at a number of our recently acquired manufacturing facilities, and by increasing effective spare capacity through productivity initiatives, targeting standard work and the automation of key processes, we can reduce the complexity of our global manufacturing footprint. We plan to relocate smaller, less efficient plants from remote locations to larger, centralized facilities with greater access to resource supply chains and more attractive freight lanes. As we relocate the facilities, we will standardize production processes and selectively automate labor intensive processes. The result of all of this will be improved service levels for our customers and a more profitable organization capable of responding more quickly to changing market conditions. Turning to Page 18, I'll highlight the financial impact of our global footprint consolidation plan. We've already begun executing our plan to reduce the number of manufacturing facilities and will utilize a standardized approach to consolidate approximately 25 facilities into our existing manufacturing footprint. This is about a 20% reduction in our total facility count and will drive approximately $100 million in annual cost savings by 2022. Project plans are complete on three quarters of our total expected cost savings or $75 million. And I expect project plans for the remaining $25 million to be finalized by early next year. We have plans to reduce our footprint within each geographic region and expect nearly 70% of the annual cost savings from this program to emanate from North America. While our annual capital spend will increase by approximately 1% of sales for the next two years to fund this restructuring, these projects carry high returns with payback periods of roughly 2.5 years. Most of the annual cost savings will be realized beginning in 2020 and 2021. However, we do expect savings of approximately $15 million in 2019. On Page 19, I'll highlight our JEM business operating system, which we expect to drive another $100 million in savings or 3% of cost of goods sold over the next few years. JEM is the cornerstone of our business and it begins with a simple philosophy of eliminating waste in all aspects of our operations. JEM is based on building a culture of problem solving, using standard work, visual management, and proven lean manufacturing tools to drive continuous performance improvement. We expect to deliver cost productivity in materials, labor, freight and overheads through the rigorous deployment of JEM tools across the enterprise. While we have already started the deployment of JEM tools at JELD-WEN, we're still early in our journey and the best is yet to come. I'll wrap things up on Page 20 with a few summary comments. I believe in the strategy and operating model of the business and in the ability of our engaged associates to deliver consistent performance. This gives me confidence that we can exceed our customers' expectations, achieve our long-term financial targets, and create shareholder value. In near-term we will continue to focus on our operations to improve customer service, delivery and quality in order to drive more revenue growth, while also improving cost productivity. We've begun to execute on the initial phase of our footprint optimization plan and are doing so in a way that maintains the highest level of service, quality and safety. We will remain focused on managing the substantial inflation on materials and freight as well as tariffs. We will be disciplined on price, but mindful with respect to core growth. And lastly, we're focused on delivering acquisition synergies from our recent M&A. Prior to opening the line for questions, I'd like to provide you with a brief update on our Steves litigation. However, we will be unable to answer any questions during the Q&A Session on this matter. As many of you are aware, we received an opinion and draft order relating to the remedies portion of the case, which we announced on October 6. As a result, we've elected to take a charge of $76.5 million in this quarter, which includes the trebling of $12.2 million of past damages plus estimated legal fees. We, along with Steves, have been asked by the court to submit additional briefings to the district court before the final judgment can be made. We currently anticipate a final judgment later this year at which point we can begin the appeals process. We remain steadfast in our opposition to the jury's original verdict, as well as the remedies being considered, and we believe that we have a strong basis for appeal. Now, I'll ask the operator to open the line for Q&A.

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Thank you. The first question comes from the line of Susan Maklari with Credit Suisse. Please proceed with your question.

Thank you. Good morning. Thanks for all the detail on the plans, it's really helpful. I guess one thing that I did want to delve into a little bit is can you give us some sense of what the sort of backdrop that this plan is built to as it relates to housing? It seems like we've seen things maybe slow down a little bit more recently. So can you just give us some sense of how this compares to what's expected from that perspective? And if there are any changes in demand, how would that impact or flow through this plan?

Thank you Susan for the question. This is Gary. Listen, we've built our improvement plan on really what I would call self-help. We clearly pointed out that on today's revenue levels we would get to the earnings levels that we have projected here. So the rooftop consolidation piece, the deployment of our business operating system called JEM, and the tools and productivity that we’ll get from that is really based on a kind of a flat revenue picture going forward. Any revenue growth that we see would be a tailwind to that program. The other caveat to that being that we continue to be able to get price to offset inflation or if there were a downturn obviously inflation stays in check. So while we may see some seasonal changes or some slow down in housing today, the other side for us is we have the opportunity to gain share and to recover from some of the service issues that we had last year that we talked about in our windows business. So we feel like we've got the opportunity to continue to increase our revenue in light of kind of our own picture versus the market. But we're not banking on significant growth in revenue in order to make this improvement plan work.

Okay, thank you. And then my next question is just around the pricing that seemed to pick up in North America this quarter. Can you just give us some more color in terms of what you saw there, what drove that? And how we should be thinking about your ability to sustain that maybe going forward?

Yes. So we – a lot of – a number of pricing changes were made throughout the year based on inflation and tariff movement. Obviously, in the traditional channels that we serve, we've been able to get pricing all the way through in a pretty timely manner. We have a heavy reliance on the retail channel, and those are little slower on the take-up on price. Those conversations are ongoing. And while we've gotten some price in those channels, we continue to work to improve our position versus the kinds of inflation that we've seen for those products.

Okay, thank you.

Next question comes from the line of Matthew Bouley with Barclays. Please proceed with your questions.

Hi, thank you for taking my questions. So I wanted to ask about the footprint consolidation and just around the timing of it. So is the $15 million in 2019, I guess if that's the actual cost savings next year, what do you see as the run rate maybe by the end of 2019. And is it fair to assume based on your plans that it's kind of a straight line path to the $100 million in 2020 or is there any kind of weighting towards, either of the year’s in between them. Thank you.

Yes thanks for the questions John. So the way these plans are built up there is a fair amount of pre work that we have to do on the front end to lay the groundwork for these projects. We want to make sure that we keep us smooth or source of supply for our customer base, so that means we're going to have to sort of go a little slow in the beginning to go fast later on. So the buildup here is – as you noted, it's about $15 million of incremental P&L savings and in 2019. But as we get towards the back half of the year, there are certainly an acceleration there. And when we noted most of the savings do start to hit run rate towards 2020, 2021. There's some projects in the plan, for example, in North America, we've got sort of three phases of – or four phases I should say, around consolidation with our door business. And so for now we're focused on sort of the first two phases which are a couple of specific geographies. The next phases, let's call it phase three and phase four probably won’t even initiate until, 2020. And so as you get later in the period, the run rate will certainly accelerate.

Okay, that's helpful. And then secondly, on the GEM side, the $100 million there, is it fair to say that that $100 million was kind of already included within the previous targets? Or Gary, I guess, have you outlined a more specific set of JEM actions that you would say that that would lead to that $100 million estimate? Thank you.

No, I’d say you're right. I mean that was kind of built into the run rate. Keep in mind what we're doing is we're really deploying, when you think of JEM, it's really the deployment of our business operating system across the entire enterprise worldwide, so teaching the tools, deploying the tools, using them rigorously and really ensuring that we make the productivity saves, the standard work and the consistency that we really desire from having a strong business operating system. So I'd say that from a run rate standpoint, it's probably already in, but the deployment will be more consistent and a more reliable going forward.

Yes, this is John. I would just add there. We would be – what's different here around the cost productivity is the cadence and the process discipline that we're going to be driving around identifying and tracking of those individual projects which are made up of many, many, many individual projects across our footprint. But it's really the cadence that we're going to be running that.

Alright, thanks for the details. The next question is from the line of Mike Dahl with RBC capital markets. Please proceed with your questions.

Good morning. Thanks for taking my questions, Gary and John just wanted to follow-up on the last question around the productivity and, and just to push on that a little bit more. I think you're your own results this year and some things that we've seen with peers over time would suggest that, you know, in a flatter or slower demand environment, it is difficult to get net cost productivity that actually drives margin expansion. Uh, so I guess I just want to get a sense you, you outlined some of the things that are going into that, but just, you know, what is giving you the confidence that you know, that you can, like what's different about these plans that you feel confident that the productivity will really ramp like this?

This is John. Let me kick it off and then I'll ask Gary to add some color. But as you think about what happened here in 2018, as you noted, we're not delivering cost productivity this year. A lot of that ties back to the predictability of the business and our ability to plan for the demand side for the labor and freight planning that allow you to optimize. And certainly it's easier to get productivity in an upmarket scenario, but – we should have been able to get productivity in 2018, the predictability side of the business was not there on the demand side to plan the staffing and on the labor and freight side. But maybe, Gary, do you want to talk about some of the specific initiatives that we're looking at around?

I’d just say to add to that, too. Recovering from the service issues in windows last year, we've talked a little bit about that. So the costs to deploy that plus the cost is a little more to get the revenue that we went after. So really building a better discipline around looking at demand planning and forecasting how we deploy manpower and have playbooks for each level of revenue is something that we're building. And the discipline that wasn't particularly strong. We're also building the pipeline on productivity, call it material, but also working on freight. Automation where it's applicable will take cost out and give us some repeatability and some disciplines that didn't necessarily exist. So all that put together, plus the way that we've looked at the rationalization of our footprint really helps us drive productivity as well further into some of the everyday activities that we're doing. So keep in mind, we may be working on some phases, as John talked about, of the rationalization, but at the same time, we're still driving productivity in all of our operations and doing that across the entire geography.

Okay. Thank you. And if I could ask just a follow-up on that. Just in terms of timing then for how to expect that portion of the cost improvement side play out, is this something where we should expect productivity to resume in 2019? Or is this more back-end weighted?

No I think from a productivity standpoint you should still consider that that will resume back to kind of our normal run rate levels in 2019. We have our service issues behind us, we've been able to start taking that cost, that extra cost out. We're focused on, obviously, material, labor efficiency and labor costs, as well as freight, which is the, kind of the big driver, where we'll see the slower take-up. We've talked about the $50 million in 2019 for the rationalization program, but the general productivity we'll see return in 2019.

Okay. And if I could squeeze one additional clarification in there also on the…

Sure.

The $15 million, is that net of cost? Or are you treating costs as nonrecurring, onetime, separately?

That's just the savings piece. There would be some cash restructuring to achieve those savings that we would view as one time in nature. I'd say the last few years we've been running and restructuring around $13 million, obviously that number is going to have to step up a bit to support this program. The payback will be really attractive in the cash restructuring that we do spend, but I would say give us still when we issue guidance for 2019 formerly we’ll tell you what that cash restructuring piece looks like.

Okay. Thank you both.

The next question is from the line of Tim Wojs with Baird. Please go ahead with your questions.

Hi, good morning. This is Josh filling in for Tim. Thank you for the color in the restructuring program. I guess historically you and the industry has had a tendency to have a higher number of plants just overall. So could you talk about the reasons for that historically, but then also as you kind of consolidate the facilities now, how do you maintain the service levels and things of that nature?

Well, thanks Josh. So yes I think industry-wise, and I can't speak to every one of the suppliers. But typically they've been very regional, very local players that have done kind of manufacturing close to a where the use point has been for doors and windows. I can speak to how JELD-WEN got to where we are in the number of facilities that we have. If you think about our history, back to 1960, a major consolidator of the industry, some 40 acquisitions, from 1960 probably well into the 2000s that – where a lot of businesses left us to operate in their regions or areas, and now a lot of consolidation and standard work built into to putting those together. In the more recent periods since probably the mid-2012, mind-2013 time period, we've made a few more acquisitions. But we started that process of standardizing work, deploying JEM, doing those types of things that company would do to start consolidating. As we look at where we are today we have that opportunity now to standardize how we build, doors and windows, for example. We have better capabilities to automate some of those processes and really start to look at how we consolidate some of the smaller, less efficient plants and still serve the broader areas from a more centralized, more efficient, more modernized plant. So that’s kind of how we found the way to where we are today. So I look at it as a great opportunity for us to improve our earnings picture, improve our capacity and planning capabilities and still serve our customers in the best possible way that we can.

Okay. Thanks for that. And then kind of relatedly, as you focus on some of these internal initiatives, does M&A necessarily slow down? Not that M&A has been an issue, but just wondering if that pace slows down as you kind of look internally?

Well, we have a number of – so part of what we're doing is by consolidating and by integrating some of the M&A that we've already done. That's where some of these benefits also come. They help us get to this kind of next phase. So we really do have a desire to integrate the acquisitions that we've already made. That being said we still are scanning for opportunities and continue to see opportunities to add bolt-on to our core M&A, and we’ll continue to do that. We're probably going to slow down a little bit as we're doing the consolidation and the internal work, but if they – if something compelling comes along that makes a lot of sense for us to do, we’ll still consider that as part of our go forward strategy.

Okay, great. Thanks for your time and color.

The next question is from the line of Doug Clark with Goldman Sachs. Please proceed with your questions.

Hey, good morning and thanks for taking the question. My first one is on kind of the operational issues. So both windows piece in North America as well as the European piece. So first if you can just give a little bit more clarity on that European piece, what's going on there? But my real question is it's been several quarters now we're kind of the service element that's been fixed and yet volumes hasn't come back. So are there any signals that you're seeing thus far that indicate volumes or market share could come back in 2019? And then more broadly kind of what is your plan to regain some of that lost footprint?

Listen, the issues that we talked about in windows, last year really emanate from last year. They stem there over a couple of years, actually even before that where we stubbed our toes a little bit on a product launch a few years back last year on being able to meet demand. Those are behind us now we're at historical of supply levels, service levels, being – we're able to meet demand. We have capacity to meet demand. And we're starting to see that those opportunities come back. If you think about it in the short term, if we're unable to meet demand, projects continue to move forward and customers make decisions at that time in order to take care of their customers. So we've had to come back and win that business and that confidence back from customers, which we're doing today. But we are seeing some share improvement not only from existing channel partners, which takes time to build that confidence back, but also we're starting to see the advantage of our new product lines, particularly in windows that are attracting new customers and new channel partners as well. So I have a lot of confidence in our ability to win back not only the confidence of our existing channel partners, but also we're seeing some opportunities in new channel partners, new customers, who are liking our products. And as long as we continue to be able to supply that becomes – goes from a negative to a competitive advantage. So it's something that I see us being able to carry that momentum into 2019.

This is John. I'll speak to the specifics of your northern Europe question. I mean, really what happened there? Well, first of all, I’d say we have a very, very good business in northern Europe, strong market shares are across Scandinavia, and brands that give us a great market position in that area. The service level issues that we had there really started on supply chain side, we had some – there was some lumber availability issues out of eastern Europe and northern Europe, that most of the market dealt with. Also we had another supplier here more recently that has been struggling on the steel side. So that was sort of what led to us falling down on the service side. I think that the good news is we've been through some leadership transition in that business. We've got a very strong leadership team in place now with good market positions. So these are sort of temporary issues in nature where smaller competitors are nipping away at share while we were struggling to keep our service levels up as opposed to something more structural going on with that business. I think about that more short term in nature.

Okay. Thanks for the detail on both those points. And then my follow-up is also on kind of the JEM productivity piece that a few people have asked on. I guess my specific question is if I look at Slide 16, there are a number of productivity plans and savings opportunities, so labor efficiency, automation, sourcing, frayed, et cetera. I mean, can you be little bit more specific as to how large or how much of a contributor each of those buckets may be as a component of that $100 million in savings?

Yes, I think, I mean if you look at the components of our cost of goods sold, materials is roughly 50%, laborer is roughly 20%, overheads the variable overheads are another 20% and the rest would be freight. So as you think about the magnitude of the savings opportunities, I would say they probably mirror the relative magnitude of the cost structure. We showed you that one benchmarking slide specifically on the labor side though, but we do think there's probably a disproportionate amount of labor efficiency savings we can get on being more productive on the labor side, as you saw the kind of earnings per employee for our business relative to peers. But, I wouldn't say that there's sort of any one of those categories that's overweight or underweight relative to their place in the cost structure.

Alright, great. Thanks a lot.

Next question is from the line of Michael Rehaut with JPMorgan. Please proceed with your question.

Thanks. Good morning everyone. First question, I was hoping to get a little clarity on 2018, how you see the overall net contribution from price flowing through and as well as the total amount of raw inflation – I'm sorry, material inflation and freight that you expect to absorb and how those numbers are currently looking for 2019 just by extrapolating current run rates and rates of realization, from an incremental standpoint as things would incrementally flow into 2019 as well?

Good morning Mike. Yes, so as we talked about the last earnings call, we were behind on the price cost equation for the first two quarters of the year and we have said that we have hope to get to parity in the third quarter and tailwind in the fourth quarter. We did make some progress on the price side in the third quarter. But as Gary alluded to, on the channel side of things was not as favorable as we would've hoped both on price realization and the big box side, as well as just where we were getting our revenue mix from in the third quarter. So I'd say the inflation sort of came in line with what we expected in terms of the material labor and freight side. There weren't too many surprises there. As we get into the fourth quarter, we do expect to be favorable on price costs. I don't think it will be quite to the magnitude that we would have hoped at the last earnings call, but certainly we do think that will be a tailwind. And so if you look at the pricing where we are, it’s about 2% year-to-date on pricing for the entire business. So if you look at a percent of sales that would imply – you can get – kind of get to the inflation side of that. And just going into 2019, I mean, I would say if you look at the big buckets for us, freight, steel, lumber, aluminum, vinyl, I would say, just big picture, those feel like they're stabilizing and they're not necessarily getting better. But certainly we would say that freight has stabilized at these higher levels, aluminum has become a bigger piece of our business with the A&L acquisition that we did in Australia. That seems like it stabilized a bit and vinyl as well for our vinyl window side. So I guess all I have to say, as we think about 2019, we do not foresee this price/cost tailwind again to the contrary. We think about sort of price/cost favorability as we get into 2019.

Thank you John, I appreciate that. I guess second question, looking at the footprint consolidation and some initial benefits expected in 2019, I was hoping just to get a little more granular there if possible what's driving the initial $15 million? I presume that that would be more back half weighted in the year. And also as you get through the year, I mean, maybe just kind of I’ll limit the question to that. What are the key actions that is driving that initial $15 million? And again, is that more of a back half-weighted number?

Yes, so what's driving is we've already started the programs. There are some things in flight. We're not sitting around waiting for January 1 to roll around to get going in 2019. So we've started some activities there. It's really, you're going to see that in some of the early wins around labor and some overhead, early wins that just makes sense to be able to do things that we can consolidate easy without taking a lot of risk or requiring a lot of heavy lifting. What we're really doing and looking at the consolidations now is understanding and deploying our standard work across the manufacturing processes, across our forecasting and our supply chain processes, really understanding what that is, agreeing to what the standard of work is. As John mentioned earlier, going slow to go fast later. So as you think about how we take labor out putting standardized or new technology around automation of certain processes, ensuring that we have standard work so that we can collapse a number of sites into one site, is really the kind of work that we're doing. So we'll start to see savings in certain areas quite soon, but the $15 I would expect to be a full year number.

Great. Thank you.

Next question is from the line of Truman Patterson with Wells Fargo. Please proceed with your question.

Hey, good morning guys.

Good morning.

Just want to touch on North America. You guys talked about windows pressuring margins, which kind of caused 100 bps core decline. Could you guys walk us through the margin performance at the other categories and through next year doors as well?

Yes, I mean we're not going to be able to break out sort of product line level profitability for you, Truman. I mean, what I would say is we have – on the door side of the business, while we had negative core growth, negative volumes in windows in Canada in the quarter, as with previous quarters we have seen positive core growth in our door business in North America we talked about before some new business with Lowe's that we took on that started in the third quarter. So we're seeing some favorability there. But I would say the productivity inefficiencies, the headwinds around inflation between – in North America were pretty broad-based across the business, not necessarily just limited to doors or windows. I mean, North America as a whole experienced some of those issues. I guess, if you think more broadly about the quarter, I guess I would bucket it for you this way, that – think about sort of the volume and related productivity issues that we had in the quarter being about third of kind of the miss to our expectations. The mix issue that Gary mentioned being weighted a little bit more towards the retail side was probably another third. And then sort of the price cost relative to our expectation is about another third of the margin underperformance in North America. That's kind of how I'd frame it up for you.

Okay, great. Gary, now that you've had a little bit of time to digest like company and I realized that this is a bit of a multiyear turnaround story. But I'm really thinking about more near term if there's any low-hanging fruit that you see to see more immediate results. I'm thinking more in the prerelease earlier last month, I believe you guys mentioned that there was a lack of focus on execution and process discipline in the organization. Just trying to get your thoughts on some of the more near term fixes.

Yes listen, as I said in the opening, I am still as excited about, the assets that we have, the strategy that the business has laid out. And as we've mentioned before, it's really about building a process capability in the company that, we can consistently deliver. So as we're looking at building our productivity pipelines back, building the process around how we deliver on productivity, how we deliver on cost improvements and cycle time improvements quite frankly within our factories, that's where that the early wins are going to happen. Those are things that I get excited about, we’re celebrating those within the company as small wins and will continue to record those as we go along. But really the longer term approach here is to do it right, do it so that it sticks. And so it becomes the nature and the fabric of the company. We're really deploying JEM deeply into the organization and broadly around the world so that we all speak the same language, we understand what’s the best known way to do our work is and that's the only way that we're going to do it here at JELD-WEN. And that will be what delivers not only shorter term productivity and cycle time wins, but also helps us win in the marketplace and helps us do this consistently over a longer period of time.

Alright, thanks guys.

Our next question is from the line of Phil Ng with Jefferies. Please proceed with your questions.

Hey guys. It sounds like you're expecting raws to stabilize next year. But with incremental tariffs coming in, in October and January potentially, can you kind of help us quantify the potential impact? And do you expect a lag in your pricing efforts? It would be kind of helpful if you could give us a sense of how to think about the shape of your margins going into 2019. And do you expect better traction on the big box side of things? Thanks.

Sure, good morning. I would say on the tariffs my comments earlier that I made about sort of stabilizing raws and inputs was specific just to the inflationary environment. You're bringing a good point on the tariff side, obviously we're still sort of assessing, on the tariff side what's going to go through and what options we have to mitigate that by moving supply to – out of China to Indonesia or Vietnam, places like that, for example. But I would say unmitigated, the run rate impact of all the tariffs that they were to go through as outlined today, would it be about in the $15 million range for 2019. And that would be something that would certainly hold back margins a little bit on that $15 million, in terms of our core business margin improvement. But the underlying raw environment has stabilized as I mentioned earlier. Gary, do you want to talk about sort of the framework for the margin improvement side of things for 2019?

Yes, I mean we're going to continue to see improvement. We're building a productivity pipeline today for the more traditional things around material, overhead labor. That's not going to change as we continue with the first phases of our rationalization programs. We'll certainly see savings in those investments, but we can't let anybody off the hook and the rest of the company. We need to be focused on productivity above and beyond the material pieces. So we're deploying that. We've got some really nice pipelines in place and we're working on the program management capabilities in order to make sure that they happen. We build a cadence into the business now, not only in the buildup of the pipeline, but also in the deployment side of that as well. So both John and I are participating as well as the leaders of the businesses. So I think we're going to start to see more consistency there and more repeatability as we look at those cost saving activities.

Got it. That's helpful color, Gary. I guess, what initiatives are you guys taking to recapture some of that chair in your windows business in North America? What really surprised you this year on the lack of traction? And would you expect positive growth in North America overall next year?

So the hardest thing to do is disappoint a customer, particularly when they've made promises around certain projects and they've got customers to please as well, right? So we need to continue to build that confidence with our channel partners that we're not going to let them down. We've been consistent on the windows side in our ability to meet historical capabilities. That is starting to show through. But a little bit of that "show me" as well, right? And it's the timing of projects. Some of the project work that would have been delivered in the third quarter was already committed well earlier in the year. So we're starting to see customers give us their faith back. It's not like you lose 100% of the customer, you'll lose a piece and you've got to earn that back. So a lot of communication, meeting with customers and building trust, our sales folks are out there. And quite frankly even our operations folks are getting involved in it because we got to build that capability, bringing people to our factory, showing them that we can be trusted in doing that. We put some programs out there to help with that confidence building to bring people back. And that seems to be working as well. So I feel like we’ll stem that tide in 2019 and probably see some real growth from there and beyond.

Got it. That's really helpful. And just one last one last one for me. With your leverage at three times and the valuation of your stock near trough levels, how are you thinking about capital deployment as it relates to the pace of the buyback program, bolt-on M&A and debt paydown. Thanks a lot.

Listen, we're always going to favor bolt-on M&A as an opportunity to really invest in and grow our business particularly where it needs. But as I said earlier, right now, we’ve got to take the M&A that we've done, we got to integrate that within the business, really focused on this margin expansion piece as well. Given where our stock price is today, it's a good value for us. A stock buyback remains a place where we'll deploy as well. We're comfortable at 2.3 to 3 times right now with our normal flows that will probably come down towards the end of the year. We think that we can operate there under the kind of the current situation. We'd like to see that under two in the long term, maybe two years out from now. And that's kind of how we'll manage that. As far as our liquidity remains strong as John said. And we want to be situated – remain situated in a place where we can do the stock buybacks, particularly at these deals, and if a good deal comes our way, be in a position to do that as well.

Thanks a lot.

The next question is from John Lovallo with Bank of America Merrill Lynch. Please proceed with your questions.

Hey guys, thanks for fitting me in here. The first question, in speaking with some of your competitors, it seems that some of the business losses in windows might have bled over into the exterior doors with some resourcing from customers. I mean, I guess the first part is this a fair assessment? And if it is, how can you kind of win that – how do you intend to kind of go about wining that business back?

I think if you look at projects, windows and patio doors do go together. The exterior door piece is probably a separate piece typically. But yes, we're looking holistically at projects. So anything that would be on a project that we would have lost, we we'd be working towards gaining back. So yes, it's why it's important not to let the customer down. They don't think about it in terms of windows or patio door separately, they think about the project. So if you are unable to deliver one window or patio door, you would be you'd be putting the entire project to jeopardy. And that loses confidence with the customer. So I think it's accurate John that customers think about it more in terms of the total project. That's why when we think about our ability to service customers, we think about it filling orders in full because that's really how customers think about it.

Okay. That, that's helpful Gary. And then the follow-up would be going back to the M&A side of this. M&A has clearly been an important part of the story since the IPO. Now you've kind of pulled your best athlete into the CFO role. So how does that affect the strategy and the who's going to lead that effort now that John is at the CFO spot?

So thank you. I do feel like we brought our best athlete into that role. So I agree with you there. We've restructured the finance function a little bit given the capabilities of John and the M&A function that will remain with John. Within finance we've made some other changes to things like IT, for example, which were part of the finance function are now a direct report to me and will at that level, which is a whole another subject. But the – I think John will be able to continue to manage that department and that capability. We'll shore that up with capability and other management-level people that we need to as time goes on. But given the workload that we have today, I think that we're still structured well. I mean, ultimately, the – because of the type of acquisitions that we do, the strategies are driven by the presidents of the businesses, and we work together to effect those acquisitions as a team. So I think we're structured correctly. We don't lose John. We gain the benefit across the entire enterprise, I feel, for that M&A activity.

Okay, thank you very much.

Thank you. The next question is from the line of Alex Rygiel with B. Riley FBR. Please proceed with your question.

Thank you. Could you go into a little bit more detail to explain the unfavorable mix issues in both the U.S., and the UK and Europe?

Sure. Let me take you at first. The mix issues in Europe are primarily between sort of the project business and the traditional residential business. So for us we do have a pretty significant piece of our business in Europe that's non-resi. So institutional government buildings, things like that. And so what we saw the mix shift there was more weighted towards the projects out of the business, which is typically a lower margin profile than our traditional residential side of the business. So that's not something structural in the market, just more, I’d say kind of a timing of where the growth is right now. And going back to North America, the mix issues are really between where the revenue was realized between traditional distribution and retail. And for us given the nature of what retail buys from us, which is a larger stock – a larger proportion of stocked product and less special order than traditional distribution $1 revenue on the retail side is going to typically be lower margin than a $1 revenue on the traditional distribution side. And so the mix issue in the quarter in North America was that we saw some of the share loss that we had on windows, for example, was at a traditional distribution, higher margin business, so we saw more of a weighting towards the retail side, which is a bit lower margin profile. So that's what we're talking about. We’re talking about mix.

On more of a macro basis why don't you guys think we've witnessed an uptick in volume as there has been a shift from multifamily towards more single family over the past two years?

Yes I'd say the multifamily side of things has been, at least in North America, has been a pretty strong area of growth. We continue to feel very good about both the single family, the long-term prospects for the single family side of things. I do think the labor constraints, have been a struggle for, from what we’ve been talking to our builders and our customers. Builders are just – your average builder, anecdotally, we hear are carrying less crews than they were before kind of pre crisis before the downturn. And so, our view would be labor constraints are being sort of the governor on why single-family is not growing faster.

Thank you.

And operator, we probably have time for one more question here.

Sure. That question will be coming from the line of Kathryn Thompson from Thompson Research Group.

Good morning. This is Steven Ramsey on for Kathryn. Maybe on pricing, can you discuss the puts and takes with windows and doors and has the push to win back business in windows has that required more discounts and therefore been a headwind to price in North America?

No, I would take the second part first. No, we are not using price as the impetus for getting share back. It's really around service levels. We have actually been able to get price in our traditional channels both in windows and doors pretty effectively, and you've probably seen competitively the announcements going into 2019 as well. So we feel pretty good about that. The index towards our retail business, that's where we've been a little bit slower in getting price this year. That's an ongoing conversation, ongoing activity in order to get price for both windows and doors in the retail channels. We've been successful in certain rounds, but we continue to have to work that to make sure that we stay ahead of the inflation, ahead of the inflation in that particular channel. So that's probably where the take up is a little bit slower, and the amount that we're indexed towards business has the effect in general.

Great. And then thinking about how ABS fits into the long-term improvement plan. Is there some strategic element with ABS that helps you on freight costs, or is it margin dilutive? And then there's – just since it's a little bit different of a business, how does it fit into the improvement plan going forward?

Listen, the strategy that we have is obviously to provide our customers with the best possible solution and service in the markets that we serve. That's going to be a mix going forward of owning our channels and our traditional channel partner strategy. So we're not married to one or the other. We're really looking at what's the best solution by market. So ABS certainly was a strategy – part of that strategy, serving our markets and being in the markets that we can best serve. Dilutive, certainly, upfront because it's a different type of business. It's just the nature of being in the distribution piece of the business. But it allows us to control a longer stream of the margin. It also allows us to control the service capabilities in those markets and how we serve our customers the best. Keep in mind that part of what we're talking about in the rationalization program going forward includes some of the acquired facilities that we've gotten from ABS and other acquisitions over time. If you think about it, it's not fully just a distribution business, there's a manufacturing piece of that as well. So as we go forward, making sure that we understand what's distribution, what's manufacturing and treating them in the proper part of our business as well.

Great. Thank you.

Alright, well thank you very much. We appreciate you all joining us today. Like we said at the top of the call, we're very excited about the structure of our business and the strategy going forward. We'll continue to work on our execution capabilities. We're excited about our ability to expand our margins over time, build out our JEM capabilities and become more capable in all of those processes as well. So thank you very much. We look forward to talking to some of you later in the day.

Thank you. This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.