Masonite International Corporation
Q4 2018 Earnings Call Transcript

Published: 19 Feb 2019

[Operator:]

Welcome to Masonite's Fourth Quarter and Full Year 2018 Earnings Conference Call. During the presentation all lines 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 Freiberger:]

Thank you, Melissa and good morning, everyone. We appreciate you joining us today. With me on the call today are Fred Lynch, Masonite's President and Chief Executive Officer and Russ Tiejema, Masonite's Executive Vice President and Chief Financial Officer. We also have Tony Hair, President of Global Residential joining us for the Q&A session since we're all here at the International Builder's Show out in Las Vegas. We issued a press release late yesterday afternoon with our fourth quarter and full year 2018 results. The release is available on our website at masonite.com. Before we begin, I would like to remind you that this call will include forward-looking statements. Each forward-looking statement contained in this call is subject to risks and uncertainties that could cause actual results to differ materially from those projected in such statements. Additional information regarding these factors appears in the section entitled Forward-Looking Statements in the press release we issued yesterday. More information about risks and uncertainties can be found under the heading Risk Factors in Masonite's most recently filed Annual Report on Form 10-K and our subsequent Form 10-Q. Our SEC filings are available online at www.sec.gov and our website at masonite.com. The forward-looking statements in this call speaks only as of today and we undertake no obligation to update or revise any of these statements. Our earnings release in today's discussion includes certain non-GAAP financial measures. Please refer to the reconciliations, which are included in the press release and the appendix of WebEx presentation. Our agenda for today's call we have a business overview from Fred, followed by a review of the fourth quarter and full year financial results from Russ along with our updated financial outlook followed by closing remarks from Fred and a question-and-answer period. And with that let me turn the call over to Fred.

[Fred Lynch:]

Thank you, Joanne. Good morning and welcome everyone. As Joanne mentioned, late yesterday, we released our fourth quarter and full year 2018 financial results. Net sales increased 4% in the fourth quarter as compared to the prior year due to 8% growth from acquisitions which was offset by soft end markets particularly in the month of December. As mentioned on our preliminary call earlier this month, we experience lighter than expected sales volume across the businesses in the quarter, primarily in our North American, Residential segment. Additionally we had anticipated some pre-buy activity in December due to our price increases that took effect near the end of the month, but that did not occur. The fourth quarter benefited from 3% growth related to AUP driven by price increases that were implemented earlier in the year. Adjusted EBITDA declined 10% year-on-year primarily due to lower volume and high material inflation resulting in significant pressure on margins in the quarter. Both the cost actions that were taken to address lower volumes and the price increases aimed at offsetting higher material cost occurred towards the end of the quarter and did not meaningfully contribute to our results. We do believe these actions will deliver positive momentum as we enter 2019. In early February, we announced the expansion of our asset base credit facility from $150 million to $250 million and while our capital deployment strategy remains unchanged. We're pleased with the increased liquidity to support the company. Moving to the right-hand of the slide, we continue to leverage the advantage lean operating system to drive productivity across the organization. The expanded continuous improvement team drove numerous process improvement initiatives throughout our manufacturing footprint 2018 which we'll share during this call. We continue to be pleased with the efforts from our MVantage system and believe the initiatives implemented throughout 2018 will improve efficiencies and increase throughput particularly for certain new products which had been constrained provides and improved operating platform as we enter 2019. Unit operation throughput improvements had allowed us eliminate third shifts at a number of sites, increased overtime and reduced total headcount across the organization. From the end of the quarter to the end of the third quarter to the end of the fourth quarter, we reduced companywide headcount, excluding the impact of BWI acquisition by roughly 3% while also cutting US overtime hours by over 20%. We further reduced US headcount by 2% in January. We believe the combination of our MVantage system and our restructuring plans will enable us to more effectively manage our operations in an uncertain demand environment and help address the impacts of wage and benefits inflation. Likewise, material inflation remained challenging in Q4 rising 5% in the quarter inclusive of tariff impacts. I shared previously we implemented [indiscernible] price increases to overcome this inflationary pressures. Albeit they were too late in the quarter to impact results. Moving to Slide 6, this is a look at the residential housing market data across our major geographies. Please note that the US housing data has not been published for December because of the government shutdown. So the fourth quarter data represents the year-on-year comparison for October and November with the same two months in 2017. As you're all well aware in the first two months of the fourth quarter US housing starts decline for the first time this year down 5.5% on a door equivalent basis. Additionally housing completion hit their lowest level in 15 months. While we still believe they are healthy fundamentals in the US housing markets it's hard to predict how long these lower market conditions will persist and we expect clarity will be limited prior to the spring selling season. Similarly Canadian single-family starts remain negative in the quarter down 7% year-on-year. And this is the second quarter in a row where starts were lower in both single and multi-family housing in Canada. On a more positive note, the new housing in the UK strengthened following the year-on-year decline of 9% through the first half of the year with starts up 2% in the third quarter and 15% in the fourth quarter. While that double-digit growth is encouraging it is worth noting that the December of 2017 was a particularly weak comparable. Excluding December starts will be up a more modest 4%. While encouraging we're planning for a soft end market in the UK for the time being given the uncertainty related to prolong negotiations surrounding BREXIT. While fourth quarter demand reflected this lower construction data, we saw some signs of improvement in January again as noted on our preliminary call. Early underlying February demand appeared similar, although the impact of the severe weather has resulted in a number of site closures both at Masonite and our customers. While encouraged by what appears to be a rebound from an unusually slow December and we anticipate operating in a relatively flat environment for 2019. Therefore, driving operating efficiency in the business and focusing on material margin expansion remains top priorities which we'll speak to next. On the third quarter call, we highlighted a series of cost and margin initiatives that we've been executing throughout the company and we'd like to update you on those as well as additional actions underway. Our MVantage operating system is the foundation of our continuous improvement efforts and is focused on improving quality, delivery and productivity and importantly driving increased employee engagement. The three key pillars of MVantage are training and standards which provides toolset for our improvement program. Pit crews which are performance improvement teams deploy through the companies to drive rapid improvement projects and finally plant transformations which are 13-week long focused improvement events with multiple teams across a single site addressing its higher value streams. Our teams completed seven plant transformation in 2018 and at driving at ways reducing variation and improving material cost. These events both reduce cost and added much needed capacity for our successful new Heritage and VistaGrande products that have been capacity constrained previously. We're adding additional engineers to this effort to increase the number of transformation events in 2019. We increased Kaizen events by 86% in 2018 compared to the prior year. These Kaizen events are conducted with our plants employees working on lean projects supported by our pit crews which fosters broader employee engagement. Many of these employees are also pursuing Lean and Six Sigma Belt certification and in 2018 we have the highest number of individuals receiving belt at Masonite since 2013. MVantage projects and Kaizen events also help identify opportunities where capital investments and improved efficiency through automation. In the last half of 2018 alone, we deployed over $30 million of capital to strategic investments focused largely on manufacturing to improve efficiency, cost and quality as well as expand capacity where required. If we look to the middle column, we previously mentioned the relocation of our Stockton, California cutstock components plan to Verdi, Nevada. We expect this new and much more automated plant to deliver 40% more capacity with almost 20% less headcount allowing us to lower our cost and internally supply material and reduced higher price third-party purchases. I was visiting the plant yesterday and this plant should be up and running by the end of the second quarter. We've also mentioned that we've made investments to increase throughput at our plant Monterrey, Mexico that have more than doubled that sites capacity allowing us to more cost effectively service demand across North America. We're also leveraging our global supplier footprint. We're at the second half of 2018, our supply chain team has looked to quality alternative suppliers throughout Southeast Asia and elsewhere to mitigate some of the impacts of tariffs on Chinese imports. To the extent practical, we plan to shift our supplier footprint to always maintain the lowest landed cost. Our actions to consolidate and streamline our UK shipping and warehousing operations were initiated in the fourth quarter and we expect them to be completed by the end of the first quarter of this year. Once completed, we should be better positioned to serve customers with reduced lead times and also lower our distribution cost. In January, we divested non-core floor joist business in the UK that was acquired as part of the National Hickman acquisition in 2015. We're also working on divesting two additional small non-core businesses in that region later this year. Between the plant consolidation of certain North American facilities and the initiatives already underway in the UK, we expect to greater than 10% reduction in the total of number of manufacturing locations. Meanwhile we've also worked to streamline our product portfolio reducing complexity for our channel partners and end customers to help aid in our buying decisions. These actions provide the added benefit of simplifying our manufacturing operations and improving material flow in our plans thereby reducing cost to serve. Importantly, we continue to invest in product innovation and are once again introducing some great new higher value products in 2019. For those of you attending the International Builder Show this week here in Las Vegas, you can see some of these new products including the new Livingston door. The Livingston is a truly transitional design that we believe will appeal to homeowners across all styles and regions. Through our initial customer surveys, we received over 70% preference ratings in professionals and consumers alike. Later this year, we're scheduled to launch the new Masonite exterior wood door with AquaSeal technology. We believe this will be the only factory seal exterior wood door on the market. We see this as a real differentiator in the marketplace and another example of a product that can command higher average enterprises and better margins. As you can see, we continue to take a multi-lever approach to driving margin expansion across Masonite. Let's spend some time on the restructuring actions on Slide 8. In the top section, you'll recognize actions we first discussed during our Q3 call, the UK site consolidation, the UK transition to a global business services model and the relocation of the cutstock facility from Stockton, California to Verdi, Nevada that I just mentioned. We expect these previously announced restructurings to be largely completed in the first half of 2019. Moving to the bottom of the slide, we outline the additional restructuring actions to which we plan to take a charge in Q1. Investments we made in 2018 to improve throughput in some of our lower cost plants. The Monterrey, Mexico plant in particular have enabled us to rationalize higher cost operations to consolidate one of our seven US residential interior door plans. We've also decided to closing our Architectural Stile and Rail door plant and consolidate that production into a facility we've acquired in the Graham and Maiman transaction in 2018. We communicated the closure of both of these facilities last week to employees. Both plants will begin reducing production immediately and will fully cease operations in the second half of 2019. As has been our practice, we're providing all effective employees with retention and severance benefits as we work through these transitions. We've also begun to reduce North American headcount related to SG&A and overheads. As we mentioned on the preliminary call after a detailed review of salary staffing levels as part of our 2019 budgeting process and given the uncertain market environment. We expect to reduce these functions by roughly 5% in the first half of 2019 through a combination of attrition and focused restructuring. The decision to close these two facilities and further reduce headcount elsewhere in the company was a difficult one taken after a careful deliberation. Unfortunately we were faced with an uncertain market and a rising cost environment. We know that our people are key to our success at Masonite and we'll as always treat impacted employees with dignity and respect as we go through these restructuring activities. I also want to [indiscernible] employees for their many efforts through the year on behalf of our customers. With that I'll turn the call over to Russ to discuss our financial performance and outlook.

[Russ Tiejema:]

Thanks Fred. Good morning, everyone. On Slide 10, we summarize our consolidated financial results for the quarter. We had net sales of $528.4 million, a 4% increase over the fourth quarter of 2017. Acquisitions and average unit price contributed approximately 8% and 3% respectively to this increase. This was partially offset by 6% decline in base volume part of which is attributable to the prior year retail line loss and to a lesser extend 1% headwind from foreign currency. Gross margin and adjusted EBITDA declines were largely driven by the same two issues. The continued impact of higher material costs and the abrupt slowing of orders in the fourth quarter particularly the month of December. Gross profit was down by 4.7% in the fourth quarter with gross margin declining 170 basis points versus the prior year to 18%. Adjusted EBITDA decreased 10.4% to $57.5 million while adjusted EBITDA margin contracted 170 basis points to 10.9%. Looking to our adjusted EBITDA bridge on the right side of the slide you can see the gap between volume price and mix and material cost in the quarter. As discussed in the third quarter call, we anticipated additional pressure on margins due to continued material inflation in the quarter and additional pricing not being implemented until late December. As Fred mentioned earlier material inflation exceeded 5% in the fourth quarter inclusive of the impact of tariffs. The primary drivers of inflation again were steel as our contract collars reset higher in the quarter and were more inline with the overall higher market prices and chemicals as higher oil prices earlier in the year flowed through resin cost realized in the quarter. Moving to factory costs, we see the sizable impact that lower volumes had on a productivity in the quarter, the headwind of approximately $7 million. as Fred noted earlier, we took steps throughout the fourth quarter to reduce our manufacturing costs, but the timing of those reductions was largely at the end of the quarter. As such we experienced higher year-on-year factory cost as a percentage of sales particularly an overhead as we lost absorption due to lower production volumes. Distribution and SG&A remain relatively flat in the quarter. our logistics team continued to effectively manage the higher carrier rates and fuel inflations we've seen across the industry. The slight increase in SG&A spending in the quarter is more than explained by cost at acquired businesses partially offset by lower share based compensation. Net income for the fourth quarter was approximately $12 million and diluted EPS was $0.46. diluted EPS was down $2.02 per share from $.248 per share in the fourth quarter of 2017. Primarily due to prior year tax benefits of $1.77 per share in 2017. Our adjusted diluted EPS was $0.68 in the fourth quarter of 2018 compared to $0.70 in the comparable period of 2017. Now let's look at our reportable segments, turning to Slide 11, we'll start with our North American Residential business where net sales decreased 3% in the fourth quarter and adjusted EBITDA decreased 21%. As discussed on the preliminary call, we experienced much lighter than expected sales volumes during the fourth quarter. on our third quarter call, we noted that October sales volume growth was noticeably down this trend continued in November and then we actually experienced year-on-year declines in wholesale sales volumes in December. The absence of pre-buy activity which is typically expected before a planned price increase was a contributor to sales volumes that missed our expectations. The retail portion of the business performed largely as anticipated with high single-digit decline in sales volumes year-on-year virtually all due to the impact of the previously announced line review loss. The loss will anniversary at the beginning of the second quarter of 2019. Adjusted EBITDA margins decreased 270 basis points in the quarter due to the price cost dynamics and factoring inefficiencies discussed earlier. Now that price increases are in place the business enter 2019 with a favorable price cost relationship. Similarly, the actions taken to reduce further reduce headcount subsequent to year end are expected to improve our factory cost structure in the North American Residential business. Lastly, as worth noting that while we're in the very early stages of integrating the BWI acquisition that work is progressing as planned. Turning to Slide 12 in our Europe segment, net sales increased by 23% compared to the fourth quarter of last year due to growth from our DW3 acquisition of 28%. Foreign exchange was 3% headwind and average unit price increased 1%. Base volumes were flat in the quarter which is somewhat encouraging given uncertainty across the UK economy related to the impending Brexit deadline. However, we experience reduced component sales due to lower volumes at our recently divested floor joist business in UK and lower sales of components in the Western Europe. Adjusted EBITDA grew in the fourth quarter by 22% over the comparable period of 2017. Adjusted EBITDA margin of 11.9% was down very slightly year-on-year 10 basis points as continued strong margin performance from DW3 was offset by cost inefficiencies related to the consolidation of distribution and warehousing operations announced last quarter. We maintained higher factory and distribution labors we progressed through that process and experienced elevated cost related to picking and shipping as we work through the resulting backlog. As of January, the operations were back on track and performing as intended. Going forward, we believe the consolidated shipping and warehousing operations will both reduce cost and improve service levels. Moving to Slide 13, in the architectural segment net sales increased by 19% in the fourth quarter primarily driven by 17% growth from our Graham and Maiman acquisition and 4% higher averaging price. These increases were partially offset by 3% decline in base volumes attributed largely to post ERP implementation recovery at our Northumberland, Pennsylvania plant. During that ERP implementation our backlog increased and efforts to work through that order book by year end were only partially successful preventing us from shipping as much as expected in the quarter. Post the ERP implementation issues also drove adjusted EBITDA and adjusted EBITDA margin declines in the fourth quarter. adjusted EBITDA was down 20% from the same period in 2017 while adjusted EBITDA margin decreased 410 basis points to 8.3%. in an effort to work through the customer backlog production schedules were revised causing inefficiencies. Distribution cost were also elevated in the quarter as payload efficiency was sacrificed or LTL freight was utilized to ensure customer delivery commitments were met. We largely work through the backlog and started 2019 at normal levels. We saw improving demand trends across 2018 and a continued recovery in early 2019 in our architectural business. the fourth quarter marks the second consecutive quarter of year-on-year increases in quoting activity and we saw solid year-on-year growth in sales volumes for January. While we're expecting some impact from the unusually cold wealthier earlier this month in the Midwest where several of our architectural plans were located. We remain encouraged by this improved trend in demand. Turning to Slide 14, we summarized our full year financial results. full year 2018 net sales increased by 7% compared to 2017 which was driven by growth of 6% from acquisition, a 3% increase in average unit price and a 1% positive impact from foreign exchange. This growth was offset by 3% decline in our base volume. Adjusted EBITDA increased 5.3% to $267.9 million for the full year while adjusted EBITDA margin contracted 20 basis points to 12.3%. I'd again point your attention to the adjusted EBITDA bridge on the right hand side of the slide. You can see that higher volume mix and price of $48 million was able to keep a slightly ahead of material and distribution inflation as well as higher factory cost driven impart by labor inflation which altogether totaled $46 million for the full year. material inflation excluding tariffs was 3.5% for the full year the top end of our originally expected range of 3% to 3.5% and in line with the levels anticipated as we reach the mid-year. SG&A increased 7% for the full year 2018 as compared to 2017 to $266.2 million. as a percentage of sales SG&A increased 10 basis points to 12.3% for the full year. the increase was largely due to additional cost from acquisitions including related professional fees and personnel related costs. Net income for the full year was approximately $93 million an diluted EPS was $3.33. diluted EPS was down a $1.76 per share from $5.09 per share in 2018. This decline was due to prior year tax benefits of $1.76 per share in 2017. Our adjusted diluted EPS was $3.68 in 2018 compared to $3.34 in 2017. I'll briefly recap our current liquidity profile on Slide 15 before moving to our 2019 outlook. Total available liquidity including unrestricted cash and accounts receivable purchase agreement and our undrawn ABL facility was $265 million or approximately 12% of our trailing 12 months net sales as of December 30, 2018. At the end of the fourth quarter, total debt and net debt to trailing 12 months adjusted EBITDA were three times and 2.5 times respectively. Fred already mentioned the expansion of the ABL, but I would add that in addition to increasing the size from $150 million to $250 million. we extended the maturity of the facility from April 9, 2020 to January 31, 2024 and we added assets from our UK businesses to the collateral base. While we foresee no immediate needs for this incremental borrowing capacity we're pleased to have strengthened our liquidity even further. We had our largest quarter and year for stock buybacks purchasing approximately 1.3 million shares in Q4 at an average of $55.40 per share totaling approximately $72 million in the quarter. we purchased approximately 2.8 million shares during all of 2018 at an average price of $60.22 a share or total of $167 million. subsequent to year end, we purchased an additional $18.6 million of shares at an average price of $51.34. Bringing our cumulative share repurchases to almost 22% of the shares that were outstanding when we began the program in 2016. Before we leave this slide, I'd like to point out our strong cash flow performance in 2018. We achieved free cash flow conversion of 118% for the full year as the business delivered strong operating cash flow of $203 million an increase of approximately $30 million as compared to 2017 as we focused intensely on working capital management. Capital expenditures were slightly higher than our annual outlook $75 million to $80 million as we finish the year strong in our execution of key strategic capital projects in our plans. Now let's move from 2018 to our 2019 outlook. On Slide 16, we framed up our view points on various external factors that we believe could impact our business in 2019 and initiatives we have put in place in response. The largest headwind we see in 2019 is the continued uncertainty around the housing market in both North America and the UK. As a result, we're planning for minimal growth in end markets overall. Given the current North American macroeconomic data and what we're hearing from our customers we're planning for flat new residential construction spending in 2019 and low single-digit growth in RRR. We're also planning for low single-digit growth in the UK housing market due to the continued uncertainty surrounding Brexit and low single-digit market growth in non-residential construction markets served by our architectural business. We continue to see tight US labor markets. We experienced elevated wage and benefit cost again in 2018 and expect to continue seeing low single-digit to mid single-digit, wage and benefit inflation again in 2019 as we compete for talent and deal with the impact of a very low unemployment rate. continued macroeconomic and political certainty is adding complexity to managing the business. US tariffs on Chinese imports impacted material costs in 2018 and we're currently planning for additional impacts in 2019. At the full 25% tariff rate Section 301 tariffs would be expected to yield approximately $20 million to $25 million of tariff related material costs increases annually. While our global sourcing team is negotiated with suppliers and shifted some of our sourcing footprint we're still expecting to see $10 million to $15 million of net tariff impact in 2019 when the full rate is enacted on March 1. This would represent over 1 percentage point increase to our overall material cost in addition to normal material inflation which we project to be approximately 3% in 2019. Moving to the right hand side of the slide, to the summary of the mitigating actions Fred and I have already covered earlier in the call. With this backdrop in mind on Slide 17, we present our outlook for 2019. We're expecting net sales growth of 3% to 5% year-on-year including approximately 1 point of unfavorable foreign exchange given current weakness of the Canadian Dollar and Pound Sterling versus the US Dollar. We anticipate top line growth to be driven primarily by higher average unit price. We also expect to benefit from about a point of net acquisition growth reflecting the full year impact of 2018 acquisitions offset partially by the anticipated impact of planned divestitures of non-core business in the UK. After accounting for one more quarter of year-on-year loss on previously announced retail business. the remaining contribution from end market demand growth is expected to be less than 2%. Taking into account this net sales outlook, we expect adjusted EBITDA to be in the range of $275 million to $305 million. It is important to point out that while we have a number of restructuring actions slated to help optimize our manufacturing footprint, the benefit of those actions is expected to largely occur post 2019 given the timing of facility consolidations and operating cost we expect to incur to facilitate the transition of production. We expect adjusted EPS in 2019 will be in the range of $3.60 to $4.40. this range incorporates an assumed tax rate of 21% to 24% and is based on our quarter end 2018 share count. At the midpoint of the range for adjusted EBITDA and adjusted EPS compared to full year adjusted EPS for 2018, we expect to benefit about $0.80 for higher EBITDA and about $0.20 from a lower share count, with offsets from higher interest cost associated with incremental debt issued in our bond offering last September and higher tax and share based compensation expense. Relative to key cash flow drivers, we expect cash taxes to increase slightly from $11 million in 2018 to a range of $12 million to $16 million in 2019. We continue to expect capital expenditures in the range of $75 million to $80 million and we also continue to anticipate free cash flow conversion in excess of 100%. Our updated three-year growth framework for net sales and adjusted EBITDA margin are shown on Slide 18. Market conditions have evolved since we provided the last version of this framework at our Investor Day in early March last year. at that time, we believe we could grow our net sales at 5% to 7% compound annual growth rate through 2020 considering market growth that was expected at that time and our strategies to drive higher average unit prices including investments in new products and value added services. While our AUP strategies and progress remain intact, we now expect to see lower end market growth which we believe equates to roughly 200 basis point reduction in our three-year revenue growth CAGR. This framework does not consider any incremental acquisition related net sales growth. While we did complete three acquisition over the course of 2018 after taking into account the expected divestitures of non-core businesses in the UK this year. the net income in net sales would be minimal over three-year horizon. Thus the three-year revenue CAGR included in the framework has declined to approximately 4% which would result in 2021 net sales of roughly $2.4 billion. Moving to the bottom of the slide, we detailed how our revised outlook for market growth and combination with increased inflationary pressures would translate to margin growth over the next three years. our prior long-term growth framework showed adjusted EBITDA margins of 16% to 17% by 2020. Driven by a combination of operating leverage from increased volume, higher average unit prices and net productivity in our manufacturing and distribution operations. Similar to our net sales growth assumptions, our AUP assumptions remain intact and we have been even more assertive where necessary on pricing actions to stay abreast of commodities inflations and tariffs. Albeit with some lumpy timing and price cost coverage such as we saw in Q4 last year. However given soft end markets, our framework reflects minimal impact from volume leverage. Further general labor and distribution inflation have been more pronounced that we anticipated a year ago. While our operations and supply chain teams have done a great job offsetting these were impossible. This remains a headwind that must be managed. This further underscores why we're laser focused on executing multiple actions to optimize our manufacturing footprint as Fred outlined earlier. Considering these factors and taking into account the lower baseline in 2018 that we stepped from, our updated long-term growth framework reflects an adjusted EBITDA margin of approximately 15% by 2021. And with that, I'll now turn the call back to Fred to summarize today's discussion.

[Fred Lynch:]

Thanks Russ. So to summarize, we delivered higher net sales and adjusted EBITDA in 2018 despite the increasing market uncertainty in a challenging cost environment. While we achieved higher average [indiscernible] price in Q4, it was not enough to cover our increasing cost. With the previously communicated pricing actions that took effect in the North American wholesale and retail channels later in the fourth quarter, we believe we're positioned to resume adjusted EBITDA margin expansion in 2019. Coupled with pricing, we're executing on initiatives to improve margins in each of our three business segments. Our MVantage lean operating system continues to make positive impacts from our operations improving quality, delivery, productivity and employee engagement. While we won't see much immediate impact our previously announced and additionally planned restructuring actions will help drive margin expansion in future periods. Lastly I want again thank the 10,000 employees across Masonite's who worked tirelessly to help people walk through walls and deliver an extraordinarily customer experience each and every day. And with that, we'd like to open the call to questions. Operator?

[Operator:]

[Operator Instructions] our first question comes from the line of Michael Rehaut with J.P. Morgan. Please proceed with your question.

[Elad Hillman:]

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

[Fred Lynch:]

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

[Elad Hillman:]

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

[Russ Tiejema:]

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

[Elad Hillman:]

Great. thank you.

[Operator:]

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

[Mason Marian:]

This is Mason Marian on for Mike. So you're $10 million to $15 million restructuring charges you expect taking 2019 weight out the additional actions. Now in your [indiscernible] presentation, if we step back what inning do you think you're in regarding your investments and your manufacturing footprint and should we expect, it will last beyond 2019. How many [indiscernible] in to-date versus how many you ultimately need to invest or will invest in?

[Fred Lynch:]

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

[Mason Marian:]

Okay, thank you and then. How are you thinking share repo and various investments in the business? Did you guys have continued to repurchase significant amount of stock or last year continued to do so in the fourth quarter?

[Russ Tiejema:]

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

[Fred Lynch:]

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

[Mason Marian:]

Great. thank you.

[Operator:]

Thank you. Our next question comes from the line of Michael Eisen with RBC Capital Markets. Please proceed with your question.

[Michael Eisen:]

I just want to start off on the inflationary environment on much higher levels than we expected in the beginning of the year and just thinking out to 2019, what levels of inflationary you guys forecasting in that guidance range and in so, is the 25% tariff all-inclusive in the guide that were to go away, does that represent upside or is that more gets you to the higher end of the range?

[Russ Tiejema:]

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

[Michael Eisen:]

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

[Fred Lynch:]

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

[Michael Eisen:]

Understood and then seeing it as a follow-up. [Indiscernible] about the 2021 metrics and kind of the overall profitability lowering to that 15%. Can you help us think about if that step down is evenly spread across all three segments or if one segment is going brought more of that then the rest from what prior expectations are?

[Russ Tiejema:]

I would think about the improvements that we're implementing particularly on the restructuring side, those are really broad based across the company. case in point, you saw us announced production consolidation in all three reportable segments, the North American Residential business, the UK business including actions we actually announced in prior quarter and now also some consolidation of production in the architectural business. so the focus is going to be on driving that margin of improvement across all three segments.

[Fred Lynch:]

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

[Michael Eisen:]

Understood. Appreciate all the color. Good luck. Fred congratulations.

[Operator:]

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

[Alex Rygiel:]

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

[Russ Tiejema:]

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

[Alex Rygiel:]

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

[Russ Tiejema:]

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

[Fred Lynch:]

And I do think it's important though, as we work on our productivity activities and transformations in the plant. We're very clear with our operating team that this is a combination of improving cost and efficiencies without sacrificing [indiscernible] capacity, though that [indiscernible] markets respond better than we anticipate will be well positioned to take care of that.

[Alex Rygiel:]

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

[Russ Tiejema:]

That would reflect just volume. We separated, our AUP in mixed initiatives separate release as you'll see on the slide that we presented in our deck.

[Alex Rygiel:]

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

[Operator:]

Thank you. Our next question comes from the line of Steven Ramsey with Thompson Research. Please proceed with your question.

[Brian Barros:]

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

[Russ Tiejema:]

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

[Brian Barros:]

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

[Russ Tiejema:]

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

[Brian Barros:]

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

[Russ Tiejema:]

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

[Brian Barros:]

Very helpful. Thank you.

[Operator:]

Thank you. [Operator Instructions] our next question comes from the line of Jay McCanless with Wedbush Securities. Please proceed with your question.

[Jay McCanless:]

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

[Tony Hair:]

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

[Jay McCanless:]

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

[Russ Tiejema:]

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

[Fred Lynch:]

Yes, I think it's important to recognize though that, we have announced the majority of these to the employees. We already begun to take down production at the sites that we plan to exit consolidating to other sites. The majority of the employees that will be effected on the SG&A and overhead reductions will be effected by the end of the first quarter, so it's - we'll have the opportunity to go into more detail of the actual details of this in or the specific to this, I should say at the end of Q1. But want to be clear that, the activity has been actually underway for several months and much of it is being driven now. There are expenses associated with some of these moves that are not restructuring charges that actually hit EBITDA to the negative, we'll offset those through some of the savings in 2019, but as Russ said, we ought to see it ramp, the savings really ramp in 2020 and beyond.

[Jay McCanless:]

All right and if I could sneak on more in, you guys highlighted the weather in February as an issue. I mean are we talking meaningful amount of days lost for your different plants and for your customers or is it, just more of a hassle as this point?

[Fred Lynch:]

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

[Jay McCanless:]

Got it. Thanks for taking my questions.

[Operator:]

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

[Fred Lynch:]

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

[Operator:]

Thank you. Thank you for joining the Masonite International fourth quarter and full year 2018 conference call. This conference call has been recorded. The replay may be accessed until March 5. To access the replay please dial 877-660-6853 in the US or 201-612-7415 outside the US. Enter the Conference ID number 13687239. This does conclude today's conference. Thank you for your participation.