Masonite International Corp (DOOR) 2018 Q3 法說會逐字稿

Welcome to Masonite's Third Quarter Earnings Conference Call. (Operator Instructions) Please note that this conference call is being recorded.

I'd now like to turn the conference over to Joanne Freiberger, Vice President and Treasurer. Thank you. You may begin.

Thank you, Matt, 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; and Graham Thayer, Senior Vice President, Business Leader of Architectural, both joining us for our Q&A session.

After market yesterday, we issued our third quarter earnings release. The release and the information for the webcast presentation are available on our website at masonite.com.

Before we begin, let me remind you that this call will include forward-looking statements, including statements about our outlook in 2018. 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 those factors appears in the section entitled Forward-Looking Statements in the press release we issued yesterday. More information about risks can be found under the heading Risk Factors in Masonite's most recently filed Annual Report on Form 10-K and our Form 10-Q anticipated to be filed by Masonite with the SEC later today. Our SEC filings are also available at www.sec.gov and on our website at masonite.com. The forward-looking statements in this call speak only as of today and we undertake no obligation to update or revise any of these statements.

Our earnings release and today's discussion include certain non-GAAP financial measures, please refer to the reconciliations of these measures to the applicable GAAP measure on the tables in the press release and in the appendix of the WebEx presentation. Our agenda for today's call includes a business overview from Fred, followed by a review of our third quarter financial results from Russ and a question-and-answer session. We will then conclude with closing comments from Fred.

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

Thank you, Joanne, good morning, everyone and welcome.

We delivered another quarter of year-on-year growth with our consolidated net sales increasing 8% due to strong performance from our acquisitions, balanced against moderating end markets. All segments had higher average unit price in excess of 4% this quarter, driven by a like-for-like increases as well as continued product mix improvements.

We implemented our previously communicated wholesale price increases in the early part of the third quarter. However, given the rate of inflation, we did not fully cover increasing costs in the quarter. This put pressure on our gross profit and ultimately limited our adjusted EBITDA growth to 2% in the quarter from 69% -- $69 million in the third quarter of 2017 to $71 million in the third quarter of this year. Towards the end of the third quarter, we communicated additional price increases to our customers across all of our residential channels. Given the timing of these additional pricing actions, they will only partially impact the fourth quarter with the full effect of their impact expected in the first quarter of 2019.

Despite input cost pressure, every segment delivered higher adjusted EBITDA margins year-on-year in the third quarter. On a consolidated basis, however, adjusted EBITDA margins fell 70 basis points from 13.4% to 12.7%, which was due solely to higher corporate costs with the most significant portion related to a reversal of bonus accruals in the third quarter of 2017. And I'll speak to our adjusted EBITDA progression more on the next slide.

As you are aware, in August, we successfully issued $300 million in senior unsecured notes. $125 million went to partially pay off a portion of our existing 2023 notes, with the remaining balance for general corporate purposes. The impact of the debt refinancing is reflected in our reported net income with costs associated with this early debt extinguishment being the principal driver of the $4 million decline from $29 million in the third quarter of last year to $25 million this year.

Moving to the right side of the slide, we've already touched on rising costs, which is really the key takeaway from this quarter. While our operations, sourcing, logistics and continuous improvement teams continued to deliver operational improvements and we have higher AUP, these were more than offset by higher costs in the quarter. We mentioned on prior calls that the timing of inflationary costs won't always line up with the pricing actions, resulting in lumpy quarterly margin performance. This was a quarter where costs outpaced higher AUP. Despite these quarterly fluctuations, the team is executing well. And with the additional price increases already communicated to our customers across all channels in the North American Residential segment, we believe we will exit the year with a favorable price-cost relationship.

A topic that we have been closely monitoring and proactively managing over the last few quarters has been the impact of tariffs on our material costs. In the third quarter, we began to feel more cost inflation in the steel markets attributable to previously implemented Section 232 tariffs. Looking ahead, we expect an additional headwind with the Section 301 tariffs on other Chinese sourced goods. And again, we'll talk about that more in a few moments.

On Monday, we completed the purchase of the operating assets of Bridgewater Wholesalers, an important partner for Masonite in the Northeast and upper mid-Atlantic regions. Again, more to come on this in a few slides. But I will let you know that our recent acquisitions, A&F and DW3, are both exceeding our initial expectations, and the Graham & Maiman integration remains on track to deliver double-digit EBITDA margins by the second year.

Turning to Slide 6. As we said earlier, every segment delivered year-on-year increases in adjusted EBITDA, with adjusted EBITDA margins up 70 basis points, 60 basis points and 40 basis points in the North America Residential, Europe and Architectural segments respectively. However, improved segment performance was largely offset by higher corporate costs in the third quarter, which were due primarily to higher incentive compensation as compared to last year, wage and benefit inflation, and higher acquisition-related costs. On the right side, you'll see that despite these higher corporate costs in the quarter and a challenging input cost environment, we continued to improve our adjusted EBITDA performance with trailing 12-month results $20 million higher than full year 2017 results.

On the next slide, we summarize the latest residential housing market data for our major geographies. As we've continued to move through 2018, U.S. housing growth has been moderated. While still higher than 2017, the growth of single-family homes in the third quarter slowed to the lowest rate in 18 months. Between the macro data and what we are hearing and seeing from our end customers as we move through the fourth quarter, we believe we have hit a pause in the U.S. housing market. While we can't predict the extent or the duration of this pause, we still believe there are healthy underlying fundamentals for new housing starts such as increasing household formation, historically low home inventories and record levels of 18 to 34-year-old adults that are still living at home.

In addition to a softening U.S. market, we saw Canadian multi-family housing starts turn negative in the quarter, while single-family starts were already down year-on-year for the first 2 quarters of 2018. This marks the first quarter with lower starts in both single and multi-family housing in Canada. So overall, the North American market has clearly softened over the last several months.

While U.K. housing starts turned positive in the third quarter, up 2% compared to 5% in the second quarter, we have not specifically seen the impact of this improvement at Masonite given the lag between starts and door installations. We track more closely with completions, which turned negative in the quarter, down 1%. Despite the modest uptick in starts, will still anticipate a continued soft end market in the U.K. for the time being, which we believe is primarily related to continued uncertainty around Brexit. Evidence early in the fourth quarter shows demand noticeably down. We're hearing from customers that the market is slowing and they are adjusting inventory levels accordingly. Given this pause, we will continue to rely on our multilever approach to increase the value of our offering, while simultaneously focusing on offsetting cost inflation through our MVantage Lean Operating System.

Moving to Slide 8. It's worth noting that the breadth of our playbook to respond to current uncertainty in end market demand and higher inflation with multiple initiatives being simultaneously executed to contain costs and improve margins. Some of these projects were initiated in the third quarter, but most of these we've been working on for quite some time. I shared many times before our MVantage Lean Operating System is an important foundation to improving operational performance. It rests on 3 core pillars: global training and standards, performance improvement teams, or what we call pit crews, and plant transformations.

Over the past 12 months, we've renewed our focus on training, specifically for those individuals working on Lean projects and pursuing belt certifications. As these individuals become trained and certified, we have seen the number of Kaizen events steadily increase. In fact, in the first 9 months of 2018, we've already held 45% more Kaizen events in our plants globally than for all of last year.

Relative to plant transformations, we are methodically rolling out structured workshops across a variety of our plants designed to drive out waste, reduce variation and improve material flow. These projects last approximately 3 months at each site and involve our continuous improvement team working with local operations to focus on 5 areas: 5S plus 1 or sort, stream, shine, standardize and sustain, with always putting safety first, is the first one; visual controls; value stream mapping; process improvement and material organization and flow.

For example, 1 site that had been underperforming relative to similar operations went through a plant transformation in 2018 and the improvement for that plant have been remarkable, with the plant now able to produce roughly 60% higher volume using only 1 shift whereas running 2 shifts in 2017 and is now operating at a higher performance on a number of metrics versus its peer plants.

We're also implementing changes in our manufacturing footprint to reduce costs and improve efficiency. Again, for example, we've taken steps to add capacity, improve throughput at our plant in Monterrey, Mexico, allowing us to exit the third quarter with 50% more capacity available there as compared to the second quarter and nearly double the capacity from 2016. And this capacity is to better support demand requirements in the U.S. market.

We're also investing capital in automation to reduce cost as well as solve for labor availability challenges. Again, another example, in the third quarter, we announced the relocation of our Stockton, California cut stock component plant to Verdi, Nevada after determining that the current facility was unable to accommodate necessary automation upgrades. Once completed in the second quarter of 2019, the new facility is expected to have roughly 40% more capacity with lower headcount, allowing us to more cost-effectively insource production that we cannot fully support at our existing facilities.

Relative to sourcing strategies, as noted on our second quarter earnings call, approximately 10% of our materials originate from China, which at a 25% tariff rate would equate to a potential exposure of between $20 million and $25 million. Through the efforts of our global sourcing team to mitigate this, in part as a result of shifts in our sourcing footprint, we now believe we can limit this impact of less than $15 million in 2019.

We're continuing to invest in new products, an important element to improve our mix in differentiated products and driving higher AUP. As an example, in our North American Residential segment, our vitality index, defined as the percentage of sales from products introduced in the past 5 years, has shown steady improvement over the last 2 years fueled by the success of products like the Heritage Series and VistaGrande.

In addition to introducing new products, we are also rationalizing low-volume and non-differentiated SKUs and products. In North America Residential, we're taking steps to simplify the number of SKUs offered in both interior and entry doors by rationalizing very unique or low-volume offerings with minimal customer impact. This will allow us to improve our manufacturing and distribution efficiency. Similarly, we have also communicated plans to discontinue a range of non-differentiated products in Central America, allowing us to prioritize that capacity for higher-end products and regions with the objective of improving the mix of products and increase AUP margins for both Masonite and for our distribution partners.

And finally, in the third quarter, we communicated a restructuring in the U.K. The former head of our components business, Clare Doyle, recently assumed leadership over our U.K. business and has worked closely with Tony, Randy and the U.K. team on a plan to consolidate and streamline shipping and warehousing operations. The U.K. grew significantly through acquisition in the last few years, so there are opportunities now to consolidate facilities and leverage existing transportation planning tools across those facilities. This is expected to improve cost performance by reducing material handling and maximizing payloads and to also reduce lead times so we can better service our customers.

Additionally, as part of that restructuring, we're transitioning the U.K. to our global business services model by consolidating certain back office functions, including accounting and customer service, into a centralized organization using common processes and systems. This should both reduce cost and improve customer service as well.

So before I turn it to Russ, I'd like to share a few more details on the acquisition we announced Monday afternoon. We completed the purchase of the assets of Bridgewater Wholesalers, Inc. BWI is headquartered in Branchburg, New Jersey and is a leading fabricator and distributor of door systems and related components with customers in the mid-Atlantic and northeastern part of the U.S. Their product offerings include both residential, interior and exterior door systems as well as value-added pre-finishing services.

BWI employs approximately 350 people across 5 facilities located in Pennsylvania, New Jersey, New York and Massachusetts. They've been an integral part of Masonite for over 3 decades. We are their largest supplier, representing almost 70% of BWI's material components purchases. And we felt that the acquisition of BWI was a unique opportunity for us because they focus almost exclusively on the door space, with over 90% of their sales related to doors and door systems. Additionally, it's important to note that Masonite has been involved in residential door distribution for a while, albeit to a limited extent, via our Louisiana Millwork and Florida Made distribution businesses.

We believe this acquisition of BWI affords us the opportunity to build a stronger presence in the Northeast and continue to provide customers with the products and services that they know and trust. On a pro forma basis, for 12 months ended September 30, the BWI acquisition would have represented approximately $55 million of incremental net sales to our North American Residential segment after adjusting for inter-company transactions. Similar to the recent acquisitions of Graham & Maiman assets from Assa Abloy, we expect by the second year, we can achieve a double-digit EBITDA margins on those incremental net sales that we will realize from the acquisition. And we want to welcome again the BWI employees to the Masonite family.

So with that, I'll turn the call over to Russ to discuss our third quarter financial performance. Russ?

All right. Thanks, Fred. Good morning, everyone.

On Slide 11, we summarize our consolidated financial results for the quarter. We saw net sales of $557.1 million, an 8% increase over the same period in 2017. Acquisitions and average unit price contributed approximately 7% and 4% respectively to this increase. This was partially offset by a 4% decline in base volume and to a lesser extent, a 1% headwind from foreign currency. As Fred mentioned, we realized AUP increases in excess of 4% across all segments, but higher inflation on raw materials and manufacturing wages and benefits largely offset that benefit. While we grew gross profit by 6.5% in the third quarter, gross margin declined 20 basis points versus the prior year to 19.9%.

Adjusted EBITDA increased 2% to $70.8 million, while adjusted EBITDA margin contracted 70 basis points to 12.7%. As discussed, all business segments saw adjusted EBITDA margin expansion in the third quarter of 2018 compared to the same period last year, partially offset by higher corporate costs, which I'll address shortly. The bridge shown on this slide provides more detail on key adjusted EBITDA drivers as compared to the prior-year. Volume, mix and price were the predominant drivers of EBITDA upside in the quarter with price/mix being the most pronounced factor. Acquisitions also were a contributor, particularly on the strength of the A&F acquisition in the fourth quarter last year and the DW3 acquisition in the first quarter this year. Significant cost inflations across multiple areas of the business were a meaningful offset, however.

We experienced higher commodity inflation again in the quarter, with the largest percentage increase in metals. While not related to direct Chinese purchases, the U.S. steel market shifted higher as Section 232 tariffs impacted Chinese import prices in the third quarter. While we have long-term contracts in place for steel, our pricing can shift within collars based on market pricing, so we did feel some inflationary pressures in this area as a result. We also faced elevated wood prices, primarily in the U.K., and higher chemicals pricing that led to resin price inflation.

Recall that we exited the first half of the year having seen commodities inflation between 2.5% and 3.0% but anticipating that full year inflation would be at the high end of our original full year outlook of 3.0% to 3.5%. This implied inflation of at least 4% in the back half of the year, and this is exactly what played out in the third quarter.

Within our factory operations, we continued to see year-on-year improvements in labor productivity in our North American operations. This progress was offset by higher inflation in wages and benefits and various overhead categories such as utilities and insurance. Timing of repair and maintenance activities in the plants was also an offset this quarter. Distribution costs remained flat year-on-year, an encouraging factor given the high rates of carrier and fuel inflation we have seen across the broader industry. Our logistics teams addressed prior year inefficiencies by driving productivity programs that fully offset inflation.

The $5 million increase in SG&A is related to higher corporate costs with the single largest driver being an increase in incentive compensation year-on-year given significant reductions taken in the third quarter last year as a result of poor performance to plan. We also incurred higher professional fees related to acquisitions and felt the impact of higher wage and benefit inflation in our corporate staffs as well.

Net income for the third quarter was approximately $25 million and diluted EPS was $0.89. Diluted EPS was down $0.11 per share from $1.00 per share in the third quarter of 2017 due primarily to a $5.4 million pre-tax loss on debt extinguishment. Excluding that, our adjusted diluted EPS was $1.03 in the quarter of 2018 compared to $1.00 in the comparable period of 2017. Adjusted diluted EPS was higher despite a higher tax rate as compared to the third quarter last year due to a lower share count resulting from our share repurchase program. We continued to aggressively purchase our shares in the third quarter, purchasing over 503,000 shares. Subsequent to the end of the quarter, we purchased an additional 730,000 shares at $58.06 per share, totaling approximately $42 million.

Now, let's look at each of our reportable segments. Turning to Slide 12, we'll begin as usual with our North America Residential business where net sales increased 1% in the third quarter and adjusted EBITDA increased 7%. We again saw high single-digit growth in our wholesale channel. But this was more than offset by the impact of our previously announced line review loss in retail, starting at the beginning of the second quarter. Excluding the impact of that retail loss, we would have seen mid-single-digit net sales growth for the overall segment.

As mentioned earlier, average unit price was up across all channels and product categories. Despite the unfavorable impact of the aforementioned retail loss, comprised largely of pre-hung units sold at higher prices, we achieved AUP of 4% due to like-for-like pricing and improved product mix from continued demand for our higher-end products. Foreign exchange was a slight headwind to the business in the quarter of roughly 1%.

While material costs were higher in the quarter, particularly steel and resins as noted earlier, the business effectively managed other cost and was able to expand adjusted EBITDA margins by 70 basis points to 14.5%.

Turning to Slide 12 and our Europe segment. Net sales in the quarter increased by 22% compared to the same period last year due to growth from acquisitions and average unit price, partially offset by base volume declines. The DW3 acquisition contributed growth of 25% in the quarter. And we realized AUP growth of 4% in the quarter due largely to pricing actions previously put in place to address material cost inflation. Soft end market conditions in the U.K., particularly in the builder channel, contributed to a 7% decline in base business volumes compared to the same period last year.

Despite weaker demand and material cost inflation, Europe delivered another quarter of adjusted EBITDA expansion with a 29% increase over the third quarter of 2017. Adjusted EBITDA margin was up 60 basis points to 11.7% due to higher AUP and the impact of DW3, which continues to generate strong margin performance. And as Fred mentioned earlier, we have initiated restructuring actions in the U.K. designed to rationalize our shipping and warehousing operations to both reduce cost and improve distribution efficiency and service levels. And we are combining certain back-office functions into a centralized organization similar to our business services structure in North America. These actions began in the fourth quarter and we expect them to be completed in 2019. As a result of this restructuring activity as well as actions associated with our cut stock plant relocation, we expect to record a restructuring charge in the fourth quarter. We currently expect that total related restructuring costs will be approximately $2 million.

Onto Slide 14. In the Architectural segment, net sales increased by 25% in the third quarter, primarily driven by acquisition growth of 26%, including A&F wood products and a full quarter of sales from the Graham & Maiman acquisition completed in June this year, and AUP growth of 4%. These increases were partially offset by 8% decline in volume in the base business, which we attribute largely to a slower-than-anticipated recovery from our 2017 architectural transformation actions, including closure of the Algoma facility.

All our service levels have improved meaningfully this year. Inbound flow in order activity is still recovering. We also ramped down orders scheduled for our Northumberland, Pennsylvania facility in September as we prepared for implementation of a new ERP system in October. Production in Northumberland has ramped back up, and we expect to resume regular production rates this month.

Meanwhile, we continued our trend of profitability improvement in the Architectural business. Adjusted EBITDA of $11 million was up 29% from the same period in 2017, while Adjusted EBITDA margin increased 40 basis points to 12.2%. This margin improvement occurred despite the fact that we have now lapped the closure of the Algoma plant last year, which provided an annual benefit of $5 million in cost savings and the impact of the Graham & Maiman acquisition. As we noted on our second quarter call, Graham & Maiman will be dilutive to margins in 2018 as we incur integration costs. But we continue to expect double-digit Adjusted EBITDA margin from this business by the end of the second year following acquisition.

Let me close with a recap of our current liquidity profile on Slide 15. Total available liquidity, including unrestricted cash and accounts receivable purchase agreement and our undrawn ABL facility, was $355 million or approximately 17% of our trailing 12-month net sales as of September 30, 2018. At the beginning of the third quarter -- I'm sorry, at the end of the third quarter, total debt and net debt to trailing 12 months adjusted EBITDA were 2.9x and 2.2x respectively. The sequential increase in our liquidity and total debt is the result of the $300 million bond issue we completed in September with $125 million of the proceeds used to retire existing notes maturing in 2023. As we've commented previously, in light of the escalating interest rate environment, we believe it was a prudent time to take this action to bifurcate our debt maturities and improve our liquidity profile, particularly in Canada, since that is a means to better support our share repurchase program.

In the first 9 months of the year, the business delivered strong cash flow performance with cash flow from operations totaling $141 million, an increase of approximately $40 million as compared to the first 9 months of 2017, from both higher profitability and improved working capital management. As mentioned in the third quarter, we repurchased $34 million of our stock. And including repurchase activity subsequent to the end of the third quarter, our year-to-date share repurchases have totaled $137 million.

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

Thanks, Russ. So to summarize, we continue to execute in this challenging cost environment. While we achieved higher AUP in the quarter, it was not enough to cover our increasing costs. With previously communicated pricing actions taking effect North American wholesale and retail channels later in the fourth quarter, we believe we will enter 2019 with a favorable price-cost relationship.

As highlighted, we're executing on initiatives to contain costs and improve margins in each of our 3 business segments. Our MVantage Lean Operating System continues to make positive impacts on our operations, improving quality, delivery, productivity, and most importantly, employee engagement. We're investing in targeted factory automation to improve efficiency and capacity as well as address workforce constraints given record low unemployment levels. And our U.K. restructuring is underway to further integrate the business operations, improve the cost structure and improve customer service. We continue to execute on our disciplined capital allocation strategy. Following the issuance of our 2026 bonds, we believe we are now even better positioned to invest in internal projects, repurchase shares and target strategic acquisitions as opportunities present themselves.

Given that we finished the third quarter at $275 million TTM adjusted EBITDA, based on the factors we've discuss today and the slowing demand environment we're now seeing, we currently expect to be near or at the low end of our original full year 2018 adjusted EBITDA outlook range of $280 million to $300 million. Despite that, we actually expect to be at the high end of our original 2018 adjusted EPS range of $3.70 to $4.20 due to the combination of a lower tax rate and the favorable impact from our share repurchasing activities.

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

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

[Operator Instruction] Our first question is from Tim Wojs from Baird.

[Ben] filling in for Tim. I think with respect to the comments, Fred, that you made about Q4 trends, did you see trends slow as you went through Q3? Or is it strictly kind of an October phenomenon? And did you see the softness in certain channels and not others? Just wanted a little bit more color on that dynamic.

Yes. So the area that's being affected I'd say the most is our North American wholesale businesses, which is related to new construction. I think as Russ mentioned, we were at high single digits through the third quarter, and we started to see that tail off as we moved into October. And we were notified by our customers -- again remember, we're at the later end of the cycle from a build perspective. So it's expected that that will be several months behind the marketing tail -- market tailing off. And of course, as you've heard from builders throughout this earnings period, they've seen a trail-off in starts. So that's why we started to see that slowdown in the October time frame.

Okay. Yes, it definitely makes sense in light of the data and the comments. And then with respect to sort of the factory costs in the quarter in the EBITDA bridge, the $7 million, you talked about higher wages and overhead, but it also sounds like some of it at least was timing in North America. So could you bifurcate for us how much of that $7 million was timing related because the other elements are probably somewhat ongoing, I would think?

Yes, this is Russ. I would say that the overhead timing relative to things like factory maintenance repairs, things of that nature, it was a relatively small minority of that, but it was clearly a driver this quarter. And those types of expenses can be lumpy quarter-to-quarter just depending on when you either take time for planned maintenance or if you've got unexpected equipment downtime that needs to be addressed in short order. So again, it was a minority of the $7 million, but it was enough of a contributor this quarter that we thought it warranted calling out.

And I think just to add to that, as we've mentioned in the past, July is our normal time frame where we make our wage increases for our hourly employees. We've talked about the fact that we have over $400 million of plant wage expense. As you consider the current environment, especially as you look at the lower wage levels of the employees at that date tend to be escalating and inflating at a higher rate. So we anticipated, obviously, coming into the quarter that we would get a bump in -- or a step function in our wage inflation, just given the timing of our annual wage increase.

Okay, that's helpful. And then last one from me, you saw a nice acceleration in the North American AUP growth. I'm thinking that business transition probably helped a little bit, but did you see core kind of like-for-like price accelerate in Q3 versus Q2? And given your price increase, would you expect the AUP to further accelerate in Q4?

This is Tony. We talked about, in our Q2 announcement, the interim price increase that we put in wholesale that began in Q3. We saw some of that impact. But to the points Russ and Fred made, we didn't see it enough to overcome the cost exposures that we also had. So a lot of that AUP is mix-driven based upon the new products that we put into the marketplace. So the success of things like Heritage and VistaGrande can drive that AUP improvement. So that was the balance in the Q3 exposure.

Yes. And this is Russ. I might also just offer -- you mentioned business transition a moment ago. Just to be clear, as we commented on the last quarter, we actually see a little bit of an AUP headwind from that transition of business out of retail, just because that's predominantly pre-hung units, which carry higher average unit prices. So despite that headwind against AUP from the loss of that retail line review business, we still generated over 4% AUP across the balance of it. It's, again, largely on strength from wholesale, as Tony commented.

Our next question is from Michael Rehaut from JPMorgan.

It's Elad on for Mike. First, in the quarter, can you just add some more color in terms of what you saw in terms of market share trends in North America and maybe some of the smaller guys taking some more share?

This is Russ. Let me take a shot at that because we look at the end markets that we serve in North America on a regular basis and trying to understand on a weighted average basis what does that growth look like, considering that about 75% of our North American businesses in the U.S. The balance is in Canada and Mexico, which have seen little, if -- in some cases, slightly unfavorable growth. And then we also bifurcate the business between new construction, which is less than half the business, and triple R, which is a little more than half the business and running at very low single-digit rates. So if we step back and look at the quarter in that context, we would say that the overall market grew less than 2%, whereas we saw a low single-digit growth in our wholesale business in North America, actually at or slightly above the market. So from that perspective, we feel like we're essentially tracking with the market at this point.

Okay. And then maybe some more color on the cost inflation in the quarter. Beyond steel, where else did you see the most cost inflation? Were there headwinds in freight? And then with lower lumber prices, how do you see that potentially being a tailwind to the business?

Yes, this is Russ again. On the distribution side, what we've seen in our business is in the neighborhood of mid-single-digit inflation. That stands in contrast to a lot of folks citing well into double-digit rates of carrier inflation and fuel inflation. We attribute that to the fact that we've got a number of strategic contracts in place with a variety of carriers that we utilize across all of our major plants, and that allows us to flex our business as necessary to achieve the lowest rates possible. So that has mitigated the inflation, again, into that mid-single-digit range and our logistics team has been able to further offset that by other savings projects that improve our payload, our mix of freight lanes, et cetera. So we feel pretty good about the progress we've made on the distribution side. Relative to the commodity side, you cited wood, in particular. I think you're probably referring to general decreases we're seeing in dimensional lumber. Remember, we don't really track against the dimensional lumber indices. The types of wood that we're purchasing are in many cases the off-cuts of that dimensional lumber production process. It's cut stock lumber that goes into the framing materials for our doors. We source that on a global basis. We move our footprint around. We have seen some inflation in wood, but it's not terribly broad across the business. The most pronounced wood inflation we've seen has been in the U.K. And we would attribute that largely to the fact that most of the wood basket used in the U.K. comes in from non-pound sterling denominated markets. And there's been a lot of transactional FX headwinds to those suppliers over the last couple of years post Brexit. So they've been pushing through more price increases down channel, and we have been feeling the impact of that. That's why we've been assertive on pricing in the U.K. also and you've seen strong AUP gains in that market to offset.

And so Russ, it's fair to say that since we don't see -- we did not see the inflation associated with lumber when lumber prices went up because we're not tied to that market directly, we won't see the deflation as lumber prices go down. So our basket base has been a pretty tight collar.

Exactly.

Okay, that's very helpful. And then lastly, just thinking about capital allocation, curious what you're seeing in terms of valuations in the market for M&A versus last year and how you're balancing that with the potential for increase in the share repurchases, given the stock price being down. Are you sort of leaning towards one over the other and what you're seeing?

I'd say, first, I'll describe that A, we think Masonite is a great investment, hence our rather large purchases over the last, not only in the third quarter, but subsequent to the third quarter. We have a great balance sheet and we're going to look at all opportunities to create value and look at those and compare them relative to each other and decide what makes the most sense. So we are going to be very thoughtful about utilizing that great balance sheet to continue to create value for our shareholders.

Our next question is from Mike Eisen from RBC Capital Markets.

I just wanted to hone in on a few of the points you guys made about end markets in North America, and it sounds like you're seeing a pretty impactful slowdown from quoting activities in orders. And, Fred, I think you mentioned some expectation of destocking in the wholesale channel. So just wanted to kind of think of that in conjunction with your expectations of additional price increases in the fourth quarter and how those are going to going to be able to stick offset input cost inflation going forward.

I think Fred mentioned that we have -- this is Tony, sorry. We've seen the -- you've seen it through other communications, the softness that is appearing in the beginning of the fourth quarter. We believe that there is a pause in terms of the build that's going on and the new-build. We do anticipate and have had communications to our customers that there is some destocking that they will do as they manage inventories appropriately. We are still very, very much liking that the dynamic will at some point return. We don't know when that will be, but we'll keep an eye on for that. And then from a pricing standpoint, as we mentioned, we put an interim price increase in wholesale. We've now communicated price increases that will be effective in the fourth quarter across all our channels. One of our disappointments was we did not get pricing action in the retail channel in the third quarter. We anticipate we will get that in the fourth quarter, have very limited impact and really start to impact in Q1 of next year. And I think based on the inflationary factors, we expect that that will stick in the market and then it will be required for us to get back in the right mode to invest in the things we want to do to drive business with those customers.

Got it. That's helpful. And then just following up on that comment, just thinking of the business loss in retail, can you help remind us the split between wholesale and retail in the North American market?

Yes, it's Russ. We typically see in the neighborhood 2/3 of the business is in the wholesale channel for our North American Residential business and approximately 1/3 associated with big box retail.

Got it. And then just transitioning to the acquisition you guys announced earlier this week, can you talk a little bit about how this business fits strategically with your desire to be more in the vertical integration and if there's any comparisons to what you…

Sorry, we lost you there.

We will go onto the next question here. Next one is from John Baugh from Stifel.

Let's go ahead and answer that question, the portion that he gave us.

I think I understood where Mike was going with that. This is Tony. Yes, so as we mentioned, BWI has been a partner with us for over 30 years and a great two-step distributor in that Northeast market. The uniqueness of them is they're very focused on doors. So greater than 90% of what they do is in door and door components. And we've been the majority supplier to them with over 70% of the COGS being Masonite products. For us, we wanted to make sure that we can continue to serve the builders and dealers in that market with the Masonite products that they've come to rely on. And so we think there's an opportunity with the value-add services that BWI has historically done to invest in resources to help the penetration of Masonite doors in that market. So it's not a new effort. We've had small distribution business we've had for a period of time. As we mentioned, Florida Made Door and Louisiana Millwork. And we're excited frankly to have that business as part of the portfolio and support those folks as they work on driving the penetration of the Masonite brand in that market. So that's been our focus with them and we're very pleased to have them on board with us. So now we can probably go to the next question.

Our next question is from John Baugh from Stifel. Let's go onto our next question here from Alex Rygiel from B. Riley FBR.

Sorry if you answered this, but could you circle back and talk about inventory in the wholesale and retail channel, right now how it stands and how you think that could get corrected or changed in the next couple of months going into year-end?

Yes. So one of the things that we've looked in the past and we've talked historically is, in 2017, early '17, we saw some destocking in the wholesale channel that was surprising to us. And so we've worked very closely with our wholesale channel partners to really make sure that we're getting better visibility to what's happening and to make sure that they're reacting quickly to the information that we're seeing in end markets. So what I would say that today we feel like we have very good line of sight to that. As the information started coming through the builders, and the builders were slowing down starts in the third quarter, we were working with, communicating, discussing that with our partners. And as we walked through that quarter, we knew that we'd start see that some of that downturn starting October. So they've been able to react very fast to the timing. And so we think that destocking is happening concurrently with what the demand is in the marketplace. So we think the efficiency in that process is much better than it has been historically, hence the slowdown we've started to see already in October.

And Russ, I know you don't like to look out in the forward year too often, but can you help us a little bit in thinking about the tax rate in 2019 and directionally how that could change versus 2018?

Alex, it's probably too early to talk about tax rates for the forward year. We're working through the outlook overall for next year. And when we get to our fourth quarter call, as customary process, we'll give a fulsome view on our outlook for all the key drivers of the business. Tax rate will be one of them that we'll be better prepared to talk about at that time.

Our next question here is from John Baugh, Stifel.

I wanted to just to circle back on the demand. I totally understand the builder slowdown on the wholesale. Are you seeing any change in the demand profile on your commercial or your triple R business in North America?

It's Graham Thayer here. Certainly on the commercial side. I think there is a different dynamic and we see fairly strong backlogs for most of our customers into next year. And in fact, we've seen improving order intake during the course of the year. So I don't think we're seeing the same situation in the commercial sector.

Yes, this is Tony. From a remodel standpoint or triple R standpoint, most of that business is primarily visible to us through the retail channel. And I would say that, obviously, we had the previously mentioned line review loss that impacts our overall retail business. And when we look at our retail and I'll say comparable basis, there still appears to be pretty decent robust strength in the remodel space outside of that line review loss that we had.

Great. That's the color I was looking for. and then we've obviously been in an environment of a lot of inflation and totally understand the lag in timing of getting price offsets. I'm curious, it sounded like there was a tiny bit of like-for-like pricing, again, trying to get retail pricing, I guess, as we go into early next year. Question simply is, how much uncertainty or unknown is there in terms of what you will ultimately realize in the like-for-like pricing to offset the input costs, the other costs that you see right now? How comfortable or uncertain are you about the level you need to go through?

Yes. I's day, first of all, we recognize that while our -- we're very happy with the execution of our operations teams and our continuous improvement teams in driving efficiencies in the plant and improvements in the plant that we can keep up with the inflationary cost on that alone. With that said, we've -- and it has been our past practice, we do not talk about the magnitude of future price increases until they've been fully implemented. So we'll respond to that at the end of the fourth quarter.

Our next question is from Kevin Hocevar from Northcoast Research.

So I wanted to -- Fred, you talked about EBITDA for the year coming closer to the low end of the guidance range you gave earlier in the year of, call it, $280 million and here you are sitting trailing 12-month EBITDA $275 million. So you've got to grow it about $5 million to hit the low end. And in the third quarter, you grew EBITDA $1 million. So it sounds like you have to see an acceleration of EBITDA growth in the fourth quarter to do that, but it also sounds like there's been -- you're starting off the quarter pretty slow in terms of demand. So there's something that must be getting a bit better. Could you help me understand what are the moving pieces that will help EBITDA growth to that magnitude in the fourth quarter?

I don't think we're going to go into much more detail on that forward-looking basis. I think where we stand today is we're at $275 million. We spend a lot of time talking to our different actions. I think on the positive side, we have the number of cost actions that have been in place. As we said, we'll have some partial impact, we believe, from a pricing perspective in the fourth quarter. And we think on a negative headwind, we have volume that's working against us negatively. And so, while we don't have perfect insight, we think that given that we're at $275 million today and our low end is $280 million, that will be near or at our low end. The difference between those 2 numbers the last time I checked was only about 2%. So that's about within the gauge of accuracy that we have.

Okay, great. And then in terms of -- curious on the acquisition. If I look at that EBITDA bridge you provided, it shows the acquisition provided $7 million of EBITDA. I think the acquisition sales were 37% or something like that. So it's about a high teens EBITDA margin. It sounds like the Graham & Maiman will be double-digit next year, meaning that the DW3 and A&F must be doing really good. Maybe just help me understand the EBITDA contribution there because it seems like it's pretty, pretty strong. So maybe you could help me understand what's driving the strong growth, especially -- and it sounds like the Graham & Maiman is -- maybe lower margin for now, but help me understand how well those businesses are doing and if you could give us some color there, that will be helpful.

Yes, sure, Kevin. It's Russ. When we announced the acquisitions, both of A&F and DW3, we acknowledged that we really liked the margin profile of these businesses. A&F obviously is not a very large business, but it is a key contributor in the quick-ship component of our USA would door business with Architectural. If you go back and take a look at the disclosures at the time that we made that business -- again, we don't get into specific margin disclosures business-by-business, but I think it's easy to see that that business was probably in the mid-to-high teens EBITDA margin and it's continued to show strength from there. If you look at what we announced when we announced the DW3 acquisition, that again was a business that was in the very high EBITDA margin range. It has continued to show strength from there. So we're really pleased with the kind of margin progression we're seeing from both of those businesses. And clearly, that is a contribution to the Architectural in the U.K. or Europe segments respectively. With respect to Graham & Maiman, that was a bit of a unique acquisition in that we were acquiring the operating assets of that division as opposed to a complete legal entity. We acknowledged that there would be some integration costs associated with carving out those assets and integrating them into the Architectural business and that that was going to cause it to be margin dilutive to the overall segment through the first year of ownership. And it's really not you get into the second year of ownership that we expect that double-digit EBITDA margin contribution. And we're continuing to remain on track with that viewpoint.

Great. And last one. Fred, you guys talked about seeing less inflation maybe than from what we've heard from others. I think you said mid-single-digit inflation versus others seeing pretty, pretty solid double-digit. And it sounds like some contract benefits you've had this year. Wondering how those are structured? As those contracts then reset -- I don't know how long they are -- but will we see kind of a catch-up at some point? Or how do you expect that to go as these contracts start resetting?

Yes, Kevin, this is Russ again. I think you're keying on the comments that I made relative to some of our commodity contracts, in particular what we're seeing an inflationary pressure in steel. We always work with our suppliers wherever possible to put in place long-term contracts. We're not going to disclose a lot of the specifics of those clearly for competitive reasons, but clearly, we're going to negotiate as best the terms as possible recognizing that there are going to be some market forces that are going to impact the price over the course of the year as we move within the collars that we often have in place in those types of contracts. So you're seeing that headwind increase through the year this year. That's consistent with our commentary a quarter or two ago where we telegraphed that we saw an escalating commodity inflation curve over the course of 2018. To the extent that market stay high, that would be on balance a headwind as we head into next year. But we're still working through what the overall commodity basket looks like and we're not prepared to provide a more specific guidance on '19 until we get out through the end of the year.

Okay, guys. And I thought the comment was about freight in terms of seeing mid-single-digit inflation and having the --

Yes.

Yes. And I guess that's what I was curious about, on the freight side, have you seen mid-single digits? Others were seeing double-digits. So as those reset, will there be a catch-up as that happens?

I think Russ said earlier that because of our contracts in place, that's we're seeing on average, clearly on the fringes if the rates are higher. So this is an area where our teams are spending significant amount of time managing this. The fact that we're flat in the quarter is as much as the fact that we had inefficiencies in 2017 that we've been -- that our teams have done a great job of overcoming. So that was -- that's partially related to the fact that we had poor performance in 2017 in the quarter with regards to freight, and we've been able to overcome those through our operational -- that continuous improvement actions, which is a credit to the our logistics team.

Our next question is from Kathryn Thompson from Thompson Research Group.

This is Steven Ramsey on for Kathryn. Just thinking about North America pricing and the acquisition of Bridgewater, is there some strategic element here in helping get pricing through the wholesale channel in that region?

No. Those are completely independent. Again, I think the BWI acquisition was one -- wanting to make sure that those customers still had access to Masonite products and the ability for us to invest in the strategies that team had already been working on to improve our penetration, so very independent discussions between those two.

And just to be clear, the owners of that business had made a decision to put that business up for sale. So we responded to an auction.

Got you. And is there -- thinking about the wholesale channel and this acquisition, is there a proactive search and push to get bigger there or is there still a preference to stay on the manufacturing side?

Yes. This was purely a unique opportunity and that's why we looked at this opportunity and took advantage of it.

Great. And then lastly, was there any impact from the hurricanes in Q3, or should we expect any impact in the coming quarters?

I think that there wasn't a significant impact. We know we lost some sales days with customers that were in the areas hit by the hurricane. We felt like that certainly those were starting to recover, and I think the greater trend is what's going to happen with housing through Q4.

Okay. We're at the end of our timing. We really appreciate the questions that we received from everyone. Thank you, operator. And again, thanks all of you for joining us today.

Again, we believe we are well positioned for the future success of our business segments and that there's still significant opportunity to improve the performance of our business as we remain committed to being the best provider of building products in the eyes of our customers, our employees, our shareholders, our suppliers and our communities. And we look forward to updating you on our next quarterly earnings call. We appreciate your interest and we appreciate your continued support in our company.

And with that, we're going to conclude our call. And operator, can you please provide the replay instructions?

Thank you for joining us on the Masonite International Third Quarter Earnings Conference Call. This conference call has been recorded. The replay may be accessed until November 21. To access the replay, please dial 877-660-6853 in the U.S. or 201-612-7415 outside of the U.S. The conference code is 13684115. Thank you for participating in today's conference call. You may disconnect your lines at this time.