JELD-WEN Holding, Inc (NYSE:JELD) Q1 2019 Earnings Conference Call May 6, 2019 8:00 AM ET
Karina Padilla – Senior Vice President, Corporate Planning and Analysis and Investor Relations
Gary Michel – President, Chief Executive Officer and Director
John Linker – Executive Vice President and Chief Financial Officer
Conference Call Participants
Truman Patterson – Wells Fargo
Tim Wojs – Baird
Elad Hillman – JPMorgan
Reuben Garner – Seaport Global Securities
Matthew Bouley – Barclays
Michael Dahl – RBC Capital Markets
Phil Ng – Jefferies
Scott Schrier – Citi
Judy Merrick – SunTrust
Pete Galbo – Bank of America
Steven Ramsey – Thompson Research Group
Good morning. My name is Melissa, and I will be your conference operator today. At this time, I would like to welcome everyone to the JELD-WEN Holding, Inc. First Quarter 2019 Conference Call. [Operator Instructions]
Karina Padilla, you may begin your conference.
Thank you. Good morning, everyone. We issued our earnings press release this morning and posted a slide presentation to the Investor Relations portion of our website, which we will be referencing during this call.
I’m joined today by Gary Michel, our CEO; and John Linker, our CFO. Begin we begin, I would like to remind everyone that during this call, we will make certain statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are subject to a variety of risks and uncertainties, including those set forth in our earnings release and provided for in our forms 10-K and 10-Q filed with the SEC. JELD-WEN does not undertake any duty to update forward-looking statements, including the guidance we are providing with respect to certain expectations for future results or statements regarding expected outcome of pending litigation.
Additionally, during today’s call, we will discuss non-GAAP measures, which we believe can be useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with GAAP. A reconciliation of these non-GAAP measures to their most directly comparable financial measure calculated under GAAP can be found in our earnings release and in the appendix to this presentation.
I would now like to turn the call over to Gary.
Thanks, Karina. Good morning, everyone, and thank you for joining us today. This morning, we announced first quarter results in line with our expectations delivering revenue and adjusted EBITDA growth of 6.8% and 3.2%, respectively, despite facing anticipated headwinds from market growth rates, shifts in mix and foreign exchange.
I’m pleased with how our associates executed during the first quarter to reinvigorate growth, deliver productivity and implement our facility, rationalization and modernization plan. We realized price in excess of cost inflation and delivered net cost productivity savings through deployment of our JELD-WEN Excellence Model. We introduced new and innovative products to the market and deployed capital through opportunistic share repurchases and M&A. JELD-WEN is on track to deliver revenue growth and accelerate core margin expansion as we progress through the remainder of 2019.
Similar to last quarter, our volume/mix challenges were largely isolated through our U.S. windows, Canadian and Australasian businesses. However, the impact of volume in these businesses was further aggravated by pockets of softer new construction demand and extreme winter weather. Despite these headwinds to our growth and profitability, we maintain core adjusted EBITDA margins in line with the first quarter of 2018 by remaining disciplined in our pricing strategy, aggressively controlling costs and driving productivity throughout the enterprise.
As mentioned, overall price cost was a tailwind in the quarter. We realized a 4% pricing benefit in North America, representing the highest rate of price realization in several years. In North America, improved pricing and cost management drove a 40 basis point increase in core margin, while positive net productivity in both Europe and Australasia, partially offset raw material inflation and volume/mix headwinds.
During the quarter, we announced and closed the acquisition of VPI Quality Windows, supplementing JELD-WEN’s existing organic growth initiatives by providing a platform for profitable growth in the mid-rise multifamily and commercial market segments. More on VPI shortly.
We also made good progress on our footprint rationalization and modernization plan, executing projects across all three of our geographic segments during the first quarter. As we previously communicated, we’re on track to realize savings from these projects beginning in the back half of 2019 on our way to our longer term targeted savings of $100 million.
Given our trajectory in the first quarter and the visibility to core margin drivers for the remainder of the year, I remain confident that we’ll achieve our full year guidance.
Please turn to Page 5 for a brief summary of our financial results for the first quarter. John will provide a more detailed view shortly, but let me hit a few highlights. Net revenues for the quarter increased by 6.8% year-over-year driven primarily by a 12% contribution from acquisitions, partially offset by a 4% impact from foreign exchange and a 1% decrease in core revenue. Net income decreased by $23.7 million to $16.6 million due to the non-recurrence of onetime benefits in the first quarter of 2018.
Adjusted EBITDA increased by $2.8 million during the quarter to $90.6 million in line with our expectations. Adjusted EBITDA margins declined by 30 basis points year-over-year to 9% due to the dilutive impact of recent acquisitions and unfavorable foreign exchange, offset by 40 basis points of core margin expansion in North America and flat core margins on a consolidated basis. Additionally, operating cash flow improved by $37.3 million year-over-year through improved working capital utilization.
Net leverage at quarter end was approximately 3.2x, temporarily above our target range due to the acquisition of VPI and seasonal working capital build. We repurchased approximately 940,000 shares during the quarter for $15 million.
We’re intently focused on driving growth and margin expansion in our core operations and will remain disciplined by investing in high return organic projects like our rationalization and modernization programs and new product development.
On Page 6, I’m excited to introduce a number of new products we launched from around the world during the first quarter. Each of these products offer unique and innovative solutions, including improved aesthetics and enhanced functionality, creating greater value for the homeowner and reducing time to install for builders and contractors. A few examples. Our new FiniShield technology for vinyl windows provides an exterior finish with improved energy control, durability and consistency unmatched by traditional paint.
In Australia, we’re extending our recent Alumiere Window series with new features and options to achieve a retro mix. The Siteline Panoramic Gliding Door received a BIMsmith best award at the International Builders Show. It addresses the rising consumer demand for larger daylight openings. Our proprietary door operation technology bridges the price and performance gap between standard patio doors and entry-level wall systems. For the most part, these products expand JELD-WEN’s existing product offerings and will deliver incremental revenue and margin expansion over time. There are more innovations to come, and I look forward to sharing them with you in the coming quarters.
Please turn the Page 7. In addition to innovation, we continue to invest in capabilities to further enhance our growth and reach. We’re pleased to welcome the engaged associates of VPI Quality Windows to the JELD-WEN family. VPI’s premier brand and product offering serving the mid-rise multifamily and commercial markets, coupled with JELD-WEN’s national distribution footprint, will provide meaningful revenue synergies. Significant growth potential exists in VPI’s traditional West Coast end markets, and we believe that VPI’s superior product performance and overall value proposition, including near-perfect historical on-site water intrusion test results position these products for broad acceptance across North America. The acquisition closed on March 29 and integration is progressing as planned.
Before turning it over to John, I’ll provide a brief update on our end market outlook for 2019. In North America, the first quarter played out as anticipated, with softness in residential new construction driven by a slowdown in key housing indicators in late 2018 and offset by healthy demand in repair and remodel markets. In Europe, we saw mixed results across our regional operating units in both new construction and repair and remodel end markets. In Australasia, softening residential new construction markets driven primarily by tightening credit standards were partially offset by relative strength in repair and remodel.
For the remainder of the year, we anticipate a modest acceleration in new construction demand in North America weighted towards the second half of the year. Many key influencers of residential new construction and repair and remodel demand have improved, including mortgage rates, home price appreciation, wage rate growth, employment and the age of existing housing stock. We also believe that growth in household formations in excess of recent new construction activity sets the stage for sustained housing growth in the United States.
For Europe, we anticipate continued mix results that differ by product line, channel and geography. Varying rates of economic growth across Europe are likely to persist, leading to mix demand for building products. Brexit remains an overhang with uncertain economic consequences. In Australasia, we anticipate a further deterioration in residential new construction in the second half of the year due in large part to tightened credit standards, partially offset by stable repair and remodel activity.
With that, I’ll turn it over to John Linker to provide a detailed view of our financial results for the first quarter of 2019.
Thanks, Gary, and good morning, everyone. I’ll start on Slide 10. For the first quarter, net revenues increased 6.8% to $1.0 billion. The increase was driven primarily by the 12% contribution of our recent acquisitions, partially offset by a 4% headwind from foreign currency and a 1% decrease in core revenues. We reported net income of $16.6 million for the first quarter, a decrease of $23.7 million versus prior year. The decrease in net income was primarily driven by the non-recurrence of a $20.8 million non-operational gain and related $7.1 million tax benefit recognized in the prior year on shares held of a minority equity investment.
Our effective tax rate was 38.4% in the first quarter, an increase compared to prior year as well as higher than our expectations for the quarter and full year of 33% to 36%. Excluding the impact of the GILTI provision of U.S. tax reform, our normalized tax rate in the first quarter would have been approximately 30%.
Diluted earnings per share was $0.16, a decrease of $0.21 compared to prior year due to the same drivers I mentioned impacting net income, partially offset by a lower share count. Adjusted diluted earnings per share was $0.23. Adjusted EBITDA increased 3.2% to $90.6 million. Adjusted EBITDA margins declined by 30 basis points in the quarter to 9.0%. Year-over-year, consolidated EBITDA margins declined due to the impact of foreign exchange and recent acquisitions. However, we did see sequential improvements in many areas of our business.
Core EBITDA margins, excluding the impact of FX and M&A were unchanged compared to prior year. Core margins improved in North America for the second consecutive quarter, while Europe core margins decreased primarily due to inflation.
Slide 11 provides a detail of our revenue drivers for the quarter. Our consolidated core revenues decreased 1% in the first quarter. We realized positive price of 2% that was offset by a 3% decline in volume and mix. Total revenue was up 6.8%, primarily coming from our recent acquisitions. We saw positive price realization across all of our segments for the first time since the second quarter of 2018.
Please move to Slide 12, where I’ll take you through the segment detail beginning with North America. Net revenues in North America for the first quarter increased 13.6%, primarily due to a 15% contribution from the acquisition of ABS. Core revenues declined by 1% comprised of a 4% pricing benefit, which did not fully offset unfavorable volume/mix. North America volume headwinds continue to be the most pronounced in our windows and Canada businesses. While our door business saw volume growth in retail and company-owned distribution, partially offset by weaker performance in traditional distribution, which was also a headwind to mix.
Adjusted EBITDA in North America increased by 13.8% to $53.5 million. Adjusted EBITDA margins expanded 10 basis points to 9.5%, a sequential improvement from the 10 basis points decrease in the fourth quarter of last year. North America generated core adjusted EBITDA margin expansion of 40 basis points that was mostly offset by the dilutive impact of the ABS acquisition. This is the second consecutive quarter of year-over-year core margin improvement in North America.
Moving on to Slide 13. Net revenues in Europe for the first quarter decreased slightly by 0.6%. The decrease in net revenues was driven primarily by foreign currency. The Domoferm acquisition contributed 7% to segment net revenue, that was more than offset by 8% headwind from foreign exchange. Excluding this impact from currency and acquisitions, Europe generated core revenue growth of 1% primarily from improved pricing.
Adjusted EBITDA in Europe decreased 16.7% or $28.2 million. Adjusted EBITDA margins decreased 180 basis points to 9.4%. Margins were impacted by 50 basis points of core margin compression primarily from inflation as well as the dilution from the unfavorable impact of foreign exchange and the Domoferm acquisition.
On Slide 14, net revenues in Australasia for the first quarter decreased 0.9%. The A&L Windows acquisitions contributed 10% to net revenues, but was not enough to offset the impact from the combination of foreign exchange and market factors that resulted in lower volumes. Core revenues declined 2% primarily to the unfavorable volume/mix impact of the continued softening of the Australia residential new construction housing market. We were pleased to see positive price benefit in Australasia in the first quarter as this is an improvement from the previous quarter.
Adjusted EBITDA in Australasia decreased 1.9% to $16.4 million. Adjusted EBITDA margins contracted by 10 basis points to 11.3%, due primarily to unfavorable foreign exchange. Core adjusted EBITDA margins were flat in the first quarter as net cost productivity was offset by the deleveraging impact of unfavorable volume/mix.
On Page 15, cash flow from operations improved $37.3 million in the first quarter of 2019 to a use of $28.0 million from a use of $65.3 million in the same period a year ago. We improved operating cash flow through more efficient working capital utilization. Our cash flow performance was in line with our expectations. As a reminder, our first quarter operating cash flows are typically negative due to the seasonality of our working capital cycle.
Our capital expenditures increased $4.5 million in the first quarter compared to prior year. The increase was in line with our expectations and outlook for the full year. On the balance sheet, we ended the first quarter with total net debt of $1.48 billion, an increase of $118 million since December 31, 2018. The increase in our net debt was driven primarily by the cash used to fund the VPI acquisition we closed during the first quarter and our seasonal operating cash flow usage. Our net leverage ratio was 3.2x at the upper end of our target range, up from 2.9x at year-end 2018.
Our balance sheet remains strong and our capital structure, liquidity and free cash flow generation will provide us with the flexibility to reduce our net leverage ratio over time and fund our strategic initiatives.
Now before turning it back to Gary, I’ll comment on why we are well positioned to deliver on our commitment in 2019. We executed to our plan in the first quarter, amidst the challenging market backdrop. The new construction housing market continues to provide mixed signals across our global end markets and while we feel good about the long-term demand drivers in these market, we have positioned ourselves to stay ahead of these near-term challenges by aggressively managing our cost structure.
We expect core adjusted EBITDA margin to accelerate in the second half of the year as a result of our already completed pricing actions, improving, but modest increases in volume/mix, our pipeline of JEM productivity projects and our footprint rationalization program. We have good visibility to each of these earnings drivers, and therefore, I believe we are well positioned to deliver on our 2019 commitments.
Now, I’d like to turn it back over to Gary to go through our latest 2019 outlook and provide you with closing comments.
Thank you, John. Please turn to Page 17. We maintain our original expectations for 2019 of consolidated revenue growth of 1% to 5%, including the partial year contribution from our VPI acquisition. Core revenue growth will be driven by pricing actions and modest volume growth in North America in the second half of the year, partially offset by moderate new construction contraction in Australasia.
We’ve increased the lower end of our outlook range for adjusted EBITDA so that the range is now $475 million to $505 million, which reflects the partial year contribution from the recent VPI acquisition for the remainder of the year. We also reaffirm our original expectations for a full year core margin improvement of at least 40 basis points.
We estimate that we will generate approximately 27% of our full year adjusted EBITDA in the second quarter. Year-over-year earnings growth in the second quarter will be limited by unfavorable foreign exchange and incremental SG&A investments, which are specific to the second quarter and not expected to recur in the remainder of the year.
Finally, I’ll note that we’ve had no significant updates on the Steves litigation since our last call in February, and due to the ongoing nature of the proceedings, we will not be able to take any questions on this topic during the Q&A session.
With that, I’d like to open up the call for Q&A. Operator?
[Operator Instructions] Your first question comes from the line of Truman Patterson from Wells Fargo. Your line is open.
Nice quarter. Just wanted to dig in to North America on the negative volume and product mix. You guys mentioned that windows, Canada and weather were a bit of a headwind. I thought windows, it started to turn the corner. Could you guys just give us an update into what it’ll take to turn the volume and mix from a headwind to a tailwind? And if you’re seeing any improvement post-first quarter?
Thanks, Tru for the question. Yes, so North America is slightly down on core volumes. We saw – it’s hard to quantify the weather obviously, but if you were to take out kind of that period of harsh winter weather, the areas where we serve, we would have seen growth – we clearly would have seen growth in the quarter, which is encouraging.
On the windows side, it does take some time to win back that business. We’re seeing some real positive response to our windows business. Number one, all the operational issues are well behind us, so that’s been a benefit for us as well as the products that we’ve launched in that area, some that we talked about this morning as well as the ones that we’ve launched in the Siteline area over the last, call, 1.5 years.
So we’re starting to see some real positive movement there. Unfortunately, it takes time for these projects to come to fruition plus to win back some of the shares that we’ve lost. We’re feeling pretty good about it. We like our chances and what we’re hearing from customers is very, very positive. So I think the mix of good products, good operational performance and the strong relations that we have in the channel will start to pay of for us here in the remainder of the year.
Okay. Okay. Looking at your JELD-WEN efficiency model initiatives, the JEM initiatives of $100 million in 2022, how should we think about the cadence of this unfolding? Is it pretty evenly each year? And if so could you just give a little bit of an update on North America as I didn’t see anything in the press release that there’s much productivity gains in the first quarter at all?
So the way we’ve laid it out is we’re still on track to see some benefit kind of in that $10 million range still in 2019 from the rationalization, modernization program. JEM is a set of tools that we’re deploying across the enterprise, not just North America, but across all of JELD-WEN. These tools very – some very basic around problem solving, visual management and the like, developing a cadence towards our productivity pipeline and the way that we measure that and each door that we program and manage each one of those. We like where we are on the rationalization program.
During the quarter, we’ve started to see some movement there. We’ve made some moves already in some of the smaller plans, but the way that it kind of lays out is – early on, we developed standard work, we take that standard work and we deploy that across the businesses and then we start the consolidation and rationalization.
Because of the issues that we had last 12, 18 months ago, we wanted to be overly cautious before we close down facilities or rationalize facilities. We want to make sure that we have the new facilities up and running and capable of meeting production so that we don’t risk any customer disruption. We’ve done that very, very effectively. Like I said, I feel really good with what the teams have done so far, and we’re on track to do that.
As you think about it going forward, clearly, maybe we’re going a little bit slow to go fast later. We’ll start to see that accelerate – accelerated benefit from both JEM and the rationalization programs kind of starting next year and into the future. We’re still committed to the $100 million from our JEM programs, a $100 million from the rationalization and modernization programs moving towards that 50% EBITDA target.
Okay. So the JEM initiatives kind of have a longer tail to them similar to the footprint rationalization. Are there any near-term gains that you might be able to discuss with us?
So Truman, let me just amplify a little bit. So as Gary mentioned couple calls ago, we laid out $100 million target for the blocking and tackling JEM initiative, that’s in the core plans that aren’t being rationalized and then $100 million for the footprint rationalization program. Yes, we mentioned in the first quarter, yes, there wasn’t a lot of talk in the materials about productivity in North America and that’s true. I mean, in a 5% headwind to volume/mix, it is difficult to extract a lot of labor productivity. And so definitely in the first quarter, Europe and Australasia performed better on the cost productivity side.
In terms of the phasing of kind of the productivity for North America and globally for the back half of the year, yes, we’ve got good visibility from sort of a pipeline of projects that build up and go throughout the year, both on the sourcing side, in terms of material sourcing as well as in the core plans due to some automation investments we’ve made and things like that. So yes, I think, it’s fair to say that there’s good visibility to improving productivity in North America in the back half of the year. It’s not one or two big projects, that’s – it’s a lot of smaller initiatives that add up to that pipeline and give us visibility.
Your next question comes from the line of Tim Wojs from Baird. Your line is open.
Nice job. Maybe just – Gary, maybe just to start off on price cost. Just given the stronger realization in the U.S. that you saw, there may be some moderation in things like steel, any change to how you’re viewing price cost overall for the overall company for the year? And then, I guess, if you look at Europe and you look at Australia, is there any opportunities to accelerate the pricing there? Or is it just going to be tougher with the tougher volume backdrop?
Tim, thank you. So let’s take the cost side of the equation first. I would say as we look at sort of the full year, we’re still viewing inflation in both material and freight. We do see some areas that should be on a year-over-year basis start to get a little bit more favorable, particularly in Europe. There’s some opportunities to start seeing some lower inflation. So if I think about sort of where the material and freight inflation is across the globe right now, certainly the highest is still in North America and Europe and Australia are sort of on the lower end.
So from where we sit today, I would say material and freight inflation in the 1.5% – 1% to 1.5% for the full year. We’re not going to forecast price for the full year, but it’s fair to say based of the actions that we’ve taken, we would expect that the same type of price/cost tailwind from the first quarter to continuing into the back half of the year.
On the pricing side, specifically, while we have most of the actions behind us in North America, there’s a – in Europe, there’s a few areas of our business that kind of contractually have April 1 effective dates on price increases, and so we would start to see some of that inflation that hit us on margins in Q1 in Europe, we would expect to start to see some relief from that as we get some price increases through in the effective April 1 in Europe.
Okay. Okay. That’s helpful. And then as we think about just how the quarter may have turned in, this might be more of a North America specific question, but how did you see trends kind of through the quarter into Q1? And then any commentary on how April’s performed so far?
Yes. I think largely the quarter played out as we expected from a – in the first quarter in North America. I mean, yes, we kind of newly had some volume headwinds going into the quarter. In windows, as we talked about in the last call, that was not a trend we thought we could turn around in the – in 1 quarter. I think certainly, the unexpected items were the weather piece of it.
I mean, winter weather is always initially in Q1, but this year it was extreme. We had Canada shutdown for a number of days, some of our retail partners in North America were slower to take orders due to weather and even in Europe, we had in Austria some pretty severe weather that shut us down for a couple of days.
So there were some surprises, but that’s part of the course that we got to execute around. I’d say, as we start to think about Q2 and where we are heading in the quarter, without getting too specific on Q2 volume trends, I mean, I think we’re sort of – we’re certainly cautiously optimistic that we’re going to see some – see the trend turnaround in the second half of the year, but probably still some of those volume/mix headwinds are going to be with us during Q2 as well.
Your next question comes from the line of Michael Rehaut from JPMorgan. Your line is open.
This is Elad on for Mike. I just wanted to look a little bit close on North America volume/mix, which is down 5% and you’ve talked a little bit around the volume impact. I was wondering how much of that relates to volume and mix? And really take deeper in the mix issue, I think, you spoke about the mix shift continuing to lower margin retail business. I was just wondering if that’s accelerating? And any actions you’re looking to take to offset this headwind or bridge the gap between the retailer versus traditional business margins in doors?
Yes. So as John said earlier, with – primarily where we got affected in and some of the softness in the first quarter was in kind of our, what we call, our traditional channel, with the move towards the retail business. There are kind of proxies a little bit as well for new home construction versus repair and replace. So the repair and replace business and that retail proxy for that continue to be relatively strong, and that’s where we’ve seen the kind of volume mix change. We do expect as we said in the comments, looking forward to the second half of the year, residential new construction in that traditional channel really starting to pick back up. And we expect to see that beat some favorable growth as well as creating some favorable mix for us.
That’s helpful. And then, also on the progress from the footprint rationalization and understanding the considerable approach to start and also point to savings in the second half of 2019, I just wanted to confirm if you’re still on track to that $10 million to $15 million given the timing of how things are progressing?
Yes, absolutely. We’re still on track. We’ve made some smaller location closures during the first quarter really across the entire enterprise in all three regions. We’re still on track. The savings within the year will still happen. The only difference between that – in that range is really not that the projects aren’t coming to fruition, it’s really just more about how fast we feel about taking out latent capacity. So the projects are really solid. We feel really, really good about them, well on our way on longer term track as well on the rationalization. So still committed to making that happen.
Your next question comes from the line of Reuben Garner from Seaport Global Securities. Your line is open.
So you updated your EBITDA range, it looked like the revenue was the same. Can you go through the buckets of your revenue outlook? Maybe what’s changed over the last few months? And I guess, walk through what your expectations are for volume, price, mix, FX, if you could?
Sure. So yes, we did roll in the acquisition of VPI, which we get about 9 months of – we had our revenue range was – for the full year was 1% to 5%, and given just how early in the year we are and just the relative small size of the VPI acquisition did not see a catalyst to move that, 1% to 5% range in terms of revenue. Certainly, I guess, the big piece of the overall 1% to 5% is coming from the acquisition that we did last year. So we had 1 quarter that we now anniversaried for ABS, A&L and Domoferm acquisitions, which all contributed to first quarter, and now we’ll get a little bit here from VPI this year. So that’s certainly a big piece of the revenue growth.
We do have a fairly significant headwind from FX on the top line and the bottom line primarily weighted towards the first 2 quarters of the year. FX, I would say is probably in the range of a 2% plus headwind to revenue. And so that would certainly be a drag in that 1% to 5% and then the remainder would be just the core revenue growth. So we’re negative here in the first quarter on core revenue by minus 1%, and so we would expect to see that accelerate as we get into the back half of the year. And as we progress and give you – we’ll get more visibility on kind of the pipeline and demand. The next few quarters, we’ll certainly update the revenue guidance as it’s merited and as we get closer.
Okay. And then your core EBITDA margin expansion target for this year, can you help us with maybe how it’s going to look on the gross margin or – and/or the SG&A line? What’s your expectations are for the next few quarters?
Sure. So we mentioned in the comments that we reaffirmed the 40 basis points of core EBITDA margin expansion in the full year. Again, on a consolidated basis, we’ve got a headwind from FX and a headwind from some of the M&A that we lapped in the first quarter that was dilutive. So not all of that 40 bps drops to the bottom line. I would say that the vast majority of that 40 basis points is going to be on the cost of goods sold, gross profit side on the core business. The price cost and the productivity, we do have some investments that we’re making in the business on IT side and some other areas, they’re going to be a bit of a headwind to SG&A, but certainly I would put most of that 40 basis points as core margin on the gross margin line.
Your next question comes from the line of Matthew Bouley from Barclays. Your line is open.
I wanted to start out with a question on VPI. It sounded like you’re calling for revenue synergies. I guess, one, are there cost synergies as well that you’d be able to quantify? And two, just kind of more broadly, I think you mentioned that VPI might be more of a platform for you in the multifamily commercial window space, so just kind of any thoughts on how you guys would be thinking about further M&A in that market?
Yes. Thanks for the question. We really like what we saw at VPI. The product portfolio, their capabilities in that multifamily commercial space really, really strong, but they’re very much indexed and most of their success has been in the – on the West Coast, and even to that extent, somewhat on the upper West. We thought that they started some other expansion and – towards the East with some really strong customer relationships.
And we thought that with our – we do believe with our distribution, their product and expertise in that area, it’s just a great match for us on the revenue side and the growth side. It’s an area that we’ve been playing in and one that we had targeted for further expansion and growth, so it just was a great match there for revenue.
On the cost side, clearly, there’s commodities that we share, and we’re already starting to see some benefits from combining our – their buy with what we already buy at JELD-WEN and seeing some commodity opportunities there as well. So really good kind of down in the middle of the fairway type of acquisition, one that expands our capabilities in commercial, multifamily, which is obviously a growing area in the market space and it combines the best of both companies.
All right. And then, I wanted to ask about Europe, even highlighting this kind of negative mix shift for a couple quarters here, sounded like channel and product mix. So just any additional detail on what’s playing out there, if that’s going to kind of persist here into the second quarter? Or if there’s any other actions you might need to take around that?
Yes. I think, when you look at it, it’s kind of mixed results depending on the regions, some up, some down, a little bit of mix between project business and our commercial and residential business. So we’re watching all of that very closely. Obviously, watching the cost side of the equation as well. Operationally, we’re doing well in Europe.
Our products are well accepted. We’ve got some price there, but we also have to be cautious that we manage that price in light of where the volumes are coming. I know that we’ve gone very specifically on what’s up, what’s down, but we’re seeing our traditionally strong North business doing pretty well, Central Europe’s now seen a little bit of softness. And of course, the overhang from Brexit continues, particularly as we look at that repair and replace business in the UK.
The next question comes from the line of Michael Dahl from RBC Capital Markets. Your line is open.
Actually, Mike Eisen on for RBC. Following up on some of the commentary, you both talked a good deal amount about 1Q being in line with what you expected, specifically in North America. When I’m thinking about the prior guide, you gave core growth of 3% to 4%. Can you help us bridge the gap for the rest of the year, and help us think of, is there anything that you see coming, whether it’d be new business wins or reloading in some of the channels? What’s going on that helps you give you confidence in such a step-up for rest of the year?
Sure. So I think as – thinking about the core growth, we’ll have to follow-up with you off-line on that 3% to 4% core, I don’t recall that commentary for the full year. I think, 1% to 5% on a consolidated revenue basis is certainly what we’re maintaining on a full year. As we think about growth rates in North America specifically, we’ve got – I think, the windows business from – Gary already mentioned, a lot of investment on the front-end commercial side on trying to regain share and build a pipeline.
And as we looked at sort of what’s in our pipeline both on the door and window side relative to both our external expectations as well as relative to the comps that we have to perform against in the back half of the year, we feel good that we’ll start to see some core volume in the back half. And then, again, pricing, we’ve already taken those actions, which contributes to the core revenue growth and feel like that’s pretty known at this point based off what we’ve already put in place. And so that gives us some visibility to that core revenue, negative 1% we had in the first quarter starting to improve probably in the Q3, Q4 time frame.
Got it. That’s helpful. And then, following up, you had some commentary in the prepared remarks about different demand trends in your different end markets and distribution channels. Can you help us think about where you think inventory levels are across those different channels? We’ve heard a lot of commentaries over the last couple of weeks about destocking in certain channels, and whether you think there’s anything nuanced about it that could cause a better reaction or rebound as we look forward?
I think from where we stand – I don’t know that there’s been destocking from where we stand. Yes, for most – mostly, what we’re saying is pretty adequate inventory levels, we’re pretty well stocked going into the season certainly compared to where we would have been in past seasons, that’s been one of the knocks that got us into trouble.
So we’re certainly prepared, our channel partners seem to be prepared. As we look at the indicators that we talked about before, repair and replace, particularly here in North America, has remained to be a pretty strong business and one that we’ve been able to benefit from. The residential new construction while it’s been a little bit choppy since fourth quarter and in the first quarter, we do see those indicators trending positive, and I think that’ll be pulled through primarily through our traditional channel. So I think, we’re adequately positioned with our channel partners. I think, we’ll see kind of more direct revenue in line with those market dynamics.
Your next question comes from the line of Phil Ng from Jefferies. Your line is now open.
Obviously, impossible to predict, but there’s potentially a threat of new tariffs being implemented by the end of the week. When you needed to implement additional price increases, how confident are you with your guidance for, I believe, at least mutual price cost? And how quickly could that impact your P&L, if this does tick?
Thanks, Phil. Yes, let’s try. When we gave guidance back in February for the full year, we anticipated there would be some step-up in tariffs later in the year. Obviously, impossible to predict in this environment sort of exactly when and how much. I would say at this point, we have – we took some pricing actions earlier in the year as noted.
We also the supply side have already started to look at alternative sources to supply outside of China for our spend. Prior – for 2018, we were in the range of around $110 million purchases of raw materials from China, and we really had already started to look to mitigate that through other solutions. So I would say we’re aware of what may go through on Friday. We’re updating our guidance as of today. At this point, I feel like even if this 10 – if the 25% goes through effective Friday, that we’ll still be able to absorb that in our guidance range that we’re affirming today through a variety of levers we have to pull.
Got it. And that’s really helpful color, John. And then, I guess, on the $100 million JEM restructuring initiatives, it’s obviously a impressive number and it’s going to ramp-up going in the next year more fully. But do you expect these efforts kind of impact top line and profitability the near term? And how much of these savings do you expect to actually drop through to the bottom line accounting for any potential sales leakage or dyssynergies?
Okay. So let me start with that first. No, we do not expect that JEM were to affect our top line negatively. In fact, quite the opposite as we improve cycle time, improve our operational performance, develop standard work and deploy that across the enterprise. We would expect that to be a net positive towards our ability to grow. So quite frankly, it’s the opposite.
When we think about JEM, the JELD-WEN Excellence Model that’s called a truly business operating system, which while – we talked about it quite a bit here in terms of the productivity that it will generate. It’s an all-encompassing business operating system that looks at standard work and how we do all the processes within the business.
So if you think about it, we’re deploying standard work and visual management in our finance and marketing department and sales departments as well. So while that may not drop out clearly as, what we call, traditional productivity, it certainly allows us to increase our cycle time and increase our market share going forward by serving our customers better.
Your next question comes from the line of Scott Schrier from Citi. Your line is open.
So a little bit following up on that last question. I think earlier in the call, you had said that you expect about $10 million of realization in 2019. And then, if I look at your guidance at the midpoint for the year, it implies roughly 33% operating leverage, seems like will be about 18% without that $10 million. And I know you’ve gone through some of the price cost to mix headwinds and everything. I’m wondering how that operating leverage kind of falls into where you look at your fixed and variable cost structure? And then if I think about what’s bracketing the guidance on the assumptions, what’s in there at the higher end of the range and what’s in there at the lower end of the range?
Okay. So if you think about it, I think it’s great question. A couple of things. On the JEM and productivity side, that’s a part of it, right? So we’re driving – obviously, we’ve got price that we’ve been talking about, price realization to be positive this year as opposed to drag last year. We’ve got productivity that we’ve driven into the business, regardless of the rationalization and modernization program, we’re driving productivity in all parts of our business, so that we’re driving that leverage.
The rationalization and modernization portion, effective part of our business across the enterprise and across the segments, but that’s where we’re investing in standard work, new automation and it will ultimately be a little bit longer term, but that’s where the $10 million drops out. The additional productivity, the additional price, you will see that shorter term and then in addition to that, that $10 million that we’ll see this year from the rationalization will then accelerate going forward towards that $100 million that we’ll expect from the total rationalization by 2022.
And then another one on VPI. You had spoken about the potential for expanding the business and it was already in progress. Can you speak to the timing and magnitude, if any, of whether it’s incremental CapEx or an SG&A that would be needed to really start to grow that business?
We believe that when we look at the capabilities that exist within VPI, certainly their expertise in that commercial and multifamily area, we’re able to leverage that across our existing coverage for the markets, so be it through distribution that we already have, through our sales resources and our architectural and commercial support capabilities that we currently have.
If we need to add resources as we grow, I think, there’ll be incremental and they’ll be part of what you would expect that would go along with the revenue, but they wouldn’t. There’s not a big huge investment that needs to go to supplement that capability. I think a lot of it exists and then you’ll just see we will see it as we grow that revenue base and we expand, there will just be a normal incremental portion of the SG&A that would be required to support that kind of sale.
Yes. I would just add on. I think we talked about on previous disclosure that the VPI acquisition would be accretive. The company margin’s going to be a little slow to start out this year with some integration costs and higher health benefits and things like that as we bring VPI into our plan.
So maybe not quite right off the bat that accretive, but certainly as we get into the back half of the year, and then into next year, we’d see that business being accretive to consolidated margins. And as we go after those revenue synergies that Gary mentioned, and as we start to get the material cost synergies, I would expect to see that start to accelerate. So I wouldn’t expect any headwind from sort of a SG&A or CapEx to go after those synergies.
Your next question comes from the line of Keith Hughes from SunTrust.
This is actually Judy in for Keith. Most of our questions have been answered, but just looking forward on what you’re looking at for acquisitions, would you expect them to be kind of similar to VPI and like a synergy and the cost synergy basis kind of similar to that or what’s your outlook for that?
So look, we’re going to – strategic M&A is the key piece of our future growth platform. We feel like our future growth strategy with our global platform, we’ve got opportunities to look at bolt-on M&A kind of globally in all three of our geographic segments and bolt-on to our existing business. I’d say right now in the short term, leverage is a little higher, it’s above our target range, and we’re going to want to see visibility to that leverage coming down.
And so any M&A activity here for the second half of this year is going to be fairly limited as we really work to execute on getting the core margins up, integrate what we bought in the last 12 to 18 months, which is pretty significant. That said, as we move forward, leverage comes down, gets through the back half of this year.
We think there’s a great M&A opportunity here for this business given our cash flow capability to really look at M&A as a core competency, but bolt-ons that are similar to VPI right down in the middle of the fairway similar products, but maybe slightly different end markets, but also starting to think about adjacencies that would have synergies in our – through distribution channel down the road. So we think there is a great opportunity looking forward.
Your next question comes from the line of John Lovallo from Bank of America. Your line is open.
This is actually Pete Galbo, on for John. John, I just wanted to confirm to one of the earlier questions around tariffs. I think, last quarter, you had said that if tariffs went to 25%, it would be $12 million to $17 million potential hit. Is that incremental relative to the 10%? Or would that have been the kind of the total overall hit that you would have seen going from 0% to 25%?
No. That was all in – sorry, I got to speak back there. I think that would be all-in tariff expectation for the full year. It was included in our recent original guidance.
Got it. Okay. Okay. And maybe just switching gears, if you guys could talk about – you had a number of new product introductions that you had mentioned. John, at the builder show, you had mentioned kind of a potential to start looking at maybe some composite based windows and other products. Can you just give us any update there? Maybe advantages that you see from offering composites, whether it’s from a price point? And maybe what you think the market opportunity could be in that material?
So yes, we did hopefully that feedback is not coming through and you’ll my answer, but we didn’t launch a number of products at IBS, went through a few of those in the prepared remarks. We did tease out the composite, we’re working towards that, and we’ll be launching that product for the market for commercial production later in the year, and we’ll be giving a lot more information about the product at that time.
But we do think there’s a real opportunity there with new materials. Innovation is going to be key, not only in windows space, but also for doors, and we’re seeing innovation that’s really crossing the business globally. So we’re able to use these material innovations as well as product innovations across all three of our operating geographies, and actually, across windows and doors as well. So we think the composite is a great example there. We talked about FiniShield earlier as an alternative to vinyl, which has some better capabilities there as well. Did you get that answer or was that...
No. I did. It came through. Sorry about that. Is there any way Gary maybe just in North America to put out a potential total market opportunity for composite windows? Or is that something you guys are not willing to disclose at this point?
Yes. We don’t typically talk about that, but as we get closer to the commercial launch, we’ll certainly give you some more commercial color on that probably later in the year.
Your next question comes from the line of Steven Ramsey from Thompson Research Group. Your line is open.
Maybe you can talk a little bit about ABS and is that a kind of an ongoing or permanent headwind to North America margins? And as far as internal improvement initiatives go, is ABS a part of this?
So in terms of ABS and some of the other value-added distribution acquisition that we did also MMI, which was done in late 2017, we had indicated at the time those deals with done, yes, initially, it’s slightly dilutive to company margins, but when you start to look at sort of the throughput – the total throughput opportunity for us of – for JELD-WEN of being able to sell our richer mix of our products, both interior and exterior doors through those channels that we thought there was an opportunity to have the total margin benefit that the JELD-WEN going to be accretive over time and particularly as we look to take out cost.
So I’d say in North America in Q1, ABS, yes, was slightly dilutive to segment margins in Q1, but as we kind of look through the second half of this year and into next year as we drive in some of those revenue synergies and also taking some of the cost out through potential facility rationalization, we would view the kind of total opportunity to JELD-WEN as being a accretive scenario.
Got you. So you’re saying that thesis going in for purchasing those companies still holds?
Yes, absolutely. Yes, we’re happy with those acquisition so far. Integration is on track and feel good about where we are.
Great. And then last question on Q1 demand and sales. I’d be interested to hear in areas that were not weather impacted, can you talk about how demand was? And if possible to break that out by the new construction side and the repair/remodel side, thinking North America there?
Yes. I don’t think we’ll break it down any further than we already have, other than to say that – like I said earlier, core – slightly down on revenue overall, but we had we have the benefit of those areas that were impacted, would have been growth. We saw the mix piece much more of a repair and replace retail versus residential new construction. We expect in the second half that to start flipping in the other direction.
There are no further questions at this time. Mr. Gary Michel, I turn the call back over to you.
Thanks a lot. And thank you all for joining us today. We do appreciate your interest in your questions. I’d like to leave you with a couple of thoughts. I’m real pleased with our sequential and sustained improvements that we’ve demonstrated across many parts of our business over the last few quarters. We delivered positive productivity for two quarters in a row and also maintained our service levels with our customers. We achieved year-over-year core margin improvement for two consecutive quarters and price cost is now a tailwind as opposed to the headwind that it was for most of 2018.
We’re confident that we have improved our operational performance combined with new product innovation. These will lead to an acceleration of core revenue growth. Additionally, we continue to make the investments that are required to drive margin improvement in future quarters as we proceed toward our long-term EBITDA margin target of 15%.
This includes executing on our footprint rationalization and modernization plan and accelerating to deployment of JEM tools across the organization. We look forward to speaking with you all again at the end of quarter in a few months and provide another update on our progress. Thanks, again, for joining us this morning. Have a great day.
This concludes today’s conference call. You may now disconnect.