Q3 2022 Masonite International Corp Earnings Call
Okay.
Greetings welcome to Masonite to third quarter 2022 earnings conference call. During the presentation, all participants will be in a listen only mode. After management's prepared remarks investors are invited to participate in a question and answer session. Please note that this conference call is being recorded.
I would now like to turn the call over to Richard Leland, Vice President Finance and Treasurer. Thank you. Please go ahead.
Thank you and good morning, everyone. We appreciate you joining us for today's call with me here. This morning are our president and Chief Executive Officer, and Russ each month Executive Vice President and Chief Financial Officer also joining us today for the Q&A as Chris Hall, our president of global residential.
We issued a press release and earnings presentation yesterday reporting our third quarter 2022 financial results. These documents are available on our website at masonite com.
Before I begin let me remind you that this call will include forward looking statements. Each forward looking statement contained in this call are subject to risks and uncertainties that could cause actual results to differ materially from those projected in such statements. Additional information regarding these factors appears in the section entitled forward looking statements in the press release we.
Issued yesterday.
More information about risks can be found under the heading risk factors. It makes sense. Most recently filed annual report on Form 10-K, and our subsequent form 10, Qs, which are available at SEC Gov and at Masonite Dot com.
We're looking statements in this call speak only as of today and we undertake no obligation to update or revise any of these statements are.
Our earnings release and today's presentation discussion includes certain non-GAAP financial measures. Please refer to the reconciliations which are in the press release and the appendix of the earnings presentation.
For today's call includes a business overview from Howard followed by a review of the third quarter results from Ross and then Howard will provide some closing remarks, and we'll begin the question and answer session.
Let me turn the call over to Howard.
Thanks, Rich good morning, and welcome everyone.
Turning on page four I am pleased to report that Masonite continued to deliver strong year over year growth in the third quarter with net sales up 12% and adjusted EBITDA up 7%.
Adjusted earnings per share increased 27% due to our higher earnings and a lower share count.
Results in our North American residential segment for the quarter were outstanding net.
Net sales for the segment grew 19% year over year and adjusted EBITDA grew 26% due to a disciplined focus on price and cost management and strong execution of our doors that do more strategy.
The segment also benefited from the diversity in our residential end markets as demand remained more resilient in the residential repair and remodel market during the quarter and helped mitigate the impact of softening demand in new construction.
In Europe , we experienced substantially greater headwinds than expected in the quarter from ongoing macroeconomic challenges, including consumer confidence energy cost and exchange rates. Our leadership team has been systematically taking a number of actions to support margins, but the rapid deterioration of the economic climate.
Did result in uncharacteristically weak performance for this segment.
The combined effect of the European results and slower than anticipated recovery in the architectural segment were a significant headwind to the overall results for the quarter, but we are pleased that strength in the core North American residential segment kept us largely on track in the quarter.
Beyond these quarterly highlights I am happy to also comment on the exciting M&A news occurring subsequent to quarter end during our normal quiet period.
On November <unk>, we announced our intention to acquire enduro products, a leading innovator and manufacturer of high performance residential door frames and door system components. We are extremely excited about the strategic fit of this acquisition and its potential to help accelerate growth for masonite.
Let's turn to slide five.
<unk> was founded in $19 54, and it's been a family owned business for three generations over nearly 70 years. It has developed into a highly respected supplier of exterior door system components. The company has delivered net sales of approximately $270 million over the last 12 months and their revenue.
As a grown at a compound annual growth rate of 17% over the past three years there.
Their products are sold to distributors located throughout the United States, and Canada, as well as direct to Oems and online.
<unk> product portfolio broadly consists of door frames door sales and other components as well as engineered styles and rails all designed to improve the performance of exterior door systems.
The team is in constant pursuit of insight that helped drive innovation and make a door system perform better.
Our research and development efforts have produced an intellectual property portfolio of over 100 active patents and dozens more that are currently pending.
The company has four production facilities located in North Carolina, Texas, and Oregon and employs over 800 people.
<unk> has been amazing supplier for over 25 years and the partnership has grown stronger recently as we have collaborated closely on several of our new exterior door systems.
We have a great respect for the way, they prioritize and demonstrate not only innovation, but quality service and integrity as well.
We believe there is a great cultural fit between our companies and are delighted that Bruce Proctor Enduro <unk> current president and his leadership team will be joining masonite following the close of the transaction.
Bruce has invested 30 years of his career into growing his family's business and is excited about the combination of masonite and enduro given our strong partnership to date. This.
This was not an auction. This acquisition was the logical next step in the evolution of our partnership.
Both the masonite and enduro management teams see tremendous potential to accelerate future growth as part of our combined organization.
We have put a cross functional integration team in place to ensure a smooth transition and deliver on the synergies already identified during due diligence.
We expect to close the transaction in near year end pending receipt of regulatory approval and satisfaction of customary closing conditions.
Turning to slide six.
Our doors that do more strategy drives how we run our existing business as well as our inorganic growth roadmap since developing this strategy. We have taken a more targeted approach to M&A that includes a clear framework of strategic growth opportunities and a list of potential targets and euro has long been at the top of that list.
<unk>.
Beyond the attractive product portfolio intellectual property valuable brand excellent manufacturing capabilities, great customer relationships and an outstanding team that endure brings the long term strategic value of this transaction comes from the ability to accelerate innovation across the complete <unk>.
Door system and unlock the value of fully integrated products.
This product integration opportunity came to light shortly after I joined the company or.
Our consumer centric research uncovered unmet needs around the hole for comfort privacy security style and convenience.
As a result of the pandemic the homeowners needs have only become more acute.
But to make a door operate seamlessly and to solve life and living problems to make it more soundproof or weatherproof or secure you need more than just the door slab you also need the frame and all the other components to be tightly integrated and work in concert.
This is what makes it a door system and gives it maximum value.
It is also why masonite and enduro been together makes so much sense.
Many of our down channel customers already by both masonite doors and indoor products to use them together and creating entry door systems.
Great example is the masonite performance store system, which we launched earlier this year as you may recall this product combines high quality masonite exterior fiberglass doors with high performance enduro frames self adjusting fills whether ceiling and more to form a highly engineered complete door.
That is 64% better at keeping air and water out then the leading competitor.
We also partnered with <unk> to design and supply components for our empower smart door solution.
These are just a few examples of the types of performance benefits that come from design and engineering across the entire door system and we are eager to further these efforts.
By fully integrating and aligning our resources, we can move even faster to deliver doors that do more.
In addition to the incremental growth potential from product integration, we anticipate other tangible benefits from this transaction.
Upon closing and neuro will provide incremental access to new markets, new product categories, and new distribution channels.
Together, we will be expanding our total addressable markets and further building on the value of both of our brands.
For all these reasons I am thrilled to welcome the <unk> team into the Masonite family as we continue to unlock the value of our doors that do more strategy by delivering door solutions that solve life and living problems for homeowners and delivering greater value to our partners and shareholders.
With that I'll turn the call over to Russ to provide more details on our financials for the quarter Russ.
Thanks, Howard and good morning, everyone turning to slide eight I'll start with an overview of our third quarter financial results.
We reported net sales of $728 million up.
Up 12% as compared to the third quarter of 2021.
The growth was driven by a 21% increase in A&P, which was up year over year on price implemented to offset inflation as well as positive product mix.
This increase was partially offset by a 6% decline in volume a 2% decrease due to foreign exchange and a 1% decline in component sales.
Gross profit increased eight 5% in the quarter to $167 million.
While gross margin decreased 60 basis points year over year to 23% due primarily to the effects of inflation and the volume deleveraging impact on factory costs in the Europe and architectural segments.
Selling general and administration expenses were $83 million up 8% compared to the same period last year, while SG&A as a percentage of sales improved 30 basis points to 11, 4%.
Net income was $57 million in the quarter, an increase of $19 million from the prior year, driven primarily by higher gross profit as well as the absence of debt extinguishment and restructuring costs incurred in the third quarter of 2021.
Partially offset by the increase in SG&A and higher income tax expense.
Diluted earnings per share were $2 54.
Up 65% versus the $1 50, <unk> realized in the third quarter of last year.
Adjusted earnings per share were $2 53 up 27% compared to the $1 99.
Realized in the third quarter of 2021, which excluded $14 million in charges related to the extinguishment of debt $1 million in restructuring costs.
The $4 million a positive impact from income tax adjustments related to the X solutions.
Adjusted EBITDA in the quarter increased 7% to $112 million.
Driven by strong gains in our North American residential segment.
Adjusted EBITDA margin declined 70 basis points year over year to 15, 4% as a result of lower results in our Europe and architectural segments.
Drivers of our adjusted EBITDA performance are shown on the right hand side of the slide.
As we have seen consistently this year the topline benefited from strong AEP driven by pricing and positive product mix.
While inflation continued to weigh heavily.
The combined impact of inflation on materials, and inbound freight exceeded 20% on a consolidated basis in the third quarter.
We have started to see some costs moderating on purchases made more recently however, we are still working through higher price materials currently in inventory.
Factory and distribution costs were up approximately $33 million due primarily to the impact of volume deleveraging and inflation on labor and overhead costs, including utilities and distribution packaging materials.
SG&A was up $8 million in the quarter driven by investments in growth initiatives higher personnel cost, including variable compensation accruals and stock compensation and higher travel expenses.
Yes.
Let's turn to slide nine for our North American residential segment results.
Net sales increased 19% to $579 million.
Strong price and mix.
Total A&P growth was 23% inclusive of three points of positive mix.
We saw volume decline as anticipated down 3% for the segment overall as our wholesale customers adjusted their inventories in response to declining housing starts.
Triple our volumes, however approved generally resilient.
Adjusted EBITDA in the North American residential segment was $115 million in the third quarter up 26% from the same period last year with an adjusted EBITDA margin of 19, 9% up 120 basis points on strong execution and price cost discipline.
The carryover benefits of pricing actions taken prior to the third quarter continued to cover both inflation and margin in North American residential.
Our <unk> operating model delivered cost benefits in the quarter, including a reduction in overtime and rebalancing production between plants to allow for the elimination of higher cost shifts.
At the same time, we are moving forward with targeted investments in the development and commercialization of new products and we are encouraged by signs that our recent launches are gaining traction in the market and earning accolades.
Recently, we announced five new builder partners that have begun including the empower smart door in select communities across the United States.
Empower was also recognized with four New awards, including the Tech home Brilliance Award for best overall product and the rave best of CD Expo Award for Best New Security solution.
The new Masonite performance store system has also been well received by our channel partners with interest accelerating quickly.
All in all we believe the North American residential business is executing extremely well and we look forward to building on their success with the acquisition of enduro.
Turning to slide 10, and our Europe segment.
Net sales of $66 million were down 22% year over year were down 9%, excluding the impact of unfavorable foreign exchange.
A&P growth of 13% was offset by 21% lower volume.
Demand among homebuilders remained steady in the quarter, but declined significantly in the merchant and contractor channels due to the severe impacts that inflation and economic uncertainty have had on consumer confidence and spending.
Adjusted EBITDA dropped to $4 million in the third quarter and adjusted EBITDA margin contracted to five 9% with approximately two thirds of the decrease due to deleveraging and one third caused by energy inflation.
Year over year price realization was enough to cover material inflation inflation, but not enough to cover either margin worthy impact of higher utilities cost, which remain extremely volatile and increased significantly in the third quarter.
Our Europe team is focused on aligning production head count with the lower demand, which as we've noted previously it takes longer in the U K due to notice requirements.
Reductions in head count resulted in almost $1 million of severance expense in the third quarter.
We expect to see a positive impact in Q4 from these cost reduction initiatives already executed.
And additional cost actions underway now will further benefit the segment heading into next year.
Moving to slide 11, and the architectural segment.
The segment returned to growth this quarter with net sales of $78 million up.
Up 3% year over year.
Higher AEP contributed 13%, partially offset by an 8% decline in volume as well as lower component sales.
Adjusted EBITDA in the quarter was essentially breakeven.
Efforts by our sourcing and R&D teams to qualify new suppliers for the cross band material, which has been in critically short supply this year, but thats successful and.
The operations team is now working with the new inventory and production.
Internal operational challenges rooted in the complexity of this business continued to limit our success more than factors related to end market demand.
The segment has demonstrated solid earnings performance historically, but recovery from the pandemic and subsequent supply chain challenges has progressed to slowly.
As the architectural team continues to execute their plans to reduce complexity and improve throughput. We will also assess opportunities to unlock the intrinsic value. We believe resides in this segment.
Turning to slide 12, who will cover liquidity and cash flow performance.
At quarter end, our total available liquidity was $504 million inclusive.
Inclusive of unrestricted cash or Undrawn ABL facility and an accounts receivable sales program.
Net debt was $616 million, resulting in a trailing 12 month net debt to adjusted EBITDA leverage ratio of approximately one four times.
Cash flow from operations was $83 million through the end of the third quarter as compared to $100 million through the third quarter of 2021.
The year over year decline is largely attributable to increased working capital, resulting from both inflation driving up inventory values and the investments we made to increase safety stocks in the face of a fragile supply chain.
Our supply chain has continued to stabilize our sourcing and operations teams are actively working to reduce inventory to more normal levels.
Capital expenditures were approximately $66 million in the first nine months of 2022.
Up from $47 million in the prior year, driven by incremental investments in our new plants.
Due to trading blackout restrictions in place pending announcement of the Enduro acquisition no share repurchase activity was conducted in the third quarter.
Year to date, we have repurchased approximately one 6 million shares for $140 million.
Turning to slide 13.
On our second quarter call, we updated our full year outlook as follows.
We maintained our outlook for net sales growth of 6% to 10% despite stronger FX headwinds.
We reaffirmed our outlook for adjusted EBITDA of between 445 and $475 million.
And we increased our outlook for adjusted EPS to between $9 60, and $10 60.
Net sales year to date are up 13% and while we are expecting increased softness in U S. New construction further channel Destocking and a persistently challenging macro environment in Europe , we still believe that full year net sales are likely to end the year near the top of our guidance range.
Adjusted EBITDA is up 12% year to date, despite significant inflation with strength in our core North American residential business, partially offset by slower than expected recovery in the architectural segment and volume and energy cost headwinds in Europe .
We're taking proactive actions to leverage our advantage operating model and cost management Playbooks. However, the majority of these benefits will be realized in 2023.
As a result, we now expect adjusted EBITDA and EPS for the full year to be near the bottom of our guidance range.
As Howard said earlier, the doors that do more strategy was created to drive growth in any macro environment.
While our leadership team is staying nimble and adapting to day to day and month to month volatility. They are also working to deliver consistent reliable supply drive specified demand and when at the point of sale to position ourselves for long term growth.
Turning to slide 14, before I hand, the call back to Howard I'd like to take you through some of the key financial aspects related to our acquisition of enduro products.
As we've said previously we evaluate all potential M&A through both a strategic lens and a financial lens.
It took you through the compelling strategic logic behind this transaction.
Now I'll cover the financial side.
The acquisition price for <unk> $375 million, which represents approximately nine times anticipated adjusted EBITDA post cost synergies.
We are targeting approximately $8 million of cost synergies related to sourcing and operational efficiencies identified during due diligence.
We expect to realize these synergies within the first two years with the majority achieved in year one.
We're also highly optimistic about the potential for incremental growth synergies as Howard noted.
We have not factored any of those benefits in the transaction multiple.
Funding for this transaction will come from a combination of cash on hand borrowings from our recently Upsized ABL credit facility and from an expected new term loan.
As I mentioned earlier exiting the third quarter Masonite had a one four times net debt to trailing 12 month adjusted EBITDA ratio.
And pro forma for the acquisition and expected cost synergies. This ratio would remain at a conservative two times.
Across functional integration team. We have established is already developing a comprehensive plan to facilitate a seamless transition upon closing.
And ensure a robust roadmap is in place to deliver the synergies we expect to achieve.
And with that I'll hand, the call back to Howard.
Thanks Ross.
In summary, we look forward to closing the acquisition of Enduro, which is a natural fit with our doors that do more strategy and we are eager to work together on the next generation of door solutions that improve life and living.
As for third quarter results I would congratulate the north American residential team again on their excellent performance and in particular on their margin growth in the quarter.
In Europe . The team is facing a difficult environment, but has committed to progressively resetting our cost base, while using M vantage tools to maintain service levels and drive productivity.
Regarding the architectural segment the prolonged impact this business has had on our consolidated margins is certainly not in line with the expectations, we had when putting together our outlook for 2022.
I'm appreciative of our team for working through some of the most critical supply chain issues that have been affecting the business. This year.
But we need to consider alternative approaches for getting the value from this business faster and we are doing that now.
Each of our segments are facing headwinds going into the final quarter of this year. Yes, we are confident in our ability to deliver another year of consolidated net sales and adjusted EBITDA growth.
We look forward to providing our outlook for 2023, and our next earnings call, but rest assured our 2025 Centennial plan goals continue to define our long term priorities, we have for our business.
Rover, we are confident in our ability to achieve these goals by consistently executing against our plan adapting quickly to the environment and taking full advantage of valuable strategic opportunities such as the <unk> acquisition.
And now I'd like to open the call to your questions operator.
Thank you Mr. Heck, Yes, if you would like to register a question. Please press star one on your telephone keypad. If you are using a speaker phone. Please lift your handset before entering your request we ask that you limit yourself to one question and one follow up again that is star one if you would like to register a question at this time.
The first question today is coming from Joe <unk> of Deutsche Bank. Please go ahead.
Yes, thanks, very much guys for taking the questions and nice results.
Thanks, Joe morning, Joe.
Sure. So the comment around the bottom of the range, maybe just a quick one if you would comment if you think about the range within that range for North America, how did that change from the summer time.
August when you updated us to now.
Yes, Joe it's Russ I'll take that one.
It's interesting there is actually a pretty clear distinction between the performance we've seen in our core North American residential business and elsewhere, but specific to your question about North American residential there are couple of factors going on one we're seeing the inflation flow through the P&L, a little bit slower than we would've anticipated.
And Thats driven primarily by the fact that volumes are coming down and we've got higher cost material that we're continuing to consume as we produce for those lower volumes and the other aspect is we are seeing some volume deleveraging that's not significant in the north American residential business, but it is at the margin and impact the team we think is doing.
A really nice job staying sharply focused on cost actions that will allow us to respond to that so if I step back and I look at how the quarters will progress from Q3 to Q4.
In the case of North American residential, we often see margins come down sequentially from the third quarter to the fourth and that likely will happen again this year, but in the case of any rez pretty modestly and they'll probably still generate pretty strong margins improvements that is year on year in the fourth quarter, alright, So thats very positive.
The distinction.
On the European side.
The team there as we commented has done a really nice job implementing cost actions. It does take us longer there because of notice periods that are required when any workforce reductions are made.
That said, we believe that business is on track to recover to a double digit margin in the fourth quarter, but there is still a likely going to be short of prior year, and then with the architectural business, probably just modest improvement quarter to quarter all of those factors taken into account form our viewpoint on how we come through the balance of the year.
And why we think it's prudent to call EBITDA closer to the bottom end of the range.
Alright, thanks for that color Ross I appreciate that now on North America I imagine that margin assumption includes some some pretty healthy continued AEP just.
Based on the realization in the third quarter, but is there also.
<unk> for a mixed benefit in the fourth quarter, just given how that plays into your longer term growth algorithm. How should we think about mix within North America into 'twenty three and beyond.
Well first of all.
Taking that A&P question head on we would expect AEP at both the consolidated level and for North American residential to drift lower in Q4 as compared to what you've seen in the last couple of quarters.
Frankly, that's a function largely of lapping price increases that we took in August of last year.
With respect to mix, we anticipate that's going to continue to be a tailwind for us we've made proactive investments in product and in marketing to make sure that we're driving more mix from <unk> to solid core from steel to fiberglass, etc.
<unk> seen the last couple of quarters, the benefit of that within our A&P in North American Res this quarter alone three points of a tailwind within the overall A&P and we.
<unk> that trend will continue that is a core part of our doors that do more strategy.
Alright, Thanks, a lot guys and good luck.
Thanks, Joe.
Thank you. The next question is coming from Michael Rehaut of Jpmorgan. Please go ahead.
Thanks, Good morning, everyone and congrats on the quarter.
First question.
Just wanted to delve a little bit into indoor and.
Congrats on the on the announcement.
Just wanted to understand when you think about.
The sales queue.
<unk> about the amount of sales if you can.
Give it on a rough basis.
That endure has to yourselves as well as two other competitor Oems and if there is.
Any potential channel conflicts or.
Yes.
The customers preceding it perhaps as a conflict.
How that might be managed.
And on the sales going into your own company.
That's a portion of the $8 million of cost synergies, you've obviously do it there will be some element of savings for us from a profit standpoint at least.
That's baked into the $8 million curious about those two factors.
Yeah. Thanks, Mike. This is Howard yes, we're very excited about enduro and what it can do for masonite forward relative to the channel conflict there customer list looks a lot like our customer list their biggest customers are really wholesale distributors, both one and two step.
And while they do sell to Oems was like Masonite that is not the biggest percentage of the business backed by a long shot and so we don't expect there to be really any any significant channel conflict there.
The benefits of the product that we do buy from <unk> is not included in those synergies that we talked about those synergies are.
More direct purchasing raw material purchasing synergies and some productivity and factory efficiencies, but not the benefit of the purchases.
Okay.
No that's helpful.
The European actions and maybe.
Some of the broader.
And vantage our cost actions that you're taking in the face of softness overseas and maybe here as well a little bit in some channels.
It sounds like you're expecting a pretty quick snap back on.
On the European margins.
But was hoping to get a sense of.
Talking about head count savings and again other actions more broadly.
What that might mean on a dollar basis annualized then.
It looks like some of it might be already begin to be realized in the fourth quarter, but.
What might be sort of incremental.
That we should think about when looking at 2023.
Yes, Mike It's Russ let me take that one I guess first I'd like to set the stage with the Q3 performance of this segment. So we printed a five 9% EBITDA margins. We acknowledged during the remarks, there was approximately a $1 million worth of severance cost that that business incurred as a result of these head.
<unk> actions.
Management team there is taking and we also had circa $1 billion higher cost and electricity utilities, which is in line with the broader energy inflation that the European market is seeing and certainly we're experiencing in the UK and Ireland, which is really where our business there is focus.
If you were to adjust for those two items.
The business was in a high single digit margin call. It on a pro forma basis so between.
The stabilizing of the head of the head count that are reducing the workforce. The actions that that team has put in place and the fact that there are some price caps being put in place on energy in the UK that we think stabilize and likely reduce our utilities costs in the fourth quarter as opposed to the third quarter.
That's what informed my comment a moment ago about returning that business to double digit EBITDA margins, we believe by the fourth quarter.
Head count piece of that essentially what the team. There is doing is the same playbook that we execute here in North America. There is an order of operations, whereby first youre going to eliminate any over time that you can you're then going to remove any temporary head count you're then going to move into more permanent head count.
Reductions, whether that's riding the attrition curve, eliminating shifts and only thereafter would you consider.
Permanent or durable capacity reductions. So the team is executing against that plan. The only additional factor I would offer that they are looking at is are there ways that we can manage ship patterns of our operations in the U K to actually reduce our consumption of electricity in the production facilities. So it's all of those factors taken together that are taking costs down.
Including reducing head count wherever possible in line with the volume decline.
Great. One last quick one if I could sneak in just the Destocking in North America do you have any sense of what that impact was on sales.
And if that should continue into the fourth quarter a lot of companies are thinking, perhaps destocking might kind of be.
<unk> finished by the channel by by the end of the year I'd be curious if you have a similar view.
Yes, Mike This is Chris here, let me take that one and just to step back for a minute to give perspective on the North America business. We've got a good balance between new construction and triple our as we mentioned in the comments earlier the triple our side of the business has been resilient. So the destocking that we saw in the third quarter and expect to continue here into the fourth is really related to our <unk>.
<unk> business, which is focused more on the new construction side of our portfolio and it's really driven by this backdrop of the softer new construction kind of new housing starts in the overall demand on that side and so as we look at the business for Q4, and that's what we have put into the outlook that Russ shared earlier.
And from an action standpoint, we've got a lot of focus on making sure. We're disciplined on price cost to make sure. We're driving the margin side of the equation, but also looking at those mix opportunities to offset some of that volume loss with the solid core doors with fiberglass and other areas for us to drive E&P growth.
Great. Thank you.
Thank you. The next question is coming from Mike Dahl of RBC capital markets. Please go ahead.
Yes.
Hi, This is actually Chris calling in for Mike. Thanks for taking my questions.
Just on the price cost just on the price cost dynamics in North America clearly.
With residential slowing.
As neatly as it is and build is likely to come if not already.
Pushback on supplier price increases how are you guys thinking about it.
The sustainability of your pricing gains I know you said, you're expecting some moderation on year over year growth that's largely yet.
Comp issue, if I understand it so just in terms of.
The ability to sustain the pricing increase that you've had to date and kind of outlook next year, how does that all shaping up.
Yeah. Thanks, Thanks, Chris I may start that and maybe Russ has something to add.
We've been Mitch.
It's been important to us and our success has been based on disciplined price cost management with the goal of always maintain favorability of price cost. This year. Obviously, we've had very significant inflation again over 20%. This quarter. So we've had to be certainly more aggressive on the price side, but our intent even going forward is to stay <unk>.
Verbal in that price cost relationships. So we've done done consumer research now three different times. Most recently just in the last month or so that again continues to suggest that consumers expect to pay a lot more for doors than they currently pay there is value in the products that we provide and then keep in mind that.
Our strategy in this evolution of doors and door systems is about driving mix and driving specified demand to higher value doors that will continue to drive mix. So.
Our goal is going to be to stay price cost favorable. We believe we can do that we believe the market will support that.
Our consumers expect to pay more for doors, and we're going to continue to drive higher mix.
Yes.
Chris the only thing I would add to that is that I would like to rewind the tape.
Three years too late 2019, and just remind everyone about the actions that we took pretty bold actions at that time around pricing and the fact that they were grounded in consumer research right. We went out and surveyed a lot of consumers and found that their viewpoint on what a door should transact.
<unk> in the marketplace was way higher than what current levels, we're seeing and that indicated there was a lot of value being left on the table up and down the value chain in our category and Thats, what gave us the confidence to move forward with some pretty full price increases effective early in 2020 with a commitment that we would reinvest back into.
The business around a reliable supply of product innovation down channel marketing and we've done those things, particularly a consistent reliable supply that's been a real focus for us over the last year year and a half as supply chains have been so fragile and we believe that has kept us kind of leading the pack with respect to.
Service levels to our customers and is clearly indicative of our commitment to maintain that so between all of that the value that we're offering not only through the distribution channel, but to the consumer as Howard mentioned, the fact that we continue to refresh that analysis. It continues to suggest that consumers' expectations for door pricing continues to go up.
The broader inflationary market so.
Just to underscore this theme of wanting to be paid fair value for the product and continue to execute a pretty disciplined approach to price cost management to ensure that happens.
Okay.
Understood I appreciate that and then just maybe turning to the cost side of that price cost equation.
Could you guys just flesh out how much inflation you guys saw.
Three <unk> on a year over year basis, what you are expecting in <unk> and.
Yes, you did mentioned you're starting to see some green shoots of alleviation in inflation.
Maybe give some more color on what that is and potentially any comment on implications for next year.
I'll pay that one off to with respect to cost. So we did see a material inflation I think as I commented during our prepared remarks over 20% in the third quarter we.
We do expect that that is going to drift somewhat lower in the fourth quarter is likely still to be in the mid to high teens on a year on year basis. However.
And in part of that is due to the fact that as I mentioned earlier, we're continuing to consume these higher cost materials that we purchased earlier and in some cases built higher levels of safety stock as it means to ensuring that we could deliver that consistent reliable supply I just spoke about so we're consuming that higher cost material that's going to continue to.
Run through the balance of this year and perhaps even into early Q1, depending on what end market demand and production volumes do we do expect that we'll see some moderation from.
From those levels in 2023.
But we're still formulating our viewpoint on what material inflation looks like by each category and we will be in a position to comment more specifically on that on our fourth quarter call.
Understood I appreciate all color.
You bet thanks, guys.
Thank you. The next question is coming from Noah Cosco of Stephens. Please go ahead.
Good morning, and thanks for taking my questions.
First I just wanted to get your high level view on 2023, as we look out today clearly there is some demand uncertainty likely see continued softening in new res it sounds like on the other hand, it sounds like the triple our market's holding in well.
So maybe if you could just talk to how you're seeing demand potentially shape up across your businesses for next year.
Yes sure no. It's Ross, let me take a shot at that.
Just as I mentioned, just a moment ago that we'll provide more color on a number of areas on the fourth quarter call. So we will comment more specifically about 2023 broadly then and what our financial outlook is for the year.
But I can still share some factors about what we're planning for as we finalize our outlook for next year and the plans for each of our businesses and so first with respect to end market demand.
U S housing market. Our current view is that the weakening conditions that.
We're seeing currently are going to continue the balance of the year, if not potentially worsened a little bit and continue into 2023 and as a result at this stage, we're planning for a double digit decline in new housing starts next year.
Now on the flip side of that on the residential repair and remodel market here in North America.
By the way just to emphasize that we estimate is just over half of our business that business has remained relatively resilient and we expect that that's likely to continue particularly as a lot of people, perhaps elect to renovate in place as opposed to move homes, because they've got favorable mortgage terms to preserve <unk>.
B, what current mortgage rates look like and we believe that could likely serve as a little bit of a buffer to just the broader economic weakness that we're seeing and as a result triple R. We would plan to be down just modestly year on year.
You think about our end markets in Europe then.
We're primarily exposed to the U K there that market has been hit pretty significantly by inflation consumer confidence is sag.
<unk> household inflation has spiked dramatically given energy and we have a pretty significant position in the exterior door renovation market, they're very high.
<unk> very high margin that business has been blunted.
We expect that that's going to continue the housing market has remained relatively resilient, so far but theres, probably risks of volume weakening a little bit there as we get into 2023.
And then I commented a moment ago on material costs. So I won't rehash that I guess, if you step back and you look at all of that and it suggests that the efforts that we're making around price cost management and vantage to optimize the operational footprint leveraging.
Leveraging our highly variable cost structure to reset labor levels in line with volume those are all going to be really important as we move into 2023. It's also by the way what leaves us confident in our ability to demonstrate solid earnings power next year. Despite what we believe is going to be a weaker demand backdrop. So again, we will comment more specifically on the fourth.
Protocol, but at least qualitatively that's how we're thinking about market drivers moving into next year.
This is Howard if I could just add I joined the company shortly before Covid.
And one thing I've learned is I'm very confident in our team's ability to navigate and market uncertainty.
And as we head into 2023, there is certainly some uncertainty as Ross pointed out, but I think our product mix strategy is working our variable cost structure is favorable and we have very disciplined price cost management and our business that's going to allow us to adapt and continue to relatively outperformed the market.
Thanks, that's really helpful and quite encouraging.
For my follow up.
Over the last couple of years Youll have created some some innovative products in house and now Youll have the enduro products. So with this portfolio do you feel that you have the right products and resources to execute on your long term goals or.
Will there be further M&A needed.
That's a great question first of all as I said on the script, but enduro. We believe is absolutely a natural fit to our doors that do more strategy first it's a great company with great people and great intellectual property and products et cetera, but this ability to integrate door systems, and salt life and living problems as our.
A real key unlock for our strategy.
And the products. They currently have in their portfolio and continue to develop and the IP that they have with articulating cells and certain frame products and locking mechanisms et cetera are certainly one big step to helping us develop and solve some of these lines and lending products now are there other things that we need.
Maybe not are there other things that might be helpful. Absolutely. So we've talked about our M&A strategy.
Pretty consistently over the last several years that we want to acquire companies that help deliver our strategy and along the lines of the driving specified demand you can begin to think there could be other there could be other things that contribute to that help us move more quickly. We're also interested from an <unk> perspective M&A.
Spectrum in things that help us deliver consistent reliable supply or when the sale and so you can think about how that might tie into our M&A roadmap that we've talked about on the call.
Got it that makes sense I appreciate the time good luck with the next quarter. Thanks.
Thank you. The next question is coming from Steven Ramsey of Thompson Research Group. Please go ahead.
Hi, Good morning wanted to think about endures trailing 12 month margin of 12% you've.
<unk> seen great sales growth as well there in the past few years can you compare it to the <unk>.
Recent margin performance of that company to prior years and does this reflect inflationary pressures on results.
Prior year had better margins than this.
Certainly they've had Steve on the same inflationary pressures similar inflationary pressures to all of us buying those types of raw materials.
And.
Price cost becomes an important driver of margin in climates like this and so that's been an interesting dynamic in the business recently.
Yes.
We think through our due diligence one the integrated product opportunity that we have and to some of the cost synergies that we have can certainly improve the margin structure of that business.
Okay helpful and then thinking about the architectural segment.
Looking at.
Unlocking intrinsic value there can you share more about what this means is this operational oriented or strategic alternatives oriented and then is there any.
Any coincidence there with the timing of this commentary along with the enduro deal being done.
No to the latter there is no nothing about the timing Stephen but just as a reminder, this has been a relatively good business for us historically and then the pandemic hit volumes fell off a cliff.
And then we had a super fragile supply chain on a number of issues and it's become a breakeven business thats been too significantly dilutive to our to our consolidated margins. So the team has developed and it's been executing a pretty thoughtful plan to get that business back to its pre pandemic profitability, but and.
Fortunately the progress has been slower than we expected for a variety of reasons some of which are outside of our control some of which are within our control. So we are certainly grateful for investors patients here, but we recognize that the clock is ticking and we are impatient ourselves. So we believe the pace of recovery can and should be faster and as a rig.
Nothing more to share today, but certainly we'll keep you informed us as those plans develop and as we execute better in that segment.
Thank you. The next question is a follow up coming from Michael Rehaut of Jpmorgan. Please go ahead.
Term loan and borrowings.
If you could give us a sense for the transaction of <unk>. If you could just give us a sense of how we should think about.
And anything around interest rates on an on the term loan and the ABL.
First of all with respect to funding the acquisition.
As part of that process, we changed the reference rate on that debt instrument from LIBOR to sulfur.
That ABL serves as our lowest cost form of funds.
We fund the acquisition.
Okay, No I appreciate that Ross.
You put out some.
Somewhat of a framework in terms of how you might think your end markets play out in North America next year.
Obviously at the same time.
Just on which product categories, which geographies et cetera case in point in the U K, we have seen a lot of our volume weakness over this past several quarters in the exterior product line portion of that business, which has a much higher margin business. So our decrementals have been in excess of that in the UK.
As a result of the mix impact of losing more volume on the exterior side than the interior side, but broadly speaking think about 30% to 40%.
The benefit in North American residential in contrast to the U K as I commented earlier, where you've got notice periods that impact how quickly you can reduce your workforce, we don't necessarily have that North America. The team can be a little bit more nimble in making head count adjustments in line with volumes now there is a downside of that also.
You don't want to move too quickly until you're pretty confident that the downturn in volume is durable because that leaves you inefficiently rehiring and training people and bringing them back up to speed.
But that all said as I commented earlier at this point, we're planning for a new housing side, a double digit decline in North America.
EBITDA margins.
And also.
The decrementals are before any.
Again cost actions are offsetting actions any sense of what that could be.
Inclusive of those actions.
So the 30% to 40% decremental, Mike to be clear, that's the amount of drop through to the bottom line and EBIT of $1 that you would incur from a reduction in sales volume and that is before any of the offsetting cost actions to address them. So clearly our objective is to continue <unk>.
Creasing, our margins over time and that means ensuring that we are resetting the cost base of the business and continuing to pursue this disciplined approach to price cost management that will allow us to absorb those volume declines and continued to maintain or grow margins.
Okay. Thank you.
Thank you.
Thank you at this time I would like to turn the floor back over to Mr. Higgins for closing comments.
Thank you Donna and thank you for joining US today. We appreciate your interest and continued support this concludes our call.
Operator, please provide the replay instructions.
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