JELD-WEN Holding, Inc. (JELD) Earnings Call Transcript & Summary

Good morning. I'm Matt Bouley, Barclays U.S. homebuilding and building products analyst. To my left here, we're happy to have John Linker, the CFO of JELD-WEN. So what we're going to do to start is have John give an overview of the company as well as a bit of background on the company. And while he's giving that overview, if you guys wouldn't mind filling out your ARS questionnaire and then we'll just quickly go over the questions and jump right into Q&A from there. So with that, I'll let John speak.

Great. Thanks, Matt. Good to be with you all. For those who are unfamiliar with JELD-WEN, I'll give a brief overview before we get into the Q&A. JELD-WEN is a global leader in manufacturing of windows and doors, about $4.3 billion in revenue, #1 market positions in the majority of the markets we serve, operating in 20 countries around the world. The company has a long history, founded in 1960 by the Wendt family, was operated as a private business for many years, transitioned to private equity in 2011. And then I'd really mark the beginning of the transformation that we're under right now in 2014. New leadership came in and started to deploy a lean playbook and a business operating system that's worked at many industrial companies and a building products company that really hadn't seen that level of business operating system before. So at that point, business is about 4% EBITDA margins. Today, we're about 10% EBITDA margins with a plan to get to 15%, so well on our way to a pretty exciting transformation. And in recent history, they got a new CEO about 1.5 years ago, closing in on 2 years, Gary Michel, who came out of a long career at Ingersoll Rand, 30-plus years there are as an operator, proven experience in turning around businesses and driving operational improvements. And myself, I've been in the CFO role for a little -- about 1.5 years. I've been with the company for 8 years, and my background prior to that was with Goodrich and United Technologies. So new leadership driving some operational change. If you look at the platform we're operating, I think the -- just to describe it at a very high level, I mentioned the market-leading positions in doors and windows, primarily residential, a little bit of nonresidential in Europe. But for the most part, these are #1 or #2 market-leading positions in the areas that we're operating in. Portfolio of trusted brand names, JELD-WEN is our brand name globally, but we do have local brands that are operated in certain countries that are -- have a lot of brand equity behind them. Takes a lot of -- a long time to build brand equity in the building products space. And I'd also highlight the product breadth. It's primary -- doors is the majority of our revenue. We do have an extensive product line there, interior and exterior doors as well as windows and some ancillary products. Good channel breadth representation in both the distribution channel as well as the retailer channel in North America and good customer breadth as well. Probably one of the more well-known aspects of our story is the operational improvement journey that we're on. We laid out a plan for a $200 million cost-out opportunity a little over a year ago, which will drive us towards that 15% EBITDA margin. About $100 million of that is coming out of the lean deployment of the JELD-WEN Excellence Model, or JEM, which is our business operating system. It's all about driving productivity through continuous improvement, standard work in our operations. And then there's another $100 million of cost-out opportunity that we've identified through facility rationalization and modernization. JELD-WEN's history is many acquisitions, I think close to 60 acquisitions over the history of the company. So we've got 130-some-odd manufacturing sites around the world, which there's a great opportunity to consolidate those rooftops. And as we do that, it's not just consolidating. It's actually modernizing some of the production processes as we do it in investing in some selected automation and new technology that drive improved cost out. So we identified a program there to take $100 million out of the business through that. We've -- and at this point, we're -- we've acted on about 1/3 of the square footage that we need to do to deliver that target, and as we exit 2020, we should be realizing savings in about of that 1/3 of $100 million run rate. And as these earnings are improving from the cost-out programs that I just identified, we've got a great opportunity to deploy cash flow as well. We've got -- in recent history, the current management team has done 14 bolt-on acquisitions over the last -- since 2014. Most of these are tuck-in deals but done at pretty attractive multiples, very attractive IRR. It's a nice way to generate both top line revenue through revenue synergies as well as cost synergies. So we see some opportunities to continue investing our free cash and M&A as well as opportunistic share repurchases. We've got $175 million buyback authorization right now, which is currently unused. So anyway at a very high level, that's the JELD-WEN story, and happy to dive into your Q&A.

Okay. Thank you for that comprehensive overview, John. I think for time purposes, we can just jump right into the Q&A. We don't need to go over the ARS questions out loud. So maybe hitting on a couple of the points that you've brought up starting with JELD-WEN adding or bringing in Gary Michel as CEO. Maybe helpful if you could kind of go through what were some of the operational challenges that led to that. What has Gary endeavored to fix as he's come onboard the company? And what's kind of his vision for the company 3 to 5 years out?

Sure. So as I mentioned, Gary joined us in, I guess, that was the summer of 2018. At that point, the Board identified a need for a CEO who was extremely deep in the weeds from an operational standpoint, and that's truly Gary's background. I mean he grew up an operator and managing businesses, ran Ingersoll Rand's HVAC business as well as their Club Car business and in both cases, had some pretty impressive results in both driving organic growth as well as operational improvement. And so I think looking at the JELD-WEN opportunity, great platform, great assets, great brands. And we were on the beginning of deploying the JELD-WEN Excellence Model, JEM operating system, which launched in 2016, but I think the Board identified the need to bring in a skill set of a leader who could really be very, very deep on the operational side and drive improvements and hold people accountable as we do it.

Okay. Great. So I think one of the initiatives he's taken on, as you mentioned, is his broader footprint rationalization and modernization initiative and coupling that with the ongoing deployment of JEM tools. And you mentioned -- and as you mentioned in the earnings call yesterday and just now that you expect to be at, I believe, you said a $33 million run rate by the end of 2020 in terms of cost out. Can you maybe go into a little more detail on what are some of these initiatives, how does all that cost out kind of phase in and then even some specifics on the productivity and JEM side?

Sure. Let me start with an example of the footprint rationalization program that we're doing. So if you take our North America door business, we've got a number of facilities, door assembly facilities, scattered around the U.S. It's -- we do need to be geographically close to our customer given the freight cost involved with shipping our products. But then you take the southeast of the U.S., we had 4 or 5 door assembly sites in pretty rural locations around the southeast. And in most cases, there was a different -- because of the history of the company through acquisition, doors were being manufactured in different ways even across those 4, 5 facilities, a very -- in many cases, a very manual-intensive process. So we identified an opportunity to use a facility we'd acquired through an acquisition a couple of years ago in Atlanta and basically consolidate several door facilities across the southeast into this Atlanta site. And as we do that, we're investing in new technology for the way the doors are assembled. So going from a legacy manual-intensive batch processing, which is very sort of slow and inefficient, a lot of opportunity for quality issues to a more automated system that is a single piece flow, drives scrap, warranty and labor reductions. And so in this case, we brought the Atlanta sight up to speed. It's producing at the rate that we had targeted, and now we're actually closing the kind of legacy facilities, if you will. We held on to them for a little while to make sure we could service our customers and support their needs. And we've closed one facility in Alabama, and we've announced closure in another one in North Carolina that is being consolidated into Atlanta. So in that case, that's one distinct project. But if you were to replicate that in other areas of the country or in other areas of the world, there'd be an example of kind of rationalizing our footprint but also modernizing. In Australia, again, a business that grew up through acquisition, a lot of facilities, and we've been very aggressive there in reducing the number of facilities that we have and consolidating campuses. The last few years, they've been in a challenging housing market, and so it's work that we would have need to been doing anyway to make sure we have the right cost structure for that housing market. But in that case, we've been really driving out the cost. And so as you think about sort of how this phases in over the next few years, these projects take some time. I mean it takes us some time to acquire the new equipment that we're going to need and consolidate and move. But we started on this program a little over a year ago. And as Matt mentioned, as we approach the end of 2020, we think we'll be exiting the year with about 1/3 of that $100 million savings under our belt. And currently here in 2020, we're launching sort of the next phase of projects that's going to feed savings in 2021 and 2022 and beyond. And so kind of as you think about the cadence of the savings opportunity, it's going to be a little slow in the beginning to -- and then you'll start to see some of the savings sort of kick in, in the later years. You also mentioned JEM, or the JELD-WEN Excellence Model, which that's really the terminology that we use to talk about the business system that we are operating at JELD-WEN, but it's also what's driving the other $100 million of sort of productivity savings that we've identified. In 2019, we did a good job of deploying JEM, and we drove some positive productivity even in the face of some challenging new construction markets in North America and Australia. That's a program that we should -- year in, year out, we should be able to deliver $20 million, $25 million of productivity under that program pretty ratably. That's blocking and tackling, driving labor efficiency, warranty, scrap production. It's not necessarily closing facilities or making big capital investments, but it's really driving standard work through our automation -- or through our operations to drive out improvement.

Okay. And I guess on that point, I believe you mentioned in the earnings call yesterday around being careful with kind of the pace of rationalizing such that you don't want to upset your customer relationships. Can you dive a little bit more into that? And kind of how do we think about that balance in 2020? Are you at the point where you can accelerate the rationalization a little bit without having to upset the customer relationships?

Yes. And I think it's just more just out of caution to make sure that we've got the right stock and inventory levels built so that we don't get in a situation where we're having to extend lead times with customers or something like that. I mean it can be disruptive to close and move plants, and so we're just trying to do it in a way that we've got contingency built into the system. And so certainly, we are at the point now, particularly in North America, where we're able to sort of take out some of that latent capacity. And so in 2019, while we were bringing up the Atlanta facility, we were also carrying the overhead burden of the legacy facilities that we were planning to close. And so we were investing the money but not yet actually seeing the savings flow through, and so 2020 would be sort of an inflection year where we start to see some of those savings drop through net-net.

Okay. So let's maybe dive into the windows business a little bit because that has been, obviously, topical of late. And there's been challenges, and the results, at least in terms of the quarter yesterday, was -- the result ended up actually coming in a little bit below your prior guidance. So -- and we're kind of putting this in the context of the 2020 guide. But what worsened relative to your guide in Q4, particularly with regard to windows? And then how do we get comfortable around the visibility to that recovery in 2020?

Sure. So for those that are a little less familiar, just to recap, in our North American window business, which is about $800 million revenue business, we had some challenges in 2019, where 1 of our larger customers went through a reset program where we were resetting inventory in some of their stores. Unfortunately, the timing of that reset and the mix of product that was asked from us, we ended up being different than what we had expected. And so from a demand planning standpoint, that put us in a position where, when we got to the summer busy season last year, instead of servicing our traditional customers, higher-margin mix, we were -- spent quite a bit of time in the second and third quarter trying to resolve some of the issues from this reset -- product reset. So the implications of that were, in the third quarter, we had about a $10 million year-over-year headwind from operational inefficiencies from our windows business as we recognized some excess material and labor and freight to sort of expedite on these programs. When we gave guidance back in October for the fourth quarter, at that point, Gary and I said that we expected to see sequential improvement in the fourth quarter and that we were starting to see improvements, which we did. We saw at that time in October, our overtime rates were coming down, our on-time and full rates were starting to improve. And as we moved through the quarter, we did see over 100 basis points of sequential margin expansion in the windows business. I think what we underestimated when we gave guidance for the fourth quarter back in October was we had dug ourselves a pretty big hole on the operational side. The magnitude of the backlogs that we had to dig out of was probably more significant than we had realized, and so relative to our results that we announced yesterday, we came in about $10 million on the EBITDA line short of sort of the Street consensus. And close to half of that was continued hangover of the windows inefficiencies where we sequentially improved, but we were below prior year. Sitting here in Q1, our window operations are healthy, are on time and full, and all of our window facilities is above 90%. Our labor rates are in check. Our material rates are in check. We need volume. We need to drive volume in that -- through that business to really recognize margin improvement. Sitting here in Q1, we still envision that windows will be a headwind for Q1 on a year-over-year basis, which we highlighted on the earnings call yesterday. But as -- moving into Q2, we envision that business getting back to sort of flat margins year-over-year and then back to sort of margin improvement in the back half of the year. Our windows business is -- it's a solid business, good market positions. It has a high labor content relative to other businesses in our portfolio. And so in a case like this, where there were some front-end issues on the demand planning side, if that happens, it does manifest itself into operational inefficiencies just given the high labor percentage rate of cost of goods sold. So we feel like we've made the changes we need to make to drive improvement. The circumstances that led to the product reset last year, we do not expect to recur this year. So the customer -- our major customers are not planning any major line reviews. There's no major product resets planned. So the circumstances that led us to have this headwind last year is not on the calendar for 2020 and feel like we're in a position to start driving improvements out of that business again.

Okay. So I guess maybe sticking on the North American side. Obviously, the macro housing data has improved meaningfully, whether it's completions or starts. I believe you mentioned on the call yesterday that there's been -- there's obviously a lag towards when that hits your business and potentially even some leaning out of inventories by your traditional distribution. Can you go into a little bit more about what you're hearing from distributors and kind of the timing around when some of that strength in U.S. new residential construction should manifest in your North American results?

Sure. So North America segment for us is about $2.5 billion in revenue. It's close to about 40% new construction on the resi side is our best estimate. So if you look at what's been happening in North America new construction, starts were down for the first half in '19, and that -- we had a flow-through impact on that of seeing a volume compression in our business for -- in North America for most of '19. Going into the last couple of months of '19, we did see an inflection point in both the housing start data as well as homebuilder orders, where we're starting to see some pretty positive commentary, pretty positive order rates from the homebuilders. We believe we lag new construction starts by 6 to 9 months just in terms of when our products go into a home. So we certainly have some enthusiasm about an inflection point here in North America on new construction. In terms of the flow-through to ourselves, I think we'll really start to see that accelerate in the Q2 through Q4 time frame of this year. And at this point, our customer base is telling us both on the retail side as well as the distribution side, we're getting pretty consistent commentary from that customer base about some unit growth this year. So at this point, there's no signs of sort of headwinds. I think I did mention on the call yesterday, we got off to a little bit of a soft start here in January of Q1. I don't know if that's just -- that's the retailers working against their fiscal year-end and managing inventory is not really totally sure that -- what that is, if anything, it's just timing related. And our backlogs are starting to build nicely across our businesses in North America. So as we think about how 2020 could shape up, we expect to really flip it from the volume headwind we had in '19 to a volume tailwind in 2020.