The AZEK Company Inc. (NYSE:AZEK) Q1 2024 Earnings Call Transcript

The AZEK Company Inc. (NYSE:AZEK) Q1 2024 Earnings Call Transcript February 6, 2024

The AZEK Company Inc. beats earnings expectations. Reported EPS is $0.35, expectations were $0.05. The AZEK Company Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Welcome to the AZEK Company’s First Quarter Fiscal 2024 Earnings Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to Eric Robinson. Please go ahead, Eric.

Eric Robinson: Thank you, and good afternoon, everyone. We issued our earnings press release and a supplemental earnings presentation this afternoon to the Investor Relations portion of our website at investors.azekco.com. The earnings press release was also furnished via 8-K on the SEC’s website. I’m joined today by Jesse Singh, our Chief Executive Officer; and Peter Clifford, our Chief Operations Officer and Chief Financial Officer. I would like to remind everyone that during this call, we may make certain statements that constitute forward-looking statements within the meaning of the federal securities laws, including remarks about future expectations, beliefs, estimates, forecasts, plans and prospects. Such statements are subject to a variety of risks and uncertainties as described in our periodic reports filed with the Securities and Exchange Commission that could cause actual results to differ materially.

We do not undertake any duty to update such forward-looking statements. Additionally, during today’s call, we will discuss non-GAAP financial measures, which we believe can be useful in evaluating our performance. These non-GAAP measures should not be considered in isolation or as a substitute for results prepared in accordance with GAAP. Reconciliations of such non-GAAP measures can be found in our earnings press release which is posted on our website. Now let me turn the call over to AZEK’s CEO, Jesse Singh.

Jesse Singh: Good afternoon and thank you for joining us. The AZEK team once again delivered strong results in our 2024 fiscal first quarter, including an 11% net sales increase year-over-year. Excluding the recently divested Vycom business, net sales increased 22% year-over-year, driven by strong residential performance. Adjusted EBITDA grew substantially year-over-year and adjusted EBITDA margin expanded 16 percentage points to 23.2%, driven by strong gross margin performance and more normalized production levels. One of our core values is that the best team wins, and we believe that our success is driven by having the best employees and partners in the industry. I want to take a moment to thank all of our expanded team members and partners for their dedicated and committed focus on delivering the best experience for our customers.

We continue to see strong contractor and consumer demand for our products and our increase in sales was driven by double-digit residential sell-through growth. Residential segment net sales increased 24% year-over-year and segment adjusted EBITDA increased 430% year-over-year. Residential segment adjusted EBITDA now includes the residential business and all corporate costs and highlight the strong performance of the core business, excluding our Commercial segment. Within the quarter, the Residential segment saw strong growth in deck, rail, accessories and exteriors products. We experienced growth in both our residential pro and retail channels as we benefited from the execution of our initiatives. We also saw strong interest in opening orders for our new products, including our new TimberTech framing aluminum substructure solution.

During the quarter and over the last year, we believe the strength of our business model, combined with ongoing material conversion away from wood that supported our above-market performance in both our exteriors and outdoor living product categories. Over the last 12 months, our Residential segment has grown 12% year-over-year which has been driven by end market demand for our products. Like Q4 of 2023, we are seeing the cumulative and structural benefits of the actions we have taken over the last few years during significant market and supply chain volatility. We have systematically gained shelf position in the pro and retail channels, launched innovative new products, invested in our brand, and added strategic acquisitions that have led to a stronger position in the market and increased our capability to drive above-market growth.

We have also increased the use of recycled materials, aggressively used our AZEK integrated management system to improve our efficiency, priced to offset supply chain issues, and improved our product design, all leading to our expanded margins. As we highlighted at our Investor Day in 2022, we believe that we have an opportunity to increase our adjusted EBITDA margin percentage by 500 basis points to 27.5% through our initiatives. The progress of these margin initiatives was masked by the combination of supply chain issues and a meaningful reduction in factory utilization during the first nine months of fiscal 2023 as we managed down inventory. After multiple years of supply chain disruption, in a year of inventory recalibration in our channel and within our business, we have now returned to a more traditional operational cadence.

We believe that we are now in a good position to sustain our gains and continue future progress through our margin initiatives. We have invested and will continue to invest in our core strengths of research and development, brand awareness, customer relationships and our world-class manufacturing operations. We are in the process of completing a new manufacturing facility outside of Pittsburgh that will increase our exteriors business capacity and allow us to expand our product offerings. We are also making incremental investments in each of our facilities to allow us to expand the use of recycled materials and accommodate new products on our road map that will support future growth. At the upcoming 2024 International Builders’ Show, we will show a broad range of our products in an interactive format.

At the show, our TimberTech advanced PVC decking is being recognized as a Best of IBS Awards finalist in the Most Innovative Building Materials category based on its innovation, functionality, sustainability, design and builder and consumer friendliness. This product line uses a high percentage of recycled PVC and is one of the only decking products on the market that has a Class A or very high fire rate. It reinforces our position as the number one brand in premium decking, driven by our proprietary products that provide unique solutions to esthetic and functional problems. From a channel perspective, we exited the fiscal first quarter with channel inventory lower than historical averages and the previous year based on days on hand. We only shipped product during the quarter to sustain the current demand in the market.

And as always, we worked with our channel partners to ensure high service levels. During the quarter, we negotiated most of our dealer agreements for calendar 2024, including shelf position, pricing and expectations for future orders. We once again had a successful process and have incrementally expanded our position in the pro channel market. These shelf gains and subsequent preseason or early-buy orders started shipping in fiscal Q2. As we look to the remainder of the year, we continue to be both optimistic and cautious about the upcoming season. Year-to-date, we have had strong double-digit sell-through growth in our Residential business. And we feel good about the progress we’ve made in establishing ourselves in preparation for the normal increase in seasonal demand.

We think it’s prudent to assume a flattish R&R market moving forward and have incorporated that into our 2024 outlook. We ended Q1 at meaningfully lower channel inventory levels than the historical average. Our Q2 revenue guidance assumes a normal spring buying process for our channel and includes the outcome of our spring negotiation. Our channel and our contractors are incrementally more positive, and we continue to have more confidence and visibility to our margins. We are raising our fiscal 2024 outlook for the year, driven by the demand we have experienced year-to-date, combined with our expectations that our adjusted EBITDA margins will range between 25.5% and 26.1% for the year. We remain confident in our ability to deliver our short- and long-term ambitions as we continue to execute our overall strategy.

2024 will be another step in the journey of realizing our potential as a business. I will now turn the call over to Peter to provide some additional context on our financial results and our outlook.

Peter Clifford: Thanks, Jesse, and good afternoon, everyone. As Eric highlighted at the beginning of the call, we have uploaded a supplemental earnings presentation on the Investor Relations portion of our website. Before we get into the first quarter results, I wanted to provide some context on the first quarter demand. First, on sell-through, consistent with last quarter, we continue to experience strong double-digit sell-through growth in fiscal 1Q ’24. This is the result of continued execution of the AZEK growth playbook, including downstream material conversion initiatives, channel expansion efforts, new product development and shelf space gains. We ended the quarter with channel inventories down approximately 20% versus the historical average days on hand.

Consistent with past quarters, we surveyed a broad base of our pro contractors and dealers to understand the environment on the ground. What we learned is that demand indicators and sentiment remained steady in the quarter. Our contractors reported project backlogs of seven weeks, just above pre-pandemic levels. From a sentiment perspective, both our dealers and our contractors recorded similar views at the end of the quarter. Current sentiment for both dealers and contractors is modestly more positive in the last quarter. On the digital side, we continue to see robust growth in both samples and web traffic. These metrics highlight continued strong interest in our products and the effectiveness of our digital engagement strategies. Finally, the retail point of sale or POS data continues to experience healthy growth year-over-year.

Total retail POS remained above our pro channel sell-through. These results underscore the strength of our retail partnerships, the continued demand for our products in store as well as the accretive growth opportunity in front of us in the retail channel. From an operating perspective, production levels were up substantially year-over-year as expected after lapping the inventory drawdown experienced in the first quarter last year. Normalized production levels in the quarter drove strong utilization and cost absorption in the quarter. We continue to execute our traditional annual recycling and product configuration initiatives. And on the material cost input front, sourcing and material savings continue to provide incremental tailwinds. These combined levers enabled us to deliver structurally different gross margins.

In terms of SG&A, our results reflect a more normalized spend profile relative to 1Q ’23. The combination of double-digit residential sell-through growth, coupled with strong execution of our material savings, conversion costs and recycling initiatives helped us drive strong results in the first quarter. As a reminder, for fiscal 1Q ’24, the Residential segment adjusted EBITDA includes all corporate expenses. All numbers reflect this change for 1Q ’24 and the prior year comparable quarter. In addition, the previously announced closing of the Vycom transaction occurred on November 1, 2023. And as a result, fiscal 2024 includes the impact of approximately one month of Vycom operations on the Commercial segment performance. To assist with modeling, Vycom net sales were approximately $3 million and profitability was approximately breakeven during the one month of ownership in October.

As a reminder, with the divestiture of Vycom, the remaining portion of the Commercial segment manufacturers fabricates and distributes lockers and bathroom partitions. In the first quarter of 2024, we increased our consolidated net sales by 11% year-over-year to $240 million, which was above our guidance expectations. Excluding the impact of the Vycom divestiture, our net sales were up 22% year-over-year. The first quarter growth was driven by our Residential business being up 24%, partially offset by the $18 million net impact from the sale of our Vycom business in our Commercial segment. Effective as of December 31, 2023, we have revised the definition of adjusted gross profit to include depreciation expense in the calculation. All numbers presented reflect this change for the first quarter of 2024 and the prior year comparable quarter.

Taking this into consideration, 1Q ’24 gross profit increased by $44 million or 92% year-over-year to $91 million. 1Q adjusted gross profit increased by $43 million or 83% year-over-year to $95 million. Our adjusted gross profit margin percentage increased 1,550 basis points year-over-year to finish at 39.6%. The adjusted gross profit increase was driven primarily by higher net sales, stronger utilization in our plants, continued execution of recycling product configuration initiatives and benefits from both sourcing and material savings. SG&A expenses increased by $4 million to $77 million. The bulk of the year-over-year increase was primarily due to higher stock-based compensation and continued investment in marketing and brand awareness, partially offset by lower personnel costs.

Adjusted EBITDA for the first quarter increased by $41 million or 269% year-over-year to $56 million. The adjusted EBITDA margin rate for the quarter increased 1,620 basis points year-over-year to 23.2%. Net income for the first quarter increased by $52 million to $26 million or $0.17 per share. Adjusted net income for the first quarter increased by $30 million to $16 million for adjusted diluted EPS of $0.10 per share. As a reminder, if we excluded the $38.5 million gain on the sale related to the divestiture of our Vycom business from adjusted net income. Now turning to our segment results. Residential segment net sales for the first quarter was $223 million, up 24% year-over-year. Residential segment adjusted EBITDA for the first quarter came in at $53 million, up approximately 430% year-over-year.

Residential segment adjusted EBITDA margins were up 1,820 basis points year-over-year to 23.7%. Commercial segment net sales for the quarter were $17 million, down 53% year-over-year, primarily due to the sale of our Vycom business. Commercial segment adjusted EBITDA for the quarter came in at $2.9 million or a decrease of $2.2 million year-over-year. The decrease was primarily driven by the disposition of the Vycom business. From a balance sheet and cash flow perspective, we ended the quarter with cash and cash equivalents of $275 million and approximately $148 million available for future borrowings under our revolving credit facility. Working capital, defined as inventory plus accounts receivable minus accounts payable, was $251 million, down $90 million year-over-year.

We ended the quarter with gross debt of $671 million, which included approximately $78 million of finance leases. Net debt was $396 million, and our net leverage ratio stood at 1.2x at the end of the first quarter. Net cash from operating activities was negative $16 million during the first quarter, a decrease of $23 million year-over-year. Capital expenditures for the quarter were approximately $18 million, down $13 million year-over-year. For the first quarter, free cash flow was negative at $34 million, a year-over-year decrease of $10 million. As a reminder, we are traditionally a net consumer of cash during the fiscal first quarter as it is our smallest quarter seasonally and coincides with the annual inventory build in preparation of the season.

As previously announced, we initiated a $100 million accelerated share repurchase program. Under the agreement, the Company received about 2.3 million shares with the balance to be delivered no later than February 2024. After the ASR is completed, the remaining authorization under our share repurchase program was approximately $101 million. As a reminder, our capital allocation priorities remain the same as we’ve previously communicated. We will continue to invest in our business, both organically and inorganically. And to the extent we have excess cash flow, we will look to repurchase shares opportunistically. As we turn to the outlook, let me provide some color on what we’re seeing and assuming for the balance of the fiscal year. We expect to see a flash R&R market in fiscal 2024, and we see our residential sell-through in the mid-single digits for the balance of the fiscal year.

We continue to focus on driving above-market growth through our strategic initiatives, including market conversion and share gains. As we’ve mentioned in the past, the early buy period kicks off in the fall, and it is the time of the year in which our dealer partners make shelf space decisions for the following year’s selling season. Once again, we were pleased with our performance, and we believe we drove shelf space wins and expansion similar to recent years. These shelf space wins will be realized as product reaches the shelves and sell-through begins in earnest in the traditional selling season. From an inventory perspective, we continue to manage the channel conservatively while maintaining high service and short lead times. Quarter-over-quarter, we increased our finished goods inventory to prepare for the season and be able to react quickly to changes in the demand environment.

Overall, consistent with our contractor and dealer surveys, we are cautiously optimistic on demand in the selling season but need to see more data in the season to update our expectations around the market and associated sell-through. On the margin side, the second fiscal quarter will be positively impacted by higher production levels, increased utilization and cost absorption. We continue to see benefits from our focus on sourcing as well as recycling initiatives, which will continue to drive lower input costs to the benefit of our gross margins in the quarter. On SG&A, we will continue to support organic growth through sales and marketing initiatives. With that context, let me move to our updated planning assumptions for fiscal 2024. With our outperformance in the first quarter and demand seen to date, coupled with increased visibility and our margin drivers, we are increasing our guidance for full year consolidated net sales to range between $1.385 billion to $1.425 billion and increasing our full year adjusted EBITDA range to between $353 million to $372 million.

Adjusting for the Vycom sale, our net sales guidance would imply 7% to 10% year-over-year growth and 27% to 34% year-over-year growth in adjusted EBITDA. Our Residential segment planning assumptions for the year is $1.312 billion to $1.348 billion in net sales and $340 million to $356 million in segment adjusted EBITDA, representing 7% to 10% sales growth year-over-year and 30% to 37% segment adjusted EBITDA growth when combining corporate expenses with our Residential reporting segment, as mentioned earlier. A few other assumptions this year include the following. We expect strong gross margin performance, enabling us to continue to invest in growth-oriented sales, marketing and brand awareness initiatives. We’re expecting a capital expenditure range between $80 million to $95 million, consistent with our stated target of CapEx of approximately 5% to 7% of revenue.

We are expecting depreciation of approximately $89 million to $92 million. We are targeting a working capital reduction of approximately $10 million to $20 million for the year. We are expecting a GAAP tax rate for the full year of 29% to 31%. And finally, for the full year fiscal 2024, we expect to deliver another strong year of free cash flow generation. For additional planning assumptions to assist with modeling fiscal ’24, please refer to the supplemental earnings presentation we have posted on our Investor Relations website. Before we turn to our guide for the second quarter, let me provide some context for the environment that we expect. For the quarter, we are expecting sell-through growth in the mid-single-digit range. Traditionally, we have seen our own inventory come down meaningfully for 1Q to 2Q.

In 2024, we expect to stage modestly more inventory on our own balance sheet for 2Q before coming down in the second half of the year. Taking these factors into consideration, our guidance for the quarter is $407 million to $413 million in revenue and $108 million to $112 million in adjusted EBITDA. We are expecting an effective tax rate of approximately 27% for the quarter. With that, I’ll now turn the call back to Jesse for some closing remarks.

Jesse Singh: Thanks, Pete. I would again like to thank our dedicated team members, channel and supplier partners and contractors that support the AZEK company. Thank you for your contribution and dedication. We are excited about the long-term material conversion opportunity ahead of us in the large and fast-growing outdoor living and home exteriors markets that AZEK plays in. Our Residential segment has continued to show remarkable resiliency and growth capability. The business has delivered a compound annual growth rate of 12% over the last 10 years and 16% since fiscal 2017. Our execution of our strategic growth and margin initiatives and the benefits we have realized to date increase our confidence in our long-term financial objectives of driving double-digit annual net sales growth and expanding our adjusted EBITDA margin to our target of approximately 27.5%. With that, operator, please open the line for questions.

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Q&A Session

Operator: [Operator Instructions] Our first question comes from the line of Keith Hughes with Truist. Keith, please go ahead.

Keith Hughes: Some good results and a really strong guide here for the second quarter. I guess that’s where my questions lie. With single-digit sell-through, the revenue implication is higher in your guide. I assume there’s an inventory build, if you could talk about where that’s coming and also any difference in growth rates between exteriors and decking?

Peter Clifford: Yes, Keith. This is Peter. Thanks for the question. So two parts there. As I mentioned in the prepared remarks, we exited the first quarter of ’24 with channel inventory down about 20% from historical kind of pre-pandemic days on hand. It’s a little lighter than what we expect. So that’s part of the equation on top of the mid-single-digit kind of sell-through assumption at just kind of normal early buy cost staging that would be customary. On the second question, we are seeing positive growth on both exteriors as well as deck, rail and accessories. And just a reminder, to clarify, Keith, if you recall, much of the inventory recalibration last year, we really didn’t have much of an impact from a exteriors perspective. It was almost exclusively in decking.

Keith Hughes: Okay. And just one follow-up to that. I know you’ve won some shelf space in some big box. Is that playing a role, a meaningful role, in these numbers out for the second quarter guidance?

Peter Clifford: I don’t know that I would call it meaningful, but there is a modest impact, right, that we won that business kind of middle of the year. So, we probably really more benefited in the third and fourth quarter of last year and probably have a net year-over-year pickup here in the first half of the year, but it’s modest.

Operator: And our next question comes from the line of Phil Ng with Jefferies. Phil, please go ahead.

Phil Ng: Congrats on a strong quarter and outlook. I guess, Pete, if I look at your sales guidance for your Residential segment for the full year and back out 1Q, it implies roughly, call it, 5.8% sales growth on the resi side for the rest of the year. Can you kind of help unpack what’s driving that? I think there’s a price increase in the marketplace by you guys. Are we seeing much traction? How much of a contribution should we anticipate? And what are you kind of thinking about sell-out demand in your busy peak season?

Peter Clifford: Yes. The math there for you on the last nine months of the year, we are implying just about 6% kind of mid-single digits kind of sell-through without a lot of assumed changes in channel inventory over the nine months. As far as pricing, it’s the same answer as last quarter. Our view hasn’t changed. Pricing is negligible for the year. We took some traditional annual price actions, and those basically washed with some of the backside programmatic pricing initiatives that we talked about in the back half of last year.

Phil Ng: Okay. That’s helpful. And then from a margin standpoint, you guys are doing — seeing the improvement that we all hoped for and you guys have talked about. You’re guiding to, call it, 25.8% EBITDA margin for the full year. Your long-term target is closer to 27.5%. It seems like there’s upside potential there. Help us kind of think about maybe is there upside there or maybe get there a little closer? And what are some of the big drivers for the pace being a little faster than perhaps we may have anticipated?

Jesse Singh: Yes. Phil, Jesse here. Your point is a good one. We certainly expected that we would have an opportunity to continue to drive margin. I think what we highlighted at the Investor Day in 2022 was a 500 basis point opportunity that gets us to 27.5%. You should think of against that. We continue to see, give or take, 100 basis points of opportunity per year moving forward. We’re not giving specific guidance to ’25 and beyond. What I highlighted in my prepared remarks is we’re incredibly confident on the 27.5% and then against that, you should consider that, give or take, 100 basis point on average margin expansion in a more normalized year. And I think as happy as we are with the progress that we’ve made against certain initiatives that are helping us with our margin, we still believe that there’s a lot of room for us to continue to drive operational efficiency, increase the use of recycled and to continue to drive down and increase productivity in a number of different areas.

So as we progress, we’ll give you a better view on ’25 and beyond. But I’ll just summarize by saying we continue to see an opportunity of 100 basis points a year over the long term.

Operator: And our next question comes from the line of Matthew Bouley from Barclays. Matthew, please go ahead.

Matthew Bouley: Obviously, there’s a lot of kind of chop out there in the R&R space. And you guys raised guidance on the top line and the bottom line. I guess the way to ask the question would be, would you be able to bridge kind of the difference between the prior guide and the new guide? Is it simply the additional shelf space wins? Does it feel like kind of material conversion is tracking a little bit better? Altogether as a result, production is a little bit higher. Just kind of put all those pieces together, difference between the prior guide and the new guide.

Jesse Singh: Yes. I’ll start at a high level, and let Pete chime in. As we said in our prepared remarks, we had strong double-digit growth really to the point that we’re out now and at now. And so clearly, when you have that, you saw our results in the first quarter and that was primarily sell-through driven. So as you complete, in our case, coming on four months of sell-through, that’s an element that has already happened against that, call it, 5% sell-through assumption. And then there’s some modest incremental pickup that we have beyond that. But if you just take a look at our three-quarter guide, Q2, Q3, Q4, that’s roughly in line with that mid-single-digit sell-through assumption. And so from our vantage point, there’s some modest tweaks, but we’re still operating under that baseline assumption of a flattish R&R plus the contribution that we see against that of our incremental initiatives and the market space that we’re in.

And as you pointed out, part of that is continued conversion. Part of that is our shelf space game. Part of that is the benefit we see from incremental new products. And I think we’ve said that’s what allows us to stack, call it, 5 to 7 points over the underlying R&R basis. So although it is certainly a step-up in our guide, if you just play through the basic fundamentals that we’re talking about, we’re not really changing that much in the guide as we look forward.

Matthew Bouley: Got it. Okay. Second one, I think I heard you say at the top that retail POS is actually above your pro channel sell-through. And correct me if I misheard you, but I think that’s probably another unique item to AZEK here. So yes, just could you kind of go into some of the specifics around your new retail business and just sort of what’s going on differently there for your products relative to what we’re seeing elsewhere in the retail world?

Jesse Singh: Yes. I think if you just step back and you look at the equation that we’re talking about from a business model standpoint, we continue to invest in our brand. We continue to invest in our sales force and we continue to add new products. Those are all elements, as we talked about, that are additive to our overall growth equation. Against that, as we talked about last year, we picked up some incremental shelf position. That is certainly contributing to the benefit that we’re seeing in that channel, and that’s flowing through. But on top of that, we believe that some of the marketing activities that we’ve had and the ongoing conversion and brand strength that we see, that, that’s also benefiting us.

Operator: [Operator Instructions] Our next question comes from the line of Ryan Merkel with William Blair. Ryan, please go ahead.

Ryan Merkel: I wanted to start on the margins. I think in the deck, you mentioned increased visibility on margins as part of the guidance range. Can you just unpack that a little bit?

Peter Clifford: Yes, Ryan. This is Peter. Look, obviously, we have plans internally every quarter to kind of hopefully out-deliver and overdrive our guide. But as we mentioned, 1Q is pretty critical when you think about the comp comparisons to ’23. Our largest variance was going to be in 1Q, so it was really important for us to see that get booked and be done as well as getting visibility or clarity on sort of seeing the early buy orders completely through the month of January. So I think that’s really — we saw the mix, we saw our backlog. Those two things combined give us confidence as well as every quarter we get into the year. Obviously, with our rollback, our balance sheet lagged. We start to get a firmer picture of what deflation is going to look like in the back half of the year.