The AZEK Company Inc. (NYSE:AZEK) Q4 2022 Earnings Call Transcript

The AZEK Company Inc. (NYSE:AZEK) Q4 2022 Earnings Call Transcript November 29, 2022

Operator: Good afternoon. My name is Emma and I will be your conference operator today. At this time, I would like to welcome everyone to the AZEK Fourth Quarter and Full Year 2022 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. Eric Robinson, you may begin your conference.

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 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 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.

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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 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 today’s call. We hope everyone had everlasting Thanksgiving and we appreciate you taking the time to join us. The AZEK team delivered solid fourth quarter performance and despite a challenging macro environment, we delivered strong growth in revenue and adjusted EBITDA for fiscal 2022. I’m proud of what the entire AZEK team has been able to accomplish as we navigated through a constantly changing external environment, while continuing to provide strong service to our customers and drive meaningful innovation in the marketplace. During our Investor Day in June of this year, we highlighted that we play in large growing and resilient markets with strong tailwinds, operate leading brands with category leadership and have multiple levers to drive growth and margin expansion.

We remain confident about our markets, our strategy and our ability to deliver on our long-term objectives and goals. As we enter fiscal 2023, we believe that our business is well positioned to navigate through any macroeconomic situation and to continue the next phase of our strategic growth and margin expansion plan. For the fiscal year, we delivered $1.36 billion in net sales, generated $301 million in adjusted EBITDA, representing increases of 15% and 10% year-over-year and delivered $0.97 in adjusted diluted earnings per share. Our fiscal fourth quarter results and execution are all in line with our guidance and expectations share the last time we spoke. As previously highlighted, we expect that our Q4 to be meaningfully impacted by the lapping of inventory build 2021 and significant channel inventory drawdown.

Q4 was consistent with our expectations with customer demand remaining steady and the channel drawing down inventory levels. The destocking we saw in the channel was primarily in our deck rail and accessories business, where we generally saw consistent positive sell through growth on a dollar basis and modest declines on a unit basis. This resulted in a meaningful drop in our net sales to our channel partners. We were able to hold our balance sheet inventory steady by lowering production levels in Q4 to the levels required to meaningfully draw down the necessary inventory from the channel. We have plans for continued lower production volumes in fiscal Q1, 2023, before we expect to increase our production levels starting in fiscal Q2. Because of our aggressive actions to move quickly past this period of under-utilization, we expect to see the greatest financial impact in Q1 and early Q2.

From a demand indicator perspective, our recent contract survey highlighted continued backlogs for the remainder of the year with many of our contractors booking into 2023. However, over the last few quarters their concerns have shifted away from material availability toward economic uncertainty and labor availability. We also saw consistent consumer engagement with leads and samples continuing to show year-over-year growth within the quarter and a continued modest year-over-year decline in web traffic. Our strategic initiatives are on track with strong growth in new products, pro-dealer channel expansion and positive retail channel point of sale trends. Our recycling expansion continues to progress as expected and we exited Q4 having achieved a key milestone in our expanded use of recycled PVC for our advanced PVC decking lines.

These decking products are now made up approximately 60% recycled materials, an increase from approximately 55% at the beginning of fiscal 2022. We also saw strong performance from our commercial segment with sales and segment adjusted EBITDA growth driven by the combination of net price realization and operational discipline. In fiscal 2022, the rapid increase in inflation during the year created a lag in our ability to deliver desired margin and deferred our margin expansion as pricing lagged raw materials. As highlighted on our last quarterly earnings call, our price cost margin coverage has moved to a net benefit and we have been running with higher recycled rates, which will provide us a cost benefit as we move through coming quarters.

We have also taken steps over the last two quarters to bring down our overall SG&A expenses, while continuing to invest in customer activity and market expansion. And we have made the conscious decision to prioritize certain customer investments in Q1, while reducing activity in Q2. As we look back on the quarter and the fiscal year, we have made significant progress in executing against the plan we laid out at the beginning of the year and against our long-term goals that we highlighted at our Investor Day in June of 2022. We operate with a clear strategy to drive above market growth through market conversion, new product innovation, multichannel expansion and a best-in-class customer journey and market expansion through adjacencies. We have a clear operational strategy of expanding the use of recycle and leveraging our AIMS program to drive increased profitability.

And our focus on ESG is a core part of how we operate and who we are. We once again received multiple awards for our culture and focus on ESG. Most notably, we were recognized by CohnReznick in their inaugural Gamechangers in ESG award, highlighting AZEK’s leadership in driving positive change for our people, our customers, our communities through ESG. We are also proud to be need to the list of America’s most trusted companies by Newsweek based on fair treatment of employees, opportunities for career development and employee compensation and trust in the company’s values, leadership and customer facing communications. In addition, we continued our history of innovation in new product development by launching multiple new products in the year.

In our exteriors segment we took home the HBSDealer Golden Hammer Award for AZEK’s Exteriors Captivate, Prefinished Siding and Trim for its innovation and value. In decking, we received Architizer A Plus product award for TimberTech’s Landmark Collection for decking in the sustainable design category. Finally at our acquired structure business unit, we are proud to have officially launched Cabana X, a non-permanent, high quality, high-tech cabana to AZEK’s pro channel and to commercial applications. This new product expands structures already robust product portfolio. Moving to our outlook. Our business is overwhelmingly focused on the repair and remodel market, with strong long-term tailwinds driven by the combination of favorable demographic trends and an aging housing stock.

AZEK is also experiencing the positive impact of a sustained focus on outdoor living in a material replacement from traditional wood products towards our long lasting and sustainable products. Industry data suggests that there are around $60 million decks in the US and approximately half are estimated to be beyond their useful life. A meaningful part of our decking business is driven by this need to replace wood decks. The large installed base and natural obsolescence for materials such as wood, helps drive our material conversion opportunity. These strong tailwinds combined with company-specific strengths around new product innovation, portfolio breadth and best-in-classes esthetics, collectively, we believe AZEK is positioned to drive above market growth and margin improvement.

While we continue to see solid contractor demand and continued interest in our category. We expect the macro-economic environment will likely impact our business in 2023. For planning purposes, we are assuming that approximately 50% of our business that is new construction focus will see high teens decline from a volume perspective. We are also assuming repair and remodel activity will be down mid to high single digits. These assumptions are based on a number of industry projections that include the impact of recent interest rate moves on new construction and the broader economy. The combined impact of new construction and R&R leads to our planning assumption of a 10% decline in volume excluding the contribution from acquisitions and pricing in fiscal 2023.

Using this assumption, we would expect to deliver $250 million to $265 million of adjusted EBITDA in fiscal year 2023. As a reminder, we are exiting 2022 with a number of positives on the margin front, including positive price, recycled benefit, productivity and a moderating raw material environment. We expect the majority of our underutilization to impact Q1 and part of Q2. In fiscal 2023, we expect an approximately $8 million impact from an update to the process by which we estimate the value of our inventory. This incorporates our increased use of recycle materials. A significant part of the impact is expected to occur in Q1 and early Q2. We expect to see the benefit of our margin and sourcing programs in Q3, as we work our way through higher cost inventory in the first half of 2023.

Our assumptions for the back half of the year include continued price realization, commodity deflation that we are already experiencing, completed productivity actions and our current recycle rates. Pete will provide more detail in a moment, but with the visibility we have in our costs in the balance of the fiscal year, we are confident that we are in a strong position to navigate the next few quarters and expand our margins as we move past the first quarter. We’re also confident in our ability to execute our business model to drive incremental market penetration and growth. Now, let me turn the call over to Pete to provide some additional context on our financial results and outlook.

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Peter Clifford: Thanks Jesse and good afternoon everyone. As Eric highlighted upfront, we have uploaded a supplemental earnings presentation on the Investor Relations portion of our website. First, I wanted to provide some color on the operating environment during the quarter. As Jesse mentioned, the demand environment has remained relatively stable. The sell through profile was positive on a dollar basis and modestly negative on a unit volume basis. This backdrop has allowed us to make real progress in taking inventory out of the channel with our partners. The 4Q inventory reduction in the channel was in line with expectations. From an operating perspective, the focal points for 4Q were around getting our conversion costs down as much as possible to match the significant drop in production levels without hurting the future.

It is important to note that we held our balance sheet inventory levels flat, sequentially quarter-to-quarter. Production levels were down more than 40% in the period. On the commodities front, we saw the bulk of our purchases portfolio remained stable in the quarter, with the exception of PVC resin, which saw a decline during the last 10 days of September. Since the close of 4Q, we’ve also seen softening in other key commodity inputs. This is a positive news for the business in the long run as it sets us up to recapture lost margin during 2022, while we were playing catch up on inflation versus pricing. There is an approximately a 4.5 month lag on purchase price variance positively impacting our income statement. Therefore, we will not fully realize the impact of that deflation until late 2Q and into the second half of 2023.

For the full year fiscal 2022, I’d like to reiterate Jesse’s point that we’re proud of the results we delivered in a very disruptive environment. To quickly recap, full year net sales were $1.356 billion, up 15% year-over-year, while our adjusted EBITDA was $301 million, up 10% year-over-year. For the fourth quarter of 2022, we saw net sales of $305 million, modestly above our guidance. Net sales declined 12% year-over-year, driven by the previously communicated channel inventory reduction and we are well on track to achieving normalized channel inventory levels by the end of the current quarter. During the quarter, we updated our process by which we estimate the value of our inventory. The primary update was made to include more consistent and predictable recycling introduction rates into our inventory valuation.

The resulting impact reduced our inventory valuation by $19.3 million during the quarter. It is important for us to do this given the significant progress we’ve made in our recycling introduction rates, which are now more consistent and the stability of our operations has made delivering the impact more predictable over time. Our business will benefit from the improved clarity and predictability around our margins. 4Q ’22 gross profit decreased by $40.4 million or 36% year-over-year to $71.9 million inclusive of the previously mentioned update and process, by which we value our inventory. 4Q ’22 adjusted gross profit decreased by $16.2 million or 12% down year-over-year to $114.2 million. The adjusted gross profit drop was in line with the decline in net sales.

Note, there is approximately at two-month lag on our labor and overhead, which will push some of the cost pressure into fiscal 1Q ’23. Selling and general administrative expenses increased by $7 million to $67.5 million or approximately 22.2% of net sales. The bulk of the year-over-year increase was the impact from the contribution from acquisitions and transaction related expenses, partially offset by one-time lower incentive compensation as a result of the reduced outlook in fiscal 2022. Adjusted EBITDA for the fourth quarter was $65.1 million, in line with guidance. Adjusted EBITDA declined 20% year-over-year, driven by lost volume leverage with the decline in both production and net sales levels. Net income for the quarter was a loss of $4.8 million or approximately negative $0.03 per share driven by the previously mentioned inventory valuation process update.

Adjusted net income for the quarter was $24.5 million for adjusted diluted EPS of $0.16 per share. Note that our effective income tax rate in fiscal 2022 was negatively impacted by increased state tax expense recognized in the current period, which reduced our earnings per share by approximately $0.02. Now turning to our segment results, residential segment net sales for the quarter were $254 million, down 16.7% year-over-year, driven by the previously mentioned channel inventory calibration impact, which was largely in our deck, rail and accessories business. The exteriors business saw positive growth year-over-year and the acquisition of structure contributed approximately $24 million in the fourth quarter. Residential segment adjusted EBITDA for the quarter came in at $64.5 million, which was down 30% year-over-year.

Commercial segment net sales for the quarter were $50.4 million, up 23% year-over-year. We saw double-digit growth at both our Vycom and Scranton Products businesses. Commercial segment adjusted EBITDA for the quarter came in at $14.6 million, an increase of $8.5 million year-over-year. Margin expansion was driven by favorable price commodity coupled with productivity. The Commercial segment team continues to exceed expectations. From a balance sheet cash flow perspective, we ended the quarter with cash and cash equivalents of $120.8 million and approximately $147.2 million available for future borrowings under our revolving credit facility. Working capital defined as current assets minus current liabilities was $348.1 million. We ended the quarter with gross debt of $678.1 million, which included approximately $78.1 million financial leases.

Net debt was $557.3 million and our net leverage ratio stood at 1.9 times at the end of the fourth quarter. Net cash from operating activities was $40.1 million during the quarter versus net cash from operating activities of $89 million in the prior year period. Capital expenditures for the quarter were approximately $31 million. During the quarter, we executed share repurchases of $23 million or $1.1 million shares. The remaining authorization under our share repurchase program is approximately $319 million and we will continue to look to act opportunistically to make repurchases. Our capital allocation priorities remain the same, as we previously communicated. As we turn to the outlook, let me provide some context and color on what we are seeing and assuming for the balance of the fiscal year.

Let me first take you back to our Investor Day back in June 2022. We articulated a sensitivity analysis in June that if our volumes were down approximately 5% in 2023, we can hold our adjusted EBITDA approximately flat on a dollar basis. The outlook that we’re providing today has two specific adjustments to the sensitivity shared at our Investor Day in June. First, our fiscal year 2023 planning assumption is volume down 10%. Second, on the incremental 5% volume drop from the 5% to 10%, we are assuming 50% decrementals driven by the first half of the year. The planning assumptions we are providing on this call should not be considered formal guidance. We are simply being transparent on our assumptions that we are planning the business around.

Our planning assumption of a 10% decline in volume, drives us to a target range of approximately $250 million to $265 million of adjusted EBITDA for the full year fiscal 2023. A few other planning assumptions to share, we expect lower capital expenditure spending in fiscal 2023 in the range of approximately $70 million to $80 million, which is approximately $100 million less than fiscal 2022 as we enter a period of more normalized capital spending. Similarly, we expect to generate significant year-over-year free cash flow in fiscal 2023. The strong free cash flow defined as operating cash flow, less capital expenditures will allow us to support our repurchase program in 2023. Additionally, we expect full year SG&A, excluding the carryover impact from acquisitions and more normalized management incentive compensation will be flat to down year-over-year.

For additional planning assumptions to assist with modeling full-year 2023, please refer to the supplemental earnings presentation that we posted on our Investor Relations website. Before we turn our guide for the first quarter, I wanted to provide context for the operating environment that we expect in fiscal 1Q 2023. Sales volume is expected to be down approximately $85 million in volume year-over-year or a 30% plus decline in sales volume driven by an inventory correction in the channel and the lapping of inventory fill from 1Q ’22. This has affected landline with what we highlighted on our last earnings call. We are well on our way to achieving normalized channel inventory levels at the end of the quarter. Similarly, production volumes are expected to be down approximately 30% year-over-year.

Just to reinforce these factors, we are making intentional decisions to deal with the impact of right sizing our channel inventory and lower production volumes in the near term. As a result we will have under-utilization flowing through in both 1Q and 2Q and labor and overhead. During the quarter, we will continue to burn through our higher cost inventory layers and we are lapping the impact from recycled costs being period expense in the prior year to being capitalized in 1Q 2023. Within SG&A, we have prioritized investments in certain sales and marketing activities in 1Q that will not reoccur and the balance of the year. For 1Q 2023, we expect consolidated net sales between $200 million to $215 million. We expect adjusted EBITDA between $8 million to $12 million.

In closing, it’s important to highlight some of the key elements that our implied outlook for the balance of 2023 between 2Q and 4Q, which include channel inventory normalization of 4Q, 2022 and 1Q, 2023 will be behind us. We had material input cost deflating in 1Q ’23 that will impact our results meaningfully in the third quarter post our lag. We expect production volumes to normalize in the second half, positively impacting utilization and setting the stage for productivity. We anticipate sales volumes will recover significantly from the 1Q 2023 seasonally low and channel inventory impacted profile. We expect the whole price in our core markets. And lastly, given the environment we think that we might see more commodity started to play. I’ll now turn the call back to Jesse for some closing remarks.

Jesse Singh: Thanks, Pete. I would like to take a moment to thank our dedicated team members, channel and supplier partners and contractors that support the AZEK company. Thank you once again for your continued focus, dedication and your contribution to the results in the fourth quarter and for all of 2022. The fundamentals of our business are strong as is our confidence in the future. We are well on our way to restoring normalized channel inventory levels and the actions we have taken position us well to realize the benefits of our recycling and sourcing initiatives late in Q2 and into Q3. Given our visibility to cost, we are in a strong position to navigate the next few quarters and expand our margins as we move past our fiscal first quarter.

Our award winning new product not only solidify our position in the core, but give us an opportunity to continue to drive material replacement. Our acquisitions, our expanded exteriors line and our constant innovation and decking and rail have put us in a position to continue to gain market presence and share. We have a clear strategy an AZEK-specific initiatives to drive above market growth and we believe that we are well positioned to win and deliver on our long-term goals. With that, operator, please open the line for questions.

Q&A Session

Operator: Thank you. Your first question comes from the line of Keith Hughes with Truist Securities. Your line is now open.

Keith Hughes: Thank you. First question on the raw material commentary helping out in the second half of fiscal year, can you give us any sort of indication how big a number this is playing in the EBITDA guidance for the year highlighted earlier?

Peter Clifford: Yes, Keith, this is Peter. I think I’ll start just generically on how we’re thinking about deflation. First and foremost, we’re comfortable and confident that we can start to recapture some of the margin that was delayed last year, what the price commodity lag starting in 2Q 2023. As far as what we’re seeing so far quarter-to-date in 1Q 2023, as I mentioned in my prepared remarks, we are seeing significant lower purchase input costs in 1Q, 2023. Keep in mind with our balance sheet lag of the 4.5 months, some of that won’t start to roll off until March of 2023. But obviously that implies and means that we will also have some carryover deflation into 2024. From an assumption perspective of what’s embedded, the way we’re thinking about and how you should think about, what’s embedded in the EBITDA profile as we expected about $50 million of annualized deflation, of which about $30 million of that will actually hit fiscal 2023 EBITDA with the remainder being a carryover favorable deflation to 2024.

Keith Hughes: And to be clear that $30 million assist here in ’23 just said is that, is that based on what you’ve seen so far, are you assuming some more deflation?

Peter Clifford: I think what gives us a lot of confidence is based upon the prices were seeing quarter-to-date 1Q. We don’t need prices to go down much further to support the $50 million and the $30 million. So obviously if the commodity markets to continue to turn in our favor, then obviously there’s potentially some upside.

Keith Hughes: And then one final thing to this, I assume in the guidance you’re assuming selling prices for products remain flat other than the roll through pricing actions you did this calendar year, is that correct?

Peter Clifford: Yeah, we’re not assuming any change the list prices.

Keith Hughes: Okay, great. Thanks. That’s very helpful. Thanks.

Peter Clifford: Yes.

Operator: Your next question comes from the line of Matt Bouley with Barclays. Your line is now open.

Matthew Bouley: Hey, good evening, everyone. Thanks for taking the questions. So given the guidance for margins, you’ve alluded to for Q1 and then the step up beyond Q1. I mean it sounds like you pointed to a few things, the production levels should increase, you’re burning through some of the higher cost inventory. I mean, should we think that the cadence of margins is going to be kind of consistent in terms of that sequential increase beyond Q1 or is there going to be a more meaningful step up in the second half. Just given where you’re starting in Q1, it’d be helpful if you kind of walk us to some kind of framework for the second quarter there? Thank you.

Peter Clifford: Yeah, at a really high level, Matt is, look, we’ll obviously see sequential improvement from 1Q to 2Q. We still have a little bit of pressure in 2Q. As you are aware, our labor and overhead lag is about two months. So some of the inefficiency in 1Q will push to 2Q, but our production levels, we really expect to start to normalize in the back half of the second quarter and recover to a much healthier level. And then we would expect an even more meaningful step up from 2Q to 3Q and that again probably a more modest step up from 3Q to 4Q. So obviously with 1Q guide and the full-year outlook, you get back into the nine-month profile. And again the second quarter will be below that average and the third and fourth quarter would be above that, if that helps give some context.

Jesse Singh: Yeah, Matt, this is Jesse. If I could just add one other component. The challenge we have — clearly, we are — we’ve got a number of components that hit Q1, some of the change in process that we talked about that will primarily be Q1, a lot of our year-over-year inventory decline will be focused in Q1 and a lot of our under-utilization, a disproportionate percentage impact will be in Q1. And that’s really against our lowest quarter. So the good news is, we get a lot of that behind us as we work through Q1. So part of the margin impact as we go into subsequent quarters is getting some of these things behind us. The other aspect of it is, typically, the other quarters are meaningfully larger as we flow through. Typically, our first quarter is give or take 17% and 18% of our volume for the year and so having those impacts in Q1, just it naturally has a different impact as we flow through in addition to all the tailwinds that we talked about.

Matthew Bouley: Got you. Okay. No, that’s really helpful. Thanks for that guys. And then second one on the volume outlook, just trying to put the pieces together. So the market planning assumption is down 10. I guess my question is just how does AZEK’s growth compare versus that? Is there an assumption of share gains we should be making? And I think about Q1, where you talked about the $85 million volume decline, which I assume includes destocking and so maybe that I don’t know how that compares with the 10%, if it kind of ends up, such that they offset each other in AZEK’s volumes end up looking like the market volumes and not to put words in your mouth, but just how should we think about AZEK’s growth relative to the market? Thanks.

Peter Clifford: Yeah, let me take the first piece on just sort of help and give some color on sort of the 1Q geography from a sales perspective. So the way you want to think about the $85 million of volume reduction is about $70 million to $75 million of that is the channel inventory recalibration. That small difference between the $75 million and the $85 million is really to sell through that we’ve talked about that we’ve seen positive on a dollar basis, but modestly negative on a unit volume basis. And just one other point on it, as it relates to the first quarter and the $85 million, that’s up almost half of the entire year down 10%.

Jesse Singh: And then, relative to your question on initiatives, clearly we — we believe in what we’re doing and the ability for the initiatives I laid out earlier in the call to impact what we’re doing. Take that for us is we reviewing that as a way to give us increased confidence for us to manage through a potentially more volatile environment than even what our scenario would have been. And so the way to think of it is, it’s not as simple to add on top of what’s there. It really depends on the macro, but we are certainly expecting a benefit from our initiatives. But what we’ve laid out is kind of market-oriented adjustments to volume.

Matthew Bouley: Great. Well, thanks, Jesse. Thanks, Pete.

Operator: Your next question comes from the line of Michael Rehaut with J.P. Morgan. Your line is now open.

Michael Rehaut: Thanks. I appreciate you taking my question and good afternoon.

Peter Clifford: Happy Birthday.

Michael Rehaut: Thank you very much. I appreciate that. First question I wanted to break down a little bit was the organic decline in 4Q. On the residential side, you said that it’s about $24 million of contribution from the acquisition, so that puts you down organically about down 25%. And I think it looks like it might be a similar type of rate that you are looking in plus or minus for the first quarter. So you compare that to your largest competitor with a guidance of revenue down, plus or minus 40%. And I was hoping to get any insights from you around what the difference could be and perhaps breaking out decking rail and accessories versus exteriors, if that might explain some of the differential, given that you’re a little more — you have exposure on the exterior side, what might be driving, what appears to be a pretty big difference?

Jesse Singh: Yeah, I think if you just — and I can’t speak specifically to what other players are experiencing in the market, although, we’re close to the market and we might have an opinion. Let me give you a couple of just basic data points, right. One is the way to think of our residential business is, it’s about two-thirds deck, rail and accessories and one-third exteriors. I’m giving you rough numbers, on average, it’ll vary quarter-to-quarter. And against that. I think what we mentioned in our prepared remarks was that, in effect all of the inventory correction that we are going through is within deck rail and accessories. And so we believe that what we’re going through is appropriate for where we are now. I think when you do calculation, so if you look at our fiscal and calendar 2022, and then you start to consider our fiscal and calendar guide for 2023, I think the math would tell you is that from a revenue standpoint, we are doing pretty well compared to other players in the marketplace.

Peter Clifford: And Mike, just to help a little bit, 4Q kind of came in line with what we talked on our last earnings call for the full year as well. You should think of the fourth quarter price as kind of low teens M&A, call it, approximately 7%. The inventory destock was about 25% headwind, which kind of leaves the normalized unit volume kind of down low single digits, again kind of consistent with how we’ve been thinking about sell-through as kind of positive on dollars and modestly negative on units.

Michael Rehaut: Thank you, Pete. That’s very helpful and Jesse. I guess secondly, looking at the EBITDA guidance for the first quarter and apologies if I missed all of these different numbers earlier from your prepared remarks. But I believe you mentioned 50% decremental if I heard right for the first half of the year, when you look at your first quarter ’22, you did about $60 million — $59 million of EBITDA. And so, if you’re talking about roughly $50 million less revenue in first quarter ’23, you’ve added 50% decremental $25 million, what’s the gap between that decremental and some of the other variables that gets you down to your guidance. I know you mentioned the $8 million of inventory flow through, if there’s any other kind of drivers that we should be thinking about?

Peter Clifford: Yeah, the way I described Mike is, look, first quarter, we’ll have kind of mid-single digits pricing right that’s been kind of announced as carryover. You’re going to have a similar profile for M&A, which again supports and points of that kind of $85 million in volume impact and that’s where we’re saying that $85 million is really not flowing through it, maybe traditional 38%, it’s closer to 50%. Because of the dynamic that Jesse mentioned that not only is that our smallest quarter from a sales perspective, but we’re also down even more on a production basis than we are on a volume basis is we’re trying to prevent building higher cost inventory. We want to get that out of the way. So that dilution of that under-utilization and the plant is skewed into 1Q and again any dollars that we’re taking there is on a much smaller base, so it’s causing that quality of earnings in 1Q to be pressured.

Jesse Singh: Yeah, and just to put a little sense on that. We — just to reiterate what we said in the prepared remarks, we are intentionally scaling down our factory. We scaled it down in Q4. We scaled it down in Q1 and it’s at or below the level of sales specifically in the area where we’re having the biggest adjustments, which is in deck rail and accessories. And so — and then we’ll start to bring it back up as volumes normalize. There is a large benefit to that and that it tends to concentrate some of the under-utilization into — in the potentially the first quarter, not all of it, but let’s call it about half of the underutilization impact that we thought out for the entire year will be concentrated give or take in — in Q1. And once again that is intentional rather than level loading because we don’t want to make products with higher cost materials and when we start making products at appropriate levels, we’ll be making it using lower cost materials.

Michael Rehaut: Got it. Great. Thanks so much.

Operator: Your next question comes from the line of Tim Wojs with Baird. Your line is now open.

Tim Wojs: Yes. Maybe just on Jesse, just your feedback or the conversations you’re having with your distributors. How are they expecting to kind of think about or how are they thinking about kind of the normal seasonal ramp of kind of taking inventory going into a season? I don’t know if you want to compare and contrast that versus like a normal year. But what have you kind of heard in terms of that kind of March, June kind of load-in effect that you would kind of normally see from the channel?

Jesse Singh: Yeah. Yeah, it’s a good question and I’ll answer it generally. And what I would tell you is that it really varies by channel — by channel partner, I should say depending on their business model. So I think number one is, they will be entering — all of our channels will be entering Q2 in a good inventory position that is lower than where they were a year before on a days on hand. So that’s kind of key point number one, which that means that they naturally need to re-inflate that inventory to meet demand. I think in general without getting too specific, they’re kind of either act or a little lower in terms of mindset than the year before and once again it varies. Some of our channel partners will be right up, some of them will be lower and some of them will be above at a distribution level.

At a dealer level, I think it similarly has the potential to vary, where some — some dealers feel good about their markets and they would expect to take almost as much as last year and other dealer are more conservative relative to their markets and might take a little less. So if you add all that up, it’s probably safe to assume as we look at Q2, which is calendar Q1 that it would be logical that it would potentially be a modestly slower ramp, although will guide Q2 when we get there, but that is logical to assume that it would be a slower ramp that it was in prior year. Now what that does is, it really sets up Q3 and Q4 to not have — first, we won’t have the same types of inventory corrections, but it also sets us up to have more seasonally oriented demand rather than kind of perfectly trying to — trying to land the plane relative to the right amount of inventory in the system.

So hopefully that gives you a general. And then as we get to Q4, obviously, we’re lapping — we are lapping what we just talked about, which is a very large inventory correction in the channel. And at that point, your — yourself who is in a good position and you just want to make sure that you’re — you got the right amount of inventory in the channel.

Tim Wojs: Okay. Okay. that sounds good. And I mean that’s — that’s kind of the thinking that you are incorporating in the commentary around guidance, right. Just kind of what you talked about?

Jesse Singh: Yeah. Well, once again, we’re not guiding Q2, I think it’s important that what I think Pete’s referring to is the subsequent three quarters, right. We know we’re getting a lot behind us in Q1. And we have estimates that we talked about, of the market being down 10 — the aggregate market being down 10 as — unit volume basis, as we work our way through those final three quarters. And then based on that, it’s really a discussion of geography and clearly, we’ll give you clarity on that. But I think the takeaway here is that we’re very confident in our ability to deliver those three quarters and manage through that given the margin tailwinds that start to come in as we lap our way through more expensive inventory.

Tim Wojs: Okay. Okay, good. And then — and then I guess as a follow-up, what is the pricing carryover that you’re assuming for ’23?

Peter Clifford: Kind of mid-single digits, low-to-mid single digits for the year. Obviously all of its really in the first half of the year, but the full-year impact is kind of low single digits.

Tim Wojs: Okay. Okay, great. Thanks guys. I appreciate it.

Operator: Your next question comes from the line of Phil Ng with Jefferies. Your line is open.

Phil Ng: Hey, guys, I appreciate all the color, not easy in this environment. I guess the first question I have is the destock and production curtailment impact is obviously give be more heavily weighted in 1Q, anyway to size up the split between 1Q versus 2Q? And should we expect EBITDA to be at least flat in 2Q on a year-over-year basis?

Peter Clifford: Yeah, I think we’re going to steer clear of kind of formal guidance on 2Q. I think we want to get closer to that. I’m highly confident we can say we expect the quality of earnings to sequentially meaningfully improve from 1Q to 2Q and that’s I think about as much as we probably can responsibly say.

Jesse Singh: Yeah. And maybe another kind of way to help me out on that is — we’re saying that there is a fair amount that’s going to impact you one, there’s certainly going to be some that impacts Q2, although not pronounced at the same level, so we need to work our way through to see how that flows through and we need to see what the revenue was.

Phil Ng: Got you. Okay, that’s helpful. Pete, I think last quarter you were talking about a $30 million price cost, potential tailwind for 2023. You threw out a few numbers today, $30 million for 2023, on an annualized basis $50 million. Does this $30 million compared to last quarter $30 or doesn’t just because some of the timing difference. Because since you’ve given that guidance to your point, some of the inputs have fallen and certainly PVC prices have fallen pretty meaningfully from the peak levels that I think was embedded in that $30 million number, that you called out last quarter?

Peter Clifford: Yeah, I mean part of it is the 4.5 month lag of the timing of it. Some of it moving to 2024 and the other piece to a smaller extent is look stint is, look, we’ve had some other overhead type inflation in 2023, that’s kind of new on the horizon and it’s really kind of two — two things specifically. One, our energy costs have moved up pretty substantially. And then secondarily our property insurance — the property insurance markets have been pretty brutal last two years and we’ve seen significant inflation there as well.

Phil Ng: Okay.

Jesse Singh: Yeah, but to answer — but — to answer your question, what — the way to think of it is, it’s the $30 million plus — what Pete is highlighting which is $50 million on a — on an annualized basis, right. So there are two different elements. One is the price raw material carryover that we’ve talked about a $30 and what we’re talking about is additional cost in sourcing actions that add up to that $50 from where we sit now. And then, as Pete pointed out some of that will get consumed with certain elements of inflation, but it’s additive.

Phil Ng: Okay. That’s helpful. Great color guys.

Operator: Your next question comes from the line of John Lovallo with UBS. Your line is now open.

Spencer Kaufman: Hey guys, good afternoon. This is actually Spencer Kaufman on for John. Thank you for the questions. Maybe the first one, what gives you guys have confidence that the inventory adjustment will be done by the end of the first quarter? And do you think that maybe price can become more of a lever for the composite decking manufacturers either gain share, just maintain reasonable volume levels?

Jesse Singh: Yeah, so let me take the latter and I’ll have Pete take the former. Just as a reminder of the structure of the market, we’ve got good, better, best, premium. We strongly believe that we have the right portfolio and the best way for us to gain market share is to show the value of our offering and to drive material conversion in each of the segments that we play in and to either expand position or to continue to drive conversion. So that’s expanding position with contractors and dealers and retailers. And then continuing to drive conversion at both the contractor and the consumer level. In doing that you need the right products for the right segment and we don’t believe lowering price is a — is a good strategy nor that we would consider executing as we move forward. And I’ll let Peter take the front part of that.

Peter Clifford: Yeah, and just add on, I mean, I think what gives us confidence is we were planning on seeing more of the destock happening in the fourth quarter, which we did see happen. Two, as you know, we have about a one-month lag on sort of getting data from our channel partners to really dial in inventory. So we’ve been kind of staying close to that obviously each month and we see the data real time. And then lastly, I think prudently with our view of demand and unit volume being down 10%, which is 5% incrementally lower than what we were thinking or suggesting last time. One of the consequences of that is, it does drive us to take out more inventory to get to a lower level on both dollars and days and we think being conservative on inventory right now, reduces the risk for the full year.

Spencer Kaufman: Okay. I appreciate all the color there guys. As my follow-up question, just on the share repo you guys obviously repurchased some shares in the quarter, but I guess why not being more aggressive here, especially with kind of CapEx coming down and the stock under pressure?

Peter Clifford: Yeah, look, I think the thing that excites us about ’23 is look, one thing we know for certain is that our CapEx profile for ’23 is going to be meaningfully down. We think it’ll be down close to $100 million sequentially from ’22 to ’23 as we’ve talked about and some of the pain we experienced in 1Q and really part of 4Q of not building inventory. As we know, we have the opportunity to take some cash off the balance sheet with working capital. So our goal is to continue to support the share repurchase program and I think the strength of the free cash flow in 2023 allows us to do that, while maintaining a responsible net leverage ratio. That as we’ve said, you’re not going to see us go far outside of the bounds of the 2 times to 2.5 times leverage that we’ve talked about historically.

Spencer Kaufman: Okay. Thanks, Peter. Good luck, guys.

Operator: Your next question comes from the line of Ryan Merkel with William Blair. Your line is now open.

Ryan Merkel: Hey everyone, thanks for taking the question. I just wanted to start off with a clarification question. It sounds like you’re not really this quarter, but for planning purposes do you think by 2Q volumes to be down 10%, did I have that right?

Peter Clifford: Hey Ryan, could you repeat that because you broke up a little bit?

Ryan Merkel: Yeah, it sounds like you’re not seeing unit sell through really slow yet in 1Q, but for planning purposes you think by 2Q volumes are down 10%. Just wanted to make sure I had that right?

Peter Clifford: Yeah, I — we are — we are seeing consistent — consistent patterns right now that we’ve seen over the last few months, which is positive dollar sales and modestly negative unit volume. Now it varies by — it varies by kind of geography and channel and product, but in general that’s what we’re seeing. I think what were challenges from a planning assumption standpoint, given the market indicators that are out there, that people are chatting about, we think it’s fair to assume for the year, it would be down 10% on our core volume. So, how that flows through? Obviously, we just told you the inventory correction that were taken in Q1, if you just do the math is half — more than half of — of kind of that correction. And then — and then we see the benefit of that on our Q4. Exactly when it manifests and how it manifest. We’ll see, but we’re just telling you it’s a planning assumption.

Ryan Merkel: Yeah. Okay that makes sense. My follow-up, Jesse are you seeing any signs that wood conversion is slowing or is it steady as she goes?

Jesse Singh: Yeah, you know the wood conversion data can — can get noisy. What I would say is in the customer sets that we deal with, we continue to see a focus on more composites, not less, right. So we haven’t — which to us shows that that conversion continues to sustain and we see it in our mix. We see it in — like the pattern that we’ve seen continues. And once again, we talked about how that’s a long-term effect of people getting the right visuals, the network effect, all those other elements that layer in converting contractors, converting architects, all that right and we continue to see that flow.

Ryan Merkel: Perfect, thanks.

Jesse Singh: Thanks, Ryan.

Operator: Your next question comes from the line of Susan Maklari with Goldman Sachs. Your line is now open.

Peter Clifford: Su, we can’t hear you, if you’re on mute.

Susan Maklari: Sorry, can you hear me now?

Peter Clifford: We can.

Jesse Singh: We can.

Susan Maklari: Okay, sorry about that. The first question is just around the mix. As you talk to customers, are you hearing about any shift or any move down in products or is it more of just an overall delay as the market kind of recovers from the level of demand we saw in the last two years or so?

Jesse Singh: Yeah. So as you as you think about the market, it’s very similar to what we said on the last call, which is in effect our core contractors and the core participants in the market continue to operate for, right. They still have backlogs, they’re still busy. Their crews are still busy. All of that is there. I think some of what you’ve seen in fiscal 2022, as we’ve move through it, some of what you’ve seen as kind of a modest, if we talk about single digit kind of unit declines is more of the intermittent participants, people there may do bathrooms, they may do general projects, they come in and they do — they do a few decks and then they do whatever, right. Some of that has left the system, and — but in general, we continue to see with our core contractor base very much business as usual in general.

Yeah, look you can talk to someone and they may have had someone switch from the most premium line to one of our other markets. But in general, if you just look at the data and our conversations, it has very much been business as usual with our core contractor set.

Susan Maklari: Okay. And then following up, Pete, you talked a little bit about working capital and the ability to generate cash. As we think about the initiatives on inventories and some of the companies specifics on recycling in those types of things, any additional thoughts on how we should be thinking about the ability of the business to generate cash and how that could potentially compare to more recent history or even what you would think of as a more normalized level of generation?

Peter Clifford: Yeah, I mean I think again, we feel comfortable that we could support our repurchase program in a similar fashion. And that’s really going to come from the fact that we think we can generate our traditional cash from operations plus $100 million less of CapEx. And we haven’t really formalized the target externally for working capital, but we know that over the last year, year and a half, we probably put $40 million to $45 million inventory on the balance sheet that we’d like to eventually over the next four quarter or five quarters get off.

Susan Maklari: Okay. Thank you.

Operator: Your next question comes from the line of Ketan Mamtora with BMO. Your line is now open.

Ketan Mamtora: Good afternoon and thanks for taking my questions. I just wanted to come back to the 2023 EBITDA bridge. So if I add up all the big pieces, right, we’ve got $30 million of positive price, we’ve got $30 million of cost deflation, we had the benefit on the M&A side and the startup costs that will not occur again in 2023. And then we’ve got more recycled PVC and kind of more LDP, all these — if I just add up these pieces that gets us sort of positive call it trough numbers $80 million, $90 million and then we’ve got the offset on the volume side, and you talk about the detrimental margins. What is the other big piece that I’m missing, because that still does not get me sort of close to that $250 million, $265 million number that you’ve got out here? Just looking at sort of top high level numbers?

Peter Clifford: Yeah, high-level numbers. I mean obviously, you can do the math on the volume and the under-utilization. I think in that bucket for people and overhead inflation, look, you should think about $8 million of energy inflation and about $5 million of property insurance. And then on the all-other, you’re really dealing with the update and the change in process on inventory, coupled with the change in SG&A.

Jesse Singh: Yeah, I think Ketan — I think the other key component here, and it starts to get kind of — I think we’ll probably add a little bit where we started. You can start to see why we feel confident about our ability to manage as we move into the back half of the year. I — your comments related to some of the positives that we have are all there. I think the challenge we have with those positive, not challenge, there is a timing component, right. So if you think about the introduction of recycle and you think about the opportunity we have with meaningful a stabilization in our raw material pricing that we talked about, there’s a 4.5 month lag on those components, which is why we’re talking about sometime during Q2 as we move into Q3, you start to see the profile of the business to reflect some of these components that you’re talking about.

So the way — the component, I would add on top of that is, there’s a timing component where you’ve got some components that have a 4.5 month delay.

Ketan Mamtora: Got it. That’s helpful. And then can you talk a little bit about the trends that you’re seeing on the exteriors business?

Jesse Singh: Yeah, the exterior side of the business, it has been steady, consistent with what we’ve described, which is modestly negative unit volume and positive dollar, as we’ve gone through. We’ve continued to launch new products. We continue to drive penetration, which has hit of a buffer against modest changes in the market. I think on the exteriors business, when we talk about our exposure to new construction, the exteriors business has some exposure to new construction and so as we extrapolate out, once again we feel really good about our ability to continue to drive market penetration and wood conversion and new products between our Versatex and our AZEK business there. But as new housing starts start to slow down, a portion of that business will be impacted and so if there is a slowdown on exteriors, we would probably expect to see it sometime as we move through the second and third quarter.

Ketan Mamtora: Got it. That’s helpful. I’ll turn it over.

Operator: This concludes our Q&A session for today. I now would like to turn the call back to Jesse Singh.

Jesse Singh: Thank you all once again for taking the time this evening to have a dialog with us. We look forward to both the follow up questions and sessions and also to chatting with you again early next year. Thanks and have a great evening.

Operator: That concludes today’s conference call. Thank you for attending. You may now disconnect.