The AZEK Company Inc. (AZEK) on Q3 2022 Results - Earnings Call Transcript

Operator: Welcome to the AZEK Company's Third Quarter 2022 Earnings Call. Please be advised that today’s conference is being recorded. I’d now like to hand the conference over to Eric Robinson. Please go ahead, Eric. Eric Robinson: Thank you, and good morning, everyone. We issued our earnings press release and a supplemental earnings presentation this morning to the Investor Relations portion of our website at investors.azekco.com as well as via 8-K on the SEC’s website. I am 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 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 morning, and thank you for joining today’s call. The AZEK team delivered strong third quarter performance, highlighted by a 21% increase in net sales and a 19% increase in adjusted EBITDA over the comparable period last year. These results exceeded our guidance for the quarter and were driven by solid in-season demand and strong operational execution. We saw continued demand from consumers and contractors as our channel maintains an aggressive posture to ensure high in-season service levels. We executed on our price cost margin coverage initiatives earlier than expected in the quarter, and we saw raw materials begin to stabilize. Net sales in our Residential segment increased 18% year-over-year, driven by solid growth across our exteriors, deck, rail and accessories and structured businesses. We also saw strong growth in profitability in our Commercial segment with very strong sales and adjusted EBITDA growth. The team has done a great job of repositioning the business over the last 2 years and put themselves in a position to drive outstanding results. During the quarter, we also made meaningful progress against our goal of increasing our use of recycled materials. While we are very proud of the team’s ability to execute and deliver in a dynamic environment, we continue to be focused on execution and positioning ourselves for long-term growth and margin expansion. As we highlighted in detail at our recent Investor Day, we operate with a clear strategy to drive above-market growth through market conversion, material science, new product innovation, multichannel expansion, a best-in-class consumer 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. As part of our release today, we announced the acquisition of INTEX Millwork, a provider of high-quality railing, column wraps, pergolas and related millwork products, utilizing low maintenance, alternative materials like PVC boards and aluminum. INTEX is a strong player in our core railing and exteriors markets and strengthens our already strong presence in these categories, allowing us to offer a high-end polymer-based product to pair with our high-end decking and experienced products. Consistent with our other investments, the acquisition fits squarely within our M&A framework, provides an attractive financial return and supports material conversion. We plan to supplement INTEX exist strength in the Northeast and Mid-Atlantic by scaling product categories and expanding the company’s reach. We are really excited to work with the existing INTEX team in taking the business to the next level. StruXure, our recently acquired tech-enabled pergola business, continues to exceed expectations as the team is delivering on operational synergies. Homeowners are finding new creative ways to customize their outdoor living spaces with aluminum outdoor structures and the structure business delivered strong top line growth and sequential margin improvement. We are excited about the launch of the new cabanas product and introducing it to the AZEK customer network over the coming quarters. We have seen strong performance from our 2022 decking and railing portfolio of new launches, including Landmark decking and new color and prime plus decking and new rail products. The Landmark collection, like our other premium collections, uses our proprietary sustainable PVC technology to create the most natural and highest-performing products on the market. On the exterior side, our focus on underpenetrated markets and new product innovation have yielded great results, especially with our Paint Pro and Shingle products, which has nearly doubled year-to-date. These products were designed to utilize higher recycled content and were specifically developed to compete against non-PVC current materials including wood and other composites. Our team is actively working on new products across the portfolio to be launched next year and we look forward to sharing more information in the future. We continue to invest in our brand, consumer journey and downstream engagement. We recently launched our new TimberTech, everything wood should be campaign, highlighting real professional and homeowner customer testimonials. These are designed to inspire consumers and their outdoor living designs. In the latest Zonda 2022 Builder Magazine brand-new study, our TimberTech brand saw the largest year-over-year improvement in the brand familiarity and brands most use categories for the composite PVC decking portfolio versus peers. This highlights the power and effectiveness of our branding and awareness investments. We also recently issued our second annual full circle ESG report. This details how ESG is at the core of our business strategy, the products and innovations we bring to market, the people we choose to hire and our unique position at both a recycler and a consumer of hundreds of millions of pounds of otherwise landfilled on waste and scrap each year. This report includes the achievement of a 23% reduction in our carbon intensity since 2019, driven by our expanded use of recycled materials which has the added benefit of reducing our costs. We are committed to pushing ourselves and the industry towards a more sustainable future, and we believe that companies like AZEK have a great responsibility to make the world a better place. Returning to results. Our third quarter saw positive sell-through growth on top of very strong growth in the same prior year period. Our channels indicated they had a strong June. And through the quarter, we secured incremental contractor and channel conversions. While demand continues to be healthy at a contractor and retail level, we have seen some signs of demand moderation versus last year. Actual end demand is tracking to be positive on a dollar basis and modestly negative on a unit basis as we last some incredible growth quarters and gather more data on the season. Our contractor surveys point to above-average market conditions and solid backlog this season, which remain elevated and consistent with the prior year. Over the last few quarters, we have seen contractors shift from supply chain inflation being a concern to a greater concern on labor and most recently, economic uncertainty. Discussions with our dealers track similarly with current demand being solid, but a more cautious view of the future. From an internal demand signal perspective, digital leads and sample order activity was quite strong in 3Q as both grew strong double digits year-over-year versus the same period in 2021 and accelerated versus the prior quarter. We believe this reinforces TimberTech’s strong consumer engagement that favorable long-term thematic trends in outdoor living and the large material conversion opportunity that make our business model so attractive. At our Investor Day in June, we highlighted the strength of our business model, and we are confident in our ability to drive above-market performance in any environment. We also highlighted that we expected our channels to begin the process of destocking as we move through the season, impacting our expected 2022 results. In recent weeks, our channel began to recalibrate their inventory needs and we are working with them to draw down their inventory. AZEK’s improved service and lower lead times allow our customers to more effectively manage their inventory and working capital to operate more efficiently. We believe that it is prudent to work with our channel to bring down inventory levels during the higher demand months within the season, and we believe that it positions us well to continue to drive ongoing penetration of the overall market. As Pete will detail later, this channel inventory recalibration is the primary driver of our reduction in our fiscal 2022 guidance. The combination of this inventory adjustment and the lapping of our prior year inventory restocking is expected to impact our next 2 quarters. In 3Q and 4Q, we have taken proactive cost reduction actions and have aligned our factories to manage for lower production while using downtime for preventive maintenance, recycle expansion and other key projects. Our modular manufacturing allows us to manage through these volume changes while still investing in future cost savings and innovation projects. We are also appropriately staging our growth capital and thoughtfully considering the time line of commissioning additional new capacity in our Wilmington and Boise facilities. And as a result, we expect to lower our CapEx needs in fiscal 2023. With respect to margin, we expect to see the benefits of our actions flowing through in 4Q and into 2023. Importantly, our pricing and productivity actions offset commodity inflationary pressures for the first time in the third quarter and combined with our recycled programs will provide margin benefits in Q4. We have seen raw materials moderate in the last couple of months. And between our pricing actions and our increasing use of recycle, we are on track with our margin initiatives. We have been able to use our slack capacity to continue to drive a greater focus on recycle and cost initiatives and expect to achieve the targets we highlighted at our Investor Day. We are confident and excited about the long-term opportunity and our business model. We play in attractive markets with a compelling opportunity, and we are well positioned to outperform and strengthen our position over the short and long term and to achieve the broad ambitions we shared in June. With that context, I’d like to pass the call over to Pete to discuss our third quarter results and the rest of the year outlook in further detail. Peter Clifford: Thanks, Jesse, and good morning, everyone. Before we get into the third quarter results, I wanted to provide some color on the operating environment during the quarter. As Jesse mentioned upfront, the majority of our underlying demand indicators remain positive with leads, samples and contractor backlogs, all pointing to strong interest in our category and products. Underlying sell-through growth trends were positive in 3Q, driven by price and end market demand. Our channels behavior began to shift in the last 4 to 6 weeks and we are working with them to lower channel inventory. We believe the inventory reduction will last approximately 2 quarters. But we are working together with our channel partners to maintain high service levels to the end markets that we serve over the period. In addition to this channel recalibration, I want to remind everyone of the prior year inventory build that we are lapping in 3Q ‘22 of approximately $30 million-plus. From an operating perspective, supply chains are stabilizing, commodities are starting to moderate, and our teams continue to execute well at the plant level. During the third quarter, commodity prices started to show signs of moderating, while material availability remained healthy. As a reminder, we priced at the spring highs of commodity inflation back in March. As we previously communicated, our balance sheet lag is about 4 months for materials and about 2 months for labor and overhead. We will talk more about these dynamics and the actions that we have taken in response to this changing environment in our outlook section later on. For the third quarter of 2022, we delivered net sales growth of 21% year-over-year to $395 million, with solid and broad-based growth across our Residential and Commercial segments. 3Q ‘22 gross profit increased by $19.6 million or approximately 18% to $126.4 million. 3Q ‘22 gross profit margins decreased to 32% versus the prior year of 32.6%. 3Q ‘22 adjusted gross profit increased by $23.4 million or approximately 19% to $147.6 million. 3Q ‘22 adjusted gross profit margins declined 50 basis points to 37.4%, driven by approximately 120 basis points of near-term dilution from the StruXure acquisition and our start-up costs for the Boise facility. Our core performance was positive year-over-year, driven by favorable net price commodity and recycling initiatives. Importantly, 3Q was the first time we covered both the inflation dollars as well as the rate with our price realization benefiting our margin. Selling and general and administrative expenses increased by $8 million to $78.7 million or 19.9% of sales. Adjusted EBITDA for the third quarter increased by $13.8 million or up 19% to $86.5 million. Adjusted EBITDA margins for the quarter declined 30 basis points to 21.9% compared to 22.2% in the prior year, including approximately 100 basis points of near-term dilution from the StruXure acquisition and Boise facility startup costs. Note 3Q dilution impact from acquisitions was 40 basis points and start-up costs were another 60 basis points. Net income increased by $5.7 million to $27.5 million for the quarter compared to $21.8 million in the prior year, driven by higher sales and partially offset by higher year-over-year depreciation expense related to our capacity expansion program and higher interest expense. Earnings per share increased by $0.04 per share to $0.18 for the quarter compared to $0.14 per share in the prior year. Adjusted net income increased by $4.6 million to $45.2 million or $0.29 per share for the third quarter compared to adjusted net income of $40.6 million or $0.26 per share a year ago. Now turning to our segment results. Residential segment net sales for the quarter increased by $51.9 million or approximately 18% to $343.1 million. This increase was driven by double-digit growth in both our exteriors and decking categories, along with approximately $24 million and structure-related sales. Residential segment adjusted EBITDA for the quarter increased by $8.6 million or approximately 10% to $91.1 million. Note that dilutive impact of the StruXure acquisition and start-up costs on the Residential segment adjusted EBITDA margins was 150 basis points of dilution in the quarter. Commercial segment net sales for the quarter increased by $15.7 million or approximately 43% to $51.9 million. We saw both Commercial businesses growth above the company average with exceptionally strong growth in Vycom. Vycom continues to see strength in Outdore Living, Marine, Semiconductor and Industrial end markets. The Commercial segment adjusted EBITDA for the quarter increased by $6 million or approximately 96% to $12.3 million. Margin expansion was driven by favorable net price commodity and productivity. Commercial business has put in a lot of effort over the last 18 months to improve the business, and we are seeing the results of that effort. From a balance sheet and cash flow perspective, we ended the quarter with cash and cash equivalents of $159.6 million and approximately $147.2 million available for future borrowings under our revolving credit facility. Working capital was $401.4 million. We ended the quarter with gross debt of $664.3 million, which include approximately $64.3 million of finance leases. Our credit facility is undrawn. Net debt was $504.7 million and our net leverage ratio stood at 1.6 at the end of the third quarter. During the quarter, we executed a $50 million accelerated share repurchase program, purchasing approximately 2.5 million shares with a volume-weighted average price of $19.93. In addition, we also repurchased approximately $8 million or 500,000 shares with a volume-weighted average price of $15.76 via open market purchases during 3Q. The remaining authorization under our share repurchase program is approximately $342 million and we will continue to look back opportunistically to make repurchases. Our capital allocation priorities remain the same as we previously communicated. Capital expenditures for the quarter were approximately $25.5 million, largely driven by timing of cash outflows related to our capacity expansion programs. Net cash provided in operating activities was $133.2 million during the quarter versus net cash provided in operating activities of $112 million during the prior year period. 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. First, some comments on the top line. As Jesse described, we are working with our channel partners to focus on recalibrating their inventory positions. We are estimating a $90 million-plus inventory recalibration headwind in 4Q, plus the previously mentioned prior year of approximately $30 million plus inventory replenishment that we are lapping from the fourth quarter of 2021. We are working with our dealer and distributor partners to reduce their inventories in fiscal 4Q ‘22 and into fiscal 1Q ‘23. Price continues to be positive, but we see modestly negative unit volume in the second half of the year. As we highlighted during our Investor Day presentation, we have a resilient business model. As we look forward, we continue to make progress on our recycling and aims continuous inherent initiatives and experienced strong price realization. We expect these initiatives, plus other cost actions, to contribute to our fourth quarter results. Our management team is confident in our ability to master any market condition. From the new capacity and CapEx perspective, we are thoughtfully considering the time line of commissioning of the remaining new capacity in Boise and Wilmington. Our capacity enables us to be nimble and flexible should new growth opportunities present themselves. We expect fiscal 2023 CapEx to be more in line with our long-term guidance. I also thought I will share a few considerations on fiscal 2023 based upon what we can see today. There is a slide on Page 12 of our posted 3Q earnings presentation that highlights some of the elements that we see and the broad timing of their impact. We have a number of initiatives that we are continuing to drive above-market growth. These include the large material conversion opportunity from one and other products, new products and channel expansion. Regardless of the conditions, the majority of our market is still good and we have an opportunity to add growth through conversion. We have carryover from pricing, which we highlighted on the last call, as a carryover benefit of approximately $30 million. We will have a full quarter of our structure acquisition plus nearly a full year contribution from the INTEX acquisition. We see signs of commodity inflation moderating, and we have a clear path on the recycling opportunities, which we highlighted at our Investor Day and are independent of volume. Now turning to our guidance. Our updated outlook for the remainder of the fiscal ‘22 reflects the demand trends and indicators we monitor combined with the expected channel inventory dynamics. The partial quarter contribution from the INTEX Millwork acquisition is expected to be immaterial during the quarter. For the full fiscal year 2022, we now expect consolidated net sales between $1.327 billion to $1.353 billion, reflecting a year-over-year increase of approximately 13% to 15%. Turning to our adjusted EBITDA guidance. We now expect adjusted EBITDA between $295 million to $307 million, reflecting a year-over-year increase of approximately 8% to 12%. We expect full year adjusted EBITDA margin dilution impact from the StruXure acquisition of approximately 50 basis points to 60 basis points and approximately 60 to 70 basis points from the capacity start-up costs at our Boise facility. We expect full year adjusted diluted EPS to be between $0.95 and $1.01 per share. For 4Q ‘22, we expect consolidated net sales between $276 million to $302 million. We expect adjusted EBITDA between $59 million to $71 million. We expect 4Q adjusted EBITDA margin dilution impact from the StruXure acquisition of 60 to 70 basis points and approximately 60 basis points from the Boise capacity start-up costs. We expect 4Q adjusted diluted EPS to be between $0.15 to $0.19 per share. To assist in modelling, we now expect capital expenditures to come in towards the lower end of the $180 million to $200 million range for full year ‘22. We expect 4Q ‘22 interest expense to be approximately $6 million to $8 million and depreciation expense to be approximately $18 million to $21 million. Our tax rate for the full year ‘22 is estimated to be approximately 25%. Our full year weighted average diluted share count is now expected to be approximately 154 million to 155 million shares. I’ll now turn it back to Jesse for 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 third quarter. We have a couple of quarters to work through an adjustment in inventory, but the fundamentals of our business are strong as is our confidence in the future. We are excited about our company and the long-term opportunities that we have in front of us to convert the outdoor living industry into a more sustainable future. AZEK is benefiting from attractive thematic tailwinds such as repair and remodel, material conversion and outdoor living that we believe are in the early innings of a long-term growth and value-creation opportunities. We have a clear strategy and AZEK-specific initiatives to drive above-market growth, and we believe that we are well positioned to win and deliver on our stated 5-year targets of double-digit growth in our Residential business and 500 basis points of adjusted EBITDA margin expansion. We remain confident and focused. With that, operator, please open the line for questions. Operator: And our first question comes from Keith Hughes. Keith Hughes: A couple of questions. First, you had referred to a $90 million recalibration. Does that $90 million include the $30 million inventory build in the prior year leasing the batteries on top of that? Peter Clifford: It’s on top of that, Keith. This is Peter. We did build $30 million in the fourth quarter of last year and we intend to take $90 million on it this year. Keith Hughes: Okay. So it’s $120 million net over the 4 – the 2, 4 quarters? Is that my understanding correct? Peter Clifford: Correct. Correct. Keith Hughes: Okay. And I guess a question on the inventory situation. At this point, do you believe it’s going to impact your December quarter as much as September quarter? Or will there be some lessening into the new fiscal year? Peter Clifford: Yes. Here’s what I would say, Keith, is obviously, it’s difficult to size the 1Q ‘23 impact right now without having the 4Q sell-through profile. But based upon what we can see today, I would kind of call the range between sort of $0 million and $35 million as kind of a likely goalpost from an inventory reduction perspective in 1Q. Keith Hughes: Okay. And then final question on production levels. Can you give us any idea of what’s your production levels are going to look like over the next 6 months to address those? Peter Clifford: Yes. I would say, Keith, it probably extends out even 9 months. We are sizing our workforce and our facilities to not only help our channel partners reduce inventory, but obviously take inventory off of our balance sheet and generate cash. So we are – we’ve aligned our operations for a little bit different perspective looking forward. Jesse Singh: Yes, Keith and If I could – yes, Keith, if I could just add one quick comment on that. I think as you look at Q1, implied in how we’re looking at it, is we would assume a days on hand as we’re looking at this to start to trend to the low side or a below normal days on hand. And so that’s part of what we’re considering is as we talk about where we might end up over the next 2 quarters. Operator: Our next question comes from Tim Wojs. Timothy Wojs: Thanks for all the details on the next few quarters. Maybe just thinking about kind of the puts and takes on margin tips. Maybe just kind of walk through how we should think about kind of the volume-related decrementals and what the impact of that is? And then just how we should think of the other kind of cost offsets and maybe what price cost looks like over the next couple of quarters? Peter Clifford: Yes, Tim, this is Peter. Look, as we communicated at our Investor Day, and we've supplied a chart here in the deck, I think it's Chart 12 that gives you some of the perspective on sort of what are some of the known considerations for 2023. Again, and similar to the Investor Day, I think what we've said, and we would reaffirm is that we're not trying to predict the macro. But if you wanted some understanding the decrementals, if volume were down 5% in our core based upon what we know that we carry over, we feel like even with volume down 5% in the core, we could probably hold revenue and EBITDA dollars flat year-over-year. Timothy Wojs: Okay. Okay. That's helpful. Jesse Singh: And if I could just add, I think as you take a look at what we're guiding to in Q4, you can clearly see as you start to do the math, the benefit of some of the actions we've talked about, whether that be price raw or the benefit of recycle, you can start to see that flowing through into the P&L. And as we talked about, those are terrific tailwinds as we look not only at the next couple of quarters, but as we look out into '23. Timothy Wojs: Okay. Okay. That's helpful. And then as you're kind of going through this destocking process, I mean, has there been any sort of kind of pressure on unit and pricing at all? Jesse Singh: No. I think the right way to think of it, if you just step back, right, as we work with our channels, they have more inventory than they want to have as we looked to end the quarter and we're making certain assumptions about Q1. The great thing about being proactive and taking actions now is that we're in the middle of the season. We're seeing really good demand products coming off the shelf, and we're in a really good position to draw down that inventory through demand and we think that sets us up well into '23. Operator: Our next question comes from Matthew Bouley. Matthew Bouley : To the extent you're speaking to production coming down, if I'm thinking about kind of the last year, do we have a situation kind of the opposite of the difficulty you had in the past year, increasing your mix of recycled materials when demand and production was so high. As we look out in this scenario, is this a case where you can perhaps more meaningfully increase the mix of recycled materials? Jesse Singh: Yes. Thanks for the question. And I'll take it at a high level. I think you're looking at it absolutely the right way. The challenge we've had over the last year and really the last 18 months is we've had to use all of our capacity to meet demand. And as we now have slack capacity, it's giving us an opportunity to more aggressively drive conversion. And PVC, in particular, we now have supply. We've got the capability and machine time to be able to do the work necessary to increase recycle. And so it puts us in a really good position to meet -- at least meet the goals that we talked about and get creative on ways we can continue to increase the recycle. Matthew Bouley : Got it. That's helpful. And then just second one back to the channel inventories. I think I heard you say, Pete, in the December quarter, a potential reduction of between $0 million and $35 million, if I heard that correctly. In your view, is that kind of the last of it? Or do these channel reductions perhaps continue into the March quarter? And maybe you could kind of layer on your views of a little crystal ball, but to the extent your views on sell-through kind of how that's going to play out through the couple of quarters here? Jesse Singh: Yes. I'll take it at a high level and Pete can to dive into a bit of detail. I think as we look at it, we think it's prudent to be proactive and have a conservative view on where channel inventories should be. And as such, we would hope that the bulk of any resizing of inventory in the channel would be complete by the end of our first quarter. And by the way, we're talking about channels, it's not just our distribution channel. It's making sure that our dealers are in a good spot as they continue to look to manage their own cash. So our intent and our hope would be we'd be through the vast majority of it through the first quarter of this year -- next year, I'm sorry. Operator: And our next question comes from Phil Ng. Philip Ng : Jesse, you would be helpful to kind of remind us, I guess, the initial plan in terms of the last few years and times the capacity you're targeting at. I forget if it was like a 70% or 80% increase from a few years back, but now that growth is moderating a little bit, I think, in your prepared remarks. You kind of alluded to maybe not ramping Boise as much as quickly or the magnitude. So can you kind of help quantify what you were targeting before and how you're thinking about now? Jesse Singh: Yes. Yes. Just at a very high level, we had talked about completing 50% already in earlier quarters and that we were targeting a 100% increase, a little over 100% increase from a 2019 baseline. We're roughly in that 80% level right now. And the remaining capacity, both in Boise that we need to add, but also in Wilmington, we'll have an ability to stage that remaining 20% appropriately. And -- so at a macro level, the way you should think of it as 80%, give or take, is deployed, and we've got another 20% to 25% that we can stage and bring online as needed either at the end of this year or earlier if we needed or later if we needed -- I'm sorry '23. Philip Ng : Got it. Any feel for how much of that 80% is consumed at this point? I mean you've obviously seen quite strong growth in the last few years. Jesse Singh: Yes. We don't guide there. We're really happy with the 80% that we have. I mean certainly, you should consider that. Right now, from a volume perspective, if you look at it from 2019 where we didn't have enough capacity to where we sit now, even with the adjusted guide down, we're more than 30% above where we were. And clearly, we have ambitions to continue to grow off that base. And so if you just do the math, we needed flat capacity. We're bigger than we were. And so we feel really good about the capacity we have online. And just as a reminder, we've said this multiple times. Our manufacturing is modular. And we have an ability to manage what lines we run and how we run it. And we're really starting to see the benefit of that as we look out over the next couple of quarters where we can bring a few lines down, do the work to continue to expand, recycle and then bring them up in relatively short order as we needed. And once again, as we look at Boise and our additional capacity, that capacity is really critical as we look to continue to drive conversion in the market and future growth opportunities. And as I mentioned, we've got a couple of quarters where we're going to have lower volumes as we realign channel inventories. But we're going to start needing that capacity again as we move through the season next year. Philip Ng : Got you. And just one really quick one for Pete. If I heard you correctly, you plan to manage your production for cash and bring your inventory down for the next 9 months or so. So could that headwind from a -- on your production kind of still over into call it 2Q where your decrementals might be a little more elevated? I know it's going to take 2 quarters flush out on the inventory at the channel side, but just kind of commingle all this for us as it relates to your inventory as well as is there going to be like a 2Q hangover effect? Peter Clifford: Yes. Jesse Singh: Let me make one quick comment before -- and I'll let Pete answer it. Remember, we're laying out some of the tailwinds that we've seen just based between recycle price laws, et cetera. And those will benefit us as we look moving forward. So I'm sorry, Pete, go ahead. Peter Clifford: Yes, yes. No, I was going to say, again, we're not here to give '23 guidance, but at Jesse's point, look, we feel pretty comfortable as we articulated in the Investor Day, the kind of known carryovers really will help us buffer some of that loss leverage, if you want to call it that during the first half of the year. Operator: And our next question comes from Susan Maklari. Susan Maklari : My next question is around the pricing. Obviously, you've seen considerable increases over the last 2 years or so. As you think about the cost of lumber coming down and moving closer to a normalized level, how are you thinking about the sustainability of the pricing that you have put through? And is there any potential bleed that could happen, especially as deflation starts to come in on the cost side? Jesse Singh: Yes. As we've talked about in the past, deflation in wood, in general, increases the affordability of our kinds of repair and remodel jobs. And if you think about decking, right, decking and rail and accessories and pergolas, they sit on top of some kind of a structure. And in general, that structure is made of wood. And decking specifically is, call it, 20% to 25% depending on the product, made a little higher of the cost of the overall project. And so as wood comes back in, it is helpful in that it increases the affordability of the kinds of construction jobs that we're a part of. And just relative to price, as we said in the past, we feel really good about our value proposition. If you look back historically, we have been in a business that has increased price and incrementally never given back price. And so that's what the historical pattern would say. But we feel good about our value proposition, and we feel good about the opportunity. And then relative to wood, I think where you would maybe see that is more in the opening price point products and some of the transactional business that may have occurred and a lot of that's DIY. And as we've mentioned, we skew across a broad category including more premium areas. And in general, we feel good about our position. Susan Maklari : Okay. That's helpful color. My follow-up is, obviously, with the macro backdrop shifting over the last quarter or so. Can you just talk about how you're thinking of the cost structure of the business? Any changes that you're perhaps walking for in the macro environment that could cause you to make further adjustments to the cost structure? Jesse Singh: Yes. Just a couple of comments. I think on the call or on the prepared remarks, we talked about moderating demand. And I think it's important to understand that when we're talking about moderating demand, we have had very, very high growth rates and unit growth rates near double digits. Moderation means we're still growing on a dollar basis in terms of actual end demand and the unit volumes are moderating off a really, really high 3-year stack. Relative to -- so as we look at that, it's important to understand the dynamics that we're seeing in the market. Relative to our cost structure, we've been prudent. As Pete mentioned, we've taken appropriate cost actions and we've grown a lot. We've grown our SG&A a lot over the last 3 years. And there's opportunities that you get after when you're seeing moderation. And we have appropriately sized the business at this point with the actions that we've taken. And we think we've appropriately sized it to what we can see in '23. If there was a different dynamic than what we see right now, we'd certainly take additional steps. But we are in a growth business. We want to make sure we continue to invest in sales and marketing. We want to make sure that we continue to invest in new products. And even with some of the changes we made recently, we're in a really good position to do that. Operator: And we have a question from Ketan Mamtora. Ketan Mamtora: One question on recycling. You talked about that's going to see a pretty nice step-up next year. Is there a way to think about the margin benefit in FY '23 from increased recycling? Peter Clifford: Yes. I mean, here's what I would say is, look, on the PVC side, as we talked at our Investor Day, we feel good about exiting this year at or close to the 60% kind of recycle introduction rates. For us, as we've said on the path on the PVC side, it's less about innovation, and it's a lot more about continuous improvement in trial and error. So we would expect consistently strong impacts from PVC recycling next year, just like we've seen in the last 2 years. And as it relates to the LD opportunity on the cap composite products, we fully expect to be cutting over on some extrusion lines in the back half of '23 to recognize the benefits on the low-density polyethylene. Jesse Singh: And if you're looking for specific numbers, Ketan, I think we did a pretty good job of laying out some of the staging and the opportunity in our Analyst Meeting -- our Investor Meeting in June. Given the opportunity we have with some additional slack capacity, we're certainly going to be at or potentially above some of those opportunities on a sequential basis that we talked about. Operator: Our next question comes from John Lovallo. John Lovallo: The first one, Jesse, you gave some color on historical pricing in response to Sue's question. I'm wondering though, specifically in periods of excess channel inventory, what are the industry's response in terms of pricing? Jesse Singh: Once again, we're not a -- we're not a transactional buy, right? And it's really important. People choose our products because they're the right product for the job and people choose it based on that. Now what you might see in general, maybe at a dealer level or a retailer level, is you might see some incremental promotional activity. And in general, your -- you rarely see a structural shift down in price, but you might see some promotional activity where X, Y, Z company that sells to contractors might run a 2- or 3-week long promotion or do a decking month or a decking week or something like that, just to stimulate probably less demand, but to get people excited. And that typically occurs during the season. And that occurs in general because there's always -- look, inventory in general is always out of balance. And along the way, people are trying to make sure that it flows. I would say that structurally, we haven't seen anything systemic nor would we expect to -- because demand is demand, you just want to get your fair share of it. John Lovallo: Got you. That's helpful. And then the second question is understanding that M&A is a part of the growth story here, is there a risk that you guys are shifting too much focus away from the core decking business? In other words, I mean, should we be concerned that composite deck and conversion could slow and acquisition growth is becoming more important? Jesse Singh: Yes, you should -- I think of all aspects, you should not be concerned that this management team is not focused on the core. I think fundamentally, we've on all been at companies where, at times, they have lost a focus on what really drives the business. As you point out, decking obviously drives the business. But if you think about outdoor living and decking itself, there are components that layer on top of decking and then similarly, exteriors, right? So StruXure was a natural additive component INTEX is sold in general with our products right now, right? It is -- when you look at the website, when you see the products in displays in the Northeast, and the areas that they are strong in, they are layered right on top of our products, right? And it is part of the solution that a contractor sells to a consumer. And so we think the acquisitions that we're doing are all part of our core thesis and strengthens the opportunity we have in decking. Operator: We have a question from Michael Rehaut. Michael Rehaut : Yes. Just going back to some of the comments around adjusting for inventory replenishment and inventory -- the inventory channel reduction this quarter. If you take out the $30 million from last year in the -- in your fiscal second quarter, you're getting to a residential growth of around 33%. Also, if you take out the $30 million -- for this current quarter, you take out the $30 million from a year ago and then add back $90 million this year, you're actually getting the growth of low 30s to low 40s, which would suggest the end market remaining fairly strong and effectively not falling off to any degree. Just wanted to make sure this is the right way to think about it and if there are other considerations here. Because obviously, across broader building products, some are moderating in the end market, some aren't. But I just want to make sure if that's the right way to think about that. And also you talked earlier about end markets being up on dollars, but down on volume and that math maybe would seem to be a little bit in contrast to that statement. Peter Clifford: Yes, Mike, this is Peter. I mean I'm going to give you a little bit of a framework for the full year '22 kind of sales elements. If you're dissecting the growth percent, M&A is approximately 5% for the year. Price given off of what we've kind of said publicly is kind of more like high teens. And this inventory calibration is about a 10% headwind, right? The $120 million net is about 10%, which means volume is about flat to up 2 points is kind of how we see the full year. Michael Rehaut : Okay. That's helpful. I guess Secondly, I'd love to delve in a little bit to the INTEX acquisition. I found it interesting. It seems like it's a relatively small acquisition from a dollar standpoint or revenue standpoint, but also on the surface, it seems like in the areas of trim and even pergolas, on a basic level, it seems like these are all product categories that you have larger businesses and kind of you're already in that space. So I was just curious about the thoughts around acquiring impacts versus just growing organically and trying to take share with your own business. And if INTEX has maybe a specific higher-end product, you might have alluded to that fills in a portfolio. But just kind of walk us through why to buy this as opposed to if you're already in a lot of these product categories just to take market share? Jesse Singh: Yes, I think you highlighted it a bit in your question. I think fundamentally, the INTEX business is a great niche business that has developed a great product. That, yes, in theory, we could develop. But they've done a really good job of building out a part of the portfolio that we do not yet play in. And add to that, it's a nice brand name that's established a really good position, and it's a terrific team, right? And they have great capabilities. So if you step back and you look at an acquisition, at some level, you're always doing a make versus buy on everything. Same with recycle, same with the other components we have acquired. But we're really excited about the team. We're excited about their aggressive stance in growing the market. We're excited about the capability. We're excited about the brand. We're excited about really what they bring it to the portfolio. And those elements really set us up to aggressively drive our portfolio and our solutions in the market. And what we bring to it, obviously, is broader geographic scale. We bring capital, we bring certain know-how. And it really gives us -- we bring capability to them to help them accelerate their business. And so it's a really nice synergy. And it really fits into how we look at the world in terms of strengthening the core or moving into modest adjacencies. This does a really good job of supporting that. Michael Rehaut : And just maybe a follow-up on that. Does the post synergies, is this acquisition margin neutral or accretive? And also actually going back to the StruXure, when would that be expected to be margin neutral or accretive? Peter Clifford: Yes. Jesse Singh: Yes. I think that -- go ahead, Pete, sorry. Peter Clifford: Yes. So let's take the StruXure question first here. So look, we literally expanded margins on the bottom line, about 1,000 basis points sequentially from 2Q to 3Q, which was in line or actually a little bit ahead of our own internal expectations. We would expect that business to be at or very close to the AZEK profile, I would say, in the first and second quarter of '23, which again is probably a little bit ahead of schedule. I would describe INTEX as kind of a similar profile, right? It's a high-growth business, sort of mid-teens kind of EBITDA-ish. And we feel like with our channel and with more obvious synergies on the cost side, that we can get that business fairly quickly to AZEK levels within a pretty short period of time. Jesse Singh: Yes. And INTEX uses -- their base material is in many of their products as PVC. And clearly, we are a meaningful PVC player with capability to do recycle in a unique way compared to anybody else. And so obviously, those are benefits that fit very nicely with INTEX. Operator: We have a question from Ryan Merkel. Ryan Merkel : Just back to the destock, if I could. It sounds like $150 million net destock over the next 2 quarters. Why is that the right number? What was the framework that you used? Peter Clifford: Yes. Jesse Singh: Let me -- Pete, I'll start at a high level just as a reminder. On a monthly basis, we see our distributors' inventory, and we see their days on hand, and we see the change in their days on hand and we're able to run that against various scenarios and calculations. And Pete in a moment, is going to kind of get into what the right number is on the $150 million Pete, I'll kind of correct that or give you that. But just at a high level, understand that we get the data and then we work with our channel on evaluating what they have in stock, what they would like to have in stock, what days on hand they would like. And what we're effectively saying is as we look out over the next couple of quarters, we would assume that they're going to be at the lower end of or below historical days on hand, and we can see the inventory that they have in stock, and we draw some assumptions relative to how it sells through. So it's really that calculation in working with our channel. And then we draw -- that's for our distributors. And at the dealer level, we work directly with our dealers. And that particular drawdown, I think, is going to be much, much more pronounced this quarter as they bought product for the season, they have product. And we're going to work with them on drawing that down as they look to turn that product into cash. And so the methodology is a dialogue, historical data that tend to be delayed by 30 to 45 days and then working on that process with our channel partners. And then Pete, you can kind of get to the $150 million number that Ryan just mentioned. Peter Clifford: Yes. So the way to think about it, Ryan, is look, we built inventory in 3Q '21 of about $30 million and we built inventory again in fourth quarter '21 of about $30 million. That's the $60 million we talked about on our last call that we would be lapping. We built an additional $30 million in 1Q '22. And then we are drawing down inventory within the fourth quarter of $90 million. So on a full year basis, it's actually $120 million of inventory impact. Ryan Merkel : Got it. Plus the $30 million that you're expecting in 1Q '23? Peter Clifford: Yes. Correct. Ryan Merkel : Okay. Yes, Jesse, you sort of answered the question there. The final one would be is the inventory that's coming out, is it safety stock that because lead times have normalized? Or is it more that you're making adjustment based on lower demand that you expect over the next 2 to 3 quarters to be conservative? Jesse Singh: No, I would say it's very much the former. They just -- they've got product and they can run at lower days on hand. And we have moved from allocation to extended lead times to now we sit -- where we sit today, we're a very normalized lead times, right? So think about going from effectively a 12-week lead time to less than 4 weeks. And so the channel rightfully so can carry a little less inventory and still have an opportunity to more than meet demand. Operator: And we have reached the time allotted for our question-and-answer session. I'll now turn the call back over to our hosts. Jesse Singh : Yes. Thanks again for joining us this morning. We really appreciate your engagement, and we look forward to a continued focus on the terrific opportunity in front of us. We're as excited as ever about the ability to continue to drive conversion and growth in the marketplace. And we look forward to following up as needed on more specific phone calls. So thanks again, and we'll chat with you next quarter. Operator: That concludes today's conference. Thank you for attending, and have a pleasant day.
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The AZEK Company Shares Up 2% on Q4 Results

The AZEK Company Inc. (NYSE:AZEK) share rose more than 2% today after the company reported its Q4 results, with revenue of $304.6 million coming in better than the Street estimate of $288.91 million. EPS was $0.16, worse than the Street estimate of $0.18.

The company expects Q1/23 revenue in the range of $200-215 million, compared to the Street estimate of $238.3 million.

Following the results, analysts at RBC Capital lowered their price target to $20 from $22, reducing their 2023 adjusted EBITDA estimate to $250 million from $297 million, at the low end of the $250-$265 million guide, with the move driven primarily by sharper expected Q1 destocking headwinds, incremental sell-out pressures, and continued cost inflation.