The AZEK Company Inc. (AZEK) Earnings Call Transcript & Summary

Great. Well, why don't -- why don't we get started? Good afternoon, everybody. I'm Tim Wojs from Baird, and welcome to our Global Industrial Conference. I cover residential and commercial building products here at Baird. And we're very excited to have AZEK join us again at the conference. And for those of you who don't know, AZEK is a relatively new public company, they IPO-ed last June, but really a leading provider of composite building products, particularly in the decking and trim markets and really a secular conversion story in a company that's in the early innings of pursuing internal recycling initiatives, which should be a nice long-term margin driver. So -- joining us from the company are Jesse Singh, President and CEO; Pete Clifford, who's SVP and CFO; Amanda Cimaglia, who is VP of ESG; and then Eric Robinson; and Chris Russell, who help with IR and corporate development. So in terms of format, I'll kick it over to Jesse just to give a few prepared remarks, and then we'll hop into Q&A. So Jesse, the floor is yours.

Sure. Thanks, Tim. Great to be here today. Just a couple of background comments. For those of you that don't know us, we're a leading player in really 2 main categories that fit within residential Deck, Rail & Accessories. And within that category, we've got a significant position in the premium segment. And then our Exteriors business, which specifically is a product line that includes trim and other types of accessories. And in that particular business, we are also a leader with the #1 and #2 brands. As you consider the business overall, we really operate with a couple of elements that would define the business. We play in growing markets that benefit from material conversion. Our core markets are about $10 billion, and we've got adjacent markets that we play in. The growth is really driven by a combination of a few different variables. One of those variables is the strength of the R&R market where we see continued strength. Another key growth driver for us is within that market, we play in outdoor living on the exterior of the house. And a third component is really the combination of new products and material conversion opportunity, where our products are -- really have an opportunity to convert wood, which is the majority of the categories that we play. We're the innovation leader in the categories that we play, we have more breadth than our competitors, and that allows us to really provide a more comprehensive portfolio. The other key aspect of us is we view growth from a portfolio standpoint, and we grow -- we view margin expansion from a portfolio standpoint. So that growth really comes from not only the market growth, but we're really focused on new products and downstream initiatives both in our core and adjacency. And then as we look at margin expansion, we see an opportunity of margin expansion, and we've got a stated goal of 500 basis points really coming through a mix of different variables. One is our continued expanded use of an in-housing of recycle. Another is continuous improvement. And then down the road, getting leverage on our SG&A. And then the last comment I'll just make on who we are is, sustainability in ESG is really core to the business. We've got the most diverse team in the industry, which we believe gives us significant strength. On top of that, we continue to expand our use of recycle. We've made a number of disclosures relative to our carbon footprint in our carbon intensity with a long-term objective of having science-based measurable objectives, which we'll disclose soon. And we've got a long-term commitment to achieving 1 billion pounds over the next 5 years of recycle. So with that, Tim, let me turn it over to you.

Yes. No. I appreciate the opening remarks there. Maybe just kind of think big picture around conversion. So I guess when you look at penetration on the decking side, a lot of moving parts with stay at home and outdoor investments and things like that over the last couple of years. But where do you think as we kind of get to the end of this year, that conversion relative to wood kind of ends the year? And -- what is kind of the -- what is composites opportunity from a conversion perspective longer term?

Yes. I started in 2016. And I think one of the -- when I started in the job, I think it was 16% to 17% composite against -- within decking against that -- the remaining in wood. Since over the last 5 years, we've moved to closer to 22%. And I think in the last, really, 18 to 24 months, that has started to accelerate from closer to 1% to 2%. It's difficult to get an exact number at the end of the year. What I would say is, as we've gone through the year, certainly, if you look at the top 2 players, and what we've guided to, you would see that we are accelerating against wood. So there's accelerating conversion there. We did a lot of research over the summer on just what the real opportunity is. We talk to those 78% of consumers that are wood consumers. And within that, there's really a tremendous opportunity to convert at least half of what is left into composites. So as we look at the long-term opportunity here, we certainly see an opportunity to convert 50%. And as you double-click on that, it's -- I think at times, there's been a perception that it's around cost, but what our research shows is that, that cost is a component for a category of people, but there's a significant percentage of people that just want a product that looks and feels like wood. They get the low maintenance part of composite, but they don't like that some of the players in the market have a plasticky feel and they want the better aesthetics. And so we think we'll all set up to continue to accelerate conversion.

Okay. Okay. That's good. Yes, I was going to ask a follow-on to that question just about that. So it seems like -- in terms of your go-forward investments, do you feel like it's less around the product portfolio and the price points within the product portfolio and it's really more about the education and maybe the look and feel of the product.

Yes. I think for us, it's really important that we hit the right aesthetics and decking, and we can get into the Exteriors business, which has a similar cycle. But within the Decking, Rail & Accessories market, it's really important that we get the right kind of product and the right kind of look, whether [ Ipe ] is a really important category in hardwoods and we've designed products that are almost indistinguishable for that. So as you think about investment, it's a combination of having the right product. It's a combination of having capacity. We've been capacity constrained over the last 18 months to really be able to service all the wood conversion opportunities that we see. And then as you point out, it really is around education. But to educate with the wrong product, it's going to limit conversion. So for us, as we attack different segments of the market, it's really important we continue to launch products that attack those segments.

Right. Okay. Okay. And then when you think about kind of incremental investment in kind of new product development, do you feel -- I know you've made some incremental investments over the last couple of years in that. I mean do you feel like you're at a good level in terms of kind of a run rate in terms of those investments. And each year, you kind of walk into the year. I think this morning, you talked about some new colors and new fastening system and things. Is that kind of the cadence you want to get on or get into in terms of new product introductions annually?

Yes. I mean, one of our -- if you take a look at our investor deck, you'll see our growth stack. And one of the aspects of that growth stack is continuing to launch new products that not only strengthen the core, but also strengthen and expand ourselves into the broader market opportunity, and in particular, on Exteriors. So Yes, we've got a cadence every year. I mean, during the pandemic, we launched an entirely new product line called Landmark, which has some really unique and -- visuals that no one else in the marketplace has. And as you pointed out this morning on -- we added to the last couple of years of product launches with some very selective colors, and we expanded the productivity. And likewise, on our Exteriors business, you'll continue to see incremental product launches that solve contractor problems and set us up for accelerated wood conversion. So certainly, a key part of our cadence, and I think if you compare us to the other folks in the market, you'll see that we have an annual cadence of that, that we believe sets us up well for the future.

Okay. Okay. Good. And then I think when you think about from a capacity perspective, I mean, there's a -- you've added a lot of capacity. I mean, pretty much every competitor has added a lot of capacity. How do you kind of balance the near-term needs on the capacity front with the kind of the long-term needs? Because there's concern that maybe a lot of the capacity and kind of the demand could create some sort of a low. But at the same time, if conversion is going to go from low 20s to 50%, I mean, the industry is going to need this capacity to grow. So how do you kind of manage that internally to make sure that you're managing near but also the longer term?

Yes. I think the benefit -- I've been in the chemicals industry where the first pound is million dollars and the last pound is effectively free. We operate with a different financial model. And so I think it's important, if you step back, we as an industry really until 2018 to 2019, we're operating with excess capacity. And it had operated in a very rational way. 70% of the cost of our product is raw materials. And incrementally, north of 80%, close to 90% of our cost from an EBITDA standpoint are variable. And so there's really no incentive if you have excess capacity in the industry to try to want it to get incremental volume. And so if you step back and you consider that, you also consider that the capacity that we're adding and we'll continue to add is modular. So it comes in extrusion line increments. And if you happen to have excess capacity, you just don't run the extrusion line, you don't have the labor, you don't have -- you don't have the material usage. So you really, on an incremental basis, lose very little by not running on a machine. So if you step back from our vantage point, the most logical thing to do in that environment is to make sure that you have enough capacity to meet demand rather than trying to balance capacity and demand perfectly so that you maximize utilization. And we've been on the other end of that curve for a couple of years now where we've been running at demand levels that are above our capacity. And with what we're doing, we expect that to normalize and give us room to be more aggressive in the marketplace.

Okay. Okay. Great. And I guess how does that tie in -- at the same time, how does it tie into distribution? Because if I think of -- if you talk to your contractors, I mean a lot of your -- the people that are installing -- at products, I mean that's kind of the preference, right? And so historically, it hasn't been a price-sensitive market from an installer standpoint, from a distributor standpoint. So I guess, could you just talk a little bit about the strength of distribution for yourselves and kind of your contract or installation guys?

Yes. I think it's important if you step back and you look at this industry, our product -- both our major product lines, Exteriors and Deck, Rail & Accessories, we've been developing our channel and network over 20 years. We sell the millions of consumers that buy from tens of thousands of contractors, that buy from thousands of dealers and their service through an exclusive distribution network. And so that entire supply chain takes years to build. And we have effectively built that out, and it's extremely difficult to dislodge. So we're well set up. Now having said that, we've had to constrain some expansion. So -- there was an earlier announcement earlier this month that we're expanding our position with warehouse to better cover the Texas market. That's something that was an opportunity for us to better serve a geography with a better distribution partner. And we have multiple options to do that, and -- but you need capacity to be able to effectively service that incremental. And then likewise, we continue to see opportunities where we can take on additional opportunity in the various dealer and retail networks. That additional capacity will allow us to engage in. So we're well set up now. It's highly defensible, but there's always opportunities, whether it's domestic or marginally internationally for us to continue to attack and better set up a network to service our customers.

Okay. Okay. Good. When we think about pricing, if you could kind of maybe step us back a little bit because we've had a lot of inflation in transportation, labor, cost inputs, those types of things. So pricing has been a lever. So I think if you could just kind of talk about the pricing implemented in the market. And the other levers that you have, maybe you can start to dovetail that into recycling around kind of eliminating some of the version cost and kind of pushing down into those lower-cost recyclable inputs.

Yes. So as you think about -- and I'll give you a high level, and Pete will chime in as stated here. But in general, and we've said this since we've gone public, we have an ability to price to offset inflation. And as we have gone through the year, we have seen unprecedented inflation in a number of things, more pronounced in raw material, but really across the spectrum. And we've taken multiple pricing actions, as we talked about on the last earnings call. And we fully expect pricing combined with additional productivity to offset from a dollar standpoint, the peak of inflation. And as inflation subsides, which it will in some of these more extreme pockets, we fully expect to be able to hold most, if not all, of that pricing to be able to bring our margins back on an acceleration pace. And then you add to that more specifically ex price raw material, we've identified 500 basis points of margin expansion. We realized through 2020, 110 basis points of that. And that really comes through a combination of continuous improvement activities. And the fact that we are under-indexed and relative to recycled materials, that combined with the in-housing of recycled materials, that combined with using lower and lower grades of recycled materials, we see a tremendous opportunity on the gross margin line. And then as we've talked about in the past, there will be an opportunity down the road as we continue to see growth to get leverage on our SG&A. We have not chosen to pull that lever just because we view that this is a market where we're going to continue to invest in, and we don't want to slow that investment down.

Okay. That makes sense. And when you think about your portfolio, like you mentioned before, I mean, price is a piece, but -- so I guess if you look at your portfolio, that conversion opportunity from wood, you don't think there's any kind of structural ramifications to that conversion opportunity which has higher prices.

Yes. We've done research in the market. We did a pretty extensive -- and this fits into some SG&A investment. We did a very extensive pricing research study over the summer. And what that's allowed us to do is understand in each of the categories that we play in. Where the threshold is relative to accelerating conversion and the right blend and customer value proposition. And so we feel very good about our ability to both manage price, but also continue to manage conversion moving forward. And so -- we've done the research on that, and we'll continue to do it. And as you pointed out, that conversion opportunity, we tend to talk a lot about decking, but that conversion opportunity exists on a pretty significant basis also in our Exteriors business and then the rest of the backyard.

Yes. And maybe on that point, in terms of Exteriors, maybe doesn't get as much -- it maybe doesn't get as much focus as the decking part of it does. But I mean, you have a pretty significant share on the Exteriors side. And even if you're like you're in the northeast, I mean, it almost seems at this point that it's kind of the de facto product when you're replacing trims. So -- what are kind of the opportunities in Exteriors to continue to kind of accelerate that conversion?

Yes. The -- as you pointed out, if we didn't have such a strong Deck, Rail & Accessories business, we'd be having a conversation on how our Exteriors business mimics the decking business in terms of conversion opportunity, in terms of brand strength and technical differentiation. There's a minor difference between the two. There's a little bit more consumer involvement on the Deck, Rail & Accessories business, the Exteriors business has incrementally more involvement from architects and contractors. So as we look at wood conversion and a great example of that is we're driving wood conversion with our PaintPro product of cedar and we're driving alternative material conversion of other people that are having supply issues. And so that particular conversion, if you take a look at the Exteriors business, and trim specifically, it's 40% wood and it goes on top of siding, which has primarily converted into alternative materials that are not wood. So the wood percentage in siding is, let's call it, the teens, and yet the trim that goes up or that is 40%. So there is a meaningful opportunity to convert that. As you point out, we've got the 2 leading brands in that market with AZEK and Versatex. And so we are #1 and #2 in that market. We continue to launch products that facilitate wood conversion. It's an ongoing stream. Some of that is a better value proposition like our PaintPro. But other products, we have an ability to integrate functionality in our new products. So think about the most simplistic thing is think about the corner of a house, typically, you've got to have 2 boards, you've got to seal it. You've got to seal it against the siding, but seal it against each other, and it's a difficult thing to make a corner on a house. We've got a prefab corner that is highly productive and works with all kinds of siding that just allows a contractor to be able to finish the job on a productive way and have all the benefits of a composite and a long-term warranty. So it's an area where we are the leader. We're continuing to drive growth, and we see tremendous opportunity moving forward in the core, but also through selective adjacencies and acquisitions.

Okay. Okay. Good. And maybe just on recycling. So I mean, I think just with the inflationary environment, maybe that's got a little bit lost here. But it's a pretty meaningful program for you, change in how you're doing business. I mean where kind of are you in that recycling journey? Because I think you've kind of pulled everything in-house, at least in cap deposit. Where do you kind of go from here in terms of what's the runway on formulations and different materials and that type of thing?

Yes. Just a simple -- Tim, you hit on it. But just simplistically, the way to think of recycle is using recycle, in-housing recycle. So you're not buying it from a third party. And then you're actually processing it yourself and then using lower-cost recycled materials. And the way to think of that is really nice plastic bottles versus plastic bags. One of the challenges we've had this year is we have had such significant growth in our business that the combination of increasing the opportunity to increase our percentage of recycle in in-house recycle and then do the development work to move to lower-cost materials has been constrained. We tried to stage it, but we're running at such high utilization rates that even though we have increased our capability to both source and process recycle at the growth rates we're at, we haven't been able to move as fast as we wanted. So as growth rates normalize as the additional investments we've made come online, will have an opportunity to incrementally increase the percentage of recycle and we'll have an opportunity to incrementally in-house more recycle. And then as we bring new capacity online, we can actually use some of the excess capacities to start to convert machines to that lower cost material. And we not only do it in polyethylene. We're one of the few companies that recycle PVC at scale. And so if you were to go into our Return Polymers operation, you would see scrap PVC, old siding, scrap siding, flooring, credit card punches, all of that, that historically gets landfilled, you would see that in our yard, and we have an ability to use that both in our deck boards, but also in our trim.

Okay. I was going to ask you on the -- I think on the capped composite side, I mean, that seems to be or has historically been a little easier to move to recycling. Where are you kind of on the PVC side because that seems to be like a pretty big opportunity as well? It's probably more around the different grades and things to try to make sure that the formula stays in could change.

Yes. It's -- PVC is not commonly recycled. And so right now in our deck boards, we're a little over 50%. We have the capability to get to closer to 60%, but we just haven't been able to expand supply fast enough to be able to do that. So we've got some -- we bought a company called Return Polymers, which has a unique ability to take all these feed streams to PVC and put it in a form that we can use in the core of our deck boards and use in our trims. So we haven't disclosed specifically what percentage we use in our trim. But there's a meaningful opportunity to step up our usage in the core of our deck boards, but also step up our usage in our trim products and also other products we're contemplating. And so -- we believe we're uniquely positioned, and it's really just a matter of continuing to build out our sourcing organization and the capital associated with processing. And then incrementally, there's some formulation work that we can do. But right now, if we have supply, we've already done the formulation work to ramp up our ability to use PVC.

Okay. Okay. Good. And then maybe just the last 1 here, just on M&A. Your portfolio is a little broader than just decking. I mean, are there M&A opportunities that are interesting to you that kind of have -- that are available or out there that capitalize on some of the similar themes around material conversion and kind of benefit from your recycling initiatives?

Yes. So if you step back, we've done 3 acquisitions now over the last 4 years. One was Return Polymers, which strengthened our recycled capability. Another was UltraLox, which is a terrific and highly differentiated panelized rail product. It's allowing us to sell into our traditional channels, but they also have a commercial channel. So call that a tuck-in product. And the third was Versatex, which is the #2 player in the Exteriors market. As we look forward, we -- our focus is really on being the player in outdoor living and on the exteriors of houses operating under a similar theme. And as you look at the breadth that we play in, that still goes through our core channel and contractors. There are certainly adjacent products. And I think as we look at capital deployment, number one is invest in our own facilities. Number two is acquisitions. And then down the road, we've got other potential uses of cash that we're generating, but we generate enough cash, and there's tremendous opportunities out there that we'll continue to look for really selective acquisitions that fit. And it's a capability that we feel like we've developed and continue to expand and accelerate.

Okay. Okay. Good. Well, we're about out of time. So thank you. Please join me in thanking the AZEK team for being here. And Jesse's here, good to see you in person or at least virtually in person, and I appreciate the conversation.

Terrific. Thanks, Tim. And hopefully, next time, we'll be live together. So have a great day.

Absolutely. Absolutely.