Tecnoglass Inc

NYSE:TGLS

Earnings Call Transcript 2018-Q3

[Operator]

Greetings, and welcome to the Tecnoglass Third Quarter 2018 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Rodny Nacier with Investor Relations. Please go ahead.

[Rodny Nacier]

Thank you for joining us for Tecnoglass' Third Quarter 2018 Conference Call. A copy of the slide presentation to accompany this call may be obtained on the Investors section of the Tecnoglass website.

Our speakers for today's call are José Manuel Daes, Chief Executive Officer; Chris Daes, Chief Operating Officer; and Santiago Giraldo, Chief Financial Officer.

Moving to Slide 2. Before turning the call over to José Manuel, I'd like to remind everyone that matters discussed in this call, except for historical information, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements regarding future financial performance, future growth and future acquisitions. These statements are based on Tecnoglass' current expectations or beliefs and are subject to uncertainty and changes in circumstances. Actual results may differ in a material nature from these expressed or implied by the statements herein due to changes in economic, business, competitive and/or regulatory factors and other risks and uncertainties affecting the operation of Tecnoglass' business. These risks, uncertainties and contingencies are indicated from time to time in the Tecnoglass filings with the Securities and Exchange Commission. The information discussed during the call is presented in light of such risks.

Further, investors should keep in mind that Tecnoglass' financial results in any particular period may not be indicative of future results. Tecnoglass is under no obligation to and expressly disclaims any obligation to update or alter its forward-looking statements whether as a result of new information, future events, changes in assumptions or otherwise.

I will now turn the call over to José Manuel, beginning on Slide #4.

[Jose Daes, executive]

Thank you, Rodny, and thank you, everyone, for participating on today's call. I will begin with a review of our operating highlights. Chris will then discuss our backlog followed by Santiago, who will take us through our financial results, market update and outlook.

Looking at our highlights. Our results for the third quarter were very strong. We also established a good base of activity to maintain positive momentum in the fourth quarter and into 2019. We reported our sixth straight quarter of record revenues, which were up 16.3% year-over-year. A strong demand in the U.S., which represented 85% of total revenues, drove third quarter results, primarily reflecting market share gains and favorable pricing.

Sales to U.S. single-family residential grew over 3x year-over-year. This puts us on track to surpass our $20 million to $25 million single-family sales goal in 2018. Along with our progress in commercial, the U.S. is expected to remain a significant contributor to our growth trajectory based on an attractive mix of projects in backlog. While activity in Colombia was soft during the quarter, sales in that region were up 9% through the first 9 months of 2018. We also ended the quarter with a strong level of backlog in that region.

Our gross margin improved to 35.8%, and adjusted EBITDA margin grew to 23.5% during the third quarter. We achieved higher margins on incremental sales, reflecting tightened cost controls, the benefit of favorable mix and a better pricing environment. We believe this stronger quarter validates our vertically integrated model, our highly efficient manufacturing capacity and our sustainable access to talented employees.

Our recently announced alliance with Schüco is another positive step. Schüco is a leading German-based architectural systems company. Through the alliance, we added Schüco as a new customer of aluminum and glass products manufactured in our facility. In addition, we have gained the ability to manufacture and sell Schüco's cutting-edge architectural systems to our customers alongside our legacy products. We view the alliance as a long-term win for both sides. We are confident in the strength of our industry-leading margin business to deliver on a stronger outlook for the year.

As per external sources, the overall architectural glass and aluminum market, including products and services, is an approximately $25 billion per year industry in the U.S. We still only represent a fraction of the industry and even within our addressable market. This gives us confidence that we can continue to gain share in commercial and residential construction activity in the industry. I am confident in the Tecnoglass team, the benefit of our highly efficient operation and our exceptional position to continue taking market share into 2019 and beyond.

I will now turn the call over to Chris to provide additional details on our backlog.

[Christian Daes, executive]

Thank you, José Manuel. And good morning to everyone on the line.

Moving to our backlog on Slide 6. We were pleased to end the quarter with a record backlog at $506 million, up 3.6% year-over-year. This compared to $497 million at the end of the second quarter. The third quarter backlog level represent more than 1.4x our trailing 12-month revenue. Attractive project wins allow us to fully replace 4 consecutive quarters of record invoicing, enhancing our position for 2019 and now building 2020.

Quoting and bidding activity in the U.S. was strong, and Latin America continues to improve. We feel good about the composition of our project pipeline and the good visibility from our backlog. The U.S. market continues to represent our largest region, comprising almost 80% of our backlog. This reflects our ongoing efforts to further penetrate the U.S. and to expand our mix of business in very good markets.

Our ramp-up in single family had been impressive. Although many of those projects are typically shorter cycle and underrepresented in our backlog, we also continue to diversify our project categories with more retail, mid-rise condos and office projects to supplement our strong high-end condo business. This includes 2 of the largest projects to come to the market in both Miami and Tampa areas.

While we were growing backlog, we are being mindful to carefully balance volume and price with a focus on the strong margins. We are experiencing a more favorable pricing environment in the U.S. partly as a result of production and labor cost inflation for U.S.-based manufacturers. We have not experienced either of those 2 cost headwinds, so we are confident that our U.S. strategy will continue to drive benefits to our results. We are seeing the impact of higher ground transportation costs, along with the rest of the industry.

In Colombia, we ended the quarter with some sequential backlog growth largely attributable to strong bookings in the third quarter. We are seeing improvement building resulting from pent-up activity, strengthening economic conditions and more certainty on a favorable business climate, following recent presidential elections. The progress we are seeing on the ground takes some time to show up in invoicing, but we are optimistic for 2019. Overall, we are actively enhancing the quality of our backlog to expand our business in a disciplined manner.

The addition of Schüco product lines to our portfolio should enable us to attract new customers and grow our reputation for excellence even more in the architectural glass industry. This is an exciting time for Tecnoglass. We are poised to win more new projects and take advantage of our vertically integrated operations to achieve our visions of becoming a worldwide leader of high-quality architectural products and novelty solutions for a sustainable future. We look forward to generate additional value in our business.

I will now turn the call over to Santiago to discuss our financial results and market.

[Santiago Giraldo, executive]

Thank you, Christian, and good morning to everybody on the line.

Beginning with our financial highlights on Slide #8. Over the past several years, we have expanded our business into new geographies, captured an increasing amount of the value chain through our vertically integrated model, invested in our facilities and implemented cost-savings initiatives. The benefits of these efforts were evident in the third quarter with double-digit growth in sales, gross profit and adjusted EBITDA. We hit record levels in each of those metrics.

Adjusted EBITDA increased 29% to $22.8 million from the prior year quarter, which produced an adjusted EBITDA margin of 23.5%, up 240 basis points from the prior year quarter. We remain confident in our ability to generate incremental margins on higher sales and will continue to source additional avenues to improve efficiencies and reduce our cost base.

Our operating cash flow performance reflects working capital investments. These include account receivables in connection with strong sales growth in the third quarter, along with a buildup of inventories to support future growth. CapEx remained fairly low at approximately 2.3% of sales, primarily dedicated to maintenance and minor efficiency initiatives. We continue to benefit from prior CapEx investments, which have created ample installed capacity to address future growth.

We ended the quarter with a strong cash position of $28 million and a conservative leverage profile of 2.7x net debt to adjusted EBITDA, a slight improvement from 2.8x at the end of the second quarter of 2018 and a positive trend that we expect to expand into year-end. This balance sheet strength supports our growth initiatives and operational enhancements moving forward.

Looking at the drivers of revenue on Slide #9. U.S. revenues increased by 20.7% to $82.2 million for the third quarter. A portion of the increase came from single-family residential, and the remainder was attributable to healthy commercial construction activity, market share gains and slight improvement in pricing. Nearly all of our business lines grew in the U.S. market, more than compensating for softer Q3 performance in Colombia. Year-to-date, the U.S. is also driving the results, reflecting our strategy to continue penetrating the U.S. market, in different geographies and in the residential segment.

Looking at the drivers of adjusted EBITDA on Slide #10. For the quarter, adjusted EBITDA expanded 29% year-over-year to $22.8 million, largely as a result of higher sales and gross profit. This represents an incremental EBITDA margin of approximately 30% for the quarter and year-to-date.

The majority of third quarter improvement came from gross margin, which increased 320 basis points year-over-year to 35.8%. This was primarily attributable to favorable sales mix, with growth coming mainly from manufacturing activities. We also saw good operating leverage on higher volumes with slight pricing improvement on essentially stable input costs per unit. Raw material cost increases and labor constraints affecting our U.S.-based peers have not had a material impact on our manufacturing.

For the quarter, we experienced a 110 basis point increase in reported SG&A to 20% of sales. This was driven by increased expenses to support higher sales. SG&A excluding onetime items on a dollar basis increased $2.7 million, primarily due to stronger volumes, which drove higher ground transportation cost per unit and overall commission cost. U.S. ground freight and trucking are the main areas where we have seen costs rise, and this is likely to continue. Marine shipping costs have so far remained relatively stable for us, given the favorable trade dynamics between Colombia and the U.S.

Based on a favorable mix of business and overall market conditions, we believe we are well positioned to continue delivering strong profitability moving forward as U.S. market pricing responds to rising cost across a variety of products and services. Additionally, we remain focused on efficiency and productivity initiatives to further enhance profitability while preserving a strong platform to support expected growth.

Moving to the Schüco alliance on Slide #11. Our recently announced alliance with Schüco is a very strategic partnership for Tecnoglass. The purpose of the alliances is for both companies to grow faster in the U.S. than either could expect to achieve on its own. It will allow us to expand our portfolio and offer more solutions to our clients while also becoming a key supplier to Schüco. The alliance creates a shared distribution network within the Americas, meaning we will help sell each other's products in currently underserved markets by either party.

Among the many benefits of this arrangement, we will gain access to more U.S. customers as we have strengthened our go-to-market capabilities. We will expand our portfolio of high-end renowned designs, and we will increase production at our state-of-the-art facilities. Additionally, Schüco is a premier architectural systems company with a globally recognized brand in over 80 countries and a 60-year reputation for excellence. This alliance further validates the quality of Tecnoglass products and elevates our profile not only in the States but in many additional markets where Schüco already has a presence. This is all highly aligned with our long-term global expansion plan. We expect to see benefits from this transaction, beginning in the middle of 2019.

Looking at the construction market on Slide #13. U.S. commercial construction activity continues to dominate our business. The environment remains favorable for us, particularly for impact-resistant windows in hurricane-prone coastal states and for energy-efficient architectural systems more broadly. Deliveries for our hurricane-resistant glass continues to be strong as recent climate conditions have created added awareness for storm preparedness. Our innovative low-E coating are helping clients to cut energy costs by limiting heat transmission.

The Architectural Billing Index, ABI, has remained above 50 for the 12 consecutive months, and it forecasts business conditions to remain strong overall, particularly in the Southeast, where we have an ever-expanding presence. Based upon our current backlog composition, the view of the ABI ratings are positive for our exposure. We believe that our market will continue to grow faster than the national average and that we will continue to take share in our markets. Expansion into new markets and new product innovations are additional catalysts for Tecnoglass specifically, which we will continue to emphasize within our growth strategy.

Turning to our Colombian market update on Slide #14. In Colombia, all economic indicators are positive and have accelerated since midyear. Interest rates and inflation remain low, providing some runway for construction to outpace GDP growth. Additionally, confidence in social and political conditions has sharply rebounded to positive territory for the first time since August 2012. This is consistent with the outcome of recent presidential elections, which point to a pro-business climate over the next several years.

Based on third quarter bidding activity and conversations with customers, we also believe conditions are improving around the country. That said, we are watching the market carefully. And as mentioned on our second quarter earnings call, we do not expect an uptick in Colombia through the remainder of the year. Our third quarter backlog and overall quotes for business improved compared to the second quarter as the average project start is stretched deep into 2019. Therefore, we continue to anticipate a gradual recovery as developers take increasing advantage of the favorable market environment over the next several years.

Moving to our 2018 outlook on Slide #16. Based on our progress year-to-date, we are increasing our outlook for the full year 2018. We now expect revenues to grow to a range of $360 million to $370 million. Our mix of revenue growth is still expected to be weighted towards the U.S., partly fueled by new products and end markets. As we have said on prior calls, we expect year-over-year growth to be higher in the first half compared to growth in the back half based on anticipated timing of invoicing in 2019 compared to 2017 and the anniversary of the GM&P acquisition in early 2018, which carries 2 months of invoicing into the year.

We now expect full year adjusted EBITDA to be in the range of $79 million to $82 million. Favorable operating leverage on higher revenues, improved mix of sales from manufacturing operations, along with limited inflation, should allow us to drive higher margins. While we have had a usage of operating cash flow during the first 9 months of the year, given the very strong growth during that period, we expect to reduce the usage for the full year, given the seasonality on some tax and interest payments not present during the last quarter of the year.

We are extremely confident in our ability to achieve our growth objectives. We look forward to continue advancing rapidly as a leading manufacturer of high-quality glass products and to continue gaining market share as we build on our competitive advantages.

We thank you for your continued support of Tecnoglass. We will be happy to answer your questions. Operator, please open the line for questions.

[Operator]

[Operator Instructions] Our first question comes from Alex Rygiel with FBR & Company.

[Alexander Rygiel, analyst]

A couple round of questions here. So for the last 12, 18 months, you've been pushing into a number of new regions and cities in the United States. Can you talk about some of those successes, whether Chicago or Boston? And talk about how they've been building the momentum in any other new cities that have been added to that list of recent success stories, would be helpful.

[Jose Daes, executive]

This is José Daes. We are finishing 2 very nice projects in Boston. Boston Properties is the owner. They are very, very happy with it. And we are finishing jobs in Washington, New York. We have entered the California market with some small jobs, and that's way out on the West Coast. We're finishing jobs in Texas. And we now even are closing a job in Phoenix. We are expanding. It's not easy for people to trust a new company, but after they hear the way we perform and the quality of the product, those open very quickly.

[Alexander Rygiel, analyst]

Could you also comment on how you think the U.S. tariffs are affecting some of your competitors? Clearly, it's limited effect to your business. But how do you think it's affecting your competition? Are you seeing that in the marketplace when you're bidding on projects?

[Jose Daes, executive]

Well, actually, everybody is increasing prices because of the momentum of the economy. There is not enough aluminum or windows or glass to supply the demand. The demand is very strong. And I don't see the tariffs affecting anyone. Everybody is making a lot of money, and everybody is happy.

[Alexander Rygiel, analyst]

And as it relates to the residential product and the success it's had to date in the markets, what was the revenue contribution in the quarter from residential? And where do we think that could go to in 2019?

[Santiago Giraldo, executive]

Alex, this is Santiago. Basically, for the quarter, we estimate it to be about $8 million. We are on target to surpass the full year guidance of $20 million to $25 million that we had guided to at first. And over time, in 2019, we think this could become a more meaningful part of the overall business. We haven't obviously come out with guidance for 2019, but the expectation is for that to continue to grow next year.

[Operator]

Our next question comes from Jeremy Hamblin with Dougherty & Company.

[David Burdick, analyst]

It's actually David on for Jeremy. So just on U.S. outlook in 2019, how should we be thinking about the growth in that segment? And then, stepping over to Colombia. It seems like it saw some pressure in the quarter. Could you just discuss kind of what is going on down there after the decent growth in the first half of the year and then also, maybe the outlook in that segment in both Q4 and 2019?

[Santiago Giraldo, executive]

Sure. On the U.S., we'll come out with guidance here in the next call, but the expectation is for that to continue growing over a record year 2018. The percentage growth is to be determined once we have more information at year-end. But that is expected to be -- to continue to be our strongest market. If you look at Q3, it accounted for 85% of overall sales. And in line with what José just said, we continue to take market share and growing to other regions. So the expectation would be for the U.S. to continue this growth trajectory. In Colombia, we had said that a lot of activity was delayed, and pent-up activity was caused by the presidential elections. And what we're seeing is basically in line with what we expected. We think that the rest of 2018 is going to be probably a 2% growth year-over-year for the full year. So very much flattish. But the good news is that we are seeing growth in the Colombia backlog and actual business is getting close after the presidential elections. So we certainly expect Colombia to grow at a good pace for 2019 versus this year.

[David Burdick, analyst]

Okay, good deal. And then SG&A in the quarter jumped a bit. Assuming some of that is a function of the higher revs, but can you just maybe break down that for us? And what is causing that jump? And is there kind of a range we should expect moving forward?

[Santiago Giraldo, executive]

No, I mean, basically, the main contributor to SG&A increase and especially as a percentage of sales, because you have some cost in there that are variable, so when you have this much higher sales, you are also going to have an incremental in nominal SG&A. But the one factor that contributed more than sales was land transportation in the U.S., which every other company is also seeing out there.

[Jose Daes, executive]

And we are going to absorb that. We're shipping directly to the ports up north. We were shipping to Miami and from Miami land to New York and to Washington and to Chicago. And now we have found a different route, and next year, the cost of transportation is a little bit lower.

[David Burdick, analyst]

Okay, that's helpful, very helpful. And then my biggest surprise was upside on gross margins, jumping to nearly 36%. We haven't seen those levels in a while. Can you just kind of break down the details of this? And how much of this improvement is favorable pricing versus favorable mix?

[Santiago Giraldo, executive]

We haven't really taken a lot of margin from incremental pricing. The main contributor was the mix of products that was sold with the manufacturing companies, basically getting the brunt of the sales for the quarter. So when you have a favorable mix of sales, with manufacturing taking a large portion of that, you're going to see this type of margin profile, which is kind of what you saw prior to the services acquisition of GM&P. But then also, you have some operating leverage in there, some of the fixed costs that are associated to the cost of the products. We gained about 50 basis points on leverage. So it's a mix of all. The main thing was the mix of sales.

[Operator]

Our next question comes from Julio Romero with Sidoti & Company.

[Julio Romero, analyst]

So can we talk about pricing? I know, last call, you mentioned your competitors were raising prices to offset some of that input cost headwind. Some of that may or may not be related to the tariff situation. But are you still kind of holding price relatively steady? And can you give us any color on how that's translating to share gains in your business?

[Jose Daes, executive]

Yes. This is José. We are going to increase prices on some products, especially the high-end products because the product is actually underpriced compared to our peers. And on the lower line, even though our product is superior to the other ones, we still see a strong competition in pricing. So we can't increase those in order to keep gaining market share. And on the big buildings, it's -- most of those are biddings under negotiations, and we will control that. But we see the competition is having higher prices, and that's good to all because we can increase our margins.

[Julio Romero, analyst]

Okay. And on Schüco, I appreciate the color you gave earlier about timing, expecting that maybe starting mid-2019. But what do you think is a conservative estimate for the incremental revenues we can expect from that partnership going forward?

[Jose Daes, executive]

Well, in the first year, which is 2019, because we are now developing products with them because the products that they have deliver mostly for the European market. So we have to take those products and convert them a little bit, I mean minor design engineering to convert them, for example, to hurricane windows and for the American market up north. We're doing that. So for the first year, maybe $3 million to $5 million; and then for the second year, which is 2020, we expected it to be 3 or 5x that.

[Julio Romero, analyst]

Helpful. And given the best sort of a luxury product in the market, I mean, should we expect you to be able to manufacture those incremental revenues at more or less the same gross margin that you're currently at?

[Jose Daes, executive]

Oh, yes, even more. Even more because they are unique products. I mean, you have no competition. Once you have a product like that, people, if they want the product, they're paying the price.

[Julio Romero, analyst]

Okay. And just on cash flow here. I know you saw some inventory tick-up in the quarter. What should we expect for cash flow in the fourth quarter? And what's kind of driving that inventory number heading upwards?

[Santiago Giraldo, executive]

The inventory number is mainly products that are being sold in the next few months. So it's not like you're seeing raw materials in there. It's already products and finished goods. So the incremental inventory is basically just associated with the work that is coming in the next few months, Julio. As far as what we're expecting on operating cash flow, it's going to depend on how much we are able to grow for the next few months. If you look at it, the main use of cash is obviously AR and inventory. But if you look at the turnover ratio, they're basically staying flat. We're just selling quite a bit more. That being said, there are some seasonal payments that do not take place in Q4. So our expectation would be to be able to generate positive cash flow for the overall year.

[Julio Romero, analyst]

Okay. And then just lastly, on backlog. I know we saw a tick-up sequentially and year-over-year. Any key projects that have entered that recently? And any color into the margin profile that you're seeing in that backlog?

[Jose Daes, executive]

Well, we have landed a couple of jobs, opened doors in Florida. I mean, we were mainly in the 3 counties, Dade, Broward and Palm Beach. We move up north to Orlando, Tampa. And we have been getting jobs up there. And from here to the end of the year, we are negotiating, I mean, a ton of projects that we believe we're going to get. We're 95% near to closing, and we believe the backlog has still increased potential.

[Operator]

Our next question comes from Johannes (sic) [ Hans ] van der Burg with Logos Investment Management.

[Hans van der Burg, analyst]

I had one additional question on the Schüco deal. Most of my questions on that are already answered. But I was wondering, do you see any increases in capital expenditures or operational expenditures as you're preparing for launching these new products in mid-2019?

[Jose Daes, executive]

No, it's minor expenditure in the new dies. I mean, every window, you have to have the dies. Since we're going to change a few, I mean, minor details of the designs, we have to develop those dies. But it is nothing major. I mean, a couple of hundred...

[Hans van der Burg, analyst]

Okay. Yes, good color. I had one other question, and that's related to the shelf registration that the company did last month. Can you provide some color or some thinking about the reasoning behind that and why at that moment?

[Santiago Giraldo, executive]

Sure. That's actually something that have been in the works for a while, just corporate practice, something that we wanted to do to have flexibility for the next several years. But nothing imminent. You would just -- good practice to have the flexibility to have the capital markets, if an opportunity does come our way.

[Hans van der Burg, analyst]

Okay. So -- but it's not -- so it's not related to specific plans, for example, acquisitions or for reduction of debt or something like that?

[Santiago Giraldo, executive]

No, if you look at the shelf, it's a universal shelf. So it has, basically, the language of general corporate purposes, which is working capital or whatever it may be. We left it very broad. Obviously, if there was a transaction, it will have to be accompanied by a supplemental prospectus related to a transaction. This is just a general filing to give us flexibility over the next 3 years.

[Operator]

There are no further questions. I would like to turn the floor over to José Manuel for closing comments.

[Jose Daes, executive]

Okay. Thank you, everybody, for attending the call. We believe we will have very good news in the next quarter and the years to come. Thank you.

[Operator]

This concludes today's teleconference. You may disconnect your lines at this time, and thank you for your participation.