Greetings. Welcome to the Tecnoglass third quarter 2018 earnings call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star 0 on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Rodney Nacier, with Investor Relations. Please go ahead.
Thank you for joining us for Tecnoglass's 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 two. 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 with 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's 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's 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. Investors should keep in mind that Tecnoglass's 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 number four.
Thank you, Rodney. 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 3 times year-over-year. This puts us on track to surpass our $20 million-$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 nine 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 progress further 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 at 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 product 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 state.
I am confident in the Tecnoglass team, the benefits of our highly efficient operations, 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.
Thank you, José Manuel, and good morning to everyone on the line. Moving to our backlog on slide six. 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 months revenue. Attractive project wins allow us to fully replace four 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 margins. Our ramp-up in single family has 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 two of the largest projects to come to the market in both the Miami and the Tampa areas. While we were growing backlog, we are being mindful to carefully balance volume and price with a focus on 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 two cost headwinds. 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 subsequential backlog growth, largely attributable to strong bookings in the third quarter. We are seeing improving bidding resulting from pent-up activity, strengthening economy 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. 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 vertical integrated operations to achieve our visions of becoming a worldwide leader of high-quality architectural products and innovative solution 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.
Thank you, Christian, and good morning to everybody on the line. Beginning with our financial highlights on slide number eight. 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. This includes account receivables in connection with strong sales growth in the third quarter, along with a build-up of inventories to support future growth. CapEx remained fairly low at approximately 2.3% of revenue. Dedicated to maintenance and minor efficiency initiatives. We continue to benefit from prior CapEx investments, which have created ample install capacity to address future growth. We ended the quarter with a strong cash position of $28 million and a conservative leverage profile of 2.7 times net debt to adjusted EBITDA, a slight improvement from 2.8 times at the end of the second quarter of 2018, and a positive trend that we expect to extend into year-end. This balance sheet strength supports our growth initiatives and operational enhancements moving forward. Looking at the drivers of revenue on slide number nine.
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 a 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 number 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 represented 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 improvements on essentially stable input cost 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 points increase in reported SG&A to 20% of sales. This was driven by increased expenses to support higher sales. SG&A, excluding one-time items on a dollar basis, increased to $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 cost rise. 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 costs 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 number 11. Our recently announced alliance with Schüco is a very strategic partnership for Tecnoglass. The purpose of the alliance 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 main benefits of this arrangement, we will gain access to more U.S. customers as we strengthen our go-to market capabilities. We will expand our portfolio of high-end renowned designs. 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 number 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, helping clients to cut energy costs by limiting heat transmission. The Architectural Billings Index, ABI, has remained above 50 for the 12th consecutive month. 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 readings are positive for our exposure.
We believe that our markets will continue to grow faster than the national average. 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 number 14. In Colombia, all economic indicators are positive and have accelerated since mid-year. 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. 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. 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 macro environment over the next several years. Moving to our 2018 outlook on slide number 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 carried two months of invoicing into the year. We now expect full year adjusted EBITDA to be in the range of $79 million-$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 nine months of the year, given the very strong growth during that period, we expect to reduce that 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.
Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question comes from Alex Rygiel with B. Riley FBR. Please go ahead.
Thanks. Good morning, gentlemen. Very nice quarter.
Good morning, Alex. Thank you. How are you?
For the last 12, 18 months, you've been pushing into a number of new regions and cities in the U.S. Can you talk about some of those successes, whether or not Chicago or Boston, talk about how they've been building the momentum, any other new cities that have been added to that list of recent success stories would be helpful.
Hi, this is José . We are finishing two very nice projects in Boston. Boston Properties is the owner. They are very, very happy with it. We are finishing jobs in Washington, New York. We have entered the California market with some small jobs as a tryout on the West Coast. We're finishing jobs in Texas. We now even are closing a job in Phoenix. We are expanding. It's not easy for people to trust a new company. After they see the way we perform and the quality of the product, doors open very quickly.
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?
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. I don't see the tariffs affecting anyone. Everybody's making a lot of money and everyone is happy.
As it relates to the residential product and the success it's had to date in the market, what was the revenue contribution in the quarter from residential, and where do we think that could go to in 2019?
Hi, 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-$25 million that we had guided to at first. Over time, in 2019, we think that 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.
Very helpful. Thanks again. Nice quarter.
All right. Thanks, Alex.
Our next question comes from Jeremy Hamblin with Dougherty & Company. Please go ahead.
Hey, guys. It's actually David on for Jeremy. Thanks for taking my questions, and very nice quarter.
Hi, David. How are you?
Good. How are you?
Good, thanks.
Just on the U.S. outlook in 2019, how should we be thinking about the growth in that segment? Stepping over to Colombia, it seems like it saw some pressure in the quarter. Could you just discuss what is going on down there after the decent growth in the first half of the year, and also maybe the outlook in that segment in both Q4 and 2019?
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 our record year 2018. The percentage growth is to be determined once we have more information at year-end, but that is expected to continue to be our strongest market. If you look at Q3, it accounted for 85% of overall sales. In line with what Santiago Giraldo said, we continue to take market share and grow into other regions. 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. 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, very much flattish. The good news is that we are seeing growth in the Colombia backlog and actual businesses getting close after the presidential election. We certainly expect Colombia to grow at a good pace for 2019 versus this year.
Okay, good deal. Then, SG&A in the quarter jumped a bit, assuming some of that is a function of the higher revs. Can you just maybe break down that for us and what is causing that jump? Is this-
Sure
Is this kind of a range we should expect moving forward?
No, basically the main contributor to SG&A increase and especially as a percentage of sales, because you have some costs in there that are variable. When you have this much higher sales, you are also going to have an incremental in nominal SG&A. The one factor that contributed more than sales was land transportation in the U.S., which every other company is also seeing out there.
We are going to offset that with 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. Now we have found a different route, and next year, the cost of transportation is going to be lower.
Okay. That's helpful, very helpful. My biggest surprise was the upside on gross margins jumping to nearly 36%, and 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?
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. 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. Also you have some operating leverage in there. Some of the fixed costs that are associated to the cost of the products, we gain about 50 basis points on leverage. It's a mix of all. The main thing was the mix of sales.
Okay. Thanks for taking my questions, and good luck.
Thank you.
Thank you.
Our next question comes from Julio Romero with Sidoti & Company. Please go ahead.
Hey, good morning, gentlemen.
Good morning, Julio. How are you?
Very good. Can we talk about pricing? I know last call you mentioned your competitors were raising prices to offset some of that input cost headwinds. Some of that may or may not be related to the tariff situation. 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?
Yes. This is José. We are going to increase prices on some products, especially the high-end product, because the product is actually underpriced compared to our peers. 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 increase those in order to keep gaining market share. On the big buildings, most of those are biddings and then negotiations. Well, we don't control that, but we see the competition is having higher prices, and that's good for us because we can increase our margins.
Okay. On Schüco, I appreciate the color you gave earlier about timing, expecting that maybe starting mid-2019. What do you think is a conservative estimate for the incremental revenues we can expect from that partnership going forward?
Well, in the first year, which is, for us, 2019, because we are now developing products with them, because the products that they have cater mostly for the European market. 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. For the first year, it might be $3 million to $5 million. For the second year, which is 2020, we expect it to be three or five times that.
Helpful. Given that's sort of a luxury product in the market. Should we expect you'll be able to manufacture those incremental revenues at more or less the same gross margin that you're currently at?
Oh, yes. Even more. Even more, because they are unique products. You have no competition. Once you have a product like that, people, if they want the product, they pay the price.
Okay. 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?
The inventory number is mainly products that are being sold in the next few months. It's not like you're seeing raw materials in there. It's already products and finished goods. The incremental inventory is basically just associated with the work that is coming in the next few months with you. 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. If you look at the turnover ratios, 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.
Okay. Just lastly on backlog. I know we saw it 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?
Well, we have landed a couple of jobs, open doors in Florida. We were mainly in the three counties, Dade, Broward, and Palm Beach. We moved up north to Orlando, Tampa, and we have been getting jobs up there. From here to the end of the year, we are negotiating a ton of projects that we believe we're going to get. We're 95% there to close it, and we believe the backlog is going to increase potentially.
Excellent. Thanks very much. I appreciate your time.
Thank you.
Thanks, Julio.
Our next question comes from Johannes Fenderberg with Logos Investment Management. Please go ahead.
Hello, guys. Congratulations on the quarter.
Good morning.
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 are preparing for launching these new products in mid 2019?
No, it's minor expenditure in the new dies. Every window, you have to have the dies. Since we're going to change a few minor details of the designs, we have to develop those dies, but it's nothing major. $200.
Okay. Yeah. Good color. Thanks. 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?
Sure. That's actually something that had been in the works for a while, just good corporate practice, something that we wanted to do to have flexibility for the next several years. Nothing imminent. It was just good practice to have the flexibility to tap the capital markets if an opportunity does come our way.
Okay. It's not related to specific plans, for example, acquisitions or for reduction of debt or something like that?
No, if you look at the shelf, it's a universal shelf, it has basically the language of general corporate purposes, just working capital or whatever it may be. We left it very broad. Obviously, if there was a transaction, it would have to be accompanied by a supplemental prospectus related to the transaction. This is just the general filing to give us flexibility over the next three years.
All right. Well, sounds good. Once again, congratulations on the quarter, guys.
All right. Thank you so much.
There are no further questions. I would like to turn the floor over to José Manuel for closing comments.
Okay. Thank you, everybody, for attending the call. We believe we're going to have very good news in the next quarter and the years to come. Thank you.
This concludes today's teleconference. You may disconnect your lines at this time, and thank you for your participation.