Q2 2021 Azek Company Inc Earnings Call
Welcome to the age that company second quarter 2021 earnings call. At this time all participants are in a listen only mode. After the speaker presentation. There will be a question and answer session. Please be advised that today's conference is being recorded.
I'll now like to hand, the conference over to your Speaker day, John Skelley, Senior Vice President strategy and execution. Thank you. Please go ahead.
Thank you good morning, everyone. We issued our earnings press release. This morning, the Investor Relations portion of our website at investors day is that co dot com as well as via 8-K on the SEC's website.
I'm joined today by Jessie, saying, our Chief Executive Officer, Ralph Nicoletti, Our Chief Financial Officer.
Greg Jorgensen, our Chief Accounting Officer, and Amanda Cimaglia, our vice President of ESG.
Before we begin I would like to remind everyone that during this call ASIC management may make certain statements that constitute forward looking statements within the meaning of the private Securities Litigation Reform Act 1995. These include remarks about future expectations anticipation beliefs estimates forecasts plans and prospects.
Statements are subject to a variety of risks uncertainties and other factors that could cause actual results to differ materially from those indicated or implied by such statements such risks and other factors are set forth in the company's earnings release posted on the website and will be provided in our form 10-Q for the second quarter of fiscal 2021 as <unk>.
Filled with the Securities and Exchange Commission the company does not undertake any duty to update such forward looking statements. Additionally, during today's call. The company will discuss non-GAAP measures, which we believe can be useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with GAAP.
Reconciliations of adjusted EBITDA to net income calculated under GAAP and adjusted gross profit to gross profit calculated under GAAP as well as reconciliations for other non-GAAP measures discussed on this call can be found in our earnings release, which is posted on our website and will be included in our form 10-Q for our second quarter of fiscal year, 2020 one.
I'd now like to turn the call over to Jessie Zheng.
Good morning, I'd like to welcome everyone to today's call as we approach the one year anniversary of our IPO I couldnt be more excited about where we are as a company and the opportunities in front of US. We continue to demonstrate that we are a unique growth company with a broadest portfolio.
And the most differentiated products in the marketplace.
We are driving growth through innovation and delivered another quarter of double digit net sales and adjusted EBITDA growth.
Man and material conversion trends in our key outdoor living and exteriors markets remained strong.
We continue to see record levels of consumer sample order activity and positive contractor sentiment.
Our team continues to execute against our key strategic initiatives to deliver on growth and margin expansion objectives. All of this while managing through the near term supply chain disruptions and inflationary pressures.
Today, we are even more confident in our outlook for the second half of fiscal 2021 and as a result, we are increasing our guidance for the year.
We are increasingly optimistic about the long term market dynamics and our upsizing our investments in capacity and key strategic initiatives for the remainder of fiscal 2021.
Specifically, we will be adding an additional 15% of decking capacity, which we expect will come online in early fiscal 'twenty 'twenty two.
This is on top of the previously announced 70% incremental capacity expansion program.
During the quarter, we experienced a continuation of the strong performance we saw during prior quarters.
Within our residential segment the demand environment remains highly favorable and we continued to drive downstream conversions through our industry leading sales team.
Given the strong demand in the marketplace. We are focused on customer service and production and our capacity expansion initiatives remain on track.
We also continue to make strong progress against our recycling and continuous improvement initiatives.
We experienced inflationary headwinds in the quarter and we expect the pricing and productivity actions. We took during the quarter will allow us to offset these costs by the end of the fiscal year.
I am proud of the team's performance and our results during the quarter. Our further reflection of the strength of our business model and our ability to drive strong results, while investing in the future.
We continue to invest in our core strengths of bran manufacturing R&D and customer connection I.
I am, particularly proud that timber tech was once again recognized as number one in quality and the builder brand use study.
Our advanced technology allows us to have the most differentiated and realistic looking decking products on the market.
As an example, our recently launched landmark decking collection incorporates our most advanced capping technology combined with visuals inspired by the on trend look a rustic reclaimed wood.
The collection has been well received and is gaining momentum in the marketplace.
We remained focused on our key initiatives to achieve our long term performance objectives. Those initiatives include growth through innovation.
Margin expansion through recycle and continuous improvement.
And positively impacting the world through our commitment to ESG stewardship.
We are driving differentiated innovation in the marketplace across our portfolio with award winning products.
As X shingle siding with paint Pro technology was named as a best new product in 2021 by L. M C.
We continue to launch new products with the best Esthetics that address customer needs increased contractor productivity and expand our market penetration.
We also recently announced the selection of Boise, Idaho as the location for our new Western United States manufacturing facility.
A combination of a location.
Dalal highly skilled workforce and common values around sustainability and growth were key criteria for selecting Boise.
Construction is underway and we are on track to be fully operational in 2022.
Earlier this week, we released our inaugural ESG report.
Unimportant milestone in our company history.
This report titled full Circle, amplifies, our collective and ambitious commitment to create a lasting positive impact on our products our people and our planet.
A few of the highlights from the report include the.
The result of our inaugural carbon footprint inventory detailing a 9.2% reduction in carbon intensity from fiscal 2019 to fiscal 2020.
This is measured in tons of cotwo per $1 million of net sales and.
In other words, we produced and sold more products in fiscal 2020, but admitted less carbon across the value chain, primarily as a result of using more recycled and less Virgin raw material inputs.
You will also see the results of the first ever peer reviewed lifecycle assessment for decking, which showed that our timber tech decking line have a lower carbon footprint than their sustainably harvested treated pine alternatives.
From a social impact perspective, our employee engagement scores continue to increase year over year, and we have begun formalizing our framework for diversity equity and inclusion.
We are committed to permanently increasing the minimum wage for our hourly employees to $15 an hour by the end of the calendar year.
With an ambitious outlook ahead, we have a goal to reach 1 billion pounds of recycled materials annually by the end of 2026, we are committed to set science base greenhouse gas emission reduction targets.
And we have added ESG as a component of individual performance under our 2021 management annual incentive plan.
We continue to focus on doing the right thing with respect to recycling.
Our full circle PVC recycling program received an honorable mention on fast company's 2021 list of world changing ideas.
While we believe that we are leading the industry in innovation transparency and accountability in many ways. We are still early on in our journey and look forward to communicating our ESG progress in the months and years ahead.
Turning to our second quarter results, we delivered strong sales and adjusted EBITDA growth.
Our residential business grew approximately 25 per cent compared to the second quarter, a year ago, while our commercial segment declined approximately 13%.
Consolidated adjusted EBITDA grew approximately 28% year over year, and adjusted EBITDA margins expanded 170 basis points over the same period.
The growth environment remains very positive driven by strong end user demand for our differentiated product offerings, our adjusted EBITDA margins benefited in the quarter from the higher rate of sales operational execution in part and pricing, partially offset by higher costs.
Within our residential business, we experienced broad based demand and saw housing and repair and remodel activity continuing to strengthen.
Sell through in the quarter exceeded our sales growth and inventory days in the channel still remain below typical levels.
We are focused on working closely with our customers to provide the highest service levels possible and ensure we have broad product availability to meet end user demand.
We also have added additional capacity coming on line during the next quarter, which will further allow us to improve service levels during the busy deck building season.
We are seeing continued improvement across our digital and marketing programs and during the quarter experienced significant double digit increases in consumer samples and leads with very strong conversion rates.
As a reminder, these are key leading indicators of future demand.
Our commercial business declined for the quarter on a year over year basis, but saw improvements in margin as the cost structure changes, we made last year took hold.
We are starting to see improvement in certain end markets and expect to see this business returned to growth later this year.
As a reminder, this business tends to track more closely to GDP and the broader economy, which has been improving.
Operationally the team continued to execute against our core initiatives of expansion of manufacturing capacity. The increased use of recycled raw materials and continuous improvement programs, while managing a difficult and dynamic period of raw material inflation and supply chain.
Disruptions.
Unusual winter storms in February that impacted Texas, and Louisiana resulted in constrained supply and meaningful inflation in raw materials, such as PVC resin.
We worked with our key supplier partners to maintain adequate supply of raw materials to minimize any production disruptions.
And continue to service our customers.
Conditions have improved and availability of supply is increasing with inflation stabilizing at elevated levels.
Our facilities are running full out to meet accelerated demand.
Two of our previously announced $180 million capacity expansion program is scheduled to be completed by the end of the third quarter of our fiscal 2021.
Providing cumulatively, 40% more decking capacity.
Given the very strong demand environment operationally, we remained focused on customer service.
To position us for additional long term growth and conversion opportunity. We are further upsizing, our capacity investments by approximately $50 million to $60 million for the remainder of fiscal 2021.
This will enable both an expansion of our recycled capabilities and an incremental 15% of decking capacity.
This on top of the 40% expected as a result of phase one and phase two combined.
The vast majority of this upsize investment is supporting incremental capacity that will come online early in our fiscal 'twenty 'twenty two.
In addition, construction is underway at our newly announced facility in Boise, which is expected to deliver 30% incremental decking capacity during 2022.
We continue to evaluate additional opportunities to maximize our capacity.
We are very focused on the customer impact of the inflationary environment and have taken appropriate actions to offset this inflation with the least amount of disruption to our customer base through a combination of pricing and continued productivity initiatives.
As it relates to pricing during the fourth quarter of fiscal 2020, we announced a low single digit price increase that went into effect at the beginning of the calendar year <unk>.
During our fiscal second quarter, we implemented an additional price increase in the low single digit range that will begin flowing through in late fiscal Q3.
And we recently announced a third price increase across both our residential and commercial businesses that will begin to take effect during fiscal Q4.
We expect the combination of our price increases and our productivity initiatives to fully offset inflation during Q4.
Now turning to our outlook.
We are raising our net sales and adjusted EBITDA growth guidance for fiscal year 2021.
This increased guidance underscores our conviction and the sustained underlying demand we are seeing across outdoor living and exteriors markets.
As previously discussed our outlook is fundamentally driven by a number of internal and external factors.
We continue to see positive signals in our internal digital and website metrics.
Simple order activity as well as dealer and contractor survey checks.
And channel inventory remains below historic levels. Our current outlook is built on meeting customer demand and doesn't contemplate significant inventory build in the channel.
The macro economic indicators that most highly correlate to our business such as repair and remodel activity and new housing construction activity continued to strengthen during the second quarter.
We continue to be diligent in evaluating short and long term market conditions.
To sum up.
We are increasing our investments to further enable long term growth potential and we have confidence in our business model and strategic positioning that allow us to deliver strong results.
With that I'd like to turn the call over to Ralph who will discuss our financial results and outlook in greater detail.
Thank you Jesse.
As I discuss our results all comparisons made will be on a year over year basis compared to the same period ending March 31 2020.
For the second quarter of 2021, net sales increased by 47, and a half million dollars or 19% to $293 $1 million the.
The increase was primarily driven by sales growth in our residential segment, partially offset by a decrease in our commercial segment of 13% year over year.
Gross profit for the second quarter of fiscal 'twenty, one increased by $18 $5 million or 23, 3% to $97 $9 million.
Adjusted gross profit for the second quarter of fiscal 'twenty, one increased by $19 $4 million or 23% to $114 $7 million.
Adjusted gross profit margin was 39, 1% an increase of approximately 30 basis points compared to the prior year period.
During the quarter, we were able to offset inflation and startup costs through a combination of pricing and productivity.
As we discussed on our call in February we said, we were experiencing additional inflationary costs in fiscal Q2 and expected the higher raw material prices to flow through our P&L, even more in the balance of the year.
Since our last call we have experienced additional inflationary headwinds mainly from the freeze in Texas and we've taken additional pricing to offset the impact selling general and administrative expenses increased by $10 2 million to $59 9 million or 24% as a percentage of total sales for the <unk>.
Second quarter.
The increase was primarily driven by higher stock based compensation expense as a result of our IPO in June of 2020 ongoing public company expenses and personnel costs.
Net income increased by $18 $6 million to net income of $22 7 million for the three months ended March 31, 2021, compared to $4 $1 million from the three months ended.
March 31, 2020, primarily due to higher net sales and lower interest expense.
Adjusted net income was $39 $3 million or 25 cents a share for the second quarter compared to adjusted net income of $18 $4 million or <unk> 17 per share a year ago.
Adjusted EBITDA for the second quarter of fiscal 'twenty, one increased by $15 7 million or 28% to $71 $5 million adjust.
Adjusted EBITDA margin expanded 170 basis points to 24, 4% from 22, 7% a year ago.
Now turning to our segment results.
Residential segment net sales for the second quarter of fiscal 'twenty, one increased by $52 million or 25% to $262 2 million.
Residential segment adjusted EBITDA for the second quarter of fiscal 'twenty, one increased by $18 9 million or 31% to $81 $7 million.
The increase was primarily driven by higher sales commercial segment net sales for the second quarter of fiscal 'twenty one.
Decreased by $4 $4 million or 13% to $30 9 million. The decrease was primarily driven by declining sales in our Scranton products and Viacom businesses as the effects of COVID-19 continues to impact certain end markets.
<unk> segment adjusted EBITDA for the second quarter of fiscal 'twenty, one was $3 7 million.
The $600000 increase year over year was primarily driven by manufacturing productivity and lower selling general and administrative expenses, partially offset by lower sales.
Looking at our balance sheet and cash flow as of March 31, 21, we had cash and cash equivalents of $151 $3 million and approximately $145 $6 million available for future borrowings under our revolving credit facility.
Total debt as of March 31, 21 was $467 $7 million and we have not drawn on our revolving credit facility. Our net leverage ratio stood at one three times at the end of fiscal Q2.
Net cash provided by operating activities was $7 million for the six months ended March 31, 21 versus a use of approximately $68 million for the six months ended March 31 of 2020.
Turning to our outlook as Jesse mentioned, we are increasing our investments in capacity and now expect total capital expenditures in fiscal 'twenty, one to be in the $175 million to $185 million range, providing both additional recycling capability and 15% more decking capacity.
As we further investing in our future growth opportunities.
For fiscal Q3, we expect total company net sales growth to be in the range of 29% to 32% year over year with the residential segment growing in the mid <unk> range and adjusted EBITDA growth in the 15% to 18% range.
I'd like to provide some additional color regarding the margin progression from fiscal Q3 through the balance of the year.
And during the second quarter, we saw significantly higher inflation, driven even higher with the impact of the severe weather in Texas, which is expected to significantly impact Q3 and Q4.
We took two additional pricing actions, which only partially benefit Q3.
And for which we expect to realize the full benefit in Q4.
As a result, our third quarter margins are forecasted to decline year over year due to the timing pricing realization relative to the cost increases as well as a return to a normalized level of SG&A investment.
We expect to fully offset our anticipated inflation and startup cost in Q4 from pricing and productivity.
On a run rate basis, we are exiting the year positioned to cover our higher cost.
Turning to the full year fiscal 'twenty, one we expect total company net sales to increase 23% to 26% year over year and adjusted EBITDA growth in the 25% to 29% range year over year.
This results in continuing adjusted EBITDA margin improvement as additional costs, including startup from our capacity expansion incremental raw material and labor inflation, a normalization of marketing and SG&A expenses and cost of being a public company are all more than offset by pricing and manufacturing.
From productivity.
From a segment perspective based on our leading indicators, we expect full year residential segment net sales growth of around 30% year over year.
In the commercial segment, we are assuming there will be economic stability with some improvement in the second half of the fiscal year, leading to our projection of net sales declining.
Mid single digit rate year over year, consistent with our prior outlook.
To assist in modeling, we continue to expect approximately 21% to $22 million of interest expense for the full year in 2021, our tax rate for 'twenty. One is estimated to be approximately 25% and our full year weighted average diluted share count is unchanged at approximately 157.
Shares.
I'll now turn the call back to Jesse for some closing remarks.
Thanks, Ralph I want to thank our team for their relentless focus on execution innovation and operational excellence.
We are a business with tremendous growth opportunity.
And are investing for the future.
We are committed to driving lasting sources of value for all of our stakeholders as we seek to revolutionize and lead the industry and creating a more sustainable future.
That operator, please open the line for questions.
As a reminder to ask a question you need to press star one on your telephone to withdraw your question press. The pound key please limit yourself to one question and one follow up question. Your first question line of Philip <unk> from Jefferies LLC.
Hey, guys congrats on a really strong quarter.
So jessie with some of the incremental Capex you are spending this year would you be able to speed up or unlock more capacity. This year and does the incremental 15% capacity youre announcing signal any wins from any of your channel partners.
First off.
Thanks.
Phil per your earlier comments.
First off relative to.
Specifically any wins in the market we've continued to.
To really focus on executing our business model and continue to focus downstream and so we're going through a constant a series of engagement either through our new products or through our downstream sales force relative to adding new business. So that's just always.
Part of our process.
I think the way to think about capacity just as a reminder, we have additional capacity that is coming online as part of that phase two near the end.
During this quarter the machines are actually in and Theyre going through the ramp up phase.
As we as we speak so we expect to see the benefit of that accident near the end of this month and then this additional capacity what it allows us to do is bring an additional 15% on line.
In the fall into the winter and that then gives us additional flexibility in terms of how we use our inventory.
And how we continue to service our customer as that comes online and in some cases prior to that capacity coming on line.
Okay, that's helpful and to move than Virgin resin prices I mean, this is pretty unprecedented great to see that the team managed inflation well and then certainly on the supply constraints as well any color on the magnitude of the third price increase I may have missed it on the call and in the past Jesse when you've seen a surge in resin prices and let's say it reverses have you been able to hold on.
To your pricing, whether it's on your resi side or commercial as well thanks a lot.
Yeah, I'll take the latter part of that and Ralph if you could take the specifics in general if you look at our pricing actions in the residential business and this is over a long arc.
We typically.
Appropriate raise.
Raise prices such that day.
They maintain their position in the marketplace for the long term.
So I'll just leave it at that Ralph do you want to touch upon.
Some of the specifics.
Sure.
Good morning, Phil.
So first on the let me just kind of go back to the inflation side.
You recall from our last earnings call. We said, we were seeing a lot of a lot of inflation in.
At that point in time, we had announced our second price increase.
To address that largely taking effect later part of Q3.
And then in full in Q4 since the last earnings call just for perspective.
We've seen $30 million about $30 million of additional inflation largely driven by the.
The free situation.
In Texas, and Louisiana, but we saw we've seen resins resins in particular spike very substantially.
And now they've stabilized, but at a pretty high level very high level.
So we took that we took a third price increase it's largely it's really an impact Q4 on that one that we recently announced an order of magnitude.
Mid single digit mid single digit price increase on an annualized basis.
And we will get a portion of that obviously in fiscal 'twenty one in the fourth quarter.
And Ralph that $30 million additional inflation is that a quarterly run rate or a full year run rate.
That's just for perspective of just what we what we experienced since the last earnings call.
In this fiscal year.
Okay, how about how it plays out ultimately.
It really depends on.
With the.
With the inflation outlook.
Comes to bear as we move forward, but with.
With this pricing.
As we said in our remarks, we've offset our costs in 'twenty, one and positioned ourselves, we think well exiting the year because we have our we have.
The costs that we see today cover.
Okay excellent guys okay.
And your next question the line of Matthew Bouley from Barclays.
Good morning, everyone. Congrats on the results and thanks for taking the question.
You can go back to the capacity add just firstly that the incremental 15% in early fiscal 'twenty two.
Does that suggest that's coming out of an existing facility rather than Boise, if you could confirm that.
But then the broader question is you said in the prepared remarks, Jesse about evaluating additional opportunities could you elaborate a little bit on that or are these type of mid teens increments the right way to think about.
Are you all looking at it going forward. Thank you.
Yeah to answer your first question, yes. The additional 15% is really an outcome of just the flexibility and the capability of our manufacturing team.
We are we will be deploying that at our existing facilities and then relative to <unk>.
Your question on on future capacity adds just as a reminder, the facility that we have that we talk about in Boise.
Has a.
Relatively large footprint 350000 square feet and we have the capability to add additional equipment. If we so choose to do that into that facility.
And what we've highlighted we're we're planning on doing in 2022 and and once again as a reminder.
Which is why we're able to deploy the 15% and also potential flexibility.
Flexibility in the future our manufacturing tends to be pretty modular and so we have an ability to scale it.
On a relatively rapid basis and it gives us a lot of flexibility in terms of meeting demand and managing through our capacity.
No that's great color really helpful. There.
Second one I wanted to ask about sales and marketing investments.
It sounds like in the near term that there are some SG&A normalization.
Upcoming but I'm more curious about the longer term.
What do you think you need to do from a scaling.
Your sales force and marketing perspective, as you continue to get bigger on the capacity side. Thank you.
Yes.
First I appreciate the question as we talked about over the last year, we feel like we've got an industry leading downstream sales force. We've got almost 200 people are actually probably over 200 salespeople now focused in our residential business.
<unk> is a large powerful footprint that allows us to continue to drive.
Market penetration and we feel really good about the structure that we have now having said that incrementally.
We're always going to look for opportunities to accelerate growth and customer service.
Relative to marketing as you can see we've continued to take steps up.
In.
In our marketing investment we feel really good about the progress that we've made both on the brand and the digital front and we will continue to make sure that we're well prepared and well positioned for the future as we continue those investments.
Great well, thank you for that Jessie and good luck.
I appreciate it thanks, Matt.
Your next question line of Mike Dahl with arc from RBC capital markets.
Hi, This is actually Chris kalata on from Mike Thanks for taking my questions.
First question is just just to clarify that incremental $30 million in costs that you guys saw from last quarter is that is that just coming from the Virgin PBC inflation Youre seeing.
And if so.
Any way you can provide either on a dollar and percentage basis. What's the total cost inflation you are currently experiencing and what's embedded in your guide.
So.
We had a little bit more perspective to it you know first I think just stepping back we're seeing inflation in a lot of places I mean, we're seeing it in labor, we're seeing it in freight we're seeing it in and.
And certainly in our raw materials, as we talk about and obviously raw materials being the largest part of our cost structure.
That has the largest impact but there is there is inflation.
We're seeing across the board the majority of that $30 million.
Incremental since the last call.
This year is in is in the resin resin side and frankly, we're seeing even the cost too.
Get the recycled material delivered to our factories and for processing has gone up too. So we're seeing it in all places.
And so that gives you the.
Some color on what we're seeing.
In aggregate.
Really.
Not get too specific on what the full year inflation is but I think maybe a way to help you think about it a little bit.
As you know we've taken three price increases this year.
Two to sort of low single digit ones, which we've previously announced and one and one mid single digit one that I had mentioned earlier and so when you kind of cumulatively think about that.
In aggregate.
That that on a run rate basis, we felt was sufficient to cover and we're seeing it's sufficient to cover inflation.
On the year and certainly at a run rate in the fourth quarter.
So I think that might help you a little bit.
Yeah, and if I could just add as Ralph mentioned on the call.
In our view this is.
Is.
A relatively the balance of ralphs talking about is a relatively.
Short term move we.
Just to reiterate we feel really good about our position as we move into Q4 and in particular as we exit Q4.
We'll be back in a really nice position and as a reminder, over the last trailing 12 months we've expanded.
Our EBITDA margins by 160.
To 170 basis points and our guidance as you as you dissect it.
Implies.
Some additional benefit as we move into next year.
Got it that's helpful color.
And from my follow up I guess, given given the price cost neutrality exiting the year.
So maybe some more color on some of the other moving pieces like like startup costs and the productivity bucket.
Anyway, you could help quantify what those startup costs look like for the incremental capacity additions and then when you. When you think about the productivity offset is that just from higher overhead leverage does that include.
The benefits from from the recycling initiatives and other continuous improvement.
Yeah.
Well, if I can I can just take it at a really high level.
In general we have startup costs.
As we ramp up.
Our.
The capacity, we have coming online now we will have additional.
Relatively modest start up costs as we added an additional 15% and we are very much on track.
With our productivity.
Programs that we talked about.
As we chatted about in the past we.
<unk>.
2019, baseline, we've got 500 basis points of of productivity and.
And margin expansion that we have.
That we've talked about EBITDA margin expansion.
That we have in front of US based on the 2019 baseline that's based on specific projects and as we move through these quarters, we continue to execute.
Against those projects and we continue to see benefit from them.
Understood. Thanks, taking my questions.
Next question the line of Tim Weiss from Baird.
Hi, Good morning. This is Josh Chan filling in for Tim Thanks for taking my question.
I guess, Mike My first question is on the demand side of things to what extent does it does.
Backlog in this industry kind of carry into the following year. So it's consumer is not able to get a project in this year, either due to labor or material availability.
Is it a brand new decision next year or is there an ability to carry some backlog that would give you confidence into into the following following second season.
Yes.
Survey, our we survey, both our contractors and our dealers relative to their backlog and the visibility.
They have.
And.
Without getting specific we see a really nice backlog of projects.
People are planning now and we fully expect to realize those projects.
Over the next two to.
12 months and as a reminder, our leading indicators.
Our leading indicators based on historic data.
They lead to 16 months right the decision making process on a deck for example, our research shows could be up to 16 months.
And so as such.
We fully expect the activity that's occurring now.
Will benefit us for for many months in the future.
Alright, Thats encouraging and then under the recycling side.
Given the raw materials, I guess could you kind of update us on where you stand in terms of the use of recycling across.
The product lines, and then also any opportunity to accelerate the use of recycling based on how the costs have gone so far this year.
Yeah Yeah.
As we highlighted we continue to invest in our recycling capability and as a reminder for US there is really.
Three phases to our recycle one one aspect of it is increasing the use of recycle.
The second is doing more in house and then the third is.
Focused on cost, reducing and finding lower cost sources of recycle we continue to make progress.
All of those fronts.
As you look at.
What we're doing without getting.
Specific even within the quarter we've identified.
Some additional <unk>.
Cost sources.
And we continue to.
To deploy and expand that effort.
We're investing to make sure that we have the capability to self supply into the future.
Okay, great well, thanks for the color and good luck on the from the second half.
I appreciate it thank you.
Your next question the line of Ryan Merkel from William Blair.
Hey, Thanks for taking the questions I guess first off thanks for the color on margins in <unk> Q I was hoping you could tell us how much of the year over year decline is price cost timing versus new capacity versus SG&A and if you don't want to get too specific maybe you could just give us the rankings.
Right.
Railcar that's related to Q3, just make sure I heard your question.
Correct.
Q3 is.
<unk> indicated on the last call we were going to have.
Pressure on margins in the.
And the moving parts, which I think you got most of them.
Here's how to think about this.
First.
The commodity the resins in particular, but overall inflation, but mainly resins even accelerated.
Terms of the impact, which we've talked about now and that that is coming through the third quarter significantly I'll come back to pricing.
But you have you have inflation generally as well as <unk>.
An acceleration coming out of the freeze in Texas will hit from the quarter, we have startup costs as we're adding capacity.
Clearly clearly in there and.
<unk>.
That we're seeing in the quarter.
Now from a pricing and productivity standpoint.
The productivity that we expected is on track and we're seeing that benefit in the third quarter pricing.
The first price increase.
That we took.
It helps the third quarter, but the last two.
More impact Q4 than Q3, so there was an imbalance on pricing relative to costs, which we which we had mentioned last time, but it was just even more magnified with the higher inflation now having said all of that.
There is also on the SG&A side public company costs, we can't forget about that.
We are now.
But about $2 million a quarter on SG&A higher just from being a public company and and.
The return to a normalized level of SG&A investment, particularly in marketing and travel.
In the third quarter. So true when you. So when you look at the third quarter and sum that up you have pricing and productivity.
Uh huh.
Partially offsetting these other these other headwinds.
Book about those those are the moving pieces.
Got it thanks for that Ralph and then Jesse you said in the prepared remarks that underlying demand has continued to strengthen can you just unpack that a little bit more and has the spike in lumber recently has that been a driver as well.
Yeah, Yeah yeah.
Thanks for the question.
As we look at future demand.
Pointed out on the call.
We look at a lot of different variables.
Yes.
We looked critically at those variables, but what we can see is the macro.
With repair and remodel and new housing and people.
Being attracted to.
Wanting new dwellings, all of that macro is manifesting itself on.
On how we are.
How we see the future and so we continue to see a lot of interest in the category.
We continue to see a lot of people.
Wanting to focus on on this part of the house. So that's really the macro backdrop I think as you look at.
Lumber prices.
I think incrementally for us.
One of the areas that.
That the way we look at the market is we view the decking conversion and the opportunity we have for wood conversion to not only be driven by pricing, but also quality of the product and the visual of the product and so as wood is difficult at times to get access to <unk>.
Do see.
People considering their options, but isn't that we see a lot of that.
Going towards.
A lot of that going towards our more premium product and so.
So the reason why I say all that is the dynamic is facilitating more consideration and that consideration, we believe will benefit and pay dividends not only in the next couple of quarters.
But as we move out into the out quarters in the out years.
Thanks Jesse.
The luck.
I appreciate it thank you.
Your next question the line of Michael Rehaut from J P. Morgan.
Hi, Congrats on the quarter. This is Maggie on for Mike.
Following up on the last question did the impact of net <unk>.
<unk> seen from some other lumber price increases I think you said that you've seen a lot of that demand going towards your premium products, but have you seen any shifts.
Towards your.
Lower price product.
Any mix shifts.
Given the higher bunker prices.
We can see.
When we look at our growth we continue to see growth broadly.
Across the portfolio so from a mix standpoint.
The demand pattern, we see continues to reflect a.
A really nice broad mix of interest.
Got it thank you.
And I apologize if I missed this in the prepared remarks, but did you break out the.
The growth between <unk> and accessories versus exteriors.
Yeah.
We did not break that growth out, but just suffice it to say that that we saw.
Nice growth across the business.
Okay and one.
One more quick one if I can.
As you as Youre seeing that nice growth do you see any need going forward to add additional capacity across your rail or exterior businesses.
Yes, we continue.
When we talk about capacity adds.
Highlights specifically some of the decking ads and the percentages associated with that but along the way the capacity adds that we've highlighted really include the.
The entirety of the residential portfolio. So we've been adding capacity in our exteriors business and capacity in our rail business and specifically in exteriors.
We're in a really good position right now, where we're able to service the market in a very differentiated way because.
We've been able to.
To really deliver high service to our customers. So we're actually seeing the benefits of.
Of <unk>.
Being able to supply our customers at a very high level.
Got it thank you.
Your next question the line of Stanley Elliott from Stifel.
Hey, good morning, everyone. Congratulations and thank you for the time.
Just you mentioned on the on the contracted survey at some of the sampling activity. It sounds like you guys have pretty good visibility out.
Moving into 2022, and then at the same time I thought you guys were talking about kind of within this guidance didn't that really account for any sort of an inventory refill.
So if all of that is correct or we are we looking at another kind of low inventory part of the start of the year into 'twenty two kind of given how strong demand has been.
Yeah. The short answer is probably.
And I think as we look at the dynamics of what's in the marketplace.
As Ralph pointed out in his prepared remarks is.
That.
The product that we're manufacturing is being used to meet.
Consumer.
And dealer end market demand and as such we're doing a really improved job of servicing the market.
But as we also pointed out in the call the opportunity for us in this demand environment.
<unk> <unk>.
Channel inventory is is diminished.
And could you comment on what you're seeing if any differences between kind of the big box and the pro channel.
Assuming there is demand is pretty evenly split, but we'd love to kind of get some commentary and any color you can provide.
Yes, we see really nice demand for us.
On both sides.
And obviously the makeup of the demand and how it manifests itself.
Aries geography by geography.
And there are some nuances between the two sides, but in general we see really strong.
Demand in growth.
Both of the pro and in.
On the retail side for us.
Great guys. Thank you very much and best of luck.
Your next question line of trade rooms from Stifel, Sorry Stephens, Inc.
Yep.
Morning, guys. Thanks for taking my question.
First would be.
I guess on the rap the normalization of SG&A, you're talking about.
Is the expectation that that will pretty well be caught up as we go into the.
300, <unk> fiscal <unk>.
Should we expect to see that kind of a normalization continue into next year as well.
Yes true.
The.
Think about this.
Two pieces of it.
The larger piece being marketing related and we've been investing.
We've been investing throughout the year.
And certainly in the second half of this year into next year.
So that's that's.
I'll call normalize more.
On the travel side.
It's it's beginning to normalize.
But its a lesser part of the total SG&A.
And I think.
Accordingly.
As you think about what we've been saying is that.
Through pricing and productivity, we've positioned ourselves we feel well.
We exit the year going at going into next year to cover the costs that we see but we're investing in SG&A.
To drive the business forward.
Great. Thank you for that and.
And then just for clarity and sorry, if I missed this but.
The third increase that you've announced this year mid single digits is that.
Net.
Across all our product lines or is it specific to certain.
Categories, our core class.
Yes.
Go ahead, Ralph go ahead.
I was just saying I mean.
Generally it's.
It's a mix across.
The different the different categories.
So, but it's touching it's touching a lot you know a lot of a lot of the a lot of different private credit scores at very at various different rates, but on average you would come to.
I said it was mid single digits.
Got it okay, alright, well thanks for taking my questions I'll leave it at that and congrats on the good quarter and good luck.
I appreciate it thanks Jay.
Next question the line of Jeff Stevenson from loop capital.
Hi, Thanks for taking my questions. Today. My first is just can you talk about commercial sales trends from a return to flat growth. Later. This year is this a function of easier comps in the back half or are you seeing a recovery in order patterns.
No.
On the commercial business.
It's a little bit of both.
Clearly seeing some recovery in order patterns on certain end markets.
An example would be in the marine side on the on the outdoor side, where we service we provide product to Oems, we're seeing we're seeing recovery there.
Areas like trade shows, which we've always said head to head significantly.
Slowed those haven't those haven't recovered. So you have a combination of recovery and you see our comps from from the second half of last year. So there is an element to that but we are seeing.
Select categories. Some some recovery our focus there has been obviously on this piece, we're talking about but also.
You're taking some taking some action that we took at the back end of last fiscal year to get the cost structure aligned to where the revenues are and you see you see in the <unk>.
Our results from some of the margin improvement coming out of that business. So we're focused there as well.
And just to remind you.
As a percentage of our total business, it's I think on a TTM basis, only somewhere around 5% of our EBITDA.
Low low low double digits percentage of our sales so.
Right, great. Thanks for that and my follow up <unk>.
Your capital allocation strategy after the increased Capex and investments you announce today just wondering if there was any update on your priorities moving forward and also on your potential appetite for a share repurchase program.
Yeah, I'll take that at a high level.
If you connect the dots here, we continue to see a.
A really nice market.
For US ahead of us and as such we're always going to continue to prioritize investing in our in our own business. Because we believe that that provides us adequate returns and selectively we will look at.
Potential acquisitions.
Better accretive.
And add to our business model and then the third component as well.
We'll always evaluate whether or not there is additional capital actions, we can take that.
That would be beneficial to shareholders.
Yes.
Great. Thank you.
Your next question from the line of Keeton Manta Ray from BMO.
Thank you for taking my questions Jesse just to follow up on that question around capital allocation.
You mentioned, you've got you know it.
It goes sort of runway ahead I'm just curious what is the right way to think about.
Sort of capital allocation capital investment run rate into the business I'm not looking at a specific number but just sort of some sort of frame up you know as you kind of increased capacity to meet this demand.
Yeah.
I'll take that one.
The way the way, we think about it first as Jesse mentioned here.
We get a very strong return you could look at our return on tangible assets.
Being able at around 40%, we've got a very strong return on our investments in particular on capacity.
So.
Investing in the business as we've said and continue to say.
This is our first priority for free deploy.
Deploying operating cash flow, but.
The framework for <unk>.
Going forward on capital and that we're not we're not in a position today to guide into 'twenty, two and beyond but.
As you can see them.
The majority of R. R.
Cash flow this year is going towards that priority, which is which is driving our capacity in and supporting our future growth and looking forward.
I've said modeling wise on a on a kind of a steady state basis, our capex as a percentage of revenue would be somewhere in the 5% to 7% range.
We're not we're not guiding 22, yet, but I'd say just sitting here today from what we're looking at.
We're going to be over 10% of revenue in 'twenty two.
But again.
All supportive of.
Continuing to drive the growth that we see.
Got it that's helpful perspective, a good luck in the back half of the year I'll turn it over.
Thank you.
Yeah.
And your next question the line of Anthony Pettinari from Citigroup.
Hi, good morning.
This does the Idaho facility being your first big facility in the Western U S does that open up opportunities in terms of regional market share either with dealers or retailers or is that not necessarily impactful and then just generally when we think about some of this capacity coming online across the network, where do you see sort of the.
Rental opportunity for you to gain share either geographically or in the dealer versus retailer channels.
Yeah.
So as you look at as you look at our footprint right now we've got terrific.
Distribution that covers the.
The western part of the U S. We took some steps to upgrade that.
Over the last few years.
And they do a really nice job of being able to service that market now having said that obviously, putting additional capacity.
In a geography, especially on the order of magnitude that we're putting in there we expect will allow us to continue to grow.
At a at a rapid rate there and then as you look at capacity coming online in general in the marketplace.
I think it's fair to assume that.
That.
Uh huh.
The leaders in the marketplace the two leaders in the marketplace.
As we bring capacity online it will allow us to continue to.
To grow the market and potentially either accelerate wood conversion or.
Continue to.
<unk> gained share against a inferior.
Competition, and so you know as capacity comes online and as we bring capacity online we do think it unlocks additional growth opportunity.
And we see opportunity to launch new products.
We see opportunities to continue to expand our footprint and to aggressively go after business.
Across the various channels that are out there including.
All channels.
National retail price.
Okay. That's very helpful. And then just one follow up if I could I mean, this is kind of maybe more of a big picture question, but.
Outdoor living was doing very well before COVID-19 ASIC was doing very well before COVID-19.
As we're sort of slowly emerging hopefully from the pandemic do you think about the experience over the last 12 months is something that.
Permanently accelerated consumer interest in this category in your products.
Was there maybe sort of a onetime benefit as we reopen.
Could that come back a little bit I'm, just from a big picture perspective, how do you kind of think about the impact of the pandemic on your products and your industry.
Yeah any.
So thanks for pointing that out.
We have growth coming into the strong growth coming into the pandemic and that was driven by underlying trends, which is a focus on outdoor living our focus on the house.
And wood conversion.
As you look at what's occurred during the pandemic more people have stayed at home and more people are evaluating.
What matters to them in the house and as a reminder, there are 60 million decks.
That are beyond their useful life, according to not draw half of them or be at $60 million of exist index half of them are beyond their useful life.
There's a lot of people that spent a lot of time.
<unk> that and so we believe.
That that will just.
Step up.
The potential acceleration of the marketplace.
Add to that and I'll just give you an anecdote.
An acquaintance of ours.
Happen to be in a housing development they put in a timber tact.
<unk> last year and 14 of their neighbors have put index in the last.
Subsequent since they've put index timber tech decks.
Cause they saw they saw the value and they saw the looks of the aesthetics of what this friend of ours put in actually a family member put in my brother in law put in and and so.
It's anecdotal, but I think in general we're in a market where the more people see our product in a more product is on the ground the greater the potential for acceleration of market conversion and what we see in the data.
Underlying that seems to bear that out and that's why we're so excited about being able to bring capacity online there.
It allows us to continue that progression.
Okay, that's great color and very helpful I'll turn it over.
And your final question comes from the line of Susan.
Larry.
From Goldman Sachs.
Good morning, this is actually Charles per round in preseason today. Thanks for taking my question.
My first one is on your guidance and if my math is right. Your guide seems to imply that residential sales will grow in the high <unk> range year over year in the fourth quarter, which is impressive considering you come off a very tough comp a year ago. I know, we're still early for fiscal 'twenty, two but should should we see this exit run rate directionally.
That's something you could sustain at least for the first part of 'twenty two assuming the demand trends remained similar to where they are today and also considering pricing and the new capacity expansion Youre having.
Well, we were obviously not going to guide to 'twenty two.
On this call, but what I'll highlight is just some of the things we talked about as we exit.
We will have.
We will have a balance in a more normalized price inflation balance exiting.
The fiscal year, and we continue to see.
Really strong.
Demand indicators exiting the fiscal year.
And as I mentioned earlier in response to a question we also see that.
Potential for lower levels of inventory in the channel exiting the year so.
Those are what we've talked about on the call and beyond.
Beyond that well.
We'll have a discussion on 'twenty two when.
The time is appropriate.
Alright, thanks for the color there and just as a quick follow up on the on the pro side have you heard from the channel the channel any constraint on the growth coming from the ability of labors at your contractor specifically.
Yeah, I think in general the one.
<unk> to get.
Labor across the economy is something that obviously exists.
And you know it's existed in our market.
Before the pandemic through the pandemic and as we exit the pandemic and so.
Think.
Certainly there's a R.
Our contractor base our dealer base.
They are focused on.
On meeting demand.
But certainly they like many of of.
Many other industries are working their way through.
Available labor and.
The ability to continue to meet demand and as we look at that what what that potentially does is it extends it extends the season it extends the curve and it starts to.
Naturally push out some of the demand that we're seeing.
In the future quarters.
Alright, Thank you for your time.
And I would like to now turn the call over to Mr Singh for closing remarks.
Great. Thank you for all taking the time this morning.
As you can see from our comments in the discussion on the call our strategy and operational expertise are allowing us to benefit.
From the longer term secular trends in the attractive markets that we play in addition, our responsiveness and capacity expansion plans will allow us to go after the strong demand we're seeing in outdoor living trends in R&R.
Thanks again for your interest in <unk>, and we look forward to updating you on our performance next quarter have a great day.
This concludes today's conference call. Thank you for participating you may now disconnect.
Okay.
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