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The AZEK Company Inc. (NYSE:AZEK)
Q2 2021 Earnings Call
May 13, 2021, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Welcome to The AZEK Company's second-quarter 2021 earnings call. [Operator instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Jon Skelly, senior vice president, strategy and execution. Thank you.

Please go ahead.

Jon Skelly -- Senior Vice President, Strategy and Execution

Thank you. Good morning, everyone. We issued our earnings press release this morning to the Investor Relations portion of our website at investors.azekco.com, as well as via 8-K on the SEC's website. I'm joined today by Jesse Singh, 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, AZEK management may make certain statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These include remarks about future expectations, anticipation, beliefs, estimates, forecasts, plans, and prospects. Such 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 and as filed 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 in our 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 2021.

I would now like to turn the call over to Jessie Singh.

Jesse Singh -- Chief Executive Officer

Good morning. I'd like to welcome everyone to today's call. As we approach the one-year anniversary of our IPO, I couldn't 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 the 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. Demand and material conversion trends in our key outdoor living and exteriors markets remain 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 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 are 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 2022. 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 remained 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 are 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 brand, manufacturing, R&D, and customer connection. I am particularly proud that TimberTech was, once again, recognized as No.

1 in quality in the Builder Brand-New 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 of rustic reclaim wood. The collection has been well received and is gaining momentum in the marketplace.

We remain 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 commitments to ESG stewardship. We are driving differentiated innovation in the marketplace across our portfolio with award-winning products. AZEK shingle siding with Paint Pro technology was named as a best new product in 2021 and by LMC.

We continue to launch new products with the best aesthetics that address customer needs, increase 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 location, available, highly skilled workforce and common values around sustainability and growth were key criteria for selecting Boise. Construction is under way, and we are on track to be fully operational in 2022.

Earlier this week, we released our inaugural ESG report, an important 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 results 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 CO2 per $1 million of net sales.

In other words, we produced and sold more products in fiscal 2020, but emitted 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 life cycle assessment for decking, which showed that our TimberTech decking lines 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-based 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% 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, 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 online during the next quarter, which will further allow us to improve service levels during the busy deck-building season. We are seeing continued improvements 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 return 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. The unusual winter storms in February that impacted Texas and Louisiana, resulted in a very 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 also 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. Phase 2 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 remain 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 1 and Phase 2 combined. The vast majority of this upsized investment is supporting incremental capacity that will come online early in our fiscal 2022. In addition, construction is under way 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 this inflationary environment and we 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. During our fiscal second quarter, we implemented an additional price increases with 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 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 in 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, sample 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 really contemplate significant inventory build in the channel. The macroeconomic 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 also 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 the business model and strategic positioning that allow us to deliver strong results. With that, I'd like to turn this call over to Ralph, who will discuss our financial results and outlook in greater detail.

Ralph Nicoletti -- Chief Financial Officer

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 about $47.5 million or 19% to $293.1 million. 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 '21 increased by $18.5 million or 23.3% to $97.9 million. Adjusted gross profit for the second quarter of fiscal '21 increased by $19.4 million or 20.3% to $114.7 million. Adjusted gross profit margin was 39.1%, an increase of 30 basis points compared to the prior year period. During the quarter, we were able to offset inflation and start-up 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, and mainly from the freeze in Texas, and we have taken additional pricing to offset the impact. Selling, general and administrative expenses increased by $10.2 million to $59.9 million or 20.4% as a percentage of total sales for the 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 for the 3 months ended at March 31, 2020, primarily due to higher net sales and lower interest expense. Adjusted net income was $39.3 million or $0.25 a share for the second quarter compared to adjusted net income of $18.4 million or $0.17 per share a year ago. Adjusted EBITDA for the second quarter of fiscal '21 increased by $15.7 million or 28% to $71.5 million. For adjusted EBITDA, our margin expanded 170 basis points to 24.4% from 22.7% a year ago.

Now turning to our segment results. Our residential segment net sales for the second quarter of fiscal '21 increased by $52 million or 25% to $262.2 million. Residential segment adjusted EBITDA for the second quarter of fiscal '21 increased by $18.9 million or 30.1% to $81.7 million. The increase was primarily driven by higher sales.

Commercial segment net sales for the second quarter of fiscal '21 decreased by $4.4 million or 13% to $30.9 million. The decrease was primarily driven by declining sales in our Scranton Products and Vycom businesses as the effects of COVID-19 continue to impact our end markets. Commercial segment adjusted EBITDA for the second quarter of fiscal '21 was $3.7 million. The $600,000 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. Company total debt as of March 31, '21, was $467.7 million, and we have not drawn on a revolving credit facility, and net leverage ratio stood at 1.3 times at the end of fiscal Q2. Net cash provided by operating activities was $7 million for the six months ended March 31 of '21 and versus a use of approximately $68 million for the six months ended of March 31, 2020.

Turning to our outlook. As Jesse mentioned, we are increasing our investments in capacity and now expect total capital expenditures in fiscal '21 to be in the $175 million to $185 million range, providing both additional recycling capability and 15% more decking capacity as we further invest 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-30s range and adjusted EBITDA growth in the 15% to 18% range. I'd also like to provide you with some additional color regarding the margin progression from fiscal Q3 through the balance of the year.

Entering 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 2 additional pricing actions, which only partially benefit Q3 and for which we expect to realize the full benefit in our Q4. As a result, our third quarter margins are forecasted to decline year over year due to this timing of 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 start-up costs in Q4 from our pricing and productivity.

So, on a run rate basis, we are exiting the year positioned to cover our higher costs. Turning to the full year of fiscal '21. 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 start-up 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 more than offset by pricing and manufacturing 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 at mid-single-digit rate year over year, consistent with our prior outlook. To assist the modeling, and we continue to really expect approximately $21 million to $22 million of interest expense for the full year in 2021. Our tax rate for '21 is estimated to be approximately 25%, and our full-year weighted average diluted share count is about unchanged at approximately 157 million shares.

I'll turn the call back to Jesse for closing remarks.

Jesse Singh -- Chief Executive Officer

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 in creating a more sustainable future.

With that, operator, please open the line for questions.

Questions & Answers:


Operator

[Operator instructions] Your first question is from the line of Philip Ng from Jefferies LLC.

Philip Ng -- Jefferies -- Analyst

Hey, guys. Congrats on a really strong quarter. So Jesse, with some of the incremental capex you're spending this year, would you be able to speed up or unlock more capacity this year? And does the incremental 15% capacity you're announcing signal any wins for many of your channel partners?

Jesse Singh -- Chief Executive Officer

First off, thanks, Phil, for your earlier comments. First off, relative to specifically any wins in the market, we've continued to really focus on executing our business model and continue to focus downstream. And so we're going through a constant 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, and just as a reminder, we have additional capacity that is coming online as part of that Phase 2 near the end -- during this quarter. The machines are actually in and they're going through the ramp-up phase, as we speak. So we expect to see the benefit of that action near the end of this month. And then this additional capacity, what it allows us to do is bring an additional 15% online 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 online.

Philip Ng -- Jefferies -- Analyst

OK. That's helpful. And the move in virgin resin prices, I mean, this is pretty unprecedented. Great to see how the team managed inflation well and then certainly on the supply constraints as well.

Any color on the magnitude of a 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.

Jesse Singh -- Chief Executive Officer

Yes. 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 appropriately raise prices such that 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?

Ralph Nicoletti -- Chief Financial Officer

Sure. Yes. Good morning, Phil. So first on the -- let me just kind of go back to the inflation side.

As you recall from our last earnings call, we said we're seeing a lot of inflation and 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 freeze situation in Texas and Louisiana but we saw -- we've seen resins in particular spike very substantially. And now they've stabilized but at a pretty high level -- very high level. So we took a third price increase.

It's largely -- it's really going to impact Q4 on that one that we've recently announced. And in order of magnitude, it's a mid-single-digit a mid-single-digit price increase on an annualized basis. And we'll get a portion of that, obviously, in fiscal '21 in the fourth quarter.

Philip Ng -- Jefferies -- Analyst

And, Ralph, that $30 million additional inflation, is that a quarterly run rate or a full year run rate?

Ralph Nicoletti -- Chief Financial Officer

No, that's just for perspective of just what we experienced since the last earnings call in this fiscal year. How it plays out ultimately, I think, really depends on what the inflation outlook comes to bear as we move forward. But with this pricing, as we said in our remarks, we've offset our costs in '21 and positioned ourselves we think, well exiting the year because we have the cost that we see today covered.

Philip Ng -- Jefferies -- Analyst

OK. Excellent, guys.

Ralph Nicoletti -- Chief Financial Officer

OK.

Operator

And your next question line of Matthew Bouley from Barclays.

Matthew Bouley -- Barclays -- Analyst

Good morning, everyone. Congrats on the results, and thanks for taking the question. Let me go back to the capacity add. Just firstly, the incremental 15% in early fiscal '22, does that suggest it's coming at 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. Can you elaborate a little bit on that? Are these type of mid-teens increments the right way to think about how you're all looking at it going forward? Thank you.

Jesse Singh -- Chief Executive Officer

Yes. 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 will be deploying that at our existing facilities. And then relative to your question on future capacity adds, just as a reminder, the facility that we have, that we talk about in Boise, has a relatively large footprint, 350,000 square feet.

And we have the capability to add additional equipment if we so choose to do that into that facility beyond what we've highlighted we're planning on doing in 2022. And once again, as a reminder, which is why we're able to deploy the 15% and also potential 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. It gives us a lot of flexibility in terms of meeting demand and managing through our capacity.

Matthew Bouley -- Barclays -- Analyst

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 there's some SG&A normalization upcoming, but I'm more curious about the longer term.

What do you think you need to do from scaling your sales force and a marketing perspective as you continue to get bigger on the capacity side? Thank you.

Jesse Singh -- Chief Executive Officer

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 or actually probably over 200 salespeople now focused in our residential business.

That is a large powerful footprint that allows us to continue to drive market penetration. 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 our marketing investment.

We feel really good about the progress that we've made, both on the brand and the digital front. And we'll continue to make sure that we're well prepared and well positioned for the future as we continue those investments.

Matthew Bouley -- Barclays -- Analyst

Great. Well, thank you for that, Jessie, and good luck.

Jesse Singh -- Chief Executive Officer

Appreciate it. Thanks, Matt.

Operator

Your next question the line of Mike Dahl with -- from RBC Capital Markets.

Unknown speaker -- RBC Capital Markets -- Analyst

This is actually Kris Klaun on for Mike. Thanks for taking my questions. My first question is just to clarify, that incremental $30 million in costs that you guys saw from last quarter, is that just coming from the virgin PVC inflation you're seeing? And if so, any way you could provide either on a dollar or percentage basis, what's the total cost inflation you're currently experiencing? And what's embedded in your guide? Thanks.

Ralph Nicoletti -- Chief Financial Officer

Yes. So I could add a little bit more perspective to it. 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 -- 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's inflation that we're seeing across the board. The majority of that $30 million incremental since the last call for this year is in the resin side. And frankly, we're seeing even the cost to 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 some color on what we're seeing.

In aggregate, it really -- not to 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 is we've taken three price increases this year. Two sort of low single-digit ones, which we previously announced, and one -- mid-single-digit one that I had mentioned earlier. And so when you kind of cumulatively think about that, in aggregate, 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 the run rate in the fourth quarter.

So I think that might help you a little bit.

Jesse Singh -- Chief Executive Officer

Yes. And if I could just add, as Ralph mentioned on the call, in our view, this is a relatively -- the balance that Ralph is 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 in our guidance, as you dissect it, implies some additional benefit as we move into next year.

Unknown speaker -- RBC Capital Markets -- Analyst

Got it. That's helpful color. And for my follow-up, I guess, given the price cost neutrality exiting the year, so maybe some color on some of the other moving pieces like start-up costs and the productivity bucket. What's -- any way you could quantify what those start-up costs look like for the incremental capacity additions? And then when you think about the productivity offset, is that just from higher overhead leverage? Does that include the benefits from the recycling initiatives and the continuous improvement? Thanks.

Jesse Singh -- Chief Executive Officer

Yes. Ralph, I can just take it at a really high level. In general, we had start-up costs as we ramp our -- the capacity we have coming online now. We will have additional relatively modest start-up costs as we add 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 -- off a 2019 baseline, we've got 500 basis points of productivity and margin expansion that we have, that we 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.

Unknown speaker -- RBC Capital Markets -- Analyst

Understood. Thanks for taking my question.

Operator

Next question from line of Tim Wojs from Baird.

Unknown speaker -- RBC Capital Markets -- Analyst

This is Josh Sheng filling in for Tim. Thanks for taking my question. I guess my first question is on the demand side of things. So to what extent does the backlog in this industry kind of carry into the following year? So if the 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 can give you confidence into the following decking season?

Jesse Singh -- Chief Executive Officer

Yes. We survey our -- we survey both our contractors and our dealers relative to their backlog and the visibility that they have. And we -- 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 based on historic data, they lead two to 16 months, right? The decision-making process on a deck, for example, our research shows could be up to 16 months. And as such, we fully expect that the activity that's occurring now will benefit us for many months in the future.

Unknown speaker -- RBC Capital Markets -- Analyst

And then to virgin, and then on 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?

Jesse Singh -- Chief Executive Officer

Yes. We -- as we highlighted, we continue to invest in our recycling capability. And as a reminder, for us, there's really three phases to our recycle. 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 on all of those fronts. As you look at what we're doing -- without getting too specific, even within the quarter, we've identified some additional lower-cost sources, and we continue to deploy and expand that effort. And we're investing to make sure that we have the capability to self-supply into the future.

Unknown speaker -- RBC Capital Markets -- Analyst

Great. Thanks for the color and good luck on the second half.

Jesse Singh -- Chief Executive Officer

Appreciate it. Thank you.

Operator

The next question the line of Ryan Merkel from William Blair.

Ryan Merkel -- William Blair -- Analyst

Hey. Thanks for taking the questions. I guess, first off, thanks for the color on margins in 3Q. I was hoping you can 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 ranking.

Ralph Nicoletti -- Chief Financial Officer

Ryan, this is Ralph. That's related to Q3? Just to make sure I heard the question.

Ryan Merkel -- William Blair -- Analyst

Yes, correct.

Ralph Nicoletti -- Chief Financial Officer

So Q3, as we even indicated on the last call, we were going to have pressure on margins. And the moving parts, which I think you got most of them, here's how to think about this. First, with commodity -- the resins in particular but overall inflation, but mainly resins even accelerated in terms of the impact, which we've talked about now. And that is coming through the third quarter significantly.

I'll come back to pricing in a minute, but you have inflation generally as well as an acceleration coming out of that freeze in Texas all hit in the quarter. We have start-up costs as we're adding capacity clearly in there and 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 helped the third quarter, but the last two really more impact Q4 than Q3.

So there was an imbalance on pricing relative to costs, which we had mentioned last time but it was just even more magnified with the higher inflation. Now having said all that, There's also on the SG&A side, public company costs. We can't forget about that. We're -- we're now about $2 million a quarter on SG&A higher just from being a public company.

And the return to a normalized level of SG&A investment, particularly in marketing and travel in the third quarter. So when you look at the third quarter and sum that up, you have pricing and productivity partially offsetting these other headwinds that I spoke about. Those are the moving pieces.

Ryan Merkel -- William Blair -- Analyst

Got it. Thanks for that, Ralph. And then, Jessie, 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?

Jesse Singh -- Chief Executive Officer

Yes. Thanks for the question. As we look at future demand, as I pointed out on the call, we look at a lot of different variables. And we look 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 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 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 the way we look at the market is we view the decking conversion, and the opportunity we have for wood conversion can 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, we do see people considering their options.

But in that, we see a lot of that going toward -- a lot of that going toward our more premium product. And 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 and the out years.

Ryan Merkel -- William Blair -- Analyst

Thanks, Jessie. Best of Luck.

Jesse Singh -- Chief Executive Officer

Appreciate it. Thank you.

Operator

Our next question the line of Michael Rehaut from JP Morgan.

Unknown speaker -- RBC Capital Markets -- Analyst

Hi. Congrats on the quarter. This is Maggie on for Mike. Following up on the last question and the impact of -- that you've seen from some of the lumber price increases.

I think you said that you've seen a lot of that demand going toward your premium product, but have you seen any shift toward your lower-priced product? Any mix shifts just given the higher lumber prices?

Jesse Singh -- Chief Executive Officer

We can -- 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 really nice broad mix of interest.

Unknown speaker -- RBC Capital Markets -- Analyst

Got it. Thank you. And second, and I apologize if I missed this in the prepared remarks, but did you break out the growth between deck rail and accessories versus exteriors?

Jesse Singh -- Chief Executive Officer

We did not break that growth out. But just suffice it to say that we saw nice growth across the business.

Unknown speaker -- RBC Capital Markets -- Analyst

OK. And one more quick one, if I can. As you're seeing that nice growth, do you see any need going forward to add additional capacity across your rail or exteriors businesses?

Jesse Singh -- Chief Executive Officer

Yes. We continue -- when we talk about capacity adds, we highlight specifically some of the decking adds and the percentages associated with that. But along the way, the capacity adds that we've highlighted really include 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 -- 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 really deliver high service to our customers. So we're actually seeing the benefits of being able to supply our customers at a very high level.

Unknown speaker -- RBC Capital Markets -- Analyst

Got it. Thank you.

Operator

Your next question is from Stanley Elliott from Stifel.

Stanley Elliott -- Stifel Financial Corp. -- Analyst

Hey. Good morning, everyone. Congratulations, and thank you for the time. Just you mentioned on the contractor survey and some of the sampling activity, it sounds like you guys have pretty good visibility out even 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's correct, are we looking at another kind of low inventory part of the start of the year into '22 kind of given how strong demand has been?

Jesse Singh -- Chief Executive Officer

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 end-consumer and dealer and 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 to replenish channel inventory is diminished.

Stanley Elliott -- Stifel Financial Corp. -- Analyst

And could you comment on what you're seeing, if any differences between kind of the big box and the pro channel? I'm assuming there's -- demand's pretty evenly split but we'd love to kind of get some commentary and any color you could provide.

Jesse Singh -- Chief Executive Officer

Yes. We see really nice demand for us on both sides. And obviously, the makeup of the demand and how it manifests itself varies geography by geography. And there are some nuances between the two sides.

But in general, we see really strong demand and growth, both in the pro and in -- on the retail side for us.

Stanley Elliott -- Stifel Financial Corp. -- Analyst

Great, guys. Thank you very much and best of luck.

Operator

Your next question is from the line of Trey Rooms from Stifel -- Stephens Inc.

Trey Rooms -- Stephens Inc. -- Analyst

Yes. Hey, good morning, guys. Thanks for taking my question. First would be, I guess on the rapid normalization of SG&A you're talking about.

Is the expectation that that will pretty well be caught up as we go into the -- through 4Q, fiscal 4Q? Should we expect to see that kind of normalization continue into next year as well?

Ralph Nicoletti -- Chief Financial Officer

Yes, Trey, the -- if you think about this, there's two pieces of it. The larger piece being marketing related, and we've been investing throughout the year and certainly in the second half of this year into next year. I think -- so that's, I'll call normalized more. On the travel side, I think it's beginning to normalize, but it's a lesser part of the total SG&A.

And I think, importantly, I think just as you think about what we have been saying is that through pricing and productivity, we've positioned ourselves. We feel well as we exit the year, going into next year to cover the cost that we see but we're investing in SG&A to drive the business forward.

Trey Rooms -- Stephens Inc. -- Analyst

Great. Thank you for that. 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 across all product lines or is it specific to certain product categories or class?

Jesse Singh -- Chief Executive Officer

Go ahead, Ralph. Go ahead.

Ralph Nicoletti -- Chief Financial Officer

Well, yes, I was -- I mean, generally, it's a mix across the different categories. So -- but it's touching a lot of the different product categories at various different rates. But on average, it comes to what I said was mid-single digits.

Trey Rooms -- Stephens Inc. -- Analyst

Got it. OK. All right. Well, thanks for taking my questions.

I'll leave it at that and congrats on the good quarter and good luck.

Ralph Nicoletti -- Chief Financial Officer

Appreciate it.

Jesse Singh -- Chief Executive Officer

Thanks, Trey.

Operator

Next question is from the line of Jeff Stevenson from Loop Capital.

Jeff Stevenson -- Loop Capital Markets -- Analyst

Hi. Thanks for taking my questions today. My first is just can you talk about commercial sales trends and the 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?

Ralph Nicoletti -- Chief Financial Officer

The -- on the commercial business, It's a little bit of both. We're clearly seeing some recovery in order patterns on certain end markets. An example would be in the marine side, on the outdoor side where we service -- we provide product to OEMs. We're seeing recovery there.

Areas like trade shows, which we've always said had significantly slowed, those haven't recovered. So you have a combination of recovery, and you see our comps from the second half of last year. So there is an element to that but we're seeing in select categories some recovery. Our focus there has been, obviously, on this piece we're talking about, but also 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 in the -- in our results, some of the margin improvement coming out of that business. Some focused there as well. And just to remind you, as a percent of our total business, it's -- I think on a TTM basis, only somewhere around 5% of our EBITDA and low double-digit percentage of our sales.

Jeff Stevenson -- Loop Capital Markets -- Analyst

Right. Right. And my follow-up was on your capital allocation strategy after the increased capex investments you announced today. Just wondering if there's any update on your priorities moving forward and also your potential appetite for a share repurchase program?

Jesse Singh -- Chief Executive Officer

I'll take that at a high level. We -- if you connect the dots here, we continue to see a really nice market for us -- ahead of us. And as such, we're always going to continue to prioritize investing in our own business because we believe that that provides us adequate returns. And selectively, we will look at potential acquisitions that are accretive and add to our business model.

And then the third component is we'll always evaluate whether or not there's additional capital actions we can take that would be beneficial to shareholders.

Jeff Stevenson -- Loop Capital Markets -- Analyst

Great. Thank you.

Operator

Your next question is from line of Ketan Mamtora from BMO.

Ketan Mamtora -- BMO Capital Markets -- Analyst

Thank you for taking my questions. Just to follow up on that question around capital allocation, you mentioned you've got a good 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 framework as you kind of increase capacity to meet this demand?

Ralph Nicoletti -- Chief Financial Officer

Yes. I'll take that one. The way we think about it, first, as Jesse mentioned here, we get a very strong return. You can look at our return on tangible assets being around 20%.

We 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, is our first priority for deploying operating cash flow. But the framework for going forward on capital, we're not in a position today to guide into '22 and beyond. But as you could see, the majority of our cash flow this year is going toward that priority, which is driving more capacity and supporting our future growth.

And looking forward, I've said modeling-wise on a kind of steady-state basis, our capex as a percent of revenue would be somewhere in the 5% to 7% range. 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 '22. But again, all supportive of continuing to drive the growth that we see.

Ketan Mamtora -- BMO Capital Markets -- Analyst

Got it. That's helpful perspective. Good luck in the back half of this year.

Jesse Singh -- Chief Executive Officer

Thank you.

Operator

And your next question from the line of Anthony Pettinari from Citigroup.

Anthony Pettinari -- Citi -- Analyst

Good morning. 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 incremental opportunity for you to gain share either geographically or in the dealer versus retailer channels?

Jesse Singh -- Chief Executive Officer

Yes. So as you look at our footprint right now, we've got terrific distribution that covers 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 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 the leaders in the marketplace -- the two leaders in the marketplace, as we bring capacity online, it will allow us to continue to grow the market and potentially either accelerate wood conversion or continue to gain share against inferior competition. And so 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, international, retail, pro.

Anthony Pettinari -- Citi -- Analyst

OK. 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, [Inaudible] was doing very well before COVID.

As we're sort of slowly emerging hopefully from the pandemic, do you think about the experience over the last 12 months as something that permanently accelerated consumer interest in this category and 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?

Jesse Singh -- Chief Executive Officer

Yes. Any -- so thanks for porting that. Obviously, we have growth coming in -- strong growth coming into the pandemic, and that was driven by underlying trends, which is a focus on outdoor living, a 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's 60 million decks that are beyond their useful life according to [Inaudible]. Half of them are -- 60 million exist in decks, half of them are beyond their useful life. There's a lot of people that spent a lot of time evaluating that. And so we believe 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 TimberTech deck last year, and 14 of their neighbors have put in decks in the last subsequent since they've put in decks -- TimberTech decks, because they saw the value and they saw the looks and the aesthetics of what this friend of ours put in -- actually a family member put in, my brother-in-law put in. And so it's anecdotal, but I think in general, we're in a market where the more people see our product and the 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 that allows us to continue that progression.

Anthony Pettinari -- Citi -- Analyst

OK. That's great color and very helpful. I'll turn it over.

Operator

And your final question comes from the line of Susan Maklari from Goldman Sachs.

Charles Perron -- Goldman Sachs -- Analyst

Good morning. This is actually Charles Perron in for Susan 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 20s 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 '22, but should we see the exit run rate directionally something you could sustain at least for the first part of '22, assuming that demand trends remain similar to where they are today and also considering pricing and the new capacity expansion you're having?

Jesse Singh -- Chief Executive Officer

Well, we're obviously not going to guide to '22 on this call but what I'll highlight is just some of the things we talked about as we exit. We'll 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 the 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 that, we'll have a discussion on '22 when the time is appropriate.

Charles Perron -- Goldman Sachs -- Analyst

All right. Thanks for the color there. And just as a quick follow-up, on the pro side, have you heard from the channel any constraint on the growth coming from the ability of labors at your contractors specifically?

Jesse Singh -- Chief Executive Officer

Yes. I think in general, the ability to get labor across the economy is something that obviously exists. And it's existed in our market before the pandemic, through the pandemic and as we exit the pandemic. And so I think certainly, there's a -- our contractor base, our dealer base, they are focused on meeting demand.

But certainly they, like many 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 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.

Charles Perron -- Goldman Sachs -- Analyst

All right. Thank you for the time.

Operator

And I would like to now turn the call over to Mr. Singh for closing remarks.

Jesse Singh -- Chief Executive Officer

Great. Thank you for all taking the time this morning. As you can see from our comments and 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 and R&R.

Thanks again for your interest in AZEK, and we look forward to updating you on our performance the next quarter. Have a great day.

Operator

[Operator signoff]

Duration: 69 minutes

Call participants:

Jon Skelly -- Senior Vice President, Strategy and Execution

Jesse Singh -- Chief Executive Officer

Ralph Nicoletti -- Chief Financial Officer

Philip Ng -- Jefferies -- Analyst

Matthew Bouley -- Barclays -- Analyst

Unknown speaker -- RBC Capital Markets -- Analyst

Ryan Merkel -- William Blair -- Analyst

Stanley Elliott -- Stifel Financial Corp. -- Analyst

Trey Rooms -- Stephens Inc. -- Analyst

Jeff Stevenson -- Loop Capital Markets -- Analyst

Ketan Mamtora -- BMO Capital Markets -- Analyst

Anthony Pettinari -- Citi -- Analyst

Charles Perron -- Goldman Sachs -- Analyst

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