The AZEK Company Inc. (AZEK) Q3 2021 Earnings Call Transcript

The AZEK Company Inc. (AZEK -2.18%)
Q3 2021 Earnings Call
Aug 12, 2021, 10:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Welcome to AZEK's Company third-quarter 2021 earnings call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded.

I'd now like to hand the conference over to Amanda Cimaglia, vice president ESG. Please go ahead.

Amanda Cimaglia -- Vice President, Investor Relations

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; Pete Clifford, our incoming chief financial officer; Jon Skelly, our senior vice president of customer experience; and Greg Jorgensen, our chief accounting officer.

Before we begin, I would like to remind everyone that during this call, AZEK's 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 our third quarter of fiscal 2021 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 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 third quarter of fiscal year 2021.

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

Jesse Singh -- Chief Executive Officer

Good morning, everyone, and thanks for joining us today. Before we begin, I'd like to officially welcome Pete Clifford, our incoming CFO, to the call. Pete was most recently CFO and then president and COO of Cantel Medical. We're fortunate to have an overlap in both Pete and Ralph's time with the company, which is sure to facilitate a smooth transition.

Pete, thank you for joining us, and I look forward to working with you for many years to come. I'll start by recognizing the impressive efforts of our team, which delivered strong revenue and EBITDA growth in the fiscal third quarter. This builds upon the momentum of our business as seen over the last several years. Since completing our IPO just over a year ago, we believe we have demonstrated the flexibility of our differentiated business model, the agility of our team and our commitment to investing for growth and delivering against our long-term sales and margin expansion goals.

We believe that the breadth of our portfolio and the strength of our market presence allows us to uniquely benefit from secular growth and material conversion opportunities. We are not only growing and expanding in decking, railing, and accessories, but are seeing strong growth and market conversion in our exteriors portfolio. This includes a broad mix of complementary products that are benefiting from wood conversion. More specifically to today's update, we continue to experience favorable end-market demand in our residential segment, and we have started to see improving sales trends in the commercial segment.

We continue to execute and invest against our strategic initiatives to deliver long-term growth and margin expansion, while managing through near-term supply chain and inflationary pressures. We remain confident in our outlook for the remainder of the year and are once again, raising our fiscal 2021 guidance. We believe that we are well-positioned to continue to grow in fiscal year '22 and are well-positioned to achieve and exceed our long-term growth and margin objectives. During the quarter, we saw strong growth across the residential portfolio.

As market demand remained strong, additional capacity came on line, and we modestly improved our inventory position at our dealer base. Our SG&A returned to more normalized levels and included additional public company costs and strategic investments. We made additional investments to ensure labor, transportation, and raw material availability to meet strong customer demand, and saw increasing raw material and inflationary pressures, as we progressed through the quarter. We have taken additional pricing and productivity actions that we expect to fully offset these headwinds in early 2022.

Given recent investments in capacity in our exteriors business combined with strong sourcing and operational execution, we've been able to provide strong service levels and support to our customers in meeting increased demand. We also improved our service levels to our contractors and dealers for our decking product. However, our distribution channel continues to operate at below normal stocking levels. We continue to make progress on key initiatives that will drive long-term value-creation through growth and margin expansion.

As a reminder, these initiatives include, first, drive above market growth and accelerate material conversion by investing in new product innovation and expanding our downstream focused sales and marketing team. Ongoing product innovation supports our core and adjacency market expansion. Our new landmark and reserve decking lines, wood replacement trim, panelized aluminum rail, and Canvas Series tongue and groove products, all performed well and position us for ongoing future growth and wood conversion. Second, expand our margins through the use of recycled materials in our manufacturing processes and through our continuous improvement program.

We continue to expand our recycling capacity and develop strategic partnerships with various OEMs. We are finding new sources of otherwise hard to recycle materials that we are uniquely positioned to recycle into our products. We have recently expanded our use of a certain type of PDC product, which has historically been landfilled, providing us with lower cost sources of PVC and reducing environmental impacts. Third, positively impact the world through our commitment to ESG stewardship.

In recognition of our ESG leadership within the vinyl industry, we recently achieved Vantage Vinyl certification by the Vinyl Sustainability Council. The Vantage Vinyl certification underscores and validates our strong efforts to be a leader in the recycle of PVC materials. Diversity, equity, and inclusion continues to remain a key focus of our full circle ESG strategy. In June, we formalized and communicated our DE&I commitment statement, which serves as the foundation upon which we build out our DE&I framework.

In short, we are committed to providing a diverse, equitable, and inclusive workplace where diversity of all kinds is sought out, valued, respected, and appreciated. We believe this fuels our innovation, drives operational excellence, and as a source of our competitive differentiation. Fourth, invest in our core strengths, which include brand, material science, integrated manufacturing, and customer connection. During the quarter, we successfully brought on phase 2 of our $230 million multi-phase capacity expansion program, increasing our total decking capacity by 40% compared to the end of 2019.

Our previously announced upsized investments in capacity are on track to deliver an incremental 15% more decking capacity by the end of the calendar year. Our third phase, the opening of our new facility in Boise is expected to be fully operational during fiscal 2022, adding approximately 30% more decking capacity for a total of an 85% increase in decking capacity versus a baseline of 2019. We are making these investments against the backdrop of expanding market opportunities. We recently conducted a proprietary consumer market research study, which showed that nearly half of consumers in the market for wood decking would consider our types of high-performance low-maintenance materials.

This leads to a non-wood market that we believe over time could reach a conversion level of nearly 50% of the total decking market versus today's approximately 22%. We believe this favorable material conversion opportunity exists in all of the outdoor living markets in which we play, including our railing and exteriors market. This research strengthens our confidence in the long-term secular growth opportunities ahead, enabled by our leadership and innovation and investment in our key strategic initiatives. Turning to our third-quarter results, we delivered strong sales and adjusted EBITDA growth.

The growth environment remains robust, and we were able to incrementally ship more product as new capacity came on line during the quarter. We are also lapping an unusual Q3 in 2020 where we saw modest growth and lower spending constrained by the pandemic. The combination of spend normalization, additional investments, and public company costs, combined with the previously discussed inflation versus price lag, led to an EBITDA margin compression within the quarter. We are appropriately focused on meeting customer demand and improving service.

And we prioritize manufacturing output and product delivery. We are operating in an unusual environment with material labor and transportation where incremental volume can lead to an increased rather than decreased costs and lower volume leverage. We view this margin compression as transitory and have taken pricing actions to offset these headwinds beginning in Q4 and continuing as we move through fiscal Q1. For our residential business, we exited the quarter with improved service but have meaningfully lower levels of inventory in our distribution channel than historical norms.

While overall web traffic has returned to typical seasonal patterns, we saw higher quality digital engagement activity on our website and an approximately 25% increase in leads. Contractor backlogs remain extended and above historic levels. Repair and remodel activities strengthened during the third quarter, and housing inventory remains near record lows. With elevated buyer demand, we expect a continued tailwind resulting from homeowners investing in and renovating their homes and outdoor spaces.

We also continue to see strong sentiment from dealers and contractors as people continue to invest in larger repair and remodel projects. As previously indicated, the strategic actions we took within our commercial segment coupled with an improvement in certain end-market conditions, started to show through in the quarter. Net sales in our Commercial segment increased by approximately 17% year over year, as we are starting to see some demands returning. We've also seen nice margin recovery in this business throughout the fiscal year, driven by our team's focused execution on productivity and pricing actions.

As a reminder, this business tends to track more closely to GDP and the broader economy, which continues to improve. Now, turning to our outlook for the full year of fiscal 2021. We are raising our consolidated net sales outlook and increasing the midpoint of the range for our full-year adjusted EBITDA guidance. This increased guidance underscores our conviction in the underlying demand we are seeing across outdoor living and exteriors markets.

While we saw additional inflation during Q3, we also executed additional price and productivity actions to cover the increased costs. As we look at current inflation and supply chain dynamics, we expect pricing actions to offset inflation, as we exit fiscal Q1 2022. We feel that we have and will continue to manage through this unique period by prioritizing customer service, while maintaining our focus on delivering against our long-term growth and margin expansion objectives. To sum up, demand in our markets remains strong with a long runway to capture the expected growth in our markets.

We continue to invest in our core strengths of brand, manufacturing, R&D, and customer connection, supported by the best team and underpinned by our commitment to ESG leadership. We have confidence in our differentiated business model, operational execution, and strategic positioning in large and growing markets that we expect will allow us to deliver sustainable, above market growth, and achieve our long-term margin expansion goals. With that, I'd like to turn the 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 June 30, 2020. For the third quarter of 2021, we delivered net sales growth of 46% year over year to $327.5 million with strong growth in both our residential and commercial segments. Gross profit for the third quarter of fiscal '21 increased by $31.7 million or approximately 42% to $106.9 million.

The increase in gross profit was primarily driven by the strong sales results in the residential and commercial segments, pricing and manufacturing productivity, partially offset by higher raw material and manufacturing costs. Gross profit margin decreased to 32.6% for the three months ended June 30, 2021, compared to 33.6% for three months ended June 30, 2020. As expected, adjusted gross profit margin decreased 290 basis points to 37.9%, compared to 40.8% for the prior-year period. As we have discussed on our last two earnings calls, we have been experiencing significant inflation, as well as disruption in our supply chain, both driving up the cost to service these strong demand levels.

During the third quarter, cost increases intensified and have reduced the progress we were expecting on incremental margin in our fourth quarter, as we prioritized servicing customers. We implemented an additional price increase on August 1st, which will take effect October 1st. Cumulatively, our pricing actions this year represent a mid-teens increase. Selling, general, and administrative expenses increased by $5.1 million to 70.3 million or 21.5% of net sales for the third quarter.

Excluding the effect of lower stock-based compensation expense SG&A increased by approximately $18 million. The increase was primarily driven by higher personnel costs, public company costs, professional fees supporting strategic research, and marketing expenses. As a reminder, last year in Q3, we significantly pulled back on marketing and travel with the onset of the COVID-19 pandemic. Net income increased by $73.9 million to $21.8 million for the quarter, compared to a net loss of $52.1 million for the same period last year, primarily due to strong operating results and a decrease in interest expense, resulting from the reduced principal amount outstanding under our term loan agreement and in absence of the $37 million loss on debt extinguishment of our formerly outstanding senior notes.

Adjusted net income was $40.5 million or $0.26 a share for the third quarter, compared to adjusted net income of $6.2 million or $0.05 share a year ago. Adjusted EBITDA for the quarter increased by $14.9 million, approximately 26% to $72.7 million. The increase was mainly driven by higher sales growth in both, our residential and commercial segments and higher gross profit. As expected adjusted EBITDA margin declined 350 basis points to 22.2% from 25.8% last year, given the mismatch of pricing relative to cost increases and SG&A expenses.

Now, turning to our segment results. Residential segment net sales for the quarter increased by $98.6 million or 51% to $291.2 million. The strong increase was primarily attributable to higher net sales in both, our deck, rail, and accessories and exteriors businesses, which grew at comparable levels. Our year-over-year sales growth benefited from strong underlying demand, a lapping of pandemic-related headwinds experienced during the same quarter of last year, and pricing, as well as a modest increase in channel inventory at the dealer level.

Inventory at the distributor level remained significantly below historical levels. And give them the demand pattern, it could be another quarter or more before inventory levels get healthier in the channel. Residential segment adjusted EBITDA for the quarter increased by $20.2 million or approximately 32% to $82.5 million. The increase was primarily driven by higher sales and manufacturing productivity, partially offset by higher raw material and manufacturing costs in selling, general and administrative expenses.

Commercial segment net sales for the quarter increased by $5.1 million or 16.5% to $36.2 million. The increase was primarily driven by higher net sales in our Vycom business, partially offset by decreased net sales in our Scranton Products business. We're seeing solid demand from outdoor living, marine, and semiconductor end markets, and also starting to see modest recovery with trade show customers. Commercial segment adjusted EBITDA for the quarter was $6.3 million.

The $1.3 million increase year over year was primarily driven by sales performance in the Vycom business and net manufacturing productivity. Looking at our balance sheet and cash flow, as of June 30, 2021, we had cash and cash equivalents of $220.5 million, and approximately $145.6 million available for future borrowings under our revolving credit facility. Total debt as of June 30, 2021 was $467.7 million. And we have not drawn on a revolving credit facility.

Our net leverage ratio stood at one time at the end of fiscal Q3. Net cash provided by operating activities was $118.7 million for the nine months ended in June of '21 versus $11.3 million for the nine months ended June 30, 2020. Turning to our outlook. For fiscal Q4, we expect total company net sales growth to be in the range of 22 to 27% year over year, with the residential segment growing in the mid to high-20s range, and the commercial segment growing in the low to mid-single-digit range.

And we expect adjusted EBITDA growth in the 19 to 25% range. I would like to provide some additional color regarding margin progression as we exit fiscal '21 and into 2022. As I discussed earlier in my remarks, the combination of inflation and supply chain disruption has significantly increased our costs to service continuing strong demand. In fact, we have seen over $10 million of additional costs since our last earnings call, with a portion impacting Q4 incremental margins.

Importantly, as we saw costs escalating, we took action and in August implemented another price increase, effective in October, in order to offset our higher costs and position as well for fiscal 2022. Given our pricing actions and productivity programs, with the current raw material and supply conditions, we expect incremental EBITDA margin to improve from the low-20s percent range to -- in Q4 to about the mid to high-20s percent range, as we exit Q1, excluding the anticipated start-up costs we project primarily for the new factory in Boise. These costs are expected to be in the 3 to $4 million range in the first quarter. Importantly, we believe that we have covered the dollar cost of this current high-cost environment and are well-positioned to expand margins during 2022.

Turning to the full year of fiscal '21, we now expect total company net sales to increase 28 to 30% year over year and have raised our outlook on adjusted EBITDA growth guidance to be in the 27 to 29% range year over year. From a segment perspective, we expect full-year residential segment net sales growth in the low to mid-30% range year over year. In the commercial segment, we are starting to see some economic stability in certain end markets, with our projection of net sales declining at a low-single-digit rate year over year, an improvement compared to our previous outlook of the mid-single-digits decline. To assist in modeling, we continue to expect approximately 175 to $185 million in capital expenditures, and 21 to $22 million of interest expense for the full year of 2021.

And our tax rate for 2021 is now estimated to be approximately 27%, as a result of higher non-deductible compensation expenses, and our full-year weighted-average diluted share count is unchanged at approximately 157 million shares. I will now turn the call back to Jesse for some closing remarks.

Jesse Singh -- Chief Executive Officer

Thanks Ralph. And as you near your well-deserved retirement, I want to personally thank you for your leadership, hard work, and dedication. You've been an instrumental part of the team, helping to ensure our organization to set up for success, especially now as a public company. You've been a terrific business partner, and I'm proud to have worked alongside you for these last several years.

While we're going to miss you, we are excited to welcome Pete Clifford to the team, and are looking forward to more formally introducing Pete to our shareholders in the weeks and months ahead.

Ralph Nicoletti -- Chief Financial Officer

Thank you, Jesse. I am grateful to have worked alongside of you for several years, and look forward to following the next phase of AZEK's growth under yours and Pete's leadership.

Jesse Singh -- Chief Executive Officer

Thanks Ralph. I'd also like to take a moment to thank our entire AZEK team and our partners for their agility and unwavering dedication to our customers, especially during such a challenging and unprecedented time. As we recently celebrated the one-year anniversary of our IPO, revolutionizing the industry to create a more sustainable future is only possible with the continued focus and dedication. In closing, we are investing in the future, investing in our brand, in our capacity, in our recycling and continuous improvement initiatives.

When you combine this with the long-term trends underpinning our end market growth, including material conversion opportunities, R&R trends, and demographic shifts, our conviction to deliver on strong growth and margin improvement is high, going into fiscal year 2022 and beyond. We continue to remain excited about the opportunity that's in front of us. With that, operator, please open the line for questions.

Questions & Answers:

Operator

[Operator instructions]. Our first question with Tim Wojs with Baird. Your line is open.

Tim Wojs -- Baird -- Analyst

Hey, guys. Thanks. Good morning. And nice job on the results.

Ralph, best wishes, and Pete, welcome.

Ralph Nicoletti -- Chief Financial Officer

Yes. Thanks. Appreciate it.

Tim Wojs -- Baird -- Analyst

I guess, maybe, just first on the pricing side of things, Ralph, you talked about mid-teens price increases from the actions that you've taken this year. I was just hoping if you can kind of breakdown what's actually being realized in sales in fiscal '21 for pricing and how much of that flows through actually into '22 at this point?

Ralph Nicoletti -- Chief Financial Officer

Yes. So, Tim, the mid-teens pricing is what we have in place by the end of the year. And as we mentioned in the remarks, we added more incrementally that's going to take effect in Q1. And that positions us very well for '22.

So, '22 is going to benefit from that. We'll share more about '22 as we guide '22. But, this year, with the pricing actions that we've taken, cumulatively, we're exiting the year in mid-teens level, and again, well-positioned for '22.

Tim Wojs -- Baird -- Analyst

Ok. That's good to hear. And then, I guess, just on a capture basis historically, I know each cycle can be different. But, could you just remind us about your ability to kind of hang on to pricing, you would kind of see a more deflationary environment on the raw materials side at some point?

Ralph Nicoletti -- Chief Financial Officer

Yes. If you just look back at our recent history, and we've been taking pricing over the last several years, those prices hold in the market. Obviously, we're not guiding to '22. But particularly on deck, rail, and accessories, but also to some degree on exteriors, we're pricing per value.

And we also, I think importantly -- and you heard this a little bit in our remarks, we're pretty analytical about this in terms of our approach. We actually even invested in some pricing analytics work. So, we're comfortable with the pricing we have in the market and how we're positioned on value across our product lines.

Tim Wojs -- Baird -- Analyst

OK. That's good. Well, good luck on the next chapter, Ralph. And I'll hop back in queue.

Thanks guys.

Jesse Singh -- Chief Executive Officer

Thanks, Tim.

Operator

And next question, we have Matthew Bouley with Barclays.

Matt Bouley -- Barclays Investment Bank -- Analyst

Hi, everyone. Thank you for taking the questions. Again, echo congratulations to Ralph, and welcome Pete. So, Jesse, you gave the stat around that market study you did that non-wood materials can reach 50% of the market one day, if I heard you correctly.

I'm just curious, if there's any more detail or context you could give there. Maybe if there's any way to glean from that study, how consumers' perceptions have changed over time? And then even on the 50% that presumably just wants wood, could you tell kind of what's holding them back? Thank you.

Jesse Singh -- Chief Executive Officer

Yes. Thanks, Matt. And so, just to give perspective, we did a really in-depth study of the wood buyers, and we had done a study three years ago. So, I think one thing to consider is the number of folks that are generally buying wood has declined.

So I think when we did the study a few years back, what you saw was high-teens people identifying themselves as composite buyers. That has progressed into the low-20s, which I think is a reflection of what we're seeing born out in the market. As we look at -- call someone a wood buyer, I think it's a bit of a misnomer, right? What it is, is people in various points of how they consider the attributes. As we look at that totality, in general much of that, even above 50% is still an opportunity.

I think where we're focusing is where we can see the greatest opportunity. And so that 50% is really made up of folks that are positively inclined. There's a portion of that that are positively inclined, but there's some kind of a barrier, right? That barrier might be a perception of composites being plasticky, that might be related to a perception of where we are in the environmental journey. And so, a portion of that are of the wood -- what was great in the research is a portion of the wood buyers are positively are inclined, they just need to be educated.

And I think that there's another portion of that, of that 50% we're talking about that that kind of defaults to wood, but fit the right characteristics and demographics of someone that should be buying composites. And once again, I'll come back to it's an education process. What's interesting in the research is, we're not including the price buyers only in that 50%. And I think it's important when we look at wood conversion, we're really looking at it in its totality based on the combination of aesthetics, value, education.

And that's really where we're defining that 50%. There's another portion of that not 50%, that's effectively a price buyer. And that's someone who just wants to price right at the beginning. That's not included in that 50%.

So what's interesting for us is, is really the opportunity here with new product development and messaging to continue to educate and aggressively convert the market.

Matt Bouley -- Barclays Investment Bank -- Analyst

Wonderful. No. That's very, very helpful color there. Thank you for that Jesse.

Second one to zoom in a little on the margins. I think, you spoke the conviction to margin improvement in '22. But it sounds like you mentioned some pressure from the start-up costs early -- in the early part of next year. I mean, just giving the daylight, that sort of expectation for expansion on a full-year basis, and correct me, if I didn't hear that correctly.

But, what's kind of the visibility, I guess, the pace of incremental margins, as you go through on a quarterly basis next year?

Ralph Nicoletti -- Chief Financial Officer

Matt, just think about -- you think about the year and of course, where we are in the cost environment, we've seen a lot of inflation, as we've talked about, and in fact, seeing a lot inflation even since the last earnings call, which we took action and addressed on. But that though leads to -- the first couple of quarters of fiscal '22 has a lot of the peak of what we're seeing right now is still flowing through it. Again, we positioned ourselves well from a price standpoint to address that. But, you have in the first couple quarters of the year the combination of still elevated costs.

And then, as we talked about before, we've worked through start-up costs older and 2021, we've added 40% capacity and there was start-up cost associated with that. But we've worked through that with offsets. Boise, the new facility, and we're starting it up in our first fiscal quarter. And that's why we thought it was important to kind of highlight that a little bit more for you, because that will be -- we're expecting it to be a more significant start-up, again, all contemplated in our outlooks and the discussions we've had.

But, the first half because Boise start-up is going to be really in the first half of fiscal '22, the first half will be weighed a little bit more than the second half in terms of margin progression.

Jesse Singh -- Chief Executive Officer

Yes. Matt, if I could just add one additional comment on top of that, I think it's important, as we look out into '22, the dynamics we're dealing with now in the way in which we're offsetting it, we believe structurally puts us in a stronger position against our long-term margin goal. And I think that's a really -- as we look at things over -- as we progress through '22 moving forward, the dynamics that we're seeing in the short-term will lead to really long-term favorability, we believe structurally.

Matt Bouley -- Barclays Investment Bank -- Analyst

Got it. Well, thank you for that, Jesse, and best of luck, Ralph.

Ralph Nicoletti -- Chief Financial Officer

Thanks, Matt.

Operator

OK. Next question, we have Mike Dahl with RBC Capital Markets.

Mike Dahl -- RBC Capital Markets -- Analyst

Good morning. Thanks for taking my questions. Jesse, Ralph, just to pick up on the last point about margins, kind of thinking longer term, but also specific to '22. Given the pricing that's put in place and some of the carryover benefits, understand that there is still some cost pressures, in fact, in the first half of the year.

But if I exclude start-up costs, treat those differently. Historically you've done something that's more in the 30s on incremental EBITDA margins and what was that coming off the base that you're coming off of that was more impacted by a price cost lag that that would have been more of a reasonable if not conservative benchmark for the incremental margin performance next year. It sounds like at least in the first half you might be talking to something that's a little bit lower than that. So, I guess, just a little more clarity on, again, excluding the start-up costs, why shouldn't incremental margins be even stronger going forward in '22, based on the pricing actions you've taken?

Ralph Nicoletti -- Chief Financial Officer

Mike, let me address question in kind of couple of different ways. First, we clearly see -- and Jesse's remarks highlighted it, the line of sight to learn from it for long-term margin goals. We clearly see that with the 500 basis points of EBITDA margin improvement. We always said quarter to quarter, there's going to be some lumpiness, particularly when you're kind of working through start-up and things like that.

So, you're highlighting that. We are not in a position to give '22 outlook just yet. But to your point, we've been in the mid-30s on incremental margins and we still have a lot of runway on productivity and principally in recycled, but others, productivity still way ahead of us. We are well-positioned from a price cost standpoint entering '22, which we feel right now is this cost environment is pretty extraordinary and transitory, frankly.

And so we think we're well-positioned there. And we'll invest behind the business selectively. So over an arc, we'll get SG&A leverage over time, as well. So, that all leads us to -- we could get ourselves back into the mid-30s with a very clear path with our outlook long-term we see our incremental margins going above the mid-30s.

Mike Dahl -- RBC Capital Markets -- Analyst

OK. Yes. That helps and that makes sense. It sounds like it'll be a good ramp.

And then, I guess, second question and sorry, this is also ventures into '22. But, I think there's -- Jesse, you made the comment that you're now expecting the 85% cumulative capacity increase in decking versus a baseline of '19. And I think in the press release, there's a comment that refers to the expansion plan of 230 million. So, I wanted to just clarify, is that -- the 230 million, does that represent the 85% capacity increase? And then, when you think about the incremental, since you've been in this multi-phase approach, in terms of what the number is in fiscal '22 versus '21, since your second phase at least hasn't fully ramped in '21.

Any way to think about how much will be incremental in '22 versus '21?

Jesse Singh -- Chief Executive Officer

So, just as a reminder on the three phases, we're through the 40% phase. And as Ralph pointed out, we brought that on line last quarter. We got an additional 15%, which will be in fiscal '22 that will come on line before the end of the year, and then, an additional 30% that will come on line during the early part of '22 calendar year. So, in aggregate, I think you should think of it as off the 2019 baseline, and we'll probably need to move away from that baseline and establish a new one.

But off the 2019 baseline, you should consider that as we move into that next season, we'll have that 85% capacity available. Relative to what we've disclosed in terms of capital, we're not going to break it out specifically to what's in '22, what's in '21?What I would say is that that capital includes the 85% decking capacity that I just talked about. But it also includes other investments we're making, including our exteriors business and including expanding some of our recycle capability. And so that number is inclusive of other capacity adds also.

And obviously, if you take a look at the performance, not only of our decking business, but of our exteriors business, we're seeing really nice growth there. And the investments we've made to position us from a capacity and new product standpoint continue to reap benefits there also.

Mike Dahl -- RBC Capital Markets -- Analyst

OK. Just a quick follow-up if I could, since you mentioned the potentially moving off 2019. I'm curious, is that -- the 85% number, is that a volume metric or is that a dollar metric that incorporates the pricing that you put into place in the market as well?

Jesse Singh -- Chief Executive Officer

Yes. I mean, we typically will do it as a volume metric. But obviously there's nuances in terms of -- these are directional. But yes, I would consider it a volume metric.

Mike Dahl -- RBC Capital Markets -- Analyst

Understood. OK, great. Thank you.

Operator

Thank you. Next, we have Philip Ng with Jefferies LLC.

Phil Ng -- Jefferies -- Analyst

Congrats on the good quarter in the challenging environment. And, Pete, looking forward to working with you; and, Ralph, thank you for all the help this past year. I guess, from a demand perspective, certainly 50% growth in revenue is very strong. You did mention that you're able to kind of replenish the inventory at the dealer channel.

Any way to kind of parse out how much of that 50% growth is tied to channel fill for resi? And it sounds like inventories still pretty depleted in the channel, particularly the distributors. Are you seeing your channel partners build inventory in fiscal fourth Q -- fourth quarter just because that 51 usually draw down inventory? So sorry, a lot to unpack there.

Ralph Nicoletti -- Chief Financial Officer

Hi, Phil. Yes. Just on the third quarter, with the 51% growth and within my remarks, I mentioned too that importantly, it was broad-based, so deck, rail, and, accessories and our exteriors business grew at comparable levels in the quarter, albeit off of a low base from last year, if you recall. Our residential business, last year grew about 5.5%.

But nonetheless, strong demand is the primary driver of that growth. And there is some pricing, but that wasn't a significant piece of it. And on inventory, specific to your question, we did make improvement in the dealer channel. But that's not work completely done.

And we really didn't make any meaningful progress in the distributor channel, yet. We still see that as tight. And at these demand levels, as we go into Q1, it could be another quarter, Q1 or even further out, before we see inventories recovered -- fully recovered in the distributor channel. But, we're making progress.

We're servicing the market better than we were earlier in the year, as we've added capacity. But, distributor channel still remains quite low.

Jesse Singh -- Chief Executive Officer

And just to kind of cut to maybe the background on the question, as we look at Q4, we are not contemplating much channel replenishment in the numbers, right? So that's -- we continue to focus on meeting demand. And just reiterate what Ralph said, that replenishment, when that occurs will potentially be in subsequent quarters.

Phil Ng -- Jefferies -- Analyst

Got it. That's helpful, Jesse. And as you kind of -- now that phase is behind you, and you're going to work toward phase 3 by year end, do you have enough capacity to meet that underlying demand, until your Greenville capacity comes on? And then, as we kind of look out the next few years, just given how strong growth is, despite all this capacity you're adding, are you starting to think about adding more capacity internally for potentially next year as you kind of position yourself for 2022 through 2024, just the growth profile including process here?

Jesse Singh -- Chief Executive Officer

Yes. So, the timing of our capacity additional, we believe sets us up pretty well. We've got incremental volume to support us through this part of the season. As we move into, typically the lower volume months, we've got additional capacity coming on line.

And that will help as we move through the slower part of the season. And then we've got additional capacity coming on line to really set us up for -- as we move into the season in '22. We clearly are selling everything that we make and we have demand for that. We would expect that to continue.

But we do feel, the timing of our capacity adds sets us up in a nice position as we move into next year. The macro question of what's next, we'll answer that question when appropriate. But, I think the way to consider the Boise facility is, if you have 350,000 square feet and the capacity we're adding into there right now is using up a portion of that facility. And it's a roof that gives us an opportunity on a relatively responsive basis to add more capacity.

Phil Ng -- Jefferies -- Analyst

OK. That's really helpful. Good luck on another quarter, guys.

Jesse Singh -- Chief Executive Officer

Appreciate it. Thanks.

Ralph Nicoletti -- Chief Financial Officer

Thanks, Phil.

Operator

Thank you. Next we have Michael Rehaut with J.P. Morgan.

Mike Rehaut -- J.P. Morgan -- Analyst

Thanks. Good morning, everyone. And congrats, Ralph, and welcome, Pete. Look forward to working with you.

First question, I just wanted perhaps a little bit more of a clarification, if possible, with regards to some of the headwinds and the timing of addressing those headwinds in the first quarter, obviously, of fiscal '22, not fully getting I guess, the full benefit of the price increases, as you kind of I assume kind of layer in. But, at points, I heard you say that the challenges would be more in the first half as well, so in other words, into the second quarter of fiscal Q or the first calendar quarter of '22. And I thought I heard that that relates to start-up costs as well. So just a little clarification there in terms of when the full offset would occur, because at points it did sound like exiting first quarter.

So, the second quarter, I presume you could expect a return to margin expansion.

Ralph Nicoletti -- Chief Financial Officer

Mike, I think, maybe just to start, everything we're talking about right here is timing. Structurally, we're well-positioned to grow our margins in '22 beyond that. We're well on-track with our line of sight of our longer term margin objective of -- or marker, if you will, of 500 basis points. So, I think, what we're working right now through is a transitory period of exceptionally higher costs and inflation, and starting up a new facility, largely in the first half of fiscal '22.

And so, that's what I'll call a lot of the noise is that we're kind of working through the quarters. We wanted to give you some visibility to at leap the first quarter on start-up, so you could start to get some sense of size and magnitude there. And again, on the price cost side, we've covered the dollars of inflation that we're seeing at the very peak levels and well-positioned for '22. So, it's hard to kind of like pin down exact timing here.

But, if you think about, long-term, we're well set up and for '22. And the first half of the year has more of these headwinds in it because of the start-up of the new facility and just working through this incredibly high inflation environment that will begin to abate at a point in time.

Jesse Singh -- Chief Executive Officer

Yes. If I could just add just at a high level, think of it as our price has offset inflation. And those two elements are offsetting in Q1. And the timing that Ralph's talking about is really around, how long do certain costs extend, how the adoption of the pricing and all that, so.

But, the way to think of it is the actions are offsetting the underlying inflation. And when appropriate, we'll disclose the specific timing of that.

Mike Rehaut -- J.P. Morgan -- Analyst

OK. Thanks for that. I guess, secondly, I'd love to hear your thoughts -- just you had mentioned earlier Jesse in your opening remarks about the potential for a 50% market share of alternative materials. I believe last year in 2020, the composite decking market took two points of share from -- versus in prior years, perhaps about one point of share per year.

There's been a lot of talk, obviously in the last six to 12 months around maybe composite decking being a little bit more attractive from a cost basis, given the run in lumber. Obviously, lumber is not fully round trips, but more or less on its way there. At the same time, you're putting through pretty solid price increases for composite decking, as you've kind of said, mid-teens. How does that change? How do those moving pieces affect the rate of adoption of composite decking? In other words, was this 2% -- should we think about that as more of just all the stars aligning and maybe return to something more of a what you'd seen in the past, or by virtue of the lower price point options that yourself and your competitors have rolled out, increased consumer marketing, consumer spend, consumer awareness, that maybe that 2% level of something that's more sustainable?

Jesse Singh -- Chief Executive Officer

So, let me just hit a couple of points on there. And it may drive a difference of dialogue between ourselves and our competitors. We do not believe that conversion is fundamentally based on price, right? There are aspects, it is a component. But, our research validates that there's a broader conversation going on that we have highlighted over the last year, which is the value, the aesthetics and wanting to create a certain type of environment.

So, I think at a macro level, we should not assume that conversion is based on a relative price. In fact, in our research, I think price, depending on the segment we looked at with was number four on the criteria. The 2% you referenced, that conversion occurred before the most recent -- before the last 12 months of run-up in, in wood pricing. So, the 2% was when wood was in the, roughly 300 range -- 300 to 400 range, kind of that historical norm.

We are above that now. We've been meaningfully above that. But, I just want to highlight that that -- the conversion that we saw and that number was occurring before. And I'll just stress that in our type of environment, there is a network effect.

And so what we see in our research, what we see on the ground is wood conversion is occurring at all price points. And wood conversion is really around a mix of criteria. So hopefully, that puts a perspective on it. Relative to recent price increases, we make sure that as we increase pricing in our different categories -- and once again, we've done additional research here, that's part of some of the strategic investments that Ralph talked about that we're making sure that we're putting ourselves in the right position, depending on the category within which we play.

Mike Rehaut -- J.P. Morgan -- Analyst

Thank you. Appreciate it. Thank you.

Operator

Next, we have Alex Rygiel with B. Riley. Your line is open.

Alex Rygiel -- B. Riley Financial Inc. -- Analyst

Thank you and nice quarter, gentlemen. As it relates to new products, can you talk a little bit about annual contribution to sales that you think you're going to be generated from new products? And just talk a little bit about your new product pipeline without giving us too much information on it.

Jesse Singh -- Chief Executive Officer

On the specific contribution, we haven't disclosed that in a while. I think it's a good question. And I think we'll evaluate how to how to disclose that directionally, or in more detail in subsequent calls. What I would tell you is, if you look at our last couple of years of growth, we've seen meaningful growth from the new products that we've introduced.

And on the exteriors side, those of us -- those of you that had a chance to see our initial analyst meeting, saw the productivity solutions that we have that integrate functionality and improve the productivity on a jobsite. Those -- that category of products that we have right now that are targeting wood conversion, has been a nice growing category. In fact, its growth has been accretive to our aggregate growth this year on the decking side, the new products we've launched to put us in a great style, position in wood conversion situation, so they are disproportionately contributing to what we see. And then on areas like rail as an example, we also have productivity solutions there with our panelized rail that reduces labor for contractors and in our other installers.

And we're seeing really nice growth there. In terms of the pipeline, last year, despite the pandemic, we launched new products. We fully expect to launch new products, again, as the season approaches. But, we're also balancing, how to make sure that we create the right timeline, in terms of staging of new products.

So, we've got a pretty broad pipeline. We're going to stage those introductions based on the opportunity for market introduction. So, we'll -- it's a great question. We'll create more transparency, both on our investor deck and on our next call relative to some metrics around that.

Alex Rygiel -- B. Riley Financial Inc. -- Analyst

And then, lastly, all across the industry, have you seen any notable market share shifts, and are there any notable line reviews ongoing or anticipated?

Jesse Singh -- Chief Executive Officer

Relative to specific customer activity, we'll let our customers or our results show that. As we look at share, we feel good about -- if you just look at our trailing 12 in our growth in both our company and our residential business, and you do a comparative analysis, we feel good about what we've been able to do. We've talked a lot about decking. We feel good about our position there.

On the exteriors business, we've had both, new products and the capacity and the service levels to be able to supply the business. And so, we feel very positive on the exteriors side too. So beyond that, you'll see results. So, I appreciate the question.

Alex Rygiel -- B. Riley Financial Inc. -- Analyst

Thank you.

Operator

Thank you. Next, we have Susan Maklari with Goldman Sachs.

Susan Maklari -- Goldman Sachs -- Analyst

Thank you. Good morning, everyone. And let me add my congrats and best wishes to both Ralph and to Pete. Looking forward to working with you.

My first question is around productivity. You mentioned in your comments that you've also taken some additional productivity initiatives in the quarter. Can you give us a little bit more color on that? And how we should be expecting those to come through?

Jesse Singh -- Chief Executive Officer

Yes. So, I'll break it into a couple of different areas, right? On the recycle side, as we're dealing with working through supply and inflation, we've taken certain actions relative to finding lower cost sources of recycle that are available. And we have been incorporating those, I mentioned, without giving the specifics. We are incorporating -- I mentioned that on the call, without being specific.

We've been incorporating that into our products and that will lead longer term to a lower cost stream. As you look at specifics, we continue to look at material utilization, uptime, OEE. And once again, those are aspects that we will see long-term benefits from as we cycle through some of these inflationary pressures.

Susan Maklari -- Goldman Sachs -- Analyst

OK. That's helpful. Thank you. My second question is around your recycling capacity.

As you have worked through this expansion plan, you also mentioned that, to some extent that includes expanding the recycling production that you have. I know you came into this year with about 55% of your inputs recycled. Can you talk to where you are today or where you expect to be the exit this year, and how we should expect that to benefit the margins, especially maybe into next year?

Jesse Singh -- Chief Executive Officer

Yes. We've added meaningful capacity to our recycle capability. But, one of the challenges has been that even though we have seen -- even though we've made a very strong progress, our growth has also been quite high. So, as we add capacity, we need to add it at a disproportionate rate to our growth, and we are balanced right now relative to that.

In certain cases, we have not been able to increase our use of recycle. I'll give you PVC decking is an example. We could be at higher percentages of recycle. But, given our growth rate there, scaling of our recycle operations to meet demand has not yet given us an ability to increase that.

The good news in that is, as we bring additional recycle capacity on line, it'll allow us to increase our percentages. And we would expect that that would be something we could do as we move into '22.

Susan Maklari -- Goldman Sachs -- Analyst

Got you. OK. Thank you. And good luck, Ralph, with everything.

Jesse Singh -- Chief Executive Officer

Appreciate it.

Ralph Nicoletti -- Chief Financial Officer

Thank you. Thank you.

Operator

Thank you. Next question, we have Ryan Merkel with William Blair.

Ryan Merkel -- William Blair & Company -- Analyst

Hey, thanks for fitting me in. So, two questions. First off on raw material prices, have they leveled out recently? And just how much confidence can we have that we won't be talking about pushing back margins again a quarter from now? And then, secondly, one of your competitors mentioned labor shortages hurting production. Did you see that as well?

Jesse Singh -- Chief Executive Officer

Ralph, maybe -- let me answer the labor one first and then I'll Ralph take the raw material. Certainly, it's a challenging labor environment. Our approach has been to be very aggressive in ensuring that we continue to staff our facility in such a way that we can maintain their operations. And as such, we have seen some of the labor dynamics, but we feel that we've done a pretty good job of working our way through those dynamics.

Now, incrementally, it's cost us a bit at times. But we believe that servicing our customers that we'll take appropriate steps to ensure that we have continuity there.

Ralph Nicoletti -- Chief Financial Officer

And, Ryan, on the inflation side, as I mentioned, clearly since our earnings call, we've seen a step up. The virgin resins, PVC, and polyethylene since May have been increasing but at a much slower rate than where were versus year ago. And on the supply side there in general, there are no new outages, so that no one is in force majeure. So, the supplies are coming back, but inventories are tight.

And it takes some time to rebuild that. But, the capacity is kind of back on and the supply lines there are getting better. We did also see some increase in prices. And these typically lag.

They're not linear, but they do lag on the recycle side. We've seen increases in recycle costs across polyethylene recycled material, as well as PVC. So kind of to your question of when does it abate? I think when you look at year on year or even since the last few months, things are leveling. There's still some increases out there.

But, I think importantly, when we see these things emerging, we will take action, and that's been our mode because it's important to cover our costs, so we continue to invest in the business. But, the environment you just characterized as certainly supply improving, but inventories in general are low in these areas.

Ryan Merkel -- William Blair & Company -- Analyst

Got it. Thanks for the color. And, Ralph, best of luck.

Ralph Nicoletti -- Chief Financial Officer

Thanks, Ryan.

Operator

OK. The question-and-answer session is over. I will turn the call back over to Jesse Singh.

Jesse Singh -- Chief Executive Officer

Well, thank you all for attending. I'll reiterate my thanks to Ralph and just the impact he has made someplace along the line. He's probably in a CFO Hall of Fame, having been a public company CFO five times. And we welcome Pete.

Let me just reiterate a couple of points that we hit. One, I think, we are in a terrific position, with capacity coming on line and some of the opportunities that we see moving forward, and some of the actions that we take, and that we believe put us in a really strong position. But that's really against a bigger backdrop of opportunity. Our core markets are near $10 billion.

And that's with trim, deck, rail, and accessories, and we view meaningful opportunity there. But, we also have adjacencies that for the long-term of the business that we're building against, which, for us represent an additional $10 billion of market opportunity. And as we continue to have a dialogue about the performance of the business, we will also continue to have a dialogue about the steps we are taking to continue to access accelerated growth in our core and also access that additional market opportunity. So really appreciate all of you taking the time, once again.

And we look forward to introducing Pete in a more direct conversation as we evolve over the next few weeks and months. Thank you so much. Take care.

Operator

[Operator signoff]

Duration: 71 minutes

Call participants:

Amanda Cimaglia -- Vice President, Investor Relations

Jesse Singh -- Chief Executive Officer

Ralph Nicoletti -- Chief Financial Officer

Tim Wojs -- Baird -- Analyst

Matt Bouley -- Barclays Investment Bank -- Analyst

Mike Dahl -- RBC Capital Markets -- Analyst

Phil Ng -- Jefferies -- Analyst

Mike Rehaut -- J.P. Morgan -- Analyst

Alex Rygiel -- B. Riley Financial Inc. -- Analyst

Susan Maklari -- Goldman Sachs -- Analyst

Ryan Merkel -- William Blair & Company -- Analyst

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