The AZEK Company Inc. (AZEK) Q4 2021 Earnings Call Transcript

The AZEK Company Inc. (AZEK -0.11%)
Q4 2021 Earnings Call
Nov 18, 2021, 10:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning. My name is Chantel, and I'll be your conference operator today. At this time, I would like to welcome everyone to the AZEK Company fourth quarter 2021 earnings conference call. [Operator instructions] Thank you.

Amanda Cimaglia, vice president of ESG, you may begin your conference.

Amanda Cimaglia -- Vice President, Environmental, Social and Governance

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; and Peter Clifford, our chief financial officer.

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-K for our fourth quarter and fiscal year-end 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-K for our fourth quarter and fiscal year-end 2021.

At this point, I would like to turn the call over to Jesse Singh.

Jesse Singh -- Chief Executive Officer

Good morning. I'd like to welcome everyone to today's call, and it's great to be speaking with you today. We are proud to announce that we once again delivered a record fourth quarter, with strong growth in net sales, adjusted EBITDA and adjusted EPS. Our results were driven by continued robust demand in both of our segments and industry-leading operational execution.

During the fourth quarter, we meaningfully improved service to our customers, made progress against our decking capacity expansions, and completed additional investments to drive long-term growth. Our teams have done a great job navigating what has been a challenging environment to deliver strong results, and we exit the year in a strong position to service our customers in 2022 and to continue to gain market share from wood and other direct and indirect competitors. Our strategy is to drive growth and share through a combination of product innovation, commercial execution and targeted acquisitions. Given the breadth of our portfolio, which includes a leading exteriors business and the most differentiated decking products on the market, we believe that we are uniquely positioned to win.

We have a proven track record of results and continue to believe our strategy and investments will drive sustained long-term growth and margin expansion. This confidence is underpinned by the continued tailwinds we are experiencing as a company, including strong repair and remodel activity, sustained interest in outdoor living, and an acceleration in wood conversion trends. On our last call, we discussed the extensive research we conducted on wood replacement and the drivers of wood conversion in the decking market. Our research indicates that there is an opportunity to convert approximately 50% of the market to natural-looking alternative materials.

With an unmatched portfolio of the highest quality and most natural-looking decking products on the market, driven by innovation in R&D, we believe AZEK is in a unique position to benefit from these underlying trends. In addition to previously announced capacity additions, we are announcing a fourth phase of decking expansion that we expect to be completed during calendar year 2022, bringing our overall decking capacity increase to over 100% from the 2019 baseline. This additional phase will take advantage of our expanded footprint in Boise, Idaho and highlights the speed and flexibility of the AZEK team to respond to market opportunities. We believe this combination of investment and execution places AZEK in a position to aggressively engage the market as we move into fiscal 2022.

More importantly, our existing footprint gives us the flexibility to add additional lines as needed. And we expect to exit 2022 with enough space to double our Boise manufacturing capacity within the existing footprint. These capacity expansions come at the right time and enable us to aggressively go after new market and wood conversion opportunities. Turning to fiscal year 2021 highlights.

In our first year as a public company, we delivered record financial results and achieved a number of milestones. We saw acceleration in the residential segment, driven by strong end market demand combined with initiatives, share gains and price realization. Our decking product line grew in the mid-40s range, and our exteriors business grew over 30%. We delivered the first two phases of our multi-phase capacity expansion plan, all while improving throughput in our existing operations.

While capacity increased by 40% in decking, our actual output capability increased meaningfully above that, driven by increased efficiency. In an unprecedented inflationary environment, the team was able to offset raw material inflation through price and productivity gains. We expanded our consumption and supply of recycled materials to meet increasing demand and are well-positioned to achieve our 2026 goal of recycling 1 billion pounds annually. In fiscal 2021, we also launched a number of new products.

We also strengthened an already strong management team with expanded leadership in sales, marketing and corporate functions. And we continued investments in sales, marketing, brand and consumer engagement, which will continue into fiscal 2022. We experienced high-quality digital engagement throughout the year, and leads increased over 40% year over year. We continue to focus on our core value of doing the right thing and building out our focus on ESG.

We We issued our inaugural FULL-CIRCLE ESG report and are making progress on multiple initiatives within each part of the E, the S and the G. In addition to our most recent board member announcements, we continue to make progress on our ongoing effort to create a more inclusive company. We recently held the TimberTech Championship in Boca Raton, Florida which is an event benefiting local area hospitals that is part of the PGA Tour of Champions. We committed to making it a zero waste event, and we were the first and only tournament in the PGA Tour champions, to do so.

We were also recognized as one of Chicago Tribune's top workplaces for creating a culture where employees feel highly engaged, appreciated and fulfilled. Turning to our fiscal fourth quarter results. Despite ongoing inflation in the quarter, we once again delivered very strong net sales and adjusted EBITDA. The combination of new manufacturing capacity and a strong execution enabled improvements in channel inventory and sets us up for growth heading into fiscal 2022.

Our teams continued to navigate supply chain challenges, including Hurricane Ida, extremely well as we continue to prioritize service to our customers. We benefited from pricing that offset inflation on a dollar basis, and we have incremental pricing that will be realized in the first quarter of fiscal year 2022. We believe that our pricing and productivity actions position us well for ongoing margin expansion. We continued to make progress during the quarter on key initiatives that drive long-term value creation.

The core products in our portfolio, as well as our new reserve and landmark decking collections, AZEK PaintPro and panelized aluminium rail products, all performed well during the quarter. Two of our newest product innovations were recently recognized by HBSDealer, which awarded our TimberTech Landmark decking collection and AZEK shingles siding with a Golden Hammer awards for their value, innovation and shelf appeal. Our landmark collection of decking also received the inaugural Design for Reuse award from the Vinyl Sustainability Institute. We are excited to continue this culture of innovation by announcing the launch of several new products this quarter for fiscal 2022.

We are also excited to have announced a partnership with Yardzen, a leading technology-enabled landscape design company where customers can design the yard of their dreams, incorporating TimberTech materials in the design process. This partnership will allow us to better access and grow an alternative channel while expanding our customer journey. We recently completed customer events that coincided with the TimberTech Championship where we engaged a significant number of our contractors and dealers on future strategy and growth opportunities. It was great to engage in person with these customers.

Our contractors and channel continue to be optimistic about the outlook for growth in fiscal 2022 and the long term. They validated data from our recent contractor and dealer survey, which highlighted ongoing optimism and strong backlogs. We continue to make progress on recycle and finding new sources of otherwise hard to recycle materials to incorporate into our products. We are proud to report that we diverted approximately 500 million tons of scrap and waste from landfills through our recycling programs in fiscal 2021, an approximately 25% increase from 400 million pounds in 2020.

Recycled materials made up approximately 56% of our extruded product portfolio waste, up from 54% last year. In fiscal 2022, we will continue to invest in our recycling capabilities and expect both our use of recycle and the cost benefit from recycling to continue to expand. Our innovative FULL-CIRCLE PVC program is gaining momentum in the marketplace and has strengthened our position as the industry-leading recycler of PVC. With the benefit of our expanded capacity, we are now able to more effectively expand our channel, geographic reach and customer relationships.

We are pleased to have recently expanded our distribution relationship with a key distribution partner, Weyerhaeuser. The expansion allows for TimberTech products and an AZEK exteriors full product line offering to be available throughout the Texas market through Weyerhaeuser's Dallas and Houston-based distribution centers. The portfolio expansion increases AZEK's relationship with Weyerhaeuser to 13 distribution facilities nationwide. We would like to thank Weyerhauser and all of our channel partners for their tremendous support and look forward to our continued partnership in the future.

To our outlook. For fiscal year 2022, we expect we will grow net sales at a mid-teens rate, driven by growth in our core and new products and previously announced price increases. We expect to deliver high teens growth in adjusted EBITDA year over year, inclusive of the start-up costs associated with our capital investment programs. Our recent actions, combined with ongoing productivity and recycle expansion, position us well for fiscal year 2022.

As raw material prices normalize, we believe we are well-positioned to achieve our margin objectives. In summary, we continue to be confident about our position in the market and the opportunity for the AZEK Company heading into fiscal 2022. Repair and remodel activity remains strong, with a number of housing-related and home remodeling indices showing continued and projected future strength. There continues to be a strong interest in outdoor living, and we see wood conversion trends accelerating.

In addition, our contractor and dealer engagement and survey reflects ongoing optimism and backlog. AZEK has continually invested in innovation and R&D to create the highest-quality, most natural-looking products. And the breadth of our portfolio, including exteriors and outdoor living, give us a competitive advantage as we continue to penetrate an almost $20 billion market opportunity. We believe we are investing ahead of increased demand with capital investments coming online to service incremental demand, and we believe we provide the best service in the industry.

We believe the future is bright for the AZEK Company. And we are excited to execute our strategy in the coming years with the support of our loyal team members, channel partners and shareholders. With that, I'd like to turn the call over to Pete, who will discuss our financial results and our outlook in greater detail. Pete?

Pete Clifford -- Chief Financial Officer

Thanks, Jesse. And good morning, everyone. Let's take a few minutes to walk through our 4Q '21 and full year '21 financial results. As a reminder that our 4Q and fiscal full year '21 results are through September 30.

The actions that we've taken on pricing, capacity expansion, as well as investments in our core have us exiting 2021 with lots of momentum and position us to outperform in 2022 and beyond. On a consolidated basis, net sales for the quarter increased 31.1% year over year to $346 million for 4Q '21. Drivers for the fourth quarter net sales for our residential segment also increased by 31.1% year over year, driven by strong deck results. Our commercial segment increased by 31.3% year over year as well.

Net sales for the year increased 31.1% year over year to $1.179 billion for the full year '21. Drivers for the year included broad-based growth in both our residential, as well as commercial divisions. Gross margins for the quarter. GAAP gross margin dollars expanded by $22 million or up 24.4% year over year, while adjusted gross margin dollars grew by $24.3 million or up 22.9% year over year.

Adjusted gross margin rates contracted 250 basis points to 37.7% versus 40.2% in the prior year. Gross margins for the full year. GAAP gross margin dollars expanded by $93.9 million or up 31.7% year over year, while adjusted gross margin dollars grew by $98.9 million or up 27.5% year over year. Adjusted gross margin rates contracted 110 basis points to 38.8% versus 39.9% in the prior year.

Our margin rate performance year over year is primarily driven by the fact that we've seen significant material commodity inflation, which would offset the dollar impact but not the accretion of our natural margin rate. Our gross margin rates were stable sequentially from 3Q to 4Q as our pricing has exceeded inflation dollars in both 3Q '21 and 4Q '21. Our last price increase was effectively an October 1 increase, so we expect pricing to continue to exceed inflation dollars in 1Q '22. Lastly, we remain confident we are positioned for structural margin change when material commodity prices start to recede.

SG&A expenses for the quarter. SG&A expenses decreased $89.5 million or down 59.7% year over year. The decrease was primarily attributable to lower stock-based compensation expense, partially offset by investments in higher personnel costs, professional fees and other public company costs. SG&A expenses for the full year.

SG&A expenses decreased $64.1 million or down 20.8% year over year. The decrease was primarily attributable to lower stock-based compensation expense, partially offset by investments in higher personnel costs, marketing and branding, professional fees and other ongoing public company expenses. Adjusted EBITDA for the quarter. Adjusted EBITDA dollars for the quarter increased by $15.4 million or up approximately 23.4% to $81.5 million.

Adjusted EBITDA margin rates for the quarter declined 150 basis points to 23.5% from 25% in the prior year. As previously mentioned, the primary driver of the EBITDA impact is price realization offset material inflation dollar for dollar, but not on a percentage basis. Adjusted EBITDA for the full year. Adjusted EBITDA dollars for the year increased by $60.7 million or 28.4% to $274.2 million.

Adjusted EBITDA margin rates for the year declined by 40 basis points to 23.3% from 23.7% in the prior year. Note, material commodity inflation did not start to accelerate until the middle of 2Q '21, so we had a relatively normal fiscal 1Q '21 year over year. Net income and EPS for the quarter. GAAP net income increased by $103 million to $38.6 million or $0.25 per share, compared to a loss of $0.43 per share in the prior-year period.

Adjusted net income increased by $5.4 million or up 12.3% to $49.8 million or adjusted diluted EPS of $0.32 per share, compared to $0.29 per share in the prior-year period. Key drivers: strong operating performance year over year, coupled with prior-year debt extinguishment impact on our formerly outstanding senior notes. Net income for the year. GAAP net income increased by $215.4 million to $93.2 million, or $0.59 per share, compared to $1.01 loss in fiscal 2020.

Adjusted net income increased by $80.3 million to $152.9 million, or adjusted diluted EPS of $0.98 per share, compared to $0.59 per share in fiscal 2020. Key drivers: strong operating performance year over year, interest expense reduction of $51 million year over year, and the elimination of certain expenses associated with the company's initial public offering in 2020. Now for the balance sheet cash flow and capex. Our balance sheet remains incredibly strong with significant capacity.

We have over $146 million of unused credit facility at 9/30/21. We ended the quarter with $250.5 million of cash and cash equivalents and $362 million of working capital. Gross debt ended the quarter at $467.7 million. Net debt came in at $217.1 million.

And our net leverage ratio came in less than one time at 0.8. Capex spending for the quarter reached $59 million, while capex for the year reached $175 million, at the low end of our annual guidance, largely driven by timing of cash outflows related to our capacity expansion programs. Cash from ops for the year came in at $207.7 million or up 111% year over year. Now for some segment results.

For our residential segment, sales for the quarter grew 31.1% to $305 million. Generic drivers for both the quarter and the full year are similar. We have benefited from strong underlying demand and price realization enabled by the commodity environment and some rightsizing of channel inventory. Sell-through was driven by broad-based strength in deck rail and accessories at 33% and exteriors at 25%.

Between capacity expansions and machine efficiency improvements, we delivered more product, which allowed us to make progress improving service levels and building channel partner inventory closer to desired levels during the quarter. Sales for the full year grew 35.4% to $1.044 billion. Sell-through was driven by broad-based strength in deck rail and accessories at 37% and exteriors at 31%. While decking grew in the mid-40s range, our rail business was constrained during the year by certain material and supply chain issues.

Channel inventory improved at year-end as new capacity came online and we made improvements to service levels. Segment adjusted EBITDA. Adjusted EBITDA for the quarter grew $17.6 million or up 23.7% to $91.6 million. Adjusted EBITDA for the full year grew $76.5 million or up 32.1% to $314.6 million.

As we have articulated, the margin impact is driven by a timing lag in price realization versus commodity inflation impact, where we have offset dollar impact but not the accretion of our natural margin rate. For our commercial segment, sales for the quarter grew 31.3% to $41 million. Sales for the full year grew 5.3% to $134.8 million. The strength in revenue for both the quarter and the year are primarily attributable to higher net sales in our Viacom business.

We are seeing solid demand in marine, outdoor living and semiconductor end markets. Segment adjusted EBITDA for the quarter grew $2.1 million or up 55.4% to $6 million. Adjusted EBITDA for the full year grew $4.3 million or up 28.4% to $19.3 million. Our commercial business did an excellent job recovering margin and profitability during the year, primarily driven by commercial mix, plant productivity, as well as pricing actions.

Before I close with some color on guidance, I wanted to provide some context on the fourth quarter '21 and first quarter of '22. Fourth quarter '21 closed in line with our expectations. A few positives to note on the quarter. First, from a revenue perspective, we continue to see strong demand while making progress in improving pro channel inventory and service levels.

Second, plant productivity performance improved as we moved past our start-up costs from the Phase 1, Phase 2 capacity projects. Third, our teams executed extremely well with the supply chain disruptions caused by Hurricane Ida. Finally, we continue to offset new commodity inflation with price realization dollar for dollar. As we enter the first quarter of '22, there are several positives coming out of the fourth quarter '21.

First, our price actions are now in place. We expect pricing to exceed material inflation dollars in every quarter in 2022 and start to become positive on a margin-rate basis in late 2Q '22, and remain positive throughout the second half of the year based upon current commodity pricing expectations. Two, we are experiencing solid trends in our digital engagement and contractor backlogs, which point to a healthy demand environment. Three, we continue to make progress on Phase 3 and new Phase 4 capacity expansion projects.

Finally, we are hitting the point in which the cost of an incremental dollar of sales have normalized versus the dilution of the last few quarters. Now turning to our outlook for next year. We believe we are well-positioned to deliver on mid-teens revenue growth in 2022, driven by a strong demand environment underpinned by material conversion and outdoor living trends. Carryover pricing, our innovative product portfolio and improved service levels that position us to win combine with our key growth initiatives, including new product launches.

We are confident in our ability to execute on our margin expansion objectives, driven by continued progress with our recycling initiatives and recycle reformulations, improved plant productivity and continuous improvement programs supported by a more stable manufacturing operations, operating leverage tailwinds, driven by strong end market demand and modest SG&A leverage as we lap the addition of new public company expenses. Additionally, our long-term opportunity and structural margin improvement remains intact with regard to the price material inflation equation. For the full year fiscal '22, we expect consolidated net sales to increase mid-teens year over year, inclusive of start-up costs associated with our capital investment programs. We expect to deliver high teens adjusted EBITDA growth year over year and associated margin expansion.

For the first quarter of 2022, our total company guidance calls for net sales growth of 18% to 21%. From an adjusted EBITDA perspective, which includes start-up costs, we expect year-over-year growth in the 14% to 17% range. The quarter includes approximately $2 million-plus of start-up expenses and also a bit of a lag in net price versus cost margin recovery. As a reminder, Q1 '21 had minimal inflation pressure.

We expect to see leverage on our bottom line starting in late '22 '2Q and accelerating throughout the second half of '22. As previously highlighted, we are adding incremental capacity, which should be considered Phase 4, which brings us over 100% capacity increase by the end of calendar year '22 when combined with the first three phases relative to the 2019 baseline capacity. In fiscal '22, our capital expenditures will include the remainder of Phase 2b and Phase 3, as well as Phase 4 expansion and other initiatives. To assist with modeling, we expect approximately $180 million to $200 million in capital expenditures for fiscal 2022.

We expect $21 million to $22 million of interest expense for the full year '22. Our effective tax rate for 2022 is estimated to be approximately 25%. Our full year weighted average diluted share count is expected to be approximately 158 million shares.

Jesse Singh -- Chief Executive Officer

Once again, I'd like to take a moment to thank our entire AZEK team for their ability to achieve strong quarterly and full year results. Thank you to our customers and partners as well for their continued support of the AZEK company. As we enter 2022, we will continue to build on our existing strategy and investments across people, manufacturing capacity and innovation. And we believe this positions the company well for strong net sales and adjusted EBITDA growth.

We remain excited about the many opportunities in front of us and believe we are well-positioned to win in the industry. With that, operator, please open the line for questions.

Questions & Answers:

Operator

[Operator instructions] Our first question comes from Ryan Merkel with William Blair. Your line is open.

Ryan Merkel -- William Blair and Company -- Analyst

So my first question is on the outlook. Yes, am I there?

Jesse Singh -- Chief Executive Officer

Yes, we can hear you now. Go ahead.

Ryan Merkel -- William Blair and Company -- Analyst

OK. So nice quarter, guys. I think, my first question, just Jesse, the outlook for mid-teens revenue growth. I was thinking number's maybe 12% to 15% price in '22 that wouldn't need a lot of volume growth.

Can you just unpack that a little bit?

Jesse Singh -- Chief Executive Officer

Yes. First, let's just step back and take a look at the market and the opportunity that we see. As we talked about, we're adding capacity. We're in a great position to start to drive new volume growth.

And we're in a terrific position to be able to get after new growth opportunities. Relative to the modeling specifically, Pete can get into that specifically. We're gonna be lapping some additional pricing. So I think, the way to think of the guide roughly is about half price and we -- I think we've indicated high single digits moving forward.

But fundamentally, the growth opportunity that we see is at or above our long-term guidance, which has historically been 8% to 10%.

Ryan Merkel -- William Blair and Company -- Analyst

Got it. OK, that's helpful. And then my second question, any signs of slower decking sell-through or trade-downs, just given all the price increases?

Jesse Singh -- Chief Executive Officer

As we look at our data overall, we've seen very, very good growth in all of the segments that we play in. I think, one of the challenges we've had last year is because of capacity constraints, we haven't really been able to service all of the opportunity that's out there and all the volume that's out there. So as we move forward, an example of that would be Landmark, right? So Landmark, we launched but we had to constrain that launch to certain geographies, just because we didn't have capacity to service that. I think, as we move forward, we continue to see opportunities with our innovation to be able to drive growth in really all the segments.

And so, as you look at decking in particular, we have really, really strong growth last year. And we believe we're in a position to drive really, really broad-based growth coming forward. And a lot of the data we see at a macro level and also in our own data supports really continued growth on the decking side.

Ryan Merkel -- William Blair and Company -- Analyst

Very helpful. Thanks, Jesse. I'll pass it on.

Jesse Singh -- Chief Executive Officer

Appreciate it. Thank you.

Operator

Your next question comes from Tim Wojs. Your line is open.

Tim Wojs -- Robert W. Baird and Company -- Analyst

Hey, guy, good morning. Nice job. Maybe just thinking about and kind of stepping back and thinking about seasonality a little bit, it's been a pretty kind of dynamic couple of years just in terms of kind of the quarterly cadence for revenue. At this point, how are you thinking about seasonality for fiscal '22 relative to normal? It does look like maybe there's some kind of normal sequential seasonality that's kind of built in, but just kind of thoughts on how we should think about the revenue cadence for the year.

Jesse Singh -- Chief Executive Officer

Yes, Tim, that's a great point. I think, as just as a reminder in terms of the seasonality of our types of businesses and our business specifically, typically when you get into our first fiscal quarter into the second fiscal quarter, you're dealing with really two quarters that involve staging for the subsequent year, right? So you'll typically see in a normal environment, you'll typically see some inventory drawdown within our channel in our fiscal first quarter, calendar fourth quarter. And then you'll start to see a reinflation of that inventory as they prepare for the season in the second quarter. I think, as we have done a great job of servicing the market, We see a more normalized progression moving forward as our capacity is catching up with macro market demand.

Tim Wojs -- Robert W. Baird and Company -- Analyst

OK, OK, that's helpful. And then when you think about just on the recycling side, it looks like you made some really good progress on just the amount of materials that you're recycling. The percent that can be recycled to 56%, I mean, where do you kind of see that going over the intermediate term? And I guess, what are the biggest opportunities moving forward?

Jesse Singh -- Chief Executive Officer

Yeah, once again, great question. As you pointed out, we made a lot of progress in terms of expanding our sourcing of recycled and our processing recycle. The challenge we had in 2021 was just our volume growth and really being able to keep up our recycle expansion against that. As we move into '22, we have made additional investments in recycle, and we would expect to be able to continue to expand our use of recycled materials.

So you should think of that percentage as having an opportunity to be above where we currently are. And we haven't given a specific number, but we clearly see a path to be in the 60s over a period of time. And so, as we are able to build up more internal capability and supply and do the reformulation, we should be able to get there. And I think, the second component is as we bring additional capacity online, that gives us line capacity to be able to finish the formulation and ramp up work to be able to increase the percentage of recycled, but I think as importantly, validate and move forward with lower-cost recycled materials.

Tim Wojs -- Robert W. Baird and Company -- Analyst

OK. Is it fair to think that the focus there kind of incrementally -- you kind of have more incremental focus on that going forward just as things kind of normalize? Versus kind of trying to just have enough material in terms of just sourcing that you've kind of gone through the last couple of years?

Jesse Singh -- Chief Executive Officer

Yeah, I think, that's the right way to think of it. I mean, if you think of the macro environment, and I'll use PVC as an example. There has been a lot of disruption in the virgin PVC market. Our expanded internal recycling of PVC put us in a great position to sustain supply and also balance some of the cost pressures on the virgin.

As we bring more capacity online, it certainly gives us an opportunity to really be able to expand our use of recycle. So I think, it's the right way to think of it.

Tim Wojs -- Robert W. Baird and Company -- Analyst

OK, OK, sounds good. Thanks, guys. Appreciate the time.

Jesse Singh -- Chief Executive Officer

Thank you.

Operator

Our next question comes from Matthew Bouley with Barclays. Your line is open.

Ashley Kim -- Barclays -- Analyst

Hi, this is actually Ashley Kim on for Matt today. So in terms of going back to the top-line guide for '22, is that dependent on new capacity coming online? Or is that achievable just on the existing capacity?

Jesse Singh -- Chief Executive Officer

Yes, I would say our capacity plan that we've laid out -- and just as a reminder, we have additional capacity coming online, that incremental 15% coming online by the end of the calendar year. We've got an additional 30% coming online, our Phase 3 at Boise. And we just announced additional capacity of an incremental 15 that comes online by the end of calendar '22. We certainly have enough capacity with what we have and the modest adds that we've got coming in the next couple of months, to be able to meet and exceed our guidance.

And then the additional capacity we've got coming online above that puts us in a position to be able to continue to aggressively expand in the market.

Ashley Kim -- Barclays -- Analyst

Great. That's much appreciated. And then just kind of staying on the topic of remodeling, how confident are you that you'll be able to source the necessary labor and materials, both on the recycled and raw side, in order to kind of fill that utilization on those lines?

Jesse Singh -- Chief Executive Officer

Yeah, we don't have -- our team has done a really, really nice job of managing through a lot of volatility. We are very, very confident in our ability to continue to scale, get the right raw materials and move down the path of recycling. The team has done a really nice job in arguably the most volatile environment already. And we feel really, really good about our opportunity to continue to execute at a high level and move forward.

So we feel really, really good about it. We're always looking at it, but we feel confident.

Pete Clifford -- Chief Financial Officer

Yeah, I'd just add again. I think, our teams have adjusted really well to the new norms for the supply chain world from key products and availability from the PVC side. I would describe the environment as capacity is back online. No concerns on availability.

On the PVC side, it's even healthier. I would describe it as, again no availability concerns And if anything, capacity is starting to exceed supply, which would give us some optimism on sort of pricing from a PE perspective.

Ashley Kim -- Barclays -- Analyst

Great. That's really helpful color, guys. I'll leave it there. Appreciate it.

Jesse Singh -- Chief Executive Officer

Thank you.

Operator

Our next question comes from Phil Ng with Jefferies. Your line is open.

Unknown Speaker

Hi, this is actually Collin on for Phil. Thank you for taking my questions. My first question, in your fiscal year 2022 guidance, what are you assuming on resin prices and availability, with the contract prices and spot prices starting to fall off in recent months?

Pete Clifford -- Chief Financial Officer

Yeah, I'll take that. As far as what we are assuming for commodity prices, it's in line with most current CDIs. And kind of embedded in that is kind of fairly stubborn PVC prices for the year 2022 and seeing some modest deflation on polyethylene in the back half of the year. And as mentioned on the supply chain comment, we actually feel very good right now about material availability and have no concerns on that.

Unknown Speaker

OK, great. And then just in terms of the start-up costs, how should we think about the magnitude of those and the timing and cadence during fiscal year 2022?

Pete Clifford -- Chief Financial Officer

Yeah, look, that's going to move a bit as the project moves. But as we're thinking about it right now, a good way to frame it up as we think on an annual basis, it's about $8 million to $10 million of start-up costs. And we're calling the first quarter at about $2 million approximately of start-up costs in 1Q '22.

Unknown Speaker

Great. Thank you for taking my question.

Operator

Our next question comes from Alex Rygiel with B. Riley Securities. Your line is open.

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

Good morning, and thank you for taking my question. Jesse, in your prepared remarks, you stated aggressively go after new markets in wood conversion. What exactly did you mean by new markets?

Jesse Singh -- Chief Executive Officer

Well, so if you step back once again and you look at what we've gone through over the last 18 months, we have not been able -- because of capacity constraints, to be able to go after new customer segments within our existing geographic footprint. Think of the U.S. and Canada. And so, as we have seen opportunities to take on new dealers and new opportunities, we have been constrained in that.

And so, at one level, we see opportunity in certain geographies. And at another level as I mentioned earlier, we have constraints in certain products. And so, as we have this additional capacity coming online, that will give us an opportunity to really go after some of those product segments that we've constrained. Some of those segments, downstream segments are somewhat obvious.

Some are less obvious. I'm not going to disclose any specifically, but we do see now that we have additional capacity to bring to bear, pretty meaningful opportunity at a number of different contractors, dealers, customers and segments and products where we can be much more aggressive. So that's about as specific as I can get.

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

That is helpful. And then you mentioned, I believe, that leads were up 40% year over year. What time period was that measured over? And what has your historical success rate been on on the leads?

Jesse Singh -- Chief Executive Officer

Yeah, that's within the fiscal year in aggregate across the year. I think, if we've done analysis on our -- and John happens to be on also if he wants to comment. But as we've done analysis on the correlation between our digital activity and our sales, it is typically directional. We are at times able to validate whether or not a lead has closed; and at other times, not.

So we use that data as directional data and an indication of the future opportunity we have. And I think, the opportunity of the challenge we have in that is just that there's typically a, as we talked about earlier, between a two- and 14-month lead time from when a consumer engages on thinking about building an outdoor living project, to when they actually execute it.

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

Thank you very much. Appreciate it.

Jesse Singh -- Chief Executive Officer

Thank you.

Operator

Our next question comes from Susan Maklari with Goldman Sachs. Your line is open.

Charles Perron -- Goldman Sachs -- Analyst

Hey, good morning, everybody. This is Charles Perron in for Susan today. Congrats on the results. The first question is on your capacity addition.

Can you provide more details for the capacity addition across product category? You said that you were constrained in rail series. Should we expect more additions going forward on the railing side relative to decking? And also, I would like to know a little bit more about your exterior business. I mean, you said it grew, I think, 30%-plus in the fourth quarter. Can you talk about the need to add more capacity there as well?

Jesse Singh -- Chief Executive Officer

Yeah, let me take the latter question first. We have publicly disclosed on the decking side exactly how much capacity we've been adding. We have also been adding exteriors capacity as part of our capital investment, we just haven't disclosed specifically. So we have additional capacity on exteriors come online last year.

We've got additional capacity coming online this year, both in our core products and our new products. And we've also had some terrific progress on both raw material sourcing and efficiency in that business. So once again, we've got it. It's in the capital numbers.

We don't disclose specifically there. We've talked, on your earlier question, on the rail side we've made investments over the last three to six months both on the supply chain, raw material and production side. We continue to ramp that up. And we believe we'll be in a position, as we move into next calendar year, to be able to continue to service that increased demand.

And as you highlighted, we were somewhat constrained on that particular business in the last quarter, and we are debottlenecking some of that as we speak. And then, on the decking side, I think we've disclosed that capacity progression. And I'll just highlight, we have -- because of our new facility, we had a lot more room under our existing roof to expand our decking and rail capacity above what we've highlighted already. The building is there, we have an opportunity to continue to expand.

Charles Perron -- Goldman Sachs -- Analyst

OK, that's super helpful color. Thanks, Jesse, for that. And then, my follow-up is on the trade situation out there and specifically considering the 100% capacity addition between 2019 and 2022. What is the ability for trades to support that growth? And is there any measures that you could put in place, maybe in terms of product design or training, that you can help -- to help support the growth that you could see there on the labor and trade side?

Jesse Singh -- Chief Executive Officer

Yeah. As it relates to our contractor base, one of our innovation focuses has been on driving more productive products. And so, on the exteriors business, we had a number of products that we have launched that are really focused on contractor productivity, whether that be our channel trim or or corners or column wrap these are products effectively meant to solve some of the contractor productivity issues. And similarly, one of our fastest-growing products is our panelized rail system on the deck rail and accessories business that solves that problem.

And then, lastly, as you point out, we continue to invest in contractor training. And we will now have four contractor training facilities, including a new one in our Boise facility. I think, as you survey contractors, and we do at length, they are -- they continue to work through the labor challenges themselves. And we work with them on continuing to educate their new employees and support them in the field with our sales force.

Charles Perron -- Goldman Sachs -- Analyst

OK, thanks for the time, and good luck. 

Jesse Singh -- Chief Executive Officer

Appreciate it. Thank you.

Operator

Our next question comes from Ketan Mamtora with BMO Capital Markets. Your line is open.

Ketan Mamtora -- BMO Capital Markets -- Analyst

Thank you, and thanks for taking my question. Jesse, can you talk a little bit about your capital allocation priorities? Balance sheet is in a very good shape. And perhaps from an M&A standpoint, what is most interesting to you guys?

Jesse Singh -- Chief Executive Officer

Yeah, I'll just repeat. As we look at our capital allocation, the best opportunity we have and the highest return on investment is investing in ourselves with capacity expansion and innovation in new products. And we have a stated objective of continuing to bring our business model into a broader area as it relates to outdoor living. And we have the internal organic capability to get there through our new product development, which we're continuing to invest in.

And you'll see that unfold over the next few years. As it relates to M&A specifically, that is our stated second objective of use of capital. And we continue to have a really nice robust pipeline. And we believe that there's gonna be opportunity for us to solidify our position as a leader in exteriors and outdoor living, both through organic and acquisition activity.

So we feel good about the pipeline. And as those deals come to fruition, you'll hear about them.

Ketan Mamtora -- BMO Capital Markets -- Analyst

That's helpful. And then, Jesse, one more on the channel inventory side, do you think that you've gotten to a point where it's kind of reached more normal levels to be able to service customers? Or do you think there's kind of more to be done there?

Jesse Singh -- Chief Executive Officer

As we talked about on the last call, during Q3 we made progress on getting our dealer channel inventory healthier. And then as we moved through Q4, we were able to continue that progress and get our distribution channel inventory healthier. There is still some room, as we move forward over the next few quarters, to continue to support our channel partners on inventory. But I would say right now, we are in a great position to really be able to attack the market and to continue to expand our service capability.

We believe right now as we sit, we are in the best, if not one of the best positions of any of the players in the industry to be able to service existing and new volume, which we think sets us up well for growth in '22.

Ketan Mamtora -- BMO Capital Markets -- Analyst

Got it. I'll turn it over. Good luck in FY '22.

Jesse Singh -- Chief Executive Officer

Thank you.

Operator

Our next question comes from Michael Rehaut with J.P. Morgan. Your line is open.

Michael Rehaut -- J.P. Morgan -- Analyst

Good morning, everyone, and congrats on the results. First question, I'd love to just circle back a bit to some of the thoughts around the composition of the sales guidance, sales growth guidance for next year fiscal '22, mid-teens. I think, you said roughly half price, half volume. Just wanted to get a sense in terms of thinking about the impact of price throughout this year.

If you could just kind of walk through I believe there's been two or three price increases. Perhaps we're thinking about mid-single digits for each, but perhaps you could clarify on that. And I believe you -- there's further pricing actions expected to be taken later this year that you alluded to. And I thought we've heard that might be a bit of a higher percentage increase.

I just want to make sure that we're thinking about that right. Because all else equal, it could potentially point to, if you just kind of flow all that through, perhaps even like a low double-digit impact of pricing on fiscal '22. And I just wanted to understand if there's parts of that methodology that I kind of laid out, that maybe we are a little off-center on.

Pete Clifford -- Chief Financial Officer

Yeah, let me take that. From a pricing perspective as we articulated, we did in fact exit the fourth quarter at kind of mid-teens. But embedded in the '21 pricing is one, we had a price action really right at the end of fiscal '20 that, obviously, carried over almost completely into '21. Obviously, that lapse right now goes away.

And ultimately as we hit the first half of the year '21 price increases, it does level us back down to a full year that's high single digits. And as far as sort of what does that mean again by quarter, just in our prepared remarks, we had articulated that look, at least on a dollar-inflationary basis, we cover all four quarters of '22 with price dollars completely. And then what's unique or different now for the first time is in the second quarter late 2Q, we finally expect to have price not only exceed the inflation dollars, but actually start to accrete the margin rates, gross margin rates, a bit.

Michael Rehaut -- J.P. Morgan -- Analyst

OK, no, that's great. That's very helpful. So then, I guess, kind of the second question, you are kind of focusing on volume. If you're thinking more high single digits price, that would -- if you're talking about mid-teens, then you're talking something in the mid-single digits, let's say, mid- to potentially high but -- and certainly fiscal '21 is a great growth year.

But with the additional capacity and the continued material conversion, plus the additional distribution with Weyerhaeuser and continued gains from that perspective, what's the ability for that, let's say, mid- to potentially high single-digit volume growth? To us, it seems somewhat conservative. And I just I don't know if there's something I'm missing, or if you're just trying to be somewhat conservative at the onset of the year.

Jesse Singh -- Chief Executive Officer

We have a -- we've got a stated guidance of long term of 8% to 10%, and we'll update that as the quarters progress. I think, we're really, really optimistic about our ability to continue to gain share in the market as we move into '22. I think, those of you that have been around us as management, we want to make sure that we are setting ourselves up to continue to progress and win in the future. And so, at this stage, we feel really good about both the market opportunity, our ability to, to win in a disproportionate way in the market.

And also, we feel good about our guidance.

Michael Rehaut -- J.P. Morgan -- Analyst

OK, great. Thanks so much.

Operator

Our next question comes from Kurt Yinger with D.A. Davidson. Your line is open.

Kurt Yinger -- D.A. Davidson -- Analyst

Great, thanks. Good morning, everyone. I just wanted to go back to an earlier question around kind of recycling constraints. And I was hoping you could maybe put a little bit more color around the investments you're making there to perhaps alleviate some of those challenges.

And then just as a point of clarification, are those constraints more on sourcing, your own internal processing capabilities, or just lack of line time to kind of implement formulation changes?

Pete Clifford -- Chief Financial Officer

Yeah, if I could take that one. I think, one of the greatest stories about 2021, as Jesse alluded to earlier, was the performance and execution by our PVC recycling teams. If you look at the product lines and categories that they were supporting in '21, many of those product categories were growing mid-20% to 30% on a volume basis. So the team really rallied to be aggressive in terms of developing and finding new sourcing alternatives for us to get product in.

We spent capex to expand our return polymers capacity. And then ultimately, the reality is they covered enormous volume growth. Every one of those pounds, if we had had chosen to get virgin PVC, we would have seen meaningful more inflation. So as we think about recycling as a margin expander it's also one of our best levers against inflation.

And when we think about '22 and what we've learned from how to source, in '21 the capacity expansions that we put in and return polymers. And now, number three, what's significantly different is the extrusion lines and the capacity expansions coming online. It makes that third piece of the equation that much more executable, that we now have line time to go chase the validations and reformulations that are required as the final step to increase percentage content of PVC recycling as an example.

Kurt Yinger -- D.A. Davidson -- Analyst

Got it. OK, that's very helpful. And then just my second one on conversion trends from wood. Any thoughts about the impact, just as lumber prices have really normalized here at the same time as you and others in the industry are raising prices? And what are the biggest kind of controllable focus areas for you in terms of working to maintain the elevated rate of conversion we've seen over the last two years?

Jesse Singh -- Chief Executive Officer

Yeah, I'll take that. As we mentioned on our previous earnings call, we did an extensive amount of research on wood conversion. And that really led us to defining the market opportunity for conversion over the next few years as getting to 50%. And when you dive into that research, it -- the key element here is that people want a more natural-looking product.

And when they're outside, they don't want to stand on what they perceive as plastic. They want to be on a sustainable material that gives them the warmth and the feel of wood. And I think, too many times, I think other players in the industry will continue to highlight a specific economic equation as the only driver. I think, there is a broad-based set of criteria.

And the fact that some of our most expensive products, which are the most expensive products in the market, continue to do well with wood conversion just really highlights that because they're the most realistic products in the market. Now having said all that, I think as you look at wood pricing vis-a-vis entry-level composite pricing, we're still in a really, really positive range. The models were never built at that opening price point on wood being in the thousands. And so, the equation for that entry-level conversion has held for the last few years, and and we expected it to hold.

But we also believe that there's a broader opportunity that's really around aesthetics, quality, and educating the market that you can have it all.

Kurt Yinger -- D.A. Davidson -- Analyst

Got it. OK, that makes sense. I appreciate all the color, and good luck here in the new fiscal year.

Jesse Singh -- Chief Executive Officer

Appreciate it. Thank you.

Operator

Our next question comes from Mike Dahl with RBC Capital Markets. Your line is open.

Ryan Frank -- RBC Capital Markets -- Analyst

Hey, guys, this is Ryan Frank on for Mike. Thanks for squeezing me in. I'm just going to ask one quick one in the interest of time. So you mentioned that inventory levels have been improving.

Just if you could just piece out what in there is improved service levels versus maybe normal seasonality and slowing of demand? And then what level of restocking is included in the 1Q sales guide? That's all for me.

Jesse Singh -- Chief Executive Officer

Thank you. Yeah, I'll just answer it at a very, very high level. We exited the year with our channel partners getting closer to where they wanted to be in order to have inventory to service the market. There was an earlier question relative to normal seasonality.

And we still believe that there is a bit more opportunity to continue to solidify inventory in the channel. But as we move through the calendar fourth quarter and the calendar first quarter, the inventory dynamics really start to move toward positioning inventory for the subsequent year. And so, I think, that's probably the best way to answer it is that we are in a great position to stage inventory, as we come through the second quarter, to be able to drive growth in the market.

Ryan Frank -- RBC Capital Markets -- Analyst

Got it. And then 1Q restocking included in the guide?

Pete Clifford -- Chief Financial Officer

Yeah, there's very modest inventory build assumption in the first half of the year.

Ryan Frank -- RBC Capital Markets -- Analyst

Got it. Thank you very much. That's all for me.

Operator

We have run out of time for the Q&A session on today's call. I'll turn the call back over to Jesse for closing remarks.

Jesse Singh -- Chief Executive Officer

Thank you, again, for participating in the call. We're really excited about the future. And we are really excited about our position as we exit '21 and enter fiscal year '22. With that, thanks, and we'll chat with you next time.

Have a great day.

Operator

[Operator signoff]

Duration: 66 minutes

Call participants:

Amanda Cimaglia -- Vice President, Environmental, Social and Governance

Jesse Singh -- Chief Executive Officer

Pete Clifford -- Chief Financial Officer

Ryan Merkel -- William Blair and Company -- Analyst

Tim Wojs -- Robert W. Baird and Company -- Analyst

Ashley Kim -- Barclays -- Analyst

Unknown Speaker

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

Charles Perron -- Goldman Sachs -- Analyst

Ketan Mamtora -- BMO Capital Markets -- Analyst

Michael Rehaut -- J.P. Morgan -- Analyst

Kurt Yinger -- D.A. Davidson -- Analyst

Ryan Frank -- RBC Capital Markets -- Analyst

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