Azek Company Inc
NYSE:AZEK
Earnings Call Analysis
Q1-2024 Analysis
Azek Company Inc
The start of fiscal 2024 has been marked by an impressive 11% increase in net sales year-over-year for AZEK, reaching 22% when excluding the recently divested Vycom business. This growth has been propelled by robust residential demand, as evidenced by a 24% hike in residential segment net sales and an astounding 430% surge in the segment's adjusted EBITDA. The company's dedication to its core values, innovative products like the new TimberTech framing aluminum substructure, and a strategic approach to market positioning, has not only enhanced brand awareness but also led to notable gains in both professional and retail channels.
These solid results stem from the cumulative effect of well-executed initiatives over recent volatile market conditions. By optimizing shelf presence, launching innovative products, and strategic acquisitions, AZEK's market share and growth have outpaced competitors. Central to this success is the emphasis on recycling and efficient manufacturing processes, which have significantly boosted adjusted EBITDA margins, now at 23.2%, and are expected to further rise to 27.5% through continuous margin-driven initiatives.
While maintaining a conservative stance on inventory levels and market growth predictions, AZEK remains confident in its margin outlook and the potential for sustained growth. The company prepares for expanded opportunities in the retail channel by actively enhancing product offerings and manufacturing capabilities, such as the upcoming launch of TimberTech Advanced PVC Decking, which is a testament to its commitment to innovation and sustainability.
AZEK's financial fortitude is evident through a substantial increase in gross profit, a total of $91 million or a growth of 92% year-over-year, and a 1,550 basis points rise in adjusted gross profit margins to 39.6%. Despite a slight increase in SG&A expenses, primarily related to enhanced marketing and brand efforts, the adjusted EBITDA skyrocketed by 269% relative to the previous year, and the company remains committed to shareholder value through buyback programs and other capital allocation strategies.
Encouraged by the first quarter's outperformance and positive demand trends, AZEK has revised its full-year guidance to $1.385 billion to $1.425 billion in consolidated net sales, signifying a 7% to 10% increase year-over-year. For adjusted EBITDA, the new guidance is set at $353 million to $372 million, which notes a substantial growth range of 27% to 34% year-over-year. The Residential segment projects net sales reaching between $1.312 billion to $1.348 billion, and segment adjusted EBITDA to span between $340 million to $356 million, pointing to a runway for growth in both revenue and profitability in the upcoming year.
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Welcome to the AZEK Company's First Quarter Fiscal 2024 Earnings Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to Eric Robinson. Please go ahead, Eric.
Thank you, and good afternoon, everyone. We issued our earnings press release and a supplemental earnings presentation this afternoon to the Investor Relations portion of our website at investors.azekco.com. The earnings press release was also furnished via 8-K on the SEC's website. I'm joined today by Jesse Singh, our Chief Executive Officer; and Peter Clifford, our Chief Operations Officer and the Chief Financial Officer. I would like to remind everyone that during this call, we may make certain statements that constitute forward-looking statements within the meaning of the federal securities laws, including remarks about future expectations, beliefs, estimates, forecasts, plans and prospects. Such statements are subject to a variety of risks and uncertainties as described in our periodic reports filed with the Securities and Exchange Commission that could cause actual results to differ materially.
We do not undertake any duty to update such forward-looking statements. Additionally, during today's call, we will discuss non-GAAP financial measures, which we believe can be useful in evaluating our performance. These non-GAAP measures should not be considered in isolation or as a substitute for results prepared in accordance with GAAP. Reconciliations of such non-GAAP measures can be found in our earnings press release which is posted on our website. Now let me turn the call over to AZEK's CEO, Jesse Singh.
Good afternoon, and thank you for joining us. The AZEK team once again delivered strong results in our 2024 fiscal first quarter, including an 11% net sales increase year-over-year. Excluding the recently divested Vycom business, net sales increased 22% year-over-year, driven by strong residential performance. Adjusted EBITDA grew substantially year-over-year and adjusted EBITDA margin expanded 16 percentage points to 23.2%, driven by strong gross margin performance and more normalized production levels. One of our core values is that the best team wins, and we believe that our success is driven by having the best employees and partners in the industry. I want to take a moment to thank all of our expanded team members and partners for their dedicated and committed focus on delivering the best experience for our customers. We continue to see strong contractor and consumer demand for our products and our increase in sales was driven by double-digit residential sell-through growth.
Residential segment net sales increased 24% year-over-year and segment adjusted EBITDA increased 430% year-over-year. Residential segment adjusted EBITDA now includes the residential business and all corporate costs and highlight the strong performance of the core business, excluding our Commercial segment.
Within the quarter, the Residential segment saw strong growth in Deck, Rail, Accessories and exteriors products. We experienced growth in both our residential pro and retail channels as we benefited from the execution of our initiatives.
We also saw strong interest in opening orders for our new products, including our new TimberTech framing aluminum substructure solution. During the quarter and over the last year, we believe the strength of our business model, combined with ongoing material conversion away from wood that supported our above-market performance in both our Exteriors and outdoor living product categories. Over the last 12 months, our Residential segment has grown 12% year-over-year which has been driven by end market demand for our products.
Like Q4 of 2023, we are seeing the cumulative and structural benefits of the actions we have taken over the last few years during significant market and supply chain volatility. We have systematically gained shelf position in the pro and retail channels, launched innovative new products, invested in our brand, and added strategic acquisitions that have led to a stronger position in the market and increased our capability to drive above-market growth. We have also increased the use of recycled materials, aggressively used our AZEK integrated management system to improve our efficiency, priced to offset supply chain issues, and improved our product design, all leading to our expanded margins.
As we highlighted at our Investor Day in 2022, we believe that we have an opportunity to increase our adjusted EBITDA margin percentage by 500 basis points to 27.5% through our initiatives. The progress of these margin initiatives was masked by the combination of supply chain issues and a meaningful reduction in factory utilization during the first 9 months of fiscal 2023 as we managed down inventory. After multiple years of supply chain disruption and a year of inventory recalibration in our channel and within our business, we have now returned to a more traditional operational cadence.
We believe that we are now in a good position to sustain our gains and continue future progress through our margin initiatives. We have invested and will continue to invest in our core strengths of research and development, brand awareness, customer relationships and our world-class manufacturing operations.
We are in the process of completing a new manufacturing facility outside of Pittsburgh that will increase our Exteriors business capacity and allow us to expand our product offerings. We are also making incremental investments in each of our facilities to allow us to expand the use of recycled materials and accommodate new products on our road map that will support future growth.
At the upcoming 2024 International Builder Show, we will show a broad range of our products in an interactive format. At the show, our TimberTech Advanced PVC Decking is being recognized as a Best of IBS Awards finalist in the Most Innovative Building Materials category based on its innovation, functionality, sustainability, design and builder and consumer friendliness. This product line uses a high percentage of recycled PVC and is one of the only decking products on the market that has a Class A or very high fire rating. It reinforces our position as the #1 brand in premium decking, driven by our proprietary products that provide unique solutions to aesthetic and functional problems. From a channel perspective, we exited the fiscal first quarter with channel inventory lower than historical averages and the previous year based on days on hand. We only shipped product during the quarter to sustain the current demand in the market. And as always, we worked with our channel partners to ensure high service levels.
During the quarter, we negotiated most of our dealer agreements for calendar 2024, including shelf position, pricing and expectations for future orders. We once again had a successful process and have incrementally expanded our position in the pro channel market. These shelf gains and subsequent preseason or early-buy orders started shipping in fiscal Q2.
As we look to the remainder of the year, we continue to be both optimistic and cautious about the upcoming season. Year-to-date, we have had strong double-digit sell-through growth in our Residential business. And we feel good about the progress we've made in establishing ourselves in preparation for the normal increase in seasonal demand. We think it's prudent to assume a flattish R&R market moving forward and have incorporated that into our 2024 outlook.
We ended Q1 at meaningfully lower channel inventory levels than the historical average. Our Q2 revenue guidance assumes a normal spring buying process for our channel and includes the outcome of our spring negotiation. Our channel and our contractors are incrementally more positive, and we continue to have more confidence and visibility to our margins. We are raising our fiscal 2024 outlook for the year, driven by the demand we have experienced year-to-date, combined with our expectations that our adjusted EBITDA margins will range between 25.5% and 26.1% for the year.
We remain confident in our ability to deliver our short- and long-term ambitions as we continue to execute our overall strategy. 2024 will be another step in the journey of realizing our potential as a business.
I will now turn the call over to Peter to provide some additional context on our financial results and our outlook.
Thanks, Jesse, and good afternoon, everyone. As Eric highlighted at the beginning of the call, we have uploaded a supplemental earnings presentation on the Investor Relations portion of our website.
Before we get into the first quarter results, I wanted to provide some context on the first quarter demand. First, on sell-through, consistent with last quarter, we continue to experience strong double-digit sell-through growth in fiscal 1Q '24. This is the result of continued execution of the AZEK growth playbook, including downstream material conversion initiatives, channel expansion efforts, new product development and shelf space gains. We ended the quarter with channel inventories down approximately 20% versus the historical average days on hand.
Consistent with past quarters, we surveyed a broad base of our pro contractors and dealers to understand the environment on the ground. What we learned is that demand indicators and sentiment remained steady in the quarter. Our contractors reported project backlogs of 7 weeks, just above pre-pandemic levels.
From a sentiment perspective, both our dealers and our contractors recorded similar views at the end of the quarter. Current sentiment for both dealers and contractors is modestly more positive in the last quarter.
On the digital side, we continue to see robust growth in both samples and web traffic. These metrics highlight continued strong interest in our products and the effectiveness of our digital engagement strategies.
Finally, the retail point of sale or POS data continues to experience healthy growth year-over-year. Total retail POS remained above our pro channel sell-through. These results underscore the strength of our retail partnerships, the continued demand for our products in store as well as the accretive growth opportunity in front of us in the retail channel.
From an operating perspective, production levels were up substantially year-over-year as expected after lapping the inventory drawdown experienced in the first quarter last year. Normalized production levels in the quarter drove strong utilization and cost absorption in the quarter. We continue to execute our traditional annual recycling and product configuration initiatives. And on the material cost input front, sourcing and material savings continue to provide incremental tailwinds. These combined levers enabled us to deliver structurally different gross margins.
In terms of SG&A, our results reflect a more normalized spend profile relative to 1Q '23. The combination of double-digit residential sell-through growth, coupled with strong execution of our material savings, conversion costs and recycling initiatives helped us drive strong results in the first quarter. As a reminder, for fiscal 1Q '24, the Residential segment adjusted EBITDA includes all corporate expenses. All numbers reflect this change for 1Q '24 and the prior year comparable quarter.
In addition, the previously announced closing of the Vycom transaction occurred on November 1, 2023. And as a result, fiscal 2024 includes the impact of approximately 1 month of Vycom operations on the Commercial segment performance.
To assist with modeling, Vycom net sales were approximately $3 million and profitability was approximately breakeven during the 1 month of ownership in October. As a reminder, with the divestiture of Vycom, the remaining portion of the Commercial segment manufactures fabricates and distributes lockers and bathroom partitions.
In the first quarter of 2024, we increased our consolidated net sales by 11% year-over-year to $240 million, which was above our guidance expectations. Excluding the impact of the Vycom divestiture, our net sales were up 22% year-over-year. The first quarter growth was driven by our Residential business being up 24%, partially offset by the $18 million net impact from the sale of our Vycom business in our Commercial segment.
Effective as of December 31, 2023, we have revised the definition of adjusted gross profit to include depreciation expense in the calculation. All numbers presented reflect this change for the first quarter of 2024 and the prior year comparable quarter.
Taking this into consideration, 1Q '24 gross profit increased by $44 million or 92% year-over-year to $91 million. 1Q adjusted gross profit increased by $43 million or 83% year-over-year to $95 million. Our adjusted gross profit margin percentage increased 1,550 basis points year-over-year to finish at 39.6%. The adjusted gross profit increase was driven primarily by higher net sales, stronger utilization in our plants, continued execution of recycling product configuration initiatives and benefits from both sourcing and material savings.
SG&A expenses increased by $4 million to $77 million. The bulk of the year-over-year increase was primarily due to higher stock-based compensation and continued investment in marketing and brand awareness, partially offset by lower personnel costs. Adjusted EBITDA for the first quarter increased by $41 million or 269% year-over-year to $56 million. The adjusted EBITDA margin rate for the quarter increased 1,620 basis points year-over-year to 23.2%.
Net income for the first quarter increased by $52 million to $26 million or $0.17 per share. Adjusted net income for the first quarter increased by $30 million to $16 million or adjusted diluted EPS of $0.10 per share. As a reminder, if we excluded the $38.5 million gain on the sale related to the divestiture of our Vycom business from adjusted net income.
Now turning to our segment results. Residential segment net sales for the first quarter was $223 million, up 24% year-over-year. Residential segment adjusted EBITDA for the first quarter came in at $53 million, up approximately 430% year-over-year. Residential segment adjusted EBITDA margins were up 1,820 basis points year-over-year to 23.7%.
Commercial segment net sales for the quarter were $17 million, down 53% year-over-year, primarily due to the sale of our Vycom business. Commercial segment adjusted EBITDA for the quarter came in at $2.9 million or a decrease of $2.2 million year-over-year. The decrease was primarily driven by the disposition of the Vycom business.
From a balance sheet and cash flow perspective, we ended the quarter with cash and cash equivalents of $275 million and approximately $148 million available for future borrowings under our revolving credit facility. Working capital, defined as inventory plus accounts receivable minus accounts payable, was $251 million, down $90 million year-over-year. We ended the quarter with gross debt of $671 million, which included approximately $78 million of finance leases. Net debt was $396 million, and our net leverage ratio stood at 1.2x at the end of the first quarter. Net cash from operating activities was negative $16 million during the first quarter, a decrease of $23 million year-over-year. Capital expenditures for the quarter were approximately $18 million, down $13 million year-over-year.
For the first quarter, free cash flow was negative at $34 million, a year-over-year decrease of $10 million. As a reminder, we are traditionally a net consumer of cash during the fiscal first quarter as it is our smallest quarter seasonally and coincides with the annual inventory build in preparation of the season.
As previously announced, we initiated a $100 million accelerated share repurchase program. Under the agreement, the company received about 2.3 million shares with the balance to be delivered no later than February 2024. After the ASR is completed, the remaining authorization under our share repurchase program was approximately $101 million. As a reminder, our capital allocation priorities remain the same as we've previously communicated. We will continue to invest in our business, both organically and inorganically. And to the extent we have excess cash flow, we will look to repurchase shares opportunistically.
As we turn to the outlook, let me provide some color on what we're seeing and assuming for the balance of the fiscal year. We expect to see a flattish R&R market in fiscal 2024, and we see our residential sell-through in the mid-single digits for the balance of the fiscal year.
We continue to focus on driving above-market growth through our strategic initiatives, including market conversion and share gains. As we've mentioned in the past, the Early Buy period kicks off in the fall, and it is the time of the year in which our dealer partners make shelf space decisions for the following year's selling season.
Once again, we were pleased with our performance, and we believe we drove shelf space wins and expansion similar to recent years. These shelf space wins will be realized as product reaches the shelves and sell-through begins in earnest in the traditional selling season. From an inventory perspective, we continue to manage the channel conservatively while maintaining high service and short lead times.
Quarter-over-quarter, we increased our finished goods inventory to prepare for the season and be able to react quickly to changes in the demand environment. Overall, consistent with our contractor and dealer surveys, we are cautiously optimistic on demand in the selling season but need to see more data in the season to update our expectations around the market and associated sell-through.
On the margin side, the second fiscal quarter will be positively impacted by higher production levels, increased utilization and cost absorption. We continue to see benefits from our focus on sourcing as well as recycling initiatives, which will continue to drive lower input costs to the benefit of our gross margins in the quarter.
On SG&A, we will continue to support organic growth through sales and marketing initiatives. With that context, let me move to our updated planning assumptions for fiscal 2024.
With our outperformance in the first quarter and demand seen to date, coupled with increased visibility and our margin drivers, we are increasing our guidance for full year consolidated net sales to range between $1.385 billion to $1.425 billion and increasing our full year adjusted EBITDA range to between $353 million to $372 million. Adjusting for the Vycom sale, our net sales guidance would imply 7% to 10% year-over-year growth and 27% to 34% year-over-year growth in adjusted EBITDA.
Our Residential segment planning assumptions for the year is $1.312 billion to $1.348 billion in net sales and $340 million to $356 million in segment adjusted EBITDA, representing 7% to 10% sales growth year-over-year and 30% to 37% segment adjusted EBITDA growth when combining corporate expenses with our Residential reporting segment, as mentioned earlier.
A few other assumptions this year include the following: we expect strong gross margin performance, enabling us to continue to invest in growth-oriented sales, marketing and brand awareness initiatives. We're expecting a capital expenditure range between $80 million to $95 million, consistent with our stated target of CapEx of approximately 5% to 7% of revenue.
We are expecting depreciation of approximately $89 million to $92 million. We are targeting a working capital reduction of approximately $10 million to $20 million for the year. We are expecting a GAAP tax rate for the full year of 29% to 31%. And finally, for the full year fiscal 2024, we expect to deliver another strong year of free cash flow generation.
For additional planning assumptions to assist with modeling fiscal '24, please refer to the supplemental earnings presentation we have posted on our Investor Relations website. Before we turn to our guide for the second quarter, let me provide some context for the environment that we expect.
For the quarter, we are expecting sell-through growth in the mid-single-digit range. Traditionally, we have seen our own inventory come down meaningfully for 1Q to 2Q. In 2024, we expect to stage modestly more inventory on our own balance sheet for 2Q before coming down in the second half of the year.
Taking these factors into consideration, our guidance for the quarter is $407 million to $413 million in revenue and $108 million to $112 million in adjusted EBITDA. We are expecting an effective tax rate of approximately 27% for the quarter. With that, I'll now turn the call back to Jesse for some closing remarks.
Thanks, Pete. I would again like to thank our dedicated team members, channel and supplier partners and contractors that support the AZEK company. Thank you for your contribution and dedication. We are excited about the long-term material conversion opportunity ahead of us in the large and fast-growing outdoor living and home exteriors markets that AZEK plays in. Our Residential segment has continued to show remarkable resiliency and growth capability.
The business has delivered a compound annual growth rate of 12% over the last 10 years and 16% since fiscal 2017. Our execution of our strategic growth and margin initiatives and the benefits we have realized to date increase our confidence in our long-term financial objectives of driving double-digit annual net sales growth and expanding our adjusted EBITDA margin to our target of approximately 27.5%. With that, operator, please open the line for questions.
[Operator Instructions] Our first question comes from the line of Keith Hughes with Truist.
Some good results and a really strong guide here for the second quarter. I guess that's where my questions lie. With single-digit sell-through, the revenue implication is higher in your guide. I assume there's an inventory build, if you could talk about where that's coming and also any difference in growth rates between exteriors and decking.
Yes, Keith. This is Peter. Thanks for the question. So 2 parts there. As I mentioned in the prepared remarks, we exited the first quarter of '24 with channel inventory down about 20% from historical kind of pre-pandemic days on hand. It's a little lighter than what we expect. So that's part of the equation on top of the mid-single-digit kind of sell-through assumption at just kind of normal Early Buy cost staging that would be customary. On the second question, we are seeing positive growth on both exteriors as well as Deck, Rail & Accessories. And just a reminder, to clarify, Keith, if you recall, much of the inventory recalibration last year, we really didn't have much of an impact from a exteriors perspective. It was almost exclusively a decking item.
Okay. And just one follow-up to that. I know you've won some shelf space in some big box. Is that playing a role, a meaningful role, in these numbers out for the second quarter guidance?
I don't know that I would call it meaningful, but there is a modest impact, right, that we won that business kind of middle of the year. So we probably really more benefited in the third and fourth quarter of last year and probably have a net year-over-year pickup here in the first half of the year, but it's modest.
And our next question comes from the line of Phil Ng with Jefferies.
Congrats on a strong quarter and outlook. I guess, Pete, if I look at your sales guidance for your Residential segment for the full year and back out 1Q, it implies roughly, call it, 5.8% sales growth on the resi side for the rest of the year. Can you help unpack, what's driving that? I think there's a price increase in the marketplace by you guys. Are we seeing much traction? How much of a contribution should we anticipate? And what are you kind of thinking about sell-out demand in your busy peak season?
Yes. The math there for you on the last 9 months of the year, we are implying just about 6% kind of mid-single digits kind of sell-through without a lot of assumed changes in channel inventory over the 9 months.
As far as pricing, it's the same answer as last quarter. Our view hasn't changed. Pricing is negligible for the year. We took some traditional annual price actions, and those basically washed with some of the backside programmatic pricing initiatives that we talked about in the back half of last year.
Okay. That's helpful. And then from a margin standpoint, you guys are doing -- seeing the improvement that we all hoped for and you guys have talked about. You're guiding to, call it, 25.8% EBITDA margin for the full year. Your long-term target is closer to 27.5%. It seems like there's upside potential there. Help us kind of think about maybe is there upside there or maybe get there a little closer? And what are some of the big drivers for the pace being a little faster than perhaps we may have anticipated?
Yes. Phil, Jesse here. Your point is a good one. We certainly expected that we would have an opportunity to continue to drive margin. I think what we highlighted at the Investor Day in 2022 was a 500 basis point opportunity that gets us to 27.5%. You should think of against that.
We continue to see, give or take, 100 basis points of opportunity per year moving forward. We're not giving specific guidance to '25 and beyond. What I highlighted in my prepared remarks is we're incredibly confident on the 27.5% and then against that, you should consider that, give or take, 100 basis point on average margin expansion in a more normalized year.
And I think as happy as we are with the progress that we've made against certain initiatives that are helping us with our margin, we still believe that there's a lot of room for us to continue to drive operational efficiency, increase the use of recycled and to continue to drive down and increase productivity in a number of different areas. So as we progress, we'll give you a better view on '25 and beyond. But I'll just summarize by saying we continue to see an opportunity of 100 basis points a year over the long term.
And our next question comes from the line of Matthew Bouley from Barclays.
Obviously, there's a lot of kind of chop out there in the R&R space. And you guys raised guidance on the top line and the bottom line. I guess the way to ask the question would be, would you be able to bridge kind of the difference between the prior guide and the new guide? Is it simply the additional shelf space wins? Does it feel like kind of material conversion is tracking a little bit better? Altogether as a result, production is a little bit higher. Just kind of put all those pieces together, difference between the prior guide and the new guide.
Yes. I'll start at a high level, and let Pete chime in. As we said in our prepared remarks, we had strong double-digit growth really to the point that we're out now and -- at now. And so clearly, when you have that, you saw our results in the first quarter and that was primarily sell-through driven. So as you complete, in our case, coming on 4 months of sell-through, that's an element that has already happened against that, call it, 5% sell-through assumption.
And then there's some modest incremental pickup that we have beyond that. But if you just take a look at our 3-quarter guide, Q2, Q3, Q4, that's roughly in line with that mid-single-digit sell-through assumption. And so from our vantage point, there's some modest tweaks, but we're still operating under that baseline assumption of a flattish R&R plus the contribution that we see against that of our incremental initiatives and the market space that we're in. And as you pointed out, part of that is continued conversion. Part of that is our shelf space gain. Part of that is the benefit we see from incremental new products.
And I think we've said that's what allows us to stack, call it, 5 to 7 points over the underlying R&R basis. So although it is a certainly a step-up in our guide, if you just play through the basic fundamentals that we're talking about, we're not really changing that much in the guide as we look forward.
Got it. Okay. Second one, I think I heard you say at the top that retail POS is actually above your pro channel sell-through. And correct me if I misheard you, but I think that's probably another unique item to AZEK here. So yes, just could you kind of go into some of the specifics around your new retail business and just sort of what's going on differently there for your products relative to what we're seeing elsewhere in the retail world?
Yes. I think if you just step back and you look at the equation that we're talking about from a business model standpoint, we continue to invest in our brand. We continue to invest in our sales force and we continue to add new products. Those are all elements, as we talked about, that are additive to our overall growth equation.
Against that, as we talked about last year, we picked up some incremental shelf position. That is certainly contributing to the benefit that we're seeing in that channel, and that's flowing through. But on top of that, we believe that some of the marketing activities that we've had and the ongoing conversion and brand strength that we see, that, that's also benefiting us.
[Operator Instructions] Our next question comes from the line of Ryan Merkel with William Blair.
Wanted to start on the margins. I think in the deck, you mentioned increased visibility on margins as part of the guidance range. Can you just unpack that a little bit?
Yes, Ryan. This is Peter. Look, obviously, we have plans internally every quarter to kind of hopefully outdeliver and overdrive our guide. But as we mentioned, look 1Q is pretty critical when you think about the comp comparisons to '23. Our largest variance was going to be in 1Q, so it was really important for us to see that get booked and be done as well as getting visibility or clarity on sort of seeing the Early Buy orders completely through the month of January. So I think that's really -- we saw the mix, we saw our backlog. Those 2 things combined give us confidence as well as every quarter we get into the year. Obviously, with our rollback, our balance sheet lagged. We start to get a firmer picture of what deflation is going to look like in the back half of the year.
Got it. Okay. That makes sense. And then maybe a question for Jesse. I'm curious, how sensitive is decking to housing turnover? And the reason I ask is your results have been really impressive in sort of a tougher macro. And if housing turnover does improve, like many of us think it will, is that a boost to your business? Or should we not think of it that way?
It's an interesting question. One of the research companies a few days ago issued a perspective on this. And I think what they highlighted was that the correlation between housing turnover and R&R has gotten to the 30s in the last few years. And so what I would say is what we're seeing and what we continue to see is that people are investing where they live. And for us, we are not a business that's about housing transactions. We're a business about people expanding where they live. I think certainly, we live within the macroeconomic environment. And so as we're sitting here and we're guiding to mid-single-digit sell-through growth, that is below where we believe this business should be. And that's really being driven by the underlying flat nature of the R&R market. So certainly, if and when the R&R market normalizes to more of a growth position, that gives us an opportunity to continue to get back to where we're guiding on double-digit growth kind of numbers pretty consistently. We're getting close to that, obviously, with our current guide in residential this year. But it's really determined by that underlying R&R market, whether that's driven by consumer sentiment or housing turnover. We certainly think that there's an opportunity for that underlying R&R market to accelerate.
And our next question comes from the line of Michael Rehaut with JPMorgan.
Great. And congrats on the results so far. First, I just wanted to make sure I'm properly appreciating the first half results and guide for 2Q and into the back half. When you look at full year residential sales, you're looking at about 15%. So '24 in the first quarter, you're guiding to about 15% in the second. And that's against sell-through of roughly 10%, I believe, in the first quarter and 5% in the second and, I believe, mid-single digits for the full year. So I apologize if you kind of hit on some of this earlier, but just trying to get a sense of the delta, let's say, of roughly 10 percentage points between sell-through for the year and your own residential growth guidance. How much of that might be share gains versus any channel inventory restocking?
Yes. Let me make sure I've got the numbers right. The numbers I'm looking at, our Residential guide is between 7% and 10% for the year. We didn't give exactly what our sell-through growth was in Q1. We said strong double digits. So you should assume it's -- that's higher than 10%. So I think that's certainly one equation, one part of the equation.
And then Mike, simply, what we're doing is we -- for the second quarter, it's a quarter where we have orders on hand as we stage over the next remaining 2 months. So the guide is inclusive of the orders we have on hand and the visibility we currently have.
And then just from that point on, we are conservatively extrapolating that for the remaining 3 quarters, we're going to be in that 5.5% sell-through with flat inventory as we work our way through flat year-over-year changes on inventory as we work our way through. So if you break that out, it's a larger number in the first quarter and then a certain -- what we think is appropriately conservative number in the remaining 3 quarters with a guide in Q2 of what we see on hand.
And as Pete pointed out, we exited Q1 with effectively a lower level of inventory than is required to be able to service the market and lower than on a days-on-hand basis than last year. As such, we do need to get some of that back to be able to service the market in addition to assuming that for the next 9 months, sell-through will equal sell-to.
I appreciate that, Jesse. I think I -- looks like I messed up my numbers looking at the total sales instead of the Residential, so I appreciate the clarification there. I guess just secondly, moving on to the EBITDA margin upside. I believe earlier, you kind of hit on different drivers of what's driving that higher margin versus relative to earlier expectations. I was hoping to get a little more clarity in terms of if it's possible to kind of break it down between incremental leverage on the additional sales versus greater-than-expected savings on some of the margin initiatives around high recycled content and productivity, et cetera.
Yes, Michael. This is Peter. As we talked about kind of having our own budget or plan for the first quarter, we're really only modestly better on the top line and modestly better from a margin perspective. And there really wasn't any one lever that was meaningfully different than what we assumed. So generally speaking, we've just been executing pretty well against broad basket, whether it's recycling, whether it's continued to seize the utilization opportunity you have with the stronger volumes and leveraging conversion cost spend. We've done pretty well just on sourcing initiatives above and beyond commodities. So as a general statement, we just came in and the execution was really strong in the first quarter, and it was pretty consistent with what we expected.
And then as you look at the second quarter guide, it's certainly -- we are lapping some underutilization from last year. I think we called it out last year. And so certainly, in the second quarter, Pete, I don't have that number in front of me, but I want to say it's close to $10 million of benefit we're getting in the second quarter from lapping pretty meaningful underutilization. And we had not fully experienced the benefit of the deflation. So in addition to the execution on top of that, the second quarter itself has some additional benefit. Peter, I don't know if you want to -- do you have that in front of you?
Yes, yes, yes. We have communicated previously. For '23, we had about $30 million of deflation that flowed through the balance sheet to the income statement. We said out loud that was basically about a half a year's impact. So you've got, obviously, that equivalent here in the first quarter already or half of that, and you'll get the other half really in the second quarter, if that helps.
And our next question comes from the line of Tim Wojs with Baird.
This is actually Robert Schultz on for Tim side. It looks like you've raised the guide for Q1 upside and then your second quarter guidance is better than expectations. But just looking at the second half, has anything really changed there versus your original expectations?
No. Basically, it's just to highlight what I -- what we mentioned earlier. We need to see the season. We think a conservative assumption relative to the back half of the year is appropriate. So we continue to assume a flattish R&R market in the back half of the year. Now incrementally, certainly behind the scenes, we feel we've got some positives on some of our initiatives. But we've got to wait to see those flow through, and we've got to wait to see the season.
And I'd just add, we haven't really seen anything in our digital kind of demand indicators that would point to any change.
Got it. And then you mentioned in the prepared remarks that sentiment for both dealers and contractors is modestly more positive than last quarter. What do you think has really changed since late November? And kind of what's driven that incremental positivity you're seeing in the market?
Well, we have highlighted over the years that -- just a couple of things. Number one, typically, the market segments we play in tend to be a more affluent consumer, a consumer that has a house, a consumer that is maybe on their second or third house, as they tend to skew a little older. We've also highlighted that we believe and we've said this throughout, right, that we believe that asset value has an impact on repair and remodel in our segment, in our type of segment.
So I think if you were to look back a few months or even last year at this time, there was certainly -- there was a lot more uncertainty relative to the stability of the economy and a concern on the potential asset value. I think the sentiment of our dealer and contractor base is not too dissimilar from the sentiment that people see as they look at the macro economy and in particular, in the more asset-based segments, right?
The market is at a record high. Housing values are holding in there. And people still have jobs and continue to invest in their homes. And so that's the backdrop.
And we believe that those elements have modestly improved, and that is what we hear reflected back from our channel base and from our contractor base. And then I think the other basic element is anytime you move into a colder season for part of the country, people worry about whether or not they're going to see a tail off on activity and backlog. And I think our -- for the most part, our contractors feel really good, and I think other surveys have validated it.
I feel really good about their backlog, the activity, the phone's ringing, and they're engaging folks on what's possible in the future. And then our own data continues to show that also from a digital perspective.
And our next question comes from the line of John Lovallo with UBS.
Jesse, maybe just a follow-up on that last one about the contractor backlogs. I think they have been pretty stable at about 8 weeks for 3 or 4 quarters now. Is there any change there that's giving you guys more confidence?
I would say the data and the sentiment is very similar over the last few -- almost over the last, I guess, over a year of surveys. Some of the froth that we may have felt is -- has normalized. And so now we're sitting at an above-average backlog for most contractors. And I think there's really 2 elements to that, right? Pete mentioned the weeks of backlog, which has varied between 7 and 8 in that range. It's 7 and change right now.
But we also ask those same contractors their assumption of growth and their sentiment beyond just the number of backlogs or the number of weeks of backlog. And in general, that's what you see as being incrementally more positive. So the combination [ that affects us ], stable business, much more normalized, good activity and a pretty good -- we're using the word cautiously optimistic view of what's ahead of them.
Okay. That's helpful. And then I think in terms of SG&A in the quarter, Pete, you called out higher stock comp and continued investment. As we think about SG&A as we move through this year, and maybe into next year, I mean, is the right way to think about it still slight deleveraging this year and then maybe a return to positive operating leverage in 2025?
I think we'll probably look at '24 as kind of a more neutral year from a leverage perspective on SG&A. And then I would think that we feel pretty passionately that beyond this year, most years, we got to get back to getting 25 bps of kind of SG&A leverage per year with growth back to double digits.
And our next question comes from the line of Susan Maklari with Goldman Sachs.
My first question is on the Exteriors side again. You mentioned that you started a new facility, I think, outside Pittsburgh in the quarter. Can you talk a bit more about that facility and how we should think about it coming online and what it could mean for growth in that part of the business?
Yes. Good question. So we have a facility in Aliquippa, which is our Versatex facility. It does make products broader, but it is the original Versatex facility. In essence, we have property and we are doubling the size of that facility by building a similar-size building nearby. Within that building, we will have -- and we didn't disclose a specific completion date, except to say that, that is where some of the capital is going. That building will have the ability to do siding profiles, which are part of our Exteriors business, and trim, traditional trim, sheet trim. And so in essence, what it does is it gives us both new product capacity for some of our new siding and other profile products in addition to giving us capability to service future growth against our Exteriors business. And once again, the benefit of the way in which we operate is we're always allocating a portion of our capital to incremental new products and incremental capacity.
Okay. That's helpful color. And then shifting gears a bit. As you think about the cash generation of the business that's expected this year and some of the perhaps priorities for that, can you talk a bit about your appetite for further repurchases post the ASR? Any updates on the M&A pipeline and what you're seeing there or any changes to your appetite for deals?
Yes. I'll take the repurchases piece of it, Sue. Ultimately, look, we do expect another year of strong flow of cash from ops as well as free cash flow. You should expect us to continue to be, at times, I'll call it programmatic at our share repurchases through the balance of the year. But withholding right to also be opportunistic if we saw any dislocation. And I think if we exceed our cash generation ambitions this year, I think we would even consider later in the year being additive to repurchases with possibly looking at some debt retirement.
And then on the M&A front, as we've talked about, we'll continue to evaluate appropriate opportunities. We're always in the market. We're always chatting with folks. We certainly believe that there's an opportunity to continue to build out our product portfolio in an appropriate way. But it's got to be the right time, and we're going to be very selective that anything we do will not alter our investor deck in terms of market focus, in terms of margins, in terms of what we want to do moving forward.
I will highlight that underneath or as we look at the business, we recognize that as we move throughout the year, this business is now in a terrific position to generate a fair amount of cash. And we've got a fair amount on the balance sheet right now even post ASR, and we'll continue to be in a good position of generating cash, which gives us a lot of optionality on the appropriate way to deploy it as both organically against the business, selectively on M&A opportunities. And then we have a lot of options relative to how we want to manage the balance sheet as Pete pointed out.
And our next question comes from the line of Mike Dahl with RBC Capital Markets.
A lot of my questions have been answered, but maybe just one more. Sorry to beat the horse on kind of the implied cadence. But if I hear the comments, you're talking about improved sentiment, no indicators, and digital could suggest that anything has really changed recently. The second half implied guide is still relatively modest. So is the right way to think about this that if what you're seeing today holds, that would be upside to your guidance in the second half, i.e., your guide implies that conditions ultimately moderate versus what you're seeing in the Early Buy season?
Yes. I -- the way I would word it, we have seen double-digit sell-through growth. And we've seen that for a reasonable period of time. You heard us talk about that last summer, and we have continued to talk about that to this point. That's what we have seen, and our guide implies mid-single-digit growth. And we think that's appropriate given that the season hasn't started, and we can give you the assumption of a flat R&R with our initiatives on top of that. If something changes, then obviously, that would have an impact on certainly the midpoint of what we're talking about.
Got it. Okay. And then, obviously, you had some nice share wins last year that you've articulated. I guess, as you've gone through the past couple of months, anything that you're seeing on the pro or retail side in terms of kind of additional opportunities or additional wins that might layer in through the year?
Yes. As we mentioned on the call, it's pretty typical this time of the year, we go through a negotiation on shelf space, new products and positioning ourselves in the marketplace. As I mentioned on the call and as Pete mentioned, we feel really, really good about our incremental opportunity. That is an outcome of those discussions. And I think the most important thing for us is we want to drive more growth in the marketplace. We want to drive more conversion in the marketplace. We want to expand our brand, supercharge it, if you will. And I think it's really, really a terrific opportunity. And these things that we just -- the discussions we've just gone through have created an opportunity for us to continue to drive broader conversion and be able to continue to expand in the marketplace.
And our final question today comes from Rafe Jadrosich with Bank of America.
Great. Peter, if I look at the EBITDA guide for the year, I think it's about $70 million growth at the midpoint. Can you just help us bridge that growth? I think it's about $30 million from costs. It sounds like price is neutral, SG&A is neutral. Just can you help us bridge to that $70 million?
Yes, Rafe. This is Peter. I mean as we had communicated before, you got about $20 million of kind of underutilization in the first half of the year. That's a piece of that. You've got, let's call it, deflation of close to $30 million and the rest being sort of the flow-through on the additional sales offset by -- at a macro, the disposition of the Vycom business. Those are the biggest pieces.
Got it. That's very helpful. And then just on the change in your guidance...
And just if I -- Rafe, if I could just highlight, under the surface -- and we tried to stress this. We still have a lot of opportunity ahead of us. But we have also been progressing over the last 2 years. And some of the kind of the combination of underutilization and having elevated supply chain cost has masked some of what was underneath. And so what Pete's highlighting is it's just, in effect, a more normal cadence, which can then let the underlying capability of the business come out. I'm sorry. You had another question.
That's really helpful. Just on the change in guidance from last quarter, sales are going up, I think, sales are going up I think at the midpoint around $50 million. And then EBITDA is going up, I think, $40 million at the midpoint. So the margins on the incremental sales that you're getting is really high. Can you just help us understand like why it's so high relative to where it's been since [indiscernible]
I would separate those 2. I would look at it as there's incremental sales that have an incremental benefit. And I think in the past, we've talked about that incremental flow-through of 30% to 40%. It's probably closer to 40% right now. And then there's the base amount of activity that, as Pete pointed out, we felt really good about our ability to drive higher margins on the business we already had. But we wanted to see a few more cards before we took off the constraints or took off some of the constraints. Obviously, we're always risk adjusting our activity.
But we have much, much better visibility on the underlying margin capability of the core business. So I would just separate the 2. There's some incremental benefit from incremental sales. But even if we had not guided sales up, what we can see on the margin side would certainly have been guided up just based on the execution we see of the core business.
And I'd just add, we're in an environment right now where extra sales means extra production, which means leverage in the plants. It means extra recycling activity, which means extra recycling impact. If we're buying more, we're getting more deflation. So we're in a pretty enviable position right now whenever we get additional revenue. It's very supportive of that incremental 40% flow-through rate.
Great. That's really helpful. See you guys at the Builder Show.
And that does conclude our Q&A session. I will now turn the call back over to Jesse Singh for closing remarks. Jesse, the floor is yours.
Appreciate it. Thank you once again for joining us. As I mentioned on the call, we have a core value of the best team wins, and we feel really good about our team. We feel really good about the opportunity that is ahead of us, and we view this as a journey, and we appreciate all of you taking the time to have this discussion this evening. Have a great evening.
Thanks, Jesse. And ladies and gentlemen, that concludes today's call. Thank you all for joining, and you may now disconnect.