Q4 2023 Azek Company Inc Earnings Call
Participants
Eric Robinson
Jesse G. Singh; CEO, President & Director; The AZEK Company Inc.
Peter G. Clifford; Senior VP, CFO & COO; The AZEK Company Inc.
John Lovallo; Senior US Homebuilding and Building Products Equity Research Analyst; UBS Investment Bank, Research Division
Keith Brian Hughes; MD; Truist Securities, Inc., Research Division
Matthew Adrien Bouley; VP; Barclays Bank PLC, Research Division
Michael Glaser Dahl; MD of U.S. Homebuilders & Building Products; RBC Capital Markets, Research Division
Michael Jason Rehaut; Senior Analyst; JPMorgan Chase & Co, Research Division
Noah Christopher Merkousko; Senior Research Associate; Stephens Inc., Research Division
Philip H. Ng; Senior Research Analyst & Equity Analyst; Jefferies LLC, Research Division
Rafe Jason Jadrosich; Director in Equity Research and Homebuilder & Building Products Analyst; BofA Securities, Research Division
Susan Marie Maklari; Analyst; Goldman Sachs Group, Inc., Research Division
Timothy Ronald Wojs; Senior Research Analyst; Robert W. Baird & Co. Incorporated, Research Division
Presentation
Operator
Welcome to The AZEK Company's Fourth Quarter Fiscal 2023 Earnings Call. (Operator Instructions) Please be advised that today's conference is being recorded.
I'd now like to hand the conference over to Eric Robinson. Please go ahead, Eric.
Eric Robinson
Thank you, and good afternoon, everyone. We issued our earnings press release and the supplemental earnings presentation this afternoon to the Investor Relations portion of our website at investors.azekco.com. The earnings press release was also furnished by an 8-K on the SEC's website. I'm joined today by Jesse Singh, our Chief Executive Officer; and Peter Clifford, our Chief Operating Officer and 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. A 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 CEO, Jesse Singh.
Jesse G. Singh
Good afternoon, and thank you for joining us. The AZEK team once again delivered strong results this quarter, including a 27.6% net sales growth year-over-year, a net profit margin of 11% and a record fourth quarter adjusted EBITDA margin of 27.4%.
Our Residential business grew 37.6% in the fourth quarter and approximately 5% year-over-year, delivering an eighth straight year of net sales growth. I'm very proud of how The AZEK team was able to navigate in an uncertain market and consistently deliver against our commitments. The team outperformed by driving above-market revenue growth and by delivering against productivity initiatives resulting in significant adjusted EBITDA margin expansion in the second half of the year.
Our focus on cash conversion and capital allocation throughout the fiscal year, including working capital efficiency and disciplined capital expenditures, delivered strong free cash flow generation of $274 million and returned $115 million to shareholders through share repurchases. AZEK sales performance was driven by continued double-digit sell-through growth in our Residential business overall and in each of our leading Deck, Rail & Accessories and Exteriors categories, which outperformed in an uncertain repair and remodel market.
We saw growth in both our Residential Pro and our Retail channels as we benefited from the execution of our initiatives. In addition to our shelf space gains and core decking and trend growth, we saw great results from new products and planning in our Exteriors business and aluminum rail in outdoor living. Our Residential segment's 5% year-over-year net sales growth in fiscal year 2023 is stacked on top of 12% growth in fiscal 2022 and 35% growth in fiscal 2021.
On a calendar year basis, we see similar results with the business growing 31% in calendar 2021 and 4% in calendar 2022 during the inventory unwind within our channel. We expect this growth to continue in this calendar year. Assuming the midpoint of our December quarter end guidance for calendar 2023, we would expect our Residential segment to grow approximately double digits year-over-year in calendar 2023. We believe that this highlights not only the resiliency of our subsegment but also the specific and unique capability of The AZEK growth model.
Our fiscal fourth quarter margins improved significantly, and we delivered 750 basis points of adjusted gross margin to 45% and 600 basis points of adjusted EBITDA margin expansion to 27.4% as we realized the benefits of excellent execution by our operations team delivering on productivity initiatives and increased production levels while reinvesting in marketing and branding.
Cash conversion and disciplined capital expenditures continue to be a focus. And in the fourth quarter, we generated free cash flow of $92 million, growing $83 million year-over-year. Our strong free cash flow generation during the quarter supported approximately $61 million worth of share repurchases.
Channel inventories have been conservatively positioned through our fiscal year-end, and we are proactively managing our finished goods inventory levels to maintain high levels of service. In addition, the business has operated with normalized operating and inventory cadence with lower lead times and our channel partners continuing to purchase as needed and managing inventory below historical averages.
In October, we also announced the sale of our Vycom business, which closed earlier this month. Vycom is a great business and is a leader in industrial plastic sheet manufacturing. We believe that the transaction puts both businesses in a better position to achieve future success. This strategic move simplifies our portfolio and further focuses AZEK on our strategic higher growth and margin opportunities in the repair and remodel and outdoor living markets associated with our residential segment.
As stated in our strategy, we also take a portfolio approach to revenue growth and margin expansion. During 2023, we successfully launched new products, including TimberTech Advanced PVC Landmark in Boardwalk and TimberTech Composite reserves in Reclaimed Chestnut along with railing options and an expansion of our Exteriors portfolio.
We recently hosted hundreds of our contractor and dealer partners and our TimberTech Championship PGA TOUR Champions event where we had the opportunity to engage in valuable discussions, gather feedback and preview our new products for the 2024 building season. Among these product launches, are the introduction of the new and improved TimberTech Composite Terrain+ Collection, new TimberTech Aluminum Substructure Framing, new TimberTech Railing Horizontal Cable Infill and new AZEK Exteriors Bevel Siding. We are expanding our position with the homeowner with better style, design and performance and strengthening our already strong position with the Pro with an expanded offering of products that increase contractor labor productivity and efficiency.
Our partners are excited about the opportunity created by these new products. During the year, we continued to make progress on our recycle initiatives and increase the amount of recycled content we use in our TimberTech Advanced PVC decking and our Exteriors products. We also expanded the geographic reach of our high recycled content, PaintPro prefinished siding and trim solutions and welcome Lumberman's and [Wassa] as new prefinishing partners.
The expansion enables us to provide high-quality prefinished siding and trim from the Northeast to Washington state. Overall, we are well positioned to capitalize on the momentum from both our shelf space games and brand awareness increases in 2023 as well as our slate of new products for 2024.
We are also pleased to be recognized for several workplace awards this past quarter. For the first time, AZEK was named a 2024 best company to work for in the construction and materials category by U.S. News & World Report as well as a top Chicago workplace for the third year in a row. One of our core values is the best team wins, and we're pleased to be recognized for our commitments and actions towards the shared goal further strengthening AZEK's position as an employer of choice.
As we look towards 2024, we are confident in our business strategy and our ability to deliver long-term above-market growth and margin expansion. Key digital metrics highlight continued elevated interest in our TimberTech brand, and we continue to see growing consumer engagement with website traffic, leads and sample orders showing year-over-year growth during the fourth quarter.
Outdoor living spaces have been ranked the #1 most popular home exteriors remodel for the last 10 years according to the American Institute of Architects. Our October quarterly Pro contractor and dealer surveys indicate they remain busy and have a cautious outlook for growth in 2024.
Contractors continue to add backlogs of approximately 8 weeks overall and anecdotally, some have indicated that their sales process is returning to a prepandemic normal. In addition to the stability of our existing contractors and dealers, we continue to expand our network, allowing us to access more of the market and drive incremental share and wood conversion.
In fiscal 2023, we added over 1,000 contractors under our Pro loyalty program driven by continued education and awareness of the composite category and the TimberTech brand. We continue to see positive residential sell-through growth and demand indicators such as our customer surveys and digital metrics remain constructive as we begin the fiscal year 2024. While we continue to see favorable demand indicators, we acknowledge the continued macroeconomic uncertainty, mixed consumer confidence and the potential for a slower repair and remodel market.
Our fiscal year 2024 planning assumptions assume a flat to down repair and remodel market and consistent with our historical track record we would expect to outperform the market, driven by AZEK's specific initiatives, including material conversion, channel expansion, new product innovations and customer journey initiatives. We believe that our business model, combined with our margin opportunities will provide us an opportunity to continue to grow sales and EBITDA for our residential business in fiscal 2024.
For the full fiscal year 2024, we expect that the sale of the Vycom business will reduce Commercial segment sales by approximately $77 million and adjusted EBITDA by approximately $17 million on an annualized basis. Taking that adjustment into account, AZEK expects consolidated net sales in the range of $1.335 billion to $1.395 billion and adjusted EBITDA in the range of $320 million to $335 million.
Adjusting for the Vycom sale, our net sales guidance would imply 3% to 8% year-over-year growth and 15% to 20% year-over-year adjusted EBITDA growth. Peter will provide more context on our guidance as we continue to see the opportunity to drive above-market growth and margin expansion.
I will now turn the call over to Peter to provide some additional context on our financial results and outlook.
Peter G. Clifford
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 fourth quarter and fiscal year 2023 results, I want to take a moment to reflect on the past year. When we offered our planning assumptions back in November 2022, we were operating in an uncertain environment at the time the market was digesting the unknown impact of the Fed's cumulative interest rate hikes of both the repair and remodel spend and consumer sentiment.
At the time of our guidance, we were getting questions around, would material conversion continue in a down market? Would pricing hold in a deflationary environment, would we see the expected deflation and a slowdown? Could we manage our plants effectively for both an efficiency and capacity perspective to seize the upside of the market were better than expected? Could we manage our channel inventory conservatively and keep best-in-class service levels? Could we drive strong cash conversion to support a repurchase program to take advantage of dislocations?
On all of these points, The AZEK team was able to effectively manage the business and outperform expectations in fiscal 2023. Our new product development and growth initiatives for continued material conversion, we're able to sustain pricing in a more normalized commodity environment. We appropriately managed capacity and manufacturing costs, and we're able to quickly react to stronger decking season by ramping production while continuing to maintain industry-leading service. And finally, our strong results and healthy cash generation allowed us to support our share repurchase ambitions during the year. To sum it all up, we have set challenging targets at the outset of the fiscal year and a period of uncertainty, and we led the business to exceed those commitments.
And when we talk about fiscal 2024, we once again encounter a similar economic backdrop. Despite this backdrop, we have confidence and credibility to deliver in fiscal 2024 based upon the execution we demonstrated in fiscal 2023. As Jesse mentioned up front, during the fourth quarter, we continue to see a positive demand environment in our residential business.
Sell-through remained equally strong through the season and contractor backlogs have been stable for the last 4 quarters at approximately 8 weeks. At the same time, our digital KPIs remained strong, and we used our positive sell-through and results to continue to accelerate investment and brand awareness in both the quarter and the year. We believe we are already reaping the benefits of these brand investments.
From an operating perspective, our production returned to normalized levels in the fourth quarter, albeit up substantially year-over-year due to the lapping of the large fiscal 4Q '22 channel inventory reduction. We continue to maintain strong service levels during the quarter while executing against our own full year inventory reduction plan, drawing down inventory year-over-year by $79 million.
On the commodities front, key raw materials have remained stable at meaningfully lower input costs supporting our material savings. The combination of double-digit residential sell-through growth, coupled with strong execution against our material savings, conversion costs and recycling initiatives helped us achieve record adjusted EBITDA margins during the fourth quarter.
For the fourth quarter of fiscal 2023, we grew net sales by 28% year-over-year to $388.8 million, which was above our guidance expectations. The fourth quarter growth was driven by the strength in the residential segment, partially offset by declines in our Commercial segment. 4Q '23 gross profit increased by $77.8 million or 108% year-over-year to $149.7 million.
4Q adjusted gross profit increased by $60.6 million or 53% year-over-year to $174.8 million. Our adjusted gross profit margin percentage increased 750 basis points year-over-year to finish at 45%. The adjusted gross profit increase was driven primarily by material deflation, manufacturing productivity, execution against material cost productivity initiatives and a onetime utilities reimbursement of approximately $2 million.
SG&A expenses increased by $17.5 million to $85 million, the bulk of the year-over-year increase was driven by our continued commitment to make investments in marketing and brand awareness. Adjusted EBITDA for the fourth quarter increased by $41.3 million or up 63% year-over-year to $106.4 million. The adjusted EBITDA margin rate for the quarter increased 600 basis points year-over-year to 27.4%. The primary driver of the year-over-year change in adjusted EBITDA was the impact of material deflation, manufacturing productivity, execution against material cost productivity initiatives and a onetime utilities reimbursement of approximately $2 million, partially offset by continued investment in marketing and branding.
Net income for the fourth quarter increased by $47.4 million to $42.6 million or $0.28 per share. Adjusted net income for the fourth quarter increased by $29 million to $53.5 million or adjusted diluted EPS of $0.36 per share.
Now turning to our segment results. Residential segment net sales for the fourth quarter was $350 million, up 38% year-over-year. Within the Residential segment, we saw positive growth in both Deck, Rail & Accessories and Exteriors while our StruXure smart pergola business navigated some destocking during the year.
Residential segment adjusted EBITDA for the fourth quarter came in at $118 million, up approximately 83% year-over-year. Residential segment adjusted EBITDA margins were up 830 basis points year-over-year to 33.7%.
Commercial segment net sales for the quarter were $39.2 million, down 22% year-over-year. These results were in line with our previous quarter's commentary and expectations. Within our Commercial segment, Vycom Net sales came in at $17.5 million, down approximately $8.6 million year-over-year.
Commercial segment adjusted EBITDA for the quarter came in at $9.2 million, a decrease of $5.3 million year-over-year. Within our Commercial segment, Vycom adjusted EBITDA was $3.3 million. It is important to note, despite a softer demand backdrop, we are able to hold our EBITDA margins for the segment at 23.6% in the quarter.
From a balance sheet and cash flow perspective, we ended the quarter with cash and cash equivalents of $278 million and approximately $147 million available for future borrowings under our revolving credit facility. Working capital defined as inventory plus accounts receivable minus AP was $223 million, down $118 million year-over-year. We ended the quarter with gross debt of $672 million, which included approximately $79 million of finance leases.
Net debt was $394 million, and our net leverage ratio stood at 1.4x at the end of the fourth quarter. Net cash from operating activities was $127 million during the fourth quarter, an increase of $87 million year-over-year.
Capital expenditures for the quarter were approximately $35 million. For the full year fiscal 2023, Free cash flow increased by $339 million year-over-year to $274 million. As expected, we were active during the quarter with our share repurchase program. Repurchasing approximately $61 million worth of shares at a weighted average of $32.70 per share.
Given the strength of our cash position, we expect to be active again in the fiscal first quarter with our share repurchase activity. As a reminder, the remaining authorization under our share repurchase program is approximately $202 million. Our capital allocation priorities remain the same. As we 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 context and color on what we are assuming for the upcoming fiscal year. As a reminder, we announced the divestiture of our Commercial segment's Vycom business in October 2023.
Starting in fiscal 2024 from a reporting perspective, we expect to combine all corporate expenses into the residential reporting segment, and we'll continue to report Scranton Products within the commercial reporting segment.
In other words, the new residential segment adjusted EBITDA definition combines residential EBITDA plus corporate expenses. We believe this change in segment reporting will help investors more easily compare our Residential business with fellow building products peers.
To assist with modeling, Vycom Net sales and adjusted EBITDA ended the fiscal year 2023 at $77 million and $13 million, respectively. As a result of the divestiture, we will incur new expenses associated with an arm's length supply agreement between Vycom and Scranton products to supply sheet with a total additional impact of approximately $4 million per year. Adjusted EBITDA for fiscal 2024, as a result of the transaction, will be impacted by approximately $17 million, which is reflected in our planning assumptions for fiscal 2024.
As previously communicated, the Vycom sale will result in cash taxes of approximately $21 million to $23 million and an effective tax rate of approximately 53% to 56% in the first quarter due to the gain on the sale. And a 32% to 33% effective tax rate for the full year. Normalized to exclude the gain on the sale from the Vycom transaction, the effective tax rate is approximately 27%.
I also wanted to revisit the previously communicated known carryover tailwinds that we have headed into fiscal 2024, adding to our confidence and conviction heading into the year. As a reminder, about what we've discussed over the past few quarters, we experienced approximately $20 million of negative impact from underutilization in the first half of fiscal 2023, which we expect not to reoccur in fiscal 2024.
We also carry approximately $20 million in known deflation currently on our balance sheet, which will flow through the P&L in 2024. The sale of Vycom business modestly reduces some of the underutilization and deflation carryover tailwind by approximately $5 million, and we will continue to expect to invest in marketing growth activities. Finally, on the revenue side, recall that in prior year 1Q '23, we experienced approximately $30 million to $35 million of net sales headwind from our channel inventory reductions, which we expect not to reoccur in fiscal 2024.
With that context, let me move to the planning assumptions for fiscal 2024. We are assuming for the full year that repair and remodel will be flat to down low single digits. For the items in our control, we are confident in our execution skills and ability to continue to drive above-market growth. We are carrying over AZEK-specific initiative wins into 2024.
We will lap the 1Q '23 channel inventory reduction, which gives us confidence in our ability to grow our residential net sales by approximately 5% year-over-year in fiscal 2024, at the midpoint of our planning assumptions. The sum of these carryover impacts and growth assumptions drives our high-level planning assumptions for the year, to $1.335 billion to $1.395 billion in revenue and $320 million to $335 million in adjusted EBITDA.
Adjusting for the Vycom sales, our net sales guidance range would imply 3% to 8% year-over-year growth and 15% to 20% year-over-year growth in adjusted EBITDA. Our residential segment planning assumptions for the year is $1.262 billion to $1.318 billion in net sales and $306 million to $319 million in segment adjusted EBITDA, representing 3% to 8% sales growth year-over-year and 18% to 23% 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 marketing and brand awareness initiatives; we're expecting capital expenditures in the range of $70 million to $95 million, consistent with our publicly stated target of CapEx of approximately 5% to 7% of revenue; we are expecting depreciation of approximately $87 million to $90 million; we are targeting working capital reduction of approximately $10 million to $20 million for the year; and finally, as detailed earlier, we are expecting a GAAP tax rate for the full year of 32% to 33%. 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 on the first quarter, I wanted to provide context for the operating environment we expect in fiscal 1Q '24. For the quarter, we are expecting sell-through growth in the mid- to high single-digit range. which, as we know, is a seasonally smaller quarter as much of the country winds down the building season.
From an inventory staging perspective, we expect the channel to remain conservative in line with last year's behavior. As a reminder, this is the period of the year in which the industry negotiates shelf space positions and stages inventory in the channel ahead of the upcoming building season.
AZEK historically ships the majority of our channel inventory build, otherwise known as early buy in our second fiscal quarter, and we are assuming that effectively all of this volume will ship in fiscal 2Q. Channel inventories were positioned conservatively at fiscal year-end, and we are proactively managing our own finished goods inventory levels to maintain high levels of service.
As a reminder, we are lapping a fiscal 1Q '23 channel inventory reduction of approximately $30 million to $35 million. From a margin perspective, we expect to have approximately $20 million of carryover benefits, including approximately $10 million from lapping the prior year's underutilization and $10 million of deflation in the first quarter.
Taking these factors into consideration, our guidance for the quarter is $230 million to $236 million in revenue and $45 million to $48 million in adjusted EBITDA. Adjusting for the Vycom sales, our net sales guidance range would imply 17% to 20% year-over-year growth and $33 million to $36 million year-over-year growth in adjusted EBITDA. We are expecting an effective tax rate of approximately 53% to 56% for the quarter, which, again, is higher as a result of the gain on the sale of Vycom business.
Our team is excited, engaged and well prepared to tackle the environment in front of us in fiscal 2024. With that, I'll now turn the call back to Jesse for some closing remarks.
Jesse G. Singh
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 a strong finish to the fiscal year.
We remain incredibly excited about the long-term material conversion opportunity ahead of us in the large and fast-growing outdoor living and home exteriors market that AZEK plays in. Our residential segment has continued to show remarkable resiliency and growth capability. The business has delivered a compounded annual growth rate of 11.6% over the last 10 years and 17.7% over the last 5 years.
Our fiscal year 2023 results reflect the strength of our industry-leading position, our focus on strategic growth initiatives, the resiliency of our markets and the significant margin expansion opportunities ahead of us.
Our strong free cash flow generation puts us in a great position from a capital allocation perspective to invest in growth opportunities and opportunistically participate in share repurchases. Our team's focus on operational excellence to drive above-market growth and margin expansion across any market condition puts us in a position of strength as we begin fiscal year 2024.
With that, operator, please open the line for questions.
Question and Answer Session
Operator
(Operator Instructions) Your first question comes from the line of Tim Wojs from Baird.
Timothy Ronald Wojs
Maybe just kind of starting on the sales guide. So I guess at the midpoint, you're guiding about 5% to 6% residential growth in an R&R market, it's maybe down 1%, 2%. So 7% to 8% outgrowth.
Maybe you can just talk about the big pieces of that and kind of what's internal, what do you kind of have visibility to? And if there is outperformance in your eyes in fiscal '24, does it really come from internal initiatives? Or is it really going to be a better market at this point.
Peter G. Clifford
Yes, Tim, this is Peter. The geography of the 7% there, about 2 points of that is the inventory lap. And then the other 5% is really our initiatives. And I would say right now, a little more than maybe half of that is carryover from commercial initiatives and shelf space wins from last year at both Pro and Retail.
Timothy Ronald Wojs
Okay. Good. And then just on shelf space, I mean, was there anything, I guess, unique in fiscal '23 on some of the shelf space gains, just double-digit kind of sell-through growth, I think it's faster than what some of your peers are reporting. I'm just kind of wondering if there's anything in there that's kind of chunky or is it really just representative of some of the investments you guys are making.
Jesse G. Singh
By the way, I apologize for my voice apparently, I've been talking to customers a bit too much. So relative to your question, most of the pickups we've had or expansions that you talk about, were pretty normalized volume feathering in. And so as Pete pointed out, you should think of it as we expand our position, there's not a huge amount of sell in. A lot of it is just incrementally being added to a position, which then yields benefits month-to-month. And obviously, we added it in some cases at the beginning of last year, in some cases in the middle of last year.
So you'll start to see the benefit as we move forward. And just as you highlighted, we saw double-digit sell-through growth in both of our core channels, both Retail and in the Pro channel.
Operator
Your next question comes from the line of Keith Hughes from Truist.
Keith Brian Hughes
Building on that, you talked about double-digit sell-through in the quarter kind of mid-single digits. And the fiscal first quarter is coming up. I guess the question is, has something slowed? Or is this a function of comps or take a conservative stand? Can you just talk around what's happening in these periods?
Jesse G. Singh
Yes. There's a natural question of where we sit now. Have we seen any kind of a slowdown from what we described in the fourth quarter. And I would say things continue as we've seen it in the last quarter as we moved into this quarter. We just think it's appropriate given that December tends to be a light month to assume a more conservative average as we go through the end of this quarter.
But in general, things have continued pretty consistently for the last 6 months -- last 6 months with that double-digit sell-through growth. And if we do happen to see some incremental volume, I mean, we would probably use that as best we can to manage inventory even more conservatively in the channel.
Keith Brian Hughes
Okay. And you're -- we're at the point that your customers, your distributor customers are just ordering to replace things going out the door. Is that correct?
Jesse G. Singh
Yes. Yes.
Keith Brian Hughes
One final question. In the reported quarter in your guidance, have you seen or are you expecting any price? Or is the growth were described in here all volumes?
Peter G. Clifford
You should think price is kind of negligible for the year to be modestly positive, but again negligible both quarter and year...
Operator
Your next question comes from the line of Matthew Bouley from Barclays.
Matthew Adrien Bouley
Sticking on the same topic of sort of outperforming the end market growth next year. Did I hear you say that a lot of that outperformance is actually just kind of the carryover of some of the wins that you've built on last year. And so if that's the case, my question is do you have line of sight to potential for new business wins, additional new products as you kind of roll out through the year, things like that, things that are sort of reminiscent of your Investor Day where you spoke about that kind of annual internal drivers of above-market growth. Is there room for additional beyond just that kind of carryover that you're speaking to?
Jesse G. Singh
Yes. I -- first, on the point of carryover, as Pete mentioned, we have a little bit of inventory lapping carryover pretty modest, and then we've got some additional carryover where we feel confident that the wins we've already secured will give us an opportunity.
And then on top of that, we expect to continue to drive our initiatives. I think the way you should think of our focus on driving above-market growth is we're not trying to land the plane at a specific number or a specific percentage. I think our intent is to always continue to drive overperformance. And in this particular case, we're giving you a range that we feel comfortable that we're able to achieve given an uncertain market and given the execution that we already see ahead of us.
We're going to constantly focus on expanding our portfolio. We announced a number of new products and many of those allow us to access some adjacencies and incremental positions. And so you should assume we're always striving for something bigger. We're just giving you what we think is an appropriate planning assumption as we move into next year.
Matthew Adrien Bouley
Got it. Second one, just thinking about recycling and the progress there. Again, going back to the Investor Day, you guys had outlined potential material uplift to margins from mixing towards greater usage of recycled materials.
So my question is, where are you on that now and kind of thinking about that EBITDA bridge for next year, what's implied in the guide around benefit from mixing towards recycled materials?
Peter G. Clifford
Yes, Matt, this is Peter. We went back and actually updated here at the end of the quarter. The preview that we gave you guys in the Investor Day and went back to 2009 through 2023, and it kind of said the same thing that ultimately, we've achieved about 50 basis points of kind of margin expansion each and every year throughout that period. That's what we would kind of expect as we lean forward. Levers are still the same, right?
We've got the opportunity to move cheaper grades to recycle, just primarily cap composite opportunity, increased recycled content, which is obviously the PVC deck and trim. And as well across all 3 product categories, we have the opportunity to reduce our cost to convert those recycled materials down. So we feel really good, again, about for us, recycling is more iteration than innovation.
Jesse G. Singh
And so I think just to put a minor point on that, relative to what we said in the investor deck, you should think that we've added another 100 basis points of benefit, 50 a year, as Pete pointed out. And as we look at our margin opportunity, as we've demonstrated in our last quarter, we certainly have a number of levers that we can pull. And certainly, recycling is one of them, but we'll continue to drive the other elements of productivity.
Operator
Your next question comes from the line of Philip Ng from Jefferies.
Philip H. Ng
Congrats on a strong quarter to finish the year. Pete, if I heard you correctly, your guidance for 2024, you're assuming 2% inventory lap and the rest is commercial initiatives. So that seems pretty conservative. Your sell-out, it sounds like fourth quarter is in the mid- to high single digits. So implicitly in your full year sales guide, what are you assuming for sellout? And it sounds like it's assuming some moderation. Is that just a function of comps, some of the wins that you add on new products this year -- this past year?
Jesse G. Singh
Yes. I -- what I would say, against the planning assumption is we're assuming in our planning assumption that there is some potential for the market to be a bit slower than what we're seeing now.
And given the data and the macroeconomic environment, we think at this stage, it's appropriate to plan for a potential slowdown in R&R to become more negative. So the way you should just look at all of this is we're assuming a modestly less constructive market next year, and that's really how the numbers were.
Philip H. Ng
Okay. On that note, Jesse, you kind of managed the channel conservatively, right? I think the color you've given us all year was when you've done your survey, channel was generally a little more upbeat. So I'm curious when you've done your survey, what is your channel partner kind of expecting, anticipating for growth in 2024? How are they kind of managing the early buy? Last year, they were a little more conservative and they kind of bought more through the year? Like how are they kind of communicating their outlook for next year -- or for calendar [2024]?
Jesse G. Singh
Yes. Obviously, we're in the midst of conversations right now. But I think if you were to aggregate a wide variety of channel partners, I think what they can tell you is as they look out next year, they see a flattish year with the opportunity if we execute together in our categories to outgrow the flattish year in our product. So that's the macro view. Now against that, we're working with them to make sure that they're being well serviced and that they're in a really good position.
So I would think of this as a pretty normal year relative to how folks are going to look at early buy. And last year, we're conservative. I think we're sitting well on top of that. I'm not saying they're going to be more aggressive. I'm not saying they're going to be more conservative. I think it will be a pretty consistent pattern, and it's really a matter of when they choose to buy and at what level.
But I think in general, the feedback from our channel is one of flat with the potential of positive in aggregate and a recognition that we have a unique ability to outgrow that.
Operator
Your next question comes from the line of Michael Rehaut from JPMorgan.
Michael Jason Rehaut
I just wanted to first circle back a little bit to the first quarter. And if I heard right, you are expecting a little bit of inventory conservatism in the channel against the sell-through up mid- to high single digits on the residential side. So is that something that we should be expecting, I guess, in effect that to shift into the second quarter?
And it sounds like you're kind of looking for sell-through to -- for the year to be maybe a little bit more moderate as the year progresses relative to the first quarter. Is that -- I just want to make sure I'm understanding that correctly and you might have a better growth number in the second quarter. Is that the right way to think about the cadence in the first half?
Jesse G. Singh
I would say, Mike, it's probably too early to start to guide on the second quarter. I think our intent has been in particular, over the last 6 to 12 months to make sure that we're doing a really good job of service so that our channel can operate with an appropriate and if necessary, conservative inventory level.
We're lapping that now as we had that at the end of the first quarter in '22. We expect channel to be in a good, but flattish situation with last year and still able to support growth.
And then as we move through the quarters, we'll see how volume progresses. And relative to sell-through assumptions, we've got pretty good visibility, obviously, in the quarter that we sit. And we've got good directional visibility as we look at January and February, just given backlogs. And so beyond that, everything is just a planning assumption. What you're trying to do is gauge the market and conservatively plan against what the market could do.
So I think we're not in the prediction game right now of what's going to happen in March, April, May, June of next year. What we're just laying out is an appropriate planning assumption that we feel really good about our ability to deliver both on top and in particular, our EBITDA against.
Michael Jason Rehaut
Okay. I appreciate that, Jesse. I guess, secondly, you kind of highlighted for your fiscal -- full year planning assumptions, continued investment in marketing and brand initiatives from a strong gross margin performance. I'm just thinking about longer term, and I'm wondering about if the investment this year is something that you would consider a little bit above average as you continue to build out the platform, you obviously over the last couple of years, have made a couple of different acquisitions, pergolas for example. And the overall category continues to gain share as well.
Would love to understand those investments? And if you kind of think over the next 2 or 3 years, you might be able to get better leverage out of the SG&A relative and I think, ultimately, how to think about incremental EBITDA margins over time.
Jesse G. Singh
Yes. I will put it in a real simple way. I think this year, we have an opportunity if we have the room to continue to invest in the business. So you're probably not -- our current assumption is that you're not going to see leverage on SG&A. If anything, it might contribute a 10, 20, 30 basis points of negative leverage. But I think as you move out beyond that, we've made pretty substantial investments in our sales and marketing organization. We've seen a benefit from it.
You should expect that it's really our choice. But I think as we move through '24 into '25. We should start being in a position to get leverage off that. We certainly could get leverage this year if we chose to. It's really a lever that we'll decide how to pull. But right now, that lever is more of an investment mode.
Michael Jason Rehaut
And so therefore, how should we think about incremental EBITDA margins over time for the Resi business?
Jesse G. Singh
I think once you move beyond this year, and Pete, please chime in, but I think what should move beyond this year, you should think of SG&A as being positive to leverage.
Peter G. Clifford
Yes. We said it won't happen every year, but most years, looking forward past '24, we would expect possibly as much as 25 bps as a leverage opportunity that's there most years. And look, in the near term here, part of the investment thesis is, look, we're continuing to clearly outperform the market as well as peers. So we want to keep that momentum.
Operator
Your next question comes from the line of John Lovallo from UBS.
John Lovallo
The first one is, Pete, you mentioned that in the fiscal year '24 outlook that pricing is going to be relatively flat to maybe a slight good guide. I mean have your thoughts changed on the ability of the business to drive sort of low single-digit price increases over time? Is that more of kind of a 2025 story? And then similarly, in the context of the growth algorithm, how are you guys thinking about material conversion in 2024?
Peter G. Clifford
Yes. First on the pricing piece. Look, we did some traditional product-by-product price increases here now that it will be basically offset by some program -- programming costs on the gross to net to kind of net to again kind of a more modest negligible price for '24. Look, that's a lot on the backdrop of the pricing that we've taken over the last 2 or 3 years. We do expect in 2025 that we'd return to a more traditional kind of annual pricing pattern.
And as far as conversion, look, I think we feel really comfortable, again, based upon the '23 performance. It was one of the questions that was opened at the beginning of the year is conversion still happen. Does it still happen at the same pace and a down cycle in our sector clearly had a slow start. And the resolute answer was it does. And again, we wake up every morning, we know the levers to pull for conversion. It's all about converting contractors. It's influencing architects. So making sure we got the right new product launches that we're fighting for shelf space so people can see the product and simplifying and educating the consumer in the journey.
John Lovallo
Makes sense. And then as a follow-up, it sounds like demand in both the Pro channel and Retail were both pretty good. Just curious on the mix side, if you've seen any kind of impact on mix down, if you will, as the economy maybe has got a little bit more challenging and consumer confidence has waned to some extent.
Peter G. Clifford
Yes. Generally speaking, our product mix has been really stable, as we called out on the last 2 calls, we were underpenetrated in the good category, right, due to capacity constraints during the pandemic. As we've relaunched here Prime and Prime+ with ample capacity, we've obviously picked up some share this year in that good category.
Jesse G. Singh
John, I think one of the things just to continue to highlight is we are predominantly Pro, and we tend to skew more premium. And I think as you see that, you tend to see pretty strong resiliency there. And we see it in all of our data. Our good -- our more premium products continue to do well.
And then as Pete pointed out, we've been able to pick up some incremental share at the entry level. But I think in reality, the more premium areas continue to be pretty stable and growing, which is what you might expect in an economy that has a fair amount of wealth that sits through equity holdings and home equity values.
Operator
Your next question comes from the line of Susan Maklari from Goldman Sachs.
Susan Marie Maklari
Thank you. Good evening, everyone. The first question is when we think about the range that you gave for sales growth next year of 3% to 8%, can you talk about the environment or the factors that would take you to the lower end versus the higher end of that range next year?
Peter G. Clifford
Yes. I mean, ultimately, it would have to be that R&R is at the lower end of kind of low to mid-single digits negative.
Susan Marie Maklari
Okay. All right. And then in the prepared remarks, when you're talking about some of the new products and initiatives for next year, it seems like rail came up quite a bit, maybe perhaps more than it has in the past. Can you talk about how you're thinking of the opportunity there? And anything that we should be thinking about as we think about the next couple of years?
Jesse G. Singh
Yes. Susan, I'll take that. We highlighted that we play in multiple markets, and that we see good opportunity in all of them. Clearly, rail is a close-in part of our business. We bought an aluminum rail company in -- at the tail end of 2018. We bought another rail company last year, which is a super premium PVC rail company.
And we've seen really, really nice growth from those acquisitions, and we have reinvested and reinvented our core portfolio by both simplifying it but also upgrading it. And so for us, as we look at 2022, we've had really, really nice rail growth that would be accretive to the growth that we've had overall in the company. And we would expect that to continue as we're uniquely positioned with having an incredibly broad portfolio, and we would expect to continue to use that portfolio to expand our position in the market.
Operator
Your next question comes from the line of Mike Dahl from RBC Capital Markets.
Michael Glaser Dahl
First one on the cost tailwinds. So I think, Pete, you articulated that, that $40 million in known deflation and production tailwinds, maybe that comes down to 35% when you account for the Vycom divestiture. Can you just elaborate more on what you're seeing on the raw material side? And you talked about this being known deflation on the balance sheet. But is there a potential for additional deflationary benefits if raw mats stay where they are today and you cycle into -- you continue to cycle into that in your [work]?
Peter G. Clifford
Yes, Mike, the view on the commodities front from an expectation perspective of kind of what's embedded in the planning assumptions is, look, the input costs have stabilized and are expected to remain kind of relatively flat all year with a few modest increases in the back half of the year. So it's kind of steady state is sort of the view from sort of the industry publications [CDI].
Michael Glaser Dahl
Okay. So the $35 million total, you think fully encompass where we're at today?
Peter G. Clifford
It does. And if you remember, commodities dropped very sharply right after we started the year. So really, they dropped fast and then they stabilized and we've been kind of right in sideways here for the last couple of 6 to 8 months.
Michael Glaser Dahl
Okay. My second question, maybe I misinterpreted this when the initial release came out. But I think when the Vycom divestiture was announced, the idea was to roll up all of the reporting into the Residential segment. Now you're putting corporate expenses into resi, but keeping Scranton Products separate and commercial. Anything to read into that in terms of whether your intent has changed on what to do with the remaining Scranton Products business?
Peter G. Clifford
Yes. I mean, look, I think it was obviously a way for us to make it easier for folks to compare us to our peers within the building product space that most folks that follow us are most interested in residential. So it seemed logical to put those two pieces together.
Operator
Your next question comes from the line of Rafe Jadrosich from Bank of America.
Rafe Jason Jadrosich
Great. First, I wanted to just ask, can you talk about the sellout trends in decking versus the exterior categories that you saw last quarter? And then what are you assuming in your outlook for each of them?
Jesse G. Singh
Yes. At a high level, both of them were roughly similar and positive. And I think as we look out to next year, we're not parsing out any specific business. As we've highlighted we've got conversion opportunity and new products on the Deck, Rail & Accessory side. And we've also got a number of new products that will help us drive wood conversion on the Exterior side. So we've seen nice sell-through growth in both of them.
Rafe Jason Jadrosich
Got it. And then just following up on some of the earlier comments on the early buy. You mentioned that normally, the majority of other buys in the second quarter, but some of it has historically fell in the first -- fiscal first quarter, but this year, effectively, it's all going to ship in the second quarter. What's -- is there a way you can quantify the rough impact of that assumption? And then what portion of your sales in a typical year would come in the early buy?
Peter G. Clifford
Yes. I mean, I'll take the first part of the question on sort of the catalyst for most of it moving to the second quarter now, is, look, it used to happen in the first quarter because capacity wasn't capable of supplying as much product as what was needed in the second quarter. Obviously, with the capacity expansions over the last 2 years, that's really, again, kind of the catalyst for why we really don't feel like there's a need to have any of the shipments in our fiscal 1Q and that virtually all of it will be in the second quarter.
Jesse G. Singh
And then relative to the percentage, we haven't talked about that. I think the most important part of this winter negotiation is that we position ourselves well with our customers to drive growth throughout the year. So for us, the most valuable part of this is the partnership discussion of how we're going to work together to grow our mutual businesses with our channel partners.
And in that respect, the quarter and the discussions are important to set up the year. What it does do is it gives us pretty good visibility on revenue within the quarter. And so as we've talked about in the past and our competitors have to, really, the October quarter and the January quarter are really quarters that end 1 year and begin another and they're staging quarters. And then we'll see the real impact in season as we move into -- our fiscal third quarter and fourth quarter.
Operator
Your next question comes from the line of Trey Grooms from Stephens Inc.
Noah Christopher Merkousko
This is Noah Merkousko on for Trey. So maybe first, I just wanted to follow up on gross margins. It sounds like continuing to ramp production from here. You've highlighted the raw material deflation that will help the front half of fiscal year '25 and the kind of roll off in the back half. So I guess would -- you'd expect gross margins to be stronger in the front half and then moderate in the back half? Is that kind of the right way to think about it here? Or are there other items we should consider as we think about '24?
Peter G. Clifford
Obviously, year-over-year, the performance on gross margin is going to be meaningfully accretive in the first half of the year, given what we're lapping. And then I would assume or expect kind of consistency in the back half of the year with this second half of '23.
Noah Christopher Merkousko
Got it. That makes sense. And then on my follow-up, it sounds like continuing to make investments in SG&A, which would prevent leverage in '24. But when you think about SG&A as a percent of sales, is '23 a pretty comparable year? Or would you expect that number to move meaningfully higher?
Peter G. Clifford
We're not expecting significantly negative leverage. It will be flat to modestly negative. As Jesse said, it's probably reasonable to think maybe 20 bps.
Noah Christopher Merkousko
Got it. That makes sense. Good luck for the rest of the year.
Jesse G. Singh
Appreciate it. And the last comment on that, that really depends on volume. And as we look at our ability to deliver EBITDA margin, we feel really good that in any scenario, we can get into that 24-plus range that we talked about that puts us on a path towards that 27.5 that we talk about by 27.
And so with that, thank you all for joining. We feel -- as you can tell, we're pretty pleased with how we ended the quarter. And we feel excited about what's ahead of us and look forward to chat with the rest of it off-line as needed. Take care, and thanks for joining us. Appreciate it.
Operator
This concludes today's conference call. Thank you for your participation, and you may now disconnect.
