Harriet Fried - Senior Vice President, Lippert/Heilshorn & Associates, Inc. William R. Gupp - Senior Vice President, General Counsel and Secretary Ronald W. Kaplan - Chairman, President and Chief Executive Officer James E. Cline - Senior Vice President and Chief Financial Officer.

Rohit Seth - SunTrust Robinson Humphrey Trey H. Grooms - Stephens, Inc. John A. Baugh - Stifel, Nicolaus & Co., Inc. Glenn A. Wortman - Sidoti & Co. LLC Min Chung Cho - FBR Capital Markets & Co. Al Kaschalk - Wedbush Securities, Inc..

Welcome to the Trex First Quarter 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. Following management's prepared remarks, we'll hold a Q&A session. As a reminder, this conference is being recorded, Friday, May 8, 2015. I would now like to turn the conference over to Harriet Fried of LHA. Please go ahead, ma'am..

Thank you, everyone, for joining us today. With us on the call are Ron Kaplan, Chairman, President and Chief Executive Officer; and Jim Cline, Senior Vice President and Chief Financial Officer.

Joining Ron and Jim are Brad McDonald, Controller; Brian Bertaux, Senior Director of Financial Planning and Analysis; and Bill Gupp, Senior Vice President, General Counsel and Secretary. The company issued a press release this morning containing financial results for the first quarter of 2015.

This release is available on the company's website as well as on various financial websites. The call is also being webcast on the Investor Relations page of the company's website where it will be available for 30 days. I'd now like to turn the call over to Bill Gupp.

Bill?.

Thank you, Harriet. Before we begin, let me remind everyone that statements on this call regarding the company's expected future performance and condition constitute forward-looking statements within the meaning of Federal securities law.

These statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those expressed in the forward-looking statements. For a discussion of such risks and uncertainties, please see our most recent Form 10-K and Form 10-Qs as well as our 33 and other 34 Act filings with the SEC.

The company expressly disclaims any obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise. With that introduction, I'll turn the call over to Ron Kaplan..

the use of recycled materials. Trex was also named the winner of the Golden Hammer Award. This award is based on a survey by Hardware + Builder Supplier (sic) [Hardware + Building Supplier] magazine. The survey asks distributors and retailers which brand they feel offers the most outstanding benefits for their business.

These latest awards follow our recent unprecedented sweep of the Builder Brand Use Study as well as the ADEX Design Award. This wide range of honors illustrates our brand and product leadership among both trade professionals and consumers. But what really tells the story is sales and market share growth; both are on the move.

Moreover, the first quarter gross margin reached 40%, up 200 basis points over last year. We are seeing the benefits of the cost reduction initiatives we implemented last year, which took effect in the second half. As you know, we continuously focus on manufacturing efficiencies.

We will continue to implement further cost reductions resulting in margin expansion as the year progresses. Our first production line serving the specialty materials market operated as expected during the first quarter. We are on track for our additional three lines to begin operation in the second half of 2015. Q2 orders are off to a strong start.

Accordingly, we are forecasting another record-setting quarter with sales of $136 million. This represents a 12% increase from last year's period.

Jim?.

Thank you, Ron. Obviously, I'm honored and happy to have the chance to lead Trex and continue working with Ron as Chairman. Our company has many competitive advantages, our employees are very talented and there are many new and compelling growth opportunities to leverage.

I'm looking forward to working with the rest of the Trex leadership team to fulfill those opportunities. Our first quarter 2015 revenue and operating income set new records for the company. Sales for the first quarter were $121 million, a 20% increase compared to 2014, reflecting strong organic sales growth.

The strong performance came across most of North America, was realized due to expanding market share and more favorable weather conditions across most of the region compared to 2014. This was partially offset by the effect of poor weather conditions in the Northeast.

Gross margin was 39.9% in the first quarter of 2015, a 200-basis-point increase compared to the prior year. Increase in gross margin was a result of ongoing cost reduction initiatives, favorable manufacturing efficiencies and product mix. The year-over-year incremental gross margin in the quarter was 50%.

SG&A for the first quarter was $20.6 million compared to $18.2 million in 2014. Branding was up $1.6 million, reflecting an expansion of our targeted advertising campaign. Incentive compensation increased $1 million. Earnings before taxes for 2015 were $27.5 million, a 40% increase over the prior year's results.

The company recorded net income of $17.6 million or $0.55 per share in the first quarter of 2015 compared to net income of $12.3 million or $0.37 per share in the first quarter of 2014. The tax rate of 36.2% was slightly lower than the first quarter of 2014. The 2015 free cash flow was negative $90 million compared to a negative $85 million in 2014.

This was due mainly to increased working capital to support higher sales and increased capital expenditures of $6 million, partially offset by increased net income.

The increase in capital expenditures was primarily related to the three additional specialty materials pellet lines and the purchase of land adjacent to our Winchester facility for a potential future expansion. Finally, I'd like to turn to our revenue guidance. Our second quarter revenue guidance is $136 million.

This reflects a 12% increase over the second quarter of 2014. We have seen a slower start to the season in the Northeast due to the heavy snows. Orders in early May have ramped up significantly, but we expect some of the demand will move into the third quarter.

Operator, we would now like to open the call up for questions, after which Ron will provide his closing statement..

[Operator Instruction] Your first question comes from the line of Keith Hughes with SunTrust Bank. Please go ahead with your question. And, Keith, please make sure that your line is not on mute..

Hey. Good morning. This is Rohit Seth in for Keith Hughes at SunTrust. Question on your inventories. They're down 24%. Can you comment on what the production rates were in the first quarter and what you're running in the second quarter? Just looking, and see if there is any additional absorptions in the second quarter given where inventories are..

Our production rates are very brisk right now. Inventory is quite low. We're operating right now at north of 50% capacity utilization. And so, we're operating lean and mean. And anybody who places an order, we're going to have to produce it for them..

Okay.

And then, do you guys have a sense of what level of volumes or dollars were shifted from first quarter due to weather, maybe into the second and third quarter?.

The shift from the first quarter to the second quarter?.

Yeah.

And then you mentioned that it's off to a slow start, so you might see some of that come in?.

Certainly. In the Northeast, we saw weather conditions that were not conducive to deck building. Boston particularly had large amounts of snow. It's a very strong region for us. We don't have an exact number on what that was, but it would be measured in millions.

And because of that strong snow pack, it was several weeks before we started to see that demand come on stream, a little bit later than what we planned. So, while it's catching up now, May has been extremely strong. We believe that we'll probably push some level of sales into the third quarter..

Got you.

And then finally on the plastic business, did you guys break out – or can you break out how much of that was in your revenue number?.

Sorry. We don't break that out..

Okay..

But I can tell the project is on plan, and we're in production..

Okay. Great. And congratulations to the both of you, Ron and Mr. Cline..

Thank you very much..

Thank you very much..

All right..

Your next question comes from the line of Trey Grooms with Stephens. Please go ahead with your question..

Thanks. First off, yeah, congratulations, Ron, on your upcoming retirement. It's been a pleasure working with you over the last seven years..

Thank you very much, Trey..

And also, Jim, congratulations on your new role as well. Well-deserved there..

Appreciate it, Trey..

My first question is on the guidance for 2Q. Pretty strong revenue growth even with backdrop you've mentioned around some weather pushing some stuff in the 3Q. You've got tougher comps there.

When you guys won the new distribution relationships, I guess it was back in the fall of 2013, and you'd mentioned at the time that it would take a few years to fully roll out.

Is that playing a role here this year? I'm just trying to get a sense for how much of this growth that you've outlined for 2Q is organic versus kind of continued rollout of those new distribution agreements?.

Well, the market share continues to increase. I think what we said at the time, it takes two to three years to fully commercialize. We can argue whether we're at the 40% mark or the 60% mark, but we got a ways to go as the commercialization program continues to roll forward with great success, I might add..

And, Trey, also, if you looked at the sales across the northern tier of the United States, which is the strongest region for all manufacturers of decking and railing, we see very strong sales across all sectors, and it's not just organic. We are seeing market share gains across the country..

Great. That's helpful. Thank you. And I guess on the cost front, this kind of goes hand-in-hand with margins. I mean, your incrementals were strong, I think a little better than kind of the 45% you guys had talked about for this year.

Should we still kind of think about the full-year incrementals in that 45% range or is there – if you look at kind of the moves that we've seen in virgin polyethylene prices, should that create a tailwind for you guys at all on the cost front? Obviously, you guys use recycled.

Just trying to get a sense of the relationship there and how that could impact you guys..

Yeah. The recycled polyethylene costs drip downwards much, much slower than virgin polyethylene. And it is continuing to drip down very slowly. Virgin polyethylene is actually starting to creep upwards. So, that is really not a significant impact to us. This is really related to the cost reduction initiatives that the company had put in place last year.

We continue to execute on new cost reduction initiatives. At this point, I would say the average across the year, we're still targeting roughly 45%. It will not necessarily be a straight line as you saw in the first quarter with the very strong performance. But, overall, I would keep using the 45% at this point..

Okay. Thanks a lot for answering my questions and good luck. Thank you..

Thank you, Trey..

Your next question comes from the line of John Baugh with Stifel. Please go ahead with your question..

Thank you. Good morning and congratulations to both, richly deserved..

Thank you..

I want to jump right into it. So, the – I guess, the first thing would be on the SG&A side. Any dollar thoughts there or percentage of revenue? You called out branding, but just a sense for incentive comp and all those things going forward would be great. Thanks, Jim..

Yeah. I think we guided before that for the year we expect our branding spend to be up several million dollars. And we haven't changed from that. We still expect that'll be up. The rest of the expenses, about 5% of it would move with sales level change year-over-year. And then you would need to put inflation on top of that.

Those are the changes I would model for if I were on your side of the table..

Great. Thank you for that. And then, I guess this is a question with, I don't know, a timeframe of what you thought a year ago versus where we sit today. I understand completely that oil prices are going to change and may well go back higher before they go lower or who knows.

But is there any change to your thought on the pellet margin opportunity which I believe you described in the past as at least equivalent to the corporate EBIT number given what's transpired thus far with oil?.

Really no change in our trajectory on that. We believe the opportunity is still at the, roughly, 20%, 21% margin. We get there not with one piece of equipment. As you know, we were operating the first line splitting the time between R&D to get the optimal configuration identified and also servicing customers.

We're pretty well down the road on those R&D runs. But the long-term trajectory is still as we described it before..

Great. Thanks. And then my last question on the first quarter, could you talk about decking volume versus price, kind of how much was realized in each? And then, anything you're seeing on mix, that I think you mentioned it was a help, but was wondering if you could be more specific. Thank you..

Well, a couple of things. If you just looked at the volume, it would be up roughly 16%. When you look at some of the changes we made, we did make a change in our pricing for our Transcend Monochromatic and the price difference between the monochromatic and the exotic actually narrowed.

So, we have a very strong presence at the high end of our product offering. And what we've been able to do is successfully interest our customers in trading up to the next level. In some cases, it's from Select to Enhance. In other cases, it's up to the Transcend. And we continue to focus on that as a strategy.

We think that's the best value for the consumer and that's the best value for Trex..

Great. Thanks and have a great retirement, Ron. Good luck..

Thanks, John..

Your next question comes from the line of Glenn Wortman with Sidoti & Co. Please go ahead..

Yeah. Good morning, guys..

Good morning..

Yeah. I also just want to wish both of you good luck and congratulations as well..

Thank you..

Thank you..

And then, Ron, I wanted to go back to some comments that you made at your Analyst Day in March. You mentioned that you thought that composite share of the decking market would start growing more meaningfully again and that it could approach 50% in the coming years. I think we're at about 35% today.

Can you just highlight what's behind that expectation and what are you seeing so far early this year?.

Yeah. What's behind that expectation is this. Five years ago, we introduced Trex Transcend. In Trex Transcend, you eliminated the primary dissatisfier among people in the composite customer base. Those two dissatisfiers were staining and fading.

Subsequent to our introduction, the marketplace has essentially copied the technology and thereby raising the overall quality of the entire composite segment. And so, the whole consumer base that we deal with has a higher level of confidence in composites than they did before, which is breaking down the resistance and a bias toward wood.

So, what we see is that composite decking is taking share from wood decking, and Trex is taking share within the composite segment. So, we've got a number of forces at play. The economic tailwind is beginning to blow, and share of composites as a percentage of total decking is rising, and Trex share within that composite category is rising.

We've got a perfect storm blowing favorable winds right now. So, that process continues and I stand by my original expectation..

No. No. Sounds like a lot of things are working in your favor. And perhaps, a fourth leg to that would be growth internationally.

Can you just update us on how that performed in the quarter and any expectations for the rest of the year?.

Well, we now sell in a total of 45 countries in total, up a couple from our last phone call. And it's the fast-growing part of our business, and it's meaningful to us and it's certainly beyond the point that we would never walk away from it.

I'll let my CFO decide when SEC rules require that it be broken out separately, but it won't be long at the rate that it's growing..

Okay. Thanks for taking my questions..

Thank you..

Your next question comes from the line of Min Cho with FBR Capital Markets. Please go ahead..

Great. Good morning and congratulations on the strong quarter and also wanted to congratulate both of you on your move going forward. Ron, you mentioned in your prepared remarks that the three additional pellet lines were supposed to start production in the second half.

And I believe in the past you had guided that the three lines are supposed to start up in the first half and then start contributing in the second half.

I just want to know if that was a change in guidance?.

Let me just provide some precise clarification. They'll be installed in the first half and they'll start operating in the second half. So, the three extra production lines are now on-site and installation is actively underway..

Okay. Perfect..

Nothing has – so, the bottom line is nothing has changed from what I've said before..

Okay. Got you. I just wanted that clarification. And also in terms of Tim Reese retiring, is he retiring at the same time that you are? And just any update on a replacement for him..

His effective retirement date is June 30, and in some future day, we'll talk more about it..

Okay. Great. Thank you and good luck..

Thank you..

Thank you..

Your next question comes from the line of Al Kaschalk with Wedbush Securities. Please go ahead with your question..

Good morning, guys, and congrats on the quarter..

Good morning..

I just want to drill a little bit down into the business, in particular on the pellet side, in terms of how that's ramping. I know you said in line with plan, but what are you hearing from the customer base about the opportunity? Because the land purchase would suggest there's a potential for some acceleration there.

Could you add any more color to that?.

Well, the land purchase is to provide – we're going to need it for the opportunities that we see on the horizon in our specialty products but not limited exclusively to pellets, necessarily, or even at all necessarily for pellets. We've got a lot in the pipeline which I referred to earlier. We're going to need that land.

The pellet business is going as advertised. We're developing the market. We have a selection of customers. We're in production. We're selling what we're making. And I think that's about all the color I want to provide.

Jim, do you want to add any more color to that?.

No. I think we said before that this first line was going to split between R&D and building the market. We continue with that. We're backing off the R&D at this point as we are moving to install those new lines.

And having those additional lines will enable us to actually cast a wider array of products at the market and be able to service those larger customers that need greater volume than what we can get off the one line..

Right. Great. No, that sounds good. And then secondly, back to the decking business.

In terms of the strategy, how would you characterize the ability and your intent to have the customers move to the upper end of the product range given the smaller price differential between sort of the good, better, best type of vantage point? Is that something you're targeting to do? And if so, obviously, it can help in terms of the performance..

It is our strategy to have people move toward the higher end. We offer the good, better, best because that was part of our dealer conversion strategy. You have to have an opening price point product.

But what we find is having an opening price point helps us add dealers, but when a customer walks into the dealer and sees the wide array of product, they still have a bias, and they'll spend the extra money for our higher end products.

So by raising the price of our monochromatic, really what happened is it drove people toward the exotics, as Jim mentioned earlier. The strategy has worked out exactly as our marketing department said it would.

Jim, do you want to add to that?.

I think when you look at what we've done, this is a win-win for everybody in the chain. You make more money on the higher-margin items. The dealers make more money. The distributors make more money and the consumer gets better value by moving to the Transcend exotics.

So, everyone in the chain that's touching this product is better off as they move to the exotic platform..

Great. Got it. Thank you, guys. Good luck..

Thank you..

Thank you..

Thank you. There are no further questions in the queue at this time. I'd like to turn the call back over to Mr. Kaplan for any concluding remarks..

Well, thank you. The past eight years have been very successful and our business in 2015 is progressing just as we planned. Everyone at Trex is galvanized to continue our winning track record and in engineering what's next in outdoor living. I can tell you that I'm looking forward to my last earnings call next quarter.

I really enjoy answering your questions. And we'll be back with you in – Jim and I in August. That's all for now. Thank you very much. Good-bye..

Ladies and gentlemen, that concludes your conference call for today. We thank you for your participation and ask that you please disconnect your lines..