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

Matthew Scott McCall - BB&T Capital Markets Rohit Seth - SunTrust Robinson Humphrey, Inc. Drew Lipke - Stephens, Inc. Morris B. Ajzenman - Griffin Securities, Inc. Dillard Watt - Stifel, Nicolaus & Co., Inc..

Welcome to the Trex Third 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. I would now like to turn the conference over to Harriet Fried. Please go ahead ma'am..

Thank you, everyone, for joining us today. With us on the call are Jim Cline, President and Chief Executive Officer and Bryan Fairbanks, Vice President and Chief Financial Officer.

Joining Jim and Bryan are Brad McDonald, Senior Director and Controller; Bryan 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 third 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. Go ahead please, 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 1933 and other 1934 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 Jim Cline..

Thank you, Bill. While we reported revenue this morning that was just shy of last year's record third quarter, our nine-month sales set another company record and was up 11% over 2014. The harsh winter in 2014 caused a delay and subsequent extension to the overall season, impacting the timing of 2014 sales.

You may recall our year-over-year increase in sales for the third quarter of 2014 was an impressive 32%. We have continued our trend of outpacing the market and advancing our industry-leading market share. In addition to the strong results with our high-performance decking products, we've been making comparable strides in railing.

During the third quarter, we swept all four railing categories of the 2015 Remodeling Brand Use Study, issued by Hanley Research. The study surveys more than 8,000 readers of Remodeling Magazine.

Trex took first place in all categories, including brand familiarity, brand most used, highest quality, confirming that the industry's professionals view Trex as a total outdoor living resource. The success of our Reveal aluminum railing line, one of our more recent offerings, is just one example.

Now turning to specialty materials, our dedicated production lines are performing as expected with shipments and sales to new customers continuing to grow, but at a slower rate than we originally anticipated. There are many applications for our recycled pellets, including bags, molded products such as bins and totes and rigid and flexible tubing.

During the quarter, we launched our first product awareness campaign for specialty materials to communicate our expanding business development initiatives through online and print publications to targeted customers. Based on the inquiries we've received to date, we are targeting the right audience.

We are continuing to enhance our capabilities and will begin to utilize our compounding expertise to combine our recycled pellets with other polymers. This will provide a greater added value to our product offering. In the quarter, we completed a share repurchase of $45 million.

In total, we purchased $120 million worth of shares since 2013, which is a testament to our strong free cash flow generation. As noted in our earnings release this morning, the Board authorized a new 3.15 million share repurchase program and a $100 million increase to our bank facility. We have also launched several key growth initiatives.

We are expanding our sales team to better support our direct sales customers and distribution partners to focus on market share growth in the overall decking and railing market.

We just announced the consolidation of our railing and poly warehousing operations as well as a new Trex University Center for training and the two new leased facilities in the Winchester area. These two new facilities will provide us with the ability to more efficiently meet the demand of our markets.

We will begin operations in the railing warehouse in December and mid-2016 for the poly warehouse. The fourth quarter is off to a good start. You'll see that reflected in our fourth quarter sales guidance of $85 million and our projection of another record year with double-digit sales growth over 2014.

We look forward to our annual distributor meeting, which is taking place later this week at which we'll be unveiling our sales strategies, pricing and programs for 2016. With that I'll hand the call over to Bryan..

Thank you, Jim. Good morning. The press release containing our financial results for the third quarter of 2015 was issued this morning. The company recognized net sales of $94 million in the 2015 quarter, nearly matching the 2014 quarter that was favorably impacted by a late start to the decking season and a shift of sales to the third quarter.

Third quarter 2015 was unfavorably impacted by a $7 million of warranty charges, primarily related to a small percentage of material produced at our Nevada plant, prior to 2007. We expect year-over-year cash payments from the surface flaking issue to continue to decline.

Compared to the first nine months of 2014, cash payments are down by $1.4 million. Gross margin for the quarter was 23.6%. Before giving effect to the warranty charge, gross margin was 31%, unfavorable to prior-year quarter by 80 basis points.

During the quarter, we expensed approximately $1.1 million of material produced in prior quarters that did not meet our heightened aesthetic standard. In response to this, we adjusted our plant operating parameters to meet the higher standard, which resulted in slightly lower operational efficiency during the quarter.

These inefficiencies have been resolved and will not carry to future periods. SG&A for the quarter was $15.7 million, which was slightly lower than the 2014 quarter. The company posted net income of $3.7 million or $0.12 per share in the third quarter compared to net income of $8.9 million or $0.28 per share in the third quarter of 2014.

The earlier mentioned charges reduced EPS by $0.14 in the 2015 quarter. Excluding those warranty charges, EPS was $0.02 lower than 2014 primarily due to slightly lower sales volume. Net sales for the first nine months of 2015 was a record $352 million, reflecting an 11% increase compared to 2014.

Sales volume, which rose 8%, accounted for most of the growth, indicating that our market share advancement initiatives continue to be effective. The remainder of the growth was due to mix and pricing. Gross margin was 35% for the first nine months, which is an 81% basis decrease from the prior year.

Including the full-year warranty charges of $7.8 million, gross margin was 37.2%, favorable over prior year by 140 basis points. The improvement in gross margin, excluding the warranty charges was favorable due to sales mix and ongoing cost reduction initiatives. SG&A for the first nine months totaled $58.8 million compared to $54.5 million in 2014.

The increase was primarily due to branding and personnel-related expenses, which were partially offset with general cost reductions. For the first nine months of 2015, the company had record earnings of $40 million or $1.25 per share compared to income of $36.4 million or $1.10 per share for the first nine months of 2014.

The earlier mentioned 2015 warranty charges reduced year-to-date EPS by $0.15. Before giving effect to the warranty charges, 2015 EPS was favorable to prior year by $0.30 or a 27% improvement.

For the first nine months of 2015, the company consumer $6.1 million of free cash flow compared to free cash flow generation of $36.6 million during the same prior-year period. The variance is primarily due to a change in payment timing from the prior year for our distributor sales programs and increased capital expenditures of $9.5 million.

Outstanding receivable balances will be collected during the fourth quarter, which will then turn free cash flow positive.

Increased year-to-date capital expenditures are primarily related to investments in our specialty materials business and land acquisition adjacent to our Winchester, Virginia manufacturing site to support future strategic opportunities. The company continues to return capital to shareholders through repurchase programs.

During the quarter the company purchased 1.1 million common shares, totaling $45 million. Over the past three years the company has returned $120 million to shareholders through repurchases. Net debt at the end of the quarter totaled $46 million, an increase of $47 million over the same period last year.

The increase of net debt is primarily related to the common stock repurchases during the quarter. The newly approved share repurchase program mentioned by Jim will be funded through operating cash flows and use of credit facilities. The Board of Directors has authorized an increase of our credit line by $100 million.

We are presently in discussions with our banking partners regarding the expanded credit line. Operator, we would now like to open up the call to questions, after which Jim will provide his closing statement..

Your first question comes from the line of Matt McCall with BB&T Capital Markets. Please go ahead..

Thanks. Good morning, everybody..

Morning, matt..

So, maybe start with gross margin. You broke out the $1.1 million expensed for the products that didn't meet your standards. So that looks like about 120 basis points on a year-over-year basis if I understood that correctly.

Can you talk about the pellet investment year-over-year and any impact that it had on the gross margin performance? And then as we look forward, you mentioned some investments, specifically the new warehouses, the impact that we should account for in our models?.

Sure. So, the pellet investment was primarily completed through the second quarter. We have had a little bit of additional spending related to it. But in the second quarter call, we did mention that our four lines were up and running at that point. So the great majority of the investment related to those lines is completed at this point.

From a gross margin perspective, operationally, we did have some issues related to our Transcend Tropics, where the aesthetics didn't quite meet what the market expected.

This was caught before it landed at the consumer level and rather than determining whether it would be a problem, we decided to act in advance and take that material back from the marketplace and resulted in those charges..

Yes. With regard to the warehouses it's a relatively modest increase because of certain cost reductions associated with the new leases that we put in place. So somewhere between a probably $0.25 million and $0.5 million additional expense is all we're looking at..

Okay.

And just to clarify, Bryan, on the pellet investment, I guess the way I was looking at it was on a year-over-year basis when you think about the investment that was made and the costs that were incurred this quarter versus a year ago, do you have any idea what those would be?.

The investment this year for that was about $6 million..

In the quarter?.

Year-to-date..

Year-to-date. Got it..

In the quarter it was very minimal..

how should we build those new items into our future estimates?.

We expect that SG&A will grow along with branding as we grow the company revenue base. But otherwise, we expect to continue to drive overall efficiencies, and it will reduce as an overall percentage of sales as we go forward. But you can expect the branding portion of the SG&A spend to increase along in the same line of sales..

Okay. Got it. Got it. Okay. And final one, Jim, you talked about the weather impact last year and how it extended the construction season. We're hearing more and more about labor shortages in the construction arena.

Is there the potential that these labor shortages could result in a similar extension this year and it could prolong the construction season a little bit?.

Well, we've certainly seen an indication in the month of October that demand continues to be pretty strong. It was strong through the end of the quarter, so we were pretty happy with what we saw there. You're exactly right; some of our contractors are struggling with getting qualified help to support their businesses.

Typically, if the weather continues to be good, we'll see this trend continue into the early part of November at least..

And is that the typical – is that an extension, or is that kind of normal?.

It's typical to – we expect it to be typical to what we saw last year, from that standpoint. But if you went back a couple of years, it really would've started to slow down quite a bit in October, but that last couple of years we have seen it extend into the fourth quarter..

Okay. Perfect. Thank you, guys..

Thank you..

Your next question comes from the line of Keith Hughes from SunTrust. Please go ahead..

Hey. Good morning. This Rohit Seth in for Keith. I just wanted to expand on the plastics business. It sounded like you were – you had talked a little bit about a new product, you're combining a compound expertise, something like that.

Can you expand on that?.

Sure. One of the things that we've experienced with polyethylene prices, if you looked at the polyethylene price September of last year, it would have been, for virgin pellets, about $1.09 a pound. If you looked at that same number today it would be in the $0.65 to $0.70 a pound. So it makes a very challenging environment.

A few months ago, we identified an opportunity to start blending other polymers with our recycled pellets, making it a more unique product, a more specialty product and enabling us to potentially move into a higher margin product.

We believe that opportunity exists, we have interest from a number of companies and we're beginning to run trials on that which will expand our product offering to differentiated products in that way..

So where are you getting the new polymers from? Is that coming from your plastic bag recycling operation or....

No. In some cases it's from other recyclers of other types of material such as rubber. In some cases it is blending some virgin material in with our recycled polyethylene pellets..

And so all that blending, so you're sourcing that new supply and then you're blending it in house.

Is that what you're doing?.

That is correct..

Okay.

And then you mentioned something about – you started marketing in 3Q 2015 and I guess is that because you're getting a little bit of a slower response? Is that how to read that? So in the second half you expecting – you're expecting a ramp in a second half?.

Yes. We felt that we're not seeing the interest that we thought would be able to drive the business to the levels we were interested in, and therefore we started a PR campaign which basically was targeting specific types of manufacturers who'd utilize the recycled pellets..

Okay.

So that you initiated in 3Q and you're getting a decent response from that? Is that what you're...?.

We are. We are. And from those responses, we can tell that the target market that we approached, we targeted properly. We were getting people who were interested in doing specific trials with specific types of products..

Okay.

And then could you just comment on your production rates for next quarter, in the fourth quarter? Are they going to go up or down on a year-over-year basis?.

We expect on a year-over-year basis our utilization level will be slightly higher than prior-year..

Okay. Great. Thank you. That's all I got..

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

Yes. Good morning, Jim. Good morning, Bryan. This is Drew Lipke on for Trey..

Morning, Drew..

First question that I had, you know historically you guys have always talked about maintaining a 3x to 4x spread relative to lumber prices and we have seen lumber prices pull back here pretty significantly throughout the year. I believe you guys have a 6% price increase, effective in October for the monochromatic.

Could you just talk about for the core decking business, how we should be thinking about your pricing strategy in light of the recent moves in lumber, and then also in light of virgin poly prices where they are?.

Sure. We have not seen any significant movement in pressure treated lumber at retail. It's been relatively stable. And in fact, if you looked at the higher grade of pressure treated, which is generally a cedar that has had less product available in the market than what a lot of the consumers would like to have. And therefore that is very stable.

So, we don't really see an impact from that, nor have we seen competitors using reduced polyethylene prices to try and drive the retail price down. I believe what's happening is over the last several years, there have been very few price increases.

And I think that it is a point in time when competitors are basically utilizing that to strengthen their margins back to where they believe they're appropriate..

Okay. And then historically you guys have always focused more on internal R&D and technological advances to drive growth and you have this new product that you were just talking about with the new blending of the new polymers.

How should we think about your preference going forward for internal R&D versus any kind of potential acquisitions versus obviously the increased desire to buy back stock?.

Well, our primary focus is growth of the business. The buyback of the stock is something we do on an opportunistic basis. If we see a share price that is exceptionally low we are out there and have been and demonstrated we've been active buyers. But our first goal is to grow the business.

We believe that through our R&D team as well as our manufacturing team we can offer more to shareholders through innovation with them than we probably can do with acquisitions. Acquisitions, of course, bring all kinds of risk with them. However, if we saw the right acquisition we would certainly be open to it.

This management group has looked at a number of potential candidates primarily in the building products area. And thus far, I have not found any that really met the requirements that we were looking for, which basically is a strong return on investment considering the risk associated with the acquisition..

Okay. And then last question from me, just it sounds like international market now getting to the size where you need to actually disclose it. From what we can tell it sounds like sales in the U.K. continue to be very strong. Could you kind of size up what you view as the U.K.

opportunity for the core decking business? And then also as you look to more continental European markets, particularly Germany, can you kind of size up that opportunity for us over time?.

Yes. We haven't broken out the international sales as a segment within the business as of yet. I expect at some point in the future we will do that when the size is appropriate. From a European perspective in breaking that out, if you look at an overall worldwide market, about half of the composite decking sales are outside of North America.

And when you break that apart from there about 50% to 60% of that outside of North America market is going to fall within Continental Europe. So that's the key reason for our focus within the major economies within Europe. Of course as you'd expect, the economies that are functioning with little bit stronger – economically have a better opportunity.

So we have focused on the U.K., France, Germany and some of the other countries up in Scandinavia, and we'll continue to go after that as we go forward..

All right. Thanks guys..

Thank you..

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

Good morning. This is Mischa (25:48) filling in for Al.

One question we had was if you could elaborate on your pellet investment? And if the four lines that are running today, if those are – how many lines do you expect to have running in 2016? Do you expect to grow on the – to grow from the four?.

We currently do not have all four lines running. We do not have the demand to support all four lines. We anticipate that in 2016, we will move into the four lines. Until we have fully loaded those lines or we see a demand curve that supports fully loading those, we will not be proceeding with any additional lines.

So I would say for 2016 based on our current trajectory we would probably be limited to four lines in 2016..

Got it. Okay. And also you mentioned that there is a distributor meeting later this week. You'll outline your strategy.

Can we expect to hear an update on the outcome of that meeting?.

We typically do not have a press release. This is where we're talking with our distribution partners as well as our sales force on internal strategies for the company. We've talked about our pricing. We do have a roughly 6% price increase that we've already implemented on Transcend monochromatic.

That is the only price increase of any significance that we've passed on. Programs also will be talking with our distributor partners and typically we do not go into those in detail with the Street..

Okay. All right. Well thanks, guys..

Thank you..

Your next question comes from the line of Morris Ajzenman with Griffin Securities. Please go ahead..

Hi, guys..

Hi, Morris..

Hi. The question is back on gross margins again. You referenced during the quarter there were two issues that you touched on at least, the warranty expense and then you spoke about the incremental – or actually the expensing of materials, $1.1 million versus I think your Transcend Tropics. So let's look out to the fourth quarter if we may.

You're guiding to revenues of $85 million and that compares to about $74 million last year. Gross margins – the last year in the fourth quarter if I'm correct were 35.9%.

How should we think about gross margins in this quarter versus last year and coming out of the third quarter if there might be any sort of follow-up – fallout from that?.

Well, as I mentioned, the operational issues related to the heightened aesthetic standard, that's behind us at this point.

We don't provide specific gross margin guidance as we go forward, but as I mentioned in a – with a prior question, we do expect utilization to be up slightly in the fourth quarter and there will also be some benefit from the price increase on the Transcend Classic colors..

Yes. In the past Jim has given us some color on incremental sales growth compared to previous quarter.

Is that model still appropriate to use?.

Yes. On a year-over-year basis, we're still targeting a 45% incremental growth..

And, Morris, in looking at that number, I think you need to look at what occurred in prior fourth quarters to put it in relationship. Fourth quarter is one of the lower months from an incremental margin standpoint, typically. Third and fourth quarter are typically challenges to that number. First and second quarter very strong.

You saw it come down slightly in the third quarter and again, typically fourth quarter is a little bit of a challenge on that 45%..

If you took the full fiscal year change in revenues and then look at a change in gross margin at 45%, you can fit the fourth quarter accordingly..

Just one last thought here. June quarter revenues were down modestly year-over-year.

How do you think you're faring vis-a-vis competition in the most recent quarter? How would you characterize that?.

Based on everything we've seen and heard, both from our Big Box business partners as well as the two-step channels is we continue to expand our market share. It is equally as clear in the third quarter as it was in the earlier part of this year..

Thank you..

Thank you, Morris..

Your next question comes from the line of Dillard Watt with Stifel. Please go ahead..

Thank you, gentlemen. Good morning. I wanted to just touch on the warranty claim. First, correct me if I'm wrong, but I assume this is continuing the issue from the Nevada facility way back when, and just anything you can give us on, I guess you said that the claims are continuing to slow, down $1.4 million year-over-year in terms of cash payments.

Is that, any color on number of claims, value, or I guess dollars per claim, what those trends look like? Because obviously this continues to be a bit of a bugaboo here..

Yes, I think one of the things you ought to look at, the Q will be out later today. Much of that information will be contained within the Q to give you more detailed color on that.

The view is that it has been a little bit more expensive because the type of claims that have come through, more cash payments as opposed to material, delivery that really relates to our ability to deliver certain materials. We don't have every state covered by a delivery program, so that causes that number in some cases to be a little bit higher.

With regard to the claims, the claims are still decreasing. They aren't decreasing as quickly as what we had anticipated.

Therefore, we see the need for the increased reserve, but as it has been the case since we first started this process, claims have continued to decline and I think one of the big telling issues is for me, is when I look at the cash out, it's down considerably from prior year. And we need to continue to see that kind of decline.

We expect that we will continue to see that kind of decline. It makes the cash implications of that less and less of an issue as time goes on..

Okay. Thanks for the color, Jim. And I'll find those details in the Q.

And then lastly, obviously not expecting any sort of guidance for 2016 at this point, but if you had to break down where you thought you might get some sales growth into kind of three buckets between share gains from sort of new distributors, picking up continued dealer conversions from distribution wins you've already won, and then kind of overall market growth, would you put it into those buckets in any sort of different weighting, or how do you think about that as you go into next year and into your distributor meeting coming up?.

Well certainly, we view an opportunity for further expansion sales with new distribution partners as an opportunity. It will be a much smaller opportunity in 2016 than it was in 2015. I think the big opportunity really comes from the conversion from wood to wood plastic composite. We saw an indication in 2014 of it starting to move.

It's been very clear and in fact, noted by others publicly that we are starting to see people move from pressure treated to wood plastic composite. So I think that trend is going to benefit us as we go into 2016. We continue to take share and just to be clear, the share gains we've had are not all from new distribution partners.

We saw share gains with new dealers across the United States. It was not just in the northeast where we added significant new distribution. So we're pretty excited about the growth that we've seen. And where we are growing compared to our competitors.

We have outstanding products out there that the market recognizes and we're being rewarded for putting those good products on the market..

And not to focus too much on the northeast wins, but if you had to put it into world series baseball winnings here, where are you in terms of converting a deal or as, obviously, we had talked about that being kind of a multi-year process.

What inning do you think you are in right now?.

I'd say we're probably in the sixth to seventh inning. There's still opportunity there, but again, that was not the primary driver for this year, it was one of the drivers..

Sure. All right. Thanks a lot gentlemen and good luck..

Thank you..

Thank you. There are no further questions at this time. I would like to turn the call back over to Jim Cline for closing remarks..

This executive team remains focused on strengthening our number one brand position, our premiere distribution network, our strong product development expertise and our low-cost position. These competitive advantages continue to allow TREX to excel in the outdoor products category and utilize our core competencies to enter new markets.

As we move into the fourth quarter, another banner year for TREX, we also have our sights set on the opportunities that lie ahead, we look forward to updating the investment community on our overall 2015 results and our expectations moving forward in our next call. Thank you for participating with us today..

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