Viktoriia Nakhla - IR, MBS Value Partners Jim Cline - President and CEO Bryan Fairbanks - VP and CFO Bill Gupp - SVP, General Counsel and Secretary.

Trey Grooms - Stephens Matt McCall - Seaport Global Securities John Baugh - Stifel Morris Ajzenman - Griffin Securities Jim Barrett - CL King & Associates.

Good morning, and welcome to the Trex Company First Quarter 2017 Earnings Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Viktoriia Nakhla. Please go ahead..

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 will be Bill Gupp, Senior Vice President, General Counsel and Secretary as well as other members of Trex management.

The Company issued a press release yesterday after market close containing financial results for the first quarter of 2017. This release is available on the company's website. This conference call is also being webcasted on the Investor Relations page of the company's website, where it will be available for 30 days.

I would now like to turn the call over to Bill Gupp.

Bill?.

Thank you, Victoria. Before we begin, let me remind everyone that statements on this call regarding the company's expected future performance and conditions 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 will turn the call over to Jim Cline..

Thanks, Bill, and thank you all for joining us this morning to review our first quarter results and discuss our business outlook. We are pleased to report our first quarter record results for Trex, reflecting strong execution across the board. Revenue for the quarter increased 10% year-over-year.

Operating leverage and continued focus on cost-reduction initiatives, including ongoing success with our procurement strategy, drove the substantially higher gross profit. Net income and diluted earnings per share were up 18% and 20%, respectively, compared to last year's first quarter.

If you recall, last year, we had a significant success with our revised procurement strategy. While this year will not contribute at the same level as last year, we clearly have a lot more runway on this initiative.

The double-digit revenue growth we achieved in the first quarter clearly demonstrates that our performance again outpaced the decking and railing sector by a significant margin.

Our ability to consistently gain market share is a function of the positive recognition of the Trex brand with both consumer and the trade, the strength of the outdoor living category and the success of our marketing programs aimed at taking share from wood.

We believe this is a good indication of the increased demand for composite decking of the quality that only Trex can provide. It is noteworthy that we were able to achieve this quarter's strong revenue growth, despite the fact that we do not have the same weather tailwinds that benefited last year's first quarter.

Again this year, and for last 10 years running, Trex captured 3 first place rankings in Builder Magazine's annual brand use study, winning top honors for Brand Familiarity, Brand Used the Most and Brand Used in the Past 2 years.

This was one of several recognitions that we have received this year that support the positive feedback we are getting from the trade customers about the quality and versatile design capability of our high-performance product lineup. Consumer response to our marketing and advertising programs and our online design tools has been equally positive.

In the first quarter, we also saw a strong demand from the DIY sector. Outside of North America, revenue growth is even more robust, especially in Europe. The number of dealers stocking Trex product has expand consistent with our expectations, and the growth in demand has been stronger than last year.

We plan to continue to invest in these successful branding and marketing initiatives, both domestically and outside of North America, in the oncoming periods as we drive further market penetration. In summary, our first quarter performance has set the stage for another positive -- year of positive developments at Trex.

We're at the forefront of the outdoor living market, which analysts expect will exceed $7 billion this year. In a recent article, Principia predicted that overall composite market penetration will surpass the prior peak of 17% in the next 5 years, reaching 20% on a volume basis. I believe the industry will achieve this prediction more quickly.

This growth is and will be driven, in part, by advancements in all-weather materials that have allowed outdoor spaces to function as extensions of the home as well as improved esthetics and other performance characteristics that are in development. Outdoor kitchens and entertainment centers are good examples of this trend.

Trex products are tailor-made for this environment. Additionally, we expect to benefit from Trex's appeal to consumers who are attracted to green building alternatives. This is likely to be an increasing draw for us, as sustainability becomes more integrated and at the consumer lifestyle choices.

Now I'd like to turn the call over to Bryan Fairbanks, our Chief Financial Officer, to provide a financial review of the quarter.

Bryan?.

we expect net sales of $160 million in the second quarter; full year guidance for incremental margin is in excess of 50%; we are projecting SG&A to be in line with the prior year as a percentage of revenue; and we expect the full year tax rate to be approximately 35%. I'll now turn the call back to Jim for closing remarks..

Thank you, Bryan. In summary, we see several key organic growth drivers ahead for Trex. As the market leader, we are in a strong position to continue to achieve share gains in a growing sector. We expect that new product development currently underway will accelerate our drive to take additional share from the wood market.

And based on our full year 2016 as well as first quarter results, we expect sales outside of North America to continue to expand at a substantially faster rate than North America. In addition to share gains, we expect favorable margin impacts continue to benefit full year 2017 results.

Acquisitions continue to be a focus of the management team and remain a part of our growth strategy. Operator, I'd like to open the call up for questions..

Thank you, sir. [Operator Instructions] The first question comes from Trey Grooms of Stephens. Please go ahead..

Jim, with the -- I guess the bumping up of the incremental margin guidance to above 50%, what are the primary drivers there versus kind of where we were a few months ago when you guys gave the guidance of kind of 45% to 50%? Is it the scrap poly or raw materials coming in a little better than you thought? Is the procurement initiative, the runway you got there, a little better than you thought and coming along better? Just can you talk about some of the drivers there of bumping that up? And obviously, in the first quarter, you guys were closer to 60% than you were 50%, and the new guidance being above 50%, should we expect a flattening as the year kind of progresses to get closer to 50% for the full year? Or is the high 50s range that we saw in the one quarter a possibility as we look through the rest of the year?.

Trey, you've got a lot going on there. Yes, we are seeing success in the procurement strategy, and that procurement strategy really focuses on a couple of things. The primary driver, though, is being more selective in the material that we're buying and identifying new sources of polyethylene that ends up driving our cost down.

And we have been very successful with that process. In addition, we've had a couple of sizable cost-reduction initiatives that, quite frankly, the team was able to pull on a little bit sooner than we had expected. You saw a little bit of that in Q1. You'll start to see more of that impacting Q2 and going forward.

If you go back and look at where we've been on incremental margins, as at last year, which was a bit unusual, I think you see that it's a little bit more lumpy; a little bit stronger in the first half of the year and then typically drops off a bit in the second half. And that's what we'd expect to see in this year..

Trey, you also mentioned scrap poly sales. So we did talk quite a bit about that last year with the declining amount of revenue from scrap poly sales. On a year-over-year basis, we expect that to equalize this year, so we're not expecting a significant fall-off.

And the total amount of those scrap poly sales at this point are immaterial from an overall perspective..

Got it. Okay, that's helpful. And then, looking at your initiative to take share from wood, of course, that's been, it sounds like you guys have been seeing some success there.

But as you kind of continue with that initiative, and you also mentioned starting to see more activity with the DIY customer, do you feel like, over time, that the, that your mix could shift more towards the entry level or lower-end products or at least in a bigger way than what we have traditionally seen? And if that's the case, do you feel like any new product introductions at the low end will be necessary? Or are you pretty comfortable with what you got there?.

Well, over the last year, I think we've talked quite a bit about the area that we believed the market would go. The largest share of the wood market is at the opening price point. It's serviced by a number of products today that are relatively at low price, anywhere from $1.60 to $1.75 at retail.

We think to see significant conversions at that price will probably end up being at a lower level than that. We are developing products at a multitude of levels, and we aren't ready to announce anything today. We always do that directly to our business partners.

But we're very focused in development of products, have been since this management team came onboard back in 2008. So I would anticipate you'll see new products. With regard to where the growth will be, you're absolutely right; the growth will be the greatest at the opening price point.

But as we've seen in the past, we've been very effective at trading up to the next level. And that's beneficial to everyone, the consumer as well as the retailer as well as our distributor and dealer business partners. So that's the same model we'd continue to focus on going forward..

And then just my last one and I'll turn it over, is I believe during the prepared comments, Bryan, you might have mentioned that SG&A as a percent of sales should be similar to last year. And I may have misunderstood that, so correct me if I'm wrong there.

But also, just kind of looking at the cadence of SG&A as we look through the year, should we see -- 2Q, I think, was up a little bit last year. Should we see something similar from a timing perspective? Just any color on that would be great..

Yes, so we talked about additional spending in the first -- or in the end of the year call as well as in the comments for this call related to higher R&D spending as well as brand spend. That brand spend, we'll continue to expand that as well as R&D into the second, third and fourth quarter of the year.

So yes, I did say that we would have flat year-over-year SG&A spending. And our heaviest branding tends to come through in the second quarter, so you can expect to see that there will be a higher percentage of SG&A in the second quarter..

The next question comes from Matt McCall of Seaport Global Securities. Please go ahead..

So let's go back to that procurement -- the savings.

Can you -- am I connecting the right dots? I remember a conversation around a new poly source, and forgive me if you said this, but was that the source of the procurement savings in Q1?.

Yes. Actually, we've got a number of new poly sources that we utilize today compared to what we did a year ago. It's been an ongoing practice for Trex to search out new and better sources of recycled polyethylene. We've happened to hit some very interesting sources for us over the last year, 1.5 years.

And every time you introduce those, it requires some work to be able to develop a process to utilize those. In some cases, we can't use 100% of it. We can only use a selective percentage of it, much lower than 100%. That has worked extremely well. We are always testing new sources of poly as we are today. And we see great opportunities going forward..

Okay. So the -- maybe this is a bit repetitive to one of the last questions, but when I think about that 57%, some of the benefits and some of the sources of pressure, I assume the procurement, you cited as one of the incremental sources of pressure.

As we progress through the year, I understand the seasonal pattern that makes sense just given the volume levels.

But what are some of the other items to take into account? So for instance, you got some savings from a new poly source, but you didn't get the full run rate of the savings in Q1 and more of that will come? Or you got the full run rate and less [common].

Just trying understand what other factors could impact your contribution margin as we progress through the year..

Sure. In Q1, we didn't see the full impact of certain cost-savings initiatives that are coming onboard. I give you one example. We had a new process that was scheduled to come onboard in July, and we've started to generate benefits this month on it. So it's well in advance of when we expected it to begin to contribute to additional earnings.

It's a substantial project that we had just anticipated we would not be able to get up and running. The guys did a great job, pulled everything together and got it started up early..

Okay.

Any, can you give us an idea of the magnitude of the opportunity there or kind of the incremental opportunities as you met, as you progress through the year beyond the normal fixed cost leverage?.

Well, I think the best thing for me to do is just say, if you look at the guidance, we've guided up from the 45% to 50% to a 50% plus. It's included in that guidance. We are not going to get in the point of detailing each and every cost-savings initiative.

Obviously, all of our competitors love to know the types of things we're doing that, potentially, they could utilize to enhance their business. And it's fair to say that this is just one of many cost-reduction initiatives that are in the state of completion. Some will complete this year. Some won't even complete until next year.

It's an ongoing process at Trex..

All right. That's fair, that's fair.

So can you talk a little bit about new products, potentially new channels? I know we've had the channel conversation a lot recently, but any update on the product side of new channel partners, anything like that or enhanced channel partner relationships?.

I'm reminded by my Vice President of Sales that discussing individual changes with business partners is probably not a good idea. We hold those relationships very confidential for mutual benefit. So I can't get into those. But certainly, we have had success with some of our business partners expanding our relationship.

And when those changes take place, it's always beneficial for both parties. And the timing of that is really up to them and not up to us with regard to disclosure..

Got it. Okay. Let's see, one question. Lumber prices have been in the news a lot. I know you're up against pressure treated more so than framing. But is there any impact on that cost dynamic you talked about earlier, in the $1.60, $1.70? Potentially, that number starts to move higher.

Or are we talking about apples and oranges here?.

Yes. On a stick lumber, the prices you see on Random Length Lumber, I believe that most of that has already been priced into the market. With regard to treated lumber, we have not seen a significant movement in treated lumber. It's been relatively stable..

The next question comes from John Baugh of Stifel. Please go ahead..

I wondered if we could talk product mix and/or channel mix. You mentioned DIY was strong.

Is that something that maybe was a slight offset to the gross margin improvement you had? Or are you seeing a lot of action on the pro decks there, so it wasn't an influence? And within your product, is Transcend still the same percentage? Or is that growing?.

The demand in the first quarter was pretty well represented across the board. The do-it-yourself channel was probably more influenced on a greater level of composite sales versus lumber sales. So we believe, based on what we see across the board, that we're seeing an expansion there.

With regard to the margins, the margins were not significantly impacted by either channel growth..

Okay..

Or product lines either..

Okay.

Are you working on a cooler deck solution? Is that something that would be high priority, low priority, won't discuss, which, unfortunately, will probably be the answer you'll give me?.

Well, I'll give you a little bit background. Trex worked on ways to cool decks a number of years ago. And we were very successful in those tests to develop decks that could reduce the temperature of the decks. At the end of the day, our findings were they did not reduce the temperature of the decks sufficiently that it was an advantage to the consumer.

We have not tested any products that reduce the temperature of a deck significantly that you would want to spend any extra money on it. Our tests with consumers has indicated, at the price we believed we'd need to charge, they were uninterested in paying that extra amount..

And final question is just you mentioned how strong Europe and international is.

And I guess, the simple question, if you're not going to give us a precise percentage of international or what it grew, is the consolidated revenue growth we're looking at, more or less, what the domestic market is doing? Or is there enough influence that that's higher as a result of international?.

By far, the lines here are still going to be the domestic market and is a good indicator -- gauge for this marketplace..

The next question comes from Morris Ajzenman of Griffin Securities. Please go ahead..

On the question related to the market share gains, and you've highlighted that you're really garnering share from the wood and deck market, what about the composite competitors? There are a couple large players out there.

Do you think you're garnering share still from the other composite players? Or is it more so from the wood deck market?.

Morris, the conversion from wood is something that we based on all of the sources we've seen, we're clearly seeing movement on. It's pretty difficult this time of year to judge share gains because, in the first quarter, most of the sales that occur in the first quarter are load-in to the distributors and into the dealers.

So until you get that sell-through, you really don't know for sure what's happening with regards to taking share from other composite manufacturers..

And have you received industry data that gives us the most recent updates over the past year or so on what the, your share is in the composite market?.

We have not seen anything on that. And I think that that's scheduled to come out later in the spring, late spring, early summer..

Okay. And lastly here, you highlight in the presentation increased capacity utilization. I think I've asked this in the past. I think you've said both 50%.

But can you give us some idea of what increased capacity utilization means? Where it is approximately and where it was, let's say, a couple of years ago?.

Yes. So the same issues with capacity utilization and our manufacturing improvements, is it doesn't reflect the financials of the company, particularly while using that as an indicator. We did indicate last year that we were over 50%. You can see where our sales growth is.

We're running at a higher level this year, but it still doesn't model the company at, whereas the incremental margin guidance, because of those additional efficiencies that we have in our operations, from a rate and yield perspective, provide a better capability to model the company..

Okay. And if we then use a little bit of the 50% capacity utilization, that would mean your revenue run rate, without much expansion, can approach $900 million, if not more. Is that fair? Not to see, not with any new capacity, new building of a factory, but you could get there based on that sort of assumptions.

Is that fair or not?.

Morris, as you're well aware, over the years, we've put a number of processes in place that actually expand our throughput and, therefore, our capacity available. I think that level is not possible without certain expansions of certain bottlenecks. We have a number of active programs in place that would assist us in overcoming that.

But the biggest problem any manufacturer has is dealing with the peak season, which, basically, is from May through July. And at that point, if you didn't have the inventory or that expanded capacity, that'd be somewhat of a bottleneck..

Okay. Well, let me phrase it differently, and I'll move on from here.

The next handful of years, there's no need for the company to think about adding new plant?.

We model that on a regular basis to make a judgment because, obviously, if you need a new plant, you've got to plan that several years in advance. And we do not have any new plans at this point for construction of a new facility.

We believe our existing capacity is more than adequate to cover the next several years, at least, without any changes or improvements in our processes..

The next question comes from Keith Hughes of SunTrust. Please go ahead. .

This is actually Jake [ph] on for Keith. I was hoping I could just get a little bit more color on some raw materials. It looks like in the fourth quarter you experienced lowered cost.

Have you seen any sequential changes? And then maybe what do you see going forward?.

We're not really seeing a change in the -- if we're addressing poly specifically, a change in the price in the marketplace, but more so of the sourcing strategy, the types of materials we're going after. We've mentioned before that we see that poly market being relatively stable from a price perspective.

So now it's more on the capability of our sourcing team to be finding the right materials and becoming more efficient as we go forward. Other raw material supplies have been relatively stable as well, but what's more important are the cost-reduction initiatives that we continue to work on and the team is executing..

One of the things we have seen, as you're probably aware, Trex uses recycled polyethylene. Over the last year, we have, in fact, seen an increase in virgin polyethylene prices, both for linear low density, which is what we use and also high-density polyethylene.

With the off-spec resin, which some people use to fill in their demand, that has been relatively stable and quite attractive, but you can't buy your whole source from that. So we do see a little bit of pressure on some of our competitors from a cost standpoint..

Okay, great.

And then also, any insights on to channel inventories right now, how are those looking?.

We're very comfortable with where the channel is at this point. As Jim mentioned, first quarter is primarily a sell-in quarter. And we look at it on a year-over-year basis. We work with our distributors, understand what they have moving into the season. And we're very comfortable moving into the second quarter..

[Operator Instructions] The next question comes from Jim Barrett of CL King & Associates. Please go ahead..

Jim, you reiterated that the March quarter is generally a load-in quarter. So I'm just trying to understand the strong volume performance given the fact that it was wintertime even though it is a load-in quarter, because historically, sales have been affected by the weather.

So with March being a wintery month, there was a lot of rain out West, was the -- can you sort of elaborate as to did your distributors simply buy product regardless? Or was the growth concentrated in Jan, Feb?.

Well, our distributors are focused on being able to service the market when the weather breaks. They began taking material in, in December and that was relatively undisrupted. The weather conditions we saw Northeast, you had the one snowfall that came in late that did slow the Northeast market a bit.

And also, you remarked on the wet weather out West, that certainly did have a temporary impact on the California and the Pac Northwest. That seems to have picked up the shortfall by now, and that's pretty much behind us..

And you typically provide pricing and volume stats in your 10-Q.

Can you tell us what that is? And although you touched upon it earlier, given your mark, what appeared to be market share gains possibly, are you seeing, how are your competitors reacting to those gains?.

Let me take the pricing first. We didn't take any pricing going into this year. And any new pricing, we would communicate to the channel. So that gain that you're seeing is all volume..

And, Jim, any reaction by your competitors to your performance?.

As we talked about last year, we do have 1 competitor who is putting aberrant programs out of there that as they try and disrupt the market and gain share back, they have been essentially ineffective with that. It creates more distress by the people that they're trying to recruit than wins their hearts. So we haven't seen any fallout from that..

This concludes our question-and-answer session. I would now like to turn the conference back over to Jim Cline for any closing remarks..

Thank you to everyone for participating in today's call. We look forward to seeing you at the upcoming conferences and investor meetings. Have a good weekend..

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect your lines. Have a great day..