Good afternoon and welcome to the Trex Company Second Quarter 2020 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please also note this event is being recorded. I would now like to turn the conference over to Viktoriia Nakhla. Please go ahead.

Thank you all for joining us today. With us on the call are Bryan Fairbanks, President and Chief Executive Officer; and Dennis Schemm, Vice President and Chief Financial Officer. Joining Bryan and Dennis is Bill Gupp, Senior Vice President General Counsel and Secretary as well as other members of Trex management. The company issued a press release today after market close containing financial results for the second quarter 2020. This release is available on the company's website. This conference call is also being webcast and will be available on the Investor Relations page of the company's website 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. Additionally, EBITDA will be referenced in this call and is considered a non-GAAP measure. A reconciliation of EBITDA to net income can be found in our earnings press release @trex.com. 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 Bryan Fairbanks.

Thank you, Bill. Good afternoon everyone. We welcome you to our second quarter 2020 earnings call. Before we get into the quarter results, let me take a moment to thank the people who made this quarter's success possible. First, I commend the entire Trex team for their hard work and dedication to ensure we maintain continuous operations and we were able to sell our products in a safe and effective manner during the COVID-19 pandemic. We are also immensely grateful to our channel partners who in no small part contributed to the success we have seen this year. Despite the unprecedented challenges arising from the pandemic, they found ways to serve customers and keep their employees safe. Thank you again to the extended Trex team. We continue to drive improvements across the company with a focus on health and safety of our employees the needs of our customers and operational excellence. This disciplined approach allows us to execute through a challenging macro environment while we continue to invest in the future and generate further shareholder value. By all measures, this was a strong quarter for Trex. We increased revenue by 7%. It's fair to say that the resilience of the Trex customer far surpassed our expectations at the beginning of the pandemic when we saw key states with major population centers shut down large portions of their economies. We increased EBITDA by 32% to $67.5 million. We invested $40 million in the second quarter primarily for capacity expansion and we achieved a 33% increase in diluted earnings per share to $0.81. Our sales growth reflected both the strength of the fast-growing outdoor living category and the high demand for Trex decking and railing products. Our Trex Enhance decking products which appeals to the more cost-conscious consumer, have significantly expanded the…

Thank you, Bryan, and good afternoon to everyone on the line. This was another period of strong financial performance for Trex. Consolidated net sales increased 7% to $221 million led by an 8% sales increase in Trex Residential products. This impressive growth reflects robust and broad-based demand for composite decking and railing products and our brand leadership, which is driving continued market share gains from our main competitor, wood. Throughout the quarter we continue to see unprecedented demand indicators from our websites including trex.com and decks.com. Consolidated gross margin in the second quarter increased 150 basis points year-over-year to 41.9%. Trex Residential Products gross margin expanded by 80 basis points to 42.5%. This improvement is primarily related to our success in removing material from the Trex Enhance board and improved throughput, which more than offset increased start-up costs associated with our Nevada lines. We expect to return to the original Trex Enhance design by the end of the third quarter of 2020. And as we have noted in the past, we will be bringing on labor in advance of the Virginia start-up, which will have an impact on the second half of the year. Trex Commercial Products, gross margin increased to 30.7% from 21.4%, reflecting our execution of higher-margin products this quarter as well as in overall operating improvements. SG&A expenses were $29 million compared to $36 million in the second quarter of 2019. As a percentage of net sales, SG&A declined to 13.2% compared to 17.3%. The savings were primarily driven by disciplined spending as the effects of the pandemic played out. Our branding and advertising expense was lower than normal as we pulled back on spending early in the quarter as many jurisdictions ordered the closure of the businesses in the construction industry and there were areas where…

Thanks, Dennis. I'm proud of the entire Trex team and the unrivaled strength of our channel partners. Their exceptional efforts and resilience have allowed Trex to execute our strategy and operate with excellence through a very challenging time. Through our combined efforts, we will continue to generate strong cash flows and reinvest that cash into our business to further build market share, extend our cost leadership and provide significant returns to our shareholders. Operator, I'd like to open the call to questions.

Thank you. We will now begin the question-and-answer session [Operator Instructions] Today's first question comes from Ryan Merkel with William Blair. Please go ahead.

Hey, guys. Congrats on the quarter.

Hi, Ryan. Appreciate it.

So first off on the revenue guidance for 3Q. It looks like it assumes that you don't see normal seasonality this year. So is this mostly about the new capacity coming online or is there some inventory channel filling going on?

I think we're seeing a little bit of both of those things going on. The market is continuing to operate at quite strong levels. Inventories are lighter than the channel would like today, so I expect there will be some backfilling of the inventory in the channel during the course of the quarter but I also expect to see significant sell-through as well.

Got it. That's what I thought. Okay. And then second question for the full year the incremental gross margin guide, it implies gross margins down year-over-year in the second half, a little bit more than I thought. I already had that in my model. But is this just the new lines coming on and this is unproductive labor and D&A, or is there anything else?

Yes. As we started the year, our guidance was 50%. Since that time we've increased the range of 45% to 50% to take into account the COVID cost that are coming into the business. But yes, exactly right. In the back half of the year, we are seeing additional labor coming into our manufacturing facilities, primarily in Virginia. That's where the majority of the labor will be as we begin to train them up for the new lines that will start in early 2021. We'll also see some of the depreciation from the new lines started it up in Nevada.

Got it. Perfect. I’ll pass it on. Thanks.

And our next question comes from Tim Wojs with Baird. Please go ahead.

Hey, guys. Nice job on the quarter. Is there any way to kind of frame up as these kind of put in the Fernley lines what capacity utilization look like today? And just – are you seeing any kind of pressure on output still, or should the Fernley lines kind of alleviate that in the near term?

Yes. So real quickly, within about two weeks after we enabled the lines, we were up running at full capacity and we continue to be running at full capacity across the plant network.

I expect that we'll continue doing that through the end of the year and as we bring on the new capacity, we'll be using that capacity as well too.

Okay. And I guess from a product portfolio standpoint, have you seen any pressure in certain areas of your portfolio? So for example like on some of the entry-level products like Enhance Basics, I mean do you see any sort of kind of stocking impacts on those levels? Are you seeing a pretty healthy kind of inventory availability across your portfolio?

All of the product lines continue to perform in line with our expectations when we look at it as a percentage of the portfolio. There could be more stock out in the channel. So from an availability perspective, we could see improved availability and that really goes across all of our product lines at the time. And that's where this additional capacity is so important to the marketplace and to our customers.

Okay. Okay. So it doesn't sound like there's any sort of kind of incremental mix impact in the back half of the year?

I wouldn't expect to see anything outside of our normal plans.

Okay. Okay. Great. Good luck on the second half guys. Nice job on the quarter.

Thanks, Tim

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

Thank you. I think you'd said in the – should be in the prepared segment that the Enhance design would be converted as of the end of the third quarter. Are there some extra costs duplicate inventory stuff that you have to do in the third quarter to get that done efficiently?

We've been able to transition that product without having any inventory issues either on our ground or at our customers. The product the form fit and function is exactly the same with the lighter board as it is with the slightly heavier board along the way. So that's not been a problem for us or for the channel.

Okay. And then the -- excuse me, the third quarter guide, do you have any sort of feel of what your Commercial business will look like in the third quarter just up down sideways whatever?

There's definitely more movement and a little bit less visibility on the Commercial business. We are seeing certain projects being pushed out to 2021, and we're also seeing other projects that are coming back in. We're not really seeing at this point any cancellations of those projects along the way. So I may see a little more volatility on that number. Of course, the growth expectations are inclusive of the consolidated number that we provided.

Okay. And final question, you'd briefly mentioned inventory earlier given how strong the channel has been it will be again here in the third quarter. Is there a possibility in the winter months you might have to run more aggressively just to kind of keep up where demand is in the channel?

I expect that we will need to run pretty aggressively for quite some time. As we bring up that new capacity in Winchester some of that we brought up and run at 100% as soon as it's available.

Okay. Thank you.

Our next question comes from Matthew Bouley with Barclays. Please go ahead.

Hey, good afternoon guys. Thanks for taking the questions. I just wanted to see if you had any more color around the start-up costs with Virginia in particularly. Just -- are the costs or the labor and start-up costs in Virginia, are they greater than kind of -- carry a greater cost than sort of the existing lines starting up? And does that anniversary in the second half of 2021? How should we think about when that's fully phased in? Thanks.

Yes. No, that's a great question. The cost will be higher in Winchester, Virginia, because there are more lines. This is a bigger facility than what we saw ramping up in Nevada this year. So then when you look forward to when the anniversary would occur, it would roughly be around the second quarter again or at the beginning of the third quarter of 2021.

Okay. Perfect. And then just secondly, I wanted to ask about lumber just given the increase in the commodity there and tightness in that market. Does that flow into pricing for, I guess, pressure treated decking at all whether at retail or at builders and sort of help that relative cost versus Enhance?

Well, sure. Lumber -- the price of lumber has gone up significantly over the past couple of months. We'll see whether this is a sustained price increase in the market or once they get back to full capacity and get back to normal inventories, if it goes back to the more normalized price along the way. Something that we do keep an eye on. I think, I've always said in the past, where minor changes in lumber really don't impact our strategy. So instead of being $0.85 a foot for a normal piece of pressure tree, let's say, it goes to $0.95, or drops down to $0.75 for a period of time. That's not going to have an impact on our strategy immediately. Now if we see a more significant shift, especially on the upside, it may be something we'd consider, but something we do keep an eye on in the marketplace.

Okay. Thanks guys. Congrats on the results.

Thanks.

And our next question comes from Phil Ng with Jefferies. Please go ahead.

Hey, guys. Pretty impressive demand backdrop and sounds like you're going to be running pretty full out for some time. Do you have enough capacity at this juncture at least for the back half for you to kind of sustain that low to mid-teen growth trajectory? And any color on how lead times are kind of shaking after your channel partners? Should that kind of return back to more normalized levels by year-end?

It's still a seasonal business. I expect that we will see some of the decking demand drop off later in the year as we normally see. There will still be some inventory building going on in the back half of the year. So I think we're setting up for a strong back half of the year. We haven't provided guidance for the last quarter.

Got it. Okay. That's helpful. And then from a raw material standpoint, any limitations due to COVID and just getting recycled plastic given any bottlenecks? And has that led to an impact on your cost side of things as well? Thanks a lot.

Early on, we did see there were some challenges in getting some of the grocery-related material. Grocery is not a huge part of what we use as an overall mix. So we were able to pick up further industrial supplies along the way. We didn't really see any sort of supply issues with the recycled materials that we were buying. Plentiful supplies available.

Okay. Thanks a lot.

Thanks.

And our next question today comes from Reuben Garner with Benchmark Company. Please go ahead.

Thank you. Good afternoon everybody and congrats on the quarter.

Thanks, Reuben.

Most of my questions have been asked. I have a follow-up on the capacity side. You mentioned you're running full out. I guess the question is, if demand is even in excess of your expectations or in excess of what you guided for the third quarter, would you be able to meet a higher level of demand in the third quarter or beyond, or are you kind of running up against what you're able to produce at this point and you're really reliant or not reliant -- waiting on that Virginia facility as we get into next year to be able to kind of ramp up what you can sell?

The additional capacity in Winchester is extremely important for us to be able to support the market in the way that we see that the growth is going to be there in the future years. So those three lines in Nevada are up and running at this point that will help us on the decking side of the business be able to drive more product to the market.

Okay. And a quick follow-up. Any changes at all to pricing in the marketplace at any of your price points have you made increases or changes of any kind I guess, or do you anticipate doing so in the near future?

We continually look at pricing. One of the things we always do with pricing is any price changes would be communicated to our channel partners first. We've not made any price changes during the course of 2020.

Great. Thanks guys. Congrats again.

And our next question comes from Kurt Yinger with D.A. Davidson. Please go ahead.

Yeah. Hi, Bryan and Dennis. Thanks for details and taking my questions. First, I was just curious could you talk about, how much the branding and advertising component was of the $7 million lower SG&A number? And is that 80 to 100 basis points of leverage you're kind of talking about for this year is that a reasonable way that we can kind of think about the next couple of years or are there some kind of benefits here in 2020?

Yes, Kurt. So SG&A as a percentage of sales, it's certainly lower this quarter because in certain jurisdictions, during the year, right or in the beginning of the quarter, businesses were closing down in that construction sector and as a result, certain of our channel partners also shut down as well. As a result, we pulled back on some of that advertising and branding, as we saw the reopening start to occur, restrictions starting to lift, we began to put that money back into play putting more branding and advertising back into the quarter. Over the longer run though, we still expect to see our branding and advertising spend to be around 5% to 6% of sales. So that seems to be something that makes sense for us on a historical basis and a go-forward basis.

Got it. Okay. Thanks, Dennis. And then just my second quickie. Could you help us think about residential D&A over the next couple of quarters? And is there a good way to think about maybe a run rate exiting 2021 as Winchester too kind of ramps up?

We've not provided any specific guidance on D&A, but you're absolutely right. It will ramp up quite significantly, especially as those lines in Virginia start coming up in the first quarter of next year. Let Dennis take that away and talk about what we can do maybe in the third quarter to help out. I think you're going to see in the third quarter a change in D&A that will help you be able to model the number for next year, because it is quite a bit more capacity in Virginia than what we're opening in Nevada.

Got it. Okay. Thanks, Bryan. Appreciate it. Good luck in coming quarter.

Thanks.

Our next question today comes from Alex Maroccia with Berenberg. Please go ahead.

Good afternoon, guys. Thanks for taking my question. In the press release, you called out potential COVID expenses in that incremental gross margin number. Is this more of a caveat in the event that cases spike again and it impacts operations, or does it just relate to costs that will absolutely be incurred in the second half of the year?

Yes and yes. There will be costs that we will incur in the back half of this year and just being able to manage the current regulations that are in place for COVID today, I feel it really picks up both of those.

Okay. Got it. And then secondly, it's on the commercial business. I know Laura is new. I'm sure there's been limited strategy talks thus far. But can we expect any major changes in that segment's market and product strategy?

I wouldn't expect anything in the short-term of major changes of what we're going after. We've laid out our strategy to continue focusing on the large higher profile projects which the company has always done very well with. But also recognizing that there's a much larger market for many of the smaller projects your malls, your residential high-rise, office buildings things like that. But clearly there'll be some questions about that I'm sure in the short-term as that marketplace begins to shake out. And we've got the utmost confidence in Laura to guide us through any strategy changes that may be necessary.

Okay. That’s helpful. Thank you.

Our next question today comes from Seldon Clarke with Deutsche Bank. Please go ahead.

Hi. Thanks. Good evening. You raised your full year capital budget from let's call it $150 million to $175 million. So can you just talk about what's driving that? And whether that implies any change to your multiyear plan of $200 million targeted for growth?

Thanks for the question. That's a really good question. The reality is the increase is mainly timing related. We provided a range in the prior quarter of $140 million to $160 million. We're only ratcheting that low end and the top end up by $10 million. So we feel really good about the range, but it's really timing.

Okay. That's helpful. And then could you just clarify whether your guidance for SG&A improvement includes the severance charges that were in the second quarter last year?

Yes, it would have included this. Yes.

Well, I appreciate the time. Thanks.

Our next question today comes from Alex Rygiel with B. Riley FBR. Please go ahead.

Great quarter, gentlemen. Congratulations.

Thanks, Alex.

Thank you.

Bryan, can you provide us a little bit of idea how the sales in the quarter expanded across separate retail division or retail market and the wholesale market?

Sure. When we last talked, I had told everybody that April was a pretty normal month. Well it was in line with our expectations, but we did see at that time the expectation of May falling off. And it did a little bit early on with the various states that were closed and then picked up in the back half of May and into June to deliver the revenue that we delivered. In those states where DIY customers remained for the most part open, we did see a bit of a shift to those retailers. But we saw that both of the products they had on the shelf as well as to the special order demand. We did see that shift back again as all of the channels were able to reopen again. So there was just a little bit of a onetime shift. I don't see that as being something that will be ongoing there.

And when we look out into 2021 and I understand you don't have guidance out there yet but how should we think about mix shift across the Enhance product and Transcend and Naturals?

We really continue to focus on the opportunity to upsell our customers. The strategy of launching Enhance wasn't just about converting that lumber buyer at 2x the price of wood. It was about bringing them into the channel, have the discussions, understand that there are other product lines that may carry a higher level of aesthetic and a potential higher level of performance. That's exactly what we've seen now that we're 1.5 years into that strategy. Now will we see some mix shift? I'm sure there will be some along the way. We are working to convert that wood marketplace and we may see more people who make that decision because of the cost within Enhance Basics that they're willing to make that change and install that product along the way. That's inclusive of the strategy that we have and we're comfortable with that.

Thank you.

Thanks Alex.

[Operator Instructions] Today's next question comes from Trey Grooms with Stephens. Please go ahead.

Hey good afternoon and I want to echo the congrats on the quarter.

Thanks Trey.

So I want to go back to one of the questions asked earlier just to make sure I heard it right. But just as far as the timing when you're bringing this labor on and D&A is increasing and Dennis I think you mentioned that kind of being a factor through kind of 2Q or 3Q of next year. But is that the -- first off I want to make sure I heard that right? And then secondly is that about the time when you guys expect to have those lines up and running to the point where I guess the volume kind of catches up with the labor and the other costs you're bringing on there. Is that the way we should think about that?

Yes. Let me step back and answer that again, so just to make sure I'm clear on that. So I would expect to see we're going to be ramping up with labor here in Q3 and Q4 to ready ourselves for those lines in Virginia coming online in the first quarter of 2021. So we're bringing on labor now. We're going to start training them, getting them geared up to be able to run those lines. And then what you would see in Q1 those lines would start coming online and by the time we get to like a Q3, yes we should be anniversarying those costs.

And we'll continue to be bringing labor on during the first quarter. It's not as if January 1 hits and all of a sudden entire building turns on. There will be a ramp-up of the lines over the course of the first half of the year.

Understood. Okay. Thank you for clarity there. And last one is just bigger picture with composites being about 20% or so of the market now and I know clearly there's the expectation for years of continued conversion there. And we've -- and I think everybody is kind of seeing those studies that suggest we could see that mix go to 35% or so over the next 10 years maybe or so. But any update on how you guys are thinking about that or where you think that mix can go over time?

Yes. We think the opportunity is definitely there for that 35%, 40%. And even beyond when we look out over the past year and the success of the Enhance launch. I'll go back to the comments I made with the last question that all those customers didn't immediately rush in and buy the entry-level product. They were there to have the discussion understand that composite products are affordable and will provide lasting low maintenance product for them. They moved up to Enhance Naturals. People who came in looking for Enhance Naturals in some cases moved up to our Select and to our Transcend product along the way. Because of that overwhelming demand that we've seen part of that we didn't have enough capacity to be able to support just, how much of that demand was going to be. We see that that top end could be quite a bit above that 35% to 40% over the longer term.

Got it. Okay, make sense. Thank you both and thank you for taking my question.

[Operator Instructions] And ladies and gentlemen this concludes the question-and-answer session. I'd like to turn the conference back over to Bryan Fairbanks for any closing remarks.

All right. Thank you for joining us today. We look forward to speaking with many of you in the coming weeks and at a number of conferences that we'll be participating in. So thanks and have a great evening. Bye.

Thank you, sir. This concludes today's conference. We thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.