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Edited Transcript of TREX earnings conference call or presentation 28-Oct-19 9:00pm GMT

Q3 2019 Trex Company Inc Earnings Call

WINCHESTER Nov 1, 2019 (Thomson StreetEvents) -- Edited Transcript of Trex Company Inc earnings conference call or presentation Monday, October 28, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Bryan Horix Fairbanks

Trex Company, Inc. - Executive VP & CFO

* James E. Cline

Trex Company, Inc. - President, CEO & Director

* Viktoriia Nakhla

Trex Company, Inc. - AdvisIRy Partner

* William R. Gupp

Trex Company, Inc. - Senior VP, General Counsel & Secretary

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Conference Call Participants

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* Alexander John Rygiel

B. Riley FBR, Inc., Research Division - Analyst

* Alexander Rocco Maroccia

Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst

* John Allen Baugh

Stifel, Nicolaus & Company, Incorporated, Research Division - MD

* Keith Brian Hughes

SunTrust Robinson Humphrey, Inc., Research Division - MD

* Kurt Willem Yinger

D.A. Davidson & Co., Research Division - Research Associate

* Matthew Schon McCall

Seaport Global Securities LLC, Research Division - MD and Furnishings & Senior Analyst

* Philip H. Ng

Jefferies LLC, Research Division - Equity Analyst

* Ryan James Merkel

William Blair & Company L.L.C., Research Division - Research Analyst

* Trey Grooms

Stephens Inc., Research Division - MD

* Yves Brian Felix Bromehead

Exane BNP Paribas, Research Division - Analyst of Building Materials

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Presentation

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Operator [1]

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Good afternoon, and welcome to the Trex Company Third Quarter 2019 Earnings Conference Call. (Operator Instructions) Please note that this event is being recorded. I would now like to turn the conference over to Viktoriia Nakhla. Please go ahead.

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Viktoriia Nakhla, Trex Company, Inc. - AdvisIRy Partner [2]

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Thank you, all for joining us today. With us on the call are Jim Cline, President and Chief Executive Officer; and Bryan Fairbanks, Executive Vice President and Chief Financial Officer. Joining Jim and Bryan 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 third quarter of 2019. This release is available on the company's website, and 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?

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William R. Gupp, Trex Company, Inc. - Senior VP, General Counsel & Secretary [3]

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Thank you, Viktoriia. 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 laws. 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.

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James E. Cline, Trex Company, Inc. - President, CEO & Director [4]

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Thank you, Bill, and thank you, all for joining our call this evening to review our third quarter performance and business outlook. I am pleased to report that we continued to experience strong market conditions in the third quarter. The repair and remodeling sector for outdoor living remains on a positive trajectory and continues to expand. The demand for Trex residential decking products remains robust, reflecting their appealing aesthetics and performance as well as the value proposition that our brand represents.

Net sales increased 17% year-on-year with residential up 24%. We achieved a strong performance despite customer delays of commercial orders to future quarters and delayed shipment of produced residential orders that caused third quarter consolidated sales to be below our expectations. This was a very positive quarter for Trex, both in terms of financial performance and the progress we have made on our production output.

Startup costs associated with our new Enhance Basics and natural products are largely behind us. Additionally, improved manufacturing throughput at both our Winchester and Fernley facility, along with the added capacity at Fernley, has increased our ability to meet the strong demand for our products. In addition, we have begun the process of removing material from our new Enhance product line. While the improvements are modest to date, I am pleased that the path forward to our original design has begun. This will provide us additional throughput as well as a modest cost reduction in the near term.

Trex residential gross margin improved 170 basis points sequentially in the third quarter, reflecting improved production performance as well as cost savings and higher capacity utilization. Thanks to the combination of strong growth in Residential Products sales, manufacturing efficiencies and cost management, we were able to achieve a significant operating leverage in the third quarter, driving a 44% year-on-year increase in consolidated diluted EPS.

Net sales contribution from Commercial Products was below our expectations in part due to market conditions and in part due to the uneven nature of that business as some large customer orders were pushed out into future quarters. We saw a gross margin improvement, both sequentially and year-over-year, reflective of our strategic shift at more semi-custom products to the portfolio and exiting an unprofitable product line.

We continue to see benefits from this acquisition, which has added significant engineering capabilities. Also, we are pleased that the newly launched Ascent Windscreen System by Trex Commercial Products captured top honors in the 2019 Glass Magazine awards. The innovative glass windscreen was chosen by voters as this year's best product hardware or system.

Trex Transcend continues to be in high demand and is recognized for its unparalleled quality and aesthetics. It is the brand of choice for top remodeler professionals and earned a spot on the professional remodelers list of top 100 products for 2019. This recognition reinforces Trex position as the go-to decking brand for trade professionals.

Trex Enhance Basics and Naturals have exceeded our expectations and have expanded our addressable market, thanks to its appeal to consumers who previously have not considered composites.

While accurate third-party market data is not available, we are confident that the level of sales growth the Trex continues to achieve is a clear indication that there is an accelerated conversion of our products from wood. In order to keep pace with demand, we have a multi-year capacity expansion program underway that will increase our capacity by at least 70% in 2021 and bring further manufacturing efficiencies to our production operations.

In the third quarter, we installed 2 additional lines in our Fernley facility. And 3 lines will begin ramping up in the second quarter of 2020. One additional production line will be in operation in the Winchester facility in the fourth quarter of 2019 and the new building being constructed in Winchester will start ramping up production by early 2021, at the latest. All of this speaks to the confidence we have in the consumer demand for Trex products and our ability to capture a greater share of the wood market in 2020 and beyond.

Now I would like to turn the call over to our CFO, Bryan Fairbanks, for the third quarter financial review. Bryan?

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Bryan Horix Fairbanks, Trex Company, Inc. - Executive VP & CFO [5]

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Thank you, Jim. Good evening, everyone.

Consolidated net sales for the quarter increased 17% year-over-year to $195 million. While growth was robust, consolidated performance was below our expectations for 2 reasons: First, we had lower-than-expected contribution from Trex Commercial Products due to customers pushing out orders to future quarters; and at Trex residential delayed shipment of completed orders pushed shipments into the first week of October.

Trex Residential Products net sales increased 24% year-over-year to $183 million. This performance was driven by continued strong demand for our decking products and due to constrained supply earlier in the year.

Trex Commercial Products contributed $12 million to consolidated net sales in the third quarter compared to $19 million in the year ago quarter, mainly due to fewer large projects and to several projects planned for the third quarter being shifted to future quarters.

Adjusted gross margin expanded 200 basis points to 42.4%. Trex residential gross margin expanded 110 basis points to 43.4%. However, please keep in mind that net sales and gross margin in the comparable quarter last year were negatively impacted by a $6 million charge related to expanded product stocking positions in residential sales channels.

Sequentially, Trex residential gross margin expanded 170 basis points as startup costs are behind us. We continued to absorb increased material cost presently to maintain a higher throughput levels for our Enhance products. While we have begun to reduce material from the product to generate increased throughput and reduce costs, we expect this will continue over the next 12 to 18 months.

Commercial Products gross margin expanded 60 basis points year-over-year to 26.5% as the adverse impact of legacy products rolled off and benefits related to improve project management were realized.

SG&A was $27 million compared to $28 million reported in the third quarter of 2019. As a percentage of net sales, SG&A was 14.1%. The year-over-year decrease was related to personnel-related expenses.

Our third quarter tax rate was 24.7% compared to 25% in the year ago quarter. Net income was $42 million or $0.72 per diluted share, increasing 42% and 44%, respectively from the comparable quarter last year. Adjusted for last year's $6 million charge, earnings per share increased 26%.

To briefly sum up our performance year-to-date. We reported a 7% increase in consolidated net sales to $581 million. Trex Residential Products sales were up 10% to $542 million, and consolidated net income amounted to $109 million or $1.86 per diluted share.

Our year-to-date operating cash flows were $99 million. Our capital expenditures were $37 million compared to $22 million in the year ago period, mainly due to our investments in improved throughput and spending related to our announced capacity expansion.

This quarter, we repurchased approximately 125,000 shares of our outstanding common stock under our stock repurchase program for a total outlay of approximately $10 million. Under the program, to date, we've repurchased approximately 835,000 shares. We have approximately 5 million shares available for repurchase left under our program.

For financial modeling purposes, please note the following items. We reaffirm our expectations for second half of 2019 consolidated incremental gross margin of approximately 45%. We revise our full year capital expenditure guidance from -- to $65 million to $70 million compared to our prior estimate of $75 million to $80 million. The decrease is due to timing of actual cash payments related to our capacity expansion project.

Now I will turn the call back to Jim for his closing remarks.

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James E. Cline, Trex Company, Inc. - President, CEO & Director [6]

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Thank you, Bryan. Market conditions continue to be positive for Trex. The strong demand for the Residential Products lineup and an expanding addressable market position Trex for strong double-digit growth in 2020. Trex continues to benefit from key competitive advantages. We are the leading brand in our industry and a clear market leader with approximately 50% share of composites. We have the best distribution and dealer network in the business and are a bestseller at the major home improvement retailers. Traffic to our website continues to expand nicely, and we are making ongoing investments in tools that guide the consumer through the entire deck design and building process.

In addition to the sustainability appeal of our products, the fact that 95% of our input materials are derived from recycled material is a major cost advantage. We have a track record of driving gross margin expansion and expect to continue to drive improvement in that regard in the upcoming quarters. Taken together, these attributes underpin our confidence heading into 2020.

2019 has been a challenging year. I would like to thank our channel partners for their hard work and continued support in 2019. Their effort and support is greatly appreciated and has positioned our collective businesses well for a strong growth in 2020 and beyond.

In the near-term, we expect this year's fourth quarter to be another period of double-digit sales growth with consolidated net sales of approximately $160 million and a modest sequential expansion in gross margin. This will be driven by expanded residential sales due to the delayed shipments from September and continued strong consumer demand in the fourth quarter. This will be partially offset by lower sales for residential products sold under our Early Buy Program compared to December of last year.

In December of 2018, Early Buy demand was quite strong as distributors and dealers placed orders in advance of an announced price increase on certain products. We expect the sales from December for the Early Buy to move into the first quarter of 2020.

Commercial sales will be down year-over-year due to customer delays and softer demand, similar to the third quarter. During the fourth quarter, we will experience downtime in both Virginia and Nevada to enable certain infrastructure modifications related to our expansion projects. This planned downtime will reduce throughput and will pressure margin during the fourth quarter.

This has all been included in the sales and incremental margin guidance, which Bryan provided. Operator, I'd now like to open the call up for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

And our first question will come from John Baugh of Stifel.

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John Allen Baugh, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [2]

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Few questions to lead off you. One, is there any color, Jim, you can provide, maybe year-to-date, on how Transcend has performed in units and pricing? And fully recognize -- feel free to throw it in there if you want the December shipments probably should be in '19 in that kind of calculation?

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James E. Cline, Trex Company, Inc. - President, CEO & Director [3]

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Yes, John. There was a significant amount of Transcend sales that were shipped in the fourth quarter of 2019-- sorry, 2018 to avoid the price increase that I mentioned earlier. We have seen a small amount of cannibalization on that product. But quite frankly, it's a little bit early to tell because the availability of our product in the marketplace suffered due to our ability to produce our entire product offering. As we were trying to give a full representation of our product across all channels, we struggle to get the mix right on the product. So I would say, at this point, we believe it's going to be approximately what we had anticipated, and further now I don't think I can give you further guidance.

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John Allen Baugh, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [4]

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Okay. And then maybe a clarification on all these line additions. So you added 2 lines in Fernley. And then you expect to add additional line in Winchester here in Q4, and then there's 3 more lines coming on in Q2 '20. I assume those will be at Fernley?

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James E. Cline, Trex Company, Inc. - President, CEO & Director [5]

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That's correct. Those 3 additional lines will be at Fernley. And we'll start ramping those up in the second quarter of 2020. The one new line is, the one in Winchester, we found a way to take a line and insert it into our existing facility, really had to shoehorn it in, but we were able to get it in. It will not be as strong from performance standpoint as a full line, but it will give us additional throughput that I know our business partners will appreciate.

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John Allen Baugh, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [6]

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Okay. And then lastly, and I'll defer to others. But anything distributor meeting, anything that we should look for that's new in '20 versus '19? Or we did enough this past year and it's kind of steady as she goes?

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James E. Cline, Trex Company, Inc. - President, CEO & Director [7]

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There are very few new products. They are primarily in the railing category but nothing of significance in the decking side of the business.

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John Allen Baugh, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [8]

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Anything with distribution changes?

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James E. Cline, Trex Company, Inc. - President, CEO & Director [9]

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No distribution changes of any significance. We did have a minor change in distribution out in the Denver market where an existing distributor -- we modified that relationship and moved to another existing distributor, but -- that's the only change for Trex. Competitors did have a couple of changes that took place. And I think the word is out publicly that Fiberon picked up a West Coast distributor by the name of OrePac.

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Operator [10]

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And the next question will come from Ryan Merkel of William Blair.

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Ryan James Merkel, William Blair & Company L.L.C., Research Division - Research Analyst [11]

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Couple of questions. First off, on the Enhance line, how close are you to fully satisfying channel demand and when do you expect to be fully caught up?

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James E. Cline, Trex Company, Inc. - President, CEO & Director [12]

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I would say in the month of November, we will be caught up with channel demand. We made significant progress in September. We will make a lot more in October. And I would guess we're going to be very close to having the inventory in place that would be a normalized inventory sometime late October, early November.

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Bryan Horix Fairbanks, Trex Company, Inc. - Executive VP & CFO [13]

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November 10th to be the low point for distributor inventory over the course of the year. So we'll be actively shipping. And with our present plant, we expect they get back roughly in line with their normalized inventory for the end of November.

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Ryan James Merkel, William Blair & Company L.L.C., Research Division - Research Analyst [14]

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Got it. Good to hear. Okay. And then next, any chance you can quantify to push sales in the quarter for both commercial and residential?

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Bryan Horix Fairbanks, Trex Company, Inc. - Executive VP & CFO [15]

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Yes. So compared to our guidance that we provided of 205 million to 210 million share, we look at last year, the amount of shipments that we had available to ship versus what we had last year available to ship, it increased by about $7 million. The remainder of that would be related to the commercial division.

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Ryan James Merkel, William Blair & Company L.L.C., Research Division - Research Analyst [16]

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Okay. And then just lastly on SG&A. 14.1% is a big improvement year-over-year. What drove this? And is it sustainable?

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Bryan Horix Fairbanks, Trex Company, Inc. - Executive VP & CFO [17]

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A much higher demand in the third quarter that we would normally see because of the deferred demand and the lower inventories that were in the channel, leading into the second quarter. So seasonally speaking, it was a much larger quarter than what you would normally have. And that really drove it from a percentage perspective.

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Operator [18]

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The next question will come from Kurt Yinger of D.A. Davidson.

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Kurt Willem Yinger, D.A. Davidson & Co., Research Division - Research Associate [19]

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First of all, this year has been a bit abnormal as far as the quarterly sales cadence. If we look back in the last couple of years, call it, 55% to 60% of revenue has kind of come in the first half. Is there any reason to think that would be different in 2020? Or should we expect I guess a typical quarterly cadence?

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Bryan Horix Fairbanks, Trex Company, Inc. - Executive VP & CFO [20]

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I would expect as we look out into next year, you get back to more of a typical cadence. What can change that is the timing of the busy part of the season kicking off. Some times that can be the end of March, sometimes it's the second week of April. You don't know until you actually get out into that timeframe, but it can't move the sales from quarter to quarter. But I would expect that you will see a much more normalized-type seasonality to our revenue next year versus what you saw this year.

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Kurt Willem Yinger, D.A. Davidson & Co., Research Division - Research Associate [21]

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Okay. That's helpful. And then -- I appreciate the timeline for the additional capacity, maybe can you put a little bit of thought around how you're thinking about potential costs associated with additional training, or labor, or lower fixed cost absorption or anything like that?

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Bryan Horix Fairbanks, Trex Company, Inc. - Executive VP & CFO [22]

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I think we discussed in prior calls, we will have some headwinds as we bring labor on before the lines are actually ramped up. We will need to train those individuals. We will need to have maintenance staffing on hand. So there will be some headwind to bringing that labor on before, it's absolutely necessary for production. Offsetting that, as we move back into next year, we've taken a bit of a pause on our cost-saving project programs this year. Mostly, as we're focused on improving the throughput to get more product available for our customers as we get into next year, there is a number of projects that we see that are available to us that will help to offset those labor headwinds.

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Kurt Willem Yinger, D.A. Davidson & Co., Research Division - Research Associate [23]

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Great. Bryan, and then just lastly. I know residential railing isn't the top growth priority. But is there anything worth calling out there as far as opportunities to maybe accelerate growth or perhaps increase the attach rate with your decking sales?

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Bryan Horix Fairbanks, Trex Company, Inc. - Executive VP & CFO [24]

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We continue to have good cooperation with our commercial division and using their engineering expertise to allow us to come to market rapidly with new railing profiles that our marketing team has desired for some time. We've got a total of 3 product lines that have now been launched using the engineering capability of our commercial division and then commercializing it within residential. So we see additional opportunity to be able to fill areas of the market that were not hitting today with our existing product lines.

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Operator [25]

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Our next question will come from Matt McCall of Seaport Global Securities.

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Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD and Furnishings & Senior Analyst [26]

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So maybe -- as I roll down the list, you've got reduced throughput, drag from new lines, you've got some maintenance downtime, increased material costs, I guess total. And then Bryan, I think you just talked about you've kind of delayed some of the cost savings. Is there any way to kind of combine all that and give us an idea of what the impact has been or is expected to be on '19? And then more importantly, what the opportunity is maybe if some of those pressures subside as we move on to '20? What could that mean from a gross margin or gross contribution margin perspective?

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Bryan Horix Fairbanks, Trex Company, Inc. - Executive VP & CFO [27]

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We've not provided guidance out to 2020 as of yet on margin. But as the management team, we are very focused on margin and providing continuous improvement. We recognize those headwinds that are out there with the additional capacity that's coming on. But we also see the opportunities and the cost-saving programs that we have and other efficiencies within our plants to be able to improve the margin along the way.

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James E. Cline, Trex Company, Inc. - President, CEO & Director [28]

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Yes. One thing to remember, Matt. Year-over-year, we had a pretty horrific first quarter. The drag on that was primarily startup-related, and we don't expect to see a repeat of that kind of drag. So by definition, we're going to start out a little bit stronger from an operational standpoint.

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Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD and Furnishings & Senior Analyst [29]

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Okay. All right. And I think you quantified the delayed shipments in resi at $7 million, if I heard that correctly. What about the early -- the impact of the Early Buy in Q4? How much -- I don't think you said a number there. What do you think the impact is on a year-over-year basis from the Early Buy that's not expected to occur? Did I say -- did I hear you say that more of it was going to show up in Q1?

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Bryan Horix Fairbanks, Trex Company, Inc. - Executive VP & CFO [30]

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Yes. The portion of the Early Buy that does not occur in typically December, for example, last year, what we shipped out in December didn't appear in the first quarter. This year, we will go back to a more normal cadence where you have a more normal December for Early Buy with remainder of that product being ordered January through March.

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Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD and Furnishings & Senior Analyst [31]

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And what was the abnormal dollars last year? Can you quantify it?

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Bryan Horix Fairbanks, Trex Company, Inc. - Executive VP & CFO [32]

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I can, but we're not going to get down to that level at this time.

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Matthew Schon McCall, Seaport Global Securities LLC, Research Division - MD and Furnishings & Senior Analyst [33]

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Okay. Last question I had. I thought you said something about exiting an unprofitable product line in commercial. Was there any impact on revenue? Is there -- was there any impact on gross margin? Is there any impact on gross margin as we move forward? Or was it kind of a small deal?

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James E. Cline, Trex Company, Inc. - President, CEO & Director [34]

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It's a smaller piece of the business, but it was quite impactful in an adverse manner over the last 2 years on their gross profit. It was a fully customized product offering that as we got into it, we determined it was not something that made sense for us. We offered them alternatives, which they believed would be a better approach to the market. So we're going off the market a little bit different way. The reason it's probably important is, as you exit a certain strategy and begin the new one, it ought to be a direct replacement but it's not. So there's a portion of that business that we'll lose for about 1.5 years as we start building the new products and putting the new products in their place. So what we saw as a ramping down of demand this year, it will be lower demand than what we saw 2 years ago for this product category, albeit, the new product is substantially higher profit than the old is.

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Operator [35]

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Our next question will come from Alex Maroccia of Berenberg.

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Alexander Rocco Maroccia, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [36]

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So the first one is on raw material pricing. Based on some industry data I've been reading recently, it looks like recycled polyethylene was up pretty drastically this month. Do you know why this was and how you're mitigating it for Q4?

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James E. Cline, Trex Company, Inc. - President, CEO & Director [37]

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We have an experience, an increase in -- price increases in raw polyethylene. We have seen a little bit of an increase in wood fibers that we buy. But as far as it relates to the polyethylene, it's been flat to slightly down.

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Alexander Rocco Maroccia, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [38]

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Okay. Good enough. And then the second one is on international strategy. Been looking at you just talking about it in the past couple of quarters. But can you just discuss a little bit about the demand you're seeing there and how you're starting to shift some of the newer products to those geographies?

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James E. Cline, Trex Company, Inc. - President, CEO & Director [39]

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The new products are certainly attractive in some of those international locations, specifically in Europe. They like the new products. Right now, we are heavily focused on North America. We are expanding the shipments into Europe, in particular, primarily focused on the consumer side of the business as opposed to commercial at this point. As we roll out into the latter part of 2020 and 2021, we will start opening the door a little bit further at that point and service the entire demand for that. We see that as a really nice growth opportunity. So we see the interest, we see the demand, but at this point, we're going to focus most of our throughput to support the North American market.

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Operator [40]

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The next question will come from Phil Ng of Jefferies.

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Philip H. Ng, Jefferies LLC, Research Division - Equity Analyst [41]

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You mentioned that resi was a little weaker because of delayed shipments. Can you add a little color what drove the delay? Was it -- did it have anything to do with their production ability?

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James E. Cline, Trex Company, Inc. - President, CEO & Director [42]

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Yes. It really was the timing of completions of the order were later in the month. And typically, this time of the year, at the end of September, we're able to basically pool our shipments together and get them out. And we ended up having a fairly large amount of orders that had been released that didn't get on trucks. Nothing more complicated than that. They basically all got out, I would say, virtually all of them got out in the first week to 10 days of October.

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Philip H. Ng, Jefferies LLC, Research Division - Equity Analyst [43]

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Okay. And then you mentioned in the fourth quarter, you're planning taking downtime. How much is that? Does that have any impact on your sales for the fourth quarter? And I think you mentioned that could have an impact on profitability. Is that enough to pressure gross margins on resi down year-over-year?

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Bryan Horix Fairbanks, Trex Company, Inc. - Executive VP & CFO [44]

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No. So within our guidance, the guidance implies increased margin. We just wanted people to understand that we have been running our lines hard over the past 6 months. We talked about running everything in the fourth quarter, which we will do. But we are taking reasonable steps to make sure that we do the appropriate maintenance and do the upgrades required on the lines that we have. I don't see that as bearing any impact on our sales in the fourth quarter, just more of let the market know how we're going about managing this period of time where we're running our operations at extremely high utilization levels.

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Philip H. Ng, Jefferies LLC, Research Division - Equity Analyst [45]

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Got it. It sounds pretty manageable.

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James E. Cline, Trex Company, Inc. - President, CEO & Director [46]

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Yes. There are certain plant shutdowns we have to do to be able to support the new production hauls and production lines that are going up. So each plant needs to take several days to shutdown so that they can, for example, put new electrical lines across to the -- where the new building site will be in Winchester. And as we do that, it just means that we have less production. It's all included in that sales projection that we provided and the incremental margin numbers that Bryan provided earlier.

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Philip H. Ng, Jefferies LLC, Research Division - Equity Analyst [47]

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Got it. Okay. And just one last one for me. The commercial business is obviously newer for most of us. You're lapping some tough comps and some of this business got pushed out. But obviously, when we look at from the macro commercial indicators, suggest the market is falling a bit. Just curious how your conversations are shaping up with your customers? And when you look out at 2020, do you expect that business to grow year-over-year?

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James E. Cline, Trex Company, Inc. - President, CEO & Director [48]

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I think there are 2 things you need to remember. This business, as we said all along, will be very lumpy. Last year, we had 2 major stadium/arena projects that basically were on high gear. We did not have a repeat of that this year. So that by itself is a drag. With regard to your other question, do we expect to see year-over-year sales expansion? The answer is yes. But not a dramatic sales expansion.

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Operator [49]

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And the next question will come from Keith Hughes of SunTrust.

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Keith Brian Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [50]

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On the gross margin guidance, 45% consolidated in the second half. It's good bit above that in the third thus implying it to be below the 45% in the fourth. I'm trying to reconcile that with some of your comments on gross margin up year-over-year in residential. I think I'm missing some numbers here. Can you describe that one more time?

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Bryan Horix Fairbanks, Trex Company, Inc. - Executive VP & CFO [51]

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So the 45% incremental, that's for the back half of the year. And that's on a consolidated basis, not just a residential basis.

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Keith Brian Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [52]

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Right. Okay. So that would imply that on same margins, it's going to be lower that in the fourth. So that would assume margins would sequentially move down on a consolidated basis?

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Bryan Horix Fairbanks, Trex Company, Inc. - Executive VP & CFO [53]

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On a consolidated, looking at it -- I'm sorry, on an adjusted basis. So you have to adjust for the $6 million in the third quarter that we had in the third quarter of 2018.

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Keith Brian Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [54]

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Okay. So that's what I was missing. Okay. So that's adjusted for the $6 million. Okay. That answers that. And I guess as you look at inventory levels, you talked about a little bit. But specifically looking at Enhance, do you think you will have the inventory levels of Enhance you want to have by November to get ready for the -- particularly the first quarter as distributors start buying for the season?

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James E. Cline, Trex Company, Inc. - President, CEO & Director [55]

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Yes. We've basically seen an improvement in our ability to supply, in particular, for example, when you look at the West Coast, as you are aware, we are on allocation on the West Coast. There were distributors that did not take the full allocation beginning in the month of September, for example. We do see production ramping up at both locations. And we are filling up the gaps in the inventory at distribution. And we think between the inventory we will build and the inventory that they have, we should be in good shape for the start of the season.

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Operator [56]

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Our next question will come from Alex Rygiel of B. Riley FBR.

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Alexander John Rygiel, B. Riley FBR, Inc., Research Division - Analyst [57]

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Bryan, were there any onetime items that impacted SG&A in the third quarter?

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Bryan Horix Fairbanks, Trex Company, Inc. - Executive VP & CFO [58]

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No, the only thing that we really had was a little bit lower personnel spending that we had last year. That's the largest variance of it. We talked earlier about why the percentage is lower than what you would normally see and that's just purely because of the high nature of the seasonality we had in the third quarter of 2019.

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Alexander John Rygiel, B. Riley FBR, Inc., Research Division - Analyst [59]

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And any chance you could quantify the cost pressure in the third quarter within the residential business?

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Bryan Horix Fairbanks, Trex Company, Inc. - Executive VP & CFO [60]

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We have not provided guidance on the additional material usage that we've had within the product line. We kept it to a higher level, including those costs as well as other opportunities that we've been able to offset some of that along the way, but we've not gotten into what their exact material cost is or margin impact at this point.

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Alexander John Rygiel, B. Riley FBR, Inc., Research Division - Analyst [61]

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Maybe I can ask the question in a different way. Well, I get the same answer but let me try. You've referenced that you'll have some cost pressure headwinds until, call it, year-end 2020. How should we think about what your, I guess, your overall pressure is from that standpoint? Or maybe what your target margin is at that point in time?

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Bryan Horix Fairbanks, Trex Company, Inc. - Executive VP & CFO [62]

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Well, Jim mentioned that we've got the 3 lines coming on at our Nevada facility. So labor will come on in advance of those lines, and we'll be bringing on labor at our Virginia facility later in the year to support the 2021 lines that are here. I mentioned earlier, we are very margin-focused organization. We see opportunities for further cost reduction, being able to improve throughput on the lines that we have. So continued focus on margin improvement is what this management team will be going after.

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Operator [63]

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Our next question will come from Trey Grooms of Stephens.

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Trey Grooms, Stephens Inc., Research Division - MD [64]

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So just a few left for me here. On SG&A, kind of looking at it going into 4Q, I mean, I usually don't see much of a change from 3Q to 4Q from an absolute dollar standpoint. Is there any reason that wouldn't be the case this year as we look in 4Q?

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Bryan Horix Fairbanks, Trex Company, Inc. - Executive VP & CFO [65]

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Generally, that's probably a good way to look at it, not a significant difference.

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Trey Grooms, Stephens Inc., Research Division - MD [66]

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Yes. Okay. So nothing unusual that will take place this year. And then on the commercial side, you had pretty good margins on that business, and you mentioned that the top line sales will be down year-over-year in commercial and the margins can swing around it seems like quite a bit in the 4Q. Is there any way that we can maybe try to quantify or give us some direction on how we should be thinking about that given the kind of unique situation, I guess, where you're having down year-over-year volume and -- or sales in that division?

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Bryan Horix Fairbanks, Trex Company, Inc. - Executive VP & CFO [67]

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Yes. I wouldn't expect a significant margin difference quarter-over-quarter. I think it's in the ballpark of the third. So we -- in the first half of the year, we had some pretty significant expenses associated with contracts that were underwater that product line that we exited. And I think we pretty much have all of that behind us now. I think there is one minor contract that was wrapped up in, I guess, October, that will no longer have that kind of drag going forward.

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Trey Grooms, Stephens Inc., Research Division - MD [68]

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I got you. Okay. That's helpful. And then kind of sticking with commercial. You mentioned that there was some business that was delayed there. And it doesn't -- at least it doesn't look like from the guidance that that would pick up in the 4Q. So is that something that would be pushed into maybe 1Q of next year? Or when the delayed projects -- when does that usually come back to you?

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James E. Cline, Trex Company, Inc. - President, CEO & Director [69]

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Yes. It's not a business that you normally see with Trex because our lead times are usually pretty tight. These actually can be pushed out quarters, not 1 quarter or 2 quarter but multiple quarters. Some of these projects have been pushed out longer than 6 months. So we'll pick them up eventually, but we aren't going to see any of those projects. And some of those projects had work that was planned that would have been recorded in sales in the fourth quarter. We're pushing that out also because we don't expect that they're going to come back in the hopper until sometime late into next year.

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Trey Grooms, Stephens Inc., Research Division - MD [70]

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Got it. Okay. And then last one for me. And this is maybe a little more high level. But Jim, I know you mentioned today and I think you've mentioned in the past expectation for strong double-digit type growth in 2020. Can you talk about your outlook just kind of for the core market, the underlying growth of the composite market as we look into next year? And just trying to kind of pace back and forth from what you guys are expecting as -- in your business versus the market? And where the rest of the growth will come from as far as market share gains and capacity increases?

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James E. Cline, Trex Company, Inc. - President, CEO & Director [71]

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Yes. Historically, if you go back to last couple of years, we've seen mid- to upper single-digit overall growth in the decking and railing market. Trex has been fortunate, and we have participated at a much higher level. If you go back to last 4, 5 years, you'd see that our average compound growth is closer to 15% incremental sales. Last year, we had 2 competitors that disclosed their growth. It was under 10%, and we grew very nicely. In 2019, because we were unable to deliver product, some of those customers should have expanded their sales to something I would guess in low-single digit. The fact that I mentioned for the first time any guidance on the top line growth, I think is noteworthy. I think what I said was that we plan to have solid double-digit growth in 2020. The demand we've got and what we see is very strong. Even though we couldn't deliver a lot of that demand this year, it is continuing, and we expect that we'll be able to drive demand through our branding activities. So we're pretty comfortable that we can drive demand as a lot of other consumer product companies do. And it's with that branding ability and having a product that is desired in the market place as we've seen this past year that we believe we continue to see a strong double-digit growth.

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Operator [72]

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(Operator Instructions) Our next question will come from Yves Bromehead with Exane BNP Paribas.

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Yves Brian Felix Bromehead, Exane BNP Paribas, Research Division - Analyst of Building Materials [73]

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I have 2 questions if I may. The first one. Could you give us more color on your comments regarding material costs which you said that you expect to come down in the next 12 to 18 months? Just wanted to understand what magnitude we are talking about and whether or not you can roll this out to your other product lines and then this -- the new Enhance products?

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James E. Cline, Trex Company, Inc. - President, CEO & Director [74]

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Well, all of our decking products, which is the core of our product offering, are made primarily of 2 things: waste polyethylene; and waste wood fibers. The waste polyethylene, over the last several years, we have seen a reduction in cost either due to the fact that the market -- underlying market has been going down or we've been able to find other sources of polyethylene -- waste polyethylene that was cheaper. This past year, that reduction has slowed and we expect 2022 to, again, be a very slow reduction, not of significance, a much lower cost reduction on that material. Wood fiber, on the other hand, has seen an increase in cost primarily due to the fact that you have to go further to get the quantities that we need, which means transportation becomes a bigger part of the product cost. In aggregate, when you combine all those, it looks to me like our cost structure is basically flat year-over-year.

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Yves Brian Felix Bromehead, Exane BNP Paribas, Research Division - Analyst of Building Materials [75]

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Yes. So -- and the second question. Do you have an idea of the addressable market in Europe? And I'm interested to understand what is the market share of composite decks versus conventional materials, probably ceramics tiles and wood?

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James E. Cline, Trex Company, Inc. - President, CEO & Director [76]

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Yves, addressable market size is fairly challenging here in North America. We've got some good estimates for it. It gets more complicated as we move into the overseas markets. We believe, at a very high level, about 60% of the market is North America, 40% of it is in the overseas market places. All of that being said, there is a large market opportunity for Trex to go after. We're a very small share of the overall market, albeit, a nicely growing one in some of the larger economies with the larger GDP. So something that we're excited about. As we become a more meaningful share within those markets, we'll be spending some additional time in studying and understand exactly where our share is against the composite players as well as the conversion opportunity against wood in those marketplaces.

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Operator [77]

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

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James E. Cline, Trex Company, Inc. - President, CEO & Director [78]

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Again, I'd like to thank everyone for their interest in Trex. We look forward to upcoming conferences to spend more time getting into a little bit more detail related to our company and encourage anyone interested to follow our website for those conferences. Have a good evening. Thank you.

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Operator [79]

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The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.