Trex Company Inc (TREX) 2006 Q1 法說會逐字稿

Welcome to the Trex Company First Quarter 2006 Conference Call. [Operator Instructions]

I would like to now turn the conference over to Harriet Fried of LHA. Please go ahead, ma'am.

Thank you, everyone, for joining us today. With us on the call our Tony Cavanna, Chairman and Chief Executive Officer of Trex Company and Paul Fletcher, Chief Financial Officer.

The Company issued a press release this morning containing financial results for the first quarter. This release is available on the Company's website as well as on various financial websites. A telephone replay of this conference call will be available through Thursday, May 4. The call is also being webcast on the Investor Relations Page of the Company's website where it will be available for 30 days.

Before we begin, let me remind you that statements on this call regarding expected sales performance and operating results, projections of net sales and earnings per share, and anticipated financial conditions constitute forward-looking statements and are subject to risks and uncertainties that could cause the actual results to differ materially. Such risks and uncertainties include the extent of market acceptance of the Company's products, sensitivity to general economic conditions and the highly competitive markets in which the Company operates.

The Company's report on 10-K, filed with the SEC in March 2006, discusses some of the most important risk factors that could cause actual results to differ from those expressed or implied on this call. The Company disclaims any obligation to update or revise 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 Mr. Cavanna. Please go ahead, Tony.

Thank you, Harriet. Good morning, everyone. As Harriet said, this morning we released our financial results for the first quarter of 2006. Revenue of $105.3 million represents an increase of 17% over the first quarter of 2005. Our net income was $4.2 million or $0.29 per diluted share, compared to net income of $8.4 million or $0.56 per diluted share for the first quarter of 2005.

Now I'd like to turn the call over to Paul Fletcher, our chief financial officer, who will describe our financial performance and financial status in more detail. Paul.

Thanks, Tony. Good morning. As you are aware our press release was issued this morning and the numbers I will reference are contained on the last few pages of the release in a condensed, consolidated statement of operations; condensed, consolidated balance sheet; and a condensed, consolidated statement of cash flow.

The first quarter of 2006 net sales were $105.3 million compared to 2005's first quarter net sales of $89.9 million, an increase of 17.1%. Our 2006 early buy program has been successful in positioning Trex for the year ahead. Compared to the first quarter of 2005, we experienced a favorable trend in volume, product mix and product pricing.

Net income in the first quarter of 2006 was $4.2 million, or $0.29 per diluted share versus 2005's first quarter net income of $8.4 million, or $0.56 per diluted share. Gross profit of $25.3 million represents 24% of sales, which compares unfavorably to the first quarter 2005's gross margin of 37%. The decline in gross margin year-over-year resulted from the under-absorption of fixed manufacturing costs and higher costs of plastic raw materials.

In order to facilitate an increase in plant utilization and produce products to our higher quality standards, our poly purchases included virgin resin materials during the quarter. By the end of the 2006 first quarter, the company was running at 100% of its installed capacity. However, the average capacity utilization during the entire quarter was 83%.

In the first quarter of 2005, our average plant utilization was approximately 93%. In addition to these factors, gross margin was negatively impacted by lowered manufacturing efficiency and an increase in direct labor as a result of the new quality standards which were implemented in late 2005.

In the first quarter of 2006, SG&A expenses totaled $17.6 million compared to $19.4 million in the first quarter of 2005. The decline in SG&A expenses is attributable to reductions in spending company-wide. As a percentage of sales, SG&A expenses represented approximately 17% in the 2006 quarter compared to 22% a year ago. We continue to expect SG&A expenses to be in the range of 20-22% of sales for the full year. As we have discussed before, SG&A expenses will fluctuate quarter-to-quarter and are affected by our consumer marketing spending.

Accounts receivables increased to $53.6 million at March 31, 2006 from $12.4 million at December 31, 2005. Our 2006 early buy sales programs included credit term options similar to previous years which allow for customers to forego a discount in place of extended payment terms.

Total inventories declined from $57 million at December 31, 2005 to $50 million at March 31, 2006. A shipment of finished goods helped pace production during the quarter. As of March 31, 2006, total debt amounted to $80.1 million, which included $10 million outstanding on the Company's short-term working capital line of credit. We would expect this balance to be paid off by the end of the second quarter as early buy receivables become due.

Capital expenditures in the first quarter were a modest $2.4 million compared to $14.6 million in the first quarter of 2005 when we were constructing our Olive Branch facility and installing the initial production capacity. Tony.

Thanks, Paul. Adding to Paul's review of the quarter, I'm going to be somewhat redundant on some of these things because I want to emphasize some of the issues. I have several comments.

Recorded revenue was within the bounds of expectations and within the bounds of the first half guidance of $220 to $230 million that I gave during our February 16 earnings conference call.

Gross profit percentage, although still depressed at 24%, is a significant improvement over that recorded in the fourth quarter of 2005. Our 2006 early buy program has been successful in positioning Trex for the year. In addition to the many customer consumer-marketing activities we initiated through the quarter, we have been working very closely with our channel partners to expand our retail outlets and to promote Trex decking and railing products.

Trex's accent decking products accounted for nearly 70% of total volume shipped during 2006 first quarter, compared to 45% in the first quarter of 2005. Also as I indicated during the fourth quarter conference call, the expected SG&A expenses can be restrained in 2006. As Paul indicated, SG&A expenses for our most recent quarter were $17.5 million or 17% of sales which compares favorably to the $19.4 million and 22% of sales recorded in the first quarter of 2005.

Manufacturing utilization steadily increased during the first quarter of 2006. Utilization for the quarter averaged 83% and finished the quarter at 100% with all 23 of the lines operating at quarter-end. Poly costs for the quarter increased from about 15% from the fourth quarter of 2005, primarily because we've purchased and used a certain percentage of virgin resins to enhance our ability to meet higher-quality standards while operating at higher manufacturing rates.

We have recently ceased purchasing virgin plastic to replace lower quality and lower cost poly seed. We are currently 85% complete in our inspection process of 2005 manufactured finished goods inventory. The market or its customer response to our new quality standards and new packaging has been very favorable. We are encouraged by the feedback and expect to complete our inspection process and solidify our new quality standards during the second half of 2006.

We also expect that our production rates, which have been steadily improving, will continue to improve during the second quarter. As I said earlier in my remarks, sales revenue increased by 17.1% for the first quarter of 2006 compared to the first quarter of 2005. This increase included a very significant increase in sales to Home Depot. The Home Depot momentum is increasing. Trex is currently stocked in 400 stores and we expect stock in stores to increase to 800 stores by year-end, up from 300 stores at year-end 2005.

Through the second quarter, spending on expanding Trex brand awareness will move into high gear. The intensity of the program will be at its highest level during the second quarter 2006.

I have not commented on our new fencing product. This program is still in its early stages of development and is still on target for a full launch in 2007. At this stage of the program, I can report a very favorable response from the market.

Market response to our quality initiative continues to be favorable. This response and increased acceptance of our new product introductions over the last few years and the new fencing programs have caused us to study the need for more manufacturing capacity for 2007. During the next few months we will determine if new lines will be installed in 2006 to satisfy anticipated demand in 2007.

I am reconfirming our financial guidance for the first half of 2006. We expect revenue to be between $220 and $230 million with per-share earnings of $0.57 to $0.62 per share. This concludes our prepared remarks and we are ready to answer any questions.

[Operator Instructions] Keith Hughes of SunTrust.

Thank you. I had actually two questions. I guess the first one, Tony, can you go over with us again why you used virgin poly in the first quarter and why you have discontinued the use now?

Well what it amounts to, Keith, we are going through a very significant change in a lot of our manufacturing activities and one of the things we're trying to do is to prepare our recycled plastic more formatively to make sure that the aesthetic issues that relate to quality, mainly some contaminants on the surface, are no longer visible. And what it amounts to is while we're trying to get this poly into better position from a recycled standpoint at a lower cost, we didn't want to encumber the ability of producing high rates during this period of time of the early buy. Are you with me?

Yes, thanks. I think so. Many of your competitors use- the fact that you use recycled materials, they think your product is inferior. Is there any merit to that?

From a standpoint of structure, absolutely none. From a standpoint of aesthetics, there has been some contamination issues on the surface that speak to the quality program we're trying to pursue. So if someone wants to say the quality of product wasn't where it should be, we concur or else we wouldn't be going as strong as we are with our quality program.

Okay.

But it's a matter of, Keith, a very low percentage that gets magnified as it relates to consensus of observation.

Right, okay. The final question, you'd said in the prepared comments looking at adding capacity, perhaps adding capacity heading into '07, that's a pretty dramatic change from a couple of quarters ago when you were running some fairly low utilization rates. Is there something in the market that you've seen that is giving you more confidence about what's going to happen both with Trex in the industry or what's changed that?

My remarks, Keith, are based entirely on what we've seen with Trex.

Okay.

What it amounts to is we've had a- from a financial standpoint I'm not happy with the returns and the income but in terms of demand and excitement with our distributors and our dealers and our customers, I believe they still realize we are the most significant part of this industry. We're seeing anecdotally comments for greater demand and then our fencing program was received at two national shows with great response and we want to be prepared to supply that.

All right, thank you.

You're welcome.

Bill Gibson with Nollenberger Capital.

Hi, Bill.

Hi, Tony. You gave us the percent number for accents. How did Brasilia do in the quarter?

Brasilia did about 6%, a little bit lower than we'd want but as I said in our last conference call, we had some issues with Brasilia in terms of being able to manufacture it at higher rates and higher quality standards. And as I indicated, we were basically taking some of that back to the drawing board as it relates, going back to R&D. Still producing in the plant but surveillance with R&D around the clock with that manufacturing, so we have not reinvigorated the marketing program yet for the Brasilia, for the reintroduction.

So it really could've been a bigger number if it weren't for the supply side, is that what you're saying?

I believe that's true, Bill.

Okay. And then you talked about the expanding, working with the distributors to expand retail outlets and you mentioned Home Depot. What about in the regular lumber yard professional outlets? Is that going up and what is that number?

Not significantly but last time it, that fluctuates, but the last time we talked we were probably talking about 3,000 or 3,100 and at the last count we're at about 3,350.

Okay and if you could refresh --

And Bill, let me answer it this way, also. As I said that fluctuates up and down. Sometimes we lose it to Gillick or it's their choice, sometimes it's our choice. So what it amounts to is, of the 3,100 we have I believe that they're stronger than the 3,100 we had, say, six months ago.

Okay, yes, so as opposed to just the total number there's a quality issue there?

Yes, there is.

And then could you refresh me on the early buy program? Is that the discount avoiding the price increase or are there additional discounts on price?

Let me have Paul answer that.

Yes, Bill, what I was referring to in terms of the discount-- there's a payment term/discount option which is fairly standard where a distributor, customer can pay under normal terms quickly and take the discount or in place of that they can pay on extended terms and pay full price.

Okay that's regular, right?

Yes, that's irrespective of the price increase between now, this being announced back in December which was 4% in January, an additional 7 after early buy.

So it's, okay, so plus 4% minus 2 to 2-1/2% for paying early.

Oh, okay.

So basically the price increase for 2006, for the first quarter, is practically zero.

And then the 7% now that took effect--

That goes into effect May 1st.

May 1st.

But in fact it's really the whole, the 4% does, also, but by having the discounts in the first four months you don't see the impact of that, either.

Are you getting pushed back on that or competitively, what are your competitors --?

As far as I know right now, Bill, the price increase will be instituted as programs and the competitors as far as we know, the market intelligence we have, is that they will do, their prices will increase in similar amounts.

Okay, thanks, Tony.

You're welcome.

John Baugh with Stifel.

Good morning.

Hi, John.

How are you doing, Tony? I understand the cost of raw material went up because of the use of virgins. Could you tell us had you not done that would your cost of recycled materials have gone up sequentially and/or year-over-year and then sort of the outlook for that assuming you're winding down the virgin purchases.

John, our recycled category price went up just a fraction of a penny from the fourth quarter of last year. So, basically it was flat. Within the bounds of accuracy on what you buy and don't buy, it was flat, so that's the answer to the first part of your question. As far as the second part of your question, what it looks like forecast for the future, if you would've asked me that question, say, two or three weeks ago I would've said the trend was flat to down a little bit. What's happened with oil exceeding 72, even hitting $74 a barrel, I'm not sure I can predict that. I couldn't predict it before but I'd say the bias has got to be up but we haven't seen it yet.

If the virgin material is down here today and is that not more tied to natural gas than oil or--?

Well, yes, it is. Most of the polyethylene is made from ethane, which comes from natural gas but the BTU value of natural gas, although might not follow the BTU value of oil month-by-month, directionally it goes in the same direction.

Okay. And I know it's very early in the season but, and you know exactly what your distributors are doing, do you have any feel for the lumber yards yet and whether they've seen any early activity in terms of contractors backing up pick-up trucks?

I don't have that yet, John and I wouldn't expect it because most of them are basically stocking now. The intensity of selling basically starts now.

Okay. And is there anything in your formula in terms of integrity of the board or mold resistance? These are issues that are kind of in general and Trex specifically I guess over the years- do you feel pretty good that you've got the, if you will, chemical formula right? Or are you going to have to change the pigment or are you trying to increase the integrity of the board or anything, or will there be no increased costs this year as it relates to that?

We don't anticipate any increased costs. We've just done a very significant study of that particular component or characteristic and we feel like we're very competitive and probably where we need to be to sell the product.

Okay and lastly on your quality initiatives, you've got, I guess, an inspector looking for contaminants- what sort of progress report there? Are you, I guess you're not where you want to be but is there light at the end of the tunnel, just kind of update on what's going on with quality.

Well there's light at the end of the tunnel but the light's not going to shine for probably six or seven or eight months and the reason for that is we are, as I said earlier, we're going through very significant changes in processing or preparing our recycled plastic to give us the aesthetic value that we think is necessary. But until we spend the money and the capital expenditures there to put the equipment in, we have to do most of that inspect, we have to effect that kind of result through inspection, through manual inspection.

So you're producing right now a fair number of off-quality boards still and you're having also to have labor on it and you're installing or will be installing equipment that will take labor out and give you higher first quality. Is that right?

Yes, the answer is this way. On the front end on the recycled plastics, we're doing things manually that we expect to do with machines some time by the end of the year.

All right.

The other part of it, the inspection part, it results in lower yield but we're making that up with higher rates so the overall net production rate is starting to approach where we want it to be.

Okay. And lastly, any further thoughts about the ability to over time, short-term, near-term, long-term, take polyethylene as a mix down as a percentage of the board content?

I would tell you that that's something that's always our target but it's still our target but no anticipated activity right now.

Thank you, good luck.

You're welcome.

Clare Davis of Perennial Advisors

Hello.

Hi.

Just a little bit of expansion, I think you've covered this pretty well but I wanted to understand a little bit more about the inputs and the decision to do more virgin [polypercosene] and then the decision to stop doing that. On a go-forward basis, should we still expect, have you quit buying virgin poly because you have enough for your production going forward or is that going to be an input that will continue to stay at higher levels because it's a necessary part of quality in the future?

No, the virgin plastic input will go down from where it was in the first quarter.

Okay.

And we're going to, we expect to-

And that's because of manufacturing changes?

No because we were doing, we were trying to run our lines at let's say a line runs 100 pounds an hour. We were trying to run them at 120, 130 to catch up for quarantining all of the inventory we had at the end of the year and that's not economic to do that with high-cost raw material long-term.

I see. Okay. And then has there been any issue with the wood, the wood part of the input? In terms of wood flour are you having, have you had any quality changes there in what you've been purchasing?

We have not.

Okay and then I wanted to see what had happened with the account that you discussed in the fourth quarter as far as customer good will [inaudible] was hitting SG&A if I remember correctly.

Mmm hmm.

Where's that stand now? Are you still having any--?

Well it's still higher than we want it to be but it's on its way down. I'm not prepared to give you the exact numbers but it was significantly down in the first quarter versus the fourth quarter last year.

Okay and is that the account where- is that how you're currently accounting for decks that are having to be ripped up and replaced from 2003 boards and some of the past quality issues?

A big part of it is in that SG&A category, yes.

Okay and do you have a sense of how many decks are still out there that may be, that may be facing that issue as spring comes and people go out on their decks and say they're not happy with them; I want Trex to come replace them.

No, I do not.

Okay, all right, that's it. Thank you.

Thank you.

Keith Hughes.

Yes, one public competitor that has a product in this space has talked about distributors pulling out inventory, a problem that you faced last year. Are you seeing any of that from your distributors at this point?

None at all.

All right. Thank you.

Thanks, Keith.

J.D. Padgett of Founders Asset Management

Hi, good morning, guys.

Hi, J.D.

Hi, J.D.

One question on the brand spend- what it was this quarter and what you're thinking for the year?

Well we had said that we were going to, when we gave our conference call in February it was going to be $20 million. We still intend to be there. I'm not sure what it was for the quarter.

It was $5 million for the quarter, J.D.

Okay. And it sounds like that's going to step up in Q2?

Q2 is when the activity will peak as Tony said and we would try to anticipate a $19, $20 million spend for the full year.

Okay is that kind of stepped up to like 10 in Q2 and then maybe 3, 2 in the back half kind of thing?

Close, yes, it wouldn't be that dramatic in Q2.

Okay.

And then you would really fall off in Q4 obviously.

Okay and then help me out in an ideal world, do you want to run utilization pretty much even through the year or will there always be peaks and valleys?

J.D., when you and I first met what I said at that time is still true. We'd like to get back to what I call a steady stay which means that we will- I describe that as having our lines running between 90 and 95% all year long, which means that in the third and fourth quarters, we start growing inventory and in the first and second quarters where inventory is declining.

Okay so if you have demand [inaudible] great this year and your read on inventory levels through the system are correct and you're kind of looking now to be running it tight and even be considering capacity, I guess that's a pretty encouraging sign.

I think it is.

Okay and then I guess that kind of sets the baseline gross margin in Q1 and to the extent you continue to improve along the cost reduction programs and product quality programs we see the upwards direction of gross margin then through the year?

That's my target, J.D., and I expect it to happen, how rapidly we get back to the 40s and 45%, I really can't tell you right now.

But in a normal world does gross margin kind of stay even through the year or are there accounting impacts that would cause that to--?

If in fact we're running 100% like I said or 90, 95%, the gross margin percent, the percent gross margin should stay flat.

Okay. There's not accounting things in terms of when things are produced relative to when they're sold that would impact--?

There might be some LIFO adjustments but-

Yes but sequentially, J.D., you're correct in terms of come out of the first quarter and through the quarter here, directionally the improvement is what we would expect.

Okay, great. Thanks, guys.

[Operator Instructions] Bill Gibson with Nollenberger Capital.

Just one follow up on the balance sheet. I knew you got waivers on your covenants at least through the first quarter- is that still on the pact or are we back to--?

We amended our bank covenants in the December quarter and those, and those amendments adjusted the covenants in place for December and March. And we don't expect those to be needed in the June quarter.

Thanks, Paul.

Since there are no further questions at this time, please proceed with your presentation or any closing remarks.

Well the only closing remarks I have is that we believe we're on a path towards recovery and I call recovery an improvement in our gross margin as we continue to grow our sales because I believe the composite market will continue to increase and we believe we will maintain our position in that composite market. And as we pursue our programs, we expect those programs to yield the results of getting back to the higher gross margins with higher profitability. And that's it. Thank you.

This concludes today's conference. Thank you for your participation.