Trex Company Inc (TREX) 2006 Q4 法說會逐字稿

Welcome to the Trex Company fourth quarter results conference call. At this time, all participants are in a listen-only mode. Following management's prepared remarks we'll hold a Q&A session. [OPERATOR INSTRUCTIONS] As a reminder, this conference is being recorded Monday, March 26th, 2007.

I would now like to turn the conference over to Ms. Jody Burfening. Please go ahead, ma'am.

Thank you, operator, and thank you, everyone, for joining us today. With us on the call are 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 fourth quarter of 2006. This release is available on the Company's website, as well as on various financial websites. A replay of this conference call will be available through Monday, April 2nd. 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 market in which the Company operates. The Company's report on Form 10-K, filed with the SEC in March 2006, and its subsequent filings on Form 10-K/A and Forms 10-Q and 10-Q/A discuss some of the important risks 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 now like to turn the call over to Mr. Cavanna. Please go ahead, Tony.

Thank you, Jody, and good afternoon. A few hours ago we released the Trex Company financial results for the fourth quarter and full year 2006. Revenue for the fourth quarter of 2006 is $32.1 million. 2006's full year revenue of $337 million exceeds 2005's full year revenue of $294 million by 15%. Trex recorded income loss of $13.8 million for the fourth quarter of 2006, and this compares to 2005's fourth quarter loss of $10.9 million. Full year 2006 income was $2.3 million or $0.16 per share, and compares to 2005's full year income of $2.3 million or $0.15 a share. Income from operations increased from $2.9 million in 2005 to $6.1 million in 2006. Even though Trex recorded revenue growth of 15% at $337 million, close to our October 2006 guidance, we obviously did not meet the income target we set for ourselves in 2006. Now I would like to turn this conference call over to my associate, Paul Fletcher, Trex's Chief Financial Officer. After Paul's more detailed discussion of the numbers, I will return to the conference to discuss business programs, current and future, and how they are progressing. Paul?

Thanks, Tony. Good afternoon. As you are aware, our press release was issued this afternoon -- this morning, and the numbers I will reference are contained on the last few pages of the release headed "Condensed Consolidated Statement of Operations," "Condensed Consolidated Balance Sheet," and "Condensed Consolidated Statement of Cash Flow." Net sales for the 2006 fourth quarter were $32.1 million compared to $44 million in the fourth quarter of 2005. In addition to a weaker building products market, we did not implement a price increase for January 2007. And as a result, there was no incentive for distributors to take inventory in the fourth quarter of 2006, in contrast to the fourth quarter of 2005, where distributors had an incentive to take delivery before the January 2006 price increase of 4%. Net sales for the fiscal year 2006 increased 14.6% to $337 million from $294.1 million in fiscal year 2005. Volume, pricing, and the product mix all contributed favorably to the growth in revenue in 2006. The Accents product line represented approximately 67% of our total revenue in 2006 in comparison to 49% in 2005. The net loss in the fourth quarter of 2006 was $13.8 million or $0.93 per share, compared to a net loss of $10.9 million or $0.73 per share for fourth quarter of 2005. Net income for fiscal year 2006 increased slightly to $2.4 million or $0.16 per diluted share, from $2.3 million or $0.15 per diluted share in 2005. FAS 123R expenses in 2006 amounted to $1.2 million or $0.05 per diluted share.

Gross profit for the 2006 fourth quarter was negative $4.6 million compared to negative $1.1 million in the fourth quarter of 2005. Gross profit in fiscal year 2006 was $79.3 million and represented 23.5% of net sales, compared to gross profit of $80.2 million or 27.3% of net sales in fiscal year 2005. The fourth quarter 2006 and full year gross profit was negatively impacted by higher purchased poly costs, production inefficiencies, and higher overhead expenses. The price of PE material increased in the 2006 fourth quarter by approximately 13% over the fourth quarter of 2005. Purchased poly prices for the entire 2006 year were up 19% over 2005.

The implementation of the Company's product quality program translated into higher packaging costs and increase in direct labor and a reduction in production yields. New product introductions also negatively impacted production yields. In the fourth quarter of 2006, SG&A expenses totaled $16.5 million compared to $16.1 million in the fourth quarter of 2005. Total SG&A expenses for the year amounted to $73.2 million or 22% of revenue compared to $77.4 million or 26.3% of revenue in 2005. The decline in SG&A spending in 2006 was primarily the result of lower branding-related expenses.

Net interest expense in the fourth quarter of 2006 amounted to $0.9 million, a slight increase to the $0.8 million in net interest expense in the fourth quarter of 2005. Net interest expense for the fiscal year 2006 was $3 million compared to $2.6 million in 2005. The increase was due to higher average outstandings on our working capital line of credit. In 2006, our effective tax rate was 23% as a result of the recognition of certain state and federal tax credits earned and expected to be realized. As of December 31st, 2006, total debt amounted to $105.4 million, an increase of $30.7 million from December 31st, 2005. The Company increased the limit on its working capital line of credit to $100 million through June 30, 2007, to fund the increase in working capital associated with the 2007 early buy program. Debt to total capitalization at December 31st, 2006 was 38%. In the 2005 fourth quarter, we did amend our bank agreement -- I'm sorry, in the 2006 fourth quarter we did amend our bank agreements to modify the financial covenants at December 31st, 2006, and March 31st, 2007.

Accounts receivable at year-end amounted to $18.2 million compared to $12.4 million at the 2005 year-end. Total inventories increased from $56.9 million at December 31st, 2005, to $111 million -- $111.4 million at December 31st, 2006. Raw materials increased $10.1 million, while finished goods were up $44.4 million. The increase to finished goods inventory was in anticipation of the 2007 early buy demand and new product introductions. Cash flow from operations was negative $4.0 million for the 2006 year compared to positive $11.2 million for the year ended December 31st, 2005. Capital expenditures during the fourth quarter were $13.2 million, bringing the year-to-date capital expenditure total to $27.7 million. Capital expenditures for fiscal 2005 amounted to $49.9 million. Investments in 2006 were focused on process improvements, poly reprocessing, and extrusion line upgrades. Tony?

Thanks, Paul. Even though, as was said before, Trex fell far short of its income target in 2006, it's apparent from our revenue growth combined with market share data that Trex products solidified and even enhanced their position in the marketplace. We believe market share, as best we can calculate it, has grown by a couple of percentage points for Trex. Poly cost year-over-year increased 19%, as Paul indicated. However, the good news is that this rate of increase has subsided, such that the price in December of 2006 was only about 4.5% higher than it was in December of 2005. As I said in December 2005 and all the communications since, we are determined to improve Trex's overall product quality. I have also said that we plan to spend more than $25 million in our plant to improve the manufacturing equipment's ability to produce quality product at higher manufacturing rate and at lower scrap rate. We intend to produce good quality product without using the inspect quality end process that results in excessive product rejection and high costs. Some of these referred to manufacturing improvements will be in place by June of this year, with the remainder being installed during the second half of 2007. This process has proven to be longer and more tedious than originally anticipated, governed not only by equipment and delivery installation schedules, but also governed by start-up issues related to process modifications. The challenge of manufacturing to meet new quality standards is progressing, but we have not yet achieved the equilibrium of high quality standards at low product cost which is our goal.

In 2006, we have -- we are also busy in product development activity. To enhance the value of our Brasilia product, we have made improvements for the product's consistency and manufacturing efficiency, and will reemphasize this important product during the first half of 2007. We have developed a deep grained Contours product that was introduced and already delivered in March of this current -- that is, this current month. This Contours product will expand the breadth of our product line and it will enhance our value to the Trex distributor, and especially the dealer who felt that he must fill the gap in our product line with competitive offering. Trex's decking -- deck railing offering has also been expanded to be more complete. In addition to the conventional 4X4 railing posts, we are now selling a hollow post sleeve for contractors and homeowners who prefer this approach. And finally, in the deck railing space, we are now offering box railing kits to facilitate the purchasing and installation process.

In the new product and new business arena, we continue to be very excited about Trex's Seclusions fencing to compete in the privacy fencing market. In 2006 we progressed nicely in product and market development efforts, and formally introduced the product nationwide. We also have, and are currently establishing relationships with fencing installers throughout the country.

In 2006, we made good progress at Home Depot. Stocking stores have increased from about 300 in December of 2005 to more than 1,000 in 2006. Overall, sales to Home Depot about doubled over the previous year. Also in the arena of big box channel marketing, we were pleased to announce earlier this year that Lowe's will also be selling Trex decking and railing in 2007. We believe that the Home Depot and Lowe's activity on behalf of Trex will complement the very effective professional distribution channel that we have developed over the past ten years. We currently have a good book of orders. The volume of orders received for delivery between January and April - that's what we call the early buy period - has met our expectations. This fact, we believe indicates that in the face of a national construction slowdown, our distributors and dealers are optimistic that 2007 will be a good year for Trex products in the marketplace.

Our sales forecast for the first half of 2007 is expected to be between $225 million and $235 million, resulting in an earnings per diluted share to range between $0.70 and $0.80. This projection compares to the first half of 2006's sales of $227 million and earnings of $0.70 per diluted share. As I look into the future, that is my look at the full year 2007, I am projecting that Trex's 2007 revenue will be between $350 million and $370 million. Our bottom line results, that is, our per diluted share income, will be between $0.80 and $0.90 per share. Now, this concludes our formal remarks, and we're ready to answer any questions you might have. Jody?

[OPERATOR INSTRUCTIONS] Keith Hughes, Robinson Humphrey.

You came into this year with a lot of inventory, and I know you said a second ago you had a -- your early buy-in period met expectation. Are we going to see that inventory number come down substantially when we get the first quarter results?

Keith, I believe we will. We expect to. Part of it -- the reason the inventory was so high at the end of the year, is we had to build up inventories for the introduction of these new products. And so, therefore, we manufactured, shall I say, the older products earlier, toward the end of the year, but not in November, December, and devoted most of our manufacturing capacity to build up inventory so we could support these introductions. Now as we go through the early buy program, we will be depleting that inventory and we'll get back to more normal levels in midyear and year end.

And the guidance you gave for the first half and second half implies only a modest contribution to the bottom line in the second half. Are we going to see a very similar profitable third quarter and a big loss in the fourth? Is that the way it's probably going to run?

I don't expect it to be that severe. In 2007, we were again being very critical and, shall I say, weaning out a lot of product that we thought was not meeting the standards that we want to deliver to the marketplace. But I don't expect that to repeat itself in 2007.

Tony, that's a program you started when you came back as CEO, and it's obviously taken longer. Is there any specific thing that has been the most frustrating to get finished?

The most frustrating thing is to make the product, Keith, at high manufacturing rates without just inspecting it and say the board is not saleable. We're starting to see some of that now in the first quarter of this year. And our yields are start to increase, and -- but towards the end last year, we went through another [scrubbing] operation and that resulted in some of the negative results of 2006.

And final question. You talked earlier about not implementing a price increase. This industry is pretty good -- has been pretty good about putting pricing in over the last ten years. Are you starting to see significant discounts on product, either at the wholesale or the retail level from competitors [inaudible]?

No, Keith, we haven't seen anything like that. The reason we didn't go with a price increase this year is we felt like we raised our prices significantly and the industry -- our competitors and ourselves raised our prices significantly in the last couple of years. And if anything, what we did to the marketplace is retard or reduce the rate of change from wood to composite lumber, and we're trying to see if we can reaccelerate that conversion rate.

All right, thanks, Tony.

Bill Gibson, Nollenberger Capital.

On the revenue guidance, which was lower than what you steered us towards three months ago -- .

Right.

Is that due to the slow down in residential construction, or what's behind that?

Well, I guess it's the slowdown in residential construction. Also, as you know, in the past, remodeling expenditures have not tracked along with new residential production. But I think we're seeing a little bit of an anomaly this year as it relates to items that go with remodeling or refurbishing that go along with the sales of older homes. And the sales for existing homes has declined also. So if anything, Bill, we're trying to track our forecasts along those lines.

Okay, and then just one last quick question. On poly costs, and you gave us some comparisons, how do they compare to the third quarter, say fourth quarter versus third quarter?

Fourth quarter to third quarter are about flat. And, quite frankly, I think we'll start seeing some decline in that respect for poly because now as we get into installing the equipment that we've ordered and expect to now process the poly a little bit more completely before we introduce it to our extruders, we'll start on a path of buying a little less costly poly.

Thanks, Tony.

Robert Kelly, Sidoti.

Just had a question. We had a lot of direct labor in the mix pulling out product. When does that begin to start falling off? Is that more of the items that you referenced toward the second half of the year?

Yes, actually, the labor is starting to dwindle now. And when I say now, we're talking about the end of 2006 on this call, but in the first quarter of 2007, we have started to reduce that - let me call it inspection labor - as we've installed some of the poly processing equipment.

Thank you very much.

Carl Reichardt, Wachovia Securities.

This is actually Chris [inaudible] in for Carl today. Just a couple quick questions here. Wondering if you could quantify or kind of give us a ballpark figure for what you think Seclusions will be in '07? Some long-term growth rates, and generally what kind of margins you get on that product versus average deck board [inaudible]?

Well let me answer the last question first. We're still in the -- and when I say we're complete development, that's probably an overstatement. We're still doing the process optimization. I think the product is more developed now than the process, because as we try to be a little more precise in our extrusion, we're still not getting the full yields we want to get. But our target short-term is to have margins superior to what we have in decking today, but comparable to where we expect decking to go back to. So what it amounts to is the overall program for fencing is moving along nicely. We will probably -- it will probably represent, as best we can tell, somewhere around 4% to 5% of our overall product mix.

Okay. And then as far as your sales base, if you guys could just parse out, if you can, any relative strengths or weaknesses you've seen in independent dealers versus big box versus national accounts?

Well, repeat the question, Robert, I'm sorry.

Oh this is Chris, actually.

Chris, I'm sorry, Chris.

Just any relative strengths or weaknesses you've seen across independent dealers versus big box versus national accounts for sales.

Our sales -- it's hard for us to tell exactly, because our sales to the big boxes are really growing. But our overall sales through our distributors and their sales to the dealers have been up, and they seem to be moving along very nicely. And if anything, the sales into the big box, as we hope would complement the visibility of composite decking or Trex composite decking, we think is carrying over into the sales of our dealers. But I can't quantify it exactly.

Okay. Well, thanks, guys.

Keith Johnson, Morgan Keegan.

Couple quick questions. Could you give us a little indication on what operating rates were in the fourth quarter overall?

The scrap rates -- ?

The operating rates.

That's right. You guys think it's -- ?

We've been in the 85%, 86% range in the that quarter.

In the fourth quarter '06?

Yes, sir.

So you came in above, I guess what you guys were expecting on the operating rate, because in the November call, I think you guys were targeting like 70% to 75%?

I don't remember that number, Keith. Part of it, as we built inventory -- one of the questions we had earlier was why were inventories higher. Well they were higher because we were operating a little bit higher to try to support the new product introduction. So I'm not sure what we -- it was about -- Paul you want to -- ?

No, we had indicated kind of a 79%, 80% range. And, Keith, when you take out the -- when you incorporate the quality initiatives, that was -- I was giving you a net rate. We are in the 79% to 80% all-in with the quality initiatives in place in the fourth quarter.

And as you've come into the March quarter, have you guys been able to move that up substantially?

In a 4 or 5 percentage point range, that's right.

And you talked a little bit about CapEx. I think you said about $25 million that were going to be related to quality initiatives in '07. Could you give us guidance on total CapEx expectation for '07?

Actually, the number I gave, is the $25 million, is part of the overall capital expenditures, almost entirely of the $27 million, $28 million we expect to spend.

Okay. And what about depreciation and amortization -- ?

For next year, approximately $22 million to $23 million.

Okay. And with your Home Depot and Lowe's relationships, what boards are targeted into those channels? Are you moving Contours in? Or is it a combination?

The stocking product is the Saddle Accents product.

Okay.

But they're able to buy all the products through the special order desk. And quite frankly, we sell more to Home Depot through the special order desk than what they stock on their shelves.

Okay. And I was trying to remember, the Contours board is in the lower price point, closer to the pressure treated lumber type price point. Is that correct?

It is the lower price point product of our product line, yes.

How much difference would Contours be between -- compared to pressure treated lumber [inaudible]?

It's still very high. It's still probably twice as much. But as you recall, the decking board only represents -- the decking and railing only represents 20% of the cost of the total deck, whereas our higher -- our most -- more pricey product, like Brasilia, is three times the price of the wood decking board. So that's the thing we're trying to back away from. Not back away from Brasilia product, but make a more broader scope product line available to the marketplace.

Okay. Thank you.

Eric Prouty, Canaccord Adams.

A complement to some of the earlier questions. I know you guys are in early there at Lowe's, but could you just give us a little indication of your product vis-a-vis the AERT product, the Choice Deck product, and how you plan on really differentiating in that channel specifically? And maybe any sort of early indications you're getting on market share at Lowe's?

I can't -- let me speak around it because I can't be specific. We started delivering to Lowe's Distribution Centers in late February, early March. It's getting on the shelves right now. It's too early to tell what is being sold in the form of Trex versus the AERT product, and quite frankly, I'd rather not try to guess because it's much too early.

Just any indication from a marketing standpoint how you plan on differentiating the products? Just is it a quality differentiator or price?

Well, the price is -- we expect it to be a little higher than the Choice Deck material, just like it is at Home Depot, higher than the -- what is it -- the Home Depot product -- .

Veranda.

Veranda. But overall, the marketing approach is going to be one of a branded product versus a non-branded product.

Thanks.

John Baugh, Stifel Nicolaus.

The high inventory level, how does that affect production schedules? Not only the first quarter, the second quarter as well, when you compare utilization year-over-year?

Actually, at the moment, John, our utilization rates are an are about -- they're really at a rate where the inventory levels will decline a couple million pounds -- I don't want -- that's a bad word. We expect the inventory levels to decline. But what it amounts to is we're operating, as Paul said, around 80% utilization. And at the moment, unless things change from an order book standpoint, that's where we expect to be operating basically most of the year.

But is that not well below where you were your prior in the first half? Were you not running closer to 100%? I don't remember, but -- .

In the first half of '06, John, you remember, we were up above 90%. But we averaged, for the year 2006, about 81%, 82%.

John, the reason we were running so high in the first quarter, first half of 2006, is I had quarantined all that product that we couldn't sell. So therefore we had to operate high rates to try to replace the product that was in the yard that we weren't able to sell until we inspected it.

Yes. No, I remember that. And I was just wondering if that was going to impact the year-over-year comparison of utilization? Moving on, I don't know where -- I mean, we have issues producing Brasilia efficiently. I know we had issues with 3 millimeter specs instead of 1 millimeter specs of paper. What's -- where were some two or three of the key problem areas? Are we to read into this that the new facility, in terms of processing plastic, isn't working properly yet? Or just too early to work into the system? Or are we having product -- production problems with Brasilia's fill, or is there something with railing? Help us a little bit with a few maybe examples of where the key problem areas are, and then how or why they get fixed between now and the second half of the year.

Actually, it's all a matter of timing, John. What it amounts to is, all the equipment we have installed -- we have 24 manufacturing lines around the country. And the things that we're doing to be able to accommodate the contaminated plastic is not just in this processing facility here in Winchester, but the equipment that we're installing on all our lines is, as it's being installed, we're gaining -- see, we're talking to you right now at the end March, and we're talking about what happened up until December. But since December to the end of March, we probably have installed about half of that equipment that we purchased to be able to handle the poly without contaminating our product. And where we've done it so far, we're getting the results we anticipated. And so really there's no disappointment there. It's a matter of getting it installed throughout the Company. And as far as the product improvements on Brasilia, we think we've made the improvements we want to. We de-emphasized the sale of that product the end of last year, and the new versions are out there. Matter of fact, they'll be out there in about another ten days.

Are you running at full speed with Brasilia?

We are -- from a marketplace standpoint, we are.

Okay. And you had, I know at one point sort of quoted rejection rates, and they were -- more than 10% of the boards were being rejected. Are you seeing improvement on that number?

On the places where we've installed -- if I try to be a little more precise, John, I told you we were probably scrapping about 18 boards out of every 100. And I said to you that we were going to try to get back to scrapping something less than ten, maybe eight -- seven or eight. And the lines that we've installed the equipment, we're seeing progress toward -- in that direction.

Okay. And then on plastics, I haven't calculated, and I don't know what virgin polyethylene did in '06, either fourth quarter year-over-year, or the year, year-over-year. I'm curious -- my impression is it was down or was flat and yet recycled was maybe up. Could you speak to that? Is there just simply a lag? And then your expectations going forward for plastics embedded in your guidance.

No, it's neither one. It's the fact that we started buying -- we continued to press to buy a little higher quality recycled to make sure that we can meet the quality standards. It was a trade-off of buying a little higher priced poly versus a rejection rate at the line, and we tried to bridge that gap.

So what are your expectations embedded in '07 for poly costs, given the fact that you can start buying lower quality poly?

Right now, to be on a little conservative side, our projection is to stay flat rather than decline.

Okay, thank you.

[OPERATOR INSTRUCTIONS] Brett Hendrickson, Bonanza Capital.

Just wanted to know, on one of your competitors calls, they mentioned something I didn't quite understand, and I haven't had a chance to follow up with them about wood, waste wood, maybe going up because there's more industrial uses for it. They mentioned about the wood pellets being used for fuel. Where are you guys on your wood prices? Is that part of what was affecting margins in Q4?

Not at all. As a matter of fact, wood has always been going to wood pellets, and we have very significant contracts and ample supply of wood. So that has not been an issue.

Okay. Good to hear. And then help me just square away the EPS guidance for '07 today. I think you said your order book is as you planned. I think you said the lines that are getting the plastic processing equipment are giving you the improvement in yield that you wanted to get so far. And I think you said there's been no discounting by your competitors. So I realize you don't have a price increase this year. But I would think -- so what really changed in terms of you guys taking your guidance down then ?

Just being a little conservative and trying to reflect what might be happening -- the unknown issues that might be in the marketplace with what's happening in the overall construction and remodeling industry.

Okay, good to hear. Thank you.

There are no further questions at this time. Please proceed with your presentation or any closing remarks.

Okay. 2006 has been a year of working hard on delivering product to the marketplace that meets higher quality standards. Also in 2006, we have concentrated on engineering and installing, and continuing into 2007, the equipment necessary to reduce manufacturing scrap rates, while delivering high quality products. Also in 2006, we made a hard assessment of the competitiveness of our product line and decided to make some changes. Also in 2006, we broadened the geographic base for our Seclusions fencing products, and remain extremely optimistic that fencing will be an important product segment for Trex. Finally, we strengthened our position with Home Depot and established a relationship with Lowe's. And that concludes my remarks. And I thank you for your attention and interest in Trex.

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