Trex Company Inc (TREX) 2007 Q1 法說會逐字稿

Welcome to the Trex Company first quarter earnings report conference call. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded Friday, May 4, 2007.

I would now like to 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 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 first quarter of 2007. 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 until Monday, May 11. The call as also being webcast on the Investor Relations page of the Company's website and 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 April, 2007, discusses some of the 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 instruction I would like to turn the call over to Mr. Cavanna. Go ahead, please, Tony.

Thank you, Harriet. Good morning, everybody. A few hours ago we released the Trex Company financial results for the first quarter of 2007. Revenue for the first quarter of 2007 is $115.9 million. 2007s first quarter revenue exceeds 2006s first quarter revenue of 105.3 million by 10%. Trex' recorded income of $3.7 million, or $0.25 per share, for the 2007 first quarter, and this compares to 2006 first quarter up favorably, $4.1 million or $0.27 per share.

Now I would like to turn this conference call over to my associate, Paul Fletcher, Trex' Chief Financial Officer. After Paul's more detailed discussion on the numbers I will return to the conference to discuss business programs, current and future and how they are progressing. Paul?

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

In the first quarter of 2007 net sales were $115.9 million, compared to 2006 first quarter net sales of $105.3 million, an increase of 10.1%. Net income in the first quarter of 2007 was $3.7 million, or $0.25 per diluted share versus 2006s first quarter net income of $4.1 million or $0.27 per diluted share. Gross profit of $24.6 million represents 21.2% of sales, which compares unfavorably to the first quarter, 2006, gross margin of 23.9. The declining gross margin year over year resulted from production inefficiencies and higher overhead expenses. Manufacturing productivity including line rates and yields were negatively impacted by the Company's new product introductions and our continued emphasis on quality.

In the first quarter of 2007 our average plant utilization was approximately 84% compared to 86% in the first quarter of 2006. Poly pricing in the first quarter of 2007 was unchanged to the first quarter of 2006. However, up 10% from the fourth quarter of 2006. We expect Poly pricing to decline during the remainder of the year due to an improved mix of Poly sources. These sources will be available to us as a result of the recent investments in Poly processing capabilities.

In the first quarter of 2007 SG&A expenses totaled $17 million compared to $17.8 million in the first quarter of 2006. SG&A expenses were favorably impacted in the quarter by a recovery of $3.25 million in legal fees from our settlement with Exxon Mobil. Offsetting this were increases in salary and benefits and professional fees. As a percent of sales SG&A expenses represented approximately 15% in the 2007 quarter, compared to 17% a year ago. As we have discussed before, SG&A expenses will fluctuate quarter to quarter and are most affected by our consumer marketing spending.

Net interest expense in the first quarter of 2007 amounted to $1.6 million, an increase of $0.7 million from the $0.9 million in the first quarter of 2006, the increase in interest expense was primarily the result of higher average outstandings on a working capital line of credit. As of March 31, 2007, total debt amounted to $139.4 million, compared to $80.1 million at March 31, 2006. Borrowings on the Company's working capital line of credit amounted to $78.4 million at the end of the quarter. The increase in borrowings on the line of credit was directly related to the increases in working capital at March 31, 2007. Debt to total capitalization at the end of the quarter was 45%. We do expect working capital to decrease significantly in the second quarter as early buy receivables are collected.

Accounts receivable at March 31, amounted to $70.7 million compared to $53.6 million at March 31, 2006. Total inventories increased from $49.6 million at March 31, 2006, to $90.8 million at March 31, 2007. Raw materials increased slightly $2.1 million while finished goods inventories increased $39 million. From December 31, 2006, inventories have declined approximately $21 million. Cash flow from operations was negative $22.7 million for the three months ended March 31, 2007, primarily as a result of the increase in receivables during the quarter. Capital expenditures during the quarter of -- first quarter of 2007 were $10.8 million. Investments in 2007 have been and will be focused on process improvements, Poly reprocessing and extrusion line upgrades. We expect capital expenditures for the full year 2007 to be approximately $25 million. Tony?

Okay, thanks, Paul. Paul's review of the quarter, I have several comments. Recorded revenue was within the bounds of expectations and within the bounds of the first half guidance of 225 to $235 million that I gave during our March 21, 2007, earnings conference call. Gross profit is still depressed. However, at 21%, partially influenced by a slightly more generous early buy payment discount.

Less than six weeks have passed since I reported on our full year 2006 results at which time I also commented on the status of our productivity and quality initiatives. Therefore I do not have very much to report that is new. At that time I said that we are determined to raise the quality standards of the Trex product we delivered to the market. I informed that you we are planning to spend $25 million to manufacture our product to meet the new standards within the -- without inspecting quality in. Our investment in quality and reduced cost is progressing but is running about one month behind schedule even though we accelerated the spending pace to more than $10 million in the first quarter. That is the bad news. The good news is that although first quarter production was not the beneficiary of our planned upgrade where the equipment has been installed since the close of the first quarter, early installations are getting results that we are expecting.

In fact we have started to reduce inspection staffing sporadically at different parts of our manufacturing plants and all the upgrade equipment is expected to be installed from a process standpoint before the year end. The challenge of manufacturing to meet new quality standards is progressing but we have not yet achieved the equilibrium of manufacturing top quality product at significantly lower cost which of course is our goal as we stated in our last communication. As scheduled we introduced our Contours decking product in March and will fully introduce our new Brasilia product in June. Unfortunately four to six weeks later than we intended. The Contours product has been very well-received and is already a significant part of our product mix. Our Contours product will also expand the breadth of our product line and will enhance our value or slash relationship with the Trex distributor dealer network while the Brasilia product will satisfy the requirement of the upscale portion f the decking market.

Trek's decking, deck rail offering has also been expanded to be more complete. In addition to the conventional four by four railing post we are now selling a hollow post lead for contractors and homeowners who prefer this approach. And finally in the deck railing space we are now offering boxed railing kits to facilitate the purchasing and installation process. We expect these two initiatives to accelerate the acceptance of Trex' railing products.

In the new product and new business arena, we continue to be very excited about Trex' exclusion fence fencing to compete in the privacy fencing market. We have been successful in developing contractual relationships with 25 fencing installers and wholesalers throughout the U.S., resulting in 45 selling locations. As I said in March in 2006, we made good progress with Home Depot. Stocking stores have increased from 320 in December, 2005, to more than 1,000 stores in December, 2006, and overall sales to Home Depot about doubled year over year. The Home Depot program is progressing nicely and Trex will be available in about 1300 stores in 2007.

Also in the arena of big box channel marketing I am pleased to announce that Lowe's will also be selling Trex decking and railing in 2007. We believe that the Home Depot and Lowe's activities on behalf of Trex will complement the very effective professional distribution channel that we have partnered with over the past ten years. As an update to my March sales and income projection and comprehending the severity of the impact of the nationwide construction slow down including in the remodeling sector I project first half 2007 revenue will be between 220 and $230 million, yielding an income of $0.60 to $0.70 per share. For full year, 2007, I'm also reducing our projection to 340 to $360 million, for net trade sales yielding income of $0.65 to $0.70 per share. That is the end of my prepared remarks. Paul and I are prepared to address some questions.Thank you.

(OPERATOR INSTRUCTIONS) First question, Bill Gibson with Nollenberger Capital.

Hi, Tony, your first half guidance seems to imply some significant margin improvement on gross margins in the second quarter, is that correct, or are we cutting back on advertising spending?

No, actually there is a little bit -- there is a little gross margin improvement in the second quarter but there's probably, there is more margin improvement projected for the second half. But, yes, there is margin improvement projected in the second quarter.

How are we scaling the marketing and brand building spending this year versus last year?

Not very much different. It's basically flat and we are not increasing our expenditures dramatically. But overall the timing is about the same, Bill.

Thanks, Tony.

Our next question comes from Trey Grooms with Stephens, Inc.

Good morning, one question on inventory if you could kind of give me your thoughts on the level that it's sitting now going into the second quarter after most of the early buy has taken place. Can you give me your thoughts on where you feel it's sitting now?

Well, I think Paul mentioned in his remarks that it's down significantly already and it's, in the, from the time -- from December of the end of last year. We are -- the reason the inventory was so high coming into the year is, number one, we wanted to be available to sell product that, and be on time with our early buy program. And we did not want to -- and we wanted to have a lot of production capacity available for the new product introduction. So we built up enough inventory so that we can devote, take lives away from taking decking product to making the new products at conventional decking products making new products. But basically I think, Paul, you said we are down about $20 million in inventories as we speak from the December, 2006; and will be down substantially more than that towards the end of the year as we try to harvest working capital or cash.

Okay. And then you said that your marketing spending was running about where it was last year. But in the press release you had mentioned that you're accelerating on your consumer branding, brand building activities. Can you kind of quantify this as far as how much was spent on branding in the quarter and kind of if you say you're accelerating going into the second quarter kind of what we are to expect there?

Branding in the first quarter, Trey, was $5.1 million. In 2007. Last year was 4.9. So it's a slight increase.

Okay. And then in the second quarter, when you say it's accelerated.

Accelerating the activities, the calendarization obviously in the first half we spend the majority of the branding is spent. So you'd see a slightly higher number in terms of branding expectations in the second quarter and then for that to fall off in the third and fourth.

So nothing unusual, just your typical seasonal increase.

Right.

Okay. Just one last question, you mentioned briefly your Lowe's relationship but can you give us an update with how much, how many stores you're in now and if it contributed any to sales in the quarter?

The target is to be in about 1300 stores also just like Home Depot.

Right.

The sales in the first quarter represented a very small portion of our revenue in the first quarter. It's in the 1 or 2% range. But, and quite frankly just like with Home Depot, it took awhile to ramp up. Not only -- we are going to be ramping up stores a lot more rapidly but then, of course, then you have to get the promotional material in there. The first couple of years at Home Depot it only represented somewhere around 1 or 2% of our sales whereas today in 2006 Home Depot represented about 10% of our sales. So I would say we should finish the year somewhere between 3 and 5% of our sales.

Okay. And the stores that you're in now, do you have a guess on how many stores you're in with Lowe's now?

I really don't know.

Okay. Thank you.

Next question comes from Keith Johnson with Morgan Keegan.

Good morning. A couple questions on the polyethylene Pau, I think you said that it was flat on a year over year basis?

That's correct.

In the March quarter, if I remember correctly you were buying a little bit or some higher priced off spec material and that pulled your average price up?

Yes.

This year, were you still in, buying the higher cost plastic sources?

We are not. We are buying -- we are not buying the off grade version that you're referring to. But we have a mixture of reprocessed material versus film material and we are a little bit higher on the reprocessed side of our mix than we intend to be. And as a matter of fact we are going to be higher and higher in the film side which is going to bring our price down as our processing equipment gets installed. In the first quarter of 2005 versus -- 2006 versus 2007 when we said we are about flat, we are actually down about 3%. But we call that flat and basically we're -- we basically will be okay and we are going to bring it down.

Okay. And then when you talk about, I guess the utilization or operating rates during the quarter, between the December quarter of '06 and the March quarter of '07, what type of yields or scrap rates were you seeing as you came through the March quarter?

The yields were down from 80, year over year about 86% down to 80% during the quarter.

Okay. That 80% during the March quarter is similar to the kind of December of '06 quarter?

Yes.

All right. That kind of covers most of my questions now. Thanks.

Thank you.

Our next question comes from John Ball with Stifel.

My first question is I think I heard you say Brasilia was being delayed six weeks, did I hear that right and if so what's the issue?

I said, John, I said four to six weeks and part of it has to do with the reason we deemphasized sales of Brasilia in the fourth quarter of last year is because we are having difficulty manufacturing it to not only quality standards but also economic standards. And I was hoping that we would have that product available right now but the process of development is still going on to my chagrin.

Second question, what has deck contributed to revenue in the quarter and is that pick up material, are you in all 25 of these selling points distributors today, some color there?

We are but we are not, they are not taking much inventory yet. I just said we've signed contracts and on some the ink is not even dry yet. But it's basically about 1% -- the whole year is expected to be somewhere around, let's see, somewhere around 2 to 3% of our sales at most.

Okay. Then last question is a little bit more complicated.

Were those questions, easy, John.

Those were the easy once much those were the layups.

All right.

As you looked at, there's obviously a whole number of factors that drive gross margin. I assume the goal is 35%, I'm curious, you ended the quarter at 21 and you touched on several factors. You have clarity yet that if you ran a good yield, you ran an efficiency -- assuming your poly costs are down, is there enough pricing? Are your prices high enough that you can get to a 35% gross margin without taking pricing up or do we have situations where demand is just not going to be good enough this year with the capacity, the productivity is going to be poor and yields are going to take longer to get back than this year, just kind of curious where we are in theory on that 35% gross margin?

Well, the 35% gross margin you are referring to is when we are together or when you and I have talked I said that's, my target for the Company was to get to 35% over the next 18 months or so with SG&A of about 20% with EBIT netting out at about 15%. We are on that journey now and even though the numbers were very bad in the first quarter, if you do the math in terms of our projections for the full year, it says we will be approaching 30% or be around 30% in the third and fourth quarter. Assuming, of course, the poly doesn't increase, doesn't increase beyond what we are predicting, and assuming we run a reasonable number of our lines with volume supporting needing to run the line and we get the absorption, the projections we gave to you are based on gross margins of about 30%.

Then you can get to 35% by just running more capacity next year and an even better yield than you are going to be running by the end of this year?

That's right.

Thank you very much.

That wasn't too bad.

Next question, Eric Glover with Canaccord Adams.

Good morning. I was just wondering if you could comment on what your pricing strategy is in the Lowe's store versus Choice Deck and how that compares with your pricing strategy at Home Depot?

Well, the pricing strategy you're referring to is Lowe's strategy and what it amounts to is with Lowe's they have Choice Deck, and I will call that their store brand, and they are using our product as the premium brand. And basically if you were to go by board for board the pricing at Lowe's is about a 15% increase, difference.

I was wondering if you could also provide some more specific on where you expect your average PE pricing to go? You did say you thought would it decline in 2007.

Well, category by category we don't expect it to decline but we, as we install the processing equipment we will be able to buy more and more of the material that's not -- some of the poly we by now is not good enough for us to use directly in our line so we send it out for processing. Even though we are buying recycle we sends it out for processing and there is a cost there. Now as we put this processing in our own line, our own lines, we won't be incurring that intermediate processing cost so that therefore our overall cost of poly to our line will come down but what we buy is basically flat from this point on.

Thank you.

Your next question comes from Robert Kelly with Sidoti and Company.

Good morning. My next question is actually on the bringing the processing inhouse. Did that benefit you at all in the quarter or is that more of a--?

In the quarter, zero, practically as close to zero as you can get. The equipment that I refer to a little bit of it has got, some of it got installed -- some of it got installed in the second quarter as in being installed as we speak and it's already installed and the rest, but the first quarter was not the beneficiary of it.

Great. And then I don't know if it's too early in the season to kind of give us an outlook downstream what your distributors and dealers are seeing as far as demand? Have the reorders started yet or is that what's kind of driving the--?

The reorders have started. What's driving the fact that we've reduced our projection somewhat is that it's still a tenuous situation. The reorders are not overwhelming but they are not bad either so, therefore, we reduced our projections of forecasts of revenue and income to be a little cautious on that side.

Bob, our early buy program runs through April. So we've just completed early buy.

So it's a little too early?

Yes.

Then finally, Paul, you were good enough to give us some of the mix information in the past of the different product lines. Could you update us on the Q1 numbers and also kind of what's embedded for the '07 sales projection, what you are thinking, the Accents and Contours and what the original products will be at the end of the year?

Accents was slightly over 70% in the quarter. The decking versus nondecking and nondecking would be railing and accessories and fencing and so on would be approximately 10% in total, across the entire volume.

And you expect that to be about the same split as we get to the end of the year?

No, I think that will improve. We would expect the accessory or the nondecking mix to improve in the next three quarters?

That's part of the margin improvement that's anticipated.

Thanks, guys.

Your next question comes from [Claire Davis] with Perennial Advisors. Please go ahead with your question.

Hello. I wanted to ask you what the impact for the quarter and going forward is on inventory and gross margins from shutting down nearly all of your lines at your Fearnley plant? And also whether or not you did that in the quarter at your other plants as well.

Well, what's your question about shutting down the Fearnley plant?

We just through our research learned that you shut down a lot of your lines at Fearnley during the quarter and I was curious how much that drove your inventory improvement and how you were planning on supporting sales going forward if that was the case.

No, we ran -- our utilization was about 84% and that was, that's fairly consistent across all three plants. At some parts of the quarter some are higher and some are lower. Actually Fearnley is--.

At the end of the quarters were the lines all up at Fearnley?

Actually all the lines at Fearnley were running 100%.

And most of them have been running -- we have eight lines there and I would tell you we've never been below six and we've been averaging like seven.

Fearnley is probably the highest utilized plant of the three.

Okay. Maybe that was misinformation, then.

Sounds like it.

Sounds that way.

Now, as far as your balance sheet, I noticed when I read your 10-K you have some covenant problems and had to amend your credit agreement earlier in the year. How does that stand now? Did you have any problems with your covenant during the quarter?

No, we did not.

I think that's all my questions.

Thank you.

Thanks.

Your next question comes from Carl Reichardt with Wachovia.

Hi, guys. You got through most of my questions already. Paul, could you tell me a little bit about the brand spend as you look forward in terms of the trade versus consumer mix, and whether or not as you look out to '08, I know it's early, if you think that you're likely to accelerate--?

Let me try that, Carl. I think in the past we have told you that from an expenditure standpoint, dollar expenditure standpoint, about 95% of our spend was towards, to attract the consumer. 90 to 95. And the other 5 to 10 was to, for the trade. But I did qualify that by saying you get a lot more exposure from 5 or 10% of the dollars in the trade because the advertising costs is a lot less expensive. However, if I stay on this, let's call it, 90/10 we are moving towards 80/20 now as we are trying to enhance our position with the contractor. So I think -- probably 80/20, is probably a good number.

I appreciate that. Thanks, guys.

Thank you.

Next question is from [Neil McConnell] with [Raymeas].

Good morning, guys. I just had a quick question on the debt capacity. It looks like back in February you took your revolver up to 100 million.

That's right.

Is that, that's up from 30 million the year prior, it looks like?

Right.

Is that enough to get you through -- I know a lot of the current debt should be worked down as you work down the working capital gains. Do you foresee that being enough or do you have to go back for some more throughout the year?

No, that actually decreased significantly, mostly driven by the receivables and as you can see the receivables in the quarter peaked. And that's what that line is funding. And that receivable balance will drop through the second quarter and therefore the need for 100 million comes down dramatically through the year.

Thank you.

(OPERATOR INSTRUCTIONS) Our next question comes from [Ryan Tibato] with Maple Leaf Partners.

Hi, in the quarter the one time benefits in the legal settlement accounted for about $0.14, it looks like. Is that included in your revised guidance for the first half and for the year?

Yes, it is.

Okay. Second question is, on the debt covenants, does that one time benefit get excluded when calculating the debt to EBITDA ratios?

No.

It does not get excluded?

No.

Okay. And last question was, given the run rate of cash flow in the first quarter and the projections for working capital improvements throughout the year do you guys expect to be cash flow positive this year?

It will be either plus, right about break even or -- after taking into consideration debt service, interest, CapEx, plan of about 25 million and not really big changes to working capital, it would be kind of plus 5 million to minus 5 million.

So given that where would you expect the total all in debt level to be as we get to the end of the year?

It would be similar, it would be similar to last year, last year's number, at the end of the year.

Okay. Thank you.

With the debt service, remember, we got about $9 million of debt service. That would be the one difference.

Thank you.

Our next question comes from with Jack Kasprzak with BB&T Capital Markets.

Thanks, good morning, guys. Have you guys seen any competitors, shutter lines, take lines off, or even close any plants? Has any capacity to your knowledge been -- come out of the industry?

Yes. The most significant one is the Louisiana Pacific and their Alabama plant which is the largest of their two plants has been mothballed and has been shut down and there are reports on the second plant is, I don't know what the utilization is but they talked about how much -- how many board feet they made which is also depressed. We have a couple other smaller competitors who have shut down lines but most of them are not, are -- companies that are shall I say smaller divisions of large companies. So the details are not always readily available. But I believe that most of our competitors are running at less than full utilization and may be significantly less than full utilization.

You stated earlier at 84%, correct?

Right.

So it's a bit of a guess I suppose but one would assume as the biggest you guys probably are toward the higher end of utilization rates right now, so that's my assumption, but anyway, do you think a shake out, a bit of a shake out is occurring right now as a result of lower utilization rates and some new entrants who maybe got in a little late towards the housing cycle and are now feeling the pain?

I would only say that my gut feel is the same as yours is the answer is yes without being able to quantify it but in our case we have picked up market share the last couple of years and we intend to pick up market share again this year, even though we don't project a big increase in our overall revenue year to year which basically says the market is not going to be very much of a growth and we are going to pick up some share as we go forward.

All right. That's great. Thanks a lot.

You're welcome.

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

Okay. 2005 and 2006 income were not satisfactory. We project that 2007 income, although also not satisfactory, will show some significant improvement in all aspects of our business. As I just said a few minutes ago, sales revenues will grow modestly as we projected. Distribution channels will broaden with the agreement with Lowe's and the expansion of Home Depot. Decking product lines will be expanded based on the product additions to our line. Trex market share in the decking and railing sector is expected to increase as it has in 2005 and 2006. Our fencing product line Seclusions will establish itself as the best available product in the market. Productivity and quality capital expenditures will start to yield reduced cost rewards in late 2006 and early 2007. That's all I have to say. I think basically as you folks as investors are not very happy with the Trex Company in terms of our income, we aren't either but I think we believe that the programs we have going forward will give us the rewards that are appropriate. Thank you very much. Thanks 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 lines.