Trex Company Inc (TREX) 2009 Q1 法說會逐字稿

Welcome to Trex Company First Quarter Earnings 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). A reminder, this conference is being recorded today, April 30th, 2009.

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

Thank you, everyone, for joining us today. With us on the call are Ron Kaplan, President and Chief Executive Officer, and Jim Cline, Chief Financial Officer. Joining Ron and Jim are Brad McDonald, Controller, Brian Bertaux, Director of Financial Planning and Analysis, and Bill Gupp, General Counsel.

The Company issued a press release this morning containing financial results for the first quarter of 2009. This release is available on the Company's website as well as on various financial websites. The call is also being webcast on the Investor Relations page of the Company's website where it will be available for 30 days.

I'd now like to turn the call over to Bill Gupp, Trex's General Counsel. Go ahead, Bill.

Thank you, Harriet. Before we begin, let me remind everyone that statements on this call regarding the Company's expected future performance and condition constitute forward-looking statements within the meaning of Section 27-A of the Securities Act of 1933 and Section 21-E of the Securities Exchange Act of 1934. These statements are subject to risks and uncertainties that could cause the Company's actual operating results to differ materially.

Such risks and uncertainties include the extent of market acceptance of the Company's products, the sensitivity of the Company's business to general economic conditions, the Company's ability to obtain raw materials at acceptable prices, the Company's ability to maintain product quality and product performance at an acceptable cost, the level of expenses associated with product replacement and consumer relation expenses to product -- related to product quality and the highly competitive markets in which the Company operates.

The Company's report on Form 10-K filed with the SEC on March 12th of 2009 discussed some of the important factors that could cause the Company's actual results to differ materially from those expressed or implied in these forward-looking statements. 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'll turn the call over to Ron Kaplan.

Thanks, Bill, and thanks, everyone, for joining us today. As we predicted in our fourth quarter release and conference call, sales for 2009 are following a different pattern than in past years. Because of the very tough economy, our customers are focused on holding inventories low and therefore did not take full advantage of the pre-spring purchase incentives. Instead, they've been ordering more based on pull-through demand from a consumer.

We said in February that we expected these forces to shift sales activity from the first to the second and third quarters, and we're definitely seeing that trend. In the first quarter of 2009, net sales totaled $67.7 million and including the fairly substantial impact of the new accounting provision relating to embedded interest on convertible debt, we reported a net loss of $3.1 million or $0.21 per diluted share.

At the same time, we've been continuing to make substantial headway introducing new products, gaining new customers and expanding our distribution presence. All of these are very important for positioning Trex for the long term and we continue to push forward with the operational improvements we started implementing when I joined the Company last year.

So first, I'd like to ask Jim Cline to provide a more in-depth look at our first quarter numbers, including the impact of FASB Staff Position APB 14-1. After that, I'll come back on to give you an overview of our product distribution and operational initiatives and why we're encouraged by their results to date.

Thank you, Ron. Good morning. As you know, the press release with Trex' first quarter financial results was issued this morning. The numbers I will reference are contained in the tables headed Condensed Consolidated Statements of Operations, Balance Sheet and Cash Flow.

The Company recognized net sales of $67.7 million in the first quarter of 2009, a 43% decrease compared to 2008. The first quarter sales volume was approximately 50% less than 2008, which was partially offset by favorable sales mix and favorable pricing. The overall economic conditions, coupled with our customers choosing to operate with leaner inventory as compared to prior years, were the primary drivers for the year-over-year decline in revenue.

The Company recorded a net loss of $3.1 million or $0.21 per share in the first quarter of 2009 compared to net income of $7.5 million or $0.50 per share in 2008. The Company's results for the first quarter of 2009 and 2008 included $1.6 million and $1.4 million respectively of non-cash interest expense due to the adoption of FASB Staff Position APB 14-1 related to embedded interest on convertible debt. This reduced earnings per share by $0.11 and $0.10 respectively.

Gross margin was 24.8% for the first quarter of 2009, a 224-basis-point decline from 2008. Our capacity utilization of 32% was down significantly from the prior year, approximately 27 points, and adversely impacted gross margin by approximately 900 basis points. Our higher pricing and improved manufacturing productivity were more than offset by operating at reduced levels of capacity utilization and an increased level of excess poly sales at lower than normal pricing due to the weak demand in Asia and North America during the first quarter.

SG&A for the first quarter was $16.6 million compared to 2008 of $20.3 million. The decrease in SG&A was primarily driven by lower personnel-related costs and other general spend reductions, which were partially offset by increased branding spend.

Net interest was $3.4 million in 2009, a $900,000 decrease from 2008. As I noted earlier, the Company's results for the first quarter of 2009 and 2008 included $1.6 million and $1.4 million of non-cash interest expense respectively due to the adoption of the FASB Staff Position APB 14-1. Net interest, excluding the non-cash recognition from the new accounting pronouncement, declined by $1.2 million.

The first quarter of 2009 effective income tax rate remained low as a result of the valuation allowance against our deferred tax assets. The Company had $19.5 million of cash on hand and no borrowings on our revolving line of credit at March 31, 2009. As of March 31st, 2009, total debt amounted to $85.2 million, which represents a $36.1 million reduction from March of 2008. Total net debt to total capitalization at March 31st, 2009, was 38% compared to 47% at March 31st, 2008. Inventory was $61 million at March 31st, 2009, a $5 million year-over-year reduction.

The Company had free cash flow of negative $3 million in the first quarter of 2009, which represents an $18 million improvement over 2008. The improved free cash flow was primarily driven by a lower level of accounts receivable compared to last year. This was principally the result of lower revenue and a higher percentage of our customers choosing early payment discount options in lieu of extended payment terms for the pre-spring order season.

Capital expenditures for the first quarter of 2009 were $2 million, a $1.2 million reduction compared to 2008. Our 2009 investment strategy continues the path we established in 2008 with a focus on lower-spend projects that support our productivity improvements, cost-reduction initiatives and new product introductions. We are also in the process of completing an upgrade to our ERP system and investing in business intelligence systems that will deliver a more efficient and robust reporting platform to enable more timely decision making.

In addition to recording the non-cash interest charges as a result of the new accounting treatment for convertible bonds, debt decreased $28.6 million and equity increased commensurately at March 31st, 2009. The amount recognized as equity will be amortized through interest expense over the remaining term of the convertibles, which will result in non-cash charges to earnings of approximately $1.7 million per quarter for 2009.

Finally, I'd like to summarize several significant achievements that we accomplished during the first three months of 2009. As I mentioned before, we operated approximately 32% capacity utilization in the first quarter of 2009 versus 59% in 2008. This negatively impacted gross margin by approximately 900 basis points, masking the favorable impact of the 2009 price increase and continued operations improvements. Both our line rates and yields have continued to improve year-over-year as a result of ongoing and new process improvements.

In addition, when excluding the effect of capacity utilization, our manufacturing cost per pound also improved year-over-year. While SG&A expenses were lower in 2009 versus 2008, we did increase spending to support specific distribution, advertising and branding initiatives that we believe will help enhance our reach and exceptional brand recognition.

We continue to focus on free cash flow. Our service levels during the first quarter exceeded our target 95% as we intend to continue performing at these levels with even higher than expected levels of sales in the second and third quarter. We are committed to consistently meeting or even exceeding our service level goals while at the same time continuing our focus on free cash flow by reducing inventories significantly.

Ron?

Trex continues to strengthen its market position and build an operating platform that should enable us to survive the recession and thrive during the recovery. Here are some specific actions that provide evidence.

First, we continue to broaden our product offering in response to consumer demand for esthetically-superior, eco-friendly outdoor living products. For example, in the past quarter, we launched our expanded Trex Artisan Series Railing. This modular construction provides the flexibility for people to mix and match colors and styles to achieve their optimal design. We're rolling out decorative balusters, a charcoal black railing system, and a graspable handrail system that meets the requirements of the Americans with Disabilities Act.

Second, we're taking market share because of our superior products, innovative marketing strategy and physical strength. For example, in just the last few months we've won contracts that give Trex exclusivity or preferred vendor status with the nation's largest supplier of material for homebuilding, profession and contract builders, the second largest supplier of structural building products to new homebuilders and the leading builder of luxury homes in the US.

All of these wins came directly at the expense of major competitors, and over time we expect them to produce significant sales increases. Equally important, with continued consolidation expected in the Pro channel, we think strategic partnerships such as these strongly position Trex for long-term success and future market share gains. We're working aggressively to gain more market share.

Third, we're lowering our costs. In 2009 first quarter, we began applying the Lean Six Sigma and other best-in-class manufacturing techniques at our Fernley plant, and we're extremely pleased with our operating results. As Jim noted, the recent reduction in capacity utilization has masked the significant progress we've made in productivity and cost reductions during the past quarter.

Fourth, our research and development efforts designed to further separate us from the competition are ongoing and productive. We have also eliminated costs that will improve operating margins by 2% to 3%. These cost savings were targeted throughout the organizations -- throughout the organization and include a recent step-change in the production methods at the Winchester plant, which has resulted in further productivity gains and cost reductions.

Turning now to our guidance for the second quarter, the shift in purchasing patterns is now clearly evident. Based on the order flow we are seeing, we expect sales to approximate $85 million for the second quarter.

Operator, we are now ready to open the call to questions.

(Operator Instructions).

Our first quarter is from Keith Hughes with SunTrust.

First reach into this accounting pronouncement, the -- I don't really understand. Why are we lowering the amount of total indebtedness? You seem to be shifting it to the equity count and then taking a hit on the income statement. It -- what is the purpose of that?

Basically, what's required is that we -- at the time the debt was issued, the convertible bond was issued, we had to calculate what the embedded value related to the convertible feature was and then amortize that interest expense across the P&L from the date of election. The reason that the debt is lowered is so that we can record that comparable interest over the term of the notes, and in the case of the notes the embedded interest rate that was used was roughly 18.4%.

So, this is a hypothetical calculation the accountants are making you do around the value of redeeming these things in cash at some point? You broke up? Was that part of the answer?

That is part of the answer, and basically you're correct. It's a requirement that we estimate what that number would have been as of June of 2007 had we offered a note without a convertible feature in it. It's all non-cash.

Yes, I understand that, okay. So, the accountants just made the financial statements that much harder to read. All right, next topic, the -- as you look at the sales number you gave us for the second quarter, will production rates come up based on that sales guidance from this 30%, 32% you had in the first quarter?

They will not.

Okay, you're going to keep them at that rate.

We're going to continue to draw down inventory.

Let me see, you had mentioned I believe costs -- poly costs had turned in your favor. Is that correct in the first quarter?

We didn't say poly costs had turned in our favor. What I was referencing was that we sold off a large amount of poly at lower prices. The poly market basically was fairly soft. We buy more poly than we utilize, and when we sold it off but we took a loss on that sale.

Okay. And finally onto SG&A, it was down nicely in the year. Will that number, do you think -- if sales stay at the kind of the rate we're seeing here, will it continue to be down year-over-year?

The total SG&A cost may be down slightly year-over-year, but I would not expect a dramatic reduction year-over-year.

All right, thank you.

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

Thanks. I wanted to ask about SG&A as well. When you say down slightly, I assume that's just from the reported amount of SG&A in '08 because there were some unusual items that hit SG&A, particularly in the first half of '08. So, is it's just simply down slightly from what was reported, including unusual items?

It will be down slightly from total reported SG&A for the year.

Okay, thank you. And then, Ron, you mentioned in your comments that cost savings should help operating margins by 2% to 3%. Is that over some period of time at higher utilization rates? Or is that -- should -- is that something you expect to gain in '09 on a year-over-year basis? Can you just help (inaudible) out.

It's an annualized number net of restructuring costs, and so we should recognize it at the current rate of production. All things being equal, it's a -- on an apples-to-apples basis, you'll see this through 2010 on an annualized basis.

Okay, very good. Thanks, a lot.

Thank you.

Thank you.

Your next question comes from Robert Kelly with Sidoti. Please, go ahead.

Good morning.

Good morning, Robert.

Good morning, Robert.

A question on the reduction in cost per pound year-on-year, is there any way you can give us help on some of the efficiency improvements you have all made compared to just the reduction in raw material costs?

Our line rates, yields and overall costs per pound are all moving in the right direction, net of -- or excluding the impact of lower capacity utilization. So, on a cash basis they're all moving the right way. The acquisition cost of poly is down several percentage points from prior year.

Does that answer your question?

Yes. Do you expect that poly trend to continue '09 and into 2010?

We certainly expect it to continue through the second and probably the third quarter but, depending on economic conditions, I don't think we can really go much further than that.

Okay, great. The point on the excess poly sales, I guess you took a little bit of a loss there. Was that part of the 900 basis point drag from being underutilized? Or is that in addition to the 900 basis point drag?

It's in addition to the 900 basis point drag.

And then, finally on the convertible, last check the public debt was trading at a pretty significant discount to par. Is there any chance you'd go back and -- are you precluded from buying the debt back in the open market at a discount?

We are not precluded from buying it back.

Is that something that you would, if you have enough excess cash, you'd look into doing?

I think it's one of the many options we look at. We've looked at it before and have elected to take a different course in the past. We've not made a decision going forward what we would do on that.

Okay. Thanks.

Your next question comes from [Alejandro Motsdonado] with [HIT Capital]. Please go ahead.

Good morning. I wanted to ask first about the magnitude of the price increase and when that kicks in and, just in general, a little bit more color on the exceptions by the market and whether competitors have followed suit.

The order of magnitude of the price increase was approximately 8% on a blended basis. It did stick. We haven't had any significant resistance to that. The distribution channel is taking it. By and large, there is some out of sync between us and some of our competitors but, by and large, the positioning of Trex price wise within the competitive landscape remains unchanged. Everybody has either moved before us or after us and there's been no significant change in pricing positioning.

And further to that, just to be clear, in the first quarter the effective impact of that, we didn't realize all 8%. It would have been closer to a 6% impact because of timing of the announcement and most people electing to take a discount versus extended payment. But we did have some people take extended payment terms.

Okay, thanks. My next question is around your loss of one of your larger distributors last year, around September. I just wanted to follow up on that and see what the impact of that loss has been and whether you've been able to pick up that business from other distributors that you had in the same area?

Well actually, we more than picked it up. But that actually has proven to be a net benefit to us, from what we can tell. So, while it was exciting when it first happened and we had to move very quickly and decisively to establish the replacement, the people who've replaced them have been extremely enthusiastic. And the overwhelming majority of the dealers have actually switched distributors and acquire their trucks through the new distribution channel.

Makes sense. Then, moving on to CapEx, I notice current levels are fairly low relative to some of the historical levels, around closer to annualized $25 million to $30 million a year. Once the economy recovers, what are the levels of CapEx that you envision that are more kind of like a growth/stable CapEx?

I expect it to be in the high single-digits, maybe up as high as $10 million, somewhere in that range.

Okay. And then, my last question is around warranty claims. Have you seen any changes in the trends on the warranty claims, anything similar to what you saw in 2007?

Well, if we were to compare the first quarter of 2008 to the first quarter of 2009, first quarter of 2008 the claims cost us about $7.6 million in cash. In the first quarter of '09, that same number was about $1.9 million. So, we see the claims -- payouts as declining.

Thank you very much.

Thank you.

Your next question comes from Steve Sharkey with Flat Creek Investors. Please go ahead.

Going back to the loss on the sale of the poly, why did you decide to sell? Is it because you think you can buy it back at a lower price in the future, or you weren't happy with the quality? And just roughly, what was the size of that loss in dollars?

Yes, it's really a combination of two things. When we buy poly, we buy it including poly that we cannot use. So, part of that was poly that was not usable poly for our operations, we do that as a convenience to the people we buy the poly from. In addition, we felt that the poly inventory we were carrying was higher than what we were comfortable carrying and made the decision to reduce the inventory.

Okay. Jim, is that sort of a normal deal then? I've just never heard of that before. Maybe the amounts have always been diminimized.

They have. For example, if we looked at the same time period last year, we were basically able to sell poly at basically what our cost was.

I see.

But what happened was the Chinese basically backed away from the market in the late fall and did not re-enter the market as robustly as expected after the Chinese New Year. Plus, with the US market being on its ear, it just left us with more poly than we wanted. And the pricing to sell it off, quite frankly, was considerably less than what we had bought it for.

When the Chinese leave the market or decrease their presence in a market, it's sort of a double-edged sword. It lowers our cost of acquiring the new policy, but it also lowers the cost of the poly that we want to sell. This time, the spread between the two began to widen.

And that dollar loss roughly was?

A couple million dollars.

Okay. And then, you mentioned new product, Trex Profiles with the deep grain board with a structured profile. What does structured profile mean?

It means that it's got a wood grain appearance to it and it is specifically for a particular customer. The structured profile can also be referred to as like a scalloped bottom.

Oh I see, okay. Okay, thank you.

Your next question comes from Kenneth Smith with Linux Equity Research. Please go ahead.

Thanks. Yes, I was going to ask a similar question about the profiles product, you seem pretty excited about it. At the same time, it sounds like some product you already have, so can you just kind of -- what is it about it -- I know what you said, but that makes it stand out as being particularly --

It has -- all I can tell you is that it's a unique appearance for a particular customer.

Okay. Ron, those new relationships you've established, you referred to earlier in the call, when would those start to benefit you on the sales line?

I would say they'd begin to benefit us in the second and third quarters.

Okay. And then in the past, you've talked about new products or products you've been developing and you wouldn't know how they are going to pan out until maybe sometime this summer or even fall. What is the status on that?

Well, what I said before remains true. I think what I said earlier this morning was that our product development efforts remain ongoing and productive.

Okay. Great, thank you.

Thank you.

Your next question comes from Eric Prouty with Canaccord. Please go ahead.

Great, thanks, just a couple things. The previous question, the accrued warranty numbers on the balance sheet went down a bit. Will we assume, given the reduced level of warranties you're paying off, that that number should continue to trend down for the remainder of the year?

Yes, that's our expectation that all the claims related to that are being charged against the reserve. And we do believe the reserve is adequate to our exposure at this point.

Okay, great. And then, you talked about it an awful lot but just to be certain on the impact, you would expect then, with this new charge related to the debt, that the interest expense kind of going forward would be on a similar run rate to what we saw in the March quarter of kind of that $3.4 million, $3.5 million per quarter on the interest expense line in total?

The entire interest would be comparable because there's no change in our planned debt. So, the answer to your question, yes.

Okay, perfect, I just wanted to make sure that was totally clear. And then on the capacity, with the low capacity utilization, I mean, is there any plans to permanently or semi-permanently take out additional capacity that you guys have? Or are you kind of comfortable that sooner or later the demand will pick up to the point where you will need most of that capacity?

Well let me answer that a couple of ways. The short answer is no, we do not plan to permanently or semi-permanently reduce capacity. Now, let me give you a little more granularity on that. We can always reduce the lines that we've got in production without shutting down a factory. In other words, let's suppose we've got four lines operating in each plant, we can always cut it back to three, two or one or even zero if we had to, without shutting the factor per se.

We have no intention of shutting either one of our factories down. I've thought about it and decided against it because the cost of shipping the material back and forth across the country eats up any savings you'd get from shutting down one of the factories. So, we're not going to go there. We've got the one plant in mothballs, it's going to stay in mothballs for the foreseeable future. And as I did say, we are working on important aspects of market share between the potential for that and the potential for recovery. We're going to keep our manufacturing capacity in tact.

Perfect. And then finally, and again you touched on this a bit, but on the raw material side, obviously the market for raw materials, at least on the plastics side, we've heard about collapsing markets quite a bit. Can you just give an update? Are you able to find enough material out there? Are you getting new channels of material or are channels disappearing? We've even heard people are now starting to landfill plastics and fibers, given the low price, so maybe a little commentary on that.

We haven't had any difficulty finding raw material. I will tell you that, while the price of acquiring poly is down on a gross basis, the cost of finding wood has gone up. Of course, we use much more poly than we do wood in terms of dollar value. We've got to drive a little further to get the wood than we used to, but we haven't had any difficulty finding the poly that we need.

Great. And is this something -- this is also for, but given the lower prices and the fact that you're keeping the price of your product in tact, should we assume prices come down enough to help out the gross margin heading forward? Are you still working through higher costs, raw material inventories, so the impact will be much later in the year?

We're having a little trouble hearing, you're breaking up. Can I ask you to repeat that one again?

Yes, sure thing, sorry about that. Hopefully, this is clearer. Just again on the poly, can we assume that, given your price in your end product is stickier, even being increased? You know, we have heard a lot of the poly price is coming down. Should be an immediate impact to your gross margin? Or are you still working through higher costs raw material inventories?

Well, we certainly have poly on hand that we will work through. It takes a while for those price reductions to filter in, so you probably would see the effect of lower poly hitting in the second and then more heavily in the third.

But I would direct your attention to the comments that Jim has already made regarding the effect of lower capacity utilization. And if you add that back, I mean you sort of see the direction that our gross margin is headed.

Sure. Okay, perfect. Thanks, guys.

Thank you.

Your next question comes from Keith Johnson with Morgan Keegan. Please go ahead.

Good morning.

Good morning, Keith.

Good morning, Keith.

Just a couple questions, I think you've covered most of mine. Just real quick, could you give us any color on quarter trends you're seeing in the different channels? I know the Pro channel is the biggest piece but also maybe the retail channel, maybe kind of trend as you have come through April versus maybe what you saw in March, has been over the last couple months?

Well, I would tell you that in the last couple of weeks April orders have exceeded the rate at which they were a few weeks before that. We did see an up tick. As a matter of fact, earlier in the month I sent a letter to the various CEOs of our distributors, pointing out that several economic indicators started to move favorable and indicating further to them that our orders have begun to up tick and reminding them that we process orders on a first-come-first-serve basis. So, we have seen some up tick. I'm reluctant to advise on the difference in growth pattern between the channels, it's a fairly sensitive subject.

Okay. I guess maybe on a different subject, you've talked in the past the economic conditions have been very challenging, you guys have done a great job managing cash. But it looks like, if you look at smaller competitors out there in the composite decking space, have you seen any more shake out or signs of stress that may have been smaller that would have been off the radar screen that may not have shown up in a release?

Well, we do see signs of stress and I believe the shake out continues. There have been a number of companies that have dropped out of the industry in the last several months. And I can read the same publicly available financial information that you guys can read, but clearly there is stress out there.

There is nobody in the distribution channel that doesn't believe that Trex won't be a survivor. And frankly, one of our strengths within Trex is the strength of our balance sheet. And it is becoming of increasing importance to the end user and various parties within the distribution channel, everybody wants to make sure they're hooked up with a survivor. Nobody wants to get caught in the distribution chain representing a company that might be here in two or three years. And that serves Trex well.

All right, thanks a lot.

Your next question comes from Stanley Elliott with Stifel Nicolaus. Please go ahead.

Good morning, sitting in for John today. A quick question about the guidance for 85 for 2Q. I guess that's a run rate of down about 29. How much do you guess got pushed into the second quarter from the first quarter? And then also, how should we look at that heading into the third quarter? Are we looking at a run rate of down about 20%? Or is it just too hard to say?

It's a great question, it's just an imponderable. I don't want to give guesses, I don't have any evidence to back up my guess so I'm just going to not go there.

Okay, fair enough. Could you also give a little more color on the major home improvement retailer on the west coast?

You know, we had their names in there and then last night we took their names out. This is such a sensitive marketplace that I just don't want to give any more color on it, other than to tell you they fit the description that I've used. You can draw your own conclusions.

All right, fair enough. And last, just for clarification, I thought you guys said 39% utilization. Did that include Olive Branch? And if so, what would it have been without that?

I don't think we said 39%, I think we said -- we're going to check here.

32%.

32%, okay.

Yes, 32%. And yes, it did include Olive Branch.

Great. And could you guys comment on what it would be without that?

Well, Olive Branch represents between 10% and 15% of our capacity.

Perfect. Great, guys, thank you very much.

Thank you.

(Operator Instructions)

Okay, Operator. Thanks, everyone, for your participation and questions today. I want to emphasize as we close that Trex is the number one brand in the category. We have the largest selection of decking and railing products and we have a great field sales and support team and we have a strong financial position.

These are important advantages and we're using all of them aggressively to expand our presence throughout the US and in Canada and position ourselves for long-term success. We look forward to speaking with you again after the second quarter. Thank you.

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