Trex Company Inc (TREX) 2009 Q2 法說會逐字稿

Welcome to the Trex Company's Second Quarter Earnings Conference Call. (Operator Instructions). As a reminder this conference is being recorded July 29th, 2009.

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 Ron Kaplan, President and Chief Executive Office and Jim Cline, Chief Financial Officer. Joining Ron and Jim are Brad McDonald, Controller, and Brian Berteau, Director of Financial Planning and Analysis.

The Company issued a Press Release this morning containing results for the second quarter of 2009. This Release is available on the Company's website. 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 everyone that statements on this call regarding the Company's expected future performance and condition constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.

These statements are subjected 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 relations expenses 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 in March 2009 and its subsequent filings on Form 10-Q and Form8-K discuss 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'd like to turn the call over to Ron Kaplan. Ron?

Thanks, Harriet, and thanks everyone for joining us this morning. During the second quarter we continued to see the impact of the dramatic change in sales patterns we predicted at the beginning of 2009. This year's buying patterns are really without precedent both in Trex and the industry as a whole. Because of the tough economy, distributors essentially abandoned the early-buy season, have kept inventories low and are simply buying materials when they need them.

The good news from Trex is that we're now in the middle of this year's buying season and we've been getting a solid flow of orders. Our results also reflect the benefits of the operational improvements that became one of our top priorities when I arrived at Trex. In the second quarter of 2009 our net sales totaled $91.5 million and we reported net income of $7.4 million and earnings per share of $0.49.

At this point I'll turn the call over to Jim Cline to give you a more in depth look at our second quarter and six month numbers. After that I'll come back on to give you an update on our marketing, distribution and new product initiatives and why we believe Trex is so well positioned for the long term. Jim?

Thank you, Ron. Good morning. The Press Release we issued with Trex's second quarter and six months financial results for 2009 this morning, the numbers I will reference are contained in the tables at a condensed, consolidated statements of operations, balance sheets and cash flow.

First I'd like to review our second quarter financial results. In the second quarter of 2009 net sales were $91.5 million compared to net sales of $95 million in the second quarter of 2008, a decrease of 4%. We experienced the expected shift in customer purchase trends during the second quarter as inventories remained at historic lows in the market place. This in turn resulted in 2009 sales being more reflective of pull through demand.

Second quarter net income was $7.4 million, or $0.49 per share, a 14% improvement over last year's second quarter net income of $6.5 million, $0.43 per share. The Company's results for the second quarter 2009 and 2008 included $1.6 million and $1.4 million respectively of non-cash interest due to the adoption of FASB Staff Positions, APB 14-1. As you will recall, this pronouncement is related to embedded interest on convertible debt. This reduced earnings per share by $0.11 in this year's second quarter and $0.09 in 2008.

The Company's second quarter 2009 gross margin was 31.2%, a 220 basis point improvement over the second quarter of 2008. Our capacity utilization was 27% and was down significantly year-over-year and adversely impacted gross margin by approximately 720 basis points. The margin improvement was driven by our 2009 price increase and our continued optimization of our proprietary manufacturing process.

Our price of purchased polyethylene material in the second quarter of 2009 was lower than the second quarter of 2008. However, we did incur incremental expense versus 2008 due to the sale of excess poly as a result of operating at reduced levels of capacity utilization. The impact year-over-year reduced margin by 150 basis points.

The Company's focus on working capital management and free cash flow generation coupled with reduced sales volume resulted in a lower capacity utilization. For the six months of 2009 net sales were $159.1 million compared to net sales of $214.5 million for 2008 a decrease of 26%. The overall economic environment coupled with customers choosing to operate with leaner inventories compared to the prior year were the primary drivers of the year-over-year decline in revenue.

Net income was $4.3 million or $0.28 per share for the six months ended June 30th, 2009, a 69% decline over last year's six-month net income of $13.9 million or $0.93 a share. The Company's results for this first six months of 2009 and 2008 included $3.3 million and $2.7 million respectively of non-cash interest expense due to the adoption of FASB Staff Position APB 14-1. This reduced earnings per share by $0.22 and $0.18 respectively.

The Company recorded a gross margin of 28.5% during the first six months ended June 30th, 2009, a 60 basis point improvement over the same period in 2008. This improvement was due to our first quarter price increase and continued manufacturing improvements. Our capacity utilization of 30% was down significantly from prior year and adversely impacted gross margin by approximately 710 basis points. Sales of excess of poly inventory due to the reduced demand adversely impacted margin by approximately 220 basis points.

SG&A expenses for the six months ended June 30th, 2009 were $34 million, or 21.4% of sales, compared to $38.1 million, or 17.8% of sales, in the first six months of 2008. The dollar decrease and SG&A spending was primarily driven by lower personnel related costs and other general spending reductions. They were partially offset by increased research and development spending.

Net interest was $7.1 million for the six months ended June 30, 2009, a $500,000 decrease from the 2008 period. As I noted earlier, the Company's results for the first six months of 2009 and 2008 included $3.3 million and $2.7 million of non-cash interest expense. Net interest, excluding the non-cash recognition of the new accounting pronouncement, declined $1.1 million.

The Company had $46.4 million of cash on hand and no borrowings on the revolving line of credit at June 30th, 2009. At the end of the second quarter total net debt amounted to $59.4 million, which represents a $23.1 million reduction from June 30th of 2008.

Net debt to total capitalization at June 30th, 2009 was 29.3% compared to 36.5% at June 30th of 2008. Excluding the impact of APB 14-1, net debt to total capitalization at June 30th, 2009 was 42.5% compared to 51.2% at June 30th of 2008.

Inventory was $40.1 million at June 30th, 2009, a $16.1 million or 35% reduction year-over-year.

The Company generated free cash flow of $24.2 million in the first six months of 2009, a $6 million improvement over 2008. The improved free cash flow was driven by effective working capital management and lower spending on capital investments.

Capital expenditures for the first six months of 2009 were $14.1 million, a $700,000 reduction -- I'm sorry, correction -- were $4.1 million, a $700,000 reduction compared to 2008 period.

Our 2009 investment strategy complements our strategic objectives by focusing on lower capital spend on productivity improvements, cost reduction of initiatives and new product introductions.

During the second quarter we also completed an upgrade to our ERP system and business intelligence systems that will deliver more efficient and more robust platform to enable our timely decision making improve customer service.

Finally, I would like to summarize several significant achievements that we accomplished during the first six months of 2009. As I mentioned earlier, we operated approximately 30% capacity utilization in the first six months of 2009 compared to 53% in 2008. This negatively impacted gross margin by approximately 710 basis points.

In addition, the sales of excess poly reduced margins by additional 220 basis points. Both of these factors masked the favorable impact of the 2009 price increase and the operational improvements. Both our line rates and yields have continued to improve year-over-year as a result of ongoing and new process improvements.

While SG&A expenses were lower in the first half of 2009, we continued to efficiently support distribution advertising and branding initiatives that we believe will help enhance Trex's reach and exceptional brand recognition. We also spent more on R&D in the first six months of 2009 versus 2008. As Ron mentioned in the last quarter's call, the Management Team is emphasizing product innovation as one of its core principles to strategically position Trex for continued market leadership.

Our service levels during the first six months of 2009 exceeded our target of 95%. In fact, we continue to perform at this high level even with the increase sales activity in the second quarter. We continue to demonstrate our ability to meet or even exceed our service level goal of 95% while continuing to significantly reduce inventory. Ron?

Thank you. Given today's tough economy and soft market demand, we're really quite pleased with the way the year is shaping up and how we've positioned Trex for long-term success. Obviously the operational improvements Jim discussed are making a big contribution.

The best in class manufacturing techniques we're implementing through all phases of Trex's manufacturing process have enabled us to operate much more efficiently despite lower capacity utilization. The fact that we could increase gross margin over 30% in the second quarter while operating at 27% of capacity utilization is really quite remarkable. We have established a very solid foundation during these difficult economic times and we're very encouraged by our future prospects.

Las quarter I talked about our new distributor relationships and the way our great products, innovative and marketing and financial strength are helping us gain market share. Today I'm happy to report that we've been very successful in transitioning our expanded distribution footprint and bringing on new customers as a result of those relationships. And we continue to secure wins and gain market share through our dealer network.

As you recall during our first quarter conference call, we discussed securing contracts that gave Trex exclusivity or preferred vender status with major players in home building supplies and in construction. These relationships are showing early stages of success and establish a solid foundation for future growth.

During the past couple of months we also extended our walk-the-walk tour adding six cities to our original schedule because it was so well received. In total, the tour has now been in 17 cities around the country and has been a great success at all of them. Dozens and dozens of contractors have come to each event showing enthusiasm for Trex's products and eager to learn more about our unique benefits straight from our Executive Management Team.

I think the tour and the presence of Senior Management have contributed to our market share gains and we'll continue to hold these events. We're also pleased with our branding strategy and our focus on using the Internet, which is a very efficient way to expand our reach.

As you know, product innovation is a key differentiator for Trex. Our goal is to give our customers more choices on building products that allow them to build a deck, railing or fence that is more attractive and versatile as well as easier to maintain than wood. We've completed our launch of our expanded Trex Artisan Series Railing last month and it's been well received so we expect this to be a good source of growth for us over time. As I mentioned on our last call, our new product development activities continue to advance as planned.

Finally, as you all know by reading the news, the building products industry remains very stressed and our competition continues to be in disarray. Trex's strong cash flow and balance sheet work to our advantage as building product dealers and contractors look to align themselves with stronger suppliers. They also put is in a very comfortable position to support our strategic initiatives moving forward which will enable our Company to achieve much more when the Company picks up again.

Let's turn now to guidance for the third quarter. As all of you know, predicting sales for virtually every business remains difficult these days. For Trex the shift in purchasing patterns I mentioned earlier adds to the complexity. To date we've been getting a good flow of orders for the end of third quarter. Based on today's trends we expect net sales in the third quarter of 2009 to approximately be $70 million.

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

(Operator Instructions). Our first question is from Jack Kasprzak with BB&T.

Ron, with regard to the sales guidance of $70 million approximately $70 million in the third quarter, that's somewhat in the range of what you reported in your first quarter where you also had a gross margin of closer to 25%. Your second quarter gross margin obviously, 31.2% on $91.5 million in revenue so would it be a fair guess that third quarter gross margin, given your sales guidance, would be closer to the first quarter than the second quarter or are there other factors that might -- that we should consider?

Well I would point out to you that our operational improvements continue. We have modified our SG&A structure since the first quarter and, of course, in the opposite direction, of course, is the level of demand as compared to the second quarter over the first quarter so you've got some cross currents going on. But the third quarter does have substantially different aspects to it than the first quarter did.

Will the drag from purchased poly be gone in the third quarter?

Jim, you want to answer that?

Sure. We expect it will be significantly reduced, if not eliminated. As the demand for poly internationally has increased we're able to move some of that at more attractive prices.

Okay and also and you sort of alluded to this making comments about a still tough economy but more recently some of the data with regard to the overall housing market at least has been interpreted as being more positive. Have you sensed any change in your business customer appetite for product or traffic or anything that might suggest a little better tone or visibility to the environment?

Well, Jack, I appreciate the question and it's a fair question. I see the same numbers that you see. What I focus on is my order book. I do anecdotally sense a greater degree of confidence about the future than I did several months ago but at the end of the day we put our forecast together based on the facts that we have in our hand so I'll just leave it at that.

Okay thanks very much. Congratulations on a great quarter.

John Baugh, Stifel Nicolaus.

Good morning and well executed. A couple of questions here -- first of all, you mentioned your polyethylene purchase costs were lower. Is that due to a reduction in the overall market price for similar grade poly year-over-year and/or are you being able to buy lower grade poly that's just inherently lower priced?

Well, I think there's a combination of things going on. One of them is our superior ability to cut below market deals in the spot market when we want to. There are overall lower trends so it would be really a combination of the two. Trex has got a very sophisticated and well established and deep tentacles into the poly market.

Okay so it's really a combination that you're able to buy lower grade and process them efficiently as well as buy on the market at some lower prices?

It's a combination of those factors.

Okay. On the warranty, any update on the claims process, how that's tracking, any changes on the gross reserves you've taken?

I'll just say that the cash going out the door is slower than had been anticipated and we believe that we are currently properly reserved.

What was the brand spend or advertising spend year-over-year in either dollars or a percentage of revenue?

Well, the brand spend is down from 2008 slightly year-to-date.

Very slightly.

We don't give specific information on branding spend. There's just a lot of detail that we resist supplying to our competitors. I know it would be nice to understand but it's a very slight reduction from last year.

That's okay thanks. And then next, Ron, you talked a lot about railing and everything. When you look at your year-to-date business if you could give us some color on decking versus railing sales and/or any other products?

Well, I will just say that railing continues to expand as percentage of the total sales.

Okay and then my last question, you keep talking about new products in R&D and I know you don't want to give away what you're working on, as you shouldn't, but are these things that we should think will hit the market and impact '010 or are they '011, '012 and any color on how meaningful you think what you've got in the lab is?

I think it will be before 2011.

Great thank you.

Keith Hughes of SunTrust.

On the SG&A spend historically, or at least the last several years, SG&A spend just in nominal dollars has been less in the second half of the year than the first half. Is there anything going on with the business in 2009 that would change that?

No I don't think so.

And secondly, on the capacity utilization at what point do we have to sit down and look at the future of the business and how much capacity you're going to need for the next several years? Is there a certain date or certain point where you're going to have to make those kind of decisions?

I'm not sure I know how to answer that question.

Well, we as an organization --

How do you look at it in terms of your planning I guess is maybe a way you could answer me?

Yes we look at our capacity requirements and this last year and a half has been a fairly interesting time for Trex because as the market demand has been going down Trex's ability to get more throughput on its operating lines has increased quite significantly so if you would have looked at the capacity utilization a year and a half ago, or capacity at a year and half ago, it would have been lower than it is today. We look at this each quarter and we evaluate the implications of capacity.

In addition, you need to remember we're also have been in the process over the last year and a half and will continue for at least another six to nine months, continue to reduce inventories so that evaluation takes place quarterly and we do focus on that considerably.

There's another point to remember. Some of you listening know this and some of you don't know it but it's not so much a function of how many factories you're going to operate, rather it's a function of how many lines are going to be operated within each factory and so once a line is turned on you run it 24/7 and so you would modify the amount of production by modifying the amount of the lines, not the amount of the factories. And so just and to further add to what Jim has said, the inventory reduction that we continue to prosecute is a significant factor in the low capacity utilization so the question becomes at what point do we stop reducing inventory. And in anticipation of that question I'll just say that it's going to go on for a few more quarters.

All right thank you.

Robert Kelly, Sidoti.

A question on -- maybe a point of clarification, you had talked about the 720 basis point drag due to low utilization. Is that relative to the 53% you were running a year ago?

Yes a year ago for the first six months we ran at 53%. We averaged 30% this year.

And the drop off for 53% to 27% cost you 720 or does that, you know, the 720 costing you from full utilization?

It's 710 and that's the drop off effect of the utilization.

Okay great. That's all I had thanks.

Eric Glover with Canaccord.

I was just wondering if you could comment, as you did, in terms of the poly pricing in terms of waste wood fiber? What are you seeing there in terms of supply of material as well as the pricing trends?

Well, there's no difficulty with supply. There's all kinds of it available. For wood we have to drive a little bit further than we normally would to get wood but there's still plenty of it available. The wood pricing is essentially unchanged. The poly pricing has come down pretty significantly. Bear with me one minute. Yes we're trending down for the polyethylene. I was just looking at the virgin poly pricing, which is --

Trending upwards.

Trending upwards.

Something more than 20% since the end of the year.

Okay and then how does that compare with the waste wood fiber pricing? Is that more stable?

I'm sorry. What did you say?

I was just wondering how that compares with the waste wood fiber pricing.

Well, the wood fiber pricing is up very slightly as opposed to the poly cost being down.

Okay and then you made a brief comment about competition. You said it was in disarray. I was wondering if you could just provide some more color there and perhaps what you're seeing relative to some of the private labels competition?

Well, the public companies, of course, you can read for yourselves. There was another company in the industry that went bankrupt about I guess about three weeks ago now. I don't want to mention the name but it is -- the information is public out there.

And we continue to see very specific evidence that, you know, there are many players that sort of skirt around the edges of the industry at one, two, three percent market share and a lot of the contractors and dealers are expressing anxiety about their future and trying to align themselves. The people that they know are going to survive and, of course, there's nobody in the distribution chain that doesn't believe that Trex won't be a survivor and a thriver between our market position that we already have and the extraordinarily strong liquidity situation that we're in and that we've worked very hard to facilitate. So we don't have any short-term debt. We've got $46 million in the bank and we're going to continue to prosecute a positive cash flow business.

And final question, what is your target for any debt reduction this year?

I'm not sure we have a publicly disclosed target about that.

Kenneth Smith, Lenox Equity Research.

On the capacity utilization would it be fair to say then that you're going to continue around the same levels in the balance of the year as you experienced in the second quarter?

Yes.

Okay and then, Ron, last quarter you mentioned there were 200 to 300 basis points of operating margin improvement you expected to be realized from cost cutting over the -- going into '010 I think is how you put it. How much of that have you realized so far and is that still your estimate from those?

I'll stick with my estimate but I'm not going to say how much has been realized so far.

Okay and then going back to the sales guidance, the number obviously implies about an 18% decline year-over-year and you were just coming off a 4% decline so I know it's difficult out there and seasonality is not what it was but is there something else going on? I mean is there -- and also you said there was kind of a steady flow of orders coming in so I'm trying to get a better sense of what is happening there as you said you based it on orders. Is July slow order time seasonally in your direct -- you're basing your forecast more on that or can you give any more color on --?

I can give some color. I can't answer the question in its totality. I understand the question and I'm not going to give a complete answer but I'll give you a partial answer. Because we're in unprecedented territory with respect to the seasonality, there's no historical precedent that I can draw on. I can't look at prior year statistics and draw trends. The classic early buy seasonality is gone for this year. It may or may not return. I'm not really sure and so we have that issue of people just buying what comes off their shelf and replacing it. There are some other factors involved, none of which are bad but I think our distributors are very astute in terms of how they're placing their orders and positioning themselves for the future.

Were there any incentives that kind of ran out with the end of the second quarter that might have drawn business at the expense of the third quarter?

There were some. There were some.

But it would have been a minor impact on the quarter. The other thing to remember is the first quarter was dramatically lower so the shift that we saw out of the first quarter into the second will continue into the third but with the economic conditions as they are we expect that the distributors and the retailers will draw their inventory down again as they see that the season comes to a close.

I mean the point is this. Number one, Trex is well positioned in the marketplace. We are gaining customers. We have the inventory that we need to serve the market. Our service levels are high and we will continue to produce less than we sell. I mean those are principles by which we're operating the Company.

Right, right okay. Thanks very much and really good job.

You have a follow-up question from John Baugh with Stifel Nicolaus.

Just a couple quick things -- when will we hear about a pricing decision for '010 and then just some D&A. What's the D&A number year-to-date? What's the budget for -- I guess that's in the Press Release but what's the budget for '09 in the CapEx budget for '09? Thank you.

Let's see. There were about four questions in there. With respect to pricing, you'll hear about that in the fourth quarter.

Now with respect to the capital spend, we've told you before it's going to be approximately $10 million. We expect that we will be in that range. It won't be exactly $10 million. It will be plus or minus slightly but that should be the number you should plan for.

Great and D&A for the '09?

D&A for '09 will be less than 2008 but not significantly. Just take the first six months, which were about $1 million less. You should expect that trend to continue.

Great thank you.

(Operator Instructions). [Morris Aceman], [Griffin].

Sorry if this question has been asked. I've been cut off a couple times but, again, the $70 million revenue estimate for the next quarter and then looking at -- perhaps from the cash flow perspective inventory is at $40 million you exit the second quarter. My presumption is I guess that continues to decline but that's my presumption and then we know CapEx for the full year is going to be down materially and relative particularly D&A so the question going forward is does cash flow from operations continue to be very let's say meaningful into the third quarter just like the top line decline? And then, is it a fair estimate that any free cash flow generated in the interim is used to pay down debt?

Morris, first thing with regard to the inventory the answer is yes you will continue to see year-over-year declines in inventory through the third quarter. That has been what we've focused on and we've consistently been able to deliver on that. You will see a meaningful cash flow generation at the level of sales that we have. We are very focused on the free cash flow generation.

With regard to the full year, we do anticipate we will have a strong cash flow for the full year. We have not released that information, don't plan to today, but we will utilize cash available for the appropriate applications against debt. That doesn't mean that we're going to take all the cash and go out there and pay all the debt off. That would reduce our liquidity considerably. We're focused on maintaining liquidity until we see the end of the economic recession and, as we start climbing out, we'll take the appropriate actions on debt at that time.

[Alondro Maldonado], Bayside Capital.

My question is along the PVC product segment. I was just wondering if you could comment on the performance of that segment and what your competitive position is like in that segment?

Well, the PVC segment has been one of the stronger areas within the industry. We have a very competitive offering and we have a very strong competitor that we compete against. It is a market that is an important market and there is a continued demand for the characteristics offered by that product line and Trex is very well suited to serve it.

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

Thank you, operator. Thanks, everyone, for your participation and questions. We're happy to have had such positive results to discuss with you today. As we progress through the rest of the year we are going to stay very focused on our primary strategies achieving operational excellence, keeping a careful eye on costs, growing our market leadership at every opportunity and expanding our product platform. We'll report back to you on all of these activities after the third 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 line.