Trex Company Inc (TREX) 2009 Q3 法說會逐字稿

Welcome to the Trex Company's third-quarter earnings conference call. At this time, all participants are in a listen-only mode. Following managements prepared remarks, we will hold a Q&A session. (Operator Instructions). As a reminder, this conference is being recorded today, Monday, November 9, 2009. I would now like to turn the conference over to Harriet Fried. Please go ahead, ma'am.

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 Berteau, Director of Financial Planning and Analysis; and Bill Gupp, General Counsel.

The Company issued a press release this morning containing financial results for the third 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 you will be available for 30 days. I would now like to turn the call over to Bill Gupp, Trex's General Counsel. 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 27A of the Securities Act of 1933 and section 21E 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 costs associated with the development and launch of new products and the market acceptance of such new 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 in the highly competitive markets in which the Company operates. The companies report on Form 10K filed with the Securities and Exchange Commission on March 12, 2009 and its subsequent reports on Form 10-Q filed on May 8, 2009 and August 10, 2009 discuss some of the important factors that could cause the Company's actual operating 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 will turn the call over to Ron Kaplan.

Thanks, Bill, and thank you, everyone, for joining us this morning. We are reporting later than usual this quarter because we wanted to coordinate our activities with Trex's 2009 distributor meeting, which is being held later this week. We will be unveiling a very exciting decking and railing product line at the meeting, one that we believe will create new standards in the industry for both performance and aesthetics.

We also recently made comprehensive enhancements to our current decking product platform. These changes offer more flexibility and design options for consumers, always one of Trex's top goals. They also offer more convenience and efficiency for distributors and dealers and further streamline our manufacturing process.

We began previewing our product changes with our major distributors this summer, after which some started adjusting their inventory. These adjustments adversely affected our third-quarter sales more than we expected. And of course, we are still dealing with economic headwinds.

Nonetheless, we have a lot to be pleased about, including our continued operational improvements, which support our decision to take a non-cash charge for our Olive Branch facility; the $40 million of cash on our balance sheet at quarter end, even after our $25 million bond redemption in September; and the refinancing of our revolving credit facility on more beneficial terms, completed just last week.

These developments clearly show the solid operational and financial foundation we've built for Trex. I can confidently say that Trex's position to execute the strategic launch initiatives mentioned earlier which we expect to have a very big impact on our industry.

At this point, I'll ask Jim Cline to present the details of our third-quarter results, and then I will close with an overview of our new products and strategy.

Thank you, Ron. Good morning, everyone. The press release with our third-quarter and nine-month financial results for 2009 was issued this morning. The numbers I will reference are contained in the tables headed, Condensed Consolidated Statement of Operations, Balance Sheet and Cash Flow.

Third-quarter net sales were $62 million compared to net sales of $85 million in the third quarter of 2008, a decrease of 27%. Economic headwinds continue to negatively impact the repair and remodeling spending, as well as housing starts. In addition, as our distributors prepared for the product changes Ron mentioned, many of them began reducing inventories of the products that will eventually be replaced, which adversely affected third-quarter sales.

The third-quarter net loss of $22.5 million or $1.49 per share. Our results for the third quarter of 2009 include a $23.3 million non-cash charge related to the Olive Branch, Mississippi facility. In addition, we recorded a $7.2 million non-cash inventory charge related to inventory manufactured prior to 2008, which we determined was no longer salable or does not meet our current quality standards.

This inventory charge gave rise to an offsetting favorable LIFO adjustment of $7.4 million, resulting in a net benefit of $200,000. Excluding these non-cash charges, our net income was $600,000 or $0.04 a share.

Our third-quarter 2009 gross margin was 29.8%, a 290 basis point improvement over the third quarter of 2008. Capacity utilization of 25% was down significantly year over year and adversely impacted gross margin by approximately 820 basis points. Reduced sales volume, coupled with our focus on working capital and free cash flow resulted in the lower capacity utilization. We were able to offset the effect of the reduced capacity utilization and improve margins in the quarter as a result of the 2009 price increase and continued optimization of our proprietary manufacturing process.

Our purchase price of Polyethylene material in the third quarter was approximately equal to the second quarter of this year.

Year to date net sales were $221 million compared to $300 million for 2008, a decrease of 26%. Poor macro economic conditions have adversely impacted poultry demand and has resulted in both distributors and dealers operating with leaner inventories, contributing to the year-over-year decline in sales.

Year-to-date net loss was $18.2 million or $1.21 per share compared to net income of $19.1 million or $1.26 per share for 2008. Excluding the previously noted non-cash charges, we had net income of $4.8 million or $0.32 per share.

Year-to-date gross margin was 28.9%, 120 basis point improvement over the same period in 2008. Our capacity utilization of 28% was down significantly from the prior year and adversely impacted gross margin by approximately 710 basis points.

Losses related to the sales of Poly inventory in the first and second quarters reduced year-to-date gross margins by approximately 150 basis points. We were able to offset the negative effects of the reduced capacity utilization and the effect of the Poly sales by the same factors I referenced for the third quarter.

Year-to-date SG&A expenses were $48 million or 21.7% of sales compared to $53 million or 17.6% of sales for the first nine months of 2008. The dollar decrease in SG&A spending was primarily driven by lower personnel-related expenses, branding costs and other general reductions that were partially offset by increased research and development spending.

Year-to-date interest of $11 million was approximately equal to 2008. Our results for the first nine months of 2009 and 2008, included a $5 million and a $4.2 million, respectively, of non-cash interest expense related to convertible bonds. Net interest excluding the non-cash interest related to the convertible bonds declined $900,000, primarily driven by reduced borrowings.

We ended the quarter with $40 million of cash and no borrowing on our line of credit. In addition, in September, we retired the full $25 million of variable rate demand bonds with available cash.

At the end of the third quarter, total net debt was $41.7 million, which represents a $16.9 million reduction from September 30 of 2008. Net debt to total capitalization at September 30, 2009 was 25.4% compared to 28.2% September 30, 2008.

Inventory was $38 million at September 30, 2009, an $11 million or 23% year-over-year decline. We generated free cash flow of $42.8 million in the first nine months of 2009, only $1.7 million less than the 2008 period. The free cash flow results in 2009 have been driven by effective working capital management and lower spending on capital investments.

Capital expenditures for the first nine months of 2009 were $5 million, a $1.2 million reduction compared to 2008.

Our 2009 investment strategy has focused on our strategic objectives, including productivity improvements, cost reduction initiatives and new product introductions. We also completed an upgrade to our ERP and business intelligence systems during the second quarter that provides a more efficient and robust reporting platform to enable more timely decision-making and improve customer service.

Finally, I'd like to highlight several significant achievements that we have accomplished during the first nine months. Our service levels during the first nine months of 2009 have exceeded our target of 95%. We have consistently performed at this high service level, even while continuing to significantly reduce inventory. As mentioned earlier, we operated at 28% capacity utilization in the first nine months of 2009 versus 51% in the 2008 period. This adversely affected gross margin by approximately 710 basis points.

In addition, the effect of the sales of Poly in the first and second quarter reduced margins by an additional 150 basis points. Both of these factors mask the favorable impact of the 2009 price increase and continued operational improvements. Furthermore, both our line rates and yields have continued to improve as a result of ongoing and new process improvements.

While SG&A expenses were lower in the first nine months of 2009, we continue to support the distribution, advertising and branding initiatives that are essential to enhance Trex's exceptional brand recognition. We also spent more on R&D in the first nine months of 2009 than in the last year's period in support of the new products launched. The management team's emphasis on product innovation is one of the core principles to strategically position Trex for the continued market share leadership.

As announced on November 6, we strengthened our liquidity by placing our revolving line of credit with an $85 million revolver, which will provide significantly greater flexibility and availability of capital than the facility it replaced. We have now completed the consolidation of our senior debt, with the replacement of our revolving line of credit, the payoff of our $25 million variable rate demand bonds and the payoff of our $5 million mortgage on our Winchester manufacturing facilities. Ron?

Thank you. First, let's address the productivity improvements in our decision to take a non-cash charge for our Olive Branch facility. Since this management team joined Trex in the first quarter of 2008, we have expanded the capacity at our two operating facilities by roughly 20% through process and productivity improvements. We intend to continue making those improvements. Based on what we have accomplished and the opportunities that we see within our operations, we believe our current productive manufacturing footprint is properly sized to meet our growth objectives.

Now let's turn to a key topic of discussion today, Trex's new product launch. Our R&D group has been working intensely on a new product line since the middle of last year, and I have made reference to this several times. For competitive reasons, we wanted to unveil it as close to the end of 2009 and the start of the new stocking season as possible. Unfortunately, given our 10-Q filing requirements, the timing of this call is still a little too early to give you all new details on the new product launch and why it represents such a big step forward technologically. We want to share that information with our distributors and dealers first. And at the conclusion of this meeting, this phone call, I will be going directly to our distributor meeting. Our annual distributor meeting is held over the next several days, so we will be able to disclose more to the investment community next week.

I am also pleased to announce that we plan to have an analyst day in Winchester in mid-March, at which time we can show you, firsthand, the advantages of our new product.

Another significant development at Trex that I can share with you in detail today is the recent enhancements to our current decking product portfolio. First, we have standardized dimensions throughout all our decking lines from Contours to Accents to Brasilia. For the first time, consumers can mix and match all of our product lines, giving them many more design choices for their decks.

Second, to respond to the growing interest and hidden fastening, all Trex composite decking products now have groove boards to accommodate our hideaway fastening system. We are also launching a new universal hidden fastener that is a lower cost and more efficient fastener than the traditional stainless steel fastener.

Third, Trex is the first to market with smaller bundle packs of decking and fascia. The smaller bundle sizes enable our distributors to stock a broader breadth of Trex product, reduce material handling and bundle all decking products on one truck.

Fourth, we've enhanced the formulation in the deck board to offer better product performance.

Before we turn to Q&A, let's go over our guidance for the current quarter. As you know, sales have been especially difficult to predict this year, given the economic headwinds. The recent product enhancements and near-term new product launch also add uncertainty about the timing of sales as we proceed through the Q4 and enter the 2010 winter buying sales program.

We are projecting net sales in the fourth quarter of 2009 to be approximately $40 million to $45 million.

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

(Operator Instructions). Keith Hughes, SunTrust.

Couple questions. One was the charge at Olive Branch, what type of D&A and other non-cash items will you save as we go into next year as a result of that move?

The reduction will be depreciation, and it's about $2.5 million. Until the facility is put for sale, remaining savings won't be realized. We will continue with all the cash-related expenditures such as taxes, security, et cetera for the near term.

What would be the total amount once the facility is sold or put up for sale that you would save?

Between $4 million and $5 million.

$4 million and $5 million. Okay. You spoke a little bit about the new product launch, but also changes to the current product line. Will we be seeing changes on all the current, existing product line of Trex, or is it just specific SKUs, where you are looking to do things differently?

Essentially, all the product lines will be changing their dimensions in one form or another.

Okay. And is this revolved around aesthetics or performance characteristics, or --?

It revolves around making our products easier for the contractors to install. It provides more design options because different boards from different lines can be mixed and matched. It also provides manufacturing efficiencies.

Okay. The final question with, you talk in the release, business being pushed off a little bit into the fourth quarter. Is that going to change the seasonality at all, the early buy period and that whole thing going into 2010?

No, I don't think it will affect the seasonality. Clearly, people were drawing down inventories in anticipation of the new product design; the new product and the design of the existing products. There have been a lot of jockeying going on, but I think fundamentally, the seasonality will remain intact.

All right. Thank you.

John Baugh, Stifel Nicolaus.

Good morning. My first question was on the inventory charge. Is that a specific product line? Is it multiple product lines? Was it goods that just weren't selling because they weren't popular, or was it damaged? Does it relate at all to the Nevada warranty claim? Any more color there. Thank you.

I'll let Jim get into the specific details, but essentially, this was a lot of product that we had uncovered that had been done at Olive Branch. We got it up at our other locations. We finally broke apart all the bundles to see what was inside. And based on our observation of what was there and the way this inventory had been treated that gave rise to our decision to write it off. That was the lion's share of it. Jim?

Yes, it's primarily the off-line material that was produced prior to 2008, older style Contours material. And basically, over time, because of the storage being outside, we ended up getting a fair amount of staining on the deck boards. And that was the primary driver that we saw. As we got further into the bundles, we just found a much greater percentage than what we had experienced in the prior quarters.

Have we -- your inventories are way down. Have we inspected every bundle to this point? Are there going to be -- obviously future production, you can't predict. But any existing finished product that hasn't "been inspected" at this point?

No. At this point, everything has been inspected.

Okay. And then the new product, when does that start shipping, and what influence does that have in your thinking about fourth-quarter revenue guidance?

Well, it starts shipping on January 2, 2010. With respect to the guidance, as I said, people are anticipating the availability of the new products starting January 2. I do think there is some pressure put on to minimize the product that they have got on the shelf. However, I want to make it clear that we will support our distributors through the coming year by manufacturing the old dimensions if they want to balance their inventory to sell the remaining stock of the old profile. We are doing that because as a matter of policy, we are not going to be taking back any of the old-style inventory. So, to support them, we will continue to make the old-style available on a special order basis for one year.

So your third-quarter revenues were a little light of my expectations. Your fourth quarter is materially above and it more or less cancels each other out. That's all old product, number one?

And then number two, what would explain sort of the more even balance between third-quarter and fourth-quarter shipments?

The thing that's really impacting is, as Ron mentioned before, there is a significant reduction that took place in the third quarter as people began balancing the inventory. We've begun shipping the new design of the existing products, the change in the dimensions, the changes in the packaging that Ron had discussed previously. So we started shipping in October that new dimension, and we anticipate that we will continue to see strong demand on that through the end of the year.

Okay. So the new dimensions are available, the new bundle sizes, all those things are available. It's just the new product launch isn't available till the first quarter of next year.

That's correct.

That's right.

Okay. Thank you for answering my questions.

Jack Kasprzak, BB&T Capital Markets.

Just following up I guess on John's line of questioning. Have the distributors had enough of a look at the new products to give you guys any indication of what their orders or demand might be when you're able to start shipping in January?

Well, to a person, they are very enthusiastic about the new product. They've seen the new product, some of the distributors, as early as July. And they have given us every encouragement to proceed. And they clearly indicate that they're going to be on board.

Now in terms of the specifics, in terms of what they're ordering patterns are going to be, that will start to flesh itself out later this week, so I'm not in a position to talk about it now.

I can tell you though that I've been very carefully testing the acceptance of the new product in a number of different ways. One is with our distributors. Number two is with our focus groups. And number three is with our internal sales folks who have been through product launches before. The level of enthusiasm here is very, very high. And one of the reasons it's high is because this is the first time in a long time in the history of Trex that everything is coming together exactly the way it's supposed to. In other words, sometimes in Trex's history, the product would be ready, but the marketing would not. The marketing would be ready; the sales weren't ready or the production wasn't ready. Or there would be some other aspect of the plan that didn't come together.

At this time, R&D, manufacturing, logistics, our advertising program, the marketing collaterals are all coming together at exactly the same time. Our production runs, which have begun, our right on schedule. The machinery is here. Everything works. And so, I expect it to be a pretty successful launch.

Okay. Thanks. With the balance sheet where it is today, can you give us some guidance on the pace, annual pace of interest expense now?

Well I think basically what you saw in the third quarter would be essentially what you will see going forward. As we look at changes in our marketing programs, I don't see a significant impact to interest going forward on that.

Okay. And SG&A in the quarter was a shade under $14 million, which was lower than what we've seen it in the first couple of quarters of this year. What's going on there? Would we expect it to ramp back up as the new product is actually out? And maybe there's some more marketing spend? Or what color can you give us there?

I think that you can expect that with any major strategic initiative, there has to be some branding expense that goes along with it. So, it would be logical to assume that there will be some increase in our branding expense for a couple of quarters.

Okay, great. Thanks a lot.

Robert Kelly, Sidoti.

Thanks. Good morning. As far as just on the branding expense, you expect that to maybe to click up a little. Do you cut back on your R&D now with the product launch kind of on your (multiple speakers)?

I don't think so. I've got some of the operational people close at hand. And I can assure you that I believe that it's critical for the long-term success of Trex or any company that you've got a solid pipeline of new products coming through the system. And as soon as we put a ribbon on this launch of this product line, the R&D team will be given a new assignment, just like they were given about a year and a half ago. And we intend to keep the product pipeline full.

And then, just as far as the fourth-quarter sales outlook, maybe just a point of clarification. It sounds like the product enhancements or upgrades, for lack of a better word, are impacting 4Q? You've yet to take orders on the what you call ground-breaking product launch? That's a 2010, 1Q 2010 event possibly?

Yes. I think you've got that straight. The current boost in sales for Q4 are with respect to the revised offering of existing products. And the new product, the groundbreaking product, will be a Q1 issue.

And for the past seven or eight quarters here in the two remaining facilities, you've been in inventory liquidation mode. Are you at the point now where you start to click up utilization or are we still in kind of in cut-back mode for the next few quarters?

Jim Cline I think we still have another six months opportunity going through the middle of next year of inventory reduction. So I think you could expect to see that through the middle of next year.

And then what was utilization in the two remaining facilities for 3Q?

For the third quarter, utilization was 25% compared to 48% last year.

And that's excluding Olive Branch, the 25%?

No, that includes Olive Branch. Olive Branch represents about 13% of our capacity. So if you excluded Olive branch, we would be at about 28%.

Okay. Thanks.

John Baugh, Stifel Nicolaus.

Just quickly, will you tell us at this point what you've done with pricing or do we have to wait for the end of the distributor meeting of the 10-Q? When does the 10-Q need to be filed? Thank you.

Well you are right, John; you do have to wait on pricing. I think this would be a wrong time for me to announce pricing over the Internet. But that information will be available shortly. And your question again about the 10-K was what?

10-Q is filed when?

It will be filed later today, and it will not speak to any price increase relative to this year.

Okay. Thank you.

Kenneth Smith, Lenox Equity Research.

Ron, are you intending to have another conference call to talk about the new product line? Or do we have to learn about it some other way?

You have to learn about it some other way. We don't intend to have another conference call, but we will be issuing a plethora of press releases over the next several days. And of course, if those are, if anyone requires additional information, I'm sure that Jim Cline or I would be able to handle individual telephone calls to flesh that out.

Are you at least willing to talk about what the financial characteristics of the new line will be compared to your existing product offering?

No, I don't think we are. I'm not trying to be cute with you, Ken. It's just that we are very competitively astute here.

Okay. All right. Thank you.

(Operator Instructions).

Well, it doesn't look like there are any more questions, so let me just close by saying that I am extraordinarily excited on a personal level. I've made allusions to the fact that we are working hard in our R&D department for the last year and a half toward a goal. In my view, the R&D department has achieved the goal, and I can't wait to get on this airplane to get to our distributors and unveil this whole program.

Everything is starting to fit together in terms of the mission of this management team at Trex, and we are on the cusp of the invasion. We look forward to the morning.

I would also like to take note of the fact that I want to pay tribute to my colleagues here at Trex. These men and women have done an extraordinary job. They've had unwavering professionalism, exhibited extraordinary competency and enthusiasm. They've been a pleasure to work with.

And ladies and gentlemen, well, as they say, I will see you on the beach. So thank you very much to everyone who has been involved. And from here we go to our distributors and we will spread the enthusiasm down the line. Thank you.

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