Trex Company Inc (TREX) 2012 Q2 法說會逐字稿

Welcome to the Trex Company second quarter 2012 conference call. At this time, all participants are in a listen-only mode. Following management's prepared remarks, we will hold a Q&A session. (Operator Instructions). As a reminder, this conference is being recorded today, July 26, 2012. I would now like to turn the conference over to you, Harriet Fried of LHA. Please go ahead ma'am.

Thank you everyone for joining us today. With us on the call are Ron Kaplan, Chairman, 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 second quarter of 2012. 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. Bill?

Thank you, Harriet. Before we begin, let me remind everyone that statements on this call regarding the Company's expected future performance and conditions 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.

Documents filed with the Securities and Exchange Commission by the Company, including in particular its latest Annual Report on Form 10-K and quarterly reports on Form 10-Q 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. To supplement the Company's consolidated financial statement, the Company is using certain non-GAAP financial measures in today's conference call. A reconciliation of these financial measures to GAAP is attached at the end of the Company's press release in two tables titled Reconciliations of Pro-Forma Results of Operations Measures to the Nearest Comparable GAAP Measures Three Months Ended June 30, 2012 and Reconciliations of Pro-Forma Results of Operations Measures to the Nearest Comparable GAAP Measures Six Months Ended June 30, 2012.

With that introduction, I'll turn the call over to Ron Kaplan.

Good morning everyone and thanks for joining our second quarter update. Our 20% of revenue growth and $6.2 million increase in net income reflect the successful execution of our comprehensive growth strategy. Even though the economy continues to present challenges, we exceeded our revenue target and continued to advance our industry-leading market share.

Today it is even more evident that Trex is leading the market's transition to ultra-low-maintenance products offering great aesthetics and superior performance. In 2010, we pioneered the shell composite deck board with the launch of Trex Transcend, which continues to be a significant driver of our sales. It's complemented by Accents and Enhance, which together fuels a full range in decking boards and make up our good, better, best decking platform strategy.

We have utilized the Transcend technology to expand our ultra-low-maintenance product offering, which also includes Trex Porch. These products combined with our railing platform TrexTrim and accessory products like Lighting and Trex Elevations Steel substructure that put us at the forefront of redefining what it means to create the outdoor ultimate living space.

In past calls, I've talked about our emphasis on improving profitability through manufacturing and productivity initiatives. We continued to make strides in this area, reaching an underlying gross margin of 37% in the second quarter. This represents a 680 basis point year-over-year increase. I am proud to say we've increased productivity 30% in last 4.5 years.

And we continue to expand our international presence. Including North America, Trex's global footprint now encompasses 26 countries. Despite the global economic headwinds, we've seen growth in sales and believe this is a very promising platform for continued development. We just hired another international sales manager who was in Germany and we'll focus on developing approved channel network of dealers and contractors in Europe, in the Middle East, both important elements for increasing our presence overseas.

We recently paid off $92 million principal balance on our convertible notes using $67 million of existing cash and $25 million from our revolving credit facility. In total, we reduced the Company's debt by $109 million since 2008 dramatically strengthening the Company's financial position. Our net debt-to-capital ratio stands at 15% and our cash conversion cycle this year has decreased by 25 days, a testament to our focus on cash management. Obviously, the stronger balance sheet gives us more flexibility to manage our business and pursue our growth strategy.

We continue to invest in R&D to broaden our product platform and appeal to an even wider range of buyers. As an example, our newest Transcend color Rope Swing was designed for hot weather markets like Florida and Texas where people prefer lighter colors. It's been a big hit in those areas and the coordinating railing has also been very successful. We think that railing provides additional opportunities to increase sales. We want to continue leading the innovation in this category and we want to give people as many design options as possible, so they can think outside of the rectangle and use Trex to design customized outdoor living spaces.

To that end, we recently introduced an iPad application that provides a deck Color Visualizer Tool to help homeowners plan their outdoor living spaces. The app allows people to experiment with color combinations, save their design and ideas and email them to family, friends and contractors. So it's a great way to make it easier for our customers to create their ideal outdoor living space. Brand equity is one of our most vital assets. We continue to look at ways to expand our reach efficiently.

In preparation for next year's building season, we've conducted an extensive review of our branding activities. We recently completed a customer segmentation study that provided a lot of insightful information to help guide our marketing efforts for 2013 and beyond. Our goal is to get even smarter by our audience and market dynamics and engage customers as they go through the decision making process.

In summary, it's been a very productive quarter and year for Trex. In the last six months, underlying gross margin was 37% while capacity utilization has been under 40%. Inventory has been reduced $15 million and free cash flow exceeded $33 million. Our plants are operating efficiently. We continue to execute well on our market share initiatives and our new product development continues to be robust. For the third quarter, we expect sales to continue to be strong and are projecting net sales of approximately $70 million. With that, I'll turn the call over to Jim Cline to provide more details on our financial results. Jim?

Thank you, Ron. Good morning, everyone. As you know, the press release with Trex's second quarter and year-to-date financial results was issued this morning. First, I'd like to review our second quarter financial results. The Company recognized net sales of $94.3 million in the second quarter of 2012, a 20% increase compared to 2011. The increase in net sales was driven by a 23% increase in sales volume. We continue to advance our market share, due in part to our expanding product portfolio. Weather conditions in 2012 have been significantly better than 2011 and has resulted in a more normal beginning to the deck building season.

The Company recorded net income of $8.3 million or $0.48 per share in the second quarter of 2012. The Company's results for the second quarter 2012 include $1.8 million of charges, consisting of $1.1 million increase to the warranty reserves and a $700,000 increase for severance charges. Before giving effect to these charges, net income was $10.1 million or $0.59 per share compared to net income of $2.1 million or $0.12 per share in 2011.

Gross margin was 35.6% in the second quarter of 2012, a 560 basis point improvement from 2011. The gross profit in the quarter was adversely affected by the warranty charge. Excluding this charge, the underlying gross margin increased by 680 basis points. Increase in gross margin was primarily due to continued improvements in manufacturing efficiencies and to a lesser extent reduced discounts and a shift in sales mix towards our ultra-low maintenance shelled products. This improvement was offset by start-up costs associated with our shelled products of $800,000.

SG&A for the second quarter of 2012 was $20.9 million compared to $17.4 million in 2011. The second quarter of 2012 included the severance charge previously mentioned. Excluding this charge, the increase of $2.8 million in SG&A expense was primarily related to an increase in personnel related expenses including incentive compensation and sales commissions.

Net interest was $4.3 million in the quarter, a $300,000 increase from 2011. The Company's results in the second quarter of 2012 and 2011 included $2.7 million and $2.3 million of non-cash interest respectively related to the convertible bonds. For the first six months of 2012, net sales were $190.4 million compared to net sales of $147.4 million for 2011, an increase of 29%. The increase in net sales was attributable to a 29% increase in sales volume. The same factors that influenced our second quarter sales volume favorably impacted our six-month sales.

In addition, we have explained in past calls, sales volumes in the first six months of 2011 were depressed as a result of customers purchasing products in late 2010 to avoid an announced 2011 Transcend price increase. The Company recorded net income of $20.7 million or $1.22 per share in the first six months of 2012 compared to net income of $7.2 million or $0.42 per share in 2011.

Company's results in the first six months of 2012 include $2.2 million of charges, consisting of $1.5 million related to an increase to the warranty reserves and $700,000 of severance charges. The Company's results for the first six months of 2011 included a favorable resolution of uncertain tax positions in the first quarter that positively impacted income taxes by $2.6 million.

Before giving effect to these items, net income for 2012 was $22.8 million or $1.34 per share compared to net income for the first six months of 2011 of $4.6 million or $0.27 per share. Gross profit was 36.2% in the first six months of 2012, a 460 basis point improvement from 2011. Gross profit in the first six months of 2012 was adversely affected by the warranty charge. Excluding the warranty charge, underlying gross margin increased by 540 basis points to 37%.

The increase in gross margin was primarily due to manufacturing efficiency improvements and to a lesser extent a shift in sales mix towards our ultra-low-maintenance shelled products. SG&A for the first six months of 2012 was $39.5 million compared to $34 million in 2011. SG&A in 2012 included a severance charge previously mentioned. Excluding this charge, the increase of $4.8 million in SG&A expenses was primarily related to an increase in personnel related expenses including incentive compensation and sales commissions.

Net interest was $8.7 million for the first six months of 2012, a $700,000 increase from 2011. The Company's results for the first six months of 2012 and 2011 include $5.5 million and $4.6 million of non-cash interest related to the convertible bonds. Effective income tax rate for the first six months of 2012 remain low as a result of the valuation allowance against the deferred tax asset. In 2011 it included $2.6 million of favorable non-cash adjustment to taxes that was previously mentioned.

At June 30, 2012, the Company had $96.5 million of cash on hand. Our debt at June 30 was $116.9 million, consisting of our revolver borrowings of $25 million and $91.9 million of convertible notes that were repaid on July 2nd of 2012. Net debt-to-total capitalization at June 30 of 2012 was 15% compared to 38% at June 30, 2011. Since January of 2008, we have reduced our debt by $109 million.

Inventory was $13.4 million at June 30, 2012, a $25.6 million year-over-year decrease. Cash flow from operating activities for the first six months of 2012 was $35.9 million compared to $3.3 million for 2011. The $32.7 million increase in cash flow from operating activities was primarily related to higher net income and the reduction in working capital. Cash used in investing activities totaled $2.9 million in 2012 compared to cash used in investing activities of $6.8 million in 2011. Free cash flow of $33 million was $36.6 million higher than the first half of 2011.

Finally, turning to our guidance for the third quarter. We believe that the start-up costs associated with our [CAP] products are now behind us. And our inventory is now in a seasonally normal level. We expect capacity utilization will be similar to the third quarter of 2011.

SG&A expenses are expected to be approximately $3 million lower than the second quarter of 2012. The impact of paying off the convertible debt will be to significantly reduce our interest expense beginning in the second half of 2012. We expect the reduction in interest expense to be over $7.6 million compared to the second half of 2011. Operator, we'd now like to open the call up for questions after which Ron will provide his closing statement.

(Operator Instructions) Trey Grooms, Stephens Incorporated.

Hey, good morning, guys.

Good Morning, Trey.

Good Morning, Trey.

First, Jim, just on the comment from just a few minutes ago. So 3Q utilization is similar to last year's 3Q. Could you remind us what that was?

Yes, the third quarter of last year was roughly 21%.

Okay. So we're going to be about that same level. Is that what you said?

That's correct.

Okay. And then also on the SG&A, so that implies SG&A is going to be up, you know, quite a bit, I guess, from the 3Q '11 period. Is that all kind of related to those personnel expenses that you were talking about or is there anything else going on there?

It's primarily personnel related expense plus branding.

Okay. So you guys had some branding expense or ad spend that you guided to in the second quarter. So did some of that kind of leak in, I guess, into the third quarter or is this just kind of typical?

Some of it moves into the third quarter. Our overall branding spend will be up year-over-year.

Okay. And on the financials here, the non-cash interest that's going to be going away with the elimination of the convert, the debt discount amortization there, you said I think was about $2.7 million in the second quarter. Was that correct?

Yes.

Okay. So going forward, we would expect D&A then should be running kind of in the $4.3 million to $4.4 million range per quarter, I guess, maybe $17 million to $17.5 million annually.

That's correct.

Okay, perfect. And then also just on the -- could you give us, Ron, maybe the initial kind of acceptance of the Enhance line, what that's been here kind of in the early stages?

Yes, we have been pleased with it so far. We are in the early stages, but the adoption rate has been consistent with our expectations. So, clearly we're moving toward a shell technology world.

Okay. Well, thanks a lot guys. Keep up the good work. Good luck.

Thank you.

Thank you.

Keith Hughes, SunTrust.

Thank you. Your comments on the capacity utilization in the third quarter low-20s. It's a pretty big deceleration from what, I think, we saw here in the second. Are you seeing orders slow down? I mean your inventory was very low as we exited the second quarter.

Well, we're exceptionally good now at the [way rate at] which we can change over our production lines between colors and products. So, our efficiency enables us to operate in a very lean fashion. Our orders are adequate enough to support our $70 million forecast. So there's a lot of different variables are going to our forecast, but we're comfortable with our forecast as we sit here today.

If you look towards next year, will we be seeing a significant product introduction for next year?

Well we'll make that decision in October. We do have some things under consideration and we won't make final decisions about major product introductions until October.

I guess, finally, as you head into next year, it appears you would be debt free or close to debt free. Future uses of cash flow, where do you think those would [go]?

Well, we have a number of options available to us. These are not necessarily in orders of preference or sequence, but R&D is something that is proven to be very worthwhile for us. I don't have any big capital expansion programs in mind, but clearly our stock buybacks or dividends, our options as well, as well as an enhanced, more aggressive view of acquisitions.

Okay, thank you.

John Baugh, Stifel Nicolaus.

Good Morning Ron and Jim.

Good Morning John.

Gross margin John.

Could you give some color around your mix of sales, how much is deck boards, how much is railing, how much is Trim? Just any kind of trends in those businesses, et cetera.

Well, it's mostly deck boards. Our railing, as a percentage of sales, was higher now than it was four years ago. We've introduced Elevations, which obviously was zero couple of years ago. We're not going to give numbers. We can't tell you that obviously Elevations is increasing as a percentage of sales. I can tell you that international is increasing as a percentage of sales. I can tell you that railing and lighting have increased as a percentage of sales, but deck boards are still predominant. I can tell you that within our decking, shell product has grown extraordinarily rapidly as a percentage of our total decking sales. And that Trim continues to grow as a percentage of our sales. That's about as much color. I know you'd like more granularity John, I know you are frustrated.

That's okay. Would you comment on all of these other products you had touched on in terms of the influence on positively or negatively on gross margin or EBIT margin?

No.

Okay. That's a [six feet] answer.

I am an operations guy. I use short sentences.

Good. You mentioned this brand review and then you've mentioned branding is going to be up. I guess I am curious, I think the branding event being up was decided earlier in the year, maybe I'm wrong on that. And then what have you learned from the brand review and what are your thoughts about spending in that area, not just the balance of this year, but next year.

Well, I would say that branding is going to be a little bit more than it has been in the past because we're prosecuting new markets and new products. When you prosecute a new market and new products you got to put some bread on the water to get it launched, but it's proving to have a pretty good pay back so far. We have performed this market study that I've referenced.

I am not going to tell you exactly what it says, but I can tell you that it helped us modify our view of who our customers really are, there were some revelations in there. I am not going to describe what they were, but it will help us more accurately use our rifle shot to target our market than we have in the past. Well, I think I was very impressed with the level of science, data collection and statistical analysis that went into the study and I'm very satisfied that the study and the resulting learnings that coming out of the study will more accurately define how we spend that brand money.

And Ron on that topic, I mean you have sort of multiple customers, you got a distributor, you got a dealer, and you got a consumer, a contractor really. Any thoughts on, you know, when you talk about targeting your customer, those four choices, it would seem like if you're increasing branding you're going more at the consumer, or am I misreading that?

Well, there is only one real customer at the end of the day and the customer is the homeowner. Everybody else in the food chain, you know makes money off the Trex transaction. Any person that doesn't make money is the homeowner who parts with his money and end up with beautiful Trex Deck. So clearly, one thing remains unchanged is we want every consumer in America asking for Trex and we want every contractor recommending Trex. The battle is fought and won or lost at the kitchen table. That remains integral to our core focus.

Okay. And then my last question is back to the wonderful topic of the warranty, you know, about $400,000 in 1Q, now we go to $1.1 million in Q2. Refresh my memory again on the methodology of estimate or what are the accounts make you do or that number just keeps coming and keeps coming, you know, it's hard for us to get our arms around where that process is. Thank you.

Well, you've got a lot of editorial remarks in there, John. I was going to let our remarks stand by themselves. Jim lives and breathes this analysis on a quarterly basis, so I will let him respond to some of your questions.

John, basically we look at the statistics of claims and the cash being paid out. As we mentioned last year, we're going to look at this on a quarterly basis. We'll make adjustments where we see it's appropriate. Claims continued to decline. We anticipate the cash payments for the year will be lower than we anticipated, but based on the way the claims came in, we felt it was appropriate to make both of those adjustments to the warranty reserve.

What would the cash number be for '12, Jim?

I'm not prepared to release that number other than to say we anticipate it will be lower than the $8 million we had last year.

Great. Thank you.

Thank you.

Morris Ajzenman, Griffin Securities.

Good morning, guys.

Good morning Morris.

Good morning.

Hey, question for Ron. You know we reference market share and in your slide presentation that you had online here, if you go to 2010 is showing your market share at 35% relative to all the others there and they have kind of trended down a little except for Fiberon. But anyhow, I think you've also said in the past calls you have a target, and correct me if I am wrong. Exiting 2012, I think you had said 50% market share. Maybe I'm misquoting you, but can you give us any update to that slide that goes to 2010, where you think your market share is currently?

Yeah, there is a couple of points. It's a good question Morris and let me hit a few of the different points. I did say that it was our internal goal of achieving 50% market share by the end of 2012. We certainly have moved north. We don't have firm numbers yet for 2011. We expect that that will be published sometime in Q4. [By principal], we'll wait and see what they have to show. But my personal guess is that they are somewhere between 35% and 40%. So they continue to move north whether we hit our 40% internal goal by the end of 2012, a history of 50% goal by the end of 2012. History will tell us what we have done. But we continue to move north in that regard. What else Morris did you have in your question?

Yeah. Different question this time for Jim. In your remarks, I was [figuring] a lot of numbers here, you gave us some sort of guidance for some items, the third quarter capacity utilization, SG&A, interest expense been down, did you touch on gross margins at all for third quarter?

I didn't describe the gross margins more so the relative information on gross margin is one we believe that the $800,000 of start-up costs associated with [CAP] products that occurred in the second quarter will not continue into the third. Typically the calculation we use internally is for every change in sales dollar up or down, it'll be a $0.50 change to the gross profit line in addition for every change of 1% of capacity utilization on a quarterly basis, up or down, that would be about a $200,000 impact on gross profit. So I think with that information you can very closely estimate what we anticipate the gross profit to be.

Okay. And [we'll run towards] calculations. The last year you had $68 million of revenues, 25.4% gross margin. You're going to $70 million. We can run on the numbers here, but should we be north of 25.4%.

I would certainly expect that.

Okay. And very last question. Going forward, it looks like interest expense is going to be virtually nil, [one for] $20,000 per quarter. Is that correct?

Exactly right.

Okay. Actually one last question. Yes. What do you see as outstanding going forward $17 million or $17.2 million?

$17.1 million roughly.

Okay, guys. Thank you.

Thank you.

Thank you.

Robert Kelly with Sidoti.

Could you just, I missed it. The capacity utilization during 2Q, we got the first path around about what was the number in Q2. 39% you, which is roughly the same as last year.

Okay, thanks.

Okay, thanks. As far as your cash balances post the convertible payoff, could you just give us an update where you are with your cash reserves?

Cash on hand has expanded since the end of June roughly at $10 million.

So that's why you have post the [convert] path?

Yes.

And then you instill revolver borrowings?

$25 million.

Okay great.

I'm sorry, correction, $18 million.

$18 million. So, just based on the first half cash flow, I know things slow down seasonally in the second half of the year here, but it's going to be a big free cash flow year. Do you end the year with a net cash position?

We anticipate it will be a net debt, you'll see an improvement. We expect an improvement in the third quarter. And then as we started building inventory for the first quarter, we'll have cash out occurring at that point.

Got you. In past quarters you talked amount CapEx being mid-teens million for 2012? Is that still the goal?

$10 million to $15 million would be the range.

Yes, so what will you be spending on the second half to get to that $10 million to $15 million range?

The focus of our capital spend is retrofitting certain of our lines to expand our shelled product capacity, new product introduction and cost reductions. There's no bricks and mortar. It's all focused on profit enhancement.

Understood. And then just, someone asked about the market share. Could you just talk about the competitive landscape at this point?

The competitive landscape we -- Trex has more than doubled the market share of its next closest competitor, there's three companies that are really sort of tied for number 2, between Fiberon, Azek and TimberTech. And then below that there is another half dozen or so competitors that sort of nibble around the edges who have single digits, low single-digit market shares. So no real blockbuster changes in the competitive landscape. There's no international penetration of our domestic markets to speak of. That would be 10,000 foot view.

If you could, I mean 30% growth in the first half is beyond what the markets doing is my guess. Where is the share shift happening?

Well, as I said earlier, I think we're gaining some market share.

Is it coming from your number 2, the [three folks type for] number 2, or is it from the bottom deck?

We think it's coming from all the above.

Okay. Fair enough. Thanks guys.

There may be couple of folks in there that are moving ahead and some are moving behind, but I can't really speak incisively about -- we've a lot of granularity about which guys are moving ahead, and which guys are falling behind. We think we were taking it across the board from what we can tell.

Thank you.

Thank you.

Paul Betz, BB&T Capital Markets.

Hi, good morning guys. You said utilization rates were similar during the quarter to last year and you kind of expect Q3 to be similar to last year's Q3. You have that formula about 1% capacity. But I guess other things are involved, like your manufacturing and productivity initiatives that made you have almost 680 basis point increase in gross margins. So I guess that 680 did come off from the initiatives that you guys did.

Not all of it, one of the things that you need to look at is the sales in 2011 for the second quarter was only $78 million. So the increase in sales revenue for the quarter of roughly $16 million would have put $8 million of additional profit into the quarter of 2012.

Okay.

And that would be a large piece of it, but the productivity would have been the additional primary driver.

And you've done a good job of reducing your inventory levels. Do you have any feel of what your distributor inventory levels are?

Yes, six out of the nine major distributors have lower inventory now than they did a year ago.

And is that attributed to your quick turnaround time or --?

No, it's attributable to the fact that the sell through rate has been brisk.

Okay. All right, that's it. Thank you very much.

Thank you.

Thank you.

That's all the time we have today. Mr. Kaplan, please proceed with your presentation or any closing remarks.

Thank you. Couple of points I'd like to make. It's always a little bit challenging to balance the desire that I've got to be responsive to the folks who were asking the questions versus the fact that I've got competitors listening to this call. So I wish I could be more responsive and not give short answers to very thoughtful questions that you guys posed to us. But I'm reminded that looking at my screen that I got competitors listening, that's the reason that I am a little bit [breezed] on times in the responses that I give.

Secondly, this last few weeks have been extraordinarily gratifying to us here at Trex, and me personally. When we paid off that convertible debt that was an extraordinary pivot point for Trex. If you look at where we were 4.5 years ago to where we are now, we've vastly reduced the inventory. We transformed the technology in the industry. We generated over $100 million of cash flow. We had game changing products and technology. We've expanded our markets internationally.

And the last major hurdle to deal with issues of the past was to pay off that debt. This really gives Trex some running room and all of these things didn't happen because of one or two smart people. They happened because this organization is filled with smart, motivated people from the top floor to the shop floor and I know a lot of them are listening to me right now and I wanted to make them aware that their work is appreciated and to make sure that you guys in the analyst community appreciate the fact that this Company does have a strategic advantage and that's its people. I'm very proud of them.

Well, thanks very much for joining us this morning. It's been a productive period for Trex with our improvement in sales, margins and cash management. We're going to continue to execute on our market share initiatives and new product development efforts. So enjoy the rest of the summer and I look forward to talking to you soon. Goodbye.

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