Trex Company Inc (TREX) 2013 Q3 法說會逐字稿

Welcome to the Trex third-quarter 2013 earnings conference call.

(Operator Instructions)

As a reminder, this conference is being recorded, October 25, 2013. 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, Chairman, President, and Chief Executive Officer; and Jim Cline, Senior Vice President and Chief Financial Officer. Joining Ron and Jim are Brad McDonald, Controller; Brian Bertaux, Director of Financial Planning and Analysis; and Bill Gupp, Chief Administrative Officer, General Counsel and Secretary.

The Company issued a press release this morning containing financial results for the third-quarter of 2013. 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 would now like to turn the call over to Bill Gupp. 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 federal securities law. These statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those expressed in the forward-looking statements. For a discussion of such risks and uncertainties, please see our most recent form 10-K and form 10-Qs, as well as our 1933 and other 1934 Act filings on file with the SEC. 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 statements, the Company is using certain non-GAAP financial measures in today's conference call. A reconciliation of these financial measures to GAAP is provided in the tables at the end of this morning's press release. With that introduction, I will turn the call over to Ron Kaplan.

Good morning. I'll start with an overview of our third-quarter financial results and then give you an update on our strategic initiatives. We have taken significant steps in the past few months to grow our sales. Some of these steps required non-cash charges to be recognized in the third quarter. The sales growth will be clearly evident next year.

Consumers continue to be enthusiastic with our recent product launches. This enthusiasm resulted in exceeding our sales guidance and prior year for the third quarter on an underlying basis.

In 2010 we launched innovative high-performance Transcend decking and railing products lines. This innovation elevated homeowners' expectations with regards to the performance and design of wood alternative products.

We pride ourselves on being responsive to changes in the marketplace. Accordingly, we introduced a full platform of high-performance products with the highest level of combined fade, scratch and stain resistance ever seen in the industry. This year we also expanded our product offering to include entrance into the combined $315 million hollow vinyl and aluminum railing markets.

Moving forward, we will only offer our comprehensive and innovative high-performance decking and railing products. We have also adjusted our pricing to optimize our value proposition. As a result, we will start to move the needle on achieving our market share goals.

In just the last month we added three major East Coast distributors, significantly increasing our presence in a strategically important region. We continue to expand share in all of our markets. Consumers are viewing Trex as the premium manufacturer of wood alternative outdoor living products as the market continues to consolidate.

Now, I realize that all of you would like to more fully understand the specifics related to each of the changes that are occurring within our distribution footprint. I am also sure that you will understand our need to be mindful of the competitive nature of this information, and our commitment to confidentiality precludes a more detailed point-by-point breakdown.

Based on the recent market share wins, we expect this element of our strategy to grow sales in 2014 by $40 million to $60 million. As with all major changes of this kind, the maximum benefit usually takes two to three years to be fully realized. Therefore, we expect market expansion from these recent initiatives to continue over the next three years.

We started utilizing our excess cash to return capital to our shareholders. During the third quarter we completed the first share repurchase program in the Company's history, providing a $25 million return to shareholders. As we announced this morning, we are moving forward a new $30 million share repurchase program. We will continue to convey the other options to optimize our capital structure and reward shareholders for their investment in Trex.

I'll close my section with outlook for the fourth quarter. We're expecting net sales for the fourth quarter to be approximately $50 million, which represents a gain of nearly 9% over last year's period. Jim?

Thank you, Ron, good morning. The press release containing our third-quarter financial results was issued this morning. The Company recognized net sales of $72 million in the third quarter of 2013, a 2% increase compared to 2012.

The increase in sales in the quarter was primarily due to a shift in sales mix towards our high-performance decking and railing products, including our recently launched Reveal aluminum and Select railing products. This was partially offset by a decrease in sales volume and a $1.8 million charge related to market share expansion, and the reset of prices for certain products as we transition to our second-generation product offering.

The Company recorded a net loss of $15.3 million or $0.91 per share in the third quarter of 2013, compared to a net loss of $14.3 million or $0.86 per share in 2012. The Company's results for the 2013 quarter included $22.9 million of charges consisting of the $1.8 million charge against net sales or sales expansion opportunities, a $20 million increase to the warranty reserve and a $1.1 million charge for a sublease exposure related to the 2005 planned relocation of our headquarters to Dulles, Virginia. The Company's results for the third quarter of 2012 included a $20 million increase to the warranty reserve.

Before giving effect to these charges, the 2013 net income was $7.7 million, or $0.45 per share. And the 2012 net income was $6.1 million or $0.36 per share. Excluding the charges just mentioned, gross margin was 29.6% in the third quarter of 2013, a 170 basis point decrease from the 2012 quarter. Favorable inventory adjustments in the 2012 quarter included the recognition of a LIFO inventory liquidation benefit which contributed 140 basis points to the underlying gross margin.

SG&A, excluding the $1.1 million sublease exposure identified previously, is $14.2 million in the third quarter of 2013, compared to $15.8 million in the 2012 quarter. The decrease was primarily due to lower incentive compensation. As a percentage of net sales, underlying SG&A expense for the 2013 quarter was 19%, compared to 22% in 2012.

Our 2013 year-to-date financial performance showed considerable improvement compared to the first nine months of 2012. Net sales for the 2013 nine-month period was $279 million, a 7% increase. Our sales were positively influenced by the launch of three new product lines during the year. It rounded out good, better, best high-performance decking and railing platforms.

Our gross margin, excluding the charges previously discussed of 35.9%, was 40 basis points better than the year-to-date 2012 gross margin. Lower sales-related costs in 2013 were partially offset by favorable inventory adjustments, including the recognition of the LIFO inventory liquidation benefit in the 2012 nine-month period.

Excluding the charges just noted, net income for the nine-month period also showed significant improvement. Year-to-date net income was $45 million or $2.57 per share. This compares favorably to the 2012 net income of $29 million or $1.70 per share for the first nine months of 2012.

We generated $44 million of free cash flow in the first nine months of 2013, compared to $55 million in 2012. The $10 million reduction of free cash flow was primarily driven by increased capital expenditures to support our cost reduction and growth strategies, and a lower reduction in inventory in 2013 compared to 2012. This was partially offset by a favorable timing of accounts receivable collections in 2013.

At September 30, 2013, the Company had no outstanding debt and $20 million of cash on hand. As Ron mentioned, our guidance for the fourth quarter is for sales of $50 million, an increase of 9% over 2012. SG&A expenses will be down about $2 million compared to the fourth quarter of 2012, due primarily to reduced incentive compensation.

As Ron mentioned previously, we expect sales in all markets will grow significantly in 2014 over 2013. This market share growth is in addition to market share growth from improving market conditions, normal market share growth as we have experienced over the last couple of years, the impact of changing prices and international sales growth.

To assist you in modeling for 2014, we estimate that the variable margin that we expect to realize on increased sales will be approximately 45%. SG&A should be no more than the SG&A expenses in 2013. Operator, we would now like to open the call up for questions, after which Ron will provide his closing statements.

(Operator Instructions)

Our first question is from Jack Kasprzak, BB&T.

Good morning, everyone.

Jack.

Congratulations on the results. With regard to the comment on pricing for next year, how should we think about that? Is that coming about from the new products that are higher-priced, so on a comparison basis you're getting that benefit? Or are there same-on-same price increases? Is there a way to break that down?

I can only tell you that due to very careful market research, some prices we decided to go up and some to go down. Some of it is attributable to existing products and some to new products. All of the products in our portfolio were analyzed. There were lots of changes but they go in both directions.

Okay. The new distribution relationships or agreements and the comment on the $40 million to $60 million of incremental revenue, I think that's the first time you guys have quantified it. It is obviously material. What is happening out there? Are these bigger companies that you are forging relationships with now who, because of the revamp of the product line, it's more desirable to them? How many of these types of announcements are potentially out there?

Well, I'm not going to put a number on how many are out there. I will tell you that the probability is greater than zero that there will be more. That is as far as I'm going to go with that. The people making the changes are largely coming to us because of what we have done with Trex over the past several years. They like what they see. They compared the alternatives. And if we find that it's in our mutual interest to make this change, it's good for the distributor and it's good for us, we make the change. It is a very rigorous analysis because we don't believe in change for the sake of change. It's got to be a wealth-creating venture for all parties involved.

Fair enough. But again, Ron, the sales value here is obviously material. Are they just -- are you impacting bigger potential customers here? Or with the new product launch? Is it something else happening in the marketplace? Or is this --?

I would say that it's wider and deeper market coverage.

Okay. Fair enough. Thanks a lot.

Thank you.

Our next question is from Keith Hughes with SunTrust. Please go ahead with your question.

Yes. My question, talking about 2014 and with that revenue growth. Are you saying that the SG&A dollars will be flat year-over-year associated with these or just as a percentage of sales?

The dollars.

The dollars will be flat. With adding this much in terms of revenue, just from effectively market share gains, why isn't there any sort of SG&A add to that?

Typically, the SG&A, we would normally see about a 5% growth for increased sales. Also each year the Board resets objectives for management, and the reset for management will reduce our anticipated incentive compensation expense for next year. We have also identified cost reduction opportunities that we are going to avail ourselves of.

And the gross margin for this additional revenue, is it roughly similar to what we've seen from Trex historically?

What we have communicated is for the incremental sales that you build in your model for next year, you ought to assume that the variable contribution from those sales would be about 45%.

And final question, we've seen the public announcements of the distributor adds over the last several weeks. In addition to those, is there something else helping to drive this $40 million to $60 million incremental business?

I will just say that if you go back to my earlier comments, that we continue to prosecute a strategy of market share penetration across all market categories. And beyond that I'm not going to comment.

Okay. Thank you.

Our next question is from Trey Grooms with Stephens, Inc. Please go ahead with your question.

Hey, good morning, guys.

Good morning, Trey.

I guess one other way to ask this, surrounding these expansion strategies that you are laying out here, and I understand the need to be careful. I totally understand that. But you mentioned wider and deeper in all market categories. With, obviously, the few distributors you got is one. Through the quarter, we can see that. In addition to that, is there any -- does this include any new distribution channels for Trex? Or is it going wider and deeper into your existing type of distribution that you historically have had?

I would say that it is wider and deeper in the historical channels that we have had. There are no channels out there that we don't participate in to some degree or another.

Yes, I guess maybe another way to put it would be to, are you expanding into a new channel, not necessarily new, but getting deeper and wider into one particular channel that you are in? Or is it a spread against or amongst everything you are currently in, is a way to ask it?

Yes. You guys can keep asking me the same question as many different ways as you want. (laughter) I don't have anything further to say.

Okay, all right. Fair enough. Looking at the expanded support for business partners, what do you mean by that exactly, Ron? You mentioned that in the press release as one of the things that were going hand-in-hand with the revamped pricing strategy, I believe.

Certainly. As we are introducing new products, certainly the requirement to properly merchandise those products across our spectrum with our new distribution partners. Obviously, we need to supply them the tools to be able to effectively sell the new products we have introduced. It really goes across all of the new customers plus most of our existing. We need to push deeper into the dealer channel and make sure both dealers, as well as the contractors, have the right tools to be able to support the product offering.

Got you. Okay. And then the incremental gross margin guidance that you gave, Jim, what's the -- we were at the 50% range, and now we are at the 45% range, which is still obviously very good. Is it more a product mix shift that is changing that in your expectations going forward? Is it more one product going through one channel as opposed to the other? What is the difference there in what we had been seeing? Or your historic guidance on that versus now what we are looking at in 2014?

Trey, we have made some significant changes in the pricing on various classes of products. Some of them down, some of them up. Trex is committed to participating in all the markets on a very active basis. Some of those changes will put pressure on margin percent. But also with that comes growth opportunity. We gave you the 45% in recognition of those pricing change implications so that as you go forward, you are clearly recognizing we are making a change in that regard.

Okay. And my last question is, with all of these changes that you are making, looking at customer concentration, do you guys foresee having to disclose a major customer that would be new and over 10% of your total sales?

We don't at this point.

Okay. That is what I needed. Thanks guys and good luck and great work.

Thank you.

Our next question is from John Baugh with Stifel. Please go ahead with your question.

Good morning Ron, Jim. Quickly, I will get more direct. Is there a home center channel assumption in this $40 million to $60 million for next year?

I'm not going to waver from the position I have taken. We're not going to get into more details about which channels of distributions we are winning in. But just to say, I don't mean to be glib or smart with you, John, I know the nature of your question. I know why you want to know it. We are in a very competitive environment, a lot of sensitivities. We're just not going to get into it.

Okay. On the three distributors you have announced in the Northeast, you've obviously got coverage in the Northeast already. I know you have said you are going to go wider and deeper. Is there any sense, though, how much of the $40 million to $60 million relates to these three? Or any kind of help on how meaningful these three might be for next year?

John, we know exactly what we believe the implications are going to be. But as Ron mentioned, we aren't going to bifurcate this down into an individual accumulation of each company's sales. They are all significant in their markets. They are all strong players in their market. We are happy to have them as part of the Trex distribution team.

Okay. And then historically you've only given a quarter out revenue, and now you go out basically a full year. Is the assumption, Jim, Ron, that the environment, the macro, the weather or whatever, is exactly the same? So the $40 million to the $60 million is just a share gain? Or is there some other assumption embedded in that?

Yes, if you reflect back on what I communicated, John, this is what we believe to be a significant market share gain. We believe we have an obligation to give guidance of the impact of this gain to the marketplace. It does not include any implications from any other change related to either weather conditions, improving market conditions beyond where we are today. It doesn't include international growth. It doesn't include the impact of the changing prices. I know you would like to have more detail on it, but unfortunately this is where we are.

Okay. And then have you communicated, I think you have, with your distributors, the new products for the coming year? Is there any color you can give us on new product launches, Ron?

This is a modest year in terms of total product launches. There are some new products. We're not going to give any further granularity in terms of what we expect from each product, but the product launches as compared to say 2010 or 2013 are modest in comparison with those years.

Okay.

This is the year of commercialization.

Got it. And two final ones, quickly. Any sense of where channel inventories sit for both your distributors and for the lumber yards? And then the tax rate for Q4 and 2014? Thank you.

They are flat. About the same as last year.

Okay. And then tax rate?

Tax rate for next year, as we mentioned before, should be a full 39% rate. Based on the trajectory we are at, we anticipate that we will be coming out of the valuation allowance in the fourth quarter, barring any unforeseen change. From a cash standpoint, next year we would expect something in the 25% range for cash taxes.

Thank you.

Thank you.

Our next question is from Morris Ajzenman with Griffin Securities. Please go ahead with your question.

Good morning, guys.

Good morning, Morris.

It sounds like, and again, I'm just listening to the nuances of the questions and your answers, that the $40 million to $60 million revenue increase for next year, there's more upside to that because you're not talking about what happens with price changes. You're not incorporating international or other things. Is that a fair summary of what has been going on that that's a minimum expectation?

That is fair, Morris.

Okay and international, is 2014 going to be anything material? I know its percentage is being increased, but still small. Will 2014 start becoming some sort of visual appealing number from an absolute basis?

It continues to grow. We continue to be happy with the rate of growth. We started from a base of zero in 2009 or 2010. It is still a relatively small number in the grand scheme of things. But soon, relatively soon, it will be within a couple years, it will be a meaningful number.

Okay. And last question, Jim, on cash flow. Looking out to 2014, I think you gave us the number $45 million for the first nine months. Next year, should we be expecting a meaningful increase in free cash flow based on improving results? And maybe not that much necessitated increase to working capital, et cetera, et cetera? How does that play out? Do we have a big bump in free cash flow for next year?

Yes. Free cash flow for next year should be considerably stronger than this year.

Okay, guys, thank you.

Thank you.

Our next question is from Alex Rygiel with FBR Capital Markets. Please go ahead with your question.

Good morning, gentlemen. Nice quarter.

Thank you.

As it relates to the $40 million to the $60 million, is there any chance that over the next year or two we hear a similar positive success story?

Possible, I suppose, the way you've crafted the question. I would not rule it out.

Certainly, as we indicated in the press release, when you make changes in distribution not all of the benefit comes in the first year. It takes time to complete conversions on a number of the dealers. And so we anticipate there will be favorable implications for future years 2015 and probably 2016.

That is helpful. And where was capacity utilization in the third quarter? Where might you think it could get to in 2014?

Some time ago we made the determination we were not going to be conveying capacity utilization information. It suffices to say, I think, that the Company has significant capacity available. We could substantially increase the sales and not require to build additional production lines.

Lastly, you've talked in the past about possibly considering alternatives to balance your recapitalization and what not. I think you suggested that maybe early in 2014 you would take a more serious look. Is there any update towards that timeline?

You are seeing the first two movements that we have elected to make in the buyback that was completed in the third quarter for $25 million, and the $30 million buyback that we announced just this quarter. We will continue to evaluate that and work with our Board on determining the proper balance sheet for the Company. I would not anticipate any significant changes taking place prior to our next call.

Very helpful. Thank you very much.

Thank you.

Our next question comes from Robert Kelly with Sidoti. Please go ahead with your question.

Hi, good morning. A question on the gross margin guidance for modeling next year. Are we incorporating the potential benefits to utilization in that 45% guideline?

Yes.

Okay. So there wouldn't be an added benefit on top of that from utilization?

There would not.

Okay, great. As far as 4Q, is that a down-sequential-utilization quarter?

No. It is an up quarter.

So inventories year-end are going to be in line with, slightly above, where you ended at 2012?

I would say they are going to be above.

Okay.

As we have indicated we've got a lot of new business. We are going to prepare for that business so that we hit the market with the right mix of inventory from the early part of the year, which is consistent with what we have done in prior years.

That leads to my next question. The phasing of the $40 million to $60 million, is that front-weighted towards 1H?

Maybe slightly. You could pretty much take where we were across 2013, but for a slight elevation in the first quarter, I think it would be pretty consistent.

Okay. Fair enough. As then as far as -- you have a lot of irons in the fire with respect to share gains. Market growth for 2014, are we still thinking like mid single-digit market recovery? Has your thoughts changed on that?

That would be my thinking. Mid to upper single-digits. It is hard for me to guess. I'm not an economist, but it would seem to be a reasonable guesstimate.

All right. Thanks a lot.

Thank you.

Our next question, looks like it's a follow-up from Morris Ajzenman with Griffin. Please go ahead.

If we look out to an optimal environment, three or four years down the road, things are really going well, things are buzzing. Based on current capacity, based on increasing utilization, getting more lines run, what sort of revenue capacity could you generate out of your existing infrastructure?

We have previously stated, Morris, that we could more than double the size of Trex with the existing footprint.

Okay. Okay, so you stick with that, more than double. Okay. Fair enough.

Just a follow-up on that. We continue to make improvements in our manufacturing environment on throughput and yields. It is a moving target. It is a growing capacity that we have, because of the improvements we make. The products that we have introduced have enabled us to make further progress on those yields and throughput. We anticipate over time that will continue to be an improving number for us.

All right. And one last question, market share. Do you have any recent data where you can give us some sort of better idea of what your market share is and what you think it can improve to next year?

We've publicly stated that our long-term goal was 50% domestic market share. The recent achievements move us significantly toward that goal. We are not at that goal, but we're certainly moving toward it from where we were, which was about a third of the market.

Thank you.

Thank you.

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

Thanks for joining us today. As you heard, our employees are not resting on their laurels of our industry leadership. We continue to work fervently on increasing our market share in current markets and our new markets and reward shareholders. We are putting initiatives in motion for 2014 and expect it to be an exciting year. We look forward to giving you more details in coming months. Thank you and 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.