Trex Company Inc (TREX) 2014 Q3 法說會逐字稿

Welcome to Trex Q3 2014 earnings conference call.

(Operator Instructions)

As a reminder this conference is being recorded October 27, 2014. 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 2014.

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. 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 33 and other 34 act filings 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.

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

Good morning. Things have gone well since our last call. We set records in both sales and earnings for the quarter and year to date.

These results reflect a continued focus on our guiding principles for increasing shareholder wealth. We have the best outdoor living products, unparalleled distribution, unmatched brand recognition, and lower cost structure. We have been executing in all of these areas. The numbers prove it.

Despite a relative soft market, the demand for Trex products was strong through the quarter. This strong demand has continued through the month of October.

In 2014 we revamped our pricing strategy to ensure that we were optimally priced at retail across our good, better, best product platform. This balanced pricing strategy is contributing to our market share growth.

We're looking forward to next month's distributor meeting where we will unveil our 2015 sales strategy. We're very excited about our strategy and believe the market will be very receptive to our programs.

In September we expanded our distribution channels by entering the eCommerce marketplace with the launch of our outdoor lighting collection on Amazon.com. ECommerce opportunities like this provide additional awareness of Trex and will drive incremental sales opportunities in all of our channels.

We are also launching a new branding campaign in 2015 to not only generate increasing awareness of our products, but to further influence the pricing decision. On the cost reduction side, in Q3 we began to realize the benefits from three cost reduction initiatives. The full impact will be realized in the fourth quarter.

Turning now to our recent entry into commercial business applications, last quarter I described our new poly pellet initiative which leverages Trex's core recycling and extrusion strengths. We are one of the nation's largest buyers of recycled polyethylene film, providing processed pellets to manufacturers of commercial products is an extension of what we already do in our decking operation and offers entry into a large non-cyclical market.

We have been continuing the ramp up of our first manufacturing line, and will begin the build out of three additional lines through the first half of next year. We have now firmly established our skill at bringing new technologies to the market profitably.

Since the end of Q3 inbound orders have remained strong. Accordingly we are forecasting sales of $70 million, a 10% year-over-year increase. We're on track for record sales for the full year, close to $390 million or 13% more than our prior high set last year.

Regarding our use of cash, our first priority will be to use our free cash flow to execute on the strategic initiatives I've described today. Our second priority is share repurchases. The board has authorized an additional purchase of 2 million shares of our common stock. This authorization will position us to pursue opportunistic share buybacks to deliver further value to our shareholders.

Folks, at the end of the day we measure our success based on winning. We are proud of our winning streak over the last seven years and our growth and shareholder value bears witness to that. Jim?

Thank you, Ron. Good morning. Our third-quarter and year-to-date 2014 financial results reflect record sales and record earnings for the Company.

We recorded net income of $9 million, or $0.28 per share, in the third quarter of 2014 compared to a net loss of $15 million, or $0.45 per share in 2013. We recorded net income of $36 million, or $1.10 per share, for the nine-month period in 2014 compared to net income of $20 million, or $0.56 per share in 2013.

The company recognized $23 million of charges in the third quarter of 2013 and $25 million for the nine-month period. Both 2013 periods included a $20 million charge to the warranty reserve and other charges related to our corporate office sublet and the mold class action.

In the following overview I will speak to the financial results on an underlying basis excluding these charges. For the third quarter we recognized net sales of $96 million, a 29% increase compared to 2013, with strong order demand in the third quarter, reflecting stronger demand from our existing distributor and dealer network, and our successful market share growth initiatives including dealer conversions.

Gross margin improved 220 basis points to 31.8% in the third quarter of 2014. The increase in gross margin was primarily the result of favorable manufacturing efficiencies, capacity utilization, and sales mix.

This was partially offset by our 2014 pricing strategy, in which we reduced pricing on two of our decking products. SG&A for the quarter was $16 million compared to $14 million in 2013. The increase was primarily related to branding. The increase in branding reflect timing due to a late start to the decking season.

As a percentage of net sales, SG&A expenses decreased to 17% in the quarter from 19% in 2013. Earnings before taxes for the 2014 were $14 million, a $7 million increase over last year's underlying results.

The third quarter's effective tax rate was 37.7% compared to essentially no taxes recorded in 2013. Moving to a normal tax rate in 2014 reduced third-quarter earnings by $0.17.

For the first nine months of 2014 net sales were $318 million, a 13% increase compared to 2013. The sales were positively influenced by strong demand from both new and existing distributors and dealers.

Our gross margin at 35.8% was comparable to the 2013 underlying margin of 35.9%. Favorable manufacturing efficiencies and higher capacity utilization were offset by the effect of our 2014 pricing strategy mentioned previously.

SG&A for the 2014 nine-month period was $55 million, compared to $56 million in 2013, a decrease of $1 million. The decrease primarily related to branding and incentive compensation.

As a percent of net sales SG&A expenses decreased to 17% in 2014 from 20% in 2013. 2014 earnings before taxes were $58 million, a 31% increase over last year's underlying results.

The 2014 effective tax rate was 37.6% compared to 1.5% in 2013. Moving to a normal tax rate in 2014 reduced the nine-month earnings by $0.64.

We generated $37 million of free cash flow for the first nine months of 2014 compared to $45 million in 2013. The $8 million variance was primarily related to increased taxes paid in 2014.

Inventory was $15 million at September 30, 2014, a $4 million year-over-year increase. We carried a higher level of inventory into the fourth quarter to support strong, early fourth-quarter demand.

Capital expenditures for the first nine months of 2014 were $9 million, which was comparable to the prior year. Capital expenditures in 2014 are related to the new poly processing lines for our entry into commercial businesses, and continued retrofit to our current production lines to support the manufacturing of our high-performance production lines.

Finally, our guidance for the fourth quarter is sales of $70 million, an increase of 10% over 2013. The effective tax rate for the fourth quarter of 2014 will be consistent with the first nine months of 2014. Operator, we would now like to open the call up for questions, after which Ron will provide his closing statement.

(Operator Instructions)

Trey Grooms, Stephens.

It's Trey with Stephens. Thanks. Good morning, guys.

Good morning.

Could you talk a little bit about the plastics or the pellets business so far this year? I know you're up and running selling a little bit. Could you give us any color on what kind of impact that had on the third quarter or into the 4Q guide?

I would say at this point it's not moving the needle materially. It will start to move the needle in the second half of 2015.

I can tell you that the line is fully operational. We're selling everything we're making and we're selling -- we're producing at the rates and yields that we expect.

So right now it's a question of waiting for the additional equipment to get here and get it installed. And if all goes according to plan you will see it move the needle in the second half of next year.

And then if I remember right, Ron, you had mentioned $50 million to $80 million revenue. Was that range for 2016 or -- is that the best way to think about that is 2016?

That was 3 to 4 years out from when we initiated.

Okay. So it would be kind of a gradual increase up to that rate, maybe in 2017 then?

A lot of it will depend on how fast we can get the second batch of equipment.

Okay. Thanks for that. And then you guys I think intra-quarter increased the price on the monochromatic Transcend line.

Can you talk a little bit about the timing there? I don't recall seeing you guys increase pricing this time of year before. And just kind of anything that's -- just thoughts behind that or any commentary you can give us on any additional pricing?

Actually we did increase last year the price on the exotic Transcend line about the same timing. It's not all that unusual for us. We just felt now was the right time and brought that price increase through.

The important thing is that there was essentially market acceptance. There was no extraordinary push back and it flowed through the system pretty well.

Okay, great. And then there's been some news recently surrounding California banning plastic bags in that state and that sort of thing. And I know we've kind of seen that coming for a little, while but can you give us a sense of at least your thoughts on any impact we should be expecting there from something like that coming out of California?

We haven't seen any impact coming from that particular move. You know plastic bags is that one of our inputs gets the publicity because everybody is familiar with plastic bags.

Plastic bags in total represent a mid single-digit portion of our input. If you then reduce it by what we get from California it reduces it much further than that.

The primary source of our raw material is stretch wrap. And so while California gets a lot of publicity, I don't expect a material impact on our prices.

Great. Thanks a lot, guys, and good luck. I'll jump back in the queue.

Thank you.

Keith Hughes, SunTrust.

Thank you. Two questions. First, heading for the 2015 season have you put the details out for the early buy, what the terms and conditions of that are going to be?

No. We'll do that on approximately on November 4, I believe.

Okay. And second question on production for the fourth quarter, it looks like you're off to a strong start. Would you expect substantially higher production rates in the fourth quarter versus last year?

Yes I think we would.

Okay. So I assume gross margin would follow along with that. Is that correct?

Yes.

Okay. That's all for me. Thank you.

Thank you.

Jack Kasprzak, BB&T.

Thanks. Good morning, guys.

Good morning.

First question is just on the share buyback. You authorized 2 million shares, but to this point you've been doing your buybacks in dollar terms, I think $25 million and $50 million.

Just curious why the change there? Is this an issue of flexibility?

Just the Board undertook and offering that fell within certain Safe Harbor provisions. We felt it was easier to communicate on a share basis; as you're aware the price in the stock does fluctuate quite a bit.

So we measured on shares internally. We always have because we need to fall under those Safe Harbor provisions.

Okay. And secondly I'm just curious about your thoughts on the marketplace. You've indicated your orders are strong here even as Q4 begins and your guidance is for sales to increase and you're taking market share.

But is the season lasting a bit later this year, given the late start we had due to the harsh winter weather? What's your sort of sense on the underlying marketplace?

My sense is -- I just got back from one of the trade shows, is that the season is extending a little bit. I'm not sure if it's because of the slow start in the first quarter or the whether that's good right now. But the season does seem to be expanding.

But the majority of our increase in sales come from a combination of market share increases plus we've got a lot of things going on here collectively. Between our licensing, our lighting, our elevations, our international, there's a lot going on here.

Okay, great. That's it for me. Thank you.

Glenn Wortman, Sidoti.

Good morning, guys.

Good morning.

Do you have a sense of how composites performed versus wood in the marketplace for the third quarter? And then your expectations going forward?

Well I think the whole decking market is probably rising low to mid-single digits. So we're clearly outpacing the market in general.

Every year composite gains a little bit on wood. That march continues northward by a percentage point or two.

Don't forget back in 1999 composites represented only 3% of the decking market. Right now it's probably approaching 35%.

Okay. And then just thinking about the gross margin heading into 4Q, it's a seasonally weaker quarter but you expect to realize additional benefits from your cost reduction initiatives.

Should we expect the gross margin to be up sequentially? Or I don't know if you get that particular.

We really don't bring it down to that level. What I did say in the previous conference call is for the second half of the year we would expect the incremental margin year over year to approximate 45%. So if you use that guidance you should be in pretty good shape.

Okay. Thanks for taking my questions.

John Baugh, Stifel.

Thank you. Good morning. Congratulations on a good quarter.

Let's see, a few things. There was a pretty high accounts receivable balance. Was that due to a late surge of orders in September?

Yes. It was basically heavy demand in the latter part of the quarter. Nothing past due or anything like that. It's just heavy demand at the tail end of the quarter.

Okay. And so I presume a lot of that shipped here in October?

Well, that all shipped in September.

Okay. It all shipped in September.

Super. And then I guess we'll learn November 4, Ron, about any new product talks for next year?

Yes.

Okay. And then on the cost initiative they are cryptically thrown out there. How does that affect, Jim, the 45% gross margin contribution going forward?

Well if you look at the first half of the year obviously we were not at a 45% incremental margin. Third quarter was clearly a little bit lower.

The guidance I've given is that the fourth quarter would be a little bit higher than the third, which would get us to a second half incremental margin of 45%. We also communicated that we anticipate for 2015 that 45% incremental margin should hold.

Okay. So the combination of the cost initiative you're doing, the price actions you've taken should still put us in that 45% area for next year?

Correct.

Okay. And then for the additional lines that are coming on, if I recall you don't need additional polyethylene purchasing to get the first four lines running.

First of all, is that still correct and secondly, when would you start acquiring additional volume to feed the next four lines? Thank you.

You are correct that the first four lines don't require any additional bricks and mortar. In fact the second four lines don't require any additional bricks and mortar either.

We don't expect to have to buy any additional plastic for the first four lines. We would for the second four lines and that would probably be occurring in probably 2017.

Okay. And current cost trends across the board, but mainly obviously polyethylene?

It's trending upward. It's trending a little faster than inflation.

Not nearly as fast as PVC is going out. But a lot of these cost increases are being offset by other manufacturing changes that we're making.

Great. And then my last question quickly on SG& A for next year you mentioned a new brand campaign. It sounds like you're going to emphasize in the messaging the cost element as well.

How do we think about SG&A dollars or percent of revenue going into next year? Thank you.

It is going to go up. Jim, do you want to comment on a percentage amount?

I think we could say the branding campaign will go up several million dollars over 2014. And if you listen to the commentary that we just had we said branding was down slightly. But you can expect several million dollars of increased branding spend for next year.

Great. Thank you. Good luck.

Thank you.

Alex Rygiel, FBR Capital.

Good morning. One quick question.

How many market share points do you think Trex has gained in 2014? And how should we think about that translating into incremental revenue or sales rollover into 2015 that you didn't capture this year?

We're thinking about how we want to answer that question or if we won't answer.

Okay. Fair enough.

Our market is up low to single mid-single digit numbers. We're growing at 2 to 3 times that rate.

And so it's obviously coming at the expense of someone else in the marketplace. What was the second part of your question?

What's the incremental sales rollover in 2015 that you've picked up this year but didn't necessarily capture a full 12 months of in sales?

I'm not sure I can answer that question. Do you want to try that?

I don't think we want to talk about that. It's been substantial.

Until we get through the fourth quarter we won't know the full effect of the additional adds to distribution that we're going to realize. Part of the change that took place over the last 12 months will continue to show benefits into 2015 and to a much lesser extent in 2016.

So we do expect to continue to have that market share growth. Your original question is how much growth did we see? It's at least several points of market share that we picked up this year.

Thank you.

You're welcome.

(Operator Instructions)

Keith Hughes, SunTrust.

Just a follow-up question on the share repurchase program. Are you willing at this point to use borrowed money to buy back shares? Or is it just going to come out of free cash flow?

Well if you look at what we've done this past year we've stayed in the revolver longer than we had in the past. So we are not concerned about going into the revolver to do the buyback.

But it is our second priority. Our first priority is strategic initiatives that Ron mentioned earlier.

So I understand going to revolver for timing aspects, but I guess what my question is would you be willing at the end of a period, end of the year to carry more debt via share repurchase?

That is a function of a spirited and ongoing and active debate. We don't have any announcements to make at this time. But it is something that we would consider.

Okay. Thank you.

Trey Grooms, Stephens.

Sorry. Just one follow-up and really just for some clarity, Ron, on some of your other commentary. Earlier you said that you will probably have to start buying additional poly for the second four lines when you guys get those up and running.

And did I hear you right, that would be 2017? So that basically implying that you will start that second four lines up and running at full steam basically?

Upon further reflection I will say 2016.

Okay. 2016. Thanks for the color. That's all.

Thank you.

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

As we move towards closing out this record-breaking year, we are energized with our prospects going into 2015 and forward. We are committed to advancing our industry-leading market share and complement this with other value enhancing strategic initiatives.

It goes without saying, but our winning strategy would not be achievable without superior execution by all of our talented employees. To them I give my thanks and best wishes on the way forward. Thank you for joining us today and take care.

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