Trex Company Inc (TREX) 2015 Q2 法說會逐字稿

Welcome to the Trex Company second-quarter 2015 earnings conference call.

(Operator Instructions)

As a reminder, this conference is being recorded August 3, 2015.

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 Bryan Fairbanks, Senior Director Supply Chain, and Executive Director International Business Development; Brad McDonald, Senior Director and Controller; Brian Bertaux, Senior Director of Financial Planning and Analysis; and Bill Gupp, Senior Vice President, General Counsel, and Secretary.

The Company issued a press release this morning containing financial results for the second quarter of 2015. 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 1933 and other 1934 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.

Thank you, Bill, and good morning, everyone. We announced another record-setting financial performance this morning. For the second quarter, we achieved a 13% increase in revenue and a 26% increase in EPS. Our Q2 and first-half record results show that Trex continues to build on strong momentum.

This continued momentum comes across several important areas: an unwavering focus on increasing our market share; a marketing campaign that continues to expand our brand reach; the reception of endless industry awards. For example, we just received the Platinum Award from Ocean Home Magazine in the deckhand flooring category, a first for Trex.

Next, we have quietly assembled a team of over two dozen engineers whose mission is to advance our technical lead in manufacturing efficiency and product innovations. This team is developing the next generation of composite decking, and will propel us further into new industries. We are pleased with the progress of our R&D initiatives. This has been, and will continue to be, a value-added initiative.

In our specialty materials area, ie, pellets, Q2 sales fully met our expectations. Customers and sales are experiencing robust growth. Three additional product production lines have now been placed in operation. This is but the first step in monetizing our recycling and extrusion expertise.

Finally, we anticipate strong free-cash-flow generation. This will compel us to evaluate our capital structure on a regular basis.

Our third-quarter revenue guidance is $96 million. Remember: The harsh 2014 winter, which caused a delay to the deck-building season, shifted sales to the third quarter. In fact, in 2014's third quarter, it was 29% higher than the previous year, so we have a tough comp. Regardless, our trailing 12-month sales guidance through the end of Q3 2015 is $428 million, or 12% above the comparable prior period. We are on pace with our market share advancement initiatives, and with that, I'll hand it over to Jim.

Thank you, Ron. Good morning.

First, I'd like to review our second-quarter financial results. Sales for the second quarter were a record $137 million, reflecting a 13% increase compared to 2014. Sales volume increased 8%.

Gross margin was 38.4% in the second quarter of 2015, a 120-basis-point increase compared to the prior year. The increase in gross margin was driven by ongoing cost-reduction initiatives. The $15-million year-over-year increase in revenue resulted in $8 million of increased gross profit, and incremental gross margin was 48%.

SG&A for the second quarter was $22 million compared to $20 million in 2014. The increase was primarily related to incentive compensation. Included in the results was $900,000 of expenses related to the recently announced management changes and contract termination fees related to our exit from the PVC trim market.

The Company posted a record net income of $19 million or $0.58 per share in the second quarter of 2015, compared to net income of $15 million or $0.46 per share in the 2014 quarter. The 2015 second-quarter tax rate of 37.3% was comparable to 2014.

Sales for the first six months of 2015 were a record $258 million, reflecting a 16% increase compared to 2014. Increased sales volume represented 12% of total sales increase in sales, indicating that our continued market share advancement initiatives are working effectively.

Gross margin was 39.1% in the first six months of 2015, a 164-basis-point increase compared to the prior year. The key drivers of the increase in year-over-year gross margin were consistent with the second quarter. The $36-million year-over-year increase in revenue resulted in an $18-million increase in gross profit. Incremental gross margin for the first six months was 49%.

SG&A for the first six months was $43 million compared to $39 million in 2014. The increase was driven by higher personnel expenses, and branding.

The Company posted a record net income of $36 million or $1.13 per share for the first six months of 2015, compared to net income of $27 million or $0.82 per share for the first six months of 2014. The effective tax rate, at 36.8% for 2015, was nearly 1% lower than the 2014 period.

For the first six months of 2015, we consumed $42 million of free cash compared to free-cash-flow generation of $7 million in 2014. The variance was due mainly to timing of cash receipts, and a $9-million increase in capital expenditures. The increase in capital expenditures primarily related to our investment in our specialty materials business and land acquisition adjacent to our Winchester manufacturing facility to support our future growth initiatives. We expect a positive full year of free cash flow.

Finally, I'd like to turn to our revenue guidance. Our third-quarter revenue guidance is $96 million. This is comparable to last year. As Ron commented, the harsh winter weather of 2014 delayed the start to the decking season, which resulted in a shift of the sales in to the third quarter of 2014. This guidance puts us on a trailing 12 months through third quarter of 2015 at $428 million, or 12% above last year's comparable 12-month period. We continue to see notable market share growth in 2015.

Operator, we'd now like to open the call up for questions, after which Ron will provide his closing statement.

(Operator Instructions)

Our first question is from Trey Grooms from Stephens. Please go ahead with your question.

Good morning, guys.

Good morning, Trey.

The question I have, I guess the first one is how much did the pellets revenue, or how much pellets revenue was in the 3Q guide that you guys have given us? I'm just trying to get a sense for the best way to think about this for the balance of the year and into next year. I think that all of us were obviously a little too aggressive in our approach on that as we looked into the third quarter at least. If you could maybe give us a little bit of color on how to think about that.

I'll give you some color to think about that, but I'm not going to give you as much detail as you probably want. It's been our practice that we don't break out sales by product line. What I can tell you is that all four production lines have now been put into service. They're all operational. They all operate as expected.

We told you that it would begin to move the needle in the second half of the year, and we stand by that. We've previously given forecasts in the odd years. Nothing has changed our view, and everything is running as expected. The number of customers that we're adding and sales that we're adding are entirely consistent with our expectations. That's about all I can tell you. Jim, do you want to add to that?

I think one other comment just to give you a little bit of direction is that in the past, orders for the pellets were viewable basically within the month we shipped. We're now seeing demand from future periods that will help us plan the production a little bit more effectively. We're seeing a view from the customers further out than what we'd seen in the past.

Is it reasonable to think that the 3Q benefit from pellets is going to be significantly different from 2Q? I know you guys guided to the second half being more meaningful.

The second half will be more meaningful. Yes.

Okay. Maybe I'll address it this way. I know you guys don't typically guide two quarters out, but I do recall a few years ago when you guys had a tough 2Q and 3Q guide. You then gave us some color on how to think about 4Q. I think you guys do have some level of visibility there. Given all the moving pieces that we have here in the back half of this year and the 3Q guide that obviously came in much below where we thought it could be, could you give us any color or any way to think about the 4Q, given all these moving pieces in light of this guidance for 3Q?

I can tell you two things. Number one is that we've said we expect a return to normal seasonality. Number two, this Company is growing at a 12% rate. I think that's plenty of information. We're not apologizing for our forecast at all.

As I've said over and over and over again, if you're trying to analyze Trex on a quarter-to-quarter basis, it is a seasonable basis, and you're in for a world of hurt. We're outpacing the market. The market is growing. We're taking market share. We're growing much faster than the rest of the market, and I expect us to continue to do that, so I think the Company is very healthy. I'm optimistic about the future. I'm optimistic about the progress that we've made. We got the cash to show for it. That's the important thing. You'll see that by the end of this year. Does that help?

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

Thank you. Good morning, Ron and Jim. Any comment on how the rain in the month of June could have affected order activity and purchasing activity in the month of July, and therefore affected your third quarter view?

I can tell you anecdotally, I've spent enough time in the field. Contractors don't work in the rain. They can't build a deck in the mud, so there is some effect. I can't really quantify it, but there has been an effect. Do you want to add to that?

Yes, I'd just say that the impact, and you're talking about primarily I think the Texas/Oklahoma market?

Exactly.

The effect on us would be relatively minor and did not significantly impact the quarter.

As it relates to the pellets business, over the last year or so, how has the price point of your pellet product fluctuated if at all with regards to competing products?

Looking at the pellet product, if you go back and look at where virgin polyethylene was at the end of the second quarter, I think it was about $1.09 a pound. Since that time, it dropped down to a low of $0.55, $0.60 a pound, and now I think it's up to about $0.80 a pound. Our price has moved relatively consistent with that change, but quite frankly we have not been really focused on driving that price up as the market firmed up. We want to get people using these pellets with only one line in production through a good share of the second quarter of this year. We were limited in our ability to supply products. Getting those customers lined up and testing the product and qualifying it was more important than making a couple of extra pennies on it.

Our next question is from John Baugh from Stifel.

Good morning. Thanks for taking my questions. I was wondering if you could comment on what decking sales are like in the month of July, and I think you have visibility maybe through the middle of August here. Are they flat year-over-year, or are you anticipating it's the way the third quarter played out? Last year, you had really strong demand in the last five, six weeks of the quarter, and you won't see that this quarter.

Decking sales are stronger than they were last year. That's without question. You want to speak to the month to month?

I think we can give you a little bit of guidance on the month to month, John. The very difficult comp we had was primarily July. If you looked at July, we're relatively flat with July last year, but I think it's important to remember, and one comment I'll make on July, our inbound orders last year in July were up 44% over the prior year. Relatively flat when you're on top of a 44% increase actually is not too bad. I think that as we go through the quarter, we took all that into consideration. We do have visibility through a week or so in the month of August, and that is part of what we utilized in putting the $96 million out there.

Great. Thanks. Then receivables, I don't think your pre-buy was any different this year. Correct me if I'm wrong. Would it have been an anomaly of timing that explained the increase in receivables which is a little bit higher than normal, or is something else going on?

Just a minor timing difference, is all it is.

We expect to be debt-free soon, and cash flow and the use of cash is going to become an increasingly important thing for us to consider.

Any update on warranty claims cash payments on the claims that you settled?

No. No update. No change in reserve was necessary.

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

Thank you. Looking at based on your revenue guidance for the third quarter, what will production rates look like in the third versus prior year? Are we up? Down? Any help would be appreciated.

Third quarter will be essentially flat to slightly up.

Given your guidance, looks like volume will be down in the quarter. Are you going to be building inventory in to the second half of the year to prepare for next year? What's the plan there?

We'll take the production down consistent with demand, and then ramp up probably in the fourth quarter.

We still have dramatic available capacity throughout the year, so we can do a little bit better job of driving production a little bit closer to when we have the actual demand.

The accounts receivable number was up pretty substantially year-over-year. Anything unusual going on there?

No, it's really just a timing issue. That's where the cash will be generated in the third quarter basically.

Okay. Final question. The comps as you go through August, September, you talked about the hard July, do they get easier as the quarter progresses?

They do.

Are they down to single digits, or how much easier do they get?

They certainly get easier. I don't think we want to start getting in to monthly details across the whole quarter. Certainly they were not in the 40% range. They were well below that.

Our next question comes from Al Kaschalk from Wedbush Securities. Please go ahead with your question.

Good morning, guys. Just a follow-up on the receivable question, have you collected the majority of that here in the first month of the third quarter?

A large portion of it. Not all of it was due, so there's essentially no past due balance.

Second, was there some large orders? Particularly I'm thinking out loud about international that have been completed and roll off going forward here?

We had a large order last year in Q2 that we finished all at once. It was a big [slug], so it was a spike in international sales in last year's Q2. Now we're achieving more stable demand flow.

Our next question comes from Matt McCall from BB&T Capital Markets. Please go ahead with your question.

Thank you. Good morning, everybody.

Good morning.

Ron, you said a couple things about growth. You said the Company is growing 12%. I think you said in the quarter though volume was up 8%. Can you talk about the impact of price versus mix in Q2, and how we should maybe think about that going forward with respect to that 12% growth rate?

We're having a little trouble hearing you. I'm going to have my colleague take a bite at this.

Matt, the combination of the mix and price increase certainly impacted the quarter by roughly 4%. The largest portion of that was related to mix. You probably would have realized a 1.5 point maybe from price, and that was the part that I could hear. I couldn't hear the rest of the question.

I'm sorry. That basically hit it.

Let me just add one more specific. Our sales volume growth in linear feet on a year-to-date basis is up 12%.

Got it. Okay. Then maybe some help on gross margin, you talked about flat production rate. You got the impact of the new line. I know you've talked about an incremental gross margin in the past. Is that still a good guide as we look at the back half of the year?

I think as I've stated before, the average margin that we've guided to has been 45%, and so what we would expect is that the quarters of lower production, you're going to see that gravitate below the 45%. In those quarters where you move above that, you ought to see an excess of 45%. Of course, the first two quarters we averaged, I think, it was 49%, so we will have a quarter where it's going to come below that number.

Our next question comes from Jim Barrett from CL King & Associates. Please go ahead with your question.

Good morning, everyone.

Good morning.

Ron, I heard your comment. It's good to hear the pellet business is on track near and long-term in terms of your prior guidance there. Can you tell us whether the Company is still on track from a margin perspective for that business? I recall the expectation is that the margins would be comparable to decking.

It is on track. Now, remember when we talk about margins, we said that gross margins would be a little bit less, but operating margin would be the same because there's virtually no SG&A in this business.

Right. Okay. Understood. Then secondly, can you tell us whether there's been any recent mid-season price increases in decking, or is that simply not going to happen this year?

There's been no announcement of any price increases to date. We historically have those conversations with our distributors, then our dealers before we put anything in to the stream of commerce publicly.

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

Hi, guys.

Hi, Morris.

My questions are pretty well picked up at this point, but just a follow-up. You talked about continued market share growth as the year progresses. Do you want to put any numbers on that, and give us some sort of feel? Then some comment on what's happening in the competitive landscape with composites, with the plays out there, your positioning with them, et cetera?

Market share is somewhere north of 40%. When I took this job it was about 30%. Our target is 50%. What's more important of what's going on is that composites are taking share from wood, so the category is taking share, and we're growing within the category.

Morris, just to give you a little bit of color, our view on the market is the composite market is growing somewhere mid- to low-single digits. At a 12% growth, obviously that's got to be coming from some of the competitors.

Thank you.

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

First, just to say thank you to you, Ron, for such a tremendous run at this Company since you came back in 2008. My question on the plastics business, is third quarter going to be the first quarter where you're running full capacity on all three lines that you sell?

We're not going to talk quarter by quarter, machine by machine. I can tell you that we expect it to begin to move the needle within the second half of the year. So far in Q2, the sales were immaterial in Q2. Are you still there?

I'm here, yes.

Okay. We heard some funny noises. I can just tell you in broad terms our sales are exactly where we expect them to be. We expect them to start moving the needle in the second half of the year. All four machines are installed, and they all work.

Okay. Thank you.

Thank you.

(Operator Instructions)

Our next question comes from Al Kaschalk from Wedbush Securities.

Ron, you used a word I haven't heard in a while, or phrase, normal seasonality that the business is getting back to. We've got a market growing low- to mid-single digits. You're taking share. As we look out, is there any detraction from an upper mid-single digit growth rate in terms of the top line for the decking business?

Do you mean our sales or for the marketplace?

Obviously, I'd like to focus on yours, so if you could add any color on that. Again, I was troubled by the phrase normal seasonality, since we haven't really had that in the last three years.

[I'd was referring to] the third quarter. Typically, if you look back over the last several years, there's a seasonality to the business. The first and second quarters, usually the majority of our sales are in the first half of the year, and the lesser amounts are in the second half of the year. There will be some flip-flop between Q1 and Q2, and Q4 is usually the lowest quarter we've got. We expect a return to that seasonality, but we do note, I said that on a year-to-date basis we're growing at 12% per year. I'm not going to comment as to whether that's a growth rate for the future, but I think if you look to the past performances over the last two or three years at rate of growth, it far exceeds the growth of the market or rate of inflation. We're quite proud of the growth that Trex has experienced, and we're optimistic about the future. That's about as close as I'm going to get to a more finite forecast for Q4.

That's helpful. On the specialty materials side, could you talk about whether the number of customers that have qualified has increased relative to your expectation, or is it just the customers you have in your target side have now been qualified?

No, we're beginning to develop new customers. I've got firm orders from new customers that we didn't have one quarter ago, and I think I'm more optimistic about that than I am about anything else. I don't want to focus just on pellets. Pellets is the only one we've announced. We've got other projects in the pipeline that are equally or more exciting than pellets, but the point is that every time Trex announces under this administration that we're going to have a new product that's going to break a new technology and it's going to increase shareholder value, it's been true. We've done it with Transcend. We're doing it with pellets. We're going to continue to do it with pellets, and we've got more behind that in the pipeline. Trex has become a technological powerhouse in our view, and it's going to be bringing some exciting things to the table. When we're ready to talk about them, we will. That includes the things we're doing within decking and railing and things unrelated to deck and railing, and unrelated to pellets.

Will those all use the same production lines?

No, they will not. In fact as I mentioned in the previous phone call, we've bought land, and we're going to need it.

Thank you.

Our next question comes from Kenneth Smith from Lenox Equity Research. Please go ahead with your question.

Good morning. I wanted to ask you about the new products you've alluded to. Could any of these be coming on so they could be a factor for next year, both in decking and the pellets business?

Some of them could be. Some will. Some won't.

I guess we might hear about that in the fall?

There are two things come into play. One is the extraordinary amount of testing that has to be done. You can only hurry up this process so much. Trex as you know is acutely aware of its responsibilities with respect to quality and the testing can only be driven so fast. The second reason is although somebody may be ready in a couple of months, if you miss the distributor meeting in October, you've got to wait a whole other year. If the product is declared to be ready, and it's not ready until one month after the distributor meeting, it's tough because you've got to wait a whole other year. Those are the two critical factors. The things in development that are outside of decking and railing of course are not subject to the distributor meeting so they may be coming on more quickly.

Okay. Thank you.

Currently, we have no further questions at this time. Mr. Kaplan, do you have any closing remarks?

Yes, I do. As you know, I am retiring this month, and today marks my last conference call for Trex. I'll retain my role as Chairman of the Board and look forward to contributing to Trex's success in that role. I couldn't be more proud of the accomplishments made at Trex during my tenure. It's been a heck of a run and could not have been achieved without the contributions of all my Trex colleagues. They are the most ambitious, bright, and dedicated group I've ever had the pleasure of leading. There's a tremendous amount of talent in this organization. I'll pass the torch to my long-time colleague and Trex CFO, Jim Cline. Brian Fairbanks, an 11-year Trex veteran, will take the helm as CFO. I have full confidence that moving forward, the Trex executive team will provide continuity on our strategy, and there's no doubt that all members of the Trex Company will demonstrate the same passion for performance and results that has been displayed for the past 7 1/2 years.

I am very optimistic about the Company's future prospects. The leadership team will continue fostering the key pillars of success that fueled Trex's phenomenal performance over the last several years, the power of the Trex brand, our continually improving product lineup, an unparalleled distribution network, our low cost manufacturing position, and monetizing new opportunities to our recycling and extrusion aptitude with a focus on market share expansion, including composites gaining share from wood, continued international expansion, and further technical breakthroughs leading to product line extensions and entries in to new industries. I believe the trajectory of value creation will continue. It's been a pleasure working with all of you in the investment community. I've enjoyed getting to meet and know those of you who have owned, followed, and cover Trex. Thanks, good luck, and stay tuned for what will no doubt be continued exceptional progress at Trex. 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.