Trex Company Inc (TREX) 2016 Q1 法說會逐字稿

Good morning and welcome to the Trex Company first-quarter 2016 earnings conference call. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to Jon Friedman. Please go ahead.

Thank you, everyone, for joining us today. With us on the call are Jim Cline, President and Chief Executive Officer; and Bryan Fairbanks, Vice President and Chief Financial Officer. Jim and Bryan will be joined on the call today by additional members of Trex's management team.

The Company issued a press release this morning containing financial results for the first quarter of 2016. This release is available on the Company's website. In addition, this call is being webcasted 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 Trex's Senior Vice President, General Counsel, and Secretary, Bill Gupp. Bill?

Thank you, Jon. 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 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 will turn the call over to Jim Cline.

Thank you, Bill; and thanks to all of you for joining us today to discuss our first-quarter 2016 results and our business outlook. This was a record first quarter for Trex in terms of revenue, gross profit, and earnings per share, and it sets the stage for continued progress in 2016.

Several factors came together to drive this exceptionally strong performance. First, we executed on our sales plan. While there's no published industry data for the period, I think it's fair to say that our 9% sales growth in the first quarter outpaced the decking and railing market by a significant margin, representing another period of market share gains for Trex.

This is particularly impressive when you consider that we came off a very strong fourth quarter, driven in part by unseasonably warm weather, which had a positive impact on this year's first quarter as well. Our market share expansion strategies are working; more on this in a moment.

Second, we achieved significant operating leverage in the first quarter, benefiting from lower raw material costs and higher capacity utilization at the same time as our manufacturing cost savings initiatives yielded strong benefits. Third, we made a deliberate decision to defer a portion of our marketing spend to the second quarter, which means we had a pickup of approximately 130 basis points in SG&A as a percentage of net sales in this year's first quarter.

Taken together, these three elements resulted in a record net income of $23.4 million, up 33% from last year's first quarter. And when you consider the share repurchases, which drove down our share count to under 30 million shares, we were able to produce a 42% year-on-year increase in diluted earnings per share. Importantly, the contributors to this year's record gross profit are expected to benefit the second-quarter gross margin as well.

The impact of our specialty materials business on the first-quarter revenue and gross profit was negligible. Virgin pellet prices remain depressed, and we do not expect a rebound anytime soon. As you know, we are working on several new applications for recycled pellets that combine them with other polymers to produce specialty products, and we have a number of samples out for trial with potential customers. However, we have not built any meaningful sales contribution from these products in our guidance.

The good news is that the sales growth we posted in Q1 was essentially related to our core Trex-branded decking and railing business. It is also an impressive growth rate considering the fact that we are facing currency headwinds in our international business due to the appreciation of the US dollar against most other currencies in the world. As you know, the sales outside of North America are not yet a significant contributor to our results, but we do see our coverage expanding nicely, with new opportunities being presented on a regular basis.

More good news is that we are on track with our sales growth initiatives. This is the second consecutive year that we have swept the annual BUILDER's magazine Brand Use Study, with Trex being named top brand in all four of the wood alternative decking categories: quality, brand familiarity, brand used most, and brand used in the last two years.

These top honors were the result of a survey of over 1,000 builders and contractors and other building industry professionals and confirm what we are hearing every day in the marketplace about the strength and versatility of our high-performance product lineup. In today's release we have noted these and other recognitions that we have gained so far this year, including one related to Trex's appeal to consumers who are attracted to green building alternatives. This is likely to be an increasing draw for us as sustainability becomes more integrated into consumer lifestyle choices.

Last quarter we mentioned that we are refocusing a significant portion of our marketing and branding campaigns to drive accelerated conversion from wood decking and railing to Trex wood alternative products. In April we launched new targeted advertising/marketing campaigns that bring home a unique possibility that Trex products provide in customizing outdoor living spaces. I encourage you to check out some of the footage on the Trex YouTube channel. We think it brings our key message directly to the consumer in a creative way and efficient -- and look forward to hearing your feedback.

Taking share from wood decking and railing will be a key driver of accelerated market share gains for Trex in the coming years. And our branding and advertising campaigns will be aimed at building greater awareness of the aesthetic and functional advantage that Trex high-performance decking and railing offers consumers compared to wood products. Once consumers understand the comparative price considerations, we believe that the Trex decision is compelling.

Of course, it is our distributors and dealers and contractors who are face-to-face with our consumers. And we are helping them by investing in multiple marketing strategies aimed at strengthening their businesses and building the bond between Trex and its partners.

Our newest development was the launch of Trex University on March 1, a 10,000-square-foot interactive educational training center that provides unparalleled product knowledge to the trade. Interest in the contractor and dealer training is at an all-time high, with more visitors attending Trex University since opening its doors two months ago than attended training in all of 2015.

With that, I will hand the call over to our CFO, Bryan Fairbanks, to provide a detailed review of the first-quarter financial results.

Thank you, Jim, and good morning, everyone. Net sales for the first-quarter 2016 were in line with our expectations, coming in approximately $700,000 higher than the guidance we provided at the end of February. We continued to benefit from more favorable weather conditions than in the prior year, as well as a strong start to the 2016 early buy season that we spoke about on our fourth-quarter earnings call.

Growth was primarily from volume, with pricing accounting for 120 basis points of the increase. This year's first-quarter sales did not benefit from scrap poly sales to the same extent as the prior year. The planned reduction we previously communicated was approximately $10 million from the 2015 level or approximately $2.5 million per quarter.

Nor did the quarter have any meaningful contribution from our specialty materials business. So in fact, the year-on-year sales growth for our decking and railing business continues to grow at low double digits.

As Jim mentioned, this was a record first quarter across our key financial metrics. The primary driver of significant upside in our first-quarter earnings was gross profit, which increased 19.4%, resulting in a 390 basis point expansion in gross margin to 43.8%. The improvement in gross margin was due to several favorable impacts, including lower raw material costs and manufacturing-related cost reductions, which together accounted for about 50% of the increase; while pricing, higher capacity utilization, and other operating efficiencies accounted for the remaining 50%.

As you will recall, our year-end finished goods inventories were down by approximately $8 million from the prior year, driven by increased sales demand in the fourth quarter. In this year's first-quarter, approximately 50% of that inventory was built back, and we expect that by the end of the second quarter, finished goods will normalize with the prior year.

SG&A for the quarter totaled $20.6 million, flat with last year's level but 130 basis points lower as a percentage of net sales, representing 15.7% versus 17% last year. For strategic reasons, we decided to defer certain branding and advertising spend to the second quarter of the year. As a result, SG&A as a percentage of net sales in the first-half 2016 is likely to be similar to the first half of 2015.

Interest expense increased to $572,000 from $137,000. This was due to a $57.5 million increase in outstanding borrowings, most of which was used to repurchase Trex common stock. The Company reported net income of $23.4 million or $0.78 per diluted share in the first quarter, increasing 33% and 42%, respectively, from the net income of $17.6 million or $0.55 per diluted share in the comparable year-ago period.

The tax rate in the year's first quarter was 35.8% compared to 36.2% in the 2015 first quarter. In the first quarter we repurchased 1.6 million shares for a total of $53.3 million, reducing the weighted average number of shares outstanding used in our calculation of fully diluted shares to 29.9 million from 32.1 million in last year's first quarter.

Capital expenditures in the first quarter were $2.4 million, with the major areas of spending focused on high return investments to capture manufacturing cost savings.

To summarize some items to take into consideration as you fine-tune your modeling for Trex 2016 performance: first, our sales in 2016 of scrap poly will be reduced by approximately $10 million, split evenly over the four quarters. For SG&A, the average of the first half is likely to be similar to 2015. We expect our effective tax rate to be about 140 basis points below last year's 37.4% due to the nonoccurrence of nondeductible tax items. And we have a new diluted weighted average share count of 29.9 million shares for the first quarter.

There are 1.6 million shares remaining on the repurchase program that the Board approved in October of last year. Also our borrowing capacity gives a significant financial flexibility to invest in organic and acquisition growth initiatives. Due to the flow-through of our strong incremental margin performance in the first quarter, we've increased our guidance for the full-year 2016 incremental margin to average 60%, up from our previous forecast of 50%.

With that, I like to turn the call back to Jim for his summary comments. Jim?

Thanks, Bryan. To sum it up, first quarter's results reflected the success of several initiatives aimed at driving sales, achieving manufacturing cost savings, and laying the foundation for a strong and sustainable long-term performance.

Our guidance for second-quarter sales is $145 million, 8% ahead of the prior year when excluding the contribution from scrap poly sales. The first-half sales is an increase of 9% on that same basis. This growth rate indicates that we continue to gain market share in our category.

Additionally, we expect to see benefits from lower cost inputs and manufacturing cost savings throughout 2016, with the greatest impact in the first half of the year, making the second quarter another period of significant operating leverage. We believe that the first-half performance will provide a very strong base from which we will continue to grow organically through continued market share gains and new product development.

We are pleased to be off to a strong start in 2016. And at this point, operator, I'd like to open the call up to questions.

(Operator Instructions) Al Kaschalk, Wedbush Securities.

I just want to hit first the incremental margin comment, Bryan. That was fairly strong in terms of the quarter. And then the -- how much of that was really the flow-through to 60% increase -- sorry, the 50% going to 60% for the full year. Can you talk about some of the details behind that?

Yes, so if you flow-through the benefit that you saw in the first quarter through the rest of the year, that will take you to the 60%. We do expect to see continued strength in the manufacturing cost efficiency as poly pricing and utilization going through the second quarter. And then we would expect that to moderate with the rest of the market in the second half of the year.

Secondly, I don't know if you could comment on the traffic in terms of the April activity? Tie that in, I guess, with a little bit more details behind the targeted marketing that you deferred and the traction that you're getting on that campaign.

Are you referring to the activity we've seen on the Web?

Well, maybe overall just general on traffic -- of activity overall for the business in April, given the -- your programs and the weather. And then, secondly, just a follow-up to that would be some of the more details behind the reason that you deferred some of the marketing spending. Was that tied to the strong weather? Just more details on maybe why you deferred the spending, Jim.

Basically, we do everything in our marketing group by the numbers. And they identified, based on what they were seeing with regard to Web traffic, that we would be better off deferring that spend until the early part of the second quarter. That's why it was deferred.

With regard to April business, it's consistent with what we had expected. We have, of course, as everybody has seen a fair amount of rain across the United States has not disrupted the installations of decks. But I think it does impact people's interest a little bit in pursuing deck building.

So rainy days are a downer when people start thinking about decks. Sunny days are a positive. We've seen more rainy days, for example, in Winchester than we have sunny so far in the second quarter.

Great. Thanks a lot. I'll hop back in queue.

John Baugh, Stifel.

Thank you for taking my questions and great incrementals. So could you talk, Jim, a little bit about -- you know, in the past few years the amount of business you do quarterly has sort of shifted as your ability to service in season is better. You had a very good fourth quarter, and I was wondering if you can somehow look at the results in the first quarter and maybe what you've seen so far in the second quarter -- is there any way of differentiating between what is shelf space fill versus pull-through demand, and how that's tracking? Sort of what the backlog or inventory, I guess, would be at the distributor level?

Sure. As you're probably aware, John, we start our programs in the late part of the fourth quarter with regard to stocking the shelves making sure that inventory is moved to the dealers. So if you have a mild winter, as we did this past year, it enables them to service the immediate needs of the contractors. So that approach to our business has been very successful.

We saw strong demand at our distributors. We do see their business as it moves to the professional lumber yards -- that was very strong. So we anticipate that inventories are at a very normal level for this time of year; and in fact, we started to see reorders coming in little bit sooner than we normally do in a typical year.

Great, thanks for that color. And then any comment on attach rates of the railings? And then any comment on the poly? You mentioned the poly input costs were down. Could you, I don't know, go into a little more detail about what you saw happen timing-wise, and when that declined? Is it flattening out now in your expectations going forward? Thank you.

Sure. On the attachment rate for the railing, we did see that railing as a percent of our sales did grow a little bit in the first quarter. A little bit unusual. Usually that's a slow quarter for the railing activity. So that has been quite modest. I'll let Bryan take the second part of that.

As it relates to poly pricing, with recycled materials it does tend to lag the virgin pricing. It does come down. But generally you're looking at 3 to 6 to 8 months after. So we have been taking advantage of that reduction in the marketplace since it started coming down.

We are seeing it level out at this point, as we are seeing the virgin pricing level out as well. There are accounts we are still working with and negotiating with, but we do expect the gains from that as we go forward to moderate.

Great. Thank you and good luck.

Thanks, John.

Trey Grooms, Stephens.

Yes, good morning, Jim and Bryan, this is Drew Lipke on for Trey. Appreciate you guys breaking out the volume and the price impact there in the quarter. And was there any sort of mix impact that we need to be aware of?

No, there was really very little mix impact. Very consistent with what we did last year.

Okay. And then just kind of following onto that: some of your competitors have been a bit more aggressive in offering up the 10% to 15% back-end rebates. Can you talk about any of the impact that you are seeing there, what you guys are doing to address it, and then how we need to think about this rebate impact throughout the remainder of the year?

Yes, we've been a little bit surprised about the aberrant behavior of the competitors with these back-end rebates. They've been fairly significant in nature. They have been relatively unsuccessful in gaining additional sales, but they certainly have been effective at holding existing customers to their product category.

Our reaction has been not to respond in kind. We think it is disruptive in the marketplace to the rest of the customers, because what happens is everybody is worried about whether or not the next guy is getting a better deal. When you do a special deal with one customer, how do they know they're getting the best deal?

We give our customers the best deal every day. And basically, we give them the same pricing formula based on the types of purchases and the way they purchase their product.

Okay, thanks for that. And second question -- your press release mentions acquisition potential. I think that's the first time that we can recall seeing that actually in there. I know it's something that's been talked on more lately.

But can you talk about potential opportunities? What might make an ideal fit for Trex? Potential size ranges? Just anything we need to be mindful of there.

Well, we certainly are open to acquisitions. We are reviewing those alternatives. I would expect that most acquisitions we would be interested in would be related to outdoor products, and they would be rather modest in size as opposed to transformational acquisitions.

Got it. All right, thanks, guys. Best of luck.

Thank you.

Alex Rygiel, FBR Capital Markets.

Great. Good morning, this is actually Min for Alex. Congrats on a strong quarter here.

I had a question about your pellets business. I know in the past, you talked about sales starting in the second quarter. I just wanted know if you're still on track there. It sounds like things might've been pushed out a little bit.

Yes, we've -- as we've talked before, the low price of the polyethylene have caused the market to be less receptive to recycled pellets. In addition, we found that the new blended pellets with the different polymers are taking a little bit longer to get through testing and qualification than what we'd anticipated. So, yes, I think it's fair to say that we pushed our horizon out a bit.

Okay. And then also in terms of -- Bryan, in terms of the SG&A guidance, you said it's -- the first half of 2016 will be in line with the first half of 2015. Do you mean on a dollar basis or as a percentage of revenue?

As a percentage of revenue.

Okay, percentage. And that's even including the -- I believe last 2Q you had a non-operating expense of about $900,000 in that line? Is it including that as well?

It would be inclusive of that, yes.

Inclusive, okay. And then just maybe a little bit different topic here, but I was just wondering: are you doing any specific marketing for the nonresidential side of your business as it relates to decking and railings? I know you've done some in the past. Or is that more kind of one-off type of opportunities?

Those are generally one-off type of opportunities. We do have some specific advertising campaigns that are not part of our core advertising that we are doing this year. But the details of that we really don't convey in advance of those taking place.

Okay. And then just a final question in terms of share repurchases. Have you repurchased any more shares subsequent to the end of the quarter? And if you could, tell us what the current share count is.

The guidance that Bryan gave you on the share count is the one that you ought to be using at this point. Typically the way we approach our share repurchases are on a very opportunistic basis. We announce those at the next quarter's release, and therefore we would not be in a position to communicate that at this point.

Okay. All right, thank you.

Keith Hughes, SunTrust.

Just following up on your comments on SG&A in the first half, talking about flat year-over-year. Were you referring to as a percentage of sales or just the dollars will be flat year-over-year?

It would be -- as a percentage of sales it would be flat on a year-over-year basis.

That was for the six months.

For the six months. That's correct, yes.

For the six months added together, okay. And just -- you had commented on the shift to a certain extent from the first to the second. I just want to dive into that a little bit more.

Traditionally, the deck -- at least in the Southeast the kind of deck planning season, if you will, begins transactually times February, March and into April. Was there any other thoughts you could give on the timing move to the second?

Yes. Basically, what we do is we look at a variety of metrics related to our website activity. And based on that we developed a view on how we could maximize the benefit from our advertising. And based on what we were seeing with our Web traffic, we felt that moving that to the second quarter would be more impactful, and that's why it was moved.

Okay, thank you.

Matt McCall, BB&T.

Hitting SG&A again, you mentioned the Trex University. Was there any investment that showed up in Q1 that we should keep in mind for modeling next year?

The investment for Trex University was in the fourth quarter as well as in the first quarter.

And that was a capital expenditure.

Capital, right.

Not SG&A.

Got it, got it. So as we think about -- a lot of questions about the first half, and I appreciate that insight into what we should expect. But when we look at the back half, and we take into account the altered advertising spend, is there anything we should look at from an SG&A perspective? Or was it basically just the shift from Q1 to Q2 that we should keep in mind?

I think it's fair -- when you look at SG&A on a full-year basis, we've tended to leverage the additional sales dollars we've had over the past number of years. We would expect to continue to have some level of leverage on a full-year basis as we go forward.

Okay. And then you talked about the elimination of scrap; I understand you've got to make that adjustment. Pricing was up 120 basis points. You mentioned weather, and I think you said early buy. Could you put some numbers behind the benefit from weather or some of the early buy activity you saw?

I wish I could put numbers against the weather piece of it. In the first quarter it's very difficult to determine the organic outgoing demand specifically related to weather.

We did have a strong early buy. Our customers all recognized that the market was growing. They built their inventory so that they could service a higher market this year than last year. And as Jim mentioned in his comments, they are very comfortable with their inventory positions coming out at the end of the first quarter.

Okay, okay. Well, I guess that question was kind of leading into the next one. I think the growth rate projected for Q2 is 8%. You just did 9%. Looking at the year-ago comps, it looks like they get easier, So I'm trying to understand the different components of that 8% growth. What does the market expect to do? How much price is in there?

It sounds like there's not much pellets expected. But can you just go through some of the components of what drives that 8% growth number?

Yes, sure. Price on a full-year basis is going to run around 80 basis points. Jim mentioned that the pellet business was insignificant in the first quarter. And going into the second quarter, we are expecting continued depressed prices. So there will be some level of improvement, but again, not a significant driver to the revenue of the Company.

We hope some of the initiatives that we are working on will result in a higher level of sales later on this year. But it's something that we will speak about further at the end of the second-quarter call. The vast majority of the benefit of what you're seeing is Trex growth in the decking and railing business, growing in excess of the market, which has been stated to be growing in the low- to mid-single digits.

,

Okay. Thanks, Bryan.

Jim Barrett, CL King and Associates.

Bryan, these are a few questions for you. Can you tell us -- what are your expectations for capital spending this year? And on a related note, how should we think about the growth in working capital when we look at the full year?

Yes, we haven't changed any of our guidance on capital spending for the year. We're still expecting the $20 million to $25 million range for the year.

From a working capital perspective, looking at our numbers historically and adding in adjustments for growth of the Company would be appropriate. One of the things that you will see -- in Q2 and Q3 last year, DSOs were quite high in those two quarters because of the programming that we had put in place. If you were to model that this year, taking an average of the prior three years of each of the quarters should get you pretty close.

Thank you. And Jim, one question for you. Could you give us an update on your -- on the Company's interest to penetrate further the private-label market for decking in the US?

Well, we're certainly very interested in the opening price point typically through the two major retailers. They do have a bid process that they utilize, and Trex will be very active in that bid process.

Thank you both.

Thank you.

Morris Ajzenman, Griffin Securities.

Capacity utilization being higher -- can you just kind of give us some sort of ballpark figure of where that is now? Where was it a year ago versus, let's say, five years ago, just to give us some sort of a trajectory of what's happening there?

So in the first quarter we ran about 10% higher than we did during the prior year. I don't have the five-year-ago number. It would be significantly higher from a volume output perspective. But our efficiencies in our plants have improved so significantly that, honestly, it wouldn't be a particularly good comparator for modeling purposes.

And what was 10% higher -- what was it last year?

Morris, we don't release information on a quarterly basis. The guidance we've given in the past is last year we were roughly 50%. And we will be close to 50% on average for this year, as we expect to continue to see improvements in our manufacturing capabilities.

Okay. And again, the incremental margin related to capacity utilization, obviously, is very high. You are [only] 50%. So if you get to 60%, 70%, that's what's driving the incremental gross margins, obviously?

Well, that, in addition to other cost drivers and efficiencies that we have within our operations as well as cost-saving initiatives.

Where would you like to be -- capacity utilization, 2 to 3 years down the road, assuming you make no major additions or tweak a lot?

I would like for our operations to continue improving their efficiencies. We'll continue to grow the Company and stay at the capacity utilization we are today. We recognize that that isn't always going to be the case, but we do believe that there's additional room for efficiency improvements within our plants.

Okay. You mentioned in the call that this quarter composites for the Company was up low double digits. I think you said in answering a question that the composites have been rising by low-single, mid-single digit area. Did that hold also for the first quarter, your best estimate? And what would you say wood decking is running at?

So we wouldn't have a split specifically for first quarter. Those growth numbers tend to be over a little bit longer period of time. So I wouldn't want to hazard a number on what the first quarter was growing. We don't see any major shift in the market that would say that composites are growing more quickly from a market perspective than the mid-single digits.

Okay. Last question and I'll get back in queue here. You talked about virgin pricing and recycled pricing. Can you give us an idea of where they are -- both virgin and recycle -- today, and what it was a year ago?

The virgin spot market or contract market, excuse me, is running around $0.60 a pound and has pretty well leveled out there; whereas last year around this time, we had already seen quite a bit of drop in that marketplace. It was around $0.70 a pound.

From a recycled perspective, we buy a lot of different classes of recycled materials. And it really depends upon the number of buyers, the cleanliness of the products in the marketplace. It's not as easy to provide just a pure percentage to that. So we're not going to provide anything further related to the recycled side of it. Suffice it to say that we are driving down our raw material purchase cost with recycled materials in line with the marketplace.

If I ventured to say a blended rate recycled $0.20, $0.25 a pound, is that in the ballpark or not?

That would be high.

That would be high. Thank you.

(Operator Instructions) Kenneth Smith, Lenox Equity Research.

A question on new products, Jim. Aside from the items you have in test right now, are there any other new products in the pipeline that we can be looking to see here in the near future?

Ken, as I think you're aware, Trex has -- one of its strengths is the development of new and exciting products. And certainly we continue to see the opportunity for new products and new product introductions to be a strong quality of Trex's growth pattern.

We normally announce any new products at our distributor meeting, which will occur around the first week of November. So stay tuned shortly after that. If there are any new products, that's when the Street will hear about them.

Thank you.

This concludes our question-and-answer session. I would like to turn the conference back over to Jim Cline for any closing remarks.

Thank you for participating in today's call. We look forward to seeing you at upcoming events. And with that, I'll turn the call back over to the operator. Thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.