Trex Company, Inc.
Q1 2008 Earnings Call Transcript

Published: 27 May 2008

[Operator:]

Welcome to the Trex Company’s first quarter 2008 conference call. Operator Instructions) I would now like to turn the conference over to Harriet Fried of LHA.

[Harriet Fried:]

With us on the call are Ron Kaplan, President and Chief Executive Officer, and Jim Kline, Chief Financial Officer. Joining Ron and Jim are Brad McDonnell, Controller, Brian [Berteau], Director of Financial Planning and Analysis, and Bill Gupp, General Counsel. The company issued a press release this morning concerning financial results for the first quarter of 2008. This release is available on their website as well as on various financial websites. The call is also being webcast on the Investor Relations page of the company’s website where it will be available for 30 days. I’d now like to turn the call over to Bill Gupp, Trex’s General Counsel.

[William R. Gupp:]

Before we begin, let me remind everyone that statements on this call regarding the company’s expected sales performance and operating results; it’s projection of net sales, net income, earnings per share, and costs, its anticipated financial condition, and its business strategy constitute forward looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E in the Securities Exchange Act of 1934. These statements are subject to risks and uncertainties that could cause the company’s actual operating results to differ materially. Such risks and uncertainties to the extent of market acceptance of the company’s products, sensitivity of the company’s business to general economic conditions, the company’s ability to obtain raw materials at acceptable prices, the company’s ability to maintain product quality and product performance at acceptable cost, level of expenses associated with product replacement and consumer relations expenses related to product quality; and the highly competitive markets in which the Company operates. The company’s report on Form 10-K filed with the SEC in March 2008 discussed some of the important factors that could cause the company’s actual results to differ materially from those expressed or implied in these forward-looking statements. The company expressly disclaims any obligation to update or revise publicly any forward-looking statements, whether as the result of new information, future events or otherwise. With that introduction, I will turn the call over to Ron Kaplan.

[Ronald W. Kaplan:]

A few hours ago we released Trex Company’s financial results for the 2008 first quarter. I think you’ll agree that they represent a strong step forward and that we’re making good progress in restoring the company to financial health. As those of you who listened to our last earnings call know, the steps we’ve taken to accomplish this include strengthening our management team, realigning our organizational structure, right sizing our workforce, and improving our cost controls. In addition to improving Trex’s day to day operational effectiveness, I want to emphasize that we’re committed to growing shareholder value based on the guiding principles of providing a best in class product offering, expanding our distribution presence, and increasing our brand leadership while advancing our low cost competitive advantage. Built on green and eco-friendly principles, Trex continues to realize the environmentally responsible use of reclaims waste plastic and waste wood. In the first quarter, new products continue to represent a higher mix of the company’s sales. We’re building a homeowner’s desire for products that allow them to build a deck or fence that is both distinctive and low maintenance. We recently added Expresso to our decking product color offering for Brasilia and the very popular Saddle for Contours. We also introduced the grooved Brasilia product line with the new Trex highway hidden fastening system which eliminated the need for all deck surface fastening and provides a cleaner, more attractive look. We’re expanding our railing offering with more choices from our Artisan line that will allow the design of a custom railing system at a lower cost to the homeowner. Trex Escapes, our ultra low maintenance deck board, has been well received in the marketplace and demand has temporarily exceeded the supply for this product. In fact, we are having trouble keeping up with demand. Therefore, we will double our supply. Trex Seclusion privacy fencing line continues to gain traction in the marketplace as contractors and consumers clearly recognize its superiority to wood in terms of durability and design. We’re really pleased with the opportunities this line presents. With our expanding big box distribution presence complementing our well established true step pro channel, Trex is now available in over 5,600 locations spanning across the United States and Canada. A recently installed capital equipment designed to reduce operating costs and increase productivity, while adhering to significantly higher quality standards, has yielded desired results. We have reduced headcount relating to purifying the waste plastic stream. We have also integrated our production process, eliminating secondary operations that required additional labor and touch points to the manufacturing process. These are the types of opportunities that reduce excess carrying cost and improve productivity. In a market in which virgin polyetheline plastic prices, a primary raw material supply for many of our competitors, has increased more has increased more than 30% over the last year, we’ve been able to reduce our purchase price of the recycled poly we use by employing innovative and proprietary reprocessing techniques. Over the past few months, I have continued to reach our to our customers, contractors, and our field sales force to assess for myself the mood of the marketplace regarding Trex; and I am encouraged by the overall response, as well as by our first quarter revenue performance. At the same time, we are cautious regarding the second quarter outlook. Since the spring decking season is just getting started, it’s still difficult to assess pull through of the product that was delivered during the early buy sales program. In addition, bad weather in many parts of the US this winter delayed some outdoor projects. The economic outlook remains uncertain, and building material dealers are choosing to operate with depressed inventory levels. As a result, while we are very pleased with our operational progress and new product introductions, we are projecting first half 2008 revenue to be approximately 85% to 90% of the level obtained in the first six months of 2007. That said, we are excited and dedicated to continuing the company’s mission of turning the backyard into the next great room in an environmentally responsible manner. We’re confident that Trex will continue to define the future of the decking market and that our new fencing and railing products will help us gain market share in some exciting new markets. I’d like to turn this call over to Jim Kline, our Chief Financial Officer, to provide a detailed discussion of our first quarter numbers.

[James E. Kline:]

Before I review the financial results with you that were released earlier today, as a newcomer to Trex, I’d like to give you my overall impression of the company’s administrative and financial processes. During my first 60 days with Trex, I have found the financial and administrative staff to be highly committed, competent, and open to change. We have identified a number of meaningful improvements and have begun to implement them. These improvements revolve around enhancing operational administrative controls, reducing the complexity of the financial processes, streamlining the financial close process, and reducing administrative cost. Because of the strength of the staff and the receptiveness to change, I believe these improvements can be accomplished over the next several months without any disruption to the company. Once the initial improvements that e have identified are implements, we’ll focus on the continued improvement of our processes, internal controls, and improving the predictability of the company’s financial results. The company recognized net sales of $119.5 million in the period, an increase of 3.1% over the first quarter of 2007. The improvement was due to favorable sales pricing mix and the impact of lower warranty costs related to the 2007 surface defect issue. The company recorded an improved revenue performance despite today’s challenging macroeconomic condition in the home building environment. The company recorded net income of $8.9 million, or $0.60 per share, which is 140% improvement over the first quarter of 2007 net income of $3.7 million or $0.25 a share. Gross margin was 27.5% in the first quarter of 2008, a 620 basis point improvement over the first quarter of 2007. Gross margin was favorably impacted by improved yield and productivity initiative. As Ron discussed, our recent capital improvement are delivering the desired results of further improving productivity and reducing costs. We achieved significant improvement in gross margin despite a reduction of capacity utilization as we focused on reducing inventories to generate pre-cash flow. We also continue to focus on standardization and process controls across the manufacturing facilities. SG&A for the first quarter of 2008 was $20.9 million or 17.5% of revenue compared to 2007’s first quarter of $17.2 million, 14.4% of revenue. The increase in SG&A was primarily the result of two factors. First, additional personnel costs including severance cost recognized as the result of the company’s reduction in workforce. Second, in the 2007 quarter, we had a credit resulting from the reimbursement of attorney fees under a settlement agreement with Exxon Mobil. These were offset by surface defect costs from products made at our Nevada manufacturing facility. Excluding the aforementioned charges and credit, SG&A was 14.4% of revenue in the first quarter of 2008 compared to 15.6% in the first quarter of 2007. That interest was $3 million in the first quarter of 2008, a $1.3 million increase over the first quarter of 2007. The increase is primarily attributable to lower capitalized interest and a net increase in the non-cash unrealized losses on interest rate swap contract due to the Fed recent monetary easing. The first quarter of 2008, effective income tax was approximately 1% compared to 37% for the first quarter of 2007. As we noted in this morning’s press release, the lower effective tax rate in 2008 resulted from recognizing a decrease in the valuation allowance against the deferred tax asset. We expect this lower effective tax rate to continue for the remainder of 2008. The company had a pre-cash flow of negative $22 million in the first quarter of 2008, a $12 million improvement over the 2007 first quarter. The improvement was primarily driven by improved EBITDA and lower capital expenditures. At March 31, we had $21.7 million of borrowings on the revolving line of credit which has a season maximum borrowing capacity of $70 million. The borrowings were utilized to fund an increase in receivables as a result of the extended terms offered during early buy sales promotion. The majority of the extended receivables carried terms into April. As these receivables have been collected, our revolving line of credit has been reduced. We are currently out of our revolving line of credit and have a cash balance of approximately $2 million. This is a real accomplishment and illustrated the progress that we’re making. That concludes my financial overview. We’re now ready to take questions.

[Operator:]

(Operator Instructions) The first question comes from Keith Hughes - SunTrust.

[Keith Hughes:]

On the sales number for the first and second quarter, the numbers you’re discussing for the second quarter, is that market related, inventory related, what’s going to be driving this down here every year?

[Ronald W. Kaplan:]

Well, the first quarter buy was very successful and, secondly, there’s been a lot of poor weather in the North Central states and in the Northeast between the moisture and the snow; so, I guess it’s some of both. Clearly, some of it is market related. Some of it is timing. And some of it is very difficult for us to assess because we’re getting mixed signals from the marketplace. For example, we put our forecast together based on just the orders that we physically have in hand. But as recently as last night, when one of the big boxes reported their weekly sales, it was the highest number we’ve ever had in terms of what the sales were at the point of purchase in the big box. So we’ve got a series of cross currents. We decided to just put our forecast based though on just on the orders that were actually in our hand and to ignore some of the anecdotal evidence.

[Keith Hughes:]

How does the early buy you put in place in the first quarter? How does that compare to the same program for the prior year? Was it similar or greater or less?

[Ronald W. Kaplan:]

It was similar.

[Keith Hughes:]

And within the sales for the quarter, from the different price strata of products you have, did you notice a meaningful change in trend on this?

[Ronald W. Kaplan:]

Well, some of our new products that we’ve introduced obviously represented a higher portion of sales than they have in the past. We did more railing and we did sell more fencing. And those are higher margin products.

[Keith Hughes:]

On fencing, can you give us some kind of idea of magnitude of how big that business is now?

[Ronald W. Kaplan:]

I don’t think I want to at this point. Respectfully, I’ll just decline to answer that for competitive reasons.

[Operator:]

Your next question comes from Bill Gibson - Nollenberger Capital.

[William Gibson:]

Jim, I’m trying to get a handle on SG&A expenses through the next three quarters. Looks like you gave us a number that was what, $17 million or something in the quarter without the extras. And I assume that ad spending kicks up this quarter. But is $20 million a good number to use in the second quarter or is it higher than that?

[James E. Kline:]

Well, actually, we have indicated that we aren’t going to be doing forecast on the future earnings. But we can tell you that the ad spending is going to be up a little bit; but we believe that we’ll continue to be able to control spending in other categories at the levels that we’ve seen.

[Ronald W. Kaplan:]

I can tell you that our cost reduction exercises have been productive and that we are moving that ball forward in terms of lowering the break even point of this company in terms of SG&A spending and other factory spending as well.

[Operator:]

Your next question comes from Robert Kelly - Sidoti.

[Robert J. Kelly:]

With most of the weakness coming from the pro distribution channel or are you feeling it just as well from the big box?

[Ronald W. Kaplan:]

I guess it would be fair to say we see most of that from the pro channel.

[Robert J. Kelly:]

Now, you’re still ramping up both Lowe’s and Depot in the home improvement channel?

[Ronald W. Kaplan:]

Yes, they continue to just expand their presence in the stores and the per store sales.

[Robert J. Kelly:]

That’s somewhat of an offset to what you’re seeing, I guess, in the pro channel?

[Ronald W. Kaplan:]

It is.

[Robert J. Kelly:]

Then, as far as SG&A, the close, the 1Q charges were in that. Was there anything from Olive Branch still in either gross margin or SG&A for this quarter and do they begin to kind of reverse as we get to the rest of the year?

[James E. Kline:]

There is. There are still expenses in there for Olive Branch.

[Ronald W. Kaplan:]

It’s a depreciation expense. There were no, and I’m looking at my colleagues here, there were no unusual expenses. It was just the runoff of depreciation and what we spend for, you know, on a night watchmen and things of that nature.

[Robert J. Kelly:]

On the tax rate, that takes us through the end of ’09. Does it spill into ‘09 or does it start to reverse at that point? Or do you have fee at the end of ’08?

[James E. Kline:]

We’ll have to do an evaluation at the end of ’08 and, at that point, we’ll be in a better position to give you guidance on that.

[Robert J. Kelly:]

And then finally, just on, even with the softer kind of 2Q outlook, are you still in a position to be generating cash where you stand right now from a working capital standpoint?

[James E. Kline:]

We will be.

[Operator:]

Your next question comes from Ryan Thibodeaux - Maple Leaf.

[Ryan Thibodeaux:]

I was just wondering if you could touch on any pricing actions you’re making since you came in on the prices at the consumer level and then, relative to your rise in input costs.

[Ronald W. Kaplan:]

Well, we don’t have rising input costs right now. Our costs of reprocessed poly are actually declining. And so, with respect to pricing, we put a price in effect at the beginning of the year. And I don’t anticipate changing those prices until next year.

[Ryan Thibodeaux:]

Can you say what the price increase was?

[Ronald W. Kaplan:]

Yes, it was about, a gross of about 7+% and the net of the yearly buy averages out to something just over 5%.

[Ryan Thibodeaux:]

Is that similar to what you did in ’06 because there was not one in ’07? Is that right?

[Ronald W. Kaplan:]

Well, I wasn’t here in ’06 and neither was my CFO. Did anybody else know?

[James E. Kline:]

It’s similar.

[Ryan Thibodeaux:]

And so, is the spread versus, you know, the traditional [inaudible], is that fairly similar to what it has been or is that, is that fairly similar to what it has been or is that --

[Ronald W. Kaplan:]

Well, price of wood continues to fall; so my guess is that spread is probably increasing somewhat.

[Ryan Thibodeaux:]

And then, do you have any control over pricing at the big box stores. I know that you notice that some of the competitive products are discounted pretty heavily, you know, next to Trex products.

[Ronald W. Kaplan:]

No. We really don’t have control over what the big boxes charge.

[Operator:]

Your next question comes from Keith Johnson - Morgan Keegan.

[Keith Johnson:]

You had mentioned that your recycled polyetheline prices had declined. Could you give us an idea of a year over year basis how much that decline was?

[Ronald W. Kaplan:]

Do we have that number available?

[James E. Kline:]

On a year over year basis, it’s down slightly. What we have done is we – poly pricing, the stretch film, and the reprocessed pellets – prices for those are – some are going up compared to last year; but with our new reprocessing equipment, we’ve been able to utilize more of a lower cost poly as opposed to the higher cost poly, and that’s how we are reducing our costs overall.

[Keith Johnson:]

And during the quarter, how much did you pay out on the warranty plan?

[Ronald W. Kaplan:]

$7.5 million.

[Keith Johnson:]

Were there any adjustments on the accruals on anything during the quarter?

[Ronald W. Kaplan:]

No.

[Keith Johnson:]

On the improvement in gross margin on a year over year basis. But is there any way you could give us a little more color on that 600+ basis point improvement, how much of it could be tied to lower recycle polyetheline versus cost reductions or something along those lines?

[Ronald W. Kaplan:]

Well, let me just give you some broad comments first and that is that we are challenging the basic decision process that management would go through to evaluate the effect of different kinds of poly on rates and yields and so on. We’ve developed, and are in the process of continuing to develop, some rather sophisticated algorithms to help us correlate the relationship between the various kinds of raw material and the run rates and the yields, ultimately leading to a decision on what will provide the lowest cost per pound. That’s a part of what’s going on. The rest of your question, I think you wanted a breakdown of what actually reconciled to the 610 basis points?

[Keith Johnson:]

Going forward, should we expect continued improvement along these lines on a year over year basis? That’s what I was really trying to get a better handle on.

[James E. Kline:]

Yes, from a detailed standpoint, Ron and I have talked about the level of detail that we’re going to be sharing. It is competitive information and we really prefer not to. We can tell you that our yields are continuing to improve.

[Keith Johnson:]

So, what are the, so did the rates.

[James E. Kline:]

And the rates, the throughput, are continuing to improve. We are challenged because we are reducing the capacity utilization, and even with that reduction we still were able to see an improvement in the gross margin.

[Ronald W. Kaplan:]

One of the things that we have done, by the way, is we have shut down one more line because our zeal to continue to lower inventory combined with our higher productivity has enabled us to manufacture what we need to manufacture with less lines running.

[Keith Johnson:]

Speed rates are up on those lines with the new equipment.

[Ronald W. Kaplan:]

Yes.

[Keith Johnson:]

Could you give us an idea of what the utilization rate was in the quarter?

[Ronald W. Kaplan:]

Yes, it’s running at about 51%

[Keith Johnson:]

If you could just comment on the sales trend as you kind of came across the quarter into April.

[Ronald W. Kaplan:]

Well, the trends right now within the month of April are relatively flat. In other words, it hasn’t gotten better and it hasn’t gotten worse within the month of April.

[Operator:]

Your next question comes from Greg Powell - Bernstein.

[Greg Powell:]

Could you just go over what triggered this decision to use the lower tax rate, please?

[James E. Kline:]

Yes, if you recall, at the end of 2007, we took what was essentially a full valuation against our net deferred tax assets in the first quarter because we generated positive income. Those net deferred tax assets reduced. So, accordingly, we reduced the valuation on those deferred tax assets. So really, both at the end of last year and currently at the end of the first quarter, we still have what was essentially a full valuation against the against the deferred tax assets. And the effect of that is that the reduction of the deferred tax, or the valuation allowance, offset the tax we normally would record in the quarter. So last year we did not take the benefit, because we took a valuation allowance against our net deferred tax asset. We didn’t take the tax benefit into our P&L last year and so this is sort of the reverse – the other side of the coin for this year.

[Greg Powell:]

But it applies for the whole year? That’s what I’m confused about.

[James E. Kline:]

We do expect it to apply for the whole year, yes.

[Ronald W. Kaplan:]

In other words, Trex had been losing money for a number of years building up a net operating loss carry forward. Now that we’re making money, we get to recognize that net operating loss carry forward

[Operator:]

Your next question comes from Rick Shay - Vardon.

[Rick Shay:]

I was just wondering if you would just spend a few minutes and detail three or four of the main initiatives and likely outcomes you would expect from those initiatives that you’re focused on in 2008.

[Ronald W. Kaplan:]

Well, the initiative continues to be a higher level of productivity from our factories and I made reference to that already in some of the ways that we’re dealing with that. There are a lot of cost control initiatives that are underway that I won’t get into the details of what they are. They do not include salaried headcount reductions. I think we’ve achieved our goal in that regard. We continue to prosecute a couple of opportunities with new distribution opportunities and a couple of opportunities with respect to the continued growth of new products. So, its new products, its expanded distribution, and its lower costs and more effective manufacturing processes combined with more effective poly purchasing and utilization.

[Operator:]

Our next question comes from John Baugh with Stifel Nicolaus.

[Analyst for John Baugh:]

You may have touched on this but my phone was cutting in and out. I heard you talking about the two changes in the SG&A line. If you were to back those out, what would be a better run rate for us to look at for 1Q?

[James E. Kline:]

Well, if you were to exclude all the unusual charges on the SG&A side, we would have been at 14.4% for the first quarter of 2008 of sales.

[Analyst for John Baugh:]

It was about 7% last year so could that ballpark same ranges the coming year?

[James E. Kline:]

Essentially the same range.

[Analyst for John Baugh:]

On the 3Q call of last year, it talked about $20 million incremental for this coming year because of the things you have going on right now. Can you update us on the progress with that and is that still reasonable given the shortfall sales expectations in 2Q?

[Ronald W. Kaplan:]

Well, I can only answer it in the way I’m capable of because neither Jim nor I were here last year. But I can tell you that the machinery that was purchased is yielding the intended results. Our productivity continues to increase in part because of that acquisition, that equipment and the new processes. And I can tell you that the incumbent management that is still here – was here then – seems to be pleased with the way in which the equipment is working and the way it has a positive influence on our output.

[Operator:]

There are no further questions at this time.

[Ronald W. Kaplan:]

Well, the only closing remarks that I would have is that I appreciate the very, very intense interest that all of you have shown evidenced by the number of visits, telephone calls that we get. I can assure you that this management team will work hard to continue to deliver the credibility that we spoke of in our very first call. We want to deliver our credibility and continue to enhance shareholder value. We’re committed to that. We have a long road ahead of us, but all the oars are in the water and the management team will remain focused on delivering those results. Well, thank you very much for your kind attention. I’m sure there will be some post conference call telephone calls. We will look forward to that. And wish you all the very best.