Trex Company, Inc.
Q4 2012 Earnings Call Transcript

Published: 19 Feb 2013

[Operator:]

Welcome to the Trex Fourth Quarter 2012 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, February 19, 2013. I would now like to turn the conference over to Harriet Fried of LHA. Please go ahead.

[Harriet C. Fried:]

Thank you, everyone, for joining us today. With us on the call are Ron Kaplan, Chairman, President and Chief Executive Officer; and Jim Cline, 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 fourth quarter of 2012. 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?

[William R. Gupp:]

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 laws. 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 10-Q, as well as our '33 and other '34 Act filings on file with SEC. The company expressly disclaims any obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise. To supplement the company's consolidated financial statements, the company is using certain non-GAAP financial measures in today's conference call. A reconciliation of these financial measures to GAAP is provided in the tables at the end of this morning's press release. With that introduction, I'll turn the call over to Ron Kaplan.

[Ronald W. Kaplan:]

Good morning, everyone, and thanks for joining our call today. As you've seen from the numbers in this morning's press release, we turned in a solid fourth quarter, capping a successful year. Sales surpassed the guidance we provided in November. Gross margin was near 30%. Productivity level set a new high. And equally important, we positioned ourselves well for the upcoming decking season, during which we expect to benefit from the housing recovery that's been picking up steam. As we move into the new decking season, I'd like to give you an update on our key strategic initiatives so you can fully appreciate why we expect 2013 to be a strong year for Trex. First and most important, we're now offering a complete best-in-class product platform. We revolutionized the industry in 2010 when we introduced our first high-performance cap deck board, Transcend, the first product we could guarantee wouldn't stain or fade. Recently, we filled out our high-performance decking line by adding 2 new options, Enhance and Select, at different price points. We also completed our good, better, best high-performance railing lineup by launching an entry price point railing and our aluminum railing, doubling the size of the railing markets in which we participate. We see railing as a big opportunity for Trex. Our expanded product lineup enables us to increase the attachment rates to our decks. All in all, we now have the most comprehensive product platform in the company's history. And I'm happy to report that our products have been well received in this year's early buy period. Another goal, of course, is to improve profitability. Not only did we increase revenue by 15% in 2012, but by continuing to focus on manufacturing efficiencies, we increased our margins. Using Lean and Six Sigma manufacturing practices, we've driven continued productivity improvements since 2008. We'll continue fine-tuning our processes and searching for low-cost materials. We're also using our superior products and aggressive sales programs to expand the number of dealers and contractors that use Trex. This is an important contributor to our goal of gaining more market share. In addition, we found in the past that some dealers trade products other than Trex because we didn't have a full lineup. That's changing this year, which should also help us gain market share. Finally, we've made a good progress in developing our global footprint. We started off as a 3-company presence in -- 3-country presence in 2008. Now we encompass 29 countries. Another initiative is to use multiple branding avenues to expand our global reach. People are already aware of Trex so we've been working to really engage customers in the deck design process. The consumer segmentation study we undertook in 2012 has helped us sharpen our brand message. We've targeted and customized our communications to encourage a whole spectrum of consumers to engage with Trex and create a unique outdoor space tailored to fit a particular home or lifestyle. We are especially energized with our new multifaceted campaign called Engineered Artistry. You can learn more about this campaign on our website where we describe its key features. Our licensing agreements, which carry the Trex brand name, include Outdoor Furniture, RainEscape, Pergola, CustomCurve and saw blades. These products are all helping raise our profile and enhance our standing as the premier destination for comprehensive outdoor living options. Finally, in 2012, we were very successful in strengthening our financial profile. We signed a new, more advantageous credit agreement with our lender and repaid our $97 million of convertible bonds, mostly with cash on hand. Over the last 5 years, we've generated enough free cash flow that we ended 2012 virtually debt-free. With all these initiatives underway, topped off by lean inventory in the channel and improving market conditions, we are very confident about our prospects for 2013. In the first quarter, we were expecting net sales of approximately $107 million or about 11% year-over-year sales growth. During the quarter, we will benefit to some extent from boardwalk rebuilding in the northeast to repair damage caused by Hurricane Sandy. In fact, we were just selected by the city of Belmar, New Jersey, to provide Transcend decking for its 1.3 mile-long boardwalk. Trex's durability, good looks and environmental benefits were also a key in our selection for 3 other coastal boardwalks in Atlantic Beach, Point Pleasant and Sea Girt. Before I turn the call over to Jim, I'd like to thank our Director, Bill Andrews, who's been in the company's board since its IPO in 1999 and is retiring in May. He has provided exceptional service for Trex. I'd also like to welcome our new Director, Michael Golden, who I know will also be a great asset. Jim?

[James E. Cline:]

Thank you, Ron. Good morning, everyone. As you know, the press release with Trex's fourth quarter and year-to-date financial results was issued this morning. First, I'd like to review the fourth quarter financial results. The company recognized net sales of $46.2 million in the fourth quarter of 2012, a 10% decrease compared to 2011. This decrease in net sales was primarily driven by lower sales volume. Purchases under our 2013 early buy program will be weighted more towards the first quarter of 2013 rather than December of 2012 due to the influence of our previously announced January new product launches. The company recorded a net loss of $3.6 million or $0.22 per share in the fourth quarter of 2012 compared to a net loss of $18.3 million or $1.18 per share in the 2011 quarter. The company's results for the 2012 quarter included a $1.5 million provision for costs related to the mold class action. The company's results in the fourth quarter of 2011 included a $10 million charge related to the increase in the surface flaking warranty reserve. Before giving effect to these charges, the 2012 net loss was $2.1 million, or $0.13 per share, and the 2011 net loss was $8.3 million, or $0.54 per share. Gross margin was 29.1% in the fourth quarter of 2012, a significant improvement from the fourth quarter 2011 underlying gross margin of 17.3%. The increase in gross margin reflected favorable sales mix, improved manufacturing efficiencies, higher capacity utilization and a $2.7 million favorable inventory valuation adjustment, due mainly to a significant reduction in inventory. SG&A for the fourth quarter was $16.6 million compared to $13.6 million in 2011. The increase in SG&A expenses in 2012 was primarily driven by increased sales commissions, incentive compensation and a $1.5 million provision related to the mold class action. Net interest was $100,000 in the quarter, a $3.5 million decrease from 2011. This decrease was primarily the result of the retirement of our convertible notes earlier this year. Our fiscal year 2012 financial performance showed considerable improvement compared to 2011. The 2012 net sales were $307.4 million, a 15.2% increase, due primarily to favorable weather conditions in 2012 and the execution of our market share growth strategy. Our underlying gross margin at 34.5% was 7.2% better than 2011. Margin was positively impacted by continued gains in manufacturing efficiency, improved sales mix and a $4.1 million favorable inventory valuation adjustment. This was partially offset by $2.5 million of start-up expenses related to shelled products. Underlying net income showed significant improvement. Underlying net income in 2012 was $26.4 million, or $1.55 per share, compared to -- compares favorably to the underlying net loss of $3.9 million or $0.25 per share in 2011. Our net debt position was $3 million at the end of the year. This is a significant improvement compared to our net debt position of $45 million at the end of 2011, reflecting a notable delevering of our financial profile. Inventory was $17.5 million at year end, an $11.4 million year-over-year decrease. Improvements in our integrated business planning and manufacturing performance now allow the company to meet a greater level of demand while procuring less inventory. 2012 free cash flow was $53 million, a $28.5 million increase compared to 2011. Earnings improvement and the reduction in inventory were the key drivers to the year-over-year improvement. We will be signing an amendment to our $100 million credit facility, which will provide a seasonal increase to our credit line of $25 million for the first half of 2013 and a reduction of the interest rate by 25 basis points. This modification is being made to support the stronger-than-expected seasonal demand. Finally, I would like to turn to our first quarter revenue guidance. I would like to reaffirm the first quarter revenue guidance at $107 million. This guidance reflects an increase in sales of approximately $61 million over the fourth quarter of 2012. The first quarter 2013 SG&A expenses will be about $2 million higher than the first quarter of 2012, primarily due to the timing of our branding spend related to our new product introductions. Operator, we would now like to open the call up for questions, after which Ron will provide his closing statements.

[Operator:]

[Operator Instructions] Your first question comes from the line of Trey Grooms with Stephens.

[Trey Grooms:]

First question is I guess, Jim, on the SG&A, you mentioned that it's going to be a couple of million dollars more than the first quarter of '12. If I remember right, it seems like '13 was kind of expected -- excuse me, for the full year to be quite a bit lower than 2012 as you guys had more compensation and expenses there, bonuses and so forth. Is that still your thought as that -- as we kind of look at 2013 for the full year of SG&A and that it would still be lower than '12? Can you give us an update there, please?

[James E. Cline:]

Sure. The guidance we provided before was that 2012 was probably a high-water number for that level of sales in particular because of the higher sales commissions and incentive compensation. 2011, on the other hand, was probably the low watermark at about $60 million. So the guidance we've given before was if you average those 2, add inflation, that would approximate what 2013 would look like. We do expect that our SG&A spending will be below the 2012 number.

[Trey Grooms:]

Okay. I guess it's just more kind of front-end loaded just due to the timing of your marketing and branding and that sort of thing.

[James E. Cline:]

Yes, with the new product introductions bringing those into focus early in the season are important to us, and that's why the branding spend is forward-focused.

[Trey Grooms:]

Okay. And then on the topic of new products, can you give us some color on kind of how the reception's been out there for the new product lines, how dealers and distributors are kind of looking at their inventory and how to position themselves there as far as given the new product mix you guys have?

[Ronald W. Kaplan:]

We've been very encouraged by the reception for the new products. We gave our distributors enough of a heads-up so they can get themselves properly in line with their inventories. So between the decking and the railing of new launches, we're very encouraged.

[Trey Grooms:]

Okay. And Jim, on the gross margins, very strong gross margins in the quarter. The last few quarters, you guys had been kind of outperforming I guess my expectations and kind of what some of the longer-term guidance you guys have given us on how to think about incremental margins. You've pretty consistently exceeded that. Do you think kind of looking forward, is that still the number that we need to kind of be thinking about as far as incremental margins or something changed? I know you've talked about efficiencies and things like that, that can help with that. Is that something that's a long-term change that where we should start thinking about the incrementals a little bit differently? That's all I've got.

[James E. Cline:]

Well, as I mentioned before, when you look at your comparatives, a lot of times people will compare back to the prior year. If you do that, you don't really see the efficiencies that have been accumulated over the prior 12 months. And I think looking at the improvements that have occurred in the most recent quarter certainly should be baked in to your forecast beginning in 2013. We continue to be very impressed with what our manufacturing teams are able to deliver from the standpoint of efficiencies and productivity. The new product introductions have been going extremely well, and we believe the combination of those 2 will continue to enhance the gross margin.

[Operator:]

Your next question comes from the line of Keith Hughes with SunTrust.

[Keith B. Hughes:]

Do you have any sort of view you're getting from your distributors and dealers for the beginning of the season and where inventory stands in the channel right now?

[Ronald W. Kaplan:]

A couple of remarks. We know that the sales out of our distributors is quite healthy as compared to last year. And we know that the inventory of the channel is leaner than it was last year. So the combination of those 2 give us some reason to be encouraged.

[Keith B. Hughes:]

Second question on the mold costs in the quarter, the $1.5 million, is that $1.5 million to settle claims? Is that legal expense? Can you give me more details on that?

[James E. Cline:]

Yes, it's really a combination of expenses, some legal and some claim costs.

[Keith B. Hughes:]

Is there a program set up to pay those in the future or is there still litigation surrounding that?

[James E. Cline:]

No, we have ongoing litigation via the class action. We believe that the expenses that are noted here and also in our 10-K will further clarify that issue for you.

[Operator:]

Your next question comes from the line of John Kasprzak with BB&T.

[John F. Kasprzak:]

With regard to the Sandy rebuild effect and your positive comments about the market in general, would your sales -- would your Q1 sales still be up even without the effect of Sandy?

[Ronald W. Kaplan:]

Definitely, yes.

[John F. Kasprzak:]

Great. And then with regard to price increases and I know it's maybe tough to generalize given the water/air products you have now. But what can you tell us about pricing initiatives for 2013?

[James E. Cline:]

Well, we only implemented one price increase in 2013. It relates to our Accent product. The Accent product line is one of our smaller decking lines now compared to all of the shelled products. We did expand some discounting. So in a net effect, you're probably looking at maybe a couple of points of improvement on the Accent line related to that.

[John F. Kasprzak:]

And that's it for -- okay. Great.

[James E. Cline:]

And just to be clear, Jack, we haven't seen cost increases over the year. If you looked at our net costs year-over-year, it actually would have been a decline. So we're able to control costs quite affectively.

[Operator:]

Your next question comes from the line of John Baugh with Stifel, Nicolaus.

[John A. Baugh:]

Couple of things. First of all, could you comment on the utilization rate in Q4? And then comment on both the quarter Q1 and '13? It's the sort of a rough expectation given that inventories are so low and you expect sales to ramp.

[Ronald W. Kaplan:]

Well, let me just talk about Q4. Q4, our capacity utilization was 27%. And John, we've taken a decision here at Trex that, that will be the last time that we give our capacity utilization. The thing is a competitive issue. You can be assured that we're not going to build inventory that we don't need. Inventory is lean. The orders are robust. We'll manufacture to respond to the market demand. What we think from this point forward, we're not -- it would be inappropriate and anticompetitive for us and not consistent with our competitive needs to continue to give out that number of capacity utilization. You know where it is. you know it's been. You know where our inventory levels are. You know what our philosophy is about building inventory. I think you'll be able to easily sort of figure it out and get to the same place you need to be.

[John A. Baugh:]

Well, okay, so let me try it another way. Your inventories -- I can't remember where they peaked at. They were so high. It was kind of scary, but they're fairly lean and obviously, we expect sales to grow this year. So one can assume, I assume the utilization rates will improve year-over-year?

[Ronald W. Kaplan:]

I would think so.

[John A. Baugh:]

Okay. Is there any color you can give us on the marketplace in general? First, I guess on pricing, what you saw out of any competitors, and then whether or not you'd seen any benefit you think from the recent merger of TimberTech and AZEK.

[Ronald W. Kaplan:]

Well, the recent merger between TimberTech and AZEK has caused some turbulence in the distribution channel. That turbulence has yet to resolve itself. Everybody's sort of waiting to see how the new company allocates their product between the existing distributor base. But there are a lot of jockeying for position. I think it creates some market share opportunities both for TimberTech-AZEK and for Trex. As the market sort of consolidates around the big 2 or the big 3, there's a lot of companies out there that handle these what I'd call off-brands. They're going to be very nervous about whether or not their suppliers are going to remain in business and they are going to get stuck with obsolete inventory. So there's going to be market share that -- falls out, we're seeing some evidence of that.

[John A. Baugh:]

Okay. And any commentary I guess for the calendar year '13 on sort of branding or ad spend?

[Ronald W. Kaplan:]

Branding should be about consistent with last year. We're changing the way in which we spend some of the money, but the overall number should be -- should approximate the prior year.

[John A. Baugh:]

Okay. And then lastly, just some, Jim, some financials. Tax rate, reported tax rate, we're not thinking of paying much, if any, in cash taxes this coming year. CapEx and, I guess, interest expense seasonally will go up a little bit, but any color on any of those metrics?

[James E. Cline:]

Sure. The tax rate should be de minimis for the year, similar to what you saw in 2012. With regard to interest cost, yes, it will go up seasonally, but we're talking a few hundred thousand dollars, not millions of dollars per quarter. We will -- the end of the revolver at the end of the first quarter will be out of the revolver at the end of the second quarter. So from that standpoint, the revolver is just a timing issue for us. It tracks directly with our programs that we offer and the extended terms that we do offer to our distributor channel partners, as well as the inventory levels that we need to carry.

[John A. Baugh:]

And then the CapEx and D&A for '13?

[James E. Cline:]

Yes, the CapEx would be in the $10 million to $15 million range, consistent with what we've guided in the past. And depreciation would be similar to 2012.

[Operator:]

Your next question comes from the line of Richard Paget with Imperial Capital.

[Richard S. Paget:]

Wanted to talk a little bit more about revenue guidance. I realize there's some Sandy impact there. And last year, you guys did about 15%. But if I try and do a little bit more apples-to-apples comparison for the change with the early buyer program and look at first quarter and fourth quarter combined and compare it to a year ago, it's about mid-single-digit growth. Is that how we should kind of think about 2013 going forward?

[James E. Cline:]

I don't think that, that would be a fair representation. One of the things that I'd like to emphasize is when customers are buying this time of the year, it's the initial stocking, so that they begin to stock both the dealers in the marketplace as well as getting their stock ready for the sales year. And you really don't see that takeaway beginning until roughly the middle of March, you start to see the sell-through beginning to take place. So I don't think that what you see in the combination of fourth and first quarter would be representative of what you would see across the selling season.

[Richard S. Paget:]

All right. And then getting back to Sandy, those 4 projects that you guys have named. Are all those sales occurring in the first quarter? And then are there any other related opportunities for boardwalk rebuild?

[Ronald W. Kaplan:]

The answer is yes to both questions. The 4 that I mentioned will be in the fourth -- in Q1, and there are other opportunities particularly when the deck building itself starts in earnest, which we don't believe will happen until Q2.

[Richard S. Paget:]

All right. And then finally, just a question for Jim with the tax rate. How should we start thinking about 2014?

[James E. Cline:]

The 2014, you ought to assume a full tax rate of 39% roughly.

[Operator:]

Your next question comes from the line of Morris Ajzenman with Griffin Securities.

[Morris Ajzenman:]

Quick follow-up here. You talked about your overall 2% increase for 2013. I don't know if you meant overall for the company or overall for the Accent line. I'm just curious would it be overall for the company?

[James E. Cline:]

The price increase on Accent was about a 5%, Morris. Accents has become a much smaller piece of our business with the introduction of the shelled products. The net impact is the Accent net impact of about 2%.

[Morris Ajzenman:]

Okay. And you said earlier, Jim, net cost's down year-over-year. Can you just put a little more meat on that? What was the climbing cost year-over-year?

[James E. Cline:]

We really aren't in the position to disclose that, Morris. That's competitive information. But it was a low-single-digit reduction.

[Morris Ajzenman:]

Right. Market share, any guess, Ron, where you would think you exited market share 2012?

[Ronald W. Kaplan:]

Well, we think it continues to march north. We'll not give out specific numbers until the next third-party study comes out later this year. But we continue to add dealers, and dealers continue to add SKUs and the dealers continue to drop competitive SKUs. So we think we're making progress. But we'll wait for third-party confirmation to come out before we start quoting numbers.

[Morris Ajzenman:]

Okay. And again during the call, you talked about expanding your dealer count. Can you give us what that count is now versus a year ago?

[Ronald W. Kaplan:]

I got competitors sitting on the line listening to this. I'd love to give you that, but we're not going to.

[Morris Ajzenman:]

Okay. Last one here, cash flow. I think you said about $53 million of free cash flow for 2012. I presume that's after CapEx. Any discussion you want to do for 2013 just for at least speaking and how that plays out? Will working capital improve? Will inventories rise or working at one improve? How does that play out for 2013 as far as $53 million in '12?

[James E. Cline:]

Morris, first of all, that $53 million is after the CapEx. So that's operating cash flow minus capital expenditures. As you're probably aware, as sales grow, we do have our inventories in a very lean position. So we do anticipate that there will be some growth required to support expanded sales during the year, but that is probably the biggest change that would take place. Receivables would not be changing appreciably. So I would expect that the cash flow would be reduced from 2012 somewhat because we will not have the large inventory reduction.

[Operator:]

Your next question comes from the line of Robert Kelly with Sidoti.

[Robert J. Kelly:]

I just had a question on Q4. I believe, Jim, you said that low-cost inventory was a $2.7 million benefit. Did I hear that right?

[James E. Cline:]

That's correct. We had a valuation adjustment that occurred in the fourth quarter and a $2.7 million favorable P&L impact.

[Robert J. Kelly:]

And then what is that number for the full year, please?

[James E. Cline:]

$4.1 million.

[Robert J. Kelly:]

So with utilization going higher, inventory building that's behind you as far as inventory valuation benefits?

[James E. Cline:]

Yes. Basically, the primary driver of those 2 numbers were reduced inventory. I think it would be difficult to see a reduction inventory for 2013.

[Robert J. Kelly:]

Okay. And then just going back to one of the earlier caller's question, you kind of implied that we should do the incremental analysis for gross margin almost on a quarter-on-quarter basis, if we're thinking about 1Q. Is it best to kind of remove that $2.7 million benefit if we're going to look at gross margin that way?

[James E. Cline:]

Exactly right. You don't want to include that in the first quarter because that would be nonrepeating in the first quarter.

[Robert J. Kelly:]

Okay, fair enough. And then just one question on the projects for the rebuild. Do these come at a normal margin for the company? Or is this kind of a brand-building effort where you give a little bit of a discount on? I'm just trying to think about what the impact to profit from the rebuild of the coast is going to be.

[Ronald W. Kaplan:]

Essentially, they were maybe a smidgen of our normal margins, but not a significant amount.

[Operator:]

And at this time, there are no other questions.

[Ronald W. Kaplan:]

Okay. Well, thanks again for joining us today. 2012 was a good year, which is a testament to the talent and hard work of all of our employees, and we have many more exciting things on our plate for 2013. I'm especially pleased with the enthusiasm that we're seeing for our expanded product lineup. I look forward to seeing many of you at our Analyst Day in New York City on Monday afternoon, March 11. We'll show you our new products and our whole executive management team will be on hand. If you have any questions about the event, please get in touch with Harriet Fried at our investor relation firm, LHA. And lastly, Bill Andrews, if you're on the line and listening, thanks so much for everything, and we wish you well. Goodbye.

[Operator:]

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