Trex Company, Inc. (TREX) Q1 2012 Earnings Report, Transcript and Summary

Welcome to the Trex Company First Quarter 2012 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded today, May 7, 2012. I would now like to turn the call 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, Chief Financial Officer. Joining Ron and Jim are Brad McDonald, Controller; Brian Bertaux, Director of Financial Planning and Analysis; and Bill Gupp, General Counsel. The company issued a press release this morning containing financial results for the first 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 now like to turn the call over to Bill Gupp, Trex's General Counsel. 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 Section 27A of the Securities Act of 1933 and Section 21E of the Securities and 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 include the extent of market acceptance of the company's products; the costs associated with the development and launch of new products and the market acceptance of such new products; the 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 an acceptable cost; the level of expenses associated with product replacement and consumer relation expenses relating to product quality; and the highly competitive markets in which the company operates. Documents filed with the Securities and Exchange Commission by the company, including in particular its latest annual report on Form 10-K and quarterly reports on Form 10-Q, discuss 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 a result of new information, future events or otherwise. With that introduction, I'll turn the call over to Ron Kaplan.

Good morning, everyone, and thanks for joining today's call. We're pleased with our first quarter results. We grew sales by 39%, which is our highest Q1 sales level since 2008. Our manufacturing and productivity initiatives continue to take hold, helping us deliver a gross margin of almost 37%. All of this resulted in recognizing EPS of $0.74, Trex's best first quarter bottom line performance since the company went public 13 years ago. We are executing a multiyear strategy that enables us to grow our business even when the overall economy is tepid. The merit of that business plan continues to be proven out. This year's early buy sales program has been effective and our distributors' response has been excellent. Our strong showing reflects our best-in-class product platform and solid execution. In addition, Q1 sales were favorably influenced by the following factors: sales on the first quarter of 2011 reflect that customers' buying transcend in late 2010 in advance of a 2011 price increase; favorable weather conditions; and stronger demand in the marketplace for our products. We're especially pleased that our 2011 product introductions contributed to our results, validating the effectiveness of our growth strategies. Trex Enhance, the high-performance board that carries the middle position of our good, better, best decking lineup, is taking off, and our porch offerings, aimed at giving us entrée into a new $1 billion market, is also off to a good start. We continue to produce positive returns with even stronger potential from Trex Elevations, our steel decking substructure. Our expansion into the international arena has been gaining momentum as well, with a substantial year-over-year sales increase. As we move into the core deck building season, our brand building efforts are now underway with ad campaigns and print in on 5 different TV networks, all designed to drive sales by enabling Trex to gain even more recognition as the preeminent brand franchise in the outdoor living market. Our TV campaign will run through June. Our new commercial, Come Home to Trex, drives home the carefree comfort Trex products bring to the outdoor living space. I encourage you to look at the commercial on our website. We also announced another licensing agreement last month, our fifth since 2010. This time, we partnered with Freud America, a world leader in the carbide cutting tool industry to introduce the first saw blade specifically designed for composite decking materials. Our agreement will expand Trex's brand presence in the tool departments of retailers across North America. The Trex/Diablo blade will be available in July. I'll close my remarks by giving you our outlook for the second quarter. Building on our strong start in the year, we're expecting another strong performance in Q2 with net sales of approximately $90 million. This would be a 15% over last year's second quarter. Jim?

Thank you, Ron. Good morning. As you know, the press release with Trex's first quarter financial results was issued this morning. The company recognized net sales of $96 million in the first quarter of 2012, a 39% increase compared to 2011. The increase in net sales was attributable to a 35% increase in sales volume and a 3% increase in the average price per unit. The increase in the average price per unit is a result of a shift to higher priced ultra low maintenance products, including our new Enhance products. The company recorded net income of $12 million or $0.74 a share in the first quarter of 2012 compared to net income of $5 million or $0.30 per share in 2011. The company's 2011 results reflected a favorable resolution of uncertain tax positions that positively impacted income taxes by $2.6 million. Excluding this favorable tax adjustment, earnings per share was $0.15. The company's results for the first quarter of 2012 and 2011 included $2.7 million and $2.3 million, respectively, of non-cash interest related to our convertible debt. This reduced earnings per share by $0.16 and $0.14, respectively. Gross margin was 36.9% in the first quarter of 2012, a 300 -- 350 basis point improvement from 2011. Improved manufacturing efficiencies contributed 5% to gross margin. This was partially offset by lower year-over-year capacity utilization, which reduced gross margin by 3%. In addition, we recognized a LIFO liquidation benefit in 2012 that contributed 1% to gross margin. SG&A was $18.6 million compared to $16.7 million in 2011. The increase in selling, general and administrative expenses in 2012 was primarily related to an increase in incentive and sales compensation as well as increased research and development spending. As a percentage of net sales, total selling, general and administrative expenses for the quarter decreased to 19% in 2012 from 24% in 2011. Net interest was $4.4 million in 2012, a $400,000 increase from 2011. The increase was due to non-cash interest related to our convertible debt. The first quarter of 2012 effective income tax rate remains low as a result of the valuation allowance against the deferred tax asset. At March 31, 2012, the company had $30 million of cash. Borrowing on our revolving line of credit was $37 million. Total net debt to total capitalization at March 31, 2012, was 48% compared to 40% at March 31, 2011. At the end of April, the company had no borrowing on our revolver. Inventory was $19 million at March 31, 2012, a $21 million year-over-year decrease. Cash used in operating activities for the 2012 quarter was $45 million compared to $9 million in 2011. The $36 million increase in cash used in operating activities was primarily driven by a $74 million year-over-year increase in accounts receivable at March 31. The unfavorable effect of accounts receivable was partially offset by the reduction in inventory and increased income in 2012. Capital expenditures for the first quarter of 2011 were $1.2 million and a $1.1 million decrease compared to 2011. Operator, we would 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 with Stephens Inc.

This is actually B.G. Dickey, sitting in for Trey. Can you just real quick give me what the utilization rates were for you guys in 1Q?

It was about 35%, 36%.

And that was in line with -- I think you've guided to that number before, right? In 35%?

Correct.

So given that your inventory level dropped pretty substantially sequentially, I was wondering, given the expectation for your $90 million in sales for 2Q, again a good job of pulling downward inventory. What kind of utilization rates does that imply for you guys in 2Q?

Well, our utilization rates are going to be reflective of the level of demand that we incur. The demand so far is supported with a $90 million forecast, and we will adjust our capacity utilization as we see fit to making sure that we get our deliveries out within 3 weeks. That's about the only guidance we can give about that. I'd say our inventories are low. And we've taken it from $80 million down to $19 million, and so we've been working together here. And so you can figure out what the capacity utilization will be based on that.

Okay. And then maybe just a little bit differently, you were obviously successful in selling into the distributor channel in 1Q. I just -- could you talk a bit about what you're seeing now with respect to sales through the channels of the distributor level? Is the demand strong, or what are your thoughts there?

I can tell you a couple of things. Number one, we know that our inventory at the distributor channel is lower than last year. And we know that the sales off of the distributor shelves, off the dealer shelves, are up quite substantially.

Okay. So do you guys have any sense of how much weather impacted results in 1Q?

Well, clearly, it had some. We can't try to quantify how much is attributable to weather versus economics versus market share. But clearly, weather has been a help.

Your next question is from Keith Hughes with SunTrust.

Switching at the interest expense with the converts coming due on July 1. After that, would I be looking at a cash interest expense of roughly what we saw in this quarter of $1.7 million?

No, it would be significantly less than that.

Do you have an estimate that you can give us?

It would be on a magnitude of a few $100,000.

Okay. And have you already had some of the bonds convert?

No. People who convert the bonds, there's really no advantage to them to convert this early. So there have been no conversions to date.

Okay. And then Ron, just briefly on the last question on the competitive dynamics. Have you seen any changes in the last several months? Anyone more or less aggressive, any one seems to be tailing off the market?

Yes. We have seen that. I'm really reluctant to use any specific names. I got competitors listening to this phone call. But the lineup that I saw 3 or 4 years ago is not the same lineup today. Trex is still clearly #1 and strengthening its #1 position, but the fight between 2 and 3 seems to be flipping around a little bit.

The next question is from Morris Ajzenman with Griffin Securities.

A quick question for Jim. What should we assume is the tax rate going forward?

Morris, for the rest of this year, the tax rate will be de minimis. And next year, we will be closer to coming out of the valuation allowance, and we aren't prepared to give guidance at this point. But next year is probable the tax rate will go up significantly.

And a quick follow-up, accounts receivable clearly funding customers' needs. Does that track down materially as the year plays out?

It will, Morris. We really developed early buy program to support our initiatives that we have this year. They worked well for us. As you could tell by the fact that we're out of the revolver at the end of April, a lot of those receivables have come in already. And certainly, you'll see a very solid cash flow in the second quarter.

And any stab at what the cash flow generation you think can be for the full year?

No, we really don't do projections on cash flow, Morris.

I thought I could ask. Last question here, international. You talked about it being up substantially, I guess, of a very little base. Will there be any point in the future where you can put some dollar signs on that?

Yes. When the SEC requires us to break it out separately, that will be the time we do that.

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

If you could, can you just give us an idea of how the sales played out on a monthly basis, January, February, March, April? Sales trends? Sales growth?

Well, it is a very typical month for the early buy. The sales are relatively flat across the quarter. And absent that, we really don't want to get into any further details at this time.

How about this way, with 2Q, I guess, representing a more normal comparison, not really, but better than, I guess, 1Q, with all the pull forward at the end of 2010. Is 15% the growth rate of Trex? And what kind of market growth can we infer from the 15% year-over-year growth you're seeing in 2Q?

Well, we're not sure how much the market is growing. We know how much our share is growing. We know how much our customers are asking from us. The actual size of the market usually is measured by an outside agency, and they'll give out their report later this year. We just know that the demand for our products is fairly robust as compared to the prior year. We're taking market share, and we're introducing new products. The sum of those 3 is why our sales are going up.

And then just as far as the brand, you talked about the brand building beginning for the selling period here. What should we assume for SG&A for maybe 2Q and the balance of 2012? Do you expect that to flex up sequentially from 1Q? And what will it look like on a full year basis?

Yes, you ought to expect that the second quarter will increase in the second quarter. We had projected it was going to be a little bit higher than what it actually came in for the first quarter. Some of those expenses ended up moving into the second, so you ought to be in rough numbers about $20 million in the second quarter, give or take a little bit. We really don't get into projecting the full year SG&A spend. But I think it's fair to say it will be typical of the spend that we've had over the last couple of years, in the latter half of the year.

The next question comes from Jeff Bernstein with AH Lisanti.

A couple of questions for you. One, any other changes in warranty reserving? Or is that essentially now completely behind us?

We will make changes in the warranty reserve as we identify changes, both for the delamination issue as well as any current product production. Any changes we expect going forward, we believe will be de minimis.

Okay. And then just to refresh us on where you are on NOLs at this point.

About $60 million at the beginning of the year, roughly.

And that's federal?

Yes.

Okay. And then just looking back a little bit historically and obviously, there's some noise in there with economic trends, et cetera. It looks like Q2 is usually up from Q1. Is there -- are you guys being conservative or is there a particular reason why you would see it down sequentially? I understand you had an easy year-to-year comp in Q1, but just purely looking on a sequential basis.

Look. We keep this fairly simple. We take the orders that we got in hand year-to-date, and we sort of prorate it. That's what we see that's, to the best of our knowledge and belief, that's our forecast for this quarter. It could be high. It could be low. But we try to make it a fairly simple calculation, and that's what it indicates right now.

That's fine. And then lastly, just on Enhance, I guess there's been some question about whether there would be any cannibalization, et cetera. It sounds like you guys think that Enhance has been a net positive for growth. Can you just talk about sort of how Enhance is shaking out among product offerings, both internally and externally in the market?

Well, it is a fairly robust demand for Enhance. It's been loaded into the shelves fairly aggressively. If it is cannibalizing anything, it looks like it's probably Accents. And so we're pleased with where it is right now. The strategy of the good, better, best is playing out as we had hoped it would.

The next question comes from Jack Kasprzak with BB&T.

I wanted to ask just some general questions around pricing because last quarter, I think there was a discussion that some competitors were out with some price increases and maybe an effort to pass along some higher raw materials costs. You guys were not out with price increases. Is that still the case? Where you seeing pricing successful out there in the marketplace, do you think that's been giving you guys an opportunity? Or is that not part of some of the success you had on the quarter?

Well, I think it is part of our success. Our pricing strategy is flat for the time being. We'll review the matter again in October at our distributor conference. But our cost structure certainly enables us to keep cost flat for the remainder of this buying season. I'm not sure that's true for our competitors.

Okay. While I got you 2, you mentioned, Jim mentioned de minimis amount of CapEx in the quarter. But for the year, can you just refresh us on the budget?

Yes, we're still anticipating a spend of approximately $15 million. I wouldn't expect any more than that.

Your next question comes from Dillard Watt with Stifel, Nicolaus.

My questions have been answered.

Your next question comes from the line of Alan Mitrani with Sylvan Lake Asset Management.

Can you just remind us, after the convert has converted, you're going to have a little over 20 million shares outstanding all in, is that right?

Well, it depends on the share price. So if for example the share price were $30 a share, the dilution related to that would be an additional $1.2 million shares issued, so it would be a little less than 20 million shares.

Okay. But somewhere between 19 and 20 something right? Several million shares above where you're at now?

No, no. One of the things you got to remember is that we do reflect in the share count about 700-and-some thousand shares at the end of the first quarter that diluted the earnings per share already.

Okay. We'll work that off offline then. Could you just remind me, I may have missed one of the question. On the branding side, did you say how much of your branding did you spend in this quarter.

We did not.

Can you talk about what percent of your budget roughly was spent this quarter?

Any of the detail information like that, we really don't disclose on the conference calls.

[Operator Instructions] Your next question comes from Kenneth Smith with Lenox Equity Research.

Two questions. Ron, what are you seeing regionally in terms of your sales last year, particularly in the second quarter, you saw some real softness from the wet, wet spring, I wonder how that's going this year. And then secondly, can you talk about your ad campaign? It sounds like it's going to be a little bit later this year relative to last year, is that correct? And just, I know you don't want to give detailed numbers as you said, but in terms of order of magnitude, is it going to amount to a similar kind of campaign? And are you doing anything a little bit different in terms of the channels for your advertising?

Well, in terms of the regionality, our regional dispersion, sales are robust across the board. It is a nationwide surging demand. Our branding program are our TV, television commercial might be running a little bit later. We have a new TV commercial, if you haven't seen it, I recommend you do. You can get it on our website. But it's on 5 TV networks and I think runs through first week in June.

Your next question comes from Keith Hughes with SunTrust.

All of my questions have been answered.

And your next question comes from Morris Ajzenman with Griffin Securities.

Just a follow-up question. Ron, you touched on, and you've articulated in the past, no price increase for this year. Your competition, probably, you are seeing price increases. Can you just best estimate of what you think the average price increases you're seeing out there by competition? What's that coming in as about?

I'd say somewhere between 5% and 10%.

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

Thanks for participating this morning. In our year end conference call in February, I laid out in some detail our overall growth strategy and how we position Trex to advance in the industry, leading market share and increase shareholder wealth. I've kept my remarks short today because the numbers speak for themselves. We are seeing the fruit that come from the rigorous execution of a sound business strategy. We continue to be the innovation leader in our category. We continue to build our market share, expand our international footprint, as well as growing the strategically sound adjacent categories. I want to take this moment to thank the employees of Trex, whose smarts and hard work enable our result for our shareholders. We look forward to talking to you again in July when we host our 2Q earnings call. 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.