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Executives

Harriet C. Fried - Senior Vice President - New York Office

William R. Gupp - Chief Administrative Officer, General Counsel and Secretary

Ronald W. Kaplan - Chairman, Chief Executive Officer and President

James E. Cline - Chief Financial Officer, Principal Accounting Officer and Vice President

Analysts

John F. Kasprzak - BB&T Capital Markets, Research Division

Trey Grooms - Stephens Inc., Research Division

Keith B. Hughes - SunTrust Robinson Humphrey, Inc., Research Division

John A. Baugh - Stifel, Nicolaus & Co., Inc., Research Division

Morris Ajzenman - Griffin Securities, Inc., Research Division

Robert J. Kelly - Sidoti & Company, LLC

Trex (TREX) Q1 2013 Earnings Call May 3, 2013 10:00 AM ET

Operator

Welcome to the Trex Company First Quarter 2013 Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, May 3, 2013.

I would now like to turn the conference over to Harriet Fried of LHA. Please go ahead, ma'am.

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 first quarter of 2013. 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 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, as well as our '33 and other '34 Act filings on file with the SEC.

The company expressly disclaims any obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.

With that introduction, I'll turn the call over to Ron Kaplan.

Ronald W. Kaplan

Good morning, everyone. Thanks for joining our call to review an excellent quarter for Trex.

Sales were up 12%, gross margin rose to 39% and we set a new quarterly EPS record for Trex. Our bottom line of $1.25 in earnings per share is the highest in our 14 years as a public company.

Many factors contributed to our impressive Q1 results. Our continued expansion of Trex's high-performance product platform, our ongoing manufacturing and supply chain initiatives, our growing distribution network and our innovative marketing strategies.

As you know, we recently launched a "good, better, best" high-performance lineup for decking and railing. Our goal is to bring products and price points that appeal to the full range of consumer segments.

First, we used our game-changing Trex Transcend technology as a springboard for expanding our high-performance decking platform. Then, in railing, we evolve beyond the WPC market, going after a much larger piece of the pie by offering products that compete in the PVC and aluminum railing markets, Trex Select and Trex Reveal. These new railing products give us access to a $325 million of market opportunity, previously not served by Trex.

These new decking and railing additions, coupled with our Trim and Elevation substructure product lines, offer the most comprehensive product portfolio in the company's history. In total, we now offer 1,200 different decking and railing combinations, an unmatched portfolio that allows homeowners endless choices for creating their ideal outdoor living space.

Our lineup was well-received in the marketplace during this year's early buy period. We're especially pleased with the gains we've been making in the sale of our new railing options. We've begun to move the needle on increasing railing attachment rates.

In addition, we were pleased to be selected for several boardwalk rebuilding projects, including the 1.3-mile boardwalk in Belmar, New Jersey that resulted from the destruction caused by Hurricane Sandy. The rebuilding along the eastern seaboard has begun in earnest, and we expect homeowners will be rebuilding their damaged decks to be influenced by the municipality's decision to use Trex's durable, striking products.

In Design Journal's recent ADEX competition, the largest, most prestigious design award program in the architecture and decor industry, we won 4 Platinum and 1 Gold Award for Design Excellence. These tributes, along with positive market response to our expanded product lineup, are very encouraging and are energizing us even more to seize every market opportunity.

Although our product lineup is growing, our continued commitment to lean principles is allowing us to service the marketplace without significantly increasing our inventory. In fact, we utilize Trex's strong balance sheet in our early buy sales program. The $117 million of accounts receivable on our balance sheet at the end of March has already started turning into cash and will be fully reflected in our free cash flow at the end of the second quarter. As we move into the core deck building season, our brand building efforts are now well underway. We unveiled our Engineered Artistry branding campaign during the first quarter with a blanket of coverage, including national TV spots. Our campaign, which uses the voice of actor, Martin Sheen, shows how Trex combines artistry and technology and enables consumers to create their own unique and beautiful outdoor living space.

Our dealers and contractors also understand the importance of a strong branding presence. Their branding efforts at the local level complement what Trex is doing at the national level to help us create the strongest possible presence in the marketplace. In addition to guiding and advertising, we ensure that they have the right training, merchandising and support to be effective advocates for all of our products.

I'll close my section with our outlook for the second quarter. As you can see, there are many different reasons to be upbeat about our prospects for 2013. In the second quarter, we expect net sales of approximately $103 million or 10% above last year's period. Jim?

James E. Cline

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 $108 million in the first quarter of 2013, a 12% increase compared to 2012. The increase in net sales was driven primarily by higher sales volume. We launched 3 new products during the quarter, expanding our product line to include "good, better and best", high-performance decking and railing platforms.

The company recorded net income of $22 million or $1.25 per share in the first quarter of 2013, compared to net income of $12 million or $0.74 per share in 2012. As Ron noted, this established a new quarterly earnings record for Trex.

Gross margin was 38.8% in the first quarter of 2013, a 190 basis point improvement from 2012. Excluding the nonrecurring LIFO inventory benefit realized in the first quarter of 2012, gross margin improved by 280 basis points. Increased capacity utilization and reduced sales-related costs contributed to the gross margin improvement.

SG&A was $19.8 million compared to $18.6 million in 2012. The increase was primarily related to personnel and branding expenses. The personnel expenses relate to the higher payroll taxes and healthcare expenses. Our branding expenses reflect to the launch of our new Engineered Artistry campaign. As a percentage of net sales, total SG&A expenses for the quarter decreased to 18% in 2013 from 19% in 2012.

Net interest was $300,000 in 2013, a $4.1 million decrease from 2012. The decrease was a direct result of the midyear 2012 retirement of our convertible notes.

Our free cash outflow for the first quarter of 2013 was $68 million compared to $47 million in 2012. The $21 million change in free cash flow was primarily driven by increased sales and a lower reduction in inventory in 2013. Our inventory was $15 million at March 31, 2013, a $4 million year-over-year decrease and represents a 5.6 turns on a forward-looking FIFO basis.

Capital expenditures for the first quarter of 2013 were $1.8 million, a $600,000 increase compared to the prior year.

At March 31, the company had $70 million of net debt. The borrowing on our revolving line of $70 million has declined significantly, as collections have occurred on our receivables of $117 million. Our net debt today is approximately $25 million.

Our guidance for the second quarter for sales is $103 million, an increase of 10% over 2012.

In the first quarter of 2013, we began the final redeployment of production equipment from our Olive Branch facility to our remaining operations. This redeployment will be completed by the end of the second quarter. In addition, we are modifying the configuration of certain production lines within our remaining manufacturing facilities. This redeployment and reconfiguration of our production facilities will create an earnings drag of approximately $1 million in the second quarter.

By the end of the year, the transformation of all production lines will be complete, allowing for further cost reduction and enhanced flexibility in future quarters. SG&A spending is projected to be about $1 million higher than last year's underlying second quarter, due mainly to timing of our branding campaign.

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

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Jack Kasprzak with BB&T.

John F. Kasprzak - BB&T Capital Markets, Research Division

Jim, with regard to your comment on the $1 million earnings drag, just a little detail on how we should think about that. Or given that you're guiding to up sales and you had good operating leverage in Q1, is that $1 million just something that would detract from operating leverage potential in Q2?

Ronald W. Kaplan

Yes. Basically if you look at the same methodology we talked before, if you spring from the first quarter to the second quarter using any change in sales as affecting the bottom line by $0.50 on the dollar, the adjustments that I provided would give you a pretty good guidance on where we expect the bottom line to be.

John F. Kasprzak - BB&T Capital Markets, Research Division

Okay. And the month of March was not a particularly good weather month this year versus particularly last year, where it was very mild. I know you guys were able to grow sales, make your guidance. Could you just talk about whether the weather was a factor at all, and just what you were seeing out there in the face of maybe a tough weather comp?

Ronald W. Kaplan

Well, we did see that the weather did have an effect. We used our planalytics, weather forecasting and algorithms to forecast that. And the weather did turn out consistent with our forecast for the month of March and parts of April, as well. So there was an effect. It will tend to compress the season a little bit. But on the whole, we're ahead of our plan and we expect to stay that way.

Operator

And your next question comes from the line of Trey Grooms with Stephens.

Trey Grooms - Stephens Inc., Research Division

As mentioned briefly in your prepared comments, some of the new products, I think you highlighted railing. But I was just wondering if you could go into a little bit more detail on those? Maybe even Select. And just talk about kind of the traction you're getting there and the rollouts, that sort of thing?

Ronald W. Kaplan

Well, we're encouraged by the rollout. We won't give any specific numbers. I can tell you that certain portions of the portfolio have exceeded our expectations. It has met with acceptability and market acceptance beyond our expectations, particularly, geographically. Where we thought it was only going to cater to certain markets, it has been more broadly accepted than we had anticipated. It's all good news. We're keeping up with deliveries. And that's about all I can say on that. I've got competitors listening to me right now.

Trey Grooms - Stephens Inc., Research Division

Sure. And maybe, just along those lines, maybe this is a question for Jim. But given that you guys have rolled out so many new products, how should we think about the long-term margin structure of the business going forward, just given the new product mix?

James E. Cline

Well, with regard to the new products, as we've mentioned before, the Select product, we believe, will eventually replace the Accent products. The margins on those products are comparable. We do gain additional flexibility with the Select product. In the long term, that will enable us to be more competitive from a cost standpoint than we are today. That is primarily due to the fact that we use 95% recycled material on our deck board products. And with that, it enables us to utilize polyethylene sources that are more cost-effective on a board that has a shell on it than a board without the shell. With regard to the railing products, we do have an opening price point product. The margins on those are slightly lower than other products, but we do have plans in the works to get those margins to higher levels. But I don't believe you will see significant impact, certainly, over the next 12 months relative to those. And by then, cost reduction efforts will have kicked in and will actually enhance margins.

Trey Grooms - Stephens Inc., Research Division

Okay, perfect. And then just one last question. On inventory, can you guys talk a little bit just about what the level of inventory looks like right now? Is it fairly lean still? Most of the channel checks that we've done seems to point that way, but I just wanted to get your take on that.

Ronald W. Kaplan

Inventory in the channel is slightly higher than it was a year ago. We attribute that to the weather and the introduction of new products so it's nothing that I'm concerned about. But to be accurate, there is some increase, on a dollar-per-dollar basis in the channel and I think it will work its way through the system in Q2.

Operator

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

Keith B. Hughes - SunTrust Robinson Humphrey, Inc., Research Division

Can you give us any idea what you're running in terms of capacity utilization in the first quarter? And what the plans are for the rest of the year?

Ronald W. Kaplan

As we mentioned in our last call, we've made the decision that we're no longer going to speak to the capacity utilization. I think that if you look at the sales levels and you look at what's taking place with the inventory, you can get a pretty good feel for what's going to be happening -- what has happened with capacity and what is going to happen. But for competitive reasons, we just made the decision. We are not going to continue releasing that information.

William R. Gupp

I can tell you that our Six Sigma initiatives continue aggressively and broadly, and we are not done with the continuous improvement to our manufacturing capability, productivity and capacity.

Keith B. Hughes - SunTrust Robinson Humphrey, Inc., Research Division

You had mentioned in the fair comments, you're moving some of the Olive Branch production machinery to other facilities. When will that be up and running? And is it specialized in terms of what it manufacturers or can it -- does it have the same capabilities of what you currently have in Nevada and Virginia?

Ronald W. Kaplan

Well, we've been moving the assets all along. This is merely the completion and final deployment of those assets. Certain of those assets will be deployed immediately in the production lines. Some of those assets will not have the immediate implementation. They will be used as spare parts. But we are positioning that facility for eventual sale. We have not listed the property. But eventually, that property will be sold. We needed to get proprietary equipment removed from the facility, and we did have a need for certain of those assets to enhance our production lines in the near-term.

Operator

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

John A. Baugh - Stifel, Nicolaus & Co., Inc., Research Division

Could we quantify brand spend? The percentage of revenue both in Q1 and maybe, thoughts for the year?

James E. Cline

Well, as we mentioned before, the brand spend for the year will be up slightly. I don't think we put a number for the full year, but it will be up slightly. We've given very rough guidance relative to the overall spend, looking at what we had spent in 2011, it's kind of a low point. 2012, kind of a high point. That kind of boxes in the estimates for SG&A. But I think from a granularity standpoint, I think we've provided sufficient information for you to get there.

Ronald W. Kaplan

I can tell you that the additional branding expense is supporting 2 major initiatives. One is our expansion internationally, which continues to move forward. And the second is the vast array of new products that we're introducing. So we are getting the bang for the buck here in the launching these new products and expanding our footprint and that's what it's for.

John A. Baugh - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And then the leverage on SG&A in the quarter, could you speak to, maybe a few of the key drivers, there, Jim?

James E. Cline

Well, I mean, if you go back and look at where we're last year, certainly when you're driving sales up double-digit as we had, that certainly assists in it. We did indicate that branding spend was up. We had anticipated branding spend to being a little bit higher than what we'd actually indicated. R&D spending was higher also. We are focused on development of not only new, innovative products but also, cost reduction initiatives. In some cases, it requires us to take production lines down and run R&D trials over those lines. Those lines are expensed as part of R&D and those are embedded in those numbers.

John A. Baugh - Stifel, Nicolaus & Co., Inc., Research Division

Okay, great. And then Jim, you'd referenced in the gross margin of reduced sales-related costs. Could you tell me what that is?

James E. Cline

Well, there's certain changes to our pricing. As I think we indicated before, we did have a 5% increase on our Accent product earlier in the year. Ron mentioned that there was a good reception to the Select product offering by moving more product to the shelled products, it is favorable to our financial results. We anticipate that we will continue to see that migration to the shelled products and Select is a strong performer early in the year compared to Accent.

John A. Baugh - Stifel, Nicolaus & Co., Inc., Research Division

But that's mix-related and price increase-related, that commentary?

James E. Cline

That's right.

John A. Baugh - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And then lastly, just quickly, anything on raw materials good, bad, indifferent?

James E. Cline

Raw materials are in line with the rate of inflation. They are slightly higher than a year ago but consistent with the rate of inflation or a little less.

Operator

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

Morris Ajzenman - Griffin Securities, Inc., Research Division

I'm curious. What's happening -- what can you bring us up to date? In the past, we've kind of talked about the -- broadly speaking, what's going on with the competitive landscape. And then, just to add on with that, where do you think your market share positioning is now, after having a pretty robust quarter?

Ronald W. Kaplan

Well, my competitors are listening to me so I'm going to be very respectful. but I can tell you, there is some turbulence in the distribution marketplace as a result of combination between 2 of the larger competitors, I forgot their names offhand. We really haven't seen any vast changes in market share because of that combination. There are a lot of dealers and the contractors who are very concerned about the implications of that merger, and we're the beneficiary to some extent. We continue to add new dealers and new SKUs and existing dealers. And the number of dealers that handle Trex exclusively continues to rise. We will not reveal exact numbers about that, other than to say that we continue to push the ball in a favorable direction. That's about all I can say about that.

James E. Cline

One other thing I'd just like to mention, as we've mentioned in previous calls, there are a number of consumers out there that do look for strong companies to purchase their decking products from. There has been a fallout over the last several years of the smaller players. That continues to occur. We continue to see a migration to quality and strength. And we believe that will continue over the next several years.

Ronald W. Kaplan

One of the things that's interesting is, that one of the major periodicals that serves the industry does a survey comparing quality, are doing a consumer survey. Trex has steadily moved up that ladder in terms of the quality. So we're very proud of that. And the market is focused on stability and strength of brand and knowing what the future will bring for any given company. Trex has been a beneficiary, as a result of the turmoil that's been created in the industry.

Morris Ajzenman - Griffin Securities, Inc., Research Division

I think the latest data that you were able to give us might be a year old at this point. Your market share was approximately 37%, 38%. Any data point, any update you could bring us to, where you think the market share is today?

James E. Cline

Well, we think it's higher than that. But there have been no independent reports published yet. We expect it to be published soon but there are no specific industry figures that have yet been published.

Morris Ajzenman - Griffin Securities, Inc., Research Division

Okay. A quick question for Jim here. Your tax rate, I think you had stated that we're going to start paying taxes this quarter, on a GAAP basis, at least. It looks like here, you had the minimal taxes, again. How is that playing out?

James E. Cline

Morris, for the year, you should expect de minimis taxes, they would be state taxes and a small federal tax, probably in the 5% or less range, occurring through the end of the year. Next year, 2014, we anticipate that we will be in a full tax position something in the 39%, 39.5% range.

Morris Ajzenman - Griffin Securities, Inc., Research Division

And last question and then I'll get back in the queue. This the facility, the Olive Branch, eventually be sold. Can you share what's the book value? Is there any potential upside to that sale? Or is it the book value close to what market value is.

James E. Cline

In rough numbers, they're comparable. Book value is, roughly, the market value. Market value is slightly above. But we haven't marketed the property. We haven't gotten close to that point yet. So we still have a bit more work before we get ready to put that on the market for sale.

Ronald W. Kaplan

What we do know is that it will be cash positive.

Operator

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

Robert J. Kelly - Sidoti & Company, LLC

Just a question on the Olive Branch items. One, was there a drag on gross margin during 1Q? And then secondly, does this amount to adding capacity or you're just kind of -- is it a productivity related action?

James E. Cline

There was a minor drag in Q1. It will add to productivity, it will add to throughput and it will reduce future costs.

Robert J. Kelly - Sidoti & Company, LLC

As far as the sales growth, you're very impressive for 1Q and then the outlook is strong as well. But the sense is, is that market demand is not quite there yet. Can you just talk about your sales performance versus what the market is doing? I know there's not a really good benchmark but what does the customer take on, on how things are trending on year-over-year just as far as market demand?

Ronald W. Kaplan

We can tell you, anecdotally, which we think is pretty good. We got a lot of feet on the street out there, listening. Contractors are busy. The phones are ringing. There has been some compression to the season because of the weather. But generally, what we see going forward is fairly robust. So we're encouraged by what we see. The next several weeks are going to tell the story and by the time we have this next quarterly phone call, we'll have an excellent handle on how the year is going to turn out, obviously. But we're not discouraged by the weather. We just think it's a compression issue. The good news for Trex is that we've got what we need. We can turn this company on a dime and we can ramp production up or down as quickly as we need to.

James E. Cline

And Bob, just to be clear, we had seen a break in the season -- have seen it. We -- the incoming sales demand, our early buy program, as well as our -- what we've seen so far in the second quarter is consistent with our expectations that we had earlier in the year.

Robert J. Kelly - Sidoti & Company, LLC

That's helpful. As far as the boardwalk related demand, is that shipping in 2Q as well? Throughout the year? Is it isolated to 1Q?

James E. Cline

No, no. It continues to ship in Q2.

Robert J. Kelly - Sidoti & Company, LLC

Okay. And then the mix of shelled products, is that the only decking board you're selling at this point? Are you in selling the traditional composite product?

Ronald W. Kaplan

We will sell the traditional composite product through December 31, 2013. That will conclude Trex's participation in the uncapped market.

Robert J. Kelly - Sidoti & Company, LLC

Understood. And then just as far as the success with railing. Attachment rates are -- that's a number I don't think you guys like to give out. Can you give just give us a sense of where the product is, availability-wise? Is railing available at every location you're selling the deck board?

Ronald W. Kaplan

I wouldn't say every location. But it is certainly the majority of locations and continues to -- that number moves north as well. You're right. We don't reveal the exact attachment rate, but it is something that we watch internally and it has been a strong movement forward.

Robert J. Kelly - Sidoti & Company, LLC

And one last one. Just as far as cash, is there a cash goal -- a cash flow goal for 2013 that you'd care to share?

James E. Cline

There is a cash flow goal. But no, we wouldn't care to share it.

Operator

[Operator Instructions] Your next question comes from the line of Keith Hughes with SunTrust.

And at this time, there are no further questions.

William R. Gupp

Well, thank you, everyone. When I took this job, I told you that we would not have any exotic stories to tell the street. You could watch our results by the numbers that we put on the board. We continue to prosecute a very aggressive, relentless pursuit of low-cost manufacturing, new product innovation and geographic expanse. I want to thank everybody for participating this morning. As you've heard, we've been executing well on the strategy we've set for ourselves. As the innovation leader in the category, we believe there is plenty of room for it to grow by moving into strategically sound adjacent categories, expanding our international footprint and taking more of the market share held by wood. Our company continues to move forward to create value for our shareholders as well as opportunities for our employees.

We look forward to giving you another update in July when we'll host our second quarter earnings call. Thank you, and have a great quarter guys. Thanks. Bye-bye.

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.

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