Trex Company, Inc.
Q2 2008 Earnings Call Transcript

Published: 31 Jul 2008

[Operator:]

Welcome to the Trex Company Second Quarter 2008 Earnings Conference Call. At this time, all participants are in a listen-only mode. Following management's prepared remarks, we will hold a Q&A session. (Operator Instructions) As a reminder, this conference is being recorded July 30, 2008. I would now like to turn the conference over to Ms. Harriet Fried. Please go ahead, ma'am.

[Harriet Fried:]

Thank you, everyone, for joining us today. With us on the call are Ron Kaplan, President and Chief Executive Officer, and Jim Cline, Chief Financial Officer. Joining Ron and Jim are Brad McDonald, Controller, Brian [Berteau] Director of Financial Planning and Analysis and Bill Gupp, General Counsel. The company issued a press release this morning containing financial results for the second quarter of 2008. 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. With that introduction, I would like to turn the call over to Bill Gupp, Trex's General Counsel. Bill?

[Bill Gupp:]

Thank you, Harriet. Before we begin, let me remind everyone that statements on this call regarding the Company's expected sales performance and operating results is a projection of net sales, net income, earnings per share and costs, its anticipated financial conditions and its business strategy constitute forward-looking statements within the meanings of Section 27A of the Securities Act of 1933 and Section 21E of 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 include the extent of market acceptance of the Company's 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 relations expenses related to product quality in the highly competitive markets in which the Company operates. The Company's report on 10-K filed with the SEC in March 2008 and its subsequent report on Form 10-Q filed on May 9, 2008 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. To supplement the Company's consolidated financial statements, the Company uses certain measures defined as non-GAAP financial measures by the SEC. A reconciliation of these results to GAAP is attached to today's earnings release. With that introduction, I will turn the call over to Ron Kaplan.

[Ron Kaplan:]

Thank you, Bill. Good morning. This morning, we released the Trex Company financial results for the 2008 second quarter. Revenue for the second quarter of 2008 was $95 million, a 20% decrease to the 2007 second quarter revenue and slightly favorable to our prior revenue guidance. Trex recorded net income of $7.9 million, or a $0.52 a share for the second quarter of 2008, a 205% increase compared to the 2007 second quarter earnings. The Company recorded net income of $16.8 million, or a $1.12 per share for the six-month 2008 period, a 166% increase compared to the 2007 six-month period. Now, I would like to turn this conference call over to Trex's Chief Financial Officer, Jim Cline. After Jim's more detailed discussion of the numbers, I will return to the call to give you more color on our accomplishments and strategy.

[Jim Cline:]

Thank you, Ron, and good morning everyone. As you are aware, our press release was issued this morning. The numbers I will reference are contained in the last few pages of the release, headed Condensed Consolidated Statements of Income -- I am sorry, Operations Condensed Consolidated Balance Sheet and Condensed Consolidated Statements of Cash Flow, and the Pro Forma and Profit Loss Statements. In the second quarter of 2008, net sales were $95 million compared to net sales of $118.8 million in the second quarter of 2007, a decline of 20%. The volume shift during the second quarter of 2008 decreased by 27% compared to the second quarter of 2007 due mainly to the macroeconomic conditions in the marketplace. Net sales were favorably impacted by a 7% price increase implemented in January 2008 and improved sales mix. The Company's favorable sales mix resulted from a higher percentage mix of Seclusions Fencing and our two new product introductions for 2008, Trex Escapes and Trex Trim, all of which carried higher pricing. In addition, the 2007 quarter included costs related to the surface flaking from certain west coast production. These costs are being recognized against the warranty reserve in 2008. For the six months ended June 30, 2008, net sales decreased 8.6% to a $114.5 million from -- I am sorry, $214.5 million from $234.7 million in the first six months of 2007, a modest decrease given the current macroeconomic environment. Volume for the first six months of 2008 was 15% lower than in the 2007 period. This decline in sales volume was partially offset by the 7% price increase, improved sales mix and the effect of the surface flaking costs recognized and revenued during the six-month period in 2007. Gross margin for the 2008 second quarter was 30% of sales compared to the second quarter of 2007 gross margin of 25%, a 500 basis point improvement. The second quarter of 2008 gross profit margin was favorably influenced by ongoing process improvement initiatives, improved productivity and reduced manufacturing costs. These favorable effects were partially offset by operating at significantly reduced levels of capacity utilization. The lower capacity utilization was a result of reduced sales demand, coupled with inventory reductions as part of our ongoing initiative to increase free cash flow. Our cost of purchase polyethylene material in the 2008 second quarter was lower than in the 2007 quarter, which is a significant accomplishment amid the current environment of escalating prices for petrochemical-based products. The recent capital investments that were put into place to increase productivity and reduce cost, coupled with our continuous focus on process improvement and cost reduction initiatives, have had a significant contribution to our improved gross margins. In the second quarter of 2008, SG&A expenses totaled $18.3 million compared to $22.9 million in the second quarter of 2007. Surface flaking costs recognized in SG&A from the west coast production were $3.3 million in 2007. Since October 1, 2007, these costs have been recognized against the warranty reserve. In addition, the Company reduced branding expenses and staffing costs in the 2008 second quarter compared to 2007 quarter. The Company is running a more efficient advertising campaign and has lowered staffing related expenses primarily due to the first quarter 2008 reduction in force. The foregoing positive factors to SG&A were partially offset by increased incentive-based compensation due to the Company's improved financial performance in 2008 and carrying costs for our idled Olive Branch Mississippi facility. SG&A expenses as a percent of revenue were 19%, which was comparable to last year's second quarter. Net interest expense in the second quarter of 2008 amounted to $1.9 million, a decrease of $600,000 from the second quarter of 2007. The decrease resulted from the recognition of a $600,000 prepayment penalty in 2007 related to the retirement of the old higher-cost senior secured notes. The second quarter of 2008 effective income tax rate was near zero compared to 31.5% for the 2007 quarter. As we explained in our last call, the lower effective tax rate in the 2008 quarter essentially resulted from utilizing the net operating loss carried forward from the Company's 2007 loss. Net income in the second quarter of 2008 was $7.9 million or $0.52 per diluted share compared to net income of $2.6 million or $0.17 per diluted share for the second quarter of 2007. Net income for the six months ended June 30th was $16.8 million or $1.12 per diluted share compared to $6.3 million or $0.42 per diluted share for the six months ended June 30, 2007. In addition to the financial information that we have supplied in the past, we have included pro forma statements of profit and loss. These statements allow the investor to more easily determine the impact on income of various unusual adjustments that were reflected in the GAAP financial statements. The pro forma statements and the GAAP statements reflect a continuous -- continued improvement of gross profit and income from operations in spite of the adverse impact of reduced demand and our inventory reduction initiatives. Our capacity utilization declined from 86% to 48% in the second quarter of 2008 and from 85% to 53% in the first half of 2008. The pro forma gross profit for the quarter exceeded 31%, and the pro forma income from operations was approximately 15%. The six month pro forma gross profit and pro forma income from operations were 30% and 14% respectively. As of June 30, 2008 the net debt after being reduced for cash amounted to $116 million, which represents an $18 million reduction from December 31, 2007. Total net debt to total capitalization at June 30, 2008 was 51% compared to 59% at December 31, 2007. Total inventories were $56 million at June 30, 2008, a $24 million a year -- year-over-year reduction. Pre-cash flow was $40 million for the second quarter of 2008 compared to $26 million for the second quarter of 2007, a $14 million improvement. The improvement was primarily the result of improved EBITDA and reduced capital spend. Capital expenditures during the second quarter of 2008 were $1.6 million, a $5 million reduction compared to the second quarter of 2007. Our 2008 investment strategy is focused primarily on lower spend projects with attractive return on investments. These investments will continue to support our productivity and cost reduction initiatives. We expect capital expenditures for the year 2008 to be approximately $10 million, $15 million lower than 2007. Ron?

[Ron Kaplan:]

As Jim's review of our numbers makes very clear, Trex continues to execute our business turnaround strategy in delivering on our commitment to grow shareholder value. We have now delivered two consecutive quarters of solid financial performance. It is too early to declare victory, but certainly encouraging. Everyone at the Company is fully focused on following a straightforward strategy of expanding margins and incremental growth. We are also pleased with our sales performance, given the current macroeconomic conditions. This performance reflects our best-in-class product offering, industry-leading distribution presence and brand leadership. New products continue to represent a higher mix of the Company's sales as we bring innovative products to market. Our objective is to deliver the homeowner a product offering that provides them the flexibility to build a deck or fence that is both distinctive and low maintenance. During the second quarter, we completed the introduction of the Groove Brazilia product line with the new Trex Hideaway Hidden Fastening System. In the second half of 2008, we will further expand our railing offering, providing 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 continues to drive strong demand in the marketplace. As I mentioned in our last conference call, demand for Escapes has temporarily exceeded supply and we are in the process of resolving this situation. The Trex Seclusion Privacy Fencing line continues to gain broader market acceptance in the marketplace. Like our decking and railing products, Seclusions offer a better performance characteristics, including longevity and enhanced aesthetics than wood. Homeowners enjoy the privacy that Seclusion brings to their backyard. In addition, homeowners' associations are discovering the benefit of using Seclusions as surrounds to their communities. In the second quarter, our gross margin was almost 30% despite our running at significantly lower capacity utilization than in 2007 as we have improved productivity and leveraged our low cost competitive advantage with our environmentally responsible use of reclaimed waste plastic and waste wood. I would like to emphasize the fact that we reduced our purchase price of reclaimed polyethylene year-over-year through the first half of 2008. This is a significant accomplishment as most of our competitors can't use reclaimed polyethylene and must therefore manufacture their product with higher cost plastic materials whose price increased 35% to 40% year-over-year. Trex's innovative re-processing techniques, capital investments and focus on production are really paying off. We also strengthened our balance sheet through the first half of 2008. I am particularly pleased with our management of the Company's working capital and our $24 million year-over-year decrease in inventories. This, coupled with our earnings improvement and reduced capital spend, resulted in free cash flow of $18 million through the first half of 2008, a $25 million improvement over the first half of 2007. In closing, I would like to reiterate that we are very pleased with our first half financial performance amidst such a challenging macroeconomic environment. Our goal is to build on our financial success on our first half and continue delivering results that provide a competitive return to our shareholders. Given the orders we currently have on hand for the third quarter, and our outlook for the remainder of the period, we project third quarter 2008 revenue to be approximately $90 million to $97 million. This is a 12% to 21% increase over 2007 third quarter after adjusting for the impact of last year's increase to the warranty reserve. We have additional productivity and cost-cutting initiatives under way. We are looking into some new distribution opportunities and we are also exploring some new product opportunities. For all of these reasons, I am confident that the strategy we are deploying in executing Trex's mission of turning the backyard into the next great room in an environmentally responsible manner will be successful. As you know, from the Company's inception, Trex has provided a product offering that is based on an eco-friendly material stream. Delivering a high quality product to the marketplace while responding to the green movement has been and will continue to be a guiding principle of our corporate mission. Now, more than ever, consumers are interested in using environmentally friendly products and Trex is well-positioned to support this movement. We are now ready to answer your questions.

[Operator:]

Thank you. (Operator Instructions) One moment please for the first question. Your first question comes from the line of Ryan Thibodeaux of Maple Leaf Partners.

[Ryan Thibodeaux:]

Good morning. Could you go through the explanation again on the increase in gross margin given the year-over-year decline in capacity utilization, and maybe just break out what the contribution from the lower poly cost year-over-year is to get into that number? Can you hear me?

[Ron Kaplan:]

Yes. Specifically, the Company has really changed their focus in the way we are targeting our production costs. Instead of looking at yield and throughput individually, we have changed our focus to look at the total cost per pound of production, and in doing that we have changed the behavior in the manufacturing process and it has identified opportunities both in poly and other production processes that have enabled us to reduce our expenses. The poly specifically has been beneficial to us in that we have been able to take poly that is of lower specification due to our investment over the last couple of years and we are able to utilize lower-grade poly at reduced costs, which enables us to have an average reduction in cost year-over-year. We have also exploited some niches within an inefficient market for recycled poly, so there have been both production improvements and the benefits associated with the way in which we purchase.

[Ryan Thibodeaux:]

Your call initiatives that are -- that you can -- there is some staying power there in these initiatives. Are these kind of a short-term -- these niche markets that you just talked about, are those short-term opportunities --?

[Ron Kaplan:]

Well, I can't predict the long-term market for recycled poly with any high level of accuracy. We do think that the processes that we employ are essentially sustainable. Certainly, the technical part of it is.

[Jim Cline:]

And the other improvements that I mentioned in the utilization of lower grade poly, this is just the beginning of the initiative over the last six months. It is not complete at this point. We see further opportunity.

[Ryan Thibodeaux:]

And then that has no impact on end-product quality?

[Ron Kaplan:]

No.

[Ryan Thibodeaux:]

Second question was could you maybe talk a little bit about Q3 guidance? If I go back past several years, I don't recall ever seeing a Q3 that was only down 5% to flat over Q2. Could you talk about maybe the reasoning for that? And is there some new sell-in to some new distribution there, or what is going on with that?

[Ron Kaplan:]

Well, there are some opportunities that we are taking advantage of to expand our distribution footprint. Those are showing some signs of progress. I am not going to be any more specific than that. I wasn't -- and I think that is really all that I'd want to say on that subject. Our sales effort is showing some signs of success in terms of our credibility within the marketplace, the quality of our product and the way in which we distribute our product. It is rather vague, but you'll excuse me for that, but I just cannot be any more specific than that without giving away a competitive information, but there is some pull-through going on in the marketplace.

[Ryan Thibodeaux:]

Yes, that's what I am getting at. Is it safe to say that the improvement versus expectations is from new initiatives versus sell-through at your existing customers?

[Ron Kaplan:]

I would say that it is really a combination of both. There is some enhanced reputation that Trex just continues to gain in the marketplace. We are getting more and more traction with our distributors and our other distribution channels. And the new product stream coming on board certainly has helped, so it is a combination -- it's a market basket of things that management is initiating and it is showing some signs of life. Operator, I think we are ready for the next question.

[Operator:]

Your next question comes from the line of Jack Kasprzak of BB&T Capital Markets.

[Jack Kasprzak:]

Thanks. Good morning everyone.

[Ron Kaplan:]

Hi, Jack.

[Jack Kasprzak:]

Congratulations on the quarter. First of all, I think there was some capacity utilization numbers that were mentioned in comparison with this year. I just didn't catch those numbers. The Q2 this year was 48%, what was last year's number?

[Ron Kaplan:]

Last year's number was 86%.

[Jack Kasprzak:]

And you said CapEx is $10 million for '08, and how about D&A for '08?

[Ron Kaplan:]

$25 million.

[Jack Kasprzak:]

And the -- in terms of -- these are modeling questions, but in terms of SG&A as a percentage of sales, is -- would -- is there any guidance you can give us in terms of where you think that should be for the full year or --?

[Ron Kaplan:]

Well, Jack, we are not going to give out any guidance about that.

[Jack Kasprzak:]

How about asking it this way -- the run rate in the second quarter, is there any reason to think it'd be terribly different in the next couple of quarters?

[Ron Kaplan:]

We are just not going to go there, Jack.

[Jack Kasprzak:]

And how about interest expense net, the $1.88 million in the second quarter, was there anything unusual in their netting out against the total interest to gross interest expense number?

[Ron Kaplan:]

No, there was really no unusual -- nothing unusual there.

[Jack Kasprzak:]

Okay. Okay, great. Thanks a lot.

[Ron Kaplan:]

Thank you.

[Jim Cline:]

Thank you.

[Operator:]

Your next question comes from the line of Trey Grooms of Stephens Inc.

[Trey Grooms:]

Good morning. Just a couple of questions. I guess the first one would be on price. The 7% price increase in January -- was that price increase across the board on products, or was it more product-specific?

[Ron Kaplan:]

It was product-specific.

[Trey Grooms:]

And could you give us some clarity on maybe which products you guys pushed through more of the price increase and which ones you remained flat on price?

[Ron Kaplan:]

We'd rather not. I am sorry, I don't mean to be cute. We just don't want to discuss that.

[Trey Grooms:]

Okay. As far as fencing, how much -- you guys mentioned that you had a improved mix with more fencing and new products. How much is fencing making up of sales now?

[Ron Kaplan:]

We are not going to give you the exact numbers. That is competitive information, but we can tell you that it is expanding significantly, but it is still a relatively small single digit component of our sales.

[Trey Grooms:]

Okay. That's helpful. Thank you. And, then, with the strength in sales, I appreciate you guys giving us some of the color that you have there. But, combined with those things, do you guys feel like you are still taking share -- market share out there now?

[Ron Kaplan:]

Well, we, just this morning I got the report through the pro-channel world monitored by a third party agency, and it would indicate that we did get a small increase in share in the second quarter. Those are real numbers from the third party agency that reflect point-of-purchase sales by skew. So, there was a small increase in market share.

[Trey Grooms:]

Okay. The only other question I have, is there any -- right now with the idle Olive Branch plant, do you guys have any updated plans for that facility?

[Ron Kaplan:]

Our plans remain unchanged, which is the plant is in good working order. It has been mothballed and we will reactivate the plant when market conditions make it appropriate.

[Trey Grooms:]

Okay, great. And congratulations again on the good quarter.

[Ron Kaplan:]

Thank you.

[Jim Cline:]

Thank you.

[Operator:]

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

[Keith Hughes:]

Thank you. Couple of questions on the -- with the revenue guidance, would you still anticipate third quarter to be a revenue drawdown, thus keeping capacity at roughly the same rates?

[Ron Kaplan:]

We will continue to draw down inventory at least through the remainder of 2008.

[Trey Grooms:]

Okay. How much capacity between Nevada and Virginia would you say you have right now?

[Ron Kaplan:]

Well --

[Trey Grooms:]

My real question is what revenue threshold will we need to get to before you would put capacity back in this Mississippi?

[Ron Kaplan:]

Yes, and to be straight about it we haven't concluded exactly what that number is yet. We are going to start working on that. When we do finish it, I am not sure that I am going to tell you exactly what the number is, but at this point in time we have not addressed what that number is. We are still focused on enhancing our sales and increasing the productivity of the plants that are in operation. I can tell you that we have got substantial room to increase production in both Fernley and in Winchester because of both the inventory drawdown and because of the increased productivity at both plants. So, I don't anticipate a quick opening of that plant, but we stand -- but I hope that becomes my biggest problem and biggest challenge is to open that plant as soon as we can.

[Keith Hughes:]

Okay. It's not a question. It's talking about raw material prices earlier. Just to be clear, the lower year-over-year expenditure is due to how you are buying and what you are buying versus any kind of market change in the product, is that correct?

[Ron Kaplan:]

Correct. It is a reflection of what we buy and how we buy it. It is not necessarily a reflection of what it is going on in the general markets.

[Keith Hughes:]

Have you in that -- in that regard, have you had to make any capital expenditures to make that happen, or has that been more just decision-making?

[Ron Kaplan:]

Expenses were incurred in prior years to acquire the equipment necessary, but those expenditures are behind us.

[Keith Hughes:]

Okay, thank you.

[Operator:]

Your next question comes from the line of Bill Gibson of Nollenberger Capital.

[Bill Gibson:]

Hi. Ron, I would like to zero in on the production issues, just so I can understand it. You mentioned looking at total costs for production versus yield throughput and yield and throughput. What -- isn't that what is going to impact your total cost of production?

[Ron Kaplan:]

Those are two of the components of it, but there are other manufacturing variables that influence the total cost of production as well. Yield and rate are just two of them.

[Bill Gibson:]

Could you walk us through some of that, just so I can understand it and --?

[Ron Kaplan:]

Well, I'd be walking my competitors through it at the same time. That's the problem. All I can say is that there are multiple manufacturing and variables, for example, if you are baking a chocolate cake and you modify any of the ingredients, that not only -- you may have to change the way in which you bake that cake.

[Bill Gibson:]

All right.

[Ron Kaplan:]

So, change the temperature or change the duration and so on. That's a very primitive example of what I am talking about, but essentially what we've done is, without getting too detailed, is we have developed the algorithms required to correlate the relationship between 14 grades of raw material in myriad number of manufacturing variables, so that management is now motivated to put together the ultimate best combination of those variables and raw material inputs that'll yield the lowest total cost per pound. All right, and how we do that is proprietary.

[Bill Gibson:]

Okay. No, I wasn't asking for the algorithm there, but that helps. Thank you. The other thing is just the inventory reduction, typically what you have got is a first quarter channel filled, which requires building inventory in the fourth quarter. Do you -- are you going to be able to meet the first quarter '09 with running off inventory through the end of the year?

[Ron Kaplan:]

Yes. Clearly, it's management intention to make sure that we have what we need to satisfy our customers. We do recognize there is heavy seasonality to our business. We have got a very intense materials management function within this company and I fully expect that we will have what we need where we need it.

[Bill Gibson:]

And then just one last question, you focused more on Seclusion and I understand --

[Ron Kaplan:]

Yes, let me, excuse me, let me back up for a minute and expand a little bit more on my answer to your prior question.

[Bill Gibson:]

Okay, thanks.

[Ron Kaplan:]

As there is seasonality in this business, we do build inventory at certain points. So, the way in which you measure inventory within this business is quarter of last year versus quarter of this year. You don't necessarily measure against prior quarter. So what we are looking for is quarter, is year-over-year inventory reductions in like quarters, as opposed to a sequential decline.

[Bill Gibson:]

Oh, okay. That makes more sense. Thank you. I appreciate your coming back to that.

[Ron Kaplan:]

Okay.

[Bill Gibson:]

And then just secondly, and this is my sense just as a consumer, is that the fencing market could be much more significant. You are down there in single digit territory, but as you look out three or four years, do you envision that potentially being in the 20% to 30%.

[Ron Kaplan:]

I won't comment on the numbers. I do see significant opportunities to expand it because we've got -- not only is the existing product line beginning to get trashed but we have got other product lines in the pipeline that we are working on that and I am sort of excited about.

[Bill Gibson:]

Good. Thank you.

[Operator:]

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

[Ron Kaplan:]

Hello, Robert.

[Robert J. Kelly:]

What was the drag from Mississippi in the quarter?

[Ron Kaplan:]

$1.2 million.

[Robert J. Kelly:]

And then as far as the underutilized facilities, what is that costing you on the gross margin line?

[Ron Kaplan:]

Hang on a second. About 800 basis points for the quarter.

[Robert J. Kelly:]

Okay. 800 basis points for the quarter.

[Ron Kaplan:]

Correct.

[Robert J. Kelly:]

Okay. And then as far as competitive dynamics in the marketplace, you guys have referenced the resin prices increasing significantly here. Has there been actions on part of your competitors to either raise prices or pass that increase through, and is that driving part of the stronger than expected 3Q outlook?

[Ron Kaplan:]

Well, one of our competitors went bankrupt. So, I guess that is one of the effects of cost increase. I -- usually pricing takes effect in the beginning of the year and the prices are usually announced in late Q3 or early Q4. So I don't expect to see anything really until then.

[Robert J. Kelly:]

Thank you very much.

[Operator:]

Your next question comes from the line of Scott Kirkpatrick of Teton Capital.

[Scott Kirkpatrick:]

Congratulations on a good quarter. What I am trying to understand is longer-term what the operating margin leverage is, and I know you don't want to give guidance to the bottom line, but what I want to get a sense of is how the operating expenses are going to look going forwards just generally speaking, and how much leverage opportunity there is there.

[Jim Cline:]

Well, Ron provided some guidance on the capacity utilization impact. I think that certainly gives you a good measure of what those numbers could be. If you look at the SG&A, I think what you see there is the percentage has not improved from prior year, but the absolute spending has, in fact, improved from the prior year, and so as sales go up, I think you get a leveraging effect of that reduction. Certainly, as the demand increases we may want to trigger additional advertising spending, but it would not be on a linear basis with the increase in sales.

[Scott Kirkpatrick:]

So it'd be on a percentage basis -- maybe a dollar number would be higher but on a percentage basis in line with where it's been?

[Ron Kaplan:]

I think if the dollar -- if the sales dollars were to increase dramatically, the percentage would go down.

[Scott Kirkpatrick:]

Have you ever talked long-term about where you think the operating margin can be?

[Ron Kaplan:]

Yes, we have.

[Scott Kirkpatrick:]

And have you shared that publicly? That's the number I am looking for?

[Ron Kaplan:]

We have not.

[Scott Kirkpatrick:]

Okay. Okay, thank you.

[Ron Kaplan:]

Thank you.

[Operator:]

Your next question comes from the line of Arieh Coll of Eaton Vance.

[Arieh Coll:]

Hello. Good afternoon. I am glad to see that manufacturing expertise still exists in the US, not just in China. So, congratulations.

[Ron Kaplan:]

Well, amen to that.

[Arieh Coll:]

A couple of questions. The first one, just a simple one. Your -- well, I will start with a very simple one. In terms of the inventory reduction for 2008, six months ago more or less you alluded to the fact that inventories might be reduced -- I was thinking about $28 million. At the halfway point here, any update for by how much will be reducing inventory for the year?

[Ron Kaplan:]

I think the year-over-year reduction will continue at about the same pace.

[Arieh Coll:]

Okay. But you'd rather not put a number on it.

[Ron Kaplan:]

That's right.

[Arieh Coll:]

Okay. The second thing is, just hypothetically, if I am one of your competitors in the composite market, I would assume that I am losing money right now because I don't have the low cost option on the polyethylene that you do, and my only response is unfortunately either close up or raise prices, and if I raise prices sufficiently, I am not going to be competitive with Trex over my -- so if I am a professional and Iam trying to determine who I want to buy from a vendor, I am going to be choosing Trex, not one of these other companies as unfortunately they have raised prices and become less competitive. So, is that a fair characterization of simplistically of the competitive market where your competitors, by virtue of having much higher costs, are being forced to sell products at higher prices, or if they don't, the professional is still saying, I want to go with Trex because three years down the road Trex can offer the guarantee on the products. This other company, Company A, might not even be around, so what's the point of buying product from them when I cannot go back to them if I have troubles three years from now?

[Ron Kaplan:]

Well, I got a job for you in our sales department. I can't -- the hypothetical that you have laid out is one that makes a lot of sense, but I simply cannot and will not speculate about what is going on inside my competitors' boardrooms right now. We are going to stick to our knitting right here and just run this business, but your hypothetical, I can't really shoot any holes in it.

[Arieh Coll:]

Okay. And the second thing is I am really amazed by is the cost for a composites decking solution has gone up -- total cost to the consumer. So, the purchase of the Trex materials plus the labor, the final cost has gone up relative to a lumber solution where the price of lumber has come down and I presume that total solution has fallen, so if the disparity in cost might have been 20%, maybe now the cost is 30%, I know my numbers are wrong, but what is your explanation for why the composite market reflective through your results is still so vibrant when the costs to use a Trex solution seems to have risen relative to the conventional lumber solution?

[Ron Kaplan:]

Yes, that's an excellent question, which I appreciate. There's a number of answers to it. Number one, this business -- people buy Trex because of the superior aesthetics and low maintenance. And we have actually done calculations that notwithstanding the disparity and initial acquisition cost of wood versus Trex, in -- within three to four years the two curves intersect in terms of total cost of ownership because of the reduced -- the lack of painting and staining and sanding that goes along with a wood deck. And for those homeowners who are cost-conscious and actually think it through, Trex pays for itself versus wood in three or four years. So that is one thing. And second of all, there are -- there is a growing green movement in this Company. Nobody has to chop down any trees to make a Trex product. And, we get more and more questions about that. Everything -- a Trex deck if we didn't use that raw material it would end up in a landfill. And we don't have to cut down any trees. Thirdly, that cost of wood will begin to go up soon. I can't predict how soon, but it will go back up and that cost disparity will begin to narrow. And then, finally, there is a resale impact and we have some pretty sophisticated marketing studies, which I think are credible that show that there is an impact on resale value when you are selling a house with a Trex deck versus a house with a wooden deck. All you have to do to confirm that is anecdotally is look in your Sunday classified section and you will see more and more homes are sold as -- let’s say 5 bedroom, 3-1/2 baths Trex deck and people are using it as a resale item. So I hope that -- that's sort of a long-winded answer to your question.

[Arieh Coll:]

Okay, thank you, and one last thing. You mentioned this earlier for another question. You have one or more plants currently that are idle due to lack of demand, and you had indicated that your carrying costs right now are reducing gross margins 800 basis points per quarter while they are not being utilized?

[Ron Kaplan:]

You have mixed a couple of statistics together. What we said was, if we were not -- if we were operating at the capacity utilization rate that we had in a prior year, we would have added about 800 basis points to gross margin.

[Arieh Coll:]

Okay. So then it was a year ago when you were at 86% utilization?

[Ron Kaplan:]

We were still at 86% and nothing else changed, we'd have about 800 basis points more margin.

[Arieh Coll:]

Right. English is my second language, so I apologize.

[Ron Kaplan:]

That's all right. Where are you from?

[Arieh Coll:]

Israel, but I was just kind of teasing. And, so, one last thing. On a price index basis, you have older products like Accent, Brazilia, if you look at some of these new products like Escapes, their relative price points are how much higher compared to some of the products you have had around for two, three years? So if you use the older products at an index of 100, are the new products at an index of 110, 120 --?

[Ron Kaplan:]

Yes, there is -- there is a substantial price difference. I do not have the statistics readily in my fingertips. It is something we could -- you could come back to us on, but there is a price differential and it is significant.

[Arieh Coll:]

Got it. Well, thank you again.

[Ron Kaplan:]

Thank you.

[Operator:]

Your next question comes from the line of Keith Johnson of Morgan Keegan.

[Keith Johnson:]

Good morning, guys.

[Ron Kaplan:]

Hi, Keith.

[Keith Johnson:]

Just, I guess -- covered a lot of ground. Just a couple of quick questions. Could you give us a little color on demand trends within the different channels that you serve, maybe as you came through the quarter and as you look ahead into the third quarter as far as the pro channel versus retail channel, that sort of thing?

[Ron Kaplan:]

We think that they are all sort of holding their own. I don't see anybody -- I don't see any major dislocations occurring within the marketplace. The market is soft in general as compared to prior year, but I don't see any real changes in where it is coming from.

[Keith Johnson:]

Okay. Which one of those channels are kind of exceeding your expectations as you look ahead?

[Ron Kaplan:]

None of them are exceeding or falling behind. They are all moving and latched up with each other.

[Keith Johnson:]

Okay. What about inventory in the channel? Is there a way you could give us a little bit of indication of what you see out there in the channel going into the back half of decking -- the decking season?

[Ron Kaplan:]

It is -- anecdotally it seems sort of thin. The reason we get that is we got people who are moving up orders. They tell initially they want the order shipped six weeks out and then we get a phone call a couple of days later that they really want it shipped three weeks out. We got more and more full truckloads going direct to dealers. I think I mentioned that in my last phone call that we still some of that. We think that the dealers and distributors are much more focused on managing their inventory levels than they ever were before. So, that might be the reason that we get more and more of these requests for quick shipments, because they are planning closer to divest themselves.

[Keith Johnson:]

All right, thanks. I appreciate it.

[Operator:]

Your next question comes from the line of Stanley Elliott of Stifel Nicolaus. John Baugh - Stifel Nicolaus & Company, Inc. Actually, John Baugh here for Stifel. Nice quarter, Ron and team. My question, and I apologize, I jumped in late here so if you have answered it my apologies, but there was a slight uptick in the non-current accrual warranty. Is that because of just you are not paying it out as fast as you thought, or was there an actual increase in the assumption of bad boards?

[Ron Kaplan:]

It is really timing on the payout. The payments came slower than what we had thought they were going to be. The total reserve is unchanged. John Baugh - Stifel Nicolaus & Company, Inc. Great. And then -- so the customer relations expense I think is what you referred to it like a year prior when you were taking a lot of hits, there wasn't a material or customer relations charge in this quarter?

[Ron Kaplan:]

With regard to the warranty, we have not made any adjustment to the warranty and we believe that it is still adequate to cover our exposure there. John Baugh - Stifel Nicolaus & Company, Inc. Okay. Great. And then, I know it is early but is there any thinking, Ron, about that you could share with us at this stage about the early buyer pricing as we go into '09, or you just want to not answer?

[Ron Kaplan:]

Well, just to let you know procedurally how it works here, we've got a meeting with our -- most of our business partners in the last week in September, and it's around that date or the month of October that we'll really bring that matter into high relief. So, we don't have any -- there's just nothing for us to say at this point. John Baugh - Stifel Nicolaus & Company, Inc. And have you seen any material change in input costs in either your sawdust or the plastic that you are buying?

[Ron Kaplan:]

With regard to the poly, what we have told everyone is our actual cost year-over-year is down on poly, not because poly cost is down but rather how we are buying. We mentioned earlier that we were able to buy poly in less expensive grades because of the processing capabilities that we have and also the use of the algorithms that we have developed that focus on how we generate the lowest cost per pound for the boards. With regard to wood, we have seen an increase versus June of '07 in the second quarter and wood is up about 20%. It is undetermined at this point how long that will last, we believe we'll be able to find ways to mitigate that increase, but just a reminder, wood makes up a fairly small portion of the total cost. John Baugh - Stifel Nicolaus & Company, Inc. Okay. And, then, are you buying -- are you able to buy similar types and therefore low cost of plastic in Fernley or is it just Winchester where you are really able to do this? And there is some benefit down the road as you are able to do that in Fernley? John Baugh - Stifel Nicolaus & Company, Inc. We do it in both locations equally as well. John Baugh - Stifel Nicolaus & Company, Inc. Okay. Thank you very much.

[Ron Kaplan:]

Thank you.

[Operator:]

Your next question comes from the line of Kenneth Smith of Lennox.

[Kenneth Smith:]

Thanks. I know you said that the Cap-Ex number for this year is going to be about $10 million. My question has more to do with as you look going forward into '09 with initiatives you are looking at and some new products I think you sort of implied or distribution channels, is the cap budget likely to tick up during much in '09 relative to '08?

[Ron Kaplan:]

I do not envision it changing substantially.

[Kenneth Smith:]

Okay. And then just going back to that warranty reserve, when do you think you will be past it having a significant impact on your cash? When do you think it'll -- payments will shrink down significantly?

[Ron Kaplan:]

I would say it is going to take two to three years for that reserve to run out.

[Kenneth Smith:]

Okay.

[Ron Kaplan:]

The actual payouts are running slower than we had anticipated, and I think originally the guidance we had given was a quicker payout. We see that taking longer to clear.

[Kenneth Smith:]

Okay. Thanks very much, and congratulations.

[Ron Kaplan:]

Thank you.

[Jim Cline:]

Thank you.

[Operator:]

Your next question comes from the line of Steve Sharkey of Flat Creek Investors.

[Steve Sharkey:]

Just a follow-up on the warranty reserve again. It looks like cash payments have been about $12 million through the first six months, is that correct?

[Ron Kaplan:]

That is correct.

[Steve Sharkey:]

Okay. And based on experience to that, you see no need to change that reserve?

[Ron Kaplan:]

That is correct.

[Steve Sharkey:]

Okay. And then, I just have a comment. I am extremely pleased with the way you are managing the business for cash flow. I really am thrilled to see the low utilization rates and the reductions in inventory. I know you could report higher profits if you were operating at higher rates, but I think you are doing exactly the right thing. So, thank you very much.

[Ron Kaplan:]

Thank you.

[Jim Cline:]

Thank you.

[Operator:]

Your next question is a follow-up from the line of Ryan Thibodeaux of Maple Leaf Partners.

[Ryan Thibodeaux:]

Hi guys. One follow-up. Could you -- considering the lower utilization and if you look at year-over-year to quarter-over when you were running at 95% utilization, you had basically the same gross margin, so could you quantify what the benefit from using the lower cost reclaim poly is having on gross margins now?

[Ron Kaplan:]

First of all, let me correct one thing you said, I think you said 95% capacity? It was really 85%.

[Ryan Thibodeaux:]

I was looking at two years ago when you were at roughly the same gross margin and you were running at 95%.

[Ron Kaplan:]

Okay.

[Ryan Thibodeaux:]

Sorry.

[Ron Kaplan:]

Okay.

[Ryan Thibodeaux:]

I am just trying to reconcile the benefits you are getting on the lower cost poly and how that is going to play out going forward?

[Ron Kaplan:]

Now we are -- I am sorry, we are not going to be more specific about that, I am sorry.

[Ryan Thibodeaux:]

Okay. And, then, does the utilization figure that you gave of 48%, does that -- is that inclusive of Olive Branch or does that -- or is that excluded from the figure?

[Ron Kaplan:]

It includes Olive Branch.

[Ryan Thibodeaux:]

It does. Okay. Can you give a utilization of the other two plants, excluding Olive Branch?

[Ron Kaplan:]

I am going to guess it is about 65%, give or take.

[Ryan Thibodeaux:]

Okay.

[Ron Kaplan:]

And that is a rough number.

[Ryan Thibodeaux:]

Okay. Thanks.

[Operator:]

Your next question comes from the line of Adam Snyder of Lowes Corporation.

[Adam Snyder:]

Good morning, gentlemen. I was just hoping that you could possibly quantify the NOL carry forwards at this point?

[Ron Kaplan:]

Hang on a second. How about -- we suggest that you can call us back on that one? There is a little -- we are a little bit fuzzy on the exact number, but if you want to call back, I am sure Jim Cline can develop a better answer for you?

[Adam Snyder:]

I will do. Thank you.

[Ron Kaplan:]

Operator, I think that’s all the questions we have.

[Operator:]

There are no further questions. Please proceed with any presentation or closing remarks.

[Ron Kaplan:]

We have had a good discussion today and I hope you will all agree that we have got Trex headed in the right direction. Our product quality is high. Our staff is talented and motivated. Our channels of distribution are strong, and our financial performance speaks for itself. And we look forward to reviewing our progress with you again after the third quarter. That is all we have got. Thank you all, and 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 line.