Trex Company Inc (TREX) 2005 Q3 法說會逐字稿

Welcome to the Trex Company third quarter conference call. [OPERATOR INSTRUCTIONS] As a reminder, this conference is being recorded October 27th, 2005. I would now like to turn the conference over to Harriet Fried. Please go ahead, ma'am.

Thank you, everyone, for joining us today. At this conference call are Tony Cavanna, Chairman and CEO of Trex Company, and Paul Fletcher, CFO.

The company issued a press release yesterday containing financial results for the third quarter. This release is available on the company's website, as well as on various financial websites.

A replay of this conference call will be available through November 3rd. The call is also being webcast on the investor relations page of the company's website, where it will be available for 30 days.

Before we begin, let me remind you that statements on this call regarding expected sales performance and operating results, projections of net sales and earnings per share and anticipated financial conditions constitute forward-looking statements and are subject to risks and uncertainties that could cause the actual results to differ materially. Such risks and uncertainties include the extent of market acceptance of the company's products, sensitivity to general economic conditions and the highly competitive markets in which the company operates.

The company's report on 10-K, filed with the SEC in March 2005, and its subsequent filings on Form 10-Q, discuss some of the important risk factors that could cause actual results to differ from those expressed or implied on this call. The company disclaims any obligation to update or revise 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 Mr. Cavanna. Please go ahead, Tony.

Thank you, Harriet, and good morning.

Last evening we issued a press release which showed the financial results of the Trex Company for the third quarter and year to date through September 2005, 9 months of our fiscal year. Revenue for the third quarter was $77.4 million, a 20% increase from the same period in 2004, while the recorded revenue for the 9-month period was $250 million, 12% more than the same 2004 period.

Income for the third quarter was $5.2 million, $0.35 per share, resulting in 9-month income of $0.84 per share, 55% unfavorable to 2004's 9-month income of $1.86.

Obviously, 2005 has proven to be a difficult year for Trex with sales and income falling well short of our expectations. Much of this difficulty came about from an unfavorable performance against a very aggressive manufacturing and new product agenda that we set for ourselves as we entered 2005. The programs that were initiated in late 2004 and 2005, however, will lead to future revenue and income growth and solidify Trex as the market leader in the company's-- in the composite decking market. I will talk more about these products later in my discussion.

Raw material cost, specifically poly, increased 49% in 2005. That's from September to September. Since our sales goals were not achieved, our manufacturing plant operated well below optimal cost levels in 2005. Manufacturing rates per line achieved reasonable levels, however, combined with the high costs and relatively poor quality poly and the less-than-successful new product manufacturing implementations, overall manufacturing efficiencies operated below standard or expected levels. And, on top of this, we initiated operations at our third manufacturing site in Olive Branch, Mississippi.

Now I'd like to turn this conference over to my associate, Paul Fletcher, the company's CFO and I'll be back with some more remarks. Thank you. Paul?

Thank you, Tony. Good morning.

As you are aware, our press release was issued last night and the numbers I will reference are contained on the last few pages of the release, headed condensed consolidated statement of operations, condensed consolidated balance sheet and condensed consolidated statement of cash flow.

Net sales for the 2005 third quarter increased 20% to $77.4 million from $64.4 million in the third quarter of 2004. We believe excess market inventory levels have largely been worked off from the first half of the year. The Accent product line continues to be very successful as total Accent volume in the quarter comprised approximately 54% of sales compared to 28% a year ago.

Net income in the third quarter of 2005 was $5.2 million or $0.35 per share, compared to net income of $7.1 million or $0.48 per share for the third quarter of 2004.

Gross profit for the 2005 third quarter represented 32% of sales, which compares unfavorably to the third quarter of 2004's gross margin of 38%. The third quarter 2005 gross profit margin compared to a year ago was negatively impacted by higher purchased poly costs and lower manufacturing plant utilization.

The price of PE material increased in the 2005 third quarter by approximately 30% over the third quarter of 2004 and year to date 2005 poly prices are up 49% over 2004.

In order to balance our finished goods inventory with current demand, certain manufacturing lines have been idled at the Winchester and Fernley manufacturing sites. During the quarter, the company's plant utilization averaged 71% as compared to 96% in the third quarter of 2004. This situation caused the under-absorption of the plants' fixed manufacturing costs. Assuming the plant had run at a similar utilization to a year ago, gross margin would have improved by approximately 350 basis points.

In the fourth quarter we anticipate curtailing production even further to manage the level of finished goods inventories at year end. We estimate utilization of installed capacity will average 50% to 55% during the last three months of the year.

Raw material acquisitions will moderate in the fourth quarter, however pricing for PE material continues-- continues to be under pressure. Projected fourth quarter cost of goods will be most affected by the low capacity utilization, poly cost, as well as year-end adjustments, including LIFO inventory valuations.

In the third quarter of 2005, SG&A expenses totaled $17 million and represented 22% of sales compared to $13 million or 20% of sales in the third quarter of 2004. The increase in spending, year-over-year, was primarily attributed to the growth in personnel, including salary and benefits, as well as the hiring and relocation expenses related to these people.

Total SG&A expenses for the fourth quarter will include the costs related to the separation agreement between Mr. Matheny and the company. Fourth quarter 2005 SG&A expenses, including this one-time compensation charge, are expected to decline by approximately $3 million from the third quarter of 2005.

As of September 30th, 2005, total debt amounted to $71 million, unchanged from June 30, 2005. Debt to total capitalization remains conservative at 31%.

Accounts receivable at quarter end amounted to $13.7 million, which is lower by approximately 50% from the receivable level-- levels at June 30, 2005.

Total inventories increased from $48 million at June 30 to $52 million at September 30, 2005. We expect to finish the year with total inventories of approximately $60 to $65 million.

Cash flow from operations amounted to $25.8 million in the first 9 months of 2005, compared to $68 million, $68.5 million in the first 9 months of 2004.

Capital expenditures during the quarter were $7.1 million, bringing the year-to-date capital expenditures to $47.1 million. For the first 9 months of fiscal 2004, CapEx was $15.9 million. The primary areas of investment in 2005 were the build-out of the Olive Branch manufacturing site, as well as incremental capacity for decking, railing and fencing at our Fernley and Winchester sites. Total CapEx for the full year 2005 are estimated at $48 to $50 million.

Net interest expense in the third quarter of 2005 amounted to $0.2 million, which compares favorably to $0.6 million in net interest expense in the third quarter of 2004. This favorable variance was primarily the result of a higher level of capitalized interest during the quarter.

Finally, as a result of several state and federal tax planning initiatives, the effective tax rate in the September quarter was 28% and taking into account our full-year estimated earnings before taxes, we estimate the full-year effective tax rate to be approximately 5% to 7%.

Tony?

Thank you, Paul. I'd like to begin this segment of my prepared remarks by providing you sales and income guidance for the fourth quarter and, therefore, the full year 2005. As most of you are aware, the fourth quarter of a Trex year results in sales rates that are relatively low because of the high seasonal nature of the deck building business.

Trex sales for the fourth quarter are expected to be between $20 million and $30 million, leading to full-year sales of between $270 million and $280 million, about 8% greater than 2004's revenue of $254 million.

Full year's earnings are expected to be between $0.18 and $0.23 per share as a consequence of a fourth quarter loss of between $0.61 and $0.66 per share.

Even though Trex's 2005 sales and overall performance proved to be unsatisfactory, I am pleased to report that Trex's product consumption in the market place continued to advance. Trex's distributor sales increased by 20%, while that of our dealers increased by 22%.

Trex's relationship with Home Depot started to demonstrate traction and is expected to represent 5% of our sales in 2005. More importantly, it is expected that Home Depot will stock Trex is 350 stores at the beginning of 2006 and expand the base of stores significantly throughout the year, also increasing the promotional setups at each store.

As I indicated at the beginning of the conference, product introductions were extensive and formidable. Brasilia decking, our composite product that provides the home owner a product that is an excellent replacement for upscale rain forest decking, was introduced and although we were not successful in producing the product in large quantity, the market viewed this product as a significant innovation.

Along with the Brasilia deck, Trex also provided the market with a full set of Brasilia railing components. Artisan railing was also introduced in 2005 and, again, this white railing system was enthusiastically received as the finest product of its kind in the market. To complete the aggressive new product offerings, new components for our conventional composite designer railing system were also introduced.

In 2006, we will not introduce any new Trex decking products and will concentrate on improving the initiatives that were undertaken in 2005. We believe that the raw material cost increases will be less dramatic and that our Olive Branch facility, our third plant location, will have completed the task of starting up not only new manufacturing lines, but also a brand-new greenfield site.

As we cross over into 2006, we will experience a full year of the efficiencies that have been gradually improving over the last few months. Efficiencies at Olive Branch and our two more mature sites in Winchester, Virginia, and Fernley, Nevada, will experience reduced costs as we improve or optimize the processes for the 2005 new products and produce more product to satisfy higher volume demand. We, therefore, will have greater absorption of costs for currently under-utilized manufacturing overhead.

As most of you know, the $4 billion decking market is made up of less than 20% composite products. We have committed capital to Olive Branch and elsewhere so that we, Trex, can drive the conversion from wood to Trex composite decking. In our manufacturing system, we currently have installed enough equipment to satisfy $400 million of sales, therefore, coming off this year's of $270 to $280.

Also in 2006, we will continue to support and expand on the Trex brand recognition. However, we are-- we will strive to spend each dollar wisely. We will challenge every expenditure and reduce our overall SG&A spending target below the historical 23% to 25% of sales.

Now, before I conclude my remarks, I'd like to give a summary of the things that we think will be in our future in 2006, things that we look forward on a favorable basis.

We have an early buy program that we introduced to the market place to motivate our-- to better motivate our stocking dealers, not only the distributor. We have a 4% price increase in January, followed by a 7% price increase -- or a total of 11% -- over the full year up through May and this is a change from previous years. In previous years we've had price increases after the early buy program.

No new decking products will be-- will be introduced, so, therefore, the scale-ups that we had in 2005 we should benefit from that in 2006. No new production line startups, so, therefore, the startup burden of a new facility or line will not be in our future in 2006.

Greater manufacturing fixed overhead absorption will be-- will be available to us because of higher sales volumes. SG&A, as I mentioned, will have-- be under greater cost control and, finally, if not lower cost poly-- if not lower cost poly, we expect to be more-- scrutinize our supply more so to have better quality poly.

So, in summary, that's how we looked at 2006 at the moment and we'd like to open it up to questions. Harriet or Marvin (ph)?

[OPERATOR INSTRUCTIONS] Scott Nelson, Stephens, Inc.

A quick question on the sell-through of your products at retail, which continued to be strong. Can you elaborate a little bit more on why the additional idled capacity in the fourth quarter? Is that just more-- higher finished goods inventory in addition to the seasonal slowdown or any other external events leading to that?

Scott, what it amounts to is we-- we're now at the end of October and we have a reasonable amount of inventory and we'll, actually in the fourth quarter, even with the low-- with the sales rates, the inventory levels will rise. In addition to that, with our new product slate that we've introduced that in most parts of the country has had very good acceptance, we have to figure out, from our production planning, which items do we want to produce so that we have enough of the demand items on the ground to satisfy the early buy program. So we're being a little cautious at the moment, as well as the fact that our inventory will rise from where it stands today.

OK. Regarding the fundamentals in the overall decking industry, it's my understand that at the dealer level growth for wood composites based on linear board feet has decelerated into below the double-digit range versus strong growth over the past few quarters. Is that anything that you've noticed in the market? Can you just comment on the general strength of the decking market?

Let me comment on your numbers first. First, the numbers that you're referring to refer only to the pro yard.

Yes.

And what it amounts to is one of the things that I think we're seeing in the market place is we're seeing a fairly significant shift over to the big boxes and that's why we think our relationship with Home Depot is going to be very important to us.

The other part of it is, if the numbers you're referring to show something less than 10% growth in the second quarter, the latest numbers we have, you also ought to look back and see in the first quarter, that was close to 32%.

Right.

So the accuracy of the numbers in terms of quarter-by-quarter, which we're doing our best to refine them, but having been involved in statistics in the past, at best I would say that what you ought to do is average those numbers and see what happens in the future.

So the majority of the shift is not a slowdown in the market, but more of a change in the channel from the pro yard to the big box retailer?

Well, I'm not-- I don't know that for sure, but I would say that that trend is in play.

OK. OK. Obviously, we all know what the price of polyethylene has done and I think what I'm trying to get my arms around, what specifics, if you can comment on anything, for 2006 can you implement in your manufacturing processes that could reduce the price of your manufacturing costs? Can you replace resins with any mineral additives or use less engineered ingredients, et cetera, to drive those costs down? Can you just-- can you comment on a few specifics that you know you can actually control?

At the moment, I don't think it's appropriate for me to discuss exactly what's happening in R&D, part of it because you never know when you're in R&D whether it'll be successful or not. We're concentrating on making the board in a very similar fashion in 2006 as we made it in 2005.

We're going to try to enhance the overall performance of the product and also, as I mentioned poor quality, not only was poly cost high, but the poor quality of poly. As demand for this scrap material has become higher, some of the suppliers have, shall we say, taken advantage of the fact that the user such as the Trex Company requires a relatively non-contaminated product.

So we're going to concentrate in that area and we think there's quite a bit-- that contributed to some of our manufacturing inefficiencies, because we were-- our material efficiency at the plant site, actually, has deteriorated also and we believe that's primarily caused by poor quality products-- poly.

OK. One last question. On the competitive landscape, with the rising raw material prices and the continued need to invest in R&D and new technologies, have you noticed a stabilization or any reduction in the amount of the smaller competing companies in the market place?

We've had a couple of companies who have-- who have exited the market and we've had a couple of smaller companies that, from the rumors we hear, are available to be combined with someone else or a white knight or some sort, but overall the answer is no.

Joel Havard, BB&T Capital Markets.

Let's see. The gross margin issue in Q3, Paul, I want to make sure I understand. You said that about 350 -- call it half -- variance was on utilization and I just-- I didn't catch the comment, if you made it. Does that say the other half was the raw material?

The other half is poly. It's actually-- we had pricing. So you're going to have favorable pricing. The poly impact was probably double that of the absorption or the utilization.

To make sure I understand that right, you had less impact from price than from quality or processing issues?

What I'm saying is a favorable-- a favorable variance, year-over-year, was pricing and mix, but that was offset, more than offset, by the rise of poly pricing, as well as the under-absorption in the quarter versus a year ago.

OK. Let's see. If you didn't say it, where were the Brasilia/Accents/Origins sales levels for Q3?

I talked about Accents being over 50%. Brasilia in the 8% to 10% and Origins being the difference in the decking line.

OK. And would Brasilia have been stronger had some of these operating inefficiencies not-- not been in your way currently and where do you see that going?

I'm going to try to answer that. Thanks, Joel. When I-- when I-- in my remarks when I said that our implementation at the manufacturing site, namely scale-up of the, quote, new process to make the product -- and it is a significant process innovation to make the variegated board -- we-- our introduction of the product from a marketing standpoint, in terms of promotions and so forth, and the ability of manufacturing were out of phase.

So when we introduced the product from a marketing standpoint and gained excitement, we were not able to deliver the product to satisfy that excitement. Then when we got better, as it relates to producing it, some of the excitement had worn off and basically, as you know, if things don't happen in this business in the first half of the year, there's not a great deal that happens on a new basis, in the second half.

So were out of phase. We're able to produce the product a lot better today than we were when we tried to introduce the product in the first quarter and, hopefully-- and we're hoping that our progress in manufacturing will continue and even though-- even if it doesn't, it's much better than it was at that time, and we'll reinvigorate the promotional program as we get into 2006.

OK. Tony, how many lines are devoted to Brasilia?

At the moment, just about 1 because we have enough inventory and we're only-- we're only running 11 lines, so 1 out of 11 still represents close to 9% or 10% of our sales.

Got it. OK. And on the poly issue, you're buying less. You're probably going to be building less product in Q4, of course, are you all in a position where you feel like this -- we don't know what the raw material/finished goods split was at Q3 yet, but--

We're buying a little less and as we go into-- finish the year, we'll buy even less less. But if you're asking us are we seeing some price declines as we buy less, the answer is yes. The question we ask ourselves is how far up, how much will the price go back up as we start buying more and turn on all our lines next year? And that-- and I don't have an answer to that question.

Exactly. OK. And then finally, the kind of downstream perspective, I know we've pestered you for years about--

No, you haven't pestered us, Joe.

Well, the question's always been, why isn't there a magic bullet? Well, there just isn't. There's no EDI, Web-enabled, no technology to bring to bear on it. What-- what boots on the ground efforts will you be doing differently, starting now, I guess, but getting through '06 to help us keep a handle on dealer stocking levels?

Well, we-- we have a much-- As you know, I left you almost 2 years ago.

Yes, sir.

And the dealer stocking levels at that time, our knowledge of that stocking level was 0 and we-- we don't have a perfect reading on the stocking level at the dealer now. As a matter of fact, we're still very deficient there, but we know through our studies or the-- not studies, the-- contracting with marketing professionals how to determine what the sales are at the dealer levels. We back-- back-calculate what we think the dealer level is and we're comfortable with where it is today versus where it was a year ago.

Tony, how long has this version of the program been in place?

About-- about 9 months.

Keith Hughes, SunTrust.

Paul, the 50% capacity utilization you're talking about in the fourth quarter, how does that compare to the prior year?

It was 88% to 90% in the fourth quarter of the prior year.

OK. So we're bringing it down drastically. You said you think you're going to end the year about $60 million in inventory?

In total inventory, Keith. The breakout would probably be, raw materials of that $60 is about $12 to $14 million.

And how much will be finished goods?

Then the difference, the $50--

$45 million.

Yes, $45 to $50 million.

So virtually no WIP so that would put you about $50 million in finished and then where would that stand versus finished goods last year?

We had about $35 million. It's up from last year.

But that's what I don't understand. With you ramping capacity down so much, I know you have a seasonal build heading into the decking season, but that still seems like a fairly heavy inventory number, given what you're doing on capacity.

Well, because we have so much more capacity than we had last year. We've got three lines--

Don't you want to have less-- pull your inventory down because of the manufacturing capacity and make it up as the business comes in?

No. You were saying-- we have to pull the capacity. We have more capacity than we had a year ago. So utilization-- that's what's driving that utilization.

You've got to look at-- Keith, probably the answer we owe you is how many lines we were running last year at this time versus how many now versus utilization rate on a different base.

I understand utilization and how it's hitting the earnings. I just didn't expect you to have finished goods inventory or total inventory, however you want to say it, up so much coming in to the end of the year, particularly with what we're going to do here in the fourth quarter.

We-- we've been carrying more inventory than prior year all year long because of the-- more capacity and we've been pulling it back since-- Since August we've been pulling back on the lines.

Also, Keith-- Also, Keith-- I mean, your point's well taken. But let me say it this way. When you expand your product line, you've got more SKUs to make sure have inventory to satisfy and you heard me say that as we go into 2006 one of the reasons we're cutting back to 50% of utilization is we have, between now and January 1st, we have to get a better feel for what-- what's the distribution of those SKU demands. I don't want to be making a lot of -- let me exaggerate the point -- a lot of Origins when we need a lot of Brasilia and-- or Accent.

All right. And if you look-- when you plan production planning, do you just-- and you think about volume, do you assume kind of the 15% unit growth that's what you think is average in this industry? How do you-- how do you think about that?

I mean, that is a reasonable way of looking at it and then if it's more than that, we believe we have enough excess capacity to respond. So looking at-- looking at a point of satisfying unit growth of around 15%, we'll probably be in the-- in the midpoint of what we're looking at.

OK. That's fine. And final question on Brasilia, are we at the point now in Brasilia that if the product really takes off next year, as Accents has done here over the last 2 years, we-- you feel comfortable meeting-- meeting that demand if it's a real success?

I do, but-- I do because we have lines-- The difference in the lines in manufacturing Brasilia versus, say Accents or Origins, is not-- not a great difference, but there is some hardware difference at the end of the line and we have done that. As I said, we're running 1 line now and we're ready to do 2 lines very quickly.

John Baugh, Legg Mason.

SG&A -- you mentioned, Paul that it was up due to, I guess, personnel costs. What-- what is the-- if we look at the third quarter, for example, of that, what was is it, $17 million? What of that is sort of fixed? What of that is the brand spend or advertising? I would assume not much.

And then if you could quantify-- I assume we'll see it at some point, Matheny's number for the fourth quarter and you already gave us a feel for '06, but I'm just wondering what kind of level of increased fixed SG&A have we incurred here and are we going to be able to spread that efficiently, going forward?

One way to get at that number is I mentioned we'll be down about $3 million from the third quarter and in that number we will take the charge for the compensation, which would be about $1.2 million. So you get down to, then, a fairly fixed level in the fourth quarter. You don't have a lot of branding spend. There still is some accruals going on and co-op expense in the quarter, but you're getting close to what is an SG&A spend without the marketing expenses in it.

Keith, I'm going to take a-- I'm going to take a risk and try to guess at your question-- an answer to your question on how much of our, say, $17 million of-- of SG&A is fixed. As Paul said, it's going to be less than that in the fourth quarter and even comprehending about $1.1 million or $1.2 million for the retirement of Bob Matheny.

My guess is that -- and we probably ought to do a little more homework on this -- it's probably in the area of $10 to $11 million.

OK. So $40 million on-- $42 million on an annualized basis on a run rate of, what $300-some odd, $325 million. That would be a 13%-type ratio.

Yes, something like that.

John, there's $21 million of branding that's going to occur in 2005 on an SG&A spend in 2005 of approximately $75 million.

Got you.

So not all of that is discretionary, but clearly a good portion of it.

And have you thought any detail -- I'm sure you have, but you haven't divulged it -- what your brand spend might be in '06?

We haven't decided yet, but what it amounts to is the remarks I gave on SG&A I said that we would be more judicious in our spending and back off a little bit on brand spending, but making sure that we don't retard the growth of the brand as a whole and allow us to come back with a stronger program if we think that's necessary in 2007.

OK. And then, to poly, you ran through some cost numbers real quick and some percentages, year-over-year, sequentially and all that. I kind of missed all that. Can you-- can you revisit that and I want to know was sequentially was poly cost down third quarter versus second? You implied it's going to be down again fourth quarter versus third, I think.

Year-over-year, John, over the-- over the third quarter of last year, we're up 30%. 9-- if you look at the 9 months, 2005 versus the 9 months 2004, we're up close to 50%, 49%-50%.

From a Q3 '05 to a Q2 '05, sequentially, we're just down slightly. So it's not significant.

OK.

Going into the fourth quarter, we're cautious. There clearly is pressure that's going against us. What's going in our favor, potentially, is our demand is going to be less.

And we're going to use that opportunity not only to buy product at lower price, John, but also reinstitute some of our quality standards in the product that we receive at our plant site.

OK. And as you-- nobody can predict poly costs for '06, much as we'd like to think we can, but what-- you had to take a guess at it when you went to 4% and 7% pricing or go with some gut feel. What-- what did you assume? Did you assume that poly costs were going to be up even more than what you really-- and, therefore, you wanted to raise prices more, but you felt reluctant because 11% is a lot, or do you feel confident that you've got it covered? What-- kind of just give me your gut on how you read poly costs going into '06 relative to your pricing.

John, I'll answer that a little evasively, but we-- as-- when we elaborate on our 2006 plan, I can tell you we are not assuming nor are we building plans around poly going down. We are-- we are assuming they are going to continue to rise and so we're going to-- we're going to be able to deal with that financially. We also have-- we're going to look at programs to be able to make the board cheaper, irrespective of the purchase price of poly. But we're going to build a plan around-- not assuming plastic is even going to be stable.

OK. And then, your revenue guidance for the fourth quarter, I think was it up 8% year-over-year? Is that right, roughly? Is that what you said?

For the fourth quarter?

Yes.

We gave revenue guidance for the full year at $270 to $280 million, which we're $250 through-- through the 9 months.

Yes. That seems a little-- I mean, if I'm not mistaken, you went up in pricing 8% year-over-year, so that would imply flat units and now you've announced a 4% increase January and I guess not even distributors want to own a lot of product in December, but I would think they'd buy a little bit ahead of that. Where is my analysis wrong on that?

Are you suggesting that there's going to be more than the $25 or $30 million?

Yes, I would think that December might benefit a little bit and, therefore, the first quarter might-- might take a little bit away by having a price increase this year effective January 1.

John, let me answer it this way. This is the first time we've had a price increase in the first month of the subsequent year, namely 2006. That 4% price increase that's effective January 1, we can't-- we can't be precise, but we would expect that would increase, somewhat, sales in December, whereas in the past they-- they didn't have-- they didn't face a price increase until after April. So without trying to quantify it, let me leave that way.

So, but if you're going to get some level falling in and we've got an 8% kind of growth, year-over-year, you did $30 million last year. Your sales-force guys-- I mean, $20 to $30 million wouldn't even be growth. I don't-- I just-- it looks awfully conservative or low.

I hope you're right.

OK. And then lastly, can you comment on, in terms of making either Artisan or Brasilia railing or Brasilia, have you-- you've talked constantly throughout the year about inefficiencies. How much of that is bad poly -- and presuming you now are going to buy good poly -- and how much of that is you just really didn't know how to make it right and where are you in figuring out both those variables, if they were both contributing to the inefficiencies?

John, on the Brasilia it was mostly-- it didn't have anything to do with poly, very little to do with poly-- the quality of poly. We were just not ready to go into mass production for that product line.

And where are you? Figured it out?

We need to go further, but we're producing at much better rates and rates are now good enough and efficiencies good enough to be profitable. Rather than being a drag on our income statement, it will contribute to our income statement, especially since the price of the product is higher in the market place. We will at least be equal to our overall product line in margin on a dollar basis or a cents per pound basis, but not where we want to be. We're not there yet.

And Brasilia railing and Artisan, were those more poly issues, then?

Brasilia railing is the same comment I just said about Brasilia decking.

OK.

But on Artisan, that was more poly quality.

Louis Corrigan (ph), Kingsford Capital (ph).

Hey, Tony, I had a couple of followup questions regarding the inventory and sort of the gross margin impact on that. It strikes me, as I guess, a bit odd that you would have increased inventory sequentially in the third quarter, then plan to increase inventory again in the fourth quarter. I mean, the-- even including the price increase and coming back to the earlier comment, 47% increase in inventory year-over-year is a big increase.

So I guess what I'm thinking here is the gross margin in the third quarter may have been overstated. The gross margin in the fourth quarter may have been overstated relative to maybe where the production line would have been. I know that the explanation for this is, well, you added manufacturing capacity, but at some point, doesn't this need to come back and haunt us, maybe in the first half of next year?

I mean, it seems to me that in addition to that, you're going to be in there buying poly again and traditionally that has driven up poly costs. I guess I'm just trying to figure out, between these things, what the first half gross margin possibility will be?

In terms of the inventory levels, we do expect to have a successful early buy, so the reason why we're curtailing production is to make sure we don't have too much inventory, but we still need to grow inventory from where we are. It's a-- you also have to look at the mix, as well, of the inventory. I think the planning aspect of what we're doing now is to try to end the year to be able to serve the market as we see it and that'll become more clear as the early buy orders come in.

The-- so I think we are definitively sensitive to watching working capital and what we have invested in finished goods and that's why we're running at 50% utilization. We have-- we've built-- we've put on over 5 lines this year in Olive Branch, Winchester and Fernley, so we have a lot more capacity relative to last year.

I think if you take your question and the question of one of your associates earlier, we are prepared to satisfy higher sales rates in the fourth quarter if, in fact, they materialize. If they don't and we're now at the end of October and we'll probably-- in another few weeks, if they don't materialize, we might cut back manufacturing even further.

Well, but I guess I come back to the issue that-- I mean, simply because you have more manufacturing lines doesn't mean that you should be using them.

That's what I just said.

OK, well.

That's what I tried to say, anyhow.

And so if that happens, then you would actually-- the utilization in the fourth quarter might go down to 30% or something if you really don't see the--

I don't see it going down that low for any sustained period of time, but as we get into the holidays, sometimes, it might be convenient to do that. But overall, our target's still 50% for the fourth quarter overall.

OK, but the $60 to $65 million in inventory is up about-- I think it's about 47% year-over-year. That just seems like a huge increase. I mean, I don't want to beat a dead horse here.

No, no. Your point's well taken.

Remember, it's dollar amount. That's not volume, so the inventory build this year, the cost of the product is higher, so some of that is the layer that we're adding this year is more expensive. That's also contributing to the volume.

The other-- the other component is we will end the year at higher poly inventory levels, even though we're going to go down in the fourth quarter, we'll end the year higher than we did last year. So it's not all finished goods.

OK. And in terms of-- in terms of your poly buy, I understand that as you buy less, the price of what you pay goes down because both you're getting better poly and you're being more selective--

Not necessarily. It's an opportunity, but not necessarily.

Well, in terms of the poly that's out there that you think is good quality poly, what percent are you, as a customer, in that market? I mean, say what percent would you have been in this past quarter and what percent would you expect to be in the first quarter, because it would have to be much higher?

I really can't answer that question. Let me try to just give some qualitative dialogue around that question. When we were buying poly -- maybe you weren't following our company at that time -- back around $0.15, $0.18 a pound, virgin poly was being sold for about-- and I'm talking about virgin prime poly, was being sold for anywhere between $0.30 and $0.35 a pound.

We're telling you today we're buying poly at an average of something less than $0.30 a pound, $0.28, $0.29. Virgin poly is now $0.70 a pound. So the spread on virgin poly has gone up $0.40 and the mix that we buy has gone up about $0.15.

The fact that people who used only virgin poly up 'til now found it absolutely necessary to come into the market to buy-- to buy recycled poly -- if you look at I think the chief executive at Rubbermaid, Newell Rubbermaid, just decided to retire. Part of it had to do with the profitability of using only virgin poly. And I don't that specific-- that comment, but the profitability is not where it was and I'm sure raw materials was a big part of that type of a result. So there is so many more people in the market place for recycled poly than there ever was before, including offshore, stuff going offshore, there's no way I could even try to answer that question.

But the expectation would be, though, that as you pick up your purchase of poly, which we all assume would happen in the first half next year, that that, alone, would cause your price that you're paying for the poly to go up because you're buying enough of it to increase the price. Is that--?

I would say directionally that's correct, but we're also look-- we-- we don't only-- when we first started back when we were buying the $0.15, $0.18 material, we were just using film-type poly. We're using different-- different levels of quality of poly as we go forward and as the overall market price rices, the ability to enhance the quality of poly we use today is greater and still not affect our overall cost, especially if it contributes to higher manufacturing efficiencies, which is not only rates per hour but also material efficiency and percentage of what you put in the extruder that comes out in the form of good product.

This is-- this is an area that's key to our business and I can assure there's all kinds of activity going on to see what is the most advantageous raw material input to our product that gives us the greatest profitability. And it might not be the lowest cost poly.

OK. I see what you're saying. A final question to double back on SG&A expense, you said that $21 million will be spent this year on branding. And, obviously, that was a significant increase this year and it sounds like you're going to try to at least spend smarter and maybe less next year.

How would rate the branding and marketing spend that you did this year? What worked? What do you think didn't work? And where you do think you might redeploy those assets-- the money?

Well, I think-- I think all of it worked. It's a matter of degrees, but if you're talking about media buy in terms of print media versus TV media, whether it be promotional activity at the-- at the point of purchase, all those things are part of our early buy and-- I mean, not early buy, I mean our branding expenses, and I think it all was effective. It's a matter of now tweaking on the degrees of which goes into those particular different categories and-- and as we be a little more judicious in 2006, we'll have to make that assessment that I'm not prepared to give you an answer on right now.

OK. Then one final question. On the early buy program, will there be extended payment terms for that? And what will the structure look like?

There will be extended payment terms and I think-- I don't have all that in front of me, but I think the first month of January it's somewhere, 2.5% or 90 days.

And then it ratchets down. It's similar to last year that you have a discount early in the early buy period and a longer dating and then it-- it-- and that's what will-- it happened last year. You'll have, depending on the choice of the distributor whether to take the discount or the terms, you clearly have receivables higher than your normal terms. Our normal terms are net 10, so that's a difference on the balance sheet.

January's 2.5%, net 90; February's 1.5%, net 60; and then it goes down like that.

Greg Nickham (ph), Bufka & Rogers (ph).

Given the 20% increase in the quarter and the problems that you mentioned a couple of smaller competitors having, and I think a couple of competitors have mentioned that they've had trouble ramping up their manufacturing, do you believe you're gaining market share, holding market share?

Well, I don't recall indicating that our competitors had difficulty manufacturing, but to answer your basic question, what is our market share, we believe in 2005 we've held market share.

Well, I guess I was referring to at least one, if not two or your competitors over the last 9 months having a significant amount of difficulty in ramping up their manufacturing lines, way below their original estimates.

Going back to the distribution networks, how many Home Depot stores are you in currently? And--

In a month or so, we'll be in about 350 stores.

OK. In your press release you mentioned that you were working to expand your retail distribution network and pull-through demand. Was this referring to the Home Depot or were you referring to something else?

I was referring to Home Depot, as well as the enhanced early buy that attracts the dealer to-- to access more of the early buy than in the past.

Steven O'Brien (ph), Wellington Management.

Just a quick question. If-- it sounded like, given the incremental number of SKUs you're carrying, going forward we should expect that maybe inventory turns will be a little bit slower than they have been in the past because the need to service more SKUs and, perhaps, capacity utilization. You may not be able to get up to the levels you had in the past. Is that a fair statement?

I would say SKUs, multiple SKUs means that we'll be running more lines than you would with fewer SKUs. However, we have capacity capabilities installed today to do 400 million pounds of-- $400 million of revenue. We haven't give you a forecast for 2006 and I'm not prepared to do so now, but I doubt if I'll be telling you that our revenue is going to go to $400 million.

So what it amounts to is we will have-- we will be conservative as we start up our lines because we do-- we will have some higher inventories than we've had when we entered the year in the past, but we will have recovery power, much stronger than we've ever had before.

OK. I wasn't thinking about just looking at next year, but just-- it just seemed if you're running more SKUs-- You know, before when you had--

One product.

--one product line, it's pretty easy to service. That means it's a lot easier to service that, both in terms of production and inventory. And the more products you're making, it gets a little more difficult to run things at the same rate and be quite as efficient.

You're right. If we have to-- and what we're going to try to do is we're going to-- since we have a lot of lines, we'll try to avoid changeover on the lines. We might shut a line down, but we'll avoid changeover. We could switch from line to line.

Right.

We have that luxury that we've paid for in the form of under-utilized capital.

Patrick Rau, Sterling Capital.

Can you speak about the tradeoff between pricing and growth that you-- that you're thinking of, not just next year, but maybe the year after that?

You mean in the penetration of the market?

That's right. Will you be satisfied with keeping your share or do you want to grow your share or grow the market and how will you use pricing to do that?

Well, we definitely expect to grow share and recapture some of the share that we've lost. We also expect that by doing that, we'll grow the market, since we are the leader. And at the moment, I don't believe compromising on pricing will be necessary and the reason for that is the market is only penetrated to something less than 20%, so 80% of the market or 60%, depending on what you think the ultimate level will be, will be available to people like ourselves and we're the leader and we expect to not only maintain our leadership but enhance it.

So overall, I-- and the price of composite decking versus wood decking has the same ratio today as it had several years ago and I don't think that will retard the acceptance of composite decking.

Greg Powell (ph), Bernstein.

You mentioned something I found a little interesting. You said that there are users of virgin poly that are now looking to either-- I guess they'd have to reformulate their product and make the capital investments to use recycled products in the future. It seems like this might really threaten your business model, because once they make that transition, they're not going to go back, even if the price of virgin poly goes down.

Greg, when I was-- when I made that statement, although it probably could apply to your question, when I made that statement I was talking about large users of virgin poly that are not in the composite business. I was referring to people like Rubbermaid and people like Sterling and Tucker and people like that who are housewares producers.

Oh, I understood, but that's going to affect the price of recycled poly much more so than a decking manufacturer would.

Absolutely. But I guess I missed your question, then.

Well, it seems like the price of recycled poly might be permanently higher, even once we get through this cycle.

Well, the prices relative to the economy for-- for-- absent, greater than, say normal inflation-- Let's put it this way. Virgin poly has gone up to well over $0.70 a pound very rapidly and that's-- that's a function of a lot of things and you and I know about the hurricanes and what it's done to oil exploration and more natural gas exploration, because polyethylene is produced primary from ethane rather than naphtha these days.

And what it amounts to is-- And also, the supply-- it so happens it's very beneficial for the chemical producers, because not only have their raw materials prices gone up, but it's gone up in a period of tight supply/demand curves on their side. So they've been able to push these things through, as well as enhance their profitability.

Those of us who have been involved in the polyethylene business in the past know that polyethylene goes through about a 14 to 15 year cycle where there's very tight utilization, then a lot of capacity comes on and then they drop below 90% utilization and prices-- price-- ability to raise prices goes down. So I'm looking for-- and I don't even want to look at reclaimed poly right now. I think what we have to do to find out what's happening to poly over all, is to watch the prices of virgin poly and I expect those will-- if they don't moderate, I think they'll even come down.

But it sounds like recycled could stay high. If virgin poly's coming down because some people are transitioning their use to--

That's-- that's certainly possible and it also depends on what's the relative cost of one versus the other and I think there's some stabilization that we'll all see in the next 12 months.

Robert Henderson (ph), Rutabaga Capital Management.

Based on your comments, it is reasonable to assume that capital spending next year will be pretty low, like well below $10 million perhaps?

It'll be significantly less than the $50 million we're projecting this year. There is a-- we clearly don't need to invest in capacity, which was the predominant reason for the spending this year. There is a maintenance of business CapEx, which has been approximately $10 million or will be approximately $10 million given-- given the lines that we have in place today. I'll give you-- you're directionally correct.

You're getting close.

I'll give you a more definitive number as we lay out 2006.

There seem to be no further questions at this time.

Well, I want to thank all of you for participating. The questions were very incisive and hopefully we've been able to satisfy your need for the knowledge of our business. We will move forward and we think we-- as I said earlier when I summarized where we-- what we're looking for in upsides for next year, we think we'll have a-- a very good year and hopefully we'll be able to communicate that to you in the future. Thank you for participating.

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