Trex Company Inc (TREX) 2007 Q3 法說會逐字稿

Welcome to the Trex company third quarter earnings conference call. At this time, all participants are in a listen-only mode. Following management's prepared remarks, we'll hold a Q&A session. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded November 6, 2007.

I would now like to turn the conference over to Ms. Harriet Freid. Please go ahead, ma'am.

Thank you, everyone, for joining us today. With us on the call are Andy Ferrari, Chief Executive Officer, and Tony Cavanna, Chief Financial Officer. Also joining us for the Q&A session are Pat Burnes, Vice President of Planning and Business Development, Brian Burtow, Director of Financial Planning and Analysis, and Brad McDonald, controller. The company issued a press release this morning containing financial results for the third quarter of 2007. This release is available on the company's web site as well as on various financial web sites. The call is also being webcast on the Investor Relations page of the company's web site, where it will be available for 30 days. In addition, we have posted presentation slides to accompany the webcast in the Investor Relations section of the Trex web site. They can be viewed by clicking on the web cast icon shown on the IR home page, and then clicking on the supporting materials shown on the following page.

Before we begin the call, 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 condition 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, the highly competitive markets in which the company operates and the company's ability to maintain product quality and performance at an acceptable cost. The company's report on 10-K filed with the SEC in April of 2007, and its subsequent filings on form 10-Q and form 8-K 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 would like to turn the call over to Mr. Ferrari. Please go ahead, Andy.

Good morning and thank you for joining us on our third quarter conference call. Today, we'll be discussing the significant progress Trex company is making, despite the severe decline in the home building and remodeling markets as well as the short-term financial impact of one-time charges we're taking, the most significant being the increase in the product defect reserve for future replacement of decking materials manufactured at our Nevada plant during the 2003 to mid-2006 time period.

I'll begin by saying how proud I am of our sales performance in the toughest market in decades. Our sales revenue on market share have increased in all three categories in which we currently compete, decking, railing and fencing. Our sales team, distributors, stocking dealers, retailers and loyal contractors should all be commended. Demand for Trex products remains strong, and we're issuing revised guidance for full year 2007 net sales of $315 million to $335 million, which includes a reduction in net sales of $17 million due to the product defect reserve. This revised guidance is consistent with the guidance given at the end of the second quarter of $330 million to $350 million in net sales, which was prior to any increase in reserves.

We are clearly not satisfied with the income performance of our company but be assured that we are taking the decisive actions necessary to return Trex company to excellent profitability and strong, free cash flow. While several of the actions taken, such as right-sizing the manufacturing footprints, writing down on obsolete and slow-moving inventories, and increasing the product defect reserve, have a short-term negative impact in profitability, they are absolutely the right things to do to promote profitable growth for our company in the years ahead.

We are also pleased with the improvement we have made in our manufacturing operations. The company is realizing the benefits of capital spent over the past year on quality and productivity. We have been able to improve quality while at the same time increase productivity and dramatically reduce our labor cost. Trex company remains focused on building the preeminent brand in the outdoor living category. We're leveraging our unparalleled brand strength by entering new markets such as fencing and exterior trim, as well as expanding our line-up in existing categories by introducing new, innovative decking and railing products. This product line-up was announced to the market last month and the response has been overwhelmingly positive. Clearly, there is a lot of good news at Trex but we have more to do.

Before I discuss our business improvement plan in detail, Tony Cavanna, our CFO, will present the third quarter and year-to-date results.

Thank you, Andy. Good morning, everyone.

Our press release was issued this morning by -- my dialogue this morning will reference the three financial statements attached to the press release by condensed, consolidated statements of operations, condensed, consolidated balance sheets and condensed, consolidated statements of cash flows. The company's third quarter and nine-month results were negatively impact by certain one-time charges, including a $45 million income reserve for product defects from product manufactured at our West Coast facility in Nevada, a $9.4 million inventory evaluation adjustment related to product obsolescence, and $1.5 million of costs related to the temporary suspension of operations at our Olive Branch, Mississippi, manufacturing plant.

In the third quarter of 2007, net sales were $64 million, $80.1 million excluding the income reserve backed -- booked in this quarter. The reserves -- the reserve sales compare -- the pre-reserve sales compare favorably to the 2006 third quarter revenue of $78.1 million, an increase of 2.6%. Nine months net sales in 2007 is $298.7 million, again $315 million if we were to exclude the reserves that I just mentioned. The pre-reserve income represents an increase of 3.5% over the nine months revenue of $304.8 million recorded in 2006. This nine-month increase in net sales on essentially flat income -- flat volume is quite an accomplishment in this environment. The net sales improvement is also reflective of a broader, richer product mix.

Overall, our sales have grown whereas, you know, the category that we participate in is having a very difficult time. The net loss in income in the third quarter of 2007 was $41.2 million or $2.77 per share. The loss was $0.34 per share excluding the one-time charges, compared to $4.6 million or $0.31 per share positive in the third quarter of 2006. The net loss in income for the nine-month period was $34.9 million or $2.35 per share, $0.09 per share of income excluding one-time charges, and this compares to $16 million or $1.08 per share for the nine months ended 2006.

In the third quarter, nine-month period, SG&A expenses amounted to $52.1 million and $92.0 million respectively. Excluding the goodwill expenses, including the income reserve and period costs for the product defects in the West, the SG&A expenses for the third quarter would be $18.2 million or 22% of net sales, excluding income reserve, while the SG&A expenses for the nine-month period would be $52.8 million or 16% of sales.

In summary, product deterioration expenses are recorded in two sections of the income statement. The cost of the material returned reduces revenue while the goodwill expenses are added to the SG&A cost. As mentioned previously, the company recognized an inventory valuation charge of $9.4 million to cost of goods sold in the third quarter related to product obsolescence. At the end of the third quarter, the company was not in compliance with certain of its debt covenants, specifically, the covenants that are based on EBITDA, debt to EBITDA and fixed charge coverage ratio. Our banks have waived these debt covenants as of September 30, 2007, and have indicated they will evaluate our position each subsequent quarter until the company becomes compliant with all debt covenants, which we project to be by the end of the second quarter of 2008. The covenants that they will evaluate for our performance against covenants that they will evaluate for the rest of the year are based on our projections that we've given them, and which they have felt comfortable to waive the covenants today.

As of September 30, 2007, Trex's total senior debt was $35.7 million, whereas our cash position was $19.7 million. Trex has a seasonal line of credit borrowing, which is currently at $40 million but will increase to $70 million in December. We currently have no borrowings against the line of credit. Accounts receivable was 2 -- $27.1 million at the end of the third quarter, compared to $18 million at the December 31, 2006. Compared with our goal to generate cash -- consistent with our goal to generate cash, inventories, namely finished goods and raw materials, are $73.6 million, almost $38 million less than the level at December 31, 2006. Cash flows from operations amounted to $15.4 million for the first nine months of 2006 and our capital expenditures, which are accelerated to get some of the pro -- productivity that Andy will talk about, amounted to $2.1 million.

That concludes my remarks. I'll now turn the conference back to Andy.

Thank you, Tony.

I would like to take you through the Trex business improvement plan, which can be downloaded from our web site. On page 2 of the presentation are the topics I will be covering. The situation overview. The claims related to past Nevada production. The underlying performance of our company. Our turnaround mission. Execution plans and status. A summary of our program going forward.

Please turn to page 3.

Let's take a look at the challenging environment in which we're operating and the actions we've taken to succeed in this environment. During the past three years, virgin plastic costs have escalated, which has created pressure on recycle streams resulting in lower quality feedstocks at higher prices. The response to -- to respond to this challenge, we added a world-class recycling facility adjacent to our Winchester, Virginia, plant, and developed proprietary in-line plastic processing, which is now installed on each line. We believe our ability to use low-cost recycled materials and process them into a like-virgin condition is a major competitive advantage.

Industry competition intensified during the 2004-2006 period. But we are now in the midst of a major shakeout with competitors exiting the market on almost a monthly basis. Trex has responded to the increased competition by raising our game in every area. We began by making a step change in quality and now we have the best in-class products in each market segment. We have expanded our distribution footprint, with Trex available now at almost 6,000 locations nationwide, including premiere independent lumberyards, national chain lumberyards, and the leading home improvement retailers, the Home Depot and Lowe's.

Trex is leading the way with innovative new products and entering new markets. We recently introduced Trex Escapes, a cellular PVC decking product setting new standards for low maintenance, durability and aesthetics. We also have expanded our Brasilia and Contours decking lines with exciting new colors, and greatly enhanced the consumer's ability to customize their railing by mixing and matching elements of our artisan and designer railing lines. In addition, for the first time, Trex Seclusions fencing will be distributed through our national Trex dealer network. In a competitive market, Trex has been able to gain market share and has well over twice the share of any competitor.

As we all know, home building and remodeling is going through a major downturn. These tough times may be far from over and we have positioned ourselves accordingly. We have right-sized our manufacturing footprint by suspending operations at our Mississippi plant and reducing the labor force at our plants, including temporary labor, by more than 30%.

The last challenge I will discuss is the surface flaking which has occurred in a small percentage of our deck boards produced at our Nevada plant from 2003 to mid-2006. We have taken the steps necessary to eliminate this problem, including a complete formulation change, significant process improvements, and QC testing of every bundle produced. We're confident that no product made at our Nevada plant after mid-2006 will exhibit this condition. We have also dealt with each claim in a manner to ensure complete customer satisfaction, going well beyond standard industry practices in support of our leading brand franchise.

Please turn to page 4.

To summarize the scope of the Western claim situation, less than 1% of the Trex products sold to date has been impacted. Only product made at the Fernley, Nevada, plant from 2003 to mid-2006 is involved. We believe actions taken after 2003 will reduce the incident rate for later years during this period. Only a small percentage of Fernley products made during the period has exhibited this condition.

Please turn to page 5.

Next, I will address the underlying performance of Trex company. The 2007 year-to-date performance has been dramatically affected by one-time charges, including claims paid during the period for material and labor replacing decks exhibiting surface flaking, the increase in the reserve to cover future deck replacements, the suspensions of operations at our Mississippi plant, the write-down of obsolete, slow-moving inventories and, on the positive side, the reimbursement of legal fees by Exxon/Mobil. If one-time extraordinary items are eliminated, the 2007 year-to-date financial performance for Trex company indicates solid underlying profitability and cash flow, given the very challenging market. Gross margin, 24%. SG&A, 17%. Income from operations, $24 million, 7.3%. Net income, $11 million, $0.76 a share. EBITDA, $40 million. With this additional detail, you can better appreciate the underlying profitability of our business.

Please turn to page 6.

Our mission is to accelerate the company's turnaround and return to the position we enjoyed in 2004, when we had very positive cash flow and EBITDA approaching $60 million. Let's discuss the plan to get us there.

Please turn to page 7.

I will first focus on cash. During Q3, we wrote down on obsolete and slow-moving inventories. This material will be reprocessed during 2008 and used in our production, resulting in cash savings of more than $5 million. Our capital spending will be at least $10 million lower in 2008, largely because we do not need to fund capacity expansion and major cost reduction projects were completed earlier this year. We will be able to work down plastic inventories by an additional $5 million, now that we have the processes in place to utilize more heavily contaminated materials. Finally, we'll be reducing finished goods inventory by 40% without sacrificing our ability to service the market. This is possible because of the search capacity we have available in our adoption of lean manufacturing practices. The total increase in cash from these actions is projected to be more than $40 million in 2008.

Please turn to page 8.

Next, I will address profit improvement. In total, we believe EBITDA can be improved by $40 million by the end of 2009. More than 50% of this improvement is in the areas of operations right-sizing, productivity improvement and other areas within our direct control. We have taken significant actions in this regard, including suspending operations at our Mississippi plant and reducing the manufacturing work force this year from 935 to 665 workers, including the elimination of 145 temporary positions. These workforce reductions were in large part made possible by our investment in quality and productivity improvement initiatives. The addition of a world-class recycling facility in Winchester, and the proprietary in-line processing equipment installed at every line in our plants, enables us to use low-cost plastic feedstocks, while achieving best-in-class product quality. Pricing and product mix will also contribute to higher profitability, as we have announced a 2008 price increase and the new products introduced will contribute to improved EBITDA. We are leveraging our brand by expanding our channel position and introducing major new products, such as Trex Escapes decking and Trex Trim. Finally, we'll continue to reduce our SG&A by identifying areas to improve spending efficiency.

Please turn to page 9.

In summary, Trex is a company poised for turnaround in profitability and cash flow. Consider the macro trends that will drive the building materials industry in the years ahead. Importance of outdoor living. The green movement. Increased influence of the female shopper. The demand for easy care products. The do-it-yourself phenomenon. We feel that Trex is very well-positioned to take advantage of these macro trends. Trex is the clear leader in markets with large volume potentials, with well over twice the market share of the next leading competitor.

The Trex management team is taking decisive actions in a challenging environment. Look at what we have accomplished during the last 90 days. We right-sized our manufacturing footprint, reducing the work force. We increased productivity, with net line rates 10% higher than at the start of the year. We introduced two entirely new product lines and greatly leveraged our brand position. We took one-time charges to address historical issues and position the company for profitable growth in the future. Whether it's cash management, manufacturing operations or branding, we are investing in the future and it looks promising for Trex.

This concludes our prepared remarks. We're now prepared to take questions.

OPERATOR INSTRUCTIONS) Our first question comes from Keith Hughes with SunTrust. Please go ahead with your question.

Thank you. Tony, when you first came back as CEO, we went through some pretty gut-wrenching kind of quality work and I thought that was all behind us, and so my question is first of all, could you tell us a little more on this obsolete product, what specific line is it and what is the defect in it? And then on the decks, I assume you're going to have to replace what was produced in Nevada. This flaking, what has caused this flaking in the product?

This is Andy, Keith. And the flaking is caused by the fact that all the wood fibers are not of fully surrounded by the plastic matrix. And I think your other question was about the -- was it about the obsolete?

Yeah. The 9 point whatever million that you wrote off.

We have continually upgraded our products. We feel we have the best-in-class product quality in every segment in which we compete. Some of our older product does not meet our high quality standards. It is a very good product, better than almost all of the competition, but not up to our standards. So, we have decided to take this product and reprocess it and use it for our material inputs, which will generate over $5 million in cost savings and cash savings during 2008.

Now, we did that a couple of years ago. We went through, I remember Tony talking about hand sorting through the products. Was this just missed or how did that come about?

This is product that is -- the past generation of product. We took a step change in quality to move past everybody in the marketplace. And it is a product, before we took that step change, that we are grinding up.

Ok. And you also, in your prepared comments, you talked about doing -- excluding one-time item $0.76 per share. That would assume it -- a positive here in the third quarter of '07. Now, I believe the fair market -- you said, excluding one-time items, was a loss of $0.34. I'm confused of -- what is the quarter without the one-time charges?

What we've done there is we've -- it was a loss of $0.34. What we've done is we've stripped out all of the expenses that we paid during the nine months for product claims related to this surface flaking issue.

Ok. So you paid some claims in the first and second quarter?

Yes.

You have. Ok. I guess you mentioned how much of it -- of your production had been cumulative. But if you look as a percentage of the Fernley production of the three-year period, how much would it be of that?

It is in the low single digits.

Low single digits. All right. Thank you.

Thank you, Keith.

Your next question will come from the line of Chris Vanis with Wachovia. Please go ahead with your question.

Hey, guys, how is it going?

Fine, Chris, thank you.

Just had a couple of questions here. You had mentioned that your production rates were up about 10% in the quarter. What did that translate into into yieldwise?

Our yield in the first and second quarters was about 80% and now we're in the third quarter, about 86% and we've even moved farther past that in the fourth quarter.

Ok. Do you think of that -- if that continues to trend up in '08 or do you think that kind of levels off?

We think that's going to trend up.

Ok. And then as far as the businesses, could you give a little bit more color on maybe what you're seeing when you break out by your customer base, as far as big box versus independent versus national chains, that kind of stuff?

We're making progress on both fronts, with national chains, independents and the big box, and we feel that -- we don't give out specific information about our position in each channel, but we are far and away the leader in independent and chain lumberyards and both Lowe's and Home Depot have expressed to us that they're very pleased with the sales results we've achieved this year.

Ok. Ok. And then finally, just a quick question on -- with all of the improvements you guys have put on the manufacturing lines as far as plastic quality and that kind of stuff and the recycling in Winchester, what do you guys think on an apples to apples basis, savingswise, you've been getting as far as per pound costs for plastic?

Savings of -- directly attributable to the --

To the new equipment and all of that kind of stuff you guys have implemented.

A minimum of $0.03 a pound.

Ok. Ok. Excellent. Thanks, guys.

Thank you.

Your next question will come from the line of Keith Johnson with Morgan Keegan. Please go ahead with your question.

Good morning, guys.

Good morning, Keith.

A few questions. I guess first just looking at the third quarter results. Could you give me an idea of what the gross margin was in the third quarter results after you kind of back out these charges and which you would say would be an operational gross margin?

Operational gross margin was about 20%.

And what about recycled polyethylene price tends? Can you give us an idea which direction those are headed in the quarter or year over year?

They're about the same as last year.

Ok. All right. And you guys talked I think on one of the slides about increasing increasing prices or just announced the selling price increase. Did I hear that correctly, for 2008?

Yes, you did.

What's that price increase?

I'm sorry we're not at liberty to talk about our pricing to our channel partners.

Ok. I guess kind of from a different side then, in the past with the differential between pressure-treated lumber and composite pricing, there was a concern about initial penetration rates and that sort of thing slowing as that pricing difference widens. Did you look into 2008, how do you characterize the market and being able to raise composite pricing while lumber prices look like they're at least flat right now and may not -- but still a wide difference?

Yeah. Outlook for our lumber pricing is probably difficult for us to project. I think that we assume it is going to probably stay down at the low level it is, based on the building and remodeling markets going through decline. Part of our price increase is in our sales of more high-margin products, and these products have added value. In fact, all of our products have added value, so I think they would compete very nicely with wood, and consumers are understanding the long-term benefits of owning a Trex deck versus wood. So, the more we can communicate that, the more we can move people from wood to Trex.

Even with a price differential that looks like maybe a little wider in '08 than it was in '07?

It will be a little wider. But I think what we're offering in products is a lot stronger.

You talked about that -- can you see a shakeout in the industry, I guess I've seen some of the larger companies. Is there any way you can quantify how that shakeout is progressing? I guess put some color around that?

We think at least about 15% of the industry capacity is involved in the shakeout.

And so far, given the housing conditions, consumer concerned about price of houses, those types of things, the fact that you -- how the rate as we go through the winter?

It is going to be a tough market and I think I would be, you know, trying to predict what our competitors are doing but I think that they're going to be under a lot of pressure.

Ok. All right. Appreciate it. Thank you.

Thank you.

Your next question will come from the line of John Baugh with Stifel Nicolaus. Please go ahead with your question.

Thanks. A couple things. One, where does the advertising budget shake out in '07 and your preliminary thoughts on '08, both in dollars and percentage of revenue?

The total branding expenses are going to be very similar to what they were in '06. That's not a place where we cut back. We are investing -- continuing to invest in our brand franchise and we feel that it is one of our greatest strengths.

'08?

In '08, we'll continue to invest in the brand.

That similar percentage of revenue or lower or higher?

It might be similar expenditures. They might be configured a little differently, especially when considering investing in the web, print advertising and other media. We're going to optimize our spending.

Ok. And then the fourth quarter seasonably is your worst quarter by far. I was curious, you know, what the loss looks like in terms of any guidance you can give. What do the cash flow metrics look like? What are you telling the banks? You know and then you have the high usage of working capital starting out the year as you build. You mention you've got, I guess, room on the revolver but can you kind of walk through -- I don't know, the next six months starting from the end of September, the cash flow outlook and how this relates to, you know, tripping the covenants and what the banks are going to be looking at, and what you're telling them in some general form?

Let me start and then I'll have Brian Burtow expand on my comments. We can't comment on the fourth quarter. I will say one thing about the quarter is that our productivity improvements continue to take hold and our sales are strong. As far as our cash position, as Tony mentioned in his remarks, we are not into our revolver at all right now. We have $20 million in cash. By the end of the year, we'll have used about $25 to $30 million of the revolver. Excuse me. We won't be that far into the revolver, excuse me.

It will be basically zero.

Yes. Because we'll use $25 to $30 million of cash but we have $20 million right now. So, we'll be into the revolver just a bit. As we go through the first quarter, at the end of the first quarter, we reach, you know, our peak use of the revolver but we're not anywhere near the limit of the revolver.

And that limit's $70 million, is it? So you don't think you'll be anywhere close to using $70 million?

Not in the first quarter.

What is it at the end of the first quarter?

Pardon me?

What is it at the end of the first quarter?

John, I'm not going to tell you the exact number but at the end of the first quarter, we'll have plenty of room on the revolver. What it amounts to is the early buy program has some extended terms and then where we are going to challenge our level -- highest levels will be in June.

Excuse me. The actual highest use of the revolver is at the end of the first quarter.

End of the first quarter, right.

And we will be cash positive by June.

And is there any -- you didn't want to talk about your pricing that you're putting through.

Not specifically, no.

Is there any change in the terms that you're putting through to dealers?

We have early buy terms, and they are similar to what we had last year.

Ok. And then back to Keith's question about the $9 million inventory. Was that across a number of decking products? Was that a railing product? Just a little more color there.

It was across all of our products, primarily decking. And I think that if you take a look at our -- Trex's Accents, for example, today, you know, it is -- it stands alone in the market place as does Contours, Brasilia and our railing products, and we're very proud of that quality.

My last question is, Tony, I know you talked about or one of the first things you did when you came in was to take a look at the cost of recycled material versus virgin material, and you concluded then that it made sense to stay recycled. Is that still the view today, and I'm sure it is on a cost basis, I guess I'm wondering on a quality basis, are you comfortable with recycled content now with all of the improvements you've made, you can produce a product without defect rates because, you know, cost is on the back end as well as the front end.

John, the productivity equipment and the quality equipment has been operating now, all of it, really since August, and then the working period of making sure that we bring it up to speed, all of the product we're making now supports the decision we made because the quality at these 90% yields that Andy referred to, and still on the up trend, all meet the characteristics and quality standards that we set out for the expenditure of that capital. So the answer is yes. We still feel like recycling using recycled equipment -- recycled raw materials with the recycling equipment that we've now installed and we're still optimizing, it was the right decision.

Thank you.

Thank you.

Your next question comes from the line of Trey Grooms with Stephens Incorporated. Please go ahead with your question.

Good morning.

Good morning.

I need some help trying to think about -- the product replacement costs or expense that you lay out in the presentation as being less than 1%, in the Q, if I remember right, it said that it was in the second quarter, it was about 2%, this replacement expense in the second quarter was 2% of sales. So, is it -- in the third quarter, did this expense, did it trend off or -- help me kind of think about how to get these numbers together.

The reference is this way. Andy mentioned that the product that is affected is less than 1% of the product. What you're referring to is the charges that we've taken, which include the goodwill and the product as it relates to the replacement. What it amounts to is the product is still at 1% or less but the charges that it is costing us is more.

Ok. And as far as the inventory write-down that you had in the quarter, do you guys -- the product that was impacted was over such a broad period of time. I mean do you guys expect anything further with that? Or going forward? And then also as far as the reserves, I mean do you expect any more of that for this year, or is that it?

We do not expect any more.

Ok. And then just to touch on the new products that you guys have announced for '08, what kind of opportunity do you think that there is surrounding those new products, going into the year?

I think there's a great opportunity, both for sales and to increase EBITDA and return on capital employed. They've been very well received by the customers that have -- had them presented to them and we're very encouraged.

Ok. And are you guys going to sell those to the same channels that you do your current products?

Yes, we are.

Ok. Thank you very much.

Your next question comes from the line of Eric Prouty with Canaccord. Please go ahead with your question.

Thank you. Couple more questions surrounding the channel. Just first, you talked about the financial health of some of your competitors, folks exiting the market. What kind of health do you believe your smaller channel partners, who -- obviously no concern about the big box guys but some of the smaller distributors? And also has the inventory been flushed out of the channel? Are people running at fairly low levels of inventory right now?

Well, we track the inventory that our distributors have and what they're sales are to their dealers and the inventory is lower than it was this time last year. Our distributors are very financially strong companies and they are moving through this downturn very well.

Ok, great. Thank you.

Your next question will come from the line of Ryan [Tada] with Maple Leaf. Please go ahead with your question.

Good morning.

Good morning.

Of the $45 million that you reserved in the quarter, how much did you actually spend in cash during the quarter on the -- whether it be the goodwill that you're calling it or product returns, and how much did it actually cost you in the quarter?

About $8 million.

Ok. Okay, and is that a run rate that you guys see kind of going forward on a quarterly basis? I think it was $4 million in the first quarter and another $6.5 million in the second quarter and so now you're saying $8 million in the third quarter. So, is it going to continue to escalate or is it going to kind of level-off at this level and as we get to the total of 45 or whatever the number is?

Well, on a year-to-year basis, it is going to be leveling off and then declining. What you'll see is some seasonal differences on how the claims are reported. Typically we have fewer claims during the winter months when people aren't out on their decks.

So, implications the claims will reaccelerate going into next year?

Next year we're looking for claims to be at the -- at about this year's level and then declining after that.

Ok. And is there a deadline on the covenant waiver that you received from the banks?

I'll let Brian talk about the covenants.

We had a waiver of the covenants as of September 30th for the waivers for the third quarter, and we'll be working with our banks going forward to determine how we handle the subsequent quarters.

So, it's potentially comes up for review each quarter?

Yes.

And I think had you said something earlier, maybe Tony did, about being -- your forecast of being back in compliance at the end of Q2 '08?

That's correct.

Is that just as you roll over on 12-month basis, as you roll over these charges and you're back to a normalized EBITDA number?

That is correct.

It has to do a lot with the early buy, so that when the people go beyond their terms and make the payments, then we'll -- that that's when our cash will improve and the overall EBITDA is not going to be affected by it but our cash will.

Ok. But then wouldn't you kind of run into the same difficulty as you get into the third and fourth quarter of '08?

Just to elaborate on that, as we improve our operating results next year, our 12-month EBITDA will improve. We will not find ourselves in this same position next year.

You anticipate paying down the debt at all over the next 12 months? Or do you anticipate it increasing?

Well, again, we'll be minimally into the revolving line of credit into December and we'll utilize the revolving line of credit during our early buy program to fund receivables, so we expect to be cash-positive in June. So during the latter part of 2008, we'll just -- our debt borrowings will be our standard, convertible bonds, the tax-exempt facility and the real estate notes. We do not anticipate using the revolving line of credit in the second half of 2008.

Ok. Did you say that you expect to use $25 to $30 million in cash for the entire '07? Is that what you said earlier?

No, what we said was $25 to $30 million of cash will be used in the fourth quarter, primarily to build inventory going into the early buy season.

But we'll only be minimally into our revolver because we have $20 million in cash right now.

Ok. And then can you say what CAPEX was in the quarter?

About $4 million in the quarter.

So, we're looking at a run rate of similar negative free cash flow as last year then?

Yes.

Ok. All right. Thank you.

Thank you.

Your next question will come from the line of Mukul Kochhar with CIBC World Markets. Please go ahead with your question.

The question on the $9.4 million inventory charge. How do you determine that? I mean, the way I think about it, you should be able to reclaim a lot of the raw material just by reprocessing it. So, is that $9.4 million of your purchase a producing cost of that inventory? How is that determined?

That's the amount that we're writing down the product from standard finished goods cost to the value that it has as a material input stream.

So, is that the cost you spend in producing the product and you can reclaim the raw material?

It's the -- the $5 million we talked about -- it is going to be more than $5 million actually, is going to be the value of that material, as we use it in our manufacturing process to replace materials that we would have purchased. $9 million is the reduction in the value from finished goods to using it as input material.

On the charges that you took, I'm just working it through my income statement, and I can touch base with you later if needed. How did that -- I mean I can get to the 20% loss margin if I just add back $17 million to your sales and take out $9.4 million from your cost of goods sold. How does SG&A work out out here? I mean I'm not getting to the $18 million figure.

Brian, maybe you can take us through that.

The SG&A, you would have to take out approximately $29 million related to the increase in the reserve and then you have to add back $17 million to revenue.

That's right.

To factor in the increase in reserve. That should get you to the SG&A percent that we had spoken to.

And what's the dollar figure there?

Dollar figure of SG&A?

Uh-huh. Is that $24 million?

Correct. That's right.

On the Lowe's roll-out, right, from what I understand, Lowe's owns the inventory in its stores and you own the inventory in the distribution centers. Now, how did that produce -- sort of proceed through the quarter? Is that roll-out pretty much complete or was it complete at the beginning of the quarter? How is that proceeding?

We've rolled out into -- into their entire chain.

All right. So that is completed during the quarter or before?

Actually, before the quarter.

All right. The last question I have is on the -- on the Olive Branch plant. So when do you exactly start production there? Was it on September 13th or did you start before that?

September 13th. That's correct.

All right. Thanks a lot for your time today, guys.

Thank you.

Your next question will come from the line of Robert Kelly with Sidoti and Company. Please go ahead with your question.

Good morning. Thanks for taking my question.

Good morning, Robert.

Just a question. Did you obtain a price increase for 2007?

We did not.

Are you going to roll it out into '08 possibly?

We have announced a price increase for '08.

Then just a point of clarification on the downstream inventory, someone had asked earlier, you said it was lower than a year ago. Is that at both your dealers and distributors? Or was it their customers, the dealers, that were lower than a year ago?

It is our distributors and we feel that the dealer inventories are also lower than they were a year ago.

Do they still have the sort of conservative outlook we've been hearing from you guys all year? Has that changed at all?

They're still conservative. I think everyone is feeling that this downturn could go on for awhile now.

Thank you. Have a good day.

Thank you.

Your next question is a follow-up question from the line of Keith Hughes with SunTrust. Please go ahead with your question.

Could you go over the debt structure as it stands at the end of the quarter, the balances on all of the different pieces?

Certainly. Brian?

Total debt was $133 million. That consisted of the $97.5 million of the convertible bonds, $25 million tax-exempt facility, and about $11 million in real estate notes.

And the tax-exempt was regarding the Mississippi facility, was it not?

Yes.

Has the status of that changed, given the plant is not in operation?

No.

And finally, the covenants -- the covenant that's most pressure as you talk about in the press release is debt to EBITDA coverage. Which one is the one most concerned?

The two covenants that are reflective of EBITDA, so it is debt to EBITDA and it is the fixed charge coverage ratio.

Thank you.

Thank you.

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

Thank you for joining us today. I hope you can now better appreciate the underlying performance of Trex and the progress we're making in returning the company to strong profitability.

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