Trex Company Inc (TREX) 2011 Q2 法說會逐字稿

Welcome to the Trex Company's second-quarter 2011 earnings conference call. (Operator Instructions). As a reminder, this conference is being recorded August 1, 2011. I would now like to turn the conference over to Harriet Fried of LHA.

Thank you, everyone, for joining us today. With us on the call are Ron Kaplan, Chairman, President, and Chief Executive Officer, and Jim Cline, Chief Financial Officer. Joining Ron and Jim are Brad McDonald, Controller; Brian Bertaux, Director of Financial Planning and Analysis; and Bill Gupp, General Counsel.

The Company issued a press release this morning containing financial results for the second quarter of 2011. This release is available on the Company's website, as well as on various financial websites. The call is also being webcast on the investor relations page of the Company's website, where it will be available for 30 days.

I'd now like to turn the call over to Bill Gupp, Trex's General Counsel. Bill?

Thank you, Harriet. Before we begin, let me remind everyone that statements on this call regarding the Company's expected future performance and condition constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.

These statements are subject to risks and uncertainties that could cause the Company's actual operating results to differ materially. Such risks and uncertainties include the extent of market acceptance of the Company's products, the costs associated with the development and launch of new products and the market acceptance of such new products, the sensitivity of the Company's business to general economic conditions, the Company's ability to obtain raw materials at acceptable prices, the Company's ability to maintain product quality and product performance at an acceptable cost, the level of expenses associated with product replacement and consumer relations' expenses relating to product quality, and the highly competitive markets in which the Company operates.

The Company's report on Form 10-K filed with the Securities and Exchange Commission on March 9, 2011, its subsequent report on Form 10-Q filed on May 2, 2011, its Forms 8-K filed on May 2, 2011, and July 14, 2011, discuss some of the important factors that could cause the Company's actual results to differ materially from those expressed or implied in these forward-looking statements.

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

To supplement the Company's consolidated financial statements, the Company is using certain non-GAAP financial measures in today's conference call. A reconciliation of these financial measures to GAAP is attached at the end of the Company's press release in the two tables titled reconciliations of pro forma results of operation measures to the nearest comparable GAAP measures, three months ended June 30, 2011, and reconciliation to pro forma results of operation measures to the nearest comparable GAAP measures, six months ended June 30, 2011.

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

Good morning, everybody.

This morning, we released our financial results for the second quarter of 2011. Our revenue of $78.4 million was in line with the revised forecast we provided last month.

In our May 2 conference call, I mentioned that extraordinarily bad weather had delayed the start of the decking season in much of the U.S. and that we expected this to defer some sales to the third quarter. What we didn't expect was that those winter storms would be followed by much heavier than normal precipitation during most of May.

In fact, weather statistics from the National Oceanic and Atmospheric Administration show that the northern part of the country experienced the wettest second quarter in more than a century. Obviously, this had a big impact on contractors' ability to build decks.

In addition, we believe consumer behavior was impacted by high gas prices and weak macroeconomic trends.

The good news, however, is that our sales started to rebound as soon as the weather improved. Our sales order activity in June exceeded the previous year's level by 15%, and July's order activity remained robust. These trends are giving us confidence that sales for Q3 will exceed last year's level.

In addition, we see indications that we're continuing to expand our industry-leading market share. Since the Early Buy sales program started in December, we've converted new dealers or expanded our relationship with existing dealers, gaining a net positive position with over 100 stocking dealers.

We believe our expanding product portfolio, led by Trex Transcend, the number one ultra-low maintenance product in the market, is helping drive this dealer conversion.

This year, I have personally participated in several Walk the Walk tours. It gives me an opportunity to meet face to face with contractors, dealers, and distributors. The enthusiasm for Trex products and loyalty to the brand is the best it's ever been and is most gratifying to me.

We are continuing to introduce innovative products that will strengthen Trex's position as the leader in outdoor living. As you know, in May we acquired Iron Deck Corporation, a manufacturer of steel deck framing systems that offers a 25-year limited warranty and an excellent value proposition when matched with our wood-alternative decking and railing product lines. This acquisition met our guiding principles of customer needs, strategic fit, and shareholder value.

Our entry into this market is off to a good start. We are now fully production-capable at our Nevada plant and moving along well in Virginia. We have begun marketing this steel deck framing under the brand name Trex Elevations.

In June, we expanded our licensing agreement with Polywood to develop and market additional categories of eco-friendly, low-maintenance outdoor furniture. We're adding porch swings, rockers, and benches, and retractable patio and deck shade umbrellas to the Trex Outdoor Furniture collection. In addition to offering consumers a more complete spectrum of outdoor furnishings and accessories, this will help us expand Trex's brand presence in the outdoor living arena and create new sales opportunities for our professional partners.

In pursuing new opportunities to expand outdoor living space, we are now taking Transcend beyond the backyard and moving it into the front of the home. The porch category is a natural extension for Trex, offering still another way to help consumers enjoy low-maintenance outdoor living and bring curb appeal to the front of the home.

Our Transcend porch flooring and railing system provides a traditional porch look with a smooth, virtually gap-free finish. Trex porch planks, which recently started shipping, are available in three colors and three lengths. We're also offering post and railing options and TrexTrim bead board, and mouldings.

Trex is the only alternative decking manufacturer that lets consumers build a porch from the ground up, and finish it off with lighting and outdoor furniture.

International sales continue to be a strategic focus and have been progressing well. We added more countries to our global footprint during the second quarter, which now takes our total to 18.

Internally, we continue to focus on manufacturing efficiencies, and I'm pleased to say we achieved yet another record performance for our decking manufacturing yields in Q2. Such accomplishments often don't generate the attention they deserve. In combination with general cost-reduction efforts, our productivity improvements help bolster the bottom line in this challenging sales environment.

Before I turn the call over to Jim, I want to comment on the outlook for the third quarter. Navigating through the severe weather and uneven economic recovery has proven challenging. The pace of order activity has improved significantly in June and July.

However, we began to see signs of economic headwinds as we approached the end of July. Accordingly, we expect third-quarter revenue to be in the range of $65 million to $70 million. Jim?

Thank you, Ron. Good morning.

As you know, the press release with Trex's second-quarter and year-to-date financial results was issued this morning. The Company recognized net sales of $78 million in the second quarter of 2011, a 32% decrease compared to 2010. The second-quarter sales volume was approximately 40% less than 2010, which was offset by favorable sales mix and price, primarily related to Transcend.

We believe the decrease in sales volume compared to 2010 was a result of poor weather conditions and, to a lesser extent, poor macroeconomic conditions. As Ron mentioned, many parts of the Company experienced high levels of precipitation throughout the spring of 2011.

The Company recorded net income of $2.1 million, or $0.12 per share, in the second quarter of 2011, compared to net income of $4.8 million, or $0.30 per share, in 2010.

The Company results for the second quarter of 2010 included $13.3 million of charges, including $9 million related to an increase to the warranty reserve, $2.4 million related to our joint venture in Spain that recycles waste polyethylene, and $1.9 million of charges related to two supply contracts. Before giving effect to these charges, our second-quarter 2010 net income was $18 million, or $1.14 per share.

Gross margin was 30% in the second quarter of 2011, a 420 basis-point improvement from 2010. Excluding the 2010 charges noted previously, gross margin decreased by 520 basis points, due mainly to the effect of lower sales, 7%, and the effect of a reduction in capacity utilization of 7%.

The elimination of our 2010 Transcend startup drag contributed 5% to gross margin. In addition, ongoing manufacturing improvements related to improved yield and throughput that Ron communicated earlier and cost-reduction initiatives contributed 3% to gross margin.

SG&A for the second quarter was $17.4 million, compared to $21.2 million in 2010. The 2010 quarter included the charge related to our joint venture in Spain of $2.4 million. The remaining decrease of $1.5 million in SG&A was due to lower personnel-related expenses, primarily related to incentive compensation.

Net interest was $4 million in 2011, a $100,000 increase from 2010. The increase was due primarily to the non-cash interest related to our convertible debt of $400,000, offset by the reduction in the average debt balance in 2011.

The second-quarter 2011 effective income tax rate remained low as we continue to utilize the valuation allowance against the deferred tax asset.

For the six months of 2011, net sales were $147.4 million, compared to net sales of $181.8 million for 2010, a decrease of 19%. The decrease in net sales was attributable to a 26% decrease in sales volume, which was primarily offset by a 10% increase in the average price per unit. The increase in the average price per unit was driven by a 2011 price increase for Transcend decking products and a shift in sales toward higher-priced products.

The same external factors, poor weather and, to a lesser extent, unfavorable macroeconomic conditions, that influenced our second quarter adversely impacted our six-month sales. In spite of the bad weather and the resulting delay on the deck building season, our distributor sales into the professional lumberyards increased by approximately 10% over the last nine months, compared to the prior year. Our sales into distribution during the last nine months were down approximately 4% over the comparable period in the prior year.

Based on these data points, we believe that inventory within the distribution channel is at a normal seasonal level.

The Company recorded net income of $7.2 million, or $0.42 per share, in the first six months of 2011, compared to a net loss of $700,000, or $0.05 per share, in 2010. The 2011 results reflect a favorable resolution of uncertain tax positions in the first quarter that positively impacted income taxes by $2.6 million. Before giving effect to this adjustment, net income for 2011 was $4.6 million, or $0.27 per share.

The Company's results for the first six months of 2010 included the $13.3 million charge, as I mentioned previously. Before giving effect to these charges, our net income for the first six months of 2010 was $12.5 million, or $0.83 per share.

Gross margin was 31.6% in the first six months of 2011, a 680 basis-point improvement from 2010. Gross profits in the first six months of 2010 were adversely affected by the charges mentioned previously. Excluding the 2010 charges, gross margin increased by 80 basis points year over year.

The elimination of the drag on earnings related to 2010 Transcend startup contributed 7% to gross margin in the first half of 2011. In addition, improvement in yields, line throughput, and cost-reduction initiatives improved margin by 2%. This was partially offset by the effect of a decline in the capacity utilization, which reduced gross margin, and the effect of reduced sales.

SG&A for the first six months of 2011 was $34 million, compared to $38.3 million in 2010. The first six months of 2010 included the charge related to our joint venture in Spain of $2.4 million. The remaining decrease of $1.9 million in SG&A was primarily related to lower personnel-related expense, again primarily driven by a decrease in incentive compensation.

Net interest was $8 million for the six months ended June 30, 2011, a $300,000 increase from 2010. The Company's results for the first six months of 2011 and 2010 included $4.6 million and $3.9 million, respectively, of non-cash interest related to the accounting treatment for convertible bonds under APB 14-1. The offsetting decrease in net interest expense in the 2011 six-month period is primarily due to the reduction in the average debt balance for that period.

The effective income tax rate for the first six months of 2011 remained low as a result of the valuation allowance against the deferred tax asset. In addition, we recorded a $2.6 million favorable non-cash adjustment to taxes related to the resolution of certain federal tax issues.

At June 30, 2011, the Company had $19.4 million of cash on hand and no borrowing on our revolving line of credit. Our only borrowing is the $97.5 million convertible note due June of 2012. Total net debt to total capitalization at June 30, 2011, was 38%, compared to 35% at June 30, 2010.

At the end of July, our cash on hand was approximately $47 million. Inventory was $39 million at June 30, 2011, a $5 million year-over-year increase.

The Company had a free cash outflow of $3.6 million in the first six months of 2011, a $7.6 million year-over-year decrease.

Free cash flow during the 2010 six-month period benefited from a $7.5 million one-time tax refund. The cash used in investing activities was $6.8 million, a $2.5 million increase compared to 2010. The 2011 amount includes the acquisition in May of substantially all the assets of Iron Deck Corporation.

Finally, we are encouraged by the pace of orders that we've had in the second half of June and July. I would like to reiterate our sales guidance of $65 million to $70 million.

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

(Operator Instructions). Trey Grooms, Stephens Inc.

A couple of questions. First off, Jim, could you give us an idea of where utilizations were in the second quarter and kind of where you see them shaking out in the third quarter?

Capacity utilization was approximately 38% in the second quarter, and we anticipate the capacity utilization will be about 25% in the third quarter as we continue to draw inventories down.

Okay, so I guess that goes to the next question of -- lower utilization rates definitely played a role in bringing down margins a little bit in the quarter, which you pointed out, and you've given us some color, I guess, on your expectations for gross margins, both in the current quarter as well as for the year. Could you give us an update on that, given where we stand today?

Well, certainly the reduction in capacity utilization is going to have a drag on the gross margins, both in the third and fourth quarter. The margins that we talked about previously had anticipated the capacity utilization at a higher level. So, you're going to be looking at some reduction in gross margin comparable to the second quarter.

And that's sequentially?

Yes.

And then, for the full year, you'd given us a 33% to 34%. Is there a new range we should consider?

We don't have a new range for you at this time.

Okay, but it would be reasonable to think it would be somewhat lower since you were expecting higher utilizations -- the utilization rates?

That's correct.

Okay, perfect. Thanks for that clarity.

And then, secondly, on SG&A, last quarter you had expected higher brand spending in second quarter. That -- did that just get postponed, or were there other things that offset that? SG&A came in a little bit lower than what we thought it would. Could you give us a little color on that?

And then, also, is this kind of a good run rate for 3Q, or could we expect it to be a little higher because of this brand spending being pushed back?

We certainly had a chance to adjust our spending levels. We did not make appreciable changes in our branding spend. There was some reduction to the branding spend.

We look at branding as critical for us to be able to continue to build the brand and gain market share, which is our primary objective in this slow season.

With regard to Q3, I think you really need to look at the way it seasonally is impacted. As you may recall, our brand spending does drop off in the third quarter, and consistent with that, we would expect to see a reduction in the spending related to branding in the third quarter of this year.

Okay. And then, my last question is for Ron. You know, [of course], you rolled out the porch application, but the new category that you guys have been talking about in the past, could you give us an update there? Have you made a go or no-go decision there yet?

We've not made a final go or no-go decision. We continue to work on it. It has proven to be very challenging. But we continue to work on it. When I've got something to say, I'll say it, but the human assets are still deployed on that research and development project.

Okay. Thanks a lot, guys. Good luck.

Jack Kasprzak, BB&T.

Could you update us on your CapEx budget for 2011, please?

Our guidance that we've given is $15 million. As you recall, we have given that guidance some time ago. We are spending at a rate close to that run rate. We still anticipate we'll be in that ballpark.

Second question is, you just talked about gross margins at pretty good length. But it's a different question on the same subject. First-quarter gross margin, this year first quarter is a little higher than 33%, and then the second quarter was 30%, but second-quarter sales were a little higher than the first quarter. What factors lead to that sort of variability from one quarter to the next, considering you had higher sales?

The first-quarter capacity utilization was in the 46%, 47% range. We were at 38% in the second quarter, and a good share of that reduction was a very abrupt reduction in the latter part of the quarter, which tends to have a more significant impact.

Latter part of the second quarter, okay.

Correct.

And with regard to acquiring new dealers, what's that conversation like in terms of the competitive landscape? I mean, are factors involved in terms of reliability among your competitors, or is it more having to do with awareness of new products with you guys? Can you add some qualitative feel to how those conversations go in acquiring the new dealers where you've had success?

I'll speak to that issue. I'd say the number-one driver is the product portfolio that we offer, the quality and technical superiority of the Transcend product line.

Additionally, we do hear that some of the smaller competitors really are just having difficulty satisfying their distributor base in terms of the breadth of product, the depth of the product, and overall operational competency.

Trex has clearly begun to establish itself as the star to hitch their wagon to, and they don't want to get left out in the cold. So, I think that's what's driving most of it.

We've got a -- we've really increased the loyalty and the brand recognition, and it's a function of what we physically deliver and the way in which we tell people about it. And plus, we're just -- we're out there selling. We don't -- you can't sell a lot of products sitting on your desk, so we all get out there and help in that regard. (Multiple speakers). Does that answer your question?

Yes, it does. Thanks, Ron.

Keith Hughes, SunTrust.

I was just following up on one comment you made in the prepared around -- there was something about your distributor sales over the last nine months. Could you just repeat that one more time, please?

Sure. The sales by our distributors into the market, into the professional lumberyards, in the last nine months was up 10%. Our sales to our distributors was up 4%.

So the conclusion you're drawing is you think the inventory channels are where they need to be or where the channel would like them right now?

We believe they are at the seasonal levels that our distributors would like them to be and the dealers would like them to be.

Based on your comments on capacity utilization, you're going to be bringing your inventory down for the rest of the year. Is that fair to say?

Yes.

What kind of metric are you using to gauge what level of inventory Trex needs to be with this dynamic going on?

We're really more focused on being able to service the customer. So, during this time period, Trex will carry heavier inventories than what they would normally carry.

We continue to see some minor opportunities to reduce inventory, but it's really more of a seasonal reduction than anything else. We seasonally bring the inventory down in the third quarter, and certainly at the end of the year we normally have inventory reduction there.

But one of your specific questions that you've asked is, what is the metric? One of the metrics we use is we want to be able to deliver to our customers in three weeks.

Three weeks. Okay. And final question, Jim, I think you said this, was it $3.9 million of non-cash interest expense in the second quarter?

No, it's (multiple speakers) 2.9, wasn't it? Second quarter?

Brad, what was that number? Was it 2.6 or 2.9?

For which?

The non-cash for the second quarter?

2.6. (Multiple speakers)

2.6. Okay. And if -- given with the shares down, if they were to stay where they are now, would the share count go back to 15.5 million or so in the quarter?

Third quarter? It wouldn't (multiple speakers) go all the way because what you do is you utilize the average share price across the first nine months compared to the strike price of $21.78.

Okay. So would it be $16 something? Can you give us any kind of metric on this?

It's really going to depend on what that average share price is for the quarter. Right now, there would be -- it would certainly go down if we maintain the current selling price. I don't think it would go down to 15 million, though.

John Baugh, Stifel Nicolaus.

My question first is, if we could talk units, I'm curious with your guidance included for the third quarter, what your unit guidance would be if I took the trailing 12 months through the end of September, because you had a sizable price increase on Transcend?

And then, how you think that they stack up with what the industry did? And you could relate it, if you wanted to, to the sellthrough versus your shipments, but really trying to get color on where you think units were for the industry for this deck-building season, and I know it's not quite over yet but will be by the end of September, versus where you'll come out. Thank you.

John, we didn't put together an analysis for the trailing nine on a unit basis. But in just looking at the numbers, clearly the six-month period is down, as we mentioned in our numbers. And as you'll recall, the fourth quarter of last year was up significantly.

I think in total, it's probably going to be pretty close to balancing out to slightly down.

And on fourth quarter, you had a significant price increase January 1. Any thoughts at this point, Ron, about pricing this coming year? Assuming you don't raise prices, I would assume the year-over-year comparison in the fourth quarter will be very difficult. Thanks.

I certainly want to tell my distributors what my pricing policy is before I tell you.

But I can tell you that our raw material input is stable and that we know that our competitors are getting whipsawed by resin prices that are tied directly to the price of oil. So, we'll make our decision about 2012 pricing in October, but I would point out that our strategy is largely sort of focused on market share.

I'm sorry if I'm not (multiple speakers) answering --

That's okay. That's good. No, that answered my question.

How do we think about inventory, Jim, in terms of -- we know directionally it's going down. How do you think that number looks at the end of the calendar year? If you run in utilization rates at substantially lower than the first quarter for the latter nine months of the year, I would assume we have enough time in those latter nine months, even though sales have been disappointing, to really get our inventories in line or maybe even lower. I'm just curious, any commentary around, numerically, addressing inventory at year-end. Thank you.

Sure. We anticipate inventory will be lower at the end of the year than it was at the end of 2010, and that we will take that down on a fairly brisk pace across that time period. It won't all come in the fourth quarter. You'll see a reduction in the third as we bring the inventory down and in a manner consistent with what the expected demand will be.

John, my take on inventory is that it's a lot easier to manage small changes in the balance sheet than it is to let it go too long and then have to deal with a big change in the balance sheet.

I think that was one of the problems that Trex got itself into years ago. My philosophy is if you take care of the balance sheet day to day, month to month, the income statement will take care of itself.

So, we're going to address inventory levels on an immediate basis. [I'd] rather than deal with small, disappointing, little, or troublesome issues with inventory, rather than letting it build up and defer a problem for a later day. So that's, philosophically, where I come out on that.

And then, Ron, lastly, on the competition, it's proven to be an extremely difficult year [of] volume, and raw materials have been going up, generally speaking. Have you seen anything -- I don't want to deal in the rumor market, but any specific actions by any competition in terms of shutdowns or -- . If you want to deal with the rumor market, great, but trying to deal with fact. Thank

There is a consolidation that's going on, underway, in the market. I think it's -- there are about 12 or 13 competitors generally out there.

But it's really starting to consolidate around what I call the top four. I forget the names of the other three. All I know is that we are at the top of the list.

But I can tell you that there are a lot of price increases that are being announced for next year. I see that specifically starting to go on. I don't have any rumors that I want to start about who is going to shut down or decrease production. I'll leave that to others.

Robert Kelly, Sidoti.

I just -- a question on orders and the lag between when they become sales. I mean, when you get an order, is that kind of how you determine what your sales outlook is?

Yes.

It's like a -- that shift within the month on order?

Yes, usually within less than a month, two to three weeks.

I'm just trying to reconcile how June was up 15%; July, you didn't really quantify, but it sounded like you had a fairly big improvement. Is the expectation that August is down or is the outlook just an attempt to gauge the sentiment of the market, now that things seem to be a little bit more pessimistic than it was three to six months ago?

Traditionally, orders in Q3 are frontloaded toward the beginning of the quarter. Sales in July usually exceed sales in September.

I'm not an economist. So, I don't have any commentary about the general state of the economy and how it's going to affect immediate sales. You can draw your own conclusions.

Understood. Understood. It sounds like you have some tools there to gauge or give yourself a snapshot of what your customer inventory is looking like. Is there anyway to tell us whether -- are inventories down compared to a year ago? You said that they are in line on a seasonal basis. What does that mean? Is that based on the sales base that you are seeing? Compared to a year ago? Maybe just some help on what your customers are telling you.

We'll do that in two parts. Jim will talk about the seasonality, but I can tell you that we enlist the aid of our largest distributors into helping us figure out what the sales are going to be for the quarter. We ask them, what are you going to buy? They tell us.

We don't talk to all the distributors. Just the big ones. And of course, with varying levels of accuracy, they respond to the best of their ability. But it's a consumer-driven market. And consumers are quite ephemeral in their behavior. Jim, do you want to add some --

Sure. Back to inventory and distribution. We don't have any specific information on inventory and distribution.

What we do have is the information that I mentioned previously. We do monitor, on a slight lag, the shipments out from our distribution partners, and our shipments in. And what we know is at this time of the year if our distributors are not being requested to ship product into the dealers, they are not reordering.

So, in basically the second half of the year -- I'm sorry, June, we saw good demand coming in, which indicated to us that it was leaving the distributors, going to the dealers, and that reorders like that were continuing in July. So, if inventory were heavy in the distribution channel, we would not have seen that turning over at the pace that it is turning over.

Good sign. And just one final one. I know the consulting firm doesn't come out until later in the year with the estimates of share. I think the last time you put something out public, it was in the 31% range as far as composite decking for Trex. Any guess of where you stand now after some of the details you put out in your prepared remarks?

Actually, that report has been issued a couple of months ago by Principia, and we are at 35% market share for residential decking and railing market.

And that's for the current year or the year 2010?

(Multiple speakers) 2010.

(Multiple speakers) 2010.

Thanks, guys.

Eric Prouty, Canaccord.

Quick question, back to the SG&A. Jim, is your expectation you come in kind of at -- around the 2010 level, or do you think you'll be slightly above or below it?

We aren't providing specific guidance on the sales level -- I'm sorry, the SG&A level going out through the remainder of the year. But certainly the seasonality would be consistent, and we had provided previous guidance on where we felt the SG&A would be and we aren't updating that guidance.

Great. And then, secondly, you mentioned from a tax standpoint. Should your -- should you be at this same low tax level for 2012, you believe? At what point, and I know that, again, takes a little projecting, but do you have enough tax credits to kind of make 2012 also, you know, a low tax or zero tax year?

From a cash basis, our taxes paid, what we'll actually pay in 2011 -- I'm sorry, 2012 was your question, will be probably 5% or less, primarily state tax related.

When you look at the book tax, there is such a wide range in what that number could be for 2012, depending on the earnings assumption, I think the appropriate guidance at this point I can give you is, I would assume an average across the year of approximately 20%.

Okay, that's fair. Just trying to get our arms around the proper tax rate.

Can you just then -- finally, the numbers didn't move much this quarter, but the accrued warranty level on the balance sheet, both short-term and long-term, moved down again. Is this still the same issues from the past? And then, two, on the warranty issue, is there a certain level at which -- what point you're going to have to re-up the amount of warranty reserve and take another charge, et cetera?

The full change in the warranty reserve related to the 2006 and prior issue out of our Fernley, Nevada, plant. So, there is no new items.

The ongoing claims related to the Trex products produced in the last five years have been de minimis.

With regards to the review on the reserve, we review that quarterly, and since we took the last reserve adjustment, everything seems to be in alignment with the assumptions on that reserve.

Okay, so going forward, we'll expect that to kind of work itself down to near zero or a low million-dollar number. There's not a certain number that you are -- that the auditors want you to keep in reserve in the balance sheet.

Basically, the reserve is based on what we calculate our future liability associated with any current claims, which I'd mentioned are de minimis, and the remaining payout on these older claims.

Ethan Steinberg, Friess Associates.

Sorry, I might have missed this because I had to jump off for a little bit, but there was a comment in the prepared statements about late July, things slowing down or some economic challenges. Were you just talking about headline macro stuff, or what are you hearing from the supply chain or just people in the field?

I would say that orders in the last week of the month were less than they were in the first week of the month.

Okay. And seasonally, what should orders do for the next couple of months?

Seasonally, if you went back and looked at the last year or two, you would anticipate that they would decline over the next two months.

Okay. Is there any reason to think that the seasonality this year is better or worse than normal?

Well, we do think that a lot of orders that were pushed out of the second quarter are going to end up in the third quarter because of the weather that I talked about.

So, they weren't hammering as many boards in Q2 because it was raining. As soon as the rain stopped, people started hammering boards. So the contractors I've talked said that rather than finishing up in September or October, they may be finishing up in October or November.

Morris Ajzenman, Griffin Securities.

Just a follow-up to that question, this previous question talking about the macro trends. Again, the previous guidance, it was weather related and macro was secondary. And now you're talking about exiting July [so sort of] the macro headwinds.

But in the second quarter, sales were down year over year about, sequentially, $37 million or so. Hold on, was that sequentially or year over year? It's year over year down $37 million, and now you're saying you're seeing some of that pick up into the third quarter. It just doesn't seem to add up because you're guiding to $65 million to $70 million. Are you just being very cautious or is this headwind more meaningful than what appears to be the case?

It's not a question of being cautious. It's just a question of putting out the best possible forecast that we can.

Obviously, the weather has been pretty good for the last few weeks. We know we are gaining market share. We know the weather is good. So, if sales slack off, then by definition it's got to be because of some underlying headwinds in the economy.

So then, basically, the bulk of the shortfall into the third -- into the second quarter year over year, by and large that's just missed sales and won't be made up until next year -- next season?

I don't know if most. There is a point at which if people can't get their decks installed, they say the heck with it. We'll wait until next year. When that date exactly falls is hard for me to say.

And I think part of it, Morris, will depend on weather conditions in the third quarter.

The deck-building season stops because deck builders can't put the decks on or the consumer has decided, it's so late in the season, I only get to enjoy it one month, therefore I'm not going to proceed. The later we go into the third quarter without those decks being built, the more likely it is that the cancellation will occur.

And it is a discretionary product, and there is some -- consumer confidence is a factor in all of this. So, you can come to your own conclusions about -- and there are statistics published about consumer confidence. You can draw your own conclusions.

One last question. Jim, I kind of got caught off for a moment there. When you gave guidance, I think you gave guidance for gross margins third and fourth quarter. Did you say they'd be lower than the second quarter or did I misunderstand that?

What I said was the capacity utilization was going to be down in the third and fourth quarter. Would have a commensurate drag on margins relative to the second quarter. So, margins would be down compared to the second quarter.

You know, I would add that when the economy turns up -- and I didn't say if, I said when -- and we have to -- and our sales expand, we'll not only get the benefit of the increased sales and the margins attendant to those sales, we're also going to be expanding our production. So we'll get -- you get the double whammy on the downside. You also get the double whammy on the upside.

Richard Whiting, Broadview Advisors.

As your competitors work through the same weather issues that affected you and their inventories at the distributor level, are you seeing any pricing out of competitors or price pressures out of competitors that have raised an eyebrow?

Do you mean with regard to competitors dropping price?

Yes. Trying to clear inventory before year-end. I mean, obviously you guys have the goal set of having your inventory levels below -- at the end of the year below what they were a year ago. I would assume you're not alone in that, and is anybody looking at price as a way of moving inventory through the system as a whole?

What we've seen is just the opposite. We've had a number of competitors that announced midseason price increases.

And they seem to have stuck across the board as you talk to your distributors?

Well, we are not sure about that, whether they're sticking. That might, possibly, account for some of the shift in market share.

Okay. And certainly you guys keep your eye on being innovative, keeping product fresh and adding product to the lineup. What's the competitive environment there? Are you seeing any new product out of competitors that looks like it's a change?

We do. There is a lot of product being introduced by competitors. We think we've got the best and we think we're on the forefront, but yes, it's some pretty aggressive competition out there.

So I don't want to -- we've got some tough competitors out there to deal with. But we're dealing with it, and we think we're on the high ground and the high ground is expanding, the distance between us and our competitors.

One of the things that came out of the Principia report was not only do we continue to maintain the leading market share by more than double the next closest competitor, but that actual spread is expanding. But we do have competitors introducing new products, and they are to be taken seriously.

Fair enough. Thank you, guys.

Kenneth Smith, Lenox Equity Research.

Ron, I don't think you made any comments about the big-box channel distribution for you. Can you talk about how you're doing there? And also, can you give us any more specific feedback on how some of these acquisitions you've made are faring? Or if they're not adding up to much at this point, what you see them contributing to the mix so far?

Our relationship with our big boxes is good. I think our big-box sales as a percentage of our total are expanding. So, they're becoming -- they're very important to us, as is the big -- the pro channel. So, that's what I'll say about that.

With respect to the acquisition that we've made, Iron Deck specifically, we're right where we expect to be at this point in time. In terms of sales and bottom line, it's not going to move the needle substantially in 2011.

You'll begin to see it in 2012, but the orders are coming in. We're in production, and orders are coming in as we speak, and we're beginning to ship product.

And what about the efforts to sell the product outside the U.S.?

Those efforts are expanding. The orders are expanding. We are in 18 countries, but to be clear about it, we'll -- first of all, we're not going to forecast what the sales are internationally. But I expect it will begin to move the needle in 2012.

Okay. Thank you.

I wanted to make a couple of comments. I'm going to go off-script here a little bit because I know how important the results were of the second quarter.

I came in this morning and took out a blank sheet of paper and wrote down how I would look at this business from 100,000 feet. And there are certain things I want to draw your attention to. Firstly, we've got a stream of products that have been coming out of Trex and will continue to come out of Trex.

We're expanding our geography. We're growing our market share. We have $47 million of cash in the bank. There was $66,000 in the bank when I got here. We're at record rates in yield in our production line, which is just superlative manufacturing performance.

Our sales are down, but our EBITDA is up. We're producing 30% gross margins despite only 38% utilization. Our raw material costs are stable. We're going to be very judicious in our spending, but we're going to continue to stand a strategy of advancing the Company. I think it would be a damn shame to give up the market share, the growing reputation that we've got, our growing footprint that we've got in the world. It would be very easy to overreact to a soft second quarter.

We're going to be judicious in our spending, but we're going to continue to prosecute our strategies. That's been confirmed by our Board meeting that we had last week. The Board is very supportive of what management is doing.

So, the question for all you folks is, is when this market recovers, who do you think is going to be in the best position to exploit the advantages of a growing marketplace, and it will begin to grow at some point. That's how I see the world, and I thought I would share that with you.

I'll go back to my last paragraph of scripted remarks, and thank everybody for their participation today. Although the second quarter didn't measure up to our expectations, we're very encouraged by the current pace of sales activity and are enthusiastic about the new products we're are bringing to market. I continue to believe that no other decking company is better positioned technically, strategically, financially, or organizationally to take advantage when the upturn occurs than Trex.

We're looking forward to talking to you again after the third quarter, and finally, my thanks again to the most switched on and motivated staff in the industry, my colleagues here at Trex. So thank you and goodbye.

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