Trex Company Inc (TREX) 2011 Q3 法說會逐字稿

Welcome to the Trex Company third quarter 2011 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, October 31, 2011. I would now like to turn the conference over to Harriett 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 Bartow, Director of Financial Planning and Analysis, and Bill Gupp, General Counsel.

The Company issued a press release this morning containing financial results for the third 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 27-A of the Securities Act of 1933, and section 21-E of the Securities and 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 relation expenses relating to product quality, and the highly competitive markets in which the Company operates. Documents filed with the Securities and Exchange Commission by the Company, including in particular its latest annual report on form 10-K and its quarterly reports on form 10-Q 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 2 tables titled Reconciliation to Pro Forma Results of Operation Measures to the Nearest Comparable GAAP Measures 3 Months Ended September 30, 2011, and Reconciliation to Pro Forma Results of Operation Measures to the Nearest Comparable GAAP Measures 6 to 9 months Ended September 30, 2011.

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

Good morning. In the third quarter, we executed well in the face of declining consumer confidence and slowing economy. Our sales for the period were 12% higher than last year's. While some of this gain came from projects that got pushed from Q2 into Q3 because of bad weather, overall we were pleased with our revenue performance considering the persistent economic headwinds. Despite these headwinds, our trailing 12-month revenue was down less than 2%.

Our revenue performance, which reflects an increase of the number of dealers selling Trex and other market intelligence, confirms that we continue to increase our market share. On an underlying basis, third-quarter gross margin improved by 390 basis points as we continue to improve manufacturing line rates and yields, and continue to lower our recycled raw material costs. We were judicious in our spending, increased our cash flow, and took a number of steps to improve our financial stability. Jim Cline will give you more details on those initiatives in a few minutes.

Most gratifying to me is our steady steam of new products that started contributing to our sales performance, market acceptance of TrexDeck lighting, a great high-margin product, has been strong, and our entry into the $2 billion sub-structure market, a market about as big as the decking market itself, is off to a good start. Trex Elevations, our lightweight, easy-to-install deck framing, is already in production in Fernley, Nevada, and will be in production in Winchester in the fourth quarter. There's also a lot of excitement around the Trex Transcend porch flooring product we introduced this summer to help bring curb appeal and consumer enjoyment of low-maintenance outdoor living to the front of the home. The boards for our porches are narrower than our deck boards, and about as close as you get you can get to being gap-free, so the porch looks like traditional flooring. With the early interest and traction we're seeing, we think this will be a strong contributor to our 2012 results.

We continue to plant seeds in the international market. Our dedicated sales and marketing resources are focused on this growth opportunity, and we will be increasing our overseas branding effort in 2012. We recently announced the launch of Trex Enhance. Enhance is a capped deck board that utilizes the Transcend technology with some of Transcend's performance features. Enhance offers a 20-year fade and stain warranty, is scratch resistant, comes in two rich colors, and fits in the middle of our Good, Better, Best product platform strategy. We expect enhanced margins to be accretive. We also entered into another trademark licensing agreement to develop and market Trex pergola kits. The kits, which will be sold by Backyard America, are being made with TrexTrim and are designed for both commercial and residential properties. Entering the pergola market offers another opportunity to extend our brand.

On the distribution side, we've continued to enlarge our industry-leading position. In August, we chalked up an important win in the Pacific Northwest, adding International Wood Products to our network of distributors. IWP is already a big player in the wood alternative market, but they recognize the opportunities Trex brand and product portfolio offered to leverage its positions. We're very excited about the new partnership and the potential it has to contribute to our goal of growing market share. While on that topic, I should note that there were further indications of industry consolidation last quarter. Every time someone exits the industry, there's more share to divide up between the other players, so over time, this trend will work to our advantage.

We remain focused on advanced expanding Trex's portfolio of products. We're continuing to invest in R&D efforts and expect to introduce some additional interesting outdoor living options for 2012 and beyond. Regarding R&D, I am sure that many of you are interested in an update on our progress related to our development of a new product category. We've made significant progress on the research and development related to a new product category. That progress has taken a number of twists and turns, as our technical team developed and evaluated a number of conceptual approaches. We have developed, tested, proven and manufactured products for the new category utilized in this new technology. However, the new category concept has not yet met our economic requirements, and we have therefore suspended further development on this project for the foreseeable future. While these developments do not currently support an introduction of the new category we envisioned, the technology that we developed through this process can and will be used in the development of innovative products in categories in which we currently participate.

Before I turn the call over to Jim to give you a detailed financial review, I'll comment on our outlook for the fourth quarter. Obviously, the sailing is still tough in this economic environment, but as we move toward the 2012 season, we believe our product offerings and sales strategy offer a solid platform for growth. I can't overstate the enthusiasm our distributors showed at this month's annual meeting for our products and program. They understand that Trex sits at the nexus of 3 important forces; outdoor living, green building, and strong brand value. They appreciate how we've transformed the Company into a manufacturer of complete outdoor systems with decking, railing, lighting, porch flooring, and steel substructures that all fit together, enabling consumers to go completely around the home with our products.

We spent a lot of time developing our sales programs and pricing strategies for 2012. They differ somewhat from last year's, when we implemented a price increase on Transcend, which had the effect of accelerating sales into the fourth quarter of 2010. This year, we're not increasing prices and expect our sales patterns and timing to be quite different, with more of the activity taking place in the first quarter. For this year's first fourth quarter, we're therefore projecting revenue to be in the range of $50 million to $55 million. However, based on the feedback we received at our annual distributor meeting last week, we expect sales in the first quarter of 2012 to exceed the first quarter of 2011 by at least 25%. Moreover, we expect sales for the full year of 2012 to grow significantly. Jim?

Thank you, Ron. Good morning, everyone. As you know, the press release with Trex's third quarter and year-to-date financial results was issued this morning. First, I would like to review our third-quarter financial results.

The Company recognized net sales of $67.9 million in the third order of 2011, a 12% increase compared to 2010. The increase in net sales was attributable to an 8% increase in sales volume and a 4% increase in the average price per unit. The increase in the average price per unit was driven by the 2011 price increase for Transcend decking products and a shift of sales mix toward higher-priced products.

The Company recorded a net loss of $500,000, or $0.03 per share in the third quarter of 2011, compared to a net loss of $8.8 million, or $0.58 per share in 2010. The Company's results for the third quarter of 2011 include a $500,000 non-cash charge related to the extinguishment of $5.6 million of our convertible notes. Before giving effect to this charge, our third quarter 2011 net income was $28,000. The Company's results for the third quarter of 2010 included unusual charges of $3.9 million. Before giving effect to these charges, our third quarter 2010 net loss was $5 million, or $0.33 per share.

Gross profit margin was 25.4% in the third quarter of 2011, 10.3% higher than 2010. Excluding the $3.9 million of 2010 charges, gross margin increased by 4%. The elimination of the earnings drag related to the 2010 Transcend introduction, improved manufacturing efficiencies, and other sales related items each contributed 3% to gross margin. This was partially offset by capacity utilization, which reduced gross margin by 5%. Capacity utilization in the third quarter of 2011 was approximately 20%. SG&A for the third quarter was $13 million, compared to $14 million in 2010, and was primarily related to lower branding expenditures. Net interest was $4.8 million in 2011, a $900,000 increase from 2010.

The Company's results for the third quarter of 2011 and 2010 include a $2.5 million and $2.1 million of non-cash interest expense related to the accounting treatment for the convertible bonds under APB 14-1. In addition, this quarter included an additional $600,000 non-cash charge related to the extinguishment of $5.6 million of our convertible notes. This charge was the result of accelerating the non-cash interest under APB 14-I, which would have been recognized in subsequent periods.

For the first 9 months of 2011, net sales were $215.3 million, compared to net sales of $242.4 million for 2010, a decrease of 11.2%. The decrease in net sales was attributable to an 18% sales volume decline, which was partially offset by an 8% increase in the average price per unit. The increase in average price per unit was driven by the 2011 price increase for Transcend decking products, and a shift in sales mix toward higher-priced products. We believe the decrease in sales volume compared to the 2010 9-month period was the result of extremely poor weather conditions through the start of the deck-building season in certain regions of the country, combined with reduced consumer spending due to the lower consumer confidence. In spite of the bad weather and challenging economic headwinds, our distributor sales into the market for the trailing 12 months increased by 10%. This compares to a 2% reduction in our sales to our distributors during the last 12 months, and indicates a healthy level of pull-through in the market.

The Company recorded net income of $6.7 million, or $0.41 per share, in the first 9 months of 2011, compared to a net loss of $9.6 million, or $0.63 per share in 2010. The 2011 results include a favorable resolution of uncertain tax positions in the first quarter that positively impacted income taxes by $2.6 million. This was partially offset by a $600,000 non-cash charge for the extinguishment of the $5.6 million of convertible notes mentioned previously. Before giving effect to these adjustments, net income for 2011 was $4.6 million, or $0.28 per share.

The Company's results for the first 9 months of 2010 included $17.2 million of charges. Before giving effect to those charges, our net income for the first 9 months of 2010 was $7.6 million, or $0.49 per share. Gross margin was 29.6%, in the first 9 months of 2011, a 7.3% improvement from 2010. Gross profits in the first 9 months of 2010 was adversely affected by $14.8 million worth of charges. Excluding the 2010 charges, gross margin increased by 1.1%. The elimination of the earnings drag related to the 2010 transcend startup contributed 6% to gross margin. This was partially offset by a decline in capacity utilization, which reduced gross margin by 3%, and other sales-related items.

SG&A for the first 9 months of 2011 was $47 million, compared to $52.3 million in 2010. The SG&A in 2010 included a $2.4 million non-cash charge to write off our joint venture in Spain. The remaining decrease of $2.9 million in SG&A was primarily related to lower branding and incentive bonuses. Net interest was $12.8 million for the 9 months ending September 30, 2011, a $1.2 million increase from 2010. The company's results for the first 9 months of 2011 and 2010 included $7.1 million and $6 million of non-cash interest related to the accounting treatment for the convertible bonds under APB 14-1. In addition, net interest expense in 2011 includes a $600,000 non-cash charge related to the extinguishment of $5.6 million of our convertible notes.

The effective income tax rate for the first 9 months of 2011 remains low, as a result of a valuation allowance against the deferred tax assets. In addition, we recorded a $2.6 million favorable non-cash adjustment to taxes in the first 9 months of 2011, related to the resolution of uncertain tax positions. At September 30, 2011, the Company had $50 million of cash on hand, and no borrowing on our revolving line of credit. Our only borrowing was the remaining $92 million related to our convertible notes. Net debt to total capitalization at September 30, 2011 was 24% compared to 28% at September 30, 2010.

Our inventory was $33 million at September 30, 2011, a $7 million year over year decrease. The company had free cash flow of $33 million in the first 9 months of 2011, an $8 million year over year increase. Free cash flow during 2010 benefited from a $7.5 million one-time tax refund. Cash used in investing activities was $8.1 million, a $2 million increase versus the prior year. The 2011 amount included the acquisition of substantially all the assets of Irondeck Corporation, a manufacturer of steel deck framing systems.

We recently agreed with our bank to extend the maturity on $55 million of our revolving line of credit through December 31, 2012. We believe this facility, coupled with our projected cash generation through June of 2012 provides adequate liquidity to handle our mid-2012 maturity of the convertible notes. However, we are actively pursuing additional financing to enhance our capital structure that will provide added flexibility to execute our strategic objectives.

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

(Operator Instructions)

Your first question comes from the line of Trey Grooms of Stephens.

Hi, good morning, guys.

Good morning.

First question is on the guidance. So, the 4Q revenue guidance is a bit lower than we would've expected, but the1Q 2012 is obviously pretty strong. First, obviously you don't have the price increase in January which you talked about, which did play a role last year in the fourth quarter; but it seems like you're expecting customers to kind of put off some purchasing from 4Q to 1Q. Can you talk about what's behind that? Why are customers delaying purchasing, or if that's even what's going on, or if it's something else?

Well, I think it's largely to do with the no price increase. Last year, they were really compelled to order early in Q4. This year, that compelling price increase isn't there. I think people are going to just control their inventory as long as they can, but we are optimistic about their ordering patterns for Q1.

Okay. Do you guys have any -- I know in the fourth quarter, it's -- typically, your early buy period, kind of goes into 1Q too -- but is there any changes going on there with your early buy program, relative to what we've seen in the past?

It will largely be a Q1, Q2 program. It's largely the same as you historically remember. We're just not incentivizing people to order in Q4 at the distributor level.

Okay. All right, got it. Then, on new products, with respect to your new enhanced product line -- first off, it sounds similar to Transcend. Could you give us a little bit more color on how it differs from Transcend, from performance, appearance, and then also lastly, price?

Sure. It will be priced less than Transcend, but more than Accents. It comes in 2 colors instead of 7 colors. It will not have matching railing. The warranty is not quite as good as Transcend, and it won't have the stain and fade resistance to the same extent that Transcend will.

Okay, and with it being a lower priced product, do you think this will cannibalize any of your other product offerings, especially, Transcend?

I don't think it will cannibalize Transcend. I think it'll probably take away from Accents.

Okay, and with that, so do you think that -- Transcend has continued to increase in the revenue mix you guys have. Should we expect that to continue in 2012?

Yes, I think I would.

Okay. Then my last question is for Jim. Could you tell us where utilization rates were in the quarter, and then also where you expect them to be in 4Q? Or I guess in 1Q, too, if we were to see the increase you're looking at?

With regard to the third quarter, we were about 21%. The fourth quarter will end up being in the 15%, 16% range, and if you looked at the first quarter of 2012, we'd be around 35%.

Okay, thanks, guys. Appreciate it, that's helpful. I will jump back in queue.

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

Thanks. Good morning, everyone.

With regard to SG&A, I think in Jim's comments you talked about it being down, and that was due to lower branding and incentive bonuses. Can you talk a little bit more about what's going on there? Are you matching some of your branding spending to how the sales opportunities have transpired over the year? Do you feel like you didn't have to spend as much to get the same sales opportunities? Could you give us a little color there?

Basically, what we saw is, in a lot of conversations with our people out in the field, the Trex pros, we felt that most of the commitments had been made as we entered the third quarter, and there was a very healthy backlog in the demand for Trex pros; and we didn't feel that continuing to pull through to the extent that we had planned was necessary. So we strategically just trimmed part of that back.

Would we expect into the first part of next year that to ramp up a bit, I would think, from where you're going to end the back half of the year? That probably makes sense.

Yes. The spend in 2012 should be relatively consistent with where we are in the spend for 2011.

Okay. With regard to weather, you mentioned on your second quarter call you thought some demand was pushed into at least the first part of the third quarter. But later in the third quarter, there was some adverse weather, the Northeast was very wet, for example. Do you think you saw any impact there in the third quarter, with regard to demand and weather?

We do think we saw some. It's hard to quantify, but I made 2 observations. 1 is that a lot of our contractors are working later into the season than they normally would. The second, though, is that a certain number of the consumers, if they can't get their deck installed by a certain point in the summer, they say the heck with it, we'll just do it next year. I don't know exactly when the turnover date is, but it generally comes around the middle of August. The deck isn't in, they'll put it off a whole year.

Jack, having said that, we still are seeing good increase year-over-year as we enter the fourth quarter. We're seeing double-digit increase year-over-year as we enter the fourth quarter.

So, obviously, you're expecting it to lessen a bit, given your fourth-quarter guidance?

Yes. The big reason for the fourth-quarter guidance decline is not the organic sales that are made in the quarter to support the market, it's the load-in related to the early buy that we don't believe will occur to the extent that it did last year.

Okay. I wanted to clarify with regard to the pricing. Ron, you said -- did you say there are no price increases out on Transcend at this point, and does that mean you are not going to have a price increase next year on Transcend?

We don't envision a price increase on Transcend. There will be a price increase on Escapes, our PVC product line, but I don't envision at this point an increase on Transcend. Our input costs are essentially flat, or down slightly.

Great. Thank you very much.

Thank you.

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

Good morning, Ron and Jim.

A couple things. Your utilization rates still remain really low. You mentioned you're suspending work on this potential new category. Is there any way to think about what your utilization roughly would be in 2012? Is it going to be in the 30s again? Where I'm going with this is just wondering, is there an opportunity to take lines out or down, since you're so far below? Or does that just not save you a lot of money, and it's just not worth it to do that?

We do an analysis regularly about that, whether we should go to 1 plant or 2 plants, and it just doesn't pay. The variable costs associated with starting a line up is relatively small. So it's a question of just -- we've got a certain number of lines in both plants. We just turn them on 1 at a time as we need them, or shut them down 1 at a time as we don't need them.

As far as capacity utilization, certainly it's going to go up in Q1 versus what it was in Q4. I'm not ready to give a prediction of what it's going to be for the whole year, but it will be up substantially in Q1 versus Q4. Well, the good news here is that the line rates and yields continue to march forward, beyond my expectations, quite frankly. So we get more and more done with less and less, and it shows you the extraordinary margin and leverage opportunities there is -- if you can make a 30% gross margin at a 33% capacity utilization for the year, it shows you the extraordinary upside potential it is when the volume comes back.

Yes. Jim, can you update us on the amount of cash claims you're paying on warranties? The previous charge, year-to-date, where that total balance is, and maybe relate that to the commentary of the ongoing accrual, it looks like, coming down?

Sure. The warranty reserve is about $8.5 million at the end of the quarter. In the third quarter, we paid out about $2.5 million. Year-to-date, we've paid out about $6 million.

Your normal accrual on that number, going forward, is? Annually?

Well, 1 thing to remember, if you went back and compared the year-over-year for the third quarter, last year we had $3.5 million, this year $2.5 million. We anticipate that those claims paid out will continue to decline at an accelerated rate. So the payout is very seasonal in nature, and we anticipate that the reserve that we have on hand right now will not require to be adjusted going forward.

Okay. Ron, maybe you could tell us what you think, overall, deck building in the industry will be in say, 2011, either preferably, I guess, in units? Where composites will be? Where you think you'll stack up against that? Then I'm also curious if you could -- you've got a lot of new products, substructure, lighting, railing, all these things. Any way to quantify how much that is helping you, versus, say, the overall deck board market?

Well, we know that the deck board market, according to Principia, is down about 37% 2011 versus 2008. At the same time, composite decking as a portion of the total has increased. I think it stands now at somewhere around 33%, 34%, something like that. I know that Trex's market share has increased from 30% to 35%. These are all independently verified numbers. So the pie has gotten a lot smaller. I think, in my view, it probably hit bottom. I think between the uplift that will inevitably occur in the market, and Trex's growing market share, I'm optimistic about the forward prospects for Trex in terms of volumes and profitability.

One of the things that we've done at Trex versus the first 3 years I was here is, you'll notice that Trex is getting a lot cleaner in terms of the ability to analyze it. I wanted to have a year where there were no write-offs, there were no surprises. Our operation is running very cleanly, the factories are running better than they've ever run in history, as far as I can tell. Our SG&A expenses are under control. Our overhead is clean, and we're well-positioned. Our market share is growing, our product portfolio is growing. The products that we've got are recognized as the best in the industry, and the number of dealers and contractors that are promoting Trex products is growing, and the marketing program and the branding program that we've got in the pipeline for the spring of 2012 is extraordinary, and it's quite exciting.

So you've got a confluence of all the forces coming to bear that I had expected, and was working toward. This team has put it together, so that if you think back to2 or 3 years ago, it's a lot easier to analyze. I'm a lot more optimistic about the future than I was before. That's probably a longer-winded answer than you wanted, but you triggered a lot of thoughts.

That's okay. Then, lastly, on the converts coming due June -- I guess with your revolver and your current cash balance you'd have that covered, but this is seasonally, I think, your peak of your cash balance. How do we think about that cash balance at the end of June, Jim? And I assume that's why you would want to try to find some additional monies, just to have a larger cushion?

That's an accurate statement. Basically, this past year, our cash really peaked in the third quarter. If you go back to the prior year, I think you would see the peak was really more in the second quarter. We anticipate our cash this year is going to peak in the late second quarter. So the combination of those give us a pretty good safety margin as we look at it. But we believe to be able to address other strategic opportunities, having additional borrowing capacity would be appropriate. So we are pursuing that actively.

John, there was one part of your question which I didn't get to, which was the extent to which all these new products are going to begin to move the needle. I can tell you that it is my expectation that it will begin to move the needle in 2012. We're not going to reveal quantities, or specifics about which products are going to gain how much of our sales revenue, but I do expect them collectively to start to move the needle.

Great, thank you.

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

Gentlemen, good morning.

Good morning.

You made some comments about your raw materials being flat year-on-year. That's not really the case for the folks you compete against. Are the expectation on your part, that your competitors go out with price increases, and does that play into the part that you will not do a price increase this year?

It does play into it. We estimate that raw material pricing for our competitors has gone up about 18%; ours is actually down a little bit, or, depending on which product line I'm looking at --

Down slightly.

Yes, it's actually down slightly on an overall basis. So we think this is a time to keep our prices flat. We can do that. Our competitors are getting whipsawed by commodity pricing and had multiple increases through the year. We think that will probably start to move the needle, as well, in terms of market share.

Great. Then you also made some comments about sell-through in the market being fairly strong. Despite what your trailing 2012 sales look like. The commentary for 1Q, the guidance for 4Q, if I add those two together, I'm still getting something along the lines of flat to slightly down with the similar 6-month period 4Q 2010 and 1Q 2011. Is the expectation that the market is going to be flat over the next 6 months here, or is that in excess of 25%, just kind of a hedge to be conservative?

Well, I don't want to characterize it as conservative or not conservative. Clearly, we would want to carefully -- well, we want to maintain our credibility, that's foremost in our minds all the time. But we think that the market is probably going to be flat -- the overall market -- we're counting on market share increases for Trex.

Okay, fair enough. I don't want to try and hold you to a number, but if 2012 does, in fact, end very similar from a utilization level as 2011, would you still see the benefits from the Transcend and the other productivity gains that you have on the board? Or is that too low a level to really have those increases shine through on the gross margin?

Well, the improvements we've made in Transcend and the introduction of the new products should contribute to the margin. I don't anticipate the low capacity utilization to eat away at that. Just the contrary. So those improvements should continue to shine through.

Okay. Thanks, guys.

Thank you.

Your next question comes from the line of Eric Prouty of Canaccord.

Thanks a lot, guys. Quick question first on the SG&A. I think you mentioned the levels were off of lower spending. Did you say that you expect 2012 to be similar absolute dollar level as 2011, or a percent of revenue level? I didn't -- a little clarification there.

Dollar level.

Okay. So in the $60 million range? Also -- and, again, I don't know if you mentioned specific numbers -- but do you have the volume and price components of the revenue growth?

For the third quarter?

That's correct, yes.

Yes. It was -- go ahead, Brian.

It was 8% volume and 4% sales price.

Okay, great. Also -- and you mentioned this -- from a working capital standpoint, given that you are expecting a lot of the sales to be coming through in Q1, why wouldn't the December -- I would think the December run rates, your utilization rates, would be higher, as in December you would be building up inventory to sell into what you're expecting to be a strong March. Maybe you can just work through how you plan on meeting those sales levels, and if your existing inventory levels are high enough, or if you're going to be needing to build up a lot of inventory to meet your Q1 guidance?

Clearly, we're going to be ready to meet our Q1 guidance, but this is part of the manufacturing improvements that we made. We can spin this Company a lot faster than we used to in terms of bringing production up, or taking production down. But we work very hard to keep our inventory as skinny as we possibly can. We feel that we can afford to have a low level of production in Q4 and similar to Q1 requirements; and part of that is coming from our ability to quickly ramp up production to a rate -- with rates and yields higher than they've been in the past.

Great. And then, on a similar vein, your Q1 revenue guidance is obviously a big improvement over last year's Q1. Yet if I have my numbers right, it looks like you're projecting lower utilization rates -- 35%; I think you did about 46% in the March 2011 -- I mean, help reconcile those numbers. Is it just again you're not going to build any inventory in the quarter?

Well, certainly, we are focused on the inventory, and the inventory growth last year was probably a little bit greater than what we would've preferred. And you saw that again in the second quarter. So we are holding inventory to a much tighter level than what we had in the past. And that is part of the reason for that difference in the capacity utilization.

Philosophically, we manage the balance sheet, frankly, before we manage the income statement. If the balance sheet looks good, the income statement will take care of itself.

Great. Okay, that's it for me. Thank you.

Thank you.

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

Most of our questions have been answered, but just to clarify on the earlier one, on the early buy program, we wouldn't see -- you know the shift -- we wouldn't see any changes to like the term or the discounts, this is going to be similar to what it was?

Well, both the terms and the discounts are different from the prior year, but we believe the effect of the program will be consistent with prior year, but for the fact that we do not have the significant price increase related to the Transcend product.

You know, let me make a comment about Q2 and Q3. I'm not giving any predictions about that, but we are not predicting another wet spring like we had last spring. So that will have some upward lift on it as well. Next question?

Your next question comes from line of Richard Haydon of Yield Capital.

Good morning. I don't have a lot of history with the Company, but can you help me better understand what created the substantial decline in accounts receivable during the quarter? As you move forward, based upon your expectations of 2012 sales, what are the implications of that being a big use of funds?

Well, the reductions in accounts receivable from the second quarter to the end of the third is very typical. If you look at prior years, you'd see it's a seasonal change that occurs very normally. When you look at the first quarter of 2012, you would see an increase in the accounts receivable balance, as we move forward, those being paid down as we enter into the second quarter. Very typical of what we've seen in prior years.

You see that's substantial, the swing, a 70% percent decline in accounts receivable?

Yes.

Based upon your thoughts for 2012 sales, how much capital do you think you would have to dedicate to funding the increase in accounts receivable?

Well, we don't really get involved in the detailed projection of what our receivable balances would be, so I really would just prefer to decline on that question.

In terms of your new financing, would that involve just debt, or would it be something -- a combination of items?

It would be just debt. We are not looking to any equity issue or convertible issue to build the additional availability.

Okay, thank you.

You're welcome.

Your next question comes from the line of Ryan Thibodeaux of Maple Leaf Partners.

Good morning. Could you talk about the overall impact on volumes since you introduced the Transcend product? Just on a volume versus price basis, compared to how the Company was before then?

Well, I'm going to let my colleague Jim help me out here, but clearly a very large portion of our sales did convert to the Transcend product line. Transcend has become dramatically more profitable this year than it was last year, as we left $17 million of start-up expenses behind us. I expect that the majority of our sales will be Transcend technology within a year or two. What else can I tell you?

So you're saying that the gross margins on Transcend are better than the old Accents product?

Gross margins are equal to or better than the Accents product offering. We don't get into detailed margin information. Just to step back and talk a little bit about the ultra-low maintenance category -- if you went back to 2007, the ultra-low maintenance category is primarily serviced by PVC products, and they represented about 8% of the market. With the introduction of Transcend in 2010, the ultra-low maintenance market moved up to about 42%. This is not Trex, this is the overall market. We don't disclose what our ultra-low maintenance category is, of that total, but I think it's reasonable to say that Trex has seen a comparable movement into the ultra-low maintenance. So the ultra-low maintenance category is expanding quite significantly.

Okay. Then as far as gross margins, looking into 2012, it should be pretty clean going forward, just adjusting for capacity utilization, right?

I would say so. Capacity utilization and sales volume would be the 2 drivers.

So there's no other start-up costs associated with the new product introductions?

The new product introductions -- basically we don't see any significant impact from that going forward.

Okay. Then, the last question -- you gave some statistics on, I think, sell-through and sell-in. Could you just repeat what you said? I missed that.

Sure. What we said was, for the trailing 12 months ending September of 2011, we saw about a 10% increase in sales from our distributors to the dealers, and Trex's sales into the distribution, into distributors, was about a 2% decline.

Did that clear that up?

Yes. But that -- so not necessarily sales to -- that's just from distributors to the dealers, but we don't have a comparable metric from the dealers into the end users?

No, we do not.

Okay, thank you.

You're welcome.

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

Hi, guys. Questions pretty well picked over here. Just a clarification -- there was an earlier question and expansion of what you said earlier on SG&A. I'm not exactly sure what was the guidance for 2012? It was going to be the same run rate recently? I'm not exactly sure what was stated about SG&A going forward?

There were 2 questions on that, Morris. 1 was a question relative to the timing of the spend, and what we said was it would be relatively consistent with the prior year; and the level of spend would be essentially consistent with the prior year. And it was really focused more about branding than anything else.

All right, thank you.

You're welcome.

Any more questions?

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

Thanks, everyone, for participating today. I'm pleased with our overall performance considering the turbulent economic environment. The vast improvements that we have made to our operating costs have been masked to a certain extent as we operate at low levels of capacity utilization. The bottom line is that there is no outdoor living company better positioned to take advantage of the upside, when it comes, than Trex. We have the most prominent brand, the best array of products, strongest distribution, lowest cost of production, a solid financial position, and the smartest people. I am optimistic about our long-term prospects, and I hope you'll join us again for our fourth quarter call. Thank you. Goodbye.

Ladies and gentlemen, that concludes your conference call for today.