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Drew Industries Inc. (NYSE:DW)

Q3 2008 Earnings Call

October 31, 2008 11:00 am ET

Executives

Leigh J. Abrams – Chief Executive Officer

Fredric M. Zinn – President

Joe Giordano – Chief Financial Officer

Jason Lippert, President and CEO of Lippert Components

[Ryan McGrath] – Lambert Edwards

Analysts

Arnold Ursaner – CJS Securities

[Scott Semboe] – Sidoti & Co.

Edward Aaron – RBC Capital Markets

David Wells – Avondale Partners

Jamie Wyland – Wyland Management

Peter [Usell] – Meadow Capital

Operator

Good day ladies and gentlemen, and welcome to the third quarter 2008 Drew Industries Inc. earnings conference call. (Operator Instructions). I would now like to turn the presentation over to your host of today's call [Mr. Ryan McGrath] of Lambert Edwards. Please proceed, sir.

[Ryan McGrath]

Welcome to Drew Industries 2008 third quarter conference call. I'm [Ryan McGrath] of Lambert Edwards, Drew's investor relations firm. And I have with me today members of Drew's management team, including Leigh Abrams, CEO and a Director of Drew, Fred Zinn, President and a Director of Drew, Jason Lippert, President and CEO of Lippert Components and a Director of Drew, and Joe Giordano, CFO and Treasurer of Drew.

We want to take a few minutes and discuss our quarterly results. However, before we do so, it is my responsibility to inform you that statements made in today's conference call regarding Drew Industries and its operations may be considered forward-looking statements under the securities laws.

As a result I must caution you that there are a number of factors, many of which beyond the company's control, which could cause actual results and events different materially than those described in the forward-looking statements.

These factors identified in the press releases are Form 10-K for the year ended 2007 and our subsequent Form 10-Qs, all filed with the SEC. Today I would like to turn the call over to Leigh Abrams.

Leigh J. Abrams

Welcome to all of you on this call and to all of those listening on the internet. Before we begin today's call, let me begin by noting the recent retirement announcement of David Webster, who has been Kinro's long time President and CEO, and a good friend of all of us.

David has been with Kinro for over 30 years, and has been with Drew since we merged with Kinro in 1980. And I can truly say that David's contribution to Drew over the years has just been totally exceptional and he is truly one of the main reasons that today Drew is respected and a profitable company. And we just can't thank David enough for his service over the years.

We're going to certainly miss David's expertise and his good humor, but we're confident with our ability to call upon David whenever his advice is needed. All I can say is publicly, thank you David.

Since everyone else in these days is focusing how bad business and the economy are, I'll begin today's call with some good news for a change. First, Drew was profitable for the third quarter and year-to-date periods. And I think in this economy that's quite an accomplishment.

Second, the RV and manufactured housing dealer network is seeing their inventories come down and getting lower. That's again a very positive sign for the industry. Thirdly, home sales both new and used, have recently shown some signs of improvement, though be it spotty around the country. And finally, gas prices at least temporarily have decreased significantly.

Rising home sales are probably the result of the lower home selling prices. But whatever the reason, there is some indication that the country's inventory of unsold homes is at least beginning to decline. I believe this process must continue before home prices and consumer confidence, which is now at a historical low, begin to recover, unless the economy as a whole and the RV industry in particular, begins to recover.

As we know the consumer confidence index has been key to the RV industry over the years, so we're really looking for that to recover, and we just don't think it's here yet. With respect to the RV and manufactured housing industries, both retail and wholesale sales are down significantly and seem to be getting worse each month.

September RV wholesale shipments were down an aggregate of 43%, with travel trailer and fifth wheel shipments down 39%, and motorhome shipments down 62%. Travel trailer and fifth wheel, again that's our primary business, and fifth wheel wholesale shipments were down 8% in the 2008 first quarter, 18% in the second quarter, 38% in the third quarter, and 21% now year-to-date.

Industry retail sales for September are not yet available but are expected to be bad. Year-to-date through August retail sales of travel trailer and fifth wheels were down 20%. When you compare this to wholesale shipments, it confirms a decline in dealer inventories.

Dealer surveys, as well as information from our customers, indicate that the RV dealers are aggressively seeking to currently further reduce inventories during the traditionally slower fall and winter seasons. Although this indicates further reductions in current reduction of RVs that use our products, we anticipate increased demand when the economy recovers and dealers re-stock their inventories.

In addition to the state of the general economy, it appears that one of the major stumbling blocks of new growth in the RV industry is tight credit, which hopefully now will improve with the recent actions by the federal government.

With respect to the manufactured housing industry, after some promising signs earlier in the year, the industry has tracked the rest of the economy and is now down 10% through August 2008 with the month of August being down 23%, but there were two less shipping days in this August than last year.

However, I think the long-term prospects for the manufactured housing industry recovery continues to be good and as you know we've been saying that for years, but really all the conditions seem to be in place.

With today's manufactured house we know is the best buy in the country and further the industry continues to work on putting together an industry image campaign and we hope this campaign will be introduced to the public during 2009.

We believe several factors point to a recovery in the manufactured housing industry. These include the lack of subprime financing for site-build housing, the eventual return to the manufactured housing industry of retirees who have been unwilling or unable to sell their homes at the severely depressed prices and the federal housing legislation which was signed into law a few months ago.

This legislation increases from about $49,000 to $70,000 in the amount of channel mortgage that can be guaranteed by the FHA and it also offers a tax credit of up to $7,500 to first time homebuyers. Both of these revisions should directly help buyers of manufactured homes, but it'll take the government a while to get all of the mechanisms in place for this. In addition, it appears that interest rates are declining and that hopefully will also help the housing market.

Despite today's grim business environment including the two industries that we serve I am pleased to report the following about Drew. We continue to be profitable, to generate positive cash flow, to have a very strong balance sheet with very little debt, to increase our market shares, to introduce new products, to make acquisitions with two being completed for cash so far this year, to seek cost savings wherever possible, and to offer our customers great service and quality products at reasonable prices.

Due to the current business environment, we continue to seek operating improvements and cost reductions with Jason Lippert now responsible for the operations of both Kinro and Lippert. Jason, along with the management from both companies, will seek to implement as many synergies and other cost savings as possible without sacrificing quality or customer service.

Further, with the joint talents of the executives of both companies, we will continue to aggressively attempt to increase our market share and develop new products. We are very fortunate to have had the talents of both David Webster and Jason Lippert and both gentlemen, both leaders have built a terrific pool of extraordinary management talent who will now work together to make Drew an even better company.

I will now ask Fred our President to say a few words.

Fredric M. Zinn

Because of the current conditions in the broader economy and in our industries are beyond our control, we have focused our attention on the key areas that we can control. Mainly aggressively pursuing market share growth, product development and cost reductions, and these actions will enable us to grow over the long-term and help us maintain our strong balance sheet and our position as an industry leader.

As you know, we've been actively controlling costs now for more than two years. We have closed more than 20 facilities and eliminated more than $12 million of fixed costs. However, recently we have really renewed our efforts in this area and we're currently implementing plans to close or mothball at least five additional manufacturing facilities over the next couple of quarters and we continue to explore additional consolidation opportunities.

We are analyzing all other potential reductions to fixed costs and we recently eliminated more than $500,000 of insurance and other administrative costs with more savings to follow. As you know we also reduced our capital expenditures which averaged $25 million annually from 2004 through 2006 to about $5 million this year, and in the last two and a half years we've collected more than $25 million from the sale of facilities.

At the same time we have to be cautious not to cut so deeply that it would impair our ability to grow once the market conditions improve. For instance, we continue to invest in product development so this is a key to our growth both now and when the economy recovers.

Our goal is to maximize profitability while preserving our strong balance sheet so that we will be able to take advantage of strategic opportunities that will likely become available during these difficult times. For example, over the past few months we've gained market share from some competitors that were forced to cease operations or in some cases were just unable to compete effectively during this severe industry contraction and we anticipate that additional opportunities like these will arise in the coming quarters.

Because of our quality products and outstanding customer service, we also anticipate other opportunities will arise to expand our market share in several product lines. In particular we're aggressively pursuing new business in our new upholstered furniture and bedding product lines. We will be taking advantage of a fragmented regional market and leveraging our marketing and manufacturing capabilities and look to gain significant market share in this product over the long term.

We're also focusing with renewed intensity on new product development. For example, we are working diligently with our customers and their efforts to build RVs, to address customer concerns about high fuel costs, energy conservation and the need for greener products. Another key factor is a careful disciplined acquisition strategy.

In this market we have to be even more cautious than usual about our acquisition opportunities because we intend to preserve our financial strength and we'll also be more cautious in evaluating other investment opportunities including our stock buy back program. But as we said before caution doesn't mean that we avoid all risks. It means we will critically evaluate many, many opportunities to find just those few where we're likely to control the risks and reap big rewards.

Another key to our success has been and will continue to be our incentive compensation plan. Most of you are familiar with the plan but I'll just take a minute to reiterate that the compensation of our management consists primarily of profit-based performance incentives. Therefore, in a period such as this where we are seeing declining profits management shares the pain with our stockholders, both through lower compensation and through the lower value of our Drew shares and options. And in many cases that represents a very significant portion of our individual net worth.

As a result we are highly motivated to maximize Dew's operating efficiencies, profitability and long-term potential. Despite current economic and industry conditions, however, we remain optimistic about the long-term future of the RV and manufactured housing industries and of Drew.

We are confident in Drew's ability to weather this perfect storm and to come out of this period as an even stronger company. While the balance of 2008 and 2009 are likely to be extremely challenging while our industries continue to suffer, we know that our experienced management team and dedicated and talented employees are up to the task.

Now, I will ask Joe, our CFO, to give you some additional color about results of this quarter.

Joe Giordano

Thank you, Frank. Our operating management has been proactive with respect to the industry slowdowns by streamlining operations, closing facilities and reducing other fixed costs wherever possible.

During the 2008 third quarter, fixed cost reductions added $1.1 million to operating profit as compared to the 2007 third quarter. These fixed cost reductions are expected to benefit operating profit by over $5 million for all of 2008 in addition to the $6 million in savings we realized in 2007.

Further, these previously implemented fixed cost reductions will have a positive impact on 2009 operating profit as compared to 2008 of over $1 million. These estimates do not include the recently implemented half a million of fixed cost reductions mentioned by Fred earlier.

Operating results for the first six months of 2008 were negatively affected by higher than average health insurance costs due to a higher number of large claims. These costs moderated during the third quarter of 2008 and were lower than the third quarter of 2007 but were still higher than we had typically experienced.

SG&A costs were 16.5% of 2008 third quarter sales, up from 13.4% in the third quarter of 2007. As smaller truckloads, higher fuel costs, an increase in bad debt expense and the spreading of fixed costs over a smaller sales base more than offset the additional cost cutting measures and a significant reduction in incentive compensation due to lower profits.

Stock-based compensation is currently running about $800,000 per quarter. In the past Drew has typically granted stock options to employees every other year at our Board of Directors' meeting in November. Beginning in 2008, we will grant stock options annually but with a reduced number of shares. As always, the option exercise price will be based upon the closing prices of stock on the day before the Board meeting. I expect the stock-based compensation expense in 2009 to remain constant.

Over the past few weeks we have begun to see an easing in the prices for certain of our raw materials from the recent highs we experienced. However, raw material prices remain very volatile and we still have high cost inventory that will last us into early 2009. Based on lower current sales volume, even with the recent decline in prices, we now estimate these raw material cost increases will aggregate approximately $40 million on an annualized basis.

In the third quarter of 2008, our effective tax rate decreased to 38.4% from 39.4% for the six months ended June 2008. The third quarter decrease in the company's effective tax rate was due primarily to the expiration of certain state and federal statute of limitations and the completion of the 2005 federal audit with no adjustments. These items were partially offset by the estimated annual affect of lower profits on state and federal tax rates.

We are in the process of tax audits in several jurisdictions and the outcome of these audits could impact future tax expenses. We review our tax positions quarterly based on the most recently available information and update our tax reserves accordingly.

In the press release, we cited our content per RV noting that it had increased 18% for the 12 months ended September 2008. September manufactured housing industry production statistics are not yet available but we estimate that our content per manufactured home produced was approximately $1,600 for the 12 months ended September 2008, consistent with the $1,615 reported for the 12 months ended June 2008.

Compared to the $1,826 per manufactured home reported for the 12 months ended September 2007, the content for the last 12 months declined 12% partly due to a reduction in the average size of homes produced by the manufactured housing industry and partly because we exited a certain business in the latter half of 2007 due to inadequate margins.

We have gained market share in our MH segment in recent months but the rolling 12-month content does not yet fully include these recent gains.

As a result of the continued downturns in our industries, during Q3 2008 the company conducted an impairment analysis on the goodwill and other intangible assets in our RV, manufactured housing and marine and leisure operations. The estimated fair value of these businesses currently exceeds the book value thus no impairment was recorded.

However, the declines in our industries have been severe in particular the marine and leisure industry and we will continue to monitor these industries and our results. A continued downturn in these industries or our profitability could result in a non-cash impairment charge for goodwill and other intangible assets in the future.

Our $70 million line of credit will expire in June of 2009. Accordingly, the $5 million of borrowings under the line of credit are classified as current debt in the balance sheet. We are finalizing the documentation with JP Morgan Chase and Wells Fargo on a new three-year $50 million line of credit and expect to be completed within a month.

Further, simultaneous with the completion of the line of credit we expect to complete with Prudential Capital Group an increase in our uncommitted shelf loan facility from $25 million to $125 million.

At September 30, 2008 the company was in the process of selling five closed facilities and some vacant land. The estimated fair value of this land and buildings approximates the current book value of $4 million. Three of these facilities with the combined carrying cost of $1.1 million are under contract and scheduled to be sold in the fourth quarter of 2008 for book value.

Effective in the third quarter of 2008, facility dispositions have been reclassified from cost of goods sold to SG&A in the statements of income. Prior periods have been reclassified to conform to this presentation.

Leigh J. Abrams

Now we would be happy to take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Arnie Ursaner – CJS Securities

Arnold Ursaner – CJS Securities

You spoke a little bit in the beginning about how the credit crisis is impacting your business, but I was wondering if you could expound on what it's doing to the dealers and their ability to finance new inventory?

Leigh J. Abrams

It's very, very tough on dealers. Some dealers have gone out of business. It would not surprise me if additional dealers went out of business in the next 90 or 120 days. So, it's having a tough time with dealers but it's also having a tough time with our customers. Even customers with good credit are having trouble getting loans, but we are hoping with all of the infusions by the federal government, that that will now start to ease.

Arnold Ursaner – CJS Securities

Can you also speak generally about what you're seeing in terms of price expectations for acquisitions?

Leigh J. Abrams

Firstly, the acquisition pipeline has been very active but as I indicated before, people have a certain number in their mind and it doesn't really affect them if prices are down. They still want that same number. So, sometimes in a down market it becomes harder to make an acquisition, but these are probably the worse times that I've seen in 20 or 30 years.

Accordingly, there may be a greater appetite for people to sell now or they may be forced to sell, so I think the acquisition pipeline is probably pretty good right now and it's just a question if we can get ourselves what we call a really good deal.

Arnold Ursaner – CJS Securities

Lastly, you've talked in the past about possible growth opportunities in plastics. Can you give an update there?

Leigh J. Abrams

All I can say is we have our bath product line along with a therma-former line and we’ve been very active particularly in the last couple of months in pushing those product lines. And there’s lots of opportunities there that we would hope to seize upon in the next several months.

Operator

Your next question comes from the line of [Scott Semboe] – Sidoti & Co.

[Scott Semboe] – Sidoti & Co.

Can you maybe talk about price increases that went through to cover rising raw material costs? How successful were you getting those through and now with material pricing coming down. How sticky will those prices be coming back down?

Leigh J. Abrams

I’m going to ask Fred to give you a brief statement and then I’m going to ask Jason to fill you in with a little bit more detail.

Frederic Zinn

Yes I think Scott as you saw that in the press release we said that material costs net of the selling price increases cost us $0.68 this quarter and it’s going to get, it will be less than that in the coming quarter. We, during the quarter, we had price increases going into effect during the third quarter. And they will be fully in effect in the fourth quarter. So it will come down from there. We’ll still be suffering a little bit, we still, our raw material costs have come down a little bit, but we still have some higher priced inventory.

Leigh J. Abrams

Jason, do you want to add to that?

Jason Lippert

No not really I mean I think Fred covered it.

[Scott Semboe] – Sidoti & Co.

And if we were to see that these raw materials were to continue to come down, obviously prices would have be adjusted the other way, give backs to your customers?

Frederic Zinn

Yes eventually after inventory of higher priced material runs dry and what remains to be seen on our end is just if the materials will stay where they’ve come down to at present. We’ve got to look more towards a longer-term stability on the price of raw materials before we decide to make a big decision to give an increase or a decrease like that.

Jason Lippert

Yes in some cases you have to watch it daily they go up they go down. They’re still very volatile.

[Scott Semboe] – Sidoti & Co.

So there could be a quarter or two just from the timing of actual benefit in theory?

Leigh J. Abrams

Could be but in today’s market whatever may have been true a few years ago, or a few months ago even is not necessarily true today. Just things are just different and you have to respond on a daily basis to things that are happening.

Frederic Zinn

And I think what Jason was saying Scott is that we still have a couple of months or two months left of the higher priced inventory. So it’s not that we’ll have a benefit; we’re trying to match our costs with our selling prices to the customers.

[Scott Semboe] – Sidoti & Co.

And as far as the five facilities that you plan to close, what’s the mix of MH versus RV?

Jason Lippert

It’s a good question, there’s some of both in there. I would say, I mean if I had to think of it.

Frederic Zinn

Probably 50, 50.

Jason Lippert

Yes I was going to say 40, 60. But it's in that range.

[Scott Semboe] – Sidoti & Co.

And in the press release there was a mention of an order with FEMA for about I think it was $8 million.

Leigh J. Abrams

$5 million.

[Scott Semboe] – Sidoti & Co.

$5 million, maybe just –

Leigh J. Abrams

Jason you want to just fill us in a little on that?

Jason Lippert

What specifically past the numbers do you need to know, or would you like to know?

[Scott Semboe] – Sidoti & Co.

Well just what it involves, what kind of —

Jason Lippert

Oh the FEMA set a bunch of new standards since the debacle with the travel trailers. So they’re homes now, they’re park models and actual manufactured houses, 14 x 50 foot houses and some park models.

[Scott Semboe] – Sidoti & Co.

So it’s just basically the content on those?

Jason Lippert

And past that I don’t have a lot of understanding. I’m assuming that a lot of the units that are built and sitting in the holding lots are not meeting current new FEMA specs. So they’ve got a whole new list of specs for manufacturers to build to and that’s where we’re at.

Frederic Zinn

And just in addition, we’re not guessing that, we’re going to get new volume out of it; we know we’re going to get new volume out of it. We have gotten new volume out of it.

Jason Lippert

We’ve been building FEMA products since about June so it’s just starting to really pick up now through the winter which will really help us out.

Leigh J. Abrams

Yes it was on a much smaller scale and then these new orders just came through.

Operator

The next question comes from the line of Ed Aaron – RBC Capital Markets

Ed Aaron – RBC Capital Markets

Couple of questions for you, so first of all with the five planned closures did you mention the savings number that you expect to get from that?

Frederic Zinn

We have not yet, we’ll we need to still to develop that. It’s clear that we need to close facilities and there will be some reasonably good savings there that we haven’t quantified yet.

Leigh J. Abrams

And if you recall from the past we generally don’t have a lot of closed end costs when we close a facility.

Frederic Zinn

Right there will be very little of that.

Ed Aaron – RBC Capital Markets

And then just thinking about the whole idea of further consolidation, maybe you Jason with you managing the Kinro operations now, how much opportunity is there to maybe integrate the two divisions more than they have in the past to help take more cost of the business and further consolidate?

Jason Lippert

Well we’re evaluating a lot of that right now and with the current industry climate specifically it makes it a little bit tricky. I mean if you looked at a snapshot of today’s volume, you would think that there’s probably a lot more that you could do than what you really should.

So Fred alluded earlier to cutting too deep and our game plan right now is to take a few facilities that makes sense and do some integration and really look hard at the synergies. And there’s been a really good reception to a lot of that as we’ve spent time on it the last five, six weeks. So I feel real good about it; it’s a huge bright spot for us right now.

Leigh J. Abrams

We hope that business will get better. I heard somebody say the other day hope is not a business strategy. So we may hope it gets better, but until it does, we’re going to take whatever steps we can to improve operations.

Ed Aaron – RBC Capital Markets

Makes sense, I know certainly forecasting is tough and I wouldn’t blame you if you didn’t want to talk a lot about 2009, but what sort of, when you look at it, what sort of incremental margin assumptions should we operate on under.

I mean can you envision a scenario where sales are maybe down next year but the margins actually improve, given the combination of cost cutting and hopefully lower commodity prices. And then finally what’s your level of confidence in your ability to be profitable in the fourth quarter?

Leigh J. Abrams

Well I’ll answer the first a little bit first and then I’ll ask Fred to fill you in. But we’ve done a lot of really, really good things in the last year. And unfortunately they just not being shown in the financials because the industry declines are so severe. But we’ve picked up really some very nice market share which certainly will help margins. But we’ve introduced lots of new products and our sales are just being buried in the industry declines.

So once we even start to see a leveling out of sales or even a small pickup, you are going to see some pretty good gains from us. And to get specific in today’s environment if we tried to be specific last October, I don’t know if we could be, because you just don’t know what the effect of just daily declining volume.

With respect to the fourth quarter, I can only say that we don’t normally give estimates. I can tell you that the business environment is as bad as we’ve ever seen it and probably will be even worse in the fourth quarter. It’s no secret that all of our customers are going to be taking a lot of time off on the fourth quarter.

And in addition to that we’ve just had some restructuring; we just had a bunch of retirements so we’ll probably take some one time right offs related to that. Very, very hard to judge what the fourth quarter will be.

Frederic Zinn

I think really Leigh said it all, specific answer to your question and I can envision circumstances where the markets would be down. But we would still be able to improve our margins. As I said we are implementing significant cost cutting and we’ll see some benefits from that and from hopefully lower raw material costs.

But in terms of certainty I have no idea really. It’s impossible to tell, I can tell you that we’ll be pretty good in terms of our performance relative to the markets. But how far the markets go down, I don’t know.

Ed Aaron – RBC Capital Markets

That’s a fair answer and you guys do a nice job all things considered.

Operator

Your next question is from David Wells – Avondale Partners

David Wells – Avondale Partners

Quick question, first off if you look at the inventory number at the quarter end. How much of an impact of that was hirer commodity prices and how much of it was actually due to increases in inventory tangible inventory?

Frederic Zinn

It was part and part, I mean I don’t have the specifics but I’m going to guess it was about half-and-half in that range. And I think as we said we are looking to reduce inventories. We did purchase quite a bit back in July, August timeframe hoping to beat some of the price increases after that, that occurred in August, September. And we’re glad that we did that, but now we have to work through those inventories so we’re not, we will be reducing our inventories in a couple of quarters.

Leigh J. Abrams

Going to be a little bit less specific as we said we don’t normally talk about the future, but at the end of September we had $17million of debt a lot of it being mortgage debt. We had $9 million of cash today our cash is higher than that and we expect it to be rather significantly higher by year-end. So we do fully intend to reduce inventories and to generate a lot of cash between now and year end.

And in today’s environment, cash is king. We’re going to be very, very cautious to make sure that we maintain a very strong balance sheet during this period. And again as Fred said earlier that doesn’t mean that we won’t take risks if they’re really good risks.

David Wells – Avondale Partners

And then secondly as you look at the dealer community with so many dealers going out of business, what push back are you seeing from a pricing perspective from your customers as you try to push through those higher materials prices.

Leigh J. Abrams

Jason, are you able to give any input on that? What’s happening with the deal is that the input with all the inventory coming back from dealers is that affecting pricing in the retail market much?

Jason Lippert

You know the manufacturers will be in a lot better spot to answer that question. But I think that it certainly is, I mean when the inventory gets pushed back to the manufacturers they’re having they’ve obviously got to get rid of it and they’re having to, especially if they’re older units. If they’re older models, they’re having to discount those heavy because dealers want the newest model they don’t want the older models.

So I think a large problem right now, that because the dealers are having problems all over the place, it’s affecting all manufacturers, so it’s an industry problem.

Leigh J. Abrams

If you look at the reports of our customers that have come out; discounting is pretty heavy and of course as dealers go under and their inventory comes back into the chain. That affects production even further.

David Wells – Avondale Partners

And as you look at your customers, are you seeing a circumstance in which balance sheets are really coming into effect in determining your ability to pass along pricing and some people just don’t have the wherewithal to accept that?

Jason Lippert

The passing along on the pricing is already come and gone. Now it’s a matter of just managing in the current environment given the lower volumes. So I would say no.

David Wells – Avondale Partners

And I guess as well if we look at the fourth quarter and end of 2009 from a gross margin perspective what steps can you take to maintain your margins absent passing on pricing increases? Do you feel like there’s some positive to be taken from that?

Leigh J. Abrams

I think we’ve already talked about that and it's we’re actively working on closing factories, actively working on synergies, actively working on every single cost that we have in the company to see how we can cut it or control it. And most important in a down economy is you see what you can do to increase sales. You try to take market share and you try to introduce some products. We made two acquisitions which I think will grow nicely.

So all that helps to spread your fixed costs, so for larger sales base. You try to outperform the industry which I think we’ve done in the past and we’re really pushing very, very hard to do that in the future. And as a lot of our competitors become weaker, customers are turning to us because they know we have the financial strength and they have to assure their ability to get supply.

And I think that’s been happening and we’ve been seeing more and more of that happening. One of our recent competitors went out of business and we picked up some market share there. And we are continuing to pick up market share, particularly from our weaker competitors.

Jason Lippert

And in a lot of cases they’re not even our competitors, they’re people that are suppliers that are building products that we could build. But because some of these guys aren’t solvent anymore we’re picking up equipment and getting into a lot of new products a lot faster than we would have in an environment where business was really good, so new product right now is probably a bigger part of our business than it ever has been. We’re spending a lot of time and energy developing new product to help manufacturers get the products they used to get from people that aren’t around anymore.

Frederic Zinn

David, I get the sense from your question that you think that we’re still going to be significantly hurt by the higher raw material costs. I think once we work through these next few months, we pretty much balanced out the higher costs with the selling price increases. I know it’s not, I’m not sure we’ll be 100% there but we won’t have significant pain from that going forward after the next three months.

David Wells – Avondale Partners

Thanks for the additional color, and then just last question here. It looked like there was some repurchase activity from a share perspective in the quarter and just some additional color on your thoughts behind that?

Leigh J. Abrams

We did some, prices dropped but as business got worse and worse, it’s our view that at this point we probably won’t do additional stock buy backs for a while unless price really just gets ridiculous, which it probably is at this point. You just don’t know in this environment, but as I said, cash is king. We can do everything we can to preserve cash and given the choice of good acquisition that comes along verses stock buy back; we will certainly do the acquisition first.

Operator

Your next question comes from Jamie Wyland – Wyland Management.

Jamie Wyland – Wyland Management

Once again, I want to commend you on your ability to manage the business and the flexibility you have between when things are good and when things are bad to be able to right size things. A couple of questions, you mentioned all the competitors that have gone out. Can you talk a little bit about who they are and how big they were?

Frederic Zinn

A couple were private companies; one was a $35 million company. A couple of the others were divisions of bigger companies where they just closed them down -

Jason Lippert

Or in some cases they are not closing their entire operations; they were getting out of a certain geographic region or deemphasizing certain products.

Leigh J. Abrams

A lot of them have not gone under, are just very weak right now -

Jason Lippert

I think there is probably more opportunity in the future than we have picked up so far, we have got some nice market shares –

Leigh J. Abrams

I really anticipate that November, December, January, maybe even February are going to be really, really tough months and we are going to just see how much staying power a lot of these companies have.

Jamie Wyland – Wyland Management

Bad for them. Good for us. You talked about the new product opportunities, but could you give us a little bit more color on what they are and just beyond what you’re current capabilities are? Are there other industries and other product lines where you currently are not in that you may consider moving into as you have the capacity and financial capabilities?

Leigh J. Abrams

I think Jason can give you some background on new products. I am going to ask him in a minute to give you a little bit more. Just to tell you a quick anecdote, this September we took our Board of Directors up to Goshen, Indiana. We normally hold our board meetings in Texas, but we brought them up to Goshen, Indiana so they could see factories and stuff like that. We went to one of our customer's factories.

I must tell you, we were very, very pleased to see all of the new products that were on the RVs that we were looking at. Most of them were all Drew products which made the board feel very good. With that, Jason if you want to add maybe some color on what kind of products you are adding.

Jason D. Lippert

Some of the newer stuff we are working on, I would rather not talk about right now until we have introduced it. We have got our Louisville national tradeshows coming up in another month and we are introducing several new products there. We have visited probably four different businesses in the last few weeks where it is just opportunities for us to take and build those products within our own four walls.

A lot of the newer stuff that is going to generate some of the higher revenues, I would rather not discuss right now. On our next call we will have – we will be able to give you a lot more insight as to what those products are, and what kind of revenue potential there is and things like that.

Frederic Zinn

We do not want to tell our competitors before we are ready.

Jamie Wyland – Wyland Management

And lastly on the Seating Technology acquisition, obviously all the acquisitions you do you have the ability to extend their network of who they do business with. Have you been able to do that with Seating Technology?

Leigh J. Abrams

The flat answer is yes. We said when we bought it, before we bought it; we expected sales to come down, probably not as much as they have come down, but it has really given us the opportunity to do a lot of prototyping for customers; a lot or re work that we wanted to do there, some synergies that we are looking at saving there too. There is good and bad news with lower volume, and I guess in this case, the bad news is we do not have the sales we thought we were going to have.

And the good news is it is allowing us to do lots of things. Jason and his team have jumped right in there and he has picked up quite a bit of business so far, starting to produce probably within the next couple of months. But it is going to be as good an acquisition as we thought it was going to be, particularly once the industry has recovered. I do not know if you want to add to that, Jason.

Jason D. Lippert

On the seating side, the number of brands that we are selling to, by the time we get to our first twelve months with Seating Tech the number of brands we service will double by then. We are already pretty close, so just to give you an idea of how much the relationship factors have helped bringing some of the Seat Tech products into existing with the relationships that Seating Tech did not have. Now we are doing the same thing with Kenro right now and any of the new products we develop, we are doing – we are running down the same way.

Jamie Wyland – Wyland Management

Lastly, as far as your receivables go, I do not know if you mentioned this before, but how are you managing them? What kind of terms are you now giving to some of the people, and obviously –

Fredric M. Zinn

We have not changed terms. We are being tight on credit. We have had a lot of long-term good customers who we are going to continue to work with. We are working very closely with them. We have taken some bad debts already; it has not been some material number, but it would not surprise me if we take more bad debts in the next six months. But that is a part of doing business, and that is a part of working with your customers.

We have always felt that a good customer deserves some special consideration from you. I should mention also, relate to that, with business being down as much as it is down, our exposure to most of these customers is way down.

Jason Lippert

The weaker customers of course, the receivables are [inaudible].

Operator

The next questions comes from Peter [Usell] – Meadow Capital

Peter [Usell] – Meadow Capital

Leigh and Fred, perhaps you could just – I know this sounds like a good opportunity for acquisitions, but can you help me out with some terms of what your comfort level is on the balance sheet in terms of how much debt you would be willing to put on given this type of environment?

Leigh J. Abrams

If you asked us a year ago, I would have said two to two and a quarter times EBITDA would be maximum tolerance. I do not know if I would have that kind of tolerance in today’s marketplace, where you just do not know how long this is going to last. Probably the only thing that I am certain of is that it will recover. We have been through many cycles in the past. Many of the younger analysts just have not seen anything like this, but we have seen it before.

Even when things are just as bleak as you can see them, everybody says the world is coming to an end, it is not coming to an end; it will turn around. Whether it turns around early '09 or late '09 or early 2010, it will turn around. We are optimistic that it is going to turn. Accordingly we would leverage the balance sheet for a good deal at an exceptional multiple. I do not think we would go to the two to two and a quarter times EBITDA that we would have gone last year.

Jason Lippert

Again, I would add from an acquisition standpoint, I mean where there is enough troubled businesses out there right now where there is a lot of good deals on equipment and customer lists where you are paying almost less than asset value just to get into some new products. I think those kinds of deals are a lot more likely to happen over the next several months as more and more troubled businesses surface for us to get into new product.

Leigh J. Abrams

So you may not hear of an acquisition, because we simply may buy some equipment, but we suddenly may be in the new product line.

Peter [Usell] – Meadow Capital

It would seem that buying these distressed assets would be the most – the highest return today for you guys.

Jason Lippert

Definitely the most effective.

Peter [Usell] – Meadow Capital

You are doing a great job, and keep up the good work under these difficult periods.

Leigh J. Abrams

As I said, we have never seen anything like this.

Operator

You have no further questions at this time.

Leigh J. Abrams

Once again, I would like to thank everybody for tuning in and would like to wish everybody a happy holiday season and a happy new year and hopefully, when we talk to you for the year end it will be more joyous than today. With that, thanks again.

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Source: Drew Industries Inc. Q3 2008 Earnings Call Transcript
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