Drew Industries Incorporated (LCI Industries) — Q3 2011 Form 10-Q
Period and business: Unaudited quarter and nine months ended September 30, 2011; comparisons are with the same 2010 periods. Drew manufactured components for recreational vehicles (RV) and manufactured housing (MH), with RV products generating 84% of nine-month sales. The filing is by Drew Industries Incorporated.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net sales | $166.7 million | $146.8 million | $521.6 million | $466.6 million |
| Gross profit | $32.0 million | $31.9 million | $111.9 million | $103.1 million |
| Operating profit | $9.2 million | $12.7 million | $42.7 million | $40.8 million |
| Net income | $5.6 million | $8.0 million | $26.0 million | $24.9 million |
| Diluted EPS | $0.25 | $0.36 | $1.16 | $1.12 |
| Operating cash flow | Not stated quarterly | Not stated quarterly | $16.3 million | $20.4 million |
- Q3 sales rose 14%, but net income fell 30%. Gross margin was approximately 19.2% versus 21.7%; operating margin was 5.5% versus 8.6%. Nine-month sales increased about 12% and net income about 4%.
- Q3 RV segment sales increased 12% to $136.2 million, while segment operating profit fell to $7.7 million from $11.1 million. MH sales increased 23% to $30.5 million and segment operating profit rose to $3.8 million from $2.9 million.
- At September 30, cash was $1.5 million, with no short-term investments, versus cash and short-term investments totaling $43.9 million at year-end 2010. Current assets were $160.3 million and current liabilities $69.5 million. Total assets were $371.4 million; total liabilities $97.6 million; stockholders’ equity $273.8 million.
- Debt was $8.1 million at a weighted-average 2.5% rate; no debt was outstanding at December 31, 2010. The company had $38.3 million available under its $50 million revolving line, after borrowings and letters of credit. Combined stated availability under the line and shelf-loan facility was $176.5 million, subject to covenants; Prudential is not obligated to purchase shelf notes.
- Nine-month investing cash use was $61.3 million, including $49.3 million for acquisitions and $17.7 million of capital expenditures. Cash declined $37.4 million during the period. Receivables and inventory absorbed cash; management reported 23 days sales outstanding and inventory turnover of 6.0 times, down from 6.5 times for 2010.
Material changes and management commentary
- Four 2011 acquisitions cost $49.3 million in aggregate and added businesses with more than $75 million in combined annual sales. The three third-quarter acquisitions contributed about $9 million of Q3 sales. Goodwill rose to $20.1 million from $7.5 million at year-end.
- Q3 profit was pressured by elevated steel and aluminum costs, which reduced net income by about $1 million; unusually high costs in one product line, another roughly $1 million net-income impact; and $0.6 million of acquisition, aluminum-extrusion start-up, and new-product costs. The prior-year quarter also benefited from a $0.6 million after-tax earn-out gain that did not recur.
- Management said steel costs had begun declining in June and aluminum had more recently declined, and expected lower-cost materials to ease the impact in coming months. It expected further, but lower, start-up and integration costs in Q4. Corrective steps were taken on elevated production costs in one product line.
- The company began production on its first aluminum-extrusion press in early October and expected lower aluminum costs beginning in early 2012; two more presses were planned. October 2011 sales were reported at $62 million, up more than 55% year over year; excluding acquisitions and price increases, management reported growth above 30%.
- Management remained optimistic about RV growth in 2012 and beyond, citing product content, market-share gains, acquisitions, and customer service. It expected manufactured-home shipments to remain low until economic, housing, and credit conditions improved. Industry risks include consumer demand and confidence, dealer inventories, customer financing, and volatile commodity prices.
- Stated estimates: 2011 capital expenditures of about $25 million and 2012 of $14–16 million; depreciation and amortization of about $20 million for 2011 and $22 million for 2012; 2011 effective tax rate of 38.5–39%, with 2012 expected at 38–38.5%.
Risks, contingencies, and unusual items
- Estimated contingent earn-out liability was $13.5 million at September 30, including $3.2 million current. Revaluations depend on product sales forecasts and discount-rate assumptions; nine-month earn-out-related expense was approximately $1.0 million.
- The company had an aluminum derivative covering 3 million pounds, about 10% of anticipated 2012 purchases. It was not designated for hedge accounting; fair-value changes are recorded in cost of sales. A 100-basis-point rise in variable borrowing rates was estimated to reduce annual cash flow by less than $0.1 million.
- Management reported compliance with debt covenants and expected continued compliance over the next twelve months. It also stated available facilities were adequate for anticipated working-capital and capital-expenditure needs.
- A previously disclosed legal proceeding was on appeal, with a decision pending. Management said other claims were not expected to materially affect financial position or annual results beyond recorded provisions, while noting outcomes are uncertain. The filing also identifies potential environmental liabilities and impairment risk for marine-related intangible assets if market conditions deteriorate.
- Management identified acquisition-integration risks, including failure to achieve expected efficiencies, customer or key-employee losses, and diversion of management attention. No goodwill or other intangible impairment tests were required or performed during the first nine months of 2011.
Investor verification priorities
- Assess whether sales growth and October momentum persist, separating acquisition, pricing, market-share, and underlying industry-volume effects.
- Track gross and operating margins, commodity-cost pass-through, production-cost remediation, and remaining integration/start-up costs.
- Monitor working-capital conversion, especially inventory levels and the sharp reduction in cash, alongside acquisition and capital-spending requirements.
- Review earn-out assumptions and payments, debt availability and covenant headroom, and the non-designated aluminum derivative’s reported effects.
- Check subsequent updates on acquisition performance, the pending appeal, environmental exposures, and any impairment indicators.