Trex Company, Inc. — Form 10-Q Summary
Reporting period: Quarterly and nine-month periods ended September 30, 2013, compared with the corresponding 2012 periods. Trex manufactures wood-alternative decking, railing, and related outdoor-living products and operates as one business segment. The filing is unaudited.
Financial Performance and Position
| Metric | Three Months 2013 | Three Months 2012 | Nine Months 2013 | Nine Months 2012 |
|---|---|---|---|---|
| Net sales | $72.2 million | $70.8 million | $278.7 million | $261.2 million |
| Gross profit | $0.2 million | $2.1 million | $78.9 million | $71.2 million |
| Gross margin | 0.2% | 3.0% | 28.3% | 27.2% |
| Operating income (loss) | $(15.2) million | $(13.7) million | $20.3 million | $15.9 million |
| Net income (loss) | $(15.3) million | $(14.3) million | $19.5 million | $6.3 million |
| Diluted EPS | $(0.91) | $(0.86) | $1.13 | $0.37 |
| Operating cash flow | Not provided for the quarter | Not provided for the quarter | $53.7 million | $60.4 million |
- Liquidity: Cash and cash equivalents were $19.6 million at September 30, 2013, versus $2.2 million at December 31, 2012. Total current assets were $61.4 million and current liabilities were $38.7 million.
- Debt: The company had no outstanding indebtedness at September 30, 2013. Its revolving facility had a $100 million maximum commitment and approximately $54.4 million of available borrowing capacity. The company was in compliance with its debt covenants.
- Cash flow and capital spending: Nine-month operating cash flow was $53.7 million; investing cash flow was $(8.7) million, including $9.0 million of capital expenditures; financing cash flow was $(27.5) million, including $25.0 million of share repurchases.
- Margins: Nine-month reported gross margin improved to 28.3% from 27.2%. Excluding specified warranty, pricing, and market-share-related charges, management reported underlying gross margin of 35.9% versus 35.5%.
Material Changes Versus the Prior Comparable Period
- Third-quarter sales increased 2.0%, while nine-month sales increased 6.7%. Nine-month volume increased 2.9% and average price per unit increased 4.4%; third-quarter volume declined 5.4%, partly offset by a 10.5% increase in average price per unit.
- Third-quarter gross profit declined 93.0% because of a $20.0 million increase in the surface-flaking warranty reserve and a $1.8 million charge related to market-share expansion and pricing resets. Excluding these charges in both periods, gross profit was approximately $22.0 million versus $22.1 million.
- Nine-month net income increased to $19.5 million from $6.3 million, substantially aided by the reduction in interest expense to $0.5 million from $8.9 million. The prior-year interest expense included debt associated with convertible notes that were repaid in July 2012.
- Selling, general and administrative expense increased 6.0% for the nine-month period to $58.6 million, driven by mold litigation costs, branding for new product launches, and corporate lease termination costs.
- The company repurchased 561,255 shares for $25.0 million during the third quarter, completing the August 2013 authorization. On October 24, 2013, the board authorized an additional repurchase program of up to $30 million through February 10, 2014.
- Inventories declined to $11.2 million from $17.5 million at December 31, 2012; accounts receivable declined to $24.0 million from $26.5 million.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
- Capital expenditures: Management estimated 2013 capital expenditures of approximately $10 million to $15 million; $9.0 million had been spent through September 30.
- Funding outlook: Management expected cash on hand, operating cash flow, and available revolver capacity to fund planned capital expenditures, warranty payments, and other cash requirements.
- Warranty exposure: The warranty reserve increased by $20.0 million during the third quarter for claims involving pre-2007 material produced at the Nevada facility. The ending warranty reserve was $43.0 million, compared with $31.6 million at September 30, 2012. A 10% change in expected remaining claims or settlement cost could change the reserve by approximately $4.3 million.
- Surface-flaking claims received during the first nine months declined to 3,639 from 3,968, but third-quarter claims increased year over year after homeowner communications and litigation-related publicity. Unresolved claims increased to 4,704 from 4,617, and average cost per resolved claim increased to $2,255 from $2,035.
- Litigation: A nationwide mold-related class-action settlement received preliminary approval in August 2013, with final approval scheduled for December 13, 2013. The settlement cost was capped at $8.25 million plus $1.45 million of attorneys’ fees, and the company had accrued $3.3 million at September 30. Management expected total net resolution costs not to exceed approximately $10 million, but final approval was not assured.
- Product transition: Trex announced that it would discontinue manufacture of Trex Accents by December 31, 2013. Management did not expect a material impact on results or cash flow, although the change increased estimated warranty replacement costs.
- Lease contingency: A subtenant default and an expired sublease increased the liability for the company’s unused corporate headquarters lease by $1.1 million during the quarter. The lease-related liability was $1.9 million at September 30, 2013, and future charges could increase if sublease assumptions deteriorate.
- Tax matters: The effective tax rate was 1.5% for the nine-month period, reflecting a valuation allowance against deferred tax assets. A future reduction of that allowance could materially affect the tax rate. The company recognized approximately $2.6 million of deferred tax assets related to excess tax benefits from stock compensation during the third quarter.
- Key ongoing risks include seasonal demand and adverse weather, economic conditions, raw-material costs and availability, product quality, warranty and replacement costs, litigation, distribution-channel inventory levels, competition, and acceptance of new products.
Investor Verification Checklist
- Verify final court approval and ultimate cash cost of the nationwide mold-related settlement.
- Monitor surface-flaking claims, unresolved claims, average settlement cost, and future warranty-reserve revisions.
- Assess whether third-quarter volume weakness was temporary or reflects broader market-share or macroeconomic pressure.
- Reconcile reported gross margin with underlying margin by separately evaluating warranty, pricing-reset, market-share, and LIFO-related items.
- Review the effect of discontinuing Trex Accents on product mix, replacement-material costs, and future warranty claims.
- Confirm completion and terms of the additional $30 million share-repurchase authorization announced after quarter end.
- Evaluate the sustainability of cash generation after warranty payments, capital expenditures, repurchases, and potential litigation payments.