Trex Company, Inc. — Q1 2013 Form 10-Q Summary
Business Context and Reporting Period
Trex is a single-segment manufacturer of wood-alternative decking and railing products marketed under the Trex brand. This unaudited quarterly report covers the three months ended March 31, 2013, compared with the three months ended March 31, 2012.
Financial Performance and Position
| Metric | Q1 2013 | Q1 2012 | Change |
|---|---|---|---|
| Net sales | $107.9 million | $96.1 million | 12.3% increase |
| Gross profit | $41.9 million | $35.4 million | 18.2% increase |
| Gross margin | 38.8% | 36.9% | 190 basis-point increase |
| Income from operations | $22.0 million | $16.8 million | 30.9% increase |
| Net income | $21.6 million | $12.3 million | 75.2% increase |
| Diluted EPS | $1.25 | $0.74 | Increase |
| Net cash used in operating activities | $66.0 million | $45.4 million | Higher use of cash |
SG&A increased 6.7% to $19.8 million, but declined to 18.4% of sales from 19.4%. Net interest expense fell to $0.3 million from $4.4 million following repayment of the $91.9 million, 6.0% convertible notes in July 2012. The effective tax rate was 0.9%, reflecting the valuation allowance against net deferred tax assets.
Cash and cash equivalents were $1.9 million at March 31, 2013, compared with $2.2 million at December 31, 2012. Accounts receivable increased to $117.4 million, primarily because distributors purchased inventory ahead of the seasonal deck-building period. Management expected substantially all outstanding receivables to be collected by the end of May 2013.
Operating cash use was driven principally by a $90.8 million increase in accounts receivable. Investing cash use was $1.8 million, including $1.9 million of capital expenditures. Financing activities provided $67.5 million, including $67.0 million of revolving-credit borrowings.
At March 31, 2013, total liabilities were $136.7 million and stockholders’ equity was $117.0 million. The company had $72.0 million outstanding under its revolving credit facility, approximately $51 million of additional borrowing capacity, and an annualized weighted-average interest rate of 2.0% on the debt.
Material Changes Versus the Prior Comparable Period
- Sales growth was attributed primarily to higher volume, including the introduction of Select railing, Reveal aluminum railing, and Select opening-price-point deck boards.
- Gross margin benefited from increased capacity utilization and sales-related factors. The comparison was partially affected by a $0.9 million LIFO benefit recognized in Q1 2012 but not in Q1 2013.
- SG&A increased due mainly to higher personnel-related expenses and branding costs.
- Interest expense declined substantially after repayment of the convertible notes.
- Operating cash flow deteriorated because of seasonal accounts-receivable growth, lower inventory-related cash benefits than in 2012, and payments of prior-year incentive compensation.
- The company amended its revolving facility on February 26, 2013, increasing maximum commitments from $100 million to $125 million through June 30, 2013 and reducing certain interest margins and costs.
Outlook, Risks, Contingencies, and Unusual Items
- Management estimated 2013 capital expenditures of approximately $10 million to $15 million, primarily for manufacturing equipment and productivity improvements.
- Seasonal working-capital borrowings were expected to be substantially repaid as receivables were collected during the following quarter.
- Management stated that cash on hand, operating cash flow, and expected revolver availability should fund planned capital expenditures, debt service, warranty payments, and other cash needs.
- Distributor inventories were believed to be slightly higher than the prior-year level because weather slowed the start of the 2013 deck-building season. The company cannot definitively determine channel inventory levels.
- The company maintained approximately $27.3 million of warranty reserves at March 31, 2013 for claims involving pre-2007 Nevada production with surface flaking. A 10% change in expected remaining claims or settlement costs could change the reserve by approximately $2.7 million.
- Product-related purported class actions concerning alleged mold defects remained pending. The company had accrued $1.7 million and stated that total net resolution costs were not expected to exceed $10 million, although costs could exceed recorded amounts.
- The company recorded a $1.0 million liability related to a previously planned but abandoned headquarters relocation. Future charges could increase if sublease timing or rental rates are less favorable than estimated.
- Key risks include seasonal demand and weather, economic conditions, distributor inventory levels, raw-material pricing and availability, product quality and warranty costs, market acceptance of new products, and competitive pressures.
Important Facts for Investors to Verify
- Whether the large seasonal accounts-receivable balance was collected as expected by the end of May 2013 and whether revolver borrowings were substantially repaid.
- The terms, borrowing-base availability, maturity, and covenant requirements of the amended $125 million revolving credit facility after June 30, 2013.
- Trends in pre-2007 surface-flaking warranty claims and whether the $27.3 million reserve remains adequate.
- Progress and ultimate cost of the pending mold-related litigation relative to the $1.7 million accrued liability and $10 million estimated maximum net cost.
- Actual 2013 capital expenditures compared with the $10 million to $15 million estimate.
- Distributor and dealer inventory levels, weather-related demand, and the sustainability of Q1 volume and gross-margin improvements.
- The effect of the valuation allowance and available tax attributes on future cash taxes and reported effective tax rates.