Trex Company, Inc. — Fiscal 2011 Form 10-K Summary
Business context and reporting period
Trex is a leading manufacturer of wood-alternative decking and railing products made primarily from waste wood fiber and reclaimed polyethylene. Its product portfolio also includes porch, fencing, trim, deck framing, lighting and related accessories. The filing covers the fiscal year ended December 31, 2011, including fourth-quarter results. The company operates as one business segment and sells primarily through wholesale distributors, retail lumber dealers, Home Depot and Lowe’s.
During 2011, Trex introduced Enhance decking, Transcend Porch Flooring and Railing, DeckLighting and Trex Elevations, following its acquisition of substantially all Iron Deck Corporation assets for approximately $2.0 million in cash plus assumed liabilities.
Key financial metrics
| Metric | 2011 | 2010 | Change or margin |
|---|---|---|---|
| Net sales | $266.8 million | $317.7 million | Down 16.0% |
| Gross profit | $62.8 million | $72.8 million | Gross margin 23.5% vs. 22.9% |
| Income from operations | $2.2 million | $5.1 million | Operating margin 0.8% vs. 1.6% |
| Net loss | $11.6 million | $10.1 million | Loss per share: $0.75 vs. $0.66 |
| EBITDA | $20.6 million | $24.7 million | Non-GAAP; down 16.5% |
| Cash flow from operations | $33.8 million | $19.0 million | Improved $14.9 million |
| Capital expenditures | $7.4 million | $10.0 million | Primarily process and productivity improvements |
| Cash and restricted cash | $41.5 million | $27.3 million | Includes $37.0 million restricted |
| Total debt, excluding unamortized discount | $91.9 million | $100.0 million | Reduced by approximately $8.1 million on a net basis |
| Stockholders’ equity | $92.5 million | $102.9 million | Down $10.4 million |
Sales volume declined 22%, partly offset by an 8% increase in average price per unit from the Transcend price increase and a higher-priced product mix. Underlying gross margin, excluding specified warranty and 2010 supply-contract charges, was 27.3% in 2011 versus 28.9% in 2010.
Fourth-quarter 2011 net sales were $51.5 million, compared with $75.3 million in the fourth quarter of 2010. Fourth-quarter gross profit was a loss of $1.1 million versus gross profit of $18.6 million in the prior-year quarter, and fourth-quarter net loss was $18.3 million versus a net loss of $0.5 million. Fourth-quarter results included a $10.0 million pre-tax increase to the warranty reserve.
Material changes versus the prior comparable period
- Net sales declined because of poor weather during the deck-building season, weaker consumer spending and the shift of Transcend purchases into late 2010 ahead of a 2011 price increase.
- Gross margin improved on a reported basis because 2010 included $15.0 million of additional warranty expense and $3.9 million of minimum-purchase penalties. However, excluding those items, 2011 underlying gross margin declined due to lower capacity utilization and sales-related factors.
- Selling, general and administrative expense decreased 10.6% to $60.6 million, although it increased as a percentage of sales to 22.7% from 21.3%.
- Operating cash flow increased primarily because accounts receivable declined by $23.9 million after customers collected balances associated with 2010 pre-price-increase purchases.
- Trex repurchased approximately $5.6 million principal amount of convertible notes, extinguished a $2.5 million real estate note and had no borrowings under its revolving credit facility during 2011.
- The company recorded a $10.0 million increase to its warranty reserve, compared with a $15.0 million increase in 2010. Warranty cash settlements were approximately $8.1 million in 2011, down from $12.0 million in 2010.
Liquidity, debt and outlook
At December 31, 2011, cash and cash equivalents were $4.5 million and restricted cash was $37.0 million. The restricted balance was established primarily to support repayment of the company’s convertible notes due July 1, 2012. Working capital was negative $18.6 million because the $86.4 million carrying amount of the convertible notes was classified as current.
On January 6, 2012, Trex entered into a new asset-based revolving credit facility with maximum commitments of $100 million, subject to borrowing-base limitations. Based on December 31, 2011 balances, the borrowing base was approximately $72.5 million. The facility matures January 9, 2015, subject to potential extension at the lenders’ discretion.
The new credit agreement requires minimum consolidated net worth of $85 million, a fixed-charge coverage ratio of at least 1.15 to 1.0 and a consolidated debt-to-EBITDA ratio no greater than 4.25 to 1.0 before the convertible notes are retired. It also requires substantial cash deposits and limits additional borrowings until the notes are repaid. Management stated that cash on hand, operating cash flow and expected revolver availability should fund planned capital expenditures, debt service, warranty obligations and other requirements for at least the next twelve months.
Management estimated 2012 capital expenditures of approximately $10 million to $15 million, primarily for process and productivity improvements and systems upgrades. The filing does not provide formal revenue or earnings guidance.
Risks, contingencies and unusual items
- Warranty exposure: Products manufactured at the Fernley, Nevada facility before 2007 remain subject to surface-flaking claims. The warranty reserve ended 2011 at $16.3 million. Management estimated that a 10% change in expected remaining claims or settlement costs could change the reserve by approximately $1.6 million.
- Product litigation: Trex is defending multiple purported class actions alleging product defects and mold-related misrepresentations. Management believes the claims lack merit, but the filing does not provide a clear estimate of potential exposure.
- Debt refinancing and maturity: The $91.9 million principal amount of convertible notes was scheduled to mature in 2012. Covenant compliance, required restricted deposits and the ability to generate seasonal cash flow were important liquidity considerations.
- Customer concentration: One customer represented approximately 24% of 2011 net sales. Sales through the 15 largest customers represented approximately 89% of gross sales.
- Market and seasonal risk: Demand depends heavily on home improvement, remodeling, consumer confidence, weather and housing conditions. Fourth-quarter sales are historically lower because of holidays and adverse weather.
- Raw materials and capacity: Trex depends on adequate supplies of reclaimed polyethylene and waste wood fiber. Manufacturing capacity utilization was only 30% in 2011, excluding the idle Olive Branch facility.
- Tax items: The company recorded a $2.6 million tax benefit from resolving uncertain tax positions and maintained a $24.2 million valuation allowance against deferred tax assets.
- Other obligations: Contractual cash obligations totaled approximately $158.5 million, including $91.9 million of debt, $28.4 million of purchase commitments and $32.7 million of operating leases.
Most important facts for an investor to verify
- Whether the company repaid or refinanced the $91.9 million convertible notes due in 2012 without impairing operating liquidity.
- Actual subsequent warranty claims, cash settlements and any further reserve increases related to pre-2007 Fernley production.
- The status and potential financial impact of the mold-related class actions and other product-liability claims.
- Whether sales volume and end-market demand recovered after the 2011 weather and consumer-spending weakness.
- Compliance with the new credit agreement’s net-worth, fixed-charge coverage, leverage and cash-deposit requirements.
- Whether 2012 capital expenditures remained within the estimated $10 million to $15 million range and generated the expected productivity benefits.
- The degree of customer and distributor concentration, including inventory levels in the two-step distribution channel.