Trex Company, Inc. 2013 Form 10-K Summary
Business context and reporting period
Trex manufactures and sells wood-alternative decking, railing, porch, fencing, trim and related outdoor-living products, primarily using reclaimed wood fiber and polyethylene. The filing covers the fiscal year ended December 31, 2013, including fourth-quarter results. The company operates in one business segment and sells primarily through wholesale distributors, retail lumber dealers, Home Depot and Lowe’s. One distributor represented more than 10% of 2013 net sales, and one customer represented approximately 28% of net sales.
Financial performance and liquidity
| Metric | 2013 | 2012 | Change or context |
|---|---|---|---|
| Net sales | $342.5 million | $307.4 million | Increased 11.4%; volume rose approximately 8% and average price per unit rose approximately 3% |
| Gross profit | $98.6 million | $84.6 million | Gross margin increased to 28.8% from 27.5% |
| Income from operations | $24.7 million | $12.7 million | Operating margin increased to 7.2% from 4.1% |
| Net income | $34.6 million | $2.7 million | Net margin increased to 10.1% from 0.9% |
| Diluted EPS | $2.02 | $0.16 | 2013 benefited from a significant tax valuation allowance reversal |
| Cash flow from operations | $45.2 million | $60.4 million | Declined primarily because of higher receivables and inventory |
| Capital expenditures | $13.1 million | $7.6 million | Focused on new products, productivity and manufacturing efficiencies |
| EBITDA | $40.6 million | $29.1 million | Non-GAAP measure disclosed by management |
| Cash and equivalents | $3.8 million | $2.2 million | Year-end cash increased by $1.6 million |
| Total debt | None | $5.0 million | Approximately $71.9 million of borrowing capacity remained available at year-end |
| Working capital | $29.0 million | $10.2 million | Improved year over year |
Fourth-quarter 2013 net sales were $63.8 million, up approximately 38% from $46.2 million in the fourth quarter of 2012. Fourth-quarter gross profit was $19.7 million versus $13.4 million, and net income was $15.1 million versus a $3.6 million net loss. Fourth-quarter net income included a $10.9 million income tax benefit related to the reversal of a valuation allowance.
Accounts receivable increased to $37.3 million from $26.5 million, and inventory increased to $22.4 million from $17.5 million, partly reflecting early-buy shipments, distribution-network additions and preparation for next-generation products. Management expected substantially all year-end receivables to be collected by May 2014.
Material changes versus the prior comparable period
- Sales growth was driven primarily by higher volume, distribution-network expansion, new product introductions and revised pricing. Product mix, including increased railing attachment, supported the average price increase.
- Underlying gross profit, excluding warranty and other identified charges, increased to approximately $120.1 million from $106.1 million. Underlying gross margin was approximately 34.9%, compared with 34.5% in 2012 as presented by management, and benefited from higher capacity utilization and manufacturing efficiencies.
- Interest expense declined to $0.6 million from $8.9 million after repayment of the $91.9 million convertible notes in July 2012.
- The company recorded a $20.0 million increase to its warranty reserve in 2013, compared with a $21.5 million increase in 2012. The reserve for surface-flaking claims ended 2013 at $40.8 million, after $8.2 million of settlements.
- The company reduced its deferred-tax valuation allowance by $19.9 million, including a $10.9 million benefit directly attributable to exiting the full valuation allowance. The remaining valuation allowance was $4.2 million.
- Trex repurchased 561,255 shares for $25.0 million at an average price of $44.54 per share. No cash dividends have been paid or are planned in the foreseeable future.
- Trex discontinued manufacture of Trex Accents decking and Designer Series Railing on December 31, 2013. Management did not expect a material effect on results or cash flow.
Guidance, outlook, commentary and risks
Management estimated 2014 capital expenditures of approximately $15 million and expected to fund operations, capital expenditures, warranty obligations and seasonal working-capital needs through operating cash flow and the revolving credit facility. The credit facility was temporarily increased from $100 million to $125 million for January 1 through June 30, 2014. The filing does not provide a specific 2014 revenue or earnings forecast.
Management expected continued growth from new products, brand development, additional distribution, manufacturing efficiencies and cost reductions. The company also expected seasonal borrowing to support working capital during the deck-building season.
- Warranty exposure: Claims related to pre-2007 Nevada production remained a major uncertainty. A 10% change in expected remaining claims or average settlement cost could change the warranty reserve by approximately $4.1 million. Additional reserve increases could reduce earnings and operating cash flow.
- Product litigation: A nationwide mold, fading and color-variation settlement received final approval in December 2013. The company accrued $3.2 million and expected the total net cost to resolve the matter not to exceed approximately $10 million, although excess costs were reasonably possible.
- Customer and channel concentration: The 15 largest customers accounted for approximately 89% of 2013 gross sales. Distributor inventory levels are difficult to monitor and could affect subsequent-period sales.
- Seasonality and weather: Demand is concentrated in the late first through third quarters and is sensitive to weather, housing activity, remodeling spending, interest rates and consumer finances.
- Raw materials and competition: Results depend on the availability and cost of reclaimed polyethylene and waste wood fiber. Trex competes with pressure-treated wood, other composite products and alternative railing materials.
- Liquidity and covenants: Although debt-free at year-end and compliant with its covenants, the company expected it might borrow during 2014. Borrowing availability is subject to a collateral-based borrowing base and financial covenants.
- Other obligations: Contractual cash obligations totaled $79.9 million, including $35.6 million of purchase commitments and $44.3 million of operating lease commitments.
Most important facts for investors to verify
- Whether warranty claims and average settlement costs decline as management expects, and whether the $40.8 million warranty reserve is adequate.
- Whether 2013 earnings are being evaluated separately from the $19.9 million deferred-tax valuation allowance benefit and the $20.0 million warranty charge.
- Whether sales growth reflects sustained end-user demand rather than early-buy shipments or inventory accumulation in the distribution channel.
- Actual 2014 borrowing needs, borrowing-base availability, covenant compliance and the January 2015 credit-facility maturity.
- Progress and costs associated with the nationwide product-quality settlement and other pending product claims.
- Execution of next-generation product launches, discontinued-product transitions and the planned approximately $15 million of 2014 capital expenditures.