Trex Company, Inc. — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2012. Trex manufactures wood-alternative decking, railing, fencing, outdoor trim, lighting and related products, primarily under the Trex brand. The company operates in one business segment.
Financial performance and position
| Metric | Three months ended September 30 | Nine months ended September 30 |
|---|---|---|
| Net sales | $70.8 million, versus $67.9 million | $261.2 million, versus $215.3 million |
| Gross profit | $2.1 million, versus $17.3 million | $71.2 million, versus $63.8 million |
| Gross margin | 3.0%, versus 25.4% | 27.2%, versus 29.6% |
| Operating income (loss) | $(13.7) million, versus $4.3 million | $15.9 million, versus $16.8 million |
| Net income (loss) | $(14.3) million, or $(0.86) diluted per share | $6.3 million, or $0.37 diluted per share |
| Net cash from operating activities | Not separately provided | $60.4 million, versus $41.2 million |
Excluding the third-quarter warranty-reserve increase, management reported third-quarter net income of approximately $6.2 million, or $0.36 per diluted share, and a 31.3% gross margin. Excluding the warranty charge, nine-month gross profit was $92.6 million and gross margin was 35.5%.
- Cash and cash equivalents were $2.5 million at September 30, 2012, compared with $4.5 million at December 31, 2011.
- Accounts receivable were $32.8 million and inventories were $8.6 million, compared with $29.2 million and $28.9 million, respectively, at year-end 2011.
- Total assets were $164.4 million and total liabilities were $66.2 million at September 30, 2012.
- Capital expenditures were $5.6 million for the first nine months. Management estimated full-year 2012 capital expenditures of approximately $10 million to $15 million.
Debt, liquidity and cash flow
- The company repaid the $91.9 million principal balance of its convertible notes on July 2, 2012 and issued 1,061,745 common shares pursuant to the notes’ conversion feature.
- At September 30, 2012, outstanding debt was $2.0 million under a revolving credit facility, with approximately $59.3 million of additional borrowing capacity. The annualized weighted-average interest rate was 2.2%.
- Financing activities used $56.8 million during the first nine months, including $91.9 million of mortgage and note repayments, partially offset by net revolving-credit borrowings of $2.0 million.
- Operating cash flow benefited from a $20.3 million reduction in inventories. The company expects to collect substantially all outstanding receivables by year-end.
- 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. The company was in compliance with its debt covenants at September 30, 2012.
Material changes versus the prior comparable period
- Third-quarter sales increased 4.3%, primarily from higher volume attributed to new products, market-share gains and growth initiatives.
- Nine-month sales increased 21.3%, reflecting favorable weather, increased market share and depressed prior-year comparisons following customer purchases ahead of a 2011 Transcend price increase.
- Reported third-quarter gross profit fell sharply because of a $20.0 million increase in the warranty reserve. Excluding that charge, gross profit increased 28.2% and gross margin improved to 31.3% from 25.4%.
- Reported nine-month gross profit increased 11.5%, but the nine-month results included a $21.5 million warranty provision. Excluding that provision, gross profit increased 45.1%.
- Third-quarter SG&A increased 21.9% to $15.8 million, driven mainly by higher incentive compensation and sales commissions, plus a $1.9 million loss on obsolete manufacturing equipment. A $1.4 million reduction in estimated Iron Deck contingent payments partially offset these costs.
- Interest expense declined to $0.2 million in the third quarter and $8.9 million for the nine-month period, reflecting the substantial reduction in debt.
Guidance, outlook, risks and unusual items
- The company did not provide a clear revenue or earnings forecast in the filing. It estimated 2012 capital expenditures of approximately $10 million to $15 million.
- The most significant unusual item was the $20.0 million third-quarter increase in the warranty reserve for surface-flaking claims related to material produced at the Nevada facility before 2007. The reserve balance was $31.6 million at September 30, 2012, compared with $8.5 million a year earlier.
- Warranty estimates depend on future claim volumes and settlement costs. A 10% change in expected remaining claims or settlement cost could change the reserve by approximately $3.2 million. Additional reserve increases could reduce future earnings, liquidity and operating cash flow.
- The company provides long-term product warranties, including coverage extending up to 25 years for certain residential products. It continues to face purported class actions alleging product defects and mold-related misrepresentations and believes the claims are without merit.
- Seasonality typically reduces fourth-quarter sales because of holidays and adverse weather. The company also noted risks from economic conditions, raw-material prices, product quality, new-product acceptance, competition and distributor inventory levels.
- The company has a lease obligation for previously planned headquarters space through June 2019. It subleases the space, but unfavorable renewal timing or rental rates could result in additional contract-termination charges.
- Interim LIFO inventory valuations are based on estimates and remain subject to final year-end valuation.
Investor verification items
- Reconcile reported third-quarter net loss of $14.3 million with management’s adjusted net income of approximately $6.2 million excluding the warranty-reserve increase.
- Review the assumptions supporting the $31.6 million warranty reserve, including claim-volume trends, settlement costs and potential additional provisions.
- Confirm borrowing-base availability and covenant compliance under the revolving credit facility, particularly given the company’s low cash balance.
- Assess whether sales growth reflects sustained end-user demand or changes in distributor inventory and early-buy-program activity.
- Monitor the cash impact of warranty settlements, remaining lease obligations, capital expenditures and potential litigation outcomes.