Trex Company, Inc. — 2011 Q2 Form 10-Q Summary
Business context and reporting period
Trex manufactures wood-alternative decking, railing, fencing, outdoor trim and related products under the Trex brand. The company operates in one business segment. This report covers the three and six months ended June 30, 2011, compared with the corresponding 2010 periods.
Financial performance and condition
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net sales | $78.4 million | $115.5 million | $147.4 million | $181.8 million |
| Gross profit | $23.5 million | $29.9 million | $46.6 million | $45.1 million |
| Gross margin | 30.0% | 25.9% | 31.6% | 24.8% |
| Income from operations | $6.2 million | $8.6 million | $12.6 million | $6.8 million |
| Net income (loss) | $2.1 million | $4.8 million | $7.2 million | $(0.7) million |
| Diluted EPS | $0.12 | $0.30 | $0.42 | $(0.05) |
- Q2 sales volume declined 39.5%, partly offset by a 12.2% increase in average price per unit. Six-month volume declined 26.0%, while average price per unit increased 14.3%.
- Q2 operating margin was 7.9%; six-month operating margin was 8.5%. SG&A was $17.4 million in Q2 and $34.0 million for the six-month period.
- Net interest expense was $4.0 million in Q2 and $8.0 million for the six-month period, including substantial non-cash amortization of convertible-debt discounts and financing costs.
- Cash provided by operating activities was $3.3 million for the six months, down from $8.3 million in 2010. Investing cash use was $6.8 million, including $4.9 million of capital expenditures and $2.0 million for the Iron Deck acquisition. Financing cash use was $4.3 million.
- Cash and cash equivalents were $19.4 million at June 30, 2011, compared with $27.3 million at December 31, 2010. Inventories increased to $39.0 million from $29.0 million.
- Debt principal totaled $97.5 million, consisting of convertible notes. The notes had a net carrying value of $86.9 million after discount. The company had no revolver borrowings and approximately $82 million of available revolver capacity.
- Current liabilities included $86.9 million classified as current debt. The convertible notes had a 6.0% coupon, an effective interest rate of 18.41%, a $21.78 conversion price and approximately 12 months of remaining discount amortization.
Material changes versus the prior comparable period
- Q2 net sales decreased 32.1% and six-month sales decreased 18.9%, primarily because poor spring weather delayed deck-building activity and macroeconomic conditions weakened demand.
- Reported gross margin improved because the 2010 periods included a $9.0 million warranty-reserve increase and $1.9 million of supply-contract charges. Excluding those items, Q2 gross margin declined from 35.3% to 30.0%, while six-month gross margin increased from 30.8% to 31.6%.
- SG&A decreased 18.2% in Q2 and 11.1% for the six months, partly because 2010 included a $2.4 million non-cash charge related to the Denplax investment.
- The company completed the May 2, 2011 acquisition of substantially all assets of Iron Deck Corporation and launched the steel deck-framing product as Trex Elevations.
- The company used $2.5 million of cash to repay its real-estate note and settled its interest-rate swap for approximately $0.3 million.
- A favorable resolution of uncertain tax positions produced an approximately $2.6 million tax benefit in the first quarter. Excluding that item, the six-month effective tax rate was approximately 3.0%.
Guidance, outlook, risks and unusual items
- Management expects 2011 capital expenditures of approximately $15 million; $4.9 million had been spent during the first six months.
- Management stated that cash on hand, operating cash flow and available revolver capacity should fund planned capital expenditures, scheduled debt payments, warranty obligations and other requirements. The filing does not provide formal revenue or earnings guidance.
- The revolving credit facility matures December 31, 2011 and may be extendable to December 31, 2012 if specified conditions are met. The company was in compliance with its debt covenants at June 30, 2011; noncompliance could accelerate the revolver and potentially trigger cross-defaults under the convertible notes.
- The company maintains warranty reserves for claims involving surface flaking in material produced at its Nevada facility through mid-2006. The warranty reserve was $11.0 million at June 30, 2011. A 10% change in expected remaining claims or settlement costs could change the reserve by approximately $1.1 million.
- Pending purported class actions allege product defects and mold-related misrepresentations. The company considers the claims without merit and intends to defend them. The filing does not provide a clear quantified potential loss.
- Key operating risks include weather and macroeconomic conditions, product acceptance, raw-material costs and availability, manufacturing capacity utilization, product quality, warranty and consumer-relations costs, competition and distribution-channel inventory levels.
- Results are seasonal, with historically lower fourth-quarter sales because of holidays and adverse weather.
Important facts for investors to verify
- Verify the company’s ability to refinance or repay the $97.5 million convertible notes and address the revolver maturity.
- Monitor sales volume, dealer and distributor inventories, and whether pricing gains can offset weaker demand.
- Assess operating cash flow after inventory investment and the planned approximately $15 million of 2011 capital expenditures.
- Track warranty claims, reserve adequacy and the outcome of mold-related litigation.
- Separate recurring profitability from the 2011 tax benefit and the unusual warranty, supply-contract and Denplax charges included in 2010 comparisons.
- Consider potential dilution from convertible notes, options and other equity awards; diluted Q2 2011 weighted-average shares were 17.2 million versus 15.9 million in Q2 2010.