Trex Company, Inc. Form 10-K Summary
Business context and reporting period
Trex manufactures wood-alternative decking, railing, porch, fencing, trim and steel deck-framing products, primarily using waste wood fiber and reclaimed polyethylene. This Form 10-K covers the fiscal year ended December 31, 2012; quarterly information includes the three months ended December 31, 2012.
Financial performance and condition
| Metric | FY 2012 | FY 2011 | Change |
|---|---|---|---|
| Net sales | $307.4 million | $266.8 million | +15.2% |
| Gross profit | $84.6 million | $62.8 million | +34.7% |
| Gross margin | 27.5% | 23.5% | +4.0 points |
| Income from operations | $12.7 million | $2.2 million | Improved |
| Net income (loss) | $2.7 million | $(11.6) million | Returned to profit |
| Diluted EPS | $0.16 | $(0.75) | Improved |
| Cash flow from operations | $60.4 million | $33.8 million | +78.7% |
| EBITDA | $29.1 million | $20.6 million | +41.6% |
FY 2012 net sales growth was driven primarily by a 15% increase in volume, favorable weather, new product introductions and market-share gains. Fourth-quarter net sales were $46.2 million versus $51.5 million in the prior-year quarter, and fourth-quarter net loss was $3.6 million versus a $18.3 million loss in fourth-quarter 2011. Fourth-quarter results remained seasonally weak and included $1.5 million of mold-related litigation expense.
Reported FY 2012 gross profit included a $21.5 million increase to the warranty reserve. Excluding this charge, gross profit was $106.1 million and underlying gross margin was 34.6%. Management attributed margin improvement to manufacturing efficiencies, favorable product mix toward shelled products and a $4.5 million benefit from LIFO inventory liquidation, partly offset by shelled-product start-up costs.
Cash and cash equivalents were $2.2 million at year-end, compared with $4.5 million at December 31, 2011; restricted cash of $37.0 million held in 2011 was used in the debt repayment. Inventories declined to $17.5 million from $28.9 million, and accounts receivable declined to $26.5 million from $29.2 million.
Material changes versus the prior comparable period
- Trex repaid the $91.9 million principal balance of its 6% convertible notes on July 2, 2012 and issued 1,061,745 common shares under the notes’ conversion feature.
- Total indebtedness fell to $5.0 million from $86.4 million. The company had approximately $56.7 million of additional availability under its $100 million revolving credit facility and was in compliance with all covenants.
- Net interest expense declined to $8.9 million from $16.4 million as a result of the debt reduction.
- SG&A increased 18.6% to $71.9 million, primarily from higher incentive compensation, commissions and severance; the company also recorded $1.9 million on obsolete equipment and $1.5 million for mold litigation.
- The warranty reserve increased to $29.0 million from $16.3 million. The company paid $8.8 million in warranty claims during 2012.
- Shareholders’ equity increased to $94.0 million from $92.5 million, while total assets declined to $168.6 million from $228.1 million.
Outlook, risks, contingencies and unusual items
- Management estimated 2013 capital expenditures of approximately $10 million to $15 million, primarily for process improvements, productivity investments and system upgrades.
- Management expected cash on hand, operating cash flow and revolver availability to fund planned capital expenditures, warranty obligations, debt service and other requirements for at least the next 12 months.
- Future performance is exposed to seasonal demand, weather, housing and remodeling activity, consumer spending, channel inventory levels, raw-material prices and product acceptance.
- Customer concentration is significant: two customers represented approximately 26% and 10% of FY 2012 net sales, and the 15 largest customers represented approximately 90% of gross sales.
- Trex continues to face product-quality and mold-related claims. Management estimated that total net cost to resolve the mold litigation would not exceed $10 million, but stated that costs could exceed amounts recorded.
- The warranty reserve depends on estimates of future claims and settlement costs. A 10% change in expected remaining claims or settlement cost could change the reserve by approximately $3.0 million.
- The company maintained a $24.1 million valuation allowance against deferred tax assets, reflecting uncertainty about future realization.
- Total contractual cash obligations were $95.0 million, including $41.2 million of purchase commitments and $48.8 million of operating leases.
- The company pays no cash dividend and expects to retain earnings for business development; credit agreement restrictions also limit dividends.
Investor verification points
- Reconcile reported earnings and cash flow excluding the $21.5 million warranty-reserve increase and assess the adequacy of the remaining $29.0 million reserve.
- Monitor warranty claim volumes, cash settlements and the unresolved mold-related litigation.
- Verify seasonal channel inventory, early-buy program effects and customer concentration, particularly exposure to Lowe’s and Boise Cascade.
- Review borrowing-base availability, covenant compliance and the January 2015 maturity of the revolving credit facility.
- Assess whether the projected 2013 capital spending and operating cash flow are sufficient given low year-end cash balances and contractual commitments.
- Evaluate the sustainability of the reported margin improvement, including the effects of product mix, manufacturing efficiency and the non-recurring LIFO liquidation benefit.