Trex Company, Inc. — 2013 Second-Quarter Form 10-Q Summary
Business Context and Reporting Period
Trex manufactures wood-alternative decking and railing products under the Trex brand and operates as one business segment. This Form 10-Q covers the three and six months ended June 30, 2013. The interim financial statements are unaudited. Results are seasonal, with typically lower sales in the fourth quarter due to holidays and adverse weather.
Financial Performance and Liquidity
| Metric | Three Months Ended June 30 | Six Months Ended June 30 |
|---|---|---|
| Net sales | $98.6 million, up 4.5% | $206.4 million, up 8.4% |
| Gross profit | $36.9 million, up 9.9% | $78.8 million, up 14.2% |
| Gross margin | 37.5%, versus 35.6% | 38.2%, versus 36.2% |
| Income from operations | $13.5 million | $35.5 million |
| Net income | $13.2 million, versus $8.3 million | $34.8 million, versus $20.7 million |
| Diluted EPS | $0.76, versus $0.48 | $2.01, versus $1.22 |
- Quarterly sales benefited from a 6.6% increase in average price per unit, partly offset by a 1.9% volume decline. Year-to-date sales reflected a 5.7% volume increase and a 2.6% average price increase.
- Gross-margin improvement reflected lower sales-related costs, manufacturing efficiencies, lower start-up costs and favorable capacity utilization. The 2012 comparable periods included warranty-reserve charges.
- Selling, general and administrative expense increased 12.1% to $23.4 million in the quarter and 9.5% to $43.2 million year to date, primarily due to mold-litigation costs and branding expenditures for new product launches.
- Net interest expense fell to $0.2 million in the quarter and $0.5 million year to date, compared with $4.3 million and $8.7 million, respectively, primarily following repayment of $91.9 million of 6.0% convertible notes on July 2, 2012.
- The effective tax rate was approximately 1.0% in both 2013 periods, substantially below statutory rates because of the valuation allowance against deferred tax assets.
Cash Flow, Debt and Balance Sheet
- Cash and cash equivalents were $15.6 million at June 30, 2013, compared with $2.2 million at December 31, 2012.
- Operating cash flow was $23.1 million for the first six months, down from $35.9 million in 2012. The decline was driven mainly by higher accounts receivable, less inventory-related cash benefit and payments of accrued expenses.
- Accounts receivable increased to $51.0 million from $26.5 million at year-end. Management expected substantially all outstanding receivables to be collected by the end of the third quarter.
- Capital expenditures were $5.1 million year to date, primarily for manufacturing equipment and process improvements. Management estimated 2013 capital expenditures of approximately $10 million to $15 million.
- Trex repaid the full $5.0 million revolving-credit balance during the quarter. At June 30, the Company reported no outstanding indebtedness, approximately $78.4 million of available revolver capacity and compliance with all debt covenants. The temporary revolver limit of $125 million reverted to $100 million on July 1, 2013.
- Stockholders’ equity increased to $130.8 million from $94.0 million at December 31, 2012, primarily reflecting year-to-date earnings.
Material Changes, Outlook and Risks
- New Reveal aluminum railing, Select railing and Select deck-board products supported sales growth and a shift toward higher-priced, lower-maintenance products.
- Weather slowed the start of the 2013 deck-building season and reduced June volume. Distributor inventory was believed to be slightly higher than the prior year, although the Company lacked complete channel inventory information.
- Management stated that cash on hand, operating cash flow and expected revolver availability should fund planned capital expenditures, warranty payments and other requirements. No formal revenue or earnings guidance was provided.
- The Company agreed to a proposed nationwide settlement of mold-growth and related product claims. The proposed cost was capped at $8.25 million plus $1.45 million of attorneys’ fees, subject to court approval. Trex accrued $3.4 million at June 30 and estimated total net resolution costs would not exceed approximately $10 million, while noting that approval was uncertain.
- The Company agreed to discontinue manufacturing non-shelled Trex Accents products by December 31, 2013 as part of the proposed settlement.
- The surface-flaking warranty reserve was $25.2 million at June 30, 2013. Management believed it was sufficient based on available claims data, but stated that a 10% change in expected remaining claims or settlement cost could change the reserve by approximately $3.0 million.
- The Company retains lease obligations for its reconsidered headquarters relocation through 2019. The related contract-termination liability was $1.1 million at June 30, and unfavorable future sublease terms or vacancies could cause additional SG&A charges.
- Key operating risks include product acceptance, economic and weather conditions, raw-material costs and availability, product quality, warranty and consumer-relations costs, channel inventory levels and intense competition.
- On August 1, 2013, after quarter-end, the Board authorized repurchases of up to $25 million of common stock over six months and approved executive severance-agreement extensions. The Company also promoted its CFO and operations leader, with related compensation increases.
Most Important Facts to Verify
- Whether the proposed nationwide mold-related settlement received court approval and the ultimate cash and product-related cost.
- Subsequent surface-flaking warranty claims, reserve adequacy and cash payments relative to the $25.2 million reserve.
- Collection of the elevated $51.0 million accounts-receivable balance and the effect of channel inventory on future sales.
- Actual 2013 capital expenditures versus the $10 million to $15 million estimate and continued revolver availability.
- Whether the unusually low effective tax rate and deferred-tax valuation allowance materially changed in later periods.
- Execution of the planned discontinuation of non-shelled Trex Accents products and the market response to newer product launches.