Business Context and Reporting Period
Trex Company, Inc. is a single-segment manufacturer of wood-alternative decking, railing, fencing, trim and related products marketed under the Trex brand. This unaudited Form 10-Q covers the three and nine months ended September 30, 2011, compared with the corresponding 2010 periods.
Financial Performance and Position
| Metric | Three Months 2011 | Three Months 2010 | Nine Months 2011 | Nine Months 2010 |
|---|---|---|---|---|
| Net sales | $67.9 million | $60.6 million | $215.3 million | $242.4 million |
| Gross profit | $17.3 million | $9.2 million | $63.8 million | $54.3 million |
| Gross margin | 25.4% | 15.2% | 29.6% | 22.4% |
| Income from operations | $4.3 million | $(4.8) million | $16.8 million | $2.0 million |
| Net income (loss) | $(0.5) million | $(8.8) million | $6.7 million | $(9.6) million |
| Diluted EPS | $(0.03) | $(0.58) | $0.41 | $(0.63) |
| Operating cash flow | Not separately provided | Not separately provided | $41.2 million | $31.1 million |
- Third-quarter sales increased 12.1%, driven by an 8% volume increase and a 4% increase in average price per unit.
- Nine-month sales declined 11.2%, reflecting an 18% volume decrease partially offset by an 8% increase in average price per unit.
- Third-quarter operating income was $4.3 million, while net loss was $0.5 million because net interest expense was $4.8 million.
- Interest expense was $12.8 million for the nine-month period, including approximately $8.0 million of primarily non-cash convertible-debt discount and financing-cost amortization.
- Cash and cash equivalents were $50.2 million at September 30, 2011, compared with $27.3 million at December 31, 2010.
- Total assets were $231.4 million and stockholders’ equity was $110.2 million at September 30, 2011.
- Capital expenditures were $6.2 million year to date; management estimated approximately $10 million of capital expenditures for full-year 2011.
Material Changes Versus the Prior Comparable Period
- Gross margin improved substantially because 2010 included $3.9 million of third-quarter charges, including warranty and supply-contract charges. Excluding those charges, third-quarter gross margin increased from 21.6% to 25.4%.
- For the nine-month period, 2010 included a $9.8 million warranty-reserve increase and $5.0 million of supply-contract charges. Excluding those items, 2011 gross margin was 29.6% versus 28.5% in 2010.
- SG&A expense decreased 7.1% in the third quarter and 10.1% for the nine-month period, primarily due to lower branding and other facility-related expenses.
- Year-to-date results benefited from favorable resolution of uncertain tax positions, producing a $2.6 million tax benefit. Excluding that item, the nine-month effective tax rate was approximately 0.1%.
- Accounts receivable declined to $14.3 million from $53.3 million at December 31, 2010, while inventory increased to $33.0 million from $29.0 million.
- The company acquired substantially all assets of Iron Deck Corporation on May 2, 2011, expanding its steel deck-framing product offering.
Debt, Liquidity, Outlook and Risks
- Debt principal outstanding at September 30, 2011 was $91.9 million, consisting of convertible notes; the net carrying amount was $84.3 million after unamortized discount. The company repurchased approximately $5.6 million of convertible notes during the third quarter.
- The company had no borrowings under its revolving credit facility and approximately $60 million of available borrowing capacity at September 30, 2011. It was in compliance with all debt covenants.
- On October 28, 2011, the credit facility was amended and extended to December 31, 2012, but maximum commitments were reduced to $40 million of revolver loans and $15 million of reducing revolver loans. The amendment also requires specified deposits, including at least $37 million through May 31, 2012.
- Management expects cash on hand, operating cash flow and available financing to fund planned capital expenditures, debt service, warranty obligations and other requirements, but is exploring additional financing sources.
- Management attributed the third-quarter sales increase partly to sales deferred from the second quarter because of poor spring weather. It noted that fourth-quarter sales are historically lower because of holidays and adverse weather.
- Key risks include economic conditions and consumer spending, seasonal demand, product acceptance, raw-material pricing and availability, manufacturing utilization, competition, product quality and warranty costs.
- The company continues to settle claims involving surface flaking in products manufactured at its Nevada facility through mid-2006. The warranty reserve was $8.5 million at September 30, 2011; management estimated that a 10% change in expected claims or settlement costs could change the reserve by approximately $0.9 million.
- Several purported class actions alleging product defects and mold-related misrepresentations remained pending. The company believes the claims are without merit and stated that other routine litigation is not expected to materially affect its financial condition or results.
Important Facts for Investors to Verify
- Whether the improved quarterly sales and margins were sustainable or primarily reflected weather-related sales deferrals and favorable comparisons with unusual 2010 charges.
- The refinancing and liquidity implications of the amended credit facility, required deposit balances and the convertible notes due in 2012.
- Future warranty claims, reserve adequacy and potential costs from product-defect and mold-related litigation.
- The effect of weak nine-month volume trends, macroeconomic conditions and distribution-channel inventory levels on future demand.
- The effect of non-cash convertible-debt amortization, debt extinguishment charges and the one-time tax benefit on reported earnings and cash generation.