Trex Company, Inc. — Form 10-Q Summary
Business context and reporting period
Trex manufactures wood-alternative decking and railing products and, following its July 2017 acquisition of SC Company, operates two reportable segments: Trex Residential Products and Trex Commercial Products. This filing covers the three months ended March 31, 2018, compared with the three months ended March 31, 2017. The 2018 results include the acquired commercial business; the 2017 reported results do not.
Key financial metrics
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Net sales | $171.2 million | $144.8 million | 18.2% increase |
| Gross profit | $76.7 million | $65.2 million | 17.7% increase |
| Gross margin | 44.8% | 45.0% | Down 20 basis points |
| Income from operations | $47.8 million | $41.9 million | 14.0% increase |
| Operating margin | 27.9% | 28.9% | Down approximately 100 basis points |
| Net income | $37.1 million | $27.9 million | 32.8% increase |
| Diluted EPS | $1.25 | $0.95 | 31.6% increase |
| Effective tax rate | 21.9% | 33.0% | Down 11.1 percentage points |
| EBITDA | $52.5 million | $45.6 million | 15.0% increase |
Residential revenue was $155.2 million, up 7.2%, while Commercial revenue contributed $16.0 million. Residential gross margin was 47.6%; Commercial gross margin was 17.7%. Commercial Products generated a $0.5 million net loss and $0.7 million of EBITDA in the quarter.
Net cash used in operating activities was $98.1 million, compared with $86.4 million in the prior-year quarter. Capital expenditures were $5.4 million, and net cash used in investing activities was $5.4 million. Financing activities provided $75.7 million, including net revolving-credit borrowings and $9.0 million of share repurchases. Cash and cash equivalents declined to $2.7 million from $30.5 million at December 31, 2017.
At March 31, 2018, accounts receivable were $206.5 million and inventories were $42.5 million. The company had $84.5 million outstanding under its revolving credit facility, with $165.5 million of remaining borrowing capacity. The facility permits borrowings of up to $250 million from January 1 through June 30 and $200 million from July 1 through December 31, and expires January 12, 2021. The company was in compliance with its debt covenants.
Material changes versus the prior comparable period
- Sales increased $26.4 million, driven by $10.6 million of volume growth in Trex-branded decking and railing and $16.0 million of Commercial Products revenue from the acquired business.
- Residential performance benefited from remodeling demand, market-share initiatives, lower raw-material costs, plant cost reductions and improved capacity utilization.
- SG&A increased 24.5% to $29.0 million, principally from $4.5 million of higher personnel costs and $1.2 million of amortization related to the SC acquisition.
- Net income benefited materially from the lower federal statutory tax rate under the Tax Cuts and Jobs Act.
- Working-capital requirements increased substantially, particularly accounts receivable, which rose to $206.5 million from $66.9 million at year-end, contributing to negative operating cash flow.
- The company repurchased 50,022 shares under its new February 2018 repurchase program and authorized repurchases of up to 2.9 million shares.
Guidance, outlook, risks and unusual items
- Management estimated 2018 capital expenditures of $20 million to $25 million and expects to fund requirements through operations and financing activities.
- Residential demand is seasonal and sensitive to weather, home-improvement activity, channel inventories and distributor incentive programs. Commercial results depend on the timing of individual projects.
- The company expects the Commercial Products acquisition to provide access to commercial and multi-family markets, complementary products and additional design and engineering capabilities; however, the segment reported a $0.5 million net loss in Q1.
- Surface-flaking warranty claims related to products manufactured at the Nevada facility before 2007 continued to decline. The warranty reserve was $34.6 million at March 31, 2018, including $27.2 million for surface-flaking claims. Management believes the reserve is sufficient, but a 10% change in expected claims or settlement cost could change the reserve by approximately $2.7 million.
- The company identifies risks including raw-material availability and pricing, transportation costs, product quality, competition, economic conditions, weather, channel inventory levels, commercial contract estimates, cybersecurity and the timing of new-product acceptance.
- The company adopted ASC Topic 606 using the full retrospective method; management reported no material effect on financial condition or results of operations.
- Subsequent to quarter-end, stockholders approved increasing authorized common shares from 80 million to 120 million, and the board approved a two-for-one stock split to be distributed June 18, 2018. The financial statements in this filing do not reflect the split.
- Subsequent to quarter-end, the company entered into long-term retention agreements with five executive officers involving restricted stock units and cash payments, generally payable upon satisfying retention conditions through 2021 to 2023.
Important facts for investors to verify
- Whether the Commercial Products segment can move from modest EBITDA contribution and a net loss to sustained profitability.
- The conversion of strong reported earnings into cash, including the elevated accounts receivable balance and recurring seasonal working-capital needs.
- Availability under, utilization of and covenant compliance with the revolving credit facility.
- Future developments in the legacy surface-flaking warranty claims and adequacy of the $34.6 million total warranty reserve.
- The effect of the stock split and increased authorized share count on per-share data, potential dilution and future capital allocation.
- Whether residential demand, pricing, raw-material costs and capacity initiatives sustain current margins despite seasonality and competitive pressures.