Trex Company, Inc. — Form 10-Q Summary
Business context and reporting period
Trex Company, Inc. is a single-segment manufacturer of wood-alternative composite decking, railing and related outdoor-living products, primarily marketed under the Trex brand. Products are manufactured largely using reclaimed wood fibers and scrap polyethylene. This report covers the quarter and six months ended June 30, 2016, compared with the corresponding 2015 periods. The financial statements are unaudited.
Financial performance and liquidity
| Metric | Three months ended June 30, 2016 | Three months ended June 30, 2015 | Six months ended June 30, 2016 | Six months ended June 30, 2015 |
|---|---|---|---|---|
| Net sales | $146.5 million | $136.8 million | $278.1 million | $257.6 million |
| Gross profit | $61.4 million | $52.5 million | $119.0 million | $100.8 million |
| Gross margin | 41.9% | 38.4% | 42.8% | 39.1% |
| Income from operations | $36.6 million | $30.1 million | $73.6 million | $57.7 million |
| Net income | $23.3 million | $18.7 million | $46.7 million | $36.3 million |
| Diluted EPS | $0.79 | $0.58 | $1.57 | $1.13 |
- Six-month operating cash flow was $15.6 million, compared with cash used of $27.9 million in the prior-year period.
- Six-month capital expenditures were $5.2 million, compared with $14.1 million in 2015. Investing cash outflow was $0.8 million.
- Cash and cash equivalents were $2.6 million at June 30, 2016, down from $6.0 million at December 31, 2015.
- Accounts receivable increased to $95.7 million from $47.4 million at year-end, reflecting seasonal and customer-payment timing factors. Inventories declined to $18.8 million from $23.1 million.
- The company had $43.0 million outstanding under its revolving credit facility, approximately $207.0 million of remaining borrowing capacity, and a stated interest rate of 1.6%. The facility matures January 12, 2021, subject to seasonal borrowing limits.
- The company was in compliance with all debt covenants at June 30, 2016. Management expects cash on hand, operating cash flow and available revolver capacity to fund planned capital expenditures, debt service, warranty payments and other requirements.
Material changes versus the prior comparable period
- Second-quarter sales increased 7.1%; six-month sales increased 8.0%, primarily due to higher volume in core decking and railing, a strong early-buy season, remodeling-sector strength and market-growth initiatives.
- Gross margin expanded 350 basis points in the quarter and 370 basis points year to date, driven primarily by lower raw-material costs, manufacturing improvements and better capacity utilization.
- Second-quarter SG&A increased 10.3%, including approximately $2.1 million of additional marketing spending that had been deferred into the quarter. Six-month SG&A increased 5.4%, while SG&A as a percentage of sales decreased to 16.3% from 16.7%.
- Six-month interest expense increased to $1.0 million from $0.3 million because of higher average borrowings and a 30-basis-point increase in the related interest rate. Borrowings supported seasonal working capital and $53.3 million of share repurchases.
- The effective tax rate decreased to 35.7% for the six months from 36.8%, partly because of prior-year nondeductible items and current-year federal research and development tax credits.
- The company repurchased 1,578,952 shares for $53.3 million under the October 2015 repurchase program through June 30, 2016. Shares outstanding declined to 29.3 million from 30.9 million at year-end 2015.
Guidance, outlook, risks and unusual items
- Management estimated 2016 capital expenditures of approximately $20 million to $25 million, primarily for research and development, specialty materials operations and cost-reduction initiatives.
- The filing does not provide specific revenue or earnings guidance.
- Demand is seasonal; adverse or prolonged weather can reduce or defer home-improvement and construction activity, while fourth-quarter sales are typically lower because of the holiday season.
- Key operating risks include acceptance of current and new products, general economic conditions, transportation availability and cost, raw-material availability and pricing, product quality, warranty and consumer-relations costs, and intense competition.
- The company continues to settle surface-flaking claims involving material produced at its Nevada facility before 2007. The warranty reserve was $27.1 million at June 30, 2016, after $2.6 million of settlements during the first six months. Claims received were below the prior-year level but above management’s expectations, and the average settlement cost of $2,778 was 9.6% higher than in 2015. A 10% change in expected remaining claims or settlement cost could change the reserve by approximately $2.7 million.
- The company sold the buildings at its Olive Branch facility for $4.2 million in January 2016 and retained approximately 62 acres of undeveloped land classified as held for sale, valued at $2.0 million at June 30, 2016.
- The company remains obligated under a former headquarters lease through June 2019. The recorded contract-termination liability was $1.8 million at June 30, 2016, with remaining gross minimum payments of approximately $5.8 million, partially offset by expected sublease receipts of approximately $3.7 million.
- Routine litigation and claims were not expected by management to have a material effect on financial condition, results, liquidity or competitive position.
- Management concluded that disclosure controls and procedures were effective as of June 30, 2016, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether improved gross margins are sustained as raw-material costs, capacity utilization and manufacturing efficiencies change.
- The collectability and seasonality of the substantially higher accounts-receivable balance and the level of inventory held by distributors and dealers.
- Future surface-flaking warranty claims, settlement costs and any required reserve increases, particularly after the summer claims season.
- The effect of share repurchases and revolver borrowings on leverage, interest expense, liquidity and covenant compliance.
- Actual 2016 capital expenditures versus the $20 million–$25 million estimate and the resulting impact on cash generation.
- Changes in weather, remodeling activity, consumer demand, competitive conditions and raw-material or transportation costs.