Trex Company, Inc. — Q2 2015 Form 10-Q Summary
Business context and reporting period
Trex is a single-segment manufacturer of wood-alternative decking, railing and related outdoor-living products marketed under the Trex brand. The filing covers the three and six months ended June 30, 2015, compared with the corresponding 2014 periods. Results are seasonal, with historically lower fourth-quarter sales due to holidays and adverse weather.
Financial performance and liquidity
| Metric | Q2 2015 | Q2 2014 | Change |
|---|---|---|---|
| Net sales | $136.8 million | $121.3 million | 12.8% increase |
| Gross profit | $52.5 million | $45.0 million | 16.7% increase |
| Gross margin | 38.4% | 37.1% | 130 basis-point increase |
| Operating income | $30.1 million | $24.7 million | 21.8% increase |
| Operating margin | 22.0% | 20.3% | Improved |
| Net income | $18.7 million | $15.2 million | 23.4% increase |
| Diluted EPS | $0.58 | $0.46 | Increase |
For the six months ended June 30, 2015, net sales were $257.6 million, up 16.0%; gross profit was $100.8 million, up 21.1%; gross margin was 39.1% versus 37.5%; operating income was $57.7 million versus $44.6 million; and net income was $36.3 million, or $1.13 diluted EPS, versus $27.5 million, or $0.82 diluted EPS.
Q2 sales growth reflected an 8.3% increase in volume and a 4.1% increase in average price per unit. Six-month growth reflected an 11.8% volume increase and a 3.8% increase in average price per unit. Management attributed volume growth to market-share gains and increased demand for wood-alternative products, while pricing benefited from product price increases and a mix shift toward higher-priced products.
Six-month operating cash flow was negative $27.9 million, compared with positive $11.5 million in 2014. The decline primarily reflected an $88.1 million increase in accounts receivable, driven by higher sales and the timing of customer collections. Management expects substantially all outstanding receivables to be collected during the following quarter.
Six-month investing cash flow was negative $14.1 million, including $14.1 million of capital expenditures versus $4.9 million in 2014. Financing cash flow was positive $36.6 million, primarily reflecting net revolver borrowings. Cash declined to $4.1 million at June 30, 2015, from $9.5 million at December 31, 2014.
At June 30, 2015, revolving-credit borrowings were $37.5 million, with approximately $112.5 million of availability through June 30 and approximately $62.5 million of availability beginning July 1 as the facility limit declines from $150 million to $100 million. The interest rate was 1.3%, and the company was in compliance with all debt covenants.
Material changes versus the prior comparable period
- Sales reached the highest quarterly level in company history.
- Gross margin improved due primarily to cost-reduction initiatives and pricing.
- SG&A increased 10.5% in Q2, primarily from higher incentive compensation, but declined as a percentage of sales to 16.4% from 16.8%.
- Six-month SG&A increased 11.7%, including $2.1 million of higher branding expenses related to a new marketing campaign; SG&A as a percentage of sales declined to 16.7% from 17.4%.
- Interest expense declined 37.5% in Q2 and 47.8% for the six-month period because of lower interest rates and, for Q2, lower average debt levels.
- The company repurchased $2.8 million of common stock during the six-month period, compared with $52.9 million in the prior-year period. No repurchases had been made under the October 2014 authorization as of June 30, 2015.
Guidance, outlook, risks and unusual items
Management estimated 2015 capital expenditures of approximately $25 million, compared with $14.1 million incurred during the first six months. Planned spending supports cost-reduction initiatives, specialty-materials equipment and land acquired for potential future expansion.
Management stated that cash on hand, operating cash flow and expected revolver availability should fund capital expenditures, debt service, warranty payments and other requirements. Borrowings are used to support seasonal working-capital needs and are generally expected to be repaid as receivables are collected.
The company maintains a material warranty reserve for surface-flaking claims involving material produced at its Nevada facility before 2007. The reserve was $28.3 million at June 30, 2015, down from $31.4 million at the beginning of the year. Claims received in the first six months were higher than expected, average cost per claim was slightly above expectations, and unresolved claims increased to 2,883 from 2,872. Management believed the reserve was sufficient, but a 10% change in expected remaining claims or settlement cost could change the reserve by approximately $2.8 million.
The company recorded $0.2 million of contract-termination costs in the first six months related to unused headquarters lease space. Remaining lease obligations and the timing and terms of future subleases could result in additional charges.
Key risks include seasonal and weather-related demand, distributor inventory levels, raw-material availability and pricing, transportation costs, product quality and warranty claims, competitive conditions, market acceptance of new products, and compliance with debt covenants. The filing does not provide a specific revenue or earnings forecast.
The company is assessing the impact of the new revenue-recognition standard and had not selected an adoption method. Management reported effective disclosure controls and no material changes to internal control over financial reporting.
Important facts for investors to verify
- Whether the substantial increase in accounts receivable converts to cash as expected in the third quarter.
- Whether seasonal demand and early-buy program activity create excess inventory in distributor channels.
- Actual 2015 capital expenditures versus the approximately $25 million estimate.
- Trends in surface-flaking claims, average settlement cost and the adequacy of the $28.3 million warranty reserve.
- Revolver borrowings, seasonal repayment patterns, facility availability and continued covenant compliance.
- Whether cost reductions, pricing and product mix can sustain the improved gross margin.
- The eventual effect and adoption method of the new revenue-recognition standard.