Trex Company, Inc. — 2020 Q3 Form 10-Q Summary
Business context and reporting period
Trex manufactures wood-alternative composite decking, residential railing and outdoor-living products, primarily through Trex Residential, and engineered commercial railing and staging systems through Trex Commercial. This unaudited report covers the three and nine months ended September 30, 2020, compared with the corresponding 2019 periods.
Key financial metrics
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Net sales | $231.5 million | $194.6 million | $652.5 million | $580.6 million |
| Gross profit | $85.0 million | $82.4 million | $267.1 million | $235.2 million |
| Gross margin | 36.7% | 42.4% | 40.9% | 40.5% |
| Income from operations | $56.9 million | $55.0 million | $175.5 million | $142.0 million |
| Operating margin | 24.6% | 28.3% | 26.9% | 24.5% |
| Net income | $42.7 million | $42.0 million | $132.3 million | $109.2 million |
| Diluted EPS | $0.37 | $0.36 | $1.14 | $0.93 |
| EBITDA | $61.5 million | $58.6 million | $187.9 million | $152.3 million |
Q3 net sales increased 19.0%, while net income increased 1.7%. Nine-month sales increased 12.4%, net income increased 21.1%, and EBITDA increased 23.4%. Q3 net margin was 18.4% versus 21.6% in the prior-year quarter; nine-month net margin was 20.3% versus 18.8%.
- Trex Residential sales increased 19.5% in Q3 and 13.4% for the nine-month period, primarily from volume growth, strong repair and remodeling demand, and conversion from wood decking.
- Trex Commercial sales increased 11.0% in Q3 but declined 1.3% for the nine-month period.
- Q3 gross margin was reduced by a $6.5 million provision for legacy surface-flaking warranty claims. Excluding that provision, Q3 gross margin was 39.5%.
- Nine-month gross margin benefited from the nonrecurrence of 2019 Enhance startup costs and improved Trex Commercial project margins, partly offset by the warranty provision.
- Nine-month SG&A declined 1.8% to $91.6 million and decreased to 14.0% of sales from 16.1%, primarily due to lower branding and advertising spending.
Cash flow, liquidity, capital investment and debt
- Nine-month operating cash flow was $12.5 million versus $99.0 million in 2019. The decline primarily reflected a $175.0 million increase in accounts receivable, associated with sales timing and customer payment discounts; management expected substantially all of the September 30 receivables to be collected in Q4.
- Capital expenditures were $99.7 million versus $36.9 million, including approximately $82 million for capacity expansion in Virginia and Nevada and $12.5 million for cost-reduction and production improvements.
- Cash and cash equivalents were $20.1 million at September 30, 2020, down from $148.8 million at December 31, 2019.
- The company had no outstanding revolving debt and reported $300 million of available borrowing capacity. The amended facilities include an additional $100 million line intended to provide flexibility during the COVID-19 pandemic. Trex was in compliance with all debt covenants.
- Cash used in financing was $43.7 million, including $44.4 million of share repurchases. Repurchases were suspended in March 2020 and were lifted on October 30, 2020, after the reporting period.
Guidance, outlook, risks and unusual items
- 2020 capital expenditure guidance was $150 million to $170 million. The multiyear capacity program was projected at approximately $200 million through 2021 and is expected to increase Trex Residential production capacity by approximately 70% when completed.
- Management reported no material COVID-19-related disruption to operations, production, supply chain, demand, cash flows or financial condition as of the filing date, but emphasized that the pandemic and its economic effects remained uncertain.
- Key risks include COVID-19-related operating or demand disruptions, labor shortages and wage inflation, raw-material availability and costs, transportation costs, capacity execution, seasonality and weather, channel inventory levels, competition, product-quality claims, cybersecurity and general economic conditions.
- Surface-flaking claims for products manufactured at the Nevada facility before 2007 increased. The company recorded a $6.5 million Q3 provision and ended the period with a total residential warranty reserve of $29.6 million, including $22.4 million for surface-flaking claims. Management believes the reserve is adequate, but a 10% change in expected remaining claims or settlement costs could change the surface-flaking reserve by approximately $2.2 million.
- The company completed a two-for-one stock split on September 14, 2020; historical share and per-share data were retroactively adjusted.
- Trex Commercial had $60.1 million of remaining performance obligations under contracts longer than one year at September 30, 2020, expected to be recognized within 24 months.
Important facts for investors to verify
- Whether the substantial September 30 accounts receivable balance converted to cash in Q4 as management expected.
- Progress, spending and returns from the Virginia and Nevada capacity expansion program, including the $150 million to $170 million 2020 capital expenditure plan.
- Subsequent trends in surface-flaking claims, warranty reserves and related cash settlements.
- Whether residential demand, channel inventories and wood-to-composite conversion remain strong after the COVID-19-driven period.
- The timing and extent of share repurchases after the October 30, 2020 suspension was lifted.
- Future gross-margin performance, particularly the effects of labor and capacity-expansion costs, product mix, material costs and the absence of the warranty charge.