Trex Company, Inc. — Q2 2019 Form 10-Q Summary
Business context and reporting period
Trex manufactures wood-alternative composite decking and residential railing products and provides commercial railing and staging systems. Reportable segments are Trex Residential and Trex Commercial. This filing covers the three and six months ended June 30, 2019, compared with the corresponding 2018 periods.
Financial performance and liquidity
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net sales | $206.5 million | $206.7 million | $386.0 million | $377.9 million |
| Gross profit | $83.4 million | $91.1 million | $152.8 million | $167.8 million |
| Gross margin | 40.4% | 44.1% | 39.6% | 44.4% |
| Operating income | $47.7 million | $57.6 million | $86.9 million | $105.4 million |
| Net income | $35.7 million | $42.8 million | $67.3 million | $79.9 million |
| Diluted EPS | $0.61 | $0.73 | $1.14 | $1.35 |
| EBITDA | $51.1 million | $62.2 million | $93.7 million | $114.7 million |
| Cash flow from operations | Not separately provided | Not separately provided | $43.1 million | $(1.7) million |
Q2 net margin was approximately 17.3%, versus 20.7% in the prior-year quarter. Six-month net margin was approximately 17.4%, versus 21.2% in the prior-year period. Selling, general and administrative expense increased 6.5% in Q2 and 5.4% for the six-month period, reaching $35.7 million and $65.9 million, respectively.
- Residential sales increased 2.3% in Q2 and 4.2% year to date, while Commercial sales declined 25.8% and 19.2%, respectively.
- Q2 Residential EBITDA declined 16.0% to $50.4 million; Commercial EBITDA declined 64.8% to $0.8 million. Six-month total EBITDA declined 18.3% to $93.7 million.
- At June 30, 2019, cash and cash equivalents were $106.1 million, compared with $105.7 million at December 31, 2018.
- The company had no borrowings under its revolving credit facility and $250 million of available borrowing capacity at June 30, 2019. The facility expires January 12, 2021, and all debt covenants were satisfied.
- Six-month capital expenditures were $19.1 million. Cash used in financing activities was $23.6 million, primarily reflecting $24.2 million of share repurchases.
- Total assets were $536.2 million and stockholders’ equity was $391.5 million at June 30, 2019.
Material changes versus the prior comparable period
- Revenue was essentially flat in Q2 despite Residential growth because Commercial volume declined. For the first six months, revenue increased 2.2%.
- Gross margin fell 370 basis points in Q2 and 480 basis points year to date. Management attributed the decline primarily to startup costs, slower production ramp-up, lower yields, increased material usage and manufacturing inefficiencies associated with the new Enhance product.
- Management reported that production rates returned to planned levels by the second quarter and that related inefficiencies had been reduced. Two equipment failures at the Nevada facility during the first quarter temporarily took two lines offline for approximately 30 days each; both lines were back in full production.
- SG&A increased due primarily to higher branding and advertising spending, personnel costs including executive severance benefits, and research and development expenses. Lower amortization expense partially offset these increases.
- Operating cash flow improved substantially because of lower working-capital investment, including earlier collections and reduced inventory investment, compared with the prior-year period.
- The company repurchased 125,151 shares under its repurchase program during Q2 and had repurchased 709,461 shares under the program through June 30, 2019. Approximately 5.1 million shares remained authorized for purchase at quarter-end.
Guidance, outlook, risks and unusual items
- Trex announced a multiyear capacity expansion program of approximately $200 million through 2021 at its Virginia and Nevada Residential facilities. The program is expected to increase capacity by approximately 70% when completed. Nevada additions were expected to begin coming online in the third quarter of 2019, with Virginia capacity expected in the first quarter of 2021.
- 2019 capital expenditure guidance was revised to approximately $75 million to $80 million.
- Management believes cash on hand, operating cash flow and available revolver capacity will fund planned capital expenditures, warranty payments and other cash requirements; however, actual capital needs may vary with demand and market opportunities.
- Demand is seasonal and can be affected by weather, home-improvement activity, construction trends and inventory held by distributors. Commercial results may fluctuate with the timing of individual projects.
- Key operating risks include raw-material availability and costs, transportation costs, competition, product quality, market acceptance of new products, cybersecurity and privacy requirements, and general economic conditions.
- The surface-flaking warranty reserve was $21.9 million at June 30, 2019, within a total residential product warranty reserve of $29.3 million. Claims received continued to decline year over year, but average settlement cost increased. Management judged the reserve sufficient; a 10% change in expected claims or settlement cost could change the reserve by approximately $2.2 million.
- Operating lease accounting adopted January 1, 2019 added approximately $42.6 million of right-of-use assets and $43.9 million of operating lease liabilities at June 30, 2019. The filing states the adoption had a significant balance-sheet effect but no material effect on results of operations.
- Remaining performance obligations on Commercial contracts with original terms exceeding one year were $48.2 million at June 30, 2019, expected to be recognized within the next 24 months.
- Routine lawsuits and claims were pending, but management did not expect their resolution to materially affect financial condition, results, liquidity or competitive position.
Important facts for investors to verify
- Whether Enhance-product manufacturing improvements translate into sustained gross-margin recovery and adequate finished-goods availability.
- The pace, cost and return on the planned $200 million capacity expansion and whether the $75 million to $80 million 2019 capital spending outlook changes.
- Commercial project timing, backlog conversion and the sustainability of the Commercial segment’s sharply lower sales and EBITDA.
- Future surface-flaking warranty claims, settlement costs and any third-quarter reserve adjustment.
- Distributor and dealer inventory levels relative to underlying end-user demand, particularly during the seasonal deck-building period.
- Cash generation after capital expenditures, share repurchases and operating lease payments, as well as continued compliance with revolver covenants.