Trex Company, Inc. 2018 Form 10-K Summary
Business context and reporting period
Trex manufactures wood-alternative composite decking, railing, fencing, framing and lighting products through Trex Residential, and custom-engineered railing and staging systems through Trex Commercial. The filing covers the fiscal year ended December 31, 2018; fourth-quarter data are included in the filing but the report is an annual Form 10-K, not a quarterly filing.
Trex Residential accounted for $613.2 million of 2018 sales, while Trex Commercial accounted for $71.0 million. Commercial results include a full year of operations following the July 2017 acquisition of certain assets and liabilities of Staging Concepts Acquisition, LLC.
Key financial metrics
| Metric | FY 2018 | FY 2017 | Change |
|---|---|---|---|
| Net sales | $684.3 million | $565.2 million | 21.1% |
| Gross profit | $294.9 million | $243.4 million | 21.2% |
| Gross margin | 43.1% | 43.1% | Unchanged |
| Income from operations | $176.7 million | $142.4 million | 24.1% |
| Net income | $134.6 million | $95.1 million | 41.5% |
| Diluted EPS | $2.28 | $1.61 | 41.6% |
| Operating cash flow | $138.1 million | $101.9 million | 35.6% |
| EBITDA, non-GAAP | $193.1 million | $159.1 million | 21.4% |
FY 2018 operating margin was approximately 25.8%, net margin was approximately 19.7%, and operating cash flow represented approximately 20.2% of sales. Cash and cash equivalents were $105.7 million at year-end, compared with $30.5 million in 2017. Working capital increased to $177.5 million from $86.3 million.
Capital expenditures were $33.8 million, including $19.2 million for plant cost-reduction initiatives, $6.3 million for domain names and $4.7 million for equipment and product development. The company used $30.1 million for share repurchases during 2018 and repurchased 459,321 shares under its February 2018 authorization through the filing date.
Trex had no debt outstanding at December 31, 2018 and had $200 million of available borrowing capacity under its revolving credit facility. The facility permits borrowings of up to $250 million from January through June and $200 million from July through December, and expires January 12, 2021. The company was in compliance with all debt covenants.
Fourth-quarter performance
| Metric | Q4 2018 | Q4 2017 | Change |
|---|---|---|---|
| Net sales | $140.0 million | $122.2 million | 14.5% |
| Gross profit | $59.9 million | $50.9 million | 17.6% |
| Gross margin | 42.8% | 41.7% | Up approximately 1.1 points |
| Net income | $25.2 million | $18.3 million | 37.6% |
| Diluted EPS | $0.43 | $0.31 | 38.7% |
Material changes versus the prior comparable period
- Residential sales increased 12.9%, driven primarily by volume growth, remodeling demand, marketing initiatives and continued conversion from wood products. Excluding a $6 million third-quarter charge related to expanding channel stocking positions for 2019, residential sales growth was approximately 14%.
- Commercial sales increased 225.7% because 2018 included a full year of the acquired commercial operation, compared with approximately five months in 2017. Commercial EBITDA improved to $6.9 million from a $1.3 million loss.
- Residential gross margin was 45.6%; excluding the $6 million channel-stocking charge, it was 46.1%, up approximately 1.8 percentage points, reflecting lower-cost recycling streams, manufacturing efficiencies and higher capacity utilization.
- SG&A increased 17.1% to $118.2 million but declined to 17.3% of sales from 17.9%. Increases included commercial personnel costs, branding and advertising, incentive and stock compensation, medical insurance and amortization.
- The effective tax rate declined to 23.9% from 33.0%, primarily reflecting the Tax Cuts and Jobs Act and the federal statutory rate reduction to 21%.
- Operating cash flow improved by $36.3 million, although accounts receivable and inventories increased by $24.3 million and $23.3 million, respectively.
- Cash used in investing activities declined to $33.7 million from $86.8 million because the 2017 period included the $71.8 million commercial acquisition.
Guidance, outlook, risks and unusual items
- Management estimated 2019 capital expenditures of approximately $40 million to $45 million for cost reduction, new product launches and general business support. No specific revenue or earnings guidance is provided in the filing text.
- Management expects cash on hand, operating cash flow and available revolver capacity to fund planned capital expenditures, warranty obligations and other needs for at least the next 12 months.
- Residential demand is seasonal and sensitive to weather, remodeling activity, consumer confidence, credit availability and housing conditions. Channel inventory accumulation could reduce subsequent-period sales.
- Customer concentration is material: two customers represented approximately 42% of 2018 net sales, and the 15 largest customers represented approximately 85% of gross sales. Boise Cascade and U.S. Lumber Group each exceeded 10% of gross sales.
- The company continues to settle claims involving pre-2007 Nevada decking with surface flaking. The warranty reserve was $30.8 million at year-end, including $24.0 million for surface-flaking claims; 2018 settlements totaled $5.3 million. A 10% change in estimated remaining claims or settlement cost could change the surface-flaking reserve by approximately $2.6 million.
- Raw-material availability and pricing, transportation costs, product quality, competition from wood and alternative-material manufacturers, and commercial project execution may affect results.
- Operating lease commitments totaled $61.8 million. Adoption of the new lease standard on January 1, 2019 was expected to add an operating lease right-of-use asset and liability in the preliminary range of $45 million to $50 million.
- Routine litigation is pending, but management believes it will not materially affect consolidated financial condition, results, liquidity or competitive position. Ernst & Young issued unqualified opinions on the financial statements and internal control over financial reporting.
Important facts for investors to verify
- Whether residential demand and channel inventory remain aligned after the 2019 stocking-position expansion.
- The sustainability of the approximately 43% consolidated gross margin and the contribution from lower-cost recycled material streams.
- Commercial segment profitability, backlog conversion and any changes in estimated costs on fixed-price contracts.
- Future surface-flaking warranty claims, settlement costs and adequacy of the $30.8 million reserve.
- Customer concentration and exposure to Home Depot, Lowe's, Boise Cascade, U.S. Lumber Group and other major accounts.
- The effect of the planned $40 million to $45 million 2019 capital program and adoption of lease accounting on reported assets, liabilities and cash flow presentation.
- Availability of the $200 million revolver, covenant compliance and seasonal borrowing requirements.