Trex Company, Inc. — 2018 Third-Quarter Form 10-Q Summary
Business Context and Reporting Period
Trex manufactures wood-alternative decking and residential railing products and, following its July 2017 acquisition of SC Company, provides commercial and multi-family architectural railing, staging, acoustical, and seating systems. The filing covers the three and nine months ended September 30, 2018, compared with the corresponding 2017 periods. Results include two reportable segments: Trex Residential Products and Trex Commercial Products.
Key Financial Metrics
| Metric | Q3 2018 | Q3 2017 | Change |
|---|---|---|---|
| Net sales | $166.4 million | $140.2 million | 18.7% |
| Gross profit | $67.2 million | $55.3 million | 21.6% |
| Gross margin | 40.4% | 39.4% | Up 100 bps |
| Operating income | $39.1 million | $30.4 million | 28.7% |
| Net income | $29.5 million | $20.1 million | 46.6% |
| Diluted EPS | $0.50 | $0.34 | 47.1% |
| EBITDA | $42.8 million | $34.9 million | 22.8% |
| Metric | Nine Months 2018 | Nine Months 2017 | Change |
|---|---|---|---|
| Net sales | $544.3 million | $442.9 million | 22.9% |
| Gross profit | $235.0 million | $192.5 million | 22.1% |
| Gross margin | 43.2% | 43.5% | Down 30 bps |
| Operating income | $144.4 million | $117.1 million | 23.4% |
| Net income | $109.4 million | $76.8 million | 42.4% |
| Diluted EPS | $1.85 | $1.30 | 42.3% |
| EBITDA | $157.5 million | $129.0 million | 22.1% |
Residential sales were $147.0 million in Q3 and $491.4 million for the first nine months, while Commercial sales were $19.4 million and $52.9 million, respectively. Commercial sales comparisons are affected by the July 2017 acquisition and the shorter comparable period in 2017.
Nine-month cash flow from operations was $115.4 million, compared with $92.8 million in 2017. Capital expenditures and intangible purchases totaled $21.6 million, including $6.3 million for domain names. Cash and cash equivalents increased to $107.3 million from $30.5 million at December 31, 2017.
At September 30, 2018, the company had no borrowings under its revolving credit facility and had $200.0 million of available capacity. Total liabilities were $106.3 million and stockholders’ equity was $328.7 million. The company was in compliance with its debt covenants.
Material Changes Versus the Prior Comparable Period
- Q3 residential sales increased 12.2%; management stated that growth was 16.8% excluding a $6.0 million charge related to expanding stocking positions across residential sales channels beginning in 2019.
- Commercial sales increased 111.8% in Q3 and 477.9% for the nine-month period, primarily reflecting the acquired SC Company operations being included for a full comparable period in 2018.
- Q3 gross margin improved to 40.4% from 39.4%. Management cited lower-cost recycling streams, manufacturing efficiencies, higher capacity utilization, warranty-claim favorability, and commercial cost reductions, partly offset by product innovation, freight, and non-recycled polyethylene costs.
- Nine-month gross margin declined modestly to 43.2% from 43.5%, despite reported residential margin of 45.4% and commercial margin of 23.0%.
- The effective tax rate declined to 25.0% in Q3 and 24.1% for the nine-month period, from 33.7% and 34.1%, respectively, primarily because the Tax Cuts and Jobs Act reduced the federal statutory rate to 21%.
- Financing cash use increased to $17.0 million from $3.3 million, primarily because of common-stock repurchases. The company repurchased 250,044 shares under its 2018 program as of the filing date; no program repurchases occurred during Q3.
- The company completed a two-for-one stock split in June 2018. All historical share and per-share data were retroactively adjusted.
Guidance, Outlook, Commentary, Risks, and Unusual Items
- Management estimated 2018 capital expenditures would exceed $30 million and expected cash on hand, operating cash flow, and available revolver capacity to fund planned expenditures, warranty payments, and other requirements.
- Management cited continued residential remodeling demand, marketing efforts to take share from wood, and demand across decking and railing products. Commercial results remain dependent on the timing of individual projects.
- Residential operations are seasonal and sensitive to adverse weather, construction activity, distributor inventory levels, and the timing of incentive programs. Commercial results may fluctuate with project timing.
- Key operating risks include raw-material availability and pricing, transportation costs, product quality and warranty costs, competition, general economic conditions, market acceptance of new products, cyber and data-security risks, and potential inventory accumulation in distribution channels.
- Warranty reserves cover long-term product obligations, including surface-flaking claims for products manufactured at the Nevada facility before 2007. The total residential warranty reserve was $32.6 million at September 30, 2018, including $24.7 million for surface flaking. Surface-flaking claims received declined to 1,314 from 1,931, while average settlement cost increased to $2,703 from $2,553.
- Management stated that the warranty reserve was adequate and that no current-quarter adjustment was required. A 10% change in expected remaining claims or settlement cost could change the surface-flaking reserve by approximately $2.5 million.
- The company adopted ASC Topic 606 using the full retrospective method without a material effect on results. It expected adoption of the new lease standard on January 1, 2019, with recognition of operating lease assets and liabilities and expanded disclosures.
- Commercial contracts have $49.0 million of remaining transaction price allocated to performance obligations expected to be recognized within 18 months. No individual contract adjustment was material during the nine-month period.
Most Important Facts for Investors to Verify
- Whether residential demand and channel inventory remain healthy after the 2019 stocking-position expansion and related $6.0 million charge.
- The sustainability of reported margin improvement amid freight, polyethylene, labor, and other input-cost inflation.
- Commercial segment growth, project backlog conversion, contract profitability, and the effect of acquisition-related amortization.
- Future surface-flaking warranty claims, average settlement costs, and potential reserve changes.
- Actual 2018 capital expenditures relative to the estimate exceeding $30 million and the company’s ongoing capital-allocation priorities.
- Whether seasonal weather, construction trends, raw-material availability, or distributor inventory changes affect subsequent-quarter results.
- The impact of the January 2019 lease-standard adoption and any resulting balance-sheet changes.