Trex Company, Inc. — 2020 Q2 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 railing and staging systems through Trex Commercial. This unaudited Form 10-Q covers the three and six months ended June 30, 2020, compared with the corresponding 2019 periods.
Key Financial Metrics
| Metric | Three Months Ended June 30, 2020 | Three Months Ended June 30, 2019 | Six Months Ended June 30, 2020 | Six Months Ended June 30, 2019 |
|---|---|---|---|---|
| Net sales | $220.6 million | $206.5 million | $421.0 million | $386.0 million |
| Gross profit | $92.4 million | $83.4 million | $182.1 million | $152.8 million |
| Gross margin | 41.9% | 40.4% | 43.3% | 39.6% |
| Income from operations | $63.4 million | $47.7 million | $118.5 million | $86.9 million |
| Net income | $47.2 million | $35.7 million | $89.6 million | $67.3 million |
| Diluted EPS | $0.81 | $0.61 | $1.54 | $1.14 |
| EBITDA | $67.5 million | $51.1 million | $126.4 million | $93.7 million |
Second-quarter net sales increased 6.9%, gross profit increased 10.7%, net income increased 32.2%, and EBITDA increased 31.9%. Six-month net sales increased 9.1%, net income increased 33.2%, and EBITDA increased 34.9%. EBITDA is a non-GAAP measure.
- Trex Residential sales increased 8.0% in the quarter and 10.3% year to date, driven by volume growth, outdoor-living demand, residential repair and remodeling activity, and wood-to-composite conversion initiatives.
- Trex Commercial sales declined 9.4% in the quarter and 6.6% year to date because of fewer large projects.
- Second-quarter SG&A declined 18.8% to $29.0 million, primarily due to lower branding, advertising, severance, meals and entertainment, and medical expenses. Six-month SG&A declined 3.5% to $63.6 million.
- The six-month effective tax rate increased to 24.8% from 22.7%, primarily because of lower excess tax benefits from share-based payments and higher nondeductible executive compensation.
Cash Flow, Balance Sheet, Debt and Liquidity
- Cash used in operating activities was $32.3 million for the first six months of 2020, compared with $43.1 million of operating cash flow in 2019. The primary driver was a $171.2 million increase in accounts receivable, reflecting sales timing and customer payment discounts; management expected most of the receivable balance to be collected in the third quarter.
- Capital expenditures were $62.6 million, including $52.6 million for capacity expansion in Virginia and Nevada and $8.8 million for plant cost-reduction and production improvements.
- Cash used in financing activities was $43.8 million, primarily reflecting $44.1 million of share repurchases during the six-month period. Repurchases were suspended on March 12, 2020 because of COVID-19-related market volatility.
- Cash and cash equivalents declined to $12.2 million at June 30, 2020 from $148.8 million at December 31, 2019. Accounts receivable increased to $249.7 million from $78.5 million, while inventories declined to $49.6 million from $56.1 million.
- The Company had no outstanding borrowings under its revolving credit facilities at June 30, 2020 and reported $350 million of available borrowing capacity. Available capacity was scheduled to be $300 million from July 1 through December 31, 2020.
- On May 26, 2020, the Company added a $100 million revolving commitment, primarily as a COVID-19 liquidity precaution and to support its growth and capacity strategy. The facilities mature or terminate on dates extending through November 2024, with the additional commitment available through May 2022.
- The Company was in compliance with all debt covenants at June 30, 2020 and stated that cash, operating cash flow and available borrowings should fund planned capital expenditures, warranty payments and other cash requirements.
Material Changes, Guidance and Unusual Items
- Gross-margin expansion reflected the nonrecurrence of 2019 Enhance product startup inefficiencies, including reduced throughput and equipment failures. Commercial margins also benefited from the nonrecurrence of legacy low-margin contracts and improved project estimating, management and manufacturing costs.
- The Company was expanding Nevada and Virginia capacity. Its multiyear capital program was projected at approximately $200 million through 2021 and was expected to increase Trex Residential production capacity by approximately 70% when completed.
- 2020 capital expenditure guidance was $150 million to $170 million.
- Management reported no material operational disruption from COVID-19 as of the filing date. Early-second-quarter sales weakness from construction and channel-partner closures was substantially offset by reopening activity later in the quarter. The pandemic remained an evolving risk with uncertain duration and economic consequences.
- Surface-flaking warranty claims from products manufactured at the Nevada facility before 2007 increased year over year. The warranty reserve was $24.1 million at June 30, 2020, including $17.3 million for surface-flaking claims. Management considered the reserve sufficient, but stated that changes in claim volume or settlement costs could materially affect earnings and cash flows. A 10% change in expected remaining claims or settlement cost could change the reserve by approximately $1.7 million.
- Trex Commercial had $63.7 million of remaining performance obligations on contracts with original durations exceeding one year, expected to be recognized within 24 months.
- On July 29, 2020, the Board approved a two-for-one stock split, payable September 14, 2020 to shareholders of record on August 19, 2020. The split was not reflected in the financial statements.
- The Company adopted accounting guidance covering cloud-computing implementation costs, goodwill impairment, and expected credit losses. Adoption did not materially affect the financial statements.
Important Facts for Investors to Verify
- Whether the unusually large accounts-receivable balance converted to cash as expected in the third quarter and whether operating cash flow normalized.
- Progress, total spending and returns from the Virginia and Nevada capacity expansion program, including achievement of the approximately 70% capacity increase.
- Actual 2020 capital expenditures relative to the $150 million to $170 million guidance range.
- COVID-19 effects on construction demand, distributor and retail inventory, supply availability, labor capacity and future operating disruptions.
- Subsequent trends in surface-flaking warranty claims, average settlement costs and required reserve revisions.
- Whether suspended share repurchases resumed and their effect on cash balances and share count.
- The effect of the two-for-one stock split on subsequent per-share data and trading activity.