Trex Company, Inc. 2014 Form 10-K Summary
Business context and reporting period
Trex manufactures wood-alternative decking, railing and related outdoor-living products made primarily from waste wood fiber and scrap polyethylene. The company operates in one business segment and sells mainly through wholesale distributors, retail lumber dealers, Home Depot and Lowe’s. The filing covers the fiscal year ended December 31, 2014, with fourth-quarter information included in the unaudited interim data.
During the second half of 2014, Trex began manufacturing and selling recycled polyethylene pellets into commercial plastic markets. One pellet line was operational at year-end, with three additional lines expected to be built in the first half of 2015.
Financial performance and liquidity
| Metric | FY 2014 | FY 2013 | Change |
|---|---|---|---|
| Net sales | $391.7 million | $342.5 million | +14.3% |
| Gross profit | $140.2 million | $98.6 million | +42.2% |
| Gross margin | 35.8% | 28.8% | +700 bps |
| Income from operations | $67.8 million | $24.7 million | +175.2% |
| Net income | $41.5 million | $34.6 million | +20.0% |
| Diluted EPS | $1.27 | $1.01 | +25.7% |
| Cash flow from operations | $58.6 million | $45.2 million | +29.7% |
| EBITDA | $82.7 million | $40.6 million | +103.6% |
FY 2014 operating margin was approximately 17.3%, compared with 7.2% in 2013, and net margin was approximately 10.6%, compared with 10.1%. Sales volume increased 16.4%, partially offset by a 2.1% decrease in average price per unit following a revised pricing strategy. Management attributed margin improvement to manufacturing efficiencies, cost reductions and higher capacity utilization.
| Fourth-quarter metric | Q4 2014 | Q4 2013 |
|---|---|---|
| Net sales | $74.2 million | $63.8 million |
| Gross profit | $26.6 million | $19.7 million |
| Gross margin | 35.9% | 30.8% |
| Net income | $5.2 million | $15.1 million |
| Basic EPS | $0.16 | $0.46 |
Fourth-quarter sales increased approximately 16%, while gross profit increased approximately 35%. Fourth-quarter 2013 net income benefited from a $10.9 million tax benefit related to reversal of a valuation allowance; therefore, the year-over-year decline in reported Q4 net income is not indicative of operating performance alone.
Cash and cash equivalents were $9.5 million at year-end, compared with $3.8 million at December 31, 2013. Working capital was $35.8 million. Trex had no outstanding debt at year-end and approximately $100 million of available borrowing capacity under its revolving credit facility. The amended facility provides for borrowing capacity of up to $150 million from January through June and $100 million from July through December, with maturity on November 20, 2019. The company was in compliance with its debt covenants.
Capital expenditures were $13.0 million in 2014, and management estimated approximately $20 million for 2015. Total contractual cash obligations were $82.6 million, consisting primarily of purchase commitments and operating leases.
Material changes versus prior comparable periods
- Net sales reached the highest annual level in company history, supported by stronger existing-dealer demand and distribution-network additions made in late 2013.
- Gross margin expanded substantially. The 2013 results included a $20.0 million increase to the surface-flaking warranty reserve and a $1.5 million product-pricing and market-share expansion charge. Excluding those items, 2014 underlying gross margin improved by approximately 90 basis points.
- Selling, general and administrative expense declined 2.2% to $72.4 million, and decreased to 18.5% of sales from 21.6%.
- Operating cash flow increased by $13.4 million, despite higher income-tax payments. Accounts receivable declined slightly to $36.4 million.
- Trex repurchased $50.0 million of common stock, or 1,657,919 post-split shares, during 2014. A separate authorization for up to two million additional shares remained unused at year-end.
- The company completed a two-for-one stock split in May 2014; all historical share and per-share data were presented on a post-split basis.
- The revolving credit facility was amended and restated in November 2014, expanding availability, reducing financial covenants and extending maturity.
Guidance, outlook, risks and unusual items
Management did not provide a specific full-year revenue or earnings forecast in the filing. It expected 2015 capital expenditures of approximately $20 million and anticipated borrowing periodically under the revolving facility to fund seasonal working-capital needs. Management stated that cash on hand, operating cash flow and available borrowings should be sufficient to fund planned requirements for at least the next 12 months.
- Warranty exposure: Trex paid approximately $8.9 million during 2014 to settle surface-flaking claims related to material produced at its Nevada facility before 2007. The surface-flaking reserve was $31.4 million at year-end. Management believed the reserve was adequate, but estimated that a 10% change in expected remaining claims or settlement cost could change the reserve by approximately $3.1 million.
- Customer concentration: One customer represented approximately 24% of 2014 net sales. The 15 largest customers accounted for approximately 86% of gross sales. Loss of a major customer or inventory accumulation in the distribution channel could adversely affect future sales.
- Seasonality and weather: Sales are typically lower in the fourth quarter because of holidays and adverse weather. Demand is linked to home improvement, construction activity and consumer economic conditions.
- Raw materials and transportation: Results depend on obtaining waste wood fiber and scrap polyethylene at acceptable prices and on the availability and cost of third-party transportation.
- Lease obligation: Trex recorded $1.5 million of additional charges in 2014 related to the under-subleased Dulles, Virginia office lease. The related liability was $3.0 million at year-end, and additional charges could result if subleasing assumptions deteriorate.
- Tax items: The 2013 results included a $19.9 million tax benefit from reversing a substantial portion of the deferred-tax valuation allowance. A $4.5 million valuation allowance remained at December 31, 2014.
- Legal matters: The mold, fading and color-variation class action settlement was substantially completed. Remaining consumer relief was not expected to exceed approximately $1.0 million, in addition to $1.8 million previously paid for legal fees and related settlements.
- Concentration of products: Most revenue remains dependent on Trex’s proprietary wood/polyethylene composite products, creating product-quality and product-acceptance risk.
Important facts for investors to verify
- Whether surface-flaking warranty claims continue to decline and whether the $31.4 million reserve remains adequate.
- Whether gross-margin gains from manufacturing efficiency and capacity utilization persist despite pricing changes, raw-material costs and competitive pressure.
- Whether the recycled polyethylene pellet expansion reaches planned capacity and generates material revenue or profitability.
- Whether seasonal distributor inventory levels and customer concentration affect 2015 sales.
- Whether the company’s planned $20 million of 2015 capital expenditures and seasonal borrowing remain within cash-flow and covenant capacity.
- Whether the Dulles lease liability produces additional charges if vacant space cannot be subleased on assumed terms.
- The effect of the 2013 tax valuation-allowance benefit on comparability of reported earnings, particularly fourth-quarter results.