Trex Company, Inc. — Q1 2014 Form 10-Q Summary
Business Context and Reporting Period
Trex Company, Inc. is a single-segment manufacturer of wood-alternative decking and railing products marketed under the Trex brand. This quarterly report covers the three months ended March 31, 2014, compared with the three months ended March 31, 2013. Results were affected by seasonal demand and unfavorable weather that delayed the start of the deck-building season.
Key Financial Metrics
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Net sales | $100.6 million | $107.9 million | Down 6.7% |
| Gross profit | $38.2 million | $41.9 million | Down 8.8% |
| Gross margin | 37.9% | 38.8% | Down 0.9 percentage points |
| Income from operations | $19.9 million | $22.0 million | Down 9.4% |
| Operating margin | 19.8% | 20.4% | Down 0.6 percentage points |
| Net income | $12.3 million | $21.6 million | Down 43.0% |
| Diluted EPS | $0.73 | $1.25 | Down 41.6% |
| Cash used in operating activities | $82.0 million | $66.0 million | Use increased $16.1 million |
| Capital expenditures | $3.2 million | $1.9 million | Increased $1.3 million |
Net sales declined because sales volume decreased 5.6% and average price per unit decreased 1.2%. Gross margin was pressured primarily by a revised pricing strategy, partly offset by manufacturing efficiencies. SG&A declined 8.2% to $18.2 million, reflecting lower branding and personnel expenses, but included a $0.6 million charge related to the corporate headquarters lease.
The effective tax rate increased to 37.3% from 0.9% in the prior-year quarter. The prior-year rate benefited from a valuation allowance against deferred tax assets. The 2014 quarter also included a $6.5 million excess tax benefit from stock-based compensation recorded in additional paid-in capital.
Liquidity, Debt, and Cash Flow
- Cash and cash equivalents were $3.7 million at March 31, 2014, versus $3.8 million at December 31, 2013.
- Accounts receivable increased to $116.5 million from $37.3 million at year-end, and inventories increased to $30.2 million from $22.4 million, reflecting seasonal pre-building-season activity.
- The company used $82.0 million in operating cash, primarily because of increases in accounts receivable and inventory, lower earnings, and reductions in accounts payable and accrued liabilities.
- Net cash provided by financing activities was $85.2 million, including $80.0 million of net borrowings under the revolving credit facility and $1.4 million of share repurchases or withholding-related stock transactions.
- Outstanding revolving debt was $80.0 million, with approximately $45.0 million of remaining borrowing capacity. The facility's temporary maximum was increased from $100 million to $125 million through June 30, 2014 to meet seasonal cash needs.
- The stated interest rate on the revolving facility was 1.9% at March 31, 2014. The company was in compliance with all debt covenants.
- Management estimated 2014 capital expenditures of approximately $15 million, primarily for poly-processing lines and production-line retrofits.
Material Changes Versus the Prior Comparable Period
- Sales and profitability declined because of weather-related volume delays and pricing changes.
- Net income fell substantially, principally because the prior-year quarter benefited from a very low tax rate while the 2014 quarter reflected a more normalized tax provision.
- Operating cash use worsened despite a favorable year-over-year timing effect in accounts receivable, as inventory increased and payments to suppliers and other liabilities used cash.
- Debt increased materially to fund seasonal working capital needs; management expects borrowings to be substantially repaid as receivables are collected in the subsequent quarter.
- Product warranty reserve declined to $38.8 million from $40.8 million at December 31, 2013 after $2.0 million of settlements. Surface-flaking claims received were lower than expected, but average cost per claim remained above the company's 2014 expectation.
- The nationwide litigation settlement received final court approval in December 2013. Trex paid $1.6 million during the quarter and reported a remaining litigation accrual of $1.6 million; total net resolution costs are expected not to exceed approximately $10 million.
Guidance, Outlook, Risks, and Unusual Items
- Management expected sales activity to improve as weather normalized and the deck-building season began, but the filing does not provide specific revenue or earnings guidance.
- Management expects substantially all outstanding receivables to be collected by the end of the second quarter of 2014 and believes available cash, operating cash flow, and revolver capacity will fund planned expenditures and obligations.
- Key risks include seasonal and weather-related demand fluctuations, distributor inventory levels, raw-material costs and availability, product quality and warranty costs, market acceptance of new products, competition, and general economic conditions.
- The surface-flaking warranty reserve is based on actuarial assumptions. A 10% change in expected remaining claims or settlement cost could change the reserve by approximately $3.9 million.
- The company remains obligated under a headquarters lease through June 2019 after abandoning the planned relocation. It recorded a $0.6 million increase in estimated termination costs during the quarter; future charges could increase if sublease receipts are lower than estimated.
- A two-for-one stock split was approved for distribution on May 7, 2014. Reported share and per-share amounts in the quarter were not retroactively adjusted; post-split diluted EPS would be $0.37 for Q1 2014 and $0.62 for Q1 2013.
- On April 30, 2014, stockholders approved increasing authorized common shares from 40 million to 80 million and approved the 2014 Stock Incentive Plan.
Important Facts for Investors to Verify
- Whether seasonal receivable collections and improved weather reduced the unusually high working-capital cash use in the second quarter.
- The pace of repayment of the $80 million revolving-credit balance and continued compliance with debt covenants after the temporary borrowing-capacity increase expires.
- Actual sales volumes, pricing, and gross-margin trends following the revised pricing strategy.
- Future surface-flaking claims, average settlement costs, and any required changes to the $38.8 million warranty reserve.
- Additional costs associated with the mold-related litigation settlement and the headquarters lease obligation.
- The impact of the stock split and increased authorized shares on reported share counts, equity compensation, and per-share metrics.