Trex Company, Inc. — 2017 Q1 Form 10-Q Summary
Business context and reporting period
Trex manufactures and distributes wood-alternative composite decking, railing, and related outdoor-living products under the Trex brand. The company operates as a single reportable segment. This filing covers the unaudited three months ended March 31, 2017, compared with the three months ended March 31, 2016.
Key financial metrics
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Net sales | $144.8 million | $131.7 million | 10.0% increase |
| Gross profit | $65.2 million | $57.6 million | 13.1% increase |
| Gross margin | 45.0% | 43.8% | Increase of 120 basis points |
| Income from operations | $41.9 million | $37.0 million | 13.2% increase |
| Operating margin | 28.9% | 28.1% | Increase of approximately 80 basis points |
| Net income | $27.9 million | $23.7 million | 17.9% increase |
| Diluted earnings per share | $0.95 | $0.79 | Increase of $0.16 |
| Net cash used in operating activities | $(86.4) million | $(84.1) million | Higher use of $2.3 million |
Net margin was approximately 19.3% in Q1 2017 versus 18.0% in Q1 2016. Gross-margin improvement was attributed primarily to improved capacity utilization, cost-reduction initiatives, and lower raw-material costs. Selling, general and administrative expense increased 12.9% to $23.3 million, including higher branding and advertising spending and research and development costs.
Cash and cash equivalents were $1.8 million at March 31, 2017, compared with $18.7 million at December 31, 2016. Accounts receivable increased to $171.3 million from $48.0 million, principally reflecting seasonal distributor and dealer incentive programs and higher sales. Inventory was $30.1 million.
The company had $77.0 million outstanding under its revolving credit facility and $173.0 million of remaining borrowing capacity at March 31, 2017. The facility permits aggregate borrowings of up to $250 million from January 1 through June 30 and $200 million from July 1 through December 31, and matures January 12, 2021. The company was in compliance with all debt covenants.
Capital expenditures were $4.3 million in Q1 2017, compared with $2.4 million in Q1 2016. Financing activities provided $73.9 million, primarily from net revolving-credit borrowings. The company repurchased $3.2 million of common stock during the quarter, primarily through shares withheld for employee tax obligations; no repurchases had been made under the February 2017 repurchase authorization as of the filing date.
Material changes versus the prior comparable period
- Sales increased $13.1 million, driven by core Trex decking and railing volume, remodeling-sector strength, market-growth initiatives, favorable weather and economic conditions, and customers participating in pre-season sales programs.
- Gross margin expanded 120 basis points to 45.0%.
- SG&A increased $2.7 million, including approximately $1.2 million of additional branding and advertising spending and $0.8 million of additional research and development expense.
- Net interest expense declined $0.4 million to $0.2 million because average borrowings were lower than in Q1 2016.
- The effective tax rate declined to 33.0% from 35.0%, primarily because excess tax benefits from stock-based awards were higher. The 2016 comparative tax provision and earnings figures were adjusted for the adoption of ASU 2016-09.
- Operating cash flow remained substantially negative because the seasonal increase in accounts receivable more than offset net income and other working-capital benefits.
Guidance, outlook, commentary, risks and unusual items
- Management estimated 2017 capital expenditures of approximately $15 million to $20 million. Capital allocation priorities include internal growth, strategically suitable acquisitions, and shareholder returns.
- Results are seasonal. Adverse weather can defer home-improvement and construction activity, while distributor and dealer incentive programs can shift sales, receivables, and inventory into the first quarter ahead of the peak decking season.
- The company expects cash on hand, operating cash flow, and available revolver capacity to fund planned capital expenditures, debt service, warranty payments, and other cash needs; however, actual funding requirements may vary with product demand and market opportunities.
- Warranty claims continue for pre-2007 products manufactured at the Nevada facility that exhibited surface flaking. Claims received declined year over year, but average settlement cost per claim increased and exceeded management’s expectations. The surface-flaking reserve was $32.7 million at March 31, 2017, within total accrued warranty liabilities of $36.7 million.
- Management considered the warranty reserve sufficient, but stated that continued elevated settlement costs or changes in claim volumes could require additional reserves and materially affect earnings, liquidity, or cash flow. A 10% change in estimated remaining claims or settlement cost could change the reserve by approximately $3.3 million.
- Other principal risks include raw-material availability and pricing, transportation costs, product quality, product replacement and consumer-relations costs, competition, general economic conditions, weather, and market acceptance of current and new products.
- Routine lawsuits and claims were not expected to have a material effect on consolidated financial condition, results of operations, liquidity, or competitive position.
Important facts for investors to verify
- Whether the large seasonal accounts-receivable balance converts to cash as expected during the peak selling season.
- Whether gross-margin gains from utilization, cost initiatives, and raw materials are sustained.
- Revolver borrowings, liquidity, covenant compliance, and the effect of seasonal working-capital requirements.
- Actual 2017 capital expenditures versus the $15 million to $20 million estimate.
- Trends in surface-flaking warranty claims, average settlement costs, and reserve adequacy.
- Whether distributor inventory and incentive-program activity reflect end-user demand or could pull future sales forward.
- The impact of stock-based compensation and related excess tax benefits on reported earnings and the effective tax rate.