Trex Company, Inc. — 2019 Third-Quarter Form 10-Q
Business Context and Reporting Period
Trex manufactures wood-alternative decking, railing and related outdoor-living products through Trex Residential, and custom-engineered railing and staging systems through Trex Commercial. The filing covers the three and nine months ended September 30, 2019, compared with the corresponding 2018 periods. Results are unaudited.
Key Financial Metrics
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Net sales | $194.6 million | $166.4 million | $580.6 million | $544.3 million |
| Gross profit | $82.4 million | $67.2 million | $235.2 million | $235.0 million |
| Gross margin | 42.4% | 40.4% | 40.5% | 43.2% |
| Income from operations | $55.0 million | $39.1 million | $142.0 million | $144.4 million |
| Net income | $42.0 million | $29.5 million | $109.2 million | $109.4 million |
| Diluted EPS | $0.72 | $0.50 | $1.86 | $1.85 |
| EBITDA | $58.6 million | $42.8 million | $152.3 million | $157.5 million |
Q3 operating margin was approximately 28.3%, compared with 23.5% in the prior-year quarter. Nine-month operating margin was approximately 24.5%, compared with 26.5% in 2018. The nine-month effective tax rate was 23.5%, compared with 24.1%.
Revenue and Segment Performance
- Q3 net sales increased 16.9%, driven by a 24.3% increase in Trex Residential sales to $182.8 million. Trex Commercial sales declined 39.2% to $11.8 million, primarily because of fewer large projects.
- Nine-month net sales increased 6.7%. Trex Residential sales increased 10.2% to $541.7 million, while Trex Commercial sales declined 26.5% to $38.9 million.
- Q3 Residential EBITDA increased 43.9% to $57.6 million, while Commercial EBITDA declined 65.1% to $1.0 million. Nine-month Residential EBITDA declined 1.2% to $150.1 million and Commercial EBITDA declined 59.7% to $2.3 million.
Cash Flow, Liquidity and Capital Allocation
- Nine-month operating cash flow was $99.0 million, down from $115.4 million, primarily due to increased accounts receivable and cash payments for accounts payable and accrued liabilities.
- Capital expenditures were $36.9 million, compared with $21.6 million in 2018. Approximately $33.7 million related to plant cost-reduction initiatives and production improvements.
- Cash and cash equivalents totaled $133.3 million at September 30, 2019, compared with $105.7 million at December 31, 2018.
- The company had no borrowings under its revolving credit facility and $200 million of remaining borrowing capacity. It was in compliance with all debt covenants.
- Nine-month share repurchases totaled $35.2 million. The company had repurchased 834,441 shares under its authorized 5.8 million-share program as of September 30, 2019.
Material Changes Versus the Prior Comparable Period
- Q3 performance improved substantially as Residential volume grew, gross margin expanded, and SG&A declined 2.6% to $27.4 million.
- Nine-month gross margin declined 270 basis points because of startup costs, lower throughput, increased material usage and lower yields associated with the new Enhance decking products.
- Management stated that production rates returned to planned levels by the third quarter and related operating inefficiencies had been reduced. Startup costs were largely behind the company, although added material costs were expected to continue for 12 to 18 months at a declining rate.
- The company adopted the new lease standard on January 1, 2019, recognizing operating lease right-of-use assets and liabilities. At adoption, these amounts were $45.8 million and $47.2 million, respectively; total lease liabilities were $42.6 million at September 30, 2019.
Guidance, Outlook, Risks and Unusual Items
- A multiyear capacity expansion program announced in June 2019 is projected to cost approximately $200 million through 2021 and is expected to increase capacity by approximately 70%. Nevada capacity came online in Q3 2019; additional Nevada lines were expected by Q2 2020, and Virginia capacity was expected to begin coming online in Q1 2021.
- The company revised 2019 capital expenditure guidance to $65 million to $70 million.
- Management cited strong residential remodeling conditions, consumer demand, brand initiatives and conversion from wood as positive factors. Residential results remain exposed to seasonality and adverse weather, while Commercial results depend on the timing of individual projects.
- Surface-flaking warranty claims continued to decline, but average settlement cost increased. The warranty reserve was $27.3 million at September 30, 2019, including $19.9 million for surface-flaking claims. A 10% change in expected claim volume or settlement cost could change the reserve by approximately $2.0 million.
- Other key risks include raw-material availability and pricing, transportation costs, product quality and warranty obligations, competition, economic conditions, channel inventory levels, cybersecurity and data-privacy requirements. Routine litigation was not expected to have a material effect.
Investor Verification Points
- Verify whether the Enhance product ramp-up and capacity investments deliver the planned throughput, margin recovery and approximately 70% capacity increase.
- Monitor Residential demand, distributor inventory and weather-related seasonality, particularly in light of incentive programs and prior supply constraints.
- Assess whether Commercial project timing and revenue recovery offset continued weakness in the segment.
- Track capital spending against the $65 million to $70 million 2019 guidance and the approximately $200 million multiyear program.
- Reassess the surface-flaking warranty reserve as claim counts decline but average settlement costs rise.
- Confirm cash generation and liquidity remain sufficient to fund expansion, warranty payments, repurchases and lease obligations without drawing on the revolving facility.