Business Context and Reporting Period
Trex Company, Inc. manufactures and distributes composite decking, railing, porch, fencing, trim, framing, lighting, and related outdoor-living products under the Trex brand. The company operates as one reportable segment. This Form 10-Q covers the three and nine months ended September 30, 2016, compared with the corresponding 2015 periods.
Financial Performance and Position
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Net sales | $106.2 million | $94.0 million | $384.3 million | $351.6 million |
| Gross profit | $29.9 million | $22.1 million | $149.0 million | $122.9 million |
| Gross margin | 28.2% | 23.6% | 38.8% | 35.0% |
| Income from operations | $10.6 million | $6.4 million | $84.2 million | $64.2 million |
| Net income | $6.9 million | $3.7 million | $53.6 million | $40.0 million |
| Diluted EPS | $0.23 | $0.12 | $1.81 | $1.25 |
- Q3 operating margin was approximately 10.0%, compared with 6.9% in the prior-year quarter; nine-month operating margin was approximately 21.9%, compared with 18.2%.
- Q3 net margin was approximately 6.5%, compared with 4.0%; nine-month net margin was approximately 13.9%, compared with 11.4%.
- Nine-month net cash provided by operating activities was $81.9 million, versus $12.2 million in 2015. Capital expenditures were $8.5 million, and net cash used in investing activities was $4.2 million.
- Cash and cash equivalents were $22.9 million at September 30, 2016, compared with $6.0 million at December 31, 2015.
- The company had no borrowings under its revolving credit facility and $200 million of available capacity at September 30, 2016. It was in compliance with all debt covenants.
- Total liabilities were $90.1 million and stockholders’ equity was $120.5 million at September 30, 2016.
Material Changes Versus the Prior Comparable Period
- Q3 sales increased 12.9%; nine-month sales increased 9.3%, primarily from higher volume of core Trex decking and railing products, continued remodeling-sector strength, and market-growth initiatives.
- Gross margin expanded 460 basis points in Q3 and 380 basis points for the nine-month period, driven mainly by lower raw-material costs, manufacturing improvements, and better capacity utilization.
- Q3 selling, general and administrative expense increased 23.4% to $19.4 million, principally due to higher incentive compensation, research and development, branding, and advertising. Nine-month SG&A increased 10.2% to $64.8 million.
- Share repurchases totaled $55.2 million in the first nine months. The company had repurchased 1,578,952 shares for $53.3 million under the October 2015 repurchase program as of September 30, 2016.
- Weighted average diluted shares declined to 29.5 million in Q3 and 29.6 million for the nine-month period, from 31.5 million and 31.9 million, respectively, in the prior-year periods.
- Interest expense increased 129.9% for the nine-month period to $1.1 million because of higher average borrowings associated with repurchases and seasonal working capital, although Q3 interest expense declined because of lower average borrowings.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
- Management estimated 2016 capital expenditures of $15 million to $18 million, primarily for research and development, specialty-materials operations, and cost-reduction initiatives.
- Management stated that cash on hand, operating cash flow, and available revolver capacity should fund planned capital expenditures, warranty payments, scheduled debt obligations, and other requirements.
- The company recorded a $9.8 million increase to its surface-flaking warranty reserve in Q3 after claims and average settlement costs exceeded expectations. The reserve for surface-flaking claims was $35.3 million at September 30, 2016.
- Surface-flaking claims received declined year over year, and cash paid for those claims declined 21% to $4.2 million in the first nine months. Management believes the reserve is sufficient, but a 10% change in expected remaining claims or settlement costs could change the reserve by approximately $3.5 million.
- Warranty obligations generally extend 10 to 25 years. Future claims, settlement costs, raw-material availability and pricing, product quality, competition, weather, seasonality, transportation costs, economic conditions, and market acceptance remain material risks.
- Sales are historically lower in the fourth quarter because of seasonality and the holiday period; adverse weather can defer home-improvement and construction activity.
- The company maintains a liability for an under-subleased office and storage facility; the remaining contract-termination liability was $1.6 million at September 30, 2016.
- Routine lawsuits and claims are pending, but management believes their resolution will not materially affect consolidated financial condition, results, liquidity, or competitive position.
- The filing states that the company was evaluating the effects of forthcoming revenue, lease, stock-compensation, and cash-flow accounting standards; the filing text does not provide a quantified adoption impact.
Important Facts for Investors to Verify
- Whether volume growth and remodeling demand remain strong after the seasonal Q3 period.
- Whether gross-margin improvements from raw-material costs, manufacturing efficiencies, and capacity utilization are sustainable.
- Actual future surface-flaking claims, average settlement costs, warranty cash payments, and any additional reserve adjustments.
- The pace and funding of share repurchases through the December 31, 2016 authorization expiration.
- Fourth-quarter sales seasonality, distributor inventory levels, weather effects, and potential channel destocking.
- Future capital expenditures relative to the $15 million–$18 million 2016 estimate and continuing access to the $200 million revolving credit capacity.