Trex Company, Inc. — Q1 2021 Form 10-Q Summary
Business Context and Reporting Period
Trex manufactures wood-alternative composite decking, residential railing and outdoor living products, as well as commercial railing and staging systems. The company reports two segments: Trex Residential and Trex Commercial. This unaudited quarterly filing covers the three months ended March 31, 2021, compared with the three months ended March 31, 2020.
Financial Performance and Key Metrics
| Metric | Q1 2021 | Q1 2020 | Change |
|---|---|---|---|
| Net sales | $245.5 million | $200.4 million | +22.5% |
| Gross profit | $95.8 million | $89.7 million | +6.8% |
| Gross margin | 39.0% | 44.8% | Down 5.8 percentage points |
| Income from operations | $64.5 million | $55.1 million | +16.9% |
| Net income | $48.5 million | $42.4 million | +14.5% |
| Diluted earnings per share | $0.42 | $0.36 | Increase |
| EBITDA | $70.9 million | $59.0 million | +20.2% |
| Effective tax rate | 24.7% | 23.8% | Up 0.9 percentage points |
- Residential: Sales increased 24.7% to $233.1 million, primarily from volume growth across product lines. Residential EBITDA increased 24.6% to $71.0 million.
- Commercial: Sales declined 7.9% to $12.5 million, and EBITDA declined to a $0.1 million loss from $2.0 million of EBITDA in the prior-year quarter. Results reflected delayed or deferred commercial construction projects, lower-margin project mix and additional project costs.
- Margins: Cost of sales increased 35.3% to $149.7 million. Gross margin was pressured by raw-material inflation, capacity-expansion start-up costs, increased depreciation and reduced overhead absorption following the Virginia facility fire. A mid-single-digit price increase on certain residential product lines partially offset these pressures.
- Operating expenses: Selling, general and administrative expenses declined 9.4% to $31.3 million, primarily due to lower branding, travel and entertainment costs.
- Liquidity: Cash and cash equivalents were $8.2 million at March 31, 2021, compared with $121.7 million at December 31, 2020. Accounts receivable increased to $309.5 million from $106.7 million, reflecting higher sales and working-capital investment.
- Cash flow: Operating activities used $142.6 million, compared with $108.8 million used in Q1 2020. Investing activities used $57.8 million, including $58.1 million of capital expenditures. Financing activities provided $86.9 million, including net revolving-credit borrowings partly offset by share repurchases.
- Debt: Revolving-credit borrowings were $136.0 million at March 31, 2021, with $214.0 million of remaining borrowing capacity. The facility matures November 5, 2024, and the company was in compliance with its debt covenants.
- Capital returns: The company repurchased 504,275 shares for approximately $49.6 million during the quarter. Total shares repurchased under the program reached approximately 3.3 million.
Material Changes Versus the Prior Comparable Period
- Residential demand remained strong, supported by outdoor-living trends, increased focus on home improvement, suburban migration, preference for sustainable products and conversion from wood decking to composite decking.
- New Virginia production lines began coming online in Q1 2021 and were expected to ramp through the end of May, one month ahead of schedule.
- The company’s capacity-expansion program increased capital spending substantially; Q1 capital expenditures rose to $58.1 million from $22.7 million.
- Cash usage increased materially because the higher sales volume generated a $202.8 million increase in accounts receivable during the quarter.
- Gross margin deteriorated despite higher sales and operating income, creating a key profitability risk if inflationary and start-up pressures persist.
- The effective tax rate increased primarily because of lower excess tax benefits from stock-based compensation and higher nondeductible executive compensation.
Guidance, Outlook, Risks and Unusual Items
- Capital spending: Management provided 2021 capital-expenditure guidance of $130 million to $150 million. The multi-year capacity program was projected at approximately $200 million through Q2 2021 and is expected to increase Trex Residential production capacity by approximately 70% versus 2019 volume levels.
- Liquidity outlook: Management expects cash on hand, operating cash flow and available revolving-credit capacity to fund planned capital expenditures, debt service, warranty payments and other requirements.
- COVID-19: The company reported no material disruption to operations, production, supply chain or product demand as of the filing date, but stated that the pandemic remained an evolving risk with uncertain economic effects.
- Virginia facility fire: An electrical fire occurred on March 13, 2021. No injuries were reported. Repairs were substantially completed by the end of March. Insurance coverage is available for repairs, incremental customer-service costs and lost operating income, but no insurance proceeds had been received during the quarter.
- Warranty exposure: The surface-flaking warranty reserve was $20.7 million at March 31, 2021, within a total residential warranty reserve of $29.5 million. Claims received and average cost per claim increased year over year. Management believes the reserve is adequate, but estimated a 10% change in remaining claims or settlement cost could change the surface-flaking reserve by approximately $2.1 million.
- Other risks: Key risks include raw-material availability and costs, transportation costs, labor shortages and wage inflation, capacity execution, seasonality and weather, commercial-project timing, product quality and warranty claims, competition, cybersecurity and future COVID-19 effects.
- Seasonality: Residential results are affected by weather and pre-season distributor incentives; commercial results can vary with the timing of individual projects.
Important Facts for Investors to Verify
- Whether residential demand and volume growth remain durable after the pandemic-related increase in home-improvement activity.
- Whether the Virginia and Nevada capacity expansions ramp as planned and deliver the expected production and cost benefits.
- Whether raw-material inflation, start-up costs and the Virginia fire continue to pressure gross margin.
- Whether accounts receivable and seasonal distributor inventory normalize sufficiently to restore positive operating cash flow.
- Whether commercial-project delays and lower-margin project mix continue to affect Trex Commercial profitability.
- Future surface-flaking warranty claims, settlement costs and potential changes to the $29.5 million residential warranty reserve.
- Available revolver capacity, borrowing levels and compliance with debt covenants as capital spending and share repurchases continue.
- The timing and amount of insurance recoveries related to the Virginia facility fire.