Business Context and Reporting Period
Trex Company, Inc. filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2018. The company manufactures wood-alternative decking and railing products through Trex Residential Products and, following its July 2017 acquisition of SC Company, commercial railing, staging, acoustical and seating systems through Trex Commercial Products.
Financial Performance and Liquidity
| Metric | Three Months Ended June 30 | Six Months Ended June 30 |
|---|---|---|
| Net sales | $206.7 million, up 30.9% | $377.9 million, up 24.8% |
| Gross profit | $91.1 million | $167.8 million |
| Gross margin | 44.1%, versus 45.6% | 44.4%, versus 45.3% |
| Income from operations | $57.6 million | $105.4 million |
| Net income | $42.8 million, versus $28.8 million | $79.9 million, versus $56.7 million |
| Diluted EPS | $0.73, versus $0.49 | $1.35, versus $0.96 |
| EBITDA | $62.2 million, up 28.2% | $114.7 million, up 21.8% |
Calculated operating margins were approximately 27.9% for both the quarter and six-month period. Calculated net margins were approximately 20.7% and 21.2%, respectively. Residential sales were $189.2 million in the quarter and $344.4 million year to date; Commercial sales were $17.5 million and $33.5 million, respectively.
- Six-month operating cash flow was negative $1.7 million, compared with $0.1 million provided in the prior-year period, primarily reflecting a $104.3 million increase in accounts receivable and higher working-capital needs from sales growth.
- Capital expenditures and intangible purchases totaled $17.7 million, including $6.3 million for domain names. Management estimates 2018 capital expenditures of $20 million to $25 million.
- Cash and cash equivalents were $2.9 million at June 30, 2018, compared with $30.5 million at December 31, 2017.
- The revolving credit facility had $8.5 million outstanding and $241.5 million of remaining capacity at June 30, 2018. The facility provides maximum capacity of $250 million through June 30 and $200 million from July 1 through December 31, and expires January 12, 2021. The company was in compliance with all debt covenants.
- Stockholders’ equity was $298.0 million, compared with $231.3 million at year-end 2017. The company repurchased 150,000 shares during the quarter and 250,044 shares under the 2018 repurchase program through the report date.
Material Changes Versus the Prior Comparable Period
- Residential volume growth was attributed to remodeling demand, market-share initiatives against wood products and broad demand for decking and railing. Commercial sales contributed $17.5 million of quarterly growth and $33.5 million of six-month growth, although the segment was not included in the 2017 comparable period.
- Quarterly gross margin declined 150 basis points, while six-month gross margin declined 90 basis points, primarily because of the acquired Commercial segment’s lower margins, raw-material and transportation inflation, and new-product and throughput development. Residential gross margin improved 30 basis points in the quarter and 140 basis points year to date.
- SG&A increased 23.1% in the quarter and 23.7% year to date, driven by personnel costs, branding initiatives and amortization related to the SC acquisition, but remained lower as a percentage of sales.
- The effective tax rate declined to 25.2% for the quarter and 23.7% for the six months, versus 35.4% and 34.2%, respectively, primarily because of the Tax Cuts and Jobs Act and its 21% federal statutory rate.
- The company adopted ASC Topic 606 using the full retrospective method; management reported no material impact on financial condition or results of operations.
- A two-for-one stock split was distributed June 18, 2018, and all historical share and per-share data were retroactively adjusted.
Guidance, Outlook, Risks and Unusual Items
- Management expects available cash, operating cash flow and revolver capacity to fund planned capital expenditures, warranty payments, debt service and other requirements. No revenue or earnings guidance is provided in the filing.
- Results are seasonal and sensitive to weather, residential remodeling and construction activity, distributor inventory levels, sales incentives and the timing of Commercial project work.
- Warranty reserves cover long-term product obligations, including surface-flaking claims from products manufactured at the Nevada facility before 2007. The reserve was $33.8 million at June 30, 2018, including $25.9 million for surface flaking. Surface-flaking claim receipts and average settlement costs declined year over year, but a 10% change in either key estimate could change the reserve by approximately $2.6 million.
- The Commercial segment recognizes revenue over time using cost-to-cost estimates on fixed-price contracts. Remaining performance obligations on contracts longer than one year were $42.0 million at June 30, 2018, expected to be recognized within 18 months. Contract-estimate changes, project timing and potential losses remain risks.
- Other risks include raw-material availability and pricing, transportation costs, product quality and warranty costs, competition, cybersecurity and data-privacy compliance. Routine litigation is not expected to have a material effect.
Important Facts for Investors to Verify
- Whether strong residential demand and the acquired Commercial business can offset seasonal, weather-related and project-timing volatility.
- The sustainability of margins amid raw-material, transportation and new-product costs, particularly the Commercial segment’s lower reported gross margin.
- Conversion of substantial accounts receivable into operating cash flow and the effect of working-capital requirements on liquidity.
- Compliance with revolver covenants and the company’s reliance on available borrowing capacity despite only $2.9 million of cash.
- Future warranty claims and reserve adequacy, especially after the principal summer claims season.
- Execution of the SC acquisition, including Commercial contract profitability, remaining performance obligations and amortization effects.