Trex Company, Inc. 10-Q Summary
Business Context and Reporting Period
Trex manufactures wood-alternative decking and railing products marketed under the Trex brand and operates in one business segment. This unaudited Form 10-Q covers the three and nine months ended September 30, 2014, compared with the corresponding 2013 periods.
Key Financial Metrics
| Metric | Q3 2014 | Q3 2013 | 9M 2014 | 9M 2013 |
|---|---|---|---|---|
| Net sales | $95.5 million | $72.2 million | $317.5 million | $278.7 million |
| Gross profit | $30.4 million | $0.2 million | $113.6 million | $78.9 million |
| Gross margin | 31.8% | 0.2% | 35.8% | 28.3% |
| Operating income (loss) | $14.5 million | $(15.2) million | $59.1 million | $20.3 million |
| Net income (loss) | $8.9 million | $(15.3) million | $36.4 million | $19.5 million |
| Diluted EPS | $0.28 | $(0.45) | $1.10 | $0.56 |
Q3 sales increased 32.2%, driven by a 36.1% increase in volume, partly offset by a 3.9% decline in average price per unit. Nine-month sales increased 13.9%, with volume up 17.3% and average price per unit down 3.4%.
Q3 net margin was 9.3%, compared with a 21.2% loss margin in the prior-year quarter. Nine-month net margin was 11.5%, compared with 7.0% in 2013. Selling, general and administrative expense was $15.9 million in Q3 and $54.5 million year to date; as a percentage of sales, it declined to 16.7% and 17.2%, respectively.
- Cash provided by operating activities was $45.3 million for the first nine months, versus $53.7 million in 2013.
- Capital expenditures were $8.8 million, primarily for poly-processing lines and production-line retrofits. Management estimated approximately $20 million of 2014 capital expenditures.
- Cash used in financing activities was $36.5 million, including $50.0 million of stock repurchases and $12.7 million of excess tax benefits from stock-based compensation.
- Cash and cash equivalents were $3.8 million at September 30, 2014, compared with $3.8 million at December 31, 2013.
- Accounts receivable increased to $45.0 million from $37.3 million at year-end, while inventories declined to $14.6 million from $22.4 million.
- Outstanding revolving-credit borrowings were $3.0 million, with approximately $63 million of remaining borrowing capacity. The stated interest rate was 1.9%, and the company was in compliance with all debt covenants.
Material Changes Versus the Prior Comparable Period
- Profitability improved substantially, primarily because the third quarter and first nine months of 2013 included a $20.0 million increase to the surface-flaking warranty reserve. Excluding that charge, Q3 2014 gross margin was 31.8% versus 27.9%, and nine-month gross margin was 35.8% versus 35.5%.
- Manufacturing efficiencies, capacity utilization and sales mix supported margins, while the revamped pricing strategy reduced average selling prices.
- Nine-month SG&A declined $4.1 million, reflecting lower class-action litigation costs, reduced branding spending and lower incentive compensation.
- The effective tax rate increased to 37.6% from 1.5% for the first nine months, primarily because the prior-year valuation allowance substantially offset tax expense. The company recorded $21.9 million of tax expense in 2014 versus $0.3 million in 2013.
- The company completed a $50.0 million stock-repurchase authorization during the second quarter and held 2.8 million treasury shares at September 30, versus 1.1 million at December 31, 2013. A new authorization for up to two million shares was approved on October 23, 2014.
- A two-for-one stock split was distributed on May 7, 2014; historical share and per-share data are presented on a post-split basis.
Guidance, Outlook, Risks and Unusual Items
The filing does not provide specific revenue or earnings guidance. Management characterized 2014 sales as record-setting for both the third quarter and first nine months and expected cash on hand, operating cash flow and revolver availability to fund capital expenditures, warranty payments and other requirements.
- Demand is seasonal, with historically lower fourth-quarter sales because of holidays and adverse weather. Distributor inventory levels are difficult to determine and could affect future sales if they change without corresponding end-user demand.
- The company continues to settle surface-flaking claims related to material produced at its Nevada facility before 2007. The warranty reserve was $33.7 million at September 30, 2014. Claims received were below expectations, but average cost per claim was higher; management stated that the reserve remained sufficient. A 10% change in expected claims or settlement cost could change the reserve by approximately $3.4 million.
- The company recorded a $1.0 million charge during the first nine months for higher estimated losses on a former headquarters lease and sublease arrangement. The remaining lease runs through June 2019, and future charges could increase if subleases are not renewed or achieved at expected rates.
- Remaining payments under the previously settled product-defect class action are expected not to exceed approximately $1.0 million; the company previously paid $1.8 million for related attorneys’ fees, plaintiff awards and corollary settlements.
- The revolving-credit facility’s maximum amount reverted to $100 million on July 1, 2014. Its termination date was subsequently extended to January 9, 2016 under an October 23, 2014 letter agreement.
- Key risks include economic and weather-sensitive demand, raw-material costs and availability, competitive pressures, product quality, warranty and consumer-relations costs, and acceptance of new products.
Important Facts for Investors to Verify
- Assess the sustainability of the sharp margin and earnings improvement after excluding the prior-year $20.0 million warranty-reserve charge.
- Monitor surface-flaking claims, reserve adequacy and the potential sensitivity of the reserve to claim frequency and settlement costs.
- Verify that receivable collection, seasonal demand and distributor inventory trends support reported sales growth.
- Review cash conversion, tax payments and the effect of stock repurchases on liquidity and share count.
- Confirm available revolver capacity, borrowing-base restrictions, covenant compliance and the January 2016 facility maturity.
- Evaluate potential future charges from the former headquarters lease and sublease shortfall.