Trex Company, Inc. 10-Q Summary
Business Context and Reporting Period
Trex manufactures wood-alternative decking, railing, porch, fencing, lighting, framing and trim products under the Trex brand. The company operates in one business segment. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2014, compared with the corresponding 2013 periods.
Key Financial Metrics
| Metric | Q2 2014 | Q2 2013 | Six Months 2014 | Six Months 2013 |
|---|---|---|---|---|
| Net sales | $121.3 million | $98.6 million | $222.0 million | $206.4 million |
| Gross profit | $45.0 million | $36.9 million | $83.2 million | $78.8 million |
| Gross margin | 37.1% | 37.5% | 37.5% | 38.2% |
| Income from operations | $24.7 million | $13.5 million | $44.6 million | $35.5 million |
| Net income | $15.2 million | $13.2 million | $27.5 million | $34.8 million |
| Diluted EPS | $0.46 | $0.38 | $0.82 | $1.00 |
Q2 sales increased 23.0%, driven by a 30.3% increase in volume, partly offset by a 5.5% decrease in average price per unit. Six-month sales increased 7.6%, reflecting an 11.0% volume increase and a 3.1% decline in average price per unit.
As of June 30, 2014, cash and cash equivalents were $5.6 million, accounts receivable were $60.1 million, inventories were $21.1 million and total assets were $211.8 million. Current liabilities were $83.6 million, including $35.0 million drawn on the revolving credit facility. Total liabilities were $115.0 million and stockholders’ equity was $96.7 million.
Operating cash flow for the first six months was $11.5 million, versus $23.1 million in 2013. Investing cash flow was negative $4.9 million, including $4.9 million of capital expenditures. Financing cash flow was negative $4.8 million after $52.9 million of share repurchases, $35.0 million of net revolver borrowings and $12.5 million of excess tax benefits from stock compensation. Year-to-date capital expenditures were $4.9 million; management estimated approximately $20 million for full-year 2014.
Material Changes Versus the Prior Comparable Period
- Operating income increased 82.4% in Q2 and 25.5% for the six-month period, helped by higher sales and lower selling, general and administrative expenses.
- Gross margin declined by 0.4 percentage points in Q2 and 0.7 percentage points year to date, primarily because of a revised pricing strategy, partly offset by manufacturing efficiencies.
- SG&A declined 13.2% in Q2 and 10.6% year to date. The decreases reflected lower legal costs, branding expenditures and incentive compensation. The 2013 period included approximately $1.7 million of Q2 and $1.9 million of year-to-date non-recurring mold-related litigation costs.
- Net income declined 21.1% year to date despite higher operating income because the effective tax rate rose to 37.6% from 1.0%. The 2013 rate benefited from a valuation allowance on deferred tax assets; the company reversed most of that allowance at December 31, 2013.
- The company repurchased 1.66 million shares for $50.0 million during Q2, completing its February 2014 repurchase authorization. Shares and per-share data reflect a two-for-one stock split distributed May 7, 2014.
- Debt increased from zero at December 31, 2013 to $35.0 million at June 30, 2014, primarily to help fund the share repurchase. Approximately $49.0 million of borrowing capacity remained available.
Guidance, Outlook, Risks and Unusual Items
- Management expected cash on hand, operating cash flow and available revolver capacity to fund capital expenditures, debt service, warranty payments and other requirements. No revenue or earnings guidance was provided in the filing.
- Demand is seasonal, with historically lower fourth-quarter sales because of holidays and adverse weather. Q2 benefited from a weather-delayed start to the 2014 deck-building season and stronger dealer demand.
- Surface-flaking warranty claims relate to material produced at the Nevada facility before 2007. The warranty reserve was $36.0 million at June 30, 2014, with total accrued warranty liabilities of $37.9 million. Claims received were below expectations, but average cost per claim was higher than expected. Management believed the reserve was adequate, but a 10% change in projected claim volume or settlement cost could change the reserve by approximately $3.6 million.
- The company recorded a $0.7 million SG&A charge for increased estimated shortfall on a headquarters lease that runs through June 2019. Future charges could increase if sublease timing or rental rates are less favorable than estimated.
- Remaining consumer relief under a settled mold, fading and color-variation class action was expected not to exceed $1.0 million, in addition to $1.7 million previously paid for legal fees and plaintiff awards. Other litigation was described as routine and not expected to be material.
- The company’s ability to borrow depends on a borrowing base and compliance with financial covenants. It was in compliance at June 30, 2014; a covenant breach could permit lenders to accelerate repayment.
- The company cited risks involving market acceptance, economic conditions, weather, raw-material costs, product quality, warranty and consumer-relations costs, competition and distribution-channel inventory levels.
Important Facts for Investors to Verify
- Whether volume growth and dealer demand continue after the weather-related Q2 benefit and whether the lower pricing strategy sustains market share and profitability.
- The effect of the substantially higher effective tax rate on full-year earnings and cash taxes.
- Warranty claim trends, average settlement costs and the adequacy of the $36.0 million surface-flaking reserve.
- Revolver availability, borrowing-base capacity, interest rates and ongoing covenant compliance following the $50.0 million repurchase.
- Whether capital expenditures approach the estimated $20 million for 2014 and remain adequately funded by operations.
- Potential future charges associated with the headquarters lease and any remaining class-action settlement obligations.