Trex Company, Inc. — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2017. Trex manufactures wood-alternative decking, railing and related outdoor-living products. Following the July 31, 2017 acquisition of certain assets and liabilities of Staging Concepts Acquisition, LLC, the Company operates through Residential Products and Commercial Products segments.
Financial performance and liquidity
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Net sales | $140.2 million | $106.2 million | $442.9 million | $384.3 million |
| Gross profit | $55.3 million | $29.9 million | $192.5 million | $149.0 million |
| Gross margin | 39.4% | 28.2% | 43.5% | 38.8% |
| Income from operations | $30.4 million | $10.6 million | $117.1 million | $84.2 million |
| Net income | $20.1 million | $7.8 million | $76.8 million | $55.2 million |
| Diluted EPS | $0.68 | $0.26 | $2.60 | $1.86 |
| Operating cash flow | Not provided for the quarter | Not provided for the quarter | $92.8 million | $83.6 million |
- Q3 sales increased 32.0%; nine-month sales increased 15.3%. Residential sales rose 23.4% in Q3 and 12.9% for the nine-month period. Commercial Products contributed $9.2 million of Q3 and nine-month sales from the acquisition date.
- Q3 operating margin was approximately 21.7% and nine-month operating margin was approximately 26.4%. Net margins were approximately 14.3% and 17.3%, respectively.
- Q3 EBITDA was $34.9 million versus $14.0 million; nine-month EBITDA was $129.0 million versus $94.8 million. Excluding the $9.8 million surface-flaking warranty charge recorded in Q3 2016, Q3 EBITDA increased 46.5% and nine-month EBITDA increased 23.3%.
- Cash and cash equivalents were $25.5 million at September 30, 2017, compared with $18.7 million at December 31, 2016. Current assets were $132.9 million and current liabilities were $66.3 million.
- Capital expenditures were $11.1 million for the nine months. Investing cash outflows were $82.6 million, including $71.5 million for the acquisition.
- The Company had no borrowings outstanding under its revolving credit facility and $200 million of remaining availability. The facility matures January 12, 2021, and all debt covenants were satisfied at quarter-end.
Material changes versus the prior comparable period
- Residential volume growth reflected continued remodeling demand, marketing intended to gain share from wood, and demand across decking and railing products.
- Gross margin improved materially. The comparison benefited from the $9.8 million surface-flaking warranty reserve increase recorded in Q3 2016; excluding that item, management reported a 2.0 percentage-point Q3 margin improvement and a 2.2 percentage-point nine-month improvement.
- Underlying residential margin benefited from cost-reduction initiatives, lower-cost raw materials, increased capacity utilization and lower sales of excess polyethylene film.
- SG&A increased 28.6% in Q3 and 16.4% for the nine months, driven by acquisition-related costs, higher incentive compensation, marketing and advertising, research and development, and a $1.5 million write-off of research and development and other assets during the nine-month period.
- The effective tax rate was 33.7% in Q3 versus 25.8% in Q3 2016, and 34.1% for nine months versus 33.5%. The change primarily reflected lower excess tax benefits from stock-based compensation.
- The SC Company acquisition added $57.9 million of preliminary goodwill and $4.9 million of intangible assets. Commercial Products generated a $75 thousand net loss from acquisition through September 30, 2017.
Outlook, risks and unusual items
- Management estimated 2017 capital expenditures of $15 million to $20 million and stated that cash on hand, operating cash flow and available revolver capacity should fund planned expenditures, warranty payments and other requirements.
- The filing does not provide formal revenue or earnings guidance.
- Results are seasonal and can be affected by weather, home-improvement and construction activity, distributor inventory levels, promotional timing and transportation availability.
- Surface-flaking warranty claims relate primarily to products manufactured at the Nevada facility before 2007. The warranty reserve for these claims was $29.4 million at September 30, 2017, with $4.4 million of settlements paid during the first nine months. A 10% change in estimated remaining claims or settlement cost could change the reserve by approximately $2.9 million.
- Commercial Products recognizes revenue using the percentage-of-completion method. Changes in estimated contract costs, performance or profitability could affect reported revenue and earnings.
- The acquisition purchase price and allocation remained preliminary and were subject to final working-capital adjustments and valuation completion. Goodwill was $68.5 million at September 30, 2017.
- The Company planned to adopt the new revenue-recognition standard in the first quarter of 2018 and was still evaluating its effect on the Commercial Products segment. It expected expanded disclosures, but stated that the impact on Residential Products was not expected to be significant.
- Routine litigation and claims were not expected by management to have a material effect. Internal control over financial reporting excluded the newly acquired subsidiary from the September 30 assessment; disclosure controls were deemed effective.
Most important facts to verify
- Final purchase price and purchase-accounting allocation for the SC Company acquisition, including goodwill and intangible-asset amortization.
- Commercial Products’ post-acquisition revenue, margins, contract backlog and profitability as a full reporting period develops.
- Actual surface-flaking warranty claims, settlement costs and adequacy of the $29.4 million reserve.
- Distributor and retailer inventory levels, seasonal demand and the sustainability of residential volume growth.
- Progress and final accounting effects of adopting the revenue-recognition and lease standards.
- Achievement of the $15 million to $20 million capital-expenditure estimate and continued compliance with revolving-credit covenants.