Trex Company, Inc. 10-Q Summary
Business Context and Reporting Period
Trex manufactures and markets wood-alternative composite decking, railing, porch, fencing, framing, lighting and related outdoor-living products under the Trex brand. The company operates as a single reportable segment. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2017, compared with the corresponding 2016 periods.
Key Financial Metrics
| Metric | Q2 2017 | Q2 2016 | Six Months 2017 | Six Months 2016 |
|---|---|---|---|---|
| Net sales | $157.9 million | $146.5 million | $302.7 million | $278.1 million |
| Gross profit | $72.0 million | $61.4 million | $137.2 million | $119.0 million |
| Gross margin | 45.6% | 41.9% | 45.3% | 42.8% |
| Income from operations | $44.8 million | $36.6 million | $86.7 million | $73.6 million |
| Operating margin | 28.4% | 25.0% | 28.6% | 26.5% |
| Net income | $28.8 million | $23.7 million | $56.7 million | $47.4 million |
| Diluted EPS | $0.97 | $0.80 | $1.92 | $1.60 |
| Net cash from operations | Not separately provided | Not separately provided | $0.1 million | $16.4 million |
Q2 net sales increased 7.8%, gross profit increased 17.3%, operating income increased 22.3%, and net income increased 21.3% year over year. Six-month net sales increased 8.9%, gross profit increased 15.2%, operating income increased 17.7%, and net income increased 19.6%.
Management attributed sales growth primarily to volume growth in branded decking and railing, continued remodeling-sector strength, marketing programs targeting wood-market share, and demand across the outdoor-living portfolio. Growth was partly offset by a $2.7 million reduction in recycled polyethylene film sales during the quarter.
Gross-margin expansion reflected cost-improvement initiatives, lower-cost raw materials, increased capacity utilization and reduced sales of excess polyethylene film. Q2 SG&A increased 9.8% to $27.2 million, including $1.4 million of additional branding and advertising expense and a $1.1 million write-off of research and development assets. Six-month SG&A increased 11.2% to $50.5 million.
Balance Sheet, Cash Flow, Debt and Liquidity
- Cash and cash equivalents were $8.6 million at June 30, 2017, down from $18.7 million at December 31, 2016.
- Accounts receivable increased to $129.9 million from $48.0 million, principally reflecting higher sales and seasonal distributor and dealer activity.
- Total assets were $282.5 million, compared with $221.4 million at year-end 2016. Stockholders’ equity increased to $190.7 million from $134.2 million, primarily through retained earnings.
- The company had no borrowings under its revolving credit facility and had $250 million of available borrowing capacity at June 30, 2017. The facility expires January 12, 2021, with capacity scheduled to decline to $200 million for the second half of each year.
- The company was in compliance with all debt covenants.
- Six-month operating cash flow fell to $0.1 million from $16.4 million, primarily because the increase in accounts receivable was $33.6 million greater than in the prior-year period.
- Capital expenditures were $7.1 million versus $5.2 million in the prior-year period. Management estimated full-year 2017 capital expenditures of $15 million to $20 million.
- Six-month financing cash outflow was $3.1 million, including $3.3 million of stock repurchases. The company had not repurchased shares under its February 2017 authorization for up to 2.96 million shares as of the report date.
Material Changes, Outlook and Risks
The company continued to experience strong demand for branded decking and railing and reported improved margins. However, working-capital investment in receivables materially reduced operating cash generation. Results are seasonal, and adverse weather can shift home-improvement and construction demand between periods. Distributor and dealer inventory levels can also affect future sales, although management was not aware of significant year-over-year changes at June 30, 2017.
Product warranties range from 10 to 25 years. The company continues to settle surface-flaking claims involving products manufactured at its Nevada facility before 2007. Surface-flaking claims received declined to 1,191 in the first six months of 2017 from 1,465 in the prior-year period, while the average cost per claim declined to $2,723 from $2,778. The related reserve was $31.2 million at June 30, 2017; management considered it sufficient, but estimated that a 10% change in expected claims or settlement cost could change the reserve by approximately $3.1 million.
Other disclosed risks include acceptance of new products, general economic conditions, weather-related demand fluctuations, transportation availability and costs, raw-material pricing and availability, product quality, warranty and consumer-relations costs, and intense competition. Routine litigation was not expected to have a material effect.
On July 31, 2017, after the reporting period, Trex acquired certain assets and liabilities of Staging Concepts Acquisition, LLC for $71.5 million in cash, subject to working-capital adjustment. The purchase was funded with cash on hand and the existing revolving facility. The acquired business provides commercial railing, staging, acoustical and seating systems. Its results were expected to be included beginning in the third quarter of 2017.
The company intended to adopt the new revenue-recognition standard in the first quarter of 2018, using retrospective application, and expected expanded disclosures but no material income-statement impact. It also disclosed pending standards for leases, cash-flow classification, goodwill impairment and stock-compensation modifications.
Important Facts for Investors to Verify
- Whether strong decking and railing volume growth continues after seasonal effects and distributor incentives.
- Whether the significant increase in accounts receivable converts to cash and whether operating cash flow normalizes.
- The ultimate cost and duration of the legacy surface-flaking warranty program, including the third-quarter actuarial review.
- The financing impact, purchase-price allocation and operating contribution of the $71.5 million Staging Concepts acquisition.
- Progress toward the $15 million to $20 million 2017 capital-expenditure plan and future capital-allocation priorities.
- Potential effects of raw-material costs, weather, transportation constraints, product quality and competitive conditions on margins and demand.