Trex Company, Inc. — 2015 First-Quarter Form 10-Q
Reporting period: Three months ended March 31, 2015; comparative period is the three months ended March 31, 2014. Trex manufactures and markets wood-alternative decking, railing, and related outdoor-living products under the Trex brand and operates in one business segment.
Financial performance and liquidity
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Net sales | $120.8 million | $100.6 million | +20.0% |
| Gross profit | $48.2 million | $38.2 million | +26.4% |
| Gross margin | 39.9% | 37.9% | +200 basis points |
| Income from operations | $27.7 million | $19.9 million | +38.7% |
| Operating margin | 22.9% | 19.8% | Improved |
| Net income | $17.6 million | $12.3 million | +42.8% |
| Diluted EPS | $0.55 | $0.37 | +48.6% |
| Net cash used in operating activities | $(81.0) million | $(82.0) million | Improved by $1.0 million |
| Capital expenditures | $9.1 million | $3.2 million | +$5.9 million |
Sales volume increased 16.0% and average price per unit increased 4.0%, reflecting market-share gains, favorable weather, price increases, and a mix shift toward higher-priced products. Gross-margin expansion was attributed primarily to cost-reduction initiatives, pricing, and product mix.
Selling, general and administrative expense increased 13.0% to $20.6 million, including $1.8 million of higher personnel-related costs and $1.6 million of increased branding expense for a new marketing campaign. SG&A declined to 17.0% of sales from 18.1%.
At March 31, 2015, cash and cash equivalents were $2.6 million, accounts receivable were $137.0 million, and total assets were $289.9 million. Accounts receivable increased substantially from $36.4 million at December 31, 2014 because distributors typically build inventory ahead of the deck-building season. Management expected substantially all outstanding receivables to be collected by mid-July 2015.
The company had $84.0 million outstanding under its revolving credit facility, approximately $66.0 million of remaining borrowing capacity, and a 1.3% interest rate. The facility permits borrowings up to $150 million from January 1 through June 30 and $100 million from July 1 through December 31, and expires November 20, 2019. Trex was in compliance with all debt covenants. Management expected cash on hand, operating cash flow, and available borrowings to fund capital expenditures, warranty payments, scheduled debt obligations, and other cash requirements.
Material changes versus the prior comparable period
- Net sales increased $20.2 million, driven by higher volume and pricing.
- Gross profit increased $10.1 million and gross margin expanded by 200 basis points.
- Operating income increased $7.7 million, while operating margin improved by approximately 310 basis points.
- Interest expense declined 57.6% to $0.1 million because of lower interest rates and lower average debt levels.
- Net cash used in operations remained substantial, primarily because of the seasonal increase in accounts receivable.
- Capital expenditures increased to $9.1 million for cost-reduction initiatives, poly-processing equipment, and adjacent land near the Winchester, Virginia facility.
- Weighted-average diluted shares declined to 32.1 million from 33.6 million, contributing to EPS growth.
Outlook, risks, contingencies, and unusual items
Management estimated 2015 capital expenditures of approximately $20 million. Seasonal working-capital borrowings were expected to be substantially repaid during the subsequent quarter as receivables were collected.
Management identified risks relating to market acceptance and competition, economic conditions, weather and seasonality, distributor inventory levels, transportation availability and costs, raw-material prices, product quality, new-product launches, and consumer-relations and product-replacement costs.
The company continues to settle warranty claims related to surface flaking in material produced at its Nevada facility before 2007. Claims received in the first quarter were higher than expected and higher than in the prior-year quarter, although management attributed some acceleration to improved weather. The surface-flaking warranty reserve was $30.1 million at March 31, 2015, and management believed it was sufficient. A 10% change in expected remaining claims or settlement cost could change the reserve by approximately $3.0 million.
Trex recorded $0.1 million of contract-termination costs related to a former headquarters lease during the quarter. The remaining lease liability was $3.0 million at March 31, 2015; future charges could increase if sublease timing or rental rates differ from estimates.
The company had $7.2 million of unrecognized stock-based compensation cost at March 31, 2015. A new revenue-recognition standard will be effective for fiscal years beginning after December 15, 2016; Trex was assessing the impact and had not selected an adoption method.
Routine lawsuits and claims were pending, but management believed their ultimate resolution would not materially affect financial condition, results, liquidity, or competitive position. Disclosure controls and procedures were deemed effective, with no material changes to internal control over financial reporting.
Key facts for investors to verify
- Whether the unusually strong first-quarter sales growth and margin expansion persist after seasonal distributor inventory purchases normalize.
- Collection of the $137.0 million accounts receivable balance and the expected repayment of seasonal borrowings.
- Compliance with revolving-credit covenants and availability under the facility as borrowing capacity declines to $100 million after June 30.
- Actual 2015 capital expenditures compared with management’s approximately $20 million estimate.
- Future surface-flaking warranty claims, reserve adequacy, and potential changes to the $30.1 million reserve.
- Distributor inventory levels and end-use demand, which the company cannot fully observe across its distribution network.
- Potential additional charges related to the former headquarters lease and sublease assumptions.