Trex Company, Inc. — 2015 Form 10-K Summary
Business context and reporting period
Trex manufactures wood-alternative decking, railing and related outdoor-living products in the United States and operates as a single reportable segment. Products primarily combine reclaimed wood fiber and scrap polyethylene. The filing covers the fiscal year ended December 31, 2015, with comparable annual data for 2014 and 2013. The filing is an annual report, not a quarterly filing, although it includes unaudited fourth-quarter results.
Financial performance and position
| Metric | 2015 | 2014 | Change |
|---|---|---|---|
| Net sales | $440.8 million | $391.7 million | 12.5% increase |
| Gross profit | $154.9 million | $140.2 million | 10.5% increase |
| Gross margin | 35.1% | 35.8% | Down 70 basis points |
| Income from operations | $77.4 million | $67.8 million | 14.1% increase |
| Operating margin | 17.6% | 17.3% | Improved |
| Net income | $48.1 million | $41.5 million | 15.8% increase |
| Diluted EPS | $1.52 | $1.27 | 19.7% increase |
| Cash from operations | $62.6 million | $58.6 million | 6.8% increase |
| Capital expenditures | $23.3 million | $13.0 million | Approximately 80% increase |
| EBITDA | $91.7 million | $82.7 million | 10.9% increase |
Net margin was approximately 10.9% in 2015, compared with approximately 10.6% in 2014. EBITDA margin was approximately 20.8%. EBITDA is a non-GAAP measure and should not be treated as a substitute for GAAP income or operating cash flow.
- Sales volume increased 10.4%, while average price per linear foot increased 2.0%, reflecting a decking price increase and product mix.
- SG&A increased 7.0% to $77.5 million, but declined to 17.6% of sales from 18.5%. Higher personnel and branding costs were partly offset by increased sublease receipts and other cost reductions.
- The effective tax rate was 37.4%, compared with 38.0% in 2014.
- Year-end cash and cash equivalents were $6.0 million, down from $9.5 million. Working capital increased to $38.6 million from $35.8 million.
- Total assets were $212.0 million and stockholders’ equity was $116.5 million at December 31, 2015.
- Year-end debt was $7.0 million under the revolving credit facility, compared with no debt at year-end 2014. Approximately $93.0 million of borrowing capacity remained available under the then-current facility.
- The company repurchased $45.2 million of common stock during 2015, or approximately 1.13 million shares, and had $120.2 million of cumulative repurchases over the three years ended December 31, 2015.
Material changes versus the prior comparable period
- Net sales reached the highest annual level in company history, driven primarily by market share gains and stronger demand for wood-alternative products.
- Underlying gross margin excluding the $7.8 million warranty-reserve increase improved by approximately 110 basis points; reported gross margin declined because of the reserve adjustment.
- Operating cash flow increased by $4.0 million despite approximately $7.2 million of cash payments for surface-flaking warranty claims.
- Capital spending increased substantially, including investment in three additional specialty-material manufacturing lines, a Fernley reprocessing line, manufacturing productivity, and land adjacent to the Winchester facility.
- Specialty-material operations remained in the early stages of market penetration; the company added three lines during 2015 after commencing initial production in 2014.
- Outstanding shares declined as a result of repurchases, contributing to higher per-share earnings.
Outlook, risks, contingencies and unusual items
- Management estimated 2016 capital expenditures of approximately $25 million, principally for cost reduction, new product launches, adjacent categories and general business support.
- Management stated that cash on hand, operating cash flow and expected revolving-credit borrowings should fund planned capital expenditures, warranty payments, scheduled debt service and other requirements for at least the next 12 months.
- On January 12, 2016, the company entered into a new revolving credit agreement expiring January 12, 2021, with capacity of $250 million from January through June and $200 million from July through December.
- The company was in compliance with its debt covenants at December 31, 2015. Key requirements included a fixed-charge coverage ratio of at least 1.5 to 1.0 and a consolidated debt-to-EBITDA ratio no higher than 3.0 to 1.0.
- The principal unusual charge was a $7.8 million pre-tax increase in the warranty reserve, including a $5.4 million increase related to pre-2007 surface flaking claims from the Nevada facility. The ending surface-flaking reserve was $29.7 million, and the total warranty reserve was $33.5 million.
- Management believed the warranty reserve was sufficient, but a 10% change in estimated remaining claims or claim costs could change the reserve by approximately $3.0 million.
- Fourth-quarter and full-year results are seasonal, with lower fourth-quarter demand typically caused by holidays and adverse weather. Fourth-quarter 2015 net sales were $89.2 million and net income was $8.1 million, compared with $74.2 million and $5.2 million, respectively, in fourth-quarter 2014.
- Customer concentration is significant: one customer represented approximately 27% of 2015 net sales, and the 15 largest customers represented approximately 89% of gross sales.
- Key risks include competition from wood and other composite products, raw-material availability and pricing, customer and distribution-channel concentration, weather and economic sensitivity, transportation availability and costs, product-quality claims, inventory build-ups, and debt-covenant compliance.
- The company recorded a $0.5 million loss on assets held for sale related to the idle Olive Branch, Mississippi facility and a $0.2 million increase in estimated contract-termination costs related to an unused headquarters lease.
- Ernst & Young issued unqualified opinions on the consolidated financial statements and internal control over financial reporting. Management concluded that disclosure controls and internal controls were effective as of December 31, 2015.
Important facts for investors to verify
- Reconcile reported gross-margin performance with the $7.8 million warranty-reserve charge and assess the remaining exposure to surface-flaking claims.
- Review the January 2016 refinancing, borrowing-base terms, interest-rate margins, collateral and covenant requirements.
- Assess whether specialty-material investments and the estimated $25 million of 2016 capital expenditures generate sufficient returns.
- Monitor customer concentration, particularly the customer contributing approximately 27% of 2015 net sales and the dependence on major distributors and retailers.
- Evaluate the sustainability of sales growth, price increases and market-share gains in a seasonal and economically sensitive housing and remodeling market.
- Review contractual obligations of $95.5 million, including $31.7 million of purchase commitments and $63.8 million of operating-lease payments.
- Confirm the accounting and expected proceeds for the Olive Branch assets held for sale and the remaining unused headquarters lease obligations.