Trex Company, Inc. — 2016 First-Quarter Form 10-Q Summary
Business context and reporting period
Trex is a single-segment manufacturer of wood-alternative decking, railing, porch, fencing, trim, steel framing, lighting, and related outdoor-living products. The filing covers the unaudited three months ended March 31, 2016, compared with the three months ended March 31, 2015. Results are seasonal, and first-quarter results are not necessarily indicative of the full year.
Financial performance and liquidity
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Net sales | $131.7 million | $120.8 million | +9.0% |
| Gross profit | $57.6 million | $48.2 million | +19.4% |
| Gross margin | 43.8% | 39.9% | +390 bps |
| Income from operations | $37.0 million | $27.7 million | +33.9% |
| Operating margin | 28.1% | 22.9% | +520 bps |
| Net income | $23.4 million | $17.6 million | +33.3% |
| Diluted EPS | $0.78 | $0.55 | +41.8% |
| Net margin | 17.8% | 14.5% | +330 bps |
| Net cash used in operating activities | $(84.5) million | $(81.0) million | More cash used |
| Capital expenditures | $2.4 million | $9.1 million | Lower by $6.6 million |
Sales growth was driven primarily by higher decking and railing volume, customer participation in the 2016 Early Buy program, and favorable weather and economic conditions. Gross-margin expansion reflected lower raw-material costs and cost-improvement initiatives, which management said accounted for approximately half of the margin benefit.
SG&A was essentially flat at $20.6 million, declining to 15.7% of sales from 17.0%. Higher personnel and management compensation was offset by lower branding spending; management stated that the branding reduction was timing-related and expected to increase in the second quarter. Interest expense rose to $0.6 million from $0.1 million because of higher borrowings and a higher interest rate. The effective tax rate was 35.8%, compared with 36.2%.
Cash and cash equivalents were $3.8 million at March 31, 2016, compared with $6.0 million at December 31, 2015. Accounts receivable increased to $156.3 million from $47.4 million, principally reflecting seasonal sales and the Early Buy program. The resulting working-capital investment was the primary reason for negative operating cash flow.
At March 31, 2016, revolving-credit borrowings were $141.5 million, the stated interest rate was 1.585%, and approximately $108.5 million of additional borrowing capacity remained. The amended facility provides maximum capacity of $250 million from January 1 through June 30 and $200 million from July 1 through December 31, with a maturity date of January 12, 2021. The company was in compliance with all debt covenants.
Material changes versus the prior comparable period
- Net sales increased $10.9 million, or 9.0%, with volume growth in decking and railing.
- Gross profit increased $9.4 million, and gross margin improved 390 basis points.
- Operating income increased $9.4 million, while SG&A remained substantially unchanged.
- Net income increased $5.8 million; diluted EPS benefited from higher earnings and approximately 2.2 million fewer diluted weighted-average shares.
- Operating cash use increased by $3.4 million because of higher receivables and other working-capital requirements.
- The company repurchased 1,578,952 shares for $53.3 million under its October 2015 repurchase program; 1,594,527 shares were purchased in total during the quarter, including shares withheld for employee tax obligations.
- Borrowings increased substantially to support share repurchases and seasonal working capital. The company entered into an amended and expanded revolving-credit agreement in January 2016.
- In January 2016, the company sold buildings at its Olive Branch facility for approximately $4.2 million and retained approximately 62 acres of undeveloped land classified as held for sale.
Guidance, outlook, risks, contingencies, and unusual items
- Management estimated 2016 capital expenditures of approximately $25 million and expected to fund capital needs through operations and financing activities.
- Management stated that cash on hand, operating cash flow, and expected revolver availability should fund planned capital expenditures, debt service, warranty payments, and other cash requirements. Seasonal working-capital borrowings are generally expected to be repaid as receivables are collected.
- The company continues to settle surface-flaking claims related to material produced at its Nevada facility before 2007. The warranty reserve was $28.6 million at March 31, 2016, compared with $30.1 million at March 31, 2015.
- Claims received declined year over year, but the average settlement cost increased 12% to $2,803. Management stated that the reserve was sufficient, while warning that sustained higher settlement costs could require additional reserves. A 10% change in expected remaining claims or settlement cost could change the reserve by approximately $2.9 million.
- The company remains obligated under a lease for previously planned headquarters space through June 30, 2019. The recorded contract-termination liability was $1.9 million at March 31, 2016, net of expected sublease receipts.
- Routine lawsuits and claims were not expected to have a material effect on financial condition, results, liquidity, or competitive position.
- Key risks include seasonal and weather-related demand, channel inventory levels, raw-material availability and costs, transportation costs, product quality and warranty obligations, economic conditions, new-product acceptance, and competitive pressures.
- The company was assessing the future effects of new accounting standards for revenue recognition, deferred-tax classification, leases, and stock-based compensation. The filing does not provide a quantified expected impact.
Most important facts for investors to verify
- Whether seasonal receivables and the $141.5 million revolver balance normalize as the selling season progresses.
- Whether gross-margin gains from raw-material costs and efficiency initiatives are sustainable after branding spending increases.
- Actual 2016 capital expenditures versus the approximately $25 million estimate.
- Future surface-flaking claim volumes, average settlement costs, and adequacy of the $28.6 million warranty reserve.
- Compliance with revolving-credit covenants and the company’s ability to repay seasonal borrowings.
- Whether Early Buy program activity and distributor inventory levels represent durable end-market demand or primarily a timing shift.
- The eventual impact and adoption method for the pending accounting standards.