Leading wood-alternative decking manufacturer Trex Company Inc (NYSE:TREX) reported first-quarter earnings on May 7, once again delivering strong double-digit revenue and earnings growth. Sales increased 18% to $171 million while earnings were up 32% to $1.25 per share, with both numbers representing best-ever levels for the company -- something it has now achieved in each of the past five quarters. 

Trex's recent success has been driven in part by a healthy economy and strong spending for outdoor home improvement products, but it has also been a product of management's efforts to best position the company to grow market share, while also making steady investments in product improvement and manufacturing quality and efficiency. Toss in the success of its recently acquired commercial products business that's also playing a big role in driving sales and profits higher, and Trex is running on all cylinders. 

A deck built with Trex decking and railing.

Image source: Trex.

But management is convinced there's more to come. There are plans to further drive down manufacturing costs and increase throughput from the residential decking business, while also improving the profitability of the new commercial products segment. Let's take a closer look at Trex's results, as well as what management has planned for the future. 

What drove another record quarter 

Here's a closer look at Trex's results, which excited the market enough to send shares up 12% on May 8:

Metric Q1 2018 Q1 2017 Year-Over-Year Change
Net sales $171.2 $144.8 18.2%
Earnings per share $1.25 $0.95 31.6%
Gross margin percent 44.8% 45% (0.4%)
SG&A percent of sales 16.9% 16.1% (5.3%)

Net sales in millions. Data source: Trex Company Inc. 

On the top and bottom lines, Trex delivered. However, its gross margin percent declined slightly. But before simply reacting to these as "bad" results, let's dig in a little deeper. 

Trex now operates two distinct and unrelated segments -- residential products and commercial products -- and it entered the commercial segment less than one year ago. When discussing the acquisition of SC Products -- now Trex Commercial -- last August, management made it clear that this business had a different margin profile than the company's residential decking and railing business. On the earnings call, Trex CFO Bryan Fairbanks pointed out that the company's gross margin in its residential products segment -- this was the entire business in the year-ago quarter -- was 47.6%. That's a substantial increase from 45% last year, and it was almost enough to make up for the lower-margin commercial products segment. 

But with that said, the lower-margin business still made a substantial contribution to profits. Trex generated $76.7 million in gross profit in the quarter, $11.5 million higher than last year. Of that increase, $3.3 million -- or 29% -- was from the commercial products segment. 

A closer look at spending 

SG&A -- sales, general, & administrative -- expenses -- increased both in actual dollars and as a portion of revenue in the quarter. On the earnings call, Fairbanks addressed this, pointing out that $1.2 million of the SG&A spend was a non-cash amortization of intangible expenses related to the SC Product acquisition. When adjusting for this item, SG&A as a percent of sales would fall to 16.2%, slightly higher than last year's 16.1%. The company will take $1.7 million in expense in this same bucket in the third quarter, at which point it will be fully amortized. For the full year, SG&A is expected to be 17.5% of sales. 

How Trex plans to make more product at lower costs

Trex has routinely invested heavily in R&D, and that has paid off in better products and more recently in cheaper, faster manufacturing. Those manufacturing gains look primed to continue advancing, too. On the call, CEO Jim Cline said that the company is in the process of implementing the first of "at least four phases" that will further improve its manufacturing:

One of our major manufacturing cost-savings initiatives, which I mentioned last quarter, involves improvements to our production lines that will provide a step-change in the manufacturing process of our deck boards. We began implementing the first phase of these manufacturing enhancements in the first quarter of 2018. We will complete the retrofit to the remaining lines by the end of this year. In the first quarter, we utilized one of our production lines for a significant number of trials, and the results of those trials of the first phase were outstanding. When the first phase of this is completed in the fourth quarter of this year, available capacity will increase by at least 20%.

The company also plans to implement some new machinery within the next year or two that will provide further enhancements in its throughput without requiring it to add additional manufacturing lines or capacity. If demand remains strong, this can be a powerful way to continue turning incremental sales into outsize profits. 

The company is working to develop a process in which it can utilize lower-quality -- and lower-cost -- recycled poly in its decking. If it can utilize this harder-to-recycle product, it would be able to lower its sourcing costs, while also helping keep this material out of landfills. From Cline: 

But we're trying to qualify these new materials that basically nobody else wants. And what that means is, we can take materials that are lower-price and being able to use those, maybe 25% or even 50% of what our material costs would be at these lower-price items, that helps drive our overall cost profile to a lower level.

Looking ahead

A healthy economy, strong housing demand, and strong spending for outdoor projects continues to bode well for Trex's prospects, but management isn't just sitting back on its heels waiting for the business to come in. Even as the company continues to deliver record quarters, Jim Cline and his management team continue to take actions to drive out costs, improve its manufacturing processes and capacity, and to grow sales faster than its peers. And that's before factoring in rising lumber prices that make Trex an even more compelling product versus plain wood. 

Even with more than 40% of the alt-wood market, Trex still commands well under 10% of total North American decking sales (including wood) by volume. As wonderful of a run as it's been for investors over the past several years, there's still a lot of room for Trex to keep running in the years to come.

Jason Hall owns shares of Trex. The Motley Fool owns shares of and recommends Trex. The Motley Fool has a disclosure policy.