This management's discussion and analysis contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements regarding our expected financial position and operating results, our business strategy, our financing plans, forecasted demographic and economic trends relating to our industry and similar matters are forward-looking statements. These statements can sometimes be identified by our use of forward-looking words such as "may," "will," "anticipate," "estimate," "expect," "intend" or similar expressions. We cannot promise you that our expectations in such forward-looking statements will turn out to be correct. Our actual results could be materially different from our expectations because of various factors, including the factors discussed under "Item 1A. Risk Factors." These statements are also subject to risks and uncertainties that could cause the Company's actual operating results to differ materially. Such risks and uncertainties include, but are not limited to, the extent of market acceptance of the Company's current and newly developed products; the costs associated with the development and launch of new products and the market acceptance of such new products; the sensitivity of the Company's business to general economic conditions; the impact of seasonal and weather-related demand fluctuations on inventory levels in the distribution channel and sales of the Company's products; the availability and cost of third-party transportation services for our products and raw materials; the Company's ability to obtain raw materials at acceptable prices; the Company's ability to maintain product quality and product performance at an acceptable cost; the Company's ability to increase throughput and capacity to adequately match supply with demand; the level of expenses associated with product replacement and consumer relations expenses related to product quality; the highly competitive markets in which the Company operates; cyber-attacks, security breaches or other security vulnerabilities; and the impact of upcoming data privacy laws and the EU General Data Protection Regulation and the related actual or potential costs and consequences. OVERVIEW General.Trex Company, Inc. currently operates in two reportable segments: Trex Residential Products (Trex Residential) andTrex Commercial Products (Trex Commercial). The Company is focused on using renewable resources within both our Trex Residential and Trex Commercial segments. Trex Residential is the world's largest manufacturer of wood-alternative composite decking and railing products marketed under the brand name Trex ® and manufactured inthe United States . We offer a comprehensive set of aesthetically pleasing, high-performance, low maintenance, eco-friendly products in the decking, railing, fencing, steel deck framing and outdoor lighting categories. We believe that the range and variety of our products allow consumers to design much of their outdoor living space using Trex brand products. We offer the following composite decking and railing products through Trex Residential: Decking and Accessories Trex Transcend ® decking Trex Enhance ® decking Trex Select ® decking Trex Hideaway ® hidden fastening system Trex DeckLighting ™ outdoor lighting system Railing Trex Transcend Railing Trex Signature ® aluminum railing Trex Select Railing Trex Enhance Railing Fencing Trex Seclusions ® Steel Deck Framing System Trex Elevations ® 25
-------------------------------------------------------------------------------- Table of Contents Trex Commercial is a leading national provider of custom-engineered railing and staging systems. We offer modular and architectural railing and staging systems and solutions for the commercial and multifamily market, including sports stadiums and performing arts venues through Trex Commercial. Highlights related to the twelve months endedDecember 31, 2019 include:
• Increase in net sales of 9%, or
twelve months ended
twelve months ended
of any year in our history.
• Trex Residential net sales increased
to 2018, and were the highest of any year in our history.
• Increase in gross profit of 4%, or
the twelve months ended
the twelve months ended
• Increase in net income to
any year in our history.
• Cash flows from operating activities were
months ended
months ended
• New capital expenditure program to increase production capacity at the
Trex Residential facilities inVirginia andNevada and projected at approximately$200 million in the aggregate by 2021.
• Repurchase of 500,059 shares of our outstanding common stock under our
Stock Repurchase Program in 2019, for a total of 959,380 shares
repurchased under the program to date.
Business Acquisition. OnJuly 31, 2017 , through our wholly-owned subsidiary,Trex Commercial Products, Inc. , we entered into a definitive agreement withStaging Concepts Acquisition, LLC (SC Company ) and on that date acquired certain assets and liabilities ofSC Company for$71.8 million in cash. The acquisition provides us with the opportunity to offer full service railing systems in the growing commercial and multi-family markets, access to a complementary product category with a track record of substantial revenue growth, the ability to achieve economies of scale around raw material procurement, and an increase in the range of products the Company may offer its core customers. The Consolidated Financial Statements include the accounts ofTrex Commercial Products, Inc. from the date of acquisition.Net Sales . Net sales consist of sales and freight, net of returns and discounts. The level of net sales is principally affected by sales volume and the prices paid for Trex products. The operating results for Trex Residential have historically varied from quarter to quarter, often due to seasonal trends in the demand for outdoor living products. Seasonal, erratic or prolonged adverse weather conditions in certain geographic regions reduce the level of home improvement and construction activity and can shift demand for its products to a later period. As part of its normal business practice and consistent with industry practices, Trex Residential has historically offered incentive programs to its distributors and dealers to build inventory levels before the start of the prime deck-building season to ensure adequate availability of its product to meet anticipated seasonal consumer demand and to enable production planning. These incentives include prompt payment discounts and favorable payment terms. In addition, we offer price discounts or volume rebates on specified products and other incentives based on increases in purchases as part of specific promotional programs. The timing of sales incentive programs can significantly impact sales, receivables and inventory levels during the offering period. However, the timing and terms of the majority of our programs are generally consistent from year to year. In addition, the operating results for Trex Commercial have not historically varied from quarter to quarter as a result of seasonality, but are driven by the timing of individual projects, which may vary significantly each period. Gross Profit. Gross profit represents the difference between net sales and cost of sales. Cost of sales consists of raw materials costs, direct labor costs, manufacturing costs, warranty costs, and freight. Raw materials costs generally include the costs to purchase and transport reclaimed wood fiber, scrap polyethylene and pigmentation 26 -------------------------------------------------------------------------------- Table of Contents for coloring Trex products. Direct labor costs include wages and benefits of personnel engaged in the manufacturing process. Manufacturing costs consist of costs of depreciation, utilities, maintenance supplies and repairs, indirect labor, including wages and benefits, and warehouse and equipment rental activities. Selling, General and Administrative Expenses. The largest component of selling, general and administrative expenses is personnel related costs, which include salaries, commissions, incentive compensation, and benefits of personnel engaged in sales and marketing, accounting, information technology, corporate operations, research and development, and other business functions. Another component of selling, general and administrative expenses is branding and other sales and marketing costs, which are used to build brand awareness of Trex. These costs consist primarily of advertising, merchandising, and other promotional costs. Other general and administrative expenses include professional fees, office occupancy costs attributable to the business functions previously referenced, and consumer relations expenses. As a percentage of net sales, selling, general and administrative expenses have varied from quarter to quarter due, in part, to the seasonality of our business. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Our significant accounting policies are described in Note 2 to our Consolidated Financial Statements appearing elsewhere in this report. Our critical accounting estimates include the areas where we have made what we consider to be particularly difficult, subjective or complex judgments in making estimates, and where these estimates can significantly affect our financial results under different assumptions and conditions. We prepare our financial statements in conformity with accounting principles generally accepted inthe United States . As a result, we are required to make estimates, judgments and assumptions that we believe are reasonable based upon the information available. These estimates, judgments and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the periods presented. Actual results could be different from these estimates. Product Warranty. We warrant that our Trex Residential products will be free from material defects in workmanship and materials. Generally, this warranty period is 25 years for residential use and 10 years for commercial use, excluding Trex Signature ® Railing, which has a warranty period of 25 years for both residential and commercial use. We further warrant that Trex Transcend, Trex Enhance, Trex Select and Universal Fascia products will not fade in color more than a certain amount and will be resistant to permanent staining from food substances or mold, provided the stain is cleaned within seven days of appearance. This warranty extends for a period of 25 years for residential use and 10 years for commercial use. If there is a breach of such warranties, we have an obligation either to replace the defective product or refund the purchase price. Depending on the product and its use, the Company also warrants its Trex Commercial products will be free of manufacturing defects for one to three years. We continue to receive and settle claims for Trex Residential products manufactured at ourNevada facility prior to 2007 that exhibit surface flaking and maintain a warranty reserve to provide for the settlement of these claims. Estimating the warranty reserve for surface flaking claims requires management to estimate (1) the number of claims to be settled with payment and (2) the average cost to settle each claim. To estimate the number of claims to be settled with payment, we utilize actuarial techniques to quantify both the expected number of claims to be received and the percentage of those claims that will ultimately require payment (collectively, elements). Estimates for these elements are quantified using a range of assumptions derived from claim count history and the identification of factors influencing the claim counts. The number of claims received has declined each year since peaking in 2009. The cost per claim varies due to a number of factors, including the size of affected decks, the availability and type of replacement material used, the cost of production of replacement material and the method of claim settlement. We monitor surface flaking claims activity each quarter for indications that our estimates require revision. Typically, a majority of surface flaking claims received in a year are received during the summer outdoor season, 27 -------------------------------------------------------------------------------- Table of Contents which spans the second and third quarters. It has been our practice to utilize the actuarial techniques discussed above during the third quarter, after a significant portion of all claims has been received for the fiscal year and variances to annual claims expectations are more meaningful. The number of incoming claims received in the year endedDecember 31, 2019 , was slightly lower than our expectations for 2019 and the number of claims received in the year endedDecember 31, 2018 , continuing the historical year-over-year decline in incoming claims. Average settlement cost per claim experienced in 2019 was considerably higher than our expectations for 2019 and the average settlement cost per claim experienced in 2018 due to an increase in larger claims settled and changes in the mix of settlement methods. We believe our reserve atDecember 31, 2019 is sufficient to cover future surface flaking obligations and no adjustments were required in the current year. Our analysis is based on currently known facts and a number of assumptions, as discussed above, and current expectations. Projecting future events such as the number of claims to be received, the number of claims that will require payment and the average cost of claims could cause the actual warranty liabilities to be higher or lower than those projected, which could materially affect our financial condition, results of operations or cash flows. We estimate that the annual number of claims received will continue to decline over time and that the average cost per claim will increase slightly, primarily due to inflation. If the level of claims received or average cost per claim differs materially from expectations, it could result in additional increases or decreases to the warranty reserve and a decrease or increase in earnings and cash flows in future periods. We estimate that a 10% change in the expected number of remaining claims to be settled with payment or the expected cost to settle claims may result in approximately a$1.9 million change in the surface flaking warranty reserve. The following table details surface flaking claims activity related to our residential product warranty: Year Ended December 31, 2019 2018 2017
Claims unresolved beginning of period 2,021 2,306 2,755 Claims received (1)
1,394 1,481 2,250 Claims resolved (2) (1,691 ) (1,766 ) (2,699 ) Claims unresolved end of period 1,724 2,021 2,306 Average cost per claim (3)$ 3,447 $ 2,631 $ 2,546
(1) Claims received include new claims received or identified during the period.
(2) Claims resolved include all claims settled with or without payment and closed
during the period.
(3) Average cost per claim represents the average settlement cost of claims
closed with payment during the period.
For additional information about product warranties, see Notes 2 and 19 to the Consolidated Financial Statements appearing elsewhere in this report.Goodwill . The Company evaluates the recoverability of goodwill in accordance with Accounting Standard Codification Topic 350, " Intangibles-Goodwill and Other ," annually or more frequently if an event occurs or circumstances change in the interim that would more likely than not reduce the fair value of the asset below its carrying amount.Goodwill is considered to be impaired when the net book value of the reporting unit exceeds its estimated fair value. The Company first assesses qualitative factors to determine if it is more likely than not that the fair value of the reporting unit is less than its carrying amount to determine if it should proceed with the evaluation of goodwill for impairment. If the Company proceeds with the two-step impairment test, the Company first compares the fair value of the reporting unit to its carrying value. If the carrying value of a reporting unit exceeds its fair value, the goodwill of that reporting unit is potentially impaired and step two of the impairment analysis is performed. In step two of the analysis, an impairment loss is recorded equal to the excess of the carrying value of the reporting unit's goodwill over its implied fair value should such a circumstance arise. The Company measures fair value of the reporting unit based on a present value of future discounted cash flows and a market valuation approach. 28 -------------------------------------------------------------------------------- Table of Contents Revenue Recognition EffectiveJanuary 1, 2018 , we adopted the requirements of Financial Accounting Standards Board Accounting Standards Update 2014-09, "Revenue from Contracts with Customers" (Topic 606) . We determined the appropriate revenue recognition for our contracts with customers by analyzing the type, terms and conditions of our contracts with our customers. Topic 606 provides a single, comprehensive model for revenue recognition arising from contracts with customers. A performance obligation is a promise in a contract to transfer a distinct good or service to the customer and is the unit of account in Topic 606. A contract's transaction price is allocated to each distinct performance obligation and revenue is recognized when or as the Company satisfies the performance obligation. Revenue is recognized at an amount that reflects the consideration to which the entity expects to be entitled in exchange for transferring control of the goods or services to a customer. Adoption of Topic 606 did not have an impact on the Company's financial condition or results of operations. The following provides additional information about our contracts with customers. Trex Residential Products Trex Residential principally generates revenue from the manufacture and sale of its high-performance, low-maintenance, eco-friendly composite decking and railing products and accessories. Substantially all of its revenues are from contracts with customers, which are individual customer purchase orders of short-term duration of less than one year. Trex Residential satisfies its performance obligations at a point in time. The shipment of each product is a separate performance obligation as the customer is able to derive benefit from each product shipped and no performance obligation remains after shipment. Upon shipment of the product, the customer obtains control over the distinct product and Trex Residential satisfies its performance obligation. Any performance obligation that remains unsatisfied at the end of a reporting period is part of a contract that has an original expected duration of one year or less. Any variable consideration related to the unsatisfied performance obligation is allocated wholly to the unsatisfied performance obligation and recognized when the product ships and the performance obligation is satisfied.Trex Commercial Products Trex Commercial generates revenue from the manufacture and sale of its modular and architectural railing and staging systems. All of its revenues are from fixed-price contracts with customers. Trex Commercial contracts have a single performance obligation as the promise to transfer the individual goods or services is not separately identifiable from other promises in the contract and is, therefore, not distinct. Trex Commercial satisfies its performance obligation over time as work progresses because control is transferred continuously to its customers. Revenue and estimated profit is recognized over time based on the proportion of actual costs incurred to date relative to total estimated costs at completion to measure progress toward satisfying the performance obligation. Incurred costs represent work performed, which corresponds with, and thereby best depicts, the transfer of control to the customer. Incurred costs include all direct material, labor, subcontract and certain indirect costs. The Company reviews and updates its estimates regularly and recognizes adjustments in estimated profit on contracts under the cumulative catch-up method. Under this method, the impact of the adjustment on revenue and estimated profit to date on a contract is recognized in the period the adjustment is identified. Revenues and profits in future periods are recognized using the adjusted estimate. If at any time the estimate of contract profitability indicates an anticipated loss on the contract, the Company recognizes the total loss in the period it is identified. During the year endedDecember 31, 2019 , no adjustment to any one contract was material to the Company's Consolidated Financial Statements and no material impairment loss on any contract was recorded. RESULTS OF OPERATIONS Below we have included a discussion of our operating results and material changes in our operating results for the year endedDecember 31, 2019 compared to the year endedDecember 31, 2018 . 29
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Table of Contents Year EndedDecember 31, 2019 Compared To Year EndedDecember 31, 2018 Net Sales Year Ended December 31, 2019 2018 $ Change % Change (dollars in thousands) Total net sales$ 745,347 $ 684,250 $ 61,097 8.9 % Trex Residential net sales$ 694,267 $ 613,229 $ 81,038 13.2 % Trex Commercial net sales$ 51,080 $ 71,021 $ (19,941 ) (28.1 )% The 9% increase in total net sales in 2019 compared to 2018 was primarily due to an increase in net sales of 13% at Trex Residential, offset by a 28% decrease in Trex Commercial net sales. The primary driver of Trex Residential net sales was increased volume growth. Through the first quarter of 2019, and to a much lesser extent in the second and third quarters of 2019, Trex Residential net sales were constrained due to supply issues primarily caused by new product startup inefficiencies related to our new Enhance decking product. These inefficiencies resulted in lower throughput than was needed to support market demand. Net sales in 2018 were impacted by a$6 million unfavorable charge related to expanded stocking positions in all residential sales channels. Excluding this impact, Trex Residential net sales increased by 12%. Trex Commercial net sales decreased mainly due to fewer large projects compared to the period of strong, large project completions experienced in 2018. Gross Profit Year Ended December 31, 2019 2018 $ Change % Change (dollars in thousands) Cost of sales$ 438,844 $ 389,356 $ 49,488 12.7 % % of total net sales 58.9 % 56.9 % Gross profit$ 306,503 $ 294,894 $ 11,609 3.9 % Gross margin 41.1 % 43.1 % Gross profit as a percentage of net sales, gross margin, was 41.1% in 2019 compared to 43.1% in 2018. Gross margin for Trex Residential and Trex Commercial products in 2019 totaled 42.4% and 23.5%, respectively, compared to 45.6% and 21.8%, respectively, in 2018. The decrease in gross margin was primarily due to a decrease in Trex Residential gross profit related to new product startup costs and manufacturing inefficiencies associated with the slower than normal production ramp up on those products, including reduced line rates, increased material usage and lower manufacturing yields. During March and through the third quarter, we made numerous changes to improve throughput. As a result, our production rates largely returned to planned levels and associated operating inefficiencies have been reduced. We believe these improvements will continue to result in improved throughput and efficiency. The startup costs are largely behind us and we expect continued improvement in throughput and efficiency in future periods. We have begun to reduce material added to the Enhance product in the first quarter of 2020 and expect to be essentially at the original design target by the end of the third quarter in 2020. Trex Commercial gross margin increased primarily due to initiatives aimed at improving project management, estimating and manufacturing. However, the increase was hampered due to under absorption of manufacturing overhead as a result of lower net sales. Selling, General and Administrative Expenses Year Ended December 31, 2019 2018 $ Change % Change (dollars in thousands) Selling, general and administrative expenses$ 118,304 $ 118,225 $ 79 0.1 % % of total net sales 15.9 % 17.3 % 30
-------------------------------------------------------------------------------- Table of Contents Selling, general and administrative expenses in 2019 were comparable to those in 2018. Incentive compensation decreased$4 million in 2019. In addition, amortization expense decreased$2.7 million in 2019 due to the full amortization of intangible assets acquired as part of theSC Company acquisition inJuly 2017 . The decreases were offset primarily by increases in other personnel expense of$3.6 million ,$0.7 million in branding and advertising spend in support of our market growth programs,$0.3 million in research and development expenses and an increase in other miscellaneous expenses. Provision for Income Taxes Year Ended December 31, 2019 2018 $ Change
% Change
(dollars in thousands)
Provision for income taxes
6.3 % Effective tax rate 23.7 % 23.9 % The effective tax rate for 2019 decreased by 0.2% compared to the effective tax rate for 2018 primarily due to an increase in excess tax benefits from the exercise of share-based payments. Net Income and Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) 1 (in thousands) Reconciliation of net income (GAAP) to EBITDA (non-GAAP): 2019 2019 2019 Trex Trex Trex Year Ended December 31 Residential Commercial Consolidated Net income$ 142,811 $ 1,927 $ 144,738 Interest income, net (1,496 ) (7 ) (1,503 ) Income tax expense 44,292 672 44,964 Depreciation and amortization 13,413 618 14,031 EBITDA$ 199,020 $ 3,210 $ 202,230 2018 2018 2018 Trex Trex Trex Year Ended December 31 Residential Commercial Consolidated Net income$ 131,823 $ 2,749 $ 134,572 Interest income, net (192 ) - (192 ) Income tax expense 41,421 868 42,289 Depreciation and amortization 13,216 3,251 16,467 EBITDA$ 186,268 $ 6,868 $ 193,136
1 EBITDA represents net income before interest, income taxes, depreciation and
amortization. EBITDA is not a measurement of financial performance under
accounting principles generally accepted in
included data with respect to EBITDA because management evaluates the
performance of its reportable segments using EBITDA. Management considers
EBITDA to be an important supplemental indicator of our core operating
performance because it eliminates interest, income taxes, and depreciation and
amortization charges to net income and, in relation to its competitors, it
eliminates differences among companies in capitalization and tax structures,
capital investment cycles and ages of related assets. For these reasons,
management believes that EBITDA provides important information regarding the
operating performance of the Company and its reportable segments.
31
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Table of Contents Year Ended December 31, 2019 2018 $ Change % Change (dollars in thousands) Total EBITDA$ 202,230 $ 193,136 $ 9,094 4.7 % Trex Residential EBITDA$ 199,020 $ 186,268 $ 12,752 6.9 % Trex Commercial EBITDA$ 3,210 $ 6,868 $ (3,658 ) (53.3 )% The Company uses EBITDA to assess performance as it believes EBITDA facilitates performance comparison between the Company and its competitors and between its reportable segments by eliminating interest, income taxes, and depreciation and amortization charges to income. Total EBITDA increased 4.7% to$202 million for 2019 compared to$193 million for 2018. The increase was primarily driven by a$13 million increase in Trex Residential EBITDA driven by the increase in net sales. The increase was offset by a decrease in EBITDA at Trex Commercial primarily related to a decrease in net sales. Year EndedDecember 31, 2018 Compared To Year EndedDecember 31, 2017 The Company hereby incorporates by reference the financial results from fiscal year 2017 and the comparison of financial results from fiscal year 2018 to fiscal year 2017 as set forth in the Company's Management's Discussion and Analysis of Financial Condition and Results of Operation in the Annual Report on Form 10-K for the year ended December 31, 2018 and filed with the U.S.Securities and Exchange Commission onFebruary 14, 2019 . LIQUIDITY AND CAPITAL RESOURCES We finance operations and growth primarily with cash flow from operations, borrowings, operating leases and normal trade credit terms from operating activities. S ources and Uses of Cash. The following table summarizes our cash flows from operating, investing and financing activities for the years endedDecember 31, 2019 , 2018, and 2017 (in thousands): Year Ended December 31, 2019 2018 2017 Net cash provided by operating activities$ 156,352 $ 138,121 $ 101,865 Net cash used in investing activities (67,244 ) (33,733 ) (86,789 ) Net cash used in financing activities (45,974 ) (29,203 ) (3,226 )
Net increase in cash and cash equivalents
Operating Activities Cash provided by operating activities increased$18.2 million in 2019 compared to 2018 primarily due to the increase in gross profit and related increase in net income resulting from the increase in net sales volume growth, offset by a decrease in working capital investment of$2.9 million . Investing Activities Investing activities in 2019 consisted of$67.3 million in capital expenditures, including$59.8 million related to capacity expansion and general plant cost reduction initiatives,$4.9 million for other production improvements and$2.2 million for general support initiatives. 32 -------------------------------------------------------------------------------- Table of Contents Financing Activities Net cash used in financing activities in 2019 increased$16.8 million compared to 2018 primarily due to the increase in stock repurchase activity in 2019 of$16.5 million . Stock Repurchase Program. OnFebruary 16, 2018 , the Board of Directors adopted a stock repurchase program of up to 5.8 million shares of the Company's outstanding common stock (Stock Repurchase Program). As of the date of this report, the Company has repurchased 959,380 shares under the Stock Repurchase Program. Inventory in Distribution Channels . We sell our Trex Residential decking and railing products through a tiered distribution system. We have over 50 distributors worldwide and two national retail merchandisers to which we sell our products. The distributors in turn sell the products to dealers and retail locations who in turn sell the products to end users. Significant increases in inventory levels in the distribution channel without a corresponding change in end-use demand could have an adverse effect on future sales. We cannot definitively determine the level of inventory in the distribution channels at any time. We are not aware of significant increases in the levels of inventory in the distribution channels atDecember 31, 2019 compared to inventory levels atDecember 31, 2018 . Business Acquisition. OnJuly 31, 2017 , through our wholly-owned subsidiary,Trex Commercial Products, Inc. , we entered into a definitive agreement withSC Company and on that date acquired certain assets and liabilities ofSC Company for$71.8 million in cash. We used cash on hand and$30.0 million from our existing revolving credit facility to acquire the business. Seasonality . The operating results for Trex Residential have historically varied from quarter to quarter. Seasonal, erratic or prolonged adverse weather conditions in certain geographic regions reduce the level of home improvement and construction activity and can shift demand for its products to a later period. As part of its normal business practice and consistent with industry practice, Trex Residential has historically offered incentive programs to its distributors and dealers to build inventory levels before the start of the prime deck-building season in order to ensure adequate availability of its product to meet anticipated seasonal consumer demand. The seasonal effects are often offset by the positive effect of the incentive programs. The operating results for Trex Commercial have not historically varied from quarter to quarter as a result of seasonality. However, they are driven by the timing of individual projects, which may vary significantly each period. Indebtedness . Indebtedness afterNovember 4, 2019 . OnNovember 5, 2019 , the Company as borrower,Trex Commercial Products, Inc. (TCP), as guarantor;Bank of America, N.A . (BOA), as a Lender, Administrative Agent, SwingLine Lender and L/C Issuer; and certain other lenders includingWells Fargo Bank, N.A . (Wells Fargo), who is also Syndication Agent; SunTrustBank (SunTrust) ; andBranch Banking and Trust Company (BB&T) (each, a Lender and collectively, the Lenders), arranged byBank of America Securities, Inc. , as Sole Lead Arranger and Sole Bookrunner, entered into a Fourth Amended and Restated Credit Agreement (Fourth Amended Credit Agreement) to amend and restate the Third Amended and Restated Credit Agreement dated as ofJanuary 12, 2016 , as amended (Third Amended Credit Agreement), by and among the Company, as borrower; BOA, as a lender, Administrative Agent, SwingLine Lender and L/C Issuer;CitiBank, N.A . (Citi);Capital One, N.A. (Capital One); and SunTrust, each as a lender; andBank of America Merrill Lynch , as Sole Lead Arranger and Sole Bookrunner. Under the Fourth Amended Credit Agreement, the Lenders agreed to provide the Company with one or more Revolving Loans in a collective maximum principal amount of$250 million fromJanuary 1 through June 30 of each year and a maximum principal amount of$200 million fromJuly 1 through December 31 of each year (Loan Limit) throughout the term, which endsNovember 5, 2024 (Term). Previously, under the Third Amended Credit Agreement, BOA, Citi, Capital One and SunTrust agreed to provide the Company with one or 33 -------------------------------------------------------------------------------- Table of Contents more revolving loans in a collective maximum principal amount of$250 million fromJanuary 1 through June 30 of each year and a maximum principal amount of$200 million fromJuly 1 through December 31 of each year throughout the term, which would have ended onJanuary 12, 2021 if not replaced by the Fourth Amended Credit Agreement. Included within the Loan Limit are sublimits for a Letter of Credit facility in an amount not to exceed$15 million and Swing Line Loans in an aggregate principal amount at any time outstanding not to exceed$5 million . The Revolving Loans, the Letter of Credit facility and the Swing Line Loans are for the purpose of raising working capital and supporting general business operations. The Notes provide the Company, in the aggregate, the ability to borrow an amount up to the Loan Limit during the Term. The Company is not obligated to borrow any amount under the Loan Limit. Within the Loan Limit, the Company may borrow, repay and reborrow at any time or from time to time while the Notes are in effect. Base Rate Loans (as defined in the Fourth Amended Credit Agreement) under the Revolving Loans and the Swing Line Loans accrue interest at the Base Rate plus the Applicable Rate (as defined in the Fourth Amended Credit Agreement) and Eurodollar Rate Loans for the Revolving Loans and Swing Line Loans accrue interest at the Adjusted London InterBank Offered Rate plus the Applicable Rate (as defined in the Fourth Amended Credit Agreement). The Base Rate for any day is a fluctuating rate per annum equal to the highest of (a) the Federal Funds Rate plus 0.50%, (b) the rate of interest in effect for such day as publicly announced from time to time by BOA as its prime rate, and (c) the Eurodollar Rate plus 1.0%. Repayment of all then outstanding principal, interest, fees and costs is due onNovember 5, 2024 . Under the terms of the Fourth Amended and Restated Security and Pledge Agreement, the Company and TCP, subject to certain permitted encumbrances, as collateral security for the above-stated loans and all other present and future indebtedness of the Company owing to the Lenders grants to BOA, as Administrative Agent for the Lenders, a continuing security interest in certain collateral described and defined in the Fourth Amended and Restated Security and Pledge Agreement. Indebtedness throughNovember 4, 2019 . OnJanuary 12, 2016 , the Company entered into a Third Amended Credit Agreement with BOA as Lender, Administrative Agent, SwingLine Lender and Letter of Credit Issuer; and certain other lenders including Citi, Capital One, and SunTrust (collectively, Lenders) arranged byBank of America Merrill Lynch as Sole Lead Arranger and Sole Bookrunner. The Third Amended Credit Agreement amended and restated the Second Amended Credit Agreement. Under the Third Amended Credit Agreement, the Lenders agreed to provide the Company with one or more revolving loans in a collective maximum principal amount of$250 million fromJanuary 1 through June 30 of each year and a maximum principal amount of$200 million fromJuly 1 through December 31 of each year throughout the term, which would have ended onJanuary 12, 2021 . Included within the revolving loan limit were sublimits for a letter of credit facility in an amount not to exceed$15 million and swing line loans in an aggregate principal amount at any time outstanding not to exceed$5 million . The revolving loans, the letter of credit facility and the swing line loans were for the purpose of funding working capital needs and supporting general business operations. Additionally, within the Revolving Loan Limit, the Company could borrow, repay, and reborrow, at any time or from time to time while the Third Amended Credit Agreement was in effect. The Company had the option to select interest rates for each loan request at the Base Rate or Eurodollar Rate. Base rate loans under the revolving loans and the swing line loans accrued interest at the Base Rate plus the Applicable Rate. Eurodollar Rate Loans for the revolving loans and swing line loans accrued interest at the Adjusted London InterBank Offered Rate plus the Applicable Rate. The Base Rate for any day was a fluctuating rate per annum equal to the highest of (a) the Federal Funds Rate plus 0.50%, (b) the rate of interest in effect for such day as publicly announced from time to time by BOA as its prime rate, and (c) the Eurodollar Rate plus 1.0%. Repayment of all then outstanding principal, interest, fees and costs would have been due onJanuary 12, 2021 . 34 -------------------------------------------------------------------------------- Table of Contents The Third Amended Credit Agreement was secured by property with respect to which liens in favor of the Administrative Agent, for the benefit of itself and the other holders of the obligations, were purported to be granted pursuant to and in accordance with the terms of the collateral documents as referenced in the Third Amended Credit Agreement. Compliance with Debt Covenants and Restrictions. Pursuant to the terms of the Fourth Amended Credit Agreement, the Company, is subject to certain loan compliance covenants. The Company was in compliance with all covenants as ofDecember 31, 2019 . Failure to comply with the financial covenants could be considered a default of repayment obligations and, among other remedies, could accelerate payment of any amounts outstanding. Contractual Obligations. The following table summarizes our contractual obligations, which consist primarily of purchase commitments and operating leases, as ofDecember 31, 2019 (in thousands): Contractual Obligations Payments Due by Period 2-3 4-5 After Total 1 year years years 5 years Purchase obligations (1)$ 33,051 $ 26,763 $ 6,274 $ 14 $ - Operating leases, including imputed interest (2) 46,935 8,858
14,743 12,255 11,079
Total contractual obligations$ 79,986 $ 35,621 $ 21,017 $ 12,269 $ 11,079
(1) Purchase obligations represent supply contracts with raw material vendors and
service contracts for hauling raw materials. Open purchase orders written in
the normal course of business for goods or services that are provided on
demand have been excluded as the timing of which is not certain.
(2) Operating leases represent office space, storage warehouses, manufacturing
facilities and certain office and plant equipment under various operating
leases, and include operating leases accounted for under Financial Accounting
Standards Board Accounting Standards Codification Topic 842 and short-term
leases.
Off-Balance Sheet Arrangements. We do not have off-balance sheet financing arrangements. Capital and Other Cash Requirements. In order to meet future demand, inJune 2019 we announced a new multi-year capital expenditure program projected at approximately$200 million between 2019 and 2021. The program will increase production capacity by at least 70% at our Trex Residential facilities inVirginia andNevada and will bring further manufacturing efficiencies to our production operations. In the third quarter of 2019, we installed two additional lines in ourNevada facility and three new lines will begin ramping up there in the second quarter of 2020. One new production line was operational inVirginia in the fourth quarter of 2019, and a new building being constructed inVirginia is scheduled to start ramping up production by early 2021 at the latest. The investment will allow us to increase production output for future projected growth related to our strategy of converting wood demand to Trex Residential composite decking. We currently estimate that capital expenditures in 2020 will be approximately$140 million to$160 million . We believe that cash on hand, cash flows from operations and borrowings expected to be available under our revolving credit facility will provide sufficient funds to enable us to fund planned capital expenditures, make scheduled principal and interest payments, fund the warranty reserve, meet other cash requirements and maintain compliance with terms of our debt agreements for at least the next 12 months. We currently expect to fund future capital expenditures from operations and borrowings under the revolving credit facility. The actual amount and timing of future capital requirements may differ materially from our estimate depending on the demand for Trex products and new market developments and opportunities. Our ability to meet our cash needs during the next 12 months and thereafter could be adversely affected by various circumstances, including increases in raw 35 -------------------------------------------------------------------------------- Table of Contents materials and product replacement costs, quality control problems, higher than expected product warranty claims, service disruptions and lower than expected collections of accounts receivable. In addition, any failure to negotiate amendments to our existing debt agreements to resolve any future noncompliance with financial covenants could adversely affect our liquidity by reducing access to revolving credit borrowings needed primarily to fund seasonal borrowing needs. We may determine that it is necessary or desirable to obtain financing through bank borrowings or the issuance of debt or equity securities to address such contingencies or changes to our business plan. Debt financing would increase our level of indebtedness, while equity financing would dilute the ownership of our stockholders. There can be no assurance as to whether, or as to the terms on which, we would be able to obtain such financing, which would be restricted by covenants contained in our existing debt agreements. NEW ACCOUNTING STANDARDS InAugust 2018 , the FASB issued ASU No. 2018-15, "Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (a consensus ofFASB Emerging Issues Task Force )". The new guidance aligns the requirements for capitalizing implementation costs in a cloud computing arrangement service contract with the requirements for capitalizing implementation costs incurred for an internal-use software license. Under that model, implementation costs are capitalized or expensed depending on the nature of the costs and the project stage during which they are incurred. Capitalized implementation costs are amortized over the term of the associated hosted cloud computing arrangement service contract on a straight-line basis, unless another systematic and rational basis is more representative of the pattern in which the entity expects to benefit from its right to access the hosted software. Capitalized implementation costs would then be assessed for impairment in a manner similar to long-lived assets. The new guidance is effective for fiscal years beginning afterDecember 15, 2019 , and interim periods within those fiscal years. Early adoption is permitted. Entities can choose to adopt the new guidance either prospectively to eligible costs incurred on or after the date the guidance is first applied or retrospectively. The Company will adopt the guidance onJanuary 1, 2020 , and has determined that adoption will not have a material impact on its financial condition or results of operations. InJanuary 2017 , the FASB issued ASU No.
2017-04,
"Intangibles-Goodwill and Other (Topic 350), Simplifying the Test forGoodwill Impairment". The guidance removes Step 2 of the goodwill impairment test and eliminates the need to determine the fair value of individual assets and liabilities to measure goodwill impairment. A goodwill impairment will now be the amount by which a reporting unit's carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. Entities will continue to have the option to perform a qualitative assessment to determine if a quantitative impairment test is necessary. The guidance will be applied prospectively, and is effective for annual and interim goodwill impairment tests in fiscal years beginning afterDecember 15, 2019 . Early adoption is permitted for any impairment tests performed on testing dates afterJanuary 1, 2017 . The Company will adopt the guidance onJanuary 1, 2020 . The Company does not believe adoption will have a material impact on its financial condition or results of operations. InJune 2016 , the FASB issued ASU 2016-13, "Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses in Financial Instruments," and issued subsequent amendments to the initial guidance inNovember 2018 within ASU No. 2018-09,April 2019 within ASU No. 2019-04, andMay 2019 within ASU No. 2019-05. The ASU amends the guidance on the impairment of financial instruments and adds an impairment model, known as the current expected credit loss (CECL) model. The CECL model requires an entity to recognize its current estimate of all expected credit losses, rather than incurred losses, and applies to trade receivables and other receivables. The CECL model is designed to capture expected credit losses through the establishment of an allowance account, which will be presented as an offset to the amortized cost basis of the related financial asset. The new guidance is effective for fiscal years beginning afterDecember 15, 2019 , including interim periods within those fiscal years, and is applied using the modified-retrospective approach. The Company will adopt the guidance onJanuary 1, 2020 . The Company has determined that adoption will not have a material impact on its financial condition or results of operations. 36
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