TREX COMPANY, INC. 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; the impact of upcoming data privacy laws and the EU General Data Protection Regulation and the related actual or potential costs and consequences; material adverse impacts from global public health pandemics, including the strain of coronavirus known as COVID-19; and material adverse impacts related to labor shortages or increases in labor costs. 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. COVID-19. Our results of operations are affected by economic conditions, including macroeconomic conditions and levels of business and consumer confidence. The COVID-19 pandemic has increased the level of volatility and uncertainty globally and has created macroeconomic disruption. We are actively managing our business to respond to this health crisis, and we continue to evaluate the nature and extent of its impact. As of the date of this report, we continue to operate at output levels similar to those prior to the COVID-19 pandemic. We have not experienced any material disruptions to our operations, production or our supply chain, and have not experienced any material reduction in demand for our products due to the COVID-19 pandemic. We experienced$2.3 million and$6.0 million in COVID-19 management costs during the three months and twelve months endedDecember 31, 2020 , respectively, of which$1.9 million and$4.8 million , respectively, were related to higher production costs. These costs reflect measures we implemented to ensure the health and safety of our employees, such as additional cleaning and sterilization of work areas, and additional personnel expenses. Even though a vaccine has been approved, the pandemic remains an evolving situation due to the continuation of the outbreak and any measures taken to contain the spread of the virus. The extent and duration of the economic fallout from COVID-19 remains unclear. We are actively managing our business to respond to the impact, such as engaging with our distributor network regarding market demand, ongoing communications with our suppliers, and continuing to ensure the safety of our employees. Our commitment to stakeholders is to take the appropriate actions to ensure the safety and well-being of our employees and partners, comply with any governmental orders relating to COVID-19, which may result in a period of disruption to our business, while at the same time leveraging our strengths and ensuring financial flexibility. We are following or exceeding allCenters for Disease Control and Prevention (CDC ) and public officials' guidelines. We have also adopted a business continuity plan and local emergency response plans at each location. 28 -------------------------------------------------------------------------------- Table of Contents We continue to take precautionary measures, make contingency plans and improve our response to the developing situation. We have assembled a cross-functional team whose chief charge is to oversee our efforts to ensure the health and safety of all employees and supply product to our customers. That team constantly monitors the latestCDC , Federal, state and other regulatory guidance, works to secure personal protective equipment, finds new ways to help mitigate risk, and identifies opportunities for us to exceed recommendations. We have implemented preventative or protective actions at our facilities, our corporate headquarters and with field sales personnel. In order to mitigate the spread of the virus, we instructed our employees to practice social distancing. Efforts for social distancing included employees working from home, where possible, revising our production processes to allow for compliance with our social distancing efforts, suspending air travel and enabling technologies to allow employees to effectively perform their functions remotely. Our sales force worked from home and conducted training sessions with our channel partners by utilizing online audio and visual technologies. Late in the second quarter, our employees began transitioning back to the workplace and conducting customer visits on a voluntary basis. In addition, face masks and other protective equipment have been distributed to employees across all of our facilities, handwashing and hand sanitizing stations have been installed, and automated temperature scanners have been provided at the entrances to our manufacturing facilities and corporate office. We have installed air purifier systems for all enclosed areas in every one of our buildings. Our internal cleaning crew sanitizes an extensive checklist of high-touch items and areas across work facilities, and our facilities are cleaned repeatedly throughout each shift withCDC -recommended chemicals and disinfectants by internal and external groups. In addition, we fabricated face shields, donated the proceeds from decking sample sales toFeeding America , and supported the COVID-19Relief Fund of our localUnited Way , supplementing our annual fund-raising campaign. 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 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 Select ® decking Trex Enhance ® decking Trex Hideaway ® hidden fastening system Trex DeckLighting ™ outdoor lighting system Railing Trex Transcend Railing Trex Select Railing Trex Enhance Railing Trex Signature ® aluminum railing Fencing Trex Seclusions ® 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. Highlights related to the twelve months endedDecember 31, 2020 include:
• Increase in net sales of 18.2%, or
the twelve months ended
the twelve months ended December 31, 2019 and were the highest of any
year in our history.
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• Trex Residential net sales increased
twelve months ended
December 31, 2019 . Net sales were the highest of any year in our history. • Increase in gross profit of 17.3%, or$53.0 million , to$359.5 million for the twelve months endedDecember 31, 2020 compared to$306.5 million for the twelve months endedDecember 31, 2019 .
• Increase in net income to
any year in our history.
• Cash flows from operating activities were $187.3 million in the twelve
months ended December 31, 2020 compared to $156.4 million in the twelve
months ended December 31, 2019 .
• Capital expenditures of
capacity at the
reduction initiatives.
• Repurchase of 884,018 shares of our outstanding common stock under our
Stock Repurchase Program in 2020, for a total of 2.8 million share
repurchased under the program as of December 31, 2020 .
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 impact sales, receivables
and inventory levels during the offering period. 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 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
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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
in the 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 1 to 3 years.
We continue to receive and settle claims for Trex Residential products
manufactured at our Nevada 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 surface flaking 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 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, 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 ended December 31, 2020 was
higher than the number of claims received in the year ended December 31, 2019
and exceeded our expectations for 2020. Prior to 2020, the number of incoming
claims received declined each year since 2009. After evaluating the rise in
incoming claims in our actuarial analysis, we increased our estimate of the
number of future claims to be settled with payment. Average cost per claim
experienced in the year ended December 31, 2020 was lower than that experienced
in the year ended December 31, 2019 , but slightly higher than our expectations
for 2020. We estimate that average cost per claim will increase in future years,
primarily due to inflation.
As a result of the increase in estimated future claims and expected rise in
future average cost per claim, in the three-month period ended September 30,
2020 , we recorded a provision of $6.5 million to our warranty reserve for the
future settlement of surface flaking claims. We believe the reserve at
December 31, 2020 is sufficient to cover future surface flaking obligations.
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
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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 $2.1 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,
2020 2019 2018
Claims unresolved beginning of period 1,724 2,021 2,306
Claims received (1) 1,441 1,394 1,481
Claims resolved (2) (1,366 ) (1,691 ) (1,766 )
Claims unresolved end of period 1,799 1,724 2,021
Average cost per claim (3) $ 3,390 $ 3,447 $ 2,631 (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 18 to the Consolidated Financial Statements appearing elsewhere in this report.Goodwill . We evaluate 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. We evaluate the recoverability of goodwill at the reporting unit level.Goodwill is considered impaired when the carrying amount of a reporting unit exceeds its fair value, and an impairment loss is recognized in an amount equal to that excess but limited to the total amount of goodwill allocated to that reporting unit. We 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, including goodwill. Qualitative factors we consider include events and circumstances such as macroeconomic conditions, industry and market considerations, cost factors, overall financial performance, and other relevant Company-specific events. We evaluate, based on the weight of evidence, the significance of all identified events and circumstances in the context of determining whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Weighing the effect of various positive and negative factors is challenging and requires the use of significant judgment. The weight we place on each factor depends on certain conditions, including uncertainty about future events. If different conditions exist in future periods, future impairment charges could result. If the qualitative assessment indicates that the carrying amount of the reporting unit exceeds its fair value, including goodwill, we are then required to perform a quantitative goodwill impairment test. The quantitative goodwill impairment test, used to identify both the existence of impairment and the amount of impairment loss, compares the fair value of a reporting unit with its carrying amount, including goodwill. The fair value of a reporting unit refers to the price that would be received to sell the unit as a whole in an orderly transaction between market participants at the measurement date. 32 -------------------------------------------------------------------------------- Table of Contents We measure the fair value of a reporting unit based on the present value of future cash flows and a market valuation approach using relevant data available through and as of the impairment testing date. The assumptions we use are consistent with those we believe a market participant would use and are evaluated and updated as appropriate. If other assumptions and estimates had been used, an impairment charge could have resulted, or if different conditions exist in future periods, future impairment charges could result. AtDecember 31, 2020 andDecember 31, 2019 , the Company had goodwill of$68.5 million . We perform the annual impairment testing of goodwill as ofOctober 31 of each year. For the years endedDecember 31, 2020 , 2019, and 2018, we completed our annual impairment test of goodwill utilizing the qualitative assessment and concluded it was not more likely than not that the fair value of the reporting units was less than the carrying amounts. 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 outdoor living products, consisting of composite decking and railing products, hidden fasteners, and a broad offering of outdoor living 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 and is included in "Accrued expenses and other liabilities". Trex Residential may offer various sales incentive programs throughout the year. It estimates the amount of sales incentive to allocate to each performance obligation, or product shipped, based on direct sales to the customer. The estimate is updated each reporting period and any changes are allocated to the performance obligations on the same basis as at inception. Changes in estimate allocated to a previously satisfied performance obligation are recognized as a reduction of revenue in the period in which the change occurs under the cumulative catch-up method. In addition to sales incentive programs, Trex Residential may offer payment discounts. It estimates the payment discount that it believes will be taken by the customer based on prior history using the most-likely-amount method of estimation. 33 -------------------------------------------------------------------------------- Table of ContentsTrex Commercial Products Trex Commercial generates revenue from the manufacture and sale of its custom, 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 are 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, 2020 , 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, 2020 compared to the year endedDecember 31, 2019 . Year EndedDecember 31, 2020 Compared To Year EndedDecember 31, 2019 Net Sales Year Ended December 31, 2020 2019 $ Change % Change (dollars in thousands) Total net sales$ 880,831 $ 745,347 $ 135,484 18.2 % Trex Residential net sales$ 827,792 $ 694,267 $ 133,525 19.2 % Trex Commercial net sales$ 53,039 $ 51,080 $ 1,959
3.8 %
The 18.2% increase in total net sales in 2020 compared to 2019 was due to an increase in net sales of 19.2% at Trex Residential and a 3.8% increase in Trex Commercial net sales. The increase in Trex Residential net sales was substantially all due to volume growth, resulting from the strong broad-based demand for our outdoor living products, positive momentum in the residential repair and remodeling sector and our initiatives to expand our addressable market and accelerate conversion from wood primarily through the growth of our newer Enhance product line. In addition, 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 in 2019. As a result of our capacity expansion program at our Trex Residential manufacturing facilities inVirginia andNevada , in 2020 we utilized capacity gains from incremental lines to address demand. The production lines at our newVirginia facility will start coming online in the first quarter of 2021 and continue to ramp up through the second quarter. Trex Commercial net sales increased reflecting the underlying growth in the commercial segment. 34 --------------------------------------------------------------------------------
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Gross Profit
Year Ended December 31,
2020 2019 $ Change % Change
(dollars in thousands)
Cost of sales $ 521,374 $ 438,844 $ 82,530 18.8 %
% of total net sales 59.2 % 58.9 %
Gross profit $ 359,457 $ 306,503 $ 52,954 17.3 %
Gross margin 40.8 % 41.1 %
Gross profit as a percentage of net sales, gross margin, was 40.8% in 2020
compared to 41.1% in 2019. Gross margin for Trex Residential and Trex Commercial
products in 2020 totaled 41.6% and 29.2%, respectively, compared to 42.4% and
23.5%, respectively, in 2019. Gross margin in 2020 at Trex Residential was
impacted by hiring and training costs in advance of capacity ramp up at both our
Virginia and Nevada facilities, initial startup costs,
COVID-19
management costs, depreciation due to capital expansion expenditures and higher
inflation, partially offset by the
non-recurrence
of Enhance startup costs experienced in 2019 and by reducing the material usage
in our Enhance decking profile to the original design target weight. To offset
these additional costs, we recently announced a
mid single-digit
price increase at Trex Residential on multiple products across our decking and
railing portfolio set to take effect at the beginning of 2021. Excluding a
$6.5 million provision to the Trex Residential warranty, consolidated gross
margin in 2020 was 41.5% and Trex Residential gross margin was 42.3%. This
charge related to the legacy surface flaking issue that affected a portion of
products produced at our Nevada facility prior to 2007. Gross margin at Trex
Commercial increased primarily due to the
non-recurrence
of legacy low margin contracts coupled with a mix of higher margin contracts,
and manufacturing cost improvements.
Selling, General and Administrative Expenses
Year Ended December 31,
2020 2019 $ Change % Change
(dollars in thousands)
Selling, general and
administrative expenses $ 125,822 $ 118,304 $ 7,518 6.4 %
% of total net sales 14.3 % 15.9 %
Selling, general and administrative expenses increased $7.5 million in 2020
compared to 2019. The increase was due to an increase in personnel related
expenses, including higher incentive compensation, of $8.5 million and a net
increase in other operating expenses of $5.3 million . The increase was offset by
a $4.0 million decrease in branding and advertising expense driven by
disciplined spending as the impacts of
COVID-19
played out during the second and third quarters of 2020, and by a $2.2 million
decrease in travel and entertainment and other expenses.
Provision for Income Taxes
Year Ended December 31,
2020 2019 $ Change % Change
(dollars in thousands)
Provision for income taxes $ 59,003 $ 44,964 $ 14,039 31.2 %
Effective tax rate 25.2 % 23.7 %
The effective tax rate for 2020 increased by 1.5% compared to the effective tax
rate for 2019 primarily due to a decrease in 2020 in excess tax benefits from
the exercise of share-based payments.
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Net Income and Earnings Before Interest, Taxes, Depreciation and Amortization
(EBITDA)
1
(in thousands)
Reconciliation of net income (GAAP) to EBITDA
(non-GAAP):
2020 2020 2020
Trex Trex Trex
Year Ended December 31 Residential Commercial Consolidated
Net income $ 171,197 $ 4,434 $ 175,631
Interest income, net (999 ) - (999 )
Income tax expense 57,488 1,515 59,003
Depreciation and amortization 17,131 809 17,940
EBITDA $ 244,817 $ 6,758 $ 251,575
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 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 believes it facilitates
performance comparison between the Company and its competitors, and 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.
Year Ended December 31,
2020 2019 $ Change % Change
(dollars in thousands)
Total EBITDA $ 251,575 $ 202,230 $ 49,345 24.4 %
Trex Residential EBITDA $ 244,817 $ 199,020 $ 45,797 23.0 %
Trex Commercial EBITDA $ 6,758 $ 3,210 $ 3,548 110.5 %
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 24.4%, or $49.3 million ,
to $251.6 million for 2020 compared to $202.2 million for 2019. The increase was
primarily driven by a $45.8 million increase in Trex Residential EBITDA driven
by the increase in net sales.
Year Ended December 31, 2019 Compared To Year Ended December 31, 2018
The Company hereby incorporates by reference the financial results from fiscal
year 2018 and the comparison of financial results from fiscal year 2019 to
fiscal year 2018 as set forth in the Company's Management's Discussion and
Analysis of Financial Condition and Results of Operation in the Annual Report
on Form 10-K for the year ended December 31, 2019 and filed with the U.S.
Securities and Exchange Commission on February 24, 2020 .
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LIQUIDITY AND CAPITAL RESOURCES
We finance operations and growth primarily with cash flow from operations,
borrowings, operating leases and normal trade credit terms from operating
activities.
S
ources and Uses of Cash.
The following table summarizes our cash flows from operating, investing and
financing activities for the years ended December 31, 2020 , 2019, and 2018 (in
thousands):
Year Ended December 31,
2020 2019 2018
Net cash provided by operating activities
(170,658 ) (67,244 ) (33,733 )
Net cash used in financing activities (43,768 ) (45,974 ) (29,203 )
Net (decrease) increase in cash and cash equivalents$ (27,132 ) $ 43,134 $ 75,185 Operating Activities Cash provided by operating activities increased$30.9 million in 2020 compared to 2019 primarily due to the increase in gross profit and related$30.9 million increase in net income resulting from the increase in net sales volume growth at Trex Residential, partially offset by a decrease in working capital investment of$8.9 million . Investing Activities Investing activities in 2020 consisted of$172.8 million in capital expenditures, including$162.9 million related to capacity expansion and general plant cost reduction initiatives,$6.2 million for other production improvements and$1.1 million for general support initiatives. Financing Activities Net cash used in financing activities in 2020 decreased$2.2 million compared to 2019 primarily due to the decrease in stock repurchase activity in 2020 of$1.7 million . Amendment of Restated Certificate of Incorporation. At the annual meeting of stockholders of the Company held onApril 29, 2020 , the Company's stockholders approved an amendment of the Company's Restated Certificate of Incorporation (Amendment), effective as ofApril 29, 2020 . The Company's Board of Directors unanimously approved the Amendment onFebruary 19, 2020 , subject to stockholder approval. The Amendment increases the number of shares of common stock, par value$0.01 per share, that the Company is authorized to issue from 120 million shares to 180 million shares. The Amendment was filed with theDelaware Secretary of State onApril 29, 2020 . Stock Repurchase Program. OnFebruary 16, 2018 , the Board of Directors adopted a stock repurchase program of up to 11.6 million shares of the Company's outstanding common stock (Stock Repurchase Program). As ofDecember 31, 2020 , the Company has repurchased 2.8 million shares under the Stock Repurchase Program. Stock Split. OnJuly 29, 2020 , the Company's Board of Directors approved a two-for-one stock split of the Company's common stock, par value,$0.01 . The stock split was in the form of a stock dividend distributed onSeptember 14, 2020 , to stockholders of record at the close of business onAugust 19, 2020 . The stock split entitled each stockholder to receive one additional share of common stock for each share they held as of the record date. All common stock share and per share data for all periods presented in the accompanying Consolidated Financial Statements and notes thereto have been retroactively adjusted to reflect the stock split. 37 -------------------------------------------------------------------------------- Table of Contents 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, 2020 compared to inventory levels atDecember 31, 2019 . 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. Our Fourth Amended and Restated Credit Agreement (Fourth Amended Credit Agreement) provides us with revolving loan capacity 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 endsNovember 5, 2024 . AtDecember 31, 2020 , we had no outstanding indebtedness under the revolving credit facilities and borrowing capacity under the facilities of$300 million . OnMay 26, 2020 , the Company entered into a First Amendment to the Original Credit Agreement (the First Amendment) to provide for an additional$100 million line of credit. The purpose of the additional$100 million line of credit is primarily to reduce risk associated with the COVID-19 pandemic should the Company need to secure additional capital to continue its strategy of accelerating the conversion of wood decking to Trex composite decking and expanding its addressable market. As a matter of convenience, the parties incorporated the amendments to the Original Credit Agreement made by the First Amendment into a new Fourth Amended and Restated Credit Agreement (New Credit Agreement). In the New Credit Agreement, the revolving commitments under the Original Credit Agreement are referred to as Revolving A Commitments and the new$100 million line of credit is referred to as Revolving B Commitments. In the New Credit Agreement, all material terms and conditions related to the original line of credit (Revolving A Commitments) remain unchanged from the Original Credit Agreement. The Company entered into the First Amendment, as borrower;Trex Commercial Products, Inc. (TCP), as guarantor;Bank of America, N.A . (BOA), as a Lender, Administrative Agent, SwingLine Lender and L/C Issuer; and certain other lenders includingWells Fargo Bank, N.A. (Wells Fargo), who is also Syndication Agent;Truist Bank (Truist); andRegions Bank (Regions) (each, a Lender and collectively, the Lenders), arranged byBofA Securities, Inc. as Sole Lead Arranger and Sole Bookrunner. The First Amendment further provides that the New Credit Agreement is amended and restated by changing Schedule 2.01 to add applicable Lender percentages related to the Revolving B Commitment for BOA of 47.5%, Well Fargo of 28.0% and Regions of 24.5%. Compliance with Debt Covenants and Restrictions. Pursuant to the terms of the Fourth Amended Credit Agreement, the Company, is subject to certain loan compliance covenants. The Company was in compliance with all covenants atDecember 31, 2020 . Failure to comply with the financial covenants could be considered a default of repayment obligations and, among other remedies, could accelerate payment of any amounts outstanding. 38 -------------------------------------------------------------------------------- Table of Contents Contractual Obligations. The following table summarizes our contractual obligations, which consist primarily of purchase commitments and operating leases, as ofDecember 31, 2020 (in thousands): Contractual Obligations Payments Due by Period After Total 1 year 2-3 years 4-5 years 5 years Purchase obligations (1)$ 71,323 $ 33,570 $ 30,577 $ 7,176 $ - Operating leases, including imputed interest (2) 39,132 7,835
13,953 10,745 6,599
Total contractual obligations$ 110,455 $ 41,405 $ 44,530 $ 17,921 $ 6,599
(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 June 2019 , we announced a new capital expenditure program to increase
production capacity at our Trex Residential facilities in Virginia and Nevada .
The new multi-year capital expenditure program is projected at approximately
$200 million through 2021 and involves the construction of a new decking
facility at the existing Virginia site and the installation of additional
production lines at the Nevada site. The investment will allow us to increase
production output for future projected growth related to our strategy of
converting wood demand to Trex Residential wood-alternative composite decking.
When completed these investments will increase our Trex Residential production
capacity by approximately 70 percent. In addition to the above, our capital
allocation priorities include expenditures for internal growth opportunities,
manufacturing cost reductions, upgrading equipment, and acquisitions which fit
our long-term growth strategy as we continue to evaluate opportunities that
would be a good strategic fit for Trex, and return of capital to shareholders.
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 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.
39--------------------------------------------------------------------------------
Table of Contents In addition, we believe our financial resources will allow us to manage the impact of the COVID-19 pandemic on the Company's business operations for the foreseeable future. However, we will continue to evaluate our financial position and liquidity needs in light of future developments. NEW ACCOUNTING STANDARDS InMarch 2020 , the FASB issued ASU No. 2020-04, " Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting ". The guidance provides temporary optional expedients and exceptions related to contract modifications and hedge accounting to ease entities' financial reporting burdens as the market transitions from the London Interbank Offered Rate and other interbank offered rates to alternative reference rates. The new guidance allows entities to elect not to apply certain modification accounting requirements, if certain criteria are met, to contracts affected by what the guidance calls reference rate reform. An entity that makes this election would consider changes in reference rates and other contract modifications related to reference rate reform to be events that do not require contract remeasurement at the modification date or reassessment of a previous accounting determination. The ASU notes that changes in contract terms that are made to affect the reference rate reform transition are considered related to the replacement of a reference rate if they are not the result of a business decision that is separate from or in addition to changes to the terms of a contract to affect that transition. The guidance is effective upon issuance and generally can be applied as ofMarch 12, 2020 throughDecember 31, 2022 . The Company does not expect adoption of the guidance to have a material effect on its consolidated financial statements. InDecember 2019 , the FASB issued ASU No. 2019-12, " Income Taxes (Topic 740), Simplifying the Accounting for Income Taxes ". The guidance eliminates certain exceptions related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period, and the recognition of deferred tax liabilities for outside basis differences related to changes in ownership of equity method investments and foreign subsidiaries. The guidance also simplifies aspects of accounting for franchise taxes and enacted changes in tax laws or rates and clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. The standard will be effective for fiscal years, and interim periods within those fiscal years, beginning afterDecember 15, 2020 , with early adoption permitted. The Company does not intend to early adopt the standard and does not expect the standard to have a material effect on its consolidated financial statements.
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