What changed in this filing

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Item 7. Management’s Discussion and Analysis

2022-02-28 compared with 2021-02-22 · 187 added, 136 removed, 261 unchanged (55% of the section changed)

Management’s Discussion and Analysis of Financial Condition and Results of Operations

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.

This Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) 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.

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and material adverse impacts related to labor shortages or increases in labor costs.

Trex Company, Inc.

currently operates in two reportable segments:

Trex Residential Products (Trex Residential) and Trex Commercial Products (Trex Commercial).

The following MD&A is intended to help the reader understand the operations and current business environment of Trex Company, Inc.

(Trex, Company, we or our).

The MD&A is provided as a supplement to — and should be read in conjunction with — our Consolidated Financial Statements and the accompanying notes thereto contained in “ Item 8.

Financial Statements and Supplementary Data

” of this report.

MD&A includes the following sections:

— a general description of our business, a brief overview of our reportable segments’ products, highlights of our operations for the twelve months ended December 31, 2021, an update on our response to the COVID-19

pandemic, and a description of our plan for the Trex Residential Arkansas facility.

Critical Accounting Policies and Estimates

— a discussion of accounting policies that require critical judgments and estimates.

Results of Operations

— an analysis of our consolidated results of operations for 2021 and 2020 and year-to-year

An analysis of our consolidated results of operations for 2020 and 2019 and year-to-year

comparisons between 2020 and 2019 can be found in MD&A in Part II, Item 7 of the Company’s Form 10-K

for the year ended December 31, 2020.

Liquidity and Capital Resources

— an analysis of cash flows;

contractual obligations, and a discussion of our capital and other cash requirements.

New Accounting Standards

— a discussion of Financial Accounting Standards Board new accounting standards not yet adopted.

Trex is the world’s largest manufacturer of high-performance, low-maintenance

wood-alternative decking and residential railing and outdoor living products and accessories, marketed under the brand name Trex ®

, with 30 years of product experience.

A majority of our products are manufactured in a proprietary process that combines reclaimed wood fibers and recycled polyethylene.

Also, the Company is a leading national provider of custom-engineered commercial railing and staging systems for the commercial and multi-family market, including sports stadiums and performing arts venues.

Trex currently operates in two reportable segments:

Trex Residential Products (Trex Residential), the Company’s principal business based on net sales, and Trex Commercial Products (Trex Commercial).

The Company is focused on using renewable resources within both our Trex Residential and Trex Commercial segments.

Our results of operations are affected by economic conditions, including macroeconomic conditions and levels of business and consumer confidence.

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

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

We experienced $2.3 million and $6.0 million in COVID-19 management costs during the three months and twelve months ended December 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 all Centers 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.

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 latest CDC, 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 with CDC-recommended

chemicals and disinfectants by internal and external groups.

In addition, we fabricated face shields, donated the proceeds from decking sample sales to Feeding America, and supported the COVID-19

Relief Fund of our local United Way, supplementing our annual fund-raising campaign.

Outdoor living remains one of the fastest growing categories within the repair and remodel sector, and the strength of the Trex Residential brand coupled with our expanded manufacturing capacity, our key competitive advantages, help us to effectively unlock potential market share and drive long term growth.

We continue to benefit from increasing consumer interest in our environmentally friendly, low maintenance product portfolio that transforms and enhances the outdoor living experience.

We remain focused on ensuring the capacity to service our Trex Residential channel partners is aligned with both current demand and expected future growth.

Having recently completed a manufacturing capacity expansion at our Virginia and Nevada facilities, our engineering team installed incremental decking and railing lines within our Virginia campus that further expanded our production capability.

Additionally, we recently announced plans to develop a third U.S.

based Trex Residential manufacturing facility on approximately 300 acres in Little Rock, Arkansas.

When this plant opens in 2024, Trex will have the strategic advantage of unmatched geographical coverage with sites servicing the East Coast, West Coast and Central regions that will provide our customers with better access to Trex Residential products when and where they need them.

The new site represents a strategic investment in the Company’s future and the success of our valued channel partners.

Little Rock emerged as the best fit for our future needs, as it offers proximity to a center of raw materials, a strong pool of qualified and skilled labor, proximity to key growth regions for wood conversion and adjacency for major transportation hubs that can optimize freight costs.

We plan to invest approximately $400 million over the next five years, funded primarily through ongoing cash generation.

With the potential to become our largest manufacturing facility over time, the Arkansas manufacturing campus will address increased demand for Trex Residential outdoor living products.

Construction is slated to begin early in 2022 with a modular development approach calibrated in alignment with demand trends.

We expect initial production output to begin in 2024 and, over time, the facility will employ approximately 500 people.

These expansion activities provide Trex Residential with additional capacity to flex with demand by adding capacity as needed, while providing bandwidth to pursue opportunities to expand domestically and internationally, as we continue to drive wood conversion and capture incremental market share from the strength of Trex Residential products and the brand.

We continue to focus on cost reduction projects and identifying continuous improvement opportunities to enhance our margins.

Specifically, our efforts are primarily centered on increased automation, modernization, enhanced energy efficiency and improvements to raw material processing.

At the same time, we intend to expand our marketing campaigns, continue highlighting the advantages of Trex Residential decking over wood, as well as focusing on innovation and new product development to further strengthen our consumer brand and distribution advantages.

These initiatives should help drive continued topline and profit growth and accelerated market share conversion.

In addition to our capacity expansion efforts and profit growth, in 2021 we continued to focus on increasing staffing to meet future needs and support our growth and welcomed approximately 400 employees to the Trex team.

As we continue to grow our employee base, additional focus on diversity, equity and inclusion remains

important to our strategy.

In 2021, we expanded our recruiting efforts to further increase diversity and sustained our focus on bringing new ideas and perspectives to our team.

The safety and wellbeing of our employees is important to us, and we consistently prioritized safety practices by building new safety teams and changing the structure of our work areas to focus on safety.

We continually emphasized employee wellbeing as we endured ongoing waves of COVID-19.

Trex Residential

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Trex Seclusions ®

fencing product

Trex Commercial

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Highlights related to the twelve months ended December 31, 2021 include:

Increase in net sales of 18.2%, or $135.5 million, to $880.8 million in the twelve months ended December 31, 2020 compared to $745.3 million in the twelve months ended December 31, 2019 and were the highest of any year in our history.

Trex Residential net sales increased $133.5 million, or 19.2%, in the twelve months ended December 31, 2020 compared to the twelve months ended December 31, 2019.

Net sales were the highest of any year in our history.

Increase in net sales of 35.9%, or $316 million, to $1.2 billion in the twelve months ended December 31, 2021 compared to $881 million in the twelve months ended December 31, 2020 and were the highest of any year in our history.

Trex Residential net sales increased $311 million, or 37.6%, to $1.14 billion in the twelve months ended December 31, 2021 compared to $828 million in the twelve months ended December 31, 2020.

Trex Residential net sales were the highest of any year in its history.

Increase in gross profit of 28.1%, or $101 million, to $461 million for the twelve months ended December 31, 2021 compared to $359 million for the twelve months ended December 31, 2020.

Increase in net income to $175.6 million, also reflecting the highest of any year in our history.

Increase in net income to $209 million, a 18.8% increase over 2020 net income of $176 million.

Cash flows from operating activities were $258 million in the twelve months ended December 31, 2021 compared to $187 million in the twelve months ended December 31, 2020.

Capital expenditures of $159 million, primarily to increase production capacity at the Virginia and Nevada facilities and for general plant cost 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.

Repurchase of 809,099 shares of our outstanding common stock under our Stock Repurchase Program in 2021, for a total of 3.6 million shares repurchased under the program as of December 31, 2021.

Net sales consist of sales and freight, net of returns and discounts.

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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.

Our results of operations are affected by economic conditions, including macroeconomic conditions and levels of business and consumer confidence.

pandemic increased the level of volatility and uncertainty globally and created macroeconomic disruption.

The pandemic remains an evolving situation and while macro-economic recovery seems likely, the duration and extent of the recovery remains uncertain.

However, we continue to manage our business to ensure the continuity of operations and the safety of our employees.

Trex Residential has not experienced any decline in demand for its outdoor living products.

Trex Commercial had not experienced any material reduction to its net sales.

However, measures taken to contain the spread of the virus have reduced new project commitments from its customer base.

The reduction in project commitments was influenced by a delay in new projects due to lingering uncertainty created in the commercial railing and staging markets by the COVID-19 virus.

The delay in new projects, coupled with the Company’s successful fulfillment of its pre-pandemic projects, resulted in lower project backlog and reduced forecasted net sales and EBITDA, which became apparent in the fourth quarter of 2021.

The Company continued to assess the impact on project commitments throughout the year and, during the fourth quarter of 2021, determined that the impact will adversely affect Trex Commercial’s financial condition and results of operations in future periods.

The continued impact of COVID-19

and its effect on project commitments was a consideration in the Company’s quantitative assessment for goodwill impairment testing at its railing and staging reporting units as of October 31, 2021.

Refer to the below discussion in “Critical Accounting Policies and Estimates” for additional information.

Trex Residential Arkansas Manufacturing Facility

On October 26, 2021, we announced our plan to add a third U.S.-based Trex Residential manufacturing facility in Little Rock, Arkansas.

The new campus will sit on nearly 300 acres of land and will address increased demand for Trex Residential outdoor living products.

Construction is slated to begin in early 2022 with the first production output anticipated in 2024.

Funded primarily through ongoing cash generation, we expect to invest approximately $400 million over the next five years in the development of the new Arkansas site.

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.

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 in the United States.

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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.

Depending on the product and its use, the Company also warrants its Trex Commercial products will be free of manufacturing defects for periods ranging from 1 year 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.

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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.

The number of incoming claims received in the year ended December 31, 2021 was lower than the number of claims received in the year ended December 31, 2020 and lower than our expectations for 2021.

Average cost per claim experienced in the year ended December 31, 2021 was higher than that experienced in the year ended December 31, 2020 but was slightly lower than our expectations for 2021.

We believe the reserve at December 31, 2021 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

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.

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.

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For additional information about product warranties, see Notes 2 and 18 to the Consolidated Financial Statements appearing elsewhere in this report.

We evaluate the recoverability of goodwill in accordance with Accounting Standard Codification Topic 350, “ Intangibles—Goodwill and Other

We evaluate the recoverability of goodwill in accordance with Accounting Standard Codification (ASC) 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.

We have determined that the Company has three reporting units:

a residential reporting unit in the Trex Residential reportable segment, and a commercial railing reporting unit and a staging reporting unit in the Trex Commercial reportable segment.

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.

We first assess 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.

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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.

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.

At December 31, 2020 and December 31, 2019, the Company had goodwill of $68.5 million.

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.

If the carrying amount of a reporting unit is in excess of the estimated fair value of that reporting unit, a goodwill impairment charge is recognized in the amount by which the reporting unit’s carrying amount exceeds its fair value, but not to exceed the total goodwill assigned to the reporting unit.

We measure the fair value of a reporting unit based on a combination of the Income Approach (i.e., the Discounted Cash Flow Method) and a Market Approach.

The Discounted Cash Flow Method is a multiple period discounting model in which the fair value of the reporting units are determined by discounting the projected free cash flows using an appropriate discount rate and indicates the fair value of the reporting units based on the present value of the cash flows that the reporting unit is expected to generate in the future.

Significant estimates in the Discounted Cash Flow Method include:

the weighted average cost of capital (or discount rate);

long-term rate of growth and profitability of the business (residual growth rate);

and working capital effects.

The Market Approach uses prices and other relevant information generated by market transactions involving identical or comparable assets, liabilities or a group of assets and liabilities, such as a business.

Significant estimates in the Market Approach model may include identifying appropriate market multiples and assessing earnings before interest, income taxes, depreciation and amortization (EBITDA) in estimating the fair value of the reporting units.

The use of different assumptions, estimates or judgements, including estimated future cash flows and the discount rate used to discount estimated cash flows to their net present value, could materially increase or decrease the fair value of the reporting unit and impact our assessment of any goodwill impairment charges.

Also, if different conditions exist in future periods, future impairment charges could result.

At December 31, 2021 and December 31, 2020, the Company had goodwill of $14.2 million and $68.5 million, respectively.

We perform the annual impairment testing of goodwill as of October 31 of each year.

For the years ended December 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.

For fiscal years 2021, 2020, and 2019, we completed our annual impairment test of goodwill for our residential reporting unit utilizing the qualitative assessment and concluded it was not more likely than not that the fair value of the reporting unit was less than its carrying amount.

For fiscal years 2020 and 2019, we completed our annual impairment test of goodwill for our commercial railing reporting unit and our staging reporting unit utilizing the qualitative assessment and concluded it was not more likely than not that the fair values of the reporting units were less than their respective carrying amounts.

For fiscal year 2021 the Company determined that it was necessary to perform the goodwill impairment test for our railing and staging reporting units utilizing the quantitative assessment.

We performed a quantitative assessment primarily due to a reduction in project commitments, which adversely impacted project backlog and forecasted net sales and EBITDA.

The reduction in project commitments was influenced by a delay in new projects due to lingering uncertainty created in the commercial railing and staging markets by the COVID-19 virus.

As a result, during the fourth quarter of 2021, we recognized an impairment charge at our commercial railing reporting unit and at our staging reporting unit of $42.5 million and $11.8 million, respectively.

Refer to Note 2 and Note 5 to the Consolidated Financial Statements in this Form 10-K

for additional discussion related to the goodwill impairment charge in 2021.

Revenue Recognition

Effective January 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

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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.

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Trex Commercial net sales

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 in Virginia and Nevada, in 2020 we utilized capacity gains from incremental lines to address demand.

The production lines at our new Virginia 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.

The 35.9% increase in total net sales in 2021 compared to 2020 was substantially due to volume growth at Trex Residential across all product lines.

Our capacity expansion program and the additional lines installed at our new Virginia facility were fully operational in 2021 enabling our ability to capture additional growth.

The increase in Trex Residential net sales was primarily driven by sustained broad-based demand, driven by continued strong, secular trends across Trex Residential’s outdoor living products, and market share gains from wood.

The increase in net sales at Trex Residential was also impacted by our price increases on certain products to address inflationary pressures across many key raw materials and transportation.

Trex Commercial contributed $57.7 million to consolidated net sales.

Year Ended December 31,

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Gross profit as a percentage of net sales, gross margin, was 38.5% in 2021 compared to 40.8% in 2020.

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.

Gross margin for Trex Residential and Trex Commercial products in 2021 were 39.3% and 22.0%, respectively, compared to 41.6% and 29.2%, respectively, in 2020.

Excluding a $6.5 million provision during 2020 to the Trex Residential legacy surface flaking warranty reserve, consolidated gross margin for 2020 was 41.5% compared to 38.5% for 2021.

Gross margin at Trex Residential was unfavorably impacted by inflationary pressures on key raw materials and transportation, by start-up

costs and increased depreciation related to the capacity expansion program at Trex Residential, and reduced overhead absorption due to the fire at the Virginia facility.

The decrease in gross margin was partially offset by price increases on certain product lines at Trex Residential.

Selling, General and Administrative Expenses

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% of total net sales

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.

Selling, general and administrative expenses increased $13.8 million in 2021 compared to 2020 primarily resulting from a $7.3 million increase in personnel related expenses, a $2.6 million increase in research and development expenses, and a $3.7 million increase in system and technology expenses.

Goodwill Impairment Loss

Year Ended December 31,

(dollars in thousands)

Goodwill impairment loss

% of total net sales

During the fourth quarter of 2021, our annual goodwill impairment testing resulted in the recognition of an impairment charge to goodwill at our commercial railing reporting unit and our staging reporting unit within the Trex Commercial reportable segment of $42.5 million and $11.8 million, respectively.

For fiscal year 2021, the Company determined that it was necessary to perform the goodwill impairment test for our railing and staging reporting units utilizing the quantitative assessment.

We performed a quantitative assessment primarily due to a reduction in project commitments, which adversely impacted project backlog and forecasted net sales and EBITDA.

The reduction in project commitments was influenced by a delay in new projects due to lingering uncertainty created in the commercial railing and staging markets by the COVID-19 virus.

Refer to Note 2 and Note 5 in the Notes to the Consolidated Financial Statements in this Form 10-K

for additional discussion of the goodwill impairment charge.

Gain on Insurance Proceeds

Year Ended December 31,

(dollars in thousands)

Gain on insurance proceeds

% of total net sales

In March 2021, an electrical fire occurred at one of our manufacturing buildings in our Virginia complex.

No injuries occurred from the event.

The building was temporarily off-line

while damage to the building’s electrical systems was addressed.

We have insurance coverage for repairs, incremental direct costs to serve our customers, and losses in operating income from the loss in net sales.

During 2021, gains on insurance proceeds primarily related to the settlement from our insurance company of $6.8 million related to the fire at the Virginia facility.

Provision for Income Taxes

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Effective tax rate

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.

The effective tax rate for 2021 was comparable to the effective tax rate for 2020.

Net Income and Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) 1

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Year Ended December 31

Net income (loss)

Interest income, net

Income tax expense

Income tax expense (benefit)

Depreciation and amortization

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EBITDA is not a measurement of financial performance under accounting principles generally accepted in the United States (GAAP).

We have 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.

We have 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.

In relation to its competitors, EBITDA eliminates differences among companies in capitalization and tax structures, capital investment cycles and ages of related assets, especially when comparing financial results to prior periods.

For these reasons, management believes that EBITDA provides important information regarding the operating performance of the Company and its reportable segments.

measures are not meant to be considered superior to or a substitute for our GAAP results.

Year Ended December 31,

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Trex Commercial EBITDA

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.

Total EBITDA increased 23.7% to $311.3 million for 2021 compared to $251.6 million for 2020.

The increase was due to a $116.7 million increase in Trex Residential EBITDA, primarily driven by volume growth in net sales, and to a lesser extent, an $8.7 million gain on insurance proceeds.

The increase was offset in part by a $56.9 million decrease in Trex Commercial EBITDA, primarily related to a $54.2 million goodwill impairment charge recognized in the fourth quarter of 2021.

Excluding the impairment charge and gain on insurance proceeds in 2021, and the $6.5 million surface flaking warranty charge in 2020, EBITDA increased 38.3% to $356.8 million for 2021 compared to $258.1 million for 2020.

Refer to Note 2 and Note 5 to the Consolidated Financial Statements in this Form 10-K

for additional discussion of the goodwill impairment charge.

Year Ended December 31, 2020 Compared To Year Ended December 31, 2019

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Net cash used in financing activities

Net (decrease) increase in cash and cash equivalents

Net increase (decrease) in cash and cash equivalents

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.

Cash provided by operating activities increased $71 million in 2021 compared to 2020.

The increase resulted from a $117 million increase in Trex Residential EBITDA, offset in part by a $44 million increase in working capital, including an increase in accounts receivable and accounts payable, which are expected to be collected or paid in the first quarter of 2022.

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.

Investing activities in 2021 consisted of $159.4 million in capital expenditures, primarily at our Trex Residential facilities, and included $126.3 million related to capacity expansion and general plant cost reduction initiatives, $24.9 million in other equipment expenditures and production improvements, $6.4 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 on April 29, 2020, the Company’s stockholders approved an amendment of the Company’s Restated Certificate of Incorporation (Amendment), effective as of April 29, 2020.

The Company’s Board of Directors unanimously approved the Amendment on February 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 the Delaware Secretary of State on April 29, 2020.

Net cash used in financing activities in 2021 consisted primarily of $82.5 million in repurchases of our common stock under our Stock Repurchase Program.

Stock Repurchase Program.

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As of December 31, 2021, the Company has repurchased 3.6 million shares under the Stock Repurchase Program.

On July 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 on September 14, 2020, to stockholders of record at the close of business on August 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.

Inventory in Distribution Channels

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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 at December 31, 2020 compared to inventory levels at December 31, 2019.

The operating results for Trex Residential have historically varied from quarter to quarter.

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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 from January 1 through June 30 of each year, and a maximum principal amount of $200 million from July 1 through December 31 of each year throughout the term, which ends November 5, 2024.

At December 31, 2020, we had no outstanding indebtedness under the revolving credit facilities and borrowing capacity under the facilities of $300 million.

On May 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).

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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%.

At December 31, 2021, we had no outstanding indebtedness under the revolving credit facilities and borrowing capacity under the facilities of $300 million.

Compliance with Debt Covenants and Restrictions.

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Contractual Obligations.

The following table summarizes our contractual obligations, which consist primarily of purchase commitments and operating leases, as of December 31, 2020 (in thousands):

Contractual Obligations

Payments Due by Period

Purchase obligations (1)

Operating leases, including imputed interest (2)

Total contractual obligations

Our contractual obligations consist primarily of purchase commitments and operating leases.

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.

As of December 31, 2021, we have purchase obligations under material supply contracts of $47 million for the year ending December 31, 2022, $49.9 million in 2023, $25.0 million in 2024, $13.3 million in 2025 and $5.6 million in 2026.

Please refer to Note 18 to the Consolidated Financial Statements in this filing for additional information on our purchase commitments.

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.

As of December 31, 2021, we have operating lease liabilities of $7.9 million for the year ending December 31, 2022, $21.9 million for the years 2023 through 2026 and $8.1 million thereafter.

Please refer to Note 9 to the Consolidated Financial Statements in this filing for additional information on our operating leases.

The Company believes that its cash on hand and cash generated through operating activities, both over the next 12 months and beyond the next 12 months, should be sufficient to cover purchase obligations and operating leases.

Sheet Arrangements.

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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.

On October 26, 2021, we announced plans to add a third U.S.-based Trex Residential manufacturing facility in Little Rock, Arkansas.

The new campus will sit on nearly 300 acres of land and will address increased demand for Trex Residential outdoor living products.

Construction is slated to begin in early 2022 with the first production output anticipated in 2024.

Funded primarily through ongoing cash generation, we expect to invest approximately $400 million over the next five years in the development of the new Arkansas site.

Our capital expenditure guidance for 2022 is $200 million to $220 million.

In addition to our capital expenditure program, our capital allocation priorities include expenditures for internal growth opportunities, manufacturing cost reductions, upgrading equipment and support systems, 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.

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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.

Our ability to meet our cash needs during the next 12 months and thereafter could be adversely affected by various circumstances, including increases in the cost of 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.

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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.

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

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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 ASU notes that changes in contract terms that are made to effect 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 effect that transition.

The guidance is effective upon issuance and generally can be applied as of March 12, 2020 through December 31, 2022.

The Company does not expect adoption of the guidance to have a material effect on its consolidated financial statements.

In December 2019, the FASB issued ASU No.

“ 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 after December 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.

In November 2021, the FASB issued ASU No.

“ Government Assistance (Topic 832):

Disclosures by Business Entities About Government Assistance

The guidance requires business entities to make annual disclosures about material transactions with a government that are accounted for by analogizing to a grant or contribution accounting model, such as International Accounting Standards 20, ASC 958-605.

The annual disclosure requirements include:

the nature of the transactions, the entity’s related accounting policy used, the line items on the balance sheet and income statement that are affected and the amounts applicable to each financial statement line item, and significant terms and conditions of the transactions.

The disclosure requirements can be applied either prospectively to all transactions in the scope of the amendments that are reflected in the financial statements at the date of initial application and new transactions that are entered into after the date of initial application, or retrospectively.

The guidance is effective for fiscal years beginning after December 15, 2021, with early application permitted.

The Company does not expect adoption of the guidance to have a material effect on its consolidated financial statements.

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis