Item 7. Management’s Discussion and Analysis
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
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. 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
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:
•
Our Business
— 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
comparisons. 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.
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OUR BUSINESS
General.
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.
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
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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
is the world’s largest manufacturer of wood-alternative composite decking and railing products marketed under the brand name Trex ®
and manufactured in the 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 ®
fencing product
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 ended December 31, 2021 include:
•
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 $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 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.
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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.
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 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.
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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. 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 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. 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, 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.
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Our analysis is based on currently known facts and a number of assumptions, as discussed above, and current expectations. Projecting future events such as the number of claims to be received, the number of claims that will require payment and the average cost of claims could cause the actual warranty liabilities to be higher or lower than those projected, which could materially affect our financial condition, results of operations or cash flows. We estimate that the annual number of claims received will continue to decline over time and that the average cost per claim will increase slightly, primarily due to inflation. If the level of claims received or average cost per claim differs materially from expectations, it could result in additional increases or decreases to the warranty reserve and a decrease or increase in earnings and cash flows in future periods. We estimate that a 10% change in the expected number of remaining claims to be settled with payment or the expected cost to settle claims may result in approximately a $1.9 million change in the surface flaking warranty reserve.
The following table details surface flaking claims activity related to our residential product warranty:
Year Ended December 31,
2021
2020
2019
Claims unresolved beginning of period
1,799
1,724
2,021
Claims received (1)
894
1,441
1,394
Claims resolved (2)
(934
)
(1,366
)
(1,691
)
Claims unresolved end of period
1,759
1,799
1,724
Average cost per claim (3)
$
3,519
$
3,390
$
3,447
(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 (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 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. 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
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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 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. 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. 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
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, Sales and marketing” in Note 7 to the Consolidated Financial Statements presented in this Form 10-K.
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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.
Trex 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 ended December 31, 2021, 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 ended December 31, 2021 compared to the year ended December 31, 2020.
Year Ended December 31, 2021 Compared To Year Ended December 31, 2020
Net Sales
Year Ended December 31,
$ Change
% Change
2021
2020
(dollars in thousands)
Total net sales
$
1,196,952
$
880,831
$
316,121
35.9
%
Trex Residential net sales
$
1,139,266
$
827,792
$
311,474
37.6
%
Trex Commercial net sales
$
57,686
$
53,039
$
4,647
8.8
%
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.
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Gross Profit
Year Ended December 31,
$ Change
% Change
2021
2020
(dollars in thousands)
Cost of sales
$
736,448
$
521,374
$
215,074
41.3
%
% of total net sales
61.5
%
59.2
%
Gross profit
$
460,504
$
359,457
$
101,047
28.1
%
Gross margin
38.5
%
40.8
%
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 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
Year Ended December 31,
$ Change
% Change
2021
2020
(dollars in thousands)
Selling, general and administrative expenses
$
139,624
$
125,822
$
13,802
11.0
%
% of total net sales
11.7
%
14.3
%
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,
$ Change
% Change
2021
2020
(dollars in thousands)
Goodwill impairment loss
$
54,245
$
—
$
54,245
N/A
% of total net sales
4.5
%
N/A
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. 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. 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.
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Gain on Insurance Proceeds
Year Ended December 31,
$ Change
% Change
2021
2020
(dollars in thousands)
Gain on insurance proceeds
$
8,741
$
—
$
8,741
N/A
% of total net sales
0.7
%
N/A
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
Year Ended December 31,
$ Change
% Change
2021
2020
(dollars in thousands)
Provision for income taxes
$
66,654
$
59,003
$
7,651
13.0
%
Effective tax rate
24.2
%
25.2
%
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
(in thousands)
Reconciliation of net income (GAAP) to EBITDA (non-GAAP):
Year Ended December 31
2021
Trex
Residential
2021
Trex
Commercial
2021
Trex
Consolidated
Net income (loss)
$
247,059
$
(38,322
)
$
208,737
Interest income, net
(15
)
—
(15
)
Income tax expense (benefit)
79,500
(12,846
)
66,654
Depreciation and amortization
34,941
1,005
35,946
EBITDA
$
361,485
$
(50,163
)
$
311,322
Year Ended December 31
2020
Trex
Residential
2020
Trex
Commercial
2020
Trex
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
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 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
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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, 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. Non-GAAP
measures are not meant to be considered superior to or a substitute for our GAAP results.
Year Ended December 31,
$ Change
% Change
2021
2020
(dollars in thousands)
Total EBITDA
$
311,322
$
251,575
$
59,747
23.7
%
Trex Residential EBITDA
$
361,485
$
244,817
$
116,668
47.7
%
Trex Commercial EBITDA
$
(50,163
)
$
6,758
$
(56,921
)
NM
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
The Company hereby incorporates by reference the financial results from fiscal year 2019 and the comparison of financial results from fiscal year 2020 to fiscal year 2019 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, 2020 and filed with the U.S. Securities and Exchange Commission on February 22, 2021.
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, 2021, 2020, and 2019 (in thousands):
Year Ended December 31,
2021
2020
2019
Net cash provided by operating activities
$
258,064
$
187,294
$
156,352
Net cash used in investing activities
(158,039
)
(170,658
)
(67,244
)
Net cash used in financing activities
(80,673
)
(43,768
)
(45,974
)
Net increase (decrease) in cash and cash equivalents
$
19,352
$
(27,132
)
$
43,134
Operating Activities
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.
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Investing Activities
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 2021 consisted primarily of $82.5 million in repurchases of our common stock under our Stock Repurchase Program.
Stock Repurchase Program.
On February 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 of December 31, 2021, the Company has repurchased 3.6 million shares under the Stock Repurchase Program.
Inventory in Distribution Channels
. We sell our Trex Residential decking and railing products through a tiered distribution system. We have over 50 distributors worldwide and two national retail merchandisers to which we sell our products. The distributors in turn sell the products to dealers and retail locations who in turn sell the products to end users. Significant increases in inventory levels in the distribution channel without a corresponding change in end-use
demand could have an adverse effect on future sales. We cannot definitively determine the level of inventory in the distribution channels at any time.
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 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.
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. 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, Swing Line Lender and L/C Issuer; and certain other lenders including Wells Fargo Bank, N.A. (Wells Fargo), who is also Syndication Agent; Truist Bank (Truist); and Regions Bank (Regions) (each, a Lender and collectively, the Lenders), arranged by BofA 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%.
At December 31, 2021, we had no outstanding indebtedness under the revolving credit facilities and borrowing capacity under the facilities of $300 million.
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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 at December 31, 2021. Failure to comply with the financial covenants could be considered a default of repayment obligations and, among other remedies, could accelerate payment of any amounts outstanding.
Contractual Obligations.
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.
Off-Balance
Sheet Arrangements.
We do not have off-balance
sheet financing arrangements.
Capital and Other Cash Requirements.
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. 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 the cost of raw materials and product replacement costs, quality control problems, higher than expected product warranty
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claims, service disruptions and lower than expected collections of accounts receivable. In addition, any failure to negotiate amendments to our existing debt agreements to resolve any future noncompliance with financial covenants could adversely affect our liquidity by reducing access to revolving credit borrowings needed primarily to fund seasonal borrowing needs. We may determine that it is necessary or desirable to obtain financing through bank borrowings or the issuance of debt or equity securities to address such contingencies or changes to our business plan. Debt financing would increase our level of indebtedness, while equity financing would dilute the ownership of our stockholders. There can be no assurance as to whether, or as to the terms on which, we would be able to obtain such financing, which would be restricted by covenants contained in our existing debt agreements.
NEW ACCOUNTING STANDARDS
In March 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 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 November 2021, the FASB issued ASU No. 2021-10,
“ 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.