TREX CO INC 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following management discussion should be read in conjunction with the Trex Company, Inc. (Trex) Annual Report on Form 10-K for the year ended December 31, 2021 filed with the U.S. Securities and Exchange Commission (SEC) and the condensed consolidated financial statements and notes thereto included in Part I, Item 1. “Financial Statements” of this quarterly report. Trex has one wholly-owned subsidiary, Trex Commercial Products, Inc. Together, Trex and Trex Commercial Products, Inc. are referred to as the Company, we or our. NOTE ON FORWARD-LOOKING STATEMENTS This management’s discussion and analysis contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements regarding our expected financial position and operating results, our business strategy, our financing plans, forecasted demographic and economic trends relating to our industry and similar matters are forward-looking statements. These statements can sometimes be identified by our use of forward-looking words such as “may,” “will,” “anticipate,” “estimate,” “expect,” “intend” or similar expressions. We cannot promise you that our expectations in such forward-looking statements will turn out to be correct. Our actual results could be materially different from our expectations because of various factors, including the factors discussed under “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2021 filed with the SEC. 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 the Company’s products and raw materials; the Company’s ability to obtain raw materials, including scrap polyethylene, wood fiber, and other materials used in making our products, at acceptable prices; increasing inflation in the macro-economic environment; 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 the Company. The MD&A is provided as a supplement to, and should be read in conjunction with, our Condensed Consolidated Financial Statements and the accompanying notes thereto contained in “ Item 1. Condensed Consolidated Financial Statements ” of this report. MD&A includes the following sections: • Operations and Products — a general description of our business, a brief overview of our reportable segments’ products, and a discussion of our operational highlights. • Highlights and Financial Performance Quarter-to-Date and Year-to-Date – a summary of financial performance and highlights for the three months and nine months ended September 30, 2022, a general discussion of factors that may affect our operations, and a description of relevant financial statement line items. • Results of Operations — an analysis of our consolidated results of operations for the three months and nine months in the period ended September 30, 2022 compared to three months and nine months in the period ended September 30, 2021, respectively. • Liquidity and Capital Resources — an analysis of cash flows; contractual obligations, and a discussion of our capital and other cash requirements. OPERATIONS AND PRODUCTS The Company 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). Refer to Note 16, Segments , in the Notes to the Condensed Consolidated Financial Statements in Part I. Item 1. Condensed Consolidated Financial Statements of this Quarterly Report on Form 10-Q for additional information. The Company is focused on using renewable resources within both our Trex Residential and Trex Commercial segments. 18 Table of Contents Trex Residential is the world’s largest manufacturer of high-performance composite decking and residential railing products, which are marketed under the brand name Trex ® and manufactured in the United States. We offer a comprehensive set of aesthetically appealing and durable, low-maintenance product offerings in the decking, residential railing, fencing and outdoor lighting categories. A majority of the products are eco-friendly and leverage recycled and reclaimed materials to the extent possible. Trex Residential decking is made in a proprietary process that combines reclaimed wood fibers and recycled polyethylene film, making Trex Residential one of the largest recyclers of plastic film in North America. In addition to resisting fading and surface staining, Trex Residential products require no sanding and sealing, resist moisture damage, provide a splinter-free surface and do not require chemical treatment against rot or insect infestation. Combined, these aspects yield significant aesthetic advantages and lower maintenance than wood decking and railing and ultimately render Trex Residential products less costly than wood over the life of the deck. Special characteristics (including resistance to splitting, the ability to bend, and ease and consistency of machining and finishing) facilitate installation, reduce contractor call-backs and afford consumers a wide range of design options. Trex Residential products are sold to distributors and home centers for final resale primarily to the residential market. Trex offers the following products through Trex Residential: Decking and Accessories Our principal decking products are Trex Transcend ® Lineage ™ , Trex Transcend ® , Trex Select ® and Trex Enhance ® . In addition, our Trex Transcend decking product can also be used as cladding. Our high-performance, low-maintenance, eco-friendly composite decking products are comprised of a blend of 95 percent reclaimed wood fibers and recycled polyethylene film and feature a protective polymer shell for enhanced protection against fading, staining, mold and scratching. We also offer accessories to our decking products, including Trex Hideaway ® and Trex DeckLighting ™ , an outdoor lighting system. Trex DeckLighting is a line of energy-efficient LED dimmable deck lighting, which is designed for use on posts, floors and steps. The line includes a post cap light, deck rail light, riser light and a recessed deck light. Railing Our residential railing products are Trex Transcend ® Railing, Trex Select ® Railing, and Trex Signature ® aluminum railing. Trex Transcend Railing, made from approximately 40 percent recycled content, is available in the colors of Trex Transcend decking and finishes that make it appropriate for use with Trex decking products as well as other decking materials, which we believe enhances the sales prospects of our railing products. Trex Select Railing, made from approximately 40 percent recycled content, is offered in a white finish and is ideal for consumers who desire a simple clean finished look for their deck. Trex Signature aluminum railing, made from a minimum of 40 percent recycled content, is available in three colors and designed for consumers who want a sleek, contemporary look. Fencing Our Trex Seclusions ® fencing product is offered through two specialty distributors. This product consists of structural posts, bottom rail, pickets, top rail and decorative post caps. Trex Commercial is a leading national provider of custom-engineered railing and staging systems. Trex Commercial designs and engineers custom solutions, which are prevalent in professional and collegiate sports facilities, commercial and high-rise applications, performing arts, sports, and event production and rentals. With a team of devoted engineers, and industry-leading reputation for quality and dedication to customer service, Trex Commercial markets to architects, specifiers, contractors, and building owners. 19 Table of Contents Trex offers the following products through Trex Commercial: Architectural Railing Systems Our architectural railing systems are pre-engineered guardrails with options to accommodate styles ranging from classic and elegant wood top rail combined with sleek stainless components and glass infill, to modern and minimalist stainless cable and rod infill choices. Trex Commercial can also design, engineer and manufacture custom railing systems tailored to the customer’s specific material, style and finish. Many railing styles are achievable, including glass, mesh, perforated railing and cable railing. Aluminum Railing Systems Our Trex Signature aluminum railings, made from a minimum of 40 percent recycled content, are a versatile, cost-effective and low-maintenance choice for a variety of interior and exterior applications that we believe blend form, function and style. Its straightforward, unobtrusive design features traditional balusters and contemporary vertical rods, and can be installed with continuously graspable rail options for added safety, comfort and functionality. The strength and durability of Trex Signature railings make them a choice for any commercial setting, from high-rise condominiums and resort projects to public walkways and balconies. Aluminum railings come in a variety of colors and stock lengths to accommodate project needs. Staging Equipment and Accessories Our advanced modular, lightweight custom staging systems, including portable platforms and other custom applications, provide solutions for facilities and venues with custom needs. Our modular stage equipment is designed to appear seamless, feel permanent, and maximize the functionality of the space. Operational Highlights: Trex Residential Arkansas Facility . Construction began on the new Trex Residential Arkansas manufacturing facility in the second quarter 2022. The new campus will sit on approximately 300 acres of land and will address increased demand for Trex Residential outdoor living products. The development approach for the new campus will be modular and calibrated to demand trends for Trex Residential outdoor living products. In July 2022, the Company entered into a design-build agreement and, as previously announced, anticipates spending approximately $400 million on the facility. The budget for the design-build agreement is contained within this amount. Trex Residential NexTrex ® Grassroots Movement. In August 2022, Trex Residential launched its NexTrex Grassroots Movement to broaden its recycling initiative to enlist communities and organizations to partner in its robust recycling efforts. The initiative provides a turnkey framework for municipalities, universities, nonprofits and other qualifying businesses to serve as centralized drop-off locations for recycling polyethylene plastic film while earnings funds for their organizations. Organizations approved for participation in the NexTrex program can earn funding by serving as drop-off locations where community members can recycle their discarded plastic film packaging. Trex will pick up and transport the material to its manufacturing facilities in Virginia or Nevada, where it will begin its new life as high-performance Trex Residential composite decking. Russian Invasion of Ukraine . The conflict between Russia and Ukraine has not directly affected our business and results of operations. We have no operations in Russia or Ukraine but continue to monitor the potential economic impact of the conflict on supply chains, commodity and fuel prices, and prices of raw materials. We cannot predict the impact of the continued conflict on the global economy, our industry or our business. HIGHLIGHTS AND FINANCIAL PERFORMANCE QUARTER-TO-DATE AND YEAR-TO-DATE Financial performance. The following table presents quarter-to-date and year-to-date highlights of our financial performance: Three Months Ended September 30 Nine Months Ended September 30 2022 2021 2022 2021 (in thousands, except per share amounts) Net sales $ 188,472 $ 335,872 $ 913,950 $ 892,991 Gross profit $ 46,208 $ 128,250 $ 338,498 $ 342,323 Net income $ 14,423 $ 73,795 $ 174,549 $ 183,705 Diluted earnings per share $ 0.13 $ 0.64 $ 1.55 $ 1.59 EBITDA $ 30,816 $ 107,997 $ 265,381 $ 270,544 20 Table of Contents Capital expenditures . During the 2022 third quarter, our capital expenditures were $41.6 million primarily at Trex Residential related to cost reduction initiatives, the new Arkansas manufacturing facility, capacity expansion in our existing facilities, our new corporate headquarters, and safety, environmental and general support. Repurchase of common shares . We repurchased 1.7 million shares of our outstanding common stock in the 2022 third quarter under our Stock Repurchase Program for a total 9.0 million shares repurchased under the program as of September 30, 2022. RESULTS OF OPERATIONS General. Our results of operations are affected by a number of factors, including, but not limited to, the cost to manufacture and distribute products, cost of raw materials, inflation, interest rates, consumer spending and preferences, the impact of any supply chain disruptions, economic conditions, and any adverse effects from the COVID-19 pandemic and geopolitical conflicts. Strong sales growth in the first and second quarters of 2022 reflected an increase in Trex Residential net sales driven by pricing actions taken in 2021 and 2022, volume growth that continued to reflect strong secular trends in the outdoor living category, continued execution of our wood-to-composite market strategy share conversion, and channel inventory build to support historically high growth rates. The channel inventory build was due in part to expected consumer demand along the lines of what was seen in 2020 and 2021, but also was a consequence of improved product availability following more than two years of capacity constraints and product allocations. However, towards the end of June Trex Residential experienced a reduction in demand from its distribution partners, spurred by concerns over a potential easing in consumer demand due to rising interest rates, declining consumer sentiment and expectations of a general slowing in the economy. As a result, beginning in the third quarter Trex Residential’s channel partners met demand partially through inventory drawdown. The drawdown negatively impacted third quarter sales and will impact fourth quarter sales. In response to this changed environment, Trex Residential immediately took measures to manage a production slowdown, including labor force reductions, production optimization, as well as other cost actions. Net Sales . Net sales consist of sales and freight, net of discounts. The level of net sales is principally affected by sales volume and the prices paid for Trex products. Trex Residential operating results have historically varied from quarter to quarter. Seasonal, erratic or prolonged adverse weather conditions in certain geographic regions reduce the level of home and commercial improvement and residential and commercial construction and can shift demand for our products to a later period. As part of our normal business practice and consistent with industry practice, we have historically provided our distributors and dealers of our Trex Residential products incentives to build inventory levels before the start of the prime deck-building season to ensure adequate availability of our product to meet anticipated seasonal consumer demand and to enable production planning. These incentives include payment discounts, favorable payment terms, 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 our incentive programs can significantly impact sales, receivables and inventory levels during the offering period. In addition, the operating results for Trex Commercial are driven by the timing of individual projects, which may vary each quarterly period. Gross Profit. Gross profit represents the difference between net sales and cost of sales. Cost of sales consists of raw material costs, direct labor costs, manufacturing costs, subcontract costs and freight. Raw material costs generally include the costs to purchase and transport reclaimed wood fiber, reclaimed polyethylene, pigmentation for coloring our products, and commodities used in the production of railing and staging. 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 includes 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. 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 may vary from quarter to quarter due, in part, to the seasonality of our business. Below is the discussion and analysis of our operating results and material changes in our operating results for the three months ended September 30, 2022 (2022 quarter) compared to the three months ended September 30, 2021 (2021 quarter), and for the nine months ended September 30, 2022 (2022 nine-month period) compared to the nine months ended September 30, 2021 (2021 nine-month period). 21 Table of Contents Three Months Ended September 30, 2022 Compared To The Three Months Ended September 30, 2021 Net Sales Three Months Ended September 30, $ Change % Change 2022 2021 (dollars in thousands) Total net sales $ 188,472 $ 335,872 $ (147,400 ) (43.9 )% Trex Residential net sales $ 177,776 $ 319,207 $ (141,431 ) (44.3 )% Trex Commercial net sales $ 10,696 $ 16,665 $ (5,969 ) (35.8 )% Total net sales decreased by 43.9% in the 2022 quarter compared to the 2021 quarter reflecting a 44.3% decrease in Trex Residential net sales and a 35.8% decrease in Trex Commercial net sales. The decrease in Trex Residential net sales was primarily due to a 48.2% decline in volume. Beginning in the third quarter, our channel partners looked to rightsize their inventory and meet demand partially through inventory drawdown rather than reordering products, which adversely impacted third quarter sales. Gross Profit Three Months Ended September 30, $ Change % Change 2022 2021 (dollars in thousands) Cost of sales $ 142,264 $ 207,622 $ (65,358 ) (31.5 )% % of total net sales 75.5 % 61.8 % Gross profit $ 46,208 $ 128,250 $ (82,042 ) (64.0 )% Gross margin 24.5 % 38.2 % Gross profit as a percentage of net sales, gross margin, was 24.5% in the 2022 quarter compared to 38.2% in the 2021 quarter. Gross margin for Trex Residential and Trex Commercial was 25.4% and 10.2%, respectively, in the 2022 quarter compared to 38.9% and 24.0%, respectively, in the 2021 quarter. The decrease in consolidated gross margin was driven by the decrease in Trex Residential gross margin. The decrease was primarily due to reduced production resulting from our channel partners inventory drawdown to rightsize their inventories and additional costs as we rightsize our inventory with current production levels. The decrease was offset by labor force reductions, production optimization, and other actions to improve our cost position. Selling, General and Administrative Expenses Three Months Ended September 30, $ Change % Change 2022 2021 (dollars in thousands) Selling, general and administrative expenses $ 26,857 $ 33,931 $ (7,074 ) (20.8 )% % of total net sales 14.2 % 10.1 % Selling, general and administrative expenses decreased $7.1 million in the 2022 quarter. Excluding the $1.2 million severance charge related to labor force reductions in the 2022 quarter, the decrease in selling, general and administrative expenses in the 2022 quarter was $8.3 million compared to the 2021 quarter. The $8.3 million decrease was primarily the result of a $10.2 million decrease in personnel related expenses, offset by a $1.9 million increase in marketing and branding spend, and a $1.7 million increase in other operating expenses. Provision for Income Taxes Three Months Ended September 30, $ Change % Change 2022 2021 (dollars in thousands) Provision for income taxes $ 4,928 $ 24,311 $ (19,383 ) (79.7 )% Effective tax rate 25.5 % 24.8 % 22 Table of Contents The effective tax rate for the 2022 quarter of 25.5% and was 0.7% higher than the effective tax rate of 24.8% for the 2021 quarter. Net Income and Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) 1 (dollars in thousands) Reconciliation of net income (GAAP) to EBITDA and EBITDA margin (non-GAAP): Three Months Ended September 30, 2022 Trex Residential Trex Commercial Total Net income (loss) $ 15,287 $ (864 ) $ 14,423 Interest (income) expense, net — — — Income tax expense (benefit) 5,211 (283 ) 4,928 Depreciation and amortization 11,194 271 11,465 EBITDA $ 31,692 $ (876 ) $ 30,816 Net income as a percentage of net sales 7.7 % EBITDA as a percentage of net sales (EBITDA margin) 16.4 % Three Months Ended September 30, 2021 Trex Residential Trex Commercial Total Net income $ 72,603 $ 1,192 $ 73,795 Interest (income), net (10 ) — (10 ) Income tax expense 23,899 412 24,311 Depreciation and amortization 9,643 258 9,901 EBITDA $ 106,135 $ 1,862 $ 107,997 Net income as a percentage of net sales 22.0 % EBITDA as a percentage of net sales (EBITDA margin) 32.2 % Three Months Ended September 30, $ Change % Change 2022 2021 (dollars in thousands) Total EBITDA $ 30,816 $ 107,997 $ (77,181 ) (71.5 )% Trex Residential EBITDA $ 31,692 $ 106,135 $ (74,443 ) (70.1 )% Trex Commercial EBITDA $ (876 ) $ 1,862 $ (2,738 ) (147.0 )% Total EBITDA decreased 71.5% to $30.8 million for the 2022 quarter compared to $108 million for the 2021 quarter. EBITDA as a percentage of net sales, EBITDA margin, was 16.4% for the 2022 quarter compared to 32.2% in the 2021 quarter. The decrease in EBITDA and EBITDA margin was driven by a 70.1% decrease in Trex Residential EBITDA, primarily due to the decrease in net sales and gross margin. 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 and EBITDA as a percentage of net sales (EBITDA margin) because management believes it facilitates performance comparison between the Company and its competitors, and management evaluates the performance of its reportable segments using several measures, including EBITDA and EBITDA margin. 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 or loss. In relation to competitors, EBITDA and EBITDA margin eliminate differences among companies in capitalization and tax structures, capital investment cycles and ages of related assets. For these reasons, management believes that EBITDA and EBITDA margin provide important information regarding the operating performance of the Company and its reportable segments. Non-GAAP financial measures should be viewed in addition to, and not as an alternative for, the Company’s reported results prepared in accordance with GAAP and are not meant to be considered superior to or a substitute for our GAAP results. 23 Table of Contents Nine Months Ended September 30, 2022 Compared To The Nine Months Ended September 30, 2021 Net Sales Nine Months Ended September 30, $ Change % Change 2022 2021 (dollars in thousands) Total net sales $ 913,950 $ 892,991 $ 20,959 2.3 % Trex Residential net sales $ 878,892 $ 850,909 $ 27,983 3.3 % Trex Commercial net sales $ 35,058 $ 42,082 $ (7,024 ) (16.7 )% Total net sales increased by 2.3% in the 2022 nine-month period compared to the 2021 nine-month period reflecting a 3.3% increase in Trex Residential net sales and a 16.7% decrease in Trex Commercial net sales. Trex Residential net sales were impacted positively by a 16.1% increase in pricing, offset by an 11.1% reduction in volume. The decrease in Trex Residential net sales was primarily due to a decline in demand in the third quarter as our distribution and pro channel partners drew down their inventory levels to address the expectations of a slowing economy. Gross Profit Nine Months Ended September 30, $ Change % Change 2022 2021 (dollars in thousands) Cost of sales $ 575,452 $ 550,668 $ 24,784 4.5 % % of total net sales 63.0 % 61.7 % Gross profit $ 338,498 $ 342,323 $ (3,825 ) (1.1 )% Gross margin 37.0 % 38.3 % Gross profit as a percentage of net sales, gross margin, was 37.0% in the 2022 nine-month period compared to 38.3% in the 2021 nine-month period. Gross margin for Trex Residential and Trex Commercial products in the 2022 nine-month period were 38.1% and 11.1%, respectively, compared to 39.2% and 21.2%, respectively, in the 2021 nine-month period. The decrease in consolidated gross margin was driven primarily by a slight decrease in gross margin at Trex Residential primarily due to reduced production volume. Selling, General and Administrative Expenses Nine Months Ended September 30, $ Change % Change 2022 2021 (dollars in thousands) Selling, general and administrative expenses $ 106,387 $ 102,880 $ 3,507 3.4 % % of total net sales 11.6 % 11.5 % Selling, general and administrative expenses increased $3.5 million during the 2022 nine-month periods. The $3.5 million increase resulted primarily from a $12.3 million increase in marketing and branding spend, offset by a $10.7 million reduction in personnel related expenses. Provision for Income Taxes Nine Months Ended September 30, $ Change % Change 2022 2021 (dollars in thousands) Provision for income taxes $ 57,665 $ 61,235 $ (3,570 ) 5.8 % Effective tax rate 24.8 % 25.0 % The effective tax rate for the 2022 nine-month period was comparable to the effective tax rate for the 2021 nine-month period. 24 Table of Contents Net Income and Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) 2 (dollars in thousands) Reconciliation of net income (GAAP) to EBITDA and EBITDA margin (non-GAAP): Nine Months Ended September 30, 2022 Trex Residential Trex Commercial Total Net income (loss) $ 176,939 $ (2,390 ) $ 174,549 Interest income, net (103 ) — (103 ) Income tax expense (benefit) 58,454 (789 ) 57,665 Depreciation and amortization 32,435 835 33,270 EBITDA $ 267,725 $ (2,344 ) $ 265,381 Net income as a percentage of net sales 19.1 % EBITDA as a percentage of net sales (EBITDA margin) 29.0 % Nine Months Ended September 30, 2021 Trex Residential Trex Commercial Total Net income $ 182,437 $ 1,268 $ 183,705 Interest expense, net — — — Income tax expense 60,797 438 61,235 Depreciation and amortization 24,873 731 25,604 EBITDA $ 268,107 $ 2,437 $ 270,544 Net income as a percentage of net sales 20.6 % EBITDA as a percentage of net sales (EBITDA margin) 30.3 % Nine Months Ended September 30, $ Change % Change 2022 2021 (dollars in thousands) Total EBITDA $ 265,381 $ 270,544 $ (5,163 ) (1.9 )% Trex Residential EBITDA $ 267,725 $ 268,107 $ (382 ) (0.1 )% Trex Commercial EBITDA $ (2,344 ) $ 2,437 $ (4,781 ) (196.2 )% Total EBITDA decreased 1.9% to $265.4 million for the 2022 nine-month period compared to $270.5 million for the 2021 nine-month period. EBITDA as a percentage of net sales, EBITDA margin, was 29.0% for the 2022 nine-month period compared to 30.3% in the 2021 nine-month period. The decrease in EBITDA and EBITDA margin was driven primarily due to the decrease in gross margin at Trex Residential and Trex Commercial. LIQUIDITY AND CAPITAL RESOURCES 2 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 and EBITDA as a percentage of net sales (EBITDA margin) because management believes it facilitates performance comparison between the Company and its competitors, and management evaluates the performance of its reportable segments using several measures, including EBITDA and EBITDA margin. 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 or loss. In relation to competitors, EBITDA and EBITDA margin eliminate differences among companies in capitalization and tax structures, capital investment cycles and ages of related assets. For these reasons, management believes that EBITDA and EBITDA margin provide important information regarding the operating performance of the Company and its reportable segments. Non-GAAP financial measures should be viewed in addition to, and not as an alternative for, the Company’s reported results prepared in accordance with GAAP and are not meant to be considered superior to or a substitute for our GAAP results. 25 Table of Contents We finance operations and growth primarily with cash flows from operations, borrowings under our revolving credit facilities, operating leases and normal trade credit terms from operating activities. At September 30, 2022 we had $5.9 million of cash and cash equivalents. S ources and Uses of Cash. The following table summarizes our cash flows from operating, investing and financing activities (in thousands): Nine Months Ended September 30, 2022 2021 Net cash provided by operating activities $ 244,393 $ 113,059 Net cash used in investing activities (108,118 ) (123,096 ) Net cash used in financing activities (271,443 ) (57,622 ) Net decrease in cash and cash equivalents $ (135,168 ) $ (67,659 ) Operating Activities Cash provided by operations was $244.4 million during the 2022 nine-month period compared to cash provided by operations of $113.1 million during the 2021 nine-month period. The increase in cash provided by operating activities was primarily due to a decrease in accounts receivable, offset by an increase in inventories and a decrease in accounts payable and accrued expenses. Investing Activities Capital expenditures in the 2022 nine-month period were $107.9 million at Trex Residential, primarily related to cost reduction initiatives, the new Arkansas manufacturing facility, capacity expansion in our existing facilities, our new corporate headquarters, and safety, environmental and general support. Financing Activities Net cash used in financing activities in the 2022 nine-month period consisted primarily of $348 million in repurchases of our common stock, offset by net borrowings of $76 million. Stock Repurchase Program. On February 16, 2018, the Trex Board of Directors adopted a stock repurchase program of up to 11.6 million shares of its outstanding common stock (Stock Repurchase Program). As of September 30, 2022, the Company has repurchased 9.0 million shares under the Stock Repurchase Program. Indebtedness On and After May 18, 2022 . On May 18, 2022, the Company, 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; Wells Fargo Bank, National Association (Wells Fargo), as lender and Syndication Agent; Regions Bank, PNC Bank, National Association, and TD Bank, N.A. (each, a Lender and collectively, the Lenders), arranged by BofA Securities, Inc. as Sole Lead Arranger and Sole Bookrunner, entered into a Credit Agreement (Credit Agreement) to amend and restate the Fourth Amended and Restated Credit Agreement dated as of November 5, 2019. Under the Credit Agreement, the Lenders agreed to provide the Company with one or more Revolving Loans in a collective maximum principal amount of $400,000,000 (Loan Limit) throughout the term, which ends May 18, 2027 (Term). Included within the Loan Limit are sublimits for a Letter of Credit facility in an amount not to exceed $60,000,000; and Swing Line Loans in an aggregate principal amount at any time outstanding not to exceed $20,000,000. The Revolving Loans, the Letter of Credit facility and the Swing Line Loans are for the purpose of raising working capital and supporting general business operations. The Facility provides the Company, in the aggregate, the ability to borrow an amount up to the Loan Limit during the Term. The Company is not obligated to borrow any amount under the Loan Limit. Within the Loan Limit, the Company may borrow, repay and reborrow at any time or from time to time while the Notes are in effect. Base Rate Loans (as defined in the Credit Agreement) under the Revolving Loans and the Swing Line Loans accrue interest at the Base Rate plus the Applicable Rate (as defined in the Credit Agreement) and Term SOFR Loans for the Revolving Loans accrue interest at the rate per annum equal to the sum of Term SOFR for such interest period plus the Applicable Rate (as defined in the Credit Agreement). The Base Rate for any day is a fluctuating rate per annum equal to the highest of (a) the Federal Funds Rate plus 0.50%, (b) the rate of interest in effect for such day as publicly announced from time to time by BOA as its prime rate, and (c) the Term SOFR plus 1.0% subject to certain interest rate floors. Repayment of all then outstanding principal, interest, fees and costs is due at the end of the Term. 26 Table of Contents The Company and BofA Securities, Inc. as a sustainability coordinator, are entitled to establish specified key performance indicators (KPIs) with respect to certain environmental, social and governance targets of the Company and its subsidiaries. The sustainability coordinator and the Company may amend the Credit Agreement for the purpose of incorporating the KPIs and other related provisions, unless the Lenders object to such amendment on or prior to the date that is ten business days after the date on which such amendment is posted for review by the Lenders. Based on the performance of the Company and its subsidiaries against the KPIs, certain adjustments (increase, decrease or no adjustment) to otherwise applicable pricing will be made; provided that the amount of such adjustments shall not exceed certain aggregate caps as in the definitive loan documentation. Under the terms of the Security and Pledge Agreement, the Company and TCP, subject to certain permitted encumbrances, as collateral security for the above-stated loans and all other present and future indebtedness of the Company owing to the Lenders grants to BOA, as Administrative Agent for the Lenders, a continuing security interest in certain collateral described and defined in the Security and Pledge Agreement but excluding the Excluded Property (as defined in the Security and Pledge Agreement). Indebtedness Prior to May 18, 2022. 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 of the material terms and conditions related to the original line of credit (Revolving A Commitments) remained 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%. The Company’s revolving credit facility executed November 5, 2019 was completely replaced by the Company’s revolving credit facility executed May 18, 2022. At September 30, 2022, we had $76 million in outstanding borrowings under the revolving credit facility and borrowing capacity under the facility of $324 million. Compliance with Debt Covenants. Pursuant to the terms of the Credit Agreement, the Company is subject to certain loan compliance covenants. The Company was in compliance with all covenants as of September 30, 2022. 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. We believe that cash on hand, cash from operations and borrowings expected to be available under our revolving credit facilities will provide sufficient funds to fund planned capital expenditures, make scheduled principal and interest payments, fund warranty payments, and meet other cash requirements. We currently expect to fund future capital expenditures from operations and financing activities. 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. Capital Requirements. In October 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 approximately 300 acres of land and will address increased demand for Trex Residential outdoor living products. The development approach for the new campus will be modular and calibrated to demand trends for Trex Residential outdoor living products. Construction began on the new facility in the second quarter 2022, and in July 2022, the Company entered into a design-build agreement. As previously announced, the Company anticipates spending approximately $400 million on the facility and the budget for the design-build agreement is contained within this amount. Construction for the new facility will be funded primarily through the Company’s ongoing cash generation or its line of credit. 27 Table of Contents Our capital expenditure guidance for 2022 is $170 million to $180 million. In addition to the construction of our third facility, which will be located in Arkansas, 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 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. Product Warranty. We warrant that our Trex Residential products will be free from material defects in workmanship and materials for warranty periods ranging from 10 years to 25 years, depending on the product and its 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, we also warrant our 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 decking products manufactured at our Trex Residential Nevada facility prior to 2007 that exhibit surface flaking and maintain a warranty reserve to provide for the settlement of these claims. 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 fiscal year are received during the summer outdoor season, which spans the second and third fiscal quarters. It has been our practice to utilize actuarial techniques 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. Our actuarial analysis is based on currently known facts and a number of assumptions. 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. The number of incoming claims received in the nine months ended September 30, 2022, was significantly lower than the number of claims received in the nine months ended September 30, 2021 and lower than our expectations for 2022. Average cost per claim experienced in the nine months ended September 30, 2022 was significantly higher than that experienced in the nine months ended September 30, 2021 and higher than our expectations for the current year. The elevated average cost per claim experienced in the nine months ended September 30, 2022, was primarily the result of the closure of three large claims, which were considered in our estimation of the surface flaking warranty reserve. We believe the reserve at September 30, 2022 is sufficient to cover future surface flaking obligations. Refer to Note 18, Commitments and Contingencies, Product Warranty , in the Notes to the Condensed Consolidated Financial Statements in Part I. Item 1. Condensed Consolidated Financial Statements of this Quarterly Report on Form 10-Q for additional information. We estimate that the annual number of claims received will decline over time and that the average cost per claim will increase. 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 $1.6 million change in the surface flaking warranty reserve. The following table details surface flaking claims activity related to our warranty: Nine Months Ended September 30, 2022 2021 Claims open, beginning of period 1,759 1,799 Claims received (1) 507 788 Claims resolved (2) (506 ) (785 ) Claims open, end of period 1,760 1,802 Average cost per claim (3) $ 5,200 $ 3,492 (1) Claims received include new claims received or identified during the period. 28 Table of Contents (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. 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 quarterly period.