Trex(TREX) - 2020 Q4 - Annual Report

PART I This section provides an overview of the company's business, including its operations, products, and strategies, alongside key risk factors, property details, and legal disclosures Business Trex Company, Inc. is the world's largest manufacturer of composite decking and railing, operating in residential and commercial segments with a growth strategy focused on innovation and market conversion from wood General Overview Trex Company, Inc. is the world's largest manufacturer of composite decking and railing products, operating in Trex Residential and Trex Commercial segments - Trex is the world's largest manufacturer of composite decking and railing products[15] - The company operates in two segments: Trex Residential Products and Trex Commercial Products[16] Products Trex Residential offers eco-friendly composite decking and railing from recycled materials, while Trex Commercial provides custom-engineered railing and staging systems for large venues Trex Residential Product Lines | Category | Products | | :--- | :--- | | Decking & Accessories | Trex Transcend®, Trex Select®, Trex Enhance®, Trex Hideaway®, Trex DeckLighting™ | | Railing | Trex Transcend Railing, Trex Select Railing, Trex Enhance Railing, Trex Signature® aluminum railing | | Fencing | Trex Seclusions® | Trex Commercial Product Lines | Category | Description | | :--- | :--- | | Architectural Railing Systems | Pre-engineered and custom guardrails with various infill options (glass, mesh, cable, etc.) | | Aluminum Railing Systems | Trex Signature aluminum railings for commercial applications | | Staging Equipment | Modular, lightweight systems including platforms, shells, guardrails, and custom applications | - Trex licenses its brand to third parties for a range of outdoor products, including furniture, drainage systems, pergolas, and outdoor kitchens[21] Customers and Distribution Trex Residential products are distributed through wholesale and direct channels to major retailers, with significant customer concentration, while Trex Commercial sells directly to facility owners - The company utilizes a dual distribution strategy for its residential products, selling through both wholesale distributors to retail lumber dealers and directly to large home improvement chains like Home Depot and Lowe's[24][25] - There is significant customer concentration, with three customers accounting for approximately 56% of total net sales in 2020, 57% in 2019, and two customers accounting for 42% in 2018[26][27] Manufacturing and Suppliers Trex manufactures residential products in Virginia and Nevada using reclaimed materials and commercial products in Minnesota, sourcing raw materials via purchase orders and supply contracts - The primary manufacturing process for residential products involves mixing reclaimed wood fiber and scrap polyethylene, which is then heated and extruded through a profile die[30] - Raw material sourcing for residential products includes reclaimed wood fiber (from cabinet/flooring manufacturers) and scrap polyethylene (plastic film/bags), secured through a mix of purchase orders and supply contracts[33][34][38] Growth Strategies The company's growth strategy aims to increase market share against wood and expand product categories and geographies through innovation, brand awareness, channel development, quality, cost reduction, and customer service - A core goal is to increase market share by converting wood buyers to composite decking and appealing to high-end homeowners[37] - Key strategies include: Innovation (new products), Brand (expand awareness), Channels (increase stocking dealers and international presence), Quality (superior product and service), Cost (lower manufacturing costs), and Customer Service[37][43] Competition Trex primarily competes with traditional wood products and, within the wood-alternative market, with The Azek Company Inc. and Fiberon, leveraging product quality, price, aesthetics, and brand strength - The main competition for residential products is traditional wood, which constitutes the majority of decking and railing sales[40] - Within the wood-alternative market, Trex has the leading market share, with principal competitors being The Azek Company Inc. and Fiberon[41] - Key competitive factors include product quality, price, aesthetics, maintenance cost, distribution, and brand strength[42] Human Capital and Governance As of December 31, 2020, Trex employed 1,719 full-time employees, focusing on workforce diversity and growth, with corporate governance details available online - As of December 31, 2020, the company had 1,719 full-time employees: 1,555 in Trex Residential and 164 in Trex Commercial[55] - The company hired approximately 350 new employees over the past year to support growth and expansion efforts[58] - The company has a whistle-blowing policy and provides a toll-free hotline for reporting issues directly to the Board of Directors and General Counsel[62] Environmental and Occupational Safety Trex prioritizes environmental stewardship by using 95% reclaimed materials in residential products, minimizing emissions, and recycling, while also maintaining strong occupational safety programs - Trex Residential's decking products are made from a blend of 95% reclaimed wood and recycled polyethylene film[64] - The company has received multiple environmental awards, including the 2020 Sustainability Leadership Award and Green Builder Media's Readers' Choice Award for "Greenest Decking" for a 10-year streak[68] - The company has adopted an Occupational Health and Safety Policy and applies industry best-practices for monitoring and reporting safety incidents[71] Risk Factors The company faces risks including market acceptance, intense competition, customer concentration, supply chain volatility, adverse weather, labor shortages, and potential impacts from the COVID-19 pandemic and cybersecurity threats - The company's growth depends on its ability to compete with wood products, which constitute a substantial majority of the market, and other wood-alternative manufacturers[79] - A limited number of customers account for a significant percentage of sales, and the loss of a major customer could have a significant negative impact on business[80] - The business is subject to risks from raw material availability and pricing, particularly for wood fiber, scrap polyethylene, aluminum, and steel[99] - The COVID-19 pandemic poses a risk of disruption to employees, suppliers, and business partners, which could adversely affect operations and financial condition[104] - Cyberattacks and security breaches are a risk, as they could compromise proprietary and confidential information, harming the business and reputation[104] Unresolved Staff Comments The company reports that there are no unresolved staff comments - None[109] Properties The company owns and leases properties for operations and R&D, with 2020 capital expenditures of $172.8 million primarily for a $200 million multi-year capacity expansion program expected to increase residential production by 70% - The company owns manufacturing facilities, storage, and office space totaling over 1.2 million square feet and 150 acres in Virginia and Nevada[110] - A multi-year capital expenditure program of approximately $200 million through 2021 is underway to increase Trex Residential production capacity by about 70%[110] - Total capital expenditures in 2020 were $172.8 million, with $162.9 million related to capacity expansion and cost reduction initiatives[110] Legal Proceedings The company is involved in routine litigation and claims, the resolution of which is not expected to materially affect its financial condition or operations - The Company has pending lawsuits and claims that are considered ordinary and incidental to the business, and their resolution is not expected to have a material effect[112] Mine Safety Disclosures This item is not applicable to the company - Not applicable[113] PART II This section covers the company's common stock market, selected financial data, management's discussion and analysis of financial condition, market risks, and internal controls Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities The company's common stock trades on the NYSE under 'TREX', with no cash dividends paid, a focus on retaining earnings for growth and share repurchases, and strong stock performance relative to market indices - The company's common stock trades on the New York Stock Exchange under the symbol 'TREX'[115] - The company has never paid cash dividends and has no current intention to do so, preferring to retain earnings for growth and share repurchases[116] - A stock repurchase program for up to 11.6 million shares was authorized in February 2018. As of October 31, 2020, 8,797,222 shares remained available for repurchase under this program[117][118] Five-Year Cumulative Total Return | | 12/31/2015 | 12/31/2016 | 12/31/2017 | 12/31/2018 | 12/31/2019 | 12/31/2020 | | :--- | :--- | :--- | :--- | :--- | :--- | :--- | | Trex Company, Inc. | $100.00 | $169.30 | $284.96 | $312.09 | $472.56 | $880.34 | | Russell 2000 Index | $100.00 | $121.31 | $139.08 | $123.77 | $155.37 | $186.38 | | S&P 600 Building Products | $100.00 | $129.78 | $156.02 | $123.59 | $175.73 | $221.52 | Selected Financial Data This section presents selected five-year financial data, including consistent growth in net sales, gross profit, and net income, with all figures retroactively adjusted for a 2020 stock split and an EBITDA reconciliation provided Selected Financial Data (2016-2020) (in thousands, except per share data) | | 2020 | 2019 | 2018 | 2017 | 2016 | | :--- | :--- | :--- | :--- | :--- | :--- | | Net sales | $880,831 | $745,347 | $684,250 | $565,153 | $479,616 | | Gross profit | $359,457 | $306,503 | $294,894 | $243,373 | $187,095 | | Income from operations | $233,635 | $188,199 | $176,669 | $142,380 | $103,955 | | Net income | $175,631 | $144,738 | $134,572 | $95,128 | $67,847 | | Diluted earnings per share | $1.51 | $1.24 | $1.14 | $0.81 | $0.58 | | Total assets | $770,492 | $592,239 | $465,122 | $326,227 | $221,430 | | Total stockholders' equity | $588,531 | $449,175 | $342,963 | $231,250 | $134,161 | EBITDA Reconciliation (Non-GAAP) (in thousands) | | 2020 | 2019 | 2018 | 2017 | 2016 | | :--- | :--- | :--- | :--- | :--- | :--- | | Net income | $175,631 | $144,738 | $134,572 | $95,128 | $67,847 | | Interest (income) expense, net | (999) | (1,503) | (192) | 461 | 1,125 | | Income tax provision | 59,003 | 44,964 | 42,289 | 46,791 | 34,983 | | Depreciation and amortization | 17,940 | 14,031 | 16,467 | 16,730 | 14,181 | | EBITDA (non-GAAP) | $251,575 | $202,230 | $193,136 | $159,110 | $118,136 | Management's Discussion and Analysis of Financial Condition and Results of Operations Management discusses the company's financial condition and results, highlighting 18.2% net sales growth to $880.8 million in 2020, critical accounting policies, liquidity, and capital resources, including a $200 million capacity expansion program Overview The company's 2020 overview highlights record net sales of $880.8 million (an 18.2% increase) and net income of $175.6 million, with operations largely undisrupted by COVID-19 despite $6.0 million in related costs - The company did not experience material disruptions to operations, production, or supply chain due to the COVID-19 pandemic[134] - In 2020, the company incurred $6.0 million in COVID-19 management costs, of which $4.8 million were related to higher production costs[134] 2020 Financial Highlights (in millions) | Metric | Value | Change vs 2019 | | :--- | :--- | :--- | | Net Sales | $880.8 | +18.2% | | Gross Profit | $359.5 | +17.3% | | Net Income | $175.6 | - | | Operating Cash Flow | $187.3 | - | Critical Accounting Policies and Estimates This section details critical accounting policies and estimates, primarily focusing on the product warranty reserve for legacy surface flaking issues, goodwill impairment testing, and revenue recognition methods for both segments - The company continues to manage and reserve for surface flaking claims on residential products manufactured at its Nevada facility prior to 2007[148] - In Q3 2020, a provision of $6.5 million was recorded to the warranty reserve for surface flaking claims due to an increase in estimated future claims and costs[152] Surface Flaking Claims Activity | | 2020 | 2019 | 2018 | | :--- | :--- | :--- | :--- | | Claims received | 1,441 | 1,394 | 1,481 | | Claims resolved | (1,366) | (1,691) | (1,766) | | Average cost per claim | $3,390 | $3,447 | $2,631 | - Goodwill of $68.5 million was tested for impairment as of October 31, 2020, with a qualitative assessment concluding that impairment was not likely[161] Results of Operations (2020 vs. 2019) In 2020, total net sales increased 18.2% to $880.8 million, driven by residential growth, while gross margin slightly decreased due to expansion costs and a $6.5 million warranty provision, and SG&A expenses rose 6.4% Net Sales Comparison (2020 vs. 2019) (in thousands) | | 2020 | 2019 | $ Change | % Change | | :--- | :--- | :--- | :--- | :--- | | Total net sales | $880,831 | $745,347 | $135,484 | 18.2% | | Trex Residential net sales | $827,792 | $694,267 | $133,525 | 19.2% | | Trex Commercial net sales | $53,039 | $51,080 | $1,959 | 3.8% | Gross Profit Comparison (2020 vs. 2019) (in thousands) | | 2020 | 2019 | $ Change | % Change | | :--- | :--- | :--- | :--- | :--- | | Gross profit | $359,457 | $306,503 | $52,954 | 17.3% | | Gross margin | 40.8% | 41.1% | | | - SG&A expenses increased by $7.5 million (6.4%) primarily due to higher personnel-related expenses, including incentive compensation[172] - Total EBITDA increased 24.4% to $251.6 million, driven by a $45.8 million increase in Trex Residential EBITDA[176] Liquidity and Capital Resources The company's liquidity is supported by $187.3 million in operating cash flow and a $300 million revolving credit facility, funding $170.7 million in capital expenditures for capacity expansion and $43.8 million in stock repurchases Summary of Cash Flows (in thousands) | | 2020 | 2019 | 2018 | | :--- | :--- | :--- | :--- | | Net cash provided by operating activities | $187,294 | $156,352 | $138,121 | | Net cash used in investing activities | ($170,658) | ($67,244) | ($33,733) | | Net cash used in financing activities | ($43,768) | ($45,974) | ($29,203) | - The company has a revolving credit facility with borrowing capacity up to $300 million and had no outstanding indebtedness at December 31, 2020[188][189] Contractual Obligations as of Dec 31, 2020 (in thousands) | | Total | 1 year | 2-3 years | 4-5 years | After 5 years | | :--- | :--- | :--- | :--- | :--- | :--- | | Purchase obligations | $71,323 | $33,570 | $30,577 | $7,176 | $— | | Operating leases | $39,132 | $7,835 | $13,953 | $10,745 | $6,599 | | Total | $110,455 | $41,405 | $44,530 | $17,921 | $6,599 | Quantitative and Qualitative Disclosures About Market Risk The company's primary market risk stems from variable interest rates on its revolving credit facility, though with no outstanding debt at year-end 2020, this risk is not considered materially adverse - The primary market risk is from changing interest rates on borrowings under the variable rate revolving line of credit[202] - As of December 31, 2020, there was no debt outstanding, and a 1% increase in interest rates would not have a material adverse effect[202] Financial Statements and Supplementary Data This item incorporates by reference the company's consolidated financial statements and supplementary data, as listed in Item 15 - The financial statements listed in Item 15 are incorporated by reference in this item[204] Changes in and Disagreements With Accountants on Accounting and Financial Disclosure The company reports no changes in or disagreements with its accountants on accounting and financial disclosure - None[205] Controls and Procedures Management concluded that disclosure controls and internal control over financial reporting were effective as of December 31, 2020, a conclusion affirmed by an unqualified audit opinion from Ernst & Young LLP - Management concluded that the Company's disclosure controls and procedures were effective as of December 31, 2020[206] - Management assessed internal control over financial reporting based on the COSO framework and concluded it was effective as of December 31, 2020[210] - Ernst & Young LLP, the independent auditor, issued an unqualified opinion on the effectiveness of the Company's internal control over financial reporting as of December 31, 2020[216] Other Information On February 17, 2021, the Board approved an amendment to the incentive plan for outside directors, increasing their annual cash retainers, equity awards, and committee fees - On February 17, 2021, the Board amended the incentive plan for outside directors, increasing their compensation[225] - Key changes include increasing the annual cash retainer to $73,750, the annual equity award to $110,000, and raising fees for committee members and chairs[226] PART III This section details corporate governance, executive compensation, security ownership, related party transactions, and principal accounting fees Directors, Executive Officers and Corporate Governance Information regarding directors, executive officers, and corporate governance, including the Code of Conduct and Ethics, is incorporated by reference from the 2021 proxy statement - Information responsive to this item is incorporated by reference from the definitive proxy statement for the 2021 annual meeting of stockholders[228] Executive Compensation Information required for this item concerning executive compensation is incorporated by reference from the company's definitive proxy statement for its 2021 annual meeting of stockholders - Information responsive to this item is incorporated by reference from the definitive proxy statement for the 2021 annual meeting of stockholders[230] Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Information required for this item regarding security ownership is incorporated by reference from the company's definitive proxy statement for its 2021 annual meeting of stockholders - Information responsive to this item is incorporated by reference from the definitive proxy statement for the 2021 annual meeting of stockholders[231] Certain Relationships and Related Transactions, and Director Independence Information required for this item concerning related transactions and director independence is incorporated by reference from the company's definitive proxy statement for its 2021 annual meeting of stockholders - Information responsive to this item is incorporated by reference from the definitive proxy statement for the 2021 annual meeting of stockholders[232] Principal Accounting Fees and Services Information required for this item regarding principal accounting fees and services is incorporated by reference from the company's definitive proxy statement for its 2021 annual meeting of stockholders - Information responsive to this item is incorporated by reference from the definitive proxy statement for the 2021 annual meeting of stockholders[233] PART IV This section provides a comprehensive list of exhibits and financial statement schedules included in the report Exhibits and Financial Statement Schedules This section lists the consolidated financial statements, financial statement schedules, and an extensive exhibit index filed as part of the Form 10-K report - This item lists the Consolidated Financial Statements, Schedule II—Valuation and Qualifying Accounts and Reserves, and all other exhibits filed with the report[235][236] Financial Statements This section presents the company's audited consolidated financial statements, including the independent auditor's report and detailed notes Report of Independent Registered Public Accounting Firm Ernst & Young LLP issued an unqualified opinion on the consolidated financial statements, identifying the Surface Flaking Warranty reserve as a Critical Audit Matter due to complex estimation judgments - Ernst & Young LLP issued an unqualified opinion on the consolidated financial statements as of December 31, 2020[241] - The audit identified the Surface Flaking Warranty reserve as a Critical Audit Matter due to the complexity and significant management judgment required for its estimation[245][248] Consolidated Financial Statements The consolidated financial statements present the company's financial performance and position, with 2020 net sales of $880.8 million and net income of $175.6 million Consolidated Statement of Comprehensive Income (Year Ended Dec 31, 2020) (in thousands) | | Amount | | :--- | :--- | | Net sales | $880,831 | | Gross profit | $359,457 | | Income from operations | $233,635 | | Net income | $175,631 | Consolidated Balance Sheet (As of Dec 31, 2020) (in thousands) | | Amount | | :--- | :--- | | Total current assets | $321,997 | | Total assets | $770,492 | | Total current liabilities | $106,353 | | Total liabilities | $181,961 | | Total stockholders' equity | $588,531 | Notes to Consolidated Financial Statements These notes provide detailed disclosures on accounting policies, including revenue recognition, customer concentration, inventory valuation, goodwill, debt, stock-based compensation, and the product warranty reserve for legacy surface flaking issues Note 2: Summary of Significant Accounting Policies This note outlines significant accounting policies, including customer concentration (three customers representing 56% of 2020 sales), inventory valuation, goodwill, product warranty, and revenue recognition methods - In 2020, three customers represented approximately 56% of the Company's total net sales[274] - Inventories for composite decking and railing products are valued using the last-in, first-out (LIFO) method[276] - Revenue for Trex Residential products is recognized at a point in time upon shipment, while revenue for Trex Commercial products is recognized over time as work progresses[293][294] Note 8: Debt The company had no outstanding debt at year-end 2020 and 2019, maintaining a revolving credit facility with $300 million in total available borrowing capacity, enhanced in May 2020 to mitigate COVID-19 risks - The Company had no outstanding indebtedness at December 31, 2020 and 2019[319] - In May 2020, the credit agreement was amended to provide an additional $100 million line of credit, bringing total available borrowing capacity to $300 million at year-end[319][321] Note 11: Stockholders' Equity This note details basic and diluted EPS, the stock repurchase program (with 2.8 million shares repurchased), the increase in authorized common stock to 180 million shares, and the two-for-one stock split in 2020 - A stock repurchase program for up to 11.6 million shares is in place, with 2.8 million shares repurchased as of December 31, 2020[333] - In April 2020, authorized common stock was increased from 120 million to 180 million shares[334] - A two-for-one stock split was distributed on September 14, 2020, and all share and per-share data have been retroactively adjusted[336] Note 13: Stock-Based Compensation This note details stock-based compensation expense, totaling $7.1 million in 2020, and provides activity tables for various equity awards, including assumptions for SARs valuation Stock-Based Compensation Expense (in thousands) | | 2020 | 2019 | 2018 | | :--- | :--- | :--- | :--- | | Time-based restricted stock/units | $3,219 | $3,676 | $2,687 | | Performance-based restricted stock/units | $2,881 | $2,399 | $3,144 | | Stock appreciation rights | $648 | $662 | $370 | | Employee stock purchase plan | $383 | $193 | $143 | | Total | $7,131 | $6,930 | $6,344 | Note 18: Commitments and Contingencies This note covers legal matters, $71.3 million in purchase commitments, and product warranties, with a $6.5 million provision added in Q3 2020 for legacy surface flaking claims, bringing the total residential warranty reserve to $29.5 million - As of December 31, 2020, the company has purchase commitments under material supply contracts of $33.6 million for 2021 and $15.0 million for 2022[380] - A provision of $6.5 million was recorded in Q3 2020 for the future settlement of legacy surface flaking claims due to an increase in estimated future claims and costs[386] Residential Product Warranty Reserve Reconciliation (in thousands) | | Surface Flaking | Other Residential | Total | | :--- | :--- | :--- | :--- | | Beginning balance, Jan 1, 2020 | $19,024 | $6,470 | $25,494 | | Provisions and changes in estimates | 6,479 | 3,382 | 9,861 | | Settlements made during the period | (4,178) | (1,704) | (5,882) | | Ending balance, Dec 31, 2020 | $21,325 | $8,148 | $29,473 |