(EDGAR Online via COMTEX) -- 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
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
COVID-19; and material adverse impacts related to labor shortages or increases in labor costs.
Operations and Products:
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Trex offers the following products through Trex Residential:
Decking and Our principal decking products are Trex Transcend Accessories � , 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 primarily of a blend of 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, Trex Enhance � 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 Enhance, made from approximately 40 percent recycled content, is available in three colors and is offered through home improvement retailers in kits that contain the complete railing system. 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 offers the following products through Trex Commercial:
Architectural Our architectural railing systems are Railing Systems 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 Our Trex Signature aluminum railings, made from a minimum of Railing Systems 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.
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Staging Our advanced modular, lightweight custom staging systems include Equipment portable platforms, orchestra shells, guardrails, stair units, and barricades, camera platforms, VIP viewing decks, ADA infills, DJ Accessories booths, pool covers, and other custom applications. Our systems provide superior staging product 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.
Highlights for the three months ended March 31, 2022:
Increase in net sales of 38.2%, or $93.7 million, to $339.2 million for the three months ended March 31, 2022 compared to $245.5 million for the three months ended March 31, 2021.
Increase in net income to $71.2 million, or $0.62 per diluted share, for the three months ended March 31, 2022 compared to $48.5 million, or $0.42 per diluted share, for the three months ended March 31, 2021.
Increase in EBITDA (earnings before interest, income tax and depreciation and amortization) of 48.7%, or $34.5 million, to $105.4 million for the three months ended March 31, 2022 compared to $70.9 million for the three months ended March 31, 2021.
Capital expenditures of $22.3 million at Trex Residential, primarily related to cost reduction initiatives, the new Arkansas manufacturing facility, capacity expansion in our existing facilities, and safety, environmental and general support.
Repurchase of 833,963 shares of our outstanding common stock during the three months ended March 31, 2022 under our Stock Repurchase Program for a total 4.4 million shares repurchased under the program as of March 31, 2022.
Selling, General and Administrative Expenses.
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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 three months ended March 31, 2022, was lower than the number of claims received in the three months ended March 31, 2021 and lower than our expectations for the first quarter of 2022. Average cost per claim experienced in the three months ended March 31, 2022 was significantly higher than that experienced in the three months ended March 31, 2021 and higher than our expectations for the current year. The elevated average cost per claim experienced in the three months ended March 31, 2022, was primarily the result of the closure of two large claims, which were considered in our estimation of the surface flaking warranty reserve. We believe the reserve at March 31, 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.
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 $1.8 million change in the surface flaking warranty reserve.
The following table details surface flaking claims activity related to our warranty:
Three Months Ended March 31, 2022 2021 Claims open, beginning of period 1,759 1,799 Claims received (1) 121 214 Claims resolved (2) (145 ) (215 ) Claims open, end of period 1,735 1,798
Average cost per claim (3) $ 6,362 $ 3,620
(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.
RESULTS OF OPERATIONS
Below is the discussion and analysis of our operating results and material changes in our operating results for the three months ended March 31, 2022 (2022 quarter) compared to the three months ended March 31, 2021 (2021 quarter).
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Three Months Ended March 31, 2022 Compared To The Three Months Ended March 31,
2021 Net Sales Three Months Ended March 31, 2022 2021 $ Change % Change (dollars in thousands) Total net sales $ 339,228 $ 245,524 $ 93,704 38.2 % Trex Residential net sales $ 327,194 $ 233,070 $ 94,124 40.4 % Trex Commercial net sales $ 12,034 $ 12,454 $ (420 ) (3.4 )%
Total net sales increased by 38.2% in the 2022 quarter compared to the 2021 quarter reflecting a 40.4% increase in Trex Residential net sales and a 3.4% decrease in Trex Commercial net sales. The increase in Trex Residential net sales was primarily due to an increase in average price per unit of 18% and an increase in volume of 19%. The increase in price was due to price increases on certain products to address inflationary pressures across many key raw materials and transportation. The sustained broad-based demand continued to reflect strong secular trends, including growth in the outdoor living category as homeowners choose to invest in their existing residences and pursue renovations that enhance their outdoor living space. In addition, we continue execute on our wood-to-composite
Gross Profit Three Months Ended March 31, 2022 2021 $ Change % Change (dollars in thousands) Cost of sales $ 204,316 $ 149,723 $ 54,593 36.5 % % of total net sales 60.2 % 61.0 % Gross profit $ 134,912 $ 95,801 $ 39,111 40.8 % Gross margin 39.8 % 39.0 %
Gross profit as a percentage of net sales, gross margin, was 39.8% in the 2022 quarter compared to 39.0% in the 2021 quarter. Gross margin for Trex Residential and Trex Commercial was 40.9% and 10.4%, respectively, in the 2022 quarter compared to 40.2% and 17.2%, respectively, in the 2021 quarter. The increase in gross margin was driven primarily by pricing realization on certain product lines at Trex Residential, partially offset by inflationary pressures on raw materials, labor and transportation.
Selling, General and Administrative Expenses Three Months Ended March 31, 2022 2021 $ Change % Change (dollars in thousands) Selling, general and administrative expenses $ 39,960 $ 31,312 $ 8,648 27.6 % % of total net sales 11.8 % 12.8 %
The increase in selling, general and administrative expenses in the 2022 quarter compared to the 2021 quarter was primarily the result of a $4.8 million increase in marketing and branding spend and a $3.8 million increase in personnel related expenses.
Provision for Income Taxes Three Months Ended March 31, 2022 2021 $ Change % Change (dollars in thousands) Provision for income taxes $ 23,727 $ 15,947 $ 7,780 48.8 % Effective tax rate 25.0 % 24.7 %
The effective tax rate for the 2022 quarter of 25.0% was relatively unchanged with an increase of 0.3% compared to the effective tax rate of 24.7% for the 2021 quarter.
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Net Income and Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) 1 (in thousands) Reconciliation of net income (GAAP) to EBITDA (non-GAAP): Three Months Ended March 31, 2022 Trex Trex Residential Commercial Total Net income (loss) $ 72,215 $ (1,004 ) $ 71,211 Interest income, net 14 - 14 Income tax expense (benefit) 24,063 (336 ) 23,727 Depreciation and amortization 10,191 282 10,473 EBITDA $ 106,483 $ (1,058 ) $ 105,425 Three Months Ended March 31, 2021 Trex Trex Residential Commercial Total Net income $ 48,745 $ (200 ) $ 48,545 Interest income, net (3 ) - (3 ) Income tax expense 16,012 (65 ) 15,947 Depreciation and amortization 6,210 213 6,423 EBITDA $ 70,964 $ (52 ) $ 70,912 Three Months Ended March 31, 2022 2021 $ Change % Change (dollars in thousands) Total EBITDA $ 105,425 $ 70,912 $ 34,513 48.7 % Trex Residential EBITDA $ 106,483 $ 70,964 $ 35,519 50.1 % Trex Commercial EBITDA $ (1,058 ) $ (52 ) $ (1,006 ) NM
Total EBITDA increased 48.7% to $105.4 million for the 2022 quarter compared to $70.9 million for the 2021 quarter. The increase was driven by a 50.1% increase in Trex Residential EBITDA, primarily due to the increase in net sales.
LIQUIDITY AND CAPITAL RESOURCES
We finance operations and growth primarily with cash flows from operations, borrowings under our revolving credit facilities, operating leases and normal . . .
May 09, 2022
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