Trex Company, Inc. (NYSE: TREX) Q4 2020 earnings call dated Feb. 22, 2021
Good afternoon and welcome to the Trex Company Fourth Quarter and Full Year 2020 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Viktoriia Nakhla. Please go ahead.
Viktoriia Nakhla — Investor Relations, AdvisIRy Partners
Thank you all for joining us today. With us on the call are Bryan Fairbanks, President and Chief Executive Officer; and Dennis Schemm, Senior Vice President and Chief Financial Officer. Joining Bryan and Dennis is Bill Gupp, Senior Vice President, General Counsel and Secretary as well as other members of Trex management. The company issued a press release today after market close containing financial results for the fourth quarter and full year 2020. This release is available on the company’s website. This conference call is also being webcast and will be available on the Investor Relations page of the company’s website for 30 days.
I would now like to turn the call over to Bill Gupp. Bill?
William R. Gupp — Senior Vice President, General Counsel and Secretary
Thank you, Viktoriia. Before we begin, let me remind everyone that statements on this call regarding the company’s expected future performance and conditions constitute forward-looking statements within the meaning of federal securities law. These statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those expressed in the forward-looking statements. For a discussion of such risks and uncertainties, please see our most recent Form 10-K and Form 10-Qs as well as our 1933 and other 1934 Act filings with the SEC. Additionally, non-GAAP financial measures will be referenced in this call. A reconciliation of these measures to the comparable GAAP financial measures can be found in our earnings press release at trex.com. The company expressly disclaims any obligation to update or revise publicly any forward-looking statements whether as a result of new information, future events or otherwise.
With that introduction, I will turn the call over to Bryan Fairbanks.
Bryan H. Fairbanks — President and Chief Executive Officer
Thank you, Bill, and good evening. Thank you all for joining us on today’s call to review Trex Company fourth quarter full year 2020 results and discuss our business outlook. I want to start by thanking the entire Trex organization and our extended family of retailers, dealers, contractors and distributors who enabled our company to distinguish itself during one of the most difficult periods in recent history. Their dedication and collaboration were essential to our ability to remain operational throughout 2020 and overcome many COVID-related challenges and to report record results ending the year with exceptional fourth quarter sales growth.
Demand for Trex products continues to benefit from strong secular trends including growth in the outdoor living category, renewed focused on the home, the shift in population from urban to suburban and smaller metropolitan areas and consumers increasing preference for environmentally sustainable products. As the recognized leader and product performance aesthetics, quality, and the use of 95% recycled content, Trex experienced robust demand achieving broad based growth across all of our residential product lines. Nowhere was that demand more apparent than in our usually slower fourth quarter. Sales of Trex Residential Products increased 40% year-on-year. As you will recall from the past our fourth quarter growth tends to be lower as it’s generally more of an inventory infill part of the season.
As our new capacity is completed and inventories get back to standard levels, our seasonality is expected to normalize where we tend to see higher growth in the second and third quarters. The fourth quarter performance was driven by continued success of our premium Select and Transcend decking and railings and strong sell through of our enhanced product line that has a specific focus on the more cost conscious consumer who may otherwise choose wood. As anticipated, we experienced increased costs in the fourth quarter related to our capacity expansion program and COVID-related costs. Despite these costs we reported significant double-digit growth across all key profitability metrics.
Trex Commercial performed in line with our expectations in the fourth quarter hosting improved revenue as we continue to provide innovative solutions in the commercial railing space. Our full year and fourth quarter residential products sales growth are clear indicators we continue to benefit from our long term strategy to convert consumers from wood decking to our eco-friendly Trex decking. The trend is not only continuing but accelerating. We estimate that composites gained approximately 200 basis points of share from the traditional wood market in 2020 and we are looking ahead to similar, if not faster conversion rates in future years. Trex’s tremendous brand equity of leading product lines and unparalleled network of distribution, dealer, retail sales channel, and contractors furthers our confidence in our ability to continue to lead the conversion opportunity.
Importantly, the conversion from wood is still in the early stages, providing us with a significant runway. With the gains in 2020, it’s estimated that composite products have approximately 22% share of the decking market in linear foot volume terms leaving significant conversion opportunity. To support that demand, our capacity expansion investment program continues on schedule. The timing of this new capacity furthers our industry leadership position allowing Trex to capture additional growth. Dennis will provide detail on the cadence of the production ramp up scheduled for our Virginia facility this year. 2020 was another record year for Trex and one in which we were able to convert 18% sales growth into an increase of 28% in adjusted EBITDA and 26% in adjusted EPS showing the continued leverage opportunity in our business model.
We see this as especially strong performance given that we absorb start-up costs associated with our capacity expansion program as well as COVID-19 management costs. Given the experience we’ve gained in managing operations during the COVID pandemic, we expect 2021 COVID costs to be less, but will still cause certain production inefficiencies and higher costs as we prioritize the health and safety of our employees. We are guiding to full-year incremental EBITDA margin of 35% to 40% on strong double-digit sales growth. During the October call, we announced that we would be taking a mid-single-digit price increase effective with January orders on certain product lines.
As expected at that time, we have seen inflationary pressures, but the actual to-date and forward projected impact are within our prior projections. As this year progresses and our capacity increases, we will be reinvigorating our international sales initiatives in key markets where sales of Trex products historically have outpaced our domestic sales growth. Additionally, innovation continues to be a key part of our strategy. And you can expect to see more product development and launches from the Trex team moving forward. Trex Company has long been known as a great place to work. And we recently received recognitions by two widely respected publications, Fortune magazine and Forbes naming us among the fastest growing companies worldwide and the best mid-sized company in the U.S., respectively.
Also we are appreciative of the industry recognitions that we receive regularly, which honor our organization for the appeal and quality of Trex products, our ongoing commitment to sustainability and our reputation within the industry. As proud as I am of our outstanding accomplishments in 2020, I’m equally proud of the work we are doing to deliver consistent and sustainable financial performance for the future. As an example, our initiative to accelerate conversion from wood decking to sustainable Trex decking will result in more plastic being diverted from landfills and allow us to employ more people, which will in turn benefit the communities in which we operate.
The company was founded almost 30 years ago on the premise that we can extract value from what was once seen as waste. And today, we are not only one of the largest recyclers of polyethylene in North America but also a proof-of-concept for building a successful business model based off of recycled and reclaimed materials. Sustainability has been in our DNA since the beginning and our recognized environmental impact together with our initiatives around fairness in the workplace and corporate responsibility are aimed at leading the highest ESG standards.
Now, I will turn the call over to Dennis Schemm, our Chief Financial Officer for a financial review of our fourth quarter and full year 2020 results, and officially congratulate him on his promotion to Senior Vice President. Dennis?
Dennis C. Schemm — Vice President and Chief Financial Officer
Thank you, Bryan, and good afternoon. I am pleased to review our record fourth quarter and full year financial performance, the progress of our capacity expansion program and our expectations for 2021. Fourth quarter consolidated net sales increased 39% to $228 million, led by 40% growth in Trex Residential Products. This robust top line growth reflects sustained broad-based demand across all of our product lines in what is usually a seasonally slower quarter. Trex Commercial Products had a positive showing this quarter, with sales increasing 20% year-on-year to $15 million. Consolidated gross margin in the fourth quarter was 40.5% compared to 43.2% in the year-ago quarter.
Trex Residential Products gross margin was 41.3% compared to 44.6% in the year-ago quarter, reflecting the hiring, training and initial start-up costs at Trex Residential in advance of our capacity ramp up at the Virginia facility, along with cost of managing our business to respond to COVID-19 pandemic that amounted to approximately $2 million this quarter. We also saw higher inflation and logistics costs associated with our raw materials as we noted during our third quarter conference call. Gross margin at Trex Commercial expanded 170 basis points to 28% due to our execution of higher margin projects this quarter, as well as our continued focus on operational improvements. SG&A expenses increased $9 million to $34 million primarily due to the timing of incentive compensation.
On a percentage of sales basis SG&A decreased 20 basis points in the fourth quarter compared to the prior year quarter. Our effective tax rate in the fourth quarter was 25.8%. Net income was $43 million or $0.37 per diluted share, up 22% and 19% respectively from the $35 million or $0.31 per diluted share reported in the fourth quarter of 2019 adjusted for the 2-for-1 stock split distributed on September 14. EBITDA increased 28% to $64 million and EBITDA margin was 27.9%. For the full-year 2020, consolidated net sales were up 18% to $881 million. Trex Residential net sales increased 19% to $828 million. Net income was $176 million or $1.51 per diluted share, up 21% and 22% respectively from $145 million or $1.24 per diluted share adjusted for the 2-for-1 stock split in 2020. EBITDA up was up 24% to $250 million while EBITDA margin was 28.6%.
In the third quarter, we recognized a one-time $6.5 million charge to the Trex Residential warranty reserve related to legacy surface flaking issue that affected a portion of the products manufactured at our Nevada plant prior to 2007. Excluding the warranty charge, net income was $180 million or a $1.55 per diluted share, up 25% and 26% respectively. EBITDA increased 28% to $258 million and EBITDA margin was 29.3%. We generated record cash from operations of $187 million in 2020 allowing us to self-finance our capital expenditures of $173 million. The majority of our capex spend was related to our expansion program. As recently announced production in our new Virginia facility started in January of 2021 and we will continue to add lines throughout the first half of 2021.
In addition to our new Virginia plant we also added lines to our Nevada plant during 2020. When our capacity expansion is completed by the end of June this year, these investments together will increase production capacity by approximately 70% when compared to 2019 volume levels. Looking ahead, we are pleased to provide guidance for our full year 2021 performance that points to another year of strong double-digit growth for Trex. We expect first quarter consolidated net sales to range from $235 million to $245 million representing year-on-year growth of 20% at the midpoint.
We expect growth to expand in the second quarter as our capacity and capabilities increase and in the third quarter as we backfill channel inventory. For the full year 2021, we anticipate incremental EBITDA margin to be between 35% to 40% inclusive of startup related expenses, which will continue as we ramp up production at our Virginia facility, higher inflation, and more normalized SG&A spending partially offset by cost saving projects. Our tax rate is anticipated at approximately 25%. Depreciation will range from $35 million to $40 million increasing throughout the year and we expect full year spending on capex to be in the range of $130 million to $150 million.
Now, I will turn the call back to Bryan for his closing remarks.
Bryan H. Fairbanks — President and Chief Executive Officer
Thank you, Dennis. We expect to demonstrate strong financial and operational performance in 2021 underpinned by growth in the outdoor living category and demand for our Trex products. We continue to be encouraged by key demand indicators from our contractors, dealers, distributors, and the consumers interacting with our websites and those features. With the conversion opportunity ahead we continue to be confident in our business strategy for growth.
Operator, I’d now like to open the call for questions.
We are still processing the Q&A portion of the conference call. We will be updating it as soon as we analyze and process the con call. Stay tuned here for more updates.