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Table of Contents

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 

x   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
       SECURITIES EXCHANGE ACT OF 1934

 

       For the quarterly period ended June 30, 2003

 

OR

 

¨   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
       SECURITIES EXCHANGE ACT OF 1934

 

       For the transition period from                          to                         

 

Commission File Number: 001-14649

 


 

Trex Company, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware

(State or other jurisdiction of

incorporation or organization)

 

54-1910453

(I.R.S. Employer

Identification No.)

     

160 Exeter Drive

Winchester, Virginia

(Address of principal executive offices)

 

22603-8605

(Zip Code)

 

Registrant’s telephone number, including area code: (540) 542-6300

 

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

 


 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  x  No  ¨

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes  x  No  ¨

 

The number of shares of the registrant’s common stock, par value $.01 per share, outstanding at July 31, 2003 was 14,679,627 shares.

 



Table of Contents

TREX COMPANY, INC.

 

INDEX

 

PART I.

 

FINANCIAL INFORMATION

    
   

Item 1.

  Financial Statements     
        Condensed Consolidated Balance Sheets as of December 31, 2002 and June 30, 2003 (unaudited)    3
        Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2002 and 2003 (unaudited)    4
        Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2002 and 2003 (unaudited)    5
        Notes to Condensed Consolidated Financial Statements for the Three and Six Months Ended March 31, 2002 and 2003 (unaudited)    6
   

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations    9
   

Item 3.

  Quantitative and Qualitative Disclosures About Market Risk    12
   

Item 4.

  Controls and Procedures    12

PART II.

  OTHER INFORMATION     
   

Item 4.

  Submission of Matters to a Vote of Security Holders    13
   

Item 6.

  Exhibits and Reports on Form 8-K    13
    Signature     

 

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Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 1.   Financial Statements

 

TREX COMPANY, INC.

 

Condensed Consolidated Balance Sheets

(In thousands)

 

    

December 31,

2002


   

June 30,

2003


 
           (unaudited)  

ASSETS

                

Current assets:

                

Cash and cash equivalents

   $ 14,893     $ 21,629  

Trade accounts receivable

     840       21,947  

Inventories

     22,429       15,981  

Prepaid expenses and other assets

     1,395       1,970  

Deferred income taxes

     2,269       2,256  
    


 


Total current assets

     41,826       63,783  

Property, plant, and equipment, net

     133,570       135,385  

Goodwill

     6,837       6,837  

Other assets

     1,323       1,698  
    


 


Total assets

   $ 183,556     $ 207,703  
    


 


LIABILITIES AND STOCKHOLDERS’ EQUITY

                

Current liabilities:

                

Trade accounts payable

   $ 10,056     $ 11,673  

Accrued expenses

     6,089       3,735  

Income taxes payable

     114       1,202  

Other current liabilities

     638       1,085  

Current portion of long-term debt

     795       873  
    


 


Total current liabilities

     17,692       18,568  
    


 


Deferred income taxes

     9,915       11,008  

Debt-related derivatives

     2,773       3,013  

Long-term debt, net of current portion

     54,401       53,917  
    


 


Total liabilities

     84,781       86,506  
    


 


Stockholders’ equity:

                

Preferred stock, $0.01 par value, 3,000,000 shares authorized; none issued and outstanding

     —         —    

Common stock, $0.01 par value, 40,000,000 shares authorized; 14,297,711 and 14,676,322 shares issued and outstanding at December 31, 2002 and June 30, 2003, respectively

     143       147  

Additional capital

     49,354       55,006  

Retained earnings

     53,397       70,027  

Deferred compensation

     (2,400 )     (2,115 )

Accumulated other comprehensive loss

     (1,719 )     (1,868 )
    


 


Total stockholders’ equity

     98,775       121,197  
    


 


Total liabilities and stockholders’ equity

   $ 183,556     $ 207,703  
    


 


 

SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED

FINANCIAL STATEMENTS (UNAUDITED).

 

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Table of Contents

TREX COMPANY, INC.

 

Condensed Consolidated Statements of Operations

(unaudited)

 

(In thousands, except share and per share data)

 

     Three Months Ended June 30,

    Six Months Ended June 30,

 
     2002

    2003

    2002

    2003

 

Net sales

   $ 45,924     $ 59,198     $ 97,920     $ 127,876  

Cost of sales

     21,676       32,300       53,710       71,220  
    


 


 


 


Gross profit

     24,248       26,898       44,210       56,656  

Selling, general and administrative expenses

     11,823       15,903       18,959       28,462  
    


 


 


 


Income from operations

     12,425       10,995       25,251       28,194  

Interest expense, net

     (3,341 )     (884 )     (5,811 )     (1,797 )
    


 


 


 


Income before taxes

     9,084       10,111       19,440       26,397  

Income taxes

     3,454       3,578       7,390       9,767  
    


 


 


 


Net income

   $ 5,630     $ 6,533     $ 12,050     $ 16,630  
    


 


 


 


Basic earnings per common share

   $ 0.40     $ 0.45     $ 0.85     $ 1.15  
    


 


 


 


Weighted average basic shares outstanding

     14,162,859       14,547,481       14,160,301       14,476,110  
    


 


 


 


Diluted earnings per common share

   $ 0.39     $ 0.44     $ 0.84     $ 1.13  
    


 


 


 


Weighted average diluted shares outstanding

     14,404,296       14,751,928       14,343,799       14,663,715  
    


 


 


 


 

SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED

FINANCIAL STATEMENTS (UNAUDITED).

 

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Table of Contents

TREX COMPANY, INC.

 

Condensed Consolidated Statements of Cash Flows

(unaudited)

 

(In thousands)

 

    

Six Months Ended

June 30,


 
     2002

    2003

 

OPERATING ACTIVITIES

                

Net income

   $ 12,050     $ 16,630  

Adjustments to reconcile net income to net cash provided by operating activities:

                

Deferred income taxes

     528       1,200  

Equity method losses

     200       150  

Amortization of deferred compensation and financing costs

     179       451  

Amortization of debt discount

     3,712       —    

Depreciation and amortization

     4,479       6,075  

Loss on disposal of property, plant and equipment

     248       21  

Changes in operating assets and liabilities:

                

Trade accounts receivable

     (12,828 )     (21,107 )

Inventories

     23,593       6,448  

Prepaid expenses and other assets

     (1,179 )     (1,266 )

Trade accounts payable

     (1,825 )     1,617  

Accrued expenses

     3,175       (2,354 )

Income taxes payable

     2,879       1,088  

Other current liabilities

     108       426  
    


 


Net cash provided by operating activities

     35,319       9,379  
    


 


INVESTING ACTIVITIES

                

Expenditures for property, plant and equipment

     (952 )     (7,891 )
    


 


Net cash used in investing activities

     (952 )     (7,891 )
    


 


FINANCING ACTIVITIES

                

Financing costs

     (1,231 )     —    

Borrowings under mortgages and term loans

     52,600       —    

Principal payments under mortgages and term loans

     (67,932 )     (406 )

Payments under line of credit

     (12,153 )     —    

Proceeds from employee stock purchase and option plans

     78       386  

Proceeds from exercise of warrant

     —         5,268  
    


 


Net cash provided by (used in) financing activities

     (28,638 )     5,248  
    


 


Net increase in cash and cash equivalents

     5,729       6,736  

Cash and cash equivalents at beginning of period

     —         14,893  
    


 


Cash and cash equivalents at end of period

   $ 5,729     $ 21,629  
    


 


Supplemental Disclosure:

                

Cash paid for interest

   $ 2,172     $ 2,288  

Cash paid for income taxes

   $ 3,842     $ 7,505  

 

SEE ACCOMPANYING NOTES TO CONDENSED CONSOLIDATED

FINANCIAL STATEMENTS (UNAUDITED).

 

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TREX COMPANY, INC.

 

Notes to Condensed Consolidated Financial Statements

For the Three and Six Months Ended June 30, 2002 and 2003 (unaudited)

 

1. BUSINESS AND ORGANIZATION

 

Trex Company, Inc., a Delaware corporation (together with its subsidiaries, the “Company”), was incorporated in 1998. The Company manufactures and distributes wood/plastic composite products primarily for residential and commercial decking applications. Trex Wood-Polymer® lumber (“Trex”) is manufactured in a proprietary process that combines waste wood fibers and reclaimed polyethylene.

 

2. BASIS OF PRESENTATION

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, the accompanying condensed consolidated financial statements do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal and recurring adjustments) considered necessary for a fair presentation have been included in the accompanying condensed consolidated financial statements. The consolidated results of operations for the three-month and six-month periods ended June 30, 2003 are not necessarily indicative of the results that may be expected for the full fiscal year. These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements as of December 31, 2001 and 2002 and for each of the three years in the period ended December 31, 2002 included in the annual report of Trex Company, Inc. on Form 10-K (File No. 001-14649), as filed with the Securities and Exchange Commission.

 

3. INVENTORY

 

Inventories (at LIFO value) consist of the following (in thousands):

 

    

December 31,

2002


    

June 30,

2003


            (unaudited)

Finished goods

   $ 17,114      $ 10,270

Raw materials

     5,315        5,711
    

    

     $ 22,429      $ 15,981
    

    

 

An actual valuation of inventory under the LIFO (last-in, first-out) method can be made only at the end of each year based on the inventory levels and costs at that time. Accordingly, interim LIFO calculations are based on management’s estimates of expected year-end inventory levels and costs. Since inventory levels and costs are subject to factors beyond management’s control, interim results are subject to the final year-end LIFO inventory valuation.

 

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4. DEBT

 

On June 19, 2002, the Company refinanced total indebtedness of $47.6 million outstanding under a senior bank credit facility and various real estate loans. The Company refinanced this indebtedness with the proceeds from its sale of $40.0 million principal amount of senior secured notes and borrowings under new real estate loans having a principal amount of $12.6 million. In connection with the refinancing, the Company replaced its existing $17.0 million revolving credit facility with a $20.0 million revolving credit facility with a new lender. The termination of the senior bank credit facility resulted in a non-cash charge to interest expense of $2.4 million in the second quarter of 2002 as a result of accelerated amortization of the remaining debt discount balance.

 

The senior secured notes accrue interest at an annual rate of 8.32%. Five principal payments of $8.0 million annually to retire the notes will be payable beginning in June 2005. The revolving credit facility and real estate loans accrue interest at annual rates equal to LIBOR plus specified margins and mature on the third anniversary of the closing date. The Company uses interest-rate swap contracts to manage its exposure to fluctuations in the interest rates under its real estate loans. At June 30, 2003, the Company had effectively capped its interest rate exposure at an annual rate of approximately 8.3% on all of its approximately $14.8 million principal amount of real estate loans. Amounts drawn under the new revolving credit facility are subject to a borrowing base consisting of accounts receivable and finished goods inventories. As of June 30, 2003, no borrowings were outstanding under the revolving credit facility and the borrowing base totaled approximately $18.9 million.

 

The revolving credit facility, real estate loans and the senior secured notes contain negative and financial covenants. As of June 30, 2003, the Company was in compliance with these covenants. Borrowings under these agreements are secured by liens on substantially all of the Company’s assets.

 

5. STOCKHOLDERS’ EQUITY

 

The following table sets forth the computation of basic and diluted earnings per share (In thousands, except share and per share data):

 

     Three Months Ended June 30,

   Six Months Ended June 30,

     2002

   2003

   2002

   2003

Numerator:

                           

Net income available to common shareholders

   $ 5,630    $ 6,533    $ 12,050    $ 16,630
    

  

  

  

Denominator:

                           

Weighted average shares outstanding, basic

     14,162,859      14,547,481      14,160,301      14,476,110

Impact of potential common shares:

                           

Options

     60,255      137,826      40,057      115,787

Warrants

     159,994      —        132,789      38,324

Restricted stock

     21,188      66,621      10,652      33,494
    

  

  

  

Weighted average shares outstanding, diluted

     14,404,296      14,751,928      14,343,799      14,663,715
    

  

  

  

Basic earnings per share

   $ 0.40    $ 0.45    $ 0.85    $ 1.15
    

  

  

  

Diluted earnings per share

   $ 0.39    $ 0.44    $ 0.84    $ 1.13
    

  

  

  

 

In November 2001, in connection with amendments to the Company’s senior bank credit facility, the Company issued to the lender a warrant to purchase up to 707,557 shares of the Company’s common stock at $14.89 per share. In June 2002, the Company refinanced its indebtedness under the senior credit facility. The refinancing eliminated the former lender’s conditional right to purchase 353,778 of the shares of common stock issuable under the warrant. On February 3, 2003, the lender exercised the warrant to purchase all 353,779 of the remaining shares of common stock issuable thereunder for a total purchase price of approximately $5.3 million.

 

6. STOCK-BASED COMPENSATION

 

In December 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure,” which provides guidance on how to transition from the intrinsic value method of accounting for stock-based employee compensation under Accounting Principles Board (“APB”) Opinion No. 25 to the fair value method of accounting of SFAS No. 123, “Accounting for Stock-Based Compensation,” if a company so elects. In 2002, the Company adopted SFAS No. 148. The adoption of this standard had no material impact on the Company’s results of operations or financial position.

 

The Company continues to account for its stock-based compensation in accordance with APB No. 25 and its related interpretations. No stock-based compensation cost related to stock option grants has been reflected in net income, as all options granted under the Company’s 1999 Stock Option and Incentive Plan had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123.

 

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Table of Contents
     Three Months
Ended June 30,


  

Six Months

Ended June 30,


     2002

   2003

   2002

   2003

Net income, as reported

   $ 5,630    $ 6,533    $ 12,050    $ 16,630

Deduct: Additional stock-based employee compensation expense determined under fair value based method, net of related tax effects

   $ 292    $ 379    $ 584    $ 758
    

  

  

  

Pro forma net income

   $ 5,338    $ 6,154    $ 11,466    $ 15,872

Earnings per share:

                           

Basic-as reported

   $ 0.40    $ 0.45    $ 0.85    $ 1.15

Basic-pro forma

   $ 0.38    $ 0.42    $ 0.81    $ 1.10

Diluted-as reported

   $ 0.39    $ 0.44    $ 0.84    $ 1.13

Diluted-pro forma

   $ 0.37    $ 0.42    $ 0.80    $ 1.08

 

In accordance with SFAS No. 123, the fair value was estimated at the grant date using a Black-Scholes option pricing model with the following weighted-average assumptions: risk-free interest rates of 4-6%; no dividends; expected life of the options of approximately five years; and volatility of 72-81%.

 

In March 2002, the Company issued 120,000 shares of restricted stock to certain employees under the Company’s 1999 Stock Option and Incentive Plan. The shares vest in equal installments on the third, fourth and fifth anniversaries of the date of grant. The Company recorded $2.8 million of deferred compensation relating to the issuance of the restricted stock. The deferred compensation is being amortized on a straight-line basis over the five-year vesting period. For the three and six months ended June 30, 2002 and 2003, the Company recorded compensation expense of $142,000 and $166,000, and $143,000 and $285,000, respectively.

 

7. SEASONALITY

 

The Company’s net sales and income from operations have historically varied from quarter to quarter. Such variations are principally attributable to seasonal trends in the demand for Trex. The Company has historically experienced lower net sales during the fourth quarter because holidays and adverse weather conditions in certain regions reduce the level of home improvement and new construction activity. Net sales during the six months ended June 30, 2001 and 2002 accounted for approximately 59.8% and 58.6% of annual net sales in 2001 and 2002, respectively.

 

8. NEW ACCOUNTING STANDARDS

 

On January 1, 2003, the Company adopted SFAS No. 143, “Accounting for Asset Retirement Obligations.” SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. This standard was effective for financial statements issued for fiscal years beginning after June 15, 2002. The adoption of this standard had no material impact on the Company’s results of operations or financial position.

 

In June 2002, the FASB issued SFAS No. 146, “Accounting for Costs of Exit or Disposal Activities.” SFAS No. 146 nullifies Emerging Issues Task Force Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” SFAS No. 146 requires that an exit or disposal activity related cost be recognized when the liability is incurred instead of when an entity commits to an exit plan. The provisions of SFAS No. 146 are effective for financial transactions initiated after December 31, 2002. On January 1, 2003, the Company adopted this standard. The adoption of this standard had no material impact on the Company’s results of operations or financial position.

 

In January 2003, the FASB issued Interpretation No. 46 “Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin No. 51” (the “Interpretation”). The Interpretation requires the consolidation of an entity in which an enterprise absorbs a majority of the entity’s expected losses, receives a majority of the entity’s expected residual returns, or both, as a result of ownership or contractual or other financial interests in the entity. Currently, an entity is generally consolidated by an enterprise when the enterprise has a controlling financial interest in the entity through ownership of a majority voting interest in the entity.

 

In 2000, the Company formed a joint venture (the “Joint Venture”) with a Spanish environmental company and an Italian equipment manufacturer to operate a plant in Spain designed to recycle waste polyethylene. The Joint Venture was financed with initial equity contributions from the Company and the other partners and debt financing. The Company does not control the Joint Venture and records its proportional 35% share of the Joint Venture’s operating results using the equity method. Under the joint venture agreement, the Company has the right to purchase up to 100% of the plant’s production. In the six months ended June 30, 2002 and 2003, the Company purchased approximately 83% and 100%, respectively, of the Joint Venture’s production, which was approximately $0.8 million and $2.3 million, respectively. As of June 30, 2003, the carrying value of the Company’s investment in the Joint Venture was $0.8 million. As of June 30, 2003, the Company did not owe any amount to the Joint Venture for trade payables.

 

The Company does not believe that adoption of the Interpretation will have a material impact on the Company’s results of operations or financial position.

 

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Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

This Management’s Discussion and Analysis of Financial Condition and Results of Operations 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. We intend our forward-looking statements to be covered by the safe harbor provisions for forward-looking statements in these sections. 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’ or “intend.” 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 risks. Such risks include the Company’s ability to increase market acceptance of Trex; the Company’s lack of product diversification; the Company’s plan to increase production levels; the Company’s current dependence on its three manufacturing facilities; the Company’s reliance on the supply of raw materials used in its production process; the Company’s sensitivity to economic conditions, which influence the level of activity in home improvements and new home construction; the Company’s ability to manage its growth; the Company’s significant capital investments and ability to access the capital markets; and the Company’s dependence on its largest distributors to market and sell its products. A discussion of these and other risks and uncertainties is contained in the Company’s 2002 Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 18, 2003.

 

Overview

 

The Company is the nation’s largest manufacturer of non-wood decking alternative products, which are marketed under the brand name Trex®. Trex Wood-Polymer® lumber is a wood/plastic composite which is manufactured in a proprietary process that combines waste wood fibers and reclaimed polyethylene. Trex is used primarily for residential and commercial decking. Trex also has non-decking product applications, including applications for parks and recreational areas, floating and fixed docks and other marine applications, and landscape edging.

 

Net sales consist of sales and freight, net of returns and discounts. Cost of sales consists of raw material costs, direct labor costs and manufacturing overhead costs, including depreciation and freight. The largest component of selling, general and administrative expenses is branding and other sales and marketing costs. Sales and marketing costs consist primarily of salaries, commissions and benefits paid to sales and marketing personnel, advertising expenses and other promotional costs. General and administrative expenses include salaries and benefits of personnel engaged in research and development, procurement, accounting and other business functions, and office occupancy costs attributable to such functions, as well as depreciation and amortization expense.

 

The Company experienced growth in net sales each year from 1996, when it began operations, through 2000. The sales increase resulted primarily from a growth in sales volume. From time to time since 1996, customer demand for Trex exceeded the Company’s manufacturing capacity. The constraints on the Company’s capacity during these periods limited the rate of the Company’s sales growth. Because of these constraints, the Company had to allocate its product supply to its network of wholesale distributors and retail dealers. In response to this allocation practice, the Company’s distributors and dealers generally stockpiled their inventories of Trex to meet anticipated customer demand.

 

In 2000, 2001 and 2002, the Company made capital expenditures totaling $98.3 million, principally to add production lines and increase the size of its facilities to accommodate the new lines. The resulting production capacity increases enabled the Company, beginning the third quarter of 2000, to eliminate its historical allocation of product supply. As a result of the termination of the allocation practice in 2000, and adverse economic conditions in 2001, the Company’s distributors and dealers generally reduced their inventories of Trex from levels built up as a result of stockpiling in prior years. Because distributors and dealers were able to meet much of the customer demand for Trex from their existing inventories, the Company experienced a decrease in product orders in 2001 compared to the prior year.

 

In response to these developments, the Company took a number of actions to reduce its finished goods inventories and conserve working capital. The Company curtailed its production capacity by temporarily suspending operation of a portion of its existing production lines. At the end of 2001, the Company was operating at approximately 40% of its manufacturing capacity. In addition, the Company suspended construction of production lines at various stages of completion and suspended construction of a new plastic processing plant.

 

In 2002, the Company sought to further reduce inventory levels before increasing utilization of its production capacity. The Company’s finished goods inventory decreased to $17.1 million at December 31, 2002 from $27.2 million at December 31, 2001, as sales exceeded production. As a result of the sales growth in 2002, the Company placed into operation all of the production lines whose operations it had suspended in 2001. At December 31, 2002, the Company’s capacity utilization was above 90%.

 

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In the first two quarters of 2003, the Company reduced its inventory and increased its production capacity. As a result of continued sales growth, the Company’s finished goods inventory decreased to $10.3 million at June 30, 2003 from $17.1 million at December 31, 2002. In addition, the Company operated all available production lines and began installing two additional production lines, with startup of these two additional lines scheduled for later in 2003. As a result of the continued increases in sales, production utilization and capacity, the Company intensified its selling and branding activities in the first two quarters of 2003. In connection with its intensified selling activities in 2003, the Company augmented its sales force, enlarged its dealer base and enhanced its TrexPro marketing programs.

 

Three Months Ended June 30, 2003 Compared with Three Months Ended June 30, 2002

 

Net Sales

 

Net sales in the three months ended June 30, 2003 (the “2003 quarter”) increased 28.9% to $59.2 million from $45.9 million in the three months ended June 30, 2002 (the “2002 quarter”). The increase in net sales was primarily attributable to a growth in sales volume as a result of an increase in demand from dealers and distributors and, to a lesser extent, to an increase in the average price of Trex, which increased 3.5% on January 1, 2003. The number of dealer outlets increased to approximately 3,300 at June 30, 2003 from approximately 2,900 at June 30, 2002.

 

Cost of Sales

 

Cost of sales increased 49.0% to $32.3 million in the 2003 quarter from $21.7 million in the 2002 quarter. The increase in cost of sales was primarily attributable to the higher net sales volume and higher unit manufacturing costs. Increased raw material costs contributed to the higher unit manufacturing costs. Cost of sales as a percentage of net sales increased to 54.6% in the 2003 quarter from 47.2% in the 2002 quarter. The increase in cost of sales as a percentage of net sales was primarily attributable to an increase in unit manufacturing costs, which was partially offset by an increase in the manufacturing utilization rate and the associated improvement in absorption of fixed manufacturing expenses.

 

Gross Profit

 

Gross profit increased 10.9% to $26.9 million in the 2003 quarter from $24.2 million in the 2002 quarter because of the increase in net sales volume. As a percentage of net sales, gross profit decreased to 45.4% in the 2003 quarter from 52.8% in the 2002 quarter as a result of higher unit manufacturing costs. The effect of the higher unit manufacturing costs was partially offset by increased manufacturing efficiencies.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses increased 34.5% to $15.9 million in the 2003 quarter from $11.8 million in the 2002 quarter. The higher selling, general and administrative expenses resulted principally from an increase of $4.4 million in branding costs. As a percentage of net sales, selling, general and administrative expenses increased to 26.9% in the 2003 quarter from 25.7% in the 2002 quarter.

 

Interest Expense

 

Net interest expense decreased to $0.9 million in the 2003 quarter from $3.3 million in the 2002 quarter. The decrease in net interest expense included a decrease of $2.4 million in non-cash amortization of debt discount. In addition, the Company had lower average debt balances and increased the amount of interest capitalized on construction in process in the 2003 quarter. The effect of these factors was offset in part by a higher average interest rate and the amortization of deferred financing costs in the 2003 quarter. The Company capitalized $0.2 million of interest on construction in process in the 2003 quarter. The Company did not capitalize any interest on construction in process in the 2002 quarter.

 

Provision for Income Taxes

 

The Company recorded a provision for income taxes of $3.6 million in the 2003 quarter compared to a provision of $3.5 million in the 2002 quarter. The provisions reflect an effective tax rate of 35% and 38% in 2003 and 2002 quarters, respectively.

 

Six Months Ended June 30, 2003 Compared with Six Months Ended June 30, 2002

 

Net Sales

 

Net sales in the six months ended June 30, 2003 (the “2003 six-month period”) increased 30.6% to $127.9 million from $97.9 million in the six months ended June 30, 2002 (the “2002 six-month period”). The increase in net sales was primarily attributable to a growth in sales volume as a result of an increase in demand from dealers and distributors and, to a lesser extent, an increase in the average

 

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price of Trex, which increased 3.5% on January 1, 2003. The number of dealer outlets increased to approximately 3,300 at June 30, 2003 from approximately 2,900 at June 30, 2002.

 

Cost of Sales

 

Cost of sales increased 32.6% to $71.2 million in the 2003 six-month period from $53.7 million in the 2002 six-month period. The increase in cost of sales was primarily attributable to increased net sales volume and, to a lesser extent, higher manufacturing unit costs. Increased raw material costs contributed to the higher unit manufacturing costs. Cost of sales as a percentage of net sales increased to 55.7% in the 2003 six-month period from 54.8% in the 2002 six-month period. The increase in cost of sales as a percentage of net sales was primarily attributable to an increase in unit manufacturing costs, which was partially offset by an increase in the manufacturing utilization rate and the associated improvement in absorption of fixed manufacturing expenses.

 

Gross Profit

 

Gross profit increased 28.2% to $56.7 million in the 2003 six-month period from $44.2 million in the 2002 six-month period because of the increased net sales volume. As a percentage of net sales, gross profit decreased to 44.3% in the 2003 six-month period from 45.1% in the 2002 six-month period as a result of higher unit manufacturing costs. The effect of the higher unit manufacturing costs was partially offset by increased manufacturing efficiencies.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses increased 50.1% to $28.5 million in the 2003 six-month period from $19.0 million in the 2002 six-month period. The higher selling, general and administrative expenses primarily resulted from an increase of $6.6 million in branding costs and $2.0 million in expense related to corporate personnel expenses and hiring costs, including compensation and benefits. As a percentage of net sales, selling, general and administrative expenses increased to 22.3% in the 2003 six-month period from 19.4% in the 2002 six-month period.

 

Interest Expense

 

Net interest expense decreased to $1.8 million in the 2003 six-month period from $5.8 million in the 2002 six-month period. The decrease in net interest expense included the reduction of approximately $3.7 million in non-cash amortization of debt discount. In addition, the Company had lower average debt balances and increased the amount of interest capitalized on construction in process in the 2003 six-month period. In the 2003 six-month period, the Company capitalized $0.5 million of interest on construction in process. The Company did not capitalize any interest on construction in process in the 2002 six-month period.

 

Provision for Income Taxes

 

The Company recorded a provision for income taxes of $9.8 million in the 2003 six-month period compared to a provision of $7.4 million in the 2002 six-month period. The provisions reflect a 37% effective tax rate in the 2003 six-month period and 38% effective tax rate in the 2002 six-month period.

 

Liquidity and Capital Resources

 

The Company’s cash provided by operating activities for the 2003 six-month period was $9.4 million compared to cash provided by operating activities of $32.9 million for the 2002 six-month period. Trade accounts receivable, net, increased from $0.8 million at December 31, 2002 to $21.9 million at June 30, 2003. The Company’s inventories decreased from $22.4 million at December 31, 2002 to $16.0 million at June 30, 2003, as the Company’s net sales of Trex exceeded production. Trade accounts payable increased from $10.0 million at December 31, 2002 to $11.7 million at June 30, 2003 as a result of the timing of payments relating to the operations of the Company.

 

On June 19, 2002, the Company refinanced total indebtedness of $47.6 million outstanding under a senior bank credit facility and various real estate loans. The Company refinanced this indebtedness from the proceeds of its sale of $40 million principal amount of senior secured notes and borrowings under new real estate loans having a principal amount of $12.6 million. In connection with the refinancing, the Company replaced its existing $17 million revolving credit facility with a $20 million revolving credit facility with a new lender. For information about this refinancing and terms of the Company’s principal current indebtedness, see Note 4 to the Condensed Consolidated Financial Statements included elsewhere in this report.

 

The Company uses interest rate swap contracts to manage its exposure to fluctuations in the interest rates under its real estate loans. As of June 30, 2003, the Company’s indebtedness totaled $57.8 million and the annualized overall weighted average interest rate of such indebtedness was approximately 8.3%. As of December 31, 2002, the Company’s indebtedness totaled $58.0 million and the annualized overall weighted average interest rate of such indebtedness was approximately 8.3%.

 

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The Company’s principal source of short-term funding consists of its $20 million revolving credit facility. The Company’s ability to borrow under the revolving credit facility is tied to a borrowing base that consists of certain receivables and inventories. As of June 30, 2003, no borrowings were outstanding under the revolving credit facility and the borrowing base totaled approximately $18.9 million. The Company’s revolving credit facility, real estate loans and senior secured notes require the Company to meet certain financial and negative covenants. As of June 30, 2003, the Company was in compliance with these covenants.

 

The Company’s ability to pay down its senior secured notes, borrow under its revolving credit facility and maintain compliance with the related financial covenants is dependent primarily on its ability to generate substantial cash flow from operations. The generation of operating cash flow is subject to the risks of the Company’s business.

 

Capital expenditures in the six months ended June 30, 2003 totaled $7.9 million. The Company currently estimates that its total capital requirements in 2003 will total approximately $20.0 million. The Company expects that its capital requirements will be significantly higher in subsequent years as the Company completes its construction in process and invests in additional production lines and facilities to meet an anticipated increase in the demand for Trex.

 

The Company believes that cash on hand, cash flow from operations and borrowings expected to be available under the Company’s existing revolving credit facility will provide sufficient funds to enable the Company to fund its planned capital expenditures, make scheduled principal and interest payments, meet its other cash requirements and maintain compliance with terms of its borrowing agreements for at least the next 12 months. Thereafter, significant capital expenditures may be required to provide increased capacity to meet the expected growth in demand for the Company’s products. The Company currently expects that it will fund its future capital expenditures from operations and financing activities. The actual amount and timing of the Company’s future capital requirements may differ materially from the Company’s estimate depending on the demand for Trex and new market developments and opportunities. The Company may determine that it is necessary or desirable to obtain financing for such requirements through bank borrowings or the issuance of debt or equity securities. Debt financing would increase the Company’s level of indebtedness, while equity financing may dilute the ownership of the Company’s stockholders. There can be no assurance as to whether, or as to the terms on which, the Company will be able to obtain such financing.

 

Item 3.   Quantitative and Qualitative Disclosures About Market Risk

 

The Company’s major market risk exposure is to changing interest rates. The Company’s policy is to manage interest rates through the use of a combination of fixed-rate and floating-rate debt. The Company uses interest rate swap contracts to manage its exposure to fluctuations in the interest rates on its floating-rate mortgage debt, all of which is based on LIBOR. At March 31 and June 30, 2003, the Company had effectively capped its interest rate exposure at an annual rate of approximately 8.3% on its $14.8 million of floating-rate debt.

 

Item 4.   Controls and Procedures

 

The Company’s management, with the participation of its President, who is the Company’s principal executive officer, and its Chief Financial Officer, who is the Company’s principal financial officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures as of June 30, 2003. Based upon that evaluation, the President and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company, including its consolidated subsidiaries, required to be included in this report and the other reports that the Company files or submits under the Securities Exchange Act of 1934.

 

During the second fiscal quarter, there have been no changes in the Company’s internal control over financial reporting that have materially affected, or that are reasonably likely to materially affect, its internal control over financial reporting.

 

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PART II. OTHER INFORMATION

 

Item 4.   Submission of Matters to a Vote of Security Holders

 

(a) The Company held its 2003 annual meeting of stockholders on May 8, 2003.

 

(c) The following sets forth information regarding each matter voted upon at the 2003 annual meeting. There were 14,654,032 shares of common stock outstanding as of the record date for, and entitled to vote at, the 2003 annual meeting.

 

Proposal 1. The stockholders approved a proposal to elect each of the nominees to the board of directors for a three-year term, which will expire at the annual meeting of stockholders in 2006. The tabulation of votes of this proposal is as follows:

 

Nominees


 

Votes for


 

Votes Withheld


Anthony J. Cavanna

  13,326,982   29,817

Patricia B. Robinson

  13,328,013   28,786

 

Proposal 2. The stockholders approved a proposal to ratify the appointment of Ernst & Young, LLP as Trex Company, Inc.’s independent auditors for the 2003 fiscal year. The tabulation of votes on this proposal is as follows:

 

Votes For    13,219,542

Votes Against

   125,753

Abstentions

   11,504

 

Item 6.   Exhibits and Reports on Form 8- K

 

  (a)   The Company files herewith the following exhibits:

 

  10.1   Consulting Agreement, dated as of March 17, 2003, between Trex Company, Inc. and Ferrari Consulting, LLC.

 

  10.2   Extension of Consulting Agreement, dated as of July 16, 2003, between Trex Company, Inc. and Ferrari Consulting, LLC.

 

  31.1   Certification of President of Trex Company, Inc. pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.

 

  31.2   Certification of Senior Vice President and Chief Financial Officer of Trex Company, Inc. pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.

 

  32   Certifications pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934 and 18 U.S.C. § 1350.

 

  (b)   Reports on Form 8-K:

 

Filing Date of Report

  

Item Reported


April 23, 2003

  

Item 9 (press release announcing operating results for the quarter ended March 31, 2003)

May 16, 2003

  

Item 9 (sales plans under Rule 10b5-1)

 

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SIGNATURE

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

       

TREX COMPANY, INC.

Date: August 5, 2003

      By:  

/s/    PAUL D. FLETCHER        


               

Paul D. Fletcher,

Senior Vice President and Chief Financial Officer

(Duly Authorized Officer and Principal Financial Officer)

 

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EXHIBIT INDEX

 

Exhibit No.

   
10.1   Consulting Agreement, dated as of March 17, 2003, between Trex Company, Inc. and Ferrari Consulting, LLC.
10.2   Extension of Consulting Agreement, dated as of July 16, 2003, between Trex Company, Inc. and Ferrari Consulting, LLC.
31.1   Certification of President of Trex Company, Inc. pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.
31.2   Certification of Senior Vice President and Chief Financial Officer of Trex Company, Inc. pursuant to Rule 13a-14(a) under Securities Exchange Act of 1934.
  32   Certifications pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934 and 18 U.S.C. § 1350.

 

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