| TREX CO INC Item 1A Risk Factors Our business is subject to a number of risks, including the following: To grow, we will have to develop or increase market acceptance of Trex, including new products and applications |
| Our ability to grow will depend largely on our success in converting the current demand for wood decking products into a demand for Trex |
| Industry studies estimate that wood decking products accounted for approximately 88prca of the 2004 decking and railing market, as measured by board feet of lumber |
| To increase our market share, we must overcome: • the low consumer awareness of non-wood decking and railing alternatives in general and Trex brand products in particular; • the resistance of many consumers and contractors to change from well-established wood products; • the greater initial expense of installing a Trex deck; • the established relationships existing between suppliers of wood decking products and contractors and homebuilders; and • the increased competition from wood/plastic composite manufacturers |
| Substantially all of our sales result from one material |
| In 2006, we will derive substantially all of our revenues from sales of Trex Wood-Polymer lumber |
| Although we have developed new Trex products and new applications for Trex since 1996, and we intend to continue this development, our product line is currently based almost exclusively on the composite formula and manufacturing process for Trex Wood-Polymer lumber |
| If we should experience any problems, real or perceived, with product quality or acceptance of Trex Wood-Polymer lumber, our lack of product diversification could have a significant adverse impact on our net sales levels |
| We currently depend on three manufacturing sites to meet the demand for Trex |
| We currently produce Trex at three manufacturing sites, which are located in Winchester, Virginia, Fernley, Nevada, and Olive Branch, Mississippi |
| Any interruption in the operations or decrease in the production capacity at any of these sites, whether because of equipment failure, fire, natural disaster, labor difficulties or otherwise, would limit our ability to meet existing and future customer demand for Trex |
| Our business is subject to risks in obtaining the raw materials we use to produce Trex |
| The production of Trex requires substantial amounts of waste wood fiber and PE material |
| Our business could suffer from the termination of significant sources of raw materials, the payment of higher prices for raw materials or the failure to obtain sufficient additional raw materials to meet planned increases in production capacity |
| In 2005, one supplier accounted for 49prca of our waste wood fiber purchases |
| Our ability to obtain 12 ______________________________________________________________________ [37]Table of Contents adequate supplies of PE material depends on our success in developing new sources, entering into long-term arrangements with suppliers and managing the collection of supplies from geographically dispersed distribution centers |
| We obtain our raw materials under supply contracts at prices established annually based on then-current market prices or under purchase orders based on market rates in effect when the orders become effective |
| These supply arrangements subject us to risks associated with fluctuations in raw materials prices |
| In recent periods, our operating results have been adversely affected by significant increases in the prices we pay for PE material |
| We have limited ability to control inventory build-ups in our distribution channel that can negatively affect our sales in subsequent periods |
| The dynamic nature of our industry can result in substantial fluctuations in inventory levels of Trex products carried in our two-step distribution channel |
| We have limited ability to control or precisely project inventory build-ups, which can adversely affect our net sales levels in subsequent periods |
| We make the substantial majority of our sales to wholesale distributors, who in turn sell our products to local lumberyards |
| Because of the seasonal nature of the demand for decking, our distribution channel partners must forecast demand for our products, place orders for the products, and maintain Trex product inventories in advance of the prime deck-building season, which generally occurs in our second and third fiscal quarters |
| Inventory levels respond to a number of changing conditions in our industry, including product price increases resulting from escalating raw materials costs, increases in the number of competitive producers and in the production capacity of those competitors, the rapid pace of product introduction and innovation, and changes in the levels of home-building and remodeling expenditures |
| The demand for decking products is influenced by general economic conditions and could be adversely affected by economic downturns |
| The demand for decking products is correlated to changes in the level of activity in home improvements and, to a lesser extent, new home construction |
| These activity levels, in turn, are affected by such factors as consumer spending habits, employment, interest rates and inflation |
| An economic downturn could reduce consumer income available for spending on discretionary items such as decking, which could adversely affect the demand for our products |
| Our performance will suffer if we do not compete effectively in the highly competitive decking and railing market |
| We must compete with an increasing number of companies in the wood/plastic composites segment of the decking and railing market and with wood producers that currently have more production capacity than is required to meet the demand for decking products |
| Our failure to compete successfully in the decking and railing market could have a material adverse effect on our ability to replace wood or increase the market share of wood/plastic composites compared to wood |
| Many of the conventional lumber suppliers with which we compete have established ties to the building and construction industry and have well-accepted products |
| Many of our competitors in the decking and railing market that sell wood products have significantly greater financial, technical and marketing resources than we do |
| Our ability to compete depends, in part, upon a number of factors outside our control, including the ability of our competitors to develop new non-wood decking alternatives that are competitive with Trex products |
| We face risks in increasing our production levels to meet customer demand for Trex |
| To support sales growth and improve customer service, we will face risks: • recruiting and training additions to our workforce; • installing and operating new production equipment; • purchasing raw materials for increased production requirements; and • maintaining product quality |
| 13 ______________________________________________________________________ [38]Table of Contents These risks could result in substantial unanticipated delays or expense, which could adversely affect our operating performance |
| The expansion and future profitability of our business could be adversely affected if we do not manage our growth effectively |
| Our recent growth has placed significant demands on our management, systems and other resources |
| Our net sales increased to dlra294dtta1 million in 2005 from dlra116dtta9 million in 2001 |
| The number of dealer outlets selling Trex has increased to approximately 3cmam260 at December 31, 2005 from approximately 2cmam600 at December 31, 2000, and we expect further increases in the future |
| To support our geographic expansion, we began production in 2005 at a third manufacturing site in Olive Branch, Mississippi |
| As part of our growth, we will have to attract, train, incentivize and retain skilled employees |
| If we fail to do so, or otherwise are unable to manage our growth effectively, our inability to do so could have a material adverse effect on the quality of our products and on our ability to expand our net sales |
| Past seasonal fluctuations in our net sales and quarterly operating results may not be a reliable indicator of future seasonal fluctuations |
| Our historical seasonality may not be a reliable indicator of our future seasonality |
| Quarterly variations in our net sales and income from operations are principally attributable to seasonal trends in the demand for Trex |
| We generally experience lower net sales levels during the fourth quarter, in which holidays and adverse weather conditions in some regions usually reduce the level of home improvement and new construction activity |
| Income from operations and net income tend to be lower in quarters with lower net sales, which are not fully offset by a corresponding reduction in expenses |
| We have significant capital invested in construction in process, some of which we may not be able to deploy productively |
| At December 31, 2005, our construction in process totaled approximately dlra24dtta6 million, with an estimated cost to complete of approximately dlra20 to dlra25 million |
| The construction in process consisted primarily of funds expended to complete production lines in various stages of construction at our Winchester, Fernley and Olive Branch sites, and to construct plastic reprocessing equipment |
| Some of these assets may become impaired due to obsolescence or other factors before we can put them into service |
| Our operating results would be adversely affected if we fail to deploy productively our construction in process, and our net income would be reduced if our assets become impaired and we are required to write down the value of those assets in our financial statements |
| We are not sure of the terms on which we will be able to obtain financing for the significant capital expenditures we plan after 2006 to increase our manufacturing capacity |
| We estimate that our capital requirements in 2006 will total approximately dlra20 to dlra30 million |
| We expect to use our capital expenditures in 2006 principally to make process and productivity improvements and to add manufacturing capacity at our existing sites |
| Our failure to generate or obtain sufficient funds to meet our capital requirements could have a material adverse effect on our ability to match the production of Trex with the demand for our products |
| It may be necessary to obtain financing for our capital requirements through bank borrowings or the issuance of debt or equity securities |
| We may not be able to obtain all of the required financing on terms we will find acceptable |
| We will have to generate substantial operating cash flow to meet our obligations and maintain compliance under our revolving credit facility, real estate loans, senior notes and bond loan documents |
| At December 31, 2005, our total indebtedness was dlra74dtta4 million and included our real estate loans, senior notes, variable rate promissory note and interest rate swaps |
| Our ability to make scheduled principal and interest payments on our real estate loans, senior notes and bond loan agreement, borrow under our revolving credit 14 ______________________________________________________________________ [39]Table of Contents facility and continue to comply with our loan covenants will depend primarily on our ability to generate substantial cash flow from operations |
| Our failure to comply with our loan covenants might cause our lenders to accelerate our repayment obligations under our credit facility, senior notes or bond reimbursement agreement, which may be declared payable immediately based on a default |
| Our ability to borrow under our revolving credit facility is tied to a borrowing base that consists of specified receivables and inventory |
| To remain in compliance with our credit facility, senior notes and bond reimbursement agreement, we must maintain specified financial ratios based on our levels of debt, capital, net worth, fixed charges, and earnings (excluding extraordinary gains and extraordinary non-cash losses) before interest, taxes, depreciation and amortization, all of which are subject to the risks of our business |
| Our dependence on a small number of significant distributors makes us vulnerable to business interruptions involving these distributors |
| Our total gross sales to our five largest wholesale distributors accounted for approximately 75prca of our gross sales in 2005 |
| Our contracts with these distributors are terminable by the distributors upon 30 days’ notice at any time during the contract term |
| A contract termination or significant decrease or interruption in business from any of our five largest distributors or any other significant distributor could cause a short-term disruption of our operations and adversely affect our operating results |
| Environmental regulation exposes us to potential liability for response costs and damages to natural resources |
| We are subject to federal, state and local environmental laws and regulations |
| The environmental laws and regulations applicable to our operations establish air quality standards for emissions from our manufacturing operations, govern the disposal of solid waste, and regulate wastewater and storm water discharge |
| As is the case with manufacturers in general, we may be held liable for response costs and damages to natural resources if a release or threat of release of hazardous materials occurs on or from our properties or any associated offsite disposal location, or if contamination from prior activities is discovered at any properties we own or operate |
| We may not have adequate protection for the intellectual property rights on which our business depends |
| Our success depends, in part, on our ability to protect our important intellectual property rights |
| The steps we have taken may not be adequate to deter misappropriation or unauthorized use of our proprietary information or to enable us to detect unauthorized use and take appropriate steps to enforce our intellectual property rights |
| We have obtained and continue to seek patents with respect to our manufacturing process |
| We or our predecessor company have been required in lawsuits to establish that our production processes and products do not infringe the patents of others |
| We also rely on a combination of trade secret, nondisclosure and other contractual arrangements, and copyright and trademark laws to protect our proprietary rights |
| We enter into confidentiality agreements with our employees and limit access to and distribution of our proprietary information |