13.

COMMITMENTS AND CONTINGENCIES

Legal Matters

The Company has lawsuits, as well as other claims, pending against it which are ordinary routine litigation and claims incidental to the business. Management has evaluated the merits of these lawsuits and claims, and believes that their ultimate resolution will not have a material effect on the Company’s consolidated financial condition, results of operations, liquidity or competitive position.

Purchase Commitments

The Company fulfills requirements for raw materials under both purchase orders and supply contracts. In the year ended December 31, 2016, the Company purchased substantially all of its reclaimed wood fiber requirements under purchase orders which do not involve long-term supply commitments. All of the Company’s scrap polyethylene purchases are under short-term supply contracts that average approximately one to two years, for which pricing is negotiated as needed, or under purchase orders that do not involve long-term supply commitments.

The wood and polyethylene supply contracts generally provide that the Company is obligated to purchase all of the wood or polyethylene a supplier provides, if the wood or polyethylene meets certain specifications. The amount of wood and polyethylene the Company is required to purchase under these contracts varies with the production of its suppliers and, accordingly, is not fixed or determinable. As of December 31, 2016, the Company has purchase commitments under material supply contracts of $20.2 million, $3.2 million, $0.35 million and $0.05 million for the years ending December 31, 2017, 2018, 2019 and 2020, respectively.

Contract Termination Costs

The Company leases 55,047 square feet of office and storage space in Dulles, Virginia, that it does not occupy, but has sublet all of the office space for the remainder of the term of its lease obligation, which ends June 30, 2019. The future sublease receipts are less than the remaining minimum lease payment obligations under the Company’s lease. Accordingly, the Company has recorded a liability for the present value of the shortfall.

As of December 31, 2016, the minimum payments remaining under the Company’s lease over the years ending December 31, 2017, 2018, and 2019 are $1.9 million, $2.0 million, and $1.0 million, respectively. The net minimum receipts remaining under the Company’s existing subleases over the years ending December 31, 2017, 2018, and 2019 are $1.3 million, $1.3 million, and $0.7 million, respectively.

The following table provides information about the Company’s liability under the lease (in thousands):


	2016			2015
Beginning balance, January 1	$	2,106		$	3,033
Net rental payments		(691	)		(1,352	)
Accretion of discount		145			220
(Decrease) increase in net estimated contract termination costs		(85	)		205

Ending balance, December 31	$	1,475		$	2,106

Product Warranty

The Company warrants that its products will be free from material defects in workmanship and materials. This warranty generally extends for a period of 25 years for residential use and 10 years for commercial use, excluding Trex Signature™ Railing, which has a warranty period of 25 years for both residential and commercial use. The Company further warrants that Trex Transcend^®, Trex Enhance^®, Trex Select^® and Universal Fascia products will not fade in color more than a certain amount and will be resistant to permanent staining from food substances or mold, provided the stain is cleaned within seven days of appearance. This warranty extends for a period of 25 years for residential use and 10 years for commercial use. If there is a breach of such warranties, the Company has an obligation either to replace the defective product or refund the purchase price.

The Company continues to receive and settle claims for products manufactured at its Nevada facility prior to 2007 that exhibit surface flaking and maintains a warranty reserve to provide for the settlement of these claims. Estimating the warranty reserve for surface flaking claims requires management to estimate (1) the number of claims to be settled with payment and (2) the average cost to settle each claim.

To estimate the number of claims to be settled with payment, the Company utilizes actuarial techniques to determine a reasonable possible range of claims to be received and the percentage of those claims that will ultimately require payment. Management utilizes a range of assumptions derived from claim count history and the identification of factors influencing the claim counts to determine its best estimate of future claims for which to record a related liability. The number of claims received has declined each year since peaking in 2009, although the rate of decline has decelerated in recent years. Additionally, events such as the 2009 settlement of a class action lawsuit covering the surface defect and communications by the Company in 2013 informing homeowners of potential hazards associated with products exhibiting surface flaking that are not timely replaced, have obscured observable trends in historical claims activity. The cost per claim varies due to a number of factors, including the size of affected decks, the availability and type of replacement material used, the cost of production of replacement material and the method of claim settlement.

The Company monitors surface flaking claims activity each quarter for indications that its estimates require revision. Typically, a majority of surface flaking claims received in a year are received during the summer outdoor season, which spans the second and third quarters. It has been the Company’s practice to utilize the actuarial techniques discussed above 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. The number of claims received in the year ended December 31, 2016 was lower than claims received in the year ended December 31, 2015, continuing the historical year-over-year decline in incoming claims, but was higher than the Company’s expectations. Also, the average settlement cost per claim experienced in the year ended December 31, 2016 was higher than the average settlement cost per claim experienced during the year ended December 31, 2015 and higher than the Company’s expectation for 2016. As a result and after actuarial review, the Company revised its estimate and recorded an increase to the warranty reserve of $9.8 million during the third quarter of 2016. Based on the facts and circumstances at December 31, 2016, the Company believes its reserve is sufficient to cover future surface flaking obligations. The Company notes that its annual cash outflows for surface flaking claims declined by $1.5 million, or 21%, in 2016 compared to 2015, and declined by $1.7 million, or 19%, in 2015 compared to 2014.

The Company’s analysis is based on currently known facts and a number of assumptions, as discussed above, and current expectations. 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 the Company’s financial condition, results of operations or cash flows. The Company estimates that the annual number of claims received will continue to decline over time and that the average cost per claim will increase slightly, primarily due to inflation. 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. The Company estimates 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 $3.4 million change in the surface flaking warranty reserve.

The following is a reconciliation of the Company’s warranty reserve that represents amounts accrued for surface flaking claims (in thousands):


	2016			2015
Beginning balance, January 1	$	29,673		$	31,419
Changes in estimates related to pre-existing warranties		9,835			5,426
Settlements made during the period		(5,661	)		(7,172	)

Ending balance, December 31	$	33,847		$	29,673

The remainder of the Company’s warranty reserve represents amounts accrued for non-surface flaking claims.