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Seasonality was the big reason fewer Trex decks got built last quarter, not weak demand. Source: Trex.

Leading recycled wood-alternative decking and railing manufacturer Trex Company (NYSE: TREX) released its third-quarter financial results on October 27, and in short, Mister Market was not pleased. After five-consecutive quarters of strong double-digit growth, Trex reported a decline in both sales and net income for the first time since the first quarter of 2014. 

However, Trex's business is heavily seasonal, so there's more to the story -- and a little context goes a long way. Here's a closer look at Trex's quarterly results.

The numbers 

  Q3 2015 Q3 2014 Change
Revenue $94MM $95.5MM -2%
Net income $3.7MM $8.9MM -58%
EPS $0.12 $0.28 -57%

Trex's sales results in the quarter need a little context. Trex's business is very seasonal, and the winter of 2013/2014 was one of the worst in recent years, and was followed by a very wet spring. This pushed the deck-building season -- which typically begins in early spring and peaks in early summer -- much later into the year in 2014.

Last year's third quarter represented a 31% increase in sales from the prior year, a huge jump that was largely due to the delayed start of the season. After all, Trex reported a decline in sales in the first quarter of that same year due to the weather impact. 

Don't get me wrong: A decline isn't good, but context is key. Here's how Trex's results for the first nine months of the year stack up:

  2015 first 9 months

2014 first nine months

Change
Revenue $351.6MM $317.5MM 11%
Net income $40MM $36.4MM 10%
EPS $1.25 $1.10

14%

Looking at the full comparable period affected by weather, we see a better picture of the company's results.

What happened in the quarter 
Here are some of the highlights from last quarter:

  • Spent $45.2 million to repurchase 1.1 million shares; $39.85 average. share price paid. Used revolving credit line to fund repurchase. 
  • Board approved new repurchase program for up to 3.15 million shares. That's just less than 10% of remaining shares outstanding. The board also approved expansion of revolving credit facility to $100 million to facilitate repurchase program. 
  • Company took a $7.8 million non-cash warranty reserve charge. This was a primary driver in the earnings decline, and also pushed gross margin to 23.6%. Factoring the warranty charge out, gross margin was 31%, down 80 bps from last year because of the slight decline in sales. 
  • Trex expensed $1.1 million in product that didn't meet aesthetic expectations, also impacting gross margin significantly. 
  • Management said the polyethylene pellet business is growing slower than expected, but a new strategy to target some specialty markets is showing early results. 
  • Company raised prices 6% on its Transcend monochromatic product at the beginning of October. 

What management had to say 
When asked to go into the weather impact last year, and the potential impact of a skilled labor shortage affecting the construction industry, CEO Jim Cline had the following to say:

Well, we've certainly seen an indication in the month of October that demand continues to be pretty strong. It was strong through the end of the quarter, so we were pretty happy with what we saw there. You're exactly right, some of our contractors are struggling with getting qualified help to support their businesses. Typically, if the weather continues to be good, we'll see this trend continue into the early part of November at least.

Management is guiding for sales to grow about 11% in the fourth quarter, and according to Cline's comments, they are already seeing strong sales as the building season carries later into the year. 

Cline also gave more color on the recycled pellets business, particularly the company's strategy to develop more custom products:

A few months ago, we identified an opportunity to start blending other polymers with our recycled pellets, making it a more unique product, a more specialty product and enabling us to potentially move them to a higher margin product. We believe that opportunity exists, we have interest from a number of companies and we're beginning to run trials on that.

Management said that the business is growing slowly, which is less than ideal, but the good news is that the existing lines are expected to support all of 2016's growth in this business. Management is anticipating minimal capital investment needed in 2016. 

CFO Bryan Fairbanks offered some color on the warranty claims, noting that they have continued to decline as less of the legacy product remains installed in customer's homes:

Third quarter 2015 was unfavorably affected by  $7.8 million of warranty charges, primarily related to a small percentage of material produced at our Nevada plant, prior to 2007. We expect year-over-year cash payments from the surface flaking issue to continue to decline. Compared to the first nine months of 2014, cash payments are down by $1.4 million.

Looking ahead 
Seasonality played a pretty big part in the sub-par results that Trex reported in the third quarter, as well as the continuing drag from poor-quality products manufactured years ago. But looking at the full year so far, business is good. Sales are up. Profits are up. Management says the company's market share is up. 

Looking forward, Trex continues to increase its domestic market share, while also working to expand in key international growth markets. The pellet business is starting slow, but there's significant opportunity there, as well, if the company can demonstrate value beyond the commodity nature of this product. 

Trex isn't going to double in size overnight, but there's a lot of steady growth out there if management can continue to execute well.

Jason Hall owns shares of Trex. The Motley Fool owns shares of and recommends Trex. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.