THE AZEK COMPANY INC. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our annual consolidated financial statements and related notes and our discussion and analysis of financial condition and results of operations, which were included in our 2020 Annual Report on Form 10-K filed with theSecurities and Exchange Commission onDecember 4, 2020 , or our 2020 Form 10-K, as well as Item 1. Financial Statements in this Form 10-Q. Forward-Looking Statements This Quarterly Report on Form 10-Q contains forward-looking statements. All statements other than statements of historical facts contained in this Quarterly Report on Form 10-Q, including statements regarding future operations are forward-looking statements. In some cases, forward looking statements may be identified by words such as "believe," "may," "will," "estimate," "continue," "anticipate," "intend," "could," "would," "expect," "objective," "plan," "potential," "seek," "grow," "target," "if," or the negative of these terms and similar expressions intended to identify forward-looking statements. In particular, statements about potential new products and product innovation, statements regarding the potential impact of the COVID-19 pandemic, statements about the markets in which we operate, including growth of our various markets and growth in the use of engineered products, and our expectations, beliefs, plans, strategies, objectives, prospects, assumptions or future events or performance contained in the Quarterly Report on Form 10-Q are forward-looking statements. We have based these forward-looking statements primarily on our current expectations and projections about future events and trends that we believe may affect our financial condition, results of operations, business strategy, short-term and long-term business operations and objectives and financial needs. These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including those described in the section titled "Risk Factors" set forth in Part II, Item 1A of this Quarterly Report on Form 10-Q and in our otherSEC filings, including the 2020 Form 10-K. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the future events and trends discussed in this Quarterly Report on Form 10-Q may not occur and actual results may differ materially and adversely from those anticipated or implied in the forward-looking statements. You should read this Quarterly Report on Form 10-Q with the understanding that our actual future results, levels of activity, performance and events and circumstances may be materially different from what we expect. In addition, statements that "we believe" and similar statements reflect our beliefs and opinions on the relevant subject. These statements are based on information available to us as of the date of this Quarterly Report on Form 10-Q. While we believe that such information provides a reasonable basis for these statements, such information may be limited or incomplete. Our statements should not be read to indicate that we have conducted an exhaustive inquiry into, or review of, all relevant information. These statements are inherently uncertain, and investors are cautioned not to unduly rely on these statements. Overview We are an industry-leading designer and manufacturer of beautiful, low-maintenance and environmentally sustainable products focused on the highly attractive, fast-growing Outdoor Living market. We define the Outdoor Living market as the market for decks, rail, trim, wood and wood-look siding, porches, pavers, outdoor furniture, outdoor cabinetry and outdoor lighting designed to enhance the utility and improve the aesthetics of outdoor living spaces. Homeowners are continuing to invest in their outdoor spaces and are increasingly recognizing the significant advantages of long-lasting products, which are converting demand away from traditional materials, particularly wood. Our products transform those outdoor spaces by combining highly appealing aesthetics with significantly lower maintenance costs compared to traditional materials. Our innovative portfolio of Outdoor Living products, including deck, rail, trim and accessories, inspires consumers to design outdoor spaces tailored to their unique lifestyle needs. We are well known in the industry, and, according to data provided byPrincipia Consulting, LLC , a third-party industry research and consulting firm, we generally hold one of the top two market share positions by revenue in our product categories. In addition to our leading suite of Outdoor Living products, we sell a broad range of highly 28
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engineered products that are sold in commercial markets, including partitions, lockers and storage solutions. One of our core values is to "always do the right thing". We make decisions according to what is right, not what is the cheapest, fastest or easiest, and we strive to always operate with integrity, transparency and the customer in mind. In furtherance of that value, we are focused on sustainability across our operations and have adopted strategies to enable us to meet the growing demand for environmentally-friendly products. Our businesses leverage a shared technology andU.S. -based manufacturing platform to create products that convert demand from traditional materials to those that are long lasting and low maintenance, fulfilling our brand commitment to deliver products that are "Beautifully Engineered to Last". We report our results in two segments: Residential and Commercial. In our Residential segment, our primary consumer brands,TimberTech andAZEK , are recognized by contractors and consumers for their premium aesthetics, uncompromising quality and performance, and diversity of style and design options. In our Commercial segment, we manufacture engineered sheet products and high-quality bathroom partitions and lockers. Over our history we have developed a reputation as a leading innovator in our markets by leveraging our differentiated manufacturing capabilities, material science expertise and product management proficiency to consistently introduce new products into the market. This long-standing commitment has been critical to our ability to stay at the forefront of evolving industry trends and consumer demands, which in turn has allowed us to become a market leader across our core product categories.
COVID-19
Since the onset of the COVID-19 pandemic, we have been focused on protecting our employees' health and safety, meeting our customers' needs as they navigate an uncertain financial and operating environment, working closely with our suppliers to protect our ongoing business operations and rapidly adjusting our short-, medium and long-term operational plans to proactively and effectively respond to the current and potential future public health crises. While the COVID-19 pandemic presents very serious concerns for our business and operations, our employees and their families, our customers and our suppliers, we believe that we are adapting well to the wide-ranging changes that the global economy is currently undergoing, and we remain confident that we will continue to maintain business continuity, produce and sell our products safely and in compliance with applicable laws and governmental orders and mandates, maintain our robust and flexible supply chains and be in a strong position to maintain financial flexibility even in the event of a potentially extended economic downturn. Although we have implemented measures to mitigate the impact of the COVID-19 pandemic on our business, financial condition and results of operations, we expect that these measures may not fully mitigate the impact of the COVID-19 pandemic on our business, financial condition and results of operations. We cannot predict the degree to, or the period over, which we will be affected by the pandemic and resulting governmental and other measures. We expect that the economic effects of the COVID-19 pandemic will likely continue to affect demand for our products over the balance of fiscal 2021. The global impact of the COVID-19 pandemic continues to rapidly evolve, and we will continue to monitor the situation closely. As the COVID-19 pandemic continues, it may also have the effect of heightening many of the risks described in "Risk Factors" in this Quarterly Report on Form 10-Q and in our otherSEC filings, including the 2020 Form 10-K. 29
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Results of Operations
The following tables summarize certain financial information relating to our
operating results that have been derived from our unaudited Consolidated
Financial Statements for the three months ended
Three Months Ended December 31,
$ %
(U.S. dollars in thousands) 2020 2019 Variance Variance
Net sales $ 212,278 $ 166,043 $ 46,235 27.8 %
Cost of sales 139,302 114,752 24,550 21.4
Gross profit 72,976 51,291 21,685 42.3
Selling, general and administrative
expenses 53,029 43,473 9,556 22.0
Other general expenses - 1,978 (1,978 ) N/M
Loss (gain) on disposal of property, plant
and equipment 212 (73 ) 285 N/M
Operating income (loss) 19,735 5,913 13,822 233.8
Interest expense, net 6,196 19,759 (13,563 ) (68.6 )
Income tax expense (benefit) 3,356 (4,000 ) 7,356 N/M
Net income (loss) $ 10,183 $ (9,846 ) $ 20,029 N/M
"N/M" indicates the variance as a percentage is not meaningful.
Net sales for the three months endedDecember 31, 2020 increased by$46.2 million , or 27.8%, to$212.3 million from$166.0 million for the three months endedDecember 31, 2019 . The increase was primarily attributable to sales growth in our Residential segment. Net sales for the three months endedDecember 31, 2020 increased for our Residential segment by 36.8% and decreased for our Commercial segment by 12.3%, in each case as compared to the prior year.
Cost of Sales
Cost of sales for the three months endedDecember 31, 2020 increased by$24.5 million , or 21.4%, to$139.3 million from$114.8 million for the three months endedDecember 31, 2019 primarily due to increased costs on higher sales volumes. Gross Profit Gross profit for the three months endedDecember 31, 2020 increased by$21.7 million , or 42.3%, to$73.0 million from$51.3 million for the three months endedDecember 31, 2019 . Gross profit as a percent of net sales increased to 34.4% for the three months endedDecember 31, 2020 compared to 30.9% for the three months endedDecember 31, 2019 . The increase in gross profit as a percent of net sales was primarily driven by the strong results in the Residential segment as well as overhead leverage on fixed costs.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased by
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Other General Expenses
Other general expenses were
Interest Expense, net
Interest expense, net, decreased by$13.6 million , or 68.6%, to$6.2 million for the three months endedDecember 31, 2020 from$19.8 million for the three months endedDecember 31, 2019 . Interest expense, net decreased primarily due to the reduced principal amount outstanding under our Term Loan Agreement and our formerly outstanding 2021 Senior Notes during the three months endedDecember 31, 2020 , when compared to the three months endedDecember 31, 2019 .
Income Tax Expense (Benefit)
Income tax expense (benefit) increased by$7.4 million to$3.4 million for the three months endedDecember 31, 2020 compared to($4.0) million for the three months endedDecember 31, 2019 . The increase in our income tax expense was primarily driven by our pre-tax operating earnings.
Net Income (Loss)
Net income (loss) increased by$20.0 million to a net income of$10.2 million for the three months endedDecember 31, 2020 compared to a net loss of$9.8 million for the three months endedDecember 31, 2019 , due to the factors described above. Segment Results of Operations We report our results in two segments: Residential and Commercial. The key segment measures used by our chief operating decision maker in deciding how to evaluate performance and allocate resources to each of the segments are Segment Adjusted EBITDA and Segment Adjusted EBITDA Margin. Depending on certain circumstances, Segment Adjusted EBITDA and Segment Adjusted EBITDA Margin may be calculated differently, from time to time, than our Adjusted EBITDA and Adjusted EBITDA Margin, which are further discussed under the heading "Non-GAAP Financial Measures." Segment Adjusted EBITDA and Segment Adjusted EBITDA Margin represent measures of segment profit reported to our chief operating decision maker for the purpose of making decisions about allocating resources to a segment and assessing its performance and are determined as disclosed in our Consolidated Financial Statements included elsewhere in this Quarterly Report on Form 10-Q consistent with the requirements of theFinancial Accounting Standards Board's , or FASB, Accounting Standards Codification, or ASC 280, Segment Reporting. We define Segment Adjusted EBITDA as a segment's net income (loss) before income tax (benefit) expense and by adding to or subtracting therefrom interest expense, net, depreciation and amortization, share-based compensation costs, asset impairment and inventory revaluation costs, business transformation costs, capital structure transaction costs, acquisition costs, initial public offering costs and certain other costs. Segment Adjusted EBITDA Margin is equal to a segment's Segment Adjusted EBITDA divided by such segment's net sales. Corporate expenses, which include selling, general and administrative costs related to our corporate offices, including payroll and other professional fees, are not included in computing Segment Adjusted EBITDA. Such corporate expenses increased by$5.5 million to$17.8 million during the three months endedDecember 31, 2020 , from$12.3 million during the three months endedDecember 31, 2019 . 31
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Residential
The following table summarizes certain financial information relating to the Residential segment results that have been derived from our unaudited Condensed Consolidated Financial Statements for the three months endedDecember 31, 2020 and 2019. Three Months Ended December 31, $ % (U.S. dollars in thousands) 2020 2019 Variance Variance Net sales$ 185,640 $ 135,668 $ 49,972 36.8 % Segment Adjusted EBITDA 58,776 38,915 19,861 51.0
Segment Adjusted EBITDA Margin 31.7 % 28.7 % N/A
N/A
Net Sales Net sales for the three months ended
Segment Adjusted EBITDA
Segment Adjusted EBITDA for the three months endedDecember 31, 2020 increased by$19.9 million , or 51.0%, to$58.8 million from$38.9 million for the three months endedDecember 31, 2019 . The increase was mainly driven by higher sales, partially offset by higher selling general and administrative expenses.
Commercial
The following table summarizes certain financial information relating to the Commercial segment results that have been derived from our unaudited Condensed Consolidated Financial Statements for the three months endedDecember 31, 2020 and 2019. Three Months Ended December 31, $ % (U.S. dollars in thousands) 2020 2019 Variance Variance Net sales$ 26,638 $ 30,375 $ (3,737 ) (12.3 %) Segment Adjusted EBITDA 3,316 3,023 293 9.7
Segment Adjusted EBITDA Margin 12.4 % 10.0 % N/A
N/A
Net Sales
Net sales for the three months ended December 31, 2020 decreased by
$3.7 million , or 12.3%, to $26.6 million from $30.4 million for the three months
ended December 31, 2019 . The decrease was primarily attributable to declining
sales in our Scranton Products and Vycom businesses as the effects of
COVID-19continue to impact certain end markets.
Segment Adjusted EBITDA
Segment Adjusted EBITDA of the Commercial segment was$3.3 million for the three months endedDecember 31, 2020 , compared to$3.0 million for the three months endedDecember 31, 2019 . The slight increase was primarily driven by lower manufacturing and selling, general and administrative expenses offset by declining sales as described above. 32
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Non-GAAP Financial Measures
To supplement our Consolidated Financial Statements prepared and presented in accordance with generally accepted accounting principles inthe United States , or GAAP, we use certain non-GAAP performance financial measures, as described below, to provide investors with additional useful information about our financial performance, to enhance the overall understanding of our past performance and future prospects and to allow for greater transparency with respect to important metrics used by our management for financial and operational decision-making. We are presenting these non-GAAP financial measures to assist investors in seeing our financial performance from management's view and because we believe they provide an additional tool for investors to use in comparing our core financial performance over multiple periods with other companies in our industry. Our GAAP financial results include significant expenses that are not indicative of our ongoing operations as detailed in the tables below. However, non-GAAP financial measures have limitations in their usefulness to investors because they have no standardized meaning prescribed by GAAP and are not prepared under any comprehensive set of accounting rules or principles. In addition, non-GAAP financial measures may be calculated differently from, and therefore may not be directly comparable to, similarly titled measures used by other companies. As a result, non-GAAP financial measures should be viewed as supplementing, and not as an alternative or substitute for, our Consolidated Financial Statements prepared and presented in accordance with GAAP. Three Months Ended December 31, (In thousands) 2020 2019 Non-GAAP Financial Measures: Adjusted Gross Profit$ 88,772 $ 66,442 Adjusted Gross Profit Margin 41.8 % 40.0 % Adjusted Net Income$ 23,029 $ 3,618 Adjusted Diluted EPS$ 0.15 $ 0.03 Adjusted EBITDA$ 48,452 $ 33,806 Adjusted EBITDA Margin 22.8 % 20.4 %
Adjusted Gross Profit, Adjusted Gross Profit Margin, Adjusted Net Income, Adjusted Diluted EPS, Adjusted EBITDA and Adjusted EBITDA Margin
We define Adjusted Gross Profit as gross profit before depreciation and
amortization, business transformation costs and acquisition costs as described
below. Adjusted Gross Profit Margin is equal to Adjusted Gross Profit divided by
net sales. We define Adjusted Net Income as net income (loss) before
amortization, stock-based compensation costs, business transformation costs,
acquisition costs, initial public offering costs, capital structure transaction
costs and certain other costs as described below. We define Adjusted Diluted EPS
as Adjusted Net Income divided by weighted average common shares
outstanding-diluted, to reflect the conversion or exercise, as applicable, of
all outstanding shares of restricted stock awards, restricted stock units and
options to purchase shares of our common stock. We define Adjusted EBITDA as net
income (loss) before interest expense, net, income tax (benefit) expense and
depreciation and amortization and by adding to or subtracting therefrom items of
expense and income as described above. Adjusted EBITDA Margin is equal to
Adjusted EBITDA divided by net sales. We believe Adjusted Gross Profit, Adjusted
Gross Profit Margin, Adjusted Net Income, Adjusted Diluted EPS, Adjusted EBITDA
and Adjusted EBITDA Margin are useful to investors because they help identify
underlying trends in our business that could otherwise be masked by certain
expenses that can vary from company to company depending on, among other things,
its financing, capital structure and the method by which its assets were
acquired, and can also vary significantly from period to period. We also add
back depreciation and amortization and stock-based compensation because we do
not consider them indicative of our core operating performance. We believe their
exclusion facilitates comparisons of our operating performance on a
period-to-period basis. Therefore, we believe that showing gross profit and net
income, as adjusted to remove the impact of these expenses, is helpful to
investors in assessing our gross profit and net income performance in a way that
is similar to the way management assesses our performance. Additionally, EBITDA
and EBITDA margin are common measures of operating performance in our industry,
and we believe they facilitate operating comparisons. Our management also uses
Adjusted Gross Profit, Adjusted Gross Profit Margin, Adjusted EBITDA and
Adjusted EBITDA Margin in conjunction with other GAAP
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financial measures for planning purposes, including as a measure of our core operating results and the effectiveness of our business strategy, and in evaluating our financial performance. Management considers Adjusted Gross Profit and Adjusted Net Income and Adjusted Diluted EPS as useful measures because our cost of sales includes the depreciation of property, plant and equipment used in the production of products and the amortization of various intangibles related to our manufacturing processes. Adjusted Gross Profit, Adjusted Gross Profit Margin, Adjusted Net Income, Adjusted Diluted EPS, Adjusted EBITDA and Adjusted EBITDA Margin have limitations as analytical tools, and you should not consider them in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are:
• These measures do not reflect our cash expenditures, future requirements for
capital expenditures or contractual commitments;
• These measures do not reflect changes in, or cash requirements for, our
working capital needs;
• Adjusted EBITDA and Adjusted EBITDA Margin do not reflect the significant
interest expense, or the cash requirements necessary to service interest or
principal payments, on our debt;
• Adjusted EBITDA and Adjusted EBITDA Margin do not reflect our income tax
expense or the cash requirements to pay our taxes;
• Adjusted Gross Profit, Adjusted Net Income, Adjusted Diluted EPS and Adjusted
EBITDA exclude the expense of depreciation, in the case of Adjusted Gross
Profit and Adjusted EBITDA, and amortization, in each case, of our assets,
and, although these are non-cash expenses, the assets being depreciated or
amortized may have to be replaced in the future;
• Adjusted Net Income, Adjusted Diluted EPS and Adjusted EBITDA exclude the
expense associated with our equity compensation plan, although equity
compensation has been, and will continue to be, an important part of our
compensation strategy;
• Adjusted Gross Profit, Adjusted Net Income, Adjusted Diluted EPS and Adjusted
EBITDA exclude certain business transformation costs, acquisition costs and
other costs, each of which can affect our current and future cash
requirements; and
• Other companies in our industry may calculate Adjusted Gross Profit, Adjusted
Gross Profit Margin, Adjusted Net Income, Adjusted Diluted EPS, Adjusted
EBITDA and Adjusted EBITDA Margin differently than we do, limiting their
usefulness as comparative measures.
Because of these limitations, none of these metrics should be considered indicative of discretionary cash available to us to invest in the growth of our business or as measures of cash that will be available to us to meet our obligations.
The following table presents reconciliations of the most comparable financial measures calculated in accordance with GAAP to these non-GAAP financial measures for the periods indicated:
Adjusted Gross Profit and Adjusted Gross Profit Margin Reconciliation
Three Months Ended
December 31,
(In thousands) 2020 2019
Gross profit $ 72,976 $ 51,291
Depreciation and amortization (1) 15,796 15,151
Adjusted Gross Profit $ 88,772 $ 66,442
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Three Months Ended
December 31,
2020 2019
Gross margin 34.4 % 30.9 %
Depreciation and amortization 7.4 9.1
Adjusted Gross Profit Margin 41.8 % 40.0 %
(1) Depreciation and amortization for the three months ended
and 2019 consists of
depreciation and
of intangible assets relating to our manufacturing process.
Adjusted Net Income and Adjusted Diluted EPS Reconciliation
Three Months Ended
December 31,
(In thousands) 2020 2019
Net income (loss) $ 10,183 $ (9,846 )
Amortization (1) 12,643 13,858
Stock-based compensation costs (2) 2,686 685
Business transformation costs (3) - 163
Acquisition costs (4) - 565
Initial public offering - 1,978
Other costs (5) 1,467 361
Tax impact of adjustments (6) (3,950 ) (4,146 )
Adjusted Net Income $
23,029 $ 3,618
Three Months Ended
December 31,
2020 2019
Net income (loss) $ 0.07 $ (0.09 )
Amortization 0.08 0.13
Stock-based compensation costs 0.02 0.01
Business transformation costs - -
Acquisition costs - -
Initial public offering - 0.02
Other costs 0.01 -
Tax impact of adjustments (0.03 ) (0.04 )
Adjusted Diluted EPS (7) $ 0.15 $ 0.03 (1) Effective as of
Income to remove depreciation expense from the calculation. The prior periods
have been recast to reflect the change.
(2) Stock-based compensation costs reflect expenses related to our initial public
offering. Expense related to our recurring long-term incentive plan is
excluded from the Adjusted Net Income reconciliation.
(3) Business transformation costs reflect consulting and other costs related to
the transformation of the senior management team of
months ended
(4) Acquisition costs reflect costs directly related to completed acquisitions
(5) Other costs include costs for legal expense of
months ended
other ancillary expenses associated with the initial public offering of
and
(6) Tax impact of adjustments are based on applying a combined
state statutory tax rate of 24.5% for both the three months ended
(7) Weighted average common shares outstanding used in computing diluted net
income (loss) per common share of 156,018,731 and 108,162,741 for the three
months ended December 31, 2020 and 2019, respectively.
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Adjusted EBITDA and Adjusted EBITDA Margin Reconciliation
Three Months Ended December 31,
(In thousands) 2020 2019
Net income (loss) $ 10,183 $ (9,846 )
Interest expense 6,196 19,759
Depreciation and amortization 24,270 24,141
Tax expense (benefit) 3,356 (4,000 )
Stock-based compensation costs 2,980 685
Business transformation costs (1) -
163
Acquisition costs (2) - 565
Initial public offering - 1,978
Other costs (3) 1,467 361
Total adjustments 38,269 43,652
Adjusted EBITDA $ 48,452 $ 33,806
Three Months Ended December 31,
2020 2019
Net margin 4.8 % (5.9 )%
Interest expense 2.9 11.9
Depreciation and amortization 11.4 14.6
Tax expense (benefit) 1.6 (2.4 )
Stock-based compensation costs 1.4 0.4
Business transformation costs - 0.1
Acquisition costs - 0.3
Initial public offering -
1.2
Other costs 0.7 0.2
Total adjustments 18.0 26.3
Adjusted EBITDA Margin 22.8 % 20.4 %
(1) Business transformation costs reflect consulting and other costs related to
the transformation of the senior management team of
months ended
(2) Acquisition costs reflect costs directly related to completed acquisitions
(3) Other costs include costs for legal expense of
months ended
other ancillary expenses associated with the initial public offering of
and December 31, 2019 , respectively.
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Liquidity and Capital Resources
Liquidity Outlook
Our primary cash needs are to fund working capital, capital expenditures, debt service and any acquisitions we may undertake. As ofDecember 31, 2020 , we had cash and cash equivalents of$210.0 million and total indebtedness of$467.7 million .CPG International LLC , our direct, wholly owned subsidiary, had approximately$143.3 million available under the borrowing base for future borrowings as ofDecember 31, 2020 .CPG International LLC also has the option to increase the commitments under the Revolving Credit Facility by up to$100.0 million , subject to certain conditions. During fiscal year 2020, we announced an acceleration and expansion of our capacity investment from$100.0 million to$180.0 million and believe we have the adequate liquidity to meet the higher level of capacity investment. OnJune 5, 2020 , we entered into an amendment to the Revolving Credit Facility, or the Amendment, which established$8.5 million of commitments for FILO Loans under the Revolving Credit Facility. The FILO Loans were available to be drawn in a single disbursement on or prior toDecember 31, 2020 . We did not draw on the FILO Loans which expired onDecember 31, 2020 . We believe we will have adequate liquidity over the next 12 months to operate our business and to meet our cash requirements as a result of cash flows from operating activities, available cash balances and availability under our Revolving Credit Facility after consideration of our debt service and other cash requirements. In the longer term, our liquidity will depend on many factors, including our results of operations, our future growth, the timing and extent of our expenditures to develop new products and improve our manufacturing capabilities, the expansion of our sales and marketing activities and the extent to which we make acquisitions. Changes in our operating plans, material changes in anticipated sales, increased expenses, acquisitions or other events may cause us to seek additional equity and/or debt financing in future periods.
Holding Company Status
We are a holding company and do not conduct any business operations of our own. As a result, we are largely dependent upon cash dividends and distributions and other transfers from our subsidiaries to meet our obligations. The agreements governing the indebtedness of our subsidiaries impose restrictions on our subsidiaries' ability to pay dividends or make other distributions to us.CPG International LLC is party to the Revolving Credit Facility and Term Loan Agreement, or, together, the Senior Secured Credit Facilities. The obligations under the Senior Secured Credit Facilities are secured by specified assets as described under "Indebtedness", and the obligations under the Senior Secured Credit Facilities are guaranteed byThe AZEK Company Inc. and the wholly owned domestic subsidiaries ofCPG International LLC other than certain immaterial subsidiaries and other excluded subsidiaries. The Senior Secured Credit Facilities contain covenants restricting payments of dividends byCPG International LLC unless certain conditions, as provided in the Senior Secured Credit Facilities, are met. The covenants under our Senior Secured Credit Facilities provide for certain exceptions for specific types of payments. However, other than restricted payments under the specified exceptions, the covenants under our Term Loan Agreement generally prohibit the payment of dividends unless the fixed charge coverage ratio ofCPG International LLC , on a pro forma basis, for the four quarters preceding the declaration or payment of such dividend would be at least 2.00 to 1.00 and such restricted payments do not exceed an amount based on the sum of$40.0 million plus 50% of consolidated net income for the period commencingOctober 1, 2013 to the end of the most recent fiscal quarter for which internal consolidated financial statements ofCPG International LLC are available at the time of such restricted payment, plus certain customary addbacks. Based on the general restrictions in our Term Loan Agreement as ofDecember 31, 2020 ,CPG International LLC would have been permitted to declare or pay dividends of up to$113.7 million , plus any dividends for the specific purposes specified in the Senior Secured Credit Facilities. Since the restricted net assets ofThe AZEK Company Inc. and its subsidiaries exceed 25% of our consolidated net assets, in accordance with Rule 12-04, Schedule 1 of Regulation S-X, refer to our Consolidated Financial Statements included elsewhere in this Form 10-Q for condensed parent company financial statements ofThe AZEK Company Inc. 37
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Cash Sources
We have historically relied on cash flows from operations generated byCPG International LLC , borrowings under the credit facilities, issuances of notes and other forms of debt financing and capital contributions to fund our cash needs. OnSeptember 30, 2013 , our subsidiary,CPG International LLC (as successor-in-interest toCPG Merger Sub LLC , a limited liability company formed to effect the acquisition ofCPG International LLC ), Deutsche Bank AG New York Branch, as administrative agent and collateral agent, or the Revolver Administrative Agent, and the lenders party thereto entered into the Revolving Credit Facility. OnMarch 9, 2017 , the Revolving Credit Facility was amended and restated to provide for maximum aggregate borrowings of up to$150.0 million , subject to an asset-based borrowing base. The borrowing base is limited to a specified percentage of eligible accounts receivable and inventory, less reserves that may be established by the Revolver Administrative Agent in the exercise of its reasonable credit judgment. OnJune 5, 2020 , we entered into the Amendment, which established$8.5 million of commitments for FILO Loans under the Revolving Credit Facility. The FILO Loans were available to be drawn in a single disbursement on or prior toDecember 31, 2020 . We did not draw on the FILO Loans which expired onDecember 31, 2020 . As ofDecember 31, 2020 andSeptember 30, 2020 ,CPG International LLC had no outstanding borrowings under the Revolving Credit Facility and had$4.4 million and$6.8 million , respectively, of outstanding letters of credit held against the Revolving Credit Facility. As ofDecember 31, 2020 andSeptember 30, 2020 ,CPG International LLC had approximately$143.3 million and$129.4 million , respectively, available under the borrowing base for future borrowings in addition to cash and cash equivalents on hand of$210.0 million and$215.0 million , respectively. Because our borrowing capacity under the Revolving Credit Facility depends, in part, on inventory, accounts receivable and other assets that fluctuate from time to time, the amount available under the borrowing base may not reflect actual borrowing capacity under the Revolving Credit Facility.
Cash Uses
Our principal cash requirements have included working capital, capital expenditures, payments of principal and interest on our debt, and, if market conditions warrant, making selected acquisitions. We may elect to use cash from operations, debt proceeds, equity or a combination thereof to finance future acquisition opportunities.
The table below details the total operating, investing and financing activity
cash flows for each of the three months ended
Cash Flows
Three Months Ended December 31,
$ %
(U.S. dollars in thousands) 2020 2019 Variance Variance
Net cash provided by (used in)
operating activities $ 20,115 $ (56,361 ) $ 76,476 135.7 %
Net cash provided by (used in)
investing activities (27,004 ) (19,018 ) (7,986 ) (42.0 )
Net cash provided by (used in)
financing activities 1,911 (8,100 ) 10,011 123.6
Net increase (decrease) in cash
N/M (1)%
(1) "N/M" indicates the variance as a percentage is not meaningful.
Operating Activities
Net cash provided by (used in) operating activities was$20.1 million and$(56.4) million for the three months endedDecember 31, 2020 and 2019, respectively. The$76.5 million increase is primarily related to receivables from increased sales in our Residential segment, as well as, the increase in net income over the three months endedDecember 31, 2019 , partially offset by higher inventory related to early buy. 38
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Investing Activities
Net cash provided by (used) in investing activities was
Financing Activities
Net cash provided by (used in) financing activities was$1.9 million and$(8.1) million for the three months endedDecember 31, 2020 and 2019, respectively. Net cash provided by financing activities for the three months endedDecember 31, 2020 primarily consisted of cash received from the exercise of stock options, as compared to the three months endedDecember 31, 2019 , which consisted of debt payments, capital redemptions and payments of costs related to our initial public offering. Indebtedness Revolving Credit Facility The Revolving Credit Facility provides for maximum aggregate borrowings of up to$150.0 million , subject to an asset-based borrowing base. Outstanding revolving loans under the Revolving Credit Facility will bear interest at a rate which equals, at our option, either (i) for alternative base rate, or ABR, borrowings, the highest of (a) the Federal Funds Rate plus 50 basis points, (b) the prime rate and (c) the LIBOR, as of such date for a deposit inU.S. dollars with a maturity of one month plus 100 basis points, plus, in each case, a spread of 50 to 100 basis points based on average historical availability, or (ii) for Eurocurrency borrowings, adjusted LIBOR plus a spread of 150 to 200 basis points, based on average historical availability. OnJune 5, 2020 , we entered into the Amendment, which established$8.5 million of commitments for FILO Loans. The FILO Loans were available to be drawn in a single disbursement on or prior toDecember 31, 2020 . We did not draw on the FILO Loans which expired onDecember 31, 2020 . A "commitment fee" accrues on any unused portion of the revolving commitments under the Revolving Credit Facility during the preceding three calendar month period. If the average daily used percentage is greater than 50%, the commitment fee equals 25 basis points, and if the average daily used percentage is less than or equal to 50%, the commitment fee equals 37.5 basis points. The Revolving Credit Facility matures onMarch 9, 2022 . The obligations under the Revolving Credit Facility are secured by a first priority security interest in certain assets, including substantially all of the accounts receivable, inventory, deposit accounts, securities accounts and cash assets ofThe AZEK Company Inc. ,CPG International LLC and the subsidiaries ofCPG International LLC that are guarantors under the Revolving Credit Facility, and the proceeds thereof (subject to certain exceptions), or the Revolver Priority Collateral, plus a second priority security interest in all of the Term Loan Priority Collateral (as defined below). The obligations under the Revolving Credit Facility are guaranteed byThe AZEK Company Inc. and the wholly owned domestic subsidiaries ofCPG International LLC other than certain immaterial subsidiaries and other excluded subsidiaries. Revolving loans under the Revolving Credit Facility may be voluntarily prepaid in whole, or in part, in each case without premium or penalty. Other than in the case of a mandatory prepayment, FILO Loans under the Revolving Credit Facility may not be repaid prior to maturity unless all revolving loans have been repaid.CPG International LLC is also required to make mandatory prepayments (i) when aggregate borrowings exceed commitments or the applicable borrowing base and (ii) during "cash dominion," which occurs if (a) the availability under the Revolving Credit Facility is less than the greater of (i)$12.5 million and (ii) 10% of the lesser of (x)$150.0 million and (y) the borrowing base, for five consecutive business days or (b) certain events of default have occurred and are continuing. 39
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The Revolving Credit Facility contains affirmative covenants that are customary for financings of this type, including allowing the Revolver Administrative Agent to perform periodic field exams and appraisals to evaluate the borrowing base. The Revolving Credit Facility contains various negative covenants, including limitations on, subject to certain exceptions, the incurrence of indebtedness, the incurrence of liens, dispositions, investments, acquisitions, restricted payments, transactions with affiliates, as well as other negative covenants customary for financings of this type. The Revolving Credit Facility also includes a financial maintenance covenant, applicable only when the excess availability is less than the greater of (i) 10% of the lesser of the aggregate commitments under the Revolving Credit Facility and the borrowing base, and (ii)$12.5 million . In such circumstances, we would be required to maintain a minimum fixed charge coverage ratio (as defined in the Revolving Credit Facility) for the trailing four quarters equal to at least 1.0 to 1.0; subject to our ability to make an equity cure (no more than twice in any four quarter period and up to five times over the life of the facility). As ofDecember 31, 2020 andSeptember 30, 2020 ,CPG International LLC was in compliance with the financial and nonfinancial covenants imposed by the Revolving Credit Facility. The Revolving Credit Facility also includes customary events of default, including the occurrence of a change of control.
We also have the option to increase the commitments under the Revolving Credit
Facility by up to
Term Loan Agreement
The Term Loan Agreement is a first lien term loan. As of each ofDecember 31, 2020 , andSeptember 30, 2020 ,CPG International LLC had$467.7 million outstanding under the Term Loan Agreement. The Term Loan Agreement will mature onMay 5, 2024 . The interest rate applicable to the outstanding principal under the Term Loan Agreement equals, at our option, either, (i) in the case of ABR borrowings, the highest of (a) the Federal Funds Rate as of such day plus 50 basis points, (b) the prime rate and (c) the LIBOR as of such day for a deposit inU.S. dollars with a maturity of one month plus 100 basis points, provided that in no event will the alternative base rate be less than 200 basis points, plus, in each case, the applicable margin of 275 basis points per annum; or (ii) in the case of Eurocurrency borrowings, the greater of (a) the LIBOR in effect for such interest period divided by one, minus the statutory reserves applicable to such Eurocurrency borrowing, if any, and (b) 100 basis points, plus the applicable margin of 375 basis points per annum. The obligations under the Term Loan Agreement are secured by a first priority security interest in the membership interests ofCPG International LLC owned byThe AZEK Company Inc. , the equity interests ofCPG International LLC's domestic subsidiaries and all remaining assets not constituting Revolver Priority Collateral (subject to certain exceptions) ofThe AZEK Company Inc. ,CPG International LLC and the subsidiaries ofCPG International LLC that are guarantors under the Term Loan Agreement, or the Term Loan Priority Collateral, and a second priority security interest in the Revolver Priority Collateral. The obligations under the Term Loan Agreement are guaranteed byThe AZEK Company Inc. and the wholly owned domestic subsidiaries ofCPG International LLC other than certain immaterial subsidiaries and other excluded subsidiaries. The Term Loan Agreement may be voluntarily prepaid in whole, or in part, in each case without premium or penalty (other than the Prepayment Premium, as defined in the Term Loan Agreement, if applicable), subject to certain customary conditions.CPG International LLC is also required to make mandatory prepayments in an amount equal to (i) 100% of the net cash proceeds from casualty events or the disposition of property or assets, subject to customary reinvestment rights, (ii) 100% of the net cash proceeds from the incurrence or issuance of indebtedness (other than permitted indebtedness) byCPG International LLC or any restricted subsidiary and (iii) 50% of excess cash flow, with such percentage subject to reduction (to 25% and to 0%) upon achievement of specified leverage ratios and which prepayment may be declined by the lenders under the Term Loan Agreement. AtSeptember 30, 2020 , no excess cash flow payment was required based on the current leverage ratio. The lenders under the Term Loan Agreement have the option to decline any prepayments based on excess cash flows. Additionally,CPG International LLC is required to pay the outstanding principal amount of the Term Loan Agreement in quarterly 40
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installments of 0.25253% of the aggregate principal amount under the Term Loan Agreement outstanding, and such quarterly payments may be reduced as a result of prepayments. Based on the prepayment of$337.7 million made with net proceeds we received from our IPO,CPG International LLC has prepaid all of the quarterly principal payments otherwise due through the maturity of the Term Loan Agreement. The Term Loan Agreement contains affirmative covenants, negative covenants and events of default, which are broadly consistent with those in the Revolving Credit Facility (with certain differences consistent with the differences between a revolving loan and term loan) and that are customary for facilities of this type. The Term Loan Agreement does not have any financial maintenance covenants. As ofDecember 31, 2020 andSeptember 30, 2020 ,CPG International LLC was in compliance with the covenants imposed by the Term Loan Agreement. The Term Loan Agreement also includes customary events of default, including the occurrence of a change of control. We have the right to arrange for incremental term loans under the Term Loan Agreement of up to an aggregate principal amount of$150.0 million , plus the amounts incurred under Incremental Amendment No. 1 thereto, plus any amounts previously voluntarily prepaid, with additional incremental term loans available if certain leverage ratios are achieved.
Restrictions on Dividends
The Senior Secured Credit Facilities each restrict payments of dividends unless certain conditions, as provided in the Revolving Credit Facility or the Term Loan Agreement, as applicable, are met.
Off-Balance Sheet Arrangements
In addition to our debt guarantees, we have contractual commitments for purchases of certain minimum quantities of raw materials at index-based prices, and non-cancelable capital and operating leases, outstanding letters of credit and fixed asset purchase commitments. We have no other material non-cancelableguarantees or commitments, and no material special purpose entities or other off-balance sheet debt obligations.
Critical Accounting Policies and Estimates
Our unaudited Condensed Consolidated Financial Statements are prepared in accordance withU.S. GAAP. The preparation of these unaudited Condensed Consolidated Financial Statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses and related disclosures. We evaluate our estimates and assumptions on an ongoing basis. Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Actual results could differ materially from those estimates. There have been no material changes to our critical accounting policies as compared to the critical accounting policies and significant judgments and estimates disclosed in our 2020 Form 10-K, except as updated in Note 1 of our Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q.
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