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, expansion plans, capital investments, capacity targets and other strategic initiatives, 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 and the economy more generally, including growth of our various markets and growth in the use of engineered products as well as our ability to share in such growth, statements about our ability to source our raw materials in line with our expectations, future pricing for our products or our raw materials and our ability to successfully manage market risk and control or reduce costs, statements with respect to our ability to meet future goals and targets, including our environmental, social and governance targets, 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. OverviewThe AZEK Company Inc. (the "Company," "we," "us" or "our") is 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 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 25
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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 Update
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 has presented and continues to present very serious concerns for our business and operations, our employees and their families, our customers and our suppliers, we believe that we have adapted and are continuing to adapt well to the wide-ranging changes to the global economy, 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. While governmental and other measures have been relaxed inthe United States since the onset of the pandemic, we cannot predict the degree to, or the period over, which we will be affected by the pandemic and such measures, including any impact of such measures being reimposed, whether as a result of increased prevalence of COVID-19 variants or otherwise. 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 in ways that may be difficult to predict. The global impact of the COVID-19 pandemic continues to evolve, and we 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.
Other Recent Developments
During the quarter endedJune 30, 2021 , prices for certain of our raw material costs, including costs for resin polyethylene and PVC material, which have historically fluctuated depending on, among other things, overall market supply and demand and general business conditions, continued to be negatively impacted by supply chain disruptions, resulting in increases to our costs of goods sold and disruption in supply. In response, we have implemented a combination of pricing increases and productivity initiatives aimed at mitigating the impact of these events and other inflationary pressures. We expect these events will continue to impact our cost of goods sold until these disruptions subside. See Item 1A. Risk Factors - "Shortages in supply, price increases or deviations in the quality of the raw materials used to manufacture our products could adversely affect our sales and operating results." 26
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Results of Operations
Three Months Ended
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 June 30,
$ %
(U.S. dollars in thousands) 2021 2020 Variance Variance
Net sales $ 327,454 $ 223,711 $ 103,743 46.4 %
Cost of sales 220,587 148,588 71,999 48.5
Gross profit 106,867 75,123 31,744 42.3
Selling, general and administrative
expenses 70,300 65,164 5,136 7.9
Other general expenses 1,443 1,623 (180 ) (11.1 )
Loss (gain) on disposal of property,
plant and
equipment 325 366 (41 ) (11.2 )
Operating income (loss) 34,799 7,970 26,829 336.6
Interest expense, net 4,219 25,148 (20,929 ) (83.2 )
Loss on extinguishment of debt - 37,538 (37,538 ) (100.0 )
Income tax expense (benefit) 8,811 (2,600 ) 11,411 N/M
Net income (loss) $ 21,769 $ (52,116 ) $ 73,885 N/M
"N/M" indicates the variance as a percentage is not meaningful.
Net sales for the three months endedJune 30, 2021 increased by$103.7 million , or 46.4%, to$327.5 million from$223.7 million for the three months endedJune 30, 2020 . The increase was attributable to higher sales growth in both our Residential and Commercial segments. Net sales for the three months endedJune 30, 2021 increased for our Residential segment by 51.2% and increased for our Commercial segment by 16.5%, in each case as compared to the prior year.
Cost of Sales
Cost of sales for the three months endedJune 30, 2021 increased by$72.0 million , or 48.5%, to$220.6 million from$148.6 million for the three months endedJune 30, 2020 primarily due to increased costs on higher sales volumes and higher costs of raw materials and manufacturing.
Gross Profit
Gross profit for the three months endedJune 30, 2021 increased by$31.7 million , or 42.3%, to$106.9 million from$75.1 million for the three months endedJune 30, 2020 . The increase in gross profit was primarily driven by the strong sales results in the Residential and Commercial segment which includes positive pricing and manufacturing productivity, partially offset by higher costs. Gross profit as a percent of net sales decreased to 32.6% for the three months endedJune 30, 2021 compared to 33.6% for the three months endedJune 30, 2020 .
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased by$5.1 million , or 7.9%, to$70.3 million , or 21.5% of net sales, for the three months endedJune 30, 2021 from$65.2 million , or 29.1% of net sales, for the three months endedJune 30, 2020 . The increase was primarily attributable to higher personnel costs, public company costs, professional fees and marketing expenses, partially offset by lower stock-based compensation expense.
Other General Expenses
Other general expenses were$1.4 million during the three months endedJune 30, 2021 , which related primarily to our secondary offering in June of 2021 and$1.6 million during the three months endedJune 30, 2020 , which related to our initial public offering inJune 2020 .
Interest Expense, net
Interest expense, net, decreased by$20.9 million , or 83.2%, to$4.2 million for the three months endedJune 30, 2021 from$25.1 million for the three months endedJune 30, 2020 . Interest expense, net decreased primarily due to the reduced principal amount outstanding under our Term Loan Agreement and our formerly outstanding 2021 Senior Notes and 2025 Senior Notes, as well as a 27
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lower interest rate on our Term Loan during the three months ended
Loss on Extinguishment of Debt
Loss on extinguishment of debt decreased by$37.5 million for the three months endedJune 30, 2021 due to the extinguishment of the 2025 Senior Notes and 2021 Senior Notes in the three months endedJune 30, 2020 .
Income Tax Expense (Benefit)
Income tax expense increased by$11.4 million to$8.8 million for the three months endedJune 30, 2021 compared to a$2.6 million income tax benefit for the three months endedJune 30, 2020 . The increase in our income tax expense was primarily driven by our pre-tax operating earnings.
Net Income (Loss)
Net income increased by
Nine Months Ended
The following tables summarize certain financial information relating to our
operating results that have been derived from our unaudited Consolidated
Financial Statements for the nine months ended
Nine Months Ended June 30,
$ %
(U.S. dollars in thousands) 2021 2020 Variance Variance
Net sales $ 832,854 $ 635,339 $ 197,515 31.1 %
Cost of sales 555,147 429,553 125,594 29.2
Gross profit 277,707 205,786 71,921 34.9
Selling, general and administrative
expenses 183,226 158,330 24,896 15.7
Other general expenses 2,592 6,716 (4,124 ) (61.4 )
Loss (gain) on disposal of property,
plant and
equipment 624 394 230 58.4
Operating income (loss) 91,265 40,346 50,919 126.2
Interest expense, net 16,931 64,882 (47,951 ) (73.9 )
Loss on extinguishment of debt - 37,538 (37,538 ) (100.0 )
Income tax expense (benefit) 19,725 (4,200 ) 23,925 N/M
Net income (loss) $ 54,609 $ (57,874 ) $ 112,483 N/M
"N/M" indicates the variance as a percentage is not meaningful.
Net sales for the nine months endedJune 30, 2021 increased by$197.5 million , or 31.1%, to$832.9 million from$635.3 million for the nine months endedJune 30, 2020 . The increase was primarily attributable to higher sales growth in our Residential segment. Net sales for the nine months endedJune 30, 2021 increased for our Residential segment by 37.2% and decreased for our Commercial segment by 3.1%, in each case as compared to the prior year.
Cost of Sales
Cost of sales for the nine months endedJune 30, 2021 increased by$125.6 million , or 29.2%, to$555.1 million from$429.6 million for the nine months endedJune 30, 2020 primarily due to increased costs on higher sales volumes and higher costs of raw materials and manufacturing.
Gross Profit
Gross profit for the nine months endedJune 30, 2021 increased by$71.9 million or 34.9%, to$277.7 million from$205.8 million for the nine months endedJune 30, 2020 . The increase in gross profit was primarily driven by the strong results in the Residential segment which includes positive pricing and manufacturing productivity, partially offset by higher costs. Gross profit as a percent of net sales increased to 33.3% for the nine months endedJune 30, 2021 compared to 32.4% for the nine months endedJune 30, 2020 . 28
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Selling, General and Administrative Expenses
Selling, general and administrative expenses increased by$24.9 million , or 15.7%, to$183.2 million , or 22.0% of net sales, for the nine months endedJune 30, 2021 from$158.3 million , or 24.9% of net sales, for the nine months endedJune 30, 2020 . The increase was primarily attributable to personnel costs, professional fees, marketing expenses and ongoing public company expenses.
Other General Expenses
Other general expenses were$2.6 million during the nine months endedJune 30, 2021 , which primarily related to our secondary offerings in January and June of 2021 and$6.7 million during the nine months endedJune 30, 2020 , which related to our initial public offering inJune 2020 .
Interest Expense, net
Interest expense, net, decreased by$48.0 million , or 73.9%, to$16.9 million for the nine months endedJune 30, 2021 from$64.9 million for the nine months endedJune 30, 2020 . Interest expense, net decreased primarily due to the reduced principal amount outstanding under our Term Loan Agreement and our formerly outstanding 2021 Senior Notes and 2025 Senior Notes during the nine months endedJune 30, 2021 , when compared to the nine months endedJune 30, 2020 .
Loss on Extinguishment of Debt
Loss on extinguishment of debt decreased by$37.5 million for the nine months endedJune 30, 2021 due to the extinguishment of the 2025 Senior Notes and 2021 Senior Notes in the nine months endedJune 30, 2020 .
Income Tax Expense (Benefit)
Income tax expense increased by$23.9 million to$19.7 million for the nine months endedJune 30, 2021 compared to an income tax benefit of$4.2 million for the nine months endedJune 30, 2020 . The increase in our income tax expense was primarily driven by our pre-tax operating earnings.
Net Income (Loss)
Net income increased by
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$6.6 million to$16.1 million for the three months endedJune 30, 2021 , from$9.5 million for the three months endedJune 30, 2020 , and increased by$15.8 million to$43.6 million for the nine months endedJune 30, 2021 , from$27.8 million for the nine months endedJune 30, 2020 .
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 and nine months endedJune 30, 2021 and 2020. 29
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Three Months Ended June 30, Nine Months Ended June 30,
$ % $ %
(U.S. dollars in thousands) 2021 2020 Variance Variance 2021 2020 Variance Variance
Net sales $ 291,209 $ 192,599 $ 98,610 51.2 % $ 739,048 $ 538,514 $ 200,534 37.2 %
Segment Adjusted EBITDA 82,525 62,326 20,199 32.4 % 222,999 164,047 58,952 35.9 %
Segment Adjusted EBITDA Margin 28.3 % 32.4 % N/A N/A 30.2 % 30.5 % N/A N/A
Net Sales
Net sales for the three months ended
Net sales for the nine months ended
Segment Adjusted EBITDA
Segment Adjusted EBITDA for the three months endedJune 30, 2021 increased by$20.2 million , or 32.4%, to$82.5 million from$62.3 million for the three months endedJune 30, 2020 . The increase was mainly driven by higher sales and manufacturing productivity, partially offset by higher raw material costs, manufacturing costs and selling, general and administrative expenses. Segment Adjusted EBITDA for the nine months endedJune 30, 2021 increased by$59.0 million , or 35.9%, to$223.0 million from$164.0 million for the nine months endedJune 30, 2020 . The increase was mainly driven by higher sales and manufacturing productivity, partially offset by higher selling, general and administrative expenses and manufacturing costs.
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 and nine months endedJune 30, 2021 and 2020. Three Months Ended June 30, Nine Months Ended June 30, $ % $ % (U.S. dollars in thousands) 2021 2020 Variance Variance 2021 2020 Variance Variance Net sales$ 36,245 $ 31,112 $ 5,133 16.5 %$ 93,806 $ 96,825 $ (3,019 ) (3.1 )% Segment Adjusted EBITDA 6,273 5,024 1,249 24.9 % 13,304 11,179 2,125 19.0 % Segment Adjusted EBITDA Margin 17.3 % 16.1 % N/A N/A 14.2 % 11.5 % N/A N/A Net Sales Net sales for the three months endedJune 30, 2021 increased by$5.1 million , or 16.5%, to$36.2 million from$31.1 million for the three months endedJune 30, 2020 . The increase was primarily attributable to higher net sales in our Vycom business, partially offset by decreased net sales in our Scranton Products business. Net sales for the nine months endedJune 30, 2021 decreased by$3.0 million , or 3.1%, to$93.8 million from$96.8 million for the nine months endedJune 30, 2020 . The decrease was primarily attributable to lower net sales in our Scranton Products and Vycom businesses, partially offset by increased pricing.
Segment Adjusted EBITDA
Segment Adjusted EBITDA of the Commercial segment was$6.3 million for the three months endedJune 30, 2021 , compared to$5.0 million for the three months endedJune 30, 2020 . The increase was primarily driven by higher sales in the Vycom business and net manufacturing productivity. Segment Adjusted EBITDA of the Commercial segment was$13.3 million for the nine months endedJune 30, 2021 , compared to$11.2 million for the nine months endedJune 30, 2020 . The slight increase was primarily driven by net manufacturing productivity and lower selling, general and administrative expenses, partially offset by lower net sales as described above. 30
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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 may not be 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 June 30, Nine Months Ended June 30, (U.S. dollars in thousands, except 2021 2020 2021 2020 per share amounts) Adjusted Gross Profit$ 124,121 $ 91,234 $ 327,559 $ 252,989 Adjusted Gross Profit Margin 37.9 % 40.8 % 39.3 % 39.8 % Adjusted Net Income$ 40,533 $ 6,249 $ 102,822 $ 28,278 Adjusted Diluted EPS $ 0.26$ 0.05 $ 0.66$ 0.25 Adjusted EBITDA$ 72,716 $ 57,820 $ 192,680 $ 147,444 Adjusted EBITDA Margin 22.2 % 25.8 % 23.1 % 23.2 %
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 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;
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• 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 June 30, Nine Months Ended June 30,
(U.S. dollars in thousands) 2021 2020 2021 2020
Gross Profit $ 106,867 $ 75,123 Depreciation and amortization (1) 17,254 15,925 49,852 46,463 Acquisitions costs (2) - 111 - 665 Other costs (3) - 75 - 75 Adjusted Gross Profit$ 124,121 $ 91,234 $ 327,559 $ 252,989 Three Months Ended June 30, Nine Months Ended June 30, 2021 2020 2021 2020 Gross Margin 32.6 % 33.6 % 33.3 % 32.4 % Depreciation and amortization 5.3 % 7.1 % 6.0 % 7.3 % Acquisitions costs - 0.1 % - 0.1 % Other costs - - - - Adjusted Gross Profit Margin 37.9 % 40.8 % 39.3 % 39.8 %
(1) Depreciation and amortization for the three months ended
2020 consists of
depreciation and
amortization of intangible assets relating to our manufacturing process.
Depreciation and amortization for the nine months ended
2020 consists of
depreciation and
amortization of intangible assets relating to our manufacturing process.
(2) Acquisition costs reflect inventory step-up adjustments related to
recording the inventory of acquired businesses at fair value on the date
of acquisition.
(3) Other costs reflect reduction in workforce costs of
three and nine months ended June 30, 2020 .
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Adjusted Net Income and Adjusted Diluted EPS Reconciliation
Three Months Ended June 30, Nine Months Ended June 30,
(U.S. dollars in thousands) 2021 2020 2021 2020
Net income (loss) $ 21,769 $ (52,116 ) $ 54,609 $ (57,874 )
Amortization (1) 12,483 13,885 37,666 41,621
Stock-based compensation
(2) 8,167 18,788 16,940 20,169
Business transformation
costs (3) - 109 - 435
Acquisition costs (4) - 182 - 1,538
Initial public offering and
secondary offering costs 1,443 1,623 2,592 6,716
Other costs (5) 1,228 2,551 3,922 3,015
Capital structure
transaction costs (6) - 37,538 - 37,538
Tax impact of adjustments
(7) (4,557 ) (16,311 ) (12,907 ) (24,880 )
Adjusted Net Income $ 40,533 $ 6,249 $ 102,822 $ 28,278
Three Months Ended June 30,
Nine Months Ended
2021 2020 2021 2020
Net income (loss) $ 0.14 $ (0.44 ) $ 0.35 $ (0.51 )
Amortization 0.08 0.12 0.23 0.37
Stock-based compensation 0.05 0.16 0.11 0.18
Business transformation costs - - - -
Acquisition costs - - - 0.01
Initial public offering and
secondary offering costs 0.01 0.01 0.02 0.06
Other costs 0.01 0.02 0.03 0.03
Capital structure transaction
costs - 0.32 - 0.33
Tax impact of adjustments (0.03 ) (0.14 ) (0.08 ) (0.22 )
Adjusted Diluted EPS (8)
0.66$ 0.25
(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 for the three and nine months ended
2021 reflect expenses related to our initial public offering. Expenses
related to our recurring awards granted each fiscal year are 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
million for the three and nine months ended
(4) Acquisition costs reflect costs directly related to completed acquisitions of
2020, respectively, and inventory step-up adjustments related to recording
the inventory of acquired businesses at fair value on the date of acquisition
of
2020, respectively.
(5) Other costs include costs for legal expense of
for the three months ended
million and
respectively, reduction in workforce costs of
three and nine months ended
plan and other ancillary expenses associated with the initial public offering
of
2020, respectively, and
ended
(6) Capital structure transaction costs include loss on extinguishment of debt
of
Notes and
(7) Tax impact of adjustments are based on applying a combined
state statutory tax rate of 24.5% for both the three and nine months ended
(8) Weighted average common shares outstanding used in computing diluted net
income (loss) per common share of 157,022,043 and 119,067,790 for the three
months ended
113,635,347 for the nine months ended
.
33
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Adjusted EBITDA and Adjusted EBITDA Margin Reconciliation
Three Months Ended June 30, Nine Months Ended June 30,
(U.S. dollars in thousands) 2021 2020 2021 2020
Net income (loss) $ 21,769 $ (52,116 ) $ 54,609 $ (57,874 )
Interest expense 4,219 25,148 16,931 64,882
Depreciation and
amortization 25,736 26,597 75,255 75,225
Income tax expense
(benefit) 8,811 (2,600 ) 19,725 (4,200 )
Stock-based compensation 9,510 18,788 19,646 20,169
Business transformation
costs (1) - 109 - 435
Acquisition costs (2) - 182 - 1,538
Initial public offering and
secondary offering costs 1,443 1,623 2,592 6,716
Other costs (3) 1,228 2,551 3,922 3,015
Capital structure
transaction costs (4) - 37,538 - 37,538
Total adjustments 50,947 109,936 138,071 205,318
Adjusted EBITDA $ 72,716 $ 57,820 $ 192,680 $ 147,444
Three Months Ended June 30,
Nine Months Ended
2021 2020 2021 2020
Net income (loss) 6.6 % -23.3 % 6.6 % -9.1 %
Interest expense 1.3 % 11.2 % 2.0 % 10.2 %
Depreciation and
amortization 7.9 % 11.9 % 9.0 % 11.8 %
Income tax expense
(benefit) 2.7 % -1.2 % 2.4 % -0.7 %
Stockbased compensation 2.9 % 8.4 % 2.3 % 3.2 %
Business transformation
costs - - - 0.1 %
Acquisition costs - 0.1 % - 0.2 %
Initial public offering
costs 0.4 % 0.7 % 0.3 % 1.1 %
Other costs 0.4 % 1.1 % 0.5 % 0.5 %
Capital structure
transaction costs - 16.9 % - 5.9 %
Total adjustments 15.6 % 49.1 % 16.5 % 32.3 %
Adjusted EBITDA Margin 22.2 % 25.8 % 23.1 % 23.2 %
(1) Business transformation costs reflect consulting and other costs related to
the transformation of the senior management team of
million for the three and nine months ended
(2) Acquisition costs reflect costs directly related to completed acquisitions of
2020, respectively, and inventory step-up adjustments related to recording
the inventory of acquired businesses at fair value on the date of acquisition
of
2020, respectively.
(3) Other costs include costs for legal expense of
for the three months ended
million and
respectively, reduction in workforce costs of
three and nine months ended
plan and other ancillary expenses associated with the initial public offering
of
2020, respectively, and
ended
(4) Capital structure transaction costs include loss on extinguishment of debt
of
Notes and
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 ofJune 30, 2021 , we had cash and cash equivalents of$220.5 million and total indebtedness of$467.7 million .CPG International LLC , our direct, wholly owned subsidiary, had approximately$145.6 million available under the borrowing base for future borrowings as ofJune 30, 2021 .CPG International LLC also has the option to increase the commitments under the Revolving Credit 34 -------------------------------------------------------------------------------- Facility by up to$100.0 million , subject to certain conditions. During fiscal year 2020, we initially announced an acceleration and expansion of our capacity investment from$100.0 million to$180.0 million . Recently we announced an additional$50 million to$60 million of capacity investment for the fiscal year 2021 and believe we have the adequate liquidity to meet the higher level of capacity investment in the fiscal year. 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 by the Company 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 ofJune 30, 2021 ,CPG International LLC would have been permitted to declare or pay dividends of up to$146.8 million , plus any dividends for the specific purposes specified in the Senior Secured Credit Facilities. Since the restricted net assets of the Company 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 of the Company. 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 ), 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. As ofJune 30, 2021 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 ofJune 30, 2021 andSeptember 30, 2020 ,CPG International LLC had approximately$145.6 million and$129.4 million , respectively, available under the borrowing base for future borrowings in addition to cash and cash equivalents on hand of$220.5 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.
35
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The table below details the total operating, investing and financing activity
cash flows for the nine months ended
Cash Flows
Nine Months Ended
June 30,
$ %
(U.S. dollars in thousands) 2021 2020 Variance Variance
Net cash provided by (used in) operating
activities $ 118,728 $ 11,286 $ 107,442 952.0 %
Net cash provided by (used in) investing
activities (115,999 ) (72,998 ) (43,001 ) 58.9 %
Net cash provided by (used in) financing
activities 2,723 170,876 (168,153 ) (98.4 )%
Net increase (decrease) in cash $ 5,452 $ 109,164 $ (103,712 ) (95.0 )%
Operating Activities
Net cash provided by (used in) operating activities was $118.7 million and $11.3
million for the nine months ended June 30, 2021 and 2020, respectively. The
$107.4 million increase in cash provided by operating activities is primarily
related the increase in net income over the nine months ended June 30, 2020 ,
partially offset by higher inventory levels.
Investing Activities
Net cash provided by (used) in investing activities was$(116.0) million and$(73.0) million for the nine months endedJune 30, 2021 and 2020, respectively. Net cash provided by (used in) investing activities for the nine months endedJune 30, 2021 primarily consisted of purchases of property, plant and equipment to support our expansion of capacity in our manufacturing facilities, as compared to the nine months endedJune 30, 2020 , which primarily consisted of purchases of property, plant and equipment in the normal course of business and$18.5 million for the acquisition ofReturn Polymers, Inc.
Financing Activities
Net cash provided by (used in) financing activities was $2.7 million and
$170.9 million for the nine months ended June 30, 2021 and 2020, respectively.
Net cash provided by (used in) financing activities for the nine months ended
June 30, 2021 primarily consisted of cash received from the exercise of stock
options and debt fees paid to third parties, as compared to the nine months
ended June 30, 2020 , which primarily consisted of proceeds from our IPO, net of
related costs, our issuance of the 2025 Senior Notes and the Revolving Credit
Facility, offset by our redemption of the 2025 Senior Notes and the 2021 Senior
Notes, debt payments and redemptions of capital contributions.
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 25 to 75 basis points based on average historical availability, or (ii) for Eurocurrency borrowings, adjusted LIBOR plus a spread of 125 to 175 basis points, based on average historical availability. The maturity of the Revolving Credit Facility is the earlier ofMarch 31, 2026 and the date that is 91 days prior to the maturity of the Term Loan Agreement or any permitted refinancing thereof. 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 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 of the Company,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 by the Company and the wholly owned domestic subsidiaries ofCPG International LLC other than certain immaterial subsidiaries and other excluded subsidiaries. 36 -------------------------------------------------------------------------------- Revolving loans under the Revolving Credit Facility may be voluntarily prepaid in whole, or in part, in each case without premium or penalty.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. 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 ofJune 30, 2021 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 ofJune 30, 2021 , 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 175 basis points, plus, in each case, the applicable margin of 150 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) 75 basis points, plus the applicable margin of 250 basis points per annum. The applicable margin may be reduced by a further 25 basis points in respect of both Eurocurrency borrowings and ABR borrowings during any period thatCPG International LLC maintains specified public corporate family ratings. The obligations under the Term Loan Agreement are secured by a first priority security interest in the membership interests ofCPG International LLC owned by the Company, the equity interests ofCPG International LLC's domestic subsidiaries and all remaining assets not constituting Revolver Priority Collateral (subject to certain exceptions) of the Company,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 by the Company 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 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 ofJune 30, 2021 andSeptember 30, 2020 ,CPG International LLC was in compliance with the covenants 37
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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-cancelable guarantees 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. 38
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