UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

 

 

For the quarterly period ended March 31, 2021

OR

 

 

For the transition period from                      to                     

Commission File Number: 001-39322

 

The AZEK Company Inc.

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code: (877) 275-2935

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

As of April 30, 2021, the registrant had 154,739,238 shares of Class A Common Stock, $0.001 par value per share, and 100 shares of Class B Common Stock, $0.001 par value per share, outstanding.

 

 

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The AZEK Company Inc.

Condensed Consolidated Balance Sheets

(In thousands of U.S. dollars, except for share and per share amounts)

(Unaudited)

 

 

See Notes to Condensed Consolidated Financial Statements (Unaudited).

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The AZEK Company Inc.

Condensed Consolidated Statements of Comprehensive Income (Loss)

(In thousands of U.S. dollars, except for share and per share amounts)

(Unaudited)

 

 

See Notes to Condensed Consolidated Financial Statements (Unaudited).

 

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The AZEK Company Inc.

Condensed Consolidated Statements of Stockholders’ Equity

(In thousands of U.S. dollars, except for share amounts)

(Unaudited)

 

 

See Notes to Condensed Consolidated Financial Statements (Unaudited).

 

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The AZEK Company Inc.

Condensed Consolidated Statements of Cash Flows

(In thousands of U.S. dollars)

(Unaudited)

 

 

See Notes to Condensed Consolidated Financial Statements (Unaudited).

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The AZEK Company Inc.

Notes to Condensed Consolidated Financial Statements

(In thousands of U.S. dollars, unless otherwise specified)

(Unaudited)

1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

a. Organization

The AZEK Company Inc. (the “Company”) is a Delaware corporation that holds all of the limited liability company interests in CPG International LLC, the entity which directly and indirectly holds all of the equity interests in the operating subsidiaries. The Company is a leading manufacturer of premium, low-maintenance building products for residential, commercial and industrial markets. The Company’s products include trim, decking, porch, moulding, railing, pavers, bathroom and locker systems, as well as extruded plastic sheet products and other non-fabricated products for special applications in industrial markets. The Company operates in various locations throughout the United States. AZEK is a brand name for residential products while the commercial products are branded under the brand names Celtec, Playboard, Seaboard, Flametec, Designboard, Cortec, Sanatec, Scranton Products, Aria Partitions, Eclipse Partitions, Hiny Hiders, Tufftec Lockers and Duralife Lockers.

Initial Public Offering

On June 16, 2020, the Company completed its initial public offering (the “IPO”) of its Class A common stock, in which it sold 38,237,500 shares, including 4,987,500 shares pursuant to the underwriters’ over-allotment option. The shares began trading on the New York Stock Exchange on June 12, 2020 under the symbol “AZEK”. The shares were sold at an IPO price of $23.00 per share for net proceeds to the Company of approximately $819.7 million, after deducting underwriting discounts and commissions of $50.6 million and offering expenses of approximately $9.2 million payable by the Company. In addition, the Company used its net proceeds to redeem $350.0 million in aggregate principal of its then-outstanding 2025 Senior Notes, $70.0 million of its then-outstanding principal amount under the Revolving Credit Facility and effected a $337.7 million prepayment of its then-outstanding principal amount under the Term Loan Agreement.

In conjunction with the Company’s conversion from a limited liability company into a corporation (the “Corporate Conversion”) prior to the closing of the IPO, the Company effected a unit split of its then-outstanding limited liability company unit and then converted the units on a one-to-one basis into shares of capital stock of the Company, including shares of Class A common stock and Class B common stock. In connection with the closing of the IPO, the Company issued additional shares of its Class A common stock, options to purchase shares of Class A common stock and certain other equity awards to its indirect equity holders prior to the IPO and certain of its officers and employees. All share and per share information presented in the Consolidated Financial Statements has been retroactively adjusted for all periods presented for the effects of the unit split converted to stock. Refer to Note 11 and 12 for additional information.

Secondary Offerings

On September 15, 2020, the Company completed an offering of 28,750,000 shares of Class A common stock, par value $0.001 per share, including the exercise in full by the underwriters of their option to purchase up to 3,750,000 additional shares of Class A common stock, at a public offering price of $33.25 per share. The shares were sold by certain stockholders of the Company (the “Selling Stockholders”). The Company did not receive any of the proceeds from the sale of the shares by the Selling Stockholders. Immediately subsequent to the closing of the secondary offering, Class B common stockholders converted 33,068,863 shares of Class B common stock into Class A common stock. In addition, the secondary offering triggered a change in performance criteria, in which certain performance-vested restricted stock awards and stock options vested as a result of the secondary offering. Refer to Note 11 and 12 for additional information.

On January 26, 2021, the Company completed an offering of 20,000,000 shares of Class A common stock, par value $0.001 per share, including the exercise in full by the underwriters of their option to purchase up to 3,000,000 additional shares of Class A common stock, at a public offering price of $40.00 per share. The shares were sold by certain of the Selling Stockholders. The Company did not receive any of the proceeds from the sale of the shares by those Selling Stockholders. In connection with the offering the Company incurred approximately $1.1 million in expenses.

b. Summary of Significant Accounting Policies

Basis of Presentation

The Company operates on a fiscal year ending September 30. The accompanying unaudited Condensed Consolidated Financial Statements and notes have been prepared in accordance with accounting principles generally accepted in the United States of America

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(“U.S. GAAP”) for interim financial information, and in management’s opinion, includes all adjustments, consisting of only normal recurring adjustments, necessary for the fair statement of the Company’s financial position, its results of operations and cash flows for the interim periods presented. The results of operations for the three and six months ended March 31, 2021 and the cash flows for the six months ended March 31, 2021 are not necessarily indicative of the results to be expected for the full fiscal year or any other period.

The Company’s financial condition and results of operations are being, and are expected to continue to be affected by the current COVID-19 public health pandemic. The economic effects of the COVID-19 pandemic will likely continue to affect demand for the Company’s products in the foreseeable future. Although management has implemented measures to mitigate any impact of the COVID-19 pandemic on the Company’s business, financial condition and results of operations, these measures may not fully mitigate the impact of the COVID-19 pandemic on the Company’s business, financial condition and results of operations. Management cannot predict the degree to, or the period over, which the Company will be affected by the COVID-19 pandemic and resulting governmental and other measures.

The accompanying unaudited Condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and notes thereto included in the Company’s 2020 Form 10-K. The Condensed Consolidated Balance Sheet as of September 30, 2020 was derived from the audited financial statements at that date. There have been no material changes in the Company’s significant accounting policies from those that were disclosed in the 2020 Form 10-K, except as noted below.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Significant estimates include revenue recognition, reserves for excess inventory, inventory obsolescence, product warranties, customer rebates, stock-based compensation, litigation, income taxes, contingent consideration, goodwill and intangible asset valuation and accounting for long-lived assets. Management’s estimates and assumptions are evaluated on an ongoing basis and are based on historical experience, current conditions and available information. Actual results may differ from estimated amounts. Estimates are revised as additional information becomes available.

Accounting Policies

Refer to the Company’s 2020 Form 10-K for a discussion of the Company’s accounting policies, as updated below and for recently adopted accounting standards.

Research and Development Costs

Research and development costs primarily relate to new product development, product claims support and manufacturing process improvements. Such costs are expensed as incurred and are included in “Selling, general and administrative expenses” within the Condensed Consolidated Statements of Comprehensive Income (Loss). Total research and development expenses were approximately $1.7 million and $1.9 million, respectively, for the three months ended March 31, 2021 and 2020, and approximately $3.6 million and $4.0 million, respectively, for the six months ended March 31, 2021 and 2020.

Recently Adopted Accounting Pronouncements

Under the Jumpstart Our Business Startups (“JOBS”) Act, the Company qualifies as an emerging growth company (“EGC”) and as such, has elected not to opt out of the extended transition period for complying with new or revised accounting pronouncements. During the extended transition period, the Company is not subject to new or revised accounting standards applicable to public companies. The accounting pronouncements pending adoption below reflect effective dates for the Company as an EGC with the extended transition period.

Based on our public float calculation at March 31, 2021, the Company will be deemed a Large Accelerated Filer under the U.S. Securities and Exchange Commission guidelines and will cease to qualify as an EGC effective September 30, 2021. The loss of EGC status will result in losing the reporting exemptions noted above, and in particular will require our independent registered public accounting firm to provide an attestation report on the effectiveness of our internal control over financial reporting as of and for the year ended September 30, 2021 under Section 404(b) of the Sarbanes-Oxley Act.

On October 1, 2019, the Company adopted ASU No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfer of Assets Other Than Inventory. The standard amends several aspects of the tax accounting and recognition timing for intra-company transfers. The Company adopted the standard using a modified retrospective approach, with an adjustment to the beginning retained earnings of approximately $1.3 million, due to the cumulative impact of adopting the standard. The adoption of this standard did not have a material impact on the Company’s Consolidated Financial Statements. Refer to Note 14 for additional information.

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On October 1, 2020, the Company adopted ASU No. 2018-13, Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement, which amends Topic 820, Fair Value Measurement. This standard modifies the disclosure requirements for fair value measurements by removing, modifying, or adding certain disclosures. The adoption of this standard did not have a material impact on the Company’s Consolidated Financial Statements.

Recently Issued Accounting Pronouncements

In February 2016, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2016-02, Leases (Topic 842), and issued subsequent amendments to the initial guidance in September 2017 within ASU No. 2017-13, in January 2018 within ASU No. 2018-01, in July 2018 within ASU Nos. 2018-10 and 2018-11, in December 2018 within ASU No. 2018-20, in March 2019 within ASU No. 2019-01, in November 2019 within ASU No. 2019-10 and in June 2020 within ASU No. 2020-05. This standard requires lessees to present right-of-use assets and lease liabilities on the balance sheet. For public entities that are not EGCs, the updated standard is effective for fiscal years beginning after December 15, 2018, and for EGCs, the updated standard is effective for fiscal years beginning after December 15, 2021 and interim periods within fiscal years beginning after December 15, 2022, with early adoption permitted. The Company will cease to qualify as an EGC effective September 30, 2021 and will adopt the standard in the fiscal year ending September 30, 2021. The Company has begun to assess the current state of accounting for leases, to catalog all current leases effected and to review all vendor contracts for the potential existence of a lease in order to understand the gaps between the current state and required future state and to implement the new processes and controls required. This standard provides the option to adopt through a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption, instead of applying the new guidance retrospectively for each prior reporting period presented. The Company is currently evaluating the impact these ASUs’ adoption will have on its Consolidated Financial Statements.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326), and issued subsequent amendments to the initial guidance in May 2019 within ASU No. 2019-05 and in November 2019 within ASU Nos. 2019-10 and 2019-11. This standard sets forth an expected credit loss model which requires the measurement of expected credit losses for financial instruments based on historical experience, current conditions and reasonable and supportable forecasts. This replaces the existing incurred loss model and is applicable to the measurement of credit losses on financial assets measured at amortized cost, and certain off-balance sheet credit exposures. For public entities that are not EGCs, the updated standard is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years, and for EGCs, the updated standard is effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. Early adoption is permitted, and the standard is adopted using a modified retrospective transition method through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. The Company will cease to qualify as an EGC effective September 30, 2021 and will adopt the standard in the fiscal year ending September 30, 2021. The Company is currently evaluating the impact the adoption of this standard will have on its Consolidated Financial Statements.

In August 2018, the FASB issued ASU No. 2018-15, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That is a Service Contract. This standard aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. For public entities, the updated standard is effective for fiscal years beginning after December 15, 2019, including interim periods within that fiscal year. The amendments in this ASU are effective for the Company, as an EGC, for annual periods beginning after December 15, 2020 and interim periods within annual periods beginning after December 15, 2021. The standard can be adopted either retrospectively or prospectively to all implementation costs incurred after the date of adoption. Early adoption is permitted. The Company intends to adopt the updated standard during its fiscal year ending September 30, 2021 and for interim periods within the fiscal year beginning October 1, 2021. The Company is currently evaluating the impact the adoption of this standard will have on its Consolidated Financial Statements.

In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740)—Simplifying the Accounting for Income Taxes. This standard simplifies the accounting for income taxes by removing certain exceptions to general principles in Topic 740 and clarifying and amending existing guidance. For public entities, the amendments in this ASU are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022. Early adoption of the amendments is permitted, including adoption in any interim period for (1) public business entities for periods for which financial statements have not yet been issued and (2) all other entities for periods for which financial statements have not yet been made available for issuance. An entity that elects to early adopt the amendments in an interim period should reflect any adjustments as of the beginning of the annual period that includes that interim period. Additionally, an entity that elects early adoption must adopt all the amendments in the same period. The amendments are applied on a prospective or retrospective basis, depending upon the amendment adopted within this ASU. The amendments in this ASU are effective for the Company for annual periods ending September 30, 2021 and thereafter and interim periods within annual periods beginning October 1, 2021. The Company is currently evaluating the impact this adoption will have on its Consolidated Financial Statements.

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In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848), Facilitation of the Effects of Reference Rate Reform on Financial Reporting. This standard provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. The ASU is effective for all entities as of March 12, 2020, and will apply through December 31, 2022. The Company is currently evaluating the impact this adoption will have on its Consolidated Financial Statements.

2. REVENUE

The Company recognizes revenues when control of the promised goods is transferred to the Company’s customers in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods, at a point in time, when shipping occurs.

The Company also engages in customer rebates, which are recorded in “Net sales” in the Condensed Consolidated Statements of Comprehensive Income (Loss) and in “Accrued rebates” and Trade receivables in the Condensed Consolidated Balance Sheets. The Company recorded accrued rebates of $22.9 million and $17.4 million as of March 31, 2021 and 2020, respectively, and contra trade receivables of $4.9 million and $4.7 million as of March 31, 2021 and 2020, respectively. The rebate activity was as follows (in thousands):

 

 

The Company records deferred revenue when cash payments are received or due in advance of the Company’s performance.

3. INVENTORIES

Inventories are valued at the lower of cost or net realizable value, and are reduced for slow-moving and obsolete inventory. The inventories cost is recorded at standard cost, which approximates actual cost, on a first-in first-out “FIFO”) basis. Inventories consisted of the following (in thousands):

 

 

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4. PROPERTY, PLANT AND EQUIPMENT—NET

Property, plant and equipment – net consisted of the following (in thousands):

 

 

The Company is considered the owner, for accounting purposes only, of leased office space, as it had taken on certain risks of construction build cost overages above normal tenant improvement allowances. Accordingly, the estimated fair value of the leased property was $9.2 million as of both March 31, 2021 and September 30, 2020. The corresponding lease financing obligation was $7.9 million as of both March 31, 2021 and September 30, 2020. The lease financing obligation was recorded in “Finance lease obligations – less current portion” in the Condensed Consolidated Balance Sheets. Refer to Note 15 for additional information.

Depreciation expense was approximately $12.7 million and $10.6 million in the three months ended March 31, 2021 and 2020, respectively, and $24.3 million and $20.9 million in the six months ended March 31, 2021 and 2020, respectively. During the three months ended March 31, 2021 and 2020, $0.5 million and $0.4 million of interest was capitalized, respectively, and during the six months ended March 31, 2021 and 2020, $0.9 million and $0.6 million of interest was capitalized, respectively. Accumulated amortization for assets under capital leases was $4.3 million and $4.0 million as of March 31, 2021 and September 30, 2020, respectively. Accumulated amortization for assets under the build-to-suit lease was $0.7 million as of March 31, 2021 and $0.5 million as of September 30, 2020.

5. GOODWILL AND INTANGIBLE ASSETS—NET

Goodwill

As of both March 31, 2021 and September 30, 2020, the Company had goodwill of $951.4 million with carrying amounts for Residential of $911.0 million and Commercial of $40.4 million. As of March 31, 2021, total accumulated goodwill impairments were $32.2 million, all attributable to the Company’s Commercial segment.

Intangible assets, net

The Company does not have any indefinite lived intangible assets other than goodwill as of March 31, 2021 and September 30, 2020. Finite-lived intangible assets consisted of the following (in thousands):

 

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Amortization expense was approximately $12.5 million and $13.9 million in the three months ended March 31, 2021 and 2020, respectively and $25.2 million and $27.7 million in the six months ended March 31, 2021 and 2020, respectively. As of March 31, 2021, the remaining weighted-average amortization period for acquired intangible assets was 12.6 years.

6. COMPOSITION OF CERTAIN BALANCE SHEET ACCOUNTS

Allowance for Doubtful Accounts

Allowance for doubtful accounts consisted of the following (in thousands):

 

 

Accrued Expenses and Other Liabilities

Accrued expenses consisted of the following (in thousands):

 

 

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7. DEBT

Debt consisted of the following (in thousands):

 

 

 Term Loan Agreement

The term loan agreement, as amended and restated from time to time (the “Term Loan Agreement”), is a first lien term loan originally entered into on September 30, 2013 by the Company’s wholly-owned subsidiary, CPG International LLC (as successor-in-interest to CPG Merger Sub LLC), as the initial borrower with a syndicate of lenders party thereto. As of March 31, 2021 and September 30, 2020, CPG International LLC had $467.7 million outstanding under the Term Loan Agreement.  The Term Loan Agreement matures on May 5, 2024.  

The obligations under the Term Loan Agreement are secured by a first priority security interest in the membership interests of CPG International LLC owned by the Company and substantially all of the present and future assets of the borrowers and guarantors named therein including equity interests of their domestic subsidiaries, subject to certain exceptions, (the “Term Loan Priority Collateral”) and a second priority lien on current assets. The obligations under the Term Loan Agreement are guaranteed by the Company and the wholly owned domestic subsidiaries of CPG International LLC other than certain immaterial subsidiaries and other excluded subsidiaries.

On February 2, 2021, the Company entered into an amendment to the Term Loan Agreement. The amendment effected a repricing of  the Applicable Margin under the Term Loan Agreement, through reducing (i) the ABR floor by 25 basis points from 2.0% to 1.75%, (ii) the Adjusted LIBOR Rate floor by 25 basis points from 1.0% to 0.75% and (iii) the Applicable Margin with respect to any Effective Date Term Loans, by up to 125 basis points from 3.75% to 2.50% in the case of any Eurocurrency Loan and by up to 125 basis points from 2.75% to 1.50% in the case of any ABR Loan. The Applicable Margin may be reduced by a further 25 basis points in respect of both Eurocurrency Loans and ABR Loans during any period that the Borrower maintains specified public corporate family ratings. Capitalized terms used but not defined in this paragraph are as defined in the Term Loan Agreement.

Following the amendment, the Term Loan Agreement provides for interest on outstanding principal thereunder at a fluctuating rate, at CPG International LLC’s option, for (i) alternative base rate (“ABR”) borrowings, the highest of (a) the Federal Funds Rate as of such day plus 50 basis points, (b) the prime commercial lending rate announced as of such day by the Administrative Agent as defined in the Term Loan Agreement, as the “prime rate” as in effect on such day and (c) the LIBOR as of such day for a deposit in U.S. dollars with a maturity of one month plus 100 basis points, provided that in no event shall the ABR be less than 175 basis points, plus the applicable margin of 150 basis points per annum; or (ii) for Eurocurrency borrowings, the highest 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.        

In connection with the February 2, 2021 amendment, the Company recognized $0.6 million in interest expense for the quarter ended March 31, 2021 related to the write-off of unamortized debt discount and debt issuance costs. The Company incurred $0.1 million in lender fees which, together with $3.6 million in remaining unamortized debt discount and debt issuance costs, have been recorded as a reduction of long-term debt  and are being amortized over the remaining contractual life of the Term Loan Agreement using the effective interest method. In addition, the Company also incurred $0.9 million in various third-party fees and expenses related to the amendment to the Term Loan Agreement, which were recorded to interest expense for the quarter ended March 31, 2021.

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As of March 31, 2021, and September 30, 2020, unamortized deferred financing fees related to the Term Loan Agreement were $3.1 million and $4.2 million, respectively. 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.

The Term Loan Agreement requires mandatory prepayments of the term loans thereunder from certain debt issuances, certain asset dispositions (subject to certain reinvestment rights) and a percentage of excess cash flow (subject to step-downs upon CPG International LLC achieving certain leverage ratios). At September 30, 2020, no excess cash flow payment was required based on the current leverage ratio. CPG International LLC is required to repay the outstanding principal amount under the Term Loan Agreement in quarterly installments equal to 0.25253% of the aggregate principal amount under the Term Loan Agreement outstanding on the amendment date of June 18, 2018 and such quarterly payments may be reduced as a result of prepayments. Based on prepayments of $337.7 million made during the three months ended June 30, 2020 with the IPO proceeds, CPG International LLC has prepaid all of the quarterly principal payments through maturity. The Company’s next scheduled principal payment on the term loan is due in fiscal year 2024. The Term Loan Agreement restricts payments of dividends unless certain conditions are met, as defined in the Term Loan Agreement.

 Revolving Credit Facility

On September 30, 2013, CPG International LLC (as successor-in-interest to CPG Merger Sub LLC) entered into a revolving credit facility, as amended and restated from time to time (the “Revolving Credit Facility”), with certain lenders party thereto. The Revolving Credit Facility provides for maximum aggregate borrowings of up to $150.0 million, subject to an asset-based borrowing base. The borrowing base is limited to a set percentage of eligible accounts receivable and inventory, less reserves that may be established by the administrative agent and the collateral agent in the exercise of their reasonable credit judgment.

CPG International LLC had no outstanding borrowings under the Revolving Credit Facility as of March 31, 2021 and September 30, 2020. In addition, CPG International LLC had $4.4 million and $6.8 million of outstanding letters of credit held against the Revolving Credit Facility as of March 31, 2021 and September 30, 2020, respectively.  CPG International LLC had approximately $145.6 million available under the borrowing base for future borrowings as of March 31, 2021. 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.

On March 31, 2021, CPG International LLC amended the Revolving Credit Facility, resulting in a repricing and extension thereof. Pursuant to such amendment, the interest rate has been reduced by 25 basis points to (i) for 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 in U.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 date for the Revolving Credit Facility was extended from May 9, 2022 to the earliest of March 31, 2026 and the date that is 91 days prior to the maturity of the Term Loan Agreement or any permitted refinancing thereof.

In connection with the March 31, 2021 amendment, the Company recognized $0.1 million in interest expense for the quarter ended March 31, 2021 related to the write-off of unamortized debt issuance costs. The Company incurred $0.9 million in lender and third-party fees which, together with $0.5 million in remaining unamortized debt issuance costs, have been recorded as other assets and are being amortized over the remaining contractual life of the facility on a straight-line basis. Deferred financing costs, net of accumulated amortization, related to the Revolving Credit Facility at March 31, 2021 and September 30, 2020 were $1.4 million and $0.8 million, respectively.

  A “commitment fee” accrues on any unused portion of the 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 commitment fees were $0.1 million and $0.1 million for the three months ended March 31, 2021 and 2020, respectively and $0.3 million and $0.2 million in the six months ended March 31, 2021 and 2020, respectively.

The obligations under the Revolving Credit Facility are guaranteed by the Company and its wholly owned domestic subsidiaries other than certain immaterial subsidiaries and other excluded subsidiaries. The obligations under the Revolving Credit Facility are secured by a first priority security interest in substantially all of the accounts receivable, inventory, deposit accounts, securities accounts and cash assets of the Company, CPG International LLC and the subsidiaries of CPG International LLC that are guarantors under the Revolving Credit Facility, and the proceeds thereof (subject to certain exceptions) (the “Revolver Priority Collateral”), plus a second priority security interest in all of the Term Loan Priority Collateral. 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.

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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, CPG International LLC 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 CPG International LLC’s 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 of March 31, 2021, 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.

2021 Senior Notes

CPG International LLC’s former 8.000% senior notes due October 2021 (the “2021 Senior Notes”) were issued on September 30, 2013, in an aggregate principal amount of $315.0 million, and had a maturity of October 1, 2021. The 2021 Senior Notes bore interest at the rate of 8.000% per annum payable in cash semi-annually in arrears on April 1 and October 1 of each year (computed based on a 360-day year of twelve 30-day months). The obligations under the 2021 Senior Notes were guaranteed by CPG International LLC and those of its subsidiaries that also guarantee the Revolving Credit Facility and the Term Loan Agreement. The redemption price of the 2021 Senior Notes (expressed as percentages of the principal amount to be redeemed) declined to the par value of the 2021 Senior Notes, plus accrued and unpaid interest based on the schedule below. The 2021 Senior Notes were redeemable in whole or in part, at any time after October 1, 2016 at the following redemption prices, if redeemed during the 12-month period beginning on October 1 of the years indicated below:

 

 

The indenture relating to the 2021 Senior Notes contained negative covenants that are customary for financings of this type. The indenture did not contain any financial maintenance covenants.

The Company issued a redemption notice on May 7, 2020 for the full $315.0 million of outstanding 2021 Senior Notes, which were redeemed on June 8, 2020.   

Interest expense consisted of the following (in thousands):

 

 

See Note 9 for the fair value of the Company’s debt as of March 31, 2021 and September 30, 2020.

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8. PRODUCT WARRANTIES

The Company provides product assurance warranties of various lengths ranging from 5 years to lifetime for limited coverage for a variety of material and workmanship defects based on standard terms and conditions between the Company and its customers. Warranty coverage depends on the product involved. The warranty reserve activity consisted of the following (in thousands):

 

 

9. FAIR VALUE OF FINANCIAL INSTRUMENTS

FASB Accounting Standards Codification (“ASC”) requirements for Fair Value Measurements and Disclosures establish a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three levels. Level 1 inputs, the highest priority, are quoted prices in active markets for identical assets or liabilities. Level 2 inputs reflect other than quoted prices included in Level 1 that are either observable directly or through corroboration with observable market data. Level 3 inputs are unobservable inputs, due to little or no market activity for the asset or liability, such as internally-developed valuation models. We do not have any assets or liabilities measured at fair value on a recurring basis that are Level 3.

The carrying values and the estimated fair values of the debt financial instruments (Level 2 measurements) consisted of the following (in thousands):

 

 

10. SEGMENTS

Operating segments for the Company are determined based on information used by the chief operating decision maker (“CODM”) in deciding how to evaluate performance and allocate resources to each of the segments. The CODM reviews Adjusted EBITDA and Adjusted EBITDA Margin as the key segment measures of performance. Adjusted EBITDA is defined as segment operating income (loss) plus depreciation and amortization, adjusted by adding thereto or subtracting therefrom stock-based compensation costs, business transformation costs, acquisition costs, capital structure transaction costs, and certain other costs. Adjusted EBITDA Margin is defined as Adjusted EBITDA divided by net sales.

The Company has two reportable segments, Residential and Commercial. The reportable segments were determined primarily based on products and end markets as follows:

• Residential—The Residential segment manufactures and distributes decking, rail, trim and accessories through a national network of dealers and distributors and multiple home improvement retailers providing extensive geographic coverage and enabling the Company to effectively serve contractors. The additions of Ultralox and Versatex are complementary to the Residential segment railing and trim businesses, respectively. The recent addition of Return Polymers provides a full-service recycled PVC material processing, sourcing, logistical support, and scrap management programs. This segment is impacted by trends in and the strength of home repair and remodel activity.

• Commercial—The Commercial segment manufactures, fabricates and distributes resin based extruded sheeting products for a variety of commercial and industrial applications through a widespread distribution network as well as directly to original equipment manufacturers. This segment includes Scranton Products which manufactures lockers and partitions and Vycom which manufactures resin based sheeting products. This segment is impacted by trends in and the strength of the new construction sector.

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The segment data below includes data for Residential and Commercial for the three and six months ended March 31, 2021 and 2020 (in thousands).

 

 

11. CAPITAL STOCK

The Company completed its IPO on June 16, 2020, in which it sold 38,237,500 shares of its Class A common stock, including 4,987,500 shares pursuant to the underwriters’ over-allotment option. The shares were sold at an IPO price of $23.00 per share for net proceeds to the Company of approximately $819.7 million, after deducting underwriting discounts and commissions of $50.6 million and offering expenses of approximately $9.2 million payable by the Company.

Immediately prior to the completion of the IPO, the Company converted to a Delaware corporation from a limited liability company. The Company’s certificate of incorporation provides for two classes of common stock: Class A common stock and Class B common stock. In addition, the certificate of incorporation authorizes shares of undesignated preferred stock, the rights, preferences and privileges of which may be designated from time to time by the board of directors. The Company is authorized to issue up to 1.1 billion shares of Class A common stock, up to 1 hundred million shares of Class B common stock and up to 1 million shares of preferred stock, each par value $0.001 per share, in one or more series. The Class A common stock and Class B common stock provide identical economic rights, but holders of Class B common stock have limited voting rights, specifically that such holders have no right to vote, solely with respect to their shares of Class B common stock, with respect to the election, replacement or removal of directors. Holders of Class A common stock and Class B common stock are not entitled to preemptive rights. Holders of Class B common stock may convert their shares of Class B common stock into shares of Class A common stock on a one-for-one basis, in whole or in part, at any time and from time to time at their option. The Company’s Class A common stock is traded on the New York Stock Exchange under the symbol “AZEK.”

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In conjunction with the Corporate Conversion and prior to the closing of the IPO, the Company effected a unit split of its then-outstanding unit, resulting in an aggregate of 108,162,741 units, including 75,093,778 Class A units and 33,068,963 Class B units. Concurrently with the Corporate Conversion, the units were converted to an aggregate of 108,162,741 shares of common stock, including 75,093,778 shares of Class A common stock and 33,068,963 shares of Class B common stock. In addition, a class of the Company’s former indirect parent’s partnership interests referred to as “Profits Interests” were exchanged for an aggregate of 2,703,243 shares of Class A common stock and 5,532,037 shares of Class A restricted stock, and 3,477,413 shares of Class A common stock reserved for issuance upon the exercise of stock options.

On September 15, 2020, the Company completed an offering of 28,750,000 shares of Class A common stock, par value $0.001 per share, including the exercise in full by the underwriters of their option to purchase up to 3,750,000 additional shares of Class A common stock, at a public offering price of $33.25 per share. The shares were sold by the Selling Stockholders. The Company did not receive any of the proceeds from the sale of the shares by the Selling Stockholders. Immediately subsequent to the closing of the secondary offering, Class B common stockholders converted 33,068,863 shares of Class B common stock into Class A common stock.

On January 26, 2021, the Company completed an offering of 20,000,000 shares of Class A common stock, par value $0.001 per share, including the exercise in full by the underwriters of their option to purchase up to 3,000,000 additional shares of Class A common stock, at a public offering price of $40.00 per share. The shares were sold by certain of the Selling Stockholders. The Company did not receive any of the proceeds from the sale of the shares by those Selling Stockholders. In connection with the offering the Company incurred approximately $1.1 million in expenses.

12. STOCK-BASED COMPENSATION

The Company grants stock-based awards to attract, retain and motivate key employees and directors.

Prior to the completion of the IPO, Profits Interests were issued through an LP Interest Agreement. The Profits Interests were, as part of the Corporate Conversion, converted into shares of common stock, restricted stock and stock options. The 2020 Omnibus Incentive Compensation Plan (“2020 Plan”), became effective as of June 11, 2020, the day of effectiveness of the registration statement filed in connection with the IPO. The 2020 Plan provides for the grant of stock options, stock appreciation rights, restricted stock, restricted stock units, dividend equivalent rights, and performance-based or other equity-related awards to the Company’s employees and directors. The maximum aggregate number of shares that may be issued under the 2020 Plan is 15,852,319 shares with 4,606,519 shares remaining in the reserve. The total aggregate number of shares may be adjusted as determined by the Board of Directors.

On February 4, 2021, the Compensation Committee of the Board of Directors authorized certain changes to our Chief Financial Officer’s (“CFO”) stock-based awards which are expected to be effective in connection with his retirement and contingent on the successful transition to his successor. These changes contemplate a retirement eligibility provision which is expected to allow certain awards to continue to vest in due course following retirement and extend the exercisability of the outstanding and exercisable stock options to the end of the contractual term of the options. This resulted in a Type III Modification (improbable to probable) as defined in accounting guidance, accounted for as a cancellation of the original award and a new grant under the revised terms, resulting in $3.8 million of share-based compensation expense in the quarter ended March 31, 2021 with additional expense being recognized through the required service period.

Stock-based compensation expense for the three months ended March 31, 2021 and 2020 was $7.2 million and $0.7 million, respectively and for the six months ended March 31, 2021 and 2020 was $10.1 million and $1.4 million, respectively, recognized in “Selling, general and administrative expenses” in the Condensed Consolidated Statements of Comprehensive Income (Loss). Total income tax benefit for the three months ended March 31, 2021 and 2020 was $0.3 million and $0.0 million, respectively and for the six months ended March 31, 2021 and 2020 was $0.8 million and $0.0 million, respectively. As of March 31, 2021, the Company had not yet recognized compensation cost on unvested stock-based awards of $33.4 million, with a weighted average remaining recognition period of 2.4 years.

The Company uses the Monte Carlo pricing model to estimate the fair value of its performance-based awards as of the grant date, and uses the Black Scholes pricing model to estimate the fair value of its service-based awards as of the grant date. Under the terms of the 2020 Plan, all stock options will expire if not exercised within ten years of the grant date.

 

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Stock Options

The following table summarizes the performance-based stock option activity for the six months ended March 31, 2021:

 

 

The following table summarizes the service-based stock option activity for the six months ended March 31, 2021:

 

 

Restricted Stock Awards

A summary of the service-based restricted stock awards activity during the six months ended March 31, 2021 was as follows:

 

 

Performance Restricted Stock Units

Performance restricted stock units were granted to officers and certain employees of the Company and represent the right to earn shares of Company common stock based on the achievement of company-wide non-GAAP performance conditions, including cumulative net sales, average return on net tangible assets and cumulative EBITDA during the three-year performance period. Compensation cost is amortized into expense over the performance period, which is generally three years, and is based on the

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probability of meeting performance targets. The fair value of each performance share award is based on the average of the high and low stock price on the date of grant.

A summary of the performance-based restricted stock unit awards activity for the six months ended March 31, 2021 presented at target was as follows:

 

 

Restricted Stock Units

A summary of the service-based restricted stock unit awards activity for the six months ended March 31, 2021 was as follows:

 

 

13. EARNINGS PER SHARE

The Company computes earnings per common share (“EPS”) under the two-class method which requires the allocation of all distributed and undistributed earnings attributable to the Company to common stock and other participating securities based on their respective rights to receive distributions of earnings or losses. The Company’s Class A common stock and Class B common stock equally share in distributed and undistributed earnings, therefore, no allocation to participating securities or dilutive securities is performed.

Basic EPS attributable to common stockholders is calculated by dividing net income (loss) attributable to common stockholders by the weighted-average number of shares of common stock outstanding. Diluted EPS is calculated by adjusting weighted average shares outstanding for the dilutive effect of potential common shares, determined using the treasury-stock method. For purposes of the diluted EPS calculation, restricted stock awards, restricted stock units and options to purchase shares of common stock are considered

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to be potential common shares. The following table sets forth the computation of the Company’s basic and diluted EPS attributable to common stockholders (in thousands, except share and per share amounts):

 

 

The following table includes the number of shares that may be dilutive common shares in the future, and were not included in the computation of diluted net income (loss) per share because the effect was anti-dilutive:

 

 

14. INCOME TAXES

The Company calculates the interim tax provision in accordance with the provisions of Accounting Standards Codification (“ASC”) 740-270, Income Taxes; Interim Reporting, specifically ASC-740-270-25-2. For interim periods, the Company estimates the annual effective income tax rate (“AETR”) and applies the estimated rate to the year-to-date income or loss before income taxes. The effective income tax rates for the three months ended March 31, 2021 and 2020 were 25.0% and 37.0%, respectively, and for the six months ended March 31, 2021 and 2020 were 24.9% and 21.7%.

The Company adopted ASU No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory, on October 1, 2019. The updated guidance requires companies to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. Income tax effects of intra-entity transfers of inventory will continue to be deferred until the inventory has been sold to a third party. The adoption of this standard did not have a material impact on the Company’s Consolidated Financial Statements.

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15. COMMITMENTS AND CONTINGENCIES

Lease Commitments

The Company leases vehicles, machinery and a manufacturing facility under various capital leases. The Company also leases office equipment, vehicles and manufacturing and office facilities under various operating leases.

In 2018, the Company entered into a lease agreement for its corporate headquarters in Chicago, IL. The Company was responsible for costs to build out the office space and spent approximately $3.4 million in improvements to meet the Company’s needs. Based on the lease agreement and the changes made to the office space the Company concluded that it was the “deemed owner” of the building (for accounting purposes only) during the construction period. The Company recorded the build out costs as an asset with a corresponding build-to-suit liability while the building was under construction. Upon completion of the improvements to the building, the Company evaluated the derecognition of the asset and liability under the provisions of ASC 840-40, Leases—Sale-Leaseback Transactions. The Company determined that the lease does not meet the criteria for sale-leaseback accounting treatment, due to the Company’s continuing involvement in the project. As a result, the building is being accounted for as a financing obligation. The underlying assets amount to approximately $9.2 million. The Company determined its incremental borrowing rate for the purpose of calculating the interest and principal components of each lease payment was 8.4%.

During the second quarter of fiscal 2021, the Company signed a fifteen-year lease for approximately 350,000 square feet in Boise, Idaho (“the Boise Lease”) to serve as a western U.S. manufacturing facility.  The Boise Lease is expected to commence upon the substantial completion of certain improvements to the building, which the Company believes will be within calendar year 2021.  The total estimated lease payments over the term of the Boise Lease is approximately $40.3 million.  The Company has the option to renew the Boise Lease for an additional five to 20 years.  

Future minimum annual payments under noncancelable leases with initial or remaining noncancelable lease terms in excess of one year as of March 31, 2021 were as follows (in thousands):

 

 

Total rent expense was approximately $ 0.8 million and $0.4 million for the three months ended March 31, 2021 and 2020, respectively and $ 1.4 million and $0.7 million for the six months ended March 31, 2021 and 2020, respectively. The future minimum sublease income under a noncancelable subleases was $0.7 million at March 31, 2021.

Legal Proceedings

In the normal course of the Company’s business, it is at times subject to pending and threatened legal actions, in some cases for which the relief or damages sought may be substantial. Although the Company is not able to predict the outcome of such actions, after reviewing all pending and threatened actions with counsel and based on information currently available, management believes that the outcome of such actions, individually or in the aggregate, will not have a material adverse effect on the Company’s results of operations or financial position. However, it is possible that the ultimate resolution of such matters, if unfavorable, may be material to the Company’s results of operations in a particular future period as the time and amount of any resolution of such actions and its relationship to the future results of operations are not currently known. The Company accrues for losses when they are probable of occurrence and such losses are reasonably estimable. Legal costs expected to be incurred are accounted for as they are incurred.

Loss Contingencies

During the year ended September 30, 2019, the Company was made aware of a worker’s compensation case that became reasonably possible to give rise to a liability. The case is in discovery as the nature and extent of the Company’s exposure is currently being determined. The Company expects a range of loss of $0.4 million to $0.5 million. As of March 31, 2021, there are various other worker’s compensation and personal injury claims that have been made against the Company. All such claims are being contested and

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the Company does not believe a loss is probable; therefore, no reserve has been recorded related to these matters. In addition, the Company carries insurance for these types of matters and is expecting to recover thereon.

The Company is a party to various legal proceedings and claims, which arise in the ordinary course of business. As of March 31, 2021, the Company determined that there was not at least a reasonable possibility that it had incurred a material loss, or a material loss in excess of a recorded accrual, with respect to such proceedings.

16. CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY ONLY)

The AZEK Company Inc. (parent company only)

Balance Sheets

(In thousands of U.S. dollars, except for share and per share amounts)

 

 

 

The AZEK Company Inc. did not have any cash as of March 31, 2021 or September 30, 2020, accordingly a Condensed Statement of Cash Flows has not been presented.

Basis of Presentation

The parent company financial statements should be read in conjunction with the Company’s Consolidated Financial Statements and the accompanying notes thereto. For purposes of this condensed financial information, the Company’s wholly owned and majority owned subsidiaries are recorded based upon its proportionate share of the subsidiaries’ net assets (similar to presenting them on the equity method).

Since the restricted net assets of The AZEK Company Inc. and its subsidiaries exceed 25% of the consolidated net assets of the Company and its subsidiaries, the accompanying condensed parent company financial statements have been prepared in accordance with Rule 12-04, Schedule 1 of Regulation S-X. This information should be read in conjunction with the accompanying Consolidated Financial Statements.

Dividends from Subsidiaries

There were no cash dividends paid to The AZEK Company Inc. from the Company’s consolidated subsidiaries during each of the three months ended March 31, 2021 and 2020.

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Restricted Payments

CPG International LLC is party to the Revolving Credit Facility and the Term Loan Agreement originally executed on September 30, 2013, both of which have been amended and extended from time to time. The obligations under the Revolving Credit Facility and Term Loan Agreement are secured by substantially all of the present and future assets of the borrowers and guarantors, including equity interests of their domestic subsidiaries, subject to certain exceptions.

The obligations under the Revolving Credit Facility and Term Loan Agreement are guaranteed by the Company and its wholly owned domestic subsidiaries other than certain immaterial subsidiaries and other excluded subsidiaries. CPG International LLC is not permitted to make certain payments unless those payments are consistent with exceptions outlined in the agreements. These payments include repurchase of equity interests, fees associated with a public offering, income taxes due in other applicable payments. Further, the payments are only permitted if certain conditions are met related to availability and fixed charge coverage as defined in the Revolving Credit Facility and described in Note 7 to these Consolidated Financial Statements.

17. SUBSEQUENT EVENTS

The Company has evaluated subsequent events through the date the Consolidated Financial Statements were issued. The Company has determined that there were no other subsequent events.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

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 the Securities and Exchange Commission on December 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 other SEC 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

The 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 by Principia 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 and U.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 and AZEK, 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

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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 continue to be relaxed in the United States, 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. 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 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 other SEC filings, including the 2020 Form 10-K.

Other Recent Developments

 

During the quarter ended March 31, 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, were negatively impacted by supply chain and weather-related disruptions, including as a result of Winter Storm Uri, 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 for the remainder of fiscal 2021 and that the combination of our price increases and productivity initiatives will fully offset this raw material inflation during the fourth quarter of 2021.  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."

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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 March 31, 2021 and 2020.

 

 

“N/M” indicates the variance as a percentage is not meaningful.

Net Sales

Net sales for the three months ended March 31, 2021 increased by $47.5 million, or 19.4%, to $293.1 million from $245.6 million for the three months ended March 31, 2020. The increase was primarily attributable to higher sales growth in our Residential segment. Net sales for the three months ended March 31, 2021 increased for our Residential segment by 24.7% and decreased for our Commercial segment by 12.5%, in each case as compared to the prior year.

Cost of Sales

Cost of sales for the three months ended March 31, 2021 increased by $29.0 million, or 17.5%, to $195.3 million from $166.2 million for the three months ended March 31, 2020 primarily due to increased costs on higher sales volumes and higher costs of materials.

Gross Profit

Gross profit for the three months ended March 31, 2021 increased by $18.5 million, or 23.3%, to $97.9 million from $79.4 million for the three months ended March 31, 2020. The increase in gross profit was primarily driven by the strong sales 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 33.4% for the three months ended March 31, 2021 compared to 32.3% for the three months ended March 31, 2020.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased by $10.2 million, or 20.5%, to $59.9 million, or 20.4% of net sales, for the three months ended March 31, 2021 from $49.7 million, or 20.2% of net sales, for the three months ended March 31, 2020. The increase was primarily attributable to stock-based compensation expense, ongoing public company expenses and personnel costs.

 Other General Expenses

Other general expenses were $1.1 million during the three months ended March 31, 2021, which related to our secondary offering in January of 2021 and $3.1 million during the three months ended March 31, 2020, which related to our initial public offering in June 2020.

Interest Expense, net

Interest expense, net, decreased by $13.5 million, or 67.4%, to $6.5 million for the three months ended March 31, 2021 from $20.0 million for the three months ended March 31, 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 during the three months ended March 31, 2021, when compared to the three months ended March 31, 2020.

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Income Tax Expense  

Income tax expense increased by $5.2 million to $7.6 million for the three months ended March 31, 2021 compared to $2.4 million for the three months ended March 31, 2020. The increase in our income tax expense was primarily driven by our pre-tax operating earnings.

Net Income  

Net income increased by $18.6 million to $22.7 million for the three months ended March 31, 2021 compared to $4.1 million for the three months ended March 31, 2020, due to the factors described above.

The following tables summarize certain financial information relating to our operating results that have been derived from our unaudited Consolidated Financial Statements for the six months ended March 31, 2021 and 2020.

 

 

“N/M” indicates the variance as a percentage is not meaningful.

Net Sales

Net sales for the six months ended March 31, 2021 increased by $93.8 million, or 22.8%, to $505.4 million from $411.6 million for the six months ended March 31, 2020. The increase was primarily attributable to higher sales growth in our Residential segment. Net sales for the six months ended March 31, 2021 increased for our Residential segment by 29.5% and decreased for our Commercial segment by 12.4%, in each case as compared to the prior year.

Cost of Sales

Cost of sales for the six months ended March 31, 2021 increased by $53.6 million, or 19.1%, to $334.6 million from $281.0 million for the six months ended March 31, 2020 primarily due to increased costs on higher sales volumes and higher costs of materials.

Gross Profit

Gross profit for the six months ended March 31, 2021 increased by $40.2 million, or 30.7%, to $170.8 million from $130.7 million for the six months ended March 31, 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 33.8% for the six months ended March 31, 2021 compared to 31.8% for the six months ended March 31, 2020.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased by $19.8 million, or 21.2%, to $112.9 million, or 22.3% of net sales, for the six months ended March 31, 2021 from $93.2 million, or 22.6% of net sales, for the six months ended March 31, 2020. The increase was primarily attributable to stock-based compensation expense, ongoing public company expenses and personnel costs.

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 Other General Expenses

Other general expenses were $1.1 million during the six months ended March 31, 2021, which related to our secondary offering in January of 2021 and $5.1 million during the six months ended March 31, 2020, which related to our initial public offering in June 2020.

Interest Expense, net

Interest expense, net, decreased by $27.0 million, or 68.0%, to $12.7 million for the six months ended March 31, 2021 from $39.7 million for the six months ended March 31, 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 during the six months ended March 31, 2021, when compared to the three months ended March 31, 2020.

Income Tax Expense (Benefit)

Income tax expense (benefit) increased by $12.5 million to income tax expense of $10.9 million for the six months ended March 31, 2021 compared to income tax benefit of $1.6 million for the six months ended March 31, 2020. The increase in our income tax expense was primarily driven by our pre-tax operating earnings.

Net Income (Loss)

Net income (loss) increased by $38.6 million to a net income of $32.8 million for the six months ended March 31, 2021 compared to a net loss of $5.8 million for the six months ended March 31, 2020, 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 the Financial 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 $8.5 million to $23.2 million for the three months ended March 31, 2021, from $14.7 million for the three months ended March 31, 2020, and increased by $14.0 million to $41.0 million for the six months ended March 31, 2021, from $27.0 million for the six months ended March 31, 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 six months ended March 31, 2021 and 2020.

 

 

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Net Sales

Net sales for the three months ended March 31, 2021 increased by $52.0 million, or 24.7%, to $262.2 million from $210.2 million for the three months ended March 31, 2020. The increase was primarily attributable to higher net sales related to our Deck, Rail & Accessories and Exteriors businesses.

Net sales for the six months ended March 31, 2021 increased by $101.9 million, or 29.5%, to $447.8 million from $345.9 million for the six months ended March 31, 2020. The increase was primarily attributable to higher net sales related to our Deck, Rail & Accessories and Exteriors businesses.

Segment Adjusted EBITDA

Segment Adjusted EBITDA for the three months ended March 31, 2021 increased by $18.9 million, or 30.1%, to $81.7 million from $62.8 million for the three months ended March 31, 2020. The increase was mainly driven by higher sales and manufacturing productivity, partially offset by higher costs.

Segment Adjusted EBITDA for the six months ended March 31, 2021 increased by $38.8 million, or 38.1%, to $140.5 million from $101.7 million for the six months ended March 31, 2020. The increase was mainly driven by higher sales and manufacturing productivity, 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 and six months ended March 31, 2021 and 2020.

 

 

Net Sales

Net sales for the three months ended March 31, 2021 decreased by $4.4 million, or 12.5%, to $30.9 million from $35.3 million for the three months ended March 31, 2020. The decrease was primarily attributable to lower net sales in our Scranton Products and Vycom businesses as the effects of COVID-19 continue to impact certain end markets, partially offset by increased pricing.

Net sales for the six months ended March 31, 2021 decreased by $8.2 million, or 12.4%, to $57.6 million from $65.7 million for the six months ended March 31, 2020. The decrease was primarily attributable to lower net sales in our Scranton Products and Vycom businesses as the effects of COVID-19 continue to impact certain end markets, partially offset by increased pricing.

Segment Adjusted EBITDA

Segment Adjusted EBITDA of the Commercial segment was $3.7 million for the three months ended March 31, 2021, compared to $3.1 million for the three months ended March 31, 2020. The increase was primarily driven by net manufacturing productivity and lower selling, general and administrative expenses, partially offset by lower net sales as described above.

Segment Adjusted EBITDA of the Commercial segment was $7.0 million for the six months ended March 31, 2021, compared to $6.2 million for the six months ended March 31, 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.

Non-GAAP Financial Measures

To supplement our Consolidated Financial Statements prepared and presented in accordance with generally accepted accounting principles in the 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

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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.

 

 

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:

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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

 

 

 

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Adjusted Net Income and Adjusted Diluted EPS Reconciliation

 

 

 

.

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Adjusted EBITDA and Adjusted EBITDA Margin Reconciliation

 

 

 

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 of March 31, 2021, we had cash and cash equivalents of $151.3 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 of March 31, 2021. 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 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.

On February 2, 2021, we entered into an amendment to the Term Loan Agreement. The amendment effected a repricing of the applicable margin under the Term Loan Agreement through reducing (i) the ABR floor by 25 basis points from 2.0% to 1.75%, (ii) the

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adjusted LIBOR rate floor by 25 basis points from 1.0% to 0.75% and (iii) the applicable margin by up to 125 basis points from 3.75% to 2.50% in the case of any Eurocurrency borrowings and by up to 125 basis points from 2.75% to 1.50% in the case of any ABR borrowings. The applicable margin may be reduced by a further 25 basis points in respect of both Eurocurrency borrowings and ABR borrowings during any period that CPG International LLC maintains specified public corporate family ratings. The maturity date for the Term Loan remains unchanged at May 5, 2024.

On March 31, 2021, we further amended the Revolving Credit Facility, resulting in a repricing and extension thereof. Pursuant to such amendment, the interest rate has been reduced by 25 basis points to (i) for 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 in U.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 date for the Revolving Credit Facility was extended from May 9, 2022 to the earliest of March 31, 2026 and the date that is 91 days prior to the maturity of the Term Loan Agreement or any permitted refinancing thereof.

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 of CPG International LLC other than certain immaterial subsidiaries and other excluded subsidiaries.

The Senior Secured Credit Facilities contain covenants restricting payments of dividends by CPG 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 of CPG 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 commencing October 1, 2013 to the end of the most recent fiscal quarter for which internal consolidated financial statements of CPG 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 of March 31, 2021, CPG International LLC would have been permitted to declare or pay dividends of up to $130.1 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 by CPG International LLC, borrowings under the credit facilities, issuances of notes and other forms of debt financing and capital contributions to fund our cash needs.

On September 30, 2013, our subsidiary, CPG International LLC (as successor-in-interest to CPG Merger Sub LLC, a limited liability company formed to effect the acquisition of CPG International LLC), and the lenders party thereto entered into the Revolving Credit Facility. On March 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 of March 31, 2021 and September 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 of March 31, 2021 and September 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

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equivalents on hand of $151.3 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 the six months ended March 31, 2021 and 2020.

Cash Flows

 

 

Operating Activities

Net cash provided by (used in) operating activities was $7.0 million and $(68.0) million for the six months ended March 31, 2021 and 2020, respectively. The $75.0 million increase in cash provided by operating activities is primarily related the increase in net income over the six months ended March 31, 2020 and increased cash provided by accounts receivable collections partially offset by higher inventory levels.

Investing Activities

Net cash provided by (used) in investing activities was $(72.0) million and $(60.2) million for the six months ended March 31, 2021 and 2020, respectively. Net cash provided by (used in) investing activities for the six months ended March 31, 2021 primarily consisted of purchases of property, plant and equipment to support our expansion of capacity in our manufacturing facilities, as compared to the six months ended March 31, 2020, which primarily consisted of purchases of property, plant and equipment in the normal course of business and $17.9 million for the acquisition of Return Polymers, Inc.

Financing Activities

          Net cash provided by (used in) financing activities was $1.3 million and $117.0 million for the six months ended March 31, 2021 and 2020, respectively. Net cash provided by (used in) financing activities for the six months ended March 31, 2021 primarily consisted of cash received from the exercise of stock options and debt fees paid to third parties, as compared to the six months ended March 31, 2020, which primarily consisted of proceeds under the Revolving Credit Facility.

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 in U.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. On March 31, 2021, we entered into an amendment to the Revolving Credit Facility, which reduced the rates under the Revolving Credit Facility and extended the maturity date from May 9, 2022 to the earliest of March 31, 2026 and the date that is 91 days prior to the maturity of the Term Loan Agreement or any permitted refinancing thereof.

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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 of CPG 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 of CPG 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. 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 of March 31, 2021 and September 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 $100.0 million, subject to certain conditions.

Term Loan Agreement

The Term Loan Agreement is a first lien term loan. As of each of March 31, 2021, and September 30, 2020, CPG International LLC had $467.7 million outstanding under the Term Loan Agreement. The Term Loan Agreement will mature on May 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 in U.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 that CPG 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 of CPG International LLC owned by the Company, the equity interests of CPG 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 of CPG 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 of CPG 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) by CPG 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. At September 30,

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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 of March 31, 2021 and September 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-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 with U.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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Item 3. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk

We are subject to interest rate risk in connection with our long-term debt. Our principal interest rate risk relates to the Senior Secured Credit Facilities. To meet our seasonal working capital needs, we borrow periodically on our variable rate revolving line of credit under the Revolving Credit Facility. As of March 31, 2021 and September 30, 2020, we had $467.7 million outstanding under the Term Loan Agreement and no outstanding amounts under the Revolving Credit Facility. The Term Loan Agreement and Revolving Credit Facility bear interest at variable rates. An increase or decrease of 100 basis points in the floating rates on the amounts outstanding under the Senior Secured Credit Facilities as of March 31, 2021 and 2019, would have increased or decreased, respectively, annual cash interest by approximately $4.7 million and $8.1 million, respectively.

 In the future, in order to manage our interest rate risk, we may refinance our existing debt or enter into interest rate swaps or otherwise hedge the risk of changes in the interest rate under the Senior Secured Credit Facilities. However, we do not intend or expect to enter into derivative or interest rate swap transactions for speculative purposes.

Credit Risk

As of March 31, 2021 and September 30, 2020, our cash and cash equivalents were maintained at major financial institutions in the United States, and our current deposits are likely in excess of insured limits. We believe these institutions have sufficient assets and liquidity to conduct their operations in the ordinary course of business with little or no credit risk to us.

Our accounts receivable primarily relate to revenue from the sale of products primarily to established distributors inside of the United States. To mitigate credit risk, ongoing credit evaluations of customers’ financial condition are performed. As of March 31, 2021, one customer represented more than 10% of our gross trade accounts receivable at 12.2%. As of September 30, 2020, three customers represented more than 10% of gross trade receivables; Customer A was 13.1%, Customer B was 12.6% and Customer C was 11.9%.

Foreign Currency Risk

Substantially all of our business is currently conducted in U.S. dollars. We do not believe that an immediate 10% increase or decrease in the relative value of the U.S. dollar as compared to other currencies would have a material effect on our operating results.

Inflation

Our cost of sales is subject to inflationary pressures and price fluctuations of the raw materials we use. Historically, we have generally been able over time to recover the effects of inflation and price fluctuations through sales price increases and production efficiencies associated with technological enhancements and volume growth; however, we cannot reasonably estimate our ability to successfully recover any price increases in the future.

Raw Materials

We rely upon the supply of certain raw materials in our production processes; however, we do not typically enter into fixed price contracts with our suppliers and currently have no fixed price contracts with our major vendors. The primary raw materials we use in the manufacture of our products are various petrochemical resins, including polyethylene, polypropylene and PVC resins, reclaimed polyethylene and PVC material, waste wood fiber and aluminum. In addition, we utilize a variety of other additives including modifiers, TiO2 and pigments. The exposures associated with these costs are primarily managed through terms of the sales and by maintaining relationships with multiple vendors. Prices for spot market purchases are negotiated on a continuous basis in line with the market at the time. We have not entered into hedges with respect to our raw material costs at this time, but we may choose to enter into such hedges in the future. Other than short term supply contracts for resins with indexed based pricing and occasional strategic purchases of larger quantities of certain raw materials, we generally buy materials on an as-needed basis.

The cost of some of the raw materials we use in the manufacture of our products is subject to significant price volatility. For example, the cost of petrochemical resins used in our manufacturing processes has historically varied significantly and has been affected by changes in supply and demand and in the price of crude oil. Substantially all of our resins are purchased under supply contracts that average approximately one to two years, for which pricing is variable based on an industry benchmark price index. The resin supply contracts are negotiated annually and generally provide that we are obligated to purchase a minimum amount of resins from each supplier. In addition, the price of reclaimed polyethylene material, waste wood fiber, aluminum, other additives (including modifiers, TiO2 and pigments) and other raw materials fluctuates depending on, among other things, overall market supply and demand and general business conditions.

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  Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our principal executive officer and our principal financial officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act), as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on the evaluation of our disclosure controls and procedures as of March 31, 2021, our principal executive officer and principal financial officer concluded that, as a result of material weaknesses in our internal control over financial reporting as described below, our disclosure controls and procedures were not effective as of March 31, 2021.

Material Weaknesses in Internal Control over Financial Reporting Summary

As of March 31, 2021, two material weaknesses existed in our internal control over financial reporting. Those material weaknesses were the following: (i) we did not design or maintain an effective control environment commensurate with our financial reporting requirements and (ii) we did not design and maintain effective controls over certain information technology, or IT, general controls for information systems and applications that are relevant to the preparation of the financial statements, specifically relating to user access controls. We are currently in the process of remediating these material weaknesses and have implemented a number of measures and taken additional actions to address the underlying causes of these material weaknesses. Our efforts to date have included the following:

 

These material weaknesses will not be remediated until we have concluded that our controls are operating effectively for a sufficient period of time, which includes additional testing of operating effectiveness.

Additional material weaknesses were previously disclosed in our Registration Statement on Form S-1 as filed with the SEC on February 7, 2020, and the following elements have been remediated: (i) we did not design and maintain adequate formal accounting policies, procedures and controls, or maintain documentary evidence of existing control activities and (ii) we did not design and maintain effective controls over certain IT general controls for information systems and applications that are relevant to the preparation of the financial statements, specifically relating to certain program change management controls, computer operations controls and testing and approval controls for program development.

Please see below for more information on our material weaknesses existing as of March 31, 2021 and our remediation plan, as well as the previous material weaknesses that were remediated as of September 30, 2020.

 

Material Weaknesses in Internal Control over Financial Reporting

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis.

We previously identified and disclosed in our Registration Statement on Form S-1 as filed with the SEC on February 7, 2020 that, as of September 30, 2019, certain material weaknesses existed in our internal control over financial reporting. The following material weaknesses in our internal control over financial reporting existed as of

March 31, 2021:

We did not design or maintain an effective control environment commensurate with our financial reporting requirements. Specifically, we lacked a sufficient complement of resources with an appropriate level of accounting knowledge, training and experience to appropriately analyze, record and disclose accounting matters timely and accurately. This material weakness resulted in the revision of our consolidated financial statements as of September 30, 2018 and for the year then ended, and in immaterial audit adjustments to our consolidated financial statements as of September 30, 2020, 2019, 2018 and 2017 and for the years then ended. This material weakness also contributed to the following additional material weakness.

We did not design and maintain effective controls over certain IT general controls for information systems and applications that are relevant to the preparation of the financial statements. Specifically, we did not design and maintain user access controls to ensure appropriate segregation of duties and that adequately restrict user and privileged access to financial applications, programs and data to appropriate company personnel. This material weakness did not result in a misstatement to our financial statements.

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Each of the material weaknesses described above involve control deficiencies that could result in a misstatement of one or more account balances or disclosures that would result in a material misstatement to the annual or interim consolidated financial statements that would not be prevented or detected, and, accordingly, we determined that these control deficiencies constitute material weaknesses.

Remediation of Previously Identified Material Weaknesses

Additional material weaknesses were previously disclosed in our Registration Statement on Form S-1 as filed with the SEC on February 7, 2020, and the following elements have been remediated as of September 30, 2020:

 

 

 

 

 

 

Management, with the oversight of the Audit Committee of the Board of Directors, has taken the following actions to remediate these material weaknesses in our internal control over financial reporting:

 

 

 

 

 

 

 

 

 

 

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Management’s Plan to Remediate the Material Weaknesses

As it relates to the material weaknesses that existed as of March 31, 2021, we are currently in the process of remediating these material weaknesses and have implemented a number of measures and taken additional steps to address the underlying causes of the material weaknesses. Our efforts to date have included the following:

 

 

 

To complete our remediation plan related to appropriate segregation of duties and adequate restricted user and privileged access, we will confirm that such controls are operating effectively over a period of time.

 

While we believe these efforts will improve our internal controls and address the underlying causes of the two material weaknesses, such material weaknesses will not be remediated until we have concluded that our controls are operating effectively for a sufficient period of time. We cannot be certain that the steps we are taking will be sufficient to remediate the control deficiencies that led to our material weaknesses in our internal control over financial reporting or prevent future material weaknesses or control deficiencies from occurring. In addition, we cannot be certain that we have identified all material weaknesses in our internal control over financial reporting, or that in the future we will not have additional material weaknesses in our internal control over financial reporting.

Changes in Internal Control over Financial Reporting

Other than the changes intended to remediate the material weaknesses noted above, there were no changes in our internal control over financial reporting during the three months ended March 31, 2021 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Limitations on Effectiveness of Controls and Procedures

Our management does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected.

 

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PART II

OTHER INFORMATION

Item 1. Legal Proceedings

We are subject to various lawsuits, as well as other claims, that arise from time to time, which are ordinary routine litigation and claims incidental to the business. With respect to pending lawsuits and claims, management has evaluated their merits, and, while their outcome cannot be predicted with certainty, management believes that their ultimate resolution will not have a material adverse effect on our business, financial condition or results of operations.

Item 1A. Risk Factors.

Investing in our Class A common stock involves a high degree of risk. You should carefully consider the following risks and uncertainties, together with all of the other information contained in the 2020 Form 10-K, and in our Consolidated Financial Statements and related notes included elsewhere in this Quarterly Report on Form 10-Q, before making an investment decision. The effects of the COVID-19 pandemic may also have the effect of significantly heightening many of the risks associated with our business and an investment in our Class A common stock, including the risks described in this Quarterly Report on Form 10-Q and in the 2020 Form 10-K. The occurrence of any of the following risks, or additional risks not presently known to us or that we currently believe to be immaterial, could materially and adversely affect our business, financial condition, results of operations and prospects. In such case, the trading price of our Class A common stock could decline, and you may lose all or part of your investment. Please refer to Item 1A. “Risk Factors” in the 2020 Form 10-K, which are incorporated herein by reference, for a discussion of some of the factors that have affected our business, financial condition and results of operations in the past and which could affect us in the future. There have been no material changes to those risk factors, except for the information disclosed elsewhere in this Quarterly Report on Form 10-Q that provides factual updates to those risk factors and the updates to the additional risk factors set forth below.

Risks Relating to Our Business and Industry

Certain of our stockholders recently completed a sale of our Class A common stock on January 26, 2021 that caused us to experience an “ownership change” for purposes of Section 382 of the Internal Revenue Code of 1986, as amended, which will limit the amount of our net operating loss carryforwards that we may use to reduce our tax liability in a given period.

As of September 30, 2020, we had net operating loss carryforwards, or NOLs, of $113.7 million. These NOLs may be used to offset future taxable income and thereby reduce our U.S. federal income taxes otherwise payable. Section 382 of the Internal Revenue Code of 1986, as amended, or the Code, imposes an annual limit on the ability of a corporation that undergoes an “ownership change” to use its NOLs to reduce its tax liability. Because of the recent sale of our Class A common stock by certain of our stockholders and our resulting ownership change for purposes of Section 382 of the Code, we will not be able to use our pre-ownership change NOLs in excess of the limitation imposed by Section 382 of the Code for each annual period. While our NOLs will be subject to an annual limitation as a result of this ownership change, and although we cannot be certain, we expect that our ability to use the NOLs over time will not be materially affected by such limitation.

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.  

The primary raw materials used in our products are various petrochemical resins, including polyethylene, polypropylene and PVC resins, reclaimed polyethylene and PVC material, waste wood fiber and aluminum. We also utilize other additives including modifiers, TiO2, and pigments. Our contracts with key suppliers are typically short term in nature, with terms generally ranging from one to three years. While we do not rely on any single supplier for the majority of our raw materials, we do obtain certain raw materials from single or a limited number of suppliers. In particular, we rely on a single supplier for certain critical capped compounds used in our decking and railing products. We do not currently have arrangements in place for a redundant or second-source supply for those compounds. If one or more suppliers were unable to satisfy our requirements for particular raw materials, we believe alternative sources of supply would be available. However, we could experience a disruption to our operations as alternative suppliers are identified and qualified and new supply arrangements are entered into, and we cannot be sure we will be able to identify alternative sources of supply rapidly, without incurring significant costs or at all.

In the event of an industry-wide general shortage of our raw materials, a shortage affecting or discontinuation in providing any such raw materials by one or more of our suppliers or a supplier’s declaration of force majeure, we may not be able to arrange for alternative sources of such materials on a timely basis or on equally favorable terms. We have also recently significantly increased the use of reclaimed polyethylene and PVC material in our products. As we increase our use of such materials and introduce new materials into our manufacturing processes, we may be unable to obtain adequate quantities of such new raw materials in a timely manner. Any such shortage may materially adversely affect our production process as well as our competitive position as compared to companies that are able to source their raw materials more reliably or at lower cost.

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In addition, significant increases in the cost of the raw materials used to manufacture our products could adversely affect our operating results. The cost of some of the raw materials we use in the manufacture of our products is subject to significant price volatility. For example, the cost of petrochemical resins used in our manufacturing processes has historically varied significantly and has been affected by changes in supply and demand and in the price of crude oil. We have not entered into hedges of our raw material costs, and our supply contracts with our major vendors do not contain obligations to sell raw materials to us at a fixed price.

Accordingly, we are exposed to the risk of increases in the market prices of raw materials used in the manufacture of our products. For example, during the quarter ended March 31, 2021, prices for certain of our raw material costs, including costs for resin polyethylene and PVC material, were negatively impacted by supply chain and weather-related disruptions, including as a result of Winter Storm Uri, resulting in increased costs and disruption in supply.  In connection with the COVID-19 pandemic and vaccination efforts, we could also see pressure on the price of certain of our raw material costs as a result of actions taken by the government to allocate certain products pursuant to the U.S. Defense Production Act in a way that affects our suppliers and impacts their ability to fulfill our orders for those raw materials, in which event such fulfillment could be delayed or the price for such products may increase.  

We seek to mitigate the effects of increases in raw material costs by broadening our supplier base, increasing our use of recycled material and scrap, reducing waste and exploring options for material substitution and by increasing prices. While we expect to be able to largely offset the impact of the cost increases described above as well as any cost increases, we could experience in the future, we may not be able to recover the increases through corresponding increases in the prices of our products or the other mitigating actions noted above. Even if we are able to implement mitigating actions and/or increase prices over time, we may not be able to take such action or increase prices as rapidly as the increase in our costs. If we are unable to, or experience a delay in our ability to, recover such increases in our costs, our gross profit will suffer. In addition, increases in the price of our products to compensate for increased costs of raw materials may reduce demand for our products and adversely affect our competitive position as compared to products made of other materials, such as wood and metal, that are not affected by changes in the price of resins and some of the other raw materials that we use in the manufacture of our products.

We are dependent upon the ability of our suppliers to consistently provide raw materials that meet our specifications, quality standards and other applicable criteria. Our suppliers’ failure to provide raw materials that meet such criteria could adversely affect production schedules and our product quality, which in turn could materially adversely affect our business, financial condition and results of operations.

Risks Relating to Our Indebtedness

Uncertainty relating to the LIBOR calculation process and potential phasing out of LIBOR in the future may adversely affect our financing costs.

Currently, the Revolving Credit Facility and the Term Loan Agreement utilize the London Interbank Offered Rate, or LIBOR, or various alternative methods set forth in the Revolving Credit Facility and the Term Loan Agreement to calculate interest on any borrowings. National and international regulators and law enforcement agencies have conducted investigations into a number of rates or indices known as “reference rates.” Actions by such regulators and law enforcement agencies may result in changes to the manner in which certain reference rates are determined, their discontinuance or the establishment of alternative reference rates. In particular, on July 27, 2017, the Chief Executive of the United Kingdom Financial Conduct Authority, or the FCA, which regulates LIBOR, announced that the FCA will no longer persuade or compel banks to submit rates for the calculation of LIBOR after 2021. On November 30, 2020, the ICE Benchmark Administration, or the IBA, the administrator of LIBOR, with the support of the United States Federal Reserve and the FCA, announced plans to consult on ceasing publication of LIBOR on December 31, 2021, for only the one-week and two-month LIBOR tenors, and on June 30, 2023, for all other LIBOR tenors. The U.S. Federal Reserve concurrently issued a statement advising banks to stop new LIBOR issuances by the end of 2021. On March 5, 2021, the IBA Benchmark Administration confirmed its intention to cease publication of (i) one week and two month USD LIBOR settings after December 31, 2021 and (ii) the remaining USD LIBOR settings after June 30, 2023. In accordance with recommendations from the Alternative Reference Rates Committee, USD LIBOR is expected to be replaced with the Secured Overnight Financing Rate, or the SOFR, a new index calculated on a daily basis by reference to short-term repurchase agreements for U.S. Treasury securities. Although there have been certain issuances utilizing SOFR or the Sterling Over Night Index Average, an alternative reference rate that is based on transactions, it is unknown whether SOFR or any other alternative reference rates will attain market acceptance as replacements for LIBOR.

At this time, it is not possible to predict the effect that these developments, any discontinuance, modification or other reforms to LIBOR or any other reference rate, or the establishment of alternative reference rates may have on LIBOR, other benchmarks or LIBOR-based debt instruments. The Revolving Credit Facility and the Term Loan Agreement include provisions intended to provide for the replacement of LIBOR with SOFR or another widely-accepted alternative benchmark rate upon the cessation of LIBOR, with corresponding adjustments to the applicable interest rate margins. However, uncertainty as to the nature of such potential discontinuance, modification, alternative reference rates, adjustments or other reforms could cause the interest rate calculated for the

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Revolving Credit Facility and the Term Loan Agreement to be materially different than expected, which could have a material adverse effect on our financing costs.

Risks Relating to Our Organizational Structure

The Sponsors continue to hold a substantial portion of our outstanding common stock following their recent sale of 23,000,000 shares of our Class A common stock on January 26, 2021, and the Sponsors’ interests may conflict with our interests and the interests of other stockholders.

Prior to their sale of 23,000,000 shares of our Class A common stock on January 26, 2021, an entity affiliated with Ares Management Corporation, or Ares, and Ontario Teachers’ Pension Plan Board, or OTPP, and together, the Sponsors, beneficially owned a majority of our outstanding common stock. Pursuant to the stockholders agreement, or the Stockholders Agreement, entered into by us and the Sponsors prior to the IPO, the Sponsors had the right to designate a number of individuals to be included in the slate of nominees for election to our board of directors equal to the greater of up to six directors and the number of directors comprising a majority of our board of directors for so long as the Sponsors collectively owned 50% or more of the outstanding shares of our common stock. Following that sale, the Sponsors ceased to own a majority of our outstanding common stock. Subject to certain exceptions, for so long as the Sponsors collectively own less than 50% of the outstanding shares of our common stock, the Sponsors will have the right to designate that number of individuals to be included in the slate of nominees for election to our board of directors (rounded up to the nearest whole number or, if such rounding would cause the Sponsors to have the right to elect a majority of our board of directors, rounded to the nearest whole number) that is the same percentage of the total number of directors comprising our board as the collective percentage of common stock owned by the Sponsors. Because our board of directors is divided into three staggered classes, the Sponsors may be able to influence or control our affairs and policies even after they cease to own a majority of our outstanding Class A common stock during the period in which the Sponsors’ nominees finish their terms as members of our board, but in any event no longer than would be permitted under applicable law and the NYSE listing requirements.

In addition, the Stockholders Agreement provides that, for so long as the Sponsors collectively own at least 30% of the outstanding shares of our common stock, certain significant corporate actions require the prior written consent of each of the Sponsors, subject to certain exceptions. If either Sponsor owns less than 10% of the outstanding shares of our common stock, such action will not be subject to the approval of such Sponsor and the shares of common stock owned by such Sponsor will be excluded in calculating the 30% threshold.

These actions include:

The interests of the Sponsors and their affiliates, including funds affiliated with the Sponsors, could conflict with or differ from our interests or the interests of our other stockholders. For example, the concentration of ownership held by the Sponsors could delay, defer or prevent a change in control of our company or impede a merger, takeover or other business combination which may otherwise be favorable for us. Additionally, the Sponsors and their affiliates are in the business of making investments in companies and may,

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from time to time, acquire and hold interests in or provide advice to businesses that compete directly or indirectly with us, or are suppliers or customers of ours. Any such investment may increase the potential for the conflicts of interest discussed in this risk factor. So long as the Sponsors continue to directly or indirectly own a significant amount of our equity, the Sponsors will continue to be able to substantially influence or effectively control our ability to enter into corporate transactions.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

None.

Item 3. Defaults Upon Senior Securities.

None.

Item 4. Mine Safety Disclosures.

None.

Item 5. Other Information

None.

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Item 6. Exhibits

 

 

 

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

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