UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2023
OR
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to ________
Commission File Number: 001-39322
The AZEK Company Inc.
(Exact name of registrant as specified in its charter)
Delaware
90-1017663
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
1330 W Fulton Street, Suite 350, Chicago, Illinois
60607
(Address of principal executive offices)
(Zip Code)
Registrant’s telephone number, including area code: (877) 275-2935
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol
Name of each exchange
on which registered
Class A Common Stock, par value $0.001 per share
AZEK
The New York Stock Exchange
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.
Large accelerated filer
Accelerated filer
Non-accelerated filer
Smaller reporting company
Emerging growth company
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 January 31, 2024, the registrant had 145,826,079 shares of Class A Common Stock, $0.001 par value per share, and no shares of Class B Common Stock, $0.001 par value per share, outstanding.
Page
PART I.
Financial Information
3
Item 1.
Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets
Condensed Consolidated Statements of Comprehensive Income (Loss)
4
Condensed Consolidated Statements of Stockholders’ Equity
5
Condensed Consolidated Statements of Cash Flows
6
Notes to Unaudited Condensed Consolidated Financial Statements
7
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
23
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
36
Item 4.
Controls and Procedures
37
PART II.
Other Information
38
Legal Proceedings
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults Upon Senior Securities
Mine Safety Disclosures
Item 5.
Item 6.
Exhibits
39
Signatures
40
2
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
(In thousands of U.S. dollars, except for share and per share amounts)
(Unaudited)
in thousands
December 31,2023
September 30,2023
ASSETS:
Current assets:
Cash and cash equivalents
$
274,759
278,314
Trade receivables, net of allowances
32,398
57,660
Inventories
261,562
221,101
Prepaid expenses
16,528
13,595
Other current assets
8,131
12,300
Total current assets
593,378
582,970
Property, plant and equipment - net
456,504
501,023
Goodwill
967,816
994,271
Intangible assets - net
183,604
199,497
Other assets
87,426
87,793
Total assets
2,288,728
2,365,554
LIABILITIES AND STOCKHOLDERS' EQUITY:
Current liabilities:
Accounts payable
43,119
56,015
Accrued rebates
67,925
60,974
Accrued interest
368
260
Current portion of long-term debt obligations
6,000
Accrued expenses and other liabilities
80,999
71,994
Total current liabilities
198,411
195,243
Deferred income taxes
47,117
56,330
Long-term debt—less current portion
579,111
580,265
Other non-current liabilities
104,784
104,073
Total liabilities
929,423
935,911
Commitments and contingencies (See Note 17)
Stockholders' equity:
Preferred stock, $0.001 par value; 1,000,000 shares authorized and no shares issued or outstanding at December 31, 2023 and September 30, 2023, respectively
—
Class A common stock, $0.001 par value; 1,100,000,000 shares authorized, 156,341,203 and 155,967,736 shares issued at December 31, 2023 and September 30, 2023, respectively
156
Class B common stock, $0.001 par value; 100,000,000 shares authorized, 0 shares and 100 shares issued and outstanding at December 31, 2023 and September 30, 2023, respectively
Additional paid‑in capital
1,650,160
1,662,322
Accumulated deficit
(19,328
)
(45,047
Accumulated other comprehensive income (loss)
(1,217
1,878
Treasury stock, at cost, 10,560,030 and 8,268,423 shares at December 31, 2023 and September 30, 2023, respectively
(270,466
(189,666
Total stockholders' equity
1,359,305
1,429,643
Total liabilities and stockholders' equity
See Notes to Condensed Consolidated Financial Statements (Unaudited).
Three Months Ended December 31,
2023
2022
Net sales
240,444
216,259
Cost of sales
149,011
168,680
Gross profit
91,433
47,579
Selling, general and administrative expenses
77,246
73,444
Loss on disposal of property, plant and equipment
2,185
Operating income (loss)
12,002
(25,865
Other income and expenses:
Interest expense, net
7,910
9,299
Gain on sale of business
(38,515
Total other income and expenses
(30,605
Income (loss) before income taxes
42,607
(35,164
Income tax expense (benefit)
16,888
(9,328
Net income (loss)
25,719
(25,836
Other comprehensive income (loss):
Unrealized loss due to change in fair value of derivatives, net of tax
(3,095
(1,796
Total other comprehensive income (loss)
Comprehensive income (loss)
22,624
(27,632
Net income (loss) per common share:
Basic
0.17
(0.17
Diluted
Weighted-average common shares outstanding:
147,297,662
150,877,635
148,876,282
(In thousands of U.S. dollars, except for share amounts)
Common Stock
Treasury Stock
Additional
Accumulated Other
Total
Class A
Class B
Paid-In
Accumulated
Comprehensive
Stockholders'
Shares
Amount
Capital
Deficit
Income (Loss)
Equity
Balance – September 30, 2023
155,967,736
100
8,268,423
Net income
Other comprehensive income (loss)
Stock-based compensation
8,422
Exercise of vested stock options
136,885
3,238
Cancellation of restricted stock awards
Issuance of common stock under employee stock plan, net of shares withheld for taxes
236,482
(3,822
Conversion of Class B common stock into Class A common stock
(100
Treasury stock purchases
2,291,607
(80,800
(20,000
(100,800
Balance – December 31, 2023
156,341,203
10,560,030
Balance – September 30, 2022
155,157,220
155
4,116,570
(73,088
1,630,378
(113,002
1,444,443
Net loss
-
3,909
(14,663
54,308
(460
352,760
(7,488
Balance – December 31, 2022
155,196,865
4,469,330
(80,576
1,633,827
(138,838
1,412,772
(In thousands of U.S. dollars)
Operating activities:
Adjustments to reconcile net income (loss) to net cash flows provided by (used in) operating activities:
Depreciation
21,773
22,002
Amortization of intangibles
10,164
11,837
Non-cash interest expense
412
Non-cash lease expense
(48
(56
Deferred income tax (benefit) provision
(8,192
1,504
Non-cash compensation expense
5,801
Fair value adjustment for contingent consideration
400
Loss on disposition of property, plant and equipment
1,003
Changes in certain assets and liabilities:
Trade receivables
21,151
21,869
(62,127
(20,978
Prepaid expenses and other currents assets
(2,031
(16,711
(9,319
13,029
Accrued expenses and interest
15,448
(7,831
Other assets and liabilities
(1,330
(36
Net cash provided by (used in) operating activities
(16,288
6,409
Investing activities:
Purchases of property, plant and equipment
(17,681
(30,328
Proceeds from disposition of fixed assets
122
65
Divestiture, net of cash disposed
133,089
Net cash provided by (used in) investing activities
115,530
(30,263
Financing activities:
Payments on Term Loan Agreement
(1,500
Repayments of finance lease obligations
(713
(650
Cash paid for shares withheld for taxes
Purchases of treasury stock
(100,000
Net cash used in financing activities
(102,797
(10,098
Net decrease in cash and cash equivalents
(3,555
(33,952
Cash and cash equivalents – Beginning of period
120,817
Cash and cash equivalents – End of period
86,865
Supplemental cash flow disclosure:
Cash paid for interest, net of amounts capitalized
7,349
13,020
Cash paid for income taxes, net
1,351
112
Supplemental non-cash investing and financing disclosure:
Capital expenditures in accounts payable at end of period
2,603
16,275
Right-of-use operating and finance lease assets obtained in exchange for lease liabilities
2,460
1,968
Notes to Condensed Consolidated Financial Statements
(In thousands of U.S. dollars, unless otherwise specified)
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a. Organization
The AZEK Company Inc. (the “Company”, “we”, “us” or “our”) is a Delaware corporation that holds all of the limited liability company interests in The AZEK Group LLC (f/k/a CPG International LLC), the entity which directly and indirectly holds all of the equity interests in the operating subsidiaries and which changed its name from CPG International LLC to The AZEK Group LLC on August 1, 2023. The Company is an industry-leading designer and manufacturer of beautiful, low-maintenance and environmentally sustainable building products for residential, commercial and industrial markets. The Company’s products include decking, railing, trim, porch, moulding, pergolas, outdoor furniture, bathroom and locker systems, and, prior to the Company’s divestiture of its Vycom business, also included 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. The Company’s residential products are primarily branded under the brand names AZEK®, TimberTech®, VERSATEX®, ULTRALOX®, StruXure® and INTEX®, while the commercial products are branded under brand names including Scranton Products®, Aria Partitions®, Eclipse Partitions®, Hiny Hiders® partitions, Tufftec Lockers® and Duralife Lockers®.
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 (“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 months ended December 31, 2023 and the cash flows for the three months ended December 31, 2023 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 affected by a number of factors, including, but not limited to, the cost to manufacture and distribute products, cost of raw materials, inflation, consumer spending and preferences, interest rates, the impact of any supply chain disruptions, economic conditions, and/or any adverse effects from geopolitical conflicts, global health pandemics and other factors beyond the Company’s control. Management cannot predict the degree to, or the period over, which the Company may be affected by such factors.
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 2023 Form 10-K. The Condensed Consolidated Balance Sheet as of September 30, 2023 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 2023 Form 10-K, except as noted below.
Certain reclassifications have been made to prior year financial statements to conform to classifications used in the current year. These reclassifications had no impact on net income, stockholder’s equity or cash flows as previously reported.
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, inventory valuation, 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 2023 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 $3.1 million and $2.1 million, respectively, for the three months ended December 31, 2023 and 2022.
Recently Adopted Accounting Pronouncements
None.
Recently Issued Accounting Pronouncements
In November 2023, the Financial Accounting Standards Board ("FASB") issued ASU 2023-07, Segment Reporting (Topic 280) : Improvements to Reportable Segment Disclosures. This standard requires all public entities that are subject to segment reporting requirements to disclose additional information, including significant segment expenses and other segment items on an annual and interim basis. It also requires the disclosure of the title and the position of the chief operating decision maker and how the reported measures are used for making business decisions. This standard is effective for fiscal years beginning after December 15, 2023 and interim periods within fiscal years beginning after December 15, 2024, with early adoption permitted. The Company intends to adopt the updated standard during the fiscal year beginning October 1, 2024. The Company is currently evaluating the impact the adoption of this standard will have on its disclosures.
In December 2023, the FASB issued ASU 2023-09, Income Taxes (Topic 740): Improvements to Income Tax Disclosures. This standard expands the disclosure requirements primarily on the rate reconciliation and income tax paid. For public entities, this standard is effective for annual reporting periods beginning after December 15, 2024, with early adoption permitted. The Company intends to adopt the updated standard during the fiscal year beginning October 1, 2025. The Company is currently evaluating the impact the adoption of this standard will have on its disclosures.
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 $67.9 million and $54.6 million as of December 31, 2023 and 2022, respectively, and contra trade receivables of $4.5 million and $6.5 million as of December 31, 2023 and 2022, respectively. The rebate activity was as follows (in thousands):
Beginning balance
66,958
56,542
Rebate expense
22,239
15,716
Rebate payments
(16,804
(11,192
Ending balance
72,393
61,066
The Company records deferred revenue when cash payments are received or due in advance of the Company’s performance.
3. DIVESTITURE
On November 1, 2023, the Company completed the sale of its Vycom business within the Commercial segment for net proceeds of approximately $133.1 million. The divestiture allows the Company to focus on the highest value portions of its business and provides additional cash to finance its capital allocation priorities. The gain on sale of $38.5 million was recognized in "Gain on sale of business" within the Condensed Consolidated Statements of Comprehensive Income (Loss) for the three months ended December 31, 2023. The Company did not report the sale in discontinued operations as it was not a strategic shift that would have a major effect on the Company's operations and financial results.
See Note 12 for more information on the Commercial segment.
8
4. 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):
Raw materials
60,918
67,330
Work in process
31,742
37,038
Finished goods
168,902
116,733
Total inventories
5. PROPERTY, PLANT AND EQUIPMENT—NET
Property, plant and equipment – net consisted of the following (in thousands):
Land
3,209
4,829
Buildings and improvements
103,824
129,031
Manufacturing equipment
595,551
624,754
Computer equipment
32,561
32,300
Furniture and fixtures
6,614
7,290
Vehicles
1,163
1,105
Total property and equipment
742,922
799,309
Construction in progress
79,314
94,422
822,236
893,731
Accumulated depreciation
(365,732
(392,708
Total property and equipment – net
Depreciation expense was approximately $20.5 million and $20.8 million in the three months ended December 31, 2023 and 2022, respectively. During the three months ended December 31, 2023 and 2022, $1.1 million and $1.3 million of interest was capitalized, respectively.
6. GOODWILL AND INTANGIBLE ASSETS—NET
Goodwill consisted of the following (in thousands):
Residential
Commercial
Goodwill before impairment as of September 30, 2023
953,882
72,589
1,026,471
Accumulated impairment losses as of September 30, 2023
(32,200
Goodwill, net as of September 30, 2023
40,389
Divestiture
Goodwill disposal before impairment
(58,655
Accumulated impairment losses
32,200
Goodwill, net disposal
(26,455
Goodwill before impairment as of December 31, 2023
13,934
Accumulated impairment losses as of December 31, 2023
Goodwill, net as of December 31, 2023
9
Intangible assets, net
The Company did not have any indefinite lived intangible assets other than goodwill as of December 31, 2023 and September 30, 2023. Finite-lived intangible assets consisted of the following (in thousands):
December 31, 2023
Lives inYears
GrossCarryingValue
AccumulatedAmortization
NetCarryingValue
Proprietary knowledge
10 — 15
300,400
(257,358
43,042
Trademarks
5 — 20
217,640
(158,382
59,258
Customer relationships
12 — 19
156,452
(77,558
78,894
Patents
9 — 10
8,500
(6,138
2,362
Other intangibles
3 — 15
4,076
(4,028
48
Total intangible assets
687,068
(503,464
September 30, 2023
Propriety knowledge
(253,608
46,792
230,240
(164,759
65,481
176,852
(92,268
84,584
(5,913
2,587
Other intangible assets
(4,023
53
720,068
(520,571
Amortization expense was $10.2 million and $11.8 million in the three months ended December 31, 2023 and 2022, respectively. As of December 31, 2023, the remaining weighted-average amortization period for acquired intangible assets was 11.1 years.
7. COMPOSITION OF CERTAIN BALANCE SHEET ACCOUNTS
Allowance for Doubtful Accounts
Allowance for doubtful accounts consisted of the following (in thousands):
1,773
1,397
Provision
(433
277
(32
1,308
1,674
10
Accrued Expenses and Other Liabilities
Accrued expenses consisted of the following (in thousands):
Taxes
28,168
6,959
Employee related liabilities
20,673
34,313
Marketing
4,799
3,868
Lease liability - operating
4,559
4,180
Customer deposits
3,771
4,152
Warranty
2,927
2,739
Lease liability - finance
2,829
2,777
Freight
1,833
1,242
Utilities
1,802
2,141
Professional fees
1,706
2,073
1,530
2,863
Commissions
873
991
Other
5,529
3,696
Total accrued expenses and other current liabilities
8. DEBT
Debt consisted of the following (in thousands):
Term Loan due April 28, 2029 — SOFR + 2.50% + 0.1% (7.96% at December 31, 2023 and 7.92% at September 30, 2023)
592,500
594,000
Revolving Credit Facility through March 31, 2026 - SOFR + 0.1%
Less unamortized deferred financing costs
(3,818
(3,996
Less unamortized original issue discount
(3,571
(3,739
Less current portion
(6,000
Long-term debt—less current portion and unamortized deferred financing costs
Term Loan Agreement
The Term Loan Agreement is a first lien term loan and will mature on April 28, 2029, subject to acceleration or prepayment. The Term Loan Agreement will amortize in equal quarterly installments of 0.25% of the aggregate principal amount of the loans outstanding, subject to reduction for certain prepayments. The loans thereunder bear an interest rate equal to (i) in the case of alternative base rate, or ABR, borrowings, the highest of (a) the Federal Funds Rate plus 0.50%, (b) the Prime Rate as in effect on such day and (c) the one-month Term Secured Overnight Financing Rate ("SOFR") plus 1.00% per annum, provided that in no event will the alternative base rate be less than 1.50% per annum, plus an applicable margin of 1.50% and (ii) in the case of SOFR borrowings, the Term SOFR rate for the applicable interest period, in each case, plus an applicable margin of 2.50%. As of December 31, 2023 and September 30, 2023, The AZEK Group LLC had $592.5 million and $594.0 million outstanding under the Term Loan Agreement.
The obligations under the Term Loan Agreement are secured by a first priority security interest in the membership interests of The AZEK Group LLC owned by the Company, the equity interests of The AZEK Group LLC’s domestic subsidiaries, other than certain immaterial subsidiaries and other excluded subsidiaries, and all remaining assets not constituting Revolver Priority Collateral (as defined below and subject to certain exceptions) of the Company, The AZEK Group LLC and the subsidiaries of The AZEK Group LLC that are guarantors under the Term Loan Agreement (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 The AZEK Group LLC other than certain immaterial subsidiaries and other excluded subsidiaries.
11
Loans under the Term Loan Agreement may be voluntarily prepaid in whole, or in part, in each case without premium or penalty, subject to certain customary conditions. The Term Loan Agreement also requires mandatory prepayments of loans under the Term Loan Agreement from the proceeds of certain debt issuances and certain asset dispositions (subject to certain reinvestment rights) and, commencing with the fiscal year ending September 30, 2023, a percentage of excess cash flow (subject to step-downs upon The AZEK Group LLC achieving certain leverage ratios and other reductions in connection with other debt prepayments).
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. The Term Loan Agreement also includes customary events of default, including the occurrence of a change of control.
As of December 31, 2023 and September 30, 2023, unamortized deferred financing fees related to the Term Loan Agreement were $3.8 million and $4.0 million, respectively.
Revolving Credit Facility
The AZEK Group LLC has also entered into a revolving credit facility, as amended and restated from time to time (the “Revolving Credit Facility”), with certain of our direct and indirect subsidiaries and 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.
The AZEK Group LLC had no outstanding borrowings under the Revolving Credit Facility as of December 31, 2023 and September 30, 2023, respectively. In addition, The AZEK Group LLC had $2.2 million and $2.8 million of outstanding letters of credit held against the Revolving Credit Facility as of December 31, 2023 and September 30, 2023, respectively. The AZEK Group LLC had approximately $147.8 million available under the borrowing base for future borrowings as of December 31, 2023. The AZEK Group 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 January 26, 2023, The AZEK Group LLC amended the Revolving Credit Facility, replacing all LIBOR-based provisions with provisions reflecting SOFR, including, without limitation, the use of a new Adjusted Term SOFR benchmark rate equal to Term SOFR (as defined in the Revolving Credit Agreement) plus 0.10%.
As of December 31, 2023, outstanding revolving loans under the Revolving Credit Facility bore interest at a rate which equaled, at the Company's option, either (i) for ABR borrowings, the highest of (a) the Federal Funds Rate plus 50 basis points, (b) the prime rate and (c) the Adjusted Term SOFR 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 SOFR borrowings, the Adjusted Term SOFR plus a spread of 125 to 175 basis points, based on average historical availability. The maturity date for the Revolving Credit Facility is the earlier 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.
Deferred financing costs, net of accumulated amortization, related to the Revolving Credit Facility at December 31, 2023 and September 30, 2023 were $0.6 million and $0.7 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 December 31, 2023 and 2022, 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, The AZEK Group LLC and the subsidiaries of The AZEK Group 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. The AZEK Group 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
12
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, The AZEK Group 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 The AZEK Group 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 December 31, 2023, The AZEK Group 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.
Interest expense consisted of the following (in thousands):
Interest expense:
11,358
8,916
150
151
1,123
1,109
Amortization - Deferred financing costs
179
66
Amortization - Original issue discount
167
Capitalized interest
(1,079
(1,289
Interest expense
11,964
Interest income
(4,054
See Note 11 for the fair value of the Company’s debt as of December 31, 2023 and September 30, 2023.
9. 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):
16,195
15,023
Adjustments to reserve
(542
(172
Warranty claims payment
(624
(313
15,029
14,538
Current portion of accrued warranty
(2,927
(2,492
Accrued warranty – less current portion
12,102
12,046
10. LEASES
The Company leases vehicles, machinery, manufacturing facilities, office space, land, and equipment under both operating and finance leases. The Company determines if an arrangement is a lease at inception. A contract is or contains a lease if the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration. As of December 31, 2023 and September 30, 2023, amounts associated with leases are included in Other assets, Accrued expense and other liabilities and Other non-current liabilities in the Company’s Condensed Consolidated Balance Sheet.
For leases with initial terms greater than 12 months, the Company considers these right-of-use, or ROU, assets and records the related asset and obligation at the present value of lease payments over the term. For leases with initial terms equal to or less than 12 months, the Company does not consider them as right-of-use assets and instead considers them short-term lease costs that are recognized on a straight-line basis over the lease term. The Company’s leases may include escalation clauses, renewal options and/or
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termination options that are factored into the determination of lease term and lease payments when it is reasonably certain the option will be exercised. Renewal options range from 1 year to 20 years.
Lease assets and lease liabilities as of December 31, 2023 and September 30, 2023 were as follows (in thousands):
Leases
Classification on Balance Sheet
Assets
ROU operating lease assets
16,068
15,423
ROU finance lease assets
70,554
71,529
Total lease assets
86,622
86,952
Liabilities
Current
Operating
Finance
Non-Current
13,916
13,699
75,276
75,718
Total lease liabilities
96,580
96,374
The components of lease expense for the three months ended December 31, 2023 and 2022 were as follows:
(in thousands)
Operating lease expense
1,478
1,501
Finance lease amortization of assets
1,301
1,248
Finance lease interest on lease liabilities
1,107
1,092
Short term
86
103
Sublease income
(28
(71
Total lease expense
3,944
3,873
The tables below present supplemental information related to leases as of December 31, 2023 and September 30, 2023:
Weighted-average remaining lease term (years)
Operating leases
6.4
6.8
Finance leases
25.3
25.4
Weighted-average discount rate
4.7
%
4.4
5.8
The following table summarizes the maturities of lease liabilities at December 31, 2023:
Operating Leases
Finance Leases
2024
4,045
5,358
9,403
2025
4,719
7,105
11,824
2026
2,844
6,942
9,786
2027
2,105
6,480
8,585
2028
1,841
5,278
7,119
Thereafter
6,071
117,012
123,083
Total lease payments
21,625
148,175
169,800
Less: interest
(3,150
(70,070
(73,220
Present value of lease liability
18,475
78,105
11. 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
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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.
Derivative Instruments
The Company’s objective in using interest rate derivative instruments is to hedge against interest rate volatility associated with its senior secured credit facilities by converting a portion of its floating rate debt to fixed rate debt. In November 2022, the Company entered into two interest rate swap agreements with Barclays Bank PLC to manage interest rate risk related to Term Loan. Each agreement has a notional amount of $150 million and will expire on October 31, 2025. One agreement swaps variable interest at a rate based on SOFR with a fixed rate of 4.39% and the second with a fixed rate of 4.48%.
At the inceptions of the swap agreements and as of December 31, 2023, both swaps were designated and qualified as cash flow hedges in accordance with ASC 815. The gain (loss) is recorded in Accumulated other comprehensive income (loss) and then reclassified into Interest expense in the same period in which the hedged transaction affects earnings. As of December 31, 2023, the Company expects to reclass approximately $0.6 million ($0.4 million after-tax) as a reduction to interest expense in the next 12 months.
The following table provides the fair values of the interest rate derivative instruments as well as their classification on the Balance Sheet as of December 31, 2023 and September 30, 2023 (in thousands):
Fair Value as of
Fair Value Hierarchy
Balance Sheet Location
Interest rate swaps
Level 2
677
2,558
2,300
The Company estimates the fair value of interest rate swaps using a valuation model based on observable market data, such as yield curves. Both swaps are classified as Level 2 measurement in the fair value hierarchy.
The following table summarizes the effects of the interest rate derivative instruments on Accumulated other comprehensive income (loss) for the three months ended December 31, 2023 and 2022 (in thousands):
Before-tax Amount
Income Tax Expense
Net of Tax Amount
Balance - September 30, 2023
2,493
615
Amount of loss recognized in other comprehensive income (loss)
(3,437
(840
(2,596
Amount of gain reclassified from accumulated other comprehensive income (loss) into net income (loss)
(678
(180
(499
Balance - December 31, 2023
(1,622
(405
Balance - September 30, 2022
(2,544
(674
(1,870
Amount of loss reclassified from accumulated other comprehensive income (loss) into net income (loss)
101
27
74
Balance - December 31, 2022
(2,443
(647
Other Financial Instruments
The carrying values and the estimated fair values of the debt financial instruments (Level 2 measurements) consisted of the following (in thousands):
CarryingValue
EstimatedFair Value
Term Loan due April 28, 2029
596,944
595,485
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Financial instruments remeasure at fair value on a recurring basis – During the year ended September 30, 2022, the Company entered into an arrangement for a contingent payment to the former owner and employee of StruXure. The contingent payment is based on achievement of a minimum EBITDA amount and a multiple of EBITDA, for EBITDA exceeding a higher threshold for calendar year 2022. Based on the formula, the potential contingent payout can range from zero to $13.9 million. At the date of acquisition, the fair value was estimated to be $9.5 million. As of March 31, 2023, the fair value was increased to $12.7 million based on the actual EBITDA amount for StruXure. Compensation expense of $9.5 million was recognized for the year ended September 30, 2022 and $3.2 million was recognized for the year ended September 30, 2023. The Company paid $12.7 million as settlement of the contingent liability in April, 2023.
In connection with the acquisition of INTEX on August 1, 2022, the Company entered into a contingent consideration arrangement with the former owner of INTEX. The contingent consideration is based on achievement of a minimum gross profit amount for calendar year 2022. Based on the formula, the potential contingent consideration can range from zero to $6.2 million. At the date of the acquisition, the fair value was estimated to be $5.8 million. As of December 31, 2022, the fair value was increased to $6.2 million. Contingent payment of $5.8 million was included in the acquisition purchase price at the date of acquisition and the change in fair value of $0.4 million was recognized in selling, general and administrative expense for the year ended September 30, 2023. The Company paid $6.2 million as settlement of this contingent liability in fiscal year 2023.
12. 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, pergolas, outdoor structures, exterior trim, siding 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. Regional recyclers provides full-service recycled PVC material processing, sourcing, logistical support, and scrap management programs that are utilized in our finished goods manufacturing processes. This segment is impacted by trends in and the strength of home repair and remodel activity.
• Commercial—The Commercial segment manufactures, fabricates and distributes lockers and bathroom partitions. This segment is impacted by trends in and the strength of the repair and remodel sector. This segment also previously included the Company’s Vycom business, which manufactured resin-based extruded sheeting products for a variety of commercial and industrial applications. The Company sold the Vycom business on November 1, 2023. See Note 3 for additional information on the divestiture.
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The segment data below includes data for Residential and Commercial for the three months ended December 31, 2023 and 2022 (in thousands).
Three Months EndedDecember 31,
Net sales to customers
223,000
179,484
17,444
36,775
Adjusted EBITDA
Residential (1)
52,762
9,946
2,905
5,154
Total Adjusted EBITDA for reporting segments
55,667
15,100
Adjustments to Income before income tax provision
Depreciation and amortization
(31,937
(33,840
Stock-based compensation costs
(8,468
(3,957
Acquisition and divestiture costs (2)
(492
(2,954
Gain on sale of business (3)
38,515
Other costs (4)
(2,768
(214
(7,910
(9,299
Income (loss) before income tax provision
13. CAPITAL STOCK
Share Repurchase Program
On May 5, 2022, the Board of Directors authorized the Company to repurchase up to $400 million of the Company’s Class A common stock (the “Share Repurchase Program”). The Share Repurchase Program allows the Company to repurchase its shares opportunistically from time to time. Purchases may be effected through one or more open market transactions, privately negotiated transactions, transactions structured through investment banking institutions, accelerated share repurchases or tender offers, some of which may be effected through Rule 10b5-1 plans, or a combination of the foregoing. The timing of repurchases will depend upon several factors, including market and business conditions, and repurchases may be discontinued at any time.
On December 4, 2023, the Company entered into a $100 million accelerated share repurchase agreement, or the “ASR” with Goldman Sachs & Co. LLC, or “Goldman Sachs”. Goldman Sachs delivered 2,291,607 initial shares to the Company on December 6, 2023, based on the closing price of the Company’s Class A common stock of $34.91 on December 4, 2023. The total value of the initial shares represents 80% of the $100 million ASR. The final settlement will be based on the volume-weighted average price of the Company's Class A common stock over the repurchase period, subject to certain adjustments. The Company expects to settle the ASR in the second quarter of fiscal year 2024.
During the three months ended December 31, 2022, the Company repurchased 352,760 shares of its Class A common stock on the open market at an average price of $21.23 per share, totaling an approximately $7.5 million reacquisition cost.
On August 16, 2022, the U.S. government enacted the Inflation Reduction Act of 2022 (the “Inflation Reduction Act”), that includes, among other provisions, a one percent excise tax on net repurchases of stock after December 31, 2022. For the three months ended December 31, 2023, the Company recognized $0.8 million excise tax as reacquisition cost of share repurchases.
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As of December 31, 2023, the Company had approximately $101.1 million available for repurchases under the Share Repurchase Program.
14. STOCK-BASED COMPENSATION
The Company grants stock-based awards to attract, retain and motivate key employees and directors.
The 2020 Omnibus Incentive Compensation Plan (“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 2,219,224 shares remaining in the reserve. The total aggregate number of shares may be adjusted as determined by the Board of Directors.
On December 11, 2023, the Compensation Committee of the Board of Directors authorized certain changes to a former employee’s stock-based awards which were effective in connection with his retirement. These changes allow certain awards to continue to vest in due course following retirement and extend the exercisability of certain 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 an issuance of a new grant, as well as, a Type I Modification (probable to probable), accounted for as an exchange of the original award for a new grant under the revised terms. The modifications resulted in $1.9 million of stock-based compensation expense in the three months ended December 31, 2023.
Stock-based compensation expense for the three months ended December 31, 2023 and 2022 was $8.5 million and $4.0 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 December 31, 2023 and 2022 was $1.7 million and $0.8 million, respectively. As of December 31, 2023, the Company had not yet recognized compensation cost on unvested stock-based awards of $36.6 million, with a weighted average remaining recognition period of 2.0 years.
The Company 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.
The following table sets forth the significant assumptions used for the calculation of stock-based compensation expense for the three months ended December 31, 2023 and 2022:
December 15,2023Grant Date
December 12,2022Grant Date
Risk-free interest rate
3.93
3.77
Expected volatility
40.00
Expected term (in years)
6.00
Expected dividend yield
0.00
Stock Options
The following table summarizes the performance-based stock option activity for the three months ended December 31, 2023:
Numberof Shares
WeightedAverageExercisePrice PerShare
WeightedAverageRemainingContractTerm
AggregateIntrinsicValue
(in years)
Outstanding at October 1, 2023
1,114,261
23.00
Granted
Exercised
(60,261
Cancelled/Forfeited
Outstanding at December 31, 2023
1,054,000
16,074
Vested and exercisable at December 31, 2023
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The following table summarizes the service-based stock option activity for the three months ended December 31, 2023:
3,361,707
25.43
138,731
38.15
(76,624
24.17
3,423,814
25.97
7.0
43,493
2,475,222
24.78
6.7
33,921
Restricted Stock Awards
A summary of the service-based restricted stock awards activity during the three months ended December 31, 2023 was as follows:
WeightedAverageGrant DateFair Value
Outstanding and unvested at October 1, 2023
82,481
Vested
(6,845
Forfeited
Outstanding and unvested at December 31, 2023
75,636
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 probability of meeting performance targets. The fair value of each performance share award is based on the closing stock price on the date of grant.
A summary of the performance-based restricted stock unit awards activity for the three months ended December 31, 2023 presented at target was as follows:
508,622
26.72
215,462
(123,821
34.82
(3,308
28.01
596,955
28.91
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Restricted Stock Units
A summary of the service-based restricted stock unit awards activity for the three months ended December 31, 2023 was as follows:
786,096
25.42
204,796
38.12
(224,591
28.14
(2,102
24.85
764,199
15. 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, and, 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 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):
Numerator:
Net income (loss) attributable to common stockholders - basic and diluted
Denominator:
Weighted-average shares of common stock
Net income (loss) per share attributable to common stockholders:
Net income (loss) per common share - basic
Net income (loss) per common share - diluted
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 per share because the effect was anti-dilutive:
547,890
5,010,161
108,736
531,462
16. INCOME TAXES
The Company calculates the interim tax provision in accordance with the provisions of 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 and
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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 December 31, 2023 and 2022 were 39.6% and 26.5%, respectively. The increase in the effective income tax rate for the three months ended December 31, 2023, as compared to the three months ended December 31, 2022, was primarily driven by the tax effects related to the sale of the Vycom business.
17. COMMITMENTS AND 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. Discovery has been completed, and the Company filed motions for summary judgment in April 2023. On November 8, 2023, the court granted the Company's motions for summary judgment seeking to dismiss Scranton Products Inc. and The AZEK Company Inc. but denied the Company's motions for summary judgment seeking to dismiss The AZEK Group LLC and Vycom Corp. A trial date has been set for May 2024.
In the normal course of the Company’s business, it is at times subject to various other 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 legal actions to which it may be subject, 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.
18. CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY ONLY)
The AZEK Company Inc. (parent company only)
Balance Sheets
Non-current assets:
Investments in subsidiaries
Total non-current assets
LIABILITIES AND STOCKHOLDERS’ EQUITY:
Stockholders’ equity:
Total stockholders’ equity
Total liabilities and stockholders’ equity
21
Net income (loss) of subsidiaries
The AZEK Company Inc. did not have any cash as of December 31, 2023 or September 30, 2023. Accordingly a Condensed Statement of Cash Flows has not been presented.
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 Condensed Consolidated Financial Statements.
Dividends from Subsidiaries
There were $100.0 million and $7.5 million in cash dividends paid to The AZEK Company Inc. from the Company’s consolidated subsidiaries during the three months ended December 31, 2023 and 2022, respectively. Cash dividends of $100.0 million were used to fund the ASR during the three months ended December 31, 2023 and $7.5 million in cash dividends were used to fund share repurchases on the open market during the three months ended December 31, 2022.
Restricted Payments
The AZEK Group LLC is party to the Revolving Credit Facility and the Term Loan Agreement. 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. The AZEK Group LLC is not permitted to make certain payments unless those payments are consistent with exceptions set forth 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 8.
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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 2023 Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission, or the SEC, on November 29, 2023, or our 2023 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, cash flows, expansion plans, capital investments, capacity targets and other strategic initiatives, are forward-looking statements. In some cases, forward looking statements may be identified by words such as “believe,” “may,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “could,” “would,” “expect,” “objective,” “plan,” “potential,” “seek,” “grow,” “target,” “if,” or the negative of these terms and similar expressions intended to identify forward-looking statements. In particular, statements about potential new products and product innovation, statements regarding the potential impact of climate change and extreme weather events, global health pandemics or geopolitical conflicts, such as the conflict between Russia and Ukraine and the conflict in the Middle East, statements about the markets in which we operate and the economy more generally, including inflation and interest rates, growth of our various markets and growth in the use of engineered products as well as our ability to share in such growth, statements about our ability to source our raw materials in line with our expectations, future pricing for our products or our raw materials and our ability to successfully manage market and interest rate risks and control or reduce costs, statements with respect to our ability to meet future goals and targets, including our environmental, social and governance targets, statements about potential share repurchases, 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 I, Item 1A of our 2023 Form 10-K. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the future events and trends discussed in this Quarterly Report on Form 10-Q may not occur and actual results may differ materially and adversely from those anticipated or implied in the forward-looking statements. You should read this Quarterly Report on Form 10-Q with the understanding that our actual future results, levels of activity, performance and events and circumstances may be materially different from what we expect. In addition, statements that “we believe” and similar statements reflect our beliefs and opinions on the relevant subject. These statements are based on information available to us as of the date of this Quarterly Report on Form 10-Q. While we believe that such information provides a reasonable basis for these statements, such information may be limited or incomplete. Our statements should not be read to indicate that we have conducted an exhaustive inquiry into, or review of, all relevant information. These statements are inherently uncertain, and investors are cautioned not to unduly rely on these statements.
Overview
We are an industry-leading designer and manufacturer of beautiful, low-maintenance and environmentally sustainable outdoor living products, including TimberTech® decking, Versatex® and AZEK® Trim, and StruXure® pergolas. Homeowners continue to invest in their homes and outdoor spaces and we believe are increasingly recognizing the significant advantages of engineered, long-lasting products, which convert 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 decking, railing, trim, siding, cladding, pergolas and cabanas and accessories, inspires consumers to design outdoor spaces tailored to their unique lifestyle needs. 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”. 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.
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. Prior to our divestiture of our Vycom business on November 1, 2023, our Commercial segment manufactured engineered sheet products and high-quality bathroom partitions and lockers. Following the divestiture of our Vycom business, our Commercial segment will continue to manufacture high-quality bathroom partitions and lockers. Over our history we have developed a reputation as a leading innovator in our markets by leveraging our differentiated manufacturing capabilities, material science expertise and product management proficiency to consistently introduce new products
into the market. This long-standing commitment has been critical to our ability to stay at the forefront of evolving industry trends and consumer demands, which in turn has allowed us to become a market leader across our core product categories.
Economic Environment; Global Events
Our business and financial performance may be affected by the macroeconomic and geopolitical environment, including increased inflation, elevated rising interest rates and geopolitical conflicts. For example, elevated interest rates and inflation levels may negatively impact the ability of consumers to purchase our products and may increase our raw material costs. Our business, financial condition and results of operations could be adversely affected if we are not able to pass any associated costs on to our customers or otherwise mitigate the impact of these pressures on us or our consumers. In addition, our business may be impacted by the direct and indirect effects of geopolitical conflicts, including possible disruptions to global supply chains generally and our supply chain in particular and an increased threat of cyberattacks against U.S. companies, which could pose risks to the security of our information technology systems, as well as the confidentiality, availability and integrity of our or our customers’ data.
We are unable to fully predict the impact that the above events and conditions will have on the global economy, our industry or our business, financial condition, results of operations or cash flows. See also Part I, Item 3 “Quantitative and Qualitative Disclosures About Market Risk” of this Quarterly Report on Form 10-Q and Part 1, Item 1A “Risk Factors” of our 2023 Form 10-K.
Recent Divestiture
On November 1, 2023, we completed the sale of our Vycom business within the Commercial segment for net proceeds of approximately $133.1 million. The divestiture allows us to focus on the highest value portions of its business and provides additional cash to finance its capital allocation priorities. We recognized a pre-tax gain on sale of $38.5 million during the three months ended December 31, 2023.
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Results of Operations
Three Months Ended December 31, 2023 Compared to Three Months Ended December 31, 2022
The following table summarizes certain financial information relating to our operating results that have been derived from our unaudited Consolidated Financial Statements for the three months ended December 31, 2023 and 2022.
(U.S. dollars in thousands)
$Variance
%Variance
24,185
11.2
(19,669
(11.7
)%
43,854
92.2
3,802
5.2
N/M%
37,867
146.4
(1,389
(14.9
26,216
281.0
51,555
199.5
“N/M” indicates the variance as a percentage is not meaningful.
Net Sales
Net sales for the three months ended December 31, 2023 increased by $24.2 million, or 11.2%, to $240.4 million from $216.3 million for the three months ended December 31, 2022. The increase was primarily due to an increase in volume in our Residential segment attributable to key growth initiatives driving demand for AZEK products, partially offset by the sale of our Vycom business in our Commercial segment. Net sales for the three months ended December 31, 2023 increased for our Residential segment by 24.2% and decreased for our Commercial segment by 52.6%, respectively, as compared to the prior year period.
Cost of Sales
Cost of sales for the three months ended December 31, 2023 decreased by $19.7 million, or 11.7%, to $149.0 million from $168.7 million for the three months ended December 31, 2022 primarily due to lower raw material costs driven by certain commodity deflation and higher utilization of manufacturing capacity.
Gross Profit
Gross profit for the three months ended December 31, 2023 increased by $43.9 million, or 92.2%, to $91.4 million from $47.6 million for the three months ended December 31, 2022. The increase in gross profit was primarily driven by higher net sales, lower raw material costs and higher plant utilization. Gross profit as a percent of net sales increased to 38.0% for the three months ended December 31, 2023 compared to 22.0% for the three months ended December 31, 2022.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased by $3.8 million, or 5.2%, to $77.2 million, or 32.1% of net sales, for the three months ended December 31, 2023 from $73.4 million, or 34.0% of net sales, for the three months ended December 31, 2022. The increase was primarily due to higher stock-based compensation and marketing and selling costs, partially offset by lower personnel costs.
Loss on Disposal of Property, Plant and Equipment
Loss on disposal of property, plant and equipment was $2.2 million in the three months ended December 31, 2023, primarily related to the removal of dispensable equipment resulting from a modification of our manufacturing process.
Interest Expense, net
Interest expense, net, decreased by $1.4 million, or 14.9%, to $7.9 million for the three months ended December 31, 2023 from $9.3 million for the three months ended December 31, 2022. Interest expense, net decreased due to interest income, partially offset by a higher interest rate on outstanding debt during the three months ended December 31, 2023, when compared to the three months ended December 31, 2022.
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Gain On Sale Of Business
Gain on sale of business was $38.5 million during the three months ended December 31, 2023, which related to the divestiture of our Vycom business within the Commercial segment.
Income Tax Expense (Benefit)
Income tax expense increased by $26.2 million to $16.9 million for the three months ended December 31, 2023 compared to income tax benefit of $9.3 million for the three months ended December 31, 2022. The increase in our income tax expense was primarily driven by our higher pre-tax income as well as the gain from the sale of our Vycom business.
Net Income (Loss)
Net income increased by $51.6 million to $25.7 million for the three months ended December 31, 2023 compared to net loss of $25.8 million for the three months ended December 31, 2022, 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 Condensed 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.
The following table summarizes certain financial information relating to the Residential segment results that have been derived from our unaudited Condensed Consolidated Financial Statements for the three months ended December 31, 2023 and 2022.
43,516
24.2
Segment Adjusted EBITDA (1)
42,816
430.5
Segment Adjusted EBITDA Margin
23.7
5.5
N/A
Net sales for the three months ended December 31, 2023 increased by $43.5 million, or 24.2%, to $223.0 million from $179.5 million for the three months ended December 31, 2022. The increase was attributable to higher net sales related to our Deck, Rail & Accessories and our Exteriors businesses.
Segment Adjusted EBITDA
Segment Adjusted EBITDA for the three months ended December 31, 2023 increased by $42.8 million, or 430.5%, to $52.8 million from $9.9 million for the three months ended December 31, 2022. The increase was mainly driven by higher net sales, lower raw material costs and higher plant utilization, partially offset by higher marketing and selling expenses.
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The following table summarizes certain financial information relating to the Commercial segment results that have been derived from our unaudited Condensed Consolidated Financial Statements for the three months ended December 31, 2023 and 2022.
(19,331
(52.6
(2,249
(43.6
16.7
14.0
Net sales for the three months ended December 31, 2023 decreased by $19.3 million, or 52.6%, to $17.4 million from $36.8 million for the three months ended December 31, 2022, primarily due to the sale of our Vycom business. Vycom net sales were $3.3 million for the three months ended December 31, 2023 (prior to its divestiture on November 1, 2023) compared to $21.7 million for the three months ended December 31, 2022.
Segment Adjusted EBITDA of the Commercial segment was $2.9 million for the three months ended December 31, 2023, compared to $5.2 million for the three months ended December 31, 2022. The decrease was primarily driven by lower net sales due to the sale of our Vycom business, partially offset by lower material costs.
Non-GAAP Financial Measures
To supplement our Condensed 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 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 Condensed Consolidated Financial Statements prepared and presented in accordance with GAAP.
(U.S. dollars in thousands, except per share amounts)
GAAP Financial Measures:
Gross Profit Margin
38.0
22.0
Net Income (Loss) Per Common Share - Diluted
Net Profit Margin
10.7
(11.9
Net Cash Provided By (Used In) Operating Activities
Net Cash Provided By (Used In) Investing Activities
Net Cash Used In Financing Activities
Non-GAAP Financial Measures:
Adjusted Gross Profit
95,302
52,185
Adjusted Gross Profit Margin
39.6
24.1
Adjusted Net Income (Loss)
15,602
(13,852
Adjusted Diluted EPS
0.10
(0.09
Adjusted EBITDA Margin
23.2
Free Cash Flow
(33,969
(23,919
Adjusted Gross Profit, Adjusted Gross Profit Margin, Adjusted Net Income, Adjusted Diluted EPS, Adjusted EBITDA, Adjusted EBITDA Margin and Free Cash Flow
Beginning for the three months ended December 31, 2023, we define Adjusted Gross Profit as gross profit before amortization, business transformation costs, acquisition costs and certain other costs as described below. Prior to the three months ended December 31, 2023, depreciation was also excluded from Adjusted Gross Profit. We believe that including depreciation expense in our Adjusted Gross Profit definition will result in easier comparability to our peers. Adjusted Gross Profit Margin is equal to Adjusted Gross Profit divided by net sales. Presentations of Adjusted Gross Profit and Adjusted Gross Profit Margin for prior periods have been recast to conform to the current period presentation for comparability. We define Adjusted Net Income as net income (loss) before amortization, stock-based compensation costs, business transformation costs, acquisition costs, initial public offering and secondary 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 below. 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. For example, we add back amortization and certain stock-based compensation costs when calculating Adjusted Gross Profit, Adjusted Gross Profit Margin, Adjusted Net Income and Adjusted Diluted EPS because we do not consider them indicative of our core operating performance. We believe their exclusion, and the exclusion of certain other expenses as described herein, 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.
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.
In addition, we provide Free Cash Flow, which is a non-GAAP financial measure that we define as net cash provided by (used in) operating activities less purchases of property, plant and equipment. We believe Free Cash Flow is useful to investors as an important liquidity measure of the cash that is available to us after capital expenditures. Free Cash Flow is used by our management as a measure of our ability to generate and use cash, including in order to invest in future growth, fund acquisitions, return capital to our stockholders and repay indebtedness. Our use of Free Cash Flow has limitations as an analytical tool and should not be considered in isolation or as a substitute for an analysis of our results under GAAP. Some of these limitations are:
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
Amortization (1)
3,869
4,606
Amortization
1.6
2.1
29
Adjusted Net Income and Adjusted Diluted EPS Reconciliation
Stock-based compensation costs (1)
2,925
1,259
492
2,954
2,768
214
Tax impact of adjustments (5)
12,049
(4,280
0.07
0.08
0.02
0.01
Acquisition and divestiture costs
(0.26
Other costs
Tax impact of adjustments
(0.03
Adjusted Diluted EPS (6)
Adjusted EBITDA and Adjusted EBITDA Margin Reconciliation
31,937
33,840
8,468
3,957
Acquisition and divestiture costs (1)
Gain on sale of business (2)
Other costs (3)
Total adjustments
29,948
40,936
30
Net profit margin
3.3
4.3
13.3
15.7
(4.3
3.5
1.8
0.2
1.3
(16.0
0.0
1.2
0.1
12.5
18.9
Free Cash Flow Reconciliation
Less: Purchases of property, plant and equipment
Liquidity and Capital Resources
Liquidity Outlook
Our primary cash needs are to fund operations, working capital, capital expenditures, debt service, share repurchases and any acquisitions we may undertake. As of December 31, 2023, we had cash and cash equivalents of $274.8 million and total indebtedness of $592.5 million. The AZEK Group LLC (f/k/a CPG International LLC), our direct, wholly owned subsidiary, had approximately $147.8 million available under the borrowing base for future borrowings as of December 31, 2023. The AZEK Group LLC also has the option to increase the commitments under the Revolving Credit Facility by up to $100.0 million, subject to certain conditions.
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.
The AZEK Group LLC is party to the Revolving Credit Facility and the Term Loan Agreement, or, together, the Senior Secured Credit Facilities. The obligations under the Senior Secured Credit Facilities are secured by specified assets. The obligations under the Senior Secured Credit Facilities are guaranteed by us and the wholly owned domestic subsidiaries of The AZEK Group LLC other than certain immaterial subsidiaries and other excluded subsidiaries.
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The Senior Secured Credit Facilities contain covenants restricting payments of dividends by The AZEK Group 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 Total Net Leverage Ratio (as defined in the Term Loan Agreement) of The AZEK Group LLC, on a pro forma basis, is no greater than 4.25:1.00 and no event of default has occurred and is occurring.
Since our and our subsidiaries’ restricted net assets exceed 25% of our consolidated net assets, in accordance with Rule 12-04, Schedule 1 of Regulation S-X, refer to our Condensed Consolidated Financial Statements included elsewhere in this Quarterly Report on 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 The AZEK Group 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, The AZEK Group LLC (as successor-in-interest to CPG Merger Sub LLC, a limited liability company formed to effect the acquisition of The AZEK Group 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 December 31, 2023 and September 30, 2023, The AZEK Group LLC had no outstanding borrowings under the Revolving Credit Facility and had $2.2 million and $2.8 million of outstanding letters of credit held against the Revolving Credit Facility, respectively. As of both December 31, 2023 and September 30, 2023, The AZEK Group LLC had approximately $147.8 million and $147.2 million, respectively available under the borrowing base for future borrowings in addition to cash and cash equivalents on hand of $274.8 million and $278.3 million, respectively. As 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, share repurchases, 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 three months ended December 31, 2023 and 2022.
Cash Flows
(22,697
(354.1
145,793
481.8
(92,699
(918.0
Net decrease in cash
30,397
89.5
Operating Activities
Net cash provided by (used in) operating activities was $(16.3) million and $6.4 million for the three months ended December 31, 2023 and 2022, respectively. The $22.7 million increase in cash used in operating activities is primarily related to the increase in inventory, partially offset by increased profitability due to higher net sales and lower raw material costs.
Investing Activities
Net cash provided by (used in) investing activities was $115.5 million and $(30.3) million for the three months ended December 31, 2023 and 2022, respectively. Net cash provided by investing activities for the three months ended December 31, 2023 primarily consisted of $(17.8) million for purchases of property, plant and equipment in the normal course of business and $133.1 million net proceeds from the sale of the Vycom business, while net cash used in investing activities for the three months ended December 31, 2022 consisted of $(30.3) million for purchases of property, plant and equipment in the normal course of business.
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Financing Activities
Net cash used in financing activities was $102.8 million and $10.1 million for the three months ended December 31, 2023 and 2022, respectively. Net cash used in financing activities for the three months ended December 31, 2023 primarily consisted of $100.0 million of treasury stock repurchases and $1.5 million of debt principal payments, while net cash used in financing activities for the three months ended December 31, 2022 primarily consisted of $7.5 million of treasury stock repurchases and $1.5 million of debt principal payments.
On May 5, 2022, the Board of Directors authorized us to repurchase up to $400 million of our Class A common stock. The program allows us to repurchase our shares opportunistically from time to time. Purchases may be effected through one or more open market transactions, privately negotiated transactions, transactions structured through investment banking institutions, accelerated share repurchases or tender offers, some of which may be effected through Rule 10b5-1 plans, or a combination of the foregoing. The timing of repurchases will depend upon several factors, including market and business conditions, and repurchases may be discontinued at any time.
On December 4, 2023, we entered into a $100 million accelerated share repurchase agreement, or the “ASR” with Goldman Sachs & Co. LLC, or “Goldman Sachs”. Goldman Sachs delivered 2,291,607 initial shares to us on December 6, 2023, based on the closing price of the Company’s Class A common stock of $34.91 on December 4, 2023. The total value of the initial shares represents 80% of the $100 million ASR. The final settlement will be based on the volume-weighted average price of our Class A common stock over the repurchase period, subject to certain adjustments. We expect to settle the ASR in the second quarter of fiscal year 2024.
During the three months ended December 31, 2022, we repurchased 352,760 shares of its Class A common stock on the open market at an average price of $21.23 per share, totaling an approximately $7.5 million reacquisition cost.
On August 16, 2022, the U.S. government enacted the Inflation Reduction Act of 2022 (the “Inflation Reduction Act”), that includes, among other provisions, a one percent excise tax on net repurchases of stock after December 31, 2022. For the three months ended December 31, 2023, we recognized $0.8 million excise tax as reacquisition cost of share repurchases.
As of December 31, 2023, we had approximately $101.1 million available for repurchases under the Share Repurchase Program.
See Note 13 in the Notes to Condensed Consolidated Financial Statements for additional information.
On January 26, 2023, The AZEK Group LLC amended the Revolving Credit Facility, replacing all LIBOR-based provisions with provisions reflecting the Secured Overnight Financing Rate, or SOFR, including, without limitation, the use of a new Adjusted Term SOFR benchmark rate equal to Term SOFR (as defined in the Revolving Credit Agreement) plus 0.10%.
The Revolving Credit Facility provides for maximum aggregate borrowings of up to $150.0 million, subject to an asset-based borrowing base. As of December 31, 2023, outstanding revolving loans under the Revolving Credit Facility bore interest at a rate which equaled, 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 Adjusted Term SOFR, 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 SOFR borrowings, the Adjusted Term SOFR plus a spread of 125 to 175 basis points, based on average historical availability. The maturity of the Revolving Credit Facility is the earlier 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.
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, The AZEK Group LLC and the subsidiaries of The AZEK Group 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 us and the wholly owned domestic subsidiaries of The AZEK Group 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. The AZEK Group 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
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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 December 31, 2023 and September 30, 2023, The AZEK Group 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.
The Term Loan Agreement is a first lien term loan and will mature on April 28, 2029, subject to acceleration or prepayment. The Term Loan Agreement will amortize in equal quarterly installments of 0.25% of the aggregate principal amount of the loans outstanding, subject to reduction for certain prepayments.
The obligations under the Term Loan Agreement are secured by a first priority security interest in the membership interests of The AZEK Group LLC owned by us, the equity interests of The AZEK Group LLC’s domestic subsidiaries, other than certain immaterial subsidiaries and other excluded subsidiaries, and all remaining assets not constituting Revolver Priority Collateral (subject to certain exceptions) of the Company, The AZEK Group LLC and the subsidiaries of The AZEK Group LLC that are guarantors under the Term Loan Agreement, and a second priority security interest in the Revolver Priority Collateral. The obligations under the Term Loan Agreement are guaranteed by us and the wholly owned domestic subsidiaries of The AZEK Group LLC other than certain immaterial subsidiaries and other excluded subsidiaries.
The interest rate applicable to the outstanding principal under the Term Loan Agreement equals, at our option, (i) in the case of alternative base rate borrowings, the highest of (a) the Federal Funds Rate (as defined in the Term Loan Agreement) plus 0.50%, (b) the Prime Rate (as defined in the Term Loan Agreement) as in effect on such day and (c) the one-month Term SOFR (as defined in the Term Loan Agreement) plus 1.00% per annum, provided that in no event will the alternative base rate be less than 1.50% per annum, plus an applicable margin of 1.50% and (ii) in the case of SOFR borrowings, Term SOFR for the applicable interest period, plus an applicable margin of 2.50%.
We have the right to arrange for incremental term loans under the Credit Agreement in an amount that shall not exceed the sum of (i) the Fixed Incremental Amount, as defined in the Term Loan Agreement, and (ii) the Ratio Amount, as defined in the Term Loan Agreement.
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.
Contingent Commitments
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. For a description of our
34
contractual obligations and commitments, see Notes 8 “Debt”, 10 “Leases” and 17 “Commitments and Contingencies” to our Condensed Consolidated Financial Statements included elsewhere in this Quarterly Report on Form 10-Q.
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 2023 Form 10-K, except as updated in Note 1 of our Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q.
In November 2023, the Financial Accounting Standards Board ("FASB") issued ASU 2023-07, Segment Reporting (Topic 280) : Improvements to Reportable Segment Disclosures. This standard requires all public entities that are subject to segment reporting requirements to disclose additional information, including significant segment expenses and other segment items on an annual and interim basis. It also requires the disclosure of the title and the position of the chief operating decision maker and how the reported measures are used for making business decisions. This standard is effective for fiscal years beginning after December 15, 2023 and interim periods within fiscal years beginning after December 15, 2024, with early adoption permitted. We intend to adopt the updated standard during the fiscal year beginning October 1, 2024. We are currently evaluating the impact the adoption of this standard will have on our disclosures.
In December 2023, the FASB issued ASU 2023-09, Income Taxes (Topic 740): Improvements to Income Tax Disclosures. This standard expands the disclosure requirements primarily on the rate reconciliation and income tax paid. For public entities, this standard is effective for annual reporting periods beginning after December 15, 2024, with early adoption permitted. We intend to adopt the updated standard during the fiscal year beginning October 1, 2025. We are currently evaluating the impact the adoption of this standard will have on our disclosures.
35
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 December 31, 2023 and September 30, 2023, we had $592.5 million and $594.0 million outstanding under the Term Loan Agreement, respectively, and no outstanding amounts under the Revolving Credit Facility, respectively. 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, after giving effect to related derivatives, as of December 31, 2023 and 2022, would have increased or decreased annual cash interest by approximately $2.9 million and $3.0 million, respectively.
We have entered into and may continue to enter into, agreements such as floating for fixed-rate interest rate swaps and other hedging contracts in order to hedge against interest rate volatility associated with our Senior Secured Credit Facilities. For example, effective November 2022, we entered into interest rate swaps, which swapped interest at a rate based on SOFR on a notional amount of $300 million for a fixed rate. We do not intend or expect to enter into interest rate swaps or other derivative transactions for speculative purposes. In the future, in order to manage our interest rate risk, we may refinance our existing debt.
Credit Risk
As of December 31, 2023 and September 30, 2023, 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.
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 and other costs, including freight and labor costs. Geopolitical tensions and other economic uncertainties may increase inflationary pressures, including causing increases in the prices for goods and services and exacerbating global supply chain disruptions, which have resulted in, and may continue to result in, shortages in materials and services and related issues. Historically, we have generally been able over time to offset, in whole or in part, 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 offset any increases in raw material prices or freight or labor costs or other inflationary pressures in the future. Sustained or increased inflationary pressures may have an adverse effect on our business, financial condition and results of operations if the selling prices of our products do not increase with these increased costs or we cannot identify cost efficiencies.
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.
Item 4. Controls and Procedures
Disclosure Controls and Procedures
Our management, with the participation of our principal executive officer and principal financial officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)) as of the end of the period covered by this report. Based on such evaluation, our principal executive officer and principal financial officer have concluded that, as of the end of such period, our disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and to provide reasonable assurance that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting
There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended December 31, 2023 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II
OTHER INFORMATION
Item 1. Legal Proceedings
From time to time, we may be involved in litigation relating to claims arising out of our operations and businesses that cover a wide range of matters, including, among others, contract and employment claims, personal injury claims, product liability claims and warranty claims. Currently, there are no claims or proceedings against us that we believe will have a material adverse effect on our business, financial condition, results of operations or cash flows. However, the results of any current or future litigation cannot be predicted with certainty and, regardless of the outcome, we may incur significant costs and experience a diversion of management resources as a result of litigation.
Item 1A. Risk Factors.
Since September 30, 2023, there have been no material changes to the risk factors previously disclosed under the heading “Risk Factors” in our 2023 Form 10-K. You should carefully consider the risk factors in our 2023 Form 10-K and our other filings made with the SEC. You should be aware that such risk factors and other information may not describe every risk we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
Issuer Purchases of Equity Securities
The following table provides information with respect to our purchases of our Class A common stock during the three months ended December 31, 2023:
Period
Total number of shares purchased
Average price paid per share
Total number of shares purchased as part of publicly announced plans or programs (1), (2), (3)
Maximum approximate dollar value of shares that may yet be purchased under the plans or programs (1), (2), (3)
October 1, 2023 - October 31, 2023
201,938,443
November 1, 2023 – November 30, 2023
December 1, 2023 – December 31, 2023
34.91
101,138,443
See Note 13 in the Notes to Condensed Consolidated Financial Statements for additional information on share repurchase program.
Item 3. Defaults Upon Senior Securities.
Item 4. Mine Safety Disclosures.
Item 5. Other Information
Item 6. Exhibits
Incorporated by Reference
Exhibit
No.
Description
Form
Filing Date
File No.
3.1
Second Restated Certificate of Incorporation of The AZEK Company Inc.
8-K
3.2
03/01/2023
001-39322
Amended and Restated Bylaws of The AZEK Company Inc.
03/10/2022
4.2
Registration Rights Agreement, by and among The AZEK Company Inc. and the other parties named therein
10-Q
08/14/2020
31.1
Certification of Principal Executive Officer Pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
31.2
Certification of Principal Financial Officer Pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*
32.1
Certification of Principal Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.+
32.2
Certification of Principal Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.+
101.INS
Inline XBRL Instance Document*
101.SCH
Inline XBRL Taxonomy Extension Schema with Embedded Linkbase Documents*
104
Cover Page Interactive Data File (formatted as inline XBRL and contained in Exhibit 101)
* Filed herewith.
+ Furnished herewith. This certification is deemed furnished and not filed for purpose of Section 18 of the Exchange Act or otherwise subject to the liability of that Section, nor shall it be deemed incorporated by reference into any filing under the Securities Act or the Exchange Act.
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.
Date: February 7, 2024
By:
/s/ Peter Clifford
Peter Clifford
Senior Vice President and Chief Financial Officer
(Principal Financial Officer)