The AZEK Company(AZEK) - 2022 Q1 - Quarterly Report

PART I. Financial Information This section provides a comprehensive overview of the company's financial performance and condition, including unaudited financial statements, management's discussion and analysis, market risk disclosures, and internal controls Item 1. Financial Statements (Unaudited) This section presents the unaudited condensed consolidated financial statements, including balance sheets, statements of comprehensive income (loss), stockholders' equity, and cash flows, along with detailed notes explaining significant accounting policies, business combinations, debt, leases, and other financial components for the period ended December 31, 2021 Condensed Consolidated Balance Sheets | Metric | Dec 31, 2021 (in thousands) | Sep 30, 2021 (in thousands) | Change (in thousands) | | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------- | | Cash and cash equivalents | $66,056 | $250,536 | $(184,480) | | Inventories | $289,059 | $188,888 | $100,171 | | Total current assets | $437,019 | $532,398 | $(95,379) | | Property, plant & equipment | $435,304 | $391,012 | $44,292 | | Goodwill | $992,513 | $951,390 | $41,123 | | Intangible assets | $272,692 | $242,572 | $30,120 | | Total assets | $2,215,106 | $2,187,834 | $27,272 | | Total current liabilities | $162,538 | $170,407 | $(7,869) | | Total liabilities | $763,955 | $760,670 | $3,285 | | Total stockholders' equity | $1,451,151 | $1,427,164 | $23,987 | Condensed Consolidated Statements of Comprehensive Income (Loss) | Metric | Three Months Ended Dec 31, 2021 (in thousands) | Three Months Ended Dec 31, 2020 (in thousands) | Change (in thousands) | YoY Growth | | :-------------------------- | :--------------------------------------------- | :--------------------------------------------- | :-------------------- | :--------- | | Net sales | $259,708 | $212,278 | $47,430 | 22.3% | | Cost of sales | $171,099 | $139,300 | $31,799 | 22.8% | | Gross profit | $88,609 | $72,978 | $15,631 | 21.4% | | Operating income (loss) | $25,440 | $19,530 | $5,910 | 30.3% | | Interest expense | $4,148 | $6,026 | $(1,878) | -31.2% | | Income tax expense (benefit)| $4,585 | $3,356 | $1,229 | 36.6% | | Net income (loss) | $16,707 | $10,148 | $6,559 | 64.6% | | Basic EPS | $0.11 | $0.07 | $0.04 | 57.1% | | Diluted EPS | $0.11 | $0.07 | $0.04 | 57.1% | Condensed Consolidated Statements of Stockholders' Equity | Metric | Dec 31, 2021 (in thousands) | Sep 30, 2021 (in thousands) | Change (in thousands) | | :----------------------------------- | :-------------------------- | :-------------------------- | :-------------------- | | Additional Paid-In Capital | $1,622,516 | $1,615,236 | $7,280 | | Accumulated Deficit | $(171,520) | $(188,227) | $16,707 | | Total Stockholders' Equity | $1,451,151 | $1,427,164 | $23,987 | - Net income contributed $16.7 million to accumulated deficit, and stock-based compensation added $4.0 million to additional paid-in capital[14] Condensed Consolidated Statements of Cash Flows | Cash Flow Activity | Three Months Ended Dec 31, 2021 (in thousands) | Three Months Ended Dec 31, 2020 (in thousands) | Change (in thousands) | | :---------------------------------- | :--------------------------------------------- | :------------------------------------------------- | :-------------------- | | Net cash from operating activities | $(30,620) | $20,298 | $(50,918) | | Net cash from investing activities | $(156,611) | $(27,004) | $(129,607) | | Net cash from financing activities | $2,751 | $1,728 | $1,023 | | Net increase (decrease) in cash | $(184,480) | $(4,978) | $(179,502) | | Cash and cash equivalents – End | $66,056 | $210,034 | $(143,978) | - Investing activities included $91.3 million for acquisitions and $65.3 million for property, plant, and equipment purchases in Q1 FY2022[150] - Operating cash flow decreased primarily due to higher inventory levels[149] Note 1. Organization and Summary of Significant Accounting Policies - The AZEK Company Inc. is an industry-leading designer and manufacturer of low-maintenance and environmentally sustainable building products for residential, commercial, and industrial markets[20] - The company operates on a fiscal year ending September 30[22] - Adoption of ASU No. 2016-02, Leases (Topic 842) resulted in recording lease assets and liabilities and a $2.1 million decrease in accumulated deficit as of October 1, 2020[28] - Research and development expenses were approximately $2.0 million for the three months ended December 31, 2021, up from $1.8 million in the prior year[27] Note 2. Revenue - Revenue is recognized when control of promised goods is transferred to customers at the point of shipping[29] Rebate Activity (in thousands) | Rebate Activity (in thousands) | Three Months Ended Dec 31, 2021 | Three Months Ended Dec 31, 2020 | | :----------------------------- | :------------------------------ | :------------------------------ | | Beginning balance | $47,648 | $32,679 | | Rebate expense | $16,150 | $13,673 | | Rebate payments | $(9,957) | $(7,533) | | Ending balance | $53,841 | $38,819 | Note 3. Business Combinations - Acquired a regional recycler for approximately $4.0 million on November 30, 2021[31] - Acquired StruXure Outdoor, LLC for approximately $87.3 million on December 29, 2021, expanding product offerings in the Residential segment[31][70] - Total consideration for both acquisitions, net of cash acquired, was $91.3 million, resulting in $41.1 million in goodwill and $43.0 million in intangible assets[33] Note 4. Inventories Inventory Category (in thousands) | Inventory Category (in thousands) | Dec 31, 2021 | Sep 30, 2021 | Change | | :-------------------------------- | :----------- | :----------- | :----- | | Raw materials | $66,758 | $46,046 | $20,712| | Work in process | $30,997 | $27,278 | $3,719 | | Finished goods | $191,304 | $115,564 | $75,740| | Total inventories | $289,059 | $188,888 | $100,171| Note 5. Property, Plant and Equipment—Net Asset Category (in thousands) | Asset Category (in thousands) | Dec 31, 2021 | Sep 30, 2021 | Change | | :---------------------------- | :----------- | :----------- | :----- | | Manufacturing equipment | $440,740 | $405,611 | $35,129| | Construction in progress | $148,815 | $129,886 | $18,929| | Total property & equipment | $700,069 | $642,073 | $57,996| | Accumulated depreciation | $(264,765) | $(251,061) | $(13,704)| | Total property & equipment – net | $435,304 | $391,012 | $44,292| - Depreciation expense increased to $15.2 million for Q1 FY2022 from $11.6 million for Q1 FY2021[38] Note 6. Goodwill and Intangible Assets—Net Goodwill (in thousands) | Goodwill (in thousands) | Sep 30, 2021 | Acquisitions | Dec 31, 2021 | | :---------------------- | :----------- | :----------- | :----------- | | Residential | $911,001 | $41,123 | $952,124 | | Commercial | $40,389 | $0 | $40,389 | | Total Goodwill | $951,390 | $41,123 | $992,513 | Intangible Asset (in thousands) | Intangible Asset (in thousands) | Dec 31, 2021 Net Carrying Value | Sep 30, 2021 Net Carrying Value | Change | | :------------------------------ | :------------------------------ | :------------------------------ | :----- | | Proprietary knowledge | $78,401 | $73,017 | $5,384 | | Trademarks | $89,123 | $84,209 | $4,914 | | Customer relationships | $102,339 | $82,258 | $20,081| | Total intangible assets | $272,692 | $242,572 | $30,120| - Amortization expense was $12.9 million for Q1 FY2022, up from $12.6 million for Q1 FY2021[43] Note 7. Composition of Certain Balance Sheet Accounts Allowance for Doubtful Accounts (in thousands) | Allowance for Doubtful Accounts (in thousands) | Three Months Ended Dec 31, 2021 | Three Months Ended Dec 31, 2020 | | :--------------------------------------------- | :------------------------------ | :------------------------------ | | Beginning balance | $1,109 | $1,332 | | Provision | $(45) | $6 | | Acquisition | $10 | $0 | | Ending balance | $1,074 | $1,338 | Accrued Expenses (in thousands) | Accrued Expenses (in thousands) | Dec 31, 2021 | Sep 30, 2021 | Change | | :------------------------------ | :----------- | :----------- | :----- | | Employee related liabilities | $17,637 | $32,996 | $(15,359)| | Customer deposits | $8,724 | $0 | $8,724 | | Total accrued expenses | $48,684 | $56,522 | $(7,838)| Note 8. Debt Debt (in thousands) | Debt (in thousands) | Dec 31, 2021 | Sep 30, 2021 | | :------------------------------------------------ | :----------- | :----------- | | Term Loan due May 5, 2024 | $467,654 | $467,654 | | Long-term debt—less current portion | $464,999 | $464,715 | - The Term Loan Agreement matures on May 5, 2024, and quarterly principal payments are prepaid through maturity due to prior IPO proceeds[50][51] - The Revolving Credit Facility provides for maximum aggregate borrowings of up to $150.0 million, with $146.7 million available as of December 31, 2021[52] Interest Expense (in thousands) | Interest Expense (in thousands) | Three Months Ended Dec 31, 2021 | Three Months Ended Dec 31, 2020 | Change | | :------------------------------ | :------------------------------ | :------------------------------ | :----- | | Term Loan Agreement | $3,884 | $5,677 | $(1,793)| | Total Interest expense | $4,148 | $6,026 | $(1,878)| Note 9. Product Warranties - Product warranties range from 5 years to lifetime for material and workmanship defects[56] Warranty Reserve Activity (in thousands) | Warranty Reserve Activity (in thousands) | Three Months Ended Dec 31, 2021 | Three Months Ended Dec 31, 2020 | | :------------------------------------- | :------------------------------ | :------------------------------ | | Beginning balance | $12,699 | $10,913 | | Adjustments to reserve | $467 | $723 | | Warranty claims payment | $(485) | $(608) | | Ending balance | $12,681 | $11,044 | Note 10. Leases - The Company adopted ASC 842 on October 1, 2020, recognizing right-of-use assets and lease liabilities[59] Lease Metrics (in thousands) | Lease Metrics (in thousands) | Dec 31, 2021 | Sep 30, 2021 | | :--------------------------- | :----------- | :----------- | | Total lease assets | $75,813 | $68,515 | | Total lease liabilities | $81,098 | $73,152 | Lease Expense (in thousands) | Lease Expense (in thousands) | Three Months Ended Dec 31, 2021 | Three Months Ended Dec 31, 2020 | | :--------------------------- | :------------------------------ | :------------------------------ | | Operating lease expense | $1,170 | $784 | | Finance lease amortization | $717 | $249 | | Finance lease interest | $804 | $203 | | Total lease expense | $2,614 | $1,190 | Note 11. Fair Value of Financial Instruments Debt Instrument (in thousands) | Debt Instrument (in thousands) | Dec 31, 2021 Carrying Value | Dec 31, 2021 Estimated Fair Value | Sep 30, 2021 Carrying Value | Sep 30, 2021 Estimated Fair Value | | :----------------------------- | :-------------------------- | :-------------------------------- | :-------------------------- | :-------------------------------- | | Term Loan due May 5, 2024 | $467,654 | $467,420 | $467,654 | $467,420 | - A contingent payment for the StruXure Outdoor acquisition, based on 2022 EBITDA, was estimated at a fair value of $9.5 million at the acquisition date[68][69] Note 12. Segments - The company has two reportable segments: Residential and Commercial[70] - Residential segment includes decking, rail, trim, and accessories, with recent additions like StruXure and regional recyclers[70] - Commercial segment manufactures and distributes resin-based extruded sheeting products, lockers, and partitions[70] - Segment performance is evaluated using Adjusted EBITDA and Adjusted EBITDA Margin[70] Note 13. Capital Stock - The company has Class A and Class B common stock, with Class A traded on the NYSE under the symbol "AZEK"[73] - In January 2021, 23,000,000 shares of Class A common stock were sold in an offering at $40.00 per share[21][73] - In June 2021, 17,250,000 shares of Class A common stock were sold in an offering at $43.50 per share[21][73] - The company did not receive any proceeds from these secondary offerings[21][73] Note 14. Stock-Based Compensation - Stock-based compensation expense was $4.0 million for Q1 FY2022, up from $2.9 million for Q1 FY2021[75] - The 2020 Omnibus Incentive Compensation Plan authorizes 15,852,319 shares for various stock-based awards[75] - As of December 31, 2021, unrecognized compensation cost on unvested awards was $34.0 million, with a weighted average remaining recognition period of 2.4 years[75] Note 15. Earnings Per Share EPS Metric | EPS Metric | Three Months Ended Dec 31, 2021 | Three Months Ended Dec 31, 2020 | Change | | :---------------------------------------- | :------------------------------ | :------------------------------ | :----- | | Net income (loss) attributable to common stockholders | $16,707 | $10,148 | $6,559 | | Basic EPS | $0.11 | $0.07 | $0.04 | | Diluted EPS | $0.11 | $0.07 | $0.04 | - The company's Class A and Class B common stock equally share in distributed and undistributed earnings[89] Note 16. Income Taxes - Effective income tax rate decreased to 21.5% for Q1 FY2022 from 24.9% for Q1 FY2021[94] - The decrease was primarily driven by the impact of discrete tax benefits on year-to-date earnings[94] Note 17. Commitments and Contingencies - A worker's compensation case has a reasonably possible liability with an estimated loss range of $0.4 million to $0.5 million[96] - Management believes current legal actions will not have a material adverse effect on the company's results of operations or financial position[96] Note 18. Condensed Financial Information of Registrant (Parent Company Only) Parent Company Financials (in thousands) | Parent Company Financials (in thousands) | Dec 31, 2021 | Sep 30, 2021 | | :--------------------------------------- | :----------- | :----------- | | Investments in subsidiaries | $1,451,151 | $1,427,164 | | Total assets | $1,451,151 | $1,427,164 | | Total liabilities | $0 | $0 | | Total stockholders' equity | $1,451,151 | $1,427,164 | - Net income of subsidiaries was $16.7 million for Q1 FY2022, up from $10.1 million for Q1 FY2021[99] - The parent company is a holding company and relies on cash dividends and distributions from subsidiaries, which are subject to restrictions under credit facilities[145] Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations This section provides management's perspective on the company's financial condition and operational results for the three months ended December 31, 2021. It covers an overview of the business, the impact of the StruXure acquisition, detailed analysis of financial performance, non-GAAP measures, liquidity, capital resources, and critical accounting policies, highlighting significant growth in sales and net income despite ongoing COVID-19 impacts and increased costs Overview - The company is an industry-leading designer and manufacturer of low-maintenance and environmentally sustainable building products for the Outdoor Living market[107] - Products are branded under AZEK, TimberTech, VERSATEX, ULTRALOX, StruXure for Residential, and Celtec, Playboard, Seaboard, Flametec, Designboard, Cortec, Sanatec, Scranton Products, Aria Partitions, Eclipse Partitions, Hiny Hiders, Tufftec Lockers, and Duralife Lockers for Commercial[20] - The company expects the economic effects of the COVID-19 pandemic to continue affecting product demand in fiscal 2022[109] StruXure Acquisition - Acquired StruXure Outdoor, LLC on December 29, 2021, for approximately $87.3 million[110] - StruXure Outdoor manufactures customizable outdoor pergolas and cabanas, expanding the Residential segment's product offerings[110][70] Results of Operations | Metric | Three Months Ended Dec 31, 2021 (in thousands) | Three Months Ended Dec 31, 2020 (in thousands) | $ Variance | % Variance | | :-------------------------- | :--------------------------------------------- | :--------------------------------------------- | :--------- | :--------- | | Net sales | $259,708 | $212,278 | $47,430 | 22.3% | | Cost of sales | $171,099 | $139,300 | $31,799 | 22.8% | | Gross profit | $88,609 | $72,978 | $15,631 | 21.4% | | Selling, general and administrative expenses | $63,169 | $53,448 | $9,721 | 18.2% | | Operating income (loss) | $25,440 | $19,530 | $5,910 | 30.3% | | Interest expense, net | $4,148 | $6,026 | $(1,878) | (31.2)% | | Income tax expense (benefit)| $4,585 | $3,356 | $1,229 | 36.6% | | Net income (loss) | $16,707 | $10,148 | $6,559 | 64.6% | - Net sales growth was 19.1% for Residential and 44.8% for Commercial segments[114] - Gross profit margin slightly decreased to 34.1% from 34.4% due to higher raw material and manufacturing costs, despite positive pricing and productivity[116] Residential Segment (in thousands) | Residential Segment (in thousands) | Three Months Ended Dec 31, 2021 | Three Months Ended Dec 31, 2020 | $ Variance | % Variance | | :--------------------------------- | :------------------------------ | :------------------------------ | :--------- | :--------- | | Net sales | $221,133 | $185,640 | $35,493 | 19.1% | | Segment Adjusted EBITDA | $69,431 | $58,776 | $10,655 | 18.1% | | Segment Adjusted EBITDA Margin | 31.4% | 31.7% | N/A | N/A | Commercial Segment (in thousands) | Commercial Segment (in thousands) | Three Months Ended Dec 31, 2021 | Three Months Ended Dec 31, 2020 | $ Variance | % Variance | | :-------------------------------- | :------------------------------ | :------------------------------ | :--------- | :--------- | | Net sales | $38,575 | $26,638 | $11,937 | 44.8% | | Segment Adjusted EBITDA | $4,748 | $3,316 | $1,432 | 43.2% | | Segment Adjusted EBITDA Margin | 12.3% | 12.4% | N/A | N/A | Non-GAAP Financial Measures - Non-GAAP measures are used to supplement GAAP results, providing additional useful information about financial performance and enhancing understanding of past performance and future prospects[131] Non-GAAP Metric (in thousands, except per share) | Non-GAAP Metric (in thousands, except per share) | Three Months Ended Dec 31, 2021 | Three Months Ended Dec 31, 2020 | | :----------------------------------------------- | :------------------------------ | :------------------------------ | | Adjusted Gross Profit | $107,090 | $88,772 | | Adjusted Gross Profit Margin | 41.2% | 41.8% | | Adjusted Net Income | $28,757 | $23,142 | | Adjusted Diluted EPS | $0.18 | $0.15 | | Adjusted EBITDA | $58,520 | $48,452 | | Adjusted EBITDA Margin | 22.5% | 22.8% | - Adjusted Gross Profit Margin decreased slightly from 41.8% to 41.2%, while Adjusted EBITDA Margin also saw a minor decrease from 22.8% to 22.5%[133][143] Liquidity and Capital Resources - As of December 31, 2021, cash and cash equivalents were $66.1 million, with $146.7 million available under the Revolving Credit Facility[144] - Net cash used in operating activities was $(30.6) million for Q1 FY2022, a decrease of $50.9 million from the prior year, primarily due to higher inventory levels[149][151] - Net cash used in investing activities was $(156.6) million for Q1 FY2022, primarily for $91.3 million in acquisitions and $65.3 million in capital expenditures[150][151] - The company plans to invest approximately $180-$200 million in capital expenditures during fiscal 2022 for capacity expansion, including a new manufacturing facility in Boise, Idaho[158] Critical Accounting Policies and Estimates - Financial statements are prepared in accordance with U.S. GAAP, requiring estimates and assumptions[159] - No material changes to critical accounting policies since the 2021 Form 10-K, except as updated in Note 1[161] Item 3. Quantitative and Qualitative Disclosures About Market Risk This section outlines the company's exposure to various market risks, including interest rate risk on its variable-rate debt, credit risk related to accounts receivable, foreign currency risk, and inflation/raw material price volatility. The company manages these risks through credit evaluations, maintaining multiple vendors, and historically offsetting cost increases through pricing and efficiencies - A 100 basis point change in floating interest rates on outstanding debt would impact annual cash interest by approximately $4.7 million[163] - No single customer accounted for 10% or more of gross trade receivables as of December 31, 2021, mitigating credit risk[164] - Substantially all business is conducted in U.S. dollars, resulting in minimal foreign currency risk[165] - Raw material costs, particularly petrochemical resins, are subject to significant price volatility, but the company aims to offset this through sales price increases and production efficiencies[166][167] Item 4. Controls and Procedures Management, including the principal executive and financial officers, concluded that the company's disclosure controls and procedures were effective as of December 31, 2021. There have been no material changes in internal control over financial reporting during the quarter - Disclosure controls and procedures were evaluated and deemed effective as of December 31, 2021[169] - No material changes in internal control over financial reporting occurred during the quarter ended December 31, 2021[170] PART II. Other Information This section covers legal proceedings, risk factors, equity sales, defaults, mine safety disclosures, and a list of exhibits filed with the report Item 1. Legal Proceedings The company is involved in various legal actions, including a worker's compensation case, but currently believes no claims will have a material adverse effect on its business, financial condition, results of operations, or cash flows - No current claims or proceedings are believed to have a material adverse effect on the company's business, financial condition, results of operations, or cash flows[172] Item 1A. Risk Factors There have been no material changes to the risk factors previously disclosed in the company's 2021 Form 10-K since September 30, 2021. Investors are advised to consider the risks outlined in the 10-K and other SEC filings - No material changes to risk factors since the 2021 Form 10-K[173] Item 2. Unregistered Sales of Equity Securities and Use of Proceeds No unregistered sales of equity securities or use of proceeds to report for the period - No unregistered sales of equity securities or use of proceeds[173] Item 3. Defaults Upon Senior Securities No defaults upon senior securities to report for the period - No defaults upon senior securities[173] Item 4. Mine Safety Disclosures No mine safety disclosures to report for the period - No mine safety disclosures[173] Item 5. Other Information No other information to report for the period - No other information[173] Item 6. Exhibits This section lists the exhibits filed with the 10-Q report, including certifications from the principal executive and financial officers, Inline XBRL documents, and previously filed corporate documents - Includes certifications (31.1, 31.2, 32.1, 32.2) from principal executive and financial officers[175][176][177][178] - Contains Inline XBRL instance and taxonomy extension documents (101.INS, 101.SCH, 101.CAL, 101.DEF, 101.LAB, 101.PRE)[179][180][181]