FOUNDATION BUILDING MATERIALS, INC. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our accompanying consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements and involves numerous risks and uncertainties, including, but not limited, to those described in Item 1A, Risk Factors, and elsewhere. Actual results may differ materially from those contained in any forward-looking statements.
Overview
We are one of the largest specialty distributors of wallboard and suspended ceiling systems inthe United States andCanada . We have expanded from a single branch inSouthern California to over 175 branches acrossNorth America , carrying a broad array of more than 30,000 SKUs. We have grown net sales faster than anyUnited States publicly traded building products distributor since 2013. Our goal is to be the leading company within specialty building products distribution and by continuing to expand into adjacent and complementary markets. We were founded in 2011 by our President and Chief Executive OfficerRuben Mendoza , our Chief Financial OfficerJohn Gorey and one of our Regional Vice Presidents,Tom Fischbeck .Mr. Mendoza previously served as Chief Executive Officer ofAcoustical Material Services where he oversaw the successful growth of the company before it was acquired byAllied Building Products in 2007. In founding our company,Mr. Mendoza applied a proven customer-centric operating model to an organization that would combine strong organic growth with an effective acquisition and integration program across a fragmented industry, where he and other members of management had long and close personal relationships with many private acquisition candidates in our industry. In our early years, we were focused on opening or acquiring new branches to leverage our founders' customer focus and strong supplier relationships. In 2012 and 2013, we began rapidly growing through both organic growth and acquisitions, and by the end of 2013, we significantly increased our number of branches and geographic footprint, and expanded fromCalifornia into the Midwest,Florida andArizona . This rapid growth resulted in the acquisition of our current ERP platform and information technology structure and added a deep bench of leaders from the acquired companies to prepare for future growth. InNovember 2013 , we strengthened our management team with the addition of our Chief Operating Officer,Pete Welly , who has over 40 years of experience in our industry. In 2014 and 2015, we grew rapidly through several acquisitions, acquiring branches throughout the Midwest. We continued to strengthen our relationships with USG andArmstrong . InAugust 2016 , we entered the Canadian market when we acquired Winroc-SPI, which also included our mechanical insulation segment. That segment was subsequently sold onNovember 1, 2018 . The Winroc-SPI acquisition also included several strategic locations inthe United States and added exclusive territories with the industry-leading suspended ceiling systems line. OnFebruary 15, 2017 , we completed our IPO of 12,800,000 shares of our common stock at a public offering price of$14.00 per share. Our common stock began trading on the NYSE onFebruary 10, 2017 , under the ticker symbol "FBM". After underwriting discounts and commissions and expenses payable by us, net proceeds from the IPO were$164.0 million . We used these proceeds to repay borrowings outstanding under our 2016 asset-based lending credit facility. After our IPO, we have continued to grow organically and through acquisitions. We completed nine acquisitions in 2017, four acquisitions in 2018 and five acquisitions in 2019. We refinanced our 2016 credit agreements during the third quarter of 2018, entering into the 2018 Revolving Credit Facility and the 2018 Term Loan Facility. We also divested the Disposed Business in late 2018 so that we could focus on our core specialty building products business. OnSeptember 24, 2019 ,LSF9 Cypress Parent 2 LLC , or the Selling Stockholder, an affiliate ofLone Star , sold 4,750,000 shares of our common stock at a price of$17.00 per share. The Selling Stockholder also granted the underwriters an option for a period of 30 days to purchase up to an additional 712,500 shares of our common stock. OnOctober 11, 2019 , the underwriters exercised their option to purchase the additional 712,500 shares of our common stock. As a result of the sale, the aggregate beneficial ownership ofLone Star decreased from 65.3% to 52.5% of our outstanding shares of common stock as ofDecember 31, 2019 , and we remain a "Controlled Company " under the corporate governance standards of the NYSE. Segments We have one reportable segment. Resources are allocated and performance is assessed by our Chief Executive Officer, whom we have determined to be our Chief Operating Decision Maker. Management evaluates performance for the segment based on gross margin. 34
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Factors and Trends Affecting Our Business and Results of Operations
General Economic Conditions and Outlook
Demand for our products is impacted by changes in general economic conditions, including, in particular, conditions inthe United States commercial construction and housing markets. Our end markets are broadly categorized as new non-residential construction, new residential construction and non-residential repair and remodel construction.
We estimate new non-residential construction represents approximately 45% of our net sales for the year endedDecember 31, 2019 . Non-residential construction includes all construction other than residential structures and encompasses office, retail, healthcare, hospitality and government building projects. Non-residential construction growth is primarily influenced by economic growth, business investment, job growth, vacancy rates and availability and cost of capital. Our revenue from new non-residential construction can lag behind construction starts by 12 to 18 months. We regularly review unemployment rates, office vacancy rates, the Architecture Billings Index, or ABI, state and local government spending and gross domestic product, or GDP, which can indicate potential changes in new non-residential construction opportunities. We believe that these statistics provide a reasonable indication of our future revenue opportunities from new non-residential construction.
We estimate new residential construction represents approximately 19% of our net sales for the year endedDecember 31, 2019 . Job growth is an important factor for a healthy housing market, and unemployment has fallen from its peak of 10.0% in 2009 to 3.5% by the end ofDecember 2019 , according to theU.S. Bureau of Labor Statistics . According to theFederal Reserve Bank of St. Louis , average housing starts in 2019 were 1.3 million. While housing starts have significantly recovered from the 0.6 million seen in 2009, they are still below the 50-year average.
We estimate non-residential repair and remodel construction represents
approximately 36% of our net sales for the year ended
Volume, Costs and Pricing Programs
Our product costs are directly impacted by fluctuations in supplier pricing and our purchasing volume. As one of the leading wallboard, suspended ceiling systems and metal framing distributors inthe United States andCanada , we are able to negotiate volume discounts and favorable pricing terms with our suppliers. As we have continued to grow, we have negotiated with our suppliers on a national level in an effort to maximize these programs across our entire branch network, and expect to continue this trend in the future.
Acquisitions
We supplement our organic growth strategy with selective acquisitions, and during the year endedDecember 31, 2019 , we completed five acquisitions. See Note 4, Acquisitions, to the accompanying consolidated financial statements. We believe that significant opportunities exist to continue to expand our geographic footprint and product offerings by executing additional strategic acquisitions, and we maintain an extensive and active acquisition pipeline. We are typically evaluating several acquisition opportunities at any given time. In executing our acquisition strategy and integrating acquired companies, we focus on the cost savings we can achieve through integrated procurement and pricing programs and brand consolidation. The five acquisitions completed in 2019 contributed approximately$25.3 million of net sales for the year endedDecember 31, 2019 . As ofFebruary 25, 2020 , all of the acquisitions made throughDecember 31, 2019 , have been fully integrated into our operations. 35 --------------------------------------------------------------------------------
Effective Date # of Branches
Acquisitions of Acquisition Branch Locations Acquired
Associated Drywall Suppliers, December 30,
Inc. 2019 Kentucky 1
Joe'sWallboard Supply Co. of Colorado Springs, Inc. October 1, 2019 Colorado
1
The Supply Guy, Inc. October 1, 2019 Washington
1
1
February 1 ,
Builders' Supplies Limited II 2019
3 Total 7 As part of our accounting for business combinations, we are required to value inventory acquired in the business combination at its net realizable value. The inventory adjustment is typically expensed within the first month after completion of an acquisition. This step-up in basis and related expense has a negative effect on profitability. For the years endedDecember 31, 2019 and 2018, the impact of the acquired step-up in inventory basis was$0.3 million and$1.1 million , respectively. Seasonality Our operating results are typically affected by seasonality. Warmer and drier weather during the second and third quarters typically result in higher activity and sales levels. The first and fourth quarters typically have lower levels of activity and lower working capital requirements due to inclement weather conditions. 36
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Results of Operations
The Year Ended
The following table summarizes certain consolidated financial information related to our operating results for the periods indicated:
Year Ended December 31,
2019 2018
(dollars in thousands) Statements of operations data Net sales$ 2,154,530 100.0 %$ 2,044,312 100.0 % Cost of goods sold 1,497,921 69.5 % 1,453,953 71.1 % Gross profit 656,609 30.5 % 590,359 28.9 % Operating expenses: Selling, general and 487,865 444,527 administrative expenses 22.6 % 21.7 % Depreciation and amortization 80,444 3.7 % 77,419 3.8 % Total operating expenses 568,309 26.3 % 521,946 25.5 % Income from operations 88,300 4.2 % 68,413 3.4 % Loss on extinguishment of debt - - % (58,475 ) (2.9 )% Interest expense (33,788 ) (1.6 )% (53,283 ) (2.6 )% Other income, net 443 - % 1,298 0.1 % Income (loss) before income taxes 54,955 2.6 % (42,047 ) (2.0 )% Income tax expense (benefit) 13,127 0.6 % (5,628 ) (0.3 )% Income (loss) from continuing operations 41,828 2.0 % (36,419 ) (1.7 )% Income from discontinued operations, net of tax - - % 10,523 0.5 % (Loss) gain on sale of discontinued operations, net of tax (1,589 ) (0.1 )% 13,713 0.7 % Net income (loss)$ 40,239 1.9 %$ (12,183 ) (0.5 )% Our net sales by major product line, gross profit and gross margin, are as follows: Year Ended December 31, Change 2019 2018 $ % (dollars in thousands) Wallboard$ 817,799 38.0 %$ 781,257 38.2 %$ 36,542 4.7 % Suspended ceiling systems 413,674 19.2 % 379,809 18.6 % 33,865 8.9 % Metal framing 392,630 18.2 % 361,493 17.7 % 31,137 8.6 % Complementary and other products 530,427 24.6 % 521,753 25.5 % 8,674 1.7 % Total net sales$ 2,154,530 100.0 %$ 2,044,312 100.0 %$ 110,218 5.4 % Total gross profit$ 656,609 $ 590,359 $ 66,250 11.2 % Total gross margin 30.5 % 28.9 % 1.6 % 37
--------------------------------------------------------------------------------Net Sales Net sales for the year endedDecember 31, 2019 were$2,154.5 million compared to$2,044.3 million for the year endedDecember 31, 2018 , representing an increase of$110.2 million , or 5.4%. There was one less day in the current period as compared to the prior period. Average daily net sales increased 5.8% over the prior period. Net sales from base business branches contributed$47.0 million of the net sales increase, and average daily base business net sales increased by 2.9% over the prior period. Net sales from acquired branches and existing branches that were strategically combined contributed$63.3 million of the net sales increase. The base business net sales increase was primarily due to strong commercial activity and product expansion into new geographic markets. The change in our base business net sales was also driven by the following factors: • an increase in wallboard net sales of$4.1 million , or 0.6%, due to an increase in average selling price and product mix of 0.4%, and an increase in wallboard unit volume of 0.2%. On an average daily net sales basis, wallboard increased by 1.0%, driven by an average daily unit volume growth of 0.6%;
• an increase in suspended ceiling systems net sales of
5.3%. On an average daily net sales basis, suspended ceiling systems
increased by 5.7%, due to an increase in average selling price, product
mix, and volume related to commercial construction activity;
• an increase in metal framing net sales of
average daily net sales basis, metal framing increased by 4.7%. The
increase in metal framing net sales was primarily due to an increase in
volume related to commercial construction activity; and
• an increase in complementary and other product net sales of $11.0 million, or 2.3%. On an average daily net sales basis, complementary and
other products increased by 2.8%.
The table below highlights net sales from our base business and acquired and
combined branches:
Year Ended December 31, Change
2019 2018 $ %
(dollars in thousands)
Base business (1) $ 1,916,308 $ 1,869,345 $ 46,963 2.5 %
Acquired and combined (2) 238,222 174,967 63,255 36.2 %
Net sales $ 2,154,530 $ 2,044,312 $ 110,218 5.4 %
(1) Represents net sales from branches that were owned by us since January 1, 2018 and branches
that were opened by us during such period.
(2) Represents branches acquired and combined after January 1, 2018 , primarily as a result of our
strategic combination of branches.
38
--------------------------------------------------------------------------------The table below highlights our changes in base business net sales and net sales from branches acquired and combined by major product line:
Acquired
Base and
Year Ended Base Business Acquired and Year Ended Total Net Business Net Combined
December 31, Net Sales Combined Net Sales December 31, Sales % Sales % Net Sales %
2018 Change Change 2019 Change Change(1) Change(2)
(dollars in
thousands)
Wallboard $ 781,257 $ 4,107 $ 32,435 $ 817,799 4.7 % 0.6 % 68.5 %
Suspended
ceiling systems 379,809 17,260 16,605 413,674 8.9 % 5.3 % 31.1 %
Metal framing 361,493 14,627 16,510 392,630 8.6 % 4.3 % 82.1 %
Complementary
and other
products 521,753 10,969 (2,295 ) 530,427 1.7 % 2.3 % (4.2 )%
Net sales $ 2,044,312 $ 46,963 $ 63,255 $ 2,154,530 5.4 % 2.5 % 36.2 %
Average daily
net sales(3) $ 8,080 $ 216 $ 254 $ 8,550 5.8 % 2.9 % 36.7 %
(1) Represents base business net sales change as a percentage of base business net sales for the year ended
Gross Profit and Gross Margin
Gross profit for the year endedDecember 31, 2019 , was$656.6 million compared to$590.4 million for the year endedDecember 31, 2018 , representing an increase of$66.3 million , or 11.2%. Gross profit increased due to an expansion of our gross margin, an increase in sales from acquisitions and base business growth. Gross margin for the year endedDecember 31, 2019 , was 30.5% compared to 28.9% for the year endedDecember 31, 2018 . The increase in gross margin was primarily due to improved profitability across our product lines driven by our ongoing pricing and purchasing initiatives and continued stabilization of our product costs.
Selling, General & Administrative ("SG&A") Expenses
SG&A expenses for the year endedDecember 31, 2019 , were$487.9 million compared to$444.5 million for the year endedDecember 31, 2018 , representing an increase of$43.3 million , or 9.7%. As a percentage of net sales, SG&A expenses were 22.6% for the year endedDecember 31, 2019 , compared to 21.7% for the year endedDecember 31, 2018 . The increase in SG&A expense as a percentage of net sales was primarily due to our continued investment in various company-wide initiatives and higher labor and related operating costs.
Depreciation and Amortization
Depreciation and amortization for the year endedDecember 31, 2019 , was$80.4 million compared to$77.4 million for the year endedDecember 31, 2018 , representing an increase of$3.0 million , or 3.9%. The increase in depreciation and amortization was primarily due to acquisitions made during the year endedDecember 31, 2019 , and certain acquisitions made in 2018, which increased the value of property and equipment and intangible assets subject to amortization.
Interest Expense
Interest expense for the year endedDecember 31, 2019 , was$33.8 million compared to$53.3 million for the year endedDecember 31, 2018 , representing a decrease of$19.5 million , or 36.6%. The decrease is primarily due to the refinancing of our Senior Secured Notes, or Notes, inAugust 2018 and reduction of debt. See Note 8, Long-Term Debt, to the consolidated financial statements. 39 --------------------------------------------------------------------------------
Loss on Extinguishment of Debt
In
Other Income, Net
Other income, net was
Income Taxes Income tax expense for the year endedDecember 31, 2019 , was$13.1 million compared to an income tax benefit of$5.6 million for the year endedDecember 31, 2018 . The effective tax rate for the year endedDecember 31, 2019 was 23.9% compared to 13.4% for the year endedDecember 31, 2018 . The items that had the most significant impact on the difference between our statutoryUnited States federal income tax rate of 21% and the effective tax rate for the year endedDecember 31, 2019 were (a) state income taxes, (b) adjustments associated with our return to provision reconciliation, and (c) non-deductible items, which were partially offset by a benefit recorded under the Foreign Derived Intangible Income provisions. The items that had the most significant impact on the difference between our statutoryUnited States federal income tax rate of 21% and the effective tax rate for the year endedDecember 31, 2018 were (a) an adjustment to our deferred tax liabilities, and (b) taxes assessed under the Global Intangible Low Taxed Income provisions contained in the 2017 Tax Cuts and Jobs Act, or Tax Act, which were partially offset by a reduction in the valuation allowance associated with state net operating loss carryovers and a non-taxable permanent item related to a discrete adjustment to the TRA liability.
Net Income (Loss) From Continuing Operations
Net income from continuing operations increased by$78.2 million to$41.8 million for the year endedDecember 31, 2019 , as compared to a net loss from continuing operations of$36.4 million in the same period in 2018. The increase was primarily due to an increase of$19.9 million in income from operations, a loss on extinguishment of debt of$58.5 million incurred in the year endedDecember 31, 2018 , and reduced interest expense of$19.5 million . These changes were partially offset by an increase of$18.8 million in income tax expense to$13.1 million for the year endedDecember 31, 2019 as compared to an income tax benefit of$5.6 million for the same period in 2018.
Liquidity and Capital Resources
Summary
We depend on cash flow from operations, cash on hand and funds available under
our 2018 Revolving Credit Facility, and in the future, we may depend on other
debt financings allowed under the terms of the 2018 Term Loan Facility and the
2018 Revolving Credit Facility, and equity financings to finance our acquisition
strategy, working capital needs and capital expenditures. We believe that these
sources of funds will be adequate to fund debt service requirements and provide
cash, as required, to support our strategy, ongoing operations, capital
expenditures, lease obligations and working capital for at least the next
12 months. However, we cannot ensure that we will be able to obtain future debt
or equity financings adequate for our future cash requirements on commercially
reasonable terms or at all. The TRA may also have a negative impact on our
liquidity if, among other things, payments we make under the TRA exceed the
actual cash savings we and our subsidiaries realize in respect of the tax
benefits covered by the TRA after we have paid our taxes and other obligations.
In addition, as a result of either an early termination of the TRA or a change
of control, we could be required to make payments under the TRA that exceed our
actual cash savings under the TRA. In these situations, our obligations under
the TRA could have a substantial, negative impact on our liquidity and could
have the effect of delaying, deferring or preventing, among other things,
capital expenditures and acquisitions.
40
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If our cash flows and capital resources are insufficient to fund our debt
service obligations, we may be forced to reduce or delay additional
acquisitions, future investments and capital expenditures, seek additional
capital, restructure or refinance our indebtedness, or sell assets. Significant
delays in our ability to finance planned acquisitions or capital expenditures
may materially and adversely affect our future sales prospects. In addition, we
cannot ensure that we will be able to refinance any of our indebtedness,
including the 2018 Revolving Credit Facility and 2018 Term Loan Facility, on
commercially reasonable terms or at all. Our ability to restructure or refinance
our debt will depend on the condition of the capital markets and our financial
condition at such time. Our TRA requires that after Lone Star no longer controls
us, any senior debt document that refinances or replaces our existing
indebtedness permits our subsidiaries to make dividends to us, without any
conditions, to the extent required for us to make payments under the TRA, unless
Lone Star otherwise consents. At the time of any such refinancing, it may not be
possible to include this term in such senior debt documents, and as a result, we
may need Lone Star's consent to complete such refinancing. The 2018 Revolving
Credit Facility and 2018 Term Loan Facility restrict our ability to enter into
certain asset sales transactions. We may not be able to consummate those asset
sales to raise capital or sell assets at prices that we believe are fair, and
proceeds that we do receive may not be adequate to meet any debt service
obligations then due.
As of December 31, 2019 , we had available aggregate undrawn borrowing capacity
of approximately $286.0 million under the 2018 Revolving Credit Facility. For
the periods presented, our use of cash was primarily driven by debt reduction,
investments in acquisitions, capital expenditures and working capital
requirements.
Cash Flows
A summary of net cash provided by, or used in, operating, investing and
financing activities by continuing operations is shown in the following table.
Year Ended December Year Ended December
31, 2019 31, 2018
(dollars in thousands)
Net cash provided by operating activities $ 145,718 $ 75,849
Net cash used in investing activities $ (60,935 ) $ (125,940 )
Net cash used in financing activities $ (80,996 ) $ (61,000 )
Operating Activities
Net cash provided by operating activities consists primarily of net income (loss) adjusted for non-cash items, including depreciation and amortization, provision for doubtful accounts, deferred income taxes and the effects of changes in working capital.
Net cash provided by operating activities increased by$69.9 million to$145.7 million for the year endedDecember 31, 2019 , as compared to$75.8 million in the same period in 2018. The increase was primarily due to higher net income from continuing operations including adjustments for non-cash items of$47.2 million and lower working capital requirements of$22.7 million .
Investing Activities
Net cash used in investing activities consists primarily of acquisitions and capital expenditures, including purchases of land, buildings, leasehold improvements, fleet assets, information technology and other equipment. Historically, capital expenditures generally have been made at relatively low levels in comparison to the operating cash flows generated during the corresponding periods, and usually range between 1.0% and 1.5% of net sales. Net cash used in investing activities decreased by$65.0 million to$60.9 million for the year endedDecember 31, 2019 , as compared to$125.9 million in the same period in 2018. The decrease was primarily due to the lower aggregate purchase price of acquisitions of$59.7 million and proceeds from the termination of the net investment hedge of$3.3 million . 41 --------------------------------------------------------------------------------
Financing Activities
Net cash used in financing activities consists primarily of borrowings and related repayments under our financing agreements.
Net cash used in financing activities increased by$20.0 million to$81.0 million in the year endedDecember 31, 2019 , as compared to$61.0 million in the same period in 2018. The increase was primarily due to higher net repayments of debt of$3.3 million in the year endedDecember 31, 2019 and the first payment under the TRA of$16.7 million made inJanuary 2019 .
2018 Revolving Credit Facility and 2018 Term Loan Facility
2018 Revolving Credit Facility
The 2018 Revolving Credit Facility provides for senior secured revolving credit financing, including aUnited States revolving credit facility of initially up to$375.0 million , or the United States Revolving Credit Facility, a Canadian revolving credit subfacility of initially up to$75.0 million , or the Canadian Revolving Credit Subfacility, and provided for a "first-in-last-out", or FILO, subfacility in an amount of up to$25.0 million in amortizing loans, or the FILO Subfacility, subject, in each case, to availability under the respective borrowing bases for each facility. OnNovember 9, 2018 , the Company terminated the$25.0 million FILO Subfacility. The aggregate amount of the 2018 Revolving Credit Facility is$375.0 million . The 2018 Revolving Credit Facility includes a letter of credit subfacility, which permits up to$10.0 million of letters of credit underthe United States Revolving Credit Facility (which may be denominated inUnited States dollars) and up to the dollar equivalent of$5.0 million of letters of credit under the Canadian Revolving Credit Subfacility (which may be denominated in Canadian dollars orUnited States dollars). In addition, pursuant to the 2018 Revolving Credit Facility, up to$50.0 million in the case of the United States Revolving Credit Facility, and$10.0 million in the case of the Canadian Revolving Credit Subfacility, may be short-term borrowings upon same-day notice. The 2018 Revolving Credit Facility is scheduled to mature onAugust 13, 2023 . The amount of available credit for each of the United States Revolving Credit Facility and the Canadian Revolving Credit Subfacility changes every month, depending on the amount of eligible trade accounts, eligible credit card receivables, eligible inventory, eligible qualifying equipment and eligible cashthe United States and Canadian loan parties have available to serve as collateral. Generally, each of the United States Revolving Credit Facility and the Canadian Revolving Credit Subfacility is limited to the sum of (a) 85% of eligible trade accounts (as defined in the 2018 Revolving Credit Facility), plus (b) 90% of eligible credit card accounts (as defined in the 2018 Revolving Credit Facility), plus (c) the lesser of (i) 75% of the value of the eligible inventory (as defined in the 2018 Revolving Credit Facility) and (ii) 85% of the net orderly liquidation value of the eligible inventory, plus (d) the lesser of (i) 85% of the net orderly liquidation value of eligible qualifying equipment and (ii) the amount obtained by multiplying (A) the amount obtained by dividing (x) the amount set forth in clause (c)(i) above by (y) the net book value of all eligible qualifying equipment as of the most recent annual appraisal, by (B) the net book value of eligible qualifying equipment (subject to amounts contributed to the borrowing base pursuant to this clause (d) being capped at the lesser of$50.0 million and 15% of the loan limit (as defined in the 2018 Revolving Credit Facility)), plus (e) eligible cash (as defined in the 2018 Revolving Credit Facility), minus (f) any eligible reserves on the borrowing base (as defined in the 2018 Revolving Credit Facility). Available credit for each tranche is calculated separately, and the borrowing base components are subject to customary reserves and eligibility criteria. Borrowings under the 2018 Revolving Credit Facility bear interest, at our option, at either an alternate base rate or Canadian prime rate, as applicable, plus an applicable margin (ranging from 0.25% to 0.75% pursuant to a grid based on average excess availability) or the LIBOR or Canadian CDOR rate (as defined in the 2018 Revolving Credit Facility), as applicable, plus an applicable margin (ranging from 1.25% to 1.75% pursuant to a grid based on average excess availability). In addition to paying interest on outstanding principal under the 2018 Revolving Credit Facility, the ABL Borrowers are required to pay a commitment fee in respect of the unutilized commitments under the 2018 Revolving Credit Facility ranging from 0.250% to 0.375% per annum and determined based on average utilization of the 2018 Revolving Credit Facility (increasing when utilization is low and decreasing when utilization is high). 42 -------------------------------------------------------------------------------- As long as commitments are outstanding under the 2018 Revolving Credit Facility, we are subject to certain restrictions under the facility if our Pro Forma Adjusted EBITDA to debt ratio, or the Total Net Leverage Ratio, exceeds a certain total. The Total Net Leverage Ratio is defined as the ratio of Consolidated Total Debt to the aggregate amount of Consolidated EBITDA for the Relevant Reference Period (as such terms are defined in the 2018 Revolving Credit Facility). Consolidated Total Debt is defined in the 2018 Revolving Credit Facility and is generally calculated as an amount equal to the aggregate outstanding principal amount of all third-party debt for borrowed money, unreimbursed drawings under letters of credit, capital lease obligations, and third-party debt obligations evidenced by notes or similar instruments on a consolidated basis and determined in accordance with generally accepted accounting principles inthe United States , or GAAP, subject to certain exclusions. Consolidated EBITDA is defined in the 2018 Revolving Credit Facility and is calculated in a similar manner to our calculation of Adjusted EBITDA, except that the 2018 Revolving Credit Facility permits pro forma adjustments in order to give effect to, among other things, the pro forma results of our acquisitions as if we had owned such acquired companies for the entirety of the Relevant Reference Period. These pro forma adjustments give effect to all acquisitions consummated in the four quarters endedDecember 31, 2019 , as though they had been consummated on the first day of the first quarter for the four quarters endedDecember 31, 2019 . The 2018 Revolving Credit Facility requires us to maintain a Total Net Leverage Ratio no greater than 6.00:1.00 to incur additional junior lien and unsecured indebtedness.
As of
Year Ended Year Ended December
(dollars in thousands) December 31, 2019 31, 2018
Pro Forma Adjusted EBITDA (1) $ 179,974 $ 162,512
Consolidated Total Debt (2)$ 541,884 $ 605,831 Total Net Leverage Ratio 3.01x 3.73x Cash $ 17,766 $ 15,299 Consolidated Total Debt (2) less Cash ("Net Debt")$ 524,118 $
590,532
Net Debt Leverage Ratio 2.91x
3.63x
(1) "Pro Forma Adjusted EBITDA" is used herein instead of "Consolidated EBITDA" to avoid confusion but is calculated in the same manner as Consolidated EBITDA under the 2018 Revolving Credit Facility. The following table presents a reconciliation of Adjusted EBITDA to Pro Forma Adjusted EBITDA for the years endedDecember 31, 2019 and 2018: Year Ended Year Ended December December 31, 2019 31, 2018 (in thousands) Adjusted EBITDA (a)$ 176,838 $ 155,170 Pro forma adjustment (b) 3,136 7,342 Pro Forma Adjusted EBITDA$ 179,974 $ 162,512 (a) See this section for the definition of Adjusted EBITDA and the section titled "Non-GAAP Financial Information" for a reconciliation of net income (loss) to Adjusted EBITDA. (b) The pro forma adjustment gives effect to all acquisitions consummated in the years endedDecember 31, 2019 and 2018, respectively, as though they had been consummated on the first day of the first quarter for the twelve months endedDecember 31, 2019 and 2018, respectively. Other adjustments are also made to conform to the terms of the 2018 Revolving Credit Facility. (2) The reconciliation of total debt on the balance sheet to Consolidated Total Debt is as follows: December 31, 2019 December 31, 2018 (in thousands) Total gross debt $ 534,500 $ 596,000 Finance leases 7,384 9,831 Consolidated Total Debt $ 541,884 $ 605,831 43
-------------------------------------------------------------------------------- As ofDecember 31, 2019 , the majority of our liquidity was from the$286.0 million available under the 2018 Revolving Credit Facility. In addition, the 2018 ABL Credit Agreement requires us to maintain a minimum fixed charge coverage ratio set at a level of 1.00:1.00, which will only be tested at times when availability under the 2018 Revolving Credit Facility is less than a certain threshold. The fixed charge coverage ratio is a material term of the 2018 ABL Credit Agreement and we believe information about how the covenant is calculated is material to an investor's understanding of our financial condition and liquidity. Should we not comply with the fixed charge coverage ratio, we would be in technical default of our 2018 ABL Credit Agreement, which could result in the 2018 Revolving Credit Facility being terminated and any outstanding debt becoming due prior to its scheduled maturity. Should all amounts under the 2018 ABL Credit Agreement become due immediately, we may be unable to pay such amounts without a material impact to our business, as we may be forced to liquidate assets to do so.
2018 Term Loan Facility
The 2018 Term Loan Facility provides senior secured debt financing in an aggregate principal amount of$450.0 million and the right, at our option, to request additional tranches of term loans. Availability of such additional tranches of term loans will be subject to the absence of any default, and, among other things, the receipt of commitments by existing or additional financial institutions. Borrowings under the 2018 Term Loan Facility bear interest at Holdco's option at either (a) LIBOR determined by reference to the costs of funds forUnited States dollar deposits for the interest period relevant to such borrowing adjusted for certain additional costs, which shall be no less than 0.00%, plus an applicable margin of 3.25% (or 3.00% if the first lien net leverage ratio (as defined in the 2018 Term Loan Facility) is no greater than 4.00 to 1.00), or (b) a base rate determined by reference to the highest of (i) the prime commercial lending rate published by Royal Bank of Canada as its "prime rate," (ii) the federal funds effective rate plus 0.50% and (iii) one-month LIBOR plus 1.0%, plus an applicable margin of 2.25 (or 2.00% if the first lien net leverage ratio is no greater than 4.00 to 1.00). We are required to make scheduled quarterly payments in an aggregate annual amount equal to 0.25% of the aggregate principal amount of the initial term loans made onAugust 13, 2018 , with the balance due onAugust 13, 2025 , seven years after the closing date for the initial term loans (as defined in the 2018 Term Loan Facility). Obligations under the 2018 Term Loan Facility are secured by a first priority lien on all Term Priority Collateral (as defined in the 2018 Term Loan Facility) and a second priority lien on all ABL Priority Collateral (as defined in the 2018 Term Loan Facility). The 2018 Term Loan Facility contains a number of covenants that, subject to certain exceptions, restrict Alpha's ability and the ability of its subsidiaries to incur additional indebtedness, pay dividends on its equity securities or redeem, repurchase or retire its equity securities or other indebtedness, make investments, loans and acquisitions, create restrictions on the payment of dividends or other amounts to us from its restricted subsidiaries, engage in transactions with its affiliates, sell assets, including equity securities of its subsidiaries, alter the business it conducts, consolidate or merge and incur liens.
Off-Balance Sheet Arrangements
As ofDecember 31, 2019 , andDecember 31, 2018 , we had no material off-balance sheet arrangements or similar obligations, such as financing or unconsolidated variable interest entities.
Critical Accounting Policies
Our management's discussion and analysis of our financial condition and results
of operations is based on our accompanying consolidated financial statements,
which have been prepared in accordance with GAAP. The preparation of these
financial statements requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, disclosure of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of sales and expenses during the reported period.
On an ongoing basis, management evaluates its estimates, including those related
to revenue recognition, allowance for doubtful accounts, inventories, taxes, and
goodwill. We base our estimates and judgments on historical experience and on
various other factors that we believe to be reasonable under the circumstances,
the results of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other
sources. Actual results may materially differ from these estimates under
different assumptions or conditions.
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--------------------------------------------------------------------------------Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of sales and expenses during the reporting period. Estimates that are more susceptible to change in the near term are the allowance for doubtful accounts, the allowance for excess and obsolete inventory and recoverability of long-lived assets. Actual results could materially differ from those estimates.
Revenue Recognition
Revenue is recognized upon transfer of control of promised products to customers in an amount that reflects the consideration expected to be received in exchange for those products. The performance obligation for product sales is met at a point in time, when the product is delivered and control is transferred to the customer. At inception of a contract with a customer, the price and quantity of goods are fixed. Accounts Receivable We sell to customers using credit terms customary in our industry. Accounts receivable are recorded at net realizable value. This value includes an appropriate allowance for estimated uncollectible accounts to reflect any loss anticipated on the trade accounts receivable balances and charged to the provision for doubtful accounts. The allowance for doubtful accounts reflects our estimate of credit exposure, determined principally on the basis of our collection experience, aging of our receivables and significant individual account credit risk. Actual results could materially differ from those estimates.
Other Receivables
Other receivables primarily consist of vendor rebates receivable. Typical arrangements with vendors provide for us to receive a rebate of a specified amount after achieving any of a number of measures generally related to the volume of purchases over a period of time. We record these rebates to effectively reduce the cost of sales in the period in which the product is sold. Throughout the year, our estimates include the amount of rebates receivable for the vendor programs based on the expected level of purchases. We accrue for vendor rebates earned based on purchase volumes and adjust inventories to reflect the reduction in the cost basis for inventories purchased that are subject to vendor rebates. Historically, our actual vendor rebates have not been materially different from management's original estimates.
Inventories
Inventories, consisting substantially of finished goods, are valued at the lower of cost or market (net realizable value). Cost is determined using the moving weighted average cost method. We routinely evaluate inventory for excess or obsolescence and consider factors such as historical usage and purchase rates and record a provision for excess and obsolete inventory. If we determine that a smaller or larger reserve is appropriate, we will record a credit or a charge to cost of sales in the period in which we make such a determination.
Impairment of Long-Lived Assets
We review property and equipment for impairment when events or circumstances
indicate these assets may not be recoverable. Factors considered include
significant underperformance relative to expected historical or projected future
operating results, significant changes in the manner of use of the acquired
assets or the strategy for the overall business and significant negative
industry or economic trends. In performing the review for recoverability, future
cash flows expected to result from the use of the asset and its eventual
disposition are estimated. If the sum of expected future undiscounted cash flows
is less than the carrying amount of the asset, an impairment loss is recorded
under the discounted cash flow method. We use our best judgment based on current
facts and circumstances related to its business when making these estimates.
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--------------------------------------------------------------------------------Right-of-Use ("ROU") Assets and Lease Liabilities
We lease the majority of our branch locations and office space and also lease vehicles and equipment for use in our operations. At inception, we determine whether an agreement represents a lease and, at commencement, evaluate each lease agreement to determine whether the lease is an operating or finance lease. These leases do not have significant rent escalations, holidays, concessions, leasehold improvement incentives, or other build-out clauses. We elected to adopt the practical expedient to account for both lease and non-lease components as a single lease component. Certain leases include one or more options to renew. The exercise of lease renewal options is typically at our discretion. We regularly evaluate the renewal options and, when the options are reasonably certain of being exercised, they are included in the lease term. Variable lease costs consist primarily of taxes, insurance, and common area or other maintenance costs for leased facilities and vehicles and equipment, which are paid based on actual costs incurred. Generally, leases do not provide an implicit rate; therefore, we use our incremental borrowing rate based on the information available at the lease commencement date in determining the present value of the lease payments. We use a portfolio approach for determining the incremental borrowing rate based on the applicable lease terms and the current economic environment.
Intangible Assets and
Intangible assets consist of tradenames, customer relationships and favorable leases under market rent, and are amortized using the straight-line method, which reflects the pattern in which the economic benefits of the assets are expected to be consumed. Intangible assets with definite lives are amortized over their respective estimated useful lives. For favorable leases under market rent, amounts are amortized over their contractual terms. We review intangible assets with finite lives for impairment when events or circumstances indicate these assets may not be recoverable. In performing the review for recoverability, future cash flows expected to result from the use of the asset are estimated. If the sum of expected future undiscounted cash flows is less than the carrying amount of the asset, an impairment loss is recorded for the amount by which the carrying amount exceeds the estimated fair value.Goodwill represents the excess of purchase price over fair value of assets acquired and liabilities assumed in a business combination. We perform our impairment test annually at the reporting unit level or more frequently if impairment indicators arise. We have defined our reporting unit consistently with our operating segment. For our goodwill impairment assessment we have adopted a standard that provides us the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Such qualitative factors may include the following: macroeconomic conditions; industry and market considerations; cost factors; overall financial performance; consistency of customer base; and other relevant entity-specific events. In the absence of sufficient qualitative factors, goodwill impairment is determined utilizing a two-step process. This process involves comparing the fair value to the carrying value of the reporting unit. If the carrying value of the net assets assigned to the reporting unit exceeds the fair value of the reporting unit, then we must determine the implied fair value of the reporting unit's goodwill and compare it to the carrying value of the reporting unit's goodwill. We determine the fair value of the reporting unit using combinations of both the income and market valuation approaches.
Acquisition Accounting
We account for business combinations using the purchase method, which requires
us to allocate the cost of an acquired business to the acquired assets and
liabilities based on their estimated fair values at the acquisition date. We
recognize the excess of an acquired business' cost over the fair value of the
acquired assets and liabilities as goodwill. Determining the fair value of
certain assets and liabilities acquired is judgmental in nature and often
involves the use of significant estimates and assumptions. We use a variety of
information sources to determine the fair value of acquired assets and
liabilities, and we generally use third party appraisers to assist us in the
determination of the fair value and useful lives of identifiable intangible
assets.
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--------------------------------------------------------------------------------Income Taxes
We use the asset and liability method of accounting for income taxes. Under this method, we recognize income tax expense for the amount of taxes payable or refundable for the current year and for the amount of deferred tax liabilities and assets for the future tax consequences of events that have been recognized in our financial statements or tax returns. We make assumptions, judgments and estimates to determine our current provision for income taxes, our deferred tax assets and liabilities, and our uncertain tax positions. Our judgments, assumptions and estimates relative to the current provision for income tax take into account current tax laws, our interpretation of current tax laws and possible outcomes of current and future audits conducted by foreign and domestic tax authorities. Changes in tax law or our interpretation of tax laws and the resolution of current and future tax audits could significantly affect the amounts provided for income taxes in our accompanying consolidated financial statements. Our assumptions, judgments and estimates relative to the value of a deferred tax asset take into account predictions of the amount and category of future taxable income. Actual operating results and the underlying amount and category of income in future years could cause our current assumptions, judgments and estimates of recoverable net deferred taxes to be inaccurate. Changes in any of the assumptions, judgments and estimates mentioned above could cause our actual income tax obligations to differ from our estimates, which could materially affect our financial position and results of operations. Our tax provision for interim periods is determined using an estimate of our annual effective tax rate, adjusted for discrete items, if any, that are taken into account in the relevant period. As the calendar year progresses, we periodically refine our estimate based on actual events and earnings by jurisdiction. This ongoing estimation process can result in changes to our expected effective tax rate for the full calendar year. When this occurs, we adjust the income tax provision during the quarter in which the change in estimate occurs so that our year-to-date provision as a percentage of income (loss) before income taxes equals our expected annual effective tax rate.
Recently Adopted and Issued Accounting Standards
See Note 2, Summary of Significant Accounting Policies, to the accompanying consolidated financial statements for a discussion of recently adopted and recently issued accounting standards.
Non-GAAP Financial Information
In addition to our results under GAAP, we also present Adjusted EBITDA for historical periods. Adjusted EBITDA is a non-GAAP financial measure and has been presented as a supplemental measure of financial performance that is not required by, or presented in accordance with, GAAP. We calculate Adjusted EBITDA as net income (loss) from continuing operations before interest expense, net, loss on extinguishment of debt, income tax expense (benefit), depreciation and amortization, unrealized gain on derivative financial instruments, offering and public company readiness expenses, stock-based compensation, and other non-recurring adjustments such as loss on the disposal of property and equipment, transaction costs and non-cash decrease in TRA liability. We calculated Pro Forma Adjusted EBITDA and Net Debt Leverage Ratio as shown in the previous section entitled "Liquidity and Capital Resources," which are also non-GAAP financial measures. Adjusted EBITDA is presented because it is an important metric used by management to assess our financial performance. We also believe Adjusted EBITDA is frequently used by analysts, investors and other interested parties to evaluate companies in our industry. This measure, when used in conjunction with related GAAP financial measures, provides investors with an additional financial analytical framework that may be useful in assessing our Company and its financial condition and results of operations. Adjusted EBITDA has certain limitations. Adjusted EBITDA should not be considered as an alternative to net income, or any other measure of financial performance derived in accordance with GAAP. Additionally, Adjusted EBITDA is not intended to be a liquidity measure because of certain limitations such as:
• It does not reflect our cash outlays for capital expenditures or future
contractual commitments;
• It does not reflect changes in, or cash requirements for, working capital;
• It does not reflect interest expense or the cash requirements necessary
to service interest or principal payments on indebtedness;
• It does not reflect income tax expense or the cash necessary to pay
income taxes; and
• Although depreciation and amortization are non-cash charges, the assets
being depreciated and amortized may have to be replaced in the future,
and this non-GAAP measure does not reflect cash requirements for such
replacements.
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Other companies, including other companies in our industry, may not use these measures or may calculate one or both differently than as presented in this Annual Report on Form 10-K, limiting their usefulness as a comparative measure.
In evaluating Adjusted EBITDA, you should be aware that in the future we will incur expenses that are the same as or similar to some of the adjustments made in our calculations, and our presentation of Adjusted EBITDA should not be construed to mean that our future results will be unaffected by such adjustments. Management compensates for these limitations by using Adjusted EBITDA as a supplemental financial metric and in conjunction with our results prepared in accordance with GAAP. The non-GAAP information should be read in conjunction with our accompanying consolidated financial statements and the related notes.
The following is a reconciliation of Adjusted EBITDA to the nearest GAAP measure, net income (loss) from continuing operations:
Year Ended December 31,
2019 2018
(dollars in thousands)
Net income (loss) from continuing operations $ 41,828 $ (36,419 )
Interest expense, net 33,695 53,201
Loss on extinguishment of debt -
58,475
Income tax expense (benefit) 13,127 (5,628 ) Depreciation and amortization 80,444
77,419
Unrealized gain on derivative financial instruments - (265 ) Offering and public company readiness expenses(a) 465
89
Stock-based compensation 4,187
2,299
Loss on disposal of property and equipment 584
552
Transaction costs(b) 2,750
6,636
Non-cash decrease in TRA liability (242 ) (1,189 ) Adjusted EBITDA$ 176,838 $ 155,170 Adjusted EBITDA margin(c) 8.2 % 7.6 %
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(a) Represents costs related to our initial public offering, secondary offering,
and public company readiness expenses.
(b) Represents costs related to our transactions, including fees to financial
advisors, accountants, attorneys, and other professionals, as well as
certain internal corporate development costs. The costs also include
non-cash purchase accounting effects to adjust for the effect of the
purchase accounting step-up in the value of inventory to fair value
recognized as a result of acquisitions.
(c) Adjusted EBITDA margin represents Adjusted EBITDA divided by net sales.
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