POOL CORPORATION For a discussion of our base business calculations, see the RESULTS OF OPERATIONS section below.
2020 FINANCIAL OVERVIEW
Impact of the COVID-19 Pandemic
OnMarch 11, 2020 , theWorld Health Organization declared the novel coronavirus disease (COVID-19) a pandemic, and onMarch 13, 2020 ,the United States declared a national emergency. States and cities have taken various measures in response to COVID-19, including mandating the closure of certain businesses and encouraging or requiring citizens to avoid large gatherings. Most of our North American operations are and have been continuously open for business as we are designated as an essential business in almost all of our markets. Our operations inEurope closed for a short period during the first half of 2020 inFrance ,Spain andItaly , in order to comply with local authorities' orders. Our products are used to maintain and protect outdoor commercial, residential and municipal environments through chemically-balanced, virus and bacteria-free swimming pool water. We also supply products used in the prevention of runoff, flood, fire and other natural disasters. These products are essential to the health and safety of the general public. As a result, our supply chain generally remains intact, with our customers continuing to meet end-user needs. The health, safety and security of our employees has been, and remains, one of our highest priorities. We have adapted our operations and implemented a number of measures to facilitate a safer sales center environment for both our customers and employees, which includes following best practices and guidelines from theCenters for Disease Control and Prevention (CDC ). We implemented enhanced hygiene and sanitation practices at our sales centers and at our corporate offices. In limited instances, we have had to close facilities in whole or in part as a result of government regulations, as well as positive or presumed positive results from COVID-19 testing. The direct impact of any closures did not have a material impact on our operations. Beginning in the middle ofMarch 2020 , when stay-at-home orders related to the COVID-19 pandemic were initially issued, we experienced sales declines across most markets. However, as stay-at-home restrictions eased in late April through early May, our business not only rebounded, but accelerated. We experienced unprecedented demand as families spent more time at home and sought out opportunities to create or expand existing home-based outdoor living and entertainment spaces, resulting in broad sales gains across nearly all of our product categories and geographies. While the short-term impact of this trend has had a positive impact on our business, it is unclear what the long-term impact will be. In addition, governmental restrictions have had a material impact on some of our customers, limiting their ability to operate in certain geographies from mid-March into mid-May. While these restrictions were lifted, new stay-at-home orders or other government mandates could have a material impact on our results. Our balance sheet is strong with low leverage and sufficient access to additional capital. Given the seasonality of our business, our warehouses were stocked with inventory in preparation for the upcoming peak season prior to the implementation of most stay-at-home orders. As a result, the limited vendor supply interruptions experienced in 2020 have had a minimal impact on our business. Supply disruptions have largely been limited to categories with the greatest demand, including heat-related equipment and above-ground swimming pools and have not been material to our business. We continue to work closely with our suppliers to maintain the flow of essential products to provide customers with the materials they need to serve their communities. Given the uncertainties caused by the COVID-19 pandemic, we began taking steps in April to reduce both capital expenditures and operating costs. As a result, capital expenditures in 2020 were$21.7 million , which is approximately 65% of 2019 capital expenditures. We specifically reduced operating costs for labor, fuel, utilities, advertising, meetings, travel and entertainment. As our business outlook and market trends improved since the implementation of these cost-saving measures, we continue to assess our discretionary spending. The impact of the ongoing pandemic on our business and financial results will continue to vary by location and depend on numerous evolving factors that we are not able to accurately predict. These factors include the duration and scope of the pandemic, global economic conditions during and after the pandemic, governmental actions that have been taken (or may be taken in the future) in response to the pandemic and changes in customer and supplier behavior in response to the pandemic. 24 --------------------------------------------------------------------------------
Financial Results
Net sales increased 23% to$3.9 billion for the year endedDecember 31, 2020 compared to$3.2 billion in 2019, while base business sales increased 22%. We realized broad sales gains across nearly all product categories. Our sales benefited from greater swimming pool usage and high demand for residential pool products, which was driven by home-centric trends influenced by the COVID-19 pandemic and aided by warmer weather conditions during the year. Gross profit reached$1.1 billion for the year endedDecember 31, 2020 , a 22% increase over gross profit of$924.9 million in 2019. Gross margin declined 20 basis points to 28.7% in 2020 compared to 28.9% in 2019. The decline in gross margin is primarily due to sales of lower margin, big-ticket items, such as pool equipment and in-ground and above-ground pools, which comprised a larger portion of our product mix in 2020 compared to 2019. Selling and administrative expenses (operating expenses) increased 14%, or$83.2 million , to$666.9 million in 2020, up from$583.7 million in 2019, with base business operating expenses up 12% over 2019. The increase in operating expenses primarily reflects a$43.9 million increase in performance-based compensation from$24.3 million in 2019 to$68.2 million in 2020 and expenses of$16.9 million from recently acquired businesses. Excluding$6.9 million of impairment charges we recorded in the first quarter of 2020 and performance-based compensation in both periods, adjusted operating expenses increased 6%, reflecting growth-driven labor and freight expenses and greater facility-related costs partially offset by lower discretionary spending. Operating income for the year increased 36% to$464.0 million , up from$341.2 million in 2019. Operating margin increased 110 basis points to 11.8% in 2020 compared to 10.7% in 2019. We recorded a$28.6 million , or$0.70 per diluted share, benefit from Accounting Standards Update (ASU) 2016-09, Improvements to Employee Share-Based Payment Accounting, for the year endedDecember 31, 2020 compared to a benefit of$23.5 million , or$0.57 per diluted share, realized in 2019. Net income increased 40% to$366.7 million in 2020 compared to$261.6 million in 2019. Earnings per share increased 40% to a record$8.97 per diluted share compared to$6.40 per diluted share in 2019. Excluding the impact of non-cash impairments, net of tax, in 2020 and the impact from ASU 2016-09 in both periods, adjusted diluted earnings per share increased 44% to$8.42 in 2020 compared to$5.83 in 2019. See the reconciliation of GAAP to non-GAAP measures included in RESULTS OF OPERATIONS below.
Financial Position and Liquidity
Cash provided by operations was
•payments of$124.6 million for acquisitions; •net debt repayments of$95.8 million ; •quarterly cash dividend payments to shareholders, totaling$91.9 million for the year; •share repurchases, totaling$76.2 million for the year; •net capital expenditures of$21.7 million ; and •growth in net working capital of$21.1 million . Total net receivables, including pledged receivables, increased 28% compared toDecember 31, 2019 , reflecting December sales growth and partially offset by improved collections. Our allowance for doubtful accounts was$4.8 million atDecember 31, 2020 and$5.5 million atDecember 31, 2019 . Our days sales outstanding ratio, as calculated on a trailing four quarters basis, was 26.5 days atDecember 31, 2020 and 29.0 days atDecember 31, 2019 . Inventory levels grew 11% to$781.0 million atDecember 31, 2020 compared to$702.3 million atDecember 31, 2019 , reflecting business growth and inventory from acquired businesses of$42.2 million . Our reserve for inventory obsolescence was$11.4 million atDecember 31, 2020 compared to$9.0 million atDecember 31, 2019 . Our inventory turns, as calculated on a trailing four quarters basis, were 3.8 times atDecember 31, 2020 and 3.2 times atDecember 31, 2019 . Accrued expenses and other current liabilities increased$82.9 million to$143.7 million in 2020, primarily reflecting increases in accrued performance-based compensation, unrealized losses on interest rate swaps and deferred payroll tax payments.
Total debt outstanding of
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--------------------------------------------------------------------------------Current Trends and Outlook
Due to the COVID-19 pandemic in 2020, families spent more time at home and sought out opportunities to create or expand existing home-based outdoor living and entertainment spaces, which resulted in an increase in new pool construction and greater expenditures for maintenance and remodeling products. We believe that increased consumer spending on homes, including outdoor living spaces, will continue in 2021 and may have longer term benefits as work-from-home trends persist or increase. The market environment fromJune 2009 , when the Great Recession ended, until 2020, when the COVID-19 pandemic-induced recession began, was characterized by steady economic expansion, the cautious recovery of consumer spending, modest housing recovery and low inflation. However, in terms of homeowners investing in their existing homes, discretionary expenditures, including backyard renovations, have flourished over this time period with steady increases in home values and lack of affordable new homes prompting homeowners to stay in their homes longer and upgrade their home environments, including their backyards. We expect that new pool and irrigation construction levels will continue to grow incrementally, constrained by availability of construction labor, but we believe that consumer investments in outdoor living spaces beyond the swimming pool will generate continued growth over the next several years. Although some constraints exist around residential construction activities, we believe that we are well positioned to take advantage of both the market expansion and the inherent long term growth opportunities in our industry. Additionally, recent regulation passed by theU.S. Department of Energy mandates all new and replacement motors and pumps for swimming pools must meet certain compliance regulations byJuly 2021 . This mandate, coupled with additional product developments and technological advancements, offers further growth opportunities over the next few years. In 2020, we benefited from strong pool construction trends as robust demand fueled by the COVID-19 pandemic led to increased home investment trends. While we estimate that new pool construction increased from approximately 80,000 units in 2019 to approximately 100,000 new units in 2020, construction levels are still down approximately 55% compared to peak historical levels and down approximately 40% from what we consider normal levels. Favorable weather plays a role in industry growth by accelerating growth in any given year, expanding the number of available construction days, extending the pool season and pool usage and positively impacting demand for discretionary products. Conversely, unfavorable weather impedes growth. In establishing our outlook each year, we base our growth assumptions on normal weather conditions and do not incorporate alternative weather predictions into our guidance. We established our initial outlook for 2021 based on reasonable expectations of organic market share growth, ongoing leverage of existing investments in our business and continuous process improvements. For 2021, we expect strong growth in the first half of the year, particularly the first quarter of 2021, due to continued elevated demand influenced by the ongoing COVID-19 pandemic. In the second half of the year, we expect to face tougher year-over-year comparisons and inherent industry capacity constraints, although we remain encouraged by positive industry outlooks. Impacts from the COVID-19 pandemic, coupled with heightened demand, could also adversely impact our supply chain, making it difficult to source and receive products needed to keep our customers adequately supplied. We anticipate that we may face product shortages or elevated prices specifically related to Trichlor, a popular sanitizer for pools and hot tubs, as the industry faces constraints resulting from the loss of a major supplier due to a fire in the summer of 2020. Although supply constraints did not have a material impact on our business in 2020, it is difficult to predict the extent to which this could impact our business in 2021. We expect to continue to gain market share through our comprehensive service and product offerings, which we continually diversify through internal sourcing initiatives and expansion into new markets. We also plan to broaden our geographic presence by opening 8 to 10 new sales centers in 2021 and by making selective acquisitions when appropriate opportunities arise. 26 --------------------------------------------------------------------------------
The following summarizes our outlook for 2021:
•We expect sales growth of 8% to 12%, impacted by the following factors and assumptions: •normal weather patterns for 2021; •continued elevated demand for residential pool products, driven by home-centric trends influenced by the COVID-19 pandemic; •a benefit from construction backlogs depending on our customers' building capacity, including the availability of labor, and weather; •estimated 4% to 5% growth from acquisitions completed throughout 2020; •market share gains; •inflationary product cost increases of approximately 2% to 3% (compared to our historical average of 1% to 2%); and •estimated 2% growth in the installed base of pools. •We expect gross margin to decline 20 to 40 basis points for the full year of 2021 compared to the full year of 2020 with gains or relatively neutral gross margin trends in the first half of 2021 and declines in the latter half of 2021. •We expect operating expenses will grow at approximately 60% to 70% of the rate of our gross profit growth, reflecting inflationary increases and incremental costs to support our sales growth expectations, with greater growth in the first half of the year and more modest growth in the back half. The main challenges in achieving this metric include managing people and facility costs in tight labor and real estate markets. However, we continue to see significant opportunity to leverage our existing infrastructure to achieve this goal. We also expect performance-based compensation for the full year of 2021 to normalize and decrease by approximately$30.0 million compared to the full year of 2020. In 2021, we expect our effective tax rate will approximate 25.5%, excluding the impact of ASU 2016-09. Our effective tax rate is dependent upon our results of operations and may change if actual results are different from our current expectation. Due to ASU 2016-09 requirements, we expect our effective tax rate will fluctuate from quarter to quarter, particularly in periods when employees elect to exercise their vested stock options or when restrictions on share-based awards lapse. Based on ourDecember 31, 2020 stock price, we estimate that we have approximately$4.5 million in unrealized excess tax benefits related to stock options that expire and restricted awards that vest in the first quarter of 2021. We may recognize additional tax benefits related to stock option exercises in 2021 from grants that expire in years after 2021, for which we have not included any expected benefits in our guidance. The estimated impact related to ASU 2016-09 is subject to several assumptions which can vary significantly, including our estimated share price and the period that our employees will exercise vested stock options. We recorded a$28.6 million benefit in our provision for income taxes for the year endedDecember 31, 2020 related to ASU 2016-09. We project that 2021 earnings will be in the range of$9.12 to$9.62 per diluted share, including an estimated$0.11 benefit from ASU 2016-09 during the first quarter of 2021. We expect cash provided by operations will approximate net income for fiscal year 2021. We expect to continue to use cash to fund opportunistic share repurchases over the next year. We also expect to use cash for the payment of cash dividends as and when declared by our Board of Directors. The forward-looking statements in this Current Trends and Outlook section are subject to significant risks and uncertainties, including the effects of the evolving COVID-19 pandemic, the sensitivity of our business to weather conditions, changes in the economy and the housing market, our ability to maintain favorable relationships with suppliers and manufacturers, competition from other leisure product alternatives and mass merchants and other risks detailed in Item 1A of this Form 10-K. Also see "Cautionary Statement for Purposes of the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995" prior to the heading "Risk Factors" in Item 1A. 27 --------------------------------------------------------------------------------
CRITICAL ACCOUNTING ESTIMATES
Critical accounting estimates are those estimates made in accordance withU.S. generally accepted accounting principles that involve a significant level of estimation uncertainty and have had, or are reasonably likely to have, a material impact on our financial condition or results of operations.
Management has discussed the development, selection and disclosure of our critical accounting estimates with the Audit Committee of our Board. Our critical accounting estimates are discussed below, including, to the extent material and reasonably available, the impact such estimates have had, or are reasonably likely to have, on our financial condition or results of operations.
Allowance for Doubtful Accounts
We maintain an allowance for doubtful accounts based on an estimate of the losses we will incur if our customers do not make required payments. We perform periodic credit evaluations of our customers and typically do not require collateral. Consistent with industry practices, we generally require payment from our North American customers within 30 days, except for sales under early buy programs for which we provide extended payment terms to qualified customers. The extended terms usually require payments in equal installments in April, May and June or May and June, depending on geographic location. Credit losses have generally been within or better than our expectations. Similar to our business, our customers' businesses are seasonal. Sales are lowest in the winter months and our past due accounts receivable balance as a percentage of total receivables generally increases during this time. We provide reserves for uncollectible accounts based on our accounts receivable aging. These reserves range from 0.05% for amounts currently due to up to 100% for specific accounts more than 60 days past due. At the end of each quarter, we perform a reserve analysis of all accounts with balances greater than$20,000 and more than 60 days past due. Additionally, we perform a separate reserve analysis on the balance of our accounts receivables with emphasis on past due accounts. We estimate future losses based upon historical bad debts, customer receivable balances, age of customer receivable balances, customers' financial conditions and current and forecasted economic trends, including certain trends in the housing market, the availability of consumer credit and general economic conditions (as commonly measured by Gross Domestic Product or GDP). We monitor housing market trends through review of the House Price Index as published by theFederal Housing Finance Agency , which measures the movement of single-family house prices. During the year, we write off account balances when we have exhausted reasonable collection efforts and determined that the likelihood of collection is remote. These write-offs are charged against our allowance for doubtful accounts. In the past five years, write-offs have averaged approximately 0.08% of net sales annually. Write-offs as a percentage of net sales approximated 0.09% in 2020, 0.12% in 2019 and 0.07% in 2018. We expect that write-offs will range from 0.05% to 0.10% of net sales in 2021. At the end of each fiscal year, we prepare a hindsight analysis by comparing the prior year-end allowance for doubtful accounts balance to (i) current year write-offs and (ii) any significantly aged outstanding receivable balances. Based on our hindsight analysis, we concluded that the prior year allowance was within a range of acceptable estimates and that our estimation methodology is appropriate. If the balance of the accounts receivable reserve increased or decreased by 20% atDecember 31, 2020 , pretax income would change by approximately$1.0 million and earnings per share would change by approximately$0.02 per diluted share (based on the number of weighted average diluted shares outstanding for the year endedDecember 31, 2020 ). Inventory Obsolescence Product inventories represent the largest asset on our balance sheet. Our goal is to manage our inventory such that we minimize stock-outs to provide the highest level of service to our customers. To do this, we maintain at each sales center an adequate inventory of stock keeping units (SKUs) with the highest sales volumes. At the same time, we continuously strive to better manage our slower moving classes of inventory, which are not as critical to our customers and thus, inherently turn at slower rates. 28 -------------------------------------------------------------------------------- We classify products at the sales center level based on sales at each location over the expected sellable period, which is the previous 12 months for most products, except for special order non-stock items that lack a SKU in our system and products with less than 12 months of usage. Below is a description of these inventory classifications: •new products with less than 12 months usage; •highest sales velocity items, which represent approximately 80% of net sales at the sales center; •lower sales velocity items, which we keep in stock to provide a high level of customer service; •products with no sales for the past 12 months at the local sales center level, excluding special order products not yet delivered to the customer; and •non-stock special order items. There is little risk of obsolescence for our highest sales velocity items, which represent approximately 80% of net sales at the sales center, because these products generally turn quickly. We establish our reserve for inventory obsolescence based on inventory with lower sales velocity and inventory with no sales for the past 12 months, which we believe represent some exposure to inventory obsolescence, with particular emphasis on SKUs with the least sales over the previous 12 months. The reserve is intended to reflect the value of inventory at net realizable value. We provide a reserve of 5% for inventory with lower sales velocity, inventory with no sales for the past 12 months and non-stock inventory as determined at the sales center level. We also provide an additional 5% reserve for excess lower sales velocity inventory and an additional 45% reserve for excess inventory with no sales for the past 12 months. We determine excess inventory, which is defined as the amount of inventory on hand in excess of the previous 12 months' usage, on a company-wide basis. We also evaluate whether the calculated reserve provides sufficient coverage of total inventory with no sales for the past 12 months. We have not changed our methodology from prior years.
In evaluating the adequacy of our reserve for inventory obsolescence, we consider a combination of factors, including:
•the level of inventory in relation to historical sales by product, including inventory usage by class based on product sales at both the sales center level and on a company-wide basis; •changes in customer preferences or regulatory requirements; •seasonal fluctuations in inventory levels; •geographic location; and •superseded products and new product offerings. We periodically adjust our reserve for inventory obsolescence as changes occur in the above-identified factors. At the end of each fiscal year, we prepare a hindsight analysis by comparing the prior year-end obsolescence reserve balance to (i) current year inventory write-offs and (ii) the value of products with no sales for the past 12 months that remain in inventory. Based on our hindsight analysis, we concluded that our prior year reserve was within a range of acceptable estimates and that our estimation methodology is appropriate. If the balance of our inventory reserve increased or decreased by 20% atDecember 31, 2020 , pretax income would change by approximately$2.3 million and earnings per share would change by approximately$0.04 per diluted share (based on the number of weighted average diluted shares outstanding for the year endedDecember 31, 2020 ). Vendor Programs Many of our vendor arrangements provide for us to receive specified amounts of consideration when we achieve any of a number of measures. These measures generally relate to the volume level of purchases from our vendors, or our net cost of products sold, and may include negotiated pricing arrangements. We account for vendor programs as a reduction of the prices of the vendor's products and therefore a reduction of inventory until we sell the product, at which time we recognize such consideration as a reduction of cost of sales in our income statement. Throughout the year, we estimate the amount earned based on our expectation of total purchases for the fiscal year relative to the purchase levels that mark our progress toward the attainment of various levels within certain vendor programs. We accrue vendor program benefits on a monthly basis using these estimates provided that we determine they are probable and reasonably estimable. Our estimates for annual purchases, future inventory levels and sales of qualifying products are driven by our sales projections, which can be significantly impacted by a number of external factors including changes in economic conditions and weather. Changes in our purchasing mix also impact our estimates, as certain program rates can vary depending on our volume of purchases from specific vendors. 29 -------------------------------------------------------------------------------- We continually revise these estimates throughout the year to reflect actual purchase levels and identifiable trends. As a result, our estimated quarterly vendor program benefits accrual may include cumulative catch-up adjustments to reflect any changes in our estimates between reporting periods. These adjustments tend to have a greater impact on gross margin in the fourth quarter since it is our seasonally slowest quarter and because the majority of our vendor arrangements are based on calendar year periods. We update our estimates for these arrangements at year end to reflect actual annual purchase or sales levels. In the first quarter of the subsequent year, we prepare a hindsight analysis by comparing actual vendor credits received to the prior year vendor receivable balances. Based on our hindsight analysis, we concluded that our vendor program estimates were within a range of acceptable estimates and that our estimation methodology is appropriate. If market conditions were to change, vendors may change the terms of some or all of these programs. Although such changes would not affect the amounts we have recorded related to products already purchased, they may lower or raise our cost for products purchased and sold in future periods.
Income Taxes
We record deferred tax assets and liabilities based on differences between the financial reporting and tax basis of assets and liabilities using currently enacted rates and laws that will be in effect when we expect the differences to reverse. Due to changing tax laws and state income tax rates, significant judgment is required to estimate the effective tax rate expected to apply to tax differences that are expected to reverse in the future. We record Global Intangible Low Tax Income (GILTI) on foreign earnings as period costs if and when incurred, although we not have realized any impacts since the enactment ofU.S. tax reform enacted inDecember 2017 . As ofDecember 31, 2020 ,U.S. income taxes were not provided on the earnings or cash balances of our foreign subsidiaries, outside of the provisions of the transition tax fromU.S. tax reform. As we have historically invested or expect to invest the undistributed earnings indefinitely to fund current cash flow needs in the countries where held, additional income tax provisions may be required. Determining the amount of unrecognized deferred tax liability on these undistributed earnings and cash balances is not practicable due to the complexity of tax laws and regulations and the varying circumstances, tax treatments and timing of any future repatriation. We determined not to change our indefinite reinvestment assertion in light ofU.S. tax reform. We operate in 39 states, 1 United States territory and 11 foreign countries. We are subject to regular audits by federal, state and foreign tax authorities, and the amount of income taxes we pay is subject to adjustment by the applicable tax authorities. We recognize a benefit from an uncertain tax position only after determining it is more likely than not that the tax position will withstand examination by the applicable taxing authority. Our estimate for the potential outcome of any uncertain tax issue is highly judgmental. We regularly evaluate our tax positions and incorporate these expectations into our reserve estimates. We believe we have adequately provided for any reasonably foreseeable outcome related to these matters. However, our future results may include favorable or unfavorable adjustments to our estimated tax liabilities in the period the assessments are made or resolved, or when statutes of limitation on potential assessments expire. These adjustments may include changes in valuation allowances that we have established. As a result of these uncertainties, our total income tax provision may fluctuate on a quarterly basis. Each year, we prepare a return to provision analysis upon filing our income tax returns. Based on this hindsight analysis, we concluded that our prior year income tax provision was within a range of acceptable estimates and that our provision calculation methodology is appropriate. Differences between our effective income tax rate and federal and state statutory tax rates are primarily due to valuation allowances recorded for certain of our international subsidiaries with tax losses.
Performance-Based Compensation Accrual
The Compensation Committee of our Board (Compensation Committee) annually
reviews our compensation structure to oversee management's implementation of
maintaining a program that attracts, retains, develops and motivates employees
without leading to unnecessary risk taking. Our compensation packages include
bonus plans that are specific to each group of eligible participants and their
levels and areas of responsibility. The majority of our bonus plans have annual
cash payments that are based primarily on objective performance criteria. We
calculate bonuses based on the achievement of certain key measurable financial
and operational results, including operating income and diluted earnings per
share (EPS).
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We use an annual cash performance award (annual bonus) to focus corporate
behavior on short-term goals for growth, financial performance and other
specific financial and business improvement metrics. Management sets the
company's annual bonus objectives at the beginning of the bonus plan year using
both historical information and forecasted results of operations for the current
plan year. Management also establishes specific business improvement objectives
for both our operating units and corporate employees. The Compensation Committee
approves objectives for annual bonus plans involving executive management.
We also utilize our medium-term (three-year) Strategic Plan Incentive Program
(SPIP) to provide senior management with an additional cash-based,
pay-for-performance award based on the achievement of specified earnings growth
objectives. Payouts through the SPIP are based on three-year compound annual
growth rates (CAGRs) of our diluted EPS.
We record annual performance-based compensation accruals based on operating
income achieved in a quarter as a percentage of total expected operating income
for the year. We estimate total expected operating income for the current plan
year using management's estimate of the total overall incentives earned per the
stated bonus plan objectives. Starting in June, and continuing each quarter
through our fiscal year end, we adjust our estimated performance-based
compensation accrual based on our detailed analysis of each bonus plan, the
participants' progress toward achievement of their specific objectives and
management's estimates related to the discretionary components of the bonus
plans, if any.
We record SPIP accruals based on our total expected EPS for the current fiscal
year and earnings growth estimates for the succeeding two years. We base our
current fiscal year estimates on the same assumptions used for our annual bonus
calculation and we base our forward-looking estimates on historical growth
trends and our projections for the remainder of the three-year performance
periods.
Our quarterly performance-based compensation expense and accrual balances may vary relative to actual annual bonus expense and payouts due to the following:
•differences between estimated and actual performance; •our projections related to achievement of multiple-year performance objectives for our SPIP; and •the discretionary components of the bonus plans. We generally make bonus payments at the end of February following the most recently completed fiscal year. Each year, we compare the actual bonus payouts to amounts accrued at the previous year's end to determine the accuracy of our performance-based compensation estimates. Based on our hindsight analysis, we concluded that our performance-based compensation accrual balances were within a reasonable range of acceptable estimates and that our estimation methodologies are appropriate.
Impairment of
Goodwill is our largest intangible asset. AtDecember 31, 2020 , our goodwill balance was$268.2 million , representing approximately 15% of total assets.Goodwill represents the excess of the amount we paid to acquire a company over the estimated fair value of tangible assets and identifiable intangible assets acquired, less liabilities assumed. We perform a goodwill impairment test in the fourth quarter of each year or on a more frequent basis if events or changes in circumstances occur that indicate potential impairment. To the extent the carrying value of a reporting unit is greater than its estimated fair value, we record a goodwill impairment charge for the difference, up to the carrying value of the goodwill. We recognize any impairment loss in operating income. Since we define an operating segment as an individual sales center and we do not have operations below the sales center level, we define a reporting unit as an individual sales center. As ofOctober 1, 2020 , we had 226 reporting units with allocated goodwill balances. The most significant goodwill balance for a reporting unit was$5.7 million and the average goodwill balance was$0.9 million .
In October of 2020, 2019 and 2018, we performed our annual goodwill impairment test and did not recognize any goodwill impairment at the reporting unit level.
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In the first quarter of 2020, we determined certain impairment triggers for our
Australian reporting units had occurred due to the impact of the COVID-19
pandemic on expected future operating cash flows. We performed interim goodwill
impairment analyses, which included discounted cash flow analyses, and
determined that the estimated fair values of our Australian reporting units no
longer exceeded their carrying values. In the period ended March 31, 2020 , we
recorded impairment equal to the total goodwill and intangibles carrying amounts
of our five Australian reporting units, which included goodwill impairment of
$3.5 million and intangibles impairment, related to the Pool Systems tradename
and trademark, of $0.9 million .
We estimate the fair value of our reporting units based on an income approach
that incorporates our assumptions for determining the present value of future
cash flows. We project future cash flows using management's assumptions for
sales growth rates, operating margins, discount rates and earnings multiples.
These estimates can significantly affect the outcome of our impairment test. We
also review for potential impairment indicators at the reporting unit level
based on an evaluation of recent historical operating trends, current and
projected local market conditions and other relevant factors as appropriate.
To test the reasonableness of our fair value estimates, we compared our
aggregate estimated fair values to our market capitalization as of the date of
our annual impairment test. We expect that a reasonable fair value estimate
would reflect a moderate acquisition premium. Our aggregate estimated fair
values fell in line with our market capitalization, which we consider to be
reasonable for the purpose of our goodwill impairment test. To facilitate a
sensitivity analysis, we reduced our consolidated fair value estimate to reflect
more conservative discounted cash flow assumptions, the sensitivity of a 50
basis point increase in our estimated weighted average cost of capital or a 50
basis point decrease in the estimated perpetuity growth rate. Our sensitivity
analysis generated a fair value estimate below our market capitalization and
resulted in the identification of no additional at-risk locations.
Based on our 2020 goodwill impairment analysis, we consider one of our Horizon
reporting units in California as most at risk for goodwill impairment due to
marginal results in recent years. The most sensitive assumptions related to our
fair value for this location relates to future projected operating results and
management's ability to effectively manage costs. As of December 31, 2020 , our
aggregate goodwill balance for this reporting unit was $1.4 million .
If our assumptions or estimates in our fair value calculations change or if
operating results are less than forecasted, we could incur impairment charges in
future periods, especially related to the reporting unit discussed
above. Impairment charges would decrease operating income, negatively impact
diluted EPS and result in lower asset values on our balance sheet.
Recent Accounting Pronouncements
See Note 1 of "Notes to Consolidated Financial Statements," included in Item 8 of this Form 10-K for details.
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--------------------------------------------------------------------------------RESULTS OF OPERATIONS
The table below summarizes information derived from our Consolidated Statements
of Income expressed as a percentage of net sales for the past three fiscal
years:
Year Ended December 31,
2020 2019 2018
Net sales 100.0 % 100.0 % 100.0 %
Cost of sales 71.3 71.1 71.0
Gross profit 28.7 28.9 29.0
Operating expenses 16.9 18.2 18.6
Operating income 11.8 10.7 10.5
Interest and other non-operating expenses, net 0.3 0.7 0.7
Income before income taxes and equity earnings 11.5 % 9.9 % 9.8 %
Note: Due to rounding, percentages may not add to operating income or income before income taxes and equity earnings.
Our discussion of consolidated operating results includes the operating results from acquisitions in 2020, 2019 and 2018. We have included the results of operations in our consolidated results since the respective acquisition dates.
Fiscal Year 2020 compared to Fiscal Year 2019
The following table breaks out our consolidated results into the base business
component and the excluded components (sales centers excluded from base
business):
(Unaudited) Base Business Excluded Total
(in thousands) Year Ended Year Ended Year Ended
December 31, December 31, December 31,
2020 2019 2020 2019 2020 2019
Net sales $ 3,886,079 $ 3,183,940 $ 50,544 $ 15,577 $ 3,936,623 $ 3,199,517
Gross profit 1,117,303 922,193 13,599 2,732 1,130,902 924,925
Gross margin 28.8 % 29.0 % 26.9 % 17.5 % 28.7 % 28.9 %
Operating expenses (1) 650,020 579,068 16,855 4,611 666,875 583,679
Expenses as a % of net sales 16.7 % 18.2 % 33.3 % 29.6 % 16.9 % 18.2 %
Operating income (loss) (1) 467,283 343,125 (3,256) (1,879) 464,027 341,246
Operating margin 12.0 % 10.8 % (6.4) % (12.1) % 11.8 % 10.7 %
(1)Base business and total include
33
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We have excluded the following acquisitions from base business for the periods
identified:
Net
Acquisition Sales Centers Periods
Acquired Date Acquired Excluded
TWC Distributors, Inc. (1) December 2020 10 December 2020
Jet Line Products, Inc. October 2020 9 October - December 2020
Northeastern Swimming Pool Distributors, September 2020 2 September - December 2020
Inc. (1)
Master Tile Network LLC (1) February 2020 4 February - December 2020
W.W. Adcock, Inc. (1) January 2019 4 January - March 2020 and
January - March 2019
Turf & Garden, Inc. (1) November 2018 4 January 2020 and
January 2019
(1)We acquired certain distribution assets of each of these companies.
When calculating our base business results, we exclude sales centers that are acquired, closed or opened in new markets for a period of 15 months. We also exclude consolidated sales centers when we do not expect to maintain the majority of the existing business and existing sales centers that are consolidated with acquired sales centers. We generally allocate corporate overhead expenses to excluded sales centers on the basis of their net sales as a percentage of total net sales. After 15 months of operations, we include acquired, consolidated and new market sales centers in the base business calculation including the comparative prior year period.
The table below summarizes the changes in our sales centers during 2020:
December 31, 2019 373 Acquired locations 25 New locations 3 Closed/consolidated locations (3)December 31, 2020 398
For information about our recent acquisitions, see Note 2 of "Notes to Consolidated Financial Statements," included in Item 8 of this Form 10-K.
34
--------------------------------------------------------------------------------Net Sales (in millions) Year Ended December 31, 2020 2019 Change Net sales$ 3,936.6 $ 3,199.5 $ 737.1 23% Net sales increased 23% compared to 2019, with 22% of this increase resulting from base business sales growth. As the pandemic forced families to spend more time at home in 2020, they sought out opportunities to create or expand existing home-based outdoor living and entertainment spaces. This created unprecedented demand throughout our markets, and we realized broad sales gains across nearly all product categories. Our sales benefited from greater swimming pool usage, high demand for residential pool products and warmer weather conditions during the year.
The following factors benefited our sales growth (listed in order of estimated magnitude):
•strong demand for discretionary products, as evidenced by improvements in sales growth rates for product offerings such as equipment, building materials and above-ground pools and hot tubs (see discussion below); •increased demand for residential swimming pool maintenance supplies due to earlier pool openings and increased usage, as evidenced by improvements in sales growth rates to retail customers (see discussion below); •market share gains, including those in building materials (see discussion below); •inflationary product cost increases of approximately 1% to 2%; •1% sales growth from recent acquisitions; and •1% sales growth from an additional selling day in 2020 compared to 2019. We believe that sales growth rates for certain product offerings, such as equipment, building materials and above-ground pools and hot tubs evidence increased spending in traditionally discretionary areas, such as pool construction, pool remodeling and equipment upgrades. In 2020, sales for equipment, such as swimming pool heaters, pumps, lights and filters, increased 31% compared to 2019, and collectively represented approximately 29% of net sales. This increase reflects both the growth of replacement activity and continued demand for higher-priced, more energy-efficient products. Sales of building materials, which includes tile and sales from recently acquired Master Tile locations, grew 23% compared to 2019 and represented approximately 12% of net sales in 2020. Sales of above-ground pools increased 57% in 2020 compared to 2019 and represented approximately 1% of net sales in 2020. Sales to customers who service large commercial installations and specialty retailers that sell swimming pool supplies are included in the appropriate existing product categories, and growth or decline in these areas are reflected in the numbers above. Sales to retail customers increased 24% compared to 2019 and represented approximately 13% of our net sales in 2020. Sales to commercial customers declined 10% in 2020, driven by COVID-19 related closures and the decline in both business and leisure travel. Sales to commercial customers represented approximately 4% of our net sales in 2020.
2020 Quarterly Sales Performance Compared to 2019 Quarterly Sales Performance
•Strong demand for discretionary products during the first quarter of 2020 led to net sales and base business sales growth of 13%. Sales were also favorably impacted by an additional selling day in the first quarter of 2020 compared to the first quarter of 2019. •Net sales and base business sales increased 14% in the second quarter of 2020 as stay-at-home restrictions eased in late April through early May, and sales benefited from greater swimming pool demand and usage, resulting in broad sales gains across many product categories and geographies. •In the third quarter of 2020, net sales and base business sales increased 27% and benefited from continued elevated demand for residential pool products, driven by home-centric trends influenced by the COVID-19 pandemic. •Net sales in the fourth quarter of 2020 increased 44%, while base business sales increased 39%. Sales benefited from continued stay-at-home trends combined with favorable weather nationwide and acquisitions, which added 4% to sales growth.
In addition to the sales discussion above, see further details of significant weather impacts under the subheading Seasonality and Quarterly Fluctuations below.
35
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Gross Profit
(in millions) Year Ended December 31,
2020 2019 Change
Gross profit $ 1,130.9 $ 924.9 $ 206.0 22%
Gross margin 28.7 % 28.9 %
Gross margin declined 20 basis points to 28.7% in 2020 compared to 28.9% in
2019, primarily due to sales of lower margin, big-ticket items, such as pool
equipment and in-ground and above-ground pools, which comprised a larger portion
of our product mix in 2020 compared to 2019.
Operating Expenses
(in millions) Year Ended December 31,
2020 2019 Change
Selling and administrative expenses $ 659.9 $ 583.7 $ 76.2 13%
Impairment of goodwill and other assets 6.9 - 6.9 100%
Operating expenses as a percentage of net
sales 16.9 % 18.2 %
Operating expenses increased 14%, or $83.2 million , to $666.9 million in 2020,
up from $583.7 million in 2019, while base business operating expenses grew 12%.
The increase in operating expenses primarily reflects a $43.9 million increase
in performance-based compensation from $24.3 million in 2019 to $68.2 million in
2020 and expenses of $16.9 million from recently acquired businesses.
In the first quarter of 2020, we recorded impairment charges of $6.9 million ,
which included non-cash goodwill and intangibles impairment charges of $4.4
million , equal to the total goodwill and intangibles carrying amounts of our
Australian reporting units, and $2.5 million from a long-term note, as
collectability was impacted by the COVID-19 pandemic.
Excluding impairment charges and performance-based compensation in both periods,
adjusted operating expenses were up 6%, reflecting growth-driven labor and
freight expenses and greater facility-related costs partially offset by lower
discretionary spending. As a result of strong expense control and our ability to
leverage our existing network, operating expenses as a percentage of net sales
declined 130 basis points, contributing to the 110 basis point expansion in our
operating margin for the year.
Interest and Other Non-operating Expenses, net
Interest and other non-operating expenses, net decreased$11.4 million compared to 2019, reflecting lower average debt levels and lower average interest rates between periods. Average outstanding debt was$422.2 million in 2020 versus$599.6 million in 2019. Our 2020 average outstanding debt balance has decreased as we utilized operating cash flows to pay off debt balances. Our weighted average effective interest rate decreased to 2.1% in 2020 compared to 3.4% in 2019. Income Taxes
Our effective income tax rate was 18.9% at
Net Income and Earnings Per Share
Net income increased 40% to$366.7 million in 2020 compared to$261.6 million in 2019. Adjusted net income, excluding the$6.3 million , or$0.15 per diluted share, impact of non-cash impairments, net of tax, increased 43% to$373.0 million . Earnings per share increased 40% to$8.97 per diluted share compared to$6.40 per diluted share in 2019. Excluding the impact of non-cash impairments, net of tax, and the impact from ASU 2016-09 in both periods, adjusted diluted earnings per share increased 44% to$8.42 in 2020 compared to$5.83 in 2019. See the reconciliation of GAAP to non-GAAP measures below. 36 --------------------------------------------------------------------------------
Reconciliation of Non-GAAP Financial Measures
Adjusted Income Statement Information
We have included adjusted net income and adjusted diluted EPS, which are
non-GAAP financial measures, as supplemental disclosures, because we believe
these measures are useful to investors and others in assessing our
year-over-year operating performance. We believe these measures should be
considered in addition to, not as a substitute for, net income and diluted EPS
presented in accordance with GAAP, respectively, and in the context of our other
disclosures included within this Form 10-Q. Other companies may calculate these
non-GAAP financial measures differently than we do, which may limit their
usefulness as comparative measures.
The table below presents a reconciliation of net income to adjusted net income.
(Unaudited) Year Ended
(in thousands) December 31,
2020
Net income $ 366,738
Impairment of goodwill and other assets 6,944
Tax impact on impairment of long-term note (1) (654)
Adjusted net income $ 373,028
(1)As described in our First Quarter 2020 Quarterly Report on Form 10-Q, our
effective tax rate at March 31, 2020 was a 0.1% benefit. Excluding impairment
from goodwill and intangibles and tax benefits from ASU 2016-09 recorded in the
first quarter of 2020, our effective tax rate for the first quarter of 2020 was
25.4%, which we used to calculate the tax impact related to the $2.5 million
long-term note impairment.
The table below presents a reconciliation of diluted EPS to adjusted diluted
EPS.
(Unaudited) Year Ended
December 31,
2020 2019
Diluted EPS $ 8.97 $ 6.40
After-tax non-cash impairment charges 0.15 -
Adjusted diluted EPS excluding after-tax non-cash impairment
charges 9.12 6.40
ASU 2016-09 tax benefit 0.70 0.57
Adjusted diluted EPS excluding after-tax non-cash impairment
charges and tax benefit $ 8.42 $ 5.83 Fiscal Year 2019 compared to Fiscal Year 2018
For a detailed discussion of the Results of Operations in Fiscal Year 2019 compared to Fiscal Year 2018, see the Results of Operations section of Management's Discussion and Analysis included in Part II, Item 7 of our 2019 Annual Report on Form 10-K.
37
--------------------------------------------------------------------------------Seasonality and Quarterly Fluctuations
For discussion regarding the effects seasonality and weather have on our business, see Item 1, "Business," of this Form 10-K.
The following table presents certain unaudited quarterly data for 2020 and 2019.
We have included income statement and balance sheet data for the most recent
eight quarters to allow for a meaningful comparison of the seasonal fluctuations
in these amounts. In our opinion, this information reflects all normal and
recurring adjustments considered necessary for a fair presentation of this data.
Due to the seasonal nature of our industry, the results of any one or more
quarters are not necessarily a good indication of results for an entire fiscal
year or of continuing trends.
(Unaudited) QUARTER
(in thousands) 2020 2019
First Second Third Fourth First Second Third Fourth
Statement of Income Data
Net sales $ 677,288 $ 1,280,846 $ 1,139,229 $ 839,261 $ 597,456 $ 1,121,328 $ 898,500 $ 582,234
Gross profit 189,629 373,481 328,698 239,095 174,631 330,314 257,931 162,050
Operating income 35,588 205,857 148,233 74,351 38,386 172,523 104,540 25,798
Net income 30,912 157,555 119,098 59,174 32,637 131,390 79,525 18,024
Net sales as a % of annual
net sales 17 % 33 % 29 % 21 % 19 % 35 % 28 % 18 %
Gross profit as a % of
annual gross profit 17 % 33 % 29 % 21 % 19 % 36 % 28 % 18 %
Operating income as a % of
annual operating income 8 % 44 % 32 % 16 % 11 % 51 % 31 % 8 %
Balance Sheet Data
Total receivables, net $ 345,915 $ 453,405 $ 307,798 $ 226,539 Product inventories, net 858,190 628,418 612,824 780,989 815,742 694,447 616,217 702,274 Accounts payable 517,620 346,272 268,412 266,753 472,487 342,335 214,309 261,963 Total debt 586,050 438,804 339,934 416,018 698,977 692,337 547,560 511,407
Note: Due to rounding, the sum of quarterly percentage amounts may not equal 100%.
38
--------------------------------------------------------------------------------Weather Impacts on Fiscal Year 2020 to Fiscal Year 2019 Comparisons
In the first quarter of 2020, sales benefited from above-average temperatures throughout the contiguousUnited States , particularly in the southernUnited States . These favorable weather conditions contrast from the first quarter of 2019 when wetter and cooler-than-normal temperatures to begin the year hindered sales growth. Weather conditions in the second quarter of 2020 were varied across the contiguousUnited States ; however, results in the second quarter of 2020 benefited from generally mild weather conditions. Much of the westernUnited States benefited from warmer weather, while the southeasternUnited States experienced slightly below-average temperatures.Southern California and the southeasternUnited States , includingFlorida , experienced more precipitation than normal. In contrast, results for the second quarter of 2019 were largely impacted by record rainfall and cooler temperatures in three of our largest markets,California ,Texas andArizona , particularly in the month of May, which was the second wettest May on record for the contiguousUnited States . Overall, weather conditions in the third quarter of 2020 were generally favorable, which benefited results. Much of the westernUnited States experienced above-average temperatures, particularly inCalifornia , which was also plagued with the most active wildfire year on record. Precipitation was below-average in most of the western half ofthe United States and normal to above-average in the eastern half. Likewise, results in the third quarter of 2019 were positively impacted by above-average temperatures and below-average precipitation throughout most of the country. Sales in the fourth quarter of 2020 benefited from above-average temperatures and below-average precipitation, particularly in the month of November, which was the fourth warmest on record in a 126-year period for the contiguousUnited States . Similarly, in the fourth quarter of 2019, sales benefited from above average temperatures, primarily in the southern and southeasternUnited States .
Weather Impacts on Fiscal Year 2019 to Fiscal Year 2018 Comparisons
For a detailed discussion of Weather Impacts on Fiscal Year 2019 compared to Fiscal Year 2018, see the Seasonality and Quarterly Fluctuations section of Management's Discussion and Analysis included in Part II, Item 7 of our 2019 Annual Report on Form 10-K. Geographic Areas
Since all of our sales centers have similar operations and share similar economic characteristics, we aggregate our sales centers into a single reportable segment. For additional details, see Note 1 of our "Notes to Consolidated Financial Statements," included in Item 8 of this Form 10-K.
For a breakdown of net sales and property, plant and equipment between our
39
--------------------------------------------------------------------------------LIQUIDITY AND CAPITAL RESOURCES
Liquidity is defined as the ability to generate adequate amounts of cash to meet short-term and long-term cash needs. We assess our liquidity in terms of our ability to generate cash to fund our operating activities, taking into consideration the seasonal nature of our business. Significant factors which could affect our liquidity include the following: •cash flows generated from operating activities; •the adequacy of available bank lines of credit; •the quality of our receivables; •acquisitions; •dividend payments; •capital expenditures; •changes in income tax laws and regulations; •the timing and extent of share repurchases; and •the ability to attract long-term capital with satisfactory terms. Our primary capital needs are seasonal working capital obligations, debt repayment obligations and other general corporate initiatives, including acquisitions, opening new sales centers, dividend payments and share repurchases. Our primary working capital obligations are for the purchase of inventory, payroll, rent, other facility costs and selling and administrative expenses. Our working capital obligations fluctuate during the year, driven primarily by seasonality and the timing of inventory purchases. Our primary sources of working capital are cash from operations supplemented by bank borrowings, which have historically been sufficient to support our growth and finance acquisitions. The same principle applies to funds used for capital expenditures and share repurchases. We prioritize our use of cash based on investing in our business, maintaining a prudent capital structure, including a modest amount of debt, and returning cash to our shareholders through dividends and share repurchases. Our specific priorities for the use of cash are as follows: •capital expenditures primarily for maintenance and growth of our sales center structure, technology-related investments and fleet vehicles; •strategic acquisitions executed opportunistically; •payment of cash dividends as and when declared by our Board of Directors (Board); •repayment of debt to maintain an average total leverage ratio (as defined below) between 1.5 and 2.0; and •repurchases of our common stock under our Board authorized share repurchase program. Capital expenditures were 0.6% of net sales in 2020, 1.0% of net sales in 2019 and 1.1% of net sales in 2018. Capital expenditures in 2020 were lower than our historical average due to cost-saving measures implemented at the beginning of the COVID-19 pandemic. Over the last five years, capital expenditures have averaged roughly 1.0% of net sales. Our capital spending primarily relates to leasehold improvements, delivery and service vehicles and information technology. We focus our capital expenditure plans on the needs of our sales centers. For 2021, based on management's current plans, we project capital expenditures will continue to approximate the historical average. As ofDecember 31, 2020 , our average total leverage ratio was 0.86, which was below our target range of between 1.5 and 2.0 and below our average total leverage ratio of 1.61 as ofDecember 31, 2019 . Our strong operating results and cash flow from operations enabled us to reduce our debt balances in 2020. We expect our average total leverage ratio through the first half of 2021 will continue to be below our target range. We believe we have adequate availability of capital to fund present operations and the current capacity to finance any working capital needs that may arise. We continually evaluate potential acquisitions and hold discussions with acquisition candidates. If suitable acquisition opportunities arise that would require financing, we believe that we have the ability to finance any such transactions. As ofFebruary 19, 2021 ,$172.0 million of the current Board authorized amount under our authorized share repurchase plan remained available. We expect to repurchase additional shares in the open market from time to time depending on market conditions. We plan to fund these repurchases with cash provided by operations and borrowings under the credit and receivables facilities. 40 --------------------------------------------------------------------------------
Sources and Uses of Cash
The following table summarizes our cash flows (in thousands):
Year Ended December 31,
2020 2019
Operating activities $ 397,581 $ 298,776
Investing activities (146,289) (42,263)
Financing activities (244,371) (244,486)
Cash provided by operations of $397.6 million for 2020 increased $98.8 million
compared to 2019, primarily reflecting the $105.2 million improvement in net
income.
Cash used in investing activities increased in 2020 due to an increase of
Cash used in financing activities was$244.4 million in 2020, consistent with$244.5 million in 2019, which primarily reflects a$59.6 million decrease in net debt payments, offset by additional share repurchases of$53.0 million and an increase in dividends paid of$8.2 million . For a discussion of our sources and uses of cash in 2018, see the Liquidity and Capital Resources - Sources and Uses of Cash section of Management's Discussion and Analysis included in Part II, Item 7 of our 2019 Annual Report on Form 10-K.
Future Sources and Uses of Cash
To supplement cash from operations as our primary source of working capital, we will continue to utilize our three major credit facilities, which are the Amended and Restated Revolving Credit Facility (the Credit Facility), the Term Facility (the Term Facility) and the Receivables Securitization Facility (the Receivables Facility). For additional details regarding these facilities, see Note 5 of our "Notes to Consolidated Financial Statements," included in Item 8 of this Form 10-K. Revolving Credit Facility Our Credit Facility provides for$750.0 million in borrowing capacity under a five-year unsecured revolving credit facility and includes sublimits for the issuance of swingline loans and standby letters of credit. Pursuant to an accordion feature, the aggregate maximum principal amount of the commitments under the Credit Facility may be increased at our request and with agreement by the lenders by up to$75.0 million , to a total of$825.0 million . The Credit Facility matures onSeptember 29, 2022 . We intend to use the Credit Facility for general corporate purposes, for future share repurchases and to fund future growth initiatives. AtDecember 31, 2020 , there was$109.0 million outstanding, a$4.8 million standby letter of credit outstanding and$636.2 million available for borrowing under the Credit Facility. The weighted average effective interest rate for the Credit Facility as ofDecember 31, 2020 was approximately 1.2%, excluding commitment fees.
Term Facility
Our Term Facility provides for$185.0 million in borrowing capacity and matures onDecember 30, 2026 . Proceeds from the Term Facility were used to pay down the Credit Facility, adding capacity for future share repurchases, acquisitions and growth-oriented working capital expansion. The Term Facility is repaid in quarterly installments of 1.250% of the Term Facility on the last business day of each quarter beginning in the first quarter of 2020. We classify the entire outstanding balance as Long-term debt on our Consolidated Balance Sheets as we intend and have the ability to refinance the obligations on a long-term basis. The total of the quarterly payments will be equal to 33.75% of the Term Facility with the final principal repayment, equal to 66.25% of the Term Facility, due on the maturity date. We may prepay amounts outstanding under the Term Facility without penalty other than interest breakage costs.
At
41
--------------------------------------------------------------------------------Financial Covenants
Financial covenants of the Credit Facility and the Term Facility include
maintenance of a maximum average total leverage ratio and a minimum fixed charge
coverage ratio, which are our most restrictive financial covenants. As of
•Maximum Average Total Leverage Ratio. On the last day of each fiscal quarter, our average total leverage ratio must be less than 3.25 to 1.00. Average Total Leverage Ratio is the ratio of the trailing twelve months (TTM) Average Total Funded Indebtedness plus the TTM Average Accounts Securitization Proceeds divided by the TTM EBITDA (as those terms are defined in the Credit Facility). As ofDecember 31, 2020 , our average total leverage ratio equaled 0.86 (compared to 1.61 as ofDecember 31, 2019 ) and the TTM average total debt amount used in this calculation was$439.3 million . •Minimum Fixed Charge Coverage Ratio. On the last day of each fiscal quarter, our fixed charge ratio must be greater than or equal to 2.25 to 1.00. Fixed Charge Ratio is the ratio of the TTM EBITDAR divided by TTM Interest Expense paid or payable in cash plus TTM Rental Expense (as those terms are defined in the Credit Facility). As ofDecember 31, 2020 , our fixed charge ratio equaled 7.81 (compared to 5.38 as ofDecember 31, 2019 ) and TTM Rental Expense was$63.2 million . The Credit Facility and the Term Facility also limit the declaration and payment of dividends on our common stock to no more than 50% of the preceding year's Net Income (as defined in the Credit Facility and the Term Facility), provided no default or event of default has occurred and is continuing, or would result from the payment of dividends. Additionally, we may declare and pay quarterly dividends notwithstanding that the aggregate amount of dividends paid would be in excess of the 50% limit described above so long as (i) the amount per share of such dividends does not exceed the amount per share paid during the most recent fiscal year in which we were in compliance with the 50% limit and (ii) our Average Total Leverage Ratio is less than 3.00 to 1.00 both immediately before and after giving pro forma effect to such dividends. Further, dividends must be declared and paid in a manner consistent with our past practice. Under the Credit Facility and the Term Facility, we may repurchase shares of our common stock provided no default or event of default has occurred and is continuing, or would result from the repurchase of shares, and our maximum average total leverage ratio (determined on a pro forma basis) is less than 2.50 to 1.00. Other covenants include restrictions on our ability to grant liens, incur indebtedness, make investments, merge or consolidate, and sell or transfer assets. Failure to comply with any of our financial covenants or any other terms of the Credit Facility and the Term Facility could result in higher interest rates on our borrowings or the acceleration of the maturities of our outstanding debt.
Receivables Securitization Facility
Our two-year accounts receivable securitization facility (the Receivables Facility) offers us a lower-cost form of financing, with a peak funding capacity of up to$295.0 million between May 1 and May 31 , which includes an additional seasonal funding capacity that is availablebetween March 1 and July 31 . Other funding capacities range from$120.0 million to$275.0 million throughout the remaining months of the year. The Receivables Facility matures onNovember 1, 2021 . We classify the entire outstanding balance as Long-term debt on our Consolidated Balance Sheets as we intend and have the ability to refinance the obligations on a long-term basis. The Receivables Facility provides for the sale of certain of our receivables to a wholly-owned subsidiary (the Securitization Subsidiary). The Securitization Subsidiary transfers variable undivided percentage interests in the receivables and related rights to certain third-party financial institutions in exchange for cash proceeds, limited to the applicable funding capacities. Upon payment of the receivables by customers, rather than remitting to the financial institutions the amounts collected, we retain such collections as proceeds for the sale of new receivables until payments become due. The Receivables Facility contains terms and conditions (including representations, covenants and conditions precedent) customary for transactions of this type. Additionally, an amortization event will occur if we fail to maintain a maximum average total leverage ratio (average total funded debt/EBITDA) of 3.25 to 1.00 and a minimum fixed charge coverage ratio (EBITDAR/cash interest expense plus rental expense) of 2.25 to 1.00. AtDecember 31, 2020 , there was$120.0 million outstanding under the Receivables Facility at a weighted average effective interest rate of 0.9%, excluding commitment fees. 42 -------------------------------------------------------------------------------- Interest Rate Swaps We utilize interest rate swap contracts and forward-starting interest rate swap contracts to reduce our exposure to fluctuations in variable interest rates for future interest payments on our variable rate borrowings. Interest expense related to the notional amounts under all swap contracts is based on the fixed rates plus the applicable margin on the respective borrowings. In 2020, we had one interest rate swap in place, which became effective onNovember 20, 2019 and terminated onNovember 20, 2020 . This swap contract was previously forward-looking and converted the variable interest rate on our variable rate borrowings to a fixed rate of 1.1425% on a notional amount of$150.0 million . As ofDecember 31, 2020 , we had two interest rate swap contracts in place, which became effective onNovember 20, 2020 and terminate onSeptember 29, 2022 . These swap contracts were previously forward-starting and convert the variable interest rates on our variable rate borrowings to fixed interest rates of 2.0925% and 1.5500%, respectively, on notional amounts of$75.0 million each. We have entered into forward-starting interest rate swap contracts to extend the hedged period for future interest payments on our variable rate borrowings. These swap contracts will convert the variable interest rate to a fixed interest rate on our variable rate borrowings. The following table provides details related to each of our forward-starting interest rate swap contracts: Notional Amount Derivative Inception Date Effective Date Termination Date (in millions) Fixed Interest Rate Forward-starting interest rate February 5, 2020 February 26, 2021 February 28, 2025$150.0 1.3800% swap 1 Forward-starting interest rate March 9, 2020 September 29, 2022 February 26, 2027$150.0 0.7400% swap 2 Forward-starting interest rate March 9, 2020 February 28, 2025 February 26, 2027$150.0 0.8130% swap 3 Compliance and Future Availability As ofDecember 31, 2020 , we were in compliance with all covenants and financial ratio requirements under our Credit Facility, our Term Facility and our Receivables Facility. We believe we will remain in compliance with all covenants and financial ratio requirements throughout 2021. For additional information regarding our debt arrangements, see Note 5 of "Notes to Consolidated Financial Statements," included in Item 8 of this Form 10-K. 43 --------------------------------------------------------------------------------
Contractual Obligations
At
Payments Due by Period
Less than More than
Total 1 year 1-3 years 3-5 years 5 years
Long-term debt $ 416,643 $ 141,119 $ 127,524 $ 18,500 $ 129,500
Operating leases 223,715 56,443 92,403 47,121 27,748
Purchase obligations (1) 106,357 36,369 69,988 - -
$ 746,715 $ 233,931 $ 289,915 $ 65,621 $ 157,248
(1) Purchase obligations include all legally binding contracts such as firm
minimum commitments for inventory purchases and software commitments. We issue
inventory purchase orders in the normal course of business, which represent
authorizations to purchase that are cancellable by their terms. We do not
consider purchase orders to be firm inventory commitments; therefore, they are
excluded from the table above.
The table below contains estimated interest payments (in thousands) related to
our long-term debt obligations presented in the table above. We calculated
estimates of future interest payments based on the December 31, 2020 outstanding
debt balances, using the fixed rates under our interest rate swap agreements for
the applicable notional amounts and the weighted average effective interest
rates as of December 31, 2020 for the remaining outstanding balances not covered
by our swap contracts. To project the estimated interest expense to coincide
with the time periods used in the table above, we projected the estimated debt
balances for future years based on the scheduled maturity dates of the Credit
Facility, the Term Facility and the Receivables Facility. For certain of our
contractual obligations, such as unrecognized tax benefits, uncertainties exist
regarding the timing of future payments and the amount by which these potential
obligations will increase or decrease over time. As such, we have excluded
unrecognized tax benefits from our contractual obligations table. See Notes 5
and 7 of "Notes to Consolidated Financial Statements," included in Item 8 of
this Form 10-K for additional discussion related to our debt and more
information related to our unrecognized tax benefits.
Estimated Interest Payments Due by Period
Less than More than
Total 1 year 1-3 years 3-5 years 5 years
Interest $ 23,659 $ 6,793 $ 8,497 $ 5,651 $ 2,718
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