POOL CORP 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations You should read the following discussion in conjunction with the accompanying interim Consolidated Financial Statements and notes, the Consolidated Financial Statements and accompanying notes in our 2020 Annual Report on Form 10-K and with Management’s Discussion and Analysis in our 2020 Annual Report on Form 10-K. For a discussion of our base business calculations, see the Results of Operations section below. Forward-Looking Statements This report contains forward-looking information that involves risks and uncertainties. Our forward-looking statements express our current expectations or forecasts of possible future results or events, including projections of earnings and other financial performance measures, statements of management’s expectations regarding our plans and objectives and industry, general economic and other forecasts of trends, future dividend payments and share repurchases, and other matters. Forward-looking statements speak only as of the date of this filing, and we undertake no obligation to update or revise such statements to reflect new circumstances or unanticipated events as they occur. You can identify these statements by the fact that they do not relate strictly to historic or current facts and often use words such as “anticipate,” “estimate,” “expect,” “intend,” “believe,” “will likely result,” “outlook,” “project,” “may,” “can,” “plan,” “target,” “potential,” “should” and other words and expressions of similar meaning. No assurance can be given that the expected results in any forward-looking statement will be achieved, and actual results may differ materially due to one or more factors, including impacts on our business from the COVID-19 pandemic and the extent to which home-centric trends will continue, accelerate or reverse; 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; excess tax benefits or deficiencies recognized under ASU 2016-09 and other risks detailed in our 2020 Annual Report on Form 10-K and in Part II, Item 1A. of this Form 10-Q. For these statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. OVERVIEW Impact of the COVID-19 Pandemic On March 11, 2020, the World Health Organization declared the novel coronavirus disease (COVID-19) a pandemic, and on March 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. We are designated as an essential business in almost all of our markets. 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. In limited instances, we have had to close facilities as a result of government regulations, as well as COVID-19 testing results. The direct impact of any closures to-date have not had a material impact on our operations. Beginning in the middle of March 2020, when stay-at-home orders related to the COVID-19 pandemic were initially issued, we experienced sales declines across most markets. As stay-at-home restrictions eased in late April through early May, our business not only rebounded, but accelerated. Throughout the remainder of 2020, 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, and these trends have continued in 2021 to-date. 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 in 2020 had a material impact on some of our customers, limiting their ability to operate in certain geographies for a short period of time. While these restrictions were lifted, new stay-at-home orders or other government mandates could have a material impact on our results. 11 Our balance sheet is strong with low leverage and sufficient access to additional capital. Supply disruptions have largely been limited to categories with the greatest demand (including heat-related equipment, chemicals, in-ground swimming pools and above-ground swimming pools) and have not been material to our business. Continued impacts from the COVID-19 pandemic, coupled with heightened demand, could adversely impact our supply chain, making it difficult to source and receive products needed to keep our customers adequately supplied throughout the swimming pool season. Given the uncertainties caused by the COVID-19 pandemic in 2020, we reduced capital expenditures and operating costs for labor, fuel, utilities, advertising, meetings, travel and entertainment. Capital expenditures in 2020 were $21.7 million or approximately 65% of 2019 capital expenditures. We expect capital expenditures in 2021 to approximate the historical average of 1.0% of net sales. Our expense growth so far in 2021 continues to be offset by lower discretionary spending for advertising, meetings, travel and entertainment as business travel remains restricted due to the COVID-19 pandemic. However, we believe that discretionary spending in the latter part of 2021 will increase depending on vaccination progress and the easing of travel restrictions in various locations, particularly when comparing these considerations to the same period of 2020. 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 the Centers for Disease Control and Prevention (CDC). We implemented enhanced hygiene and sanitation practices at our sales centers and at our corporate offices in 2020, and we continue to evaluate and maintain them. We expect the impact of the pandemic on our business and financial results in 2021 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. Financial Results In the first quarter of 2021, net sales increased 57% to $1.06 billion compared to $677.3 million in the first quarter of 2020, while base business sales grew 51%. Our sales have continued to benefit from elevated demand for residential pool products, driven by home-centric trends influenced by the COVID-19 pandemic. Maintenance, replacement, refurbishment and construction activity remain strong as families create and expand home-based outdoor living and entertainment spaces, resulting in broad sales gains across nearly all product categories. Gross profit increased 59% to $301.1 million in the first quarter of 2021 from $189.6 million in the same period of 2020. Base business gross profit improved 54% over the first quarter of 2020. Gross margin increased 40 basis points to 28.4% in the first quarter of 2021 compared to 28.0% in the first quarter of 2020 reflecting a combination of strong demand with higher volume-based purchasing incentives, a favorable customer sales mix and some inflation benefit year-over-year. Selling and administrative expenses (operating expenses) increased 12% to $172.1 million in the first quarter of 2021 compared to $154.0 million in the first quarter of 2020, reflecting an increase of $11.5 million in performance-based compensation expense and increases in other growth-driven costs. As a percentage of net sales, operating expenses decreased 650 basis points to 16.2% in the first quarter of 2021 compared to 22.7% in the same period of 2020 primarily due to strong expense control and our ability to leverage our existing network. Excluding the prior year impact of non-cash impairments, operating expenses increased 17% in the first quarter of 2021 compared to the first quarter of 2020 and decreased 550 basis points as a percentage of net sales from 21.7% in the first quarter of 2020. Operating income in the first quarter of 2021 increased 263% to $129.0 million compared to $35.6 million in the same period in 2020. Operating margin was 12.2% in the first quarter of 2021 compared to 5.3% in the first quarter of 2020. We recorded a $4.0 million, or $0.10 per diluted share, tax benefit from Accounting Standards Update (ASU) 2016-09, Improvements to Employee Share-Based Payment Accounting , in the quarter ended March 31, 2021, compared to a tax benefit of $8.0 million, or $0.19 per diluted share, realized in the same period of 2020. Net income increased 219% to $98.7 million in the first quarter of 2021 compared to $30.9 million in the first quarter of 2020. Earnings per diluted share increased 223% to $2.42 in the first quarter of 2021 compared to $0.75 in the same period of 2020. References to product line and product category data throughout this report generally reflect data related to the North American swimming pool market, as it is more readily available for analysis and represents the largest component of our operations. 12 Financial Position and Liquidity As of March 31, 2021, total net receivables, including pledged receivables, increased 41% compared to March 31, 2020, driven by our March sales growth and partially offset by improved collections. Our days sales outstanding (DSO), as calculated on a trailing four quarters basis, was 26.6 days at March 31, 2021 and 29.2 days at March 31, 2020. Our allowance for doubtful accounts balance was $4.7 million at March 31, 2021 and $6.9 million at March 31, 2020. Net inventory levels increased 14% compared to levels at March 31, 2020, reflecting organic business growth and inventory from recently acquired businesses of $55.5 million. The inventory reserve was $13.7 million at March 31, 2021 and $10.3 million at March 31, 2020. Our inventory turns, as calculated on a trailing four quarters basis, were 4.0 times at March 31, 2021 and 3.2 times at March 31, 2020. Accrued expenses and other current liabilities increased 115% compared to March 31, 2020, primarily reflecting growth-driven increases in accrued performance-based compensation and accrued tax payments. Total debt outstanding at March 31, 2021 was $433.2 million, down 26% compared to total debt at March 31, 2020, as we continue to utilize operating cash flows to decrease debt balances. We have used debt proceeds over the past 12 months primarily to fund business-driven working capital growth, acquisitions, payments of cash dividends and share repurchases. Current Trends and Outlook For a detailed discussion of trends through 2020, see the Current Trends and Outlook section of Management’s Discussion and Analysis included in Part II, Item 7 of our 2020 Annual Report on Form 10-K. We expect 2021 diluted EPS of $11.85 to $12.60, including the impact of year-to-date tax benefits of $0.10. Our previous 2021 earnings guidance range disclosed in our 2020 Annual Report on Form 10-K was $9.12 to $9.62, including an estimated tax benefit of $0.11. Our 2021 earnings guidance range assumes average weather conditions and no adverse impacts from a resurgence of COVID-19 and related government responses. We project net sales growth for 2021 of 20% or more with continued strong growth in the second quarter of 2021, due to elevated demand trends and a solid backlog of customer projects. We believe that we will face tougher year-over-year comparisons in the second half of the year and inherent industry capacity constraints, although we remain encouraged by positive industry outlooks. We estimate that sales will be favorably impacted by inflationary product cost increases of 4% to 5% (above our historical average of 1% to 2%). Impacts from the COVID-19 pandemic, coupled with heightened demand, could adversely impact our supply chain, making it difficult to source and receive products needed to keep our customers adequately supplied. We expect gross margin for the full year of 2021 to be relatively flat or decline slightly (up to 20 basis points) compared to the full year of 2020 with gains or relatively neutral gross margin trends in the second quarter of 2021 and neutral or slight declines in the latter half of 2021. We expect operating expenses to reflect inflationary increases and incremental costs to support our sales growth expectations, which we believe will enable us to exceed operating margin improvement of 100 basis points for the full year of 2021 compared to 2020. We believe that discretionary spending for advertising, meetings, travel and entertainment in the latter part of 2021 will increase depending on vaccination progress and the easing of travel restrictions in various locations. We project that our annual effective tax rate (excluding the benefit from ASU 2016-09) for 2021 will approximate 25.0%, which is consistent with 2020. Our effective tax rate is dependent on several variables, including our results of operations and may change if actual results differ materially from our current expectations, particularly any significant changes in our geographic mix of sales. Due to ASU 2016-09, 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. We recorded a $4.0 million, or $0.10 per diluted share, tax benefit from ASU 2016-09 for the three months ended March 31, 2021. We may recognize additional tax benefits related to stock option exercises in 2021 from grants that expire in years after 2021. We have not included any expected benefits in our guidance beyond what we have recognized as of March 31, 2021. 13 We believe that cash provided by operations will approximate net income for the 2021 fiscal year. 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 Board). The forward-looking statements in the foregoing section are based on current market conditions, speak only as of the filing date of this report, and are subject to significant risks and uncertainties. See “Cautionary Statement for Forward-Looking Statements.” RESULTS OF OPERATIONS As of March 31, 2021, we conducted operations through 400 sales centers in North America, Europe and Australia. For the three months ended March 31, 2021, approximately 93% of our net sales were from our operations in North America. The following table presents information derived from the Consolidated Statements of Income expressed as a percentage of net sales: Three Months Ended March 31, 2021 2020 Net sales 100.0 % 100.0 % Cost of sales 71.6 72.0 Gross profit 28.4 28.0 Selling and administrative expenses 16.2 21.7 Impairment of goodwill and other assets — 1.0 Operating income 12.2 5.3 Interest and other non-operating expenses, net 0.2 0.7 Income before income taxes and equity earnings 11.9 % 4.5 % Note: Due to rounding, percentages presented in the table above may not add to Income before income taxes and equity earnings. We have included the results of operations from acquisitions in 2021 and 2020 in our consolidated results since the acquisition dates. Three Months Ended March 31, 2021 Compared to Three Months Ended March 31, 2020 The following table breaks out our consolidated results into the base business component and the excluded component (sales centers excluded from base business): (Unaudited) Base Business Excluded Total (in thousands) Three Months Ended Three Months Ended Three Months Ended March 31, March 31, March 31, 2021 2020 2021 2020 2021 2020 Net sales $ 1,015,632 $ 674,082 $ 45,113 $ 3,206 $ 1,060,745 $ 677,288 Gross profit 290,115 188,292 11,016 1,337 301,131 189,629 Gross margin 28.6 % 27.9 % 24.4 % 41.7 % 28.4 % 28.0 % Operating expenses (1) 160,995 152,815 11,105 1,226 172,100 154,041 Expenses as a % of net sales 15.9 % 22.7 % 24.6 % 38.2 % 16.2 % 22.7 % Operating income (loss) (1) 129,120 35,477 (89) 111 129,031 35,588 Operating margin 12.7 % 5.3 % (0.2) % 3.5 % 12.2 % 5.3 % (1) Base business and total for 2020 reflect $6.9 million of impairment from goodwill and other assets. 14 In our calculation of our base business results, we have excluded the following acquisitions for the periods identified: Acquired Acquisition Date Net Sales Centers Acquired Periods Excluded TWC Distributors, Inc. (1) December 2020 10 January - March 2021 Jet Line Products, Inc. October 2020 9 January - March 2021 Northeastern Swimming Pool Distributors, Inc. (1) September 2020 2 January - March 2021 Master Tile Network LLC (1) February 2020 4 January - March 2021 and February - March 2020 (1) We acquired certain distribution assets of this company. 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 center count during the first three months of 2021: December 31, 2020 398 Acquired locations — New locations 3 Consolidated location (1) March 31, 2021 400 Net Sales Three Months Ended March 31, (in millions) 2021 2020 Change Net sales $ 1,060.7 $ 677.3 $ 383.4 57% Net sales increased 57% in the first quarter of 2021 compared to the first quarter of 2020, while base business net sales grew 51% over the same period. Our sales have continued to benefit from elevated demand for residential pool products, driven by home-centric trends influenced by the COVID-19 pandemic. Maintenance, replacement, refurbishment and construction activity remain strong as families create and expand home-based outdoor living and entertainment spaces. The following factors benefited our sales (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 and building materials (see discussion below); • increased demand for residential swimming pool maintenance supplies due to 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); • 6% sales growth from recent acquisitions; • inflationary product cost increases of approximately 3% (compared to our historical average of 1% to 2%); and • sales growth of approximately 1% to 2% (or $15.0 million to $20.0 million) from increased replacement activity in Texas due to the February 2021 winter storm. 15 Higher sales growth rates for certain product offerings, such as equipment and building materials, reflect increased spending in traditionally discretionary areas, such as pool construction, pool remodeling and equipment upgrades. In the first quarter of 2021, sales for equipment, which includes swimming pool heaters, pumps, lights and filters, increased 61% compared to the same period last year, and collectively represented approximately 32% of net sales for the period. Sales of building materials grew 34% compared to the first quarter of 2020 and represented approximately 12% of net sales in the first quarter of 2021. 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 43% in the first quarter of 2021 compared to the first quarter of 2020 and represented approximately 11% of our net sales for the first quarter of 2021. Sales to commercial customers increased 3% in the first quarter of 2021 compared to the first quarter of 2020, as business and leisure travel resumed in 2021 following COVID-19 related closures in 2020. Sales to commercial customers represented approximately 4% of our net sales for the first quarter of 2021. Gross Profit Three Months Ended March 31, (in millions) 2021 2020 Change Gross profit $ 301.1 $ 189.6 $ 111.5 59% Gross margin 28.4 % 28.0 % Gross margin increased 40 basis points to 28.4% in the first quarter of 2021 compared to 28.0% in the first quarter of 2020. Gross margin was favorably impacted by improvements from supply chain initiatives and timing differences in customer early buy purchases year-over-year, which were partially offset by lower gross margin from recently acquired businesses and increased sales of lower margin, big-ticket items in the first quarter of 2021 compared to the first quarter of 2020. Operating Expenses Three Months Ended March 31, (in millions) 2021 2020 Change Selling and administrative expenses $ 172.1 $ 147.1 $ 25.0 17% Impairment of goodwill and other assets — 6.9 (6.9) (100)% Operating expenses as a % of net sales 16.2 % 22.7 % Operating expenses increased 12% in the first quarter of 2021 compared to the first quarter of 2020, reflecting an increase of $11.5 million in performance-based compensation expense and increases in other growth-driven costs. Our expense growth was partially offset by lower discretionary spending, which we expect to increase as the year progresses . As a percentage of net sales, operating expenses decreased 650 basis points to 16.2% in the first quarter of 2021 compared to 22.7% in the same period of 2020 primarily due to strong expense control and our ability to leverage our existing network. Excluding the prior year impact of non-cash impairments, operating expenses increased 17% in the first quarter of 2021 compared to the first quarter of 2020 and decreased 550 basis points as a percentage of net sales from 21.7% in the first quarter of 2020. Interest and Other Non-Operating Expenses, Net Interest and other non-operating expenses, net for the first quarter of 2021 decreased $2.2 million compared to the first quarter of 2020. The decrease reflects lower average debt levels and lower average interest rates between periods. Our weighted average effective interest rate decreased to 2.2% for the first quarter of 2021 from 2.7% for the first quarter of 2020 on lower average outstanding debt of $397.3 million versus $493.7 million for the respective periods. 16 Income Taxes Our effective income tax rate was 22.0% for the three months ended March 31, 2021 compared to a 0.1% benefit for the three months ended March 31, 2020. We recorded a $4.0 million tax benefit from ASU 2016-09 in the quarter ended March 31, 2021 compared to a tax benefit of $8.0 million realized in the same period last year. In the period ended March 31, 2020, we recorded a goodwill and intangibles impairment charge of $4.4 million, which was non-deductible for tax purposes and increased our effective tax rate by 0.4%. Excluding the benefits from ASU 2016-09 and prior year impact of the goodwill and intangibles impairment charge, our effective tax rate was 25.2% for the first quarter of 2021 and 25.4% for the first quarter of 2020. Net Income and Earnings Per Share Net income increased 219% to $98.7 million in the first quarter of 2021 compared to $30.9 million in the first quarter of 2020. Adjusted net income, excluding the prior year impact of non-cash impairments, net of tax, increased 165% in the first quarter of 2021 compared to the prior year period. Earnings per diluted share increased 223% to $2.42 in the first quarter of 2021 compared to $0.75 in the same period of 2020. Excluding the impact from ASU 2016-09 in both periods and the impact of non-cash impairments, net of tax, in 2020, adjusted earnings per diluted share increased 227% to $2.32 in the first quarter of 2021 compared to $0.71 in the first quarter of 2020. See the reconciliation of GAAP to non-GAAP measures below. 17 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) Three Months Ended (in thousands) March 31, 2021 2020 Net income $ 98,655 $ 30,912 Impairment of goodwill and other assets — 6,944 Tax impact on impairment of long-term note (1) — (654) Adjusted net income $ 98,655 $ 37,202 (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) Three Months Ended March 31, 2021 2020 Diluted EPS $ 2.42 $ 0.75 After-tax non-cash impairment charges — 0.15 Adjusted diluted EPS excluding after-tax non-cash impairment charges 2.42 0.90 ASU 2016-09 tax benefit (0.10) (0.19) Adjusted diluted EPS excluding after-tax non-cash impairment charges and tax benefit $ 2.32 $ 0.71 18 Seasonality and Quarterly Fluctuations Our business is highly seasonal. In general, sales and operating income are highest during the second and third quarters, which represent the peak months of both swimming pool use and installation and irrigation and landscape installations and maintenance. Sales are substantially lower during the first and fourth quarters, when we may incur net losses. In 2020, we generated approximately 61% of our net sales and 76% of our operating income in the second and third quarters of the year. We typically experience a build-up of product inventories and accounts payable during the winter months in anticipation of the peak selling season. Excluding borrowings to finance acquisitions and share repurchases, our peak borrowing usually occurs during the second quarter, primarily because extended payment terms offered by our suppliers typically are payable in April, May and June, while our peak accounts receivable collections typically occur in June, July and August. The following table presents certain unaudited quarterly data for the first quarter of 2021, the four quarters of 2020 and the fourth, third and second quarters of 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 (and recent pandemic-driven increased demand for our products), the results of any one or more quarters are not necessarily a good indication of results for an entire fiscal year or of continuing future trends. (Unaudited) QUARTER (in thousands) 2021 2020 2019 First Fourth Third Second First Fourth Third Second Statement of Income Data Net sales $ 1,060,745 $ 839,261 $ 1,139,229 $ 1,280,846 $ 677,288 $ 582,234 $ 898,500 $ 1,121,328 Gross profit 301,131 239,095 328,698 373,481 189,629 162,050 257,931 330,314 Operating income 129,031 74,351 148,233 205,857 35,588 25,798 104,540 172,523 Net income 98,655 59,174 119,098 157,555 30,912 18,024 79,525 131,390 Balance Sheet Data Total receivables, net $ 487,602 $ 289,200 $ 366,412 $ 453,405 $ 345,915 $ 226,539 $ 307,798 $ 417,126 Product inventories, net 977,228 780,989 612,824 628,418 858,190 702,274 616,217 694,447 Accounts payable 634,998 266,753 268,412 346,272 517,620 261,963 214,309 342,335 Total debt 433,171 416,018 339,934 438,804 586,050 511,407 547,560 692,337 We expect that our quarterly results of operations will continue to fluctuate depending on the timing and amount of revenue contributed by new and acquired sales centers. Based on our peak summer selling season, we generally open new sales centers and close or consolidate sales centers, when warranted, either in the first quarter before the peak selling season begins or in the fourth quarter after the peak selling season ends. 19 Weather is one of the principal external factors affecting our business. The table below presents some of the possible effects resulting from various weather conditions. Weather Possible Effects Hot and dry • Increased purchases of chemicals and supplies for existing swimming pools • Increased purchases of above-ground pools and irrigation and lawn care products Unseasonably cool weather or extraordinary amounts • Fewer pool and irrigation and landscape of rain installations • Decreased purchases of chemicals and supplies • Decreased purchases of impulse items such as above-ground pools and accessories Unseasonably early warming trends in spring/late cooling • A longer pool and landscape season, thus positively trends in fall impacting our sales (primarily in the northern half of the U.S. and Canada) Unseasonably late warming trends in spring/early cooling • A shorter pool and landscape season, thus negatively trends in fall impacting our sales (primarily in the northern half of the U.S. and Canada) Weather Impacts on 2021 and 2020 Results Sales in the first quarter of 2021 benefited from generally mild weather conditions throughout the contiguous United States. In February 2021, Texas experienced the most costly winter storm event on record for the United States, which damaged many swimming pools and added to the existing, strong replacement opportunity in that market. In contrast, sales in the first quarter of 2020 benefited from much above-average temperatures throughout the contiguous United States, particularly in the southern United States. CRITICAL ACCOUNTING ESTIMATES We prepare our Consolidated Financial Statements in accordance with U.S. generally accepted accounting principles (GAAP), which require management to make estimates and assumptions that affect reported amounts and related disclosures. Management identifies critical accounting estimates as: • those that require the use of assumptions about matters that are inherently and highly uncertain at the time the estimates are made; and • those for which changes in the estimates or assumptions, or the use of different estimates and assumptions, could have a material impact on our consolidated results of operations or financial condition. Management has discussed the development, selection and disclosure of our critical accounting estimates with the Audit Committee of our Board. For a description of our critical accounting estimates that require us to make the most difficult, subjective or complex judgments, please see our 2020 Annual Report on Form 10-K. We have not changed any of these policies from those previously disclosed in that report. Recent Accounting Pronouncements See Note 1 of “Notes to Consolidated Financial Statements,” included in Part I, Item 1 of this Form 10-Q for discussion of recent accounting pronouncements. 20 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. We have funded our capital expenditures and share repurchases in substantially the same manner. 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 network, 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 target 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. Over the last five years, capital expenditures have averaged roughly 1.0% of net sales. Capital expenditures in 2020 were lower than our historical average due to cost-saving measures implemented at the beginning of the COVID-19 pandemic. We project capital expenditures in 2021 will continue to approximate the historical average. As of March 31, 2021, our average total leverage ratio equaled 0.69 compared to 0.86 as of December 31, 2020. Our strong operating results and cash flow from operations in 2020 and through the first quarter of 2021 enabled us to reduce our debt balances. We expect our average total leverage ratio through the second quarter of 2021 will continue to be below our target range. Sources and Uses of Cash The following table summarizes our cash flows (in thousands): Three Months Ended March 31, 2021 2020 Operating activities $ 77,113 $ 19,728 Investing activities (9,522) (21,982) Financing activities (75,194) (8,149) 21 Net cash provided by operations of $77.1 million for the first three months of 2021 increased $57.4 million compared to the first three months of 2020. The improvement in cash provided by operations primarily reflects an increase in net income between periods. Net cash used in investing activities for the first three months of 2021 decreased compared to the first three months of 2020 primarily due to a $13.0 million decrease in cash used for the acquisition of businesses. Net cash used in financing activities was $75.2 million for the first three months of 2021 compared to $8.1 million for the first three months of 2020, which reflects a $57.5 million increase in debt payments net of borrowings, additional share repurchases of $4.9 million and an increase in dividends paid of $1.2 million. Future Sources and Uses of Cash 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 on September 29, 2022. We intend to continue to use the Credit Facility for general corporate purposes, for future share repurchases and to fund future growth initiatives. At March 31, 2021, there was $142.9 million outstanding, a $4.8 million standby letter of credit outstanding and $602.3 million available for borrowing under the Credit Facility. We pay interest on revolving borrowings under the Credit Facility at a variable rate based on the one month London Interbank Offered Rate (LIBOR), plus an applicable margin. The weighted average effective interest rate for the Credit Facility as of March 31, 2021 was approximately 2.3%, excluding commitment fees. Term Facility Our Term Facility provides for $185.0 million in borrowing capacity and matures on December 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 facility's debt balance 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 quarterly payments over the life of the facility will be equal to 33.75% of the Term Facility with the final principal payment, 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 March 31, 2021, there was $173.4 million outstanding under the Term Facility with a weighted average effective interest rate of 2.9%. We pay interest on borrowings under the Term Facility at a variable rate based on the one month LIBOR, plus an applicable margin. 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 March 31, 2021, the calculations of these two covenants are detailed below: • 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 of March 31, 2021, our average total leverage ratio equaled 0.69 (compared to 0.86 as of December 31, 2020) and the TTM average total debt amount used in this calculation was $411.7 million. 22 • 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 of March 31, 2021, our fixed charge ratio equaled 9.00 (compared to 7.81 as of December 31, 2020) and TTM Rental Expense was $64.9 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 available between 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 on November 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. At March 31, 2021, there was $105.0 million outstanding under the Receivables Facility at a weighted average effective interest rate of 0.9%, excluding commitment fees. 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. As of March 31, 2021, we had three interest rate swap contracts in place, two of which became effective on November 20, 2020, and terminate on September 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% on notional amounts of $75.0 million each. The third interest rate swap contract currently in place became effective on February 26, 2021, and terminates on February 28, 2025. This swap contract was previously forward-starting and converts the variable interest rate on our variable rate borrowings to a fixed rate of 1.3800% on a notional amount of $150.0 million. Interest expense related to the notional amounts under these swap contracts is based on the fixed rate plus the applicable margin on our variable rate borrowings. 23 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: Derivative Inception Date Effective Date Termination Date Notional Amount (in millions) Fixed Interest Rate Forward-starting interest rate swap 1 March 9, 2020 September 29, 2022 February 26, 2027 $150.0 0.7400% Forward-starting interest rate swap 2 March 9, 2020 February 28, 2025 February 26, 2027 $150.0 0.8130% Compliance and Future Availability As of March 31, 2021, we believe we were in compliance with all material 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 material covenants and financial ratio requirements throughout the next twelve months. For additional information regarding our debt arrangements, see Note 5 of “Notes to Consolidated Financial Statements,” included in Part II, Item 8 of our 2020 Annual Report on Form 10-K and in Part I, Item 1 of this Form 10-Q. 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 of April 26, 2021, $107.4 million of the current Board-authorized amount under our share repurchase program remained available. We expect to repurchase additional shares on 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. 24