Item 2. Management’s Discussion and Analysis
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 publicly 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 strong demand driven by 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. 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
We continue to monitor the effects of the COVID-19 pandemic, which began impacting our business and the global economy in the first quarter of 2020.
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 cases. 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 this trend has had a positive impact on our financial performance over the past year and a half, 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.
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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 had a material impact on our net sales. Beginning in the second quarter of 2021 and continuing through the third quarter, we have made significant investments in inventory to support increased demand and help manage potential supply chain disruptions that could negatively impact customer service. 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.
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. Although we have increased our capital spending in 2021, we expect our capital expenditures for the year to be lower than our historical average of 1.0% of net sales due to our significant sales growth. Our expense growth through the third quarter of 2021 was partially offset by lower discretionary spending for advertising, meetings, travel and entertainment, which we expect to continue through the end of the year as business travel activity lagged in the third quarter of 2021 with the onset of the Delta variant.
The health, safety and security of our employees has been, and remains, our highest priority. 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, the re-institution of governmental actions that could restrict the activities of our customers, vendors or employees, the possibility of additional subsequent outbreaks, the sustainability of current home-centric trends and other changes in customer and supplier behavior in response to the pandemic.
Financial Results
In the third quarter of 2021, net sales increased 24% to $1.4 billion compared to $1.1 billion in the third quarter of 2020, while base business sales grew 19%. This growth is on top of 27% growth in the third quarter of last year, bringing our year-to-date net sales growth to $1.2 billion. Our sales continued to benefit from elevated demand for outdoor living products along with favorable weather conditions. Our rigorous commitment to operating efficiency and capacity creation, along with our strategic focus on inventory purchases to serve demand has allowed us to fulfill our customers' high volumes.
Gross profit increased 34% to $441.9 million in the third quarter of 2021 from $328.7 million in the same period of 2020. Base business gross profit improved 29% over the third quarter of 2020. Gross margin increased 240 basis points to 31.3% in the third quarter of 2021 compared to 28.9% in the third quarter of 2020, while base business gross margin increased 250 basis points, primarily reflecting benefits from our supply chain management initiatives.
Selling and administrative expenses (operating expenses), including the recovery of goodwill and other assets, increased 13% to $204.6 million in the third quarter of 2021 compared to $180.5 million in the third quarter of 2020, while base business operating expenses grew 7%, primarily due to growth-driven labor, facility and freight costs, along with increased investments in technology. In the third quarter of 2021, we recovered $1.4 million of a $2.5 million note impairment recorded in the first quarter of 2020. As a percentage of net sales, operating expenses decreased to 14.5% in the third quarter of 2021 compared to 15.8% in the same period of 2020, reflecting continued strong expense control.
Operating income in the third quarter of 2021 increased 60% to $237.3 million compared to $148.2 million in the same period in 2020. Operating margin was 16.8% in the third quarter of 2021 compared to 13.0% in the third quarter of 2020 while base business operating margin was 17.1%, up 410 basis points from the prior year period.
We recorded a $4.2 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 September 30, 2021, compared to a tax benefit of $8.5 million, or $0.21 per diluted share, realized in the same period of 2020.
Net income increased 55% to $184.7 million in the third quarter of 2021 compared to $119.1 million in the third quarter of 2020. Earnings per diluted share increased 55% to $4.54 in the third quarter of 2021 compared to $2.92 in the same period of 2020. Without the impact from ASU 2016-09 in both periods, earnings per diluted share increased 64% to $4.44 in the third quarter of 2021 compared to $2.71 in the third quarter of 2020.
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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.
Financial Position and Liquidity
As of September 30, 2021, total net receivables, including pledged receivables, increased 30% compared to September 30, 2020, primarily driven by our sales growth and recent acquisitions. Our days sales outstanding (DSO), as calculated on a trailing four quarters basis, was 25.7 days at September 30, 2021 and 27.6 days at September 30, 2020. Our allowance for doubtful accounts balance was $5.4 million at September 30, 2021 and $5.3 million at September 30, 2020.
Net inventory levels increased 70% compared to levels at September 30, 2020. Our inventory balance has increased as we have made significant investments in inventory throughout the year to support elevated demand and help manage potential supply chain disruptions that could negatively impact customer service. Our inventory reserve was $15.7 million at September 30, 2021 and $11.4 million at September 30, 2020. Our inventory turns, as calculated on a trailing four quarters basis, were 3.8 times at September 30, 2021 and 3.7 times at September 30, 2020.
Accrued expenses and other current liabilities increased 59% compared to September 30, 2020, primarily due to higher income tax payables. As allowed for companies impacted by Hurricane Ida, we deferred our 2021 third quarter estimated federal tax payment of $56.0 million, which will be paid in January 2022.
Total debt outstanding at September 30, 2021 was $362.8 million, up 7% compared to total debt at September 30, 2020. 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.
Upon reporting our results through the third quarter of 2021, we increased our 2021 diluted EPS guidance range to $14.85 to $15.35, including the impact of year-to-date tax benefits of $0.39. Our previous 2021 earnings guidance range disclosed in our Second Quarter 2021 Quarterly Report on Form 10-Q was $13.75 to $14.25, including tax benefits of $0.29 for the first six months of 2021. We increased our range based on exceeding our third quarter expectations, along with expected continued gross margin improvement through the end of 2021. 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 to exceed 30% based on expectations of continued elevated demand trends, a solid backlog of customer projects and inflationary benefits. We estimate that sales will be favorably impacted by inflationary product cost increases of 6% to 7% (above our historical average of 1% to 2%), which we began to realize in the second quarter of 2021. Inflationary product costs had a greater impact in the third quarter of 2021, and we expect this to continue through the end of the year. 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. To address known and anticipated supply chain constraints, beginning in the second quarter of 2021 and into the third quarter, we have made significant investments in inventory in product areas where we forecasted continued high demand. Our strong inventory position has allowed us to gain share and to continue to provide exceptional service in a high demand and tight supply chain environment.
Based on our supply chain management efforts implemented during the second quarter of 2021, coupled with the current inflationary environment, we believe gross margin for the full year of 2021 has the potential to increase more than 170 basis points compared to the full year of 2020.
We expect operating expenses to reflect inflationary increases and incremental costs to support our sales growth expectations. Combined with purposeful expense management, we believe this will drive operating margin improvement of 350 basis points for the full year of 2021 compared to 2020. We expect performance-based compensation for the full year of 2021 to increase approximately $15 million from 2020 due to our projected 2021 net sales growth with most of this increase recognized through the third quarter of 2021 based on year-to-date results.
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We project that our annual effective tax rate (without the benefit from ASU 2016-09) for 2021 will approximate 25.0%, which is consistent with 2020. 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 $15.9 million, or $0.39 per diluted share, tax benefit from ASU 2016-09 for the nine months ended September 30, 2021. We may recognize additional tax benefits related to stock option exercises in 2021 from grants that expire in future years. We have not included any expected tax benefits in our guidance beyond what we have recognized as of September 30, 2021.
We have made significant investments in inventory throughout the year to support increased demand and help manage potential supply chain disruptions that could negatively impact customer service. While these investments will negatively impact our cash provided by operations in 2021, we believe that our investments in inventory will provide benefits to our customers and favorably impact our gross margin through the end of this year and into at least the first quarter of next year. We expect to continue to use cash to fund opportunistic share repurchases through the remainder of 2021. 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, as based on several assumptions, and are subject to significant risks and uncertainties. See “Cautionary Statement for Forward-Looking Statements.”
RESULTS OF OPERATIONS
As of September 30, 2021, we conducted operations through 409 sales centers in North America, Europe and Australia. For the nine months ended September 30, 2021, approximately 94% 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 Nine Months Ended
September 30, September 30,
2021 2020 2021 2020
Net sales 100.0 % 100.0 % 100.0 % 100.0 %
Cost of sales 68.7 71.1 69.6 71.2
Gross profit 31.3 28.9 30.4 28.8
Selling and administrative expenses 14.6 15.8 13.9 16.0
(Recovery) impairment of goodwill and other assets (0.1) — — 0.2
Operating income 16.8 13.0 16.5 12.6
Interest and other non-operating expenses, net 0.2 0.2 0.2 0.3
Income before income taxes and equity earnings 16.6 % 12.8 % 16.4 % 12.3 %
Note: Due to rounding, percentages presented in the table above may not add to Operating income or 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.
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Three Months Ended September 30, 2021 Compared to Three Months Ended September 30, 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
September 30, September 30, September 30,
2021 2020 2021 2020 2021 2020
Net sales $ 1,348,758 $ 1,136,946 $ 62,690 $ 2,283 $ 1,411,448 $ 1,139,229
Gross profit 423,238 328,140 18,661 558 441,899 328,698
Gross margin 31.4 % 28.9 % 29.8 % 24.4 % 31.3 % 28.9 %
Operating expenses (1)
192,061 179,990 12,562 475 204,623 180,465
Expenses as a % of net sales 14.2 % 15.8 % 20.0 % 20.8 % 14.5 % 15.8 %
Operating income (1)
231,177 148,150 6,099 83 237,276 148,233
Operating margin 17.1 % 13.0 % 9.7 % 3.6 % 16.8 % 13.0 %
(1) Base business and total reflect a $1.4 million recovery of goodwill and other assets in 2021.
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
Vak Pak Builders Supply, Inc. June 2021 1 July - September 2021
Pool Source, LLC April 2021 1 July - September 2021
TWC Distributors, Inc. December 2020 10 July - September 2021
Jet Line Products, Inc. October 2020 9 July - September 2021
Northeastern Swimming Pool Distributors, Inc. September 2020 2 July - September 2021 and September 2020
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 nine months of 2021:
December 31, 2020 398
Acquired locations 2
New locations 10
Consolidated location (1)
September 30, 2021 409
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Net Sales
Three Months Ended
September 30,
(in millions) 2021 2020 Change
Net sales $ 1,411.4 $ 1,139.2 $ 272.2 24%
Net sales increased 24% in the third quarter of 2021 compared to the third quarter of 2020, while base business net sales grew 19% over the same period. Our sales in the third quarter of 2021 continued to benefit from elevated demand for our outdoor living products along with favorable weather conditions.
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);
• inflationary product cost increases of approximately 7% (compared to our historical average of 1% to 2%); and
• 5% sales growth from recent acquisitions.
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 third quarter of 2021, sales for equipment, which includes swimming pool heaters, pumps, lights, filters and automation, increased 23% compared to the same period last year, and collectively represented approximately 28% of net sales for the period. Sales of building materials grew 24% compared to the third quarter of 2020 and represented approximately 12% of net sales in the third 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 in these areas is reflected in the numbers in the paragraph above. Sales to retail customers increased 16% in the third quarter of 2021 compared to the third quarter of 2020 and represented approximately 11% of our net sales for the third quarter of 2021. Sales to commercial customers increased 25% in the third quarter of 2021 compared to the third quarter of 2020, as business and leisure travel improved in 2021 as public facilities reopened following COVID-19 related closures in 2020. Sales to commercial customers represented approximately 3% of our net sales for the third quarter of 2021.
Gross Profit
Three Months Ended
September 30,
(in millions) 2021 2020 Change
Gross profit $ 441.9 $ 328.7 $ 113.2 34%
Gross margin 31.3 % 28.9 %
Gross margin increased 240 basis points to 31.3% in the third quarter of 2021 compared to 28.9% in the third quarter of 2020. Gross margin was favorably impacted by benefits from focused supply chain management initiatives during this inflationary environment and improvements in rates earned under our vendor programs due to increased inventory purchases.
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Operating Expenses
Three Months Ended
September 30,
(in millions) 2021 2020 Change
Selling and administrative expenses $ 206.0 $ 180.5 $ 25.5 14%
Recovery of goodwill and other assets (1.4) — (1.4) (100)%
Operating expenses as a % of net sales 14.5 % 15.8 %
Operating expenses, including the recovery of goodwill and other assets, increased 13% in the third quarter of 2021 compared to the third quarter of 2020, while base business operating expenses grew 7%, primarily due to growth-driven labor, facility and freight costs along with increased investments in technology. In the third quarter of 2021, we recovered $1.4 million of a $2.5 million note impairment recorded in the first quarter of 2020. As a percentage of net sales, operating expenses decreased to 14.5% in the third quarter of 2021 compared to 15.8% in the same period of 2020, reflecting continued strong expense control.
Interest and Other Non-Operating Expenses, Net
Interest and other non-operating expenses, net for the third quarter of 2021 increased $0.5 million compared to the third quarter of 2020. Our weighted average effective interest rate increased to 2.8% for the third quarter of 2021 from 1.9% for the third quarter of 2020 on average outstanding debt of $354.3 million versus $331.5 million for the respective periods.
Income Taxes
Our effective income tax rate was 21.4% for the three months ended September 30, 2021 compared to 18.7% for the three months ended September 30, 2020. We recorded a $4.2 million tax benefit from ASU 2016-09 in the quarter ended September 30, 2021 compared to a tax benefit of $8.5 million realized in the same period last year. Without the benefits from ASU 2016-09, our effective tax rate was 23.2% for the third quarter of 2021 and 24.5% for the third quarter of 2020. Our third quarter effective income tax rate is typically lower compared to other quarters due to the timing of our accounting for uncertain tax positions, including the expiration of statutes of limitations.
Net Income and Earnings Per Share
Net income increased 55% to $184.7 million in the third quarter of 2021 compared to $119.1 million in the third quarter of 2020. Earnings per diluted share increased 55% to $4.54 in the third quarter of 2021 compared to $2.92 in the same period of 2020. Without the impact from ASU 2016-09 in both periods, earnings per diluted share increased 64% to $4.44 in the third quarter of 2021 compared to $2.71 in the third quarter of 2020.
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Nine Months Ended September 30, 2021 Compared to Nine Months Ended September 30, 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) Nine Months Ended Nine Months Ended Nine Months Ended
September 30, September 30, September 30,
2021 2020 2021 2020 2021 2020
Net sales $ 4,052,044 $ 3,091,270 $ 207,983 $ 6,092 $ 4,260,027 $ 3,097,362
Gross profit 1,237,728 889,494 56,988 2,313 1,294,716 891,807
Gross margin 30.5 % 28.8 % 27.4 % 38.0 % 30.4 % 28.8 %
Operating expenses (1)
549,913 500,196 39,910 1,934 589,823 502,130
Expenses as a % of net sales 13.6 % 16.2 % 19.2 % 31.7 % 13.8 % 16.2 %
Operating income (1)
687,815 389,298 17,078 379 704,893 389,677
Operating margin 17.0 % 12.6 % 8.2 % 6.2 % 16.5 % 12.6 %
(1) Base business and total reflect a $1.4 million recovery of goodwill and other assets in 2021 and $6.9 million of impairment from goodwill and other assets recorded in the first quarter of 2020.
In our calculation of base business results, we have excluded the following acquisitions for the periods identified:
Acquired
Acquisition
Date
Net
Sales Centers
Acquired
Periods
Excluded
Vak Pak Builders Supply, Inc. June 2021 1 June - September 2021
Pool Source, LLC
April 2021 1 April - September 2021
TWC Distributors, Inc. December 2020 10 January - September 2021
Jet Line Products, Inc. October 2020 9 January - September 2021
Northeastern Swimming Pool Distributors, Inc.
September 2020 2 January - September 2021 and September 2020
Master Tile Network LLC
February 2020 4 January - May 2021 and February - May 2020
For a more detailed explanation of how we calculated base business results and a summary of the changes in our sales centers since December 31, 2020, please refer to the discussion under the heading Three Months Ended September 30, 2021 Compared to Three Months Ended September 30, 2020.
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Net Sales
Nine Months Ended
September 30,
(in millions) 2021 2020 Change
Net sales $ 4,260.0 $ 3,097.4 $ 1,162.6 38%
Net sales for the first nine months of 2021 increased 38% compared to the same period last year, while base business net sales increased 31%. During the first nine months of 2021, maintenance, refurbishment and construction activity remained strong as families continued to create and expand home-based outdoor living spaces. Through the third quarter of 2021, households continued to invest in outdoor living spaces, contributing to the robust demand for our products and yielding sales gains across nearly all categories.
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 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);
• 7% sales growth from recent acquisitions; and
• inflationary product cost increases of approximately 6% to 7% (compared to our historical average of 1% to 2%).
We believe that sales growth rates for certain product offerings, such as equipment, building materials and above-ground pools and spas, evidence increased spending in traditionally discretionary areas, such as pool construction, pool remodeling and equipment upgrades. In the first nine months of 2021, sales for equipment, which includes swimming pool heaters, pumps, lights, filters and automation, increased approximately 39% compared to the same period last year. Equipment collectively represented 28% of net sales in the first nine months of 2021. Sales of building materials grew 30% compared to the first nine months of 2020 and represented approximately 11% of net sales in the first nine months 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 in these areas is reflected in the numbers in the paragraph above. In the first nine months of 2021, sales to retail customers increased 21% and represented approximately 13% of our consolidated net sales. Sales to commercial customers increased 24% in the first nine months of 2021, as business and leisure travel improved in 2021 as public facilities reopened following COVID-19 related closures in 2020. Sales to commercial customers represented approximately 3% of our consolidated net sales in the first nine months of 2021.
Gross Profit
Nine Months Ended
September 30,
(in millions) 2021 2020 Change
Gross profit $ 1,294.7 $ 891.8 $ 402.9 45%
Gross margin 30.4 % 28.8 %
Gross margin improved 160 basis points to 30.4% in the nine months ended September 30, 2021 compared to 28.8% in the first nine months of 2020. This improvement primarily reflects focused supply chain management initiatives to address inflation, with most of the year-to-date benefits realized in the second and third quarters of 2021. Also, with our increased purchase volumes, improvements in rates earned under our vendor programs benefited our gross margin compared to the same period in 2020.
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Operating Expenses
Nine Months Ended
September 30,
(in millions) 2021 2020 Change
Selling and administrative expenses $ 591.2 $ 495.2 $ 96.0 19%
(Recovery) impairment of goodwill and other assets (1.4) 6.9 (8.3) (120)%
Operating expenses as a % of net sales 13.8 % 16.2 %
Operating expenses, including the recovery of goodwill and other assets in 2021 and impairment in 2020, for the nine months ended September 30, 2021 increased 17% compared to the first nine months of 2020. In the first quarter of 2020, we recorded impairment charges of $6.9 million, which included $2.5 million from a note and non-cash goodwill and intangibles impairment charges of $4.4 million. In the third quarter of 2021, we recovered $1.4 million of the previously impaired note. Without the impact of the recovery in 2021 and the prior year impairment charges, operating expenses were up 19%, primarily due to growth-driven labor, performance-based compensation, facility and freight costs along with increased investments in technology.
Interest and Other Non-Operating Expenses, Net
Interest and other non-operating expenses, net for the first nine months of 2021 decreased $2.4 million compared to the same period last year. Our weighted average effective interest rate increased to 2.6% for the first nine months of 2021 from 2.2% for the same period of 2020 on average outstanding debt of $376.2 million versus $439.4 million for the respective periods.
Income Taxes
Our effective income tax rate was 22.2% for the nine months ended September 30, 2021 compared to 19.2% for the nine months ended September 30, 2020. We recorded a $15.9 million, or $0.39 per diluted share, tax benefit from ASU 2016-09 in the nine months ended September 30, 2021 compared to a $22.6 million, or $0.55 per diluted share, tax benefit in the same period of 2020. Without the benefits from ASU 2016-09, our effective tax rate was 24.5% for the nine months ended September 30, 2021 and 25.2% for the nine months ended September 30, 2020.
Net Income and Earnings Per Share
Net income increased 77% to $543.0 million for the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020. Adjusted net income for the first nine months of 2021, without the note recovery in 2021 and the prior year impact of non-cash impairments, both net of tax, increased 73%. Earnings per diluted share increased to $13.32 for the nine months ended September 30, 2021 versus $7.53 per diluted share for the nine months ended September 30, 2020. Adjusted diluted EPS (as calculated in the reconciliation below) increased 81% to $12.90 for the nine months ended September 30, 2021 compared to $7.13 for the nine months ended September 30, 2020. See the reconciliation of GAAP to non-GAAP measures below.
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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 period-to-period operating performance.
Adjusted net income and adjusted diluted EPS are key measures used by management to demonstrate the impact of our non-cash and non-recurring charges and to provide investors and others with additional information about our potential future operating performance to supplement GAAP measures.
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 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) Nine Months Ended
(in thousands) September 30,
2021 2020
Net income $ 543,015 $ 307,565
(Recovery) impairment of goodwill and other assets (1,400) 6,944
Tax impact on (recovery) impairment of note (1)
351 (654)
Adjusted net income $ 541,966 $ 313,855
(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 note impairment.
The table below presents a reconciliation of diluted EPS to adjusted diluted EPS.
(Unaudited) Nine Months Ended
September 30,
2021 2020
Diluted EPS $ 13.32 $ 7.53
After-tax non-cash (recovery) impairment charges (0.03) 0.15
Adjusted diluted EPS excluding after-tax (recovery) impairment charges 13.29 7.68
ASU 2016-09 tax benefit (0.39) (0.55)
Adjusted diluted EPS excluding after-tax (recovery) impairment charges and tax benefit $ 12.90 $ 7.13
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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, second and third quarters of 2021, the four quarters of 2020 and the fourth quarter 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
Third Second First Fourth Third Second First Fourth
Statement of Income Data
Net sales $ 1,411,448 $ 1,787,833 $ 1,060,745 $ 839,261 $ 1,139,229 $ 1,280,846 $ 677,288 $ 582,234
Gross profit 441,899 551,685 301,131 239,095 328,698 373,481 189,629 162,050
Operating income 237,276 338,586 129,031 74,351 148,233 205,857 35,588 25,798
Net income 184,665 259,695 98,655 59,174 119,098 157,555 30,912 18,024
Balance Sheet Data
Total receivables, net $ 476,150 $ 585,566 $ 487,602 $ 289,200 $ 366,412 $ 453,405 $ 345,915 $ 226,539
Product inventories, net 1,043,407 894,654 977,228 780,989 612,824 628,418 858,190 702,274
Accounts payable 414,156 439,453 634,998 266,753 268,412 346,272 517,620 261,963
Total debt 362,819 423,116 433,171 416,018 339,934 438,804 586,050 511,407
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.
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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
Generally favorable weather conditions benefited sales in the third quarter of 2021. Temperatures ranged from above-average to substantially above-average throughout most of the contiguous United States with September being the fifth warmest on record. Precipitation was below-average in most of the western half of the United States and normal to above-average in the eastern half. Likewise, results in the third quarter of 2020 were favorably impacted by above-average temperatures and below-average precipitation.
Overall, varied weather conditions in the second quarter of 2021 favorably impacted our sales growth. While the southern states saw mild temperatures and above-average precipitation, the western states, particularly California, experienced severely high temperatures and drought. The average U.S. temperature in June was the hottest on record in 127 years. Comparatively, in the second quarter of 2020, we observed generally mild weather conditions with warmer weather throughout the western United States.
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 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.
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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.
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;
• inventory and other operating expenses;
• 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. Although we have increased our capital spending in 2021, we expect our capital expenditures for the year to be lower than our historical average of 1.0% of net sales due to our significant sales growth.
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Sources and Uses of Cash
The following table summarizes our cash flows (in thousands):
Nine Months Ended
September 30,
2021 2020
Operating activities $ 359,065 $ 388,914
Investing activities (42,110) (41,552)
Financing activities (267,765) (300,161)
Net cash provided by operations of $359.1 million for the first nine months of 2021 decreased $29.8 million compared to the first nine months of 2020, primarily reflecting our supply chain investments in inventory to enable us to continue to meet strong customer demand.
Net cash used in investing activities for the first nine months of 2021 increased slightly compared to the first nine months of 2020. Capital expenditures increased $7.3 million year-over year following the delay in capital spending last year due to the onset of the COVID-19 pandemic, while cash used for the acquisition of businesses decreased $6.8 million in the first nine months of 2021 compared to the first nine months of 2020.
Net cash used in financing activities was $267.8 million for the first nine months of 2021 compared to $300.2 million for the first nine months of 2020, which reflects a $119.9 million decrease in net debt payments, additional share repurchases of $61.8 million and an increase in dividends paid of $18.9 million during the first nine months of 2021.
Future Sources and Uses of Cash
Revolving Credit Facility
On September 27, 2021, we amended and restated our 2017 credit agreement (as amended, the “Credit Agreement”) to extend its maturity date from September 29, 2022 to September 25, 2026, and to increase our borrowing capacity from $750.0 million to $1.0 billion through the addition of a delayed-draw term loan facility of $250.0 million. Under this term loan facility, we may draw term loans at any time prior to March 25, 2022. Any such term loans would require quarterly amortization payments aggregating to 20% of the original principal amount of the loan during the third, fourth and fifth years of the loan, with all remaining principal due on September 25, 2026. All other terms of any such term loans would be substantially similar to those governing revolving credit loans under the Credit Agreement. Under the Credit Agreement, we continue to have access to a $750 million unsecured revolving credit facility (the “Credit Facility”) on substantially the same terms and subject to the same sublimits for swingline loans and standby letters of credit as in the past, other than the amendments described below.
The Credit Agreement further amended and restated the Credit Facility in the following ways:
• making available lower interest rates;
• increasing the amount of incremental facility commitments that we can request from $75.0 million to $250.0 million; and
• providing additional capacity under certain negative covenants related to indebtedness, liens, investments, acquisitions, share repurchases and dividends.
We intend to continue to use the Credit Facility for general corporate purposes, for future share repurchases and to fund future growth initiatives.
At September 30, 2021, there was $170.3 million outstanding, a $4.8 million standby letter of credit outstanding and $574.9 million available for borrowing under the Credit Facility. Currently, 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 September 30, 2021 was approximately 2.0%, excluding commitment fees.
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Term Facility
On October 12, 2021, we amended our 2019 credit agreement (as amended, the “Term Facility Agreement”) among us, as Borrower, and Bank of America, N.A., as the Lender. Among other items, the amendment provides additional capacity under certain negative covenants related to indebtedness, liens, investments, acquisitions, share repurchases and dividends to match the recent changes to the covenants in the Credit Agreement. The term facility available under this Agreement (the “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 in December 2019, adding capacity for future share repurchases, acquisitions and growth-oriented working capital expansion. The Term Facility is repaid in quarterly amortization installments of 1.250% of the facility's debt balance. The total of quarterly amortization 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 September 30, 2021, there was $168.8 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.
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 intend to amend the Receivables Facility on or ahead of its maturity date. 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 September 30, 2021, there was $15.0 million outstanding under the Receivables Facility at a weighted average effective interest rate of 0.8%, excluding commitment fees.
Financial Covenants
Financial covenants of the Credit Facility and the Term Facility (each as recently revised) and the Receivables 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 September 30, 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 September 30, 2021, our average total leverage ratio equaled 0.48 (compared to 0.53 as of June 30, 2021) and the TTM average total debt amount used in this calculation was $397.6 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 of September 30, 2021, our fixed charge ratio equaled 11.31 (compared to 10.48 as of June 30, 2021) and TTM Rental Expense was $70.1 million.
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The Credit Facility and Term Facility limit the declaration and payment of dividends on our common stock to a manner consistent with past practice, provided no default or event of default has occurred and is continuing, or would result from the payment of dividends. We may declare and pay quarterly dividends so long as (i) the amount per share of such dividends is not greater than the most recently publicly announced amount dividends per share and (ii) our Average Total Leverage Ratio is less than 3.25 to 1.00 both immediately before and after giving pro forma effect to such dividends. Under the Credit Facility and 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 3.25 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.
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 September 30, 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.
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 September 30, 2021, 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, as updated by Note 5 of “Notes to Consolidated Financial Statements,” included 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 would have the ability to finance any such transactions.
As of October 25, 2021, $494.7 million of the current Board-authorized amount under our share repurchase program remained available. We expect to repurchase 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.
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