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 2022 Annual Report on Form 10-K and with Management’s Discussion and Analysis in our 2022 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 strategic, operational and capital allocation plans and objectives, management's views on industry, economic, competitive, technological and regulatory conditions and other forecasts of trends 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 the sensitivity of our business to weather conditions; changes in the economic conditions, consumer discretionary spending, the housing market, inflation or interest rates; our ability to maintain favorable relationships with suppliers and manufacturers; the extent to which home-centric trends associated with the pandemic will moderate or reverse; competition from other leisure product alternatives or mass merchants; our ability to continue to execute our growth strategies; changes in the regulatory environment; new or additional taxes, duties or tariffs; excess tax benefits or deficiencies recognized under ASU 2016-09 and other risks detailed in our 2022 Annual Report on Form 10-K, as updated by our subsequent filings with the U.S. Securities and Exchange Commission. 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
Financial Results
In the first quarter of 2023, differing weather conditions contributed to variability in our results across geographies. Our southern markets experienced more typical weather during the quarter and generated encouraging results. However, higher precipitation and cooler temperatures suppressed results in our western markets, hampering new pool construction activities and sales of maintenance-related products. These conditions continued into late March where we saw a considerable impact on our biggest sales month of the quarter.
Net sales decreased 15% in the first quarter of 2023 to $1.2 billion compared to $1.4 billion in the first quarter of 2022 following 33% net sales growth in the first quarter of 2022 and 57% growth in the first quarter of 2021. Weather conditions were generally favorable in our southern markets, where Texas and Florida, our two largest markets in the South, realized combined base business sales in line with 2022. In contrast, results were unfavorably impacted by unusually wet and cold weather in the western U.S., including California and Arizona, two of our largest markets, where base business sales were down a combined 21% from last year. We estimate that sales were also negatively impacted 2% from lower customer early buy activity in the first quarter of 2023 versus the first quarter of 2022 and 1% from continued softness in our European markets.
Gross profit decreased 17% to $369.8 million in the first quarter of 2023 from $447.2 million in the same period of 2022. Consistent with our expectations, gross margin decreased 110 basis points to 30.6% in the first quarter of 2023 compared to 31.7% in the first quarter of 2022.
Selling and administrative expenses (operating expenses) increased 6% to $224.0 million in the first quarter of 2023 compared to $211.5 million in the first quarter of 2022. Our largest expense growth drivers during the quarter related to higher rent and facility costs, the return of in-person customer-facing retail events and investments in customer-focused projects. As a percentage of net sales, operating expenses increased to 18.6% in the first quarter of 2023 compared to 15.0% in the same period of 2022.
Operating income in the first quarter of 2023 decreased 38% to $145.8 million from a tough comparison of $235.7 million in the same quarter last year but was 13% higher than operating income in the first quarter of 2021 of $129.0 million. Operating margin was 12.1% in the first quarter of 2023 compared to 16.7% in the first quarter of 2022.
Interest and other non-operating expenses, net for the first quarter of 2023 increased $10.6 million compared to the first quarter of 2022, primarily reflecting higher average interest rates between periods.
We recorded a $4.8 million tax benefit from Accounting Standards Update (ASU) 2016-09, Improvements to Employee Share-Based Payment Accounting, in the quarter ended March 31, 2023, compared to a tax benefit of $7.3 million realized in the same period of 2022. This resulted in a $0.12 per diluted share tax benefit compared to an $0.18 per diluted share tax benefit realized in the same period of 2022.
Net income decreased 43% to $101.7 million in the first quarter of 2023 compared to $179.3 million in the first quarter of 2022. Earnings per diluted share decreased 41% to $2.58 in the first quarter of 2023 compared to $4.41 in the same period of 2022. Without the impact from ASU 2016-09 in both periods, earnings per diluted share decreased 42% to $2.46 compared to $4.23 in the first quarter of 2022.
References to product line and product category data throughout this report generally reflect data related to the North American swimming pool market, as this data is more readily available for analysis and represents the largest component of our operations.
Financial Position and Liquidity
As of March 31, 2023, total net receivables, including pledged receivables, decreased 17% compared to March 31, 2022, driven by our sales trends. Our days sales outstanding (DSO), as calculated on a trailing four quarters basis, was 26.5 days at March 31, 2023 and 26.4 days at March 31, 2022. Our allowance for doubtful accounts balance was $9.0 million at March 31, 2023 and $6.0 million at March 31, 2022.
Net inventory levels increased 3% compared to levels at March 31, 2022, which compares to the 19% increase that we reported as of December 31, 2022 (compared to December 31, 2021). We are pleased with the progress in utilizing our strategic inventory buys and believe that we are appropriately stocked to ensure product availability during the swimming pool season and to support our new locations. Our inventory reserve was $24.5 million at March 31, 2023 and $19.8 million at March 31, 2022. Our inventory turns, as calculated on a trailing four quarters basis, were 2.5 times at March 31, 2023 and 3.1 times at March 31, 2022.
Total debt outstanding at March 31, 2023 was $1.4 billion compared to $1.5 billion at March 31, 2022 as we have used operating cash flows to make payments on our debt balances. We have utilized debt proceeds over the past twelve months primarily to fund share repurchases and investments in working capital.
Current Trends and Outlook
For a detailed discussion of trends through 2022, see the Current Trends and Outlook section of Management’s Discussion and Analysis included in Part II, Item 7 of our 2022 Annual Report on Form 10-K.
Based on our results to-date and trends observed into the second quarter, we now expect sales for the full year of 2023 to be down in the mid-single digits compared to 2022 versus the flat to down 3% from our initial projections disclosed in our 2022 Annual Report on Form 10-K. Our 2022 Annual Report on Form 10-K outlines the details of our initial projections. Our overall expectations related to renovation and remodel activity, our Horizon business, and European business remain relatively unchanged. However, we now believe that it is possible that new pool construction could decline up to 30% based on less available buildable days and current permit trends. Maintenance revenue is also expected to see a 1% lower increase than previously expected, from the use of less consumables stemming from the unfavorable weather in the first quarter.
As previously disclosed in our 2022 Annual Report on Form 10-K, we project gross margin for the full year of 2023 to be in line with our long-term outlook of approximately 30.0% with higher gross margin in the first half of 2023 compared to the latter half of the year as we sell through inventory purchased prior to recent price increases.
We plan to leverage our existing infrastructure and manage discretionary spending to limit expense growth between plus or minus 2% compared to the full year of 2022.
We project that our annual effective tax rate (without the benefit from ASU 2016-09) for 2023 will approximate 25.3% to 25.5%. We expect our effective tax rate will fluctuate from quarter to quarter due to ASU 2016-09, particularly in periods when employees elect to exercise their vested stock options or when restrictions on share-based awards lapse. We recorded a $4.8 million, or $0.12 per diluted share, tax benefit from ASU 2016-09 for the three months ended March 31, 2023. We may recognize additional tax benefits related to stock option exercises in 2023 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 March 31, 2023.
We expect 2023 diluted EPS in the range of $14.62 to $16.12, including the impact of year-to-date tax benefits of $0.12. We expect to continue to use cash for the payment of cash dividends as and when declared by our Board and to fund opportunistic share repurchases through the remainder of 2023.
The forward-looking statements in the foregoing section are based on current market conditions, speak only as of the filing date of this report, are based on several assumptions, and are subject to significant risks and uncertainties. See “Cautionary Statement for Forward-Looking Statements.”
RESULTS OF OPERATIONS
As of March 31, 2023, we conducted operations through 427 sales centers in North America, Europe and Australia. For the three months ended March 31, 2023, approximately 95% 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, | | |
| | 2023 | | 2022 | | | | |
Net sales | | 100.0 | % | | 100.0 | % | | | | |
Cost of sales | | 69.4 | | | 68.3 | | | | | |
Gross profit | | 30.6 | | | 31.7 | | | | | |
Selling and administrative expenses | | 18.6 | | | 15.0 | | | | | |
| | | | | | | | |
Operating income | | 12.1 | | | 16.7 | | | | | |
Interest and other non-operating expenses, net | | 1.3 | | | 0.4 | | | | | |
Income before income taxes and equity in earnings | | 10.8 | % | | 16.3 | % | | | | |
Note: Due to rounding, percentages presented in the table above may not add to Operating income or Income before income taxes and equity in earnings.
We have included the results of operations from acquisitions in 2023 and 2022 in our consolidated results since the acquisition dates.
Three Months Ended March 31, 2023 Compared to Three Months Ended March 31, 2022
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, |
| | 2023 | | 2022 | | 2023 | | 2022 | | 2023 | | 2022 |
Net sales | | $ | 1,130,353 | | | $ | 1,337,685 | | | $ | 76,421 | | | $ | 74,965 | | | $ | 1,206,774 | | | $ | 1,412,650 | |
| | | | | | | | | | | | |
Gross profit | | 339,597 | | | 416,167 | | | 30,158 | | | 31,022 | | | 369,755 | | | 447,189 | |
Gross margin | | 30.0 | % | | 31.1 | % | | 39.5 | % | | 41.4 | % | | 30.6 | % | | 31.7 | % |
| | | | | | | | | | | | |
Operating expenses | | 204,922 | | | 195,909 | | | 19,062 | | | 15,557 | | | 223,984 | | | 211,466 | |
Expenses as a % of net sales | | 18.1 | % | | 14.6 | % | | 24.9 | % | | 20.8 | % | | 18.6 | % | | 15.0 | % |
| | | | | | | | | | | | |
Operating income | | 134,675 | | | 220,258 | | | 11,096 | | | 15,465 | | | 145,771 | | | 235,723 | |
Operating margin | | 11.9 | % | | 16.5 | % | | 14.5 | % | | 20.6 | % | | 12.1 | % | | 16.7 | % |
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 |
Pro-Water Irrigation & Landscape Supply, Inc. | | March 2023 | | 2 | | March 2023 |
Tri-State Pool Distributors | | April 2022 | | 1 | | January - March 2023 |
Porpoise Pool & Patio, Inc. | | December 2021 | | 1 | | January - March 2023 and January - March 2022 |
Wingate Supply, Inc. | | December 2021 | | 1 | | January - February 2023 and January - February 2022 |
| | | | | | |
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 2023:
| | | | | |
December 31, 2022 | 420 | |
Acquired locations | 2 | |
New locations | 5 | |
| |
March 31, 2023 | 427 | |
Net Sales
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | |
| | March 31, | | |
(in millions) | | 2023 | | 2022 | | Change |
Net sales | | $ | 1,206.8 | | | $ | 1,412.7 | | | $ | (205.9) | | | (15)% |
Net sales and base business net sales decreased 15% in the first quarter of 2023 compared to the first quarter of 2022 following 33% net sales growth in the first quarter of 2022 and 57% growth in the first quarter of 2021. In the first quarter of 2023, differing weather conditions contributed to variability in our results across geographies. Our southern markets experienced more typical weather during the quarter and generated encouraging results. However, higher precipitation and cooler temperatures suppressed results in our western markets, including California and Arizona, two of our largest markets, hampering new pool construction activities and sales of maintenance-related products.
We faced several challenges during the quarter, with unfavorable weather being the most significant. The following factors impacted our sales during the quarter and are listed in order of estimated magnitude.
•We estimate that unfavorable weather conditions in the first quarter negatively impacted sales by approximately 5%.
•Net sales benefited approximately 4% to 5% from inflationary product cost increases, which compares to a benefit of 10% to 12% in the first quarter of 2022.
•Sales were also negatively impacted 2% from lower customer early buy activity in the first quarter of 2023 versus the first quarter of 2022 and 1% from continued softness in our European markets.
Net sales in our North American seasonal markets, representing 38% of our total base business net sales in the first quarter of 2023, decreased 23% compared to the first quarter of 2022 as these markets are more sensitive to weather conditions, particularly in the shoulders of the season when unfavorable weather delays the openings of swimming pools. Comparatively, net sales in our year-round markets, representing 57% of our total base business net sales in the first quarter of 2023, decreased 9% compared to the first quarter of 2022 as differing weather conditions led to varied results across our four largest markets. Weather conditions were generally favorable in our southern markets, where Texas and Florida realized combined base business sales in line with 2022. In contrast, results were negatively impacted by unusually wet and cold weather in the western U.S., including California and Arizona, where base business sales were down a combined 21% from last year.
Related to our product sales, following a period of significant growth over the past three years, we observed a decline in volumes of discretionary products sold as new construction activities moderated and were further impacted by unfavorable weather conditions and macroeconomic impacts. This is evidenced by lower sales for product offerings such as equipment and building materials. In the first quarter of 2023, base business sales of equipment, which includes swimming pool heaters, pumps, lights, filters and automation, decreased 14% compared to the same period last year, and collectively represented approximately 30% of net sales for the period. Sales of building materials decreased 7% compared to the first quarter of 2022 and represented approximately 14% of net sales in the first quarter of 2023.
Sales to specialty retailers that sell swimming pool supplies and customers who service large commercial installations are included in the appropriate existing product categories, and sales trends in these areas are reflected in the discussion above. Base business sales to retail customers decreased 16% in the first quarter of 2023 compared to the first quarter of 2022 and represented approximately 10% of our net sales for the first quarter of 2023. Including the impact of our December 2021 acquisition of Porpoise Pool & Patio, sales to retail customers decreased 12% and represented approximately 14% of our net sales. Sales to commercial swimming pool customers increased 12% in the first quarter of 2023 compared to the first quarter of 2022 and represented approximately 5% of our net sales for the first quarter of 2023.
Net sales in Europe, representing 4% of our total net sales in the first quarter of 2023, declined 25% compared to the first quarter of 2022, impacted by continued macroeconomic uncertainty from the war in Ukraine and increased fuel prices.
Gross Profit
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | |
| | March 31, | | |
(in millions) | | 2023 | | 2022 | | Change |
Gross profit | | $ | 369.8 | | | $ | 447.2 | | | $ | (77.4) | | | (17)% |
Gross margin | | 30.6 | % | | 31.7 | % | | | | |
Gross margin decreased 110 basis points to 30.6% in the first quarter of 2023 compared to the first quarter of 2022 when gross margin increased 330 basis points to 31.7% (over the same period in 2021). Our prior year gross margin benefited from higher levels of inflation and price increases, while gross margin in the first quarter of 2023 began to trend more in line with our longer-term annual gross margin outlook of 30.0%. Gross margin in the first quarter of 2023 also reflected continued benefits from sales of strategic lower cost inventory purchases ahead of recent vendor price increases.
Operating Expenses
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended | | |
| | March 31, | | |
(in millions) | | 2023 | | 2022 | | Change |
Selling and administrative expenses | | $ | 224.0 | | | $ | 211.5 | | | $ | 12.5 | | | 6% |
| | | | | | | | |
Operating expenses as a % of net sales | | 18.6 | % | | 15.0 | % | | | | |
Operating expenses increased 6% in the first quarter of 2023 compared to the first quarter of 2022. Our largest expense growth drivers during the quarter related to higher rent and facility costs, increased labor costs, the return of in-person customer-facing retail events and investments in customer-focused projects. These increases were partially offset by lower performance-based compensation expense.
Interest and Other Non-Operating Expenses, Net
Interest and other non-operating expenses, net for the first quarter of 2023 increased $10.6 million compared to the first quarter of 2022. Our weighted average effective interest rate increased to 4.8% in the first quarter of 2023 from 1.5% in the first quarter of 2022 on average outstanding debt of $1.3 billion in both periods.
Income Taxes
Our effective income tax rate was 21.8% for the three months ended March 31, 2023 compared to 22.3% for the three months ended March 31, 2022. We recorded a $4.8 million tax benefit from ASU 2016-09 in the quarter ended March 31, 2023 compared to a tax benefit of $7.3 million realized in the same period last year. Without the benefit from ASU 2016-09 in both periods, our effective tax rate was 25.5% for the first quarter of 2023 and 25.4% for the first quarter of 2022.
Net Income and Earnings Per Share
Net income decreased 43% to $101.7 million in the first quarter of 2023 compared to $179.3 million in the first quarter of 2022. Earnings per diluted share decreased 41% to $2.58 in the first quarter of 2023 compared to $4.41 in the same period of 2022. Without the impact from ASU 2016-09 in both periods, earnings per diluted share decreased 42% to $2.46 in the first quarter of 2023 compared to $4.23 in the first quarter of 2022. See the reconciliation of GAAP to non-GAAP measures below.
Reconciliation of Non-GAAP Financial Measures
The non-GAAP measures described below should be considered in the context of all of our other disclosures in this Form 10-Q.
Adjusted Diluted EPS
We have included adjusted diluted EPS, a non-GAAP financial measure, as a supplemental disclosure, because we believe this measure is useful to management, investors and others in assessing our period-to-period operating performance.
Adjusted diluted EPS is a key measure used by management to demonstrate the impact of tax benefits from ASU 2016-09 on our diluted EPS and to provide investors and others with additional information about our potential future operating performance to supplement GAAP measures.
We believe this measure should be considered in addition to, not as a substitute for, diluted EPS presented in accordance with GAAP, and in the context of our other disclosures within this Form 10-Q. Other companies may calculate this non-GAAP financial measure differently than we do, which may limit its usefulness as a comparative measure.
The table below presents a reconciliation of diluted EPS to adjusted diluted EPS.
| | | | | | | | | | | | | | | | | | | | | |
(Unaudited) | | Three Months Ended | | | |
| | March 31, | | | |
| | 2023 | | 2022 | | | | | |
Diluted EPS | | $ | 2.58 | | | $ | 4.41 | | | | | | |
| | | | | | | | | |
| | | | | | | | | |
| | | | | | | | | |
ASU 2016-09 tax benefit | | (0.12) | | | (0.18) | | | | | | |
| | | | | | | | | |
Adjusted diluted EPS | | $ | 2.46 | | | $ | 4.23 | | | | | | |
| | | | | | | | | |
| | | | | | | | | |
Seasonality and Quarterly Fluctuations
Our business is 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 lower during the first and fourth quarters. In 2022, we generated approximately 59% of our net sales and 67% 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 2023, the four quarters of 2022 and the fourth, third and second quarters of 2021. 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. 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 for a variety of reasons, including the seasonal nature of our business and the impact of new and acquired sales centers.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(Unaudited) | | QUARTER | |
(in thousands) | | 2023 | | 2022 | | 2021 | |
| | First | | Fourth | | Third | | Second | | First | | Fourth | | Third | | Second | |
Statement of Income Data | | | | | | | | | | | | | | | | | |
Net sales | | $ | 1,206,774 | | | $ | 1,095,920 | | | $ | 1,615,339 | | | $ | 2,055,818 | | | $ | 1,412,650 | | | $ | 1,035,557 | | | $ | 1,411,448 | | | $ | 1,787,833 | | |
Gross profit | | 369,755 | | | 315,731 | | | 503,687 | | | 666,804 | | | 447,189 | | | 322,376 | | | 441,899 | | | 551,685 | | |
Operating income | | 145,771 | | | 107,295 | | | 263,877 | | | 418,888 | | | 235,723 | | | 127,891 | | | 237,276 | | | 338,586 | | |
Net income | | 101,699 | | | 71,863 | | | 190,055 | | | 307,283 | | | 179,261 | | | 107,609 | | | 184,665 | | | 259,695 | | |
| | | | | | | | | | | | | | | | | |
Balance Sheet Data | | | | | | | | | | | | | | | | | |
Total receivables, net | | $ | 564,171 | | | $ | 351,448 | | | $ | 549,796 | | | $ | 756,585 | | | $ | 679,927 | | | $ | 376,571 | | | $ | 476,150 | | | $ | 585,566 | | |
Product inventories, net | | 1,686,683 | | | 1,591,060 | | | 1,539,572 | | | 1,579,101 | | | 1,641,155 | | | 1,339,100 | | | 1,043,407 | | | 894,654 | | |
Accounts payable | | 739,749 | | | 406,667 | | | 442,226 | | | 604,225 | | | 685,946 | | | 398,697 | | | 414,156 | | | 439,453 | | |
Total debt | | 1,365,750 | | | 1,386,803 | | | 1,512,545 | | | 1,595,398 | | | 1,505,073 | | | 1,183,350 | | | 362,819 | | | 423,116 | | |
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.
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 2023 and 2022 Results
Weather conditions varied across the contiguous United States throughout the first quarter of 2023. Conditions were generally favorable in our southern markets, where sales benefited from warmer weather and below-average precipitation. In contrast, results were unfavorably impacted by unusually wet and cold weather in the western U.S., particularly in California and Arizona, which are two of our largest markets. Comparatively, in the first quarter of 2022, overall weather conditions were generally favorable, and sales benefited from above-average temperatures along much of the west and the east coast, although Texas experienced cooler-than-normal temperatures.
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 2022 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.
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;
•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.
We focus our capital expenditure plans principally on the needs of our sales centers, and in recent years have increased our spending on information technology. Historically, our capital expenditures have averaged roughly 1.0% of net sales. Capital expenditures were 0.7% of net sales in 2022 and 2021 and 0.6% of net sales in 2020. Since 2020, our capital expenditures as a percentage of net sales were lower than our historical average primarily due to our significant sales growth. Based on management’s current plans, we project capital expenditures in 2023 will approximate 1.0% of net sales.
Sources and Uses of Cash
The following table summarizes our cash flows (in thousands):
| | | | | | | | | | | | | | |
| | Three Months Ended |
| | March 31, |
| | 2023 | | 2022 |
Operating activities | | $ | 103,203 | | | $ | (208,109) | |
Investing activities | | (17,560) | | | (9,159) | |
Financing activities | | (105,518) | | | 228,717 | |
Net cash provided by operations improved to $103.2 million for the first three months of 2023 from net cash used in operations of $208.1 million for the first three months of 2022, primarily driven by positive changes in working capital, particularly as we sell through our prior year strategic inventory purchases, partially offset by lower net income.
Net cash used in investing activities for the first three months of 2023 increased compared to the first three months of 2022, primarily due to a $6.4 million increase in capital expenditures and $1.8 million of cash used for the acquisition of a business in the first quarter of 2023.
Net cash used in financing activities was $105.5 million for the first three months of 2023 compared to net cash provided by financing activities of $228.7 million for the first three months of 2022, primarily reflecting $21.2 million of net debt payments in the first three months of 2023 versus $321.5 million of net debt proceeds in the first three months of 2022 and an increase in dividends paid of $6.9 million, partially offset by an $11.9 million decrease in share repurchases between periods.
Future Sources and Uses of Cash
To supplement cash from operations as our primary source of working capital, we plan to continue to utilize our three major credit facilities, which are the Amended and Restated Revolving Credit Facility (the Credit Facility), the Term Facility (the Term Facility) and the Receivables Securitization Facility (the Receivables Facility). For additional details regarding these facilities, see the summary descriptions below and more complete descriptions in Note 5 of our "Notes to Consolidated Financial Statements,” included in Part II, Item 8 in our 2022 Annual Report on Form 10-K and Note 5 of “Notes to Consolidated Financial Statements” included in Part I, Item 1 of this Form 10-Q.
Credit Facility
Our Credit Facility provides for $1.25 billion in borrowing capacity consisting of a $750.0 million five-year unsecured revolving credit facility and a $500.0 million term loan facility. The Credit Facility also includes sublimits for the issuance of swingline loans and standby letters of credit. We pay interest on revolving and term loan borrowings under the Credit Facility at a variable rate based on the one month London Interbank Offered Rate (LIBOR), plus an applicable margin. The term loan requires quarterly amortization payments beginning in September 2023 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 the Credit Facility maturity date of September 25, 2026. 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, 2023, there was $398.9 million of revolving borrowings outstanding, a $500.0 million term loan, a $4.8 million standby letter of credit outstanding and $346.3 million available for borrowing under the Credit Facility. The weighted average effective interest rate for the Credit Facility as of March 31, 2023 was approximately 4.6%, 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 in December 2019, adding borrowing capacity for future share repurchases, acquisitions and growth-oriented working capital expansion. We pay interest on borrowings under the Term Facility at a variable rate based on the one month LIBOR, plus an applicable margin. The Term Facility is repaid in quarterly installments of 1.250% of the Term Facility on the last business day of each quarter beginning in the first quarter of 2020. We classify the entire outstanding balance as Long-term debt on our Consolidated Balance Sheets as we intend and have the ability to refinance the obligations on a long-term basis. The total of the quarterly payments through maturity will be equal to 33.75% of the Term Facility with the final principal repayment, equal to 66.25% of the Term Facility, due on the maturity date. We may prepay amounts outstanding under the Term Facility without penalty other than interest breakage costs.
At March 31, 2023, there was $154.9 million outstanding under the Term Facility with a weighted average effective interest rate of 6.0%.
Receivables Securitization Facility
Our two-year accounts receivable securitization facility (the Receivables Facility) offers us a lower-cost form of financing. Under this facility, we can borrow up to $350.0 million between April through August and from $210.0 million to $340.0 million during the remaining months of the year. The Receivables Facility matures on November 1, 2024. 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.
At March 31, 2023, there was $299.6 million outstanding under the Receivables Facility at a weighted average effective interest rate of 5.7%, excluding commitment fees.
Financial Covenants
Financial covenants of the Credit Facility, Term Facility and 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 March 31, 2023, 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 sum of (i) Total Non-Revolving Funded Indebtedness as of such date, (ii) the trailing twelve months (TTM) Average Total Revolving Funded Indebtedness and (iii) the TTM Average Accounts Securitization Proceeds divided by TTM EBITDA (as those terms are defined in the Credit Facility). As of March 31, 2023, our average total leverage ratio equaled 1.48 (compared to 1.37 as of December 31, 2022) and the TTM average total indebtedness amount used in this calculation was $1.5 billion.
•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, 2023, our fixed charge ratio equaled 7.96 (compared to 9.57 as of December 31, 2022) and TTM Rental Expense was $83.2 million.
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 of 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 in each of our credit facilities 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 our credit facilities could result in, among other things, 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 March 31, 2023, we had two interest rate swap contracts in place and one forward-starting interest rate swap contract, each of which has the effect of converting our exposure to variable interest rates on a portion of our variable rate borrowings to fixed interest rates. For more information, see Note 4 of “Notes to Consolidated Financial Statements” included in Part I, Item 1 of this Form 10-Q.
Compliance and Future Availability
As of March 31, 2023, 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 2022 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 April 24, 2023, $186.4 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 above-described credit facilities.