Hayward Holdings, Inc. (HAYW) FY 2024 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion of our results of operations and financial condition together with the discussion in Part I, Item 1A, “Risk Factors,” and our audited consolidated financial statements and notes thereto, each included elsewhere in this Form 10-K. In addition to historical financial information, this discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results may differ materially from those contained in or implied by any forward-looking statements.
We define the year ended December 31, 2024 as “Fiscal Year 2024” and the year ended December 31, 2023 as “Fiscal Year 2023.” Our fiscal quarters are 13 weeks except the fourth quarter that ends on December 31 of each fiscal year. The first quarter 2024 refers to the quarter ended March 30, the second quarter 2024 refers to the quarter ended June 29, the third quarter 2024 refers to the quarter ended September 28, and the fourth quarter 2024 refers to the quarter ended December 31.
Our Company
We are an industry-leading global designer, manufacturer, and marketer of a broad portfolio of pool equipment and associated automation systems. With the pool as the centerpiece of the growing outdoor living space, the pool industry has attractive market characteristics, including significant aftermarket requirements (such as the ongoing repair, replacement, remodeling and upgrading of equipment for existing pools), innovation-led growth opportunities, and a favorable industry structure. We are a leader in this market with a highly-recognized brand, one of the largest installed bases of pool equipment in the world, decades-long relationships with our key channel partners and trade customers and a history of technological innovation. Our engineered products, which include various energy efficient and more environmentally sustainable offerings, enhance the pool owner’s outdoor living lifestyle while also delivering high quality water, pleasant ambiance and ease of use for the ultimate backyard experience. Aftermarket replacements and upgrades to higher value IoT and energy efficient models are a primary growth driver for our business.
We have an estimated North American seasonal residential pool market share of approximately 33%. We believe that we are well-positioned for future growth. Historically aftermarket sales represented 80% of our net sales and are generally recurring in nature since these products are critical to the ongoing operation of pools given requirements for water quality and sanitization. Our product replacement cycle of approximately 8 to 11 years drives multiple replacement opportunities over the typical life of a pool, creating opportunities to generate aftermarket product sales as pool owners repair and replace equipment and remodel and upgrade their pools. We estimate aftermarket sales based upon feedback from certain representative customers and management’s interpretation of available industry and government data, and not upon our GAAP net sales results.
We manufacture our products at seven facilities worldwide, which are located in North Carolina, Georgia, Tennessee, Rhode Island, Spain (two) and China.
Segments
Our business is organized into two reportable segments: North America (“NAM”) and Europe & Rest of World (“E&RW”). The Company determined its reportable segments based on how the Chief Operating Decision Maker (“CODM”) reviews the Company’s operating results in assessing performance and allocating resources. NAM and E&RW accounted for approximately 85% and 15%, and 83% and 17%, of total net sales for Fiscal Year 2024 and Fiscal Year 2023, respectively.
The NAM segment manufactures and sells a complete line of residential and commercial swimming pool equipment and supplies in the United States and Canada and manufactures and sells flow control products.
The E&RW segment manufactures and sells residential and commercial swimming pool equipment and supplies in Europe, Central and South America, the Middle East, Australia and other Asia Pacific countries.
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Key Trends and Uncertainties Regarding Our Existing Business
The following trends and uncertainties affect the period-to-period comparability of our results of operations and may affect our financial performance in the future:
•Demand related to the aging base of pools and the COVID-19 pandemic. Irrespective of broader macroeconomic trends, the primary driver for the industry continues to be aftermarket spending on the base of installed pools. In the United States, our primary market, the record construction of pools from 1999 to 2005 is manifesting itself in the aftermarket repair, replace, and remodel cycle given that the average age of this pool cohort is over 20 years. Residential pool equipment sales increased during the first two years of the COVID-19 pandemic. This increase in demand was experienced broadly across all our product lines as consumers refocused attention on improving the quality of the homeowner’s outdoor living experience. We believe that during this period, the pandemic reinforced existing pool industry growth trends, as well as partially accelerated demand due to the impact of longer lead times that resulted from supply chain shortages. As the impact of the COVID-19 pandemic has lessened, we believe that these pandemic-fueled demand trends have generally abated, and the industry has returned to more normalized historical seasonal trends.
•Seasonality. Our business is seasonal, with sales typically higher in the second and fourth quarters. During the second quarter, sales are higher in anticipation of the start of the summer pool season and in the fourth quarter, we incent trade customers to buy and stock in preparation for next year’s pool season under an “Early Buy” program, which features a price discount and extended payment terms. Shipments for the 2024 Early Buy program began in the late third quarter and will continue through approximately the first quarter of 2025. The favorable payment terms extended as part of the Early Buy program generally do not exceed 180 days. Revenue is recognized upon shipment of products, which cannot be returned after ten days from receipt of goods. For more information, see “—Key Factors and Measures We Use to Evaluate Our Business—Net Sales.’’ We aim to keep our manufacturing plants running at a constant level throughout the year and consequently we generally build inventory in the first and third quarters and inventory is sold-down in the second and fourth quarters. Our accounts receivable balance increases from September to April as a result of the Early Buy extended terms and increases through June due to higher sales in the second quarter. Also, because most of our sales are to distributors whose inventory of our products may vary, including due to reasons beyond our control, such as end-user demand, supply chain lead times and macroeconomic factors, our revenue may fluctuate from period to period.
•Targeted expansion efforts. We continue to pursue attractive product and global geographic market opportunities to grow our presence in new markets or markets in which we have less penetration. We believe that our business can effectively address these opportunities through new product development and scalable sales, marketing, and administration. We also have and may in the future pursue acquisitions to opportunistically add product offerings or increase our geographic footprint. If we do not execute this strategic objective, our core net sales growth will likely be limited or may decline.
•New product offerings. Our business is primarily driven by aftermarket spending. Pool owners are increasingly demanding new technologies, such as IoT-enabled and more energy efficient products, as they replace or upgrade their existing pool equipment. In Fiscal Year 2024, approximately 20% of gross sales was from new or next-generation products launched in the last three years. These new products offer higher energy efficiency, automation capabilities and enhanced water care solutions, and we expect will become primary drivers of our sales growth. Staying at the forefront of technological innovation and introducing new product offerings with new features will continue to be critical in growing our market share and revenue.
•Geopolitical events. Geopolitical conflicts around the world have created substantial uncertainty in the global economy, including as a result of sanctions and penalties imposed in response to these conflicts. In particular, armed conflicts in the Middle East and in Ukraine and Russia have adversely affected market demand in the Middle East and Asia, which has negatively impacted our results in our E&RW segment. See “—Segment—Europe & Rest of World (“E&RW”),” below. Given the nature of our business and global operations, if these or other geopolitical conflicts continue or worsen, our business and results of operations may be adversely affected.
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Key Factors and Measures We Use to Evaluate Our Business
We consider a variety of financial and operating measures in assessing the performance of our business. The key GAAP measures we use are net sales, gross profit and gross profit margin, selling, general, and administrative (“SG&A”) expense, research, development and engineering (“RD&E”) expense, operating income and operating income margin. The key non-GAAP measures we use are EBITDA, adjusted EBITDA, adjusted EBITDA margin, adjusted segment income and adjusted segment income margin.
Net sales
We offer a broad range of pool equipment including pumps, filters, heaters, automatic cleaners, sanitizers, chlorine generators, controls, LED lights, as well as industrial thermoplastic valves and process liquid control products. Sales are impacted by product and geographic segment mix, as well as promotional and competitive activities. Growth of our sales is primarily driven by market demand, expansion of our trade customers and product offering.
Revenue is recognized upon shipment and recorded net of related discounts, allowances, returns, and sales tax. Customers are offered volume discounts and other promotional benefits. We estimate these volume discounts, promotional allowance benefits, and returns based upon the terms of the customer contracts and historical experience and record such amounts as a reduction of gross sales with either an offsetting adjustment to accounts receivable or recognition of an accrued liability. We regularly monitor the adequacy of these allowances.
Gross profit and gross profit margin
Gross profit is equal to net sales less cost of sales. Cost of sales includes the direct cost of manufacturing, including direct materials, labor and related overhead, as well as inbound and outbound freight and import duties.
Gross profit margin is gross profit as a percentage of net sales. Gross profit margin is impacted by costs of raw material, product mix, salary and wage inflation, production costs, shipping and handling costs, and import duties, all of which can vary.
Selling, general and administrative expense
Our SG&A includes expenses arising from activities in selling, marketing, technical and customer services, warranty, warehousing, and administrative expenses. Other than warranty and variable compensation, SG&A is generally not directly proportional to net sales.
Research, development and engineering expense
The Company primarily conducts RD&E activities in its own facilities. These expenses consist primarily of salaries, supplies and overhead costs related to the active development of new products, enhanced product applications and improved manufacturing and value engineering of existing products.
Generally, RD&E costs are expensed as incurred. Certain RD&E costs applicable to the development of software are capitalized and amortized over the expected life of the product.
Amortization of intangible assets
Customer relationships, trademarks and other intangible assets arising from business combinations are amortized over their expected useful lives of 5-20 years.
Acquisition and restructuring related costs (or income)
The Company records costs or expenses incurred related to business combinations, organizational restructuring, or gains or losses attributable to any sales or dispositions of assets, including impairments, to acquisition and restructuring related expense, net.
Operating income
Operating income is gross profit less SG&A, RD&E, acquisition and restructuring related expense or income and amortization of intangible assets. Operating income excludes interest expense, income tax expense, and other non-operating expenses, net. We use operating income as well as other indicators as a measure of the profitability of our business.
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Interest expense, net
The Company incurs interest expense on its Credit Facilities, as defined herein. The amortization of debt issuance costs and impact of our interest rate hedging instruments are also included in interest expense.
Net income
Net income is operating income less net interest expense, other non-operating items, and provision for income taxes.
EBITDA, Adjusted EBITDA, Adjusted EBITDA margin, Adjusted segment income, Adjusted segment income margin
EBITDA, adjusted EBITDA, adjusted EBITDA margin, adjusted segment income and adjusted segment income margin are key metrics used by management and our Board of Directors to assess our financial performance. For information about our use of these Non-GAAP measures and a reconciliation of these metrics to the nearest GAAP metric see “—Non-GAAP Reconciliation.”
Results of Operations
The following tables summarize key components of our results of operations for the periods indicated, both in dollars and as a percentage of our net sales. We derived the consolidated statements of operations for the Fiscal Years 2024 and 2023 from our audited consolidated financial statements. Our historical results are not necessarily indicative of the results that may be expected in the future. A discussion regarding our financial condition and results of operations for the year ended December 31, 2023, compared to the year ended December 31, 2022, is included under “Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2023, filed with the SEC on February 29, 2024.
The following table summarizes our results of operations and a comparison of the change between the periods (in thousands):
| Years Ended December 31, | ||||||
|---|---|---|---|---|---|---|
| 2024 | 2023 | |||||
| Net Sales | $ | 1,051,606 | $ | 992,452 | ||
| Cost of sales | 520,849 | 515,502 | ||||
| Gross profit | 530,757 | 476,950 | ||||
| Selling, general, and administrative expense | 260,928 | 233,607 | ||||
| Research, development, and engineering expense | 25,778 | 24,547 | ||||
| Acquisition and restructuring related expense | 6,464 | 13,213 | ||||
| Amortization of intangible assets | 28,800 | 30,361 | ||||
| Operating income | 208,787 | 175,222 | ||||
| Interest expense, net | 62,163 | 73,584 | ||||
| Loss on debt extinguishment | 4,926 | — | ||||
| Other expense (income), net | (2,484) | 551 | ||||
| Total other expense | 64,605 | 74,135 | ||||
| Income from operations before income taxes | 144,182 | 101,087 | ||||
| Provision for income taxes | 25,527 | 20,400 | ||||
| Net income | $ | 118,655 | $ | 80,687 | ||
| Adjusted EBITDA (a) | $ | 277,447 | $ | 247,273 |
(a) See “— Non-GAAP Reconciliation.”
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Fiscal Year 2024 Compared to Fiscal Year 2023
Net sales
Net sales increased to $1,051.6 million in Fiscal Year 2024 from $992.5 million in Fiscal Year 2023, an increase of $59.1 million, or 6.0%. See segment discussion below for further information.
| 2024 | ||
|---|---|---|
| Volume | 1.8 | % |
| Price, net of discounts and allowances | 3.2 | % |
| Acquisitions | 1.1 | % |
| Currency and other | (0.1) | % |
| Total | 6.0 | % |
The Fiscal Year 2024 increase in net sales was primarily driven by an increase in net price, as well as by an increase in volume and the favorable impact from acquisitions. The increase in net price was due to price increases enacted to offset inflationary pressures. The increase in volume was primarily the result of normalized channel inventory movements, partially offset by market declines in the Middle East and Asia and lower new construction and remodel activity in the United States.
Gross profit and Gross profit margin
Gross profit increased to $530.8 million in Fiscal Year 2024 from $477.0 million in Fiscal Year 2023, an increase of $53.8 million or 11.3%.
Gross profit margin increased to 50.5% in Fiscal Year 2024 compared to 48.1% in Fiscal Year 2023, an increase of 240 basis points primarily due to operational efficiencies, net price increases and management of our manufacturing costs, partially offset by an increase to cost of goods sold resulting from the fair value inventory step-up adjustment recognized as part of the purchase accounting for the acquisition of ChlorKing HoldCo, LLC and related entities (“ChlorKing”) ($3.3 million) and discrete inventory adjustments in Europe.
Selling, general and administrative expense
Selling, general and administrative expense increased to $260.9 million in Fiscal Year 2024 from $233.6 million in Fiscal Year 2023, an increase of $27.3 million or 11.7%, driven by normalized annual incentive compensation, higher salary costs driven by wage inflation, targeted investments in our customer care, selling and business analytics teams, and discrete legal expenses, partially offset by decreased warranty costs.
As a percentage of net sales, SG&A increased to 24.8% in Fiscal Year 2024 as compared to 23.5% in Fiscal Year 2023, an increase of 130 basis points, primarily due to the factors described above.
Research, development and engineering expense
RD&E expense increased to $25.8 million in Fiscal Year 2024 compared to $24.5 million in Fiscal Year 2023, an increase of $1.3 million, or 5.0%. As a percentage of net sales, RD&E remained relatively flat at 2.5% in each year. RD&E spend continues to be focused on new product development and new product quality.
Acquisition and restructuring related expense
Acquisition and restructuring related expense decreased to $6.5 million in Fiscal Year 2024 as compared to $13.2 million in Fiscal Year 2023, a decrease of $6.7 million.
The $6.5 million expense in Fiscal Year 2024 was primarily driven by $4.3 million of acquisition and integration costs associated with the acquisition of the ChlorKing business, including $3.2 million of compensation expenses for the retention of key employees acquired in the ChlorKing acquisition. Fiscal Year 2024 also included costs associated with the centralization and consolidation of operations in Europe. In comparison, the $13.2 million expense in Fiscal Year 2023 was primarily driven by costs related to the discontinuation of a product line leading to an impairment of the associated fixed assets, inventory and intangible assets, programs to centralize and consolidate manufacturing operations and professional services in Europe, as well as costs associated with the relocation of the corporate headquarters to Charlotte, North Carolina.
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For additional information, see Note 19. “Acquisition and Restructuring Related Expense” of Notes to Consolidated Financial Statements in this Form 10-K.
Amortization of intangible assets
Amortization of intangible assets decreased to $28.8 million in Fiscal Year 2024 from $30.4 million in Fiscal Year 2023, a decrease of $1.6 million, or 5.1%, due to the amortization pattern of certain intangibles based on the declining balance method.
Operating income and operating income margin
Operating income increased to $208.8 million in Fiscal Year 2024 from $175.2 million in Fiscal Year 2023, an increase of $33.6 million, or 19.2%, due to the accumulated effect of the items described above. Operating income as a percentage of net sales (“operating margin”) was 19.9% in Fiscal Year 2024, a 220 basis point increase from the 17.7% operating margin in Fiscal Year 2023.
Interest expense, net
Interest expense, net, decreased to $62.2 million in Fiscal Year 2024 from $73.6 million in Fiscal Year 2023, a decrease of $11.4 million, or 15.5%. The decrease was primarily due to the repayment of the Incremental Term Loan B principal balance in April 2024 and interest income on cash investment balances.
Interest expense in Fiscal Year 2024 consisted of $68.0 million of interest on the outstanding debt, net of the impact from the interest rate swaps, and $4.2 million of amortization of deferred financing fees, partially offset by $10.1 million of interest income. Interest expense in Fiscal Year 2023 consisted of $76.0 million on the outstanding debt and $4.7 million of amortization of deferred financing fees, partially offset by $7.1 million of interest income.
Loss on extinguishment of debt
The $4.9 million loss on extinguishment of debt was incurred as a result of the voluntary repayment of the Incremental Term Loan B principal balance in April 2024.
Provision for income taxes
We incurred income tax expense of $25.5 million for Fiscal Year 2024 and $20.4 million for Fiscal Year 2023, a increase of $5.1 million or 25.1%. This increase in tax expense was primarily due to increased income from operations.
Our effective income tax rate decreased to 17.7% for Fiscal Year 2024 from 20.2% for Fiscal Year 2023 primarily due to decreased foreign withholding taxes and state taxes, partially offset by decreased excess tax benefit from stock compensation.
Net income
As a result of the foregoing, net income increased to $118.7 million in Fiscal Year 2024 compared to net income of $80.7 million in Fiscal Year 2023, an increase of $38.0 million, or 47.1%.
Adjusted EBITDA
Adjusted EBITDA increased to $277.4 million in Fiscal Year 2024 from $247.3 million in Fiscal Year 2023, an increase of $30.1 million, or 12.2%, driven primarily by increased net sales and an increase in gross profit of $53.8 million, partially offset by an increase in SG&A expenses of $27.3 million.
See “— Non-GAAP Reconciliation” for a reconciliation of these non-GAAP measures to the most directly comparable GAAP measures.
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Segment Results of Operations
The Company manages its business primarily on a geographic basis. The Company’s reportable segments consist of NAM and E&RW.
We evaluate performance based on net sales, segment income and adjusted segment income, and use segment income margin and adjusted segment income margin as comparable performance measures for our reporting segments.
Segment income represents net sales less cost of sales, less segment SG&A and RD&E, excluding acquisition and restructuring related expense, as well as amortization of intangible assets. Adjusted segment income represents segment income adjusted for the impact of depreciation, amortization of certain intangible assets, stock-based compensation and certain non-cash, nonrecurring or other items that are included in segment income that we do not consider indicative of the ongoing segment operating performance. See “—Non-GAAP Reconciliation” for a reconciliation of these non-GAAP measures to the most directly comparable GAAP measures.
North America (“NAM’’)
(Dollars in thousands)
| Years Ended December 31, | ||||||
|---|---|---|---|---|---|---|
| 2024 | 2023 | |||||
| Net sales | $ | 895,498 | $ | 823,276 | ||
| Gross profit | $ | 474,274 | $ | 410,641 | ||
| Gross profit margin % | 53.0 | % | 49.9 | % | ||
| Segment income | $ | 261,735 | $ | 215,425 | ||
| Segment income margin % | 29.2 | % | 26.2 | % | ||
| Adjusted segment income(a) | $ | 290,964 | $ | 237,693 | ||
| Adjusted segment income margin %(a) | 32.5 | % | 28.9 | % |
(a)See “—Non-GAAP Reconciliation.”
Year-over-year net sales increase was driven by the following:
| 2024 | ||
|---|---|---|
| Volume | 4.0 | % |
| Price, net of discounts and allowances | 3.6 | % |
| Acquisitions | 1.4 | % |
| Currency and other | (0.2) | % |
| Total | 8.8 | % |
Net sales
Net sales increased to $895.5 million in Fiscal Year 2024 from $823.3 million in Fiscal Year 2023, an increase of $72.2 million, or 8.8%.
This increase was primarily the result of volume growth and an increase in net price, as well as the favorable impact of acquisitions. The increase in volume was primarily the result of normalized channel inventory movements. The increase in the net price was due to price increases enacted to offset inflation, while the favorable impact from acquisitions resulted from the acquisition of the ChlorKing business in June 2024.
Gross profit and Gross profit margin
Gross profit increased to $474.3 million in Fiscal Year 2024 from $410.6 million in Fiscal Year 2023, an increase of $63.7 million, or 15.5%.
Gross profit margin increased to 53.0% in Fiscal Year 2024 from 49.9% in Fiscal Year 2023, an increase of 310 basis points, primarily due to operational efficiencies, net price increases and management of our manufacturing
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costs, partially offset by an increase to cost of goods sold resulting from the fair value inventory step-up adjustment recognized as part of the purchase accounting for the acquisition of ChlorKing.
Segment income and Segment income margin
Segment income increased to $261.7 million in Fiscal Year 2024 from $215.4 million in Fiscal Year 2023, an increase of $46.3 million, or 21.5%. This was primarily driven by an increase in sales and gross profit as discussed above, partially offset by higher SG&A expense driven by normalized annual incentive compensation. As a percentage of segment net sales, SG&A and RD&E expenses remained consistent at 23.7% for each year.
Segment income margin increased to 29.2% in Fiscal Year 2024 from 26.2% in Fiscal Year 2023, an increase of 300 basis points primarily resulting from the increase in sales and gross profit as discussed above.
Adjusted segment income and Adjusted segment income margin
Adjusted segment income increased to $291.0 million in Fiscal Year 2024 from $237.7 million in Fiscal Year 2023, an increase of $53.3 million, or 22.4%. This was driven by higher segment income as discussed above, adjusted for additional non-cash or non-recurring charges.
Adjusted segment income margin increased to 32.5% in Fiscal Year 2024 from 28.9% in Fiscal Year 2023, an increase of 360 basis points.
Europe & Rest of World (“E&RW”)
(Dollars in thousands)
| Years Ended December 31, | ||||||
|---|---|---|---|---|---|---|
| 2024 | 2023 | |||||
| Net sales | $ | 156,108 | $ | 169,176 | ||
| Gross profit | $ | 56,483 | $ | 66,309 | ||
| Gross profit margin % | 36.2 | % | 39.2 | % | ||
| Segment income | $ | 21,632 | $ | 33,518 | ||
| Segment income margin % | 13.9 | % | 19.8 | % | ||
| Adjusted segment income(a) | $ | 22,857 | $ | 34,503 | ||
| Adjusted segment income margin %(a) | 14.6 | % | 20.4 | % |
(a)See “—Non-GAAP Reconciliation.”
Year-over-year net sales decrease was driven by the following:
| 2024 | ||
|---|---|---|
| Volume | (8.5) | % |
| Price, net of discounts and allowances | 1.0 | % |
| Currency and other | (0.2) | % |
| Total | (7.7) | % |
Net sales
Net sales decreased to $156.1 million in Fiscal Year 2024 from $169.2 million in Fiscal Year 2023, a decrease of $13.1 million, or 7.7%.
The decrease in net sales was primarily due to a decline in volume, partially offset by the favorable impact of net price. The decline in volume was primarily driven by market declines in the Middle East and Asia, partially as a result of the impact of geopolitical conflicts in the Middle East.
Gross profit and Gross profit margin
Gross profit decreased to $56.5 million in Fiscal Year 2024 from $66.3 million in Fiscal Year 2023, a decrease of $9.8 million or 14.8%.
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Gross profit margin decreased to 36.2% in Fiscal Year 2024 compared to 39.2% in Fiscal Year 2023, a decrease of 300 basis points, primarily driven by lower operating leverage, discrete inventory adjustments and unfavorable mix due to the impact of geopolitical conflicts in the Middle East, partially offset by the net price increases discussed above.
Segment income and Segment income margin
Segment income decreased to $21.6 million in Fiscal Year 2024 from $33.5 million in Fiscal Year 2023, a decrease of $11.9 million, or 35.5%. This was primarily driven by a decrease in sales and gross profit as discussed above. As a percentage of segment net sales, SG&A and RD&E expenses increased from 19.4% in the Fiscal Year 2023 to 22.3% as a result of lower net sales as discussed above.
Segment income margin decreased to 13.9% in Fiscal Year 2024 from 19.8% in Fiscal Year 2023, a decrease of 590 basis points. The decline was primarily attributable to the decreased sales and operating leverage.
Adjusted segment income and Adjusted segment income margin
Adjusted segment income decreased to $22.9 million in Fiscal Year 2024 from $34.5 million in Fiscal Year 2023, a decrease of $11.6 million or 33.8%. This was primarily driven by the decreased sales and operating leverage, adjusted for additional non-cash or non-recurring charges.
Adjusted segment income margin decreased to 14.6% in Fiscal Year 2024 from 20.4% in Fiscal Year 2023, a decrease of 580 basis points.
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Non-GAAP Reconciliation
The Company uses EBITDA, adjusted EBITDA, adjusted EBITDA margin, adjusted segment income and adjusted segment income margin to supplement GAAP measures of performance to evaluate the effectiveness of our business strategies. These metrics are also frequently used by analysts, investors and other interested parties to evaluate companies in our industry, when considered alongside other GAAP measures.
EBITDA is defined as earnings before interest (including amortization of debt costs), income taxes, depreciation, and amortization. Adjusted EBITDA is defined as EBITDA adjusted for the impact of restructuring related income or expenses, stock-based compensation, currency exchange items and certain non-cash, nonrecurring, or other items that are included in net income and EBITDA that we do not consider indicative of our ongoing operating performance. Adjusted EBITDA margin is defined as adjusted EBITDA divided by net sales. Adjusted segment income is defined as segment income adjusted for the impact of depreciation, amortization of intangible assets recorded within cost of sales, stock-based compensation, and certain non-cash, nonrecurring or other items that are included in segment income that we do not consider indicative of the ongoing segment operating performance. Adjusted segment income margin is defined as adjusted segment income divided by segment net sales.
EBITDA, adjusted EBITDA, adjusted EBITDA margin, adjusted segment income and adjusted segment income margin are not recognized measures of financial performance under GAAP. We believe these non-GAAP measures provide analysts, investors and other interested parties with additional insight into the underlying trends of our business and assist these parties in analyzing our performance across reporting periods on a consistent basis by excluding items that we do not believe are indicative of our core operating performance, which allows for a better comparison against historical results and expectations for future performance. Management uses these non-GAAP measures to understand and compare operating results across reporting periods for various purposes including internal budgeting and forecasting, short and long-term operating planning, employee incentive compensation and debt compliance. These non-GAAP measures are not intended to replace the presentation of our financial results in accordance with GAAP.
Use of the terms EBITDA, adjusted EBITDA, adjusted EBITDA margin, adjusted segment income and adjusted segment income margin may differ from similar measures reported by other companies. EBITDA, adjusted EBITDA, adjusted EBITDA margin, adjusted segment income and adjusted segment income margin are not calculated in the same manner by all companies, and accordingly, are not necessarily comparable to similarly entitled measures of other companies and may not be an appropriate measure for performance relative to other companies. EBITDA, adjusted EBITDA, and adjusted segment income should not be construed as indicators of a company’s operating performance in isolation from, or as a substitute for, net income (loss) and operating income, which are prepared in accordance with GAAP. We have presented EBITDA, adjusted EBITDA, adjusted EBITDA margin, adjusted segment income and adjusted segment income margin solely as supplemental disclosure because we believe it allows for a more complete analysis of results of operations. In the future we may incur expenses such as those added back to calculate adjusted EBITDA. Our presentation of adjusted EBITDA and adjusted segment income should not be construed as an inference that our future results will be unaffected by these items.
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Following is a reconciliation from net income to adjusted EBITDA (dollars in thousands):
| Years Ended December 31, | ||||||
|---|---|---|---|---|---|---|
| 2024 | 2023 | |||||
| Net income | $ | 118,655 | $ | 80,687 | ||
| Depreciation | 20,078 | 15,983 | ||||
| Amortization | 35,783 | 37,079 | ||||
| Interest expense | 62,163 | 73,584 | ||||
| Income taxes | 25,527 | 20,400 | ||||
| Loss on extinguishment of debt | 4,926 | — | ||||
| EBITDA | 267,132 | 227,733 | ||||
| Stock-based compensation(a) | 608 | 1,270 | ||||
| Currency exchange items(b) | (836) | 786 | ||||
| Acquisition and restructuring related expense, net(c) | 6,464 | 13,213 | ||||
| Other(d) | 4,079 | 4,271 | ||||
| Total Adjustments | 10,315 | 19,540 | ||||
| Adjusted EBITDA | $ | 277,447 | $ | 247,273 | ||
| Net income margin | 11.3 | % | 8.1 | % | ||
| Adjusted EBITDA margin | 26.4 | % | 24.9 | % |
| (a) | Represents non-cash stock-based compensation expense related to equity awards issued to management, employees, and directors. The adjustment includes only expense related to awards issued under the 2017 Equity Incentive Plan, which were awards granted prior to the effective date of Hayward’s initial public offering (the “IPO”). | |
|---|---|---|
| (b) | Represents unrealized non-cash (gains) losses on foreign denominated monetary assets and liabilities and foreign currency contracts. | |
| (c) | Adjustments in the year ended December 31, 2024 are primarily driven by $3.2 million of compensation expenses for the retention of key employees acquired in the ChlorKing acquisition. Pursuant to the ChlorKing acquisition agreement, this $3.2 million was part of a total $6.3 million employee retention payment that was deposited into an escrow account on the date of acquisition. The full amount held in escrow will be released to the specified key employees if such employees are employed by Hayward on the one-year anniversary of the acquisition. These payments are contingent on continued employment and are not dependent on the achievement of any metric or performance measure. The retention costs will be recognized over the twelve-month period from the date of acquisition. Further, other adjustments for the year ended December 31, 2024 include $1.1 million of transaction and integration costs associated with the acquisition of the ChlorKing business, $0.9 million of termination benefits related to a reduction-in-force within E&RW, $0.8 million of separation and other costs associated with the centralization and consolidation of operations in Europe and $0.4 million of costs to finalize restructuring actions initiated in prior years. Adjustments in the year ended December 31, 2023 primarily include $6.7 million of costs related to the discontinuation of a product line leading to an impairment of the associated fixed assets, inventory and intangible assets, $2.4 million related to programs to centralize and consolidate manufacturing operations and professional services in Europe, $1.9 million of costs associated with the relocation of the corporate headquarters to Charlotte, North Carolina, $1.2 million separation costs associated with the 2022 cost reduction program and $0.8 million of costs associated with integration costs from prior acquisitions. | |
| (d) | Adjustments in the year ended December 31, 2024 are primarily driven by a $3.3 million increase in cost of goods sold resulting from the fair value inventory step-up adjustment recognized as part of the purchase accounting for the acquisition of the ChlorKing business, $0.7 million of costs sustained from flood damage associated with a hurricane at a contract manufacturing facility and $0.5 million of costs incurred related to litigation, partially offset by $0.5 million of gains on the sale of assets. Adjustments in the year ended December 31, 2023 primarily include $1.8 million related to inventory and fixed asset write-offs in Europe and $1.5 million of costs incurred related to the selling stockholder offerings of shares in March, May and August 2023, which are reported in SG&A in our consolidated statements of operations. |
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Following is a reconciliation from segment income to adjusted segment income for NAM (dollars in thousands):
| Years Ended December 31, | ||||||
|---|---|---|---|---|---|---|
| 2024 | 2023 | |||||
| Segment income | $ | 261,735 | $ | 215,425 | ||
| Depreciation | 17,989 | 14,610 | ||||
| Amortization | 6,985 | 6,718 | ||||
| Stock-based compensation (a) | 176 | 437 | ||||
| Other (b) | 4,079 | 503 | ||||
| Total Adjustments | 29,229 | 22,268 | ||||
| Adjusted segment income | $ | 290,964 | $ | 237,693 | ||
| Segment income margin | 29.2 | % | 26.2 | % | ||
| Adjusted segment income margin | 32.5 | % | 28.9 | % |
| (a) | Represents non-cash stock-based compensation expense related to equity awards issued to management, employees, and directors. The adjustment includes only expense related to awards issued under the 2017 Equity Incentive Plan, which were awards granted prior to the effective date of the IPO. | |
|---|---|---|
| (b) | Adjustments in the year ended December 31, 2024 for NAM include a $3.3 million increase in cost of goods sold resulting from the fair value inventory step-up adjustment recognized as part of the purchase accounting for the acquisition of the ChlorKing business and $0.7 million of costs related to a flood sustained at a contract manufacturer. Adjustments in the year ended December 31, 2023 for NAM include miscellaneous items we believe are not representative of our ongoing business operations. |
Following is a reconciliation from segment income to adjusted segment income for E&RW (dollars in thousands):
| Years Ended December 31, | ||||||
|---|---|---|---|---|---|---|
| 2024 | 2023 | |||||
| Segment income | $ | 21,632 | $ | 33,518 | ||
| Depreciation | 1,215 | 940 | ||||
| Amortization | — | — | ||||
| Stock-based compensation (a) | 10 | 45 | ||||
| Total Adjustments | 1,225 | 985 | ||||
| Adjusted segment income | $ | 22,857 | $ | 34,503 | ||
| Segment income margin | 13.9 | % | 19.8 | % | ||
| Adjusted segment income margin | 14.6 | % | 20.4 | % |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| (a) | Represents non-cash stock-based compensation expense related to equity awards issued to management, employees, and directors. The adjustment includes only expense related to awards issued under the 2017 Equity Incentive Plan, which were awards granted prior to the effective date of the IPO. |
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Liquidity and Capital Resources
Our primary sources of liquidity are net cash provided by operating activities and availability under the ABL Facility. Primary working capital requirements are for raw materials, assembled components and certain finished goods inventories and supplies, payroll, manufacturing, freight and distribution, facility, and other operating expenses. Cash flow and working capital requirements fluctuate during the year, driven primarily by the seasonal demand for our products, an Early Buy program, the timing of inventory purchases and receipt of customer payments. As such, the utilization of the ABL Facility fluctuates during the year.
During the end of the year we incentivize trade customers to buy and stock up in preparation for next year’s pool season under an “Early Buy” program that features a price discount and extended payment terms. Shipments under the 2024 Early Buy program began in the late third quarter and will continue through approximately the first quarter of 2025. We expect to receive payments for the majority of these shipments during the second quarter of 2025. As a result, our accounts receivable balance increases from the late third quarter through the first quarter of 2025 before the Early Buy payments are received. In addition, cash flow is higher in the second quarter as the seasonality of our business peaks and payments are received.
Unrestricted cash and cash equivalents totaled $196.6 million as of December 31, 2024, which is an increase of $18.5 million from $178.1 million at December 31, 2023. As of December 31, 2024 and December 31, 2023, the Company had zero and $25 million, respectively, in certificates of deposit, which was included in short-term investments on the consolidated balance sheets.
We focus on increasing cash flow, solidifying the liquidity position through working capital initiatives, and paying our debt obligations, while continuing to fund business growth initiatives and return of capital to stockholders. We believe that net cash provided by operating activities and availability under the ABL Facility will be adequate to finance our working capital requirements, inclusive of capital expenditures, and debt service over the next 12 months.
The Organisation for Economic Co-operation and Development introduced an international tax framework under Pillar Two which includes a global minimum tax of 15%. While the United States has not enacted legislation to adopt Pillar Two, certain countries in which we operate have adopted legislation, and other countries are in the process of introducing legislation to implement Pillar Two. We do not expect Pillar Two to have a material impact on our effective tax rate or taxes paid.
Accounts Receivable Sales
On July 3, 2024, we entered into a Receivables Purchase Agreement under which we may offer to sell eligible accounts receivable. The agreement is uncommitted and the eligible accounts receivable to be sold under the agreement consist of up to $125 million in accounts receivable generated by sales to specified customers of the Company. The Company will be paid a discounted purchase price for each receivable sold. The discount rate used to determine the purchase price for the subject receivables is based upon an annual interest rate equal to the forward-looking term rate based on the secured overnight financing rate for the period of time between payment to the Company and the due date for the receivable plus a buffer period specific to the obligor, plus a margin applicable to the specified obligor.
Transactions under this agreement are accounted for as sales of accounts receivable, and the receivables sold are removed from the consolidated balance sheets at the time of the sales transaction. For ease of administration, the Company collects customer payments related to the receivables sold and remits those payments to the purchaser. Proceeds received from the sales of accounts receivable are classified as operating cash flows and collections of previously sold accounts receivable not yet submitted to the financial institution are classified as financing cash flows in the consolidated statements of cash flows. We record the discount in the “Other expense, net” line in the consolidated statements of operations. During the twelve months ended December 31, 2024, there were immaterial proceeds from the sale of receivables under the Receivables Purchase Agreement.
Credit Facilities
The First Lien Term Facility and ABL Facility (collectively “Credit Facilities”) contain various restrictions, covenants and collateral requirements. Refer to Note 9, “Long-Term Debt” of Notes to the Consolidated Financial Statements in this Form 10-K for further information on the terms of the Credit Facilities.
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Long-term debt consisted of the following (in thousands):
| December 31, | ||||||
|---|---|---|---|---|---|---|
| 2024 | 2023 | |||||
| First Lien Term Facility, due May 28, 2028 | $ | 965,000 | $ | 975,000 | ||
| Incremental Term Loan B, due May 28, 2028 | — | 123,438 | ||||
| ABL Revolving Credit Facility | — | — | ||||
| Other bank debt | 6,461 | 8,775 | ||||
| Finance lease obligations | 2,448 | 4,729 | ||||
| Subtotal | 973,909 | 1,111,942 | ||||
| Less: Current portion of long-term debt | (13,991) | (15,088) | ||||
| Less: Unamortized debt issuance costs | (9,356) | (17,574) | ||||
| Total | $ | 950,562 | $ | 1,079,280 |
ABL Facility
The aggregate amount of the revolving loan commitments on the ABL Facility is $425.0 million, with a peak season commitment of $475.0 million, subject to a borrowing base calculation based on available eligible receivables, inventory, and qualified cash in North America. Accounts receivable sold under the Receivables Purchase Agreement are not eligible receivables under the ABL Facility. An amount of up to 30% (or up to 40% with agent consent) of the then-outstanding commitments under the ABL Facility is available to our Canada and Spain subsidiaries. A portion of the ABL Facility not to exceed $50.0 million is available for the issuance of letters of credit in U.S. Dollars, of which $20.0 million is available for the issuance of letters of credit in Canadian dollars. The ABL Facility also includes a $50.0 million swingline loan facility and a $17.5 million First-In, Last-Out Sublimit (“FILO Sublimit”).
The borrowings under the ABL Facility bear interest at a rate equal to an adjusted term of the Secured Overnight Financing Rate (“SOFR”) or a base rate plus a margin of between 1.25% to 1.75% or 0.25% to 0.75%, respectively, while the FILO Sublimit borrowings bear interest at a rate equal to SOFR or a base rate plus a margin of between 2.25% to 2.75% or 1.25% to 1.75%, respectively. The ABL Facility matures June 1, 2026. We have the option to increase the ABL Facility, subject to certain conditions, including the commitment of the participating lenders.
For the year ended December 31, 2024, the average borrowing base under the ABL Facility was $212.6 million and the average loan balance outstanding was zero. As of December 31, 2024, the loan balance was zero with a borrowing availability of $163.4 million.
For the year ended December 31, 2023, the average borrowing base under the ABL Facility was $265.8 million and the average loan balance outstanding was $17.3 million. As of December 31, 2023 the loan balance was zero with a borrowing availability of $256.5 million.
First Lien Term Facilities
The First Lien Term Facility bears interest at a rate equal to a base rate or SOFR (which includes an applicable credit spread adjustment), plus, in either case, an applicable margin. In the case of SOFR tranches, the applicable margin is 2.75% per annum with a 0.50% floor, with a stepdown to 2.50% per annum with a 0.50% floor when net secured leverage as defined by the First Lien Credit Agreement is less than 2.5x. The loan under the First Lien Term Facility amortizes quarterly at a rate of 0.25% of the original principal amount and requires a $2.5 million repayment of principal on the last business day of each March, June, September and December. For the periods prior to May 22, 2023, before the Company entered into the Fifth Amendment to the Company’s First Lien Credit Agreement to replace the LIBOR based reference rate with an adjusted term SOFR, the borrowings under the First Lien Term Facility bore interest at a rate equal to LIBOR or a base rate plus an applicable margin of 2.75% per annum with a 0.50% floor, with a stepdown to 2.50% per annum with a 0.50% floor when net secured leverage ratio as defined by the credit agreement is less than 2.5x.
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The First Lien Term Facility included an incremental term loan in an aggregate original principal amount of $125 million (the “Incremental Term Loan B”). The Incremental Term Loan B bore interest at an annual floating rate based on SOFR (with a 0.50% floor) plus 3.25% and a 0.10% credit spread adjustment. In April 2024, the Company voluntarily prepaid the Incremental Term Loan B in full.
Under the agreement governing the First Lien Credit Facility (the “First Lien Credit Agreement”), the Company must make an annual mandatory prepayment of principal for between 0% and 50% of the excess cash and subject to permitted deductions, as defined in the First Lien Credit Agreement, generated in the prior calendar year. The amount due varies with the First Lien Leverage Ratio as defined in the First Lien Credit Agreement, from zero if the First Lien Leverage Ratio is less than or equal to 2.5x, to 50% if the First Lien Leverage Ratio is greater than 3.0x, less certain allowed deductions, in each case as of December 31 of the prior year. Pursuant to this provision, the Company does not have a mandatory excess cash flow prepayment in 2025 based on the First Lien Leverage Ratio and permitted deductions as of December 31, 2024. The First Lien Term Facility matures on May 28, 2028.
As of December 31, 2024, the balance outstanding under the First Lien Term Facility was $965.0 million. The effective interest rate on borrowings under the First Lien facilities, including the impact of an interest rate hedge, was 6.77%.
As of December 31, 2023, the balance outstanding under the First Lien Term Facility was $975.0 million and the balance outstanding under the Incremental Term Loan B was $123.4 million. The effective interest rate on borrowings under the First Lien facilities, including the impact of an interest rate hedge, was 6.85%.
Covenant Compliance
The Credit Facilities contain various restrictions, covenants and collateral requirements. As of December 31, 2024, we were in compliance with all covenants under the Credit Facilities.
Sources and Uses of Cash
Following is a summary of our cash flows from operating, investing, and financing activities (dollars in thousands):
| Years Ended December 31, | |||||||
|---|---|---|---|---|---|---|---|
| 2024 | 2023 | ||||||
| Net cash provided by operating activities | $ | 212,068 | $ | 184,540 | |||
| Net cash used in investing activities | (54,131) | (55,381) | |||||
| Net cash used in financing activities | (136,790) | (7,612) | |||||
| Effect of exchange rate changes on cash and cash equivalents and restricted cash | (2,655) | 373 | |||||
| Change in cash and cash equivalents and restricted cash | $ | 18,492 | $ | 121,920 |
Net cash provided by operating activities
Net cash provided by operating activities increased to $212.1 million for the year ended December 31, 2024 from $184.5 million for the year ended December 31, 2023, an increase of $27.6 million, or 14.9%. The increase was driven by the increase in net income.
Net cash used in investing activities
Net cash used in investing activities decreased to $54.1 million for the year ended December 31, 2024 compared to $55.4 million for the year ended December 31, 2023, a decrease of $1.3 million, or 2.3%. For the year ended December 31, 2024, net cash used in investing activities was driven by the acquisition of the ChlorKing business and purchases of property, plant and equipment, partially offset by the proceeds of certificates of deposit investments. For the year ended December 31, 2023, net cash used in investing activities was driven by purchases of property, plant and equipment along with investments made into certificates of deposit.
Net cash (used in) provided by financing activities
Net cash used in financing activities increased to $136.8 million for the year ended December 31, 2024 compared to $7.6 million for the year ended December 31, 2023, an increase of $129.2 million. The increase was primarily driven by the prepayment of the Incremental Term Loan B.
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Contractual Obligations and Other Commitments
The following table summarizes our contractual cash obligations as of December 31, 2024 (in thousands):
| 2025 | 2026 | 2027 | 2028 | 2029 | Thereafter | Total | ||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Long-term debt (a) | $ | 12,424 | $ | 12,420 | $ | 11,117 | $ | 935,347 | $ | 102 | $ | 51 | $ | 971,461 | ||||||||||||
| Letters of credit | 4,310 | — | — | — | — | — | 4,310 | |||||||||||||||||||
| Operating lease commitments (b) | 11,517 | 10,148 | 8,040 | 7,302 | 7,216 | 33,767 | 77,990 | |||||||||||||||||||
| Finance lease commitments | 1,836 | 272 | 270 | 177 | 30 | — | 2,585 | |||||||||||||||||||
| Total | $ | 30,087 | $ | 22,840 | $ | 19,427 | $ | 942,826 | $ | 7,348 | $ | 33,818 | $ | 1,056,346 |
(a) For further information on the terms of the Credit Facilities, please see Note 9. “Long-Term Debt” of Notes to Consolidated Financial Statements in this Form 10-K and “Liquidity and Capital Resources”.
(b) Operating lease commitments primarily relate to our office, distribution, and manufacturing facilities. All of these obligations require cash payments to be made by us over varying periods of time. Certain leases are renewable at our option for periods of one to ten years and certain of these arrangements are cancellable on short notice while others require payment upon early termination. Refer to Note 15. “Leases” of Notes to Consolidated Financial Statements in this Form 10-K for further information.
Off-Balance Sheet Arrangements
We had $4.3 million of outstanding letters of credit on our ABL Facility as of each of December 31, 2024 and December 31, 2023.
Critical Accounting Estimates
Our consolidated financial statements have been prepared in accordance with GAAP. The preparation of our consolidated financial statements and notes to consolidated financial statements requires us to make estimates that affect the reported amounts of assets, liabilities, sales and expenses, and related disclosures of contingent assets and liabilities. We base these estimates on historical results and various other assumptions believed to be reasonable, all of which form the basis for making estimates concerning the carrying value of assets and liabilities that are not readily available from other sources. Actual results may differ from these estimates.
Our significant accounting policies are described in the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K. We believe that the following critical accounting estimates include the most significant estimates and management judgments used in preparing the consolidated financial statements.
Customer Rebates
Many of our major customer agreements provide for rebates, some of which require achievement of various performance targets. We account for customer rebates as a reduction of gross sales with either a corresponding offset to accounts receivable or recognition of an accrued liability. We estimate the rebates based on our latest projection of customer performance. We update the estimates regularly to reflect any changes to the projection of customer performance for the applicable period.
Goodwill and Indefinite Lived Intangibles
We review goodwill and indefinite lived intangible assets for impairment annually or on an interim basis whenever events or changes in circumstances indicate the fair value of such assets may be below their carrying amount. As of December 31, 2024, goodwill and indefinite lived intangible assets were $943.6 million and $736.0 million, respectively.
For goodwill, we may first make a qualitative assessment of whether it is more likely than not that a reporting unit’s fair value is less than its carrying value. The qualitative impairment assessment includes considering various factors including macroeconomic conditions, industry and market conditions, cost factors and any reporting unit specific events. If it is determined through the qualitative assessment that the reporting unit’s fair value is more
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likely than not greater than its carrying value, the quantitative impairment assessment is not required. If the qualitative assessment indicates it is more likely than not that the reporting unit’s fair value is no greater than its carrying value, we must perform a quantitative impairment assessment. If it is determined a quantitative assessment is necessary, we would compare the fair value of the reporting unit to the respective carrying value, which includes goodwill. If the fair value of the reporting unit exceeds its carrying value, goodwill is not considered impaired. If the carrying value is higher than the fair value, the difference would be recognized as an impairment loss. Fair value of the reportable unit is estimated using a discounted six-year projected cash flow analyses and a terminal value calculation at the end of the six-year period. For the year-ended December 31, 2024, the Company performed a qualitative analysis and determined that the fair values of the reporting units were more likely than not greater than the carrying amounts. As such, the Company did not need to proceed beyond the qualitative analysis, and no goodwill impairments were recorded. For the year-ended December 31, 2023, the Company performed a quantitative analysis and determined that the fair value of each of the reporting units exceeded the corresponding carrying value.
Similar to the test for impairment of goodwill, we may first make a qualitative assessment of whether it is more likely than not that an indefinite lived intangible assets’ fair value is less than its carrying value to determine whether it is necessary to perform a quantitative impairment assessment. If it is determined a quantitative assessment is necessary, we would compare their estimated fair values to their carrying values. Fair value is generally estimated using discounted cash flows or relief from royalty approaches. We would recognize an impairment charge when the estimated fair value of the indefinite lived intangible asset is less than its carrying value. We annually evaluate whether the trade names continue to have an indefinite life.
Stock-Based Compensation
We recognize stock-based compensation expense for awards of equity instruments based on the grant-date fair value of those awards. The grant-date fair value of the award is recognized as compensation expense ratably over the requisite service period, which generally equals the vesting period of the award. We also grant performance-based restricted share units (“PSUs”). PSU awards are recognized as compensation expense beginning at the grant date and reassessed quarterly for probability. We reassess the probability of achievement at each reporting period and adjust compensation cost, as necessary. If there are any changes in our probability assessment, we recognize a cumulative catch-up adjustment in the period of the change in estimate, with the remaining unrecognized expense recognized prospectively over the remaining requisite service period. If we subsequently determine that the performance criteria are not met or are not expected to be met, any amounts previously recognized as compensation expense are reversed in the period when such determination is made. We record actual forfeitures in the period in which the forfeiture occurs. We use the Black-Scholes option pricing model to estimate the fair value of option awards.
Warranties
We provide base warranties on the products we sell for specific periods of time, which vary depending upon the type of product and the geographic location of its sale. Pursuant to these warranties, we will repair, replace or remodel all parts that are defective in factory-supplied materials or workmanship. We accrue the estimated cost of warranty coverages at the time of sale using historical information regarding the nature, frequency, and average cost of claims for each product. We then compare the resulting accruals with present spending rates, among other factors, to assess whether the balances are adequate to meet expected future obligations. Based on this data, we update the estimates as necessary.
Inventory Valuation
Inventories consist of merchandise held for sale and are stated at the lower of cost or net realizable value. When evidence exists that the net realizable value of inventory is lower than its cost, the difference is recorded in cost of sales in our consolidated statement of operations as a loss in the period in which it occurs. We provide provisions for losses related to inventories based on historical purchase cost, selling price, margin and current business trends. The estimates have calculations that require us to make assumptions based on the current rate of sales, age, salability of inventory, and profitability of inventory, all of which may be affected by changes in merchandising mix and consumer preferences. We review and update these reserves on a quarterly basis.
Due to the uncertainty and potential volatility of the factors used in establishing estimates, changes in assumptions could materially affect our financial condition and results of operations.
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Acquisitions
We apply the provisions of the Accounting Standards Codification (“ASC”) 805, Business Combinations. Under this provision, we use the acquisition method of accounting where the purchase consideration is allocated to the underlying net tangible and intangible assets acquired, based on their respective fair values. The excess of the purchase consideration over the estimated fair values of the net assets acquired is recorded as goodwill. Identifiable assets acquired, liabilities assumed and any noncontrolling interest in the acquiree are recognized and measured as of the acquisition date at fair value. Additionally, any contingent consideration is recorded at fair value on the acquisition date and classified as a liability. Goodwill is recognized to the extent by which the aggregate of the acquisition-date fair value of the consideration transferred and any noncontrolling interest in the acquiree exceeds the recognized basis of the identifiable assets acquired, net of assumed liabilities.
Determining the fair value of assets acquired, liabilities assumed and noncontrolling interest requires management’s judgement and often involves the use of estimates and assumptions, including but not limited to, the selection of appropriate valuation methodology, projected revenue, expense and cash flows, weighted average cost of capital, discount rates, estimate of customer turnover, estimates of terminal values, and royalty rates. We may use third party valuation specialists to determine the assets acquired, liabilities assumed, and corresponding offset to goodwill.
Recently Issued and Adopted Accounting Standards
See Note 2. “Significant Accounting Policies” of Notes to Consolidated Financial Statements in this Form 10-K for additional information.
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