# Hayward Holdings, Inc. (HAYW) FY 2021 MD&A

Verbatim Item 7 Management's Discussion and Analysis from Hayward Holdings, Inc.'s 10-K for fiscal year 2021.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1834622/000183462222000024/hayw-20211231.htm
Accession: 0001834622-22-000024
Filing date: 2022-03-09
Report date: 2021-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary. Published MD&A gate trimmed front/tail over-capture.
Confidence: high

Company profile: /company/HAYW/
All MD&A years: /company/HAYW/mda/
Next year: /company/HAYW/mda/fy2022/ (FY 2022)

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, 2021 as Fiscal Year 2021 and the year ended December 31, 2020 as Fiscal Year 2020. Our fiscal quarters are 13 weeks except the fourth quarter which ends on December 31 of each fiscal year. The first quarter 2021 refers to the quarter ended April 3, the second quarter 2021 refers to the quarter ended July 3, the third quarter 2021 refers to the quarter ended October 2, and the fourth quarter 2021 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, 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 34%. We believe that we are well-positioned for future growth. On average, we have 20+ year relationships with our top 20 customers. Based upon feedback from certain representative customers and our interpretation of available industry and government data in the United States, we estimate that aftermarket sales represented approximately 80% of net sales. Aftermarket sales are not based upon our GAAP net sales results. We believe aftermarket sales 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 manufacture our products at eight facilities worldwide, which are located in North Carolina, Tennessee, Rhode Island, Florida, Spain (three) 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 operating 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 83% and 17% and 81% and 19% of total net sales for Fiscal Year 2021 and Fiscal Year 2020, 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 globally.

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.

Key Trends and Uncertainties Regarding Our Existing Business

The following trends and uncertainties 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 have increased during the COVID-19 pandemic. This increase in demand has broadly been across all of our product lines as consumers have refocused attention on improving the quality of the homeowner’s outdoor living experience especially for products such as heaters to extend the pool season. Urban flight along with desire for second homes is also driving residential pool construction as homeowners remodel or upgrade their existing outdoor living spaces.

•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 readiness for next year’s pool season under an “early buy” program which offers a price discount and extended payment terms. Under the early buy program in 2021, we ship products during October through March and receive payments for these shipments during February through July 2022. Revenue is recognized upon shipment of products, which cannot be returned unless damaged. 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 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 October to April as a result of the early buy extended terms and increases through June due to higher sales in the second quarter.

•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 2021, new products launched in the last three years contributed approximately 14% of net sales. These new products, for example, a new generation of variable speed pumps, enhanced Omni controls, and advanced robotic cleaners, offer higher energy efficiency, automation capabilities and enhanced water care solutions, and 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.

•Materials and other cost increases. We have experienced increases in the cost of raw materials and commodities. We strive for productivity improvements, and implement price increases to help mitigate this impact. We expect to see continuing price volatility (metals, resins, and electronic sub- assemblies) and import duty charges (motors, electronics, valves and cleaner products) for some of our raw materials. We are uncertain as to the timing and impact of these market changes, but have mitigation activities in place to minimize the impact on costs.

Factors Affecting the Comparability of our Results of Operations

Our comparative results have been affected by the following, among other events, which must be understood to assess the comparability of our period-to-period financial performance and condition.

Impact of COVID-19

Residential pool equipment sales have increased during the COVID-19 pandemic. This increase in demand has broadly been across all of our product lines as consumers have refocused attention on improving the quality of the homeowner’s outdoor living experience. We believe that the pandemic has only reinforced existing pool industry growth trends.

Recently, cost inflation stemming from the COVID-19 pandemic has caused prices to increase across various sectors of the economy and we have been impacted by increases in the prices of our raw materials and other associated manufacturing costs. We strive for productivity improvements and seek to implement increases in selling prices to help mitigate cost increases in raw materials (especially metals and resins), energy and other costs including wages, pension, health care and insurance. While we continue to face challenges in the form of higher costs and delays in both obtaining raw materials and components and in shipping finished goods, the aforementioned increase in selling price and customer demand during the COVID-19 pandemic has thus far mitigated the negative impact of these cost increases and resulted in a increase of our net sales and profitability in 2021 in comparison to prior comparative periods.

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 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, 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 inclusive of outbound shipping and handling charges billed to customers and 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 an offsetting adjustment to account receivable. 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, but is expected to increase over time to support the needs of a public company and business growth.

Research, development and engineering expense

The Company 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, patents 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 to acquisition and related income, net.

Operating income

Operating income is gross profit less SG&A, RD&E, acquisition and restructuring related expense or income and amortization intangible assets. Operating income excludes interest expense, income tax expense, and other expenses, net. We use operating income as well as other indicators as a measure of our profitability of our business.

Interest expense

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 interest expense, other non-operating items, and provision for income taxes.

Adjusted EBITDA, Adjusted EBITDA margin, Adjusted segment income, Adjusted segment income margin

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 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 2021 and 2020 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, 2020 compared to the year ended December 31, 2019 is included under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our prospectus for the IPO, which was filed with the SEC pursuant to Rule 424(b) on March 15, 2021.

The following table summarizes our results of operations and a comparison of the change between the periods (in thousands):

[[GREPCENT_TABLE]]
[["","Years Ended December 31,"],["","2021","","2020"],["Net Sales","$","1,401,794","","","$","875,402"],["Cost of sales","746,012","","","478,371"],["Gross profit","655,782","","","397,031"],["Selling, general, and administrative expense","267,264","","","195,220"],["Research, development, and engineering expense","22,867","","","20,046"],["Acquisition and restructuring related expense","15,030","","","19,317"],["Amortization of intangible assets","32,647","","","37,896"],["Operating income","317,974","","","124,552"],["Interest expense, net","50,854","","","73,615"],["Loss on debt extinguishment","9,418","","","\u2014"],["Other (income) expense, net","(2,439)","","","(6,848)"],["Total other expense","57,833","","","66,767"],["Income from operations before income taxes","260,141","","","57,785"],["Provision for income taxes","56,416","","","14,483"],["Net income","$","203,725","","","$","43,302"],["Adjusted EBITDA(a)","$","421,737","","","$","231,551"]]
[[/GREPCENT_TABLE]]

(a) See “— Non-GAAP Reconciliation.”

Fiscal Year 2021 Compared to Fiscal Year 2020

Net sales

Net sales increased to $1,401.8 million in Fiscal Year 2021 from $875.4 million in Fiscal Year 2020, an increase of $526.4 million or 60.1%. See segment discussion below for further information.

[[GREPCENT_TABLE]]
[["","2021"],["Volume","50.4","%"],["Price, net of discounts and allowances","7.5","%"],["Currency and other","2.2","%"],["Total","60.1","%"]]
[[/GREPCENT_TABLE]]

The Fiscal Year 2021 increase in net sales was primarily the result of higher volumes, mainly in residential pool equipment sales from continued demand for pool upgrades and increasing new pool construction, a net 7.5% price impact, and favorable foreign currency effects.

Gross profit and Gross profit margin

Gross profit increased to $655.8 million in Fiscal Year 2021 from $397.0 million in Fiscal Year 2020, an increase of $258.8 million or 65.2%.

Gross profit margin increased to 46.8% in Fiscal Year 2021 compared to 45.4% in Fiscal Year 2020, an increase of 143 basis points primarily resulting from higher sales volumes, price increases to offset inflationary pressures on raw material, freight and tariffs, and a favorable mix due to stronger growth of higher margin NAM sales.

Selling, general, and administrative expense

Selling, general, and administrative expense increased to $267.3 million in Fiscal Year 2021 from $195.2 million in Fiscal Year 2020, an increase of $72.0 million or 36.9% primarily driven by volume-based expenses related to selling and distribution expense, incentive compensation expense, and warranty expense. The Company also incurred increased costs in connection with its IPO for stock-based compensation expense, debt refinancing costs, and other IPO costs, which are non-recurring in nature. The year over year increase was also

driven by additional costs related to becoming a public company including additional expense for certain insurance and information technology.

As a percentage of net sales, SG&A decreased to 19.1% in Fiscal Year 2021 as compared to 22.3% in Fiscal Year 2020, a decrease of 323 basis points primarily due to increased productivity and operating leverage.

Research, development, and engineering expense

RD&E expense increased to $22.9 million in Fiscal Year 2021 from $20.0 million in Fiscal Year 2020 as a result of increased activities to support business growth and product development. As a percentage of net sales, RD&E dropped to 1.6% in Fiscal Year 2021 compared to 2.3% in Fiscal Year 2020, a decrease of 66 basis points, as sales growth outpaced increases in RD&E expense.

Acquisition and restructuring related expense

Acquisition and restructuring related expense decreased to $15.0 million in Fiscal Year 2021 as compared to $19.3 million in Fiscal Year 2020, a decrease of $4.3 million.

The $15.0 million expense in Fiscal Year 2021 was primarily driven by expenses related to a product discontinuance related to an early-stage product business acquired in 2018, the pending relocation of the corporate headquarters to Charlotte, North Carolina, and business-restructuring-related costs associated with the exit of redundant manufacturing and distribution facilities.

The $19.3 million expense in Fiscal Year 2020 was primarily driven by additional costs consequential to the cessation of certain manufacturing and distribution operations and the start-up of a new distribution center in the Southwestern United States.

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 $32.6 million in Fiscal Year 2021 from $37.9 million in Fiscal Year 2020, a decrease of $5.2 million or 13.9%, due to the amortization pattern of certain intangibles based on the declining balance method.

Operating income

Operating income increased to $318.0 million in Fiscal Year 2021 from $124.6 million in Fiscal Year 2020, an increase of $193.4 million or 155.3% due to the accumulated effect of the items described above.

Interest expense, net

Interest expense, net, inclusive of the loss on debt extinguishment, decreased to $60.3 million in Fiscal Year 2021 from $73.6 million in Fiscal Year 2020, a decrease of $13.3 million or 18.1%, primarily driven by a lower debt position in 2021 following $364.6 million of debt repayments in the first quarter 2021, to reduced interest rates on our floating rate debt as a result of debt refinancings in the second quarter 2021, and a reduction in the use of our ABL Facility.

Interest expense in Fiscal Year 2021 consisted of $46.9 million of interest on the outstanding debt, $9.4 million of a loss on debt extinguishment, and $4.0 million of amortization of deferred financing fees. Interest expense in Fiscal Year 2020 consisted of $68.5 million on the outstanding debt, $5.4 million of amortization of deferred financing fees net of interest income.

Provision for income taxes

We incurred income tax expense of $56.4 million for Fiscal Year 2021 and $14.5 million for Fiscal Year 2020, an increase of $41.9 million or 289.5%. This increase in tax expense was primarily due to increased income from operations.

Our effective income tax rate decreased to 21.7% for Fiscal Year 2021 from 25.1% for Fiscal Year 2020 primarily due to lower state tax expenses, the release of a valuation allowance against certain international net operating losses, and a higher tax deduction related to stock option exercises.

Net income

As a result of the foregoing, net income increased to $203.7 million in Fiscal Year 2021 compared to net income of $43.3 million in Fiscal Year 2020, an increase of $160.4 million or 370.5%.

Adjusted EBITDA and Adjusted EBITDA margin

Adjusted EBITDA increased to $421.7 million in Fiscal Year 2021 from $231.6 million in Fiscal Year 2020, an increase of $190.2 million or 82.1% driven primarily by higher net sales and operating leverage resulting in an increase in gross profit of $258.8 million, partially offset by an increase in SG&A expenses of $72.0 million.

Adjusted EBITDA margin increased to 30.1% in Fiscal Year 2021 compared to 26.5% in Fiscal Year 2020, an increase of 363 basis points.

See “— Non-GAAP Reconciliation” for a reconciliation of these non-GAAP measures to the most directly comparable GAAP measures.

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, gross profit, segment income and adjusted segment income, and use gross profit margin, 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. A reconciliation of segment income to our operating income is detailed below. 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:

[[GREPCENT_TABLE]]
[["(Dollars in Thousands)","Fiscal Year 2021","","Fiscal Year 2020"],["","Total","","NAM","","E&RW","","Total","","NAM","","E&RW"],["Net sales","$","1,401,794","","","$","1,160,850","","","$","240,944","","","$","875,402","","","$","706,514","","","$","168,888"],["Gross profit","$","655,782","","","$","558,950","","","$","96,832","","","$","397,031","","","$","334,611","","","$","62,420"],["Gross profit margin %","46.8","%","","48.2","%","","40.2","%","","45.4","%","","47.4","%","","37.0","%"],["Segment income","$","419,081","","","$","359,886","","","$","59,195","","","$","202,619","","","$","171,815","","","$","30,804"],["Segment income margin %","29.9","%","","31.0","%","","24.6","%","","23.1","%","","24.3","%","","18.2","%"],["Adjusted segment income(a)","$","457,530","","","$","396,410","","","$","61,120","","","$","241,140","","","$","206,904","","","$","34,236"],["Adjusted segment income margin %(a)","32.6","%","","34.1","%","","25.4","%","","27.5","%","","29.3","%","","20.3","%"],["Expenses not allocated to segments"],["Corporate expense, net","$","53,430","","","","","","","$","20,854"],["Acquisition and restructuring related expense","$","15,030","","","","","","","$","19,317"],["Amortization of intangible assets","$","32,647","","","","","","","$","37,896"],["Operating income","$","317,974","","","","","","","$","124,552"]]
[[/GREPCENT_TABLE]]

(a)See “—Non-GAAP Reconciliation.”

North America (“NAM’’)

(Dollars in thousands)

[[GREPCENT_TABLE]]
[["","Years Ended December 31,"],["","2021","","2020"],["Net sales","$","1,160,850","","","$","706,514"],["Gross profit","$","558,950","","","$","334,611"],["Gross profit margin %","48.2","%","","47.4","%"],["Segment income","$","359,886","","","$","171,815"],["Segment income margin %","31.0","%","","24.3","%"],["Adjusted segment income(a)","$","396,410","","","$","206,904"],["Adjusted segment income margin %(a)","34.1","%","","29.3","%"]]
[[/GREPCENT_TABLE]]

(a)See “—Non-GAAP Reconciliation.”

Year-over-year net sales increases were driven by the following:

[[GREPCENT_TABLE]]
[["","2021"],["Volume","54.5","%"],["Price, net of discounts and allowances","8.3","%"],["Currency and other","1.5","%"],["Total","64.3","%"]]
[[/GREPCENT_TABLE]]

Net sales

Increased to $1,160.9 million in Fiscal Year 2021 from $706.5 million in Fiscal Year 2020, an increase of $454.3 million or 64.3%.

This was primarily the result of a 54.5% increase in volume mostly due to higher sales of residential pool equipment as demand for more efficient, environmentally friendly and automated pool products remained robust, a 8.3% favorable impact from price increases, and a 1.5% favorable impact of foreign currency translation.

Gross profit and Gross profit margin

Gross profit increased to $559.0 million in Fiscal Year 2021 from $334.6 million in Fiscal Year 2020, an increase of $224.3 million or 67.0%.

Gross profit margin rose to 48.2% in Fiscal Year 2021 from 47.4% in Fiscal Year 2020, an increase of 79 basis points, primarily driven by the net price increase discussed above, manufacturing leverage, and cost savings, partially offset by the inflationary increases from raw materials, freight, and higher import duties.

Segment income and Segment income margin

Segment income increased to $359.9 million in Fiscal Year 2021 from $171.8 million in Fiscal Year 2020, an increase of $188.1 million or 109.5%. This was primarily driven by an increase in gross profit as discussed above offset in part by higher SG&A expenses of $30.7 million, or 20.6%, primarily driven by volume-related higher selling and distribution expenses, incentive and stock-based compensation expense, and warranty expenses. As a percentage of segment net sales, SG&A and RD&E expenses decreased from 23.0% in the Fiscal Year 2020 to 17.1% as a result of increased productivity and operating expense leverage.

Segment income margin increased to 31.0% in Fiscal Year 2021 from 24.3% in Fiscal Year 2020, an increase of 668 basis points achieved from increased gross profit margin and operating expense leverage as discussed above.

Adjusted segment income and Adjusted segment income margin

Adjusted segment income increased to $396.4 million in Fiscal Year 2021 from $206.9 million in Fiscal Year 2020, an increase of $189.5 million or 91.6%. This was driven by the higher segment income as discussed above, adjusted by the adjustments for additional non-cash or non-recurring charges.

Adjusted segment income margin increased to 34.1% in Fiscal Year 2021 from 29.3% in Fiscal Year 2020, an increase of 486 basis points.

Europe & Rest of World (“E&RW”)

(Dollars in thousands)

[[GREPCENT_TABLE]]
[["","Years Ended December 31,"],["","2021","","2020"],["Net sales","$","240,944","","","$","168,888"],["Gross profit","$","96,832","","","$","62,420"],["Gross profit margin %","40.2","%","","37.0","%"],["Segment income","$","59,195","","","$","30,804"],["Segment income margin %","24.6","%","","18.2","%"],["Adjusted segment income(a)","$","61,120","","","$","34,236"],["Adjusted segment income margin %(a)","25.4","%","","20.3","%"]]
[[/GREPCENT_TABLE]]

(a)See “—Non-GAAP Reconciliation.”

Year-over-year net sales increases were driven by the following:

[[GREPCENT_TABLE]]
[["","2021"],["Volume","33.1","%"],["Price, net of discounts and allowances","4.0","%"],["Currency and other","5.6","%"],["Total","42.7","%"]]
[[/GREPCENT_TABLE]]

Net sales

Increased to $240.9 million in Fiscal Year 2021 from $168.9 million in Fiscal Year 2020, an increase of $72.1 million or 42.7%.

This increase was primarily due to 33.1% volume growth driven by continuing strong customer demand for pool products and the easing of governmental restrictions relating to COVID-19 in Fiscal Year 2021 as compared to Fiscal Year 2020, the favorable impact of foreign currency translation, and favorable pricing.

Gross profit and Gross profit margin

Gross profit increased to $96.8 million in Fiscal Year 2021 from $62.4 million in Fiscal Year 2020, an increase of $34.4 million or 55.1%.

Gross profit margin increased to 40.2% in Fiscal Year 2021 from 37.0% in Fiscal Year 2020, an increase of 323 basis points, primarily driven by volume leverage, price increases, favorable product mix, and the favorable impact of foreign currency translation, partially offset by inflationary cost pressures on shipping costs, supplies and raw materials.

Segment income and Segment income margin

Segment income increased to $59.2 million in Fiscal Year 2021 from $30.8 million in Fiscal Year 2020, an increase of $28.4 million or 92.2%. This was primarily driven by an increase in gross profit as discussed above offset in part by higher SG&A expenses of $5.8 million, or 20.7%, primarily driven by increased selling and distribution costs and higher other general and administrative costs. As a percentage of segment net sales, SG&A and RD&E expenses decreased from 18.8% in the Fiscal Year 2020 to 15.6% as a result of increased productivity and operating expense leverage.

Segment income margin increased to 24.6% in Fiscal Year 2021 from 18.2% in Fiscal Year 2020, an increase of 633 basis points. The improvement was primarily attributable to higher gross profit margin as described above.

Adjusted segment income and Adjusted segment income margin

Adjusted segment income increased to $61.1 million in Fiscal Year 2021 from $34.2 million in Fiscal Year 2020, an increase of $26.9 million or 78.5%. This was primarily driven by the increased sales and operating leverage adjusted by the adjustments for additional non-cash or non-recurring charges.

Adjusted segment income margin increased to 25.4% in Fiscal Year 2021 from 20.3% in Fiscal Year 2020, an increase of 510 basis points.

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 further adjusted for the impact of restructuring related income or expenses, stock-based compensation, currency exchange items, sponsor management fees and certain non-cash, nonrecurring, or other items that are included in net income 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 and amortization, stock-based compensation, sponsor management fees, currency exchange items, 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 segment 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 should not be construed as an inference that our future results will be unaffected by these items.

Following is a reconciliation from net income to adjusted EBITDA (dollars in thousands):

[[GREPCENT_TABLE]]
[["","Years Ended December 31,"],["","2021","","2020"],["Net income","$","203,725","","","$","43,302"],["Depreciation","18,826","","","18,783"],["Amortization","38,990","","","44,039"],["Interest expense","50,854","","","73,615"],["Income taxes","56,416","","","14,483"],["Loss on extinguishment of debt","9,418","","","\u2014"],["EBITDA","378,229","","","194,222"],["Stock-based compensation(a)","19,019","","","1,946"],["Sponsor management fees(b)","90","","","796"],["Currency exchange items(c)","4,485","","","(4,721)"],["Acquisition and restructuring related expense, net(d)","15,030","","","19,311"],["Other(e)","4,884","","","19,997"],["Total Adjustments","43,508","","","37,329"],["Adjusted EBITDA","$","421,737","","","$","231,551"],["Adjusted EBITDA margin","30.1","%","","26.5","%"]]
[[/GREPCENT_TABLE]]

(a)Represents non-cash stock-based compensation expense related to equity awards issued to management, employees, and directors.

(b)Represents discretionary fees paid to certain of our Sponsors for services rendered pursuant to a 2017 management services agreement. This agreement and the corresponding payment obligation ceased on March 16, 2021, the effective date of the consummation of our IPO.

(c)Represents non-cash mark to market (gains) losses on foreign currency contracts.

(d)Adjustments in 2021 primarily include $9.9 million of business restructuring related costs associated with the exit of an early-stage product business acquired in 2018, $3.0 million severance and relocation costs associated with the relocation of our Corporate headquarters, and $2.1 million of business restructuring related costs associated with the exit of redundant manufacturing and distribution facilities. Adjustments in 2020 include business restructuring costs related to a global manufacturing and distribution consolidation and expansion project. Costs associated with an early stage product business acquired in 2018 have been reclassified from “Acquisition and restructuring related expense, net” to “Other” to be consistent with the current period’s presentation.

(e)Adjustments for the year ended December 31, 2021 primarily include $7.4 million net insurance settlement proceeds which reflects an incurred property damage loss of $5.4 million, recorded in the second quarter, offset by insurance policy reimbursement of $12.8 million received in the fourth quarter for the aforementioned property loss as well as the consequential business interruption loss amount caused by the fire incident in Yuncos Spain, a $4.0 million legal reserve and fees, $4.0 million of operating losses related to the early stage product business acquired in 2018 mentioned above, $1.9 million related to debt refinancing, $1.0 million related to our IPO, and other immaterial items. Adjustments for the year ended December 31, 2020 include $5.1 million of operating losses related to the same early stage product business, $4.0 million of inventory write-offs, $2.5 million of COVID-19 related health and safety expenses, $2.3 million of severance and retention costs, $2.0 million of IPO related costs and other miscellaneous costs that we believe are not representative of our ongoing business operations.

Following is a reconciliation from segment income to adjusted segment income (dollars in thousands):

[[GREPCENT_TABLE]]
[["","Years Ended December 31,"],["","2021","","2020"],["Segment income","$","419,081","","","$","202,619"],["Depreciation","17,891","","","18,082"],["Amortization","6,352","","","6,233"],["Stock-based compensation","9,231","","","1,521"],["Other (a)","4,948","","","12,685"],["Total Adjustments","$","38,422","","","$","38,521"],["Adjusted segment income","$","457,503","","","$","241,140"],["Adjusted segment income margin","32.6","%","","27.5","%"]]
[[/GREPCENT_TABLE]]

(a)Adjustments in the years ended December 31, 2021 and December 31, 2020 include non-recurring severance expenses, retention bonuses, legal fees, and the operating losses of approximately $4.0 million and $5.1 million, respectively, related to an early stage product business acquired in 2018 that was phased out in 2021. $5.4 million of costs related to a fire at our manufacturing and administrative facilities in Yuncos Spain incurred in the second quarter of 2021 were offset by insurance proceeds received in the fourth quarter of 2021. The operating losses that were recorded in prior periods under “Acquisition and restructuring related expense, net” have been reclassified to “Other” to be consistent with the current period’s presentation. The remaining adjustments for Fiscal Year 2020 include $4.0 million of inventory write-offs, $2.5 million of additional health and safety expenses related to COVID-19, professional fees and other miscellaneous costs we believe are not representative of our ongoing business operations. Currency exchange items have been reclassified from “Currency exchange items” to “Other” to be consistent with the current period’s presentation.

Following is a reconciliation from segment income to adjusted segment income for NAM (dollars in thousands):    

[[GREPCENT_TABLE]]
[["","Years Ended December 31,"],["","2021","","2020"],["Segment income","$","359,886","","","$","171,815"],["Depreciation","16,871","","","16,568"],["Amortization","6,351","","","6,233"],["Stock-based compensation","8,641","","","1,183"],["Other (a)","4,665","","","11,105"],["Total Adjustments","$","36,528","","","$","35,089"],["Adjusted segment income","$","396,414","","","$","206,904"],["Adjusted segment income margin","34.1","%","","29.3","%"]]
[[/GREPCENT_TABLE]]

(a)Adjustments in the years ended December 31, 2021 and December 31, 2020 include non-recurring severance expenses, retention bonuses, legal fees, and the operating losses of approximately $4.0 million and $5.1 million, respectively, related to an early stage product business acquired in 2018 that was phased out in 2021. The operating losses that were recorded in prior periods under “Acquisition and restructuring related expense, net” have been reclassified to “Other” to be consistent with the current period’s presentation. The remaining adjustments for Fiscal Year 2020 include professional fees, additional health and safety expenses related to COVID-19, additional reserves for obsolete and nonsalable inventories and other miscellaneous costs 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):

[[GREPCENT_TABLE]]
[["","Years Ended December 31,"],["","2021","","2020"],["Segment income","$","59,195","","","$","30,804"],["Depreciation","1,020","","","1,514"],["Amortization","1","","","\u2014"],["Stock-based compensation","590","","","338"],["Other (a)","283","","","1,580"],["Total Adjustments","$","1,894","","","$","3,432"],["Adjusted segment income","$","61,089","","","$","34,236"],["Adjusted segment income margin","25.4","%","","20.3","%"]]
[[/GREPCENT_TABLE]]

(a)The year ended December 31, 2021 includes $5.4 million of costs related to a fire at our manufacturing and administrative facilities in Yuncos Spain incurred in the second quarter of 2021 that were offset by the insurance proceeds received in the fourth quarter of 2021. The year ended December 31, 2020 includes additional reserves for obsolete and nonsalable inventories, COVID-19 related health and safety expenses, and other miscellaneous costs we believe are not representative of our ongoing business operations. Currency exchange items have been reclassified from “Currency exchange items” to “Other” to be consistent with the current period’s presentation.

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, component 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 and as such, the utilization of the ABL Facility fluctuates during the year.

In the fourth quarter, we incentivize trade customers to buy and stock up in preparation for next year’s pool season under an “early buy” program that offers a price discount and extended payment terms. Under the early buy program in 2021, we ship products from October through March and receive payments for these shipments on extended credit terms, generally from February through July 2022. As a result, our accounts receivable balance increases from October through March 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.

During the fourth quarter, we continued to generate strong cash provided by operating activities, which allowed us to make strategic inventory purchases to mitigate supply chain constraints without any borrowing under the ABL Facility.

Unrestricted cash and cash equivalents totaled $265.8 million as of December 31, 2021, which is an increase of $150.9 million from $114.9 million at December 31, 2020.

We focus on increasing cash flow and solidifying the liquidity position through working capital initiatives while continuing to fund business growth initiatives. 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. On June 1, 2021, we increased the ABL Facility from $250.0 million to $475.0 million to provide for future liquidity needs.

Credit Facilities

We amended the First Lien Term Facility and ABL Facility (collectively “Credit Facilities”) in the second quarter of 2021. For further information on the terms of the Credit Facilities, please see Note 9, “Long-Term Debt” of Notes to the Consolidated Financial Statements in this Form 10-K.

Long-term debt consisted of the following (in thousands):

[[GREPCENT_TABLE]]
[["","December 31,"],["","2021","","2020"],["First Lien Term Facility, due May 28, 2028","$","995,000","","","$","957,985"],["Incremental First Lien Term Facility, due August 4, 2026","\u2014","","","150,000"],["Second Lien Term Facility, due August 4, 2025","\u2014","","","205,000"],["ABL Revolving Credit Facility","\u2014","","","\u2014"],["Finance lease obligations","7,780","","","9,682"],["Subtotal","1,002,780","","","1,322,667"],["Less: Current portion of the long-term debt","(12,155)","","","(2,768)"],["Less: Unamortized debt issuance costs","(17,501)","","","(19,643)"],["Total","$","973,124","","","$","1,300,256"]]
[[/GREPCENT_TABLE]]

ABL Facility

On June 1, 2021, the Company amended the ABL Facility to increase the aggregate amount of the revolving loan commitments to $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. 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. The maturity of the ABL Facility was extended to June 1, 2026. The borrowings under the ABL Facility bear interest at a rate equal to the London Interbank Offered Rate (LIBOR) or a base rate plus a margin of between 1.25% to 1.75% or 0.25% to 0.75% respectively, which interest rate provisions were not affected by the amendment. In addition, 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, 2021, the average borrowing base under the ABL Facility was $170.1 million and the average loan balance outstanding was $14.3 million. As of December 31, 2021, the loan balance was zero with a borrowing availability of $128.9 million. During the year ended December 31, 2021, the effective interest rate was 3.37%.

For the year ended December 31, 2020, the average borrowing base under the ABL Facility was $149.5 million and the average loan balance outstanding was $51.7 million. As of December 31, 2020 the loan balance was zero with a borrowing availability of $87.0 million. During the year ended December 31, 2020, the effective interest rate was 4.82%.

First Lien Term Facilities

On May 28, 2021, the Company amended its First Lien Term Facility to, among other things, increase the aggregate amount available to borrow by $51.0 million to $1.0 billion, reduce the interest rate, and extend the maturity date to May 28, 2028. In addition, the Company has the option to increase the First Lien Term Facility subject to certain conditions, including the commitment of the participating lenders. On such date, the Company increased its borrowings under the First Lien Term Facility to $1.0 billion.

The First Lien Term Facility bears interest at a rate equal to a base rate or LIBOR, plus, in either case, an applicable margin. In the case of LIBOR 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 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, commencing on September 30, 2021.

During the year ended December 31, 2021, the company made $8.0 million and $356.6 million of voluntary term loan repayments on February 19, 2021 and March 19, 2021, respectively. The total voluntary loan repayments made in the year ended December 31, 2021 was $364.6 million. The March 19, 2021 repayment was funded with a portion of the net proceeds received from the IPO, of which (i) $205.0 million was used to repay the outstanding borrowings under the Company’s Second Lien Term Facility in full, (ii) $131.1 million was used to repay borrowings under the Company’s First Lien Term Facility and (iii) $20.5 million was used to repay the borrowings under the Incremental First Lien Term Facility. The $8.0 million voluntary repayment on February 19, 2021 was applied to the First Lien Term Facility and the incremental First Lien Term Facility on a pro rata basis. The Company recorded $5.8 million of debt extinguishment loss related to the write off of unamortized deferred financing costs as a result of the partial repayments of the First Lien Term Facility and Incremental First Lien Term Facility.

In the second quarter 2021, due to the May 28, 2021 amendment to the First Lien Term Facility and a change in participating lenders, the Company recorded a $3.6 million debt extinguishment loss related to the write-off of unamortized deferred financing costs. During the year ended December 31, 2021, the Company recorded an aggregate total loss on debt extinguishment of $9.4 million.

As of December 31, 2021, the balance outstanding under the First Lien Term Facility was $995.0 million and the effective interest rate, net of the interest rate hedge, was 4.77%. The Incremental First Lien Term Facility was paid off as part of the refinancing of our Credit Facilities.

As of December 31, 2020, the balance outstanding under the First Lien Term Facility was $958.0 million and the effective interest rate, net of the interest rate hedge, was 5.16%. The balance outstanding under the Incremental First Lien Term Facility was $150.0 million and the effective interest rate was 4.93%.

Second Lien Term Facility

During the year ended December 31, 2021, we made $364.6 million of voluntary term loan repayments of which $205.0 million was used to repay outstanding borrowings under the Company’s Second Lien Term Facility in full. As of December 31, 2020, the balance outstanding under the Second Lien Term Facility was $205.0 million and the effective interest rate, net of the interest rate hedge, was 9.98%.

Covenant Compliance

The Credit Facilities contain various restrictions, covenants and collateral requirements. As of December 31, 2021, 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):

[[GREPCENT_TABLE]]
[["","","Years Ended December 31,"],["","","2021","","2020"],["Net cash provided by operating activities","","$","189,387","","","$","213,841"],["Net cash used in investing activities","","(48,777)","","","(12,998)"],["Net cash provided (used) by financing activities","","10,957","","","(135,121)"],["Effect of exchange rate changes on cash and cash equivalents and restricted cash","","(1,065)","","","2,366"],["Change in cash and cash equivalents and restricted cash","","$","150,502","","","$","68,088"]]
[[/GREPCENT_TABLE]]

Net cash provided by operating activities

Net cash provided by operating activities decreased to $189.4 million for the year ended December 31, 2021 from $213.8 million for the year ended December 31, 2020, a decrease of $24.5 million, or 11.4%. The decrease was primarily driven by an increase in net working capital in 2021 (compared to a net working capital decrease in 2020) driven by strategic inventory purchases to support strong demand coupled with inflationary impact to raw materials and longer transit time as a result of supply chain bottlenecks, and higher accounts receivables resulting from growth in net sales and lower collections from early buy program during the third and fourth quarters of 2021 as compared to prior year. This impact on working capital was partially offset by an increase in net income and an increase in non-cash adjustments.

Net cash used in investing activities

Net cash used in investing activities increased to $48.8 million for the year ended December 31, 2021 compared to $13.0 million for the year ended December 31, 2020, an increase of $35.8 million, or 275.3%. The increase was primarily driven by three acquisitions during the fourth quarter (SmartPower™, SmartValve, and Water Works Technologies Group, LLC) combined with increased capital expenditures in property, plant and equipment to support production capacity ramp up and a new distribution center in North Carolina.

Net cash provided (used) by financing activities

Net cash provided by financing activities was $11.0 million for the year ended December 31, 2021 compared to net cash used of $135.1 million for the year ended December 31, 2020, an increase of $146.1 million. For the year ended December 31, 2021, net cash provided by financing activities was primarily driven by net proceeds from the IPO and proceeds from new borrowings, partially offset by the payment of long-term debt. For the year ended December 31, 2020, net cash used was primarily driven by dividends, partially offset by proceeds from the incremental First Lien Term Facility.

Contractual Obligations and Other Commitments

The following table summarizes our contractual cash obligations as of Fiscal Year 2021 (in thousands):

[[GREPCENT_TABLE]]
[["","2022","","2023","","2024","","2025","","2026","","Thereafter","","Total"],["Long-term debt (a)","$","10,000","","","10,000","","","10,000","","","10,000","","","10,000","","","945,000","","","995,000"],["Letters of credit","4,500","","","\u2014","","","\u2014","","","\u2014","","","\u2014","","","\u2014","","","4,500"],["Operating lease commitments (b)","9,950","","","8,920","","","7,591","","","6,893","","","6,809","","","48,602","","","88,765"],["Finance lease commitments","1,946","","","1,978","","","2,035","","","1,739","","","82","","","\u2014","","","7,780"],["Total","$","26,396","","","$","20,898","","","$","19,626","","","$","18,632","","","$","16,891","","","$","993,602","","","1,096,045"]]
[[/GREPCENT_TABLE]]

(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 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 $4.5 million and $4.4 million of outstanding letters of credit on our ABL Facility as of December 31, 2021 and December 31, 2020, respectively.

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 upon achievement of various performance targets. We account for customer rebates as a reduction of gross sales with a corresponding offset to accounts receivable. 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. At December 31, 2021, goodwill and indefinite lived intangible assets were $924.3 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 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. As of December 31, 2021 we performed a qualitative analysis and determined that the fair values of the reporting units were more likely than not greater than the carrying amounts. In 2021 and 2020, the Company did not need to proceed beyond the qualitative analysis, and no goodwill impairments were recorded.

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.

Income Taxes

We account for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the future tax consequences attributable to differences between the financial statement carrying amounts and tax bases of existing assets and liabilities. Deferred tax assets, including the benefit of net operating loss and tax credit carryforwards, are evaluated based on the guidelines for realization and are reduced by a valuation allowance if it is deemed more likely than not that such assets will not be realized. We consider several factors in evaluating the realizability of our deferred tax assets, including the nature, frequency and severity of recent losses, the remaining years available for carryforwards, changes in tax laws, the future profitability of the operations in the jurisdiction, and tax planning strategies.

The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which the associated temporary differences become deductible. On a quarterly basis, we evaluate whether it is more likely than not that our deferred tax assets will be realized in the future and conclude whether a valuation allowance must be established.

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 stock options. The grant-date fair value of the performance-based stock options is recognized as compensation expense once it is probable that the performance condition will be achieved. 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 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.

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.