Latham Group, Inc. (SWIM) 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
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with other sections of this Annual Report, including “Item 1. Business,” “Item 1A. Risk Factors” and our audited consolidated financial statements and related notes for the three years ended December 31, 2024, 2023 and 2022, included elsewhere in this Annual Report.
As used in this Annual Report, references to “Latham,” “the Company,” “we,” “us,” and “our” refer to the Company and its consolidated subsidiaries unless otherwise indicated of the context requires otherwise.
Overview
We are the largest designer, manufacturer, and marketer of in-ground residential swimming pools in North America, Australia, and New Zealand. We hold the leading position in North America in every product category in which we compete. It is our view that we are the most sought-after brand in the pool industry and the only pool company that has established a direct relationship with the homeowner. We are Latham, The Pool Company.
With an operating history that spans over 65 years, we offer the industry’s broadest portfolio of pools and related products, including in-ground swimming pools, pool covers, and pool liners.
We have a heritage of innovation. In an industry that has traditionally marketed on a business-to-business basis (pool manufacturer to dealer), we pioneered the first “direct-to-homeowner” digital and social marketing strategy that has transformed the homeowner’s purchase journey. Through this marketing strategy, we are able to create demand for our pools and to provide high quality, purchase-ready consumer leads to our dealer partners.
Partnership with our dealers is integral to our collective success, and we have enjoyed long-tenured relationships averaging over 14 years. We support our dealer network with business development tools, co-branded marketing programs.
The full resources of our company are dedicated to designing and manufacturing high-quality pool products, with the homeowner in mind, and positioning ourselves as a value-added partner to our dealers.
We conduct our business as one operating and reportable segment that designs, manufactures, and markets in-ground swimming pools, pool covers, and pool liners.
Our operations consist of approximately 1,800 employees across about 30 locations. The broad geographic reach of our national manufacturing and distribution network allows us to service our customers on short lead times and to deliver our products in a cost-effective manner. Our mission is to design and manufacture high-quality pool products, with the homeowner in mind, and to be a value-added partner to our dealers.
Recent Developments
Highlights for the year ended December 31, 2024
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | Decrease in net sales of 10.2%, or $58.0 million, to $508.5 million for the year ended December 31, 2024, compared to $566.5 million for the year ended December 31, 2023. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | Increase in net loss of $15.5 million, to $17.9 million for the year ended December 31, 2024, compared to a net loss of $2.4 million for the year ended December 31, 2023, representing a 3.5% net loss margin for the year ended December 31, 2024. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | Decrease in Adjusted EBITDA (as defined below) of $7.8 million, to $80.2 million for the year ended December 31, 2024, compared to $88.0 million for the year ended December 31, 2023. |
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Business Update
Ongoing macroeconomic softness has impacted and is expected to continue to impact consumer spending and demand. As anticipated, this resulted in a decline in new in-ground residential pool installations during the year ended December 31, 2024. Within our in-ground pool product line, fiberglass pools continue to show strength relative to packaged pools.
We continue to make progress executing our strategy to drive adoption and awareness of fiberglass pools and automatic safety covers and gain additional operating efficiencies through value engineering and lean manufacturing initiatives. We continue to take a disciplined approach to capital investments, with the focus on the completion of previously announced projects such as our recent multi-year capital plan to invest in our facilities, technology and systems. Notably, this involves continued investment in our sales, marketing, engineering and research and development efforts that are designed to accelerate conversion to fiberglass pool products and ongoing digital transformation programs.
As previously disclosed, we have responded to economic uncertainty by implementing cost reduction programs and lean manufacturing initiatives that structurally reduce our cost basis, while maintaining capacity.
We believe that Latham’s financial model has changed structurally, which has increased our underlying earnings capabilities amid an industry recovery. We are increasing our investments in sales and marketing and product development initiatives to ensure that we capture an incremental share of in-ground pool sales once volumes rebound.
Strategic Acquisition
Strategic transactions continue to be part of our growth strategy. On August 2, 2024, we completed a stock acquisition of Coverstar Central, our exclusive dealer of automatic safety covers in 29 states – mainly in the center of the U.S. Coverstar Central has been our trusted partner since 2006, and this acquisition represents a valuable strategic opportunity that we expect to benefit from in multiple ways. First, the vertical integration of our automatic safety cover product line in the acquired geographies is expected to increase margins. Second, as one company with a fully integrated sales and marketing strategy, we expect to accelerate the sales growth of this product line. Finally, we see opportunities to leverage Coverstar Central’s long-standing relationships with pool builders in its markets to increase the awareness of, and conversion to, fiberglass pools. The Coverstar Central Acquisition was immediately accretive to our net income, Adjusted EBITDA and Adjusted EBITDA margin for the fiscal year ended December 31, 2024 and will enhance our gross margins in the long-term. The cash purchase price was $64.5 million, net of cash acquired. The transaction was fully funded with cash on hand. With key integration activities completed, we are moving forward with a unified sales and marketing strategy designed to accelerate the sales growth of this product line. We further strengthened our position in this growing category by acquiring two of our smaller autocover dealers in February of this year.
Key Factors Affecting our Performance
Our results of operations and financial condition are affected by the following factors, which reflect our operating philosophy and focus on designing, manufacturing, and marketing high quality and innovative pools and pool covers for the in-ground swimming pool market.
Volume of Products Sold
Our net sales depend primarily on the volume of products we sell during any given period, and volume is affected by the following items, among others:
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | Sales, distribution, and marketing: While we have traditionally relied on our dealers and distributors to raise awareness of our products, we pioneered the first “direct-to-homeowner” digital and social marketing strategy that has transformed the homeowner’s purchase journey. Through this marketing strategy, we are able to create demand for our pools and generate and provide high quality, purchase-ready consumer leads to our dealer partners. |
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In order to strengthen our relationship with our loyal dealer partners, we have implemented “Latham Grand,” a key dealer strategy whereby we have secured exclusivity from over 300 of our largest dealers in North America. We also have a strong distribution network as a result of over 475 distributor branch locations that represent our products. Through our significant investments in partnerships with dealers and distributors and our consumer-oriented marketing efforts, we have created both a “push and pull” demand dynamic for our products in the marketplace. We invest in our exclusive dealers through localized marketing spend, co-branding opportunities, tailored offerings, and priority lead generation. We also provide our dealers with enhanced product literature, in-store display samples, and other initiatives to drive sales. We have directed a significant portion of our advertising spend to digital channels, including social media and search advertising. Our improved digital marketing engine has the ability to strategically target market spend and to generate leads in territories where dealers have capacity to install more pools, markets where we are underpenetrated, or simply into the largest in-ground swimming pool markets. Our volume of product sales in a given period will be impacted by changes in our distribution platform and by our ability to generate leads for our dealers.
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | Material conversion: We have continued to consummate sales of our products through our focused efforts to drive material conversion and market penetration of our products, specifically our fiberglass pools, which continue to take market share from traditional concrete pools and enable meaningfully improved economics for consumers, dealers, and pool installers. From our perspective this will be a long-term trend toward material conversion from traditional concrete pools. We believe that our fiberglass pools offer a compelling value proposition because of their lower up-front and lifecycle cost of ownership, less maintenance, higher quality, lower usage of harsh chemicals, quicker installation, and more convenient experience, compared to products manufactured from traditional materials. We anticipate that sales of our fiberglass pool products will continue to benefit from material conversion. The success of our efforts to drive conversion during any given period will impact the volume of our products sold during that period. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | Product innovation: We continue to develop and introduce innovative products to accelerate material conversion and to expand our markets. The continuous evolution and expansion of our product portfolio is critical to our future sales growth, expansion of market share, and overall success. Our broad product offering allows dealers and distributors to offer consumers a wide variety of innovative pool shapes, depths, and lengths. Specifically, our innovative fiberglass pool offering employs the most durable components, consisting of a carbon fiber, Kevlar, and ceramic fiberglass build. Our use of innovative technology and premium materials result in long-lasting products that not only require lower up-front costs, but also save homeowners time and money from continuous maintenance throughout the product lifecycle. We expect that new products will enhance our ability to compete with traditional materials at a variety of price points, and that we will continue to devote significant resources to developing innovative new products. The volume of our products sold during a given period will depend in part on our successfully introducing new products that generate additional demand, as well as the extent to which new products may impact our sales of existing products. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | Economic conditions: Demand for our products is affected by a number of economic factors impacting our customers and consumers. Customers typically pay for their new pools from assets on hand or from borrowing. A frequent source of borrowing is home equity financing, and accordingly, the level of equity in homes will affect consumers’ ability to obtain a home equity line of credit and to engage in backyard renovations that would result in purchases of our products. Demand for our products is also affected by the level of interest rates and the availability of credit, consumer confidence and spending, housing affordability, demographic trends, employment levels, and other macroeconomic factors that may influence the extent to which consumers engage in renovations to their backyard, including pool installation projects to enhance the outdoor living spaces of their homes. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | Seasonality and weather: Although we generally have demand for our products throughout the year, our business is seasonal, and weather is one of the principal external factors affecting the business. In general, net sales and net income are highest during spring and summer, representing the peak months of swimming pool use, pool installation and remodeling and repair activities. Severe weather also may play a role in affecting sales growth, as particularly rainy or cold years tend to slow the volume of sales, including as a result of complicating conditions for pool installations. Catastrophic events, such as hurricanes, tornadoes, and |
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| Column 1 | Column 2 | Column 3 |
|---|---|---|
| earthquakes can cause interruptions to our operations, as well as our dealers and distributors, and may cause customers to delay purchases. These scenarios are partially mitigated by our geographic diversity, both across the United States and through international markets. |
Pricing
In general, our products are priced to be competitive in the in-ground swimming pool market, including the prices for concrete pools, and to keep in line with changes in our input costs.
Cost and Availability of Materials
Raw material costs, including costs of PVC plastic, galvanized steel, fiberglass, aluminum, various resins, high impact polystyrene, gelcoat and polypropylene fabric, represent a majority of our cost of sales. Our supply agreements with key suppliers are typically negotiated on an annual basis. The cost of the raw materials used in our manufacturing processes is subject to volatility and has been affected by changes in supply and demand. We have minimal fixed-price contracts with our major vendors. We have not entered into hedges of our raw material costs historically, but we may choose to enter into such hedges in the future.
Prices for spot market purchases are negotiated on a continuous basis in line with current market prices. Other than occasional strategic purchases of larger quantities of certain raw materials, we generally buy materials on an as-needed basis. Changes in prices of our raw materials have a direct impact on our cost of sales.
Acquisitions and Partnerships
On August 2, 2024, we acquired Coverstar Central, our exclusive dealer of automatic safety covers. This acquisition has allowed us to vertically integrate the automatic safety cover product line and to align on sales and marketing strategies.
On November 8, 2022, we acquired certain fiberglass pool manufacturing assets in Seminole, Oklahoma, which qualified as a business combination. This acquisition replaced lost fiberglass manufacturing capacity in Odessa, TX because of a plant fire and placed our production closer to strong consumer markets in the region.
The consolidated financial statements include the results of operations of these acquisitions since their respective acquisition dates. The total purchase consideration was allocated to the assets acquired and liabilities assumed at their estimated fair values as of the date of acquisition, as determined by management. The excess of the purchase price over the amounts allocated to assets acquired and liabilities assumed has been recorded as goodwill.
On October 30, 2020, we entered into a long-term strategic partnership with and acquired a minority interest in Premier Pools & Spas, a pool builder focusing on in-ground swimming pools. The purpose of this investment in Premier Pools & Spas is to help expand our sales and distribution channels. Products are sold directly to the franchisees, third parties independent of Premier Pools & Spas, and are therefore not considered related party transactions. Our investment in Premier Pools & Spas is reflected as an equity method investment on our consolidated balance sheet as of December 31, 2024 and 2023, and our proportionate share of earnings or losses of Premier Pools & Spas is recognized in earnings (losses) from equity method investment in our consolidated statement of operations on a three-month lag.
Key Performance Indicators
Net Sales
We derive our revenue from the design, manufacture, and sale of in-ground swimming pools, pool covers, and pool liners. We sell fiberglass pools, which are one-piece manufactured fiberglass pools that are ready to be installed in a consumer’s backyard, and custom vinyl pools, which are manufactured pools that are made out of non-corrosive steel or composite polymer frame, on top of which a vinyl liner is installed. We sell liners for the interior surface of vinyl pools (including pools that were not manufactured by us). We also sell all-season covers, which are winterizing mesh or solid
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pool covers that protect pools against debris and cold or inclement weather, and automatic safety covers for pools that can be operated with a switch.
Our sales are made through one-step and two-step business-to-business distribution channels. In our one-step distribution channel, we sell our products directly to dealers who, in turn, sell our products to consumers. In our two-step distribution channel, we sell our products to distributors who warehouse our products and sell them on to dealers, who ultimately sell our products to consumers.
Each product shipped is considered to be one performance obligation. With the exception of our extended service warranties and our custom product contracts, we recognize our revenue when control of our promised goods is transferred to our customers (dealer in one-step distribution channel or distributor in two-step distribution channel), either upon shipment or arrival at our customer’s destination depending upon the terms of the purchase order. Sales are recognized net of any estimated rebates, returns, allowances, cash discounts or other sales incentives. Revenue that is derived from our extended service warranties, which are separately priced and sold, is recognized over the term of the contracts. Revenue from custom products is recognized over time utilizing an input method that compares the cost of cumulative work-in-process to date to the most current estimates for the entire cost of the performance obligation. See “— Critical Accounting Policies and Estimates — Revenue Recognition.”
Gross Margin
Gross margin is gross profit as a percentage of our net sales. Gross margin depends upon several factors, such as the prices we charge buyers, changes in prices of raw materials, the volume and relative sales mix among product lines, and plant performance, among other factors. Gross margin is also impacted by the costs of distribution and occupancy costs, which can vary.
Our gross profit is variable in nature and generally follows changes in net sales. The components of our cost of sales may not be comparable to the components of cost of sales or similar measures of other companies. As a result, our gross profit and gross margin may not be comparable to similar data made available by other companies.
Adjusted EBITDA and Adjusted EBITDA Margin
Adjusted EBITDA and Adjusted EBITDA margin are key metrics used by management and our Board to assess our financial performance. Adjusted EBITDA and Adjusted EBITDA margin are also frequently used by analysts, investors, and other interested parties to evaluate companies in our industry, when considered alongside other GAAP measures. We use Adjusted EBITDA and Adjusted EBITDA margin to supplement GAAP measures of performance to evaluate the effectiveness of our business strategies, to make budgeting decisions, to utilize as a significant performance metric in our annual management incentive bonus plan compensation, and to compare our performance against that of other companies using similar measures. We have presented Adjusted EBITDA and Adjusted EBITDA margin solely as supplemental disclosures because we believe they allow for a more complete analysis of results of operations and assist investors and analysts in comparing our operating performance across reporting periods on a consistent basis by excluding items that we do not believe are indicative of our core operating performance, such as (i) depreciation and amortization, (ii) interest expense, net, (iii) income tax expense (benefit), (iv) loss (gain) on sale and disposal of property and equipment, (v) restructuring charges, (vi) stock-based compensation expense, (vii) unrealized (gains) losses on foreign currency transactions, (viii) strategic initiative costs, (ix) acquisition and integration related costs, (x) loss on extinguishment of debt, (xi) underwriting fees related to offering of common stock, (xii) the Odessa fire and other such unusual events, and (xiii) other.
Adjusted EBITDA and Adjusted EBITDA margin are non-GAAP financial measures and should not be considered as alternatives to net income (loss) as a measure of financial performance or any other performance measure derived in accordance with GAAP, and they should not be construed as an inference that our future results will be unaffected by unusual or non-recurring items. You are encouraged to evaluate these adjustments and the reasons we consider them appropriate for supplemental analysis. In evaluating Adjusted EBITDA and Adjusted EBITDA margin, you should be aware that in the future we may incur expenses that are the same as or similar to some of the adjustments in this presentation. There can be no assurance that we will not modify the presentation of Adjusted EBITDA and
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Adjusted EBITDA margin in the future, and any such modification may be material. Our presentation of Adjusted EBITDA and Adjusted EBITDA margin should not be construed to imply that our future results will be unaffected by any such adjustments. In addition, other companies, including companies in our industry, may not calculate Adjusted EBITDA and Adjusted EBITDA margin at all or may calculate Adjusted EBITDA and Adjusted EBITDA margin differently and accordingly, are not necessarily comparable to similarly entitled measures of other companies, which reduces the usefulness of Adjusted EBITDA and Adjusted EBITDA margin as tools for comparison.
We believe Adjusted EBITDA and Adjusted EBITDA margin are useful measurements for investors as they help identify underlying trends that could otherwise be masked by certain expenses that we do not consider indicative of our ongoing operating performance. We also use Adjusted EBITDA and Adjusted EBITDA margin for planning purposes, assessing our financial performance, and other strategic decisions. For a discussion of Adjusted EBITDA and Adjusted EBITDA margin and the limitations on their use, and the reconciliation of Adjusted EBITDA to net income (loss), the most directly comparable GAAP financial measure, and our calculation of Adjusted EBITDA margin see “— Non-GAAP Financial Measures” below.
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Results of Operations
Year ended December 31, 2024 Compared to Year ended December 31, 2023
The following table summarizes our results of operations for the years ended December 31, 2024 and 2023:
| | | | | | | | | | | | | | | | | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | Year Ended December 31, | ||||||||||||||
| | | | | | | | | | | | | | | | Change | |
| | | | | | % of | | | | | % of | | Change | | % of | | |
| | 2024 | Net Sales | 2023 | Net Sales | Amount | Net Sales | ||||||||||
| | | (dollars in thousands) | ||||||||||||||
| Net sales | | $ | 508,520 | | 100.0 | % | $ | 566,492 | | 100.0 | % | $ | (57,972) | | — | % |
| Cost of sales | | 354,776 | 69.8 | % | 413,548 | 73.0 | % | (58,772) | (3.2) | % | ||||||
| Gross profit | | 153,744 | 30.2 | % | 152,944 | 27.0 | % | 800 | 3.2 | % | ||||||
| Selling, general, and administrative expense | | 108,364 | 21.3 | % | 110,296 | 19.5 | % | (1,932) | 1.8 | % | ||||||
| Amortization | | 27,103 | 5.3 | % | 26,519 | 4.7 | % | 584 | 0.6 | % | ||||||
| Income from operations | | 18,277 | 3.6 | % | 16,129 | 2.8 | % | 2,148 | 0.8 | % | ||||||
| Other expense (income): | | | | | | | | |||||||||
| Interest expense, net | | 24,840 | 4.9 | % | 30,916 | 5.5 | % | (6,076) | (0.6) | % | ||||||
| Other expense (income), net | | 6,237 | 1.2 | % | (1,004) | (0.2) | % | 7,241 | 1.4 | % | ||||||
| Total other expense, net | | 31,077 | 6.1 | % | 29,912 | 5.3 | % | 1,165 | 0.8 | % | ||||||
| Earnings from equity method investment | | | 4,060 | | 0.8 | % | | 3,723 | | 0.7 | % | | 337 | | 0.1 | % |
| Loss before income taxes | | (8,740) | (1.7) | % | (10,060) | (1.8) | % | 1,320 | 0.1 | % | ||||||
| Income tax expense (benefit) | | 9,120 | 1.8 | % | (7,672) | (1.4) | % | 16,792 | 3.2 | % | ||||||
| Net loss | | $ | (17,860) | (3.5) | % | $ | (2,388) | (0.4) | % | $ | (15,472) | (3.1) | % | |||
| Adjusted EBITDA | | $ | 80,219 | 15.8 | % | $ | 88,025 | 15.5 | % | $ | (7,806) | 0.3 | % |
Net Sales
Net sales was $508.5 million for the year ended December 31, 2024, compared to $566.5 million for the year ended December 31, 2023. The $58.0 million, or 10.2%, decrease in net sales was driven by a $55.1 million decrease from volume and a $2.9 million decrease from pricing. The $55.1 million volume decrease was largely driven by soft industry conditions. The decrease in total net sales across our product lines was $38.6 million for in-ground swimming pools, $9.7 million for liners and $9.6 million for covers.
Cost of Sales and Gross Margin
Cost of sales was $354.8 million for the year ended December 31, 2024, compared to $413.5 million for the year ended December 31, 2023, and decreased as a percentage of net sales by 3.2%. Gross margin increased by 3.2% to 30.2% for the year ended December 31, 2024, compared to 27.0% for the year ended December 31, 2023. The $58.7 million, or 14.2%, decrease in cost of sales was primarily the result of a decrease in sales volume. The 3.2% increase in gross margin was primarily driven by production efficiencies from lean manufacturing and value engineering initiatives, improved procurement, and modest deflation.
Selling, General, and Administrative Expense
Selling, general, and administrative expense was $108.4 million for the year ended December 31, 2024, compared to $110.3 million for the year ended December 31, 2023, and increased as a percentage of net sales by 1.8%. The $1.9 million, or 1.8%, decrease in selling, general, and administrative expense was primarily driven by an $11.3 million reduction in non-cash stock-based compensation expenses, as well as our cost containment initiatives and restructuring programs, which were partially offset by approximately $8 million in higher performance-based
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compensation and higher sales and marketing spend to gain share in the Sand States and further strengthen our market position.
Amortization
Amortization was $27.1 million for the year ended December 31, 2024, compared to $26.5 million for the year ended December 31, 2023. The $0.6 million, or 2.2%, increase in amortization was driven by the acquisition of Coverstar Central.
Interest Expense, Net
Interest expense, net was $24.8 million for the year ended December 31, 2024, compared to $30.9 million for the year ended December 31, 2023. The $6.1 million, or 19.7%, decrease in interest expense, net was primarily the result of the change in the fair value of our interest rate swap, compared to the year ended December 31, 2023.
Other Expense (Income), Net
Other expense (income), net was $6.2 million for the year ended December 31, 2024, compared to $ (1.0) million for the year ended December 31, 2023. The $7.2 million increase in other expense (income), net was primarily driven by an unfavorable change in net foreign currency transaction gains and losses associated with our international subsidiaries.
Earnings from Equity Method Investments
Earnings from equity method investment of Premier Pools & Spas was $4.1 million for the year ended December 31, 2024, compared to $3.7 million for the year ended December 31, 2023, primarily because of the financial performance of Premier Pools & Spas.
Income Tax Expense (Benefit)
Income tax expense was $9.1 million for the year ended December 31, 2024, compared to a $ (7.7) million income tax benefit for the year ended December 31, 2023. Our effective tax rate was (104.3)% for the year ended December 31, 2024, compared to 76.3% for the year ended December 31, 2023. The income tax expense of $9.1 million for the year ended December 31, 2024 was primarily due to the valuation allowance established on foreign deferred tax assets, the effects of branch accounting and the jurisdictional mix of income. The income tax benefit of $7.7 million for the year ended December 31, 2023 was primarily due to a $10.3 million benefit related to the release of uncertain tax positions and a $2.1 million benefit related to restructuring, partially offset by $3.1 million expense related to a change in valuation allowance and non-deductible stock compensation of $2.4 million.
Net Loss
Net loss was $17.9 million for the year ended December 31, 2024, compared to $2.4 million for the year ended December 31, 2023. The $15.5 million, or 647.9%, increase in net loss was primarily driven by the factors described above.
Net Loss Margin
Net loss margin was 3.5% for the year ended December 31, 2024, compared to net loss margin of 0.4% for the year ended December 31, 2023. The 3.1% increase in net loss margin was driven by a $15.5 million increase in net loss and a $58.0 million decrease in net sales, compared to the year ended December 31, 2023 because of the factors described above.
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Adjusted EBITDA
Adjusted EBITDA was $80.2 million for the year ended December 31, 2024, compared to $88.0 million for the year ended December 31, 2023. The $7.8 million, or 8.9%, decrease in Adjusted EBITDA was primarily because of higher performance-based compensation and increased investment in sales and marketing programs to further strengthen our market position. For a discussion of Adjusted EBITDA and Adjusted EBITDA margin and the limitations on their use, and the reconciliation of Adjusted EBITDA to net income (loss), the most directly comparable GAAP financial measure, and our calculation of Adjusted EBITDA margin see “— Non-GAAP Financial Measures” below.
Adjusted EBITDA Margin
Adjusted EBITDA margin was 15.8% for the year ended December 31, 2024, compared to 15.5% for the year ended December 31, 2023.
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Year ended December 31, 2023 Compared to Year ended December 31, 2022
| | | | | | | | | | | | | | | | | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | Year Ended December 31, | ||||||||||||||
| | | | | | | | | | | | | | | | Change | |
| | | | | | % of | | | | | % of | | Change | | % of | | |
| | 2023 | Net Sales | 2022 | Net Sales | Amount | Net Sales | ||||||||||
| | | (dollars in thousands) | ||||||||||||||
| Net sales | | $ | 566,492 | | 100.0 | % | $ | 695,736 | | 100.0 | % | $ | (129,244) | | — | % |
| Cost of sales | | 413,548 | 73.0 | % | 479,267 | 68.9 | % | (65,719) | 4.1 | % | ||||||
| Gross profit | | 152,944 | 27.0 | % | 216,469 | 31.1 | % | (63,525) | (4.1) | % | ||||||
| Selling, general, and administrative expense | | 110,296 | 19.5 | % | 146,842 | 21.1 | % | (36,546) | (1.6) | % | ||||||
| Underwriting fees related to offering of common stock | | | — | | — | % | | 11,437 | | 1.6 | % | | (11,437) | (1.6) | % | |
| Amortization | | 26,519 | 4.7 | % | 28,180 | 4.1 | % | (1,661) | 0.6 | % | ||||||
| Income from operations | | 16,129 | 2.8 | % | 30,010 | 4.3 | % | (13,881) | (1.5) | % | ||||||
| Other expense (income): | | | | | | | | | ||||||||
| Interest expense, net | | 30,916 | 5.5 | % | 15,753 | 2.3 | % | 15,163 | 3.2 | % | ||||||
| Loss on extinguishment of debt | | | — | | — | % | 3,465 | | 0.5 | % | (3,465) | (0.5) | % | |||
| Other (income) expense, net | | (1,004) | (0.2) | % | 1,301 | 0.1 | % | (2,305) | (0.3) | % | ||||||
| Total other expense, net | | 29,912 | 5.3 | % | 20,519 | 2.9 | % | 9,393 | 2.4 | % | ||||||
| Earnings from equity method investment | | | 3,723 | | 0.7 | % | | 4,230 | | 0.6 | % | | (507) | 0.1 | % | |
| (Loss) income before income taxes | | (10,060) | (1.8) | % | 13,721 | 2.0 | % | (23,781) | (3.8) | % | ||||||
| Income tax (benefit) expense | | (7,672) | (1.4) | % | 19,415 | 2.8 | % | (27,087) | (4.2) | % | ||||||
| Net loss | | $ | (2,388) | (0.4) | % | $ | (5,694) | (0.8) | % | $ | 3,306 | 0.4 | % | |||
| Adjusted EBITDA | | $ | 88,025 | 15.5 | % | $ | 143,252 | 20.6 | % | $ | (55,227) | (5.1) | % |
For discussion on comparison of the years ended December 31, 2023 and 2022, see the Results of Operations section disclosed in Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the year ended December 31, 2023, which was filed with the SEC on March 13, 2024.
Non-GAAP Financial Measures
We track our non-GAAP financial measures to monitor and manage our underlying financial performance. The following discussion includes the presentation of Adjusted EBITDA and Adjusted EBITDA margin, which are non-GAAP financial measures that exclude the impact of certain costs, losses and gains that are required to be included in our profit and loss measures under GAAP. Although it is our view these measures are useful to investors and analysts for the same reasons it is useful to management, as discussed below, these measures are neither a substitute for, nor superior to, U.S. GAAP financial measures or disclosures. Other companies may calculate similarly-titled non-GAAP measures differently, limiting their usefulness as comparative measures. To address these limitations, we have reconciled Adjusted EBITDA to the applicable most comparable GAAP measure, net income (loss), throughout this Annual Report.
Adjusted EBITDA and Adjusted EBITDA Margin
Adjusted EBITDA and Adjusted EBITDA margin are key metrics used by management and our Board to assess our financial performance. Adjusted EBITDA and Adjusted EBITDA margin are also frequently used by analysts, investors, and other interested parties to evaluate companies in our industry, when considered alongside other GAAP measures. We use Adjusted EBITDA and Adjusted EBITDA margin to supplement GAAP measures of performance to evaluate the effectiveness of our business strategies, to make budgeting decisions, to utilize as a significant performance metric in our annual management incentive bonus plan compensation, and to compare our performance against that of other companies using similar measures. We have presented Adjusted EBITDA and Adjusted EBITDA margin solely as
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supplemental disclosures because we believe they allow for a more complete analysis of results of operations and assist investors and analysts in comparing our operating performance across reporting periods on a consistent basis by excluding items that we do not believe are indicative of our core operating performance, such as (i) depreciation and amortization, (ii) interest expense, net, (iii) income tax expense (benefit), (iv) loss (gain) on sale and disposal of property and equipment, (v) restructuring charges, (vi) stock-based compensation expense, (vii) unrealized (gains) losses on foreign currency transactions, (viii) strategic initiative costs, (ix) acquisition and integration related costs, (x) loss on extinguishment of debt, (xi) underwriting fees related to offering of common stock, (xii) the Odessa fire and other such unusual events, and (xiii) other.
Adjusted EBITDA and Adjusted EBITDA margin are non-GAAP financial measures and should not be considered as alternatives to net income (loss) as a measure of financial performance or any other performance measure derived in accordance with GAAP, and they should not be construed as an inference that our future results will be unaffected by unusual or non-recurring items. You are encouraged to evaluate these adjustments and the reasons we consider them appropriate for supplemental analysis. In evaluating Adjusted EBITDA and Adjusted EBITDA margin, you should be aware that in the future we may incur expenses that are the same as or similar to some of the adjustments in this presentation. There can be no assurance that we will not modify the presentation of Adjusted EBITDA and Adjusted EBITDA margin in the future, and any such modification may be material. Our presentation of Adjusted EBITDA and Adjusted EBITDA margin should not be construed to imply that our future results will be unaffected by any such adjustments. In addition, other companies, including companies in our industry, may not calculate Adjusted EBITDA and Adjusted EBITDA margin at all or may calculate Adjusted EBITDA and Adjusted EBITDA margin differently and accordingly, are not necessarily comparable to similarly entitled measures of other companies, which reduces the usefulness of Adjusted EBITDA and Adjusted EBITDA margin as tools for comparison.
Adjusted EBITDA and Adjusted EBITDA margin have their limitations as analytical tools, and you should not consider them in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are that Adjusted EBITDA and Adjusted EBITDA margin:
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | do not reflect every expenditure, future requirements for capital expenditures or contractual commitments; |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | do not reflect changes in our working capital needs; |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | do not reflect the interest expense, or the amounts necessary to service interest or principal payments, on our outstanding debt; |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | do not reflect income tax (benefit) expense, and because the payment of taxes is part of our operations, tax expense is a necessary element of our costs and ability to operate; |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | do not reflect non-cash stock-based compensation, which will remain a key element of our overall compensation package; and |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | do not reflect the impact of earnings or charges resulting from matters we consider not to be indicative of our ongoing operations. |
Although depreciation and amortization are eliminated in the calculation of Adjusted EBITDA and Adjusted EBITDA margin, the assets being depreciated and amortized will often have to be replaced in the future, and Adjusted EBITDA and Adjusted EBITDA margin do not reflect any costs of such replacements.
Management compensates for these limitations by primarily relying on our GAAP results, while using Adjusted EBITDA and Adjusted EBITDA margin as supplements to the corresponding GAAP financial measures.
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The following table provides a reconciliation of our net loss to Adjusted EBITDA for the periods presented and the calculation of Adjusted EBITDA margin:
| | | | | | | | | | |
|---|---|---|---|---|---|---|---|---|---|
| | Year Ended December 31, | ||||||||
| | 2024 | 2023 | 2022 | ||||||
| | (in thousands) | ||||||||
| Net loss | $ | (17,860) | | $ | (2,388) | | $ | (5,694) | |
| Depreciation and amortization | 44,446 | | 40,751 | | 38,175 | | |||
| Interest expense, net | 24,840 | | 30,916 | | 15,753 | | |||
| Income tax expense (benefit) | 9,120 | | (7,672) | | 19,415 | | |||
| Loss on sale and disposal of property and equipment | 408 | | 138 | | 193 | | |||
| Restructuring charges(a) | 512 | | 3,727 | | 1,607 | | |||
| Stock-based compensation expense(b) | 7,392 | | 18,804 | | 50,634 | | |||
| Unrealized losses (gains) on foreign currency transactions(c) | 6,223 | | (110) | | 2,534 | | |||
| Strategic initiative costs(d) | 3,329 | | 4,092 | | 3,948 | | |||
| Acquisition and integration related costs(e) | 2,348 | | 911 | | 326 | | |||
| Loss on extinguishment of debt(f) | | — | | | — | | | 3,465 | |
| Underwriting fees related to offering of common stock(g) | | — | | | — | | | 11,437 | |
| Odessa fire(h) | | — | | | (2,600) | | | 869 | |
| Other(i) | | (539) | | 1,456 | | 590 | | ||
| Adjusted EBITDA | $ | 80,219 | | $ | 88,025 | | $ | 143,252 | |
| Net sales | $ | 508,520 | | $ | 566,492 | | $ | 695,736 | |
| Net loss margin | (3.5) | % | (0.4) | % | (0.8) | % | |||
| Adjusted EBITDA margin | 15.8 | % | 15.5 | % | 20.6 | % |
| Column 1 | Column 2 |
|---|---|
| (a) | Represents costs related to a cost reduction plan that includes severance and other costs for our executive management changes and additional costs related to our cost reduction plans, which include further actions to reduce our manufacturing overhead by reducing headcount in addition to facility shutdowns. |
| Column 1 | Column 2 |
|---|---|
| (b) | Represents non-cash stock-based compensation expense. |
| Column 1 | Column 2 |
|---|---|
| (c) | Represents unrealized foreign currency transaction losses associated with our international subsidiaries. |
| Column 1 | Column 2 |
|---|---|
| (d) | Represents fees paid to external consultants and other expenses for our strategic initiatives. |
| Column 1 | Column 2 |
|---|---|
| (e) | Represents acquisition and integration costs as well as other costs related to potential transactions. |
| Column 1 | Column 2 |
|---|---|
| (f) | Represents the loss on extinguishment of debt in connection with our debt refinancing on February 23, 2022. |
| Column 1 | Column 2 |
|---|---|
| (g) | Represents underwriting fees related to our offering of common stock that was completed in January 2022. |
| Column 1 | Column 2 |
|---|---|
| (h) | Represents costs incurred and insurance recoveries related to a production facility fire in Odessa, Texas. |
| Column 1 | Column 2 |
|---|---|
| (i) | Other costs consist of other discrete items as determined by management, primarily including: (i) fees paid to external advisors for various matters, (ii) other items. |
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Liquidity and Capital Resources
Overview
Our primary sources of liquidity are net cash provided by operating activities and availability under our Revolving Credit Facility. Historically, we have funded working capital requirements, capital expenditures, payments related to acquisitions, and debt service requirements with internally generated cash on hand, through borrowings under our credit facilities, and through the issuance of shares of our common stock. Our primary cash needs are to fund working capital, capital expenditures, debt service requirements, and any acquisitions or investments we may undertake.
As of December 31, 2024, we had $56.4 million of cash, $281.5 million of outstanding borrowings, and an additional $75.0 million of availability under our Revolving Credit Facility. On August 2, 2024, we completed the Coverstar Central Acquisition. The purchase price was $64.5 million, subject to certain adjustments, including for working capital, as compared to an agreed upon target and transaction expenses. The Coverstar Central Acquisition was fully funded with cash on hand. While our existing cash balances and net cash provided by operating activities have generally been sufficient to fund our general corporate and working capital needs, our use of significant existing cash on hand to fund the Coverstar Central Acquisition may require us in the future to utilize a portion of our borrowing availability under our Revolving Credit Facility.
Our primary working capital requirements are for the purchase of inventory, payroll, rent, facility costs and other selling, general, and administrative costs. Our working capital requirements fluctuate during the year, driven primarily by seasonality and the timing of raw material purchases. Our capital expenditures are primarily related to our growth strategy, including production capacity, storage, and delivery equipment. We are in the middle of our digital transformation effort to upgrade all of our technology and enterprise resource planning systems. We expect to fund these capital expenditures from net cash provided by operating activities or the utilization of a portion of our borrowing availability under our Revolving Credit Facility.
It is our belief that our existing cash, cash generated from operations and availability under our Revolving Credit Facility, will be adequate to fund our operating expenses and capital expenditure requirements over the next 12 months, as well as our longer-term liquidity needs. We have based this estimate on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we expect. We may issue debt or equity securities, which may provide an additional source of liquidity. However, there can be no assurance equity or debt financing will be available to us when we need it or, if available, the terms will be satisfactory to us and not dilutive to our then-current stockholders.
Our Indebtedness
On February 23, 2022, Latham Pool Products, Inc. (“Latham Pool Products”), our wholly owned subsidiary, entered into the Credit Agreement with Barclays Bank PLC (the “Credit Agreement”), which provides a senior secured multicurrency revolving line of credit (the “Revolving Credit Facility”) in an initial principal amount of $75.0 million and a U.S. Dollar senior secured term loan (the “Term Loan”) in an initial principal amount of $325.0 million. On the closing date, proceeds under the agreement were used to repay and replace $294.0 million under, and terminate, the previous credit agreement and for general corporate purposes.
Revolving Credit Facility
The Revolving Credit Facility may be utilized to finance ongoing general corporate and working capital needs and permits Latham Pool Products to borrow loans in U.S. Dollars, Canadian Dollars, Euros and Australian Dollars. The Revolving Credit Facility matures on February 23, 2027. Loans outstanding under the Revolving Credit Facility denominated in U.S. Dollars and Canadian Dollars bear interest, at the borrower’s option, at a rate per annum based on Term SOFR or CDO (each, as defined in the Credit Agreement), as applicable, plus a margin of 3.50%, or at a rate per annum based on the Base Rate or the Canadian Prime Rate (each, as defined in the Credit Agreement), plus a margin of 2.50%. Loans outstanding under the Revolving Credit Facility denominated in Euros or Australian Dollars bear interest based on EURIBOR or the AUD Rate (each, as defined in the Credit Agreement), respectively, plus a margin of 3.50%.
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A commitment fee accrues on any unused portion of the commitments under the Revolving Credit Facility. The commitment fee is due and payable quarterly in arrears and is, initially, 0.375% per annum and will, thereafter, accrue at a rate per annum ranging from 0.25% to 0.50%, depending on the First Lien Net Leverage Ratio. The Revolving Credit Facility is not subject to amortization.
Term Loan
The Term Loan matures on February 23, 2029. Loans outstanding under the Term Loan bear interest, at the borrower’s option, at a rate per annum based on Term SOFR (as defined in the Credit Agreement), plus a margin ranging from 3.75% to 4.00%, depending on the First Lien Net Leverage Ratio (as defined in the Credit Agreement, the “First Lien Net Leverage Ratio”), or based on the Base Rate (as defined in the Credit Agreement), plus a margin ranging from 2.75% to 3.00%, depending on the First Lien Net Leverage Ratio. Loans under the Term Loan are subject to scheduled quarterly amortization payments equal to 0.25% of the initial principal amount of the Term Loan.
Cash Flows
The following table summarizes our sources and uses of cash for each of the periods presented:
| | | | | | | | | | |
|---|---|---|---|---|---|---|---|---|---|
| | | Year Ended December 31, | |||||||
| | | 2024 | 2023 | 2022 | |||||
| | | (in thousands) | |||||||
| Net cash provided by operating activities | | $ | 61,307 | | $ | 116,369 | | $ | 32,309 |
| Net cash used in investing activities | | (84,643) | | (31,726) | | (45,018) | |||
| Net cash (used in) provided by financing activities | | (22,021) | | (13,875) | | 3,775 | |||
| Effect of exchange rate changes on cash | | (1,008) | | (631) | | (2,392) | |||
| Net (decrease) increase in cash | | $ | (46,365) | | $ | 70,137 | | $ | (11,326) |
Operating Activities
During the year ended December 31, 2024, operating activities provided $61.3 million of cash. Net loss, after adjustments for non-cash items, provided cash of $50.8 million. Cash provided by operating activities was further driven by changes in our operating assets and liabilities, which provided $10.5 million. Net cash provided in changes in our operating assets and liabilities for the year ended December 31, 2024 consisted primarily of a $22.7 million decrease in inventories and a $1.3 million decrease in other assets, partially offset by a $4.0 million decrease in accounts payable, a $3.0 million increase in income tax receivable, a $2.4 million increase in trade receivables, a $2.0 million increase in prepaid expenses and other current assets, a $1.3 million decrease in accrued expenses and other current liabilities and a $0.7 million decrease in other long-term liabilities. The change in trade receivables was primarily driven by the amount and timing of net sales, and the decrease in inventories was primarily driven by a business decision to right size our inventory levels to better align with demand. The changes in accrued expenses and other current liabilities, and accounts payable were primarily because of volume of purchases and timing of payments, as well as an increase in incentive compensation.
During the year ended December 31, 2023, operating activities provided $116.4 million of cash. Net loss, after adjustments for non-cash items, provided cash of $57.1 million. Cash provided by operating activities was further driven by changes in our operating assets and liabilities, which provided $59.3 million. Net cash provided in changes in our operating assets and liabilities for the year ended December 31, 2023 consisted primarily of a $68.2 million decrease in inventories, a $13.0 million decrease in trade receivables, a $2.8 million increase in other long-term liabilities and a $1.3 million decrease in income tax receivable, partially offset by a $11.9 million decrease in accrued expenses and other current liabilities, a $8.5 million decrease in accounts payable, a $4.3 million increase in other assets and a $1.3 million increase in prepaid expenses and other current assets. The change in trade receivables was primarily driven by the amount and timing of net sales, and the decrease in inventories was primarily driven by a business decision to right size our inventory levels to better align with demand. The changes in accrued expenses and other current liabilities, and accounts payable were primarily because of volume of purchases and timing of payments.
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Investing Activities
During the year ended December 31, 2024, investing activities used $84.6 million of cash, consisting of our acquisition of Coverstar Central for $64.5 million and the purchase of property and equipment for $20.1 million. The purchase of property and equipment was primarily to expand capacity for production and diversify offerings, especially for fiberglass pools, as well as our ongoing digital transformation project.
During the year ended December 31, 2023, investing activities used $31.7 million of cash, primarily consisting of the purchase of property and equipment for $33.2 million partially offset by capital reimbursed from insurance proceeds for $1.5 million. The purchase of property and equipment was primarily to expand capacity for production, especially for fiberglass pools.
Financing Activities
During the year ended December 31, 2024, financing activities used $22.0 million of cash, consisting of repayments on long-term debt borrowings of $21.2 million, and repayments of finance lease obligations of $0.8 million.
During the year ended December 31, 2023, financing activities used $13.9 million of cash, primarily consisting of repayments on revolving credit facilities of $48.0 million, repayments on long-term debt borrowings of $13.2 million, and repayments of finance lease obligations of $0.6 million, partially offset by borrowings on revolving credit facilities of $48.0 million.
For discussion on operating, investing, and financing activities of the year ended December 31, 2022, see the Liquidity and Capital Resources section disclosed in Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the year ended December 31, 2023, which was filed with the SEC on March 13, 2024.
Inflation
We are experiencing inflationary pressures in certain areas of our business, including with respect to our employee wages, although, to date, we have been able to offset such pressures, to some extent, through price increases and other measures. We cannot, however, predict any future trends in the rate of inflation or associated increases in our operating costs and how that may impact our business. There is a substantial risk that demand for our products may continue to soften as we continue to increase the prices of our products to offset the inflationary pressure.
Contractual Obligations
Our largest contractual obligations as of December 31, 2024 consisted of principal payments related to our long-term indebtedness that are included in our consolidated balance sheet and the related periodic interest payments, and non-cancelable operating leases. For a description of our contractual obligations and commitments, see Notes 9 and 13 to our Consolidated Financial Statements included elsewhere in this Annual Report.
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States. Throughout the preparation of these financial statements, we have made estimates and assumptions that impact the reported amounts of assets, liabilities, and the disclosure of contingent liabilities at the date of the financial statements and revenues and expenses during the reporting period. These estimates are based on historical results, trends, and other assumptions we estimate to be reasonable. We evaluate these estimates on an ongoing basis. Actual results may differ from estimates.
Our significant accounting policies are presented in Note 2 to our Consolidated Financial Statements. We believe that the following critical accounting policies affect the most significant estimates and management judgments used in preparation of the consolidated financial statements.
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Revenue Recognition
With the exception of our extended service warranties and our custom product contracts, we recognize our revenue at a point in time when control of the promised goods is transferred to our customers, and in an amount that reflects the consideration we expect to be entitled to in exchange for those goods. Control of the goods is considered to have been transferred upon shipping or upon arrival at the customer’s destination, depending on the terms of the purchase order. Revenue that is derived from our extended service warranties, which are separately priced and sold, is recognized over the term of the contract. Revenue from custom products is recognized over time utilizing an input method that compares the cost of cumulative work-in-process to date to the most current estimates for the entire cost of the performance obligation. Custom products are generally delivered to the customer within three days of receipt of the purchase order. Each product shipped is considered to be one performance obligation. For each product shipped, the transaction price by product is specified in the purchase order.
We recognize revenue on the transaction price less any estimated rebates, returns, allowances, cash discounts, or other sales incentives. Customer rebates, returns, allowances, cash discounts, and other sales incentives are estimated by applying the portfolio approach using the most-likely-amount method and are recorded as a reduction to revenue.
Customer Rebates and Cash Discounts
We offer rebates to our customers based on factors such as the total amount of the customer’s purchase and expected sales for a particular customer during the year. Rebates are estimated by applying the portfolio approach using the most-likely-amount method and are deducted from revenue at the time of sale. Estimates are updated each reporting period and are allocated accordingly to the performance obligations of the contract (the individual products).
Business Combinations
We account for business combinations that are deemed to be businesses under the acquisition method of accounting. Application of this method of accounting requires that the identifiable assets acquired (including identifiable intangible assets) and liabilities assumed generally be measured and recognized at fair value as of the acquisition date. Any contingent assets acquired and contingent liabilities assumed are also recognized at fair value if we can reasonably estimate fair value during the measurement period. We remeasure any contingent liabilities at fair value in each subsequent reporting period. The excess of the purchase price over the fair value of net assets acquired is recorded as goodwill. Determining the fair value of assets acquired and liabilities assumed requires management’s judgment, based on available information at the time of acquisition and subsequently obtained during a measurement period up to one year following the date of acquisition, relating to events or circumstances that existed at the acquisition date. Management’s judgment relies upon estimates and assumptions related to future cash flows, discount rates, useful lives of assets, market conditions, and other items. The fair value of intangible assets other than goodwill acquired in a business combination are estimated in accordance with the policy described below.
The fair value of intangible assets other than goodwill acquired in a business combination is recorded at fair value at the date of acquisition. Management values dealer relationships and franchise relationships using the multi-period excess earnings method. Under this method, the value of an intangible asset is equal to the present value of the after-tax cash flows attributable solely to the intangible asset, after making adjustments for the required return on and of the other associated assets. We value trade names, trademarks, and proprietary pool designs using the relief from royalty method. The relief-from-royalty method determines the present value of the economic royalty savings associated with the ownership or possession of the trade name, trademark, or proprietary pool design based on an estimated royalty rate applied to the cash flows to be generated by the business. The estimated royalty rate is determined based on the assessment of a reasonable royalty rate that a third party would negotiate in an arm’s-length license agreement for the use of the trade name, trademark, or proprietary pool design.
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Impairment of Goodwill
We evaluate goodwill for impairment at least annually, or more frequently when events or changes in circumstances indicate that the carrying value may not be recoverable. We have selected the first day of the fourth quarter to perform our annual goodwill impairment testing.
We may assess our goodwill for impairment initially using a qualitative approach, or step zero, to determine whether conditions exist to indicate that it is more likely than not that the fair value of the reporting unit is less than its carrying value. The qualitative assessment requires significant judgments by management about economic conditions including the entity’s operating environment, its industry and other market considerations, entity-specific events related to financial performance or loss of key personnel, and other events that could impact the reporting unit. If management concludes, based on assessment of relevant events, facts, and circumstances, that it is more likely than not that the reporting unit’s fair value is greater than its carrying value, no further impairment testing is required.
If our assessment of qualitative factors indicates that it is more likely than not that the fair value of the reporting unit is less than its carrying value, then a quantitative assessment is performed. We may also elect to initially perform a quantitative analysis instead of starting with step zero. The quantitative analysis requires comparing the carrying value of the reporting unit, including goodwill, to its fair value. If the fair value of the reporting unit exceeds its carrying amount, goodwill is not considered to be impaired and no further testing is required. If the carrying amount of the reporting unit exceeds its fair value, there is an impairment of goodwill and an impairment loss is recorded. We calculate the impairment loss by comparing the fair value of the reporting unit less the carrying value, including goodwill. The goodwill impairment is limited to the carrying value of the goodwill.
Based on the results of the qualitative assessment performed for our one reporting unit, we determined that goodwill was not impaired at September 29, 2024. Based on the results of the quantitative assessment performed for our one reporting unit, we determined that goodwill was not impaired at October 1, 2023. However, if factors exist that could indicate an impairment in the future, including a sustained decrease in our stock price, we may be required to record impairment charges in future periods.
For our quantitative impairment test performed for our reporting unit at October 1, 2023, we estimated the fair value of our reporting unit based on a market approach. Under the market approach, we estimated the fair value of our single reporting unit based on enterprise value using our share price on the Nasdaq Global Select Market and an appropriate control premium. The market approach utilizes consideration of control premium associated with cost synergies that arise from obtaining control over a reporting unit and guideline transactions. The qualitative factors we assessed included economic conditions, industry and market considerations, cost factors, overall financial performance, and other entity specific events. In addition, we considered our market capitalization based on quoted market prices of our securities on the Nasdaq Global Select Market, adjusted for the effect of a control premium as contemplated by ASC 350.
Stock-Based Compensation
Stock-based compensation is measured and recognized based on the grant date fair value of the awards. The fair value of our common stock is determined based on the quoted market price of our common stock for purposes of computing stock-based compensation expense. For stock options and stock appreciation rights, we use a Black-Scholes model for estimating the grant date fair value. The Black-Scholes pricing model requires critical assumptions including risk-free rate, volatility, expected term and expected dividend yield. The expected term is computed using the simplified method. We use the simplified method to calculate expected term of the stock options since we do not have sufficient historical exercise data to provide a reasonable basis upon which to estimate expected term. The risk-free interest rate is based on the yield available on U.S. Treasury zero-coupon issues similar in duration to the expected term of the stock-based award. We consider the historical volatility of our stock price, as well as implied volatility. We utilized a dividend yield of zero, as we have no history or plan of declaring dividends on our common stock. The assumptions underlying these valuations represented our best estimate, which involved inherent uncertainties and the application of judgment. As a result, if we had used significantly different assumptions or estimates, the fair value of our stock-based compensation expense could have been materially different.
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For stock options, restricted stock awards, restricted stock units, stock appreciation rights and performance stock units, stock-based compensation is recognized using a graded vesting method over the requisite service period in which employees earn the awards. We account for forfeitures of stock-based awards as they occur rather than applying an estimated forfeiture rate to stock-based compensation expense.
Contemporaneously with the pricing of our initial public offering, on April 22, 2021, we effected the Latham Group, Inc. 2021 Omnibus Incentive Plan in which we granted to certain of our employees restricted stock awards, restricted stock units, and option awards inclusive of the as converted Class B units as a result of the Company’s parent entity, Latham Investment Holdings, L.P. merged with and into Latham Group, Inc.
Income Taxes
Deferred tax assets and liabilities are determined based on temporary differences resulting from the different treatment of items for tax and financial reporting purposes. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to reverse. We reduce deferred taxes by a valuation allowance when we conclude such deferred taxes are not more than likely to be realized. The determination of whether a deferred tax asset will be realized is made on both a jurisdictional basis and the use of our estimate of the recoverability of the deferred tax asset. In evaluating whether a valuation allowance is required under such rules, we consider all available positive and negative evidence, including our prior operating results, the nature and reason for any losses, our forecast of future taxable income in each respective tax jurisdiction and the dates on which any deferred tax assets are expected to expire. These assumptions require a significant amount of judgment, including estimates of future taxable income. As of December 31, 2024 and 2023, our valuation allowance was $8.7 million and $3.1 million, respectively. We continue to assess whether any significant changes in circumstances or assumptions have occurred that could materially affect our ability to realize deferred tax assets. We released the valuation allowance in 2021 since we believed we had sufficient positive evidence, including, but not limited to, three years’ of cumulative pre-tax book income, including permanent adjustments and recent profits within taxing jurisdictions, to overcome any negative evidence related to loss utilization expiration periods.
We record liabilities for uncertain income tax positions based on a two-step process. The first step is recognition, where an individual tax position is evaluated as to whether it has a likelihood of greater than 50% of being sustained upon examination based on the technical merits of the position, including resolution of any related appeals or litigation processes. The amount of the benefit that may be recognized is the largest amount that has a greater than 50% likelihood of being realized on ultimate settlement. The actual benefits ultimately realized may differ from the estimates. We classify interest and penalties related to unrecognized tax benefits as a component of income tax expense (benefit) within the consolidated statements of operations.
Although we believe that we have adequately reserved for our uncertain tax positions, we can provide no assurance that the final tax outcome of these matters will not be materially different. In future periods, changes in facts, circumstances, and new information may require us to change the recognition and measurement estimates with regard to individual tax positions. Our liabilities for uncertain tax positions were $0.0 million and $0.0 million for the years ended December 31, 2024 and 2023, respectively. Changes in recognition and measurement estimates are recorded in income tax expense (benefit)and liability in the period in which such changes occur.
Emerging Growth Company Status
The JOBS Act permits an “emerging growth company” such as us to take advantage of an extended transition period to comply with new or revised accounting standards applicable to public companies until those standards would otherwise apply to private companies. We have elected not to “opt out” of such extended transition period, which means that when a standard is issued or revised and it has different application dates for public or private companies, we will adopt the new or revised standard at the time private companies adopt the new or revised standard and will do so until such time that we either (i) irrevocably elect to “opt out” of such extended transition period or (ii) no longer qualify as an emerging growth company. We may choose to early adopt any new or revised accounting standards whenever such early adoption is permitted for private companies.
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Recently Issued and Adopted Accounting Pronouncements
A description of recently issued accounting pronouncements that may potentially impact our financial position, results of operations, or cash flows is disclosed in Note 2 to our Consolidated Financial Statements included elsewhere in this Annual Report.
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