Pool Corp: Form 10-Q for the period ended Sep 30, 2017

You should read the following discussion in conjunction with Management’s Discussion and Analysis included in our 2016 Annual Report on Form 10-K.

For a discussion of our base business calculations, see the RESULTS OF OPERATIONS section below.

Cautionary Statement for Purposes of the “Safe Harbor” Provisions of the Private Securities Litigation Reform Act of 1995

Our disclosure and analysis in this report contains forward-looking information that involves risks and uncertainties. Our forward‑looking statements express our current expectations or forecasts of possible future results or events, including projections of earnings and other financial performance measures, statements of management’s expectations regarding our plans and objectives and industry, general economic and other forecasts of trends and other matters. Forward-looking statements speak only as of the date of this filing, and we undertake no obligation to update or revise such statements to reflect new circumstances or unanticipated events as they occur. You can identify these statements by the fact that they do not relate strictly to historic or current facts and often use words such as “anticipate,” “estimate,” “expect,” “believe,” “will likely result,” “outlook,” “project,” “should” and other words and expressions of similar meaning.

No assurance can be given that the results in any forward-looking statements will be achieved and actual results may differ materially due to one or more factors, including the sensitivity of our business to weather conditions, changes in the economy and the housing market, our ability to maintain favorable relationships with suppliers and manufacturers, competition from other leisure product alternatives and mass merchants, excess tax benefits or deficiencies recognized under ASU 2016-09 and other risks detailed in our 2016 Annual Report on Form 10-K. For these statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act.

OVERVIEW

Financial Results

Our business performed very well in the third quarter of 2017, despite severe weather in Florida, Texas, Puerto Rico and Mexico from Hurricanes Irma, Harvey, Maria and Katia and despite the devastating earthquake in Mexico. While these events are disruptive in the short term, we believe they will not have a material impact on our operating results for the year.

Net sales increased 8% to $743.4 million for the third quarter of 2017 compared to $691.4 million in the third quarter of 2016. We realized base business sales growth of 6%. We had one less selling day in the third quarter of 2017 compared to the same period last year, which we believe negatively impacted base business sales growth by approximately 1%. Continued increases in in swimming pool repair and remodel activities, including major pool refurbishment and replacement of key pool equipment, led our sales growth. The recent weather events negatively impacted our third quarter 2017 net sales by an estimated $4.0 million.

Gross profit increased 9% for the third quarter of 2017 compared to the same period in 2016. Base business gross profit improved 7% over the third quarter of last year. Gross profit as a percentage of net sales (gross margin) increased approximately 20 basis points to 29.1% compared to the third quarter of 2016, reflecting product mix and benefits from sourcing initiatives.

Selling and administrative expenses (operating expenses) increased 7% compared to the third quarter of 2016, with base business operating expenses up 5% over the comparable 2016 period. As a percentage of net sales, base business operating expenses declined to 17.9% for the third quarter versus 18.1% last year.

Operating income for the third quarter increased 10% compared to the same period in 2016. Operating income as a percentage of net sales (operating margin) was 11.0% for the third quarter of 2017 compared to 10.7% for the third quarter of 2016.

During the first quarter of 2017, we adopted Accounting Standards Update (ASU) 2016-09, Improvements to Employee Share-Based Payment Accounting, on a prospective basis. This adoption resulted in a benefit recorded in our Provision for income taxes of $0.3 million for the three months ended September 30, 2017 and $7.7 million for the nine months ended September 30, 2017, which positively impacted our net income and earnings per share, but was partially offset by a required increase of approximately 500,000 and 550,000 diluted weighted average shares outstanding, respectively, used to calculate our diluted earnings per share. The total first and second quarter benefit to our diluted earnings per share from the adoption of this new accounting pronouncement was $0.14, and there was no impact in the third quarter of 2017.

Net income attributable to Pool Corporation was $48.8 million in the third quarter of 2017 compared to $44.5 million for the third quarter of 2016. Earnings per share increased to a record $1.16 per diluted share for the three months ended September 30, 2017 versus $1.03 per diluted share for the same period in 2016.

References to product line and product category data throughout this Form 10-Q generally reflect data related to the North American swimming pool market, as it is more readily available for analysis and represents the largest component of our operations.

Financial Position and Liquidity

Total net receivables, including pledged receivables, increased 13% from September 30, 2016, including a 2% increase from acquisitions. Our days sales outstanding (DSO), as calculated on a trailing four quarters basis, was 29.8 days at September 30, 2017, an improvement from 30.3 days at September 30, 2016, reflecting the effectiveness of our collection efforts. Our allowance for doubtful accounts balance was $4.1 million at September 30, 2017 and $3.7 million at September 30, 2016.

Net inventory levels grew 6% compared to levels at September 30, 2016. The inventory reserve was $7.8 million at September 30, 2017 and $8.1 million at September 30, 2016. Our inventory turns, as calculated on a trailing four quarters basis, were 3.5 times at both September 30, 2017 and September 30, 2016.

Total debt outstanding at September 30, 2017 was $564.6 million, an increase of $174.4 million, or 45%, compared to total debt at September 30, 2016, primarily because of share repurchases of $199.0 million over the last 12 months, as well as debt incurred to fund business driven working capital growth.

Current Trends and Outlook

For a detailed discussion of trends through 2016, see the Current Trends and Outlook section of Management’s Discussion and Analysis included in Item 7 of our 2016 Annual Report on Form 10-K.

In conjunction with the release of our first quarter 2017 results, we updated our 2017 earnings guidance from an initial range of $3.80 to $4.00 per diluted share to a range of $4.12 to $4.32 per diluted share, which reflected both an estimated benefit of $0.30 due to the adoption of ASU 2016-09 and $0.02 from better than expected first quarter 2017 operating results. We maintained this guidance following the release of our second quarter 2017 earnings results, which were largely in line with our expectations. Given changes in employee stock option exercise patterns in the third quarter of 2017, we updated our expectations for the remainder of 2017 to include only the $0.14 tax benefit from ASU 2016-09 realized in the first and second quarters of 2017. Our operating results were in line with our expectations, and we have narrowed our earnings guidance to a range of $4.01 to $4.11 per diluted share. The estimated impact related to ASU 2016-09 is subject to several assumptions which can vary significantly, including our estimated share price and the period that our employees will exercise shares of outstanding vested options.

We project base business sales growth of 6% to 7% for the full year and expect gross margin to be similar to 2016, including an expected decline in gross margin in the fourth quarter of 2017 due to anticipated product mix changes following major third quarter weather events as well as an unfavorable comparison to fourth quarter 2016 results, which benefited by 20 basis points from an increase in the vendor incentive accrual at year-end. For the year, we have incurred growth-driven expense increases related to labor, facilities expansion and delivery costs, although the growth in these types of operating expenses has moderated as we have moved throughout the year. We expect base business operating expenses as a percentage of net sales for 2017 to decline between 20 and 40 basis points as compared to 2016, resulting in a 20 to 40 basis points increase in base business operating income as a percentage of net sales.

Given our $174.4 million increase in debt as of September 30, 2017 over the prior year and the increase in 30-Day LIBOR of approximately 70 basis points over last year, we expect our Interest and other non-operating expenses, net for the full year 2017 to increase by approximately $1.5 million to $2.0 million over 2016, depending on fourth quarter borrowings to fund future share repurchases.

Excluding the impact from the adoption of ASU 2016-09, we expect our effective tax rate will be consistent with 2016. Our effective tax rate is dependent upon our results of operations and may change if actual results are different from our current expectations, particularly any significant changes in our geographic mix. Due to the adoption of the new accounting standard, we expect our effective tax rate will fluctuate from quarter to quarter, particularly in periods when employees elect to exercise their vested stock options or when restrictions on share-based awards lapse. Based on our comparison of our deferred tax assets for share-based compensation to the current intrinsic value of the underlying awards, we expect to recognize material income tax benefits in periods when these transactions occur. The impact related to ASU 2016-09 is subject to several variables, including our share price and the period in which our employees will exercise shares of outstanding vested options.

We expect cash provided by operations will exceed net income for the 2017 fiscal year. We anticipate that we may use approximately $140.0 million to $160.0 million in cash to fund share repurchases in 2017.

RESULTS OF OPERATIONS

As of September 30, 2017, we conducted operations through 346 sales centers in North America, Europe, South America and Australia.

The following table presents information derived from the Consolidated Statements of Income expressed as a percentage of net sales:

Note: Due to rounding, percentages may not add to Operating income or Income before income taxes and equity earnings.

We have included the results of operations from the acquisitions in 2017 and 2016 in our consolidated results since the acquisition dates.

Three Months Ended September 30, 2017 Compared to Three Months Ended September 30, 2016

The following table breaks out our consolidated results into the base business component and the excluded component (sales centers excluded from base business):

(Unaudited)

(in thousands)

In our calculation of base business results, we have excluded the following acquisitions for the periods identified:

(1) We acquired certain distribution assets of this company.

When calculating our base business results, we exclude sales centers that are acquired, closed, or opened in new markets for a period of 15 months. We also exclude consolidated sales centers when we do not expect to maintain the majority of the existing business and existing sales centers that are consolidated with acquired sales centers.

We generally allocate corporate overhead expenses to excluded sales centers on the basis of their net sales as a percentage of total net sales. After 15 months of operations, we include acquired, consolidated and new market sales centers in the base business calculation including the comparative prior year period.

The table below summarizes the changes in our sales center count during the first nine months of 2017:

16

Net Sales

(in millions)

Net sales increased 8% in the third quarter of 2017 compared to the third quarter of 2016, with base business sales up 6% for the period. Severe weather events during the third quarter of this year, particularly Hurricanes Irma and Harvey, were the most disruptive impact to our sales growth. Sales in Texas largely recovered by the end of the quarter, but sales in Florida remain behind the growth levels experienced prior to Hurricane Irma. We estimate these recent weather events negatively impacted net sales by approximately $4.0 million. Our seasonal markets generated sales growth of 6% during the quarter.

The following factors positively impacted our sales growth (listed in order of estimated magnitude):

• continued consumer investments in enhancing outdoor living spaces, as evidenced by improvements in sales growth rates for product offerings such as building materials and equipment (see discussion below);
• market share gains;
• pool and spa chemical sales, our largest product category at 14% of total net sales for the quarter, increased 2% over the third quarter of 2016 under less attractive weather conditions in 2017 and excluding the recent Lincoln Aquatics acquisition; and
• inflationary product cost increases (estimated at close to 1%).

The following factors negatively impacted our sales growth (listed in order of estimated magnitude):

• one less selling day in the third quarter of 2017 compared to the same period last year, affecting net sales growth approximately 1%; and
• recent weather events (described above).

We believe that sales growth rates for certain product offerings, such as building materials and equipment, evidence increased spending in traditionally discretionary areas including pool construction and pool remodeling, as well as equipment upgrades. In the third quarter of 2017, the sales growth rate for equipment, such as swimming pool heaters, pumps, lights and filters, collectively, was similar to the 8% growth rate for total net sales compared to the third quarter of 2016. This increase reflects both the ongoing recovery of replacement activity and continued demand for higher-priced, more energy-efficient products. Sales of building materials, which includes tile, represent approximately 10% of net sales for the third quarter of 2017 and grew by 9% compared to the third quarter of 2016.

Sales to customers who service large commercial swimming pool installations such as hotels, universities and community recreational facilities are included in the appropriate existing product categories and growth in this area is reflected in the numbers above. These sales represented just over 4% of our consolidated net sales for the third quarter of 2017 and increased 12% compared to the third quarter of 2016, excluding the recent acquisition of Lincoln Aquatics. With Lincoln Aquatics, commercial sales represent approximately 5% of our consolidated net sales, and this acquisition furthers our efforts to increase not only our focus on the commercial market, but also the resources assigned to this area, including designated warehouse space, increased staffing and additional vendor relationships.

Gross Profit

(in millions)

Gross margin for the third quarter of 2017 increased approximately 20 basis points compared to the third quarter of 2016. This increase primarily reflects product mix and benefits from sourcing initiatives.

Operating Expenses

(in millions)

Operating expenses increased 7% in the third quarter of 2017 compared to the third quarter of 2016, with base business operating expenses up 5% compared to the same period last year. Increased growth-driven labor and freight expenses, as well as higher performance-based and equity-based compensation costs comprised the majority of our operating expense growth. As a percentage of net sales, base business operating expenses declined to 17.9% for the third quarter versus 18.1% last year.

Interest and Other Non-operating Expenses, Net

Interest and other non-operating expenses, net increased $1.0 million compared to the third quarter of 2016, primarily due to higher interest rates on our debt and an increase in borrowings. Our weighted average effective interest rate increased to 2.7% for the third quarter of 2017 from 2.0% for the third quarter of 2016 on higher average outstanding debt of $535.5 million versus $426.7 million for the respective periods.

Income Taxes

Our effective income tax rate was 37.4% for the three months ended September 30, 2017 and 37.7% for the three months ended September 30, 2016. Our third quarter effective income tax rate is typically lower compared to other quarters, primarily due to the timing of our accounting for uncertain tax positions, including the expiration of statutes of limitations. The decline also reflects a $0.3 million tax benefit recorded in our provision for income taxes from the adoption of ASU 2016-09.

Net Income and Earnings Per Share

Net income attributable to Pool Corporation increased 10% to $48.8 million in the third quarter of 2017 compared to the third quarter of 2016. Earnings per diluted share increased to $1.16 for the third quarter of 2017 versus $1.03 per diluted share for the comparable period in 2016. The adoption of ASU 2016-09 did not have an impact our earnings per diluted share in the third quarter of 2017.

Nine Months Ended September 30, 2017 Compared to Nine Months Ended September 30, 2016

The following table breaks out our consolidated results into the base business component and the excluded component (sales centers excluded from base business):

(Unaudited)

(in thousands)

In our calculation of base business results, we have excluded the following acquisitions for the periods identified:

(1) We acquired certain distribution assets of each of these companies.

For a more detailed explanation of how we calculated base business results and a summary of the changes in our sales centers since December 31, 2016, please refer to the discussion under the heading Three Months Ended September 30, 2017 Compared to Three Months Ended September 30, 2016.

Net Sales

(in millions)

Net sales for the first nine months of 2017 increased 7% compared to the same period last year, with much of this growth resulting from the 6% improvement in base business sales.

The following factors contributed to our sales growth (listed in order of estimated magnitude):

• continued improvement in consumer discretionary expenditures, including market recovery in remodeling and replacement activity (see discussion below);
• market share growth, particularly in building materials and commercial product categories;
• pool and spa chemical sales, our largest product category at 13% of total net sales for the nine months ended September 30, 2017, increased 3% compared to the first nine months of 2016, excluding the recent Lincoln Aquatics acquisition; and
• inflationary (estimated at close to 1%) product cost increases.

We believe that sales growth rates for certain product offerings, such as building materials and equipment, evidence increased spending in traditionally discretionary areas including pool construction, pool remodeling, as well as equipment upgrades. In the first nine months of 2017, the sales growth rate for equipment, such as swimming pool heaters, pumps, lights and filters, collectively, was similar to the 7% growth rate for total net sales compared to the same period in 2016. This increase reflects both the ongoing recovery of replacement activity and continued demand for higher-priced, more energy-efficient products. Sales of building materials, which includes tile, represent approximately 11% of net sales for the first nine months of 2017 and grew by 12% compared to the first nine months of 2016.

Sales to customers who service large commercial installations such as hotels, universities and community recreational facilities are included in the appropriate existing product categories and growth in this area is reflected in the numbers above. These sales represented 4% of our consolidated net sales for the first nine months of 2017 and increased 12% compared to the same period in 2016, excluding the recent acquisition of Lincoln Aquatics.

Gross Profit

(in millions)

Gross margin for the nine months ended September 30, 2017 was in line with gross margin for the nine months ended September 30, 2016.

Operating Expenses

(in millions)

For the first nine months of 2017, operating expenses were up 7% over the same period last year, with base business operating expenses up 5%. The increase in base business operating expenses was primarily due to higher growth-driven labor and freight expenses, as well as greater employee-related health insurance costs, equity-based compensation, and technology spending as we continue to invest in our business. Operating expenses as a percentage of net sales was consistent for the first nine months of 2017 and 2016 and improved by 20 basis points on a base business basis.

Interest and Other Non-operating Expenses, Net

Interest and other non-operating expenses, net for the first nine months of 2017 increased $1.7 million compared to the same period last year, primarily due to higher interest rates on our debt and an increase in borrowings. Our weighted average effective interest rate increased to 2.6% for the first nine months of 2017 from 2.0% for the same period of 2016 on higher average outstanding debt of $501.0 million versus $437.3 million for the respective periods.

Income Taxes

Our effective income tax rate was 35.2% for the nine months ended September 30, 2017 compared to 38.2% for the nine months ended September 30, 2016. The decline in our effective income tax rate is primarily due to the $7.7 million tax benefit recorded in our provision for income taxes, which reflects the impact of the adoption of ASU 2016-09.

Net Income and Earnings Per Share

Earnings per share for the first nine months of 2017, including a favorable $0.14 per diluted share impact from the adoption of ASU 2016-09, increased to $3.89 per diluted share on Net income attributable to Pool Corporation of $166.0 million, compared to $3.39 per diluted share on Net income attributable to Pool Corporation of $146.3 million in the comparable 2016 period.

Seasonality and Quarterly Fluctuations

Our business is highly seasonal. In general, sales and operating income are highest during the second and third quarters, which represent the peak months of both swimming pool use and installation and landscape maintenance and installation. Sales are substantially lower during the first and fourth quarters, when we may incur net losses. In 2016, we generated approximately 63% of our net sales and 85% of our operating income in the second and third quarters of the year.

We typically experience a build-up of product inventories and accounts payable during the winter months in anticipation of the peak selling season. Excluding borrowings to finance acquisitions and share repurchases, our peak borrowing usually occurs during the second quarter, primarily because extended payment terms offered by our suppliers typically are payable in April, May and June, while our peak accounts receivable collections typically occur in June, July and August.

The following table presents certain unaudited quarterly data for the first, second and third quarters of 2017, the four quarters of 2016 and the fourth quarter of 2015. We have included income statement and balance sheet data for the most recent eight quarters to allow for a meaningful comparison of the seasonal fluctuations in these amounts. In our opinion, this information reflects all normal and recurring adjustments considered necessary for a fair presentation of this data. Due to the seasonal nature of our industry, the results of any one or more quarters are not necessarily a good indication of results for an entire fiscal year or of continuing trends.

(Unaudited)

(in thousands)

We expect that our quarterly results of operations will continue to fluctuate depending on the timing and amount of revenue contributed by new and acquired sales centers. Based on our peak summer selling season, we generally open new sales centers and close or consolidate sales centers, when warranted, either in the first quarter before the peak selling season begins or in the fourth quarter after the peak selling season ends.

Weather is one of the principal external factors affecting our business. The table below presents some of the possible effects resulting from various weather conditions.

Weather Impacts on 2017 and 2016 Results

Severe storms in the third quarter of 2017, particularly Hurricanes Irma and Harvey, hindered our sales growth in Florida and Texas, although Texas largely recovered by the end of September. In the Central and Midwest, temperatures were normal for this time of year, contrasting with the above-average temperatures in the third quarter of 2016. The West experienced record heat and normal rainfall in the third quarter of 2017, similar to the above average heat in the same period last year.

Cold and wet weather throughout the Mid-South and North impacted those seasonal markets in the middle of the second quarter, while the weather impact overall for the quarter was fairly neutral. Temperatures and precipitation throughout most areas other than those described above, were normal, with only Texas benefiting from drier weather in the second quarter of 2017 compared to the above average rainfall experienced in the same period of 2016.

Unseasonably mild weather benefited sales in the first quarter of 2017. However, while favorable weather trends early in the year normally have a seasonally larger impact, the comparison to the first quarter of 2016 was especially tough given the benefit of the warmer-than-normal weather across nearly all markets in the United States in the first quarter of 2016. For the first quarter of 2017, Texas and surrounding markets experienced record warm temperatures, which when coupled with below-average precipitation for that area, spurred higher sales growth. In two of the more seasonal regions where we operate, below-average temperatures in the North and above-average precipitation in the West negatively impacted our first quarter 2017 sales growth.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity is defined as the ability to generate adequate amounts of cash to meet short-term and long-term cash needs. We assess our liquidity in terms of our ability to generate cash to fund our operating activities, taking into consideration the seasonal nature of our business. Significant factors which could affect our liquidity include the following:

• cash flows generated from operating activities;
• the adequacy of available bank lines of credit;
• acquisitions;
• scheduled debt payments;
• dividend payments;
• capital expenditures;
• the timing and extent of share repurchases; and
• the ability to attract long-term capital with satisfactory terms.

Our primary capital needs are seasonal working capital requirements and other general corporate purposes, including acquisitions, dividend payments and share repurchases. Our primary sources of working capital are cash from operations supplemented by borrowings, which have historically been sufficient to support our growth and finance acquisitions. The same principle applies to funds used for capital expenditures and share repurchases.

We prioritize our use of cash based on investing in our business, maintaining a prudent debt structure and returning money to our shareholders. Our specific priorities for the use of cash are as follows:

• maintenance and new sales center capital expenditures;
• strategic acquisitions executed opportunistically;
• payment of cash dividends as and when declared by our Board of Directors (Board);
• repayment of debt to maintain an average total leverage ratio (as defined below) between 1.5 and 2.0; and
• repurchases of our common stock under our Board authorized share repurchase program.

For 2017, we project capital expenditures will be approximately 1.5% of net sales as we expand facilities and purchase delivery vehicles to address growth opportunities. Over the last five years, capital expenditures have averaged roughly 1.0% of net sales. Capital expenditures were 1.4% of net sales in 2016, 1.0% of net sales in 2015 and 0.8% of sales in 2014.

Sources and Uses of Cash

The following table summarizes our cash flows (in thousands):

Cash provided by operating activities of $112.0 million decreased during the first nine months of 2017 compared to the first nine months of 2016 due to a combination of growth-related increases in inventories and receivables and the payment of our normal scheduled payment of our third quarter estimated taxes. These estimated payments for the third quarter of 2016 were deferred as allowed for areas affected by severe storms and flooding in Louisiana.

Cash used in investing activities for the first nine months of 2017 decreased compared to the first nine months of 2016. While we made increased investments in capital expenditures for vehicle additions in the first nine months of 2017, our cash used for acquisitions was considerably lower in the current period.

Cash used in financing activities decreased for the first nine months of 2017 compared to the first nine months of 2016, which reflects a $65.4 million increase in amounts provided by net borrowings, partially offset by a $23.7 million increase in amounts used for share repurchases. Dividends paid to shareholders increased by $6.2 million in the first nine months of 2017 compared to the first nine months of 2016.

Future Sources and Uses of Cash

Revolving Credit Facility

On September 29, 2017, we amended and restated our existing senior credit facility (the Credit Facility) principally in the following ways:

• extends the maturity date to September 29, 2022;
• increases the borrowing capacity to $750.0 million from $465.0 million;
• increases sublimits for swingline loans;
• decreases the pricing of all loans; and
• provides additional capacity under certain negative covenants related to indebtedness, liens, investments and dispositions of assets.

Pursuant to an accordion feature, the aggregate maximum principal amount of the commitments under the Credit Facility may be increased at our request and with agreement by the lenders by up to $75.0 million, to a total of $825.0 million. We intend to use the Credit Facility for general corporate purposes, for future share repurchases and to fund future growth initiatives.

At September 30, 2017, there was $415.3 million outstanding, a $4.2 million standby letter of credit outstanding and $330.5 million available for borrowing under the Credit Facility. We utilize interest rate swap contracts and forward-starting interest rate swap contracts to reduce our exposure to fluctuations in variable interest rates for future interest payments on the Credit Facility. As of September 30, 2017, we have three interest rate swap contracts in place that became effective on October 19, 2016. These swap contracts were previously forward-starting and were amended in October 2015 to bring the fixed rates per our forward-starting contracts in line with current market rates and extend the hedged period for future interest payments on our Credit Facility. Now effective, these amended swap contracts convert the Credit Facility’s variable interest rate to fixed rates of 2.273% on a notional amount of $75.0 million and 2.111% on two separate notional amounts, one $25.0 million and the other $50.0 million, totaling $75.0 million. Interest expense related to the notional amounts under these swap contracts is based on the fixed rates plus the applicable margin on the Credit Facility. These interest rate swap contracts will terminate on November 20, 2019.

In July 2016 we entered into a forward-starting interest rate swap contract to extend the hedged period for future interest payments on our Credit Facility to its maturity date at that time. This swap contract will convert the Credit Facility’s variable interest rate to a fixed rate of 1.1425% on a notional amount of $150.0 million. The contract becomes effective on November 20, 2019 and terminates on November 20, 2020.

The weighted average effective interest rate for the Credit Facility as of September 30, 2017 was approximately 2.7%, excluding commitment fees.

Financial covenants on the Credit Facility include maintenance of a maximum average total leverage ratio and a minimum fixed charge coverage ratio. As of September 30, 2017, the calculations of these two covenants are detailed below:

• Maximum Average Total Leverage Ratio. On the last day of each fiscal quarter, our average total leverage ratio must be less than 3.25 to 1.00. Average Total Leverage Ratio is the ratio of the trailing twelve months (TTM) Average Total Funded Indebtedness plus the TTM Average Accounts Securitization Proceeds divided by the TTM EBITDA (as those terms are defined in the Credit Facility). As of September 30, 2017, our average total leverage ratio equaled 1.60 (compared to 1.54 as of June 30, 2017) and the TTM average total debt amount used in this calculation was $496.5 million.
• Minimum Fixed Charge Coverage Ratio. On the last day of each fiscal quarter, our fixed charge ratio must be greater than or equal to 2.25 to 1.00. Fixed Charge Ratio is the ratio of the TTM EBITDAR divided by TTM Interest Expense paid or payable in cash plus TTM Rental Expense (as those terms are defined in the Credit Facility). As of September 30, 2017, our fixed charge ratio equaled 5.50 (compared to 5.52 as of June 30, 2017) and TTM Rental Expense was $53.5 million.

The Credit Facility also limits the declaration and payment of dividends on our common stock to no more than 50% of the preceding year’s Net Income (as defined in the Credit Facility), provided no default or event of default has occurred and is continuing, or would result from the payment of dividends. Additionally, we may declare and pay quarterly dividends notwithstanding that the aggregate amount of dividends paid would be in excess of the 50% limit described above so long as (i) the amount per share of such dividends does not exceed the amount per share paid during the most recent fiscal year in which we were in compliance with the 50% limit and (ii) our Average Total Leverage Ratio is less than 3.00 to 1.00 both immediately before and after giving pro forma effect to such dividends. Further, dividends must be declared and paid in a manner consistent with our past practice.

Under the Credit Facility, we may repurchase shares of our common stock provided no default or event of default has occurred and is continuing, or would result from the repurchase of shares, and our maximum average total leverage ratio (determined on a pro forma basis) is less than 2.50 to 1.00. Other covenants include restrictions on our ability to grant liens, incur indebtedness, make investments, merge or consolidate, and sell or transfer assets. Failure to comply with any of our financial covenants or any other terms of the Credit Facility could result in penalty payments, higher interest rates on our borrowings or the acceleration of the maturities of our outstanding debt.

Receivables Securitization Facility

Our two-year Receivables Facility offers us a lower cost form of financing, with a peak funding capacity of up to $220.0 million between May 1 and June 30, which includes an additional seasonal funding capacity that is available between March 1 and July 31. Other funding capacities range from $65.0 million to $150.0 million throughout the remaining months of the year.

The Receivables Facility provides for the sale of certain of our receivables to a wholly owned subsidiary (the Securitization Subsidiary). The Securitization Subsidiary transfers variable undivided percentage interests in the receivables and related rights to certain third party financial institutions in exchange for cash proceeds, limited to the applicable funding capacities. Upon payment of the receivables by customers, rather than remitting to the financial institutions the amounts collected, we retain such collections as proceeds for the sale of new receivables until payments become due.

The Receivables Facility contains terms and conditions (including representations, covenants and conditions precedent) customary for transactions of this type. Additionally, an amortization event will occur if we fail to maintain a maximum average total leverage ratio (average total funded debt/EBITDA) of 3.25 to 1.00 and a minimum fixed charge coverage ratio (EBITDAR/cash interest expense plus rental expense) of 2.25 to 1.00.

At September 30, 2017, there was $142.3 million outstanding under the Receivables Facility at a weighted average effective interest rate of 2.0%, excluding commitment fees.

As of September 30, 2017, we were in compliance with all covenants and financial ratio requirements under our Credit Facility and our Receivables Facility. We believe we will remain in compliance with all covenants and financial ratio requirements throughout the next twelve months. For additional information regarding our debt arrangements, see Note 5 of “Notes to Consolidated Financial Statements,” included in Item 8 of our 2016 Annual Report on Form 10-K.

We believe we have adequate availability of capital to fund present operations and the current capacity to finance any working capital needs that may arise. We continually evaluate potential acquisitions and hold discussions with acquisition candidates. If suitable acquisition opportunities arise that would require financing, we believe that we have the ability to finance any such transactions.

As of October 26, 2017, $53.4 million of the current Board authorized amount under our share repurchase program remained available. We expect to repurchase additional shares on the open market from time to time depending on market conditions. We plan to fund these repurchases with cash provided by operations and borrowings under the credit and receivables facilities.

CRITICAL ACCOUNTING ESTIMATES

We prepare our Consolidated Financial Statements in accordance with U.S. generally accepted accounting principles (GAAP), which require management to make estimates and assumptions that affect reported amounts and related disclosures. Management identifies critical accounting estimates as:

• those that require the use of assumptions about matters that are inherently and highly uncertain at the time the estimates are made; and
• those for which changes in the estimate or assumptions, or the use of different estimates and assumptions, could have a material impact on our consolidated results of operations or financial condition.

Management has discussed the development, selection and disclosure of our critical accounting estimates with the Audit Committee of our Board. For a description of our critical accounting estimates that require us to make the most difficult, subjective or complex judgments, please see our 2016 Annual Report on Form 10-K. We have not changed these policies from those previously disclosed.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (ASU 2014-09). The FASB also issued subsequent amendments to ASU 2014-09 to provide clarification on the guidance. ASU 2014-09 will be effective for annual periods beginning after December 15, 2017, which for us will be in the period beginning January 1, 2018. We are continuing to perform our detailed evaluation, using a five-step model specified in the guidance, to assess the impacts of the new standard.

• Under the new standard, revenue will be recognized when we satisfy our performance obligation by transferring promised products or services to our customer. The standard allows for application of the guidance to a portfolio of contracts or performance obligations with similar characteristics. Since our individual sales transactions are very similar in nature, we anticipate applying the guidance to all transactions as a portfolio. We expect that the effects of applying this guidance to the portfolio would not differ materially from applying the guidance to individual performance obligations within that portfolio.
• Our revenue recognition will be achieved upon delivery of products as there are no other promised services as part of our contracts with customers that are material in the context of the contract. Because our shipping and handling activities are performed before the customer obtains control of the goods, we do not consider these activities to be a promised service to the customer. Rather shipping and handling are activities to fulfill our promise to transfer the goods. Product warranties do not constitute a performance obligation for us, as products are warrantied directly by the manufacturer or the third party carrier.
• To determine the amount of consideration to which we expect to be entitled in exchange for transferring promised goods, we have considered if variable consideration exists. We have reviewed our standard terms and conditions and our customary business practices to determine the transaction price. We have reviewed our pricing policies including marketing programs, coupons and free products for the purpose of determining whether we have any variable or non-cash consideration. We do not issue future-dated coupons or free product rebates. When we process manufacturer coupons, we record the customer sales price as revenue and receive reimbursement of the coupon value from the manufacturer. In addition, we reviewed our current accounting policies related to returns and price concessions for which no material changes in policy were noted. Volume rebates is a sales incentive program where we make a cash payment or apply credit to a customer account on a quarterly or annual basis, if the customer reaches a specified level of purchases. The volume rebates are accounted for as a reduction of the transaction price, and a liability is recorded until the related payment to the customer is made. We do not offer any volume discounts. We will continue our accounting policy election to exclude from revenue all amounts we collect and remit to governmental authorities.
• The majority of our sales transactions do not require any additional performance obligation after delivery, therefore we do not have multiple performance obligations for which we will have to allocate the transaction price. We do not offer customer loyalty programs.
• We expect to recognize revenue when control of the product has been transferred to the customer upon delivery to the customer or the freight carrier, if delivered by a third party, as we believe our performance obligation will be satisfied at that point in time.

We expect to apply the guidance using the modified retrospective transition method. Based on our analysis performed to date, we do not expect the adoption of ASU 2014-09 will have a material impact on our financial position or results of operations, but we expect it will result in additional disclosures regarding our revenue recognition policies. We also do not expect the adoption will require material or significant changes to our internal controls over financial reporting. We have expanded our revenue recognition inquiries to additional departments and updated our questionnaires primarily to identify matters that would signal variable consideration implications under the new guidance. We are also in the process of drafting additional pricing policies to address potential revenue recognition implications.

In February 2016, the FASB issued ASU 2016-02, Leases, which requires lessees to record most leases on their balance sheets but recognize expenses in a manner similar to current guidance. ASU 2016-02 will be effective for annual periods beginning after December 15, 2018. The guidance is required to be applied using a modified retrospective approach. The adoption of ASU 2016-02 will have a significant impact on our Consolidated Balance Sheets as we will be recording a right-of-use asset and corresponding liability for our current operating leases. We are evaluating the effect that ASU 2016-02 will have on our results of operations and related disclosures. We are primarily focused on evaluating our internal controls over financial reporting, including information technology requirements, related to the adoption of this new accounting pronouncement.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses - Measurement of Credit Losses on Financial Instruments, which changes the way companies evaluate credit losses for most financial assets and certain other instruments. For trade and other receivables, held-to-maturity debt securities, loans and other instruments, entities will be required to use a new forward-looking “expected loss” model to evaluate impairment, potentially resulting in earlier recognition of allowances for losses. The new standard also requires enhanced disclosures, including the requirement to disclose the information used to track credit quality by year of origination for most financing receivables. ASU 2016-13 will be effective for annual periods beginning after December 15, 2019. Early adoption is permitted for all entities for annual periods beginning after December 15, 2018. We have not elected to early adopt this guidance. The guidance must be applied using a cumulative-effect transition method. We are currently evaluating the effect that ASU 2016-13 will have on our financial position, results of operations and related disclosures.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230), Classification of Certain Cash Receipts and Cash Payments, which may change the classification of certain cash receipts and cash payments on an entity’s statement of cash flows. The new guidance specifies how cash flows should be classified for debt prepayment or extinguishment costs, settlement of zero-coupon debt instruments, contingent consideration payments made after a business combination, proceeds for the settlement of insurance claims, proceeds from the settlement of corporate-owned life insurance, distributions from equity method investees and beneficial interests in securitization transactions. Current guidance for these topics is principles-based, requiring judgment in application and creating diversity in practice. ASU 2016-15 will be effective for annual periods beginning after December 15, 2017 and must be applied retrospectively. Early adoption is permitted for all entities. We have not elected to early adopt this guidance. We are currently evaluating the effect that ASU 2016-15 will have on our financial position and related disclosures.

In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other (Topic 350), Simplifying the Test for Goodwill Impairment, which eliminates the requirement to calculate the implied fair value of goodwill to measure a goodwill impairment charge (commonly referred to as Step 2 under the current guidance). Rather, the measurement of a goodwill impairment charge will be based on the excess of a reporting unit’s carrying value over its fair value (Step 1 under the current guidance). ASU 2017-04 will be effective for annual and interim impairment tests performed in periods beginning after December 15, 2019 and should be applied prospectively. Early adoption is permitted for annual and interim goodwill impairment tests beginning after January 1, 2017. We are currently evaluating the effect that ASU 2017-04 will have on our financial position, results of operations and related disclosures.

Interest Rate Risk

There have been no material changes from what we reported in our Annual Report on Form 10-K for the year ended December 31, 2016 that affect fiscal 2017.

Currency Risk

There have been no material changes from what we reported in our Annual Report on Form 10-K for the year ended December 31, 2016 that affect fiscal 2017.

The term “disclosure controls and procedures” is defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (the Act). The rules refer to the controls and other procedures designed to ensure that information required to be disclosed in reports that we file or submit under the Act is (1) recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and (2) accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure. As of September 30, 2017, management, including the CEO and CFO, performed an evaluation of the effectiveness of our disclosure controls and procedures. Based on that evaluation, management, including the CEO and CFO, concluded that as of September 30, 2017, our disclosure controls and procedures were effective.

We maintain a system of internal control over financial reporting that is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Based on the most recent evaluation, we have concluded that no change in our internal control over financial reporting occurred during the last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

There have been no material changes from the risk factors disclosed in Part I, Item 1A “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2016.