What changed in this filing

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Item 2. Management’s Discussion and Analysis

2020-07-31 compared with 2020-04-30 · 216 added, 147 removed, 231 unchanged (61% of the section changed)

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For these statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act.

Financial Results

We started the year with robust growth as we believe that underlying demand for our products has been strong.

During the first quarter of 2020, we benefited from earlier pool openings, as mild weather combined with school closures drove greater early-season residential pool usage.

Beginning in the middle of March, when stay-at-home orders related to the COVID-19 pandemic were being issued, sales growth began to level off.

Most of our North American operations are and have been continuously open for business as we are designated ‘essential’ in almost all of our markets.

Impact of COVID-19 Pandemic

On March 11, 2020, the World Health Organization declared the novel coronavirus disease (COVID-19) a pandemic, and on March 13, 2020, the United States declared a national emergency.

States and cities have taken various measures in response to COVID-19, including mandating the closure of certain businesses and encouraging or requiring citizens to avoid large gatherings.

Most of our North American operations are and have been continuously open for business as we are designated as an essential business in almost all of our markets.

In Europe, our operations closed for a short period in France, Spain and Italy, in order to comply with local authorities’ orders.

Our products and services are used to maintain and protect outdoor commercial, residential and municipal environments, including chemically-balanced, virus and bacteria-free swimming pool water and in the prevention of runoff, flood, fire and other natural disasters, and are ‘essential’ to the health and safety of the general public.

As a result, our supply chain remains relatively intact, and with some exceptions, our customers are continuing to meet end-user needs.

As of the end of April, stay-at-home orders of varying degrees are now in place in almost all jurisdictions in which we operate, resulting in year-over-year sales declines for the month of April of five to ten percent as these orders impact our business unevenly throughout our network.

It is unclear how long these conditions will last and what the continuing social and economic impact will be on our business after these restrictions are lifted.

We have taken steps to preserve capital and reduce costs where warranted, while retaining options for further business adjustments as conditions evolve and we gain more clarity.

For example, we currently project that our capital expenditures for 2020 will be approximately half of the $33.4 million spent in 2019.

Our lower planned capital expenditures include the deferral of previously planned sales center openings until future conditions are clearer.

We are working closely with our suppliers to maintain the flow of essential products to provide customers with the materials they need to serve their communities.

Given the seasonality of our business, our warehouses were already stocked with inventory in preparation for the upcoming peak season prior to the implementation of most stay-at-home orders.

As a result, the limited vendor supply interruptions experienced to date have had a minimal impact on our business, although that could change depending on the duration and severity of social distancing conditions.

Net sales increased 13% to $677.3 million in the first quarter of 2020 compared to $597.5 million in the first quarter of 2019, while base business sales also grew 13% compared to the same period last year.

During the quarter, sales benefited from strong demand for discretionary products as evidenced by higher sales growth in construction materials and products used in the remodel and replacement of in-ground pools.

In addition, sales were favorably impacted by a pull forward of lower margin customer early-buy sales from the second quarter into the first and by an additional selling day in the first quarter of 2020 compared to the first quarter of 2019.

Gross profit increased 9% to $189.6 million in the first quarter of 2020 from $174.6 million in the same period of 2019.

Base business gross profit improved 8% over the first quarter of 2019.

Gross margin decreased 120 basis points to 28.0% in the first quarter of 2020 compared to 29.2% in the first quarter of 2019.

Gross margin in the first quarter of 2019 reflected benefits from strategic inventory purchases we made ahead of vendor price increases resulting in a comparative decline in the first quarter of 2020 in addition to the impact of the customer early-buys mentioned above.

Selling and administrative expenses increased 13% to $154.0 million in the first quarter of 2020 compared to the first quarter of 2019.

Base business operating expenses also increased 13% over the comparable 2019 period.

In the first quarter of 2020, we recorded impairment charges of $6.9 million, which included $2.5 million from a long-term note, as collectability was impacted by the COVID-19 pandemic, and non-cash goodwill and intangibles impairment charges of $4.4 million, equal to the total goodwill and intangibles carrying amount of our Australian reporting units.

Excluding non-cash impairments, both selling and administrative expenses and base business operating expenses increased 8%, reflecting increases in growth-driven variable labor and freight expenses as well as greater facility-related costs.

Operating income in the first quarter of 2020 decreased 7% to $35.6 million compared to the same period in 2019.

Adjusted operating income, excluding non-cash impairments, was $42.5 million in the first quarter of 2020 compared to operating income of $38.4 million in the first quarter of 2019, an 11% increase.

Operating margin was 5.3% in the first quarter of 2020, or 6.3% excluding impairment charges, compared to 6.4% in the first quarter of 2019.

We recorded an $8.0 million, or $0.19 per diluted share, tax benefit from Accounting Standards Update (ASU) 2016-09, Improvements to Employee Share-Based Payment Accounting , in the quarter ended March 31, 2020 compared to a tax benefit of $8.8 million, or $0.21 per diluted share, realized in the same period of 2019.

Net income decreased 5% to $30.9 million in the first quarter of 2020 compared to $32.6 million in the first quarter of 2019.

Adjusted net income in the first quarter of 2020, excluding the tax-effected impact of non-cash impairments of $6.3 million, or $0.15 per diluted share, increased 14% to $37.2 million.

Earnings per share decreased 6% to $0.75 per diluted share in the first quarter of 2020 compared to $0.80 in the same period of 2019.

Excluding after-tax non-cash impairments in the first quarter of 2020 and tax benefits in both periods, adjusted earnings per diluted share increased 20% to $0.71 in the first quarter of 2020 compared to $0.59 in the first quarter of 2019.

See the reconciliation of GAAP to non-GAAP measures included in RESULTS OF OPERATIONS below.

Our products are used to maintain and protect outdoor commercial, residential and municipal environments through chemically-balanced, virus and bacteria-free swimming pool water.

We also supply products used in the prevention of runoff, flood, fire and other natural disasters.

These products are essential to the health and safety of the general public.

As a result, our supply chain remains intact, with our customers continuing to meet end-user needs.

The health, safety and security of our employees has been, and remains, one of our highest priorities.

We have adapted our operations and implemented a number of measures to facilitate a safer sales center environment for both our customers and employees, which includes following best practices and guidelines from the Centers for Disease Control and Prevention (CDC).

Where possible, office-based employees are working remotely or in scheduled, staggered shifts.

At our sales centers, we’ve implemented enhanced hygiene and sanitation practices.

In rare instances, we have had to close facilities in whole or in part as a result of government regulations, as well as positive or presumed positive results from COVID-19 testing.

The direct impact of any closures to date has not been material to our operations.

Beginning in the middle of March, when stay-at-home orders related to the COVID-19 pandemic were initially issued, we experienced sales declines across most markets.

However, as stay-at-home restrictions eased in late April through early May, our business not only rebounded, but accelerated, resulting in net sales of $1.28 billion for the second quarter of 2020.

As families spend more time at home, our sales have benefited from greater swimming pool demand and usage, resulting in broad sales gains across our product categories and geographies.

While the short-term impact of this trend has had a positive impact on our business, it is unclear what the long-term impact will be.

In addition, governmental restrictions have had a material impact on some of our customers, limiting their ability to operate in certain geographies from mid-March into mid-May.

While these restrictions were lifted, new stay-at-home orders or other government mandates could have a material impact on our results.

Our balance sheet remains strong with low leverage and sufficient access to additional capital.

Given the seasonality of our business, our warehouses were stocked with inventory in preparation for the upcoming peak season prior to the implementation of most stay-at-home orders.

As a result, the limited vendor supply interruptions experienced to date have had a minimal impact on our business.

Supply disruptions have largely been limited to categories with the greatest demand, including heat-related equipment and above-ground swimming pools.

We continue to work closely with our suppliers to maintain the flow of essential products to provide customers with the materials they need to serve their communities.

In April, we began taking steps to reduce both capital expenditures and operating costs.

In our First Quarter 2020 Quarterly Report on Form 10-Q, we communicated that we expected capital expenditures in 2020 to approximate half of the $33.4 million spent in 2019 as we deferred the opening of sales centers we previously planned to launch in 2020.

Given our positive results in the second quarter of 2020, we now expect capital expenditures to approximate 65% of 2019 capital expenditures, or approximately $20.0 million to $25.0 million, as we continue to reevaluate deferred capital expenditures.

Likewise, in the second quarter of 2020, we reduced expenses for labor, fuel, utilities, advertising, meetings, travel and entertainment.

As our business outlook and market trends have improved, we continue to assess our discretionary spending.

The impact of the ongoing pandemic on our business and financial results will continue to vary by location and depend on numerous evolving factors that we are not able to accurately predict.

These factors include the duration and scope of the pandemic, global economic conditions during and after the pandemic, governmental actions that have been taken (or may be taken in the future) in response to the pandemic and changes in customer and supplier behavior in response to the pandemic.

Financial Results

In the second quarter of 2020, net sales increased 14% to $1.28 billion compared to $1.12 billion in the second quarter of 2019.

As families are spending more time at home, our sales have benefited from greater swimming pool demand and usage, resulting in broad sales gains across our product categories and geographies.

Gross profit increased 13% to $373.5 million in the second quarter of 2020 from $330.3 million in the same period of 2019.

Gross margin decreased 30 basis points to 29.2% in the second quarter of 2020 compared to 29.5% in the second quarter of 2019.

Gross margin in the second quarter of 2019 reflected benefits from strategic inventory purchases ahead of vendor pricing increases.

In addition, sales of some lower margin, big-ticket items, such as in-ground and above-ground pools and pool equipment, comprised a larger portion of our product mix in the second quarter of 2020 compared to the second quarter of 2019, which, combined with the difficult prior year comparison, resulted in a decline in gross margin between periods.

Selling and administrative expenses (operating expenses) increased 6% to $167.6 million in the second quarter of 2020 compared to $157.8 million in the second quarter of 2019, reflecting an increase of $13.0 million in performance-based compensation in the second quarter of 2020.

As a percentage of net sales, operating expenses decreased to 13.1% in the second quarter of 2020 compared to 14.1% in the same period of 2019 as we continue to closely monitor discretionary operating expenses.

Operating income in the second quarter of 2020 increased 19% to $205.9 million compared to $172.5 million in the same period in 2019.

Operating margin was 16.1% in the second quarter of 2020 compared to 15.4% in the second quarter of 2019.

We recorded a $6.2 million, or $0.15 per diluted share, tax benefit from Accounting Standards Update (ASU) 2016-09, Improvements to Employee Share-Based Payment Accounting , in the quarter ended June 30, 2020, compared to a tax benefit of $7.8 million, or $0.19 per diluted share, realized in the same period of 2019.

Net income increased 20% to $157.6 million in the second quarter of 2020 compared to $131.4 million in the second quarter of 2019.

Earnings per share increased 20% to $3.87 per diluted share in the second quarter of 2020 compared to $3.22 in the same period of 2019.

Excluding the impact from ASU 2016-09 in both periods, earnings per diluted share increased 23% to $3.72 in the second quarter of 2020 compared to $3.03 in the second quarter of 2019.

References to product line and product category data throughout this report 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

As of March 31, 2020, total net receivables, including pledged receivables, increased 10% compared to March 31, 2019, driven by our March sales growth.

Our DSO, as calculated on a trailing four quarters basis, was 29.2 days at March 31, 2020 and 29.8 days at March 31, 2019.

Our allowance for doubtful accounts balance was $6.9 million at March 31, 2020 and $5.6 million at March 31, 2019.

Net inventory levels grew 5% compared to levels at March 31, 2019.

The inventory reserve was $10.3 million at March 31, 2020 and $8.5 million at March 31, 2019.

Our inventory turns, as calculated on a trailing four quarters basis, were 3.2 times at March 31, 2020 and 3.1 times at March 31, 2019.

Total debt outstanding at March 31, 2020 was $586.1 million, down 16% compared to total debt at March 31, 2019.

As of June 30, 2020, total net receivables, including pledged receivables, increased 9% compared to June 30, 2019, driven by our June sales growth.

Our days sales outstanding (DSO), as calculated on a trailing four quarters basis, was 28.5 days at June 30, 2020 and 29.5 days at June 30, 2019.

Our allowance for doubtful accounts balance was $6.0 million at June 30, 2020 and $6.4 million at June 30, 2019.

Net inventory levels decreased 10% compared to levels at June 30, 2019, reflecting the strong pace of sales in the second quarter of 2020 and the normalization of inventory levels following the sale of strategic inventory purchases included in our prior year inventory balance.

The inventory reserve was $10.8 million at June 30, 2020 and $9.5 million at June 30, 2019.

Our inventory turns, as calculated on a trailing four quarters basis, were 3.5 times at June 30, 2020 and 3.1 times at June 30, 2019.

Total debt outstanding at June 30, 2020 was $438.8 million, down 37% compared to total debt at June 30, 2019, as we have utilized our operating cash flows to decrease debt balances.

We have used debt proceeds over the past 12 months primarily to fund business-driven working capital growth, acquisitions and share repurchases.

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For a detailed discussion of trends through 2019, see the Current Trends and Outlook section of Management’s Discussion and Analysis included in Part II, Item 7 of our 2019 Annual Report on Form 10-K.

We expect 2020 diluted EPS of $5.30 to $5.90, including the impact of first quarter tax benefits of $0.19 and the $0.15 impact of non-cash impairments recorded in the first quarter of 2020.

Excluding the impact of non-cash impairments, we expect 2020 adjusted diluted EPS of $5.45 to $6.05.

Our updated guidance range includes a wide range of outcomes as the severity and duration of the COVID-19 pandemic remains unknown.

Our previous 2020 earnings guidance range disclosed earlier in the year was $6.47 to $6.77 per diluted share, including an estimated $0.06 tax benefit.

See the reconciliation of GAAP to non-GAAP measures included in RESULTS OF OPERATIONS below.

The top of our earnings guidance range assumes sales growth of 2% from 2019, while the bottom of our range assumes a sales decline of 2.5%.

Based on our results to date and expectations for the remainder of the year, we expect 2020 diluted EPS of $6.90 to $7.30, including the impact of year-to-date tax benefits of $0.34 and the $0.15 impact of non-cash impairments recorded in the first quarter of 2020.

Our previous 2020 earnings guidance range disclosed in our First Quarter 2020 Quarterly Report on Form 10-Q was $5.30 to $5.90, including first quarter tax benefits of $0.19 and the $0.15 impact of non-cash impairments.

Our 2020 earnings guidance range assumes average weather conditions and no adverse impacts from a resurgence of COVID-19 and related government responses.

We expect net sales growth for 2020 to approximate 11% to 13%.

The majority of our business is driven by recurring revenue streams from the installed base of pools, and we believe that underlying demand for most discretionary products, including those serving the renovation and construction markets, remains strong.

At the same time, the impact of extended stay-at-home and social distancing orders as well as unfavorable economic conditions resulting from the COVID-19 pandemic could have a more severe adverse impact on our business, including an easing of demand for products dependent on discretionary spending.

We expect gross margin to decline in the second quarter of 2020 compared to the second quarter of 2019 when margin growth was 30 basis points.

Depending on competitor price concessions, we expect that gross margin for the full year of 2020 could decline slightly to moderately compared to gross margin for the full year of 2019.

We expect base business operating expenses for the remainder of the year to benefit from actions taken by management to reduce costs and to vary in line with changes in sales performance.

For the year, we expect operating expenses to range from modest growth to modest declines compared to 2019.

In addition, we believe that our sales for the second half of 2020 will benefit from delayed projects, subject to our customers’ building capacity, including the availability of labor, and favorable weather.

At the same time, the impact of new stay-at-home orders or government mandates, as well as unfavorable economic conditions resulting from the COVID-19 pandemic and the resurgence of COVID-19 cases in some of our markets, could have an adverse impact on our business, including an easing of demand for products dependent on discretionary spending.

We expect gross margin for the second half of 2020 to be relatively flat compared to the second half of 2019.

Given the decline in gross margin through the first half of 2020, we expect gross margin for the full year of 2020 to decline moderately compared to gross margin for the full year of 2019.

We expect base business operating expenses for the remainder of the year to benefit from actions taken by management in the second quarter of 2020 to reduce costs and to vary in line with changes in sales performance.

For the year, we expect operating expenses to increase 6% to 8% compared to 2019.

We expect our annual effective tax rate (excluding the benefit from ASU 2016-09) for 2020 will approximate 25.5%, which is consistent with 2019.

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Due to ASU 2016-09, 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.

We recorded an $8.0 million, or $0.19 per diluted share, tax benefit from ASU 2016-09 for the three months ended March 31, 2020.

We recorded a $14.2 million, or $0.34 per diluted share, tax benefit from ASU 2016-09 for the six months ended June 30, 2020.

We may recognize additional tax benefits related to stock option exercises in 2020 from grants that expire in years after 2020.

We have not included any expected benefits in our guidance beyond what we have recognized as of March 31, 2020.

We have not included any expected benefits in our guidance beyond what we have recognized as of June 30, 2020.

We expect cash provided by operations will remain strong in comparison to net income for the 2020 fiscal year.

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We also expect to use cash for the payment of cash dividends as and when declared by our Board of Directors (the Board).

Most recently, on April 23, 2020, the Board declared a quarterly cash dividend of $0.58 per share, a five percent increase over the previous dividend amount of $0.55 per share.

The dividend will be payable on May 29, 2020 to holders of record on May 15, 2020.

RESULTS OF OPERATIONS

As of March 31, 2020, we conducted operations through 378 sales centers in North America, Europe and Australia.

For the three months ended March 31, 2020, approximately 95% of our net sales were from our operations in North America.

As of June 30, 2020, we conducted operations through 378 sales centers in North America, Europe and Australia.

For the six months ended June 30, 2020, approximately 94% of our net sales were from our operations in North America.

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

Three Months Ended

Three Months Ended Six Months Ended

June 30, June 30,

2020 2019 2020 2019

Net sales 100.0 % 100.0 % 100.0 % 100.0 %

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We have included the results of operations from acquisitions in 2020 and 2019 in our consolidated results since the acquisition dates.

Three Months Ended March 31, 2020 Compared to Three Months Ended March 31, 2019

Three Months Ended June 30, 2020 Compared to Three Months Ended June 30, 2019

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

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(in thousands) Three Months Ended Three Months Ended Three Months Ended

March 31, March 31, March 31,

June 30, June 30, June 30,

2020 2019 2020 2019 2020 2019

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Operating expenses 166,068 156,879 1,556 912 167,624 157,791

150,873 133,599 3,168 2,646 154,041 136,245

Expenses as a % of net sales 13.0 % 14.0 % 36.2 % 26.8 % 13.1 % 14.1 %

Operating income (loss) 205,432 172,846 425 (323) 205,857 172,523

35,937 39,009 (349) (623) 35,588 38,386

Operating margin 16.1 % 15.5 % 9.9 % (9.5) % 16.1 % 15.4 %

(1) Base business and total include $6.9 million of impairment from goodwill and other assets.

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

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

Sales Centers

Master Tile Network LLC (1)

February 2020 4 February - March 2020

January 2019 4 January - March 2020 and

January - March 2019

Turf & Garden, Inc.

November 2018 4 January 2020 and

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

February 2020 4 April - June 2020

(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.

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After 15 months of operations, we include acquired, consolidated and new market sales centers in the base business calculation including the comparative prior year period.

The table below summarizes the changes in our sales center count during the first three months of 2020:

The table below summarizes the changes in our sales center count during the first six months of 2020:

December 31, 2019 373

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New locations 3

Consolidated locations (1)

March 31, 2020 378

Closed/consolidated locations (2)

June 30, 2020 378

Three Months Ended

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Net sales $ 1,280.8 $ 1,121.3 $ 159.5 14%

Net sales and base business net sales increased 13% in the first quarter of 2020 compared to the first quarter of 2019.

During the first quarter of 2020, sales benefited from earlier pool openings, as mild weather combined with school closures, drove greater early-season residential pool usage.

In the first quarter of 2020, we observed above-average temperatures in most of the contiguous United States, particularly in the southern United States, whereas in the first quarter 2019, wetter and cooler-than-normal temperatures prevailed.

Net sales and base business net sales increased 14% in the second quarter of 2020 compared to the second quarter of 2019.

As families are spending more time at home, our sales have benefited from greater swimming pool demand and usage, resulting in broad sales gains across our product categories and geographies.

The following factors benefited our sales (listed in order of estimated magnitude):

• strong demand for discretionary products, as evidenced by improvements in sales growth rates for product offerings such as building materials (see discussion below);

• market share gains, particularly in building materials and commercial products (see discussion below);

• inflationary product cost increases of approximately 1% - 2%.

Additionally, sales were favorably impacted by a pull forward of lower margin customer early-buy sales from the second quarter into the first and by an additional selling day in the first quarter of 2020 compared to the first quarter of 2019.

We believe that higher sales growth rates for certain product offerings, such as equipment and building materials, evidence increased spending in traditionally discretionary areas, such as pool construction, pool remodeling and equipment upgrades.

In the first quarter of 2020, sales for equipment, which includes swimming pool heaters, pumps, lights and filters, increased 18% compared to the same period last year.

• strong demand for discretionary products, as evidenced by improvements in sales growth rates for product offerings such as equipment, building materials and above-ground pools and spas (see discussion below);

• increased demand for residential swimming pool maintenance supplies due to earlier pool openings and increased usage, as evidenced by improvements in sales growth rates to retail customers;

• market share gains, including those in building materials (see discussion below);

• inflationary product cost increases of approximately 1% to 2%.

We believe that higher sales growth rates for certain product offerings, such as equipment, building materials and above-ground pools and spas evidence increased spending in traditionally discretionary areas, such as pool construction, pool remodeling and equipment upgrades.

In the second quarter of 2020, sales for equipment, which includes swimming pool heaters, pumps, lights and filters, increased 22% compared to the same period last year.

These products collectively represented approximately 27% of net sales for the period.

Sales of building materials grew 14% compared to the first quarter of 2019 and represented approximately 14% of net sales in the first quarter of 2020.

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.

Sales to these customers represented approximately 5% of our consolidated net sales for the first quarter of 2020 and increased 5% compared to the first quarter of 2019.

Sales of building materials, including recently acquired Master Tile sales centers, grew 7% compared to the second quarter of 2019 and represented approximately 11% of net sales in the second quarter of 2020.

Sales of above-ground pools and spas increased 55% in the second quarter of 2020 compared to the second quarter of 2019 and represented approximately 3% of net sales for the period.

Sales to both retail and commercial customers are included in the appropriate existing product categories, and growth or decline in these areas are reflected in the numbers above.

Sales to retail customers increased 22% in the second quarter of 2020 compared to the second quarter of 2019 and represented approximately 16% of our consolidated net sales for the second quarter of 2020.

Sales to commercial customers declined 21% in the second quarter of 2020 compared to the second quarter of 2019, driven by COVID-19 related closures and the decline in both business and leisure travel.

Sales to commercial customers represented approximately 3% of our consolidated net sales for the second quarter of 2020.

Three Months Ended

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Gross margin 29.2 % 29.5 %

Gross margin was impacted in the first quarter of 2020 by a pull forward of lower margin customer early-buy sales from the second quarter into the first.

In addition, gross margin in the first quarter of 2019 reflected benefits from strategic inventory purchases ahead of vendor price increases resulting in a comparative decline in the first quarter of 2020.

Gross margin in the second quarter of 2019 reflected benefits from strategic inventory purchases ahead of vendor pricing increases.

Operating Expenses

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Selling and administrative expenses $ 167.6 $ 157.8 $ 9.8 6%

Operating expenses as a % of net sales 13.1 % 14.1 %

Operating expenses and base business operating expenses increased 6% in the second quarter of 2020 compared to the second quarter of 2019, reflecting an increase in performance-based compensation of $13.0 million in the second quarter of 2020.

Excluding performance-based compensation in both periods, operating expenses declined 2% due to control measures put in place over a number of discretionary spending categories at the start of the pandemic and further supported by our capacity creation activities, including increased efforts to promote the use of digital order fulfillment tools.

In the second quarter of 2020, we reduced expenses for labor, fuel, utilities, advertising, meetings, travel and entertainment.

Interest and Other Non-Operating Expenses, Net

Interest and other non-operating expenses, net for the second quarter of 2020 decreased $3.8 million compared to the second quarter of 2019.

The decrease reflects lower average debt levels and lower average interest rates between periods.

Our weighted average effective interest rate decreased to 1.8% for the second quarter of 2020 from 3.5% for the second quarter of 2019 on lower average outstanding debt of $493.4 million versus $650.5 million for the respective periods.

Our effective income tax rate was 22.5% for the three months ended June 30, 2020 compared to 20.9% for the three months ended June 30, 2019.

We recorded a $6.2 million tax benefit from ASU 2016-09 in the quarter ended June 30, 2020 compared to a tax benefit of $7.8 million realized in the same period last year.

Excluding the benefits from ASU 2016-09, our effective tax rate was 25.6% for the second quarters of 2020 and 2019.

Net Income and Earnings Per Share

Net income increased 20% to $157.6 million in the second quarter of 2020 compared to the second quarter of 2019.

Earnings per diluted share increased 20% to $3.87 in the second quarter of 2020 versus $3.22 per diluted share for the comparable 2019 period.

The benefit from ASU 2016-09 increased diluted earnings per share by $0.15 in the second quarter of 2020 and $0.19 in the second quarter of 2019.

Excluding tax benefits in both periods, earnings per diluted share increased 23% to $3.72 in the second quarter of 2020 compared to $3.03 in the second quarter of 2019.

Six Months Ended June 30, 2020 Compared to Six Months Ended June 30, 2019

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

(Unaudited) Base Business Excluded Total

(in thousands) Six Months Ended Six Months Ended Six Months Ended

June 30, June 30, June 30,

2020 2019 2020 2019 2020 2019

Net sales $ 1,944,855 $ 1,706,312 $ 13,279 $ 12,472 $ 1,958,134 $ 1,718,784

Gross profit 558,310 502,333 4,800 2,612 563,110 504,945

Gross margin 28.7 % 29.4 % 36.1 % 20.9 % 28.8 % 29.4 %

Operating expenses (1)

316,941 290,477 4,724 3,559 321,665 294,036

Expenses as a % of net sales 16.3 % 17.0 % 35.6 % 28.5 % 16.4 % 17.1 %

Operating income (loss) (1)

241,369 211,856 76 (947) 241,445 210,909

Operating margin 12.4 % 12.4 % 0.6 % (7.6) % 12.3 % 12.3 %

(1) Base business and total include $6.9 million of impairment from goodwill and other assets recorded in the first quarter 2020.

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

Sales Centers

Master Tile Network LLC (1)

February 2020 4 February - June 2020

January 2019 4 January - March 2020 and

January - March 2019

Turf & Garden, Inc.

November 2018 4 January 2020 and

(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, 2019, please refer to the discussion under the heading Three Months Ended June 30, 2020 Compared to Three Months Ended June 30, 2019.

Six Months Ended

(in millions) 2020 2019 Change

Net sales $ 1,958.1 $ 1,718.8 $ 239.3 14%

Net sales and base business net sales for the first six months of 2020 increased 14% compared to the same period last year.

During the first quarter of 2020, sales benefited from earlier pool openings, as mild weather combined with school closures, drove greater early-season residential pool usage.

Additionally, sales were favorably impacted approximately 1% by an additional selling day in the first half of 2020.

As stay-at-home restrictions eased in late April through early May, families continued to search for safe, at-home leisure activities, resulting in broad sales gains across our product categories and geographies.

The following factors benefited our sales (listed in order of estimated magnitude):

• increased demand for residential swimming pool maintenance supplies due to earlier pool openings and increased usage, as evidenced by improvements in sales growth rates to retail customers;

• market share gains, including those in building materials (see discussion below);

• inflationary product cost increases of approximately 1% to 2%.

We believe that sales growth rates for certain product offerings, such as equipment, building materials and above-ground pool and spas evidence increased spending in traditionally discretionary areas, such as pool construction, pool remodeling and equipment upgrades.

In the first six months of 2020, sales for equipment, which includes swimming pool heaters, pumps, lights and filters, increased approximately 20% compared to the same period last year.

These products collectively represented 29% of net sales in the first six months of 2020.

Sales of building materials, including recently acquired Master Tile sales centers, grew 12% compared to the first six months of 2019 and represented approximately 12% of net sales in the first six months of 2020.

Sales of above-ground pools and spas increased 49% in the first six months of 2020 and represented approximately 2% of net sales in the first six months of 2020.

Sales to both retail and commercial customers are included in the appropriate existing product categories, and growth or decline in these areas are reflected in the numbers above.

In the first six months of 2020, sales to retail customers increased 22% and represented approximately 15% of our consolidated net sales.

Sales to commercial customers declined 10% in the first six months of 2020, driven by COVID-19 related closures and the decline in both business and leisure travel.

Sales to commercial customers represented approximately 4% of our consolidated net sales in the first six months of 2020.

Six Months Ended

(in millions) 2020 2019 Change

Gross profit $ 563.1 $ 504.9 $ 58.2 12%

Gross margin 28.8 % 29.4 %

Gross margin declined 60 basis points to 28.8% compared to 29.4% in the same period last year, primarily due to differences in product mix and benefits from strategic inventory purchases recognized in the first half of 2019, resulting in a comparative decline between periods.

Operating Expenses

Six Months Ended

(in millions) 2020 2019 Change

Selling and administrative expenses $ 314.7 $ 294.0 $ 20.7 7%

Impairment of goodwill and other assets 6.9 — 6.9 100%

Operating expenses as a % of net sales 16.4 % 17.1 %

Operating expenses and base business operating expenses increased 13% in the first quarter of 2020 compared to the first quarter of 2019.

Operating expenses for the six months ended June 30, 2020 increased 9% compared to the first six months of 2019.

Excluding impairment charges, operating expenses and base business operating expenses were up 8%, reflecting increases in growth-driven variable labor and freight expenses as well as greater facility-related costs.

Excluding impairment charges, operating expenses were up 7%, reflecting increases in performance-based compensation, growth-driven freight expenses and greater facility-related costs.

Interest and Other Non-Operating Expenses, Net

Interest and other non-operating expenses, net for the first quarter of 2020 decreased $1.8 million compared to the first quarter of 2019.

Interest and other non-operating expenses, net for the first six months of 2020 decreased $5.6 million compared to the same period last year.

The decrease reflects lower average debt levels and lower average interest rates between periods.

Our weighted average effective interest rate decreased to 2.7% for the first quarter of 2020 from 3.7% for the first quarter of 2019 on lower average outstanding debt of $493.7 million versus $674.6 million for the respective periods.

Our effective income tax rate was a 0.1% benefit for the three months ended March 31, 2020 compared to a 2.5% benefit for the three months ended March 31, 2019.

We recorded an $8.0 million tax benefit from ASU 2016-09 in the quarter ended March 31, 2020 compared to a benefit of $8.8 million realized in the same period last year.

Excluding the benefits from ASU 2016-09, our effective tax rate was 25.8% for the first quarter of 2020 and 25.1% for the first quarter of 2019.

Since the goodwill and intangibles impairment charge of $4.4 million is non-deductible for tax purposes, it increased our effective tax rate 0.4% for the period ended March 31, 2020.

Our weighted average effective interest rate decreased to 2.2% for the first six months of 2020 from 3.6% for the same period of 2019 on average outstanding debt of $493.6 million versus $662.8 million for the respective periods.

Our effective income tax rate was 19.5% for the six months ended June 30, 2020 compared to 17.2% for the six months ended June 30, 2019.

We recorded a $14.2 million, or $0.34 per diluted share, tax benefit from ASU 2016-09 in the six months ended June 30, 2020 compared to a $16.6 million, or $0.40 per diluted share, tax benefit in the same period of 2019.

Excluding the benefits from ASU 2016-09, our effective tax rate was 25.6% for the six months ended June 30, 2020 and 25.5% for the six months ended June 30, 2019.

Net Income and Earnings Per Share

Net income decreased 5% to $30.9 million in the first quarter of 2020 compared to the first quarter of 2019.

Adjusted net income in the first quarter of 2020, excluding the tax-effected impact of non-cash impairments of $6.3 million, or $0.15 per diluted share, increased 14% to $37.2 million.

Earnings per diluted share decreased 6% to $0.75 in the first quarter of 2020 versus $0.80 per diluted share for the comparable 2019 period.

The benefit from ASU 2016-09 increased diluted earnings per share by $0.19 in the first quarter of 2020 and $0.21 in the first quarter of 2019.

Excluding non-cash impairments, net of tax, in the first quarter of 2020 and tax benefits in both periods, earnings per diluted share increased 20% to $0.71 in the first quarter of 2020 compared to $0.59 in the first quarter of 2019.

Net income increased 15% to $188.5 million for the six months ended June 30, 2020 compared to the six months ended June 30, 2019.

Earnings per diluted share increased to $4.62 for the six months ended June 30, 2020 versus $4.02 per diluted share for the six months ended June 30, 2019.

Adjusted net income for the first six months of 2020, excluding the $6.3 million, or $0.15 per diluted share, impact of non-cash impairments, net of tax, increased 19% to $194.8 million.

Excluding the impact of non-cash impairments, net of tax, and tax benefits in both periods, adjusted diluted EPS increased 22% to $4.43 for the six months ended June 30, 2020 compared to $3.62 for the six months ended June 30, 2019.

See the reconciliation of GAAP to non-GAAP measures below.

Reconciliation of Non-GAAP Financial Measures

2020 Diluted EPS Guidance

We have included adjusted projected 2020 diluted EPS, a non-GAAP financial measure, as a supplemental disclosure in order to demonstrate the impact of our first quarter 2020 non-cash impairment charge on our projected 2020 diluted EPS and provide investors and others with additional information about our potential future operating performance.

We believe adjusted projected 2020 diluted EPS should be considered in addition to, and not as a substitute for, our projected 2020 diluted EPS presented in accordance with GAAP, and in the context of our other forward-looking and cautionary statements included within this Form 10-Q.

The table below presents a reconciliation of projected 2020 diluted EPS to adjusted projected 2020 diluted EPS.

(Unaudited) 2020 Guidance Range

Floor Ceiling

Diluted EPS (1)

$ 5.30 $ 5.90

After-tax non-cash impairment charges 0.15 0.15

Adjusted Diluted EPS (1)

$ 5.45 $ 6.05

(1) Includes first quarter 2020 ASU 2016-09 tax benefit of $0.19 per diluted share and does not include potential additional tax benefits.

Adjusted Income Statement Information

We have included adjusted operating income, adjusted net income and adjusted diluted EPS, which are non-GAAP financial measures, as supplemental disclosures because we believe these measures are useful to investors and others in assessing our year-over-year operating performance.

We believe these measures should be considered in addition to, not as a substitute for, operating income, net income, and diluted EPS presented in accordance with GAAP, respectively, and in the context of our other disclosures included within this Form 10-Q.

We have included adjusted net income and adjusted diluted EPS, which are non-GAAP financial measures, as supplemental disclosures, because we believe these measures are useful to investors and others in assessing our year-over-year operating performance.

We believe these measures should be considered in addition to, not as a substitute for, net income and diluted EPS presented in accordance with GAAP, respectively, and in the context of our other disclosures included within this Form 10-Q.

Other companies may calculate these non-GAAP financial measures differently than we do, which may limit their usefulness as comparative measures.

The table below presents a reconciliation of operating income to adjusted operating income.

(Unaudited) Three Months Ended

(in thousands) March 31,

Operating income $ 35,588

Impairment of goodwill and other assets 6,944

Adjusted operating income $ 42,532

The table below presents a reconciliation of net income to adjusted net income.

(Unaudited) Three Months Ended

(in thousands) March 31,

(Unaudited) Six Months Ended

(in thousands) June 30,

Net income $ 188,467

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Adjusted net income $ 194,757

(1) Our effective tax rate at March 31, 2020 was a 0.1% benefit.

Excluding impairment from goodwill and intangibles of $4.4 million and the $8.0 million tax benefit from ASU 2016-19, our effective tax rate was 25.4%, which was used to calculate the tax impact related to the $2.5 million impairment from our long-term note.

(1) As described in our First Quarter 2020 Quarterly Report on Form 10-Q, our effective tax rate at March 31, 2020 was a 0.1% benefit.

Excluding impairment from goodwill and intangibles and tax benefits from ASU 2016-19 recorded in the first quarter of 2020, our effective tax rate was 25.4%, which we used to calculate the tax impact related to the $2.5 million long-term note impairment.

The table below presents a reconciliation of diluted EPS to adjusted diluted EPS.

(Unaudited) Three Months Ended

(Unaudited) Six Months Ended

Diluted EPS $ 4.62 $ 4.02

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Excluding borrowings to finance acquisitions and share repurchases, our peak borrowing usually occurs during the second quarter, primarily because extended payment terms offered by our suppliers typically are payable in April, May and June, while our peak accounts receivable collections typically occur in June, July and August.

The following table presents certain unaudited quarterly data for the first quarter of 2020, the four quarters of 2019 and the fourth, third and second quarters of 2018.

The following table presents certain unaudited quarterly data for the first and second quarters of 2020, the four quarters of 2019 and the third and fourth quarters of 2018.

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.

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(in thousands) 2020 2019 2018

First Fourth Third Second First Fourth Third Second

Second First Fourth Third Second First Fourth Third

Statement of Income Data

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Weather Impacts on 2020 and 2019 Results

Weather conditions in the second quarter of 2020 were varied across the contiguous United States;

however, results in the second quarter of 2020 benefited from generally mild weather conditions.

Much of the western United States benefited from warmer weather, while the southeastern United States experienced slightly below-average temperatures.

Southern California and the southeastern United States, including Florida, experienced more precipitation than normal.

In contrast, results for the second quarter of 2019 were largely impacted by record rainfall and cooler temperatures in three of our largest markets, California, Texas and Arizona, particularly in the month of May, which was the second wettest May on record for the contiguous United States.

In the first quarter of 2020, sales benefited from above-average temperatures throughout the contiguous United States, particularly in the southern United States.

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Over the last five years, capital expenditures have averaged roughly 1.0% of net sales.

We expect total capital expenditures in 2020 to be half of 2019 capital expenditures as we reduce spending in response to the economic impacts of the COVID-19 pandemic.

Given our positive results in the second quarter of 2020, we now expect capital expenditures to approximate 65% of 2019 capital expenditures and range from $20.0 million to $25.0 million.

Sources and Uses of Cash

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

Three Months Ended

Six Months Ended

Operating activities $ 221,200 $ 97,441

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Financing activities (177,794) (25,198)

Cash provided by operations of $19.7 million for the first three months of 2020 decreased $9.1 million compared to the first three months of 2019 due to fluctuations in our working capital balances primarily related to growth of our receivables and inventories, which were offset by increases in our accounts payable.

Cash used in investing activities for the first three months of 2020 increased compared to the first three months of 2019 primarily due to the acquisition of Master Tile Network LLC, which we completed in February 2020.

Cash used in financing activities was $8.1 million for the first three months of 2020 compared to $2.1 million for the first three months of 2019, which reflects additional share repurchases of $43.5 million and an increase in dividends paid of $4.3 million, offset by a $42.4 million increase in amounts provided by net borrowings.

Cash provided by operations of $221.2 million for the first six months of 2020 increased $123.8 million compared to the first six months of 2019.

The improvement in cash provided by operations primarily reflects an increase in net income, a decline in inventory balances between periods and an increase in accrued expenses and other current liabilities, primarily due to deferred tax payments of $18.2 million, of which we paid $14.7 million in the third quarter of 2020.

Cash used in investing activities for the first six months of 2020 decreased compared to the first six months of 2019 primarily due to lower capital expenditures, partially offset by the acquisition of Master Tile Network LLC, which we completed in February 2020.

Cash used in financing activities was $177.8 million for the first six months of 2020 compared to $25.2 million for the first six months of 2019, which reflects the following:

• net debt payments of $72.8 million in 2020 versus net debt proceeds of $25.4 million in 2019;

• additional share repurchases of $47.1 million;

• an increase in dividends paid of $5.6 million.

Future Sources and Uses of Cash

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We intend to use the Credit Facility for general corporate purposes, for future share repurchases and to fund future growth initiatives.

At March 31, 2020, there was $192.8 million outstanding, a $4.8 million standby letter of credit outstanding and $552.4 million available for borrowing under the Credit Facility.

At June 30, 2020, there was $14.7 million outstanding, a $4.8 million standby letter of credit outstanding and $730.5 million available for borrowing under the Credit Facility.

We pay interest on revolving borrowings under the Credit Facility at a variable rate based on the one month London Interbank Offered Rate (LIBOR), plus an applicable margin.

The weighted average effective interest rate for the Credit Facility as of March 31, 2020 was approximately 1.9%, excluding commitment fees.

The weighted average effective interest rate for the Credit Facility as of June 30, 2020 was approximately 1.0%, excluding commitment fees.

Term Facility

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The Term Facility will be repaid in quarterly installments of 1.250% of the Term Facility on the last business day of each quarter beginning in the first quarter of 2020.

The total of the quarterly payments will be equal to 33.75% of the Term Facility with the final principal repayment equal to 66.25% of the Term Facility due on the maturity date.

The total of the quarterly payments will be equal to 33.75% of the Term Facility with the final principal payment, equal to 66.25% of the Term Facility, due on the maturity date.

We may prepay amounts outstanding under the Term Facility without penalty other than interest breakage costs.

At March 31, 2020, there was $182.7 million outstanding under the Term Facility with a weighted average effective interest rate of 2.4%.

At June 30, 2020, there was $180.4 million outstanding under the Term Facility with a weighted average effective interest rate of 2.1%.

We pay interest on borrowings under the Term Facility at a variable rate based on the one month LIBOR, plus an applicable margin.

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Financial covenants of the Credit Facility and the Term Facility include maintenance of a maximum average total leverage ratio and a minimum fixed charge coverage ratio, which are our most restrictive financial covenants.

As of March 31, 2020, the calculations of these two covenants are detailed below:

As of June 30, 2020, the calculations of these two covenants are detailed below:

• Maximum Average Total Leverage Ratio .

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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 March 31, 2020, our average total leverage ratio equaled 1.49 (compared to 1.61 as of December 31, 2019) and the TTM average total debt amount used in this calculation was $572.7 million.

As of June 30, 2020, our average total leverage ratio equaled 1.26 (compared to 1.49 as of March 31, 2020) and the TTM average total debt amount used in this calculation was $525.9 million.

• Minimum Fixed Charge Coverage Ratio .

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Fixed Charge Ratio is the ratio of the TTM EBITDAR divided by TTM Interest Expense paid or payable in cash plus TTM Rental Expense (as those terms are defined in the Credit Facility).

As of March 31, 2020, our fixed charge ratio equaled 5.56 (compared to 5.38 as of December 31, 2019) and TTM Rental Expense was $60.6 million.

As of June 30, 2020, our fixed charge ratio equaled 6.27 (compared to 5.56 as of March 31, 2020) and TTM Rental Expense was $60.8 million.

The Credit Facility and the Term Facility also limit 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 and the Term Facility), provided no default or event of default has occurred and is continuing, or would result from the payment of dividends.

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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 March 31, 2020, there was $195.1 million outstanding under the Receivables Facility at a weighted average effective interest rate of 1.6%, excluding commitment fees.

At June 30, 2020, there was $235.0 million outstanding under the Receivables Facility at a weighted average effective interest rate of 0.9%, excluding commitment fees.

Interest Rate Swaps

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Interest expense related to the notional amounts under all swap contracts is based on the fixed rates plus the applicable margin on the respective borrowings.

As of March 31, 2020, we had one interest rate swap contract in place, which became effective on November 20, 2019 and terminates on November 20, 2020.

As of June 30, 2020, we had one interest rate swap contract in place, which became effective on November 20, 2019 and terminates on November 20, 2020.

This swap contract was previously forward-starting and converts the variable interest rate on our variable rate borrowings to a fixed rate of 1.1425% on a notional amount of $150.0 million.

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Compliance and Future Availability

As of March 31, 2020, we believe we were in compliance with all covenants and financial ratio requirements under our Credit Facility, our Term Facility and our Receivables Facility.

As of June 30, 2020, we believe we were in compliance with all covenants and financial ratio requirements under our Credit Facility, our Term Facility and our Receivables Facility.

We believe we will remain in compliance with all covenants and financial ratio requirements throughout the next twelve months.

For additional information regarding our debt arrangements, see Note 5 of “Notes to Consolidated Financial Statements,” included in Part II, Item 8 of our 2019 Annual Report on Form 10-K.

For additional information regarding our debt arrangements, see Note 5 of “Notes to Consolidated Financial Statements,” included in Part II, Item 8 of our 2019 Annual Report on Form 10-K and in Part I, Item 1 of this Form 10-Q.

We believe we have adequate availability of capital to fund present operations and the current capacity to finance any working capital needs that may arise.

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If suitable acquisition opportunities arise that would require financing, we believe that we have the ability to finance any such transactions.

As of April 27, 2020, $182.8 million of the current Board-authorized amount under our share repurchase program remained available.

As of July 28, 2020, $182.8 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.

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For a description of our critical accounting estimates that require us to make the most difficult, subjective or complex judgments, please see our 2019 Annual Report on Form 10-K.

See Allowance for Doubtful Accounts in Note 1 for more information on our adoption of ASU 2016-13.

See Allowance for Doubtful Accounts in Note 1 of Part I, Item 1 of this Form 10-Q for more information on our adoption of ASU 2016-13.

We have not changed any other policies from those previously disclosed.

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis