What changed in this filing

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Item 2. Management’s Discussion and Analysis

2020-10-30 compared with 2020-07-31 · 156 added, 135 removed, 312 unchanged (48% of the section changed)

14 unchanged sentences

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.

In Europe, our operations closed for a short period during the first half of 2020 in France, Spain and Italy, in order to comply with local authorities’ orders.

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

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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.

We implemented enhanced hygiene and sanitation practices at our sales centers and at our corporate offices.

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.

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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.

In the third quarter of 2020, we realized net sales of $1.14 billion, as our sales continued to benefit from elevated demand for residential pool products, driven by home-centric trends influenced by the COVID-19 pandemic.

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.

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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.

We began taking steps in April to reduce both capital expenditures and operating costs.

Specifically, we reduced expenses for labor, fuel, utilities, advertising, meetings, travel and entertainment.

As our business outlook and market trends have improved since the implementation of these cost-saving measures, we continue to assess our discretionary spending.

We continue to reevaluate previously deferred capital expenditures and currently expect capital expenditures in 2020 to approximate 65% of 2019 capital expenditures and range from $20.0 million to $25.0 million.

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.

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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.

In the third quarter of 2020, net sales increased 27% to $1.14 billion compared to $898.5 million in the third quarter of 2019.

Our sales benefited from continued elevated demand for residential pool products, driven by home-centric trends influenced by the COVID-19 pandemic, as working from home became routine and families created and enjoyed safe social and entertainment alternatives in their own backyards.

We realized broad sales gains across many product categories, as maintenance, replacement, refurbishment and construction activities across most geographies were strong.

Gross profit increased 27% to $328.7 million in the third quarter of 2020 from $257.9 million in the same period of 2019.

Gross margin increased 20 basis points to 28.9% in the third quarter of 2020 compared to 28.7% in the third quarter of 2019, with increased purchase volumes driving improvements in supply chain management.

Selling and administrative expenses (operating expenses) increased 18% to $180.5 million in the third quarter of 2020 compared to $153.4 million in the third quarter of 2019, primarily reflecting a $20.1 million increase in performance-based compensation.

Excluding performance-based compensation in both periods, operating expenses increased 5% due to growth-driven freight expenses and greater facility-related costs.

As a percentage of net sales, operating expenses decreased to 15.8% in the third quarter of 2020 compared to 17.1% in the same period of 2019, as we continued to realize benefits from discretionary spending controls implemented earlier in the year.

Operating income in the third quarter of 2020 increased 42% to $148.2 million compared to $104.5 million in the same period in 2019.

Operating margin was 13.0% in the third quarter of 2020 compared to 11.6% in the third quarter of 2019.

We recorded an $8.5 million, or $0.21 per diluted share, tax benefit from Accounting Standards Update (ASU) 2016-09, Improvements to Employee Share-Based Payment Accounting , in the quarter ended September 30, 2020, compared to a tax benefit of $4.5 million, or $0.11 per diluted share, realized in the same period of 2019.

Net income increased 50% to $119.1 million in the third quarter of 2020 compared to $79.5 million in the third quarter of 2019.

Earnings per share increased 50% to $2.92 per diluted share in the third quarter of 2020 compared to $1.95 in the same period of 2019.

Excluding the impact from ASU 2016-09 in both periods, earnings per diluted share increased 47% to $2.71 in the third quarter of 2020 compared to $1.84 in the third 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 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.

As of September 30, 2020, total net receivables, including pledged receivables, increased 19% compared to September 30, 2019, driven by our September sales growth and partially offset by improved collections.

Our days sales outstanding (DSO), as calculated on a trailing four quarters basis, was 27.6 days at September 30, 2020 and 29.0 days at September 30, 2019.

Our allowance for doubtful accounts balance was $5.3 million at September 30, 2020 and $6.2 million at September 30, 2019.

Net inventory levels decreased 1% compared to levels at September 30, 2019, reflecting the strong pace of sales in the third quarter of 2020.

The inventory reserve was $11.4 million at September 30, 2020 and $9.9 million at September 30, 2019.

Our inventory turns, as calculated on a trailing four quarters basis, were 3.7 times at September 30, 2020 and 3.2 times at September 30, 2019.

Accrued expenses and other current liabilities increased 79% compared to September 30, 2019, primarily reflecting increases in accrued performance-based compensation and unrealized losses on interest rate swaps.

Total debt outstanding at September 30, 2020 was $339.9 million, down 38% compared to total debt at September 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, payments of cash dividends and share repurchases.

Current Trends and Outlook

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Based on our results to date and expectations for the remainder of the year, we expect 2020 diluted EPS of $8.05 to $8.35, including the impact of year-to-date tax benefits of $0.55 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 previous 2020 earnings guidance range disclosed in our Second Quarter 2020 Quarterly Report on Form 10-Q was $6.90 to $7.30, including year-to-date tax benefits of $0.34 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.

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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.

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.

In addition, we believe that our sales for the fourth quarter of 2020 will continue to 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 adversely impact our business, including an easing of demand for products dependent on discretionary spending.

We expect gross margin for the full year of 2020 to decline modestly compared to gross margin for the full year of 2019 given the decline in gross margin through the first nine months of 2020.

We expect gross margin for the fourth quarter of 2020 to be relatively flat compared to the fourth quarter 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 ratably with changes in sales performance.

For the year, we expect operating expenses to increase 10% to 12% compared to 2019, primarily due to increases in performance-based compensation.

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 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 recorded a $22.6 million, or $0.55 per diluted share, tax benefit from ASU 2016-09 for the nine months ended September 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 June 30, 2020.

We have not included any expected benefits in our guidance beyond what we have recognized as of September 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).

The following summarizes our current expectations for 2021:

• We expect sales growth in 2021 to be impacted by the following factors and assumptions:

◦ normal weather patterns;

◦ continued elevated demand for residential pool products, driven by home-centric trends influenced by the COVID-19 pandemic;

◦ a benefit from delayed projects depending on our customers’ building capacity, including the availability of labor, and weather;

◦ estimated 2% growth in the installed base of pools;

◦ estimated 4% growth from acquisitions completed throughout 2020;

◦ inflationary product cost increases of approximately 2% to 3% (compared to our historical average of 1% to 2%).

• We expect performance-based compensation for the full year of 2021 to normalize and decrease by $15.0 million to $20.0 million compared to the full year of 2020.

RESULTS OF OPERATIONS

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.

As of September 30, 2020, we conducted operations through 381 sales centers in North America, Europe and Australia.

For the nine months ended September 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 Six Months Ended

June 30, June 30,

Three Months Ended Nine Months Ended

September 30, September 30,

2020 2019 2020 2019

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Income before income taxes and equity earnings 12.8 % 11.0 % 12.3 % 11.3 %

Due to rounding, percentages presented in the table above may not add to Income before income taxes and equity earnings.

Due to rounding, percentages presented in the table above may not add to Operating income and Income before income taxes and equity earnings.

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

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

Three Months Ended September 30, 2020 Compared to Three Months Ended September 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

June 30, June 30, June 30,

September 30, September 30, September 30,

2020 2019 2020 2019 2020 2019

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Operating margin 13.0 % 11.7 % 5.6 % (11.8) % 13.0 % 11.6 %

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

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

Sales Centers

Northeastern Swimming Pool Distributors, Inc.

September 2020 3 September 2020

Master Tile Network LLC (1)

February 2020 4 April - June 2020

February 2020 4 July - September 2020

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

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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 six months of 2020:

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

December 31, 2019 373

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Closed/consolidated locations (2)

June 30, 2020 378

September 30, 2020 381

Three Months Ended

September 30,

(in millions) 2020 2019 Change

Net sales $ 1,139.2 $ 898.5 $ 240.7 27%

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.

Net sales and base business net sales increased 27% in the third quarter of 2020 compared to the third quarter of 2019.

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 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;

• increased demand for residential swimming pool maintenance supplies due to increased usage, as evidenced by improvements in sales growth rates to retail customers (see discussion below);

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

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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, 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.

In the third quarter of 2020, sales for equipment, which includes swimming pool heaters, pumps, lights and filters, increased 36% compared to the same period last year.

Equipment collectively represented approximately 28% of net sales for the period.

Sales of building materials, including sales from recently acquired Master Tile locations, grew 29% compared to the third quarter of 2019 and represented approximately 11% of net sales in the third quarter of 2020.

Sales of above-ground pools and spas increased 60% in the third quarter of 2020 compared to the third quarter of 2019 and represented approximately 2% of net sales for the period.

Sales to customers who service large commercial installations and specialty retailers that sell swimming pool supplies 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 28% in the third quarter of 2020 compared to the third quarter of 2019 and represented approximately 14% of our consolidated net sales for the third quarter of 2020.

Sales to commercial customers declined 10% in the third quarter of 2020 compared to the third 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 third quarter of 2020.

Three Months Ended

September 30,

(in millions) 2020 2019 Change

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Gross margin 28.9 % 28.7 %

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

Operating Expenses

Three Months Ended

September 30,

(in millions) 2020 2019 Change

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Operating expenses as a % of net sales 15.8 % 17.1 %

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.

Operating expenses increased 18% in the third quarter of 2020 compared to the third quarter of 2019, reflecting an increase in performance-based compensation of $20.1 million in the third quarter of 2020.

Excluding performance-based compensation in both periods, operating expenses increased 5% due to 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 second quarter of 2020 decreased $3.8 million compared to the second quarter of 2019.

Interest and other non-operating expenses, net for the third quarter of 2020 decreased $3.6 million compared to the third 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.

Our weighted average effective interest rate decreased to 1.9% for the third quarter of 2020 from 3.4% for the third quarter of 2019 on lower average outstanding debt of $331.5 million versus $568.3 million for the respective periods.

Our effective income tax rate was 18.7% for the three months ended September 30, 2020 compared to 19.8% for the three months ended September 30, 2019.

We recorded an $8.5 million tax benefit from ASU 2016-09 in the quarter ended September 30, 2020 compared to a tax benefit of $4.5 million realized in the same period last year.

Excluding the benefits from ASU 2016-09, our effective tax rate was 24.5% for the third quarter of 2020 and 24.3% for the third quarter of 2019.

Our third quarter effective income tax rate is typically lower compared to other quarters due to the timing of our accounting for uncertain tax positions, including the expiration of statutes of limitations.

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

Net income increased 50% to $119.1 million in the third quarter of 2020 compared to the third quarter of 2019.

Earnings per diluted share increased 50% to $2.92 in the third quarter of 2020 versus $1.95 per diluted share for the comparable 2019 period.

The benefit from ASU 2016-09 increased diluted earnings per share by $0.21 in the third quarter of 2020 and $0.11 in the third quarter of 2019.

Excluding tax benefits in both periods, earnings per diluted share increased 47% to $2.71 in the third quarter of 2020 compared to $1.84 in the third quarter of 2019.

Nine Months Ended September 30, 2020 Compared to Nine Months Ended September 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,

(in thousands) Nine Months Ended Nine Months Ended Nine Months Ended

September 30, September 30, September 30,

2020 2019 2020 2019 2020 2019

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Operating margin 12.6 % 12.2 % 2.0 % (8.4) % 12.6 % 12.1 %

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

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

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

Sales Centers

Northeastern Swimming Pool Distributors, Inc.

September 2020 3 September 2020

Master Tile Network LLC (1)

February 2020 4 February - June 2020

February 2020 4 February - September 2020

January 2019 4 January - March 2020 and

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(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

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 September 30, 2020 Compared to Three Months Ended September 30, 2019.

Nine Months Ended

September 30,

(in millions) 2020 2019 Change

Net sales $ 3,097.4 $ 2,617.3 $ 480.1 18%

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

Net sales and base business net sales for the first nine months of 2020 increased 18% 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.

In the third quarter of 2020, our sales benefited from continued elevated demand for residential pool products, driven by home-centric trends influenced by the COVID-19 pandemic.

Sales were also favorably impacted approximately 1% by an additional selling day in the first nine months of 2020.

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;

• 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 (see discussion below);

• 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

We believe that 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 first nine months of 2020, sales for equipment, which includes swimming pool heaters, pumps, lights and filters, increased approximately 26% compared to the same period last year.

Equipment collectively represented 28% of net sales in the first nine months of 2020.

Sales of building materials, including sales from recently acquired Master Tile locations, grew 18% compared to the first nine months of 2019 and represented approximately 12% of net sales in the first nine months of 2020.

Sales of above-ground pools and spas increased 53% in the first nine months of 2020 and represented approximately 2% of net sales in the first nine months of 2020.

In the first nine months of 2020, sales to retail customers increased 22% and represented approximately 14% of our consolidated net sales.

Sales to commercial customers declined 10% in the first nine 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 nine months of 2020.

Nine Months Ended

September 30,

(in millions) 2020 2019 Change

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Gross margin 28.8 % 29.1 %

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.

Gross margin declined 30 basis points to 28.8% compared to 29.1% in the same period last year, primarily due to sales of lower margin, big-ticket items, such as in-ground and above-ground pools and pool equipment, which comprised a larger portion of our product mix in the nine months ended September 30, 2020 compared to the first nine months of 2019.

Operating Expenses

Six Months Ended

Nine Months Ended

September 30,

(in millions) 2020 2019 Change

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Operating expenses as a % of net sales 16.2 % 17.1 %

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

Operating expenses for the nine months ended September 30, 2020 increased 12% compared to the first nine months of 2019.

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 amounts of our Australian reporting units.

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

Excluding impairment charges, operating expenses were up 11%, reflecting a $32.1 million increase in performance-based compensation, in addition to 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 six months of 2020 decreased $5.6 million compared to the same period last year.

Interest and other non-operating expenses, net for the first nine months of 2020 decreased $9.2 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 2.2% 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.

Our weighted average effective interest rate decreased to 2.2% for the first nine months of 2020 from 3.5% for the same period of 2019 on average outstanding debt of $439.4 million versus $631.1 million for the respective periods.

Our effective income tax rate was 19.2% for the nine months ended September 30, 2020 compared to 18.0% for the nine months ended September 30, 2019.

We recorded a $22.6 million, or $0.55 per diluted share, tax benefit from ASU 2016-09 in the nine months ended September 30, 2020 compared to a $21.1 million, or $0.52 per diluted share, tax benefit in the same period of 2019.

Excluding the benefits from ASU 2016-09, our effective tax rate was 25.2% for the nine months ended September 30, 2020 and 25.1% for the nine months ended September 30, 2019.

Net Income and Earnings Per Share

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.

Net income increased 26% to $307.6 million for the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019.

Earnings per diluted share increased to $7.53 for the nine months ended September 30, 2020 versus $5.97 per diluted share for the nine months ended September 30, 2019.

Adjusted net income for the first nine months of 2020, excluding the $6.3 million, or $0.15 per diluted share, impact of non-cash impairments, net of tax, increased 29% to $313.9 million.

Excluding the impact of non-cash impairments, net of tax, and tax benefits from ASU 2016-09 in both periods, adjusted diluted EPS increased 31% to $7.13 for the nine months ended September 30, 2020 compared to $5.45 for the nine months ended September 30, 2019.

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

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

(Unaudited) Six Months Ended

(in thousands) June 30,

(Unaudited) Nine Months Ended

(in thousands) September 30,

Net income $ 307,565

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(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.

Excluding impairment from goodwill and intangibles and tax benefits from ASU 2016-09 recorded in the first quarter of 2020, our effective tax rate for the first quarter of 2020 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) Six Months Ended

(Unaudited) Nine Months Ended

September 30,

Diluted EPS $ 7.53 $ 5.97

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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 and second quarters of 2020, the four quarters of 2019 and the third and fourth quarters of 2018.

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

Second First Fourth Third Second First Fourth Third

Third Second First Fourth Third Second First Fourth

Statement of Income Data

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Weather Impacts on 2020 and 2019 Results

Overall, weather conditions in the third quarter of 2020 were generally favorable, which benefited results.

Much of the western United States experienced above-average temperatures, particularly in California, which was also plagued with the most active wildfire year on record.

Precipitation was below-average in most of the western half of the United States and normal to above-average in the eastern half.

Likewise, results in the third quarter of 2019 were positively impacted by above-average temperatures and below-average precipitation throughout most of the country.

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

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

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.

Due to the deferral of capital expenditures earlier in the year to address the COVID-19 pandemic, we expect capital expenditures in 2020 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):

Six Months Ended

Nine Months Ended

September 30,

Operating activities $ 388,914 $ 243,253

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Financing activities (300,161) (187,734)

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.

Cash provided by operations of $388.9 million for the first nine months of 2020 increased $145.7 million compared to the first nine 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 improvements in working capital management.

Cash used in investing activities for the first nine months of 2020 increased compared to the first nine months of 2019 primarily due to the acquisitions of Master Tile Network LLC, which we completed in February 2020, and Northeastern Swimming Pool Distributors, Inc., which we completed in September 2020.

The increase in cash used in investing activities due to acquisitions was partially offset by lower capital expenditures.

Cash used in financing activities was $300.2 million for the first nine months of 2020 compared to $187.7 million for the first nine months of 2019, which reflects a $52.2 million increase in net debt payments, additional share repurchases of $53.0 million and an increase in dividends paid of $6.8 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 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.

At September 30, 2020, there was $40.9 million outstanding, a $4.8 million standby letter of credit outstanding and $704.3 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 June 30, 2020 was approximately 1.0%, excluding commitment fees.

The weighted average effective interest rate for the Credit Facility as of September 30, 2020 was approximately 1.1%, excluding commitment fees.

Term Facility

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

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

At September 30, 2020, there was $178.1 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 June 30, 2020, the calculations of these two covenants are detailed below:

As of September 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 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.

As of September 30, 2020, our average total leverage ratio equaled 1.01 (compared to 1.26 as of June 30, 2020) and the TTM average total debt amount used in this calculation was $466.3 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 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.

As of September 30, 2020, our fixed charge ratio equaled 7.10 (compared to 6.27 as of June 30, 2020) and TTM Rental Expense was $61.2 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 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.

At September 30, 2020, there was $110.0 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 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.

As of September 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 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.

As of September 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.

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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 July 28, 2020, $182.8 million of the current Board-authorized amount under our share repurchase program remained available.

As of October 26, 2020, $176.9 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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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