POOL CORP 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations You should read the following discussion in conjunction with the accompanying interim Consolidated Financial Statements and notes, the Consolidated Financial Statements and accompanying notes in our 2021 Annual Report on Form 10-K and with Management’s Discussion and Analysis in our 2021 Annual Report on Form 10-K. For a discussion of our base business calculations, see the Results of Operations section below. Forward-Looking Statements This report contains forward-looking information that involves risks and uncertainties. Our forward-looking statements express our current expectations or forecasts of possible future results or events, including projections of earnings and other financial performance measures, statements of management’s expectations regarding our strategic, operational and capital allocation plans and objectives and industry, general economic and other forecasts of trends and other matters. Forward-looking statements speak only as of the date of this filing, and we undertake no obligation to publicly update or revise such statements to reflect new circumstances or unanticipated events as they occur. You can identify these statements by the fact that they do not relate strictly to historic or current facts and often use words such as “anticipate,” “estimate,” “expect,” “intend,” “believe,” “will likely result,” “outlook,” “project,” “may,” “can,” “plan,” “target,” “potential,” “should” and other words and expressions of similar meaning. No assurance can be given that the expected results in any forward-looking statement will be achieved, and actual results may differ materially due to one or more factors, including impacts on our business from the COVID-19 pandemic and the extent to which strong demand driven by home-centric trends will continue, accelerate or reverse; the sensitivity of our business to weather conditions; changes in the economy; consumer discretionary spending; the housing market or inflation rates; our ability to maintain favorable relationships with suppliers and manufacturers; competition from other leisure product alternatives or mass merchants; our ability to continue to execute our growth strategies; excess tax benefits or deficiencies recognized under ASU 2016-09 and other risks detailed in our 2021 Annual Report on Form 10-K. For these statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. OVERVIEW Financial Results Net sales increased 15% in the second quarter of 2022 to $2.1 billion compared to $1.8 billion in the second quarter of 2021. Base business sales grew 10%. Our results are indicative of healthy demand for our products as maintenance, replacement, refurbishment and construction activity remained strong. Net sales benefited approximately 10% to 11% from elevated price inflation, but were unfavorably impacted 1% from currency exchange rate fluctuations. Gross profit increased 21% to $666.8 million in the second quarter of 2022 from $551.7 million in the same period of 2021. Base business gross profit improved 14% over the second quarter of 2021. Gross margin increased 150 basis points to 32.4% in the second quarter of 2022 compared to 30.9% in the second quarter of 2021, reflecting benefits from our supply chain initiatives, increased pricing and recent acquisitions. Base business gross margin increased 100 basis points. Selling and administrative expenses (operating expenses) increased 16% to $247.9 million in the second quarter of 2022 compared to $213.1 million in the second quarter of 2021, including a 1% benefit from currency exchange rate fluctuations. As a percentage of net sales, operating expenses increased to 12.1% in the second quarter of 2022 compared to 11.9% in the same period of 2021. Our operating expenses have increased to support our business growth, including recent acquisitions. Operating income in the second quarter of 2022 increased 24% to $418.9 million compared to $338.6 million in the same period of 2021. Operating margin was 20.4% in the second quarter of 2022 compared to 18.9% in the second quarter of 2021. Base business operating margin was 20.3%, up 130 basis points from the prior year period. We recorded a $1.6 million, or $0.04 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, 2022, compared to a tax benefit of $7.7 million, or $0.19 per diluted share, realized in the same period of 2021. 14 Net income increased 18% to $307.3 million in the second quarter of 2022 compared to $259.7 million in the second quarter of 2021. Earnings per diluted share increased 20% to $7.63 in the second quarter of 2022 compared to $6.37 in the same period of 2021. Without the impact from ASU 2016-09 in both periods, earnings per diluted share increased 23% to $7.59 in the second quarter of 2022 compared to $6.18 in the second quarter of 2021. See RESULTS OF OPERATIONS below for definitions of our non-GAAP measures and reconciliations of our non-GAAP measures to GAAP measures. On May 4, 2022, our Board of Directors (our Board) authorized an additional $196.2 million under our share repurchase program bringing its total authorization available to $600.0 million. Further, the Board announced a 25% increase over the previous quarterly dividend amount to $1.00 per share. References to product line and product category data throughout this report generally reflect data related to the North American swimming pool market, as this data is more readily available for analysis and represents the largest component of our operations. COVID-19 Pandemic We continue to monitor the ongoing impact of the COVID-19 pandemic, including the effects of recent notable variants of the virus. The health, safety and security of our employees and the communities in which we operate remain our highest priority. We implemented enhanced hygiene and sanitation practices at our sales centers and at our corporate offices in 2020, and we continue to evaluate and maintain them where necessary. Beginning in the second quarter of 2020, we experienced unprecedented demand as families spent more time at home and sought out opportunities to create or expand home-based outdoor living and entertainment spaces. While this trend has had a positive impact on our financial performance over the past couple of years, it is unclear what the long-term impact will be. Our industry experienced supply chain constraints in 2021. In response, we have been proactive in making significant investments in inventory to enable us to continue to meet strong customer demand and position ourselves to provide exceptional customer service through the 2022 swimming pool season. While we were challenged by supply chain constraints through the first half of 2022, we have observed improvements in our supply chain dynamics beginning in the second quarter of 2022. These trends, caused in large part from global disruptions related to the COVID-19 pandemic, may persist in the near-term. We expect the impact of the pandemic on our business and financial results in 2022 will continue to vary by location and depend on numerous evolving factors that we are unable to accurately predict. These factors include the duration and scope of the pandemic, global economic conditions during and after the pandemic, the possible re-institution of governmental restrictions on the activities of our customers, vendors or employees, the possibility of additional subsequent outbreaks, the sustainability of current home-centric trends and other changes in customer and supplier behavior in response to the pandemic. Financial Position and Liquidity As of June 30, 2022, total net receivables, including pledged receivables, increased 29% compared to June 30, 2021, primarily driven by our sales growth and recent acquisitions. Our days sales outstanding (DSO), as calculated on a trailing four quarters basis, was 27.2 days at June 30, 2022 and 25.8 days at June 30, 2021. Our allowance for doubtful accounts balance was $6.5 million at June 30, 2022 and $5.4 million at June 30, 2021. Net inventory levels increased 77% compared to levels at June 30, 2021. We increased our purchasing beginning in the second half of 2021 to improve our customer experience and minimize the impact of longer lead times from our vendors. Our inventory balance also reflects impacts from inflation and recent acquisitions. Our inventory reserve was $20.9 million at June 30, 2022 and $15.2 million at June 30, 2021. Our inventory turns, as calculated on a trailing four quarters basis, were 2.8 times at June 30, 2022 and 4.1 times at June 30, 2021. Our inventory turns have averaged 3.4 times over the past five years. Total debt outstanding at June 30, 2022 was $1.6 billion compared to $423.1 million at June 30, 2021. Our debt balance has increased between periods as we have utilized debt proceeds to fund investments in working capital, recent acquisitions and share repurchases. Current Trends and Outlook For a detailed discussion of trends through 2021, see the Current Trends and Outlook section of Management’s Discussion and Analysis included in Part II, Item 7 of our 2021 Annual Report on Form 10-K. 15 We are updating our annual earnings guidance range to include the $0.04 tax benefit from ASU 2016-09 recognized in the second quarter of 2022. We expect 2022 diluted EPS of $18.38 to $19.13, including the impact of year-to-date tax benefits of $0.22. Our previous earnings guidance range disclosed in our First Quarter 2022 Report on Form 10-Q was $18.34 to $19.09. Our earnings guidance range assumes average weather conditions. We expect sales growth for the full year in the range of 17% to 19% as previously disclosed in our 2021 Annual Report on Form 10-K. We project 2022 inflationary product cost increases of approximately 10% to 11% (compared to 7% to 8% in 2021). Our gross margin trends depend on the amounts and timing of inflationary product cost increases, sales growth expectations and product mix. We expect a slight improvement in gross margin for the full year of 2022 compared to the full year of 2021 given the impact of inflation in the first half of the year. Compared to 2021 periods, we project declines in the latter half of the year. We project our operating expense growth rate in 2022 will be less than our gross profit growth rate. We expect that our operating expense growth will reflect inflationary increases and incremental costs to support our investment initiatives, including increased investments in our digital transformation initiatives and expansion of our sales center network. We also expect increased expenses from tight labor and real estate markets in 2022, which are heightened focus areas in our expense management. We project that our annual effective tax rate (without the benefit from ASU 2016-09) for 2022 will approximate 25.5%. We expect our effective tax rate will fluctuate from quarter to quarter due to ASU 2016-09, particularly in periods when employees elect to exercise their vested stock options or when restrictions on share-based awards lapse. We recorded a $8.9 million, or $0.22 per diluted share, tax benefit from ASU 2016-09 for the six months ended June 30, 2022. We may recognize additional tax benefits related to stock option exercises in 2022 from grants that expire in future years. We have not included any expected tax benefits in our guidance beyond what we have recognized as of June 30, 2022. We expect to continue to use cash to fund opportunistic share repurchases through the remainder of 2022 and to use cash for the payment of cash dividends as and when declared by our Board. The forward-looking statements in the foregoing section are based on current market conditions, speak only as of the filing date of this report, are based on several assumptions, and are subject to significant risks and uncertainties. See “Cautionary Statement for Forward-Looking Statements.” RESULTS OF OPERATIONS As of June 30, 2022, we conducted operations through 416 sales centers in North America, Europe and Australia. For the six months ended June 30, 2022, approximately 95% 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, 2022 2021 2022 2021 Net sales 100.0 % 100.0 % 100.0 % 100.0 % Cost of sales 67.6 69.1 67.9 70.1 Gross profit 32.4 30.9 32.1 29.9 Selling and administrative expenses 12.1 11.9 13.2 13.5 Operating income 20.4 18.9 18.9 16.4 Interest and other non-operating expenses, net 0.4 0.1 0.4 0.2 Income before income taxes and equity in earnings 20.0 % 18.8 % 18.5 % 16.3 % Note: Due to rounding, percentages presented in the table above may not add to Operating income or Income before income taxes and equity in earnings. We have included the results of operations from acquisitions in 2022 and 2021 in our consolidated results since the acquisition dates. 16 Three Months Ended June 30, 2022 Compared to Three Months Ended June 30, 2021 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) Three Months Ended Three Months Ended Three Months Ended June 30, June 30, June 30, 2022 2021 2022 2021 2022 2021 Net sales $ 1,963,974 $ 1,782,894 $ 91,844 $ 4,939 $ 2,055,818 $ 1,787,833 Gross profit 625,843 550,509 40,961 1,176 666,804 551,685 Gross margin 31.9 % 30.9 % 44.6 % 23.8 % 32.4 % 30.9 % Operating expenses 226,728 212,425 21,188 674 247,916 213,099 Expenses as a % of net sales 11.5 % 11.9 % 23.1 % 13.6 % 12.1 % 11.9 % Operating income 399,115 338,084 19,773 502 418,888 338,586 Operating margin 20.3 % 19.0 % 21.5 % 10.2 % 20.4 % 18.9 % In our calculation of our base business results, we have excluded the following acquisitions for the periods identified: Acquired Acquisition Date Net Sales Centers Acquired Periods Excluded Tri-State Pool Distributors April 2022 1 May - June 2022 Porpoise Pool & Patio, Inc. December 2021 1 April - June 2022 Wingate Supply, Inc. December 2021 1 April - June 2022 Vak Pak Builders Supply, Inc. June 2021 1 April - June 2022 and June 2021 Pool Source, LLC April 2021 1 April - June 2022 and April - June 2021 When calculating our base business results, we exclude sales centers that are acquired, closed, or opened in new markets for a period of 15 months. We also exclude consolidated sales centers when we do not expect to maintain the majority of the existing business and existing sales centers that are consolidated with acquired sales centers. We generally allocate corporate overhead expenses to excluded sales centers on the basis of their net sales as a percentage of total net sales. After 15 months of operations, we include acquired, consolidated and new market sales centers in the base business calculation including the comparative prior year period. The table below summarizes the changes in our sales center count during the first six months of 2022: December 31, 2021 410 Acquired locations 1 New locations 5 June 30, 2022 416 17 Net Sales Three Months Ended June 30, (in millions) 2022 2021 Change Net sales $ 2,055.8 $ 1,787.8 $ 268.0 15% Net sales increased 15% in the second quarter of 2022 on top of net sales of $1.8 billion and 40% growth in the second quarter of 2021. Base business net sales in the second quarter of 2022 grew 10% over the same period. Our growth was largely driven by inflationary product cost increases and strong demand that boosted sales by 16% in our year-round markets. Volume growth was challenged by unfavorable weather conditions in our seasonal markets and constrained conditions in Europe. Heavy rainfall and cooler temperatures, particularly in the month of April, limited sales in certain of our markets although we observed improvement through the latter half of the second quarter. We believe that our results reflect the positive impact of growth in the installed base of pools, robust demand and heightened consumer interest in enhanced pool customizations, and we remain confident in our expectation of 17% to 19% sales growth for the full year of 2022. For more discussion of our expectations for the remainder of the year, see “Current Trends and Outlook” above. The following factors impacted our sales (listed in order of estimated magnitude): • inflationary product cost increases of approximately 10 to 11%; • 5% sales growth from recent acquisitions; • favorable trends for our products including: ◦ strong demand for discretionary products, as evidenced by sales growth for product offerings such as equipment and building materials (see discussion below); ◦ market share gains, including those in building materials (see discussion below); ◦ increased demand for residential swimming pool maintenance supplies, as the installed base of pools continues to increase; and • challenges presented in the second quarter including: ◦ 2% unfavorable impact from currency exchange rate fluctuations and customer early buys shifted into the first quarter of 2022; ◦ cooler, wet weather conditions in our seasonal markets (see discussion below); and ◦ unfavorable weather conditions and macroeconomic impacts in Europe (see discussion below). Higher sales for certain product offerings, such as equipment and building materials, indicate continued strong demand in traditionally discretionary areas, such as pool construction, pool remodeling and equipment upgrades. In the second quarter of 2022, sales of equipment, which includes swimming pool heaters, pumps, lights, filters and automation, increased 7% compared to the same period last year, and collectively represented approximately 26% of net sales for the period. Equipment growth in the quarter was limited by supply chain constraints and customer early buys shifted into the first quarter of 2022. Sales of building materials grew 22% compared to the second quarter of 2021 and represented approximately 13% of net sales in the second quarter of 2022. Sales of chemicals, representing 12% of total net sales, increased 25% compared to the second quarter of 2021. The increase in chemical sales was driven by inflation, improved supply and strong demand for non-discretionary maintenance products. Sales to specialty retailers that sell swimming pool supplies and customers who service large commercial installations are included in the appropriate existing product categories, and growth in these areas is reflected in the discussion above. Sales to retail customers increased 7% in the second quarter of 2022 compared to the second quarter of 2021 and represented approximately 13% of our net sales for the second quarter of 2022. Certain of our retail customers were adversely impacted by unfavorable weather conditions in the quarter, hindering sales growth. Sales to commercial customers increased 23% in the second quarter of 2022 compared to the second quarter of 2021 and represented approximately 3% of our net sales for the second quarter of 2022. Net sales in our seasonal markets (not considering Europe), representing 50% of our total base business net sales in the second quarter of 2022, increased 9% compared to the second quarter of 2021. Comparatively, net sales in our year-round markets, representing 45% of our total base business net sales in the second quarter of 2022, increased 16% compared to the second quarter of 2021. 18 Net sales in Europe, representing 5% of our total net sales in the second quarter of 2022, declined 8% in local currency compared to 31% growth in the second quarter of 2021. While we estimate that net sales in Europe benefited 10% from inflationary product cost increases, our results were negatively impacted by a decline in volume growth driven by macroeconomic uncertainty and poor weather. Gross Profit Three Months Ended June 30, (in millions) 2022 2021 Change Gross profit $ 666.8 $ 551.7 $ 115.1 21% Gross margin 32.4 % 30.9 % Gross margin increased 150 basis points to 32.4% in the second quarter of 2022 compared to 30.9% in the second quarter of 2021, reflecting benefits from our supply chain initiatives, increased pricing and recent acquisitions. Base business gross margin increased 100 basis points. Operating Expenses Three Months Ended June 30, (in millions) 2022 2021 Change Selling and administrative expenses $ 247.9 $ 213.1 $ 34.8 16% Operating expenses as a % of net sales 12.1 % 11.9 % Operating expenses increased 16% in the second quarter of 2022 compared to the second quarter of 2021, including a 1% benefit from currency exchange rate fluctuations. As a percentage of net sales, operating expenses increased to 12.1% in the second quarter of 2022 compared to 11.9% in the same period of 2021. Our operating expenses have increased to support our business growth, including recent acquisitions. Employee-related expenses increased as we expand our workforce and reward employees through performance-based compensation. Other incremental operating expense increases related to growth-driven facility and freight costs, and investments in our digital transformation initiatives. Interest and Other Non-Operating Expenses, Net Interest and other non-operating expenses, net for the second quarter of 2022 increased $6.6 million compared to the second quarter of 2021, primarily due to higher average debt levels between periods. Our average outstanding debt was $1.6 billion in the second quarter of 2022 versus $376.8 million for the second quarter of 2021. Our weighted average effective interest rate decreased to 2.0% from 2.7% for the respective periods. Income Taxes Our effective income tax rate was 25.1% for the three months ended June 30, 2022 compared to 22.9% for the three months ended June 30, 2021. We recorded a $1.6 million tax benefit from ASU 2016-09 in the quarter ended June 30, 2022 compared to a tax benefit of $7.7 million realized in the same period last year. Without the benefit from ASU 2016-09 in both periods, our effective tax rate was 25.5% for the second quarter of 2022 and 25.2% for the second quarter of 2021. Net Income and Earnings Per Share Net income increased 18% to $307.3 million in the second quarter of 2022 compared to $259.7 million in the second quarter of 2021. Earnings per diluted share increased 20% to $7.63 in the second quarter of 2022 compared to $6.37 in the same period of 2021. Without the impact from ASU 2016-09 in both periods, earnings per diluted share increased 23% to $7.59 in the second quarter of 2022 compared to $6.18 in the second quarter of 2021. See the reconciliation of GAAP to non-GAAP measures below. 19 Six Months Ended June 30, 2022 Compared to Six Months Ended June 30, 2021 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, 2022 2021 2022 2021 2022 2021 Net sales $ 3,292,100 $ 2,840,676 $ 176,368 $ 7,903 $ 3,468,468 $ 2,848,579 Gross profit 1,039,122 850,948 74,872 1,869 1,113,994 852,817 Gross margin 31.6 % 30.0 % 42.5 % 23.6 % 32.1 % 29.9 % Operating expenses 420,655 383,710 38,727 1,490 459,382 385,200 Expenses as a % of net sales 12.8 % 13.5 % 22.0 % 18.9 % 13.2 % 13.5 % Operating income 618,467 467,238 36,145 379 654,612 467,617 Operating margin 18.8 % 16.4 % 20.5 % 4.8 % 18.9 % 16.4 % In our calculation of base business results, we have excluded the following acquisitions for the periods identified: Acquired Acquisition Date Net Sales Centers Acquired Periods Excluded Tri-State Pool Distributors April 2022 1 May - June 2022 Porpoise Pool & Patio, Inc. December 2021 1 January - June 2022 Wingate Supply, Inc. December 2021 1 January - June 2022 Vak Pak Builders Supply, Inc. June 2021 1 January - June 2022 and June 2021 Pool Source, LLC April 2021 1 January - June 2022 and April - June 2021 TWC Distributors, Inc. December 2020 10 January - February 2022 and January - February 2021 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, 2021, please refer to the discussion under the heading Three Months Ended June 30, 2022 Compared to Three Months Ended June 30, 2021. 20 Net Sales Six Months Ended June 30, (in millions) 2022 2021 Change Net sales $ 3,468.5 $ 2,848.6 $ 619.9 22% Net sales for the first six months of 2022 increased 22% compared to the same period last year. Base business net sales increased 16%. Our results in the first half of the year were driven by continued strong demand for outdoor living products and elevated price inflation. While we have been challenged by supply chain and labor constraints, we have observed improvements in our supply chain dynamics beginning in the second quarter of 2022. Following our astounding 33% sales growth in the first quarter of 2022, results in our seasonally significant second quarter were dampened by unfavorable weather conditions in certain markets. We expect that our results will continue to benefit from favorable industry trends in the long-term, including growth in the installed base of pools, robust demand and heightened consumer interest in enhanced pool customizations. The following factors impacted our sales (listed in order of estimated magnitude): • inflationary product cost increases of approximately 10% to 11% (compared to our historical average of 1% to 2%); • favorable trends for our products including: ◦ strong demand for discretionary products, as evidenced by sales growth for product offerings such as equipment and building materials (see discussion below); ◦ market share gains, including those in building materials (see discussion below); ◦ increased demand for residential swimming pool maintenance supplies, as the installed base of pools continues to grow; • 6% sales growth from recent acquisitions; • 1% sales growth from an extra selling day in the first half of 2022 compared to the first half of 2021; and • challenges presented in 2022 including: ◦ 1% unfavorable impact from currency exchange rate fluctuations; ◦ cooler, wet weather conditions in our seasonal markets (see discussion below); and ◦ unfavorable weather conditions and macroeconomic impacts in Europe (see discussion below). Higher sales for certain product offerings, such as equipment and building materials, indicate continued strong demand in traditionally discretionary areas, such as pool construction, pool remodeling and equipment upgrades. In the first six months of 2022, sales of equipment, which includes swimming pool heaters, pumps, lights, filters and automation, increased approximately 12% compared to the same period last year. Equipment collectively represented 27% of net sales in the first six months of 2022. Sales of building materials grew 25% compared to the first six months of 2021 and represented approximately 13% of net sales in the first six months of 2022. Sales of chemicals, representing 11% of total net sales, increased 35% compared to the first six months of 2021. The increase in chemical sales was driven by inflation, improved supply and strong demand for non-discretionary maintenance products. Sales to specialty retailers that sell swimming pool supplies and customers who service large commercial installations are included in the appropriate existing product categories, and growth in these areas is reflected in the discussion above. In the first six months of 2022, sales to retail customers increased 13% compared to the first six months of 2021 and represented approximately 12% of our consolidated net sales. Certain of our retail customers were adversely impacted by unfavorable weather conditions in the second quarter, hindering sales growth. Sales to commercial customers increased 27% in the first six months of 2022 compared to the first six months of 2021 and represented approximately 4% of our consolidated net sales in the first six months of 2022. Net sales in our seasonal markets (not considering Europe), representing 47% of our total base business net sales in the first half of 2022, increased 16% compared to the first half of 2021. Comparatively, net sales in our year-round markets, representing 48% of our total base business net sales in the first half of 2022, increased 20% compared to the first half of 2021. Net sales in Europe, representing 5% of our total net sales in the first half of 2022, were flat in local currency compared to 49% growth in the first half of 2021. While we estimate that net sales in Europe benefited 10% from inflationary product cost increases, our results were negatively impacted by a decline in volume growth driven by macroeconomic uncertainty and poor weather. 21 Gross Profit Six Months Ended June 30, (in millions) 2022 2021 Change Gross profit $ 1,114.0 $ 852.8 $ 261.2 31% Gross margin 32.1 % 29.9 % Gross margin improved 220 basis points to 32.1% in the six months ended June 30, 2022 compared to 29.9% in the first six months of 2021. This improvement reflects focused supply chain management initiatives to address inflation, increased pricing and benefits from our recent acquisitions. Operating Expenses Six Months Ended June 30, (in millions) 2022 2021 Change Selling and administrative expenses $ 459.4 $ 385.2 $ 74.2 19% Operating expenses as a % of net sales 13.2 % 13.5 % Operating expenses for the six months ended June 30, 2022 increased 19% compared to the first six months of 2021, including a 1% benefit from currency exchange rate fluctuations. Our operating expenses have increased to support our business growth, including recent acquisitions. Our expense growth reflects increases in growth-driven labor, facility and freight costs, along with increased investments in technology and higher performance-based compensation. Interest and Other Non-Operating Expenses, Net Interest and other non-operating expenses, net for the first six months of 2022 increased $9.2 million compared to the same period last year, primarily due to higher average debt levels between periods. Our average outstanding debt was $1.4 billion for the first six months of 2022 versus $387.1 million for the same period of 2021. Our weighted average effective interest rate decreased to 1.8% from 2.5% for the respective periods. Income Taxes Our effective income tax rate was 24.1% for the six months ended June 30, 2022 compared to 22.6% for the six months ended June 30, 2021. We recorded a $8.9 million, or $0.22 per diluted share, tax benefit from ASU 2016-09 in the six months ended June 30, 2022 compared to a $11.7 million, or $0.29 per diluted share, tax benefit in the same period of 2021. Without the benefits from ASU 2016-09, our effective tax rate was 25.5% for the six months ended June 30, 2022 and 25.2% for the six months ended June 30, 2021. Net Income and Earnings Per Share Net income increased 36% to $486.5 million for the six months ended June 30, 2022 compared to the six months ended June 30, 2021. Earnings per diluted share increased 37% to $12.03 for the six months ended June 30, 2022 versus $8.78 per diluted share for the six months ended June 30, 2021. Without the impact from ASU 2016-09 in both periods, earnings per diluted share increased 39% to $11.81 for the six months ended June 30, 2022 compared to $8.49 for the six months ended June 30, 2021. See the reconciliation of GAAP to non-GAAP measures below. 22 Reconciliation of Non-GAAP Financial Measures Adjusted Diluted EPS We have included adjusted diluted EPS, a non-GAAP financial measure, as a supplemental disclosure, because we believe this measure is useful to investors and others in assessing our period-to-period operating performance. Adjusted diluted EPS is a key measure used by management to demonstrate the impact of tax benefits from ASU 2016-09 on our diluted EPS and to provide investors and others with additional information about our potential future operating performance to supplement GAAP measures. We believe this measure should be considered in addition to, not as a substitute for, diluted EPS presented in accordance with GAAP, and in the context of our other disclosures within this Form 10-Q. Other companies may calculate this non-GAAP financial measure differently than we do, which may limit its usefulness as a comparative measure. The table below presents a reconciliation of diluted EPS to adjusted diluted EPS. (Unaudited) Three Months Ended Six Months Ended June 30, June 30, 2022 2021 2022 2021 Diluted EPS $ 7.63 $ 6.37 $ 12.03 $ 8.78 ASU 2016-09 tax benefit (0.04) (0.19) (0.22) (0.29) Adjusted diluted EPS $ 7.59 $ 6.18 $ 11.81 $ 8.49 23 Seasonality and Quarterly Fluctuations Our business is seasonal. In general, sales and operating income are highest during the second and third quarters, which represent the peak months of both swimming pool use and installation and irrigation and landscape installations and maintenance. Sales are lower during the first and fourth quarters. In 2021, we generated approximately 60% of our net sales and 69% of our operating income in the second and third quarters of the year. We typically experience a build-up of product inventories and accounts payable during the winter months in anticipation of the peak selling season. Excluding borrowings to finance acquisitions and share repurchases, our peak borrowing usually occurs during the second quarter, primarily because extended payment terms offered by our suppliers typically are payable in April, May and June, while our peak accounts receivable collections typically occur in June, July and August. The following table presents certain unaudited quarterly data for the first and second quarters of 2022, the four quarters of 2021 and the third and fourth quarters of 2020. We have included income statement and balance sheet data for the most recent eight quarters to allow for a meaningful comparison of the seasonal fluctuations in these amounts. In our opinion, this information reflects all normal and recurring adjustments considered necessary for a fair presentation of this data. The results of any one or more quarters are not necessarily a good indication of results for an entire fiscal year or of continuing future trends for a variety of reasons, including the seasonal nature of our business, the recent pandemic-driven increased demand for our products and the impact of new and acquired sales centers. (Unaudited) QUARTER (in thousands) 2022 2021 2020 Second First Fourth Third Second First Fourth Third Statement of Income Data Net sales $ 2,055,818 $ 1,412,650 $ 1,035,557 $ 1,411,448 $ 1,787,833 $ 1,060,745 $ 839,261 $ 1,139,229 Gross profit 666,804 447,189 322,376 441,899 551,685 301,131 239,095 328,698 Operating income 418,888 235,723 127,891 237,276 338,586 129,031 74,351 148,233 Net income 307,283 179,261 107,609 184,665 259,695 98,655 59,174 119,098 Balance Sheet Data Total receivables, net $ 756,585 $ 679,927 $ 376,571 $ 476,150 $ 585,566 $ 487,602 $ 289,200 $ 366,412 Product inventories, net 1,579,101 1,641,155 1,339,100 1,043,407 894,654 977,228 780,989 612,824 Accounts payable 604,225 685,946 398,697 414,156 439,453 634,998 266,753 268,412 Total debt 1,595,398 1,505,073 1,183,350 362,819 423,116 433,171 416,018 339,934 We expect that our quarterly results of operations will continue to fluctuate depending on the timing and amount of revenue contributed by new and acquired sales centers. Based on our peak summer selling season, we generally open new sales centers and close or consolidate sales centers, when warranted, either in the first quarter before the peak selling season begins or in the fourth quarter after the peak selling season ends. 24 Weather is one of the principal external factors affecting our business. The table below presents some of the possible effects resulting from various weather conditions. Weather Possible Effects Hot and dry • Increased purchases of chemicals and supplies for existing swimming pools • Increased purchases of above-ground pools and irrigation and lawn care products Unseasonably cool weather or extraordinary amounts • Fewer pool and irrigation and landscape of rain installations • Decreased purchases of chemicals and supplies • Decreased purchases of impulse items such as above-ground pools and accessories Unseasonably early warming trends in spring/late cooling • A longer pool and landscape season, thus positively trends in fall impacting our sales (primarily in the northern half of the U.S. and Canada) Unseasonably late warming trends in spring/early cooling • A shorter pool and landscape season, thus negatively trends in fall impacting our sales (primarily in the northern half of the U.S. and Canada) Weather Impacts on 2022 and 2021 Results We observed unfavorable weather conditions in certain markets throughout the second quarter of 2022. Heavy rainfall and cooler temperatures throughout the northeastern United States and Canada resulted in slower sales activity and limited sales growth in the second quarter of 2022. Additionally, results in Europe continued to be impacted by unfavorable weather conditions. In contrast, our southern markets benefited from above-average temperatures, particularly in Texas. In the second quarter of 2021, overall weather conditions favorably impacted sales growth with the average U.S. temperature in June 2021 being the hottest on record in 127 years. Overall, weather conditions in the first quarter of 2022 were less favorable than weather conditions in the first quarter of 2021. Sales benefited from above-average temperatures along much of the west and the east coast, although Texas experienced cooler-than-normal temperatures. In addition, some seasonal markets had unfavorable weather compared to the first quarter of 2021 when construction activity started earlier than normal. Similarly, results in Europe were hindered by unfavorable weather conditions. In the first quarter of 2021, sales benefited from favorable and generally mild weather conditions throughout the contiguous United States. In February 2021, Texas experienced the most costly winter storm event on record for the United States, which damaged many swimming pools and added to already strong replacement activity . CRITICAL ACCOUNTING ESTIMATES We prepare our Consolidated Financial Statements in accordance with U.S. generally accepted accounting principles (GAAP), which require management to make estimates and assumptions that affect reported amounts and related disclosures. Management identifies critical accounting estimates as: • those that require the use of assumptions about matters that are inherently and highly uncertain at the time the estimates are made; and • those for which changes in the estimates or assumptions, or the use of different estimates and assumptions, could have a material impact on our consolidated results of operations or financial condition. Management has discussed the development, selection and disclosure of our critical accounting estimates with the Audit Committee of our Board. For a description of our critical accounting estimates that require us to make the most difficult, subjective or complex judgments, please see our 2021 Annual Report on Form 10-K. We have not changed any of these policies from those previously disclosed in that report. 25 Recent Accounting Pronouncements See Note 1 of “Notes to Consolidated Financial Statements,” included in Part I, Item 1 of this Form 10-Q for discussion of recent accounting pronouncements. LIQUIDITY AND CAPITAL RESOURCES Liquidity is defined as the ability to generate adequate amounts of cash to meet short-term and long-term cash needs. We assess our liquidity in terms of our ability to generate cash to fund our operating activities, taking into consideration the seasonal nature of our business. Significant factors which could affect our liquidity include the following: • cash flows generated from operating activities; • the adequacy of available bank lines of credit; • the quality of our receivables; • acquisitions; • dividend payments; • capital expenditures; • changes in income tax laws and regulations; • the timing and extent of share repurchases; and • the ability to attract long-term capital with satisfactory terms. Our primary capital needs are seasonal working capital obligations, debt repayment obligations and other general corporate initiatives, including acquisitions, opening new sales centers, dividend payments and share repurchases. Our primary working capital obligations are for the purchase of inventory, payroll, rent, other facility costs and selling and administrative expenses. Our working capital obligations fluctuate during the year, driven primarily by seasonality and the timing of inventory purchases. Our primary sources of working capital are cash from operations supplemented by bank borrowings, which have historically been sufficient to support our growth and finance acquisitions. We have funded our capital expenditures and share repurchases in substantially the same manner. We prioritize our use of cash based on investing in our business, maintaining a prudent capital structure and returning cash to our shareholders through dividends and share repurchases. Our specific priorities for the use of cash are as follows: • capital expenditures primarily for maintenance and growth of our sales center network, technology-related investments and fleet vehicles; • investing in inventory and funding other operating expenses; • strategic acquisitions executed opportunistically; • payment of cash dividends as and when declared by our Board; • repayment of debt to maintain an average total target leverage ratio (as defined below) between 1.5 and 2.0; and • repurchases of our common stock under our Board-authorized share repurchase program. We focus our capital expenditure plans principally on the needs of our sales centers, and in recent years have increased our spending on information technology. We project capital expenditures in 2022 will approximate our historical average of 1.0% of net sales. Capital expenditures were 0.7% of net sales in 2021, 0.6% of net sales in 2020 and 1.0% of net sales in 2019 and have averaged roughly 1.0% of net sales over the past five years. Sources and Uses of Cash The following table summarizes our cash flows (in thousands): Six Months Ended June 30, 2022 2021 Operating activities $ 28,731 $ 187,228 Investing activities (27,431) (32,495) Financing activities 64,643 (131,061) 26 Net cash provided by operations was $28.7 million for the first six months of 2022 compared to $187.2 million for the first six months of 2021. The decrease in our operating cash flows was driven by federal tax payments of $79.5 million in 2022, which were allowed to be deferred and included in accrued expenses and other liabilities at December 31, 2021. Additional impacts relate to growth-driven working capital outflows, including increased inventory purchases, which were largely offset by an increase in net income. Net cash used in investing activities for the first six months of 2022 decreased compared to the first six months of 2021 due to a decrease in cash used for the acquisition of businesses of $7.5 million, offset by an increase in capital expenditures of $2.5 million. Net cash provided by financing activities increased $195.7 million to $64.6 million for the first six months of 2022 compared to net cash used in financing activities of $131.1 million for the first six months of 2021. The increase in cash provided by financing activities reflects a $404.7 million increase in net debt proceeds, partially offset by a $188.5 million increase in share repurchases and an increase in dividends paid of $16.6 million. Future Sources and Uses of Cash Credit Facility Our Credit Facility, as amended on December 30, 2021, provides for $1.25 billion in borrowing capacity consisting of a $750.0 million five-year unsecured revolving credit facility and a $500.0 million term loan facility. The Credit Facility includes a $750.0 million revolving credit facility and sublimits for the issuance of swingline loans and standby letters of credit. The term loans require quarterly amortization payments aggregating to 20% of the original principal amount of the loan during the third, fourth and fifth years of the loan, with all remaining principal due on the Credit Facility maturity date of September 25, 2026. We intend to continue to use the Credit Facility for general corporate purposes, for future share repurchases and to fund future growth initiatives. At June 30, 2022, there was $566.2 million of revolving borrowings outstanding, a $500.0 million term loan, a $4.8 million standby letter of credit outstanding and $179.0 million available for borrowing under the Credit Facility. Currently, we pay interest on revolving and term loan 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, 2022 was approximately 2.6%, excluding commitment fees. Term Facility Our Term Facility, as amended on October 12, 2021, provides for $185.0 million in borrowing capacity and matures on December 30, 2026. Proceeds from the Term Facility were used to pay down the Credit Facility in December 2019, adding borrowing capacity for future share repurchases, acquisitions and growth-oriented working capital expansion. The Term Facility is 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. We classify the entire outstanding balance as Long-term debt on our Consolidated Balance Sheets as we intend and have the ability to refinance the obligations on a long-term basis. 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. We may prepay amounts outstanding under the Term Facility without penalty other than interest breakage costs. At June 30, 2022, there was $161.9 million outstanding under the Term Facility with a weighted average effective interest rate of 2.8%. We pay interest on borrowings under the Term Facility at a variable rate based on the one month LIBOR, plus an applicable margin. Receivables Securitization Facility Our two-year accounts receivable securitization facility (the Receivables Facility) offers us a lower-cost form of financing. Under this facility, we can borrow up to $350.0 million between April through June and from $175.0 million to $315.0 million during the remaining months of the year. The Receivables Facility matures on November 1, 2023. We classify the entire outstanding balance as Long-term debt on our Consolidated Balance Sheets as we intend and have the ability to refinance the obligations on a long-term basis. 27 The Receivables Facility provides for the sale of certain of our receivables to a wholly-owned subsidiary (the Securitization Subsidiary). The Securitization Subsidiary transfers variable undivided percentage interests in the receivables and related rights to certain third-party financial institutions in exchange for cash proceeds, limited to the applicable funding capacities. Upon payment of the receivables by customers, rather than remitting to the financial institutions the amounts collected, we retain such collections as proceeds for the sale of new receivables until payments become due. The Receivables Facility contains terms and conditions (including representations, covenants and conditions precedent) customary for transactions of this type. Additionally, an amortization event will occur if we fail to maintain a maximum average total leverage ratio (average total funded debt/EBITDA) of 3.25 to 1.00 and a minimum fixed charge coverage ratio (EBITDAR/cash interest expense plus rental expense) of 2.25 to 1.00. At June 30, 2022, there was $350.0 million outstanding under the Receivables Facility at a weighted average effective interest rate of 2.5%, excluding commitment fees. Financial Covenants 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, 2022, the calculations of these two covenants are detailed below: • Maximum Average Total Leverage Ratio . On the last day of each fiscal quarter, our average total leverage ratio must be less than 3.25 to 1.00. Average Total Leverage Ratio is the ratio of the trailing twelve months (TTM) Average Total Funded Indebtedness plus the TTM Average Accounts Securitization Proceeds divided by the TTM EBITDA (as those terms are defined in the Credit Facility). As of June 30, 2022, our average total leverage ratio equaled 1.15 (compared to 1.06 as of March 31, 2022) and the TTM average total indebtedness amount used in this calculation was $1.2 billion. • Minimum Fixed Charge Coverage Ratio . On the last day of each fiscal quarter, our fixed charge ratio must be greater than or equal to 2.25 to 1.00. Fixed Charge Ratio is the ratio of the TTM EBITDAR divided by TTM Interest Expense paid or payable in cash plus TTM Rental Expense (as those terms are defined in the Credit Facility). As of June 30, 2022, our fixed charge ratio equaled 12.22 (compared to 12.38 as of March 31, 2022) and TTM Rental Expense was $75.4 million. The Credit Facility and Term Facility limit the declaration and payment of dividends on our common stock to a manner consistent with past practice, provided no default or event of default has occurred and is continuing, or would result from the payment of dividends. We may declare and pay quarterly dividends so long as (i) the amount per share of such dividends is not greater than the most recently publicly announced amount of dividends per share and (ii) our Average Total Leverage Ratio is less than 3.25 to 1.00 both immediately before and after giving pro forma effect to such dividends. Under the Credit Facility and Term Facility, we may repurchase shares of our common stock provided no default or event of default has occurred and is continuing, or would result from the repurchase of shares, and our maximum average total leverage ratio (determined on a pro forma basis) is less than 3.25 to 1.00. Other covenants in each of our credit facilities include restrictions on our ability to grant liens, incur indebtedness, make investments, merge or consolidate, and sell or transfer assets. Failure to comply with any of our financial covenants or any other terms of our credit facilities could result in, among other things, higher interest rates on our borrowings or the acceleration of the maturities of our outstanding debt. Interest Rate Swaps We utilize interest rate swap contracts and forward-starting interest rate swap contracts to reduce our exposure to fluctuations in variable interest rates for future interest payments on our variable rate borrowings. 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, 2022, we had three interest rate swap contracts in place and two forward-starting interest rate swap contracts, each of which has the effect of converting our exposure to variable interest rates on our variable rate borrowings to fixed interest rates. For more information, see Note 4 of “Notes to Consolidated Financial Statements” included in Part I, Item 1 of this Form 10-Q. 28 Compliance and Future Availability As of June 30, 2022, we were in compliance with all material 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 material 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 2021 Annual Report on Form 10-K, as updated by Note 5 of “Notes to Consolidated Financial Statements,” included 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. We continually evaluate potential acquisitions and hold discussions with acquisition candidates. If suitable acquisition opportunities arise that would require financing, we believe that we would have the ability to finance any such transactions. As of July 25, 2022, $422.8 million of the current Board-authorized amount under our share repurchase program remained available. We expect to repurchase shares on the open market from time to time depending on market conditions. We plan to fund these repurchases with cash provided by operations and borrowings under the above-described credit facilities. 29