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Item 2. Management’s Discussion and Analysis

2023-07-27 compared with 2023-04-27 · 174 added, 144 removed, 195 unchanged (62% of the section changed)

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 2022 Annual Report on Form 10-K and with Management’s Discussion and Analysis in our 2022 Annual Report on Form 10-K.

For a discussion of our base business calculations, see the Results of Operations section below.

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 2022 Annual Report on Form 10-K and Management’s Discussion and Analysis in our 2022 Annual Report on Form 10-K.

Forward-Looking Statements

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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 the sensitivity of our business to weather conditions;

changes in the economic conditions, consumer discretionary spending, the housing market, inflation or interest rates;

changes in economic conditions, consumer discretionary spending, the housing market, inflation or interest rates;

our ability to maintain favorable relationships with suppliers and manufacturers;

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Financial Results

In the first quarter of 2023, differing weather conditions contributed to variability in our results across geographies.

Our southern markets experienced more typical weather during the quarter and generated encouraging results.

However, higher precipitation and cooler temperatures suppressed results in our western markets, hampering new pool construction activities and sales of maintenance-related products.

These conditions continued into late March where we saw a considerable impact on our biggest sales month of the quarter.

Net sales decreased 15% in the first quarter of 2023 to $1.2 billion compared to $1.4 billion in the first quarter of 2022 following 33% net sales growth in the first quarter of 2022 and 57% growth in the first quarter of 2021.

Weather conditions were generally favorable in our southern markets, where Texas and Florida, our two largest markets in the South, realized combined base business sales in line with 2022.

In contrast, results were unfavorably impacted by unusually wet and cold weather in the western U.S., including California and Arizona, two of our largest markets, where base business sales were down a combined 21% from last year.

We estimate that sales were also negatively impacted 2% from lower customer early buy activity in the first quarter of 2023 versus the first quarter of 2022 and 1% from continued softness in our European markets.

Gross profit decreased 17% to $369.8 million in the first quarter of 2023 from $447.2 million in the same period of 2022.

Consistent with our expectations, gross margin decreased 110 basis points to 30.6% in the first quarter of 2023 compared to 31.7% in the first quarter of 2022.

Selling and administrative expenses (operating expenses) increased 6% to $224.0 million in the first quarter of 2023 compared to $211.5 million in the first quarter of 2022.

Our largest expense growth drivers during the quarter related to higher rent and facility costs, the return of in-person customer-facing retail events and investments in customer-focused projects.

As a percentage of net sales, operating expenses increased to 18.6% in the first quarter of 2023 compared to 15.0% in the same period of 2022.

Operating income in the first quarter of 2023 decreased 38% to $145.8 million from a tough comparison of $235.7 million in the same quarter last year but was 13% higher than operating income in the first quarter of 2021 of $129.0 million.

Operating margin was 12.1% in the first quarter of 2023 compared to 16.7% in the first quarter of 2022.

Interest and other non-operating expenses, net for the first quarter of 2023 increased $10.6 million compared to the first quarter of 2022, primarily reflecting higher average interest rates between periods.

We recorded a $4.8 million tax benefit from Accounting Standards Update (ASU) 2016-09, Improvements to Employee Share-Based Payment Accounting , in the quarter ended March 31, 2023, compared to a tax benefit of $7.3 million realized in the same period of 2022.

This resulted in a $0.12 per diluted share tax benefit compared to an $0.18 per diluted share tax benefit realized in the same period of 2022.

Net income decreased 43% to $101.7 million in the first quarter of 2023 compared to $179.3 million in the first quarter of 2022.

Earnings per diluted share decreased 41% to $2.58 in the first quarter of 2023 compared to $4.41 in the same period of 2022.

Without the impact from ASU 2016-09 in both periods, earnings per diluted share decreased 42% to $2.46 compared to $4.23 in the first quarter of 2022.

A slow start to the swimming pool season combined with cautious consumer sentiment resulted in net sales of $1.9 billion in the second quarter of 2023, a decrease of 10% compared to $2.1 billion in the second quarter of 2022.

This decrease in net sales follows 15% net sales growth in the second quarter of 2022 and 40% net sales growth in the second quarter of 2021.

From 2019 to 2023, our second quarter net sales grew at a compound annual growth rate (“CAGR”) of 13%.

Our results in the second quarter of 2023 reflect challenging macro trends and negative impacts from cooler weather at the beginning of the quarter across many of our markets.

These conditions led to slower maintenance activity than anticipated, reduced outdoor living construction activity and deferred discretionary replacement activity.

Gross profit decreased 15% to $567.8 million in the second quarter of 2023 from $666.8 million in the same period of 2022.

Our gross profit increased at a 15% CAGR from the second quarter of 2019 to the second quarter of 2023.

Consistent with our expectations, gross margin decreased 180 basis points to 30.6% in the second quarter of 2023 compared to 32.4% in the second quarter of 2022.

Selling and administrative expenses (operating expenses) decreased 3% to $240.8 million in the second quarter of 2023 compared to $247.9 million in the second quarter of 2022 as we managed variable expenses with reduced sales volumes.

As a percentage of net sales, operating expenses increased to 13.0% in the second quarter of 2023 compared to 12.1% in the same period of 2022.

While operating income in the second quarter of 2023 decreased 22% to $327.0 million from a record high of $418.9 million in the second quarter of 2022, operating income increased at a 17% CAGR from the second quarter of 2019 to the second quarter of 2023.

Operating margin was 17.6% in the second quarter of 2023 compared to 20.4% in the second quarter of 2022.

Interest and other non-operating expenses, net for the second quarter of 2023 increased $8.4 million compared to the second quarter of 2022, primarily reflecting higher average interest rates.

We recorded a $0.6 million tax benefit from Accounting Standards Update (ASU) 2016-09, Improvements to Employee Share-Based Payment Accounting , in the quarter ended June 30, 2023, compared to a tax benefit of $1.6 million realized in the same period of 2022.

This resulted in a $0.02 per diluted share tax benefit in the second quarter of 2023 compared to a $0.04 per

diluted share tax benefit realized in the same period of 2022.

Net income decreased 24% to $232.3 million in the second quarter of 2023 compared to $307.3 million in the second quarter of 2022.

Earnings per diluted share decreased 23% to $5.91 in the second quarter of 2023 compared to $7.63 in the same period of 2022.

Without the impact from ASU 2016-09 in both periods, earnings per diluted share decreased 22% to $5.89 compared to $7.59 in the second quarter of 2022.

Our earnings per diluted share increased at a 16% CAGR from the second quarter of 2019 to the second quarter of 2023 and an 18% CAGR without the impact of ASU 2016-19 over the same period.

See RESULTS OF OPERATIONS below for definitions of our non-GAAP measures and reconciliations of our non-GAAP measures to GAAP measures.

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.

Financial Position and Liquidity

As of March 31, 2023, total net receivables, including pledged receivables, decreased 17% compared to March 31, 2022, driven by our sales trends.

Our days sales outstanding (DSO), as calculated on a trailing four quarters basis, was 26.5 days at March 31, 2023 and 26.4 days at March 31, 2022.

Our allowance for doubtful accounts balance was $9.0 million at March 31, 2023 and $6.0 million at March 31, 2022.

Net inventory levels increased 3% compared to levels at March 31, 2022, which compares to the 19% increase that we reported as of December 31, 2022 (compared to December 31, 2021).

We are pleased with the progress in utilizing our strategic inventory buys and believe that we are appropriately stocked to ensure product availability during the swimming pool season and to support our new locations.

Our inventory reserve was $24.5 million at March 31, 2023 and $19.8 million at March 31, 2022.

Our inventory turns, as calculated on a trailing four quarters basis, were 2.5 times at March 31, 2023 and 3.1 times at March 31, 2022.

Total debt outstanding at March 31, 2023 was $1.4 billion compared to $1.5 billion at March 31, 2022 as we have used operating cash flows to make payments on our debt balances.

We have utilized debt proceeds over the past twelve months primarily to fund share repurchases and investments in working capital.

As of June 30, 2023, total net receivables, including pledged receivables, decreased 17% compared to June 30, 2022, primarily due to lower sales.

Our days sales outstanding (DSO), as calculated on a trailing four quarters basis, was 26.2 days at June 30, 2023 and 27.2 days at June 30, 2022.

Our allowance for doubtful accounts balance was $10.1 million at June 30, 2023 and $6.5 million at June 30, 2022.

Net inventory levels of $1.4 billion decreased $186.2 million, or 12%, compared to June 30, 2022.

This decrease also compares to our March 31, 2023 net inventory balance of $1.7 billion, which was 3% higher than March 31, 2022.

This ongoing improvement reflects progress toward reducing our inventory balance following prior year strategic purchases made to mitigate supply chain challenges.

Our inventory reserve was $25.4 million at June 30, 2023 and $20.9 million at June 30, 2022.

Our inventory turns, as calculated on a trailing four quarters basis, were 2.5 times at June 30, 2023 and 2.8 times at June 30, 2022.

Total debt outstanding at June 30, 2023 was $1.2 billion compared to $1.6 billion at June 30, 2022 down $410.8 million from June 30, 2022 and $202.2 million lower than December 31, 2022, as we have used operating cash flows to reduce our debt.

Our debt proceeds over the past twelve months have been utilized primarily to fund share repurchases, dividends, capital expenditures and acquisitions.

Current Trends and Outlook

For a detailed discussion of trends through 2022, see the Current Trends and Outlook section of Management’s Discussion and Analysis included in Part II, Item 7 of our 2022 Annual Report on Form 10-K.

Based on our results to-date and trends observed into the second quarter, we now expect sales for the full year of 2023 to be down in the mid-single digits compared to 2022 versus the flat to down 3% from our initial projections disclosed in our 2022 Annual Report on Form 10-K.

Our 2022 Annual Report on Form 10-K outlines the details of our initial projections.

Our overall expectations related to renovation and remodel activity, our Horizon business, and European business remain relatively unchanged.

However, we now believe that it is possible that new pool construction could decline up to 30% based on less available buildable days and current permit trends.

Maintenance revenue is also expected to see a 1% lower increase than previously expected, from the use of less consumables stemming from the unfavorable weather in the first quarter.

As previously disclosed in our 2022 Annual Report on Form 10-K, we project gross margin for the full year of 2023 to be in line with our long-term outlook of approximately 30.0% with higher gross margin in the first half of 2023 compared to the latter half of the year as we sell through inventory purchased prior to recent price increases.

We plan to leverage our existing infrastructure and manage discretionary spending to limit expense growth between plus or minus 2% compared to the full year of 2022.

We project that our annual effective tax rate (without the benefit from ASU 2016-09) for 2023 will approximate 25.3% to 25.5%.

For a detailed discussion of trends impacting us through 2022, see the Current Trends and Outlook section of Management’s Discussion and Analysis included in Part II, Item 7 of our 2022 Annual Report on Form 10-K.

Based on our results to date and trends observed through the first half of 2023, we now expect sales for the full year of 2023 to be down in the range of around 10% compared to 2022 versus our expectation of a mid-single digit decline disclosed in our First Quarter 2023 Report on Form 10-Q.

Considering the slower than expected start to the pool season and greater visibility as the season progresses, we believe the possible trends outlined in our First Quarter 2023 Report on Form 10-Q for new pool construction and repair and remodel will fall to the lower end of the sales ranges.

Further, the slower start resulted in reduced revenues for maintenance needs, such as chemicals, further leading us to reduce our sales expectations for the full year.

As previously disclosed in our 2022 Annual Report on Form 10-K, we project gross margin for the full year of 2023 to be in line with our long-term outlook of approximately 30.0% with higher gross margin in the first half of 2023 compared to the latter half of the year as we sold through most of our prior year strategic inventory purchases in the first half of the year.

We plan to leverage our existing infrastructure and manage discretionary spending to limit operating expense growth to 1% compared to the full year of 2022, not considering any acquisitions that may arise in the second half of the year.

We project that our annual effective tax rate (without the benefit from ASU 2016-09) for 2023 will approximate our 2022 annual tax rate of 25.2%.

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 $4.8 million, or $0.12 per diluted share, tax benefit from ASU 2016-09 for the three months ended March 31, 2023.

We recorded a $5.4 million, or $0.14 per diluted share, tax benefit from ASU 2016-09 for the six months ended June 30, 2023.

We may recognize additional tax benefits related to stock option exercises in 2023 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 March 31, 2023.

We have not included any expected tax benefits in our guidance beyond what we have recognized as of June 30, 2023.

We expect 2023 diluted EPS in the range of $13.14 to $14.14, including the impact of year-to-date tax benefits of $0.14.

We expect to continue to use cash for the payment of cash dividends as and when declared by our Board and to fund opportunistic share repurchases through the remainder of 2023.

expect to continue to use cash for the payment of cash dividends as and when declared by our Board of Directors (Board) and to fund opportunistic share repurchases through the remainder of 2023.

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.

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RESULTS OF OPERATIONS

As of March 31, 2023, we conducted operations through 427 sales centers in North America, Europe and Australia.

For the three months ended March 31, 2023, approximately 95% of our net sales were from our operations in North America.

As of June 30, 2023, we conducted operations through 432 sales centers in North America, Europe and Australia.

For the six months ended June 30, 2023, 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

Three Months Ended Six Months Ended

June 30, June 30,

2023 2022 2023 2022

Net sales 100.0 % 100.0 % 100.0 % 100.0 %

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We have included the results of operations from acquisitions in 2023 and 2022 in our consolidated results since the acquisition dates.

Three Months Ended March 31, 2023 Compared to Three Months Ended March 31, 2022

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

March 31, March 31, March 31,

2023 2022 2023 2022 2023 2022

Three Months Ended June 30, 2023 Compared to Three Months Ended June 30, 2022

Three Months Ended

(in millions) 2023 2022 Change

Net sales $ 1,857.4 $ 2,055.8 $ (198.4) (10)%

Following 15% net sales growth in the second quarter of 2022 and 40% net sales growth in the second quarter of 2021 (in both cases compared to the prior year quarter), net sales of $1.9 billion in the second quarter of 2023 were down 10% compared to the second quarter of 2022.

From 2019 to 2023, our second quarter net sales grew at a CAGR of 13%.

Our results in the current quarter reflect challenging macro trends and negative impacts from cooler weather at the beginning of the quarter across many of our markets.

These conditions led to slower maintenance activity than anticipated, reduced outdoor living construction activity and deferred discretionary replacement activity.

The following factors also impacted our sales during the quarter and are listed in order of estimated magnitude.

• Net sales benefited approximately 3% to 4% from inflationary product cost increases, which compares to a benefit of 10% to 11% in the second quarter of 2022.

• We estimate that unfavorable weather conditions in the second quarter negatively impacted sales by approximately $30.0 million.

• Sales were also negatively impacted 1% from lower customer early buy activity in the second quarter of 2023 versus the second quarter of 2022.

Related to our product sales, following a period of significant growth over the past three years, we observed a period-over-period decline in volumes of discretionary products sold as new construction activities moderated.

In the second quarter of 2023, sales of equipment, which includes swimming pool heaters, pumps, lights, filters and automation, decreased 8% compared to the same period last year, and collectively represented approximately 27% of net sales for the period.

Sales of building materials decreased 8% compared to the second quarter of 2022 and represented approximately 12% of net sales in the second quarter of 2023.

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 sales trends in these areas are reflected in the discussion above.

Sales to retail customers decreased 11% in the second quarter of 2023 compared to the second quarter of 2022 and represented approximately 15% of our total net sales.

As consumers take advantage of travel opportunities, sales to commercial swimming pool customers increased 8% in the second quarter of 2023 compared to the second quarter of 2022 and represented approximately 4% of our net sales for the second quarter of 2023.

Three Months Ended

(in millions) 2023 2022 Change

Gross profit $ 567.8 $ 666.8 $ (99.0) (15)%

Gross margin 30.6 % 32.4 %

Gross margin decreased 180 basis points to 30.6% in the second quarter of 2023 compared to the second quarter of 2022 when gross margin increased 150 basis points (over the same period in 2021) to 32.4%.

Our prior year gross margin benefited from higher levels of inflation and price increases, while gross margin in the second quarter of 2023 began to trend more in line with our longer-term annual gross margin outlook of 30.0%.

Gross margin in the second quarter of 2023 reflects a seasonal benefit that is typical for the second quarter.

Operating Expenses

Expenses as a % of net sales 18.1 % 14.6 % 24.9 % 20.8 % 18.6 % 15.0 %

Operating income 134,675 220,258 11,096 15,465 145,771 235,723

Operating margin 11.9 % 16.5 % 14.5 % 20.6 % 12.1 % 16.7 %

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

Sales Centers

Pro-Water Irrigation & Landscape Supply, Inc.

March 2023 2 March 2023

Tri-State Pool Distributors April 2022 1 January - March 2023

Porpoise Pool & Patio, Inc.

December 2021 1 January - March 2023 and January - March 2022

Wingate Supply, Inc.

December 2021 1 January - February 2023 and January - February 2022

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 three months of 2023:

Three Months Ended

(in millions) 2023 2022 Change

Selling and administrative expenses $ 240.8 $ 247.9 $ (7.1) (3)%

Operating expenses as a % of net sales 13.0 % 12.1 %

Operating expenses decreased 3% in the second quarter of 2023 compared to the second quarter of 2022.

During the second quarter, we were able to better offset inflationary expense increases with productivity actions.

Our operating expenses reflect lower employee-related costs, variable and discretionary expenses and reduced delivery and vehicle operating costs.

Employee-related expenses were down 10% from the second quarter of 2022, primarily reflecting lower performance-based compensation expense and controlled overtime and temporary employee pay with lower sales volumes.

Freight related costs declined due to lower fuel costs and lower sales.

These expense decreases were partially offset by higher building and insurance costs between periods related to inflation and the expansion of our network.

Interest and Other Non-Operating Expenses, Net

Interest and other non-operating expenses, net for the second quarter of 2023 increased $8.4 million compared to the second quarter of 2022, primarily due to higher average interest rates between periods.

Our weighted average effective interest rate increased to 5.2% in the second quarter of 2023 from 2.0% in the second quarter of 2022 on average outstanding debt of $1.3 billion and $1.6 billion for the respective periods.

Our effective income tax rate was 25.1% for both the three months ended June 30, 2023, and the three months ended June 30, 2022.

We recorded a $ 0.6 million tax benefit from ASU 2016-09 in the quarter ended June 30, 2023, compared to a tax benefit of $ 1.6 million realized in the same period last year.

Without the benefit from ASU 2016-09 in both periods, our effective tax rate was 25.4% for the second quarter of 2023 and 25.5% for the second quarter of 2022.

Net Income and Earnings Per Share

Net income decreased 24% to $232.3 million in the second quarter of 2023 compared to $307.3 million in the second quarter of 2022.

Earnings per diluted share decreased 23% to $5.91 in the second quarter of 2023 compared to $7.63 in the same period of 2022.

Without the impact from ASU 2016-09 in both periods, earnings per diluted share decreased 22% to $5.89 in the second quarter of 2023 compared to $7.59 in the second quarter of 2022.

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

Six Months Ended June 30, 2023 Compared to Six Months Ended June 30, 2022

We have not provided separate base business income statements within this Form 10-Q as base business results approximated consolidated results, and acquisitions and sales centers excluded from base business impacted net sales growth less than 1% in the second quarter of 2023.

The table below summarizes the changes in our sales center count during the first six months of 2023:

December 31, 2022 420

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New locations 8

March 31, 2023 427

Three Months Ended

June 30, 2023 432

Six Months Ended

(in millions) 2023 2022 Change

Net sales $ 3,064.1 $ 3,468.5 $ (404.4) (12)%

Net sales and base business net sales decreased 15% in the first quarter of 2023 compared to the first quarter of 2022 following 33% net sales growth in the first quarter of 2022 and 57% growth in the first quarter of 2021.

In the first quarter of 2023, differing weather conditions contributed to variability in our results across geographies.

Our southern markets experienced more typical weather during the quarter and generated encouraging results.

However, higher precipitation and cooler temperatures suppressed results in our western markets, including California and Arizona, two of our largest markets, hampering new pool construction activities and sales of maintenance-related products.

We faced several challenges during the quarter, with unfavorable weather being the most significant.

The following factors impacted our sales during the quarter and are listed in order of estimated magnitude.

• We estimate that unfavorable weather conditions in the first quarter negatively impacted sales by approximately 5%.

• Net sales benefited approximately 4% to 5% from inflationary product cost increases, which compares to a benefit of 10% to 12% in the first quarter of 2022.

• Sales were also negatively impacted 2% from lower customer early buy activity in the first quarter of 2023 versus the first quarter of 2022 and 1% from continued softness in our European markets.

Net sales in our North American seasonal markets, representing 38% of our total base business net sales in the first quarter of 2023, decreased 23% compared to the first quarter of 2022 as these markets are more sensitive to weather conditions, particularly in the shoulders of the season when unfavorable weather delays the openings of swimming pools.

Comparatively, net sales in our year-round markets, representing 57% of our total base business net sales in the first quarter of 2023, decreased 9% compared to the first quarter of 2022 as differing weather conditions led to varied results across our four largest markets.

Weather conditions were generally favorable in our southern markets, where Texas and Florida realized combined base business sales in line with 2022.

In contrast, results were negatively impacted by unusually wet and cold weather in the western U.S., including California and Arizona, where base business sales were down a combined 21% from last year.

Related to our product sales, following a period of significant growth over the past three years, we observed a decline in volumes of discretionary products sold as new construction activities moderated and were further impacted by unfavorable weather conditions and macroeconomic impacts.

This is evidenced by lower sales for product offerings such as equipment and building materials.

In the first quarter of 2023, base business sales of equipment, which includes swimming pool heaters, pumps, lights, filters and automation, decreased 14% compared to the same period last year, and collectively represented approximately 30% of net sales for the period.

Sales of building materials decreased 7% compared to the first quarter of 2022 and represented approximately 14% of net sales in the first quarter of 2023.

Net sales for the first six months of 2023 decreased 12% compared to the same period last year.

Differing weather conditions throughout the first half of 2023 contributed to variability in our results across our geographic markets.

While our southern markets experienced more typical weather during the first quarter of 2023 and generated encouraging results, higher precipitation and cooler temperatures suppressed results in our western markets, including two of our largest markets, California and Arizona.

In the second quarter of 2023, cautious consumer sentiment combined with a slow start to the swimming pool season after unfavorable weather early in the second quarter led to slower maintenance activity than anticipated, reduced outdoor living construction activity and deferred discretionary replacement activity.

The following factors impacted our sales and are listed in order of estimated magnitude.

• Net sales benefited approximately 4% from inflationary product cost increases, which compares to a benefit of 10% to 11% in the first half of 2022.

• We estimate that unfavorable weather conditions in the first half of 2023 negatively impacted sales by approximately 3%.

• Sales were also negatively impacted 2% from lower customer early buy activity in the first half of 2023 versus the first half of 2022.

The impact of differing weather patterns contributed to variability in the results of our markets in the first half of the year.

Net sales in our North American seasonal markets, representing 44% of our net sales in the first six months of 2023, decreased 15% compared to the first six months of 2022 as these markets are more sensitive to weather conditions, particularly in the shoulders of the season when unfavorable weather delays the openings of swimming pools.

Comparatively, net sales in our year-round markets, representing 51% of our net sales in the first six months of 2023, decreased 9% compared to the first six months of 2022.

Related to our product sales, following a period of significant growth over the past three years, we observed a year-over-year decline in volumes of discretionary products sold as new construction activities moderated.

In the first six months of 2023, sales of equipment, which includes swimming pool heaters, pumps, lights, filters and automation, decreased approximately 10% compared to the same period last year and collectively represented 29% of net sales in the first six months of 2023.

Sales of building materials decreased 8% compared to the first six months of 2022 and represented approximately 13% of net sales in the first six months of 2023.

Base business sales to retail customers decreased 16% in the first quarter of 2023 compared to the first quarter of 2022 and represented approximately 10% of our net sales for the first quarter of 2023.

Including the impact of our December 2021 acquisition of Porpoise Pool & Patio, sales to retail customers decreased 12% and represented approximately 14% of our net sales.

Sales to commercial swimming pool customers increased 12% in the first quarter of 2023 compared to the first quarter of 2022 and represented approximately 5% of our net sales for the first quarter of 2023.

Net sales in Europe, representing 4% of our total net sales in the first quarter of 2023, declined 25% compared to the first quarter of 2022, impacted by continued macroeconomic uncertainty from the war in Ukraine and increased fuel prices.

Three Months Ended

Sales to retail customers decreased 12% in the first six months of 2023 compared to the first six months of 2022 and represented approximately 15% of our consolidated net sales.

As consumers take advantage of travel opportunities, sales to commercial customers increased 10% in the first six months of 2023 compared to the first six months of 2022 and represented approximately 4% of our consolidated net sales in the first six months of 2023.

Six Months Ended

(in millions) 2023 2022 Change

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Gross margin 30.6 % 32.1 %

Gross margin decreased 110 basis points to 30.6% in the first quarter of 2023 compared to the first quarter of 2022 when gross margin increased 330 basis points to 31.7% (over the same period in 2021).

Our prior year gross margin benefited from higher levels of inflation and price increases, while gross margin in the first quarter of 2023 began to trend more in line with our longer-term annual gross margin outlook of 30.0%.

Gross margin in the first quarter of 2023 also reflected continued benefits from sales of strategic lower cost inventory purchases ahead of recent vendor price increases.

Gross margin declined 150 basis points to 30.6% in the six months ended June 30, 2023, compared to 32.1% in the first six months of 2022.

Our prior year gross margin benefited from higher levels of inflation and price increases, while gross margin in the first half of 2023 began to trend more in line with our longer-term annual gross margin outlook of 30.0%.

Our gross margin in the first half of 2023 reflected benefits from sales of strategic lower cost inventory purchases ahead of vendor price increases, which was more impactful in the first quarter of 2023 when a higher portion of lower-priced inventory was sold.

Gross margin in the second quarter of 2023 reflected a seasonal benefit that is typical for the period.

Operating Expenses

Three Months Ended

Six Months Ended

(in millions) 2023 2022 Change

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Operating expenses as a % of net sales 15.2 % 13.2 %

Operating expenses increased 6% in the first quarter of 2023 compared to the first quarter of 2022.

Our largest expense growth drivers during the quarter related to higher rent and facility costs, increased labor costs, the return of in-person customer-facing retail events and investments in customer-focused projects.

These increases were partially offset by lower performance-based compensation expense.

Operating expenses for the six months ended June 30, 2023, moderated to a 1% increase over the prior year period following the 6% increase realized in the first quarter of 2023.

During the second quarter, we were able to better offset inflationary expense increases with productivity actions.

Our largest expense growth drivers related to higher rent and facility costs, increased insurance and healthcare-related costs, the return of in-person customer-facing retail events and investments in customer-focused projects.

These increases were largely offset by lower employee-related costs, variable and discretionary expenses and reduced delivery and vehicle operating costs.

Interest and Other Non-Operating Expenses, Net

Interest and other non-operating expenses, net for the first quarter of 2023 increased $10.6 million compared to the first quarter of 2022.

Our weighted average effective interest rate increased to 4.8% in the first quarter of 2023 from 1.5% in the first quarter of 2022 on average outstanding debt of $1.3 billion in both periods.

Our effective income tax rate was 21.8% for the three months ended March 31, 2023 compared to 22.3% for the three months ended March 31, 2022.

We recorded a $4.8 million tax benefit from ASU 2016-09 in the quarter ended March 31, 2023 compared to a tax benefit of $7.3 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 first quarter of 2023 and 25.4% for the first quarter of 2022.

Interest and other non-operating expenses, net for the first six months of 2023 increased $19.0 million compared to the same period last year, primarily due to higher average interest rates between periods.

Our weighted average effective interest rate increased to 5.0% from 1.8% for the respective periods on average outstanding debt of $1.3 billion for the first six months of 2023 versus $1.4 billion for the same period of 2022.

Our effective income tax rate was 24.1% for both the six months ended June 30, 2023, and the six months ended June 30, 2022.

We recorded a $5.4 million, or $0.14 per diluted share, tax benefit from ASU 2016-09 in the six months ended June 30, 2023, compared to an $ 8.9 million, or $0.22 per diluted share, tax benefit in the same period of 2022.

Without the benefits from ASU 2016-09, our effective tax rate was 25.4% for the six months ended June 30, 2023, and 25.5% for the six months ended June 30, 2022.

Net Income and Earnings Per Share

Net income decreased 43% to $101.7 million in the first quarter of 2023 compared to $179.3 million in the first quarter of 2022.

Earnings per diluted share decreased 41% to $2.58 in the first quarter of 2023 compared to $4.41 in the same period of 2022.

Without the impact from ASU 2016-09 in both periods, earnings per diluted share decreased 42% to $2.46 in the first quarter of 2023 compared to $4.23 in the first quarter of 2022.

Net income decreased 31% to $333.9 million for the six months ended June 30, 2023, compared to the six months ended June 30, 2022.

Earnings per diluted share decreased 30% to $ 8.48 for the six months ended June 30, 2023, versus $ 12.03 per diluted share for the six months ended June 30, 2022.

Without the impact from ASU 2016-09 in both periods, earnings per diluted share decreased 29% to $8.34 for the six months ended June 30, 2023, compared to $11.81 for the six months ended June 30, 2022.

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

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

(Unaudited) Three Months Ended

(Unaudited) Three Months Ended Six Months Ended

June 30, June 30,

2023 2022 2023 2022

Diluted EPS $ 5.91 $ 7.63 $ 8.48 $ 12.03

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

The following table presents certain unaudited quarterly data for the first quarter of 2023, the four quarters of 2022 and the fourth, third and second quarters of 2021.

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 following table presents certain unaudited quarterly 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.

We believe 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 and the impact of new and acquired sales centers.

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(in thousands) 2023 2022 2021

First Fourth Third Second First Fourth Third Second

Second First Fourth Third Second First Fourth Third

Statement of Income Data

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Weather Impacts on 2023 and 2022 Results

Overall, weather conditions unfavorably impacted sales in the second quarter of 2023, particularly at the beginning of the second quarter.

The first week of April through Easter weekend was much cooler across the West versus both average temperatures and prior year.

The last week of April was also significantly cooler than normal from Texas through the mid-Atlantic region, excluding the coastal Southeast.

While the Northeast had warmer than average weather the first few weeks of April, temperatures cooled dramatically through the first week of May and smoke from wildfires in Canada unfavorably impacted sales in early June.

Weather in Florida was more normal and consistent with prior year, while favorable weather conditions compared to the second quarter of 2022 were limited to the Pacific Northwest and Europe.

Similarly, sales growth in the second quarter of 2022 was challenged by unfavorable weather conditions when compared to the second quarter of 2021 in our seasonal markets and Europe;

however, our southern markets benefited from above-average temperatures, particularly in Texas.

Weather conditions varied across the contiguous United States throughout the first quarter of 2023.

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For a description of our critical accounting estimates that require us to make the most difficult, subjective or complex judgments, please see our 2022 Annual Report on Form 10-K.

We have not changed any of these policies from those previously disclosed in that report.

We have not changed any of these

policies from those previously disclosed in that report.

Recent Accounting Pronouncements

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• repayment of debt to maintain an average total target leverage ratio (as defined below) between 1.5 and 2.0;

• repurchases of our common stock under our Board-authorized share repurchase program.

• discretionary 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.

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Capital expenditures were 0.7% of net sales in 2022 and 2021 and 0.6% of net sales in 2020.

Since 2020, our capital expenditures as a percentage of net sales were lower than our historical average primarily due to our significant sales growth.

Based on management’s current plans, we project capital expenditures in 2023 will approximate 1.0% of net sales.

From 2020 to 2022, our capital expenditures as a percentage of net sales were lower than our historical average primarily due to our significant sales growth.

Based on management’s current plans and our spending through June 30, 2023, we project capital expenditures in 2023 will approximate 1.0% of net sales.

Sources and Uses of Cash

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

Three Months Ended

Six Months Ended

Operating activities $ 376,777 $ 28,731

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Financing activities (328,542) 64,643

Net cash provided by operations improved to $103.2 million for the first three months of 2023 from net cash used in operations of $208.1 million for the first three months of 2022, primarily driven by positive changes in working capital, particularly as we sell through our prior year strategic inventory purchases, partially offset by lower net income.

Net cash used in investing activities for the first three months of 2023 increased compared to the first three months of 2022, primarily due to a $6.4 million increase in capital expenditures and $1.8 million of cash used for the acquisition of a business in the first quarter of 2023.

Net cash used in financing activities was $105.5 million for the first three months of 2023 compared to net cash provided by financing activities of $228.7 million for the first three months of 2022, primarily reflecting $21.2 million of net debt payments in the first three months of 2023 versus $321.5 million of net debt proceeds in the first three months of 2022 and an increase in dividends paid of $6.9 million, partially offset by an $11.9 million decrease in share repurchases between periods.

Net cash provided by operations improved to $376.8 million for the first six months of 2023 from $28.7 million for the first six months of 2022, primarily driven by positive changes in working capital, particularly as we sell through our prior year strategic inventory purchases, partially offset by lower net income.

Net cash used in investing activities for the first six months of 2023 increased $14.4 million compared to the first six months of 2022, primarily due to a $10.4 million increase in capital expenditures and a $3.9 million increase in cash used for acquisitions.

Net cash used in financing activities was $328.5 million for the first six months of 2023 compared to net cash provided by financing activities of $64.6 million for the first six months of 2022, primarily reflecting $202.5 million of net debt payments in the first six months of 2023 versus $411.6 million of net debt proceeds in the first six months of 2022 and an increase in dividends paid of $10.0 million, partially offset by a $227.9 million decrease in share repurchases between periods.

Future Sources and Uses of Cash

To supplement cash from operations as our primary source of working capital, we plan to continue to utilize our three major credit facilities, which are the Amended and Restated Revolving Credit Facility (the Credit Facility), the Term Facility (the Term Facility) and the Receivables Securitization Facility (the Receivables Facility).

For additional details regarding these facilities, see the summary descriptions below and more complete descriptions in Note 5 of our "Notes to Consolidated Financial Statements,” included in Part II, Item 8 in our 2022 Annual Report on Form 10-K and Note 5 of “Notes to Consolidated Financial Statements” included in Part I, Item 1 of this Form 10-Q.

Effective June 30, 2023, we amended the index rate used to pay interest on our Credit Facility and Term Facility, from the one month London Interbank Offer Rate (LIBOR) to the one month Term Secured Overnight Financing Rate Index Rate (Term SOFR).

For additional details regarding these facilities, including recent amendments, see the summary descriptions below and more complete descriptions in Note 5 of our “Notes to Consolidated Financial Statements,” included in Part II, Item 8 in our 2022 Annual Report on Form 10-K and Note 5 of “Notes to Consolidated Financial Statements” included in Part I, Item 1 of this Form 10-Q.

Credit Facility

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The Credit Facility also includes sublimits for the issuance of swingline loans and standby letters of credit.

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 term loan requires quarterly amortization payments beginning in September 2023 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 pay interest on revolving and term loan borrowings under the Credit Facility at a variable rate based on one month Term SOFR, plus an applicable margin.

The term loan requires quarterly amortization payments during the third, fourth and fifth years of the loan, beginning in September 2023 aggregating to 20% of the original principal amount 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 March 31, 2023, there was $398.9 million of revolving borrowings outstanding, a $500.0 million term loan, a $4.8 million standby letter of credit outstanding and $346.3 million available for borrowing under the Credit Facility.

The weighted average effective interest rate for the Credit Facility as of March 31, 2023 was approximately 4.6%, excluding commitment fees.

At June 30, 2023, there was $217.1 million of revolving borrowings outstanding, a $500.0 million term loan, a $14.3 million standby letter of credit outstanding and $518.6 million available for borrowing under the Credit Facility.

The weighted average effective interest rate for the Credit Facility as of June 30, 2023, was approximately 4.5%, excluding commitment fees.

Term Facility

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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.

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

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

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 with the final principal repayment due on the maturity date.

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

At March 31, 2023, there was $154.9 million outstanding under the Term Facility with a weighted average effective interest rate of 6.0%.

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.

At June 30, 2023, there was $109.9 million outstanding under the Term Facility with a weighted average effective interest rate of 6.3%.

Receivables Securitization Facility

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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.

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.

At March 31, 2023, there was $299.6 million outstanding under the Receivables Facility at a weighted average effective interest rate of 5.7%, excluding commitment fees.

At June 30, 2023, there was $348.2 million outstanding under the Receivables Facility at a weighted average effective interest rate of 6.0%, excluding commitment fees.

Financial Covenants

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

As of March 31, 2023, the calculations of these two covenants are detailed below:

As of June 30, 2023, 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 sum of (i) Total Non-Revolving Funded Indebtedness as of such date, (ii) the trailing twelve months (TTM) Average Total Revolving Funded Indebtedness and (iii) the TTM Average Accounts Securitization Proceeds divided by TTM EBITDA (as those terms are defined in the Credit Facility).

As of March 31, 2023, our average total leverage ratio equaled 1.48 (compared to 1.37 as of December 31, 2022) and the TTM average total indebtedness amount used in this calculation was $1.5 billion.

As of June 30, 2023, our average total leverage ratio equaled 1.48 (compared to 1.48 as of March 31, 2023) and the TTM average total indebtedness amount used in this calculation was $1.3 billion.

• Minimum Fixed Charge Coverage Ratio .

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

As of March 31, 2023, our fixed charge ratio equaled 7.96 (compared to 9.57 as of December 31, 2022) and TTM Rental Expense was $83.2 million.

As of June 30, 2023, our fixed charge ratio equaled 6.74 (compared to 7.96 as of March 31, 2023) and TTM Rental Expense was $85.7 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.

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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 March 31, 2023, we had two interest rate swap contracts in place and one forward-starting interest rate swap contract, each of which has the effect of converting our exposure to variable interest rates on a portion of our variable rate borrowings to fixed interest rates.

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, 2023, we had two interest rate swap contracts in place and one forward-starting interest rate swap contract, each of which has the effect of converting our exposure to variable interest rates on a portion of 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.

Compliance and Future Availability

As of March 31, 2023, we were in compliance with all material covenants and financial ratio requirements under our Credit Facility, our Term Facility and our Receivables Facility.

As of June 30, 2023, 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.

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

As of April 24, 2023, $186.4 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.

As of July 24, 2023, $600.0 million remained available to purchase shares of our common stock under our current Board-approved share repurchase program.

We expect to repurchase shares on the open market from time to time subject to market conditions.

We plan to fund these repurchases with cash provided by operations and borrowings under the above-described credit facilities.

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