Item 2. Management’s Discussion and Analysis
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 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
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, management's views on industry, economic, competitive, technological and regulatory conditions 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 the sensitivity of our business to weather conditions; changes in economic conditions, consumer discretionary spending, the housing market, inflation or interest rates; our ability to maintain favorable relationships with suppliers and manufacturers; the extent to which home-centric trends associated with the pandemic will moderate or reverse; competition from other leisure product alternatives or mass merchants; our ability to continue to execute our growth strategies; changes in the regulatory environment; new or additional taxes, duties or tariffs; excess tax benefits or deficiencies recognized under ASU 2016-09 and other risks detailed in our 2022 Annual Report on Form 10-K, as updated by our subsequent filings with the U.S. Securities and Exchange Commission. 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
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
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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 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 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 $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 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
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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. See “Cautionary Statement for Forward-Looking Statements.”
RESULTS OF OPERATIONS
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 Six Months Ended
June 30, June 30,
2023 2022 2023 2022
Net sales 100.0 % 100.0 % 100.0 % 100.0 %
Cost of sales 69.4 67.6 69.4 67.9
Gross profit 30.6 32.4 30.6 32.1
Selling and administrative expenses 13.0 12.1 15.2 13.2
Operating income 17.6 20.4 15.4 18.9
Interest and other non-operating expenses, net 0.9 0.4 1.1 0.4
Income before income taxes and equity in earnings 16.7 % 20.0 % 14.4 % 18.5 %
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 2023 and 2022 in our consolidated results since the acquisition dates.
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Three Months Ended June 30, 2023 Compared to Three Months Ended June 30, 2022
Net Sales
Three Months Ended
June 30,
(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.
Gross Profit
Three Months Ended
June 30,
(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.
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Operating Expenses
Three Months Ended
June 30,
(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.
Income Taxes
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.
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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
Acquired locations 4
New locations 8
June 30, 2023 432
Net Sales
Six Months Ended
June 30,
(in millions) 2023 2022 Change
Net sales $ 3,064.1 $ 3,468.5 $ (404.4) (12)%
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.
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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 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.
Gross Profit
Six Months Ended
June 30,
(in millions) 2023 2022 Change
Gross profit $ 937.5 $ 1,114.0 $ (176.5) (16)%
Gross margin 30.6 % 32.1 %
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
Six Months Ended
June 30,
(in millions) 2023 2022 Change
Selling and administrative expenses $ 464.8 $ 459.4 $ 5.4 1%
Operating expenses as a % of net sales 15.2 % 13.2 %
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 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.
Income Taxes
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.
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Net Income and Earnings Per Share
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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Reconciliation of Non-GAAP Financial Measures
The non-GAAP measures described below should be considered in the context of all of our other disclosures in this Form 10-Q.
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 management, 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,
2023 2022 2023 2022
Diluted EPS $ 5.91 $ 7.63 $ 8.48 $ 12.03
ASU 2016-09 tax benefit (0.02) (0.04) (0.14) (0.22)
Adjusted diluted EPS $ 5.89 $ 7.59 $ 8.34 $ 11.81
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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 2022, we generated approximately 59% of our net sales and 67% 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 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.
(Unaudited) QUARTER
(in thousands) 2023 2022 2021
Second First Fourth Third Second First Fourth Third
Statement of Income Data
Net sales $ 1,857,363 $ 1,206,774 $ 1,095,920 $ 1,615,339 $ 2,055,818 $ 1,412,650 $ 1,035,557 $ 1,411,448
Gross profit 567,783 369,755 315,731 503,687 666,804 447,189 322,376 441,899
Operating income 327,009 145,771 107,295 263,877 418,888 235,723 127,891 237,276
Net income 232,250 101,699 71,863 190,055 307,283 179,261 107,609 184,665
Balance Sheet Data
Total receivables, net $ 630,950 $ 564,171 $ 351,448 $ 549,796 $ 756,585 $ 679,927 $ 376,571 $ 476,150
Product inventories, net 1,392,886 1,686,683 1,591,060 1,539,572 1,579,101 1,641,155 1,339,100 1,043,407
Accounts payable 485,100 739,749 406,667 442,226 604,225 685,946 398,697 414,156
Total debt 1,184,586 1,365,750 1,386,803 1,512,545 1,595,398 1,505,073 1,183,350 362,819
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.
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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 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. Conditions were generally favorable in our southern markets, where sales benefited from warmer weather and below-average precipitation. In contrast, results were unfavorably impacted by unusually wet and cold weather in the western U.S., particularly in California and Arizona, which are two of our largest markets. Comparatively, in the first quarter of 2022, overall weather conditions were generally favorable, and sales benefited from above-average temperatures along much of the west and the east coast, although Texas experienced cooler-than-normal temperatures.
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 2022 Annual Report on Form 10-K. We have not changed any of these
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policies from those previously disclosed in that report.
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, including a modest amount of debt, 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;
• inventory and 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
• 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. Historically, our capital expenditures have averaged roughly 1.0% of net sales. Capital expenditures were 0.7% of net sales in 2022 and 2021 and 0.6% of net sales in 2020. 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.
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Sources and Uses of Cash
The following table summarizes our cash flows (in thousands):
Six Months Ended
June 30,
2023 2022
Operating activities $ 376,777 $ 28,731
Investing activities (41,860) (27,431)
Financing activities (328,542) 64,643
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). 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
Our Credit Facility 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 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 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 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
Our Term Facility 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. 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. We classify the entire outstanding balance as Long-term debt on our Consolidated
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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
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 August and from $210.0 million to $340.0 million during the remaining months of the year. The Receivables Facility matures on November 1, 2024. 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 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.
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 June 30, 2023, 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 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 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 . 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, 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. 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
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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 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. For additional information regarding our debt arrangements, see Note 5 of “Notes to Consolidated Financial Statements,” included in Part II, Item 8 of our 2022 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 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.
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