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Item 2. Management’s Discussion and Analysis

2023-10-26 compared with 2023-07-27 · 154 added, 138 removed, 231 unchanged (56% of the section changed)

18 unchanged sentences

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

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.

Net sales decreased 9% in the third quarter of 2023 to $1.5 billion compared to $1.6 billion in the third quarter of 2022 following 14% net sales growth in the third quarter of 2022 and 24% net sales growth in the third quarter of 2021.

Our base business results approximated our consolidated results for the period.

At the core of our business, maintenance activities remained stable, indicating steady demand for non-discretionary products, while pool construction-related activities remained weaker as challenging macroeconomic conditions continue weighing heavily on major project consumer spending.

Our results were also negatively impacted 1% from one less selling day in the third quarter of 2023 versus the third quarter of 2022.

Gross profit decreased 15% to $428.7 million in the third quarter of 2023 from $503.7 million in the same period of 2022.

Our gross profit increased at a 14% compound annual growth rate (CAGR) from the third quarter of 2019 to the third quarter of 2023.

Gross margin decreased 210 basis points to 29.1% in the third quarter of 2023 compared to 31.2% in the third quarter of 2022 as we sold through our prior year lower cost inventory purchases.

Selling and administrative expenses (operating expenses) decreased 2% to $234.3 million in the third quarter of 2023 compared to $239.8 million in the third quarter of 2022 as volume-driven expenses were well managed during the quarter.

As a percentage of net sales, operating expenses increased to 15.9% in the third quarter of 2023 compared to 14.8% in the same period of 2022.

While operating income in the third quarter of 2023 decreased 26% to $194.4 million from $263.9 million in the third quarter of 2022, operating income increased at a 17% CAGR from the third quarter of 2019 to the third quarter of 2023.

Operating margin was 13.2% in the third quarter of 2023 compared to 16.3% in the third quarter of 2022.

Interest and other non-operating expenses, net for the third quarter of 2023 increased $1.9 million compared to the third quarter of 2022, primarily driven by higher average interest rates.

We recorded a $0.4 million tax benefit from Accounting Standards Update (ASU) 2016-09, Improvements to Employee Share-Based Payment Accounting , in the quarter ended September 30, 2023, compared to a tax benefit of $0.6 million realized in the same period of 2022.

This resulted in a $0.01 per diluted share tax benefit in the third quarter of 2023 compared to a $0.02 per diluted share tax benefit realized in the same period of 2022.

Net income decreased 27% to $137.8 million in the third quarter of 2023 compared to $190.1 million in the third quarter of 2022.

Earnings per diluted share decreased 27% to $3.51 in the third quarter of 2023 compared to $4.78 in the same period of 2022.

Without the impact from ASU 2016-09 in both periods, earnings per diluted share decreased 26% to $3.50 compared to $4.76 in the third quarter of 2022.

Our earnings per diluted share increased at a 16% CAGR from the third quarter of 2019 to the third quarter of 2023 and a 17% 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.

1 unchanged sentence

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.

As of September 30, 2023, total net receivables, including pledged receivables, decreased 16% compared to September 30, 2022, primarily due to our lower sales in 2023.

Our days sales outstanding (DSO), as calculated on a trailing four quarters basis, was 26.3 days at September 30, 2023 and 27.0 days at September 30, 2022.

Our allowance for doubtful accounts balance was $10.6 million at September 30, 2023 and $8.9 million at September 30, 2022.

Net inventory levels of $1.3 billion as of September 30, 2023 decreased $280.3 million, or 18%, compared to September 30, 2022 and $331.8 million, or 21%, compared to December 31, 2022 as we sold the remainder of prior year strategic purchases we made to compensate for supply chain challenges.

Our inventory reserve was $25.9 million at September 30, 2023 and $23.4 million at September 30, 2022.

Our inventory turns, as calculated on a trailing four quarters basis, were 2.6 times at September 30, 2023 and 2.7 times at September 30, 2022.

Total debt outstanding at September 30, 2023 was $1.0 billion compared to $1.5 billion at September 30, 2022 down $478.6 million from September 30, 2022 and $352.9 million lower than $1.4 billion at December 31, 2022, as we have used operating cash flows to reduce our debt.

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 sales for the full year of 2023 to be down in the range of around 10% compared to 2022 as previously disclosed in our Second Quarter 2023 Report on Form 10-Q with sales in the fourth quarter of 2023 down in the mid- to high-single digits, primarily dependent on weather conditions and pool construction activities.

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%.

We expect gross margin in the fourth quarter of 2023 of approximately 29.0%.

We project that our annual effective tax rate (without the benefit from ASU 2016-09) for 2023 will approximate 25.0% to 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 recorded a $5.9 million, or $0.15 per diluted share, tax benefit from ASU 2016-09 for the nine months ended September 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 have not included any expected tax benefits in our guidance beyond what we have recognized for the nine months ended September 30, 2023.

We expect 2023 diluted EPS in the range of $13.15 to $13.65, including the impact of year-to-date tax benefits of $0.15.

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.

We 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 under our Board-authorized share repurchase program.

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.”

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.

As of September 30, 2023, we conducted operations through 434 sales centers in North America, Europe and Australia.

For the nine months ended September 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,

Three Months Ended Nine Months Ended

September 30, September 30,

2023 2022 2023 2022

8 unchanged sentences

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

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

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

Base Business

We calculate base business results by excluding, for a period of 15 months, sales centers that we acquire, open in new markets or close.

We also exclude consolidated sales centers when we do not expect to maintain the majority of the existing business and existing sales centers that we consolidate 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, we include acquired, consolidated and new market sales centers in the base business calculation including the comparative prior year period.

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 contributed less than 1% to the change in net sales.

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

December 31, 2022 420

Acquired locations 4

New locations 10

September 30, 2023 434

Three Months Ended

September 30,

(in millions) 2023 2022 Change

Net sales $ 1,474.4 $ 1,615.3 $ (140.9) (9)%

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.

Following 14% net sales growth in the third quarter of 2022 and 24% net sales growth in the third quarter of 2021 (in both cases compared to the prior year quarter), net sales of $1.5 billion in the third quarter of 2023 decreased 9% compared to $1.6 billion in the third quarter of 2022.

Our base business results approximated our consolidated results for the period.

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

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

• Our net sales were negatively impacted by lower sales volumes from reduced pool construction activity and discretionary replacement activity (see discussion below).

• Net sales benefited approximately 2% to 3% from inflationary product cost increases, which is net of price deflation for some products including chemical sanitizers, PVC pipe and rebar.

This compares to a benefit of 9% to 10% in the third quarter of 2022.

• Sales were negatively impacted 1% from one less selling day in the third quarter of 2023 versus the third quarter of 2022.

In the third quarter of 2023, sales of equipment, which includes swimming pool heaters, pumps, lights, filters and automation, decreased 9% compared to the same period last year, and collectively represented approximately 28% of net sales for the period.

Sales of building materials decreased 13% compared to the third quarter of 2022 and represented approximately 12% of net sales in the third 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.

Sales to retail customers decreased 2% in the third quarter of 2023 compared to the third quarter of 2022 and represented

approximately 14% of our total net sales.

As consumers take advantage of travel opportunities, sales to commercial swimming pool customers increased 10% in the third quarter of 2023 compared to the third quarter of 2022 and represented approximately 4% of our net sales for the third quarter of 2023.

Three Months Ended

September 30,

(in millions) 2023 2022 Change

1 unchanged sentence

Gross margin 29.1 % 31.2 %

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.

Gross margin decreased 210 basis points to 29.1% in the third quarter of 2023 compared to 31.2% in the third quarter of 2022.

Our prior year gross margin benefited from our strategic inventory buys, when we purchased product ahead of vendor price increases.

As our sales benefited from higher inflation, we were able to sell those products at a lower average cost to our sales price.

Our gross margin in the third quarter of 2023 was also unfavorably impacted by a variety of factors, including product mix and customer mix and a more competitive pricing environment.

Related to product mix, we realized lower sales of higher margin building materials due to a decline in construction and remodel activity, in addition to price deflation on trichlor.

Changes in our customer mix resulted from a higher proportion of sales to larger, lower margin customers.

Gross margin in the third quarter of 2023 also reflects a typical sequential decrease from the 30.6% gross margin realized in the second quarter of 2023.

Operating Expenses

Three Months Ended

September 30,

(in millions) 2023 2022 Change

1 unchanged sentence

Operating expenses as a % of net sales 15.9 % 14.8 %

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.

Operating expenses decreased 2% in the third quarter of 2023 compared to the third quarter of 2022 as volume-driven expenses were well managed during the quarter.

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

Employee-related expenses were down 5% from the third quarter of 2022, primarily reflecting lower performance-based compensation expense and controlled overtime and temporary employee pay that correlate 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.

We recorded goodwill impairment of $0.6 million during the third quarter of 2023, primarily related to one of our Horizon reporting units in Texas that we previously identified as being most at risk of goodwill impairment.

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.

Interest and other non-operating expenses, net for the third quarter of 2023 increased $1.9 million compared to the third quarter of 2022, as higher average interest rates more than offset a decrease in average debt between periods.

Our weighted average effective interest rate increased to 5.2% in the third quarter of 2023 from 3.2% in the third quarter of 2022 on average outstanding debt of $1.0 billion and $1.5 billion for the respective periods.

Our effective income tax rate was 23.8% for the three months ended September 30, 2023, compared to 24.7% for the three months ended September 30, 2022.

We recorded a $ 0.4 million tax benefit from ASU 2016-09 in the quarter ended September 30, 2023, compared to a tax benefit of $ 0.6 million realized in the same period last year.

Without the benefit from ASU 2016-09 in both periods, our effective tax rate was 24.1% for the third quarter of 2023 and 24.9% for the third quarter of 2022.

Our third quarter effective income tax rate is typically lower compared to other quarters due to the annual expiration of statutes of limitations in the various jurisdictions where we have recorded uncertain tax positions.

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.

Net income decreased 27% to $137.8 million in the third quarter of 2023 compared to $190.1 million in the third quarter of 2022.

Earnings per diluted share decreased 27% to $3.51 in the third quarter of 2023 compared to $4.78 in the same period of 2022.

Without the impact from ASU 2016-09 in both periods, earnings per diluted share decreased 26% to $3.50 in the third quarter of 2023 compared to $4.76 in the third 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

Acquired locations 4

New locations 8

June 30, 2023 432

Six Months Ended

Nine Months Ended September 30, 2023 Compared to Nine Months Ended September 30, 2022

Nine Months Ended

September 30,

(in millions) 2023 2022 Change

Net sales $ 4,538.5 $ 5,083.8 $ (545.3) (11)%

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.

Net sales for the first nine months of 2023 decreased 11% compared to the same period last year.

Differing weather conditions in the first half of 2023 contributed to variability in our results across our geographic markets in the first and second quarters of the year.

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.

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

In the third quarter of 2023, results reflected lower sales volumes from reduced pool construction activity and discretionary replacement activity.

Net sales benefits from record hot temperatures across the southern United States in the third quarter were largely offset by rainy conditions in the Northeast.

The following factors also 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 9% to 10% in the first nine months of 2022.

• We estimate that unfavorable weather conditions in the first nine months of 2023 negatively impacted sales by approximately 2%.

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

The impact of differing weather patterns contributed to variability in the results of our geographic markets in the first nine months of the year, particularly in the first half of the year.

Net sales in our North American seasonal markets, representing 44% of our net sales in the first nine months of 2023, decreased 14% compared to the first nine 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 North American year-round markets, representing 52% of our net sales in the first nine months of 2023, decreased 9% compared to the first nine months of 2022.

In the first nine 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 nine months of 2023.

Sales of building materials decreased 9% compared to the first nine months of 2022 and represented approximately 13% of net sales in the first nine months of 2023.

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

Sales to retail customers decreased 9% in the first nine months of 2023 compared to the first nine 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 nine months of 2023 compared to the first nine months of 2022 and represented approximately 4% of our consolidated net sales in the first nine months of 2023.

Nine Months Ended

September 30,

(in millions) 2023 2022 Change

1 unchanged sentence

Gross margin 30.1 % 31.8 %

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.

Gross margin declined 170 basis points to 30.1% in the nine months ended September 30, 2023, compared to 31.8% in the first nine months of 2022.

Our prior year gross margin benefited from higher levels of inflation and price increases, while gross margin in the first nine months of 2023 is 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 we made ahead of vendor price increases, which was most impactful in the first quarter of 2023 when a higher portion of lower-priced inventory was sold.

Gross margin in the third quarter of 2023 was also impacted by less advantageous product and customer mix and a competitive pricing environment.

Operating Expenses

Six Months Ended

Nine Months Ended

September 30,

(in millions) 2023 2022 Change

1 unchanged sentence

Operating expenses as a % of net sales 15.4 % 13.8 %

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.

Operating expenses for the nine months ended September 30, 2023 were flat compared to the prior year period.

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.

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

We also recorded goodwill impairment of $0.6 million in the first nine months of 2023, primarily related to one of our Horizon reporting units in Texas that we previously identified as being most at risk of goodwill impairment.

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.

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.

Interest and other non-operating expenses, net for the first nine months of 2023 increased $20.9 million compared to the same period last year, as higher average interest rates more than offset a decrease in average debt between periods.

Our weighted average effective interest rate increased to 5.1% from 2.3% for the respective periods on average outstanding debt of $1.2 billion for the first nine months of 2023 versus $1.5 billion for the same period of 2022.

Our effective income tax rate was 24.1% for the nine months ended September 30, 2023, compared to 24.3% for the nine months ended September 30, 2022.

We recorded a $5.9 million, or $0.15 per diluted share, tax benefit from ASU 2016-09 in the nine months ended September 30, 2023, compared to a $ 9.5 million, or $0.24 per diluted share, tax benefit in the same period of 2022.

Without the benefits from ASU 2016-09, our effective tax rate was 25.0% for the nine months ended September 30, 2023, and 25.3% for the nine months ended September 30, 2022.

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.

Net income decreased 30% to $471.8 million for the nine months ended September 30, 2023, compared to the nine months ended September 30, 2022.

Earnings per diluted share decreased 29% to $ 12.00 for the nine months ended September 30, 2023, versus $ 16.82 per diluted share for the nine months ended September 30, 2022.

Without the impact from ASU 2016-09 in both periods, earnings per diluted share decreased 29% to $11.85 for the nine months ended September 30, 2023, compared to $16.58 for the nine months ended September 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 Six Months Ended

June 30, June 30,

(Unaudited) Three Months Ended Nine Months Ended

September 30, September 30,

2023 2022 2023 2022

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(in thousands) 2023 2022 2021

Second First Fourth Third Second First Fourth Third

Third Second First Fourth Third Second First Fourth

Statement of Income Data

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Weather Impacts on 2023 and 2022 Results

During the third quarter of 2023, sales benefited from record breaking temperatures and below average precipitation across the southern United States, especially Texas, Louisiana and Florida.

These benefits were largely offset by rainy conditions in the Northeast.

Comparatively, sales in the third quarter of 2022 were generally aided by above-average temperatures throughout much of the contiguous United States, although Florida saw a decline in sales due to closures resulting from Hurricane Ian towards the end of the quarter.

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

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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;

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

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

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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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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.

Based on management’s current plans and our spending through September 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):

Six Months Ended

Nine Months Ended

September 30,

Operating activities $ 750,018 $ 307,470

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Financing activities (656,835) (248,404)

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.

Net cash provided by operations improved to $750.0 million for the first nine months of 2023 from $307.5 million for the first nine months of 2022, primarily driven by positive changes in working capital, particularly as we sold through our prior year strategic inventory purchases, partially offset by lower net income.

Net cash used in investing activities for the first nine months of 2023 increased $20.0 million compared to the first nine months of 2022, primarily due to a $15.0 million increase in capital expenditures and a $3.2 million increase in cash used for acquisitions.

Net cash used in financing activities was $656.8 million for the first nine months of 2023 compared to $248.4 million for the first nine months of 2022, primarily reflecting $353.4 million of net debt payments in the first nine months of 2023 versus $328.6 million of net debt proceeds in the first nine months of 2022 and an increase in dividends paid of $13.4 million, partially offset by a $284.1 million decrease in share repurchases between periods.

Future Sources and Uses of Cash

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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.

At September 30, 2023, there was $176.8 million of revolving borrowings outstanding, a $493.8 million term loan, a $16.0 million standby letter of credit outstanding and $557.2 million available for borrowing under the Credit Facility.

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

Term Facility

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

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%.

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 September 30, 2023, there was $109.9 million outstanding under the Term Facility with a weighted average effective interest rate of 6.5%.

Receivables Securitization Facility

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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.

At September 30, 2023, there was $242.3 million outstanding under the Receivables Facility at a weighted average effective interest rate of 6.2%, 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:

As of September 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 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.

As of September 30, 2023, our average total leverage ratio equaled 1.48 (compared to 1.48 as of June 30, 2023) and the TTM average total indebtedness amount used in this calculation was $1.2 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 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.

As of September 30, 2023, our fixed charge ratio equaled 6.07 (compared to 6.74 as of June 30, 2023) and TTM Rental Expense was $89.0 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 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.

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 September 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.

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

As of October 23, 2023, $463.3 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.

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

What changed 10-Q

Item 2. Management’s Discussion and Analysis